UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(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)

(248) 312-2000

     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 ninety days.

Yes þ No o.

     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 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 o No o.

      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 the 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 þ		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ.

     As of May 4, 2009, 90,380,043 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.

 

 

FORWARD—LOOKING STATEMENTS

     This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Flagstar Bancorp, Inc. (“Flagstar” or the “Company”) and these statements are subject to risk and uncertainty. Forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, include those using words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions.

     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, but are not limited to, those discussed under the heading “Risk Factors” in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, including: (1) our business has been and may continue to be adversely affected by conditions in the global financial markets and economic conditions generally; (2) general business, economic and political conditions may significantly affect our earnings; (3) we depend on our institutional counterparties to provide services that are critical to our business. If one of more of our institutional counterparties defaults on its obligations to us or becomes insolvent, it could have a material adverse affect our earnings, liquidity, capital position and financial condition; (4) defaults by another larger financial institution could adversely affect financial markets generally; (5) if we cannot effectively manage the impact of the volatility of interest rates, our earnings could be adversely affected; (6) the value of our mortgage servicing rights could decline with reduction in interest rates; (7) certain hedging strategies that we use to manage our investment in mortgage servicing rights may be ineffective to offset any adverse changes in the fair value of these assets due to changes in interest rates; (8) we use estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; (9) changes in the fair value or ratings downgrades of our securities may reduce our stockholders’ equity, net earnings, or regulatory capital ratios; (10) current and further deterioration in the housing and commercial real estate markets may lead to increased loss severities and further increases in delinquencies and non-performing assets in our loan portfolios. Additionally, the performance of our standby and commercial letters of credit may be adversely affected as well. Consequently, our allowance for loan losses and guarantee liability may not be adequate to cover actual losses, and we may be required to materially increase our reserves; (11) our secondary market reserve for losses could be insufficient; (12) our home lending profitability could be significantly reduced if we are not able to resell mortgages; (13) our commercial real estate and commercial business loan portfolios carry heightened credit risk; (14) our ability to borrow funds maintain or increase deposits or raise capital could be limited, which could adversely affect our liquidity and earnings; (15) our inability to realize our deferred tax assets may have a material adverse affect on our consolidated results of operations and our financial condition; (16) we may be required to raise capital at terms that are materially adverse to our stockholders; (17) our holding company is dependent on the Bank for funding of obligations and dividends; (18) future dividend payments and common stock repurchases are restricted by the terms of the Treasury’s equity investment in us; (19) we may not be able to replace key members of senior management or attract and retain qualified relationship managers in the future; (20) the network and computer systems on which we depend could fail or experience a security breach; (21) our business is highly regulated; (22) our business has volatile earnings because it operates based on a multi-year cycle; (23) our loans are geographically concentrated in only a few states; (24) we are subject to heightened regulatory scrutiny with respect to bank secrecy and anti-money laundering statutes and regulations; (25) we are a controlled company that is exempt from certain NYSE corporate governance requirements.

     The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

FLAGSTAR BANCORP, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2009
TABLE OF CONTENTS

PART I. — FINANCIAL INFORMATION
Item 1. Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures about Market Risk			46
Item 4. Controls and Procedures			46
PART II. — OTHER INFORMATION
Item 1. Legal Proceedings			47
Item 1A. Risk Factors			47
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			47
Item 3. Defaults upon Senior Securities			47
Item 4. Submission of Matters to a Vote of Security Holders			47
Item 5. Other Information			47
Item 6. Exhibits			48
SIGNATURES			49

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

The unaudited condensed consolidated financial statements of the Company are as follows:

Consolidated Statements of Financial Condition — March 31, 2009 (unaudited) and December 31, 2008.

Unaudited Consolidated Statements of Operations — For the three months ended March 31, 2009 and 2008.

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss — For the three months ended March 31, 2009 (unaudited) and for the year ended December 31, 2008.

Unaudited Consolidated Statements of Cash Flows — For the three months ended March 31, 2009 and 2008.

Unaudited Notes to Consolidated Financial Statements.

Flagstar Bancorp, Inc.
Consolidated Statements of Financial Condition
(In thousands, except for share data)

		At March 31,				At December 31,
		2009				2008
		(Unaudited)
Assets
Cash and cash items		$	221,926			$	300,989
Interest-bearing deposits			87,492				205,916
Cash and cash equivalents			309,418				506,905
Securities classified as trading			1,693,140				542,539
Securities classified as available for sale			775,812				1,118,453
Other investments			36,993				34,532
Loans available for sale ($3,573,997 at fair value on March 31, 2009)			3,660,259				1,484,680
Loans held for investment			8,946,195				9,082,121
Less: allowance for loan losses			(466,000	)			(376,000	)
Loans held for investment, net			8,480,195				8,706,121
Total interest-earning assets			14,733,891				12,092,241
Accrued interest receivable			62,848				55,961
Repossessed assets, net			106,546				109,297
Federal Home Loan Bank stock			373,443				373,443
Premises and equipment, net			246,203				246,229
Mortgage servicing rights at fair value			515,500				511,294
Mortgage servicing rights, net			7,271				9,469
Other assets			542,189				504,734
Total assets		$	16,809,817			$	14,203,657
Liabilities and Stockholders’ Equity Liabilities
Deposits		$	9,785,701			$	7,841,005
Federal Home Loan Bank advances			5,200,000				5,200,000
Security repurchase agreements			108,000				108,000
Long term debt			248,660				248,660
Total interest-bearing liabilities			15,342,361				13,397,665
Accrued interest payable			29,537				36,062
Secondary market reserve			48,900				42,500
Other liabilities			458,285				255,137
Total liabilities			15,879,083				13,731,364
Commitments and Contingencies
Stockholders’ Equity
Preferred stock $0.01 par value, liquidation value $1,000 per share 25,000,000 shares authorized; 566,657 issued and outstanding at March 31, 2009			6				—
Common stock $0.01 par value, 150,000,000 shares authorized; 90,379,297 and 83,626,726 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively			904				836
Additional paid in capital — preferred			511,148				—
Additional paid in capital — common			124,034				119,024
Accumulated other comprehensive loss			(105,029	)			(81,742	)
Retained earnings			399,671				434,175
Total stockholders’ equity			930,734				472,293
Total liabilities and stockholders’ equity		$	16,809,817			$	14,203,657

The accompanying notes are an integral part of these consolidated financial statements.

