UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012 |
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number: 001-16577
(Exact name of registrant as specified in its charter)
Michigan | 38-3150651 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
5151 Corporate Drive, Troy, Michigan | 48098-2639 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (248) 312-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, par value $0.01 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer | o | Accelerated Filer | x | Non-Accelerated Filer | o | Smaller Reporting Company | o | |||
(Do not check if a smaller reporting company) | ||||||||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No ý
The estimated aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing sale price ($8.40 per share) as reported on the New York Stock Exchange on June 30, 2012, was approximately $167.1 million. The registrant does not have any non-voting common equity shares.
As of February 28, 2013, 56,003,453 shares of the registrant’s Common Stock, $0.01 par value, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement relating to the 2013 Annual Meeting of Stockholders have been incorporated into Part III of this Report on Form 10-K.
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FORWARD-LOOKING STATEMENTS
This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements, by their nature, involve estimates, projections, goals, forecasts, assumptions, risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in a forward-looking statement. Examples of forward-looking statements include statements regarding our expectations, beliefs, plans, goals, objectives and future financial or other performance. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. Except to fulfill our obligations under the U.S. securities laws, we undertake no obligation to update any such statement to reflect events or circumstances after the date on which it is made.
There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include:
(1) | Volatile interest rates that impact, amongst other things, (i) the mortgage business, (ii) our ability to originate loans and sell assets at a profit, (iii) prepayment speeds and (iv) our cost of funds, could adversely affect earnings, and our ability to pay dividends to stockholders; |
(2) | Competitive factors for mortgage loan originations could negatively impact gain on loan sale margins; |
(3) | Competition from banking and non-banking companies for deposits and loans can affect our earnings, gain on sale margins and market share; |
(4) | Changes in the regulation of financial services companies and government-sponsored housing enterprises, and in particular, declines in the liquidity of the residential mortgage loan secondary market, could adversely affect our business; |
(5) | Changes in regulatory capital requirements or an inability to achieve or maintain desired capital ratios could adversely affect our earnings opportunities and our ability to originate certain types of loans, as well as our ability to sell certain types of assets for fair market value; |
(6) | General business and economic conditions, including unemployment rates, movements in interest rates, the slope of the yield curve, any increase in mortgage fraud and other related criminal activity and the further decline of asset values in certain geographic markets, may significantly affect our business activities, loan losses, reserves, earnings and business prospects; |
(7) | Repurchases and indemnity demands by mortgage loan purchasers, guarantors and insurers, uncertainty related to foreclosure procedures, and the outcome of current and future legal or regulatory proceedings could result in unforeseen consequences and adversely affect our business activities and earnings; |
(8) | The Dodd-Frank Wall Street Reform and Consumer Protection Act has resulted in the elimination of the Office of Thrift Supervision (the "OTS"), tightening of capital standards, and the creation of a new Consumer Financial Protection Bureau and has resulted, or will result, in new laws and regulations, such as the emerging mortgage servicing standards, that are expected to increase our costs of operations. In addition, the change to the Board of Governors of the Federal Reserve System (the “Federal Reserve”) as our primary federal regulator and to the Office of the Comptroller of the Currency (the "OCC") as Flagstar Bank, FSB's (the “Bank”) primary federal regulator may result in interpretations affecting our operations different than those of the OTS; |
(9) | Both the volume and the nature of consumer actions and other forms of litigation against financial institutions have increased and to the extent that such actions are brought against us or threatened, the cost of defending such suits as well as potential exposure could increase our costs of operations; |
(10) | Our compliance with the terms and conditions of the agreement with the U.S. Department of Justice, the impact of performance and enforcement of commitments under, and provisions contained in the agreement, and our accuracy and ability to estimate the financial impact of that agreement, including the fair value of the future payments required, could accelerate our litigation settlement expenses relating thereto; |
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(11) | Our, or the Bank's, failure to comply with the terms and conditions of the Supervisory Agreement with the Federal Reserve or the Consent Order with the OCC, respectively, could result in further enforcement actions against us, which could negatively affect our results of operations and financial condition; |
(12) | The downgrade of the long-term credit rating of the U.S. by one or more ratings agencies could materially affect global and domestic financial markets and economic conditions, which may affect our business activities, financial condition, and liquidity; and |
(13) | The sale of a substantial portion of our commercial loan portfolio is subject to the satisfaction of settlement conditions and certain post-closing indemnification obligations. Because of business, economic or market conditions or for any other reasons within or outside of our discretion, the sale may not have the projected impact or be consummated in a timely manner. |
All of the above factors are difficult to predict, contain uncertainties that may materially affect actual results, and may be beyond our control. New factors emerge from time to time, and it is not possible for our management to predict all such factors or to assess the effect of each such factor on our business.
Please also refer to Item 1A to Part I of this Annual Report on Form 10-K, which is incorporated by reference herein, for further information on these and other factors affecting us.
Although we believe that these forward-looking statements are based on reasonable, estimates and assumptions, they are not guarantees of future performance and are subject to known and unknown risks, uncertainties, contingencies and other factors. Accordingly, we cannot give you any assurance that our expectations will in fact occur or that actual results will not differ materially from those expressed or implied by such forward-looking statements. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved.
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PART I
ITEM 1. | BUSINESS |
Where we say "we," "us," or "our," we usually mean Flagstar Bancorp, Inc. However, in some cases, a reference to "we," "us," or "our" will include our wholly-owned subsidiary Flagstar Bank, FSB, and Flagstar Capital Markets Corporation ("FCMC"), its wholly-owned subsidiary, which we collectively refer to as the "Bank."
General
We are a Michigan-based savings and loan holding company founded in 1993. Our business is primarily conducted through our principal subsidiary, the Bank, a federally chartered stock savings bank founded in 1987. At December 31, 2012, our total assets were $14.1 billion, making us the largest bank headquartered in Michigan and one of the top 10 largest savings banks in the United States. Our common stock is listed on the New York Stock Exchange ("NYSE") under the symbol "FBC." We are considered a controlled company for NYSE purposes because MP Thrift Investments, L.P. ("MP Thrift") held approximately 63.7 percent of our common stock as of December 31, 2012.
As a savings and loan holding company, we are subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Bank is subject to regulation, examination and supervision by the Office of the Comptroller of the Currency ("OCC") of the United States Department of the Treasury ("U.S. Treasury"). The Bank is also subject to regulation, examination and supervision by the Federal Deposit Insurance Corporation ("FDIC") and the Bank's deposits are insured by the FDIC through the Deposit Insurance Fund ("DIF"). The Bank is also subject to the rule-making, supervision and examination authority of the Consumer Financial Protection Bureau (the "CFPB"), which is responsible for the principal federal consumer protection laws. The Bank is a member of the Federal Home Loan Bank ("FHLB") of Indianapolis.
Our primary business is the Mortgage Banking segment, in which we originate or purchase residential first mortgage loans throughout the country and sell them into securitization pools, primarily to Fannie Mae, Freddie Mac and Ginnie Mae (collectively, government sponsored entities or the "GSEs") or as whole loans. Approximately 98.6 percent of our total loan originations during the year ended December 31, 2012 represented mortgage loans that were collateralized by residential first mortgages on single-family residences and were eligible for sale. Our revenue primarily consists of net gain on loan sales, loan fees and charges, net loan administration income, and interest income from residential first mortgage loans held-for-investment and held-for-sale, second mortgage loans and warehouse loans held-for-investment. We originate residential first mortgage loans through our wholesale relationships with over 1,700 mortgage brokers and approximately 1,300 correspondents, which are located in all 50 states and serviced by 134 account executives. We also operate 31 home lending centers located in 14 states, which primarily originate one-to-four family residential first mortgage loans as part of our Mortgage Banking segment. These loan origination centers employ approximately 200 loan officers. We also originate mortgage loans through referrals from our 111 banking centers, consumer direct call center and our website, www.flagstar.com. The combination of our home lending, broker and correspondent channels gives us broad access to customers across diverse geographies to originate, fulfill, sell and service our residential first mortgage loan products. Our servicing activities primarily include collecting cash for principal, interest and escrow payments from borrowers, assisting homeowners through loss mitigation activities, and accounting for and remitting principal and interest payments to investors and escrow payments to third parties.
Our business also includes the Community Banking segment, in which our revenues include net interest income and fee-based income from community banking services. At December 31, 2012, we operated 111 banking centers (of which 15 are located in retail stores), all of which are located in Michigan. Of the 111 banking centers, 66 facilities are owned and 45 facilities are leased. Through our banking centers, we gather deposits and offer a line of consumer and commercial financial products and services to individuals and businesses. We provide deposit and cash management services to governmental units on a relationship basis. We leverage our banking centers to cross-sell loan and deposit products to existing customers and to increase our customer base by attracting new customers. At December 31, 2012, we had a total of $8.3 billion in deposits, including $6.4 billion in retail deposits, $1.0 billion in company controlled deposits, $0.8 billion in government deposits, and $0.1 billion in wholesale deposits.
At December 31, 2012, we had 3,662 full-time equivalent salaried employees of which 334 were account executives and loan officers.
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Commercial Loan Sales
In late 2012, we made a strategic decision to exit our New England based commercial loan production offices. These offices are in the process of being closed, and we expect that operations will cease by June 30, 2013. In connection with this decision, we also entered into two agreements to sell our New England commercial loan portfolios.
Effective December 31, 2012, the Bank entered into a definitive Transaction Purchase and Sale Agreement (the "CIT Agreement") with CIT Bank, the wholly-owned U.S. commercial bank subsidiary of CIT Group Inc. ("CIT"). Under the terms of the CIT Agreement, CIT will acquire $1.3 billion in commercial loan commitments, $784.3 million of which were outstanding at December 31, 2012. The loans sold consist primarily of asset-based loans, equipment leases and commercial real estate loans. The sale resulted in a reversal of $12.6 million in loan loss reserves associated with such loans which was recognized at December 31, 2012. We expect that the total purchase price for the portfolio will be approximately $779.2 million and that a majority of the assets will be sold during the first quarter of 2013. Through March 1, 2013, we sold $573.2 million of these loans to CIT.
Effective February 5, 2013, the Bank entered into a definitive Asset and Portfolio Purchase and Sale Agreement (the "Customers Agreement") with Customers Bank ("Customers") located in Wyomissing, Pennsylvania. Under the terms of the Customers Agreement, Customers will acquire $187.6 million in commercial loan commitments, $150.9 million of which were outstanding at December 31, 2012. The loans sold consist primarily of commercial and industrial loans. We expect that the total purchase price for the portfolio will be approximately $148.5 million and that a majority of the assets will be transferred during the first quarter 2013.
The loans sold pursuant to CIT Agreement and Customers Agreement were transferred from the loans held-for-investment portfolio to the loans held-for-sale portfolio at December 31, 2012.
Assured Litigation
On February 5, 2013, the United States District Court for the Southern District of New York (the "Court") issued a decision in the civil lawsuit against the Bank filed by Assured Guaranty Municipal Corp., formerly known as Financial Security Assurance Inc. ("Assured"). The Court granted judgment in favor of Assured on its claims for breach of contract against the Bank in the amount of $89.2 million plus contractual interest and attorneys’ fees and costs.
Following the Court’s decision in the Assured case, we increased our accrual for pending and threatened litigation and recognized such increase in 2012, which resulted in a decrease in net income of $161.0 million, or $2.87 per share (diluted), for the year ended December 31, 2012. This accrual increased the total expense for pending and threatened litigation, including amounts paid in anticipation of future settlements, to approximately $244.6 million at December 31, 2012. Included in this accrual are amounts for the Court's decision regarding Assured and for the lawsuit that MBIA Insurance Corporation ("MBIA") filed against the Bank on January 11, 2013, along with other pending litigation. See Note 29 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.
Reverse Stock Split
Our board of directors authorized a one-for-ten reverse stock split on September 24, 2012 following the annual meeting of stockholders on that date at which the reverse stock split was approved by our stockholders. Our common stock began trading on a post-split basis on October 11, 2012. Unless noted otherwise, all share-related amounts herein reflect the one-for-ten reverse stock split.
In connection with the reverse stock split, stockholders received one new share of common stock for every ten shares held at the effective time. The reverse stock split reduced the number of outstanding shares of common stock from approximately 558.3 million to 55.8 million. The number of authorized shares of common stock was reduced from 700 million to 70 million. Proportional adjustments were made to our outstanding options, warrants and other securities entitling holders to purchase or receive shares of common stock. In lieu of fractional shares, stockholders received cash payments based on the common stock's closing price on October 9, 2012, adjusted for the reverse stock split. The reverse stock split did not negatively affect any of the rights that accrue to holders of our outstanding options, warrants and other securities entitling holders to purchase or receive shares of common stock, except to adjust the number of shares relating thereto accordingly. For further information on the reverse stock split, see Note 22 and Note 23 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.
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Management Change
On October 1, 2012, we announced that our and the Bank's respective boards of directors appointed Michael J. Tierney to serve as our President, effective immediately, and as our and the Bank's Chief Executive Officer, effective November 1, 2012, in each case subject to receipt of non-objection from the Federal Reserve, our primary regulator, and the OCC, the Bank's primary regulator. Mr. Tierney also was appointed to our board of directors and to the board of directors of the Bank, subject to receipt of Federal Reserve and OCC non-objections. We have received non-objection from the Federal Reserve for Mr. Tierney to serve as our President and Chief Executive Officer and a member of our board of directors, and we have received OCC approval for Mr. Tierney to serve as the Bank's President and Chief Executive Officer on an interim basis and as a member of its board of directors. We also announced that John D. Lewis, Managing Director of Donnelly Penman & Partners and former Vice Chairman of Comerica Bank, was appointed to serve as the Non-Executive Chairman of the boards of directors of us and the Bank, in each case subject to receipt of regulatory non-objection. We received non-objection from the Federal Reserve and the OCC for Mr. Lewis to serve as Non-Executive Chairman.
