IndyMac Bancorp, Inc. (NYSE: NDE) (�Indymac�� or the �Company�),
the holding company for IndyMac Bank, F.S.B. (�Indymac Bank��),
today released its annual letter to shareholders from Chairman and
CEO Michael W. Perry, that will be contained in the Company�s
annual report, which will be issued as scheduled at the end of
March. The purpose of releasing the letter today is to provide an
update on the Company to shareholders in light of the current
volatile conditions in the mortgage market. Indymac has also filed
a Form 8-K containing the annual shareholder letter with the
Securities and Exchange Commission. The Form 8-K is available on
Indymac�s Website at www.indymacbank.com. The text of the letter is
contained below. Dear Shareholders: 2006 was a challenging year in
the mortgage banking industry. Industry loan volumes of $2.5
trillion were 34 percent below 2003�s historic high level and 17
percent lower than in 2005. Mortgage banking revenue margins
declined further after sharp declines in 2005, and net interest
margins continued to compress, as the yield curve inverted with the
average spread between the 10-year Treasury yield and the 1-month
LIBOR declining from 89 basis points in 2005 to negative 31 basis
points in 2006. To cap it off, the housing industry slowed down
significantly, increasing loan delinquencies and non-performing
assets and driving up credit costs for all mortgage lenders. Yet,
despite these challenges, Indymac again reached new performance
heights in 2006, achieving: Record mortgage loan production of $90
billion, a 48 percent increase over 2005; Record mortgage market
share of 3.58 percent, a 78 percent gain over the 2.01 percent
share we had in 2005; Record net revenues of $1.3 billion, a 22
percent increase over 2005; Record earnings-per-share (EPS) of
$4.82, a 9 percent gain; Record growth in total assets, which
increased by $8 billion, or 37 percent, to $29.5 billion; Record
growth in our portfolio of loans serviced for others, which
increased by $55 billion, or 65 percent, to $140 billion; Strong
return on equity (ROE) of 19 percent, slightly lower than last
year�s 21 percent level. Notwithstanding our solid results for the
year in the face of challenging market conditions, our year ended
on a disappointing note. Our fourth quarter EPS declined both
sequentially and versus the fourth quarter of 2005, and we fell
short of EPS expectations for the quarter. Also, our ROE of 14.6
percent for the quarter, while solid, was at the lowest level in 23
quarters. While I am disappointed with how we finished 2006 and
with our outlook for 2007, where EPS will likely be down from 2006
given tough conditions in the mortgage market, I believe we will
emerge from this difficult mortgage environment a stronger and more
competitive company. We remain fundamentally committed to our
hybrid thrift/mortgage banking business model and our strategies
inasmuch as we are outperforming most of our mortgage banking and
thrift peers, are earning a solid return on our shareholders�
capital (at what we hope is the low point of our cyclical business)
and believe strongly in the long-term opportunities presented in
the housing and mortgage markets. Nonetheless, in our constant
drive to improve our business, we have taken a fresh look at our
hybrid model and decided to fine tune it in ways we feel will make
us stronger. Hybrid Thrift/Mortgage Banking Business Model �
Updated for the New Market Reality As you know, our hybrid business
model balances our mortgage production and servicing businesses
with thrift investing. On the mortgage banking side, we generate
earnings largely by originating, securitizing and selling loans and
securities at a profit and by servicing loans for others. On the
thrift side, we generate core spread income from our investment
portfolio of prime SFR mortgages, home equity loans, consumer and
builder construction loans and mortgage-backed securities (MBS).
The combination of mortgage banking and thrift investing has proven
to be a powerful business model for Indymac, and, given our strong
execution in the past, we have been able to outperform our peers
and produce both strong and relatively stable returns on our
shareholders� equity. An important tool in understanding our strong
financial performance has been our detailed segment reporting,
where we allocate capital to different segments of our business,
calculate ROEs for each segment every quarter and then adjust our
capital allocations according to where we can earn the best returns
for our shareholders. In the fourth quarter of 2006, we saw a
fairly dramatic decrease in the ROE in our thrift segment, mostly
caused by net interest margin erosion in our whole loan and MBS
portfolios. Of greatest concern to me is that I see this as part of
a broader trend, the continuation of which is inevitable. Let me
explain. First, there is fierce competition for consumer deposits,
particularly as Wall Street firms and other non-bank entities have
over the years made significant inroads in attracting deposits away
from banks and thrifts by paying high rates on money market funds.
