Former mortgage lending giant faces its grim future

NEW YORK (Fortune) -- IndyMac has become the latest mortgage lender to announce what is by now a familiar routine to battered investors: Shuttered business lines, failed attempts at capital raising and massive layoffs. A look at how it got here shows the risks of dominating a lending niche it had long argued was minimally risky: low documentation loans to residential mortgage borrowers with middling (at best) credit profiles.

In a letter to investors released early this morning, IndyMac (IMB) - which has 33 branches and $18 billion in saving deposits in addition to its mortgage-lending franchise - announced that it was firing 53% of its workforce and exiting its retail and wholesale lending units. Last year, prior to the collapse, the lender was ranked eleventh in residential mortgage origination, according to trade publication Inside Mortgage Finance.

More importantly, the Pasadena-based IndyMac also disclosed that regulators from the Office of Thrift Supervision no longer consider it "Well capitalized." As a result, the bank can't accept brokered deposits, or short-term investments in large dollar amounts from brokers seeking the highest return on certificates of deposit. The company has appealed to the Federal Deposit Insurance Corporation to allow it to accept brokered deposits - and thus jump-start its higher-margin loan origination efforts.

Over the past two years, IndyMac has dropped over 95% in stock price, or about $3.5 billion in market capitalization. In late morning trading Tuesday, its shares were down about 43% to 41 cents. Adding insult to injury, Fitch Ratings cut IndyMac's long-term issuer default ratings today to CC from B-, a sign that the ratings agency sees default as a looming possibility.

IndyMac's troubles - it lost $184.2 million in the first quarter and announced yesterday that it expects a wider loss for the second quarter; it lost $614 million last year - stem from its focus on the Alt-A mortgage sector, where it originates loans to borrowers who fall between prime (or conforming) and sub-prime on the credit spectrum. The lender's chief executive, Michael Perry, had long argued that it was being unfairly punished given its relatively paltry exposure to sub-prime mortgages.

Rising Alt-A and prime mortgage delinquencies likely were enough indication for investors, however, that the housing crisis had moved beyond the weakest borrowers. Even worse, with the securitization markets in collapse, IndyMac has no way to get new loans off its books. As it turns out, IndyMac was a leader in loans requiring little income and asset documentation, a category that has had disastrous levels of delinquencies at other troubled lenders. What loans that the bank has made recently are to borrowers with well-documented assets and income, but those are sharply less profitable with respect to fees and interest income.

Instead of mortgage origination, IndyMac's filing yesterday said it will focus on its reverse mortgage, its retail branch network and its mortgage servicing operations. But as a practical matter, the growth restrictions placed on IndyMac by regulators and the banks and brokerages it does business with, as well as the sharply higher borrowing costs, place the profitability of even its non-mortgage-related banking efforts in doubt.

Even efforts to prop up the bank have hurt it. Last month, Senator Charles Schumer (D-NY) wrote a series of letters to bank regulators in Washington D.C. and California asking them to take steps to prevent the bank's "likely collapse." In response, about $100 million in customer deposits has been withdrawn from the bank, according to one of its filings.