Effective December 18, 2012, our and the Bank's boards of directors appointed Alessandro DiNello as the President of the Bank and as our and the Bank's Chief Administrative Officer, subject to receipt of OCC and, if necessary, Federal Reserve non-objection, requests for which are pending. In addition, the Bank's boards of directors appointed Matthew A. Kerin as the President of the Bank's Mortgage Banking Division, subject to regulatory OCC non-objection. The Bank has received OCC non-objection for Mr. Kerin to serve as President of the Bank's Mortgage Banking Division.
Consent Order
Effective October 23, 2012, the Bank's board of directors executed a Stipulation and Consent (the "Stipulation"), accepting the issuance of a Consent Order (the "Consent Order") by the OCC. The Consent Order replaces the supervisory agreement entered into between the Bank and the OTS on January 27, 2010. The OCC terminated the supervisory agreement simultaneous with issuance of the Consent Order. We are still subject to a supervisory agreement, dated January 27, 2010, with the Federal Reserve.
Under the terms of the Consent Order, the Bank's board of directors has agreed to, among other things, take the following actions:
• | forward to the OCC a written capital plan covering at least a three-year period and establishing projections for our overall risk profile, earnings performance, growth expectations, balance sheet mix, off-balance sheet activities, liability and funding structure, capital and liquidity adequacy, as well as a contingency capital funding process and a plan that identifies alternative capital sources should the primary sources not be available, and at least annually thereafter, review, revise and resubmit the written capital plan; |
• | review, revise, adopt and forward to the OCC written policies and procedures for maintaining an adequate allowance for loan losses in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"); |
• | review, revise, adopt and forward to the OCC written policies and procedures for maintaining an adequate representation and warranty reserve in accordance with U.S. GAAP; |
• | adopt and forward to the OCC a comprehensive written liquidity risk management policy that systematically requires us to reduce liquidity risk; |
• | adopt, implement, and ensure our adherence to an independent, internal audit program covering all our operations and shall implement appropriate actions to remedy deficiencies cited in such audit reports; |
• | develop, adopt, and forward to the OCC a written enterprise risk management program that is designed to ensure that we effectively identify, monitor, and control our enterprise-wide risks, including by developing risk limits for each line of business; |
• | adopt, implement, and ensure adherence to an independent, ongoing loan review system to review our loan and lease portfolios, which system shall provide for the filing with our board of directors of internal loan and lease review reports and shall require our board of directors to review the reports and take immediate remedial action if appropriate; |
• | establish, adopt, and forward to the OCC written policies and procedures designed to identify, measure, monitor, and control risks associated with our credit concentrations; |
• | review, revise, and ensure adherence to our written Bank Secrecy Act/Anti-Money Laundering ("BSA/AML") Risk Assessment to ensure BSA/AML risks posed to us are accurately identified after consideration of all pertinent information; |
• | review, revise, and ensure adherence to our written program of policies and procedures adopted in accordance with the Bank Secrecy Act ("BSA"), which shall include the production of periodic reports designed to identify, monitor, and evaluate unusual or suspicious activity; |
• | update the status of our plan and timeline for the implementation of enhanced BSA/AML internal controls and shall forward a copy of the plan and timeline to the OCC; |
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• | review, revise, and ensure adherence to our risk-based processes to obtain and analyze appropriate information from our customer due diligence program, both at the time of account opening and on an ongoing basis, in order to effectively monitor for, and investigate, suspicious or unusual activity; |
• | review, revise, and ensure adherence to our BSA independent testing program; |
• | adopt and forward to the OCC a written program to improve our compliance management process, which our board of directors shall implement and ensure compliance with following the OCC's determination of non-objection; |
• | adopt, implement, and ensure adherence to (i) written Flood Disaster Protection Act ("FDPA") policies and procedures detailing a coordinated program to ensure compliance with the FDPA, and (ii) a comprehensive FDPA training program for all applicable lending staff to ensure awareness of their FDPA compliance responsibilities; and |
• | adopt and forward to the OCC a comprehensive written business continuity plan, which the Bank's board of directors shall implement and ensure compliance with following the OCC's determination of non-objection. |
Each of the plans, policies and procedures referenced above in the Consent Order, as well as any subsequent amendments or changes thereto, must be submitted to the OCC for a determination that the OCC has no supervisory objection to them. Upon receiving a determination of no supervisory objection from the OCC, we must implement and adhere to the respective plan, policy or procedure.
The Consent Order also requires the Bank to establish a Compliance Committee to oversee its adherence to the provisions of the Consent Order. The Bank's board of directors has re-designated the existing Regulatory Oversight Committee as the Compliance Committee. The current members of the Compliance Committee are Jay J. Hansen, John D. Lewis, David J. Matlin and Peter Schoels. The Compliance Committee is responsible for monitoring and coordinating the Bank's adherence to the provisions of the Consent Order. The Bank's board of directors has appointed John D. Lewis to serve as the Chairman of the Compliance Committee and Peter Schoels to serve as Vice Chairman of the Compliance Committee.
We intend to address the banking issues identified by the OCC in the manner and within the time periods required for compliance by the OCC, as the OCC may extend one or more of those time frames from time to time. There can be no assurance that the OCC will not provide substantive comments on the capital plan or other submissions that we make pursuant to the Consent Order that will have a material impact on us. We believe that our compliance with the Consent Order should, over time, improve our enterprise risk management practices and our risk profile.
The foregoing summary of the Stipulation and the Consent Order does not purport to be a complete description of all of the terms of such documents, and is qualified in its entirety by reference to copies of the Stipulation and the Consent Order filed with the SEC on October 24, 2012 as exhibits to our Current Report on Form 8-K.
Supervisory Agreement
We are subject to a supervisory agreement, dated January 27, 2010, with the Federal Reserve, as a successor regulator to the OTS (the "Supervisory Agreement"). The Supervisory Agreement will remain in effect until terminated, modified, or suspended in writing by the Federal Reserve, and the failure to comply with the Supervisory Agreement could result in the initiation of further enforcement action by the Federal Reserve, including the imposition of further operating restrictions. We have taken actions which we believe are appropriate to comply with, and intend to maintain compliance with, all of the requirements of the Supervisory Agreement.
Pursuant to the Supervisory Agreement, we submitted a capital plan to the OTS, predecessor in interest to the Federal Reserve. In addition, we agreed to request prior non-objection of the Federal Reserve to pay dividends or other capital distributions, purchases, repurchases or redemptions of certain securities, incurrence, issuance, renewal, rolling over or increase of any debt and certain affiliate transactions, and comply with restrictions on the payment of severance and indemnification payments, director and management changes and employment contracts and compensation arrangements. The foregoing summary of the Supervisory Agreement does not purport to be a complete description of all of the terms of the Supervisory Agreement, and is qualified in its entirety by reference to the copy of the Supervisory Agreement filed with the SEC as an exhibit to our Current Report on Form 8-K filed on January 28, 2010.
We addressed the banking issues identified by the Federal Reserve in the manner and within the time periods required for compliance with the Supervisory Agreement.
Troubled Asset Relief Program
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (initially introduced as the Troubled Asset Relief Program ("TARP")) was enacted, and the U.S. Treasury injected capital into U.S. financial institutions. On January 30, 2009, we
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entered into a letter agreement including the securities purchase agreement with the U.S. Treasury pursuant to which, among other things, we sold to the U.S. Treasury preferred stock and warrants. As long as the preferred stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including our common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions. The preferred stock accrues cumulative dividends quarterly at a rate of 5 percent per annum until January 30, 2014, and 9 percent per annum thereafter.
On January 27, 2012, we provided notice to the U.S. Treasury exercising the contractual right to defer regularly scheduled quarterly payments of dividends and interest, beginning with the February 2012 payment, on preferred stock issued and outstanding in connection with participation in the TARP Capital Purchase Program. These payments will be periodically evaluated and reinstated when appropriate, subject to the provisions of our supervisory agreement with the Federal Reserve. Concurrently, we also exercised contractual rights to defer interest payments with respect to our trust preferred securities.
On December 18, 2012, the U.S. Treasury announced its intention to auction our preferred stock issued and outstanding under the TARP Capital Purchase Program during 2013. Through March 5, 2013, our preferred stock had not been auctioned and was still held by the U.S. Treasury.
Payment of Dividend and Interest Payments
We are a legal entity separate and distinct from the Bank and our non-banking subsidiaries. In 2008, we discontinued the payment of dividends on common stock. On January 27, 2012, we provided notice to the U.S. Treasury exercising our contractual right to defer regularly scheduled quarterly payments of dividends, beginning with the February 2012 payment, on preferred stock issued and outstanding in connection with our participation in the TARP Capital Purchase Program. Under the terms of the preferred stock, we may defer payments of dividends for up to six quarters in total without default or penalty. Following the sixth quarter, the holders of such preferred stock will have the right to elect two directors to our board of directors. Concurrently, we also exercised our contractual rights to defer interest payments with respect to trust preferred securities. We may not recommence payments on either the preferred stock or trust preferred securities without commencing payments on the other as well. Under the terms of the indentures related to the trust preferred securities, we may defer interest payments for up to 20 consecutive quarters without default or penalty. These payments will be periodically evaluated and reinstated when appropriate, subject to provisions of the Supervisory Agreement.
In addition, we are generally prohibited from making any dividend payments on stock except pursuant to the prior non-objection of the Federal Reserve as set forth in the Supervisory Agreement. Our principal sources of funds are cash dividends paid by the Bank and other subsidiaries, investment income and borrowings. Federal laws and regulations limit the amount of dividends or other capital distributions that the Bank may pay us. The Bank has an internal policy to remain "well-capitalized" under OCC capital adequacy regulations. The Bank does not currently expect to pay dividends to us and, even if it determined to do so, would not make payments if the Bank was not well-capitalized at the time or if such payment would result in the Bank not being well-capitalized. In addition, the Bank must seek prior approval from the OCC at least 30 days before it may make a dividend payment or other capital distribution to us.
Agreement with U.S. Department of Justice
On February 24, 2012, we announced that the Bank had entered into an agreement (the "DOJ Agreement") with the U.S. Department of Justice ("DOJ") relating to certain underwriting practices associated with loans insured by the Federal Housing Administration ("FHA") of the Department of Housing and Urban Development ("HUD"). The Bank and the DOJ entered into the DOJ Agreement pursuant to which the Bank agreed to comply with all applicable HUD and FHA rules related to its continued participation in the direct endorsement lender program, make an initial payment of $15.0 million within 30 business days of the effective date of the DOJ Agreement (paid on April 3, 2012), make payments of approximately $118.0 million contingent upon the occurrence of certain future events (as further described below) (the "Additional Payments"), and complete a monitoring period by an independent third party chosen by the Bank and approved by HUD. The Additional Payments will occur if and only if each of the following events happen:
• | we generate positive income for a sustained period, such that part or all of our Deferred Tax Asset ("DTA"), which has been offset by a valuation allowance (the "DTA Valuation Allowance"), is more likely than not to be realized, as evidenced by the reversal of the DTA Valuation Allowance in accordance with U.S. GAAP; |
• | we are able to include capital derived from the reversal of the DTA Valuation Allowance in our Tier 1 capital; and |
• | our obligation to repay the $266.7 million in preferred stock held by the U.S. Treasury under the TARP Capital Purchase Program has been either extinguished or excluded from Tier 1 capital for purposes of calculating the Tier 1 capital ratio as described in the paragraph below. |
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Upon the occurrence of each of the future events described above, and provided doing so would not violate any banking regulatory requirement or the OCC does not otherwise object, we will begin making Additional Payments provided that (i) each annual payment would be equal to the lesser of $25.0 million or the portion of the Additional Payments that remains outstanding after deducting prior payments, and (ii) no obligation arises until our call report as filed with the OCC, including any amendments thereto, for the period ending at least six months prior to the making of such Additional Payments, reflects a minimum Tier 1 capital ratio, after excluding any un-extinguished portion of the preferred stock issued in connection with our participation in the TARP Capital Purchase Program, of 11 percent (or higher ratio if required by regulators).
We made the $15.0 million initial payment during the second quarter 2012. At December, 31, 2012, we had accrued $19.1 million to reflect the fair value of the remaining $118.0 million liability. Future changes in the fair value of the Additional Payments could affect earnings in future quarters. See Note 4 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein, for the key assumptions used in valuing the litigation settlement.
Business and Strategy
We, as well as the rest of the mortgage industry and most other lenders, were negatively affected in recent years by increased credit losses from the prolonged and unprecedented economic recession. Since the latter part of 2008, financial institutions experienced significant declines in the value of collateral for real estate loans and heightened credit losses, resulting in record levels of non-performing assets, charge-offs, foreclosures and losses on disposition of the underlying assets. Moreover, liquidity in the debt markets remained low throughout 2012, further contributing to the decline in asset prices due to the low level of purchasing activity in the marketplace. While there have been moderate improvements during 2012 in a number of macroeconomic factors which impact our business, near term concerns remain over unemployment, the U.S. mortgage market, real estate values, access to credit and liquidity markets, energy costs, and global political issues such as sovereign debt defaults. Financial institutions also continue to face heightened levels of scrutiny from regulators regarding capital and liquidity requirements, credit risk, and other matters.