In addition, consumers, assisted by the Internet and deposit
insurance, are getting more savvy and efficient with their deposit
funds, moving them to the highest yielding options. Both of these
factors are driving up deposit costs relative to market funding
sources and reducing the funding advantage and net interest margins
of depository institutions. Second, spreads to Treasury securities
on financial assets that can be securitized (home loans and most
other consumer loan types) continue to tighten given the efficiency
of the secondary market, reducing asset yields and further
compressing net interest margins for depository institutions. While
there may be temporary periods where asset spreads widen in the
secondary market � such as what we are experiencing as I write this
letter � the long-term inevitable trend is toward continued
increases in market efficiency and generally tighter asset spreads.
Third, the regulatory capital requirements for holding these assets
(mortgage and home equity loans, in particular) generally exceed
those of the secondary market. As a result of the above, we have
seen the ROEs we are earning on our whole loan and MBS portfolios
decline, and even fall below our cost of capital at times for some
assets, such that it does not make economic sense for us to grow
these portfolios to the extent that we had previously planned.
Frankly, we have also not received the price/earnings multiple
increase we had expected from growing our investment portfolio and
building more �stable, core� spread income into our overall
earnings picture. Accordingly, our capital deployment and profit
growth will be more focused in the future on the two broad segments
of our mortgage banking business: Mortgage Production � our core
business where, as the 9th largest originator and 2nd largest
independent mortgage banker in the nation, we have strong focus,
industry leading expertise, operational scale and consistently earn
very strong ROEs; and Mortgage Servicing � where, with a portfolio
of loans serviced for others now exceeding $140 billion, we have
achieved strong economies of scale and earn solid ROEs.
Importantly, unlike our other business segments, servicing is not
subject to the competitive margin pressures and credit risks that
come with the housing and mortgage production cycles. While we will
continue to maintain some level of investments in our whole loan
and MBS portfolios, going forward, the growth of these portfolios
will be based on the extent to which (1) their ROEs exceed our cost
of both core and risk-based capital or (2) they are needed to
support our core mortgage banking investments in mortgage servicing
rights and residual and non-investment grade securities, if their
ROEs are below our cost of capital. These changes in our business
model and strategy represent fine-tuning more than a major
strategic shift. The new reality of narrowing net interest margins
actually favors Indymac from a competitive standpoint in that,
unlike many other depository institutions, we already have a
relatively high, market-based cost of funds and have learned,
through trading assets and loans in the secondary market, how to
earn strong overall ROEs despite that fact. Other financial
institutions rely on their low cost of funds to achieve the same or
lower ROEs as Indymac, and, as their cost of funds advantage
erodes, I believe they will struggle to sustain their performance
levels. At Indymac, understanding the nuances of the capital
requirements for assets both on-balance-sheet and in the secondary
market and knowing how to effectively trade assets into the
secondary market gives us a competitive advantage that should not
be underestimated. With these adjustments to our business model,
the real question is, what is the outlook for Indymac long and
short term? Long-term Outlook Everyone knows that the housing and
mortgage industries are cyclical and can produce volatile economic
results. But, as I have said many times before, the market for
mortgages is huge, and long-term, mortgage lending is a great
business with U.S. mortgage debt outstanding growing by eight to 10
percent per year. And over the long-term Indymac has produced great
results, with the bottom line being that, over the fourteen years
through December 31, 2006 since the current management team has
been in place, Indymac has delivered a compounded annual rate of
return to its shareholders of 23 percent versus 12 percent for the
Dow Jones Industrial Average and 11 percent for the S&P 500. We
can accept some short-term earnings volatility with long-term
performance like what we have achieved, and in this respect I like