Flagstar Bancorp, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)

		For the Three Months Ended
		March 31,
		2009				2008
		(Unaudited)
Interest Income
Loans		$	158,622			$	176,294
Mortgage-backed securities held to maturity			—				15,576
Securities classified as available for sale and trading			25,477				15,591
Interest-bearing deposits			856				2,768
Other			23				624
Total interest income			184,978				210,853
Interest Expense
Deposits			67,350				84,050
FHLB advances			56,809				64,558
Security repurchase agreements			1,153				3,155
Other			2,936				4,292
Total interest expense			128,248				156,055
Net interest income			56,730				54,798
Provision for loan losses			158,214				34,262
Net interest (loss) income after provision for loan losses			(101,484	)			20,536
Non-Interest Income
Loan fees and charges			32,922				884
Deposit fees and charges			7,233				6,031
Loan administration			(31,801	)			(17,046	)
Net gain on loan sales			195,694				63,425
Net (loss) gain on sales of mortgage servicing rights			(82	)			287
Total other-than-temporary impairment losses			(126,172	)			—
Loss recognized in other comprehensive income (before taxes)			(108,930	)			—
Net impairment losses recognized in earnings			(17,242	)			—
Gain (loss) on trading securities			11,212				(9,482	)
Other fees and charges			(6,977	)			8,575
Total non-interest income			190,959				52,674
Non-Interest Expense
Compensation and benefits			91,789				53,993
Occupancy and equipment			18,879				19,821
Asset resolution			24,873				3,741
Communication			1,722				1,785
Other taxes			1,007				891
General and administrative			44,399				8,937
Total non-interest expense			182,669				89,168
Loss before federal income taxes			(93,194	)			(15,958	)
Benefit for federal income taxes			(28,696	)			(5,359	)
Net Loss			(64,498	)			(10,599	)
Preferred stock dividends			(2,919	)			—
Net Loss Applicable To Common Stock		$	(67,417	)		$	(10,599	)
Loss per share
Basic		$	(0.76	)		$	(0.18	)
Diluted		$	(0.76	)		$	(0.18	)

The accompanying notes are an integral part of these consolidated financial statements.

Flagstar Bancorp, Inc.
Consolidated Statements of Stockholders’ Equity and Comprehensive Loss
(In thousands)

																		Accumulated
																		Other												Total
		Preferred				Common				Additional Paid in Capital								Comprehensive				Treasury				Retained				Stockholders’
		Stock				Stock				Preferred				Common				Loss				Stock				Earnings				Equity
Balance at January 1, 2008		$	—			$	637			$	—			$	64,350			$	(11,495	)		$	(41,679	)		$	681,165			$	692,978
Net loss			—				—				—				—				—				—				(275,407	)			(275,407	)
Reclassification of gain on dedesignation of swaps used in cash flow hedges			—				—				—				—				(236	)			—				—				(236	)
Reclassification of gain on sale of securities available for sale			—				—				—				—				(3,262	)			—				—				(3,262	)
Reclassification of loss on securities available for sale due to other than temporary impairment			—				—				—				—				40,541				—				—				40,541
Change in net unrealized loss on securities available for sale			—				—				—				—				(107,290	)			—				—				(107,290	)
Total comprehensive loss			—				—				—				—				—				—				—				(345,654	)
Cumulative effect adjustment due to change of accounting for residential MSR mortgage servicing rights			—				—				—				—				—				—				28,417				28,417
Issuance of preferred stock			1				—				—				45,796				—				—				—				45,797
Issuance of common stock			—				199				—				54,162				—				—				—				54,361
Issuance of treasury stock			—				—				—				—				—				41,092				—				41,092
Conversion of preferred stock			(1	)			—				—				(45,796	)			—				—				—				(45,797	)
Restricted stock issued			—				—				—				(587	)			—				587				—				—
Stock options exercised			—				—				—				77				—				—				—				77
Stock-based compensation			—				—				—				1,227				—				—				—				1,227
Tax effect from stock-based compensation			—				—				—				(205	)			—				—				—				(205	)
Balance at December 31, 2008 (Unaudited)			—				836				—				119,024				(81,742	)			—				434,175				472,293
Net loss			—				—				—				—				—				—				(64,498	)			(64,498	)
Reclassification of loss on securities available for sale due to other-than- temporary impairment			—				—				—				—				11,208				—				—				11,208
Change in net unrealized loss on securities available for sale			—				—				—				—				(1,581	)			—				—				(1,581	)
Total comprehensive loss			—				—								—				—				—				—				(54,871	)
Cumulative effect for adoption of FSP FAS 115-2 and FAS 124-2			—				—				—				—				(32,914	)			—				32,914				—
Issuance of preferred stock			6				—				510,487				—				—				—				—				510,493
Issuance of common stock			—				67				—				5,254				—				—				—				5,321
Restricted stock issued			—				1				—				(46	)			—								—				(45	)
Dividends preferred			—				—				—				—				—				—				(2,259	)			(2,259	)
Accretion of preferred stock			—				—				661				—				—				—				(661	)			—
Stock-based compensation			—				—				—				255				—				—				—				255
Tax effect from stock-based compensation			—				—				—				(453	)			—				—				—				(453	)
Balance at March 31, 2009		$	6			$	904			$	511,148			$	124,034			$	(105,029	)		$	—			$	399,671			$	930,734

The accompanying notes are an integral part of these consolidated financial statements.

Flagstar Bancorp, Inc.
Consolidated Statements of Cash Flows
(In thousands)

		For the Three Months Ended
		March 31,
		2009				2008
		(Unaudited)
Operating Activities
Net loss		$	(64,498	)		$	(10,599	)
Adjustments to net loss to net cash used in operating activities
Provision for loan losses			158,214				34,262
Depreciation and amortization			5,776				6,434
Increase (decrease) in valuation allowance in mortgage servicing rights			1,548				(119	)
Loss on fair value of residential mortgage servicing rights, net of hedging gains			69,571				46,961
Stock-based compensation expense			255				130
Loss on interest rate swap			99				1,611
Net loss (gain) on the sale of assets			1,262				(370	)
Net gain on loan sales			(195,694	)			(63,425	)
Net loss (gain) on sales of mortgage servicing rights			82				(287	)
Net loss on securities classified as available for sale			17,242				—
Net (gain) loss on trading securities			(11,212	)			9,482
Proceeds from sales of trading securities			518,793				—
Proceeds from sales of loans available for sale			6,776,177				6,271,453
Origination and repurchase of mortgage loans available for sale, net of principal repayments			(9,379,932	)			(6,489,510	)
Purchase of trading securities, net of principal repayments			(831,552	)			—
(Increase) decrease in accrued interest receivable			(6,887	)			2,082
Increase in other assets			(30,219	)			(123,830	)
Decrease in accrued interest payable			(6,525	)			(6,822	)
Net tax effect for stock grants issued			453				198
Decrease in federal income taxes payable			(5,637	)			(14,592	)
Increase in other liabilities			50,163				10,244
Net cash used in operating activities			(2,932,521	)			(326,697	)
Investing Activities
Net change in other investments			(2,461	)			(1,589	)
Repayment of mortgage-backed securities held to maturity			—				90,846
Repayment of investment securities available for sale			42,717				26,157
Proceeds from sales of portfolio loans			16,403				—
Origination of portfolio loans, net of principal repayments			13,800				100,244
Proceeds from the disposition of repossessed assets			50,737				18,990
Acquisitions of premises and equipment, net of proceeds			(4,787	)			(9,815	)
Proceeds from the sale of mortgage servicing rights			1,543				—
Net cash provided by investing activities			117,952				224,833
Financing Activities
Net increase in deposit accounts			1,944,696				191,060
Net decrease in Federal Home Loan Bank advances			—				(94,000	)
Net receipt of payments of loans serviced for others			107,915				5,213
Net receipt of escrow payments			15,238				7,287
Proceeds from the exercise of stock options			—				42
Net tax effect of stock grants issued			(453	)			(198	)
Issuance of preferred stock U.S. Treasury			266,657				—
Issuance of preferred stock			277,708				—
Issuance of common stock			5,321				—
Net cash provided by financing activities			2,617,082				109,404
Net (decrease) increase in cash and cash equivalents			(197,487	)			7,540
Beginning cash and cash equivalents			506,905				340,169
Ending cash and cash equivalents		$	309,418			$	347,709

		For the Three Months Ended
		March 31,
		2009				2008
		(Unaudited)
Supplemental disclosure of cash flow information:
Loans held for investment transferred to repossessed assets		$	117,462			$	62,699
Total interest payments made on deposits and other borrowings		$	134,773			$	162,876
Federal income taxes paid		$	590			$	—
Reclassification of mortgage loans originated available for sale then transferred to portfolio loans		$	16,403			$	592,874
Mortgage servicing rights resulting from sale or securitization of loans		$	82,680			$	100,752
Reclassification of mortgage backed securities held to maturity to securities available for sale		$	—			$	1,163,681

The accompanying notes are an integral part of these consolidated financial statements.