We believe that despite the increased scrutiny and heightened capital and liquidity requirements, regulated financial institutions should benefit from reduced competition from unregulated entities that lack the access to and breadth of significant funding sources as well as the capital to meet the financing needs of their customers and the ability to satisfy compliance requirements.
We believe that our management team has the necessary experience to appropriately manage through the credit and operational issues that are present in today's challenging markets. Our Mortgage Banking and Community Banking segments complement each other and contribute to the establishment of a diversified mix of revenue streams.
We intend to continue to seek ways to maximize the value of our Mortgage Banking segment while effectively managing and mitigating risk, with a critical focus on expense management, improving asset quality, increasing profitability, and preserving capital. We expect to pursue opportunities to build our core deposit base through our existing branch banking structure and to serve the credit and non-credit needs of the business customers in our markets, as we diversify our businesses and risk through executing our business plan and transitioning to a full-service and diversified community banking model.
In December 2012, we reorganized the way our operations are managed. The segments are based on an internally-aligned segment leadership structure, which is also how the results are monitored and performance assessed. We expect that the combination of our business model and the services that our operating segments provide will result in a competitive advantage that supports revenue and earnings. Our business model emphasizes the delivery of a complete set of mortgage and banking products and services, including originating, acquiring, selling and servicing one-to-four family residential first mortgage loans, which we believe is distinguished by timely processing and customer service.
Operating Segments
Our business is comprised of two primary operating segments - Community Banking and Mortgage Banking. Our Community Banking segment currently offers a line of financial products and services to individuals, small and middle market businesses, and mortgage lenders. Our Mortgage Banking segment originates, acquires, sells and services residential first mortgage loans on one-to-four family residences. In addition to the two primary segments, we also have an Other segment which includes corporate treasury, tax benefits not assigned to specific operating segments, and miscellaneous other expenses of a corporate nature. Each operating segment supports and complements the operations of the other. For example, funding for the Mortgage Banking segment is primarily provided by deposits obtained through the Community Banking segment. Financial information regarding
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the three operating segments is set forth in Note 30 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, herein. A more detailed discussion of the three operating segments is set forth below.
Community Banking
Our Community Banking segment is represented primarily by four groups: Branch Banking, Commercial and Business Banking, Government Banking, and Warehouse Lending. Our Community Banking segment's two strategic responsibilities are providing a stable funding source for the Mortgage Banking segment and operating as a standalone, profitable line of business. The groups within the Community Banking segment originate consumer loans, commercial loans and warehouse loans, gather consumer, business and governmental deposits, and offer liquidity management products. The liquidity management products include customized treasury management solutions, equipment and technology leasing, international services, capital markets services such as interest rate risk protection products, foreign exchange hedging, and trading of securities. At December 31, 2012, Branch Banking included 111 banking centers located throughout Michigan. Commercial and Business Banking includes relationship and portfolio managers throughout Michigan's major markets. Government Banking provides deposit and cash management services to all sizes of government units and school districts on a relationship basis throughout Michigan and, to a much lesser degree, Georgia. We intend to exit our Government Banking operations in Georgia during 2013. Warehouse Lending offers lines of credit to other mortgage lenders, allowing those lenders to fund the closing of residential first mortgage loans.
Our Community Banking segment plans to achieve its strategic objective of becoming a standalone, profitable line of business through a number of important initiatives, including a strengthened leadership team, an enhanced sales process, improved operating efficiencies, and the implementation of a streamlined account opening strategy. Branch Banking will continue to optimize its network of offices through strategic growth and relocations. Commercial and Business Banking and Warehouse Lending will continue its focus on acquiring new customer relationships throughout Michigan, and Government Banking will acquire new and expand existing relationships through a focus on checking accounts and treasury services.
Our Community Banking segment's mission is to build strong and lasting relationships with customers, and such relationships are intended to include multiple financial products and services. Regardless of whether customers are first introduced to us through a deposit account, mortgage loan, or other product, the Community Banking segment's focus is to strengthen those relationships by meeting multiple additional financial needs. Our Community Banking segment also cross-sells primary products, such as checking accounts, savings accounts, investment products, and consumer loans, to new and existing customers. These efforts tend to produce incrementally higher relationship profitability and improved customer retention.
Commercial loans held-for-investment. Our Commercial and Business Banking includes relationship and portfolio managers throughout Michigan's major markets. Our commercial loans held-for-investment totaled $0.7 billion at December 31, 2012 and $1.7 billion at December 31, 2011, and consists of three loan types: commercial real estate, commercial and industrial and commercial lease financing, each of which is discussed in more detail below. During the year ended December 31, 2012, we originated $727.1 million in commercial loans. During the year ended December 31, 2012, we transferred $779.2 million and $148.5 million of commercial loans held-for-investment to the loans held-for-sale category related to the previously discussed CIT Agreement and Customers Agreement transactions, respectively, both of which are expected to be substantially closed in the first quarter 2013. The following table identifies the commercial loan held-for-investment portfolio by loan type and selected criteria at December 31, 2012.
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Commercial Loans Held-for-Investment | ||||||||
December 31, 2012 | Unpaid Principal Balance (1) | Average Note Rate | Loan on Non-accrual Status | |||||
(Dollars in thousands) | ||||||||
Commercial real estate loans: | ||||||||
Fixed rate | $ | 342,296 | 5.5 | % | $ | 38,909 | ||
Adjustable rate | 299,489 | 4.1 | % | 47,458 | ||||
Total commercial real estate loans | 641,785 | $ | 86,367 | |||||
Net deferred fees and other | (1,470 | ) | ||||||
Total commercial real estate loans | $ | 640,315 | ||||||
Commercial and industrial loans: | ||||||||
Fixed rate | $ | 33,124 | 3.5 | % | $ | — | ||
Adjustable rate | 58,544 | 2.7 | % | 41 | ||||
Total commercial and industrial loans | 91,668 | $ | 41 | |||||
Net deferred fees and other | (1,103 | ) | ||||||
Total commercial and industrial loans | $ | 90,565 | ||||||
Commercial lease financing loans: | ||||||||
Fixed rate | $ | 5,634 | 6.2 | % | $ | — | ||
Net deferred fees and other | 666 | |||||||
Total commercial lease financing loans | $ | 6,300 | ||||||
Total commercial loans: | ||||||||
Fixed rate | $ | 381,054 | $ | 38,909 | ||||
Adjustable rate | 358,033 | 47,499 | ||||||
Total commercial and industrial loans | 739,087 | $ | 86,408 | |||||
Net deferred fees and other | (1,907 | ) | ||||||
Total commercial and industrial loans | $ | 737,180 | ||||||
(1) | Unpaid principal balance does not include premiums or discounts. During the year ended December 31, 2012, we transferred $779.2 million and $148.5 million of commercial loans held-for-investment to the loans held-for-sale category related to the CIT Agreement and Customers Agreement, respectively. |
At December 31, 2012, our commercial real estate loans held-for-investment totaled $640.3 million, or 11.8 percent of our held-for-investment loan portfolio, our commercial and industrial held-for-investment loan portfolio was $90.6 million, or 1.7 percent of our held-for-investment loan portfolio, and our commercial lease financing loans held-for-investment totaled $6.3 million, or 0.1 percent of our held-for-investment loan portfolio. At December 31, 2011, our commercial real estate held-for-investment loan portfolio totaled $1.2 billion, or 17.7 percent of our held-for-investment loan portfolio, our commercial and industrial held-for-investment loan portfolio was $328.9 million, or 4.7 percent of our held-for-investment loan portfolio, and our commercial lease financing held-for-investment loans totaled $114.5 million, or 1.6 percent of our held-for-investment loan portfolio.
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The following table sets forth the unpaid principal balance of our commercial loan held-for-investment portfolio at December 31, 2012 by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Commercial real estate (1) (2) | $ | 494,074 | $ | 7,519 | $ | 15,488 | $ | 35,057 | $ | 89,647 | $ | 641,785 | |||||||||||
Commercial and industrial (2) | 1,198 | 169 | 673 | 40,818 | 48,810 | 91,668 | |||||||||||||||||
Commercial lease financing (2) | — | — | — | 4,924 | 710 | 5,634 | |||||||||||||||||
Total | $ | 495,272 | $ | 7,688 | $ | 16,161 | $ | 80,799 | $ | 139,167 | $ | 739,087 | |||||||||||
(1) | During the year ended December 31, 2012, we sold $20.9 million in non-performing commercial real estate loans and charged off $124.0 million. |
(2) | During the year ended December 31, 2012, we transferred $779.2 million and $148.5 million of commercial loans held-for-investment to the loans held-for-sale category related to the CIT Agreement and Customers Agreement, respectively, for a total of $927.7 million, which consisted of $280.4 million of commercial real estate, $488.4 million of commercial and industrial, and $158.9 million of commercial lease financing loans. |
The average loan balance in our total commercial held-for-investment loan portfolio was approximately $0.9 million for the period ending December 31, 2012, with the largest loan being $39.9 million. There are approximately eight loans with more than $10.2 million of exposure and those loans comprised approximately $143.0 million, or 19.3 percent, of the total commercial held-for-investment loan portfolio.
Commercial real estate loans. Our commercial real estate ("CRE") held-for-investment loan portfolio is comprised of loans that are collateralized by real estate properties intended to be income-producing in the normal course of business and consists of CRE loans originated prior to 2011, including CRE loans refinanced during 2009 and 2010 and CRE loans originated during 2011 and 2012.
The following table discloses our total unpaid principal balance of CRE held-for-investment loans that were geographically concentrated at December 31, 2012.
December 31, 2012 | ||||||
State | Percent | Amount (1) | ||||
(Dollars in thousands) | ||||||
Michigan | 66.5 | % | $ | 427,043 | ||
Indiana | 7.0 | % | 44,577 | |||
Georgia | 6.4 | % | 40,783 | |||
Virginia | 5.3 | % | 33,867 | |||
Florida | 3.5 | % | 22,519 | |||
Other | 11.3 | % | 72,996 | |||
Total | 100.0 | % | 641,785 | |||
(1) | Unpaid principal balance does not include premiums or discounts. |
In early 2008, we ceased the origination of commercial real estate loans and allowed the amortization of this remaining portfolio. For the management of such loans, we replaced the previous commercial real estate management and loan officers with experienced workout officers and relationship managers. In addition, we prepared a comprehensive review, including customized workout plans for all classified loans, and risk assessments were prepared on a loan level basis for the entire commercial real estate portfolio. Such loans are managed by our special assets group, whose primary objectives are working out troubled loans, reducing classified assets and taking pro-active steps to prevent deterioration in performance. We expect to retain a portion of these loans in our loans held-for-investment portfolio while continuing to dispose of the remainder through workouts, charge offs and payoffs.
In February 2011, we began originating CRE loans under enhanced underwriting guidelines through our Northeast commercial lending operations under a lending team in our commercial banking group to establish commercial banking relationship and provide cross-sell opportunities. In connection with the two commercial loan sales noted above, the majority of the loans originated by this group have been sold. Management expects to continue to originate such loans going forward, with a focused concentration on our primary geographic market (e.g., Michigan).
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The following table set forth the performance of the unpaid principal balance of CRE loans originated during 2011 and 2012 and contained in our loan held-for-investment portfolio at December 31, 2012.
CRE , originated 2011 and later (1) | |||||||||||||||||||
Property Type | 30 Days Past Due | 60 Days Past Due | 90+ Days Past Due (2) | Balance | Total Reserves | ||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Land | $ | — | $ | — | $ | — | $ | 149 | $ | 3 | |||||||||
One-to-four family conventional | — | — | — | 1,645 | 31 | ||||||||||||||
Multi-family conventional | — | — | — | 10,829 | 201 | ||||||||||||||
Commercial non-owner occupied | 6,603 | — | — | 88,482 | 1,645 | ||||||||||||||
Secured by nonfarm, nonresidential | — | — | — | 36,626 | 682 | ||||||||||||||
Other | — | — | — | 12,154 | 226 | ||||||||||||||
Negative escrow | — | — | — | (3 | ) | — | |||||||||||||
Net deferred fees and other | — | — | — | (1,844 | ) | — | |||||||||||||
Total | $ | 6,603 | $ | — | $ | — | $ | 148,038 | $ | 2,788 | |||||||||
(1) | Includes commercial real estate held-for-investment loans originated during 2011 and 2012. |
(2) | Greater than 90 days past due includes performing non-accrual loans. |
The following table sets forth the performance of the unpaid principal balance of CRE loans originated prior to 2011, including CRE loans refinanced during 2009 and 2010.