to quote Warren Buffet when he says, �Charlie [Munger] and I would
much rather earn a lumpy 15 percent over time than a smooth 12
percent.� Over the long run I have confidence in our business
model, our strategic plans, our management team and our ability to
execute on our plans and adapt as necessary to continue performing
for shareholders. In this respect, based on our long-term
experience over the housing and mortgage cycles, during the trough
periods such as what we are currently experiencing, I would expect
Indymac to be able to achieve, roughly speaking, an ROE in the 10
percent to 15 percent range, similar to what traditional thrifts
achieve over the long term. When the mortgage and housing markets
stabilize, I would expect that Indymac�s ROE could improve to the
15 percent to 20 percent level, and during boom times for our
business, our ROEs could exceed 20 percent. Short-Term Game Plan
While we run Indymac with a vision for the long-term, I am acutely
aware that we must also deliver results short-term, especially in
today�s environment, where many shareholders own our stock for
relatively brief time periods and, overall, our shares turn over
six times per year. Given that reality, here is what we will do to
improve performance for our shareholders right now: 1. Manage our
credit risks by being smart and prudent in adjusting our mortgage
underwriting guidelines, setting our risk-based pricing, making
decisions as to what assets go into our investment portfolio and/or
distributing our risk into the secondary market, and executing on
best in class loss prevention and loss mitigation practices. 2.
Control our costs with our current hiring freeze on
non-revenue-generating personnel, base salary freeze company-wide,
significant variable compensation tied to revenue and EPS growth,
and goals to significantly increase outsourcing of our workforce by
year-end and cut our non-labor expenses from our fourth quarter run
rate; in general, get more out of the infrastructure we have built
up in the last several years as we continue to grow our business.
With respect to the hiring freeze, given our normal employee
attrition rate of roughly 20 percent per year, we expect to be able
to reduce our administrative headcount and overhead while still
being able to stick to our stated goal of avoiding mass layoffs
except under the most extreme circumstances. Our estimate is that
all these measures combined could produce up to $60 million in
pre-tax cost savings annually. 3. Focus our capital expenditures
and the activities of our new business incubator and M&A group
on investments that have lower execution risk and produce both
attractive short- and long-term paybacks. For example, in support
of our production growth/market share strategy, we will pursue
�make sense� acquisitions of mortgage operations, such as our
recently announced purchase of the retail mortgage platform of the
New York Mortgage Co., LLC. 4. Continue to profitably grow mortgage
production and gain market share by taking advantage of the
difficulties experienced by our competitors and aggressively
growing our sales force with top producers. 5. Spur on our
production growth by having healthy, internal competition within
our sales forces, leading to better penetration of our existing
wholesale and correspondent customers, both with increased volume
of products they currently deliver to us and new volume of products
they do not currently deliver to us, i.e., reverse mortgages and
certain other specialty products. 6. Support our shareholders by
working extremely hard to return to higher levels of profitability.
Maintain our dividend at its current level, in all but the most
extreme circumstances, which results in a current annual yield in
excess of five percent. Explore issuing non-cumulative perpetual
preferred stock and repurchasing our common stock to enhance EPS,
although this strategy could change based on the market for our
preferred stock as well as investment opportunities that present
themselves other than buying back our own stock. Even with these
measures, 2007 will likely be a down year for our EPS, although our
ROE should still be solid, in a broad range of 10 percent to 15
percent. Factored into this forecast is a continuation of tough
conditions for loan originations, credit performance and in the
secondary market. Our more detailed internal forecast shows that
our ROEs for the early quarters of the year will be at the low end
of the range above; however, during the second half of the year, if
we execute on our plans as we expect, and with a little luck, our
ROEs could be at or even somewhat above the high end of the range.