Flagstar Bancorp, Inc.
Notes to Consolidated Financial Statements
(Unaudited)

Note 1. Nature of Business

     Flagstar Bancorp, Inc. (“Flagstar” or the “Company”), is the holding company for Flagstar Bank, FSB (the “Bank”), a federally chartered stock savings bank founded in 1987. With $16.8 billion in assets at March 31, 2009, Flagstar is the largest savings institution and banking institution headquartered in Michigan.

     The Company’s principal business is obtaining funds in the form of deposits and wholesale borrowings and investing those funds in single-family mortgages and other types of loans. Its primary lending activity is the acquisition or origination of single-family mortgage loans. The Company may also originate consumer loans, commercial real estate loans, and non-real estate commercial loans and services a significant volume of residential mortgage loans for others.

     The Company sells or securitizes most of the mortgage loans that it originates and generally retains the right to service the mortgage loans that it sells. These mortgage-servicing rights (“MSRs”) are occasionally sold by the Company in transactions separate from the sale of the underlying mortgages. The Company may also invest in a portion of its loan production in order to enhance the Company’s leverage ability and to receive the interest spread between earning assets and paying liabilities.

     The Bank is a member of the Federal Home Loan Bank System (“FHLB”) and is subject to regulation, examination and supervision by the Office of Thrift Supervision (“OTS”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank’s deposits are insured by the FDIC through the Deposit Insurance Fund (“DIF”).

Note 2. Recent Developments

Capital Investment

     On December 17, 2008, the Company entered into an investment agreement with MP Thrift Investments L.P. (“MatlinPatterson”), an entity formed by MP Thrift Global Partners III LLC, an affiliate of MatlinPatterson Global Advisors LLC, for the purchase by MatlinPatterson of 250,000 shares of a newly authorized series of our convertible participating voting preferred stock for $250 million. Such preferred shares will automatically convert, at $0.80 per share, into 312.5 million shares of the Company’s common stock upon stockholder approval authorizing additional shares of common stock. On January 30, 2009, MatlinPatterson consummated the purchase. Upon consummation, the Company became a “controlled company,” as defined in the rules of the New York Stock Exchange (the “NYSE”), based on MatlinPatterson’s beneficial ownership of a majority of the Company’s voting stock. As a “controlled company,” the Company is exempt from certain of the NYSE’s corporate governance requirements, including the requirement to maintain a majority of independent directors and requirements related to the compensation committee and the nomination/corporate governance committee. The terms of the preferred stock allow MatlinPatterson to vote such shares on an as-converted basis and, as a result, MatlinPatterson controlled approximately 77.6% of the voting power of the Company as of January 30, 2009.

     As a condition under the investment agreement, on January 30, 2009, certain of the Company’s officers and directors acquired in the aggregate, 6.65 million shares of common stock at a purchase price of $0.80 per share for a total of $5.32 million. The preferred stock and the common stock were each offered and sold to individual accredited investors in an offering exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Section 4(2) thereof.

     Also, on January 30, 2009, the Company entered into a closing agreement with MatlinPatterson pursuant to which it agreed to sell to MatlinPatterson (i) an additional $50 million of convertible preferred stock substantially in the form of the Preferred Stock, in two equal parts, on substantially the same terms as the $250 million investment by MatlinPatterson (the “Additional Preferred Stock”) and (ii) $50 million of trust preferred securities with a 10% coupon (the “Trust Preferred Securities”). On February 17, 2009, MatlinPatterson acquired the first $25 million of the Additional Preferred Stock, pursuant to which the Company issued 25,000 shares of the Additional Preferred Stock with a conversion price of $0.80 per share. On February 27, 2009, MatlinPatterson acquired the second $25 million of the Additional Preferred Stock, pursuant to which the Company issued 25,000 shares of the Additional Preferred Stock with a conversion price of $0.80 per share. Upon receipt of stockholder approval, the 50,000 shares of Additional Preferred Stock will automatically convert into 62.5 million shares of the Company’s common stock. The $50 million sale of the Trust Preferred Securities is expected to be consummated during the second quarter of 2009 and will consist of 50,000 shares that will be convertible into common stock at the option of MatlinPatterson on April 1, 2010 at a conversion price of 90% of the volume weighted-average price per share of common stock during the period from February 1, 2009 to April 1, 2010, subject to a price per share minimum of $0.80 and maximum

of $2.00. If the Trust Preferred Securities are not converted, they will remain outstanding perpetually unless redeemed by the Company at any time after January 30, 2011.

Troubled Asset Relief Program (“TARP”)

     On January 30, 2009, the Company entered into a Letter Agreement and a Securities Purchase Agreement with the United States Department of Treasury (the “Treasury”), pursuant to which the Company sold to the Treasury 266,657 shares of the Company’s fixed rate cumulative non-convertible perpetual preferred stock for $266.7 million, and a warrant (the “Treasury Warrant”) to purchase up to 64.5 million shares of the Company’s common stock at an exercise price of $0.62 per share, subject to certain anti-dilution and other adjustments. The issuance and the sale of the preferred stock and Treasury Warrant are exempt from the registration requirements of the Securities Act pursuant to Section 4(2) thereof. The preferred stock qualifies as Tier 1 capital and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Treasury Warrant is exercisable upon receipt of stockholder approval and has a 10 year term.

Issuance of Warrants to Certain Stockholders

     In full satisfaction of the Company’s obligations under anti-dilution provisions applicable to certain investors (the “May Investors”) in the Company’s May 2008 private placement capital raise, the Company granted warrants (the “May Investor Warrants”) to the May Investors on January 30, 2009 for the purchase of 14,259,794 shares of the Company’s common stock at $0.62 per share. The holders of such warrants will be entitled to acquire the Company’s common shares for a period of ten years. EITF 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock became effective for financial statements issued for fiscal years after December 15, 2008. Therefore, this EITF is required to be applied to any outstanding instruments as of the beginning of the fiscal year in which it is initially applied. EITF 07-5 nullifies the guidance in EITF 01-6, The Meaning of Indexed to a Company’s Own Stock. As such, this EITF is required to be applied to the May Investor Warrants since they were issued on January 30, 2009.

     Based on management’s analysis, the May Investor Warrants do not meet the definition of a contract that is indexed to the Company’s own stock under EITF 07-5 and as such the May Investor Warrants will be classified as a liability and will be measured at fair value, with changes in fair value recognized through operations. See Note 11, “Warrant Liabilities”.

Note 3. Basis of Presentation

     The accompanying unaudited consolidated financial statements include the accounts of the Company and its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated. In accordance with current accounting principles, the Company’s trust subsidiaries are not consolidated. In addition, certain prior period amounts have been reclassified to conform to the current period presentation.

