In addition to the B of A report, TheStreet.com’s “Two Ways to Play Mortgage Lenders” (6/25/06) once again points out the difficult environment that all mortgage bankers are operating in at the present time. This is nothing new, and we agree, it is a tough operating environment for mortgage bankers. However, the article goes on to present a bullish case for investing in Impac Mortgage Holdings (IMH) and the bearish case for Indymac (IMB), and here we must take exception and point out some facts.

The basic premise is that for Impac “the worst of times are behind it because the company has adequately set up loss reserves to handle loan defaults”, whereas the article quotes a research report that says “we believe that Countrywide and IndyMac's credit risk and anticipated increase in future credit losses are not yet reflected in their current stock prices and that their risk/reward profile support our sell rating.” We have nothing against Impac, but here are some facts in comparing credit quality at Impac versus Indymac based on the Alt-A loans we each have originated and sold as securities in the secondary market as of 3/31/07 (data provided by First American LoanPerformance, whose data includes mortgages that have been packaged and sold as mortgage-backed securities):

Indymac Impac
Loan serviced in billions $53.8 $20.8
Original Wtd. Avg. Combined LTV 72.6% 77.3%
Original Wtd. Avg. Credit Score 708 695
30+ day delinquency rate 5.46% 12.83%
60+ day delinquency rate 2.90% 7.90%
90+ day delinquency rate 1.97% 6.16%
Loans in Foreclosure 1.00% 2.72%

Clearly, the credit quality and performance of Indymac’s Alt-A loans is far superior to Impac. Furthermore, as of 3/31/07 we have $805 million (39% of capital) of reserves associated with our on and off balance sheet credit risk, and our overall delinquency and foreclosure rates are below industry averages, as thoroughly presented in our first quarter earnings reports, which can be accessed through the following link:

http://phx.corporate-ir.net/phoenix.zhtml?c=118924&p=irol-newsArticle&ID=990353&highlight=

The article goes on to discuss the problems at Bear Stearns’ two leveraged mortgage funds, indicating that this spells trouble for lenders like Indymac. This notion is misguided. The Bear Stearns funds own the most leveraged and riskiest collateralized debt obligation (CDO) structures from subprime securitizations, utilizing a combination of bullish and bearish bets (similar to Long Term Capital’s “hedging/arbitrage” strategy back in the late 1990’s). These CDO structures already have enormous leverage built into them, and, on top of this imbedded leverage, Bear then levered these funds over 10:1, funding them with volatile reverse repurchase facilities from Wall Street firms, including Merrill Lynch. When Bear’s bets went against them, Merrill and others moved swiftly with margin calls and stepped in to try and liquidate their positions at distressed prices, in the same way as Merrill pulled its lines on many companies back in 1998 during the Global Liquidity/Long Term Capital crisis and most recently a few months ago with numerous subprime lenders. The bottom line for Indymac is that we don’t own ANY CDOs…not one. Furthermore, we had over $3.0 billion of liquidity during the first quarter of 2007 and, as a federally insured depository institution, have 83% of our balance sheet funded by deposits and Federal Home Loan Bank borrowings as of 3/31/07, which are highly stable sources of funds. We only have 6% of our $29 billion balance sheet funded by repurchase lines of credit, and, while we do have a $500 million line with Merrill Lynch, we currently have zero borrowings against it.

Finally, Bear Stearns’ problem is with subprime securities, and subprime lending accounted for only 4% of Indymac’s loan originations in 2006 and Q1 07. In the higher credit quality segment of the market that Indymac primarily participates in, conditions, though difficult, are substantially better than in the subprime market, with adequate liquidity through BB credit issues and spreads that have been relatively stable as compared to the first quarter.

To get a different investment point of view on Indymac (the bullish case), click on the link below for an article by Sahul Sharma from BankStocks.com:

http://www.bankstocks.com/article.asp?type=1&id=9881415

Grove Nichols
Communications Director
Indymac Bank

Post Script:
In TheStreet.com’s bull case on Impac the author states the following:

“The added bonus is that the company may raise its dividend back to the level of a year ago, says Roth Capital Partners analyst Richard Eckert. News of a dividend boost could propel the stock, which trades at a 33% discount to book value and has a 32% short interest. Impac shares currently trade around $5.90. Assuming a 0.35% loss rate on its loan assets held for investment, Impac can generate $1.05 per share of taxable income and pay a $1 annual dividend, up from the current 40-cent annual level, according to Eckert's projection. If Eckert is correct and Impac pays a $1 dividend, the stock's dividend yield would jump to 16% from its current 6.5%.”

As we post this, Impac has just announced that it is cutting its dividend to zero for the second quarter, and its stock is trading down over 20% today (June 27) to $4.65 per share.