With all of that said, if market conditions deteriorate
significantly from what we are forecasting today � which is always
a possibility � there could be some downside to the above ROE
range. In addition to tough market conditions, mortgage lenders
will also be facing scrutiny from Congress and regulators on
�non-traditional� mortgage products, so let me say a few words
about that. Non-traditional Mortgage Products � The Current Climate
Our industry has come into some criticism recently, some warranted
and some not, over the proliferation of �non-traditional� mortgage
products, such as Option ARMs and Interest-Only mortgages, as well
as limited documentation underwriting. While these loans do contain
more risk for lender and borrower alike, when they are offered by
lenders and used by consumers responsibly, they bring great value
to both. We believe we are a prudent and responsible lender with
these products and also believe that they have been a key
contributor to the increase in the homeownership rate in America
from 64 percent to 69 percent in the last twelve years. The
increase in the homeownership rate alone has allowed six million
additional Americans to make the dream of homeownership a reality
in the last twelve years, significantly increasing their personal
wealth as home values have increased, as well as strengthening
communities and stimulating the national and local economies. Our
industry needs to do a much better job of telling the story of the
benefits that innovative mortgage products have brought to the
country, and later on in this report we address this issue in
greater depth, including a number of profiles of customers whom we
have helped with our array of mortgage products. Certainly,
mortgage foreclosures and credit losses will increase in the
current environment, and the percentage increases will look
extremely high and get headlines in the press. But, we need to
remember that foreclosures and credit losses are increasing off of
record and unsustainably low levels and are returning to more
normal levels now. As long as we have properly priced for credit
risk and prudently distributed the risk into the secondary market �
both of which we feel we have largely done, although not perfectly
� our credit costs will continue to be manageable. The bottom line
is that we need to be more forceful in standing up for ourselves as
an industry. For Indymac in particular, we also need to dispel any
misperceptions in the market that we are a subprime lender when, in
fact, subprime loans make up only roughly 4 percent of our overall
production. Welcome Aboard As we continue to build the capabilities
of our team, I am pleased to welcome Gabrielle E. Greene to the
Board of Directors of Indymac Bank. Her experience on both sides of
a public company � as a chief financial officer and a director, as
well as an investment manager � will bring a broad and valuable
perspective to the Bank�s Board. Ms. Greene is a General Partner of
Rustic Canyon/Fontis Partners, a private equity fund based in
Pasadena, California, and also serves on the boards of Bright
Horizons, where she serves on the audit committee, and Whole Foods,
where she is chairman of the audit committee and a member of the
compensation committee. In Closing � The current environment makes
this a really good time to step back and take stock of the mortgage
banking industry and of Indymac Bank. We know our industry is
cyclical. During boom times, almost everyone makes money, and it is
very difficult to distinguish good management teams from bad. In
fact, my view is that weaker management teams can often outperform
stronger teams in terms of short-term earnings during boom times
precisely because they are undisciplined, cut corners and loosen
controls in order to drive revenue in the door. Over the long term,
these same firms can suffer losses and reversals, causing many of
them to close their doors, unfortunately tainting the entire
mortgage industry. Given the robust housing market and highly
liquid secondary markets (for even the �riskiest loans�) � both of
which persisted for years longer than anticipated � and given
strong competition in a declining overall mortgage market, Indymac,
in order to compete and grow, also loosened its lending standards,
though in a much more responsible way. That we did not do this to
the same extent as many other lenders is evidenced by the fact that
our mortgage production in 2006 had an average FICO of 701 and
average combined loan-to-value (CLTV) ratio of 80 percent as
compared to an average FICO of 702 and average CLTV of 76 percent
in 2005. Though we suffered increased credit losses in the fourth
quarter even after we began tightening our lending standards early
in 2006, these losses in no way threaten the viability of our
company. With the benefit of hindsight, if I had to do it over
again, I would not do anything materially different for two
important reasons: (1) Indymac�s competitive position in the
industry has been significantly enhanced for the long-term by the
market share we have gained and will hold and grow as a result of
our product innovation and reasonable risk-taking, and (2) you
don�t just lose short-term profits if you do not meet the