     The unaudited consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. The accompanying interim financial statements are unaudited; however, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three month period ended March 31, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. For further information, you should refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, which can be found on the Company’s Investor Relations web page, at www.flagstar.com, and on the website of the SEC, at www.sec.gov.

Note 4. Recent Accounting Developments

     In November 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS 160, Non-controlling Interest in Consolidated Financial Statements — an amendment to ARB No. 51. SFAS 160 changes the way consolidated net earnings are presented. The new standard requires consolidated net earnings to be reported at amounts attributable to both the parent and the non-controlling interest and will require disclosure on the face of the consolidated statement of operations amounts attributable to the parent and the non-controlling interest. The adoption of this statement will result in more transparent reporting of the net earnings attributable to the non-controlling interest. The statement establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. The statement also requires that a parent recognize a gain or loss in net earnings when a subsidiary is deconsolidated. The adoption of SFAS 160 was effective for the Company on January 1, 2009. The adoption of this statement did not have a material impact on the Company’s consolidated financial condition, results of operation or liquidity.

     In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions. FSP 140-3 requires the initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with or in contemplation of the initial transfer, to be treated as a linked transaction under SFAS 140, unless certain criteria are met, then the initial transfer and repurchase will not be evaluated as a linked transaction, but will be evaluated separately under SFAS 140. FSP FAS 140-3 is effective for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The adoption of FSP FAS 140-3 did not have a material impact on the Company’s consolidated financial condition, results of operations or liquidity.

     In March 2008, the FASB issued SFAS 161, Disclosures About Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133. SFAS 161 requires entities to provide enhanced qualitative disclosures about objectives and strategies with respect to an entity’s derivative and hedging activities. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The adoption of SFAS 161 did not have a material impact on the Company’s consolidated financial condition, results of operations or liquidity.

     In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP FAS 157-3 clarifies the application of SFAS 157, Fair Value Measurements in an inactive market and provides key considerations in determining the fair value of an asset where the market is not active. FSP FAS 157-3 was effective immediately upon issuance. The adoption of FSP FAS 157-3 did not have a material impact on the Company’s consolidated financial condition, results of operations or liquidity.

     In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interest in Variable Interest Entities. FSP FAS 140-4 and FIN 46(R)-8 require enhanced disclosures about the transfers of financial assets and interests in variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 are effective for interim and annual reporting periods ending after December 15, 2008. The adoption of FSP FAS 140-4 and FIN 46(R)-8 did not have a material impact on the Company’s consolidated financial condition, results of operations or liquidity.

     In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary guidance to make the guidance more operational and to improve the presentation of other-than-temporary impairments in the financial statements. The FSP modifies the current indicator that, to avoid considering an impairment to be other-than temporary, management must assert that it has both the intent and ability to hold an impaired security for a period of time sufficient to allow for any anticipated recovery in fair value. The new FSP would require management to assert that (a) it does not have the intent to sell the security and (b) it is more likely than not that it will not have to sell the security before its recovery. The FSP changes the total amount recognized in earnings when there are factors other than credit losses associated with an impairment of a debt security. The impairment is separated into impairments related to credit losses and impairments related to all other factors. The adoption of FSP FAS 115-2 and FAS 124-2 resulted in a cumulative adjustment increasing retained earnings and other comprehensive loss by $50.6 million offset by a tax benefit of $17.7 million, or $32.9 million net of tax. The cumulative adjustment represents the non-credit portion of other-than-temporary impairment, related to securities available for sale, that the Company had recorded prior to January 1, 2009. See Accumulated other comprehensive loss in Note 12, “Stockholders Equity”.

     In April 2009, FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FAS 157-4 provides additional guidance on determining whether a market for a financial asset is not active and a transaction is not distressed for fair value measurements under SFAS 157. The adoption of FAS 157-4 did not have a material impact on the Company’s consolidated financial condition, results of operations or liquidity.

     In April 2009, FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, requires disclosures about the fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The provision of FSP FAS 107-1 and APB 28-1 were adopted by the Company effective January 1, 2009. As FSP FAS 107-1 and APB 28-1 amends only the disclosure requirements about fair value of financial instruments in interim periods, the adoption of FSP FAS 107-1 and APB 28-1 did not affect the Company’s consolidated statements of operations and financial condition.

Note 5. Fair Value Accounting

     On January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements and SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 was issued to establish a uniform definition of fair value. The definition of fair value under SFAS 157 is market-based as opposed to company-specific and includes the following:

	•		Defines fair value as the price that would be received to sell an asset or paid to transfer a liability, in either case through an orderly transaction between market participants at a measurement date, and establishes a framework for measuring fair value;
	•		Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date;
	•		Nullifies the guidance in EITF 02-3, which required the deferral of profit at inception of a transaction involving a derivative financial instrument in the absence of observable data supporting the valuation technique;
	•		Eliminates large position discounts for financial instruments quoted in active markets and requires consideration of the company’s creditworthiness when valuing liabilities; and
	•		Expands disclosures about instruments that are measured at fair value.

     SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized Company commitments and written loan commitments not previously recorded at fair value. In accordance with the provisions of SFAS 159, the Company, as of January 1, 2008, elected the fair value option for certain non-investment grade residual securities from private-label securitizations. The Company elected fair value on these residual securities and reclassified these investments to securities — trading to provide consistency in the accounting for the Company’s residual interests.

     Effective January 1, 2008, the Company elected the fair value measurement method for residential MSRs under SFAS 156, Accounting for Servicing of Financial Assets an amendment of FASB 140. Upon election, the carrying value of the residential MSRs was increased to fair value by recognizing a cumulative effect adjustment to retained earnings of $43.7 million before tax, or $28.4 million after tax. Management elected the fair value measurement method of accounting for residential MSRs to be consistent with the fair value accounting method required for its risk management strategy to hedge the fair value of these assets. Changes in the fair value of MSRs, as well as changes in fair value of the related derivative instruments, are recognized each period within loan administration income (loss) on the consolidated statement of operations.

     Effective January 1, 2009, the Company elected the fair value option in accordance with SFAS 159 for the majority of its loans available for sale. Only loans available for sale originated subsequent to January 1, 2009 are affected. Prior to the Company’s fair value election, loans available for sale were carried at the lower of aggregate cost or estimated fair value. The effect on consolidated operations of this election amounted to an increase in gain on loans sales of $22.0 million for the first quarter 2009. See Note 7, “Loans Available for Sale”.

Determination of Fair Value

     The following is a description of the Company’s valuation methodologies for assets measured at fair value which have been applied to all assets carried at fair value, whether as a result of the adoption of SFAS 159 or previously carried at fair value.

     The Company has an established process for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, fair value is based upon internally developed models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves and option volatilities. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, creditworthiness, liquidity and unobservable parameters that are applied consistently over time. Any changes to the valuation methodology are reviewed by management to determine appropriateness of the changes. As markets develop and the pricing for certain products becomes more transparent, the Company expects to continue to refine its valuation methodologies.

     The methods described above may produce a fair value estimate that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different estimates of fair values of the same financial instruments at the reporting date.

Valuation Hierarchy

     SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy favors the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows.

•

Level 1 — Fair value is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets in which the Company can participate.