CRE, originated prior to 2011 (1) | |||||||||||||||||||
Property Type | 30 Days Past Due | 60 Days Past Due | 90+ Days Past Due (2) | Balance | Total Reserves | ||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Land | $ | — | $ | — | $ | 1,745 | $ | 4,802 | $ | 276 | |||||||||
One-to-four family conventional | 102 | 141 | 62 | 756 | 74 | ||||||||||||||
Multi-family conventional | — | 6,411 | 3,022 | 41,484 | 3,387 | ||||||||||||||
Commercial non-owner occupied | — | 438 | 77,114 | 412,324 | 32,309 | ||||||||||||||
Secured by nonfarm, nonresidential | 274 | — | 4,424 | 32,535 | 2,476 | ||||||||||||||
Negative escrow | — | — | — | 1,613 | — | ||||||||||||||
Net deferred fees and other | — | — | — | (1,237 | ) | — | |||||||||||||
Total | $ | 376 | $ | 6,990 | $ | 86,367 | $ | 492,277 | $ | 38,522 | |||||||||
(1) | Includes commercial real estate held-for-investment loans originated prior to 2011. |
(2) | Greater than 90 days past due includes performing non-accrual loans. |
Commercial and industrial loans. Commercial and industrial held-for-investment loan facilities typically include lines of credit to our small or middle market businesses for use in normal business operations to finance working capital needs, equipment purchases and expansion projects. Commercial and industrial held-for-investment loans include those loan facilities previously described, as well as asset based lending and auto dealer floor plan financing. We participate, with other lenders, in syndicated deals to well known larger companies. As of December 31, 2012, we had no auto dealer floor plan financing loans. At December 31, 2012 our commercial and industrial held-for-investment loans totaled $90.6 million, compared to $330.1 million at December 31, 2011. During the year ended December 31, 2012, we transferred $488.4 million of commercial and industrial loans held-for-investment to the loans held-for-sale category as a result of our agreements to sell such loans pursuant to the CIT Agreement and Customers Agreement.
Commercial lease financing loans. Our commercial lease financing held-for-investment loan portfolio is comprised of equipment leased to customers in a direct financing lease. The net investment in financing leases includes the aggregate amount of lease payments to be received and the estimated residual values of the equipment, less unearned income. Income from lease financing is recognized over the lives of the leases on an approximate level rate of return on the unrecovered investment. The residual value represents the estimated fair value of the leased asset at the end of the lease term. Unguaranteed residual values of leased assets are reviewed at least annually for impairment. If any declines in residual values are determined to be other-than-temporary they will be recognized in earnings in the period such determinations are made. At December 31, 2012 our commercial lease financing held-for-investment loans totaled $6.3 million, compared to $114.5 million at December 31, 2011. During the year
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ended December 31, 2012, we transferred $158.9 million of commercial lease financing loans held-for-investment to the loans held-for-sale category related to the CIT Agreement.
Warehouse lending. We also continue to offer warehouse lines of credit to other mortgage lenders. These allow the lender to fund the closing of residential first mortgage loans. Each extension or drawdown on the line is collateralized by the residential first mortgage loan being funded, and during 2012, we subsequently acquired approximately 76.7 percent of residential first mortgage loans funded through the warehouse lines. Underlying mortgage loans are predominately originated using GSE underwriting standards. These lines of credit are, in most cases, personally guaranteed by one or more qualified principal officers of the borrower. The aggregate amount of adjustable rate warehouse lines of credit granted to other mortgage lenders at December 31, 2012 was $2.3 billion, of which $1.3 billion was outstanding and had an average rate of 5.4 percent, compared to $2.1 billion granted at December 31, 2011, of which $1.2 billion was outstanding and had an average rate of 5.5 percent. The levels of outstanding balances of such warehouse lines are generally correlated to the level of our overall production levels because our correspondents (from whom we purchase mortgage loans) also comprise a substantial portion of our warehouse lending customers. As of December 31, 2012 and December 31, 2011, our warehouse lines funded over 62 percent of the loans in our correspondent channel. There were 311 warehouse lines of credit to other mortgage lenders with an average size of $7.5 million at December 31, 2012, compared to 293 warehouse lines of credit with an average size of $7.0 million at December 31, 2011. At December 31, 2012 we had no warehouse lines on non-accrual status, as compared to $28,000 at December 31, 2011.
Mortgage Banking
Our Mortgage Banking segment originates, acquires, sells and services one-to-four family residential first mortgage loans. The origination or acquisition of residential first mortgage loans held-for-sale constitutes our most significant lending activity.
Throughout 2012, we remained one of the country's leading mortgage loan originators. We utilize three production channels to originate or acquire mortgage loans: Home Lending Centers (also referred to as "retail"), as well as, Broker and Correspondent (also collectively referred to as "wholesale"). Each production channel produces similar mortgage loan products and applies the same underwriting standards. We expect to continue to leverage technology to streamline the mortgage origination process and bring service and convenience to brokers and correspondents. Sales support offices are maintained that assist brokers and correspondents nationwide. We also continue to make increasing use of the Internet as a tool to facilitate the mortgage loan origination process through each of our production channels. Brokers and correspondents are able to register and lock loans, check the status of inventory, deliver documents in electronic format, generate closing documents, and request funds through the Internet. Most mortgage loans that closed in 2012 utilized the Internet in the completion of the mortgage origination or acquisition process.
Home Lending Centers. In a home lending center transaction, loans are originated through a nationwide network of our stand-alone loan origination centers, as well as referrals from our Banking segment and the national call center. When loans are originated on a retail basis, the origination documentation is completed internally inclusive of customer disclosures and other aspects of the lending process and the funding of the transactions. At December 31, 2012, we maintained 31 loan origination centers. At the same time, our centralized loan processing gained efficiencies and allowed lending sales staff to focus on originations. For the year ended December 31, 2012, we closed $3.4 billion of loans utilizing this origination channel, which equaled 6.4 percent of total originations, compared to $1.8 billion or 6.7 percent of total originations during the year ended December 31, 2011.
Broker. In a broker transaction, an unaffiliated bank or mortgage brokerage company completes the loan paperwork, but the loans are underwritten on a loan-level basis to our underwriting standards and we supply the funding for the loan at closing (also known as "table funding") thereby becoming the lender of record. Currently, we have active broker relationships with over 1,700 banks, credit unions, and mortgage brokerage companies located in all 50 states. For the year ended December 31, 2012, we closed loans totaling $14.7 billion utilizing this origination channel, which equaled 27.5 percent of total originations, compared to $7.9 billion or 29.6 percent during the year ended December 31, 2011.
Correspondent. In a correspondent transaction, an unaffiliated bank or mortgage company completes the loan paperwork and also supplies the funding for the loan at closing. After the bank or mortgage company has funded the transaction, we purchase the loan at a market price. We do not acquire loans on a bulk basis without prior review from correspondents, but instead we acquire each loan after review on a loan-level basis and each loan is required to be originated to our underwriting guidelines. We have active correspondent relationships with over 1,300 companies, including banks, credit unions, and mortgage companies located in all 50 states. For the year ended December 31, 2012, we closed loans totaling $35.4 billion utilizing the correspondent origination channel, which equaled 66.1 percent of total originations, compared to $16.9 billion or 63.7 percent originated during the year ended December 31, 2011.
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The following tables disclose residential first mortgage loan originations by channel, type and mix for each respective period.
2012 | |||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Year to Date | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Home Lending Centers | $ | 729,369 | $ | 751,075 | $ | 961,591 | $ | 998,804 | $ | 3,440,839 | |||||||||
Broker | 2,909,446 | 3,156,949 | 4,117,742 | 4,524,775 | 14,708,912 | ||||||||||||||
Correspondent | 7,530,594 | 8,638,977 | 9,434,287 | 9,833,218 | 35,437,076 | ||||||||||||||
Total | $ | 11,169,409 | $ | 12,547,001 | $ | 14,513,620 | $ | 15,356,797 | $ | 53,586,827 | |||||||||
Purchase originations | $ | 2,188,508 | $ | 3,324,501 | $ | 3,267,788 | 2,915,724 | $ | 11,696,521 | ||||||||||
Refinance originations | 8,980,901 | 9,222,500 | 11,245,832 | 12,441,073 | 41,890,306 | ||||||||||||||
Total | $ | 11,169,409 | $ | 12,547,001 | $ | 14,513,620 | $ | 15,356,797 | $ | 53,586,827 | |||||||||
Conventional | $ | 7,859,960 | $ | 8,762,268 | $ | 10,020,863 | $ | 10,427,131 | $ | 37,070,222 | |||||||||
Government | 2,611,691 | 3,085,247 | 3,178,563 | $ | 3,363,134 | 12,238,635 | |||||||||||||
Jumbo | 697,758 | 699,486 | 1,314,194 | 1,566.532 | 4,277,970 | ||||||||||||||
Total | $ | 11,169,409 | $ | 12,547,001 | $ | 14,513,620 | $ | 15,356,797 | $ | 53,586,827 | |||||||||
2011 | |||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Year to Date | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Home Lending Centers | $ | 329,973 | $ | 354,359 | $ | 481,057 | $ | 616,765 | $ | 1,782,154 | |||||||||
Broker | 1,341,973 | 1,436,632 | 2,178,801 | 2,931,106 | 7,888,512 | ||||||||||||||
Correspondent | 3,184,364 | 2,851,716 | 4,266,593 | 6,639,229 | 16,941,902 | ||||||||||||||
Total | $ | 4,856,310 | $ | 4,642,707 | $ | 6,926,451 | $ | 10,187,100 | $ | 26,612,568 | |||||||||
Purchase originations | $ | 1,702,041 | $ | 2,347,212 | $ | 2,538,925 | $ | 2,148,300 | $ | 8,736,478 | |||||||||
Refinance originations | 3,154,269 | 2,295,495 | 4,387,526 | 8,038,800 | 17,876,090 | ||||||||||||||
Total | $ | 4,856,310 | $ | 4,642,707 | $ | 6,926,451 | $ | 10,187,100 | $ | 26,612,568 | |||||||||
Conventional | $ | 2,965,986 | $ | 2,726,979 | $ | 4,431,229 | $ | 7,180,349 | $ | 17,304,543 | |||||||||
Government | 1,645,232 | 1,680,766 | 1,759,984 | 2,135,840 | 7,221,822 | ||||||||||||||
Jumbo | 245,092 | 234,962 | 735,238 | 870,911 | 2,086,203 | ||||||||||||||
Total | $ | 4,856,310 | $ | 4,642,707 | $ | 6,926,451 | $ | 10,187,100 | $ | 26,612,568 | |||||||||
2010 | |||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Year to Date | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Home Lending Centers | $ | 413,663 | $ | 441,693 | $ | 581,334 | $ | 549,908 | $ | 1,986,598 | |||||||||
Broker | 1,661,460 | 1,811,108 | 2,545,969 | 3,051,509 | 9,070,046 | ||||||||||||||
Correspondent | 2,249,998 | 3,198,866 | 4,486,089 | 5,562,820 | 15,497,773 | ||||||||||||||
Total | $ | 4,325,121 | $ | 5,451,667 | $ | 7,613,392 | $ | 9,164,237 | $ | 26,554,417 | |||||||||
Purchase originations | $ | 1,624,556 | $ | 2,536,104 | $ | 2,053,092 | $ | 1,679,921 | $ | 7,893,673 | |||||||||
Refinance originations | 2,700,565 | 2,915,563 | 5,560,300 | 7,484,316 | 18,660,744 | ||||||||||||||
Total | $ | 4,325,121 | $ | 5,451,667 | $ | 7,613,392 | $ | 9,164,237 | $ | 26,554,417 | |||||||||
Conventional | $ | 2,671,186 | $ | 3,316,366 | $ | 5,007,734 | $ | 6,249,138 | $ | 17,244,424 | |||||||||
Government | 1,424,570 | 1,843,956 | 2,141,729 | 2,516,125 | 7,926,380 | ||||||||||||||
Jumbo | 229,365 | 291,345 | 463,929 | 398,974 | 1,383,613 | ||||||||||||||
Total | $ | 4,325,121 | $ | 5,451,667 | $ | 7,613,392 | $ | 9,164,237 | $ | 26,554,417 | |||||||||
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Underwriting
During the year ended December 31, 2012, we primarily originated residential first mortgage loans for sale that conformed to the respective underwriting guidelines established by GSEs.
Residential first mortgage loans
At December 31, 2012, most of our held-for-investment residential first mortgage loans had been originated in 2008 or prior years with underwriting criteria that varied by product and with the standards in place at the time of origination. Loans originated after 2008 are loans that generally satisfy specific criteria for sale into securitization pools insured by the GSEs or were repurchased from the GSEs subsequent to such sales.
Set forth below is a table describing the characteristics of the residential first mortgage loans in our held-for-investment portfolio at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Unpaid principal balance (1) | $ | 2,778,879 | $ | 62,432 | $ | 37,214 | $ | 47,458 | $ | 48,031 | $ | 2,974,014 | |||||||||||
Average note rate | 4.11 | % | 4.87 | % | 4.11 | % | 4.21 | % | 3.90 | % | 4.13 | % | |||||||||||
Average original FICO score | 713 | 690 | 693 | 722 | 738 | 712 | |||||||||||||||||
Average current FICO score (2) | 686 | 650 | 685 | 719 | 734 | 686 | |||||||||||||||||
Average original LTV ratio | 75.8 | % | 85.9 | % | 79.9 | % | 78.3 | % | 74.6 | % | 76.1 | % | |||||||||||
Housing Price Index LTV, as recalculated (3) | 93.8 | % | 91.7 | % | 84.8 | % | 82.1 | % | 73.0 | % | 93.2 | % | |||||||||||
Underwritten with low or stated income documentation | 38.0 | % | 3.0 | % | 6.0 | % | 1.0 | % | — | % | 35.0 | % | |||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Current FICO scores obtained at various times during the year ended December 31, 2012. |
(3) | The housing price index ("HPI") LTV is updated from the original LTV based on Metropolitan Statistical Area-level Office of Federal Housing Enterprise Oversight ("OFHEO") data as of September 30, 2012. |
Average original loan-to-value ("LTV") represents the loan balance at origination, as a percentage of the original appraised value of the property. LTVs are refreshed quarterly based on estimates of home prices using the most current OFHEO data, and reflect the modest recovery in home prices over the past 18 months.
