Analysts upbeat on IndyMac despite elements of risk.

While many mortgage lenders are getting hammered as the housing market has headed south this year, Pasadena-based IndyMac Bancorp Inc. should continue to hold its ground, industry analysts say.

Indeed, the consensus among analysts is that IndyMac's third quarter earnings--to be released later this week--should be off only slightly from a better-than-expected second quarter as the company benefits from a shakeout in the industry.

"Despite the likelihood of a reduction in industrywide loan originations, IndyMac will likely grow its business in 2006 by picking up market share," said Stuart Plesser, an analyst with Standard & Poor's, a unit of the McGraw Hill Cos.

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A major reason why IndyMac's earnings are expected to remain strong despite these adverse trends is the company's relatively limited exposure to two types of risky loans: subprime loans and option adjustable rate mortgages. Borrowers with these loans are viewed as much more likely to run into trouble as the housing market slows, since they stretched their finances to assume these loans in the first place.

IndyMac has no subprime loans and only about 16 percent of its loan portfolio contains option ARMs. Subprime lenders and those with high proportions of option ARMs in their loan portfolios are viewed as most susceptible to a widely expected industry shakeout over the next 18 months or so.

In an Oct. 11 report, Plesser forecast IndyMac would earn $1.29 per share in the third quarter, down from a record $1.49 a share in the second quarter but still higher than any other quarter in the last five years. That would put IndyMac on track to earn a record $5.23 per share for the year.

Plesser's forecast is right in line with consensus forecasts and the company's own earnings guidance, which calls for total 2006 earnings between $5 and $5.40 per share.

Through a spokesman, IndyMac executives declined to comment on future earnings beyond the guidance issued earlier this year.

IndyMac reported second quarter earnings of $105 million, or $1.49 per share, up from $81.7 million, or $1.16 per share in the second quarter of 2005.

When those earnings were released in late July, IndyMac president Richard Wohl said the company has made a conscious effort to gain market share while the industry has been hit with a slowdown prompted by rising interest rates.

Growing concern

There's been growing concern both in industry circles and among government regulators that lenders have allowed their criteria to grow too lax and have approved loans to borrowers with somewhat shaky personal finances, especially through the use of nontraditional loans.

This was punctuated by a warning last month from federal banking regulators about the industry's over-reliance on nontraditional loans, which include interest-only loans and option ARMs. The warning said that a wave of borrower defaults could be in the offing, which could translate into losses for lenders.

Surveying all this, Countrywide Financial Corp. chairman Angelo Mozilo warned in an earnings conference call last week that a "cleansing" would take place in the industry as the overall volume of mortgage loans declines.

With its lower risk profile and its ability to either sell or retain mortgages depending on market conditions, IndyMac is expected to ride out this rough patch, leaving it with a smaller field of competitors once the dust settles. Mozilo said that could be by mid-2008.

As a result, analysts are generally bullish on IndyMac's earnings. "Continued market share gains ... should sustain EPS growth," said Friedman Billings Ramsey analyst Paul Miller in a summary report on IndyMac issued earlier this month. In that report, Miller predicts IndyMac should post earnings of $1.34 per share in the third quarter.

But Miller said this robust earnings per share growth may not translate into improved stock price performance. That's because IndyMac's stock has shot up 21 percent in the last six weeks to $45.79 per share at market close on Oct. 25.

The run-up began around the time IndyMac announced that its board had reached a five-year deal to retain longtime Chairman and Chief Executive Michael Perry, who has presided over the company's steady growth from a marginal operation with four employees to the lending giant it is today. The company now has more than 8,000 workers.

"IndyMac's recent run could leave it vulnerable to a short-lived correction following earnings season," Miller said.

Of greater long-term risk to IndyMac is the possibility of a steeper-than-expected decline in home loans. Also, as long-term mortgage rates have slipped in recent weeks, analysts have been predicting a rise in refinancings. If that doesn't materialize to offset a drop in home loans, the industry could face an adverse impact.

Another risk factor is increased competition in the secondary loan market, which could hurt what has been a profitable segment of IndyMac's business.