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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FLAGSTAR CAPITAL CORPORATION

     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 x   No o .

     As of August 12, 2002, 1,000,000 shares of the registrant’s Common Stock, $1.00 par value, were issued and outstanding and 2,300,000 shares of the registrant’s Series A Preferred Shares, $25.00 par value, were issued and outstanding.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

The condensed financial statements of the Registrant are as follows:

		Statements of Financial Condition – June 30, 2002 (unaudited) and December 31, 2001
		Unaudited Statements of Earnings — For the three and six months ended June 30, 2002 and June 30, 2001
		Unaudited Statements of Cash Flows — For the three and six months ended June 30, 2002 and June 30, 2001
		Condensed Notes to Financial Statements — unaudited

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Flagstar Capital Corporation
Statements of Financial Condition
(In thousands)

The accompanying notes are an integral part of these statements.

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Flagstar Capital Corporation
Unaudited Statements of Earnings
(in thousands, except per share data)

The accompanying notes are an integral part of these statements.

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Flagstar Capital Corporation
Unaudited Statements of Cash Flows
(in thousands)

The accompanying notes are an integral part of these statements.

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Flagstar Capital Corporation
Condensed Notes to Financial Statements-unaudited

Note 1 — Nature of Business

Flagstar Capital Corporation (the “Company”) is a subsidiary of Flagstar Intermediate Holding Company (“IHC”), a wholly-owned operating subsidiary of Flagstar Bank, FSB (the “Bank”), a federally chartered stock savings bank founded in 1987. The primary business of the Company is to acquire, hold, and manage residential mortgage loans that will generate net earnings that can be distributed to stockholders. The Company has elected to be treated as a Real Estate Investment Trust (“REIT”) for federal tax purposes and must satisfy various requirements as discussed herein.

Note 2. — Basis of Presentation

The accompanying consolidated unaudited 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. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All interim amounts are subject to year-end audit, the results of operations for the interim period herein are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

Note 3. Significant Events

The Company removed its preferred stock listing from the Nasdaq Stock Market on July 12, 2001. On July 13, 2001, the Company moved those same shares to the New York Stock Exchange. The securities, which formerly traded under the symbol “FLGSP”, now trade under the symbol “FBC-P”.

In September, 2001, Flagstar Bank, FSB contributed it’s common stock investment in the Company to Flagstar Intermediate Holding Company, a newly formed, wholly-owned subsidiary. The purpose of the transaction is to allow the Bank greater flexibility in the manner in which the common stock of the Company is held. The change will also increase the mortgage investments the Company is allowed to invest in while still complying with various federal tax requirements. At the same time, IHC contributed $150 million of equity to the Company. The Company then invested the proceeds in a 15% interest in mortgage securities 100% owned by Flagstar LLC.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The principal business of the Company is to acquire, hold, and manage residential mortgage loans that will generate net earnings that can be distributed to stockholders. The Company intends to acquire all its mortgage loans from the Bank.

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Results of Operation

Three months

The Company recorded a 43.3% increase in net earnings for the quarter ended June 30, 2002 compared to the quarter ended June 30, 2001. This increase was the result of a larger average investment in Mortgage Loans and mortgage securities during the 2002 quarter. The Company’s parent, IHC, contributed $150 million of equity during September 2001 and the Company invested in additional Mortgage Loans and mortgage securities.

The Company reported net earnings for the quarter ended June 30, 2002 of $2.6 million. Interest income from loans and investments was $2.7 million, which was offset by $36,000 in administrative expenses and $63,000 in advisory fees. The reported net earnings for the quarter ended June 30, 2001 were $1.8 million. Interest income from loans was $1.9 million, which was offset by $36,000 in administrative expenses and $62,000 in advisory fees during the 2001 period.

The Company reported net earnings per common share of $1.35 for the quarter ended June 30, 2002 and $0.57 for the quarter ended June 30, 2001.

During the quarters ended June 30, 2002 and 2001, the Company declared and paid $1,222,000 in preferred stock dividends.

The Company declared and paid or accrued common stock distributions of $1,345,000 and $569,000 for the quarters ended June 30, 2002 and 2001, respectively

Six months

Flagstar Capital recorded a 58.0 %, or $2.1 milllion, increase in net earnings for the six months ended June 30, 2002 versus the same period in 2001. As prevoiusly discussed this increase in net earning was the result of a higher average investment in Mortgage Loans and mortgage securities during the six months ended June 30, 2002 compared to the same period ended June 30, 2001. The company’s parent, IHC, contributed $150 million of equity during September 2001 and the Company invested in additional Mortgage Loans and mortgage securities.

The Company reported net earnings for the six months ended June 30, 2002 of $5.8 million. Interest income from loans and investments was $6.0 million, which was offset by $64,000 in administrative expenses and $125,000 in advisory fees. The reported net earnings for the six months ended June 30, 2001 were $3.7 million. Interest income from loans was $3.9 million, which was offset by $118,000 in administrative expenses and $125,000 in advisory fees during the 2001 period.

The Company reported net earnings per common share of $3.38 and $1.24 for the six months ended June 30, 2002 and 2001, respectively.

For the six months ended June 30, 2002 and 2001, the Company declared and paid $2,444,000 in preferred stock dividends.