Residential first mortgage loans are underwritten on a loan-by-loan basis rather than on a pool basis. Generally, residential first mortgage loans produced through our production channels in the held-for-investment loan portfolio are reviewed by one of our in-house loan underwriters or by a contract underwriter. In all cases, loans must be underwritten to our underwriting standards.
Our criteria for underwriting generally includes, but are not limited to, full documentation of borrower income and other relevant financial information, fully indexed rate consideration for variable rate loans, and for GSE loans, the specific GSEs eligible LTV ratios with full appraisals when required. Variances from any of these standards are permitted only to the extent allowable under the specific program requirements. These specific program requirements include the ability to originate loans with less than full documentation and variable rate loans with an initial interest rate less than the fully indexed rate. Mortgage loans are collateralized by a first or second mortgage on a one-to-four family residential property.
In general, for loans in the portfolio originated in years 2008 and prior, loan balances under $1,000,000 required a valid GSE automated underwriting system ("AUS") response for approval consideration. Documentation and ratio guidelines are driven by the AUS response. A FICO credit score for the borrower was required and a full appraisal of the underlying property that would serve as collateral is obtained.
For loan balances over $1,000,000, traditional manual underwriting documentation and ratio requirements are required as are two years plus year to date of income documentation and two months of bank statements. Income documentation based solely on a borrower's statement was an available underwriting option for each loan category. Even so, in these cases employment of the borrower was verified under the vast majority of loan programs, and income levels were typically checked against third party sources to confirm validity.
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We believe that our underwriting process, which relies on the electronic submission of data and images and is based on an award-winning imaging workflow process, allows for underwriting at a higher level of accuracy and with more timeliness than exists with processes which rely on paper submissions. We also provide our underwriters with integrated quality control tools, such as automated valuation models, multiple fraud detection engines and the ability to electronically submit IRS Form 4506 to ensure underwriters have the information that they need to make informed decisions. The process begins with the submission of an electronic application and an initial determination of eligibility. The application and required documents are then uploaded to our corporate underwriting department and all documents are identified by optical character recognition or our underwriting staff. The underwriter is responsible for checking the data integrity and reviewing credit. The file is then reviewed in accordance with the applicable guidelines established by us for the particular product. Quality control checks are performed by the underwriting department using the tools outlined above, as necessary, and a decision is then made and communicated to the prospective borrower.
The following table identifies our held-for-investment mortgages by major category, at December 31, 2012. Loans categorized as subprime were initially originated for sale and comprised only 0.1 percent of the portfolio of first lien mortgage loans.
December 31, 2012 | Unpaid Principal Balance (1) | Average Note Rate | Average Original FICO Score | Average Current FICO Score (2) | Weighted Average Maturity | Average Original LTV Ratio | Housing Price Index LTV, as recalculated (3) | ||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Residential first mortgage loans | |||||||||||||||||||||
Amortizing | |||||||||||||||||||||
3/1 ARM | $ | 118,026 | 3.26 | % | 682 | 672 | 261 | 82.2 | % | 83.6 | % | ||||||||||
5/1 ARM | 408,593 | 3.80 | % | 717 | 703 | 282 | 75.0 | % | 82.3 | % | |||||||||||
7/1 ARM | 20,532 | 4.31 | % | 722 | 714 | 279 | 75.2 | % | 78.6 | % | |||||||||||
Other ARM | 68,620 | 3.27 | % | 702 | 657 | 264 | 83.1 | % | 85.3 | % | |||||||||||
Fixed mortgage loans (4) | 1,046,982 | 4.45 | % | 676 | 655 | 332 | 77.7 | % | 98.6 | % | |||||||||||
Total amortizing | 1,662,753 | 4.15 | % | 704 | 669 | 311 | 77.5 | % | 92.7 | % | |||||||||||
Interest only | |||||||||||||||||||||
3/1 ARM | 170,198 | 3.65 | % | 722 | 703 | 269 | 74.7 | % | 89.5 | % | |||||||||||
5/1 ARM | 797,347 | 3.64 | % | 723 | 713 | 272 | 74.3 | % | 90.3 | % | |||||||||||
7/1 ARM | 54,417 | 6.00 | % | 731 | 706 | 298 | 74.6 | % | 104.9 | % | |||||||||||
Other ARM | 40,495 | 3.64 | % | 725 | 702 | 277 | 75.9 | % | 97.5 | % | |||||||||||
Other interest only | 189,201 | 6.06 | % | 727 | 700 | 296 | 74.1 | % | 104.1 | % | |||||||||||
Total interest only | 1,251,658 | 4.11 | % | 74 | 709 | 276 | 74.4 | % | 93.2 | % | |||||||||||
Option ARMs | 55,848 | 3.54 | % | 717 | 684 | 309 | 70.4 | % | 108.9 | % | |||||||||||
Subprime (5) | |||||||||||||||||||||
3/1 ARM | 205 | 9.84 | % | 645 | 628 | 294 | 91.2 | % | 102.0 | % | |||||||||||
Other ARM | 507 | 9.50 | % | 618 | 631 | 291 | 72.8 | % | 87.3 | % | |||||||||||
Other subprime | 3,043 | 8.08 | % | 594 | 654 | 295 | 72.3 | % | 102.4 | % | |||||||||||
Total subprime | $ | 3,755 | 8.37 | % | 616 | 650 | 295 | 73.4 | % | 100.4 | % | ||||||||||
Total residential first mortgage loans | $ | 2,974,014 | 4.13 | % | 712 | 686 | 296 | 76.1 | % | 93.2 | % | ||||||||||
Second mortgage loans (6) | $ | 114,867 | 7.68 | % | 733 | 733 | 133 | 20.4 | % | 23.5 | % | ||||||||||
HELOC loans (6) | $ | 172,081 | 5.13 | % | 735 | 735 | 44 | 26.5 | % | 28.7 | % | ||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Current FICO scores obtained at various times during the year ended December 31, 2012. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
(4) | Includes substantially fixed rate mortgage loans. |
(5) | Subprime loans are defined in accordance with the FDIC's assessment regulations definitions for subprime loans, which includes loans with FICO scores below 620 or similar characteristics. |
(6) | Reflects lower LTV only as to second liens because information regarding the first liens is not available. |
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The following table sets forth characteristics of those loans in our held-for-investment mortgage portfolio as of December 31, 2012 that were originated with less documentation than is now required by the GSEs. Loans as to which underwriting information was accepted from a borrower without validating that particular item of information are referred to as "low doc" or "stated." Substantially all of those loans were underwritten with verification of employment but with the related job income or personal assets, or both, stated by the borrower without verification of actual amount. Those loans may have additional elements of risk because information provided by the borrower in connection with the loan was limited. Loans as to which underwriting information was supported by third party documentation or procedures are referred to as "full doc," and the information therein is referred to as "verified." Also set forth are different types of loans that may have a higher risk of non-collection than other loans.
Low Doc | |||||||||
December 31, 2012 | % of Held-for-Investment loans | % of Residential First Mortgage loans | Unpaid Principal Balance (1) | ||||||
(Dollars in thousands) | |||||||||
Characteristics | |||||||||
SISA (stated income, stated asset) | 1.80 | % | 3.37 | % | $ | 99,859 | |||
SIVA (stated income, verified assets) | 11.11 | % | 20.83 | % | 617,472 | ||||
High LTV (i.e., at or above 95% at origination) | 0.15 | % | 0.28 | % | 8,405 | ||||
Second lien products (HELOCs, second mortgages) | 1.46 | % | 2.74 | % | 81,252 | ||||
Loan types | |||||||||
Option ARM loans | 0.65 | % | 1.22 | % | 36,250 | ||||
Interest-only loans | 8.53 | % | 15.98 | % | 473,708 | ||||
Subprime (2) | 0.04 | % | 0.07 | % | 2,181 | ||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Subprime loans are defined in accordance with the FDIC's assessment regulations definitions for subprime loans, which includes loans with FICO scores below 620 or similar characteristics. |
Adjustable-rate mortgage loans. Adjustable rate mortgage ("ARM") loans held-for-investment were originated using Fannie Mae and Freddie Mac guidelines as a base framework, and the debt-to-income ratio guidelines and documentation typically followed the AUS guidelines. Our underwriting guidelines were designed with the intent to minimize layered risk. The maximum ratios allowable for purposes of both the LTV ratio and the combined loan-to-value ("CLTV") ratio, which includes second mortgages on the same collateral, was 100 percent, but subordinate (i.e., second mortgage) financing was not allowed over a 90 percent LTV ratio. At a 100 percent LTV ratio with private mortgage insurance, the minimum acceptable FICO score, or the "floor," was 700, and at lower LTV ratio levels, the FICO floor was 620. All occupancy and specific-purpose loan types were allowed at lower LTVs. At times ARMs were underwritten at an initial rate, also known as the "start rate," that was lower than the fully indexed rate but only for loans with lower LTV ratios and higher FICO scores. Other ARMs were either underwritten at the note rate if the initial fixed term was two years or greater, or at the note rate plus two percentage points if the initial fixed rate term was six months to one year.
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Set forth below is a table describing the characteristics of our ARM loans in our residential first mortgage held-for-investment loan portfolio at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Unpaid principal balance (1) | $ | 1,686,118 | $ | 8,058 | $ | 6,256 | $ | 20,289 | $ | 14,067 | $ | 1,734,788 | |||||||||||
Average note rate | 3.71 | % | 5.05 | % | 4.45 | % | 4.13 | % | 3.69 | % | 3.72 | % | |||||||||||
Average original FICO score | 717 | 696 | 727 | 744 | 773 | 717 | |||||||||||||||||
Average current FICO score (2) | 702 | 688 | 720 | 738 | 776 | 703 | |||||||||||||||||
Average original LTV ratio | 75.4 | % | 81.2 | % | 72.5 | % | 72.2 | % | 61.8 | % | 75.3 | % | |||||||||||
Housing Price Index LTV, as recalculated (3) | 89.3 | % | 88.8 | % | 77.2 | % | 70.6 | % | 61.0 | % | 88.8 | % | |||||||||||
Underwritten with low or stated income documentation | 35.0 | % | 13.0 | % | — | % | 1.0 | % | — | % | 34.0 | % | |||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Current FICO scores obtained at various times during the current quarter. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
At December 31, 2012, we had $55.8 million of ARM loans referred to as option ARM loans in our held-for-investment loan portfolio. Option ARM loans permit a borrower to vary the monthly payment, including paying an amount that excludes interest otherwise due which is then added to the unpaid principal balance of the loan (a process referred to as "negative amortization"). The amount of negative amortization reflected in such loan balances for the year ended December 31, 2012 was $3.5 million. The maximum balance that all option ARMs could reach cumulatively is $86.9 million at December 31, 2012.
Set forth below is a table describing specific characteristics of option ARMs in our held-for-investment mortgage portfolio at December 31, 2012, which were originated in 2008 or prior.
Year of Origination | 2008 and Prior | ||
(Dollars in thousands) | |||
Unpaid principal balance (1) | $ | 55,848 | |
Average note rate | 3.54 | % | |
Average original FICO score | 717 | ||
Average current FICO score (2) | 684 | ||
Average original LTV ratio | 70.4 | % | |
Average original CLTV ratio | 78.7 | % | |
Housing Price Index LTV, as recalculated (3) | 108.9 | % | |
Underwritten with low or stated income documentation | $ | 36,250 | |
Total principal balance with any accumulated negative amortization | $ | 37,747 | |
Percentage of total ARMS with any accumulated negative amortization | 2.2 | % | |
Amount of net negative amortization (i.e., deferred interest) accumulated as interest income during the year ended December 31, 2012 | $ | 3,513 | |
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Current FICO scores obtained at various times during the year ended December 31, 2012. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
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Set forth below are the accumulated amounts of interest income arising from the net negative amortization portion of loans during the years ended December 31, 2012.
Unpaid Principal Balance of Loans in Negative Amortization At Year-End (1) | Amount of Net Negative Amortization Accumulated as Interest Income During Period | ||||||
(Dollars in thousands) | |||||||
2012 | $ | 37,747 | $ | 3,513 | |||
2011 | $ | 82,536 | $ | 7,847 | |||
2010 | $ | 93,550 | $ | 16,219 | |||
(1) | Unpaid principal balance does not include premiums or discounts. |
Set forth below are the frequencies at which the interest rate on ARM loans outstanding at December 31, 2012, will reset.
Reset frequency | # of Loans | Balance | % of the Total | ||||||
(Dollars in thousands) | |||||||||
Monthly | 78 | $ | 13,381 | 0.8 | % | ||||
Semi-annually | 3,347 | 1,032,862 | 59.5 | % | |||||
Annually | 2,960 | 445,406 | 25.7 | % | |||||
No reset — non-performing loans | 909 | 243,139 | 14.0 | % | |||||
Total | 7,294 | $ | 1,734,788 | 100.0 | % | ||||
Set forth below as of December 31, 2012, are the amounts of the ARM loans in our held-for-investment loan portfolio with interest rate reset dates in the periods noted. As noted in the above table, loans may reset more than once over a three-year period and non-performing loans do not reset while in the non-performing status. Accordingly, the table below may include the same loans in more than one period.