	•		Level 2 — Fair value is based upon quoted prices for similar (i.e., not identical) assets and liabilities in active markets, and other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
	•		Level 3 — Fair value is based upon financial models using primarily unobservable inputs.

     A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

     The following is a description of the valuation methodologies used by the Company for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Assets

     Securities classified as trading. These securities are comprised of U.S. government sponsored agency mortgage-backed securities, U.S. Treasury bonds and non-investment grade residual securities that arose from private-label securitizations of the Company. The U.S. government sponsored agency mortgage-backed securities and U.S. Treasury bonds trade in an active, open market with readily observable prices and are classified within the Level 1 valuation hierarchy. The non-investment grade residual securities do not trade in an active, open market with readily observable prices and are therefore classified within the Level 3 valuation hierarchy. Accordingly, the fair value of residual securities is determined by discounting estimated net future cash flows using expected prepayment rates and discount rates that approximate current market rates. Estimated net future cash flows include assumptions related to expected credit losses on these securities. The Company maintains a model that evaluates the default rate and severity of loss on the residual securities’ collateral, considering such factors as loss experience, delinquencies, loan-to-value ratios, borrower credit scores and property type. See Note 9, “Private Label Securitization Activity” for the key assumptions used in the residual interest valuation process.

     Securities classified as available for sale. Where quoted prices for securities are available in an active market, those securities are classified within Level 1 of the valuation hierarchy. If such quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of securities with similar characteristics, which would generally be classified within Level 2 of the valuation hierarchy, include certain AAA-rated U.S. government sponsored agency mortgage-backed securities. Due to illiquidity in the markets, the Company determined the fair value of certain non-agency securities using internal valuation models and therefore classified them within the Level 3 valuation hierarchy as these models utilize significant inputs which are unobservable.

     Other Investments. Other investments are primarily comprised of various mutual fund holdings. These mutual funds trade in an active market and quoted prices are available. Other investments are classified within Level 1 of the valuation hierarchy.

     Loans available for sale. At March 31, 2009, the majority of the Company’s loans originated and classified as available for sale are reported at fair value and are classified as Level 2 of the valuation hierarchy. The Company estimates the fair value of mortgage loans based on quoted market prices for securities backed by similar types of loans. Otherwise, the fair value of loans are estimated by using discounted cash flows using management’s best estimate of market interest rates for similar collateral. At March 31, 2009, the Company continued to have a small number of loans which were originated prior to the fair value election and accounted for at lower of cost or market.

     Loans held for investment. The Company does not record these loans at fair value on a recurring basis. However, from time to time a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS 114, Accounting by Creditors for Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as a nonrecurring Level 2 valuation.

     Repossessed assets. Loans on which the underlying collateral has been repossessed are adjusted to fair value upon transfer to repossessed assets. Subsequently, repossessed assets are carried at the lower of carrying value or fair value, less anticipated marketing and selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the repossessed asset as a nonrecurring Level 2 valuation.

     Mortgage Servicing Rights. The Company has obligations to service residential first mortgage loans and consumer loans (i.e. home equity lines of credit (“HELOCs”) and second mortgage loans obtained through private-label securitization transactions). Residential MSRs are accounted for at fair value on a recurring basis. Consumer servicing assets are carried at amortized cost and are periodically evaluated for impairment.

     Residential Mortgage Servicing Rights. The current market for residential mortgage servicing rights is not sufficiently liquid to provide participants with quoted market prices. Therefore, the Company uses an option-adjusted spread valuation approach to determine the fair value of residential MSRs. This approach consists of projecting servicing cash flows under multiple interest rate scenarios and discounting these cash flows using risk-adjusted discount rates. The key assumptions used in the valuation of residential MSRs include mortgage prepayment speeds and discount rates. Management periodically obtains third-party valuations of the residential MSR portfolio to assess the reasonableness of the fair value calculated by its internal valuation model. Due to the nature of the valuation inputs, residential MSRs are classified within Level 3 of the valuation hierarchy. See Note 12, “Mortgage Servicing Rights” for the key assumptions used in the residential MSR valuation process.

     Consumer Servicing Assets. Consumer servicing assets are subject to periodic impairment testing. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate determined by management, is used in the completion of impairment testing. If the valuation model reflects a value less than the carrying value, consumer servicing assets are adjusted to fair value through a valuation allowance as determined by the model. As such, the Company classifies consumer servicing assets subject to nonrecurring fair value adjustments as Level 3 valuations.

     Derivative Financial Instruments. Certain classes of derivative contracts are listed on an exchange and are actively traded, and are therefore classified within Level 1 of the valuation hierarchy. These include U.S. Treasury futures, U.S. Treasury options and interest rate swaps. The Company’s forward loan commitments may be valued based on quoted prices for similar assets in an active market with inputs that are observable and are classified within Level 2 of the valuation hierarchy. Rate lock commitments are valued using internal models with significant unobservable market parameters and therefore are classified within Level 3 of the valuation hierarchy.

Liabilities

     Warrants. The warrant liabilities arose from the investor transactions completed during the first quarter of 2009. Warrant liabilities are valued using a Binomial Lattice Model and are classified as Level 2 of the valuation hierarchy.

     Assets and liabilities measured at fair value on a recurring basis

     The following table presents the financial instruments carried at fair value as of March 31, 2009, by caption on the Consolidated Statement of Financial Condition and by SFAS 157 valuation hierarchy (as described above) (in thousands):

														Total carrying
														value in the
														Consolidated
														Statement of
														Financial
		Level 1				Level 2				Level 3				Condition
Securities classified as trading:
Residual interests		$	—			$	—			$	18,296			$	18,296
Mortgage-backed securities			1,674,844				—				—				1,674,844
Securities classified as available for sale			234,843				—				540,969				775,812
Loans available for sale			—				3,573,997				—				3,573,997
Residential mortgage servicing rights			—				—				515,500				515,500
Other investments			36,993				—				—				36,993
Derivative financial instruments:
Rate lock commitments			—				—				82,645				82,645
Forward agency and loan sales			(58,572	)			—				—				(58,572	)
Agency forwards			33,321				—				—				33,321
Treasury futures			3,911				—				—				3,911
Interest rate swaps			(1,349	)			—				—				(1,349	)
Warrant liabilities			—				(44,901	)			—				(44,901	)
Total assets and liabilities at fair value		$	1,923,991			$	3,529,096			$	1,157,410			$	6,610,497

Changes in Level 3 fair value measurements

     A determination to classify a financial instrument within Level 3 of the valuation hierarchy is based upon the significance of the unobservable factors to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources); accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are included within the valuation methodology. Also, the Company manages the risk associated with the observable components of Level 3 financial instruments using securities and derivative positions that are classified within Level 1 or Level 2 of the valuation hierarchy; these Level 1 and Level 2 risk management instruments are not included below, and therefore the gains and losses in the tables do not reflect the effect of the Company’s risk management activities related to such Level 3 instruments.

     Fair value measurements using significant unobservable inputs

     The table below includes a rollforward of the Consolidated Statement of Financial Condition amounts for the three months ended March 31, 2009 (including the change in fair value) for financial instruments classified by the Company within Level 3 of the valuation hierarchy (in thousands).