competitive tactics of your major long-term competitors � you lose
customers and you lose your sales force (to your competitors) �
which would, in my view, have impaired Indymac more than the credit
losses we will suffer over the next few years. However, for many of
our competitors in the mortgage and thrift industries who took on
too much risk, it is now time to �pay the piper,� and now you can
clearly see the distinction between the strong and the weak
management teams. While there are low barriers to entry in the
mortgage business, today�s tough environment clearly illustrates
that there are many demanding requirements to succeed and survive
over the cycles. Long-term success in our business requires
competence in many, many areas � product development; risk-based
pricing; marketing and sales management; scaling operations;
automation, standardization and outsourcing; interest rate, credit
and liquidity risk management; talent recruitment and management;
detailed profitability analysis by business segment, product and
customer; management accountability systems and capital
optimization � to name a few. Mastering all of these requires
discipline and hard work. And given the complexity of the mortgage
business, it also helps immensely to have laser-like focus. For
Indymac, unlike some of our key competitors which are divisions of
much larger companies, our focus on home lending and mortgage
banking is undiluted, which I believe is an important and
sustainable competitive advantage. Once again, I�d like to thank
all our customers, employees, shareholders and business partners
for their continuing support of Indymac. The difficult market
environment we are facing � though unpleasant now, particularly in
its negative impact on our stock price � will have longer term
benefits as it separates the weak from the strong, weeds out some
of the more reckless competitors and causes us to get better and
better at everything we do. I am confident that we will emerge from
this environment in a stronger competitive position than ever
before, which makes me very optimistic about our future. Michael W.
Perry Chairman and Chief Executive Officer About Indymac Bank
IndyMac Bancorp, Inc. (NYSE: NDE) (Indymac�) is the holding company
for IndyMac Bank, F.S.B. (Indymac Bank�), the 7th largest savings
and loan and the 2nd largest independent mortgage lender in the
nation. Indymac Bank, operating as a hybrid thrift/mortgage banker,
provides cost-efficient financing for the acquisition, development,
and improvement of single-family homes. Indymac also provides
financing secured by single-family homes and other banking products
to facilitate consumers� personal financial goals. With an
increased focus on building customer relationships and a valuable
consumer franchise, Indymac is committed to becoming a top five
mortgage lender in the U.S. by 2011, with a long-term goal of
providing returns on equity of 15 percent or greater. The company
is dedicated to continually raising expectations and conducting
itself with the highest level of ethics. For more information about
Indymac and its affiliates, or to subscribe to the company�s Email
Alert feature for notification of company news and events, please
visit http://about.indymacbank.com/investors. FORWARD-LOOKING
STATEMENTS Certain statements contained in this press release may
be deemed to be forward-looking statements within the meaning of
the federal securities laws. The words �anticipate,� �believe,�
�estimate,� �expect,� �project,� �plan,� �forecast,� �intend,�
�goal,� �target,� and similar expressions identify forward-looking
statements that are inherently subject to risks and uncertainties,
many of which cannot be predicted or quantified. Actual results and
the timing of certain events could differ materially from those
projected in or contemplated by the forward-looking statements due
to a number of factors, including, the effect of economic and
market conditions including industry volumes and margins(1); the
level and volatility of interest rates(1); the Company�s hedging
strategies, hedge effectiveness and asset and liability
management(1); the accuracy of subjective estimates used in
determining the fair value of financial assets of Indymac(1); the
credit risks with respect to our loans and other financial
assets(1); the actions undertaken by both current and potential new
competitors(1); the availability of funds from Indymac�s lenders
and from loan sales and securitizations, to fund mortgage loan
originations and portfolio investments; the execution of Indymac�s
growth plans and ability to gain market share in a significant
market transition(1); the impact of disruptions triggered by
natural disasters; pending or future legislation, regulations or
litigation; and other risk factors described in the reports that
Indymac files with the Securities and Exchange Commission,
including its Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, and its reports on Form 8-K. (1) While all of the above items
are important, the highlighted items represent those that, in
management�s view, merit increased focus given current conditions.
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