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | ||||||||||||
(Dollars in thousands) | |||||||||||||||
2013 | $ | 585,652 | $ | 639,601 | $ | 642,697 | $ | 628,907 | |||||||
2014 | 644,090 | 666,707 | 685,221 | 646,153 | |||||||||||
2015 | 661,524 | 693,451 | 711,666 | 671,669 | |||||||||||
Later years (1) | 679,764 | 707,759 | 732,925 | 690,921 | |||||||||||
(1) | Later years reflect one reset period per loan. |
Interest only mortgages. We offered adjustable and fixed term loans with 10-year interest only options. These loans were originated using Fannie Mae and Freddie Mac guidelines as a base framework. We generally applied the debt-to-income ratio guidelines and documentation using the automated underwriting Approve/Reject response requirements of Fannie Mae and Freddie Mac.
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Set forth below is a table describing the characteristics of the interest only mortgage loans at the dates indicated in our held-for-investment mortgage portfolio at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||
(Dollars in thousands) | |||||||||||||||||||
Unpaid principal balance (1) (2) | $ | 1,249,699 | $ | 350 | $ | 1,609 | N/A | N/A | $ | 1,251,658 | |||||||||
Average note rate | 4.11 | % | 3.00 | % | 5.25 | % | N/A | N/A | 4.11 | % | |||||||||
Average original FICO score | 724 | 613 | 727 | N/A | N/A | 724 | |||||||||||||
Average current FICO score (3) | 709 | 585 | 679 | N/A | N/A | 709 | |||||||||||||
Average original LTV ratio | 74.4 | % | 100.0 | % | 63.8 | % | N/A | N/A | 74.4 | % | |||||||||
Housing Price Index LTV, as recalculated (4) | 93.2 | % | 80.6 | % | 66.3 | % | N/A | N/A | 93.2 | % | |||||||||
Underwritten with low or stated income documentation | 38.0 | % | — | % | — | % | N/A | N/A | 38.0 | % | |||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Interest only loans placed in portfolio in 2010 comprise loans that were initially originated for sale. There are two loans in this population. |
(3) | Current FICO scores obtained at various times during the year ended December 31, 2012. |
(4) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
Set forth below is a table describing the amortization date and payment shock of current interest only mortgage loans at the dates indicated in our held-for-investment mortgage portfolio at December 31, 2012.
2013 | 2014 | 2015 | 2016 | 2017 | Thereafter | Total / Weighted Average | |||||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||||||
Unpaid principal balance (1) | $ | 23,189 | $ | 330,691 | $ | 402,644 | $ | 72,167 | $ | 384,507 | $ | 14,621 | $ | 1,227,819 | |||||||||||||
Weighted average rate | 3.67 | % | 3.67 | % | 3.67 | % | 3.85 | % | 4.83 | % | 5.79 | % | 3.96 | % | |||||||||||||
Average original monthly payment per loan (dollars) | $ | 1,321 | $ | 1,362 | $ | 1,408 | $ | 1,765 | $ | 2,665 | $ | 1,911 | $ | 1,695 | |||||||||||||
Average current monthly payment per loan (dollars) | $ | 949 | $ | 959 | $ | 870 | $ | 1,114 | $ | 2,137 | $ | 1,802 | $ | 1,200 | |||||||||||||
Average amortizing payment per loan (dollars) | $ | 1,762 | $ | 2,159 | $ | 1,643 | $ | 1,884 | $ | 3,146 | $ | 2,135 | $ | 2,144 | |||||||||||||
Loan count | 77 | 1,068 | 1,441 | 232 | 795 | 47 | 3,660 | ||||||||||||||||||||
Payment shock (dollars) | $ | 813 | $ | 1,200 | $ | 773 | $ | 770 | $ | 1,009 | $ | 334 | $ | 943 | |||||||||||||
Payment shock (percent) | 85.7 | % | 125.1 | % | 88.9 | % | 69.2 | % | 47.2 | % | 18.5 | % | 78.6 | % | |||||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
Second mortgage loans. The majority of second mortgages we originated were closed in conjunction with the closing of the residential first mortgages originated by us. We generally required the same levels of documentation and ratios as with our residential first mortgages. For second mortgages closed in conjunction with a residential first mortgage loan that was not being originated by us, our allowable debt-to-income ratios for approval of the second mortgages were capped at 40 percent to 45 percent. In the case of a loan closing in which full documentation was required and the loan was being used to acquire the borrower's primary residence, we allowed a CLTV ratio of up to 100 percent; for similar loans that also contained higher risk elements, we limited the maximum CLTV to 90 percent. FICO floors ranged from 620 to 720, and fixed and adjustable rate loans were available with terms ranging from five to 20 years.
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Set forth below is a table describing the characteristics of the second mortgage loans in our held-for-investment portfolio at December 31, 2012, by year of origination.
Year of Origination | Prior to 2008 | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Unpaid principal balance (1) | $ | 112,850 | $ | 1,276 | $ | 383 | $ | 54 | $ | 304 | $ | 114,867 | |||||||||||
Average note rate | 7.70 | % | 6.93 | % | 6.86 | % | 7.14 | % | 4.26 | % | 7.68 | % | |||||||||||
Average original FICO score | 733 | 712 | 693 | 681 | 763 | 733 | |||||||||||||||||
Average original LTV ratio (2) | 20.4 | % | 17.4 | % | 14.6 | % | 16.5 | % | 21.0 | % | 20.4 | % | |||||||||||
Average original CLTV ratio | 73.1 | % | 87.6 | % | 31.8 | % | 92.8 | % | 77.9 | % | 73.1 | % | |||||||||||
Housing Price Index LTV, as recalculated (3) | 23.6 | % | 18.2 | % | 14.1 | % | 14.1 | % | 17.0 | % | 23.5 | % | |||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Reflects lower LTV only as to second liens because information regarding the first liens is not available. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
Home Equity Line of Credit ("HELOC") loans. We originated HELOC loans from 2002 to mid-2009. The majority of these HELOC loans were closed in conjunction with the closing of related first mortgage loans originated and serviced by us. Documentation requirements for HELOC applications were generally the same as those required of borrowers for the first mortgage loans originated by us, and debt-to-income ratios were capped at 50 percent. For HELOCs closed in conjunction with the closing of a first mortgage loan that was not being originated by us, our debt-to-income ratio requirements were capped at 40 percent to 45 percent and the LTV was capped at 80 percent. The qualifying payment varied over time and included terms such as either 0.75 percent of the line amount or the interest only payment due on the full line based on the current rate plus 0.5 percent. HELOCs were available in conjunction with primary residence transactions that required full documentation, and the borrower was allowed a CLTV ratio of up to 100 percent. For similar loans that also contained higher risk elements, we limited the maximum CLTV to 90 percent. FICO floors ranged from 620 to 720. The HELOC terms called for monthly interest only payments with a balloon principal payment due at the end of 10 years. At times, initial teaser rates were offered for the first three months.
HELOC loan originations were re-launched in June 2011 as a banking center originated portfolio product. Current HELOC guidelines and pricing parameters have been established to attract high credit quality loans with long term profitability. The minimum FICO is 680, maximum CLTV is 80 percent, and the maximum debt-to-income ratio is 45 percent.
Set forth below is a table describing the characteristics of the HELOCs in our held-for-investment portfolio at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Unpaid principal balance (1) | $ | 158,749 | $ | 689 | N/A | $ | 2,089 | $ | 10,554 | $ | 172,081 | ||||||||||
Average note rate (2) | 5.23 | % | 5.48 | % | N/A | 3.91 | % | 3.75 | % | 5.13 | % | ||||||||||
Average original FICO score | 733 | — | N/A | 754 | 763 | 735 | |||||||||||||||
Average original LTV ratio | 25.0 | % | 31.1 | % | N/A | 41.2 | % | 45.8 | % | 26.5 | % | ||||||||||
Housing Price Index LTV, as recalculated (3) | 28.1 | % | 27.5 | % | N/A | 32.8 | % | 36.2 | % | 28.7 | % | ||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Average note rate reflects the rate that is currently in effect. As these loans adjust on a monthly basis, the average note rate could increase, but would not decrease, as currently the minimum rate on virtually all of the loans is in effect. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. Reflects lower LTV because these are second liens and information regarding the first lien is not available. |
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Loan Sales and Securitizations
We sell substantially all of the residential mortgage loans we produce into the secondary market on a whole loan basis or by first securitizing the loans into mortgage-backed securities. Our securitizations are with Fannie Mae, Ginnie Mae and to a lesser extent Freddie Mac.
The following table indicates the breakdown of our loan sales/securitizations for the period as indicated.
For the Years Ended December 31, | ||||||||
2012 Principal Sold % | 2011 Principal Sold % | 2010 Principal Sold % | ||||||
Agency securitizations | 99.0 | % | 96.1 | % | 90.8 | % | ||
Whole loan sales | 1.0 | % | 3.9 | % | 9.2 | % | ||
Total | 100.0 | % | 100.0 | % | 100.0 | % | ||
Upon our sale of mortgage loans, we may retain the servicing of the mortgage loans, or even sell the servicing rights ("MSRs")to other secondary market investors. In general, we do not sell the servicing rights to mortgage loans that we originate for our own portfolio or that we privately securitize. When we retain MSRs, we are entitled to receive a servicing fee equal to a specified percentage of the outstanding principal balance of the loans. We may also be entitled to receive additional servicing compensation, such as late payment fees and earn additional income through the use of non-interest bearing escrows.
Prior to 2008, we engaged in a total of four private-label securitizations, which consisted of two second mortgage loan securitizations and two HELOC loan securitizations. In a private-label securitization, we sold mortgage loans to our wholly-owned bankruptcy remote special purpose entity, which then sold the mortgage loans to separate, transaction-specific trusts formed for this purpose in exchange for cash and certain interests in the trust and those mortgage loans. Each trust then issued and sold mortgage-backed securities to third party investors that are secured by payments on the mortgage loans. These securities were rated by two of the nationally recognized statistical rating organizations (i.e. rating agencies) and insured by two insurance companies. We are in litigation with Assured and MBIA regarding the alleged breach of various loan level representations and warranties made by the Bank in connection with the four private-label securitizations. See Notes 11 and 29 of the Notes to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, herein.
In addition to the cash we receive from the securitization of mortgage loans, we retain certain interests in the securitized mortgage loans and the trusts. Such retained interests include residual interests, which arise as a result of private-label securitizations, and MSRs, which can arise as a result of our securitizations, whole loan sales or private-label securitizations.
The residual interests created upon the issuance of private-label securitizations represent the first loss position and are not typically rated by any nationally recognized statistical rating organization. Residual interests are designated by us as trading securities and are marked to market in current period operations. We use an internally maintained model to value the residual interest. The model takes into consideration the cash flow structure specific to each transaction, such as over-collateralization requirements and trigger events, and key valuation assumptions, including credit losses, prepayment rates and discount rates. See Note 11 of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.
Loan servicing. The Mortgage Banking segment also services mortgage loans for others. Servicing residential mortgage loans for third parties generates fee income and represents a significant business activity. During 2012, we serviced portfolios of mortgage loans of $76.8 billion. The servicing generated gross revenue of $209.6 million. The fair value estimate uses a valuation model that calculates the present value of estimated future net servicing cash flows by taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions.
As part of our business model, we periodically sell MSRs into the secondary market, in transactions separate from the sale of the underlying loans, principally for capital management, balance sheet management or interest rate risk purposes. MSRs created in a lower interest rate environment generally will have a higher market value because the underlying loan is less likely to be prepaid. Conversely, an MSR created in a higher interest rate environment will generally sell at a market price below the original fair value recorded because of the increased likelihood of prepayment of the underlying loans, resulting in a loss. MSRs can be sold on a bulk basis or a flow basis. MSRs sold on a bulk basis are reflected in our financial statements following loan sales and later sold to a third party as the opportunity arises. MSRs sold on a flow basis is completed when we sell the servicing rights shortly after it is acquired pursuant to an existing arrangement, generally with little or no gain realized on the sale. All MSR sales were completed on a bulk basis.
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Over the past three years, we sold MSRs related to $40.0 billion of loans serviced for others, including $17.4 billion in 2012. We did not record significant gains or losses on such loans because the changes in values of the MSRs were recorded on an ongoing basis as a mark to market adjustment.
Set forth below is a table describing the characteristics of the mortgage loans serviced for others at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total / Weighted Average | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
Unpaid principal balance (1) | $ | 8,119,833 | $ | 6,925,907 | $ | 8,097,666 | $ | 11,812,250 | $ | 41,865,549 | $ | 76,821,205 | |||||||||||
Average unpaid principal balance per loan | $ | 152,122 | $ | 155,349 | $ | 184,866 | $ | 199,084 | $ | 237,727 | $ | 203,660 | |||||||||||
Weighted average service fee (basis points) | 0.30 | % | 0.35 | % | 0.29 | % | 0.27 | % | 0.27 | % | 0.28 | % | |||||||||||
Weighted average rate | 5.53 | % | 5.24 | % | 4.76 | % | 4.30 | % | 3.65 | % | 4.21 | % | |||||||||||
Weighted average original maturity (months) | 356 | 339 | 338 | 308 | 322 | 327 | |||||||||||||||||
Weighted average age (months) | 68 | 42 | 29 | 16 | 6 | 20 | |||||||||||||||||
Average current FICO score (2) | 679 | 707 | 735 | 748 | 756 | 741 | |||||||||||||||||
Average original LTV ratio | 81.0 | % | 87.3 | % | 82.6 | % | 74.7 | % | 74.6 | % | 77.3 | % | |||||||||||
Housing Price Index LTV, as recalculated (3) | 91.6 | % | 90.2 | % | 82.2 | % | 71.6 | % | 73.1 | % | 77.3 | % | |||||||||||
Loan count | 53,377 | 44,583 | 43,803 | 59,333 | 176,108 | 377,204 | |||||||||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
(2) | Average note rate reflects the rate that is currently in effect. As these loans adjust on a monthly basis, the average note rate could increase, but would not decrease, as in the current market, the floor rate on virtually all of the loans is in effect. |
(3) | The HPI LTV is updated from the original LTV based on Metropolitan Statistical Area-level OFHEO data as of September 30, 2012. |
Set forth below is a table of the past due trends in mortgage loans serviced for others at December 31, 2012, by year of origination.