																						Changes in
																						unrealized
																						gains and
																						(losses)
																						related to
										Purchases,												financial
						Total				issuances				Transfers								instruments
		Fair value,				realized/				and				in and/or				Fair value,				held at
Three months ended		January 1,				unrealized				settlements,				out of				March 31,				March 31,
March 31, 2009		2009				gains/(losses)				net				Level 3				2009				2009
Securities classified as trading:
Residual interests(a)		$	24,808			$	(6,512	)		$	—			$	—			$	18,296			$	—
Securities classified as available for sale(b)(c)			563,083				2,916				(25,030	)			—				540,969				(20,158	)
Residential mortgage servicing rights			511,294				(78,474	)			82,680				—				515,500				—
Derivative financial Instruments:
Rate lock commitments			78,613				—				4,032				—				82,645				—
Totals		$	1,177,798			$	(82,070	)		$	61,682			$	—			$	1,157,410			$	(20,158	)

     The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These include assets that are measured at the lower of cost or market and had a fair value below cost at the end of the period as summarized below (in thousands).

Assets Measured at Fair Value on a Nonrecurring Basis

		Balance at
		March 31, 2009				Level 1				Level 2				Level 3
Loans held for investment		$	452,269			$	—			$	452,269			$	—
Repossessed assets			106,546				—				106,546				—
Consumer servicing assets			7,271				—				—				7,271
Totals		$	566,086			$	—			$	558,815			$	7,271

Financial Disclosures about Fair Value of Financial Instruments Required by FSP FAS 107-1

     FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, requires disclosures of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate their fair values. Certain financial instruments and all nonfinancial instruments are excluded from the scope of FSP FAS 107-1. Accordingly, the fair value disclosures required by FSP FAS 107-1 are only indicative of the value of individual financial instruments, as of the dates indicated and should not be considered an indication of the fair value of the Company.

     The following table presents the carrying amount and estimated fair value of certain financial instruments as required by FSP FAS 107-1 (in thousands).

		March 31, 2009								December 31, 2008
		Carrying				Fair				Carrying				Fair
		Value				Value				Value				Value
Financial instruments:
Assets:
Cash and cash equivalents		$	309,418			$	309,418			$	506,905			$	506,905
Securities — trading			1,693,140				1,693,140				542,539				542,539
Securities available for sale			775,812				775,812				1,118,453				1,118,453
Other investments			36,993				36,993				34,532				34,532
Loans available for sale			3,660,259				3,663,142				1,484,680				1,526,031
Loans held for investment, net			8,480,195				8,545,636				8,706,121				8,845,398
FHLB stock			373,443				373,443				373,443				373,443
Liabilities:
Retail deposits:
Demand deposits and savings accounts			(1,535,880	)			(1,535,880	)			(1,386,330	)			(1,386,330	)
Certificates of deposit			(4,647,037	)			(4,738,919	)			(3,967,985	)			(4,098,135	)
Municipal deposits			(616,319	)			(646,216	)			(597,638	)			(599,849	)
National certificates of deposit			(2,237,363	)			(2,294,430	)			(1,353,558	)			(1,412,506	)
Company controlled deposit			(749,102	)			(749,102	)			(535,494	)			(535,494	)
FHLB advances			(5,200,000	)			(5,569,300	)			(5,200,000	)			(5,612,624	)
Security repurchase agreements			(108,000	)			(112,350	)			(108,000	)			(113,186	)
Long term debt			(248,660	)			(247,031	)			(248,660	)			(247,396	)
Warrant liabilities			44,901				44,901				—				—
Derivative Financial Instruments:
Forward delivery contracts			(58,572	)			(58,572	)			(61,256	)			(61,256	)
Commitments to extend credit			82,645				82,645				78,613				78,613
Interest rate swaps			(1,349	)			(1,349	)			(1,280	)			(1,280	)
Agency Forwards			37,232				37,232				60,813				60,813
Options			—				—				17,219				17,219

     The methods and assumptions that were used to estimate the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The following methods and assumptions were used to estimate the fair value for other financial instruments for which it is practicable to estimate that value:

     Cash and cash equivalents. Due to their short term nature, the carrying amount of cash and cash equivalents approximates fair value.

     Loans held for investment. The fair value of loans is estimated by using internally developed discounted cash flow models using market interest rate inputs as well as management’s best estimate of spreads for similar collateral.

     FHLB stock. No secondary market exists for FHLB stock. The stock is bought and sold at par by the FHLB. Management believes that the recorded value is the fair value.

     Deposit Accounts. The fair value of demand deposits and savings accounts approximates the carrying amount. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for certificates of deposits with similar remaining maturities.

     FHLB Advances. Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of the existing debt.

     Security Repurchase Agreements. Rates currently available for repurchase agreements with similar terms and maturities are used to estimate fair values for these agreements.

     Long Term Debt. The fair value of the long-term debt is estimated based on a discounted cash flow model that incorporates the Company’s current borrowing rates for similar types of borrowing arrangements.

Note 6. Investment Securities

     As of March 31, 2009 and December 31, 2008, investment securities were comprised of the following (in thousands):

		March 31,				December 31,
		2009				2008
Securities — trading
U.S. government sponsored agencies		$	1,674,844			$	517,731
Non-investment grade residual			18,296				24,808
Total securities — trading		$	1,693,140			$	542,539
Securities — available-for-sale
Non-agencies		$	540,969			$	563,083
U.S. government sponsored agencies			234,843				555,370
Total mortgage-backed securities — available-for-sale		$	775,812			$	1,118,453
Other investments
Mutual funds		$	36,993			$	34,532

Trading

     Securities classified as trading are comprised of AAA-rated U.S. government sponsored agency mortgage-backed securities, U.S. Treasury bonds, and non-investment grade residual interests from four private-label securitizations. At March 31, 2009 and December 31, 2008 there were $1.7 billion and $517.7 million, respectively, in U.S. government sponsored agency mortgage-backed securities in trading, all of which were pledged as collateral. U.S. government sponsored agency mortgage-backed securities held in trading are distinguished from available-for-sale based upon the intent of management to use them as an economic offset against changes in the valuation of the MSR portfolio; however, these securities do not qualify as an accounting hedge as defined in SFAS 133, Accounting for Derivative Instruments.

     The non-investment grade residual interests resulting from our private label securitizations were $18.3 million at March 31, 2009 versus $24.8 million at December 31, 2008. Non-investment grade residual securities classified as trading decreased as a result of the increase in the actual and expected losses in the second mortgages and HELOCs that underly these assets.

     The fair value of residual securities is determined by discounting estimated net future cash flows using discount rates that approximate current market rates and expected prepayment rates. Estimated net future cash flows include assumptions related to expected credit losses on these securities. The Company maintains a model that evaluates the default rate and severity of loss on the residual securities’ collateral, considering such factors as loss experience, delinquencies, loan-to-value ratio, borrower credit scores and property type.

Available-for-Sale

     At March 31, 2009 and December 31, 2008, the Company had $0.8 billion and $1.1 billion, respectively, in securities classified as available-for-sale which were comprised of U.S. government sponsored agency and non-agency mortgage-backed securities. Securities available-for-sale are carried at fair value, with unrealized gains and losses reported as a component of other comprehensive loss to the extent they are temporary in nature. If losses are, at any time, deemed to have arisen from “other-than-temporary impairments” (“OTTI”), then the credit related portion is reported as an expense for that period.

     At March 31, 2009 and December 31, 2008, $441.2 million and $683.0 million of the securities classified as available-for-sale, respectively, were pledged as collateral for security repurchase agreements or FHLB borrowings. Contractual maturities of the securities generally range from 2020 to 2038.

     The following table summarizes the amortized cost and estimated fair value of U.S. government sponsored agency and non-agency mortgage-backed securities classified as available-for-sale (in thousands):

		March 31,				December 31,
		2009				2008
Amortized cost		$	937,394			$	1,244,145
Gross unrealized holding gains			4,048				10,522
Gross unrealized holding losses			(165,630	)			(136,214	)
Estimated fair value		$	775,812			$	1,118,453

     The following table summarizes unrealized loss positions, at March 31, 2009, on securities classified as available-for-sale categorized by the duration of the unrealized loss position (dollars in thousands):

		Unrealized Loss Position with Duration												Unrealized Loss Position with
		12 Months and Over												Duration Under 12 Months
										Current												Current
						Number of				Unrealized								Number of				Unrealized
Type of Security		Principal				Securities				Loss				Principal				Securities				Loss
U.S. government sponsored agency securities		$	—				—			$	—			$	5,575				12			$	(47	)
Collateralized mortgage obligations			736,942				12				(165,583	)			—				—				—
Totals		$	736,942				12			$	(165,583	)		$	5,575				12			$	(47	)

     The fair value of all other non-agency and U.S. government sponsored agency mortgage-backed securities is estimated based on market information.

     The unrealized losses on securities-available-for-sale amounted to $165.6 million on $742.5 million of agency and non-agency collateralized mortgage obligations (“CMOs”) at March 31, 2009. These CMOs consist of interests in investment vehicles backed by mortgage loans. In the first quarter of 2009, the Company adopted FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. The FSP changes the amount of impairment recognized in operations when there are credit losses associated with an impairment of a debt security. The impairment is separated into impairments related to credit losses, which are recorded in operations, and impairments related to all other factors, which are recorded to other comprehensive income.

     During the fourth quarter of 2008, the Company recognized an other-than-temporary impairment of $62.4 million on three collateralized mortgage obligations. Under the newly adopted FSP, the credit loss portion of the other-than-temporary impairment was $11.8 million while the impairment related to all other factors was $50.6 million. Effective January 1, 2009, the $50.6 million loss, net of $17.7 million of tax benefit, was reclassified from retained earnings to other comprehensive loss as a cumulative adjustment.

     In the three months ended March 31, 2009, additional credit losses on the original three and seven additional CMOs totaled $17.2 million, which was recognized in current operations. At March 31, 2009, the total amount of other than temporary impairment credit losses totaled $31.8 million.

     At March 31, 2009, the Company had total impairments of $190.3 million on 11 securities in the available-for-sale portfolio with $31.8 million in total credit losses recognized through operations.

     The following table shows the activity for OTTI credit loss for the three months ended March 31, 2009 (dollars in thousands):

										Additions on				Reductions
						Additions on				securities with				for sold
		January 1, 2009				securities with				previous OTTI				securities				March 31, 2009
		balance				no prior OTTI				recognized				with OTTI				balance
Collateralized Mortgage Obligations		$	(14,526	)		$	(10,937	)		$	(6,304	)		$	—			$	(31,767	)

     Gains (losses) on the sale of U.S. government sponsored agency mortgage-backed securities available for sale that are recently created with underlying mortgage products originated by the Company are reported within net gain on loan sale. Securities in this category have typically remained in the portfolio less than 90 days before sale. During the three months ended March 31, 2009, sales of these agency securities with underlying mortgage products originated by the Company was $418.7 million resulting in $11.1 million of net gain on loan sale versus $1.5 billion resulting in $2.9 million of net loss on loan sale during the same period in 2008.

     Gain (loss) on sales for all other available for sale securities types are reported in net gain on sale of available for sales securities. There were no such sales in the three months ended March 31, 2009 nor for the same period in 2008.

     As of March 31, 2009, the aggregate amount of available-for-sale securities from each of the following non-agency issuers were greater than 10% of the Company’s stockholders’ equity.

		Amortized				Fair Market
Name of Issuer		Cost				Value
		(In thousands)
Countrywide Alternative Loan Trust		$	98,430			$	61,869
Countrywide Home Loans			234,402				171,531
Flagstar Home Equity Loan Trust 2006-1			220,285				207,197
		$	553,117			$	440,597

Other Investments

     The Company has other investments because of interim investment strategies in trust subsidiaries, collateral requirements required in swap and deposit transactions, and Community Reinvestment Act investment requirements. These securities had a fair value that approximates their recorded amount for each period presented.

Note 7. Loans Available for Sale

     The following table summarizes loans available for sale (in thousands):

		March 31,				December 31,
		2009				2008
Mortgage loans		$	3,660,258			$	1,484,649
Second mortgage loans			1				31
Total		$	3,660,259			$	1,484,680

     Through December 31, 2008, loans available for sale were carried at the lower of aggregate cost or estimated fair value. As of December 31, 2008, these loans had an aggregate fair value that exceeded their recorded amount. Effective January 1, 2009, the Company elected to record the majority of its loans available for sale on the fair value method and as such will not apply SFAS 91, Accounting for Non-Refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, to these loans. Because the fair value method was required to be adopted prospectively, only loans originated for sale subsequent to January 1, 2009 are affected. At March 31, 2009, $3.6 billion of loans available for sale were recorded at fair value. During the first quarter 2009, the effect on consolidated operations of the adoption of fair value for these assets amounted to an increase in gain on loan sales of $22.0 million. The Company estimates the fair value of mortgage loans based on quoted market prices for securities backed by similar types of loans. Where quoted market prices were available, such market prices were utilized as estimates for fair values. Otherwise, the fair values of loans were estimated by discounting estimated cash flows using management’s best estimate of market interest rates for similar collateral.

Note 8. Loans Held for Investment

     Loans held for investment are summarized as follows (in thousands):

		March 31,				December 31,
		2009				2008
Mortgage loans		$	5,754,604			$	5,958,748
Second mortgage loans			266,198				287,350
Commercial real estate loans			1,758,612				1,779,363
Construction loans			45,187				54,749
Warehouse lending			569,120				434,140
Consumer loans			527,221				543,102
Commercial loans			25,253				24,669
Total			8,946,195				9,082,121
Less allowance for loan losses			(466,000	)			(376,000	)
Total		$	8,480,195			$	8,706,121

     Activity in the allowance for loan losses is summarized as follows (in thousands):

		For the Three Months Ended March 31,
		2009				2008
Balance, beginning of period		$	376,000			$	104,000
Provision charged to operations			158,214				34,262
Charge-offs			(69,442	)			(17,192	)
Recoveries			1,228				330
Balance, end of period		$	466,000			$	121,400

     Loans on which interest accruals have been discontinued totaled approximately $893.8 million and $268.3 million at March 31, 2009 and 2008, respectively. Interest on these loans is recognized as income when collected. Interest that would have been accrued on such loans totaled approximately $9.8 million and $3.2 million during the three months ended March 31, 2009 and 2008, respectively. There were no loans greater than 90 days past due still accruing interest on the OTS method at March 31, 2009 and 2008.