Year of Origination | 2008 and Prior | 2009 | 2010 | 2011 | 2012 | Total | |||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||
30-59 days past due | $ | 560,072 | $ | 355,497 | $ | 152,219 | $ | 127,473 | $ | 133,912 | $ | 1,329,173 | |||||||||||
60-89 days past due | 335,454 | 176,588 | 69,989 | 39,789 | 18,998 | $ | 640,818 | ||||||||||||||||
90 days or greater past due | 1,540,313 | 158,352 | 93,304 | 35,561 | 10,210 | $ | 1,837,740 | ||||||||||||||||
Total past due | 2,435,839 | 690,437 | 315,512 | 202,823 | 163,120 | $ | 3,807,731 | ||||||||||||||||
Current | 5,683,994 | 6,235,471 | 7,782,155 | 11,609,427 | 41,702,427 | $ | 73,013,474 | ||||||||||||||||
Unpaid principal balance (1) | 8,119,833 | 6,925,908 | 8,097,667 | 11,812,250 | 41,865,547 | $ | 76,821,205 | ||||||||||||||||
(1) | Unpaid principal balance does not include premiums or discounts. |
Representation and warranty reserve. Our representation and warranty reserve represents our estimate of the lifetime losses associated with loans we have previously sold into the secondary market and as to which we may later be required to repurchase or to indemnify the holder thereof. We sell most of the residential first mortgage loans that we originate into the secondary mortgage market. When we sell mortgage loans, we make customary representations and warranties to the purchasers, including sponsored securitization trusts and their insurers, about various characteristics of each loan, such as the manner of origination, the nature and extent of underwriting standards applied and the types of documentation being provided. Typically, these representations and warranties are in place for the life of the loan. If a defect in the origination process is identified, we may be required to either repurchase the loan or indemnify the purchaser for losses it sustains on the loan. If there are no such defects, generally we have no liability to the purchaser for losses it may incur on such loan.
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We maintain a representation and warranty reserve to account for the expected losses related to loans we might be required to repurchase (or the indemnity payments we may have to make to purchasers). The representation and warranty reserve takes into account both our estimate of expected losses on loans sold during the current accounting period, as well as adjustments to previous estimates of expected losses on loans sold. Our previous estimates reflect our estimates of probable losses on loans in repurchase demand (i.e. loans submitted for repurchase but not yet resolved between the holder and us) and loans as to which no demand for repurchase or indemnification has yet been made. In each case, these estimates are based on the most recent data available to us, including data from third parties, regarding demands for loan repurchases, actual loan repurchases, and actual credit losses on repurchased loans, among other factors. Provisions added to the representation and warranty reserve for current loan sales reduce our net gain on loan sales. Adjustments to our previous estimates are recorded under non-interest income in the Statement of Operations as an increase or decrease to representation and warranty reserve - change in estimate. The amount of our representation and warranty reserve equaled $193.0 million and $120.0 million at December 31, 2012 and 2011, respectively.
Non-bank Subsidiaries
At December 31, 2012, our corporate legal structure consisted of the Bank, including its wholly-owned subsidiaries, and several non-bank subsidiaries which we conduct other business through. The material active non-bank subsidiaries are discussed below.
Paperless Office Solutions, Inc.
Paperless Office Solutions, Inc. ("POS"), our wholly-owned subsidiary, provides on-line paperless office solutions for mortgage originators. DocVelocity is the flagship product developed by POS to bring web-based paperless mortgage processing to mortgage originators. POS’s activities are not material to our business. On February 13, 2013, we announced an agreement to sell the assets and operations of POS to Capsilon Corporation, a provider of cloud-based document sharing, imaging and collaboration solutions for mortgage lenders.
Other Non-bank Subsidiaries
In addition to the subsidiaries listed above, we have a number of wholly-owned non-bank subsidiaries that are either not material or inactive. We also own nine statutory trusts that are not consolidated with our operations. For additional information, see Notes 3 and 31 of the Notes to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, herein.
Regulation and Supervision
We are registered as a savings and loan holding company under the Home Owners Loan Act ("HOLA") and are currently subject to the Federal Reserve regulation, examination and supervision. The Bank is a federally chartered savings bank and subject to OCC regulation, examination and supervision. In addition, the Bank is subject to regulation by the FDIC and the CFPB, and the Bank’s deposits are insured by the FDIC through the DIF. Accordingly, we and the Bank are subject to an extensive regulatory framework which imposes activity restrictions, minimum capital requirements, lending and deposit restrictions and numerous other requirements primarily intended for the protection of depositors, the federal deposit insurance fund and the banking system as a whole, rather than for the protection of stockholders and creditors. Many of these laws and regulations have undergone significant changes and, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), will significantly change in the future. Our non-bank financial subsidiaries are also subject to various federal and state laws and regulations.
Pursuant to the Dodd-Frank Act, the OTS ceased to exist on July 21, 2011 and its functions were transferred to the OCC and the Federal Reserve. After the transfer, the Federal Reserve became our primary regulator and supervisor, and the OCC became the primary regulator and supervisor of the Bank. In addition, the CFPB assumed responsibility for regulation of the principal federal consumer protection laws. However, the laws and regulations applicable to us did not materially change by virtue of the elimination of the OTS, other than as otherwise modified by the Dodd-Frank Act. HOLA and the regulations issued thereunder generally still apply but are subject to interpretation by the Federal Reserve and the OCC. Many provisions of the Dodd-Frank Act became effective on the transfer date and throughout the remaining months. In addition, the scope and impact of many of the Dodd-Frank Act's provisions will continue to be determined through the rulemaking process. Because there are many provisions of the Dodd-Frank Act that have not yet been implemented, we cannot fully predict the ultimate impact of the Dodd-Frank Act on us or the Bank.
In addition to the terms and conditions of the Supervisory Agreement and the Consent Order discussed above, we are generally subject to certain laws and regulations that are summarized below.
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Holding Company Status, Acquisitions and Activities
We are a savings and loan holding company, as defined by federal banking law, as is our controlling stockholder, MP Thrift. Neither we nor MP Thrift may acquire control of another savings bank unless the Federal Reserve approves such transaction and we may not be acquired by a company other than a bank holding company unless the Federal Reserve approves such transaction, or by an individual unless the Federal Reserve does not object after receiving notice. We may not be acquired by a bank holding company unless the Federal Reserve approves such transaction. In any case, the public must have an opportunity to comment on any such proposed acquisition and the OCC or Federal Reserve must complete an application review. Without prior approval from the Federal Reserve, we may not acquire more than 5 percent of the voting stock of any savings bank. In addition, the Gramm-Leach-Bliley Act (the "GLBA") generally restricts any non-financial entity from acquiring us unless such non-financial entity was, or had submitted an application to become, a savings and loan holding company on or before May 4, 1999. Also, because we were a savings and loan holding company prior to May 4, 1999 and control a single savings bank that meets the qualified thrift lender ("QTL") test under HOLA, we may engage in non-financial or commercial activities.
Source of Strength
We are required to act as a source of strength to the Bank and to commit managerial assistance and capital to support the Bank. Capital loans by a savings and loan holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of the Bank. In the event of a savings and loan holding company’s bankruptcy, any commitment by the savings and loan holding company to a federal bank regulator to maintain the capital of a subsidiary bank should be assumed by the bankruptcy trustee and may be entitled to a priority of payment.
Standards for Safety and Soundness
Federal law requires each U.S. bank regulatory agency to prescribe certain safety and soundness standards for all insured financial institutions. The U.S. bank regulatory agencies adopted Interagency Guidelines Establishing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the U.S. bank regulatory agencies use to identify and address problems at insured financial institutions before capital becomes impaired. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, compensation, and other operational and managerial standards as the agency deems appropriate. If the appropriate U.S. banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.
Regulatory Capital Requirements
Savings and loan holding companies, like us, are not currently subject to consolidated capital requirements. Pursuant to the Dodd-Frank Act, the U.S. bank regulatory agencies are required to establish minimum leverage and risk-based capital requirements for savings and loan holding companies. Typically, bank holding companies are required to maintain Tier 1 capital of at least 4 percent of risk-weighted assets and off-balance sheet items, total capital (the sum of Tier 1 capital and Tier 2 capital) of at least 8 percent of risk-weighted assets and off-balance sheet items, and Tier 1 capital of at least 3 percent of adjusted quarterly average assets (subject to an additional cushion of 1 percent to 2 percent if the Bank has less than the highest regulatory rating), and we expect that savings and loan holding companies will be subject to similar consolidated capital requirements. There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the consolidated capital requirements should apply to savings and loan holding companies. However, the rule proposed by the U.S. bank regulatory agencies that would establish such capital requirements for savings and loan holding companies failed to acknowledge either the grandfather for trust preferred securities or the five-year transition period. As a result, it is unclear whether and, if so, when the U.S. bank regulatory agencies will implement the statutory grandfather and transitional period. The Dodd-Frank Act also contains a number of provisions that will affect the regulatory capital requirements of the Bank. Numerous regulations implementing provisions of the Dodd-Frank Act have not been issued and finalized. Accordingly, the ultimate impact on us of the Dodd-Frank Act cannot be determined at this time.
The Bank must maintain a minimum amount of capital to satisfy various regulatory capital requirements under OCC regulations and federal law. Federal law and regulations establish five levels of capital compliance: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. At December 31, 2012, the Bank was considered "well-capitalized" for regulatory purposes, with regulatory capital ratios of 9.26 percent for Tier 1 capital and 17.18 percent for total risk-based capital. An institution is considered well-capitalized if its ratio of total risk-based capital to risk-weighted assets is 10.0 percent or more, its ratio of Tier 1 capital to risk-weighted assets is 6.0 percent or more, its leverage ratio (also
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referred to as its core capital ratio) is 5.0 percent or more, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the OCC to meet and maintain a specific capital level for any capital measure. An institution is only considered to be "adequately-capitalized" if its capital structure satisfies lesser required levels, such as a total risk-based capital ratio of not less than 8.0 percent, a Tier 1 risk-based capital ratio of not less than 4.0 percent, and (unless it is in the most highly-rated category) a leverage ratio of not less than 4.0 percent. Any institution that is neither well capitalized nor adequately-capitalized is considered undercapitalized. Any institution with a tangible equity ratio of 2.0 percent or less is considered critically undercapitalized.
In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as "Basel III.” Basel III, when implemented by the U.S. bank regulatory agencies and fully phased-in, will require U.S. banks to maintain substantially more capital, with a greater emphasis on common equity.
In June 2012, the U.S. bank regulatory agencies requested comment on three sets of proposed rules that implement the Basel III capital framework and also make other changes to U.S. regulatory capital standards for banking institutions. The Basel III proposed rules include heightened capital requirements for banking institutions in terms of both higher quality capital and higher regulatory capital ratios. These proposed rules, among other things, would revise the capital levels at which a banking institution would be subject to the prompt corrective action framework (including the establishment of a new Tier 1 common capital requirement), eliminate or reduce the ability of certain types of capital instruments to count as regulatory capital, eliminate the Tier 1 treatment of trust preferred securities (as required by the Dodd-Frank Act) following a phase-in period beginning in 2013, and require new deductions from capital for investments in unconsolidated financial institutions, mortgage servicing assets and deferred tax assets that exceed specified thresholds. The proposed rules also would establish a new capital conservation buffer and, for large or internationally active banks, a supplemental leverage capital requirement that would take into account certain off-balance sheet exposures and a countercyclical capital buffer that would initially be set at zero. Once fully phased in, the Basel III capital rules will significantly reduce the allowable amount of the fair value of MSRs included in Tier 1 capital. While the proposed Basel III rules would have become effective under a phase-in period that was to have begun January 1, 2013 and to be in full effect on January 1, 2019, the U.S. bank regulatory agencies announced on November 9, 2012 that the implementations of the proposed Basel III rules would be delayed. No date or time period for implementation has subsequently been announced.
In addition, proposed rules issued by the U.S. bank regulatory agencies in June 2012 would revise the manner in which a banking institution determines risk-weighted assets for risk-based capital purposes under the Basel II framework applicable to large or internationally active banks (referred to as the advanced approach) and under the Basel I framework applicable to all banking institutions (referred to as the standardized approach). These rules would replace references to credit ratings with alternative methodologies for assessing creditworthiness. Among other things, the advanced approach proposal would implement the changes to counterparty credit risk weightings included in the Basel III capital framework, and the standardized approach would modify the risk weighting framework for residential mortgage assets. The standardized approach changes to the Basel I risk-weighting rules are proposed to become effective no later than July 1, 2015.