     A loan is impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impaired loans were as follows (in thousands):

		March 31,				December 31,
		2009				2008
Impaired loans with no allowance for loan losses allocated		$	62,384			$	77,332
Impaired loans with allowance for loan losses allocated			504,398				373,424
Total impaired loans		$	566,782			$	450,756
Amount of the allowance allocated to impaired loans		$	144,683			$	121,321
Average investment in impaired loans		$	508,769			$	265,448
Cash-basis interest income recognized during impairment		$	3,593			$	10,601

     Those impaired loans with no allowance for loan losses allocated represent loans for which the fair value of the related collateral less estimated selling costs exceeded the recorded investments in such loans. At March 31, 2009, approximately 90.8% of the total impaired loans were evaluated based on the fair value of related collateral.

Note 9. Private-label Securitization Activity

     During the quarters ended March 31, 2009 and 2008, the Company did not consummate any private-label-securitizations transactions.

     At March 31 2009, key assumptions used in determining the value of residual interests resulting from the Company’s private-label securitizations were as follows (dollars in thousands):

																		Weighted -
		Fair Value								Projected				Annual				Average
		at				Prepayment				Cumulative				Discount				Remaining Life
		March 31, 2009				Speed				Credit Losses				Rate				(in years)
2005 HELOC Securitization		$	17,523				12	%			5.61	%			20	%			3.9
2006 HELOC Securitization			—				7	%			20.92	%			20	%			5.8
2006 Second Mortgage Securitization			773				16	%			4.81	%			20	%			4.3
2007 Second Mortgage Securitization			—				13	%			9.61	%			20	%			5.5

     Certain cash flows received from securitization trusts outstanding were as follows (in thousands):

		For the Three Months Ended March 31,
		2009				2008
Proceeds from new securitizations		$	—			$	—
Proceeds from collections reinvested in securitizations			—				6,960
Servicing fees received			1,495				1,756
Loan repurchases for representations and warranties			—				—

Credit Risk on Securitization

     With respect to the issuance of private-label securitizations, the Company retains certain limited credit exposure in that it retains non-investment grade residual securities in addition to customary representations and warranties. The Company does not have credit exposure associated with non-performing loans in securitizations beyond its residual interests and the amount of draws on HELOCs that it funds and which are not reimbursed by the respective trust. The value of the Company’s residual interests reflects the Company’s credit loss assumptions as to the underlying collateral pool. To the extent that actual credit losses exceed these assumptions, the value of the Company’s residual interests will be diminished.

     The following table summarizes the loan balance associated with the Company’s servicing portfolio and the balance of related retained assets with credit exposure, which includes residual interests that are included as trading securities and unreimbursed HELOC draws that are included in loans held for investment at March 31, 2009 (in thousands):

						Balance of Retained
		Total Loans				Assets with Credit
		Serviced				Exposure
Private-label securitizations		$	1,141,270			$	70,546
U.S. government sponsored agencies			57,714,319				—
Other investors			539				—
Total		$	58,856,128			$	70,546

     Mortgage loans that have been securitized in private-label securitizations at March 31, 2009 and 2008 that are sixty days or more past due and the credit losses incurred in the securitization trusts are presented below (in thousands):

																		Credit Losses
		Total Principal								Principal Amount								(Net of Recoveries)
		Amount of Loans								Of Loans 60 Days								For the Three
		Outstanding								Or More Past Due								Months Ended
		March 31,								March 31,								March 31,
		2009				2008				2009				2008				2009				2008
Securitized mortgages loans		$	1,141,270			$	1,344,041			$	74,415			$	28,501			$	30,125			$	16,266

Note 10. Mortgage Servicing Rights

     The Company has obligations to service residential first mortgage loans and consumer loans (HELOC and second mortgage loans obtained through private-label securitization transactions). A description of these classes of servicing assets follows.

     Residential Mortgage Servicing Rights. Servicing of residential first mortgage loans is a significant business activity of the Company. The Company recognizes MSR assets on residential first mortgage loans when it retains the obligation to service these loans upon sale. MSRs are subject to changes in value from, among other things, changes in interest rates, prepayments of the underlying loans and changes in credit quality of the underlying portfolio. Historically, the Company has treated this risk as a counterbalance to the increased production and gain on loan sale margins that tend to occur in an environment with increased prepayments. In the quarter ended March 31, 2008, the Company began to specifically hedge the risk by hedging the fair value of MSRs with derivative instruments which are intended to change in value inversely to part or all changes in the value of MSRs.

     Changes in the carrying value of residential MSRs, accounted for at fair value are as follows:

		For the Three Months Ended
		March 31,
		2009				2008
		(In thousands)
Balance at beginning of period		$	511,294			$	402,243
Cumulative effect of change in accounting			—				43,719
Additions from loans sold with servicing retained			82,680				100,680
Changes in fair value due to:
Payoffs(a)			(36,303	)			(17,942	)
All other changes in valuation inputs or assumptions (b)			(42,171	)			(42,116	)
Fair value of MSRs at end of period		$	515,500			$	486,584
Unpaid principal balance of loans serviced for others		$	57,714,858			$	37,034,015

     The fair value of residential MSRs are estimated using a valuation model that calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors, which were determined based on current market conditions. The Company periodically obtains third-party valuations of its residential MSRs to assess the reasonableness of the fair value calculated by the valuation model.

     The key economic assumptions used in determining the fair value of MSRs capitalized during the three month periods ended March 31, 2009 and 2008 periods were as follows:

		For the Three Months Ended March 31,
		2009				2008
Weighted-average life (in years)			5.5				6.1
Weighted-average constant prepayment rate (CPR)			24.4	%			13.8	%
Weighted-average discount rate			8.6	%			8.5	%

     The key economic assumptions used in determining the fair value of MSRs at period end were as follows:

		March 31,
		2009				2008
Weighted-average life (in years)			4.3				5.3
Weighted-average CPR			23.8	%			15.2	%
Weighted-average discount rate			7.8	%			8.3	%

     Consumer Servicing Assets. Consumer servicing assets represent servicing rights related to HELOC and second mortgage loans that were created in the Company’s private-label securitizations. These servicing assets are initially measured at fair value and subsequently accounted for using the amortization method. Under this method, the assets are amortized in proportion to and over the period of estimated servicing income and are evaluated for impairment on a periodic basis. When the carrying value exceeds the fair value and is believed to be temporary, a valuation allowance is established by a charge to loan administration income (loss) in the consolidated statement of operations.

     The fair value of consumer servicing assets is estimated by using an internal valuation model. This method is based on calculating the present value of estimated future net servicing cash flows, taking into consideration discount rates, prepayments, and servicing costs. The internal valuation model is validated periodically through a third-party valuation.

     Changes in the carrying value of the consumer servicing assets and the associated valuation allowance follow:

		For the Three Months Ended
		March 31,
		2009				2008
		(In thousands)
Consumer servicing assets
Balance at beginning of period		$	9,469			$	11,914
Additions:
From loans securitized with servicing retained			—				72
Subtractions:
Amortization			(650	)			(643	)
Carrying value before valuation allowance at end of period			8,819				11,343
Valuation allowance
Balance at beginning of period			—				(144	)
Impairment recoveries (charges)			(1,548	)			92
Balance at end of period			(1,548	)			(52	)
Net carrying value of servicing assets at end of period		$	7,271			$	11,291
Unpaid principal balance of consumer loans serviced for others		$	1,141,270			$	1,344,041
Fair value of servicing assets:
Beginning of period		$	12,284			$	11,861
End of period		$	9,278			$	11,555