In June 2012, the U.S. bank regulatory agencies also adopted final market risk capital rules to implement the enhancements to the market risk framework adopted by the Basel Committee (commonly referred to as "Basel II.5"). The final rules became effective January 1, 2013 and, among other things, establish new stressed Value at Risk ("VaR") and incremental risk charges for covered trading positions and replace references to credit ratings in the market risk rules with alternative methodologies for assessing credit risk.
The regulations ultimately applicable to us may be substantially different from the Basel III framework as published in December 2010 and the rules proposed by the U.S. bank regulatory agencies in June 2012. Until such regulations, as well as any other capital regulations under the Dodd-Frank Act, are adopted, we cannot be certain that such regulations will apply to us or of the impact such regulations will have on our capital ratios. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely affect our results of operations and financial condition.
Qualified Thrift Lender
The Bank is required to meet a Qualified Thrift Lender ("QTL") test to avoid certain restrictions on operations, including the activities restrictions applicable to multiple savings and loan holding companies, restrictions on the ability to branch interstate, and our mandatory registration as a bank holding company under the Bank Holding Company Act of 1956. A savings bank satisfies the QTL test if: (i) on a monthly average basis, for at least nine months out of each twelve month period, at least 65 percent of a specified asset base of the savings bank consists of loans to small businesses, credit card loans, educational loans, or certain assets related to domestic residential real estate, including residential mortgage loans and mortgage securities; or (ii) at least 60 percent of the savings bank’s total assets consist of cash, U.S. government or government agency debt or equity securities, fixed assets,
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or loans secured by deposits, real property used for residential, educational, church, welfare, or health purposes, or real property in certain urban renewal areas. The Bank is currently, and expects to remain, in compliance with QTL standards.
American Recovery and Reinvestment Act of 2009
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 ("ARRA"), more commonly known as the economic stimulus or economic recovery package was enacted into law. ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. In addition, ARRA imposed certain new executive compensation and corporate expenditure limits on all current and future TARP recipients that are in addition to those previously announced by the U.S. Treasury, until the financial institution has repaid the U.S. Treasury, which is now permitted under ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the recipient’s appropriate banking agency.
FDIC Insurance and Assessment
The FDIC insures the deposits of the Bank and such insurance is backed by the full faith and credit of the U.S. government through the DIF. The Dodd-Frank Act raised the standard maximum deposit insurance amount to $250,000 per depositor, per insured financial institution for each account ownership category. Under the Dodd-Frank Act, non-interest-bearing transaction accounts had unlimited deposit insurance through December 31, 2012.
Pursuant to the Dodd-Frank Act, the minimum reserve ratio designated by the FDIC each year is 1.35 percent of the assessment base, as opposed to 1.15 percent under prior law. The FDIC is required to meet the minimum reserve ratio by September 30, 2020 and is required to offset the effect of the increased reserve ratio for banks with less than $10 billion. The Dodd-Frank Act also eliminates requirements under prior law that the FDIC pay dividends to member institutions if the reserve ratio exceeds certain thresholds, and the FDIC has proposed that in lieu of dividends, it will adopt lower rate schedules when the reserve ratio exceeds certain thresholds. The FDIC has established a higher reserve ratio of 2% as a long-term goal beyond what is required by statute.
The FDIC maintains the DIF by assessing each financial institution an insurance premium. Prior to April 2011, the amount of the FDIC assessments paid by an insured depository institution was based on its relative risk of default as measured by our FDIC supervisory rating, and other various measures, such as the level of brokered deposits, unsecured debt and debt issuer ratings, and the amount of deposits.
Effective April 2011, the FDIC defined deposit insurance assessment base for an insured depository institution was changed to such institution's average consolidated total assets during the assessment period, minus average tangible equity. The FDIC adopted a final rule implementing this change to the assessment calculation effective April 1, 2011. The assessment rate schedule for larger institutions, such as the Bank (i.e., financial institutions with at least $10 billion in assets), differentiates between such large financial institutions by use of a scorecard that combines a financial institution's Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity ("CAMELS") ratings with certain forward-looking financial information to measure the risk to the DIF. Pursuant to this scorecard method, two scores (a performance score and a loss severity score) are combined and converted to an initial base assessment rate (also referred to as IBAR). The performance score measures a financial institution's financial performance and ability to withstand stress. The loss severity score measures the relative magnitude of potential losses to the FDIC in the event of the financial institution's failure. Total scores are converted pursuant to a predetermined formula into an initial base assessment rate, which is subject to adjustment based upon significant risk factors not captured in the scoreboard. Total assessment rates range from 2.5 basis points to 45 basis points for such large financial institutions. Premiums for the Bank are calculated based upon the average balance of total assets minus average tangible equity as of the close of business for each day during the calendar quarter. The new assessment calculation has increased the Bank's insurance premiums. For further information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Expense.
All FDIC-insured financial institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, which are referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation, and the assessments will continue until the bonds mature in 2019.
Affiliate Transaction Restrictions
We are subject to the affiliate and insider transaction rules applicable to member banks of the Federal Reserve as well as additional limitations imposed by the OCC. These provisions prohibit or limit a banking institution from extending credit to, or entering into certain transactions with, affiliates, principal stockholders, directors and executive officers of the banking institution
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and its affiliates. The Dodd-Frank Act imposed further restrictions on transactions with affiliates and extension of credit to executive officers, directors and principal stockholders that were effective as of July 21, 2012.
Incentive Compensation
In June 2010, the U.S. bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of U.S. banks do not undermine the safety and soundness of such banks by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of a bank, either individually or as part of a group, is based upon the key principles that a bank’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the bank’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the bank’s board of directors.
The U.S bank regulatory agencies will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of U.S. banks that are not "large, complex banking organizations." These reviews will be tailored to each bank based on the scope and complexity of the bank’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the bank’s supervisory ratings, which can affect the bank’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a bank if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the bank’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Federal Reserve
Numerous regulations promulgated by the Federal Reserve affect the business operations of the Bank and us. These include regulations relating to electronic fund transfers, collection of checks, availability of funds, and cash reserve requirements.
Bank Secrecy Act
The BSA requires all financial institutions, including banks, to, among other things, establish a risk-based system of internal controls reasonably designed to prevent money laundering and the financing of terrorism. The BSA includes a variety of recordkeeping and reporting requirements (such as cash and suspicious activity reporting), as well as due diligence/know-your-customer documentation requirements. The Bank has established a global anti-money laundering program in order to comply with BSA requirements.
USA Patriot Act of 2001
The USA Patriot Act of 2001 (the "Patriot Act"), which was enacted following the events of September 11, 2001, includes numerous provisions designed to detect and prevent international money laundering and to block terrorist access to the U.S. financial system. We have established policies and procedures intended to fully comply with the Patriot Act’s provisions, as well as other aspects of anti-money laundering legislation and the BSA.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the "OFAC" rules based on their administration by the U.S. Treasury’s Office of Foreign Assets Control ("OFAC"). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on "U.S. persons" engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Consumer Protection Laws and Regulations
The Bank is subject to many federal consumer protection statutes and regulations, the examination and enforcement of which has become more pronounced. Pursuant to the Dodd-Frank Act the CFPB has assumed the responsibility for the development
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and enforcement of the federal consumer protection statutes and regulations, such as the Truth in Lending Act (the "TILA"), the Equal Credit Opportunity Act (the "ECOA"), the Real Estate Settlement Procedures Act ("RESPA") and the Truth in Saving Act. The Dodd-Frank Act gave the CFPB broad rule-making, supervisory and examination authority in this area over financial institutions, such as the Bank, that have assets of $10 billion or more and expanded data collecting powers for fair lending purposes for both small business and mortgage loans and authority to prevent unfair, deceptive and abusive practices. The consumer complaint function of the OCC also has been transferred into the CFPB. The Dodd-Frank Act also narrows the scope of federal preemption of state laws related to federally chartered financial institutions, including savings banks such as the Bank.
Predatory lending. Federal regulations require additional disclosures and consumer protections to borrowers for certain lending practices, including predatory lending. The term "predatory lending," much like the terms "safety and soundness" and "unfair and deceptive practices," is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. Predatory lending typically involves at least one, and perhaps all three, of the following elements:
• | Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation; |
• | Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced, also known as loan flipping; and/or |
• | Engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower. |
Many states also have predatory lending laws, and although the Bank may be exempt from those laws due to federal preemption, they do apply to the brokers and correspondents from whom we purchase loans and, therefore have an effect on our business and our sales of certain loans into the secondary market.
GLBA. The GLBA includes provisions that protect consumers from the unauthorized transfer and use of their non-public personal information by financial institutions. Privacy policies are required by federal banking regulations which limit the ability of banks and other financial institutions to disclose non-public personal information about consumers to non-affiliated third parties. Pursuant to those rules, financial institutions must provide:
• | Initial notices to customers about their privacy policies, describing the conditions under which they may disclose non-public personal information to non-affiliated third parties and affiliates; |
• | Annual notices of their privacy policies to current customers; and |
• | A reasonable method for customers to "opt out" of disclosures to non-affiliated third parties. |
These privacy protections affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. In addition, states are permitted under the GLBA to have their own privacy laws, which may offer greater protection to consumers than the GLBA. Numerous states in which the Bank does business have enacted such laws.
FACT Act. The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act (the "FACT Act"), requires financial firms to help deter identity theft, including developing appropriate fraud response programs, and gives consumers more control of their credit data. It also reauthorizes a federal ban on state laws that interfere with corporate credit granting and marketing practices. In connection with the FACT Act, U.S. bank regulatory agencies proposed rules that would prohibit an institution from using certain information about a consumer it received from an affiliate to make a solicitation to the consumer, unless the consumer has been notified and given a chance to opt out of such solicitations. A consumer's election to opt out would be applicable for at least five years.
ECOA. The ECOA generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.
TILA. The TILA is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things. In addition, the TILA also provides a variety of substantive protections for consumers.
FH Act. The Fair Housing Act (the "FH Act") regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered illegal, under the FH Act, including some that are not specifically mentioned in the FH Act itself.
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HMDA. The Home Mortgage Disclosure Act (the "HMDA") grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a "fair lending" aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. In 2004, the Federal Reserve amended regulations issued under HMDA to require the reporting of certain pricing data with respect to higher-priced mortgage loans. This expanded reporting is being reviewed by U.S. bank regulatory agencies and others from a fair lending perspective.
RESPA. Lenders are required by RESPA to provide borrowers with disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of RESPA may result in civil liability or administrative sanctions.
Enforcement actions under the above laws may include fines, reimbursements and other penalties. Due to heightened regulatory concern related to compliance with the FACT Act, ECOA, TILA, FH Act, HMDA and RESPA generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.
Community Reinvestment Act
The Community Reinvestment Act ("CRA") requires the Bank to ascertain and help meet the credit needs of the communities it serves, including low- to moderate-income neighborhoods, while maintaining safe and sound banking practices. The primary banking agency assigns one of four possible ratings to an institution's CRA performance and is required to make public an institution's rating and written evaluation. The four possible ratings of meeting community credit needs are outstanding, satisfactory, needs to improve and substantial non-compliance. In 2009, the Bank received a "satisfactory" CRA rating from the OTS (as predecessor to the OCC) and this remains our current rating.
Regulatory Reform
On July 21, 2010, the Dodd-Frank Act was signed into law. This law has changed the current bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies, including us and the Bank. Various federal agencies have begun to adopt a broad range of rules and regulations and are given significant discretion in drafting these rules and regulations. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
Pursuant to the Dodd-Frank Act, the OTS ceased to exist on July 21, 2011 and its functions were transferred to the OCC and the Federal Reserve. After the transfer, the Federal Reserve became our primary regulator and supervisor, and the OCC became the primary regulator and supervisor of the Bank. Except as described below, however, the laws and regulations applicable to us and the Bank did not generally change by virtue of the elimination of the OTS - the HOLA and the regulations issued under the Dodd-Frank Act do still apply (although these laws and regulations will be interpreted by the Federal Reserve and the OCC, respectively). The Dodd-Frank Act also transferred to the CFPB the responsibility for the development and enforcement of the federal consumer protection statutes and regulations, such as TILA, ECOA, RESPA and the Truth in Saving Act.
The Dodd-Frank Act contains a number of provisions intended to strengthen capital. For example, the bank regulatory agencies are directed to establish minimum leverage and risk-based capital that are at least as stringent as those currently in effect. In addition, we will be subject to consolidated capital requirements for the first time and will be required to serve as a source of strength to the Bank.
The Dodd-Frank Act also expands the affiliate transaction rules in Sections 23A and 23B of the Federal Reserve Act to broaden the definition of affiliate and to apply to securities lending, repurchase agreement and derivatives activities that the Bank may have with an affiliate, as well as to strengthen collateral requirements and limit Federal Reserve exemptive authority. Also, the definition of "extension of credit" for transactions with executive officers, directors and principal shareholders is expanded to include credit exposure arising from a derivative transaction, a repurchase or reverse repurchase agreement and a securities lending or borrowing transaction. These expansions became effective one year after the transfer date. These provisions did not have a material effect on us or the Bank.
The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called "golden parachute" payments. In addition, the Federal Reserve adopted a rule addressing interchange fees applicable to debit card transactions which lowered fee income generated from this source. The reduced debit card fee income did not have a material impact on the Bank.
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The Dodd-Frank Act requires the federal financial regulatory agencies to adopt rules that prohibit banks and affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds), with implementation starting in July 2012. The sta