The Company declared and paid or accrued common stock distributions of $3,375,000 and $1,239,000 for the six months ended June 30, 2002 and 2001, respectively.

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Mortgage Loans

The Company’s residential mortgage loans (“Mortgage Loans”) consist of adjustable rate mortgages (“ARMs”), and fixed rate mortgages (“FRM’s”). Reinvestments made in Mortgage Loans will be initiated in a manner to maintain the original composition of approximately 70% ARMs and 30% FRMs. All Mortgage Loans are expected to be purchased from the Bank.

The following table gives a breakdown of the Mortgage Loans at June 30, 2002.

Allowance for Loan Losses

The Company’s allowance for loan losses was $250,000 at June 30, 2002. Management has based the allowance on assessments of relevant factors including the types and amount of delinquent loans, historical loss experience on such types of loans experienced by the Bank, and current economic conditions. Management is of the opinion that the allowance for loan losses is adequate to meet potential losses in the portfolio. The Company’s non-performing assets consisted of three mortgage loans totaling $698,121 or 0.61%, of the portfolio, at June 30, 2002. The Company, in accordance with applicable disclosure requirements, defines an asset as non-performing if it meets any of the following criteria: 1) a loan more than 90 days past due; 2) real estate acquired in a settlement of a loan; or 3) a restructured loan whose terms have been modified due to the borrower’s inability to pay as contractually specified including loans the Company has classified as impaired. Loans are generally placed into non-accrual status when they become 90 days delinquent.

The Company had a $250,000 allowance for loan losses at December 31, 2001. The Company’s non-performing loans were limited to three mortgage loans totaling $1,250,000, or 1.05%, of the portfolio, at December 31, 2001. The Company has certain representations and warranties from the Bank, which are related to the performance of the Mortgage Loans.

The Bank, in its role as Advisor, has implemented comprehensive internal asset review systems to provide for early detection of problem assets. Although this system will not eliminate future losses due to unanticipated declines in the real estate market or economic downturns, it should provide for timely identification of any losses created from problem loans.

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Investment in Mortgage Securities

During September 2001, the Company invested in mortgage securities owned by Flagstar, LLC, a second-tier subsidiary of the Bank. The Company currently has a 15% interest in these mortgage securities, which is equal to $139.9 million. The mortgage securities currently have a yield of 6.619% and interest payments are made monthly to the Company. The mortgage securities are managed and serviced by the Bank.

Liquidity

The objective of maintaining liquidity within the Company is to ensure the availability of sufficient cash flows to meet all of the Company’s financial commitments. In managing liquidity, the Company takes into account various legal limitations placed on a REIT.

The Company’s principal liquidity needs are to maintain the current portfolio size through the acquisition of additional Mortgage Loans as Mortgage Loans currently in the portfolio mature, or prepay, and to pay dividends on the Series A Preferred Shares and common stock. The acquisition of additional Mortgage Loans is intended to be funded with the proceeds obtained from the repayment of principal balances by individual borrowers.

During September 2001, the Company received an additional capital investment from its parent company, IHC, of $150 million. This additional capital was used to purchase REIT qualifying mortgage securities from Flagstar LLC, a second-tier subsidiary of the Bank.

During the quarter ended June 30, 2002, the Company purchased from the Bank $11.9 million in principal balance of residential mortgage loans at a purchase price of $11.9 million. During the quarter ended June 30, 2001, the Company purchased from the Bank $11.7 million in principal balance of residential mortgage loans at a purchase price of $11.8 million.

During the six months ended June 30, 2002, the Company purchased from the Bank $29.9 million in principal balance of residential mortgage loans at a purchase price of $30.1 million. During the same period ended June 30, 2001, the Company purchased from the Bank $11.7 million in principal balance of residential mortgage loans at a purchase price of $11.8 million.

For the quarters ended June 30, 2002 and 2001, the Company received repayments of principal from mortgage loans totaling approximately $14.2 million and $14.9 million, respectively. For the six months ended June 30, 2002 and 2001, the Company received principal repayments from mortgage loans totaling approximately $38.4 million and $19.4 million respectively.

At June 30, 2002 the Company had a liquidity coverage ratio (Projected interest income divided by REIT dividends plus Advisory Fees plus Servicing Fees) of 3.27 versus 3.19 at December 31, 2001 and 1.50 at June 30, 2001.

The Company does not anticipate any material capital expenditures other than for the acquisition of additional residential mortgage loans.

REIT Qualification

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As of June 30, 2002, the Company believed that it was in compliance with the REIT tax rules and that it will continue to qualify as a REIT under the provision of the Internal Revenue Code (the “Code”). The Company calculates that:

•		Its Qualified REIT Assets, as defined in the Code, are approximately 100% of its total assets, as compared to the federal tax requirements that at least 75% of its total assets must be Qualified REIT Assets.
•		100% of its revenues qualify for the 75% source of income test and 100% of its revenues qualify for the 90% source of income test under the REIT rules.
•		None of the revenue was subject to the 30% income limitation under the REIT rules.

The Company also met all REIT requirements regarding the ownership of its common and preferred stocks and anticipates meeting the 2002 annual distribution and administrative requirements.

Item 3. Market Risk

The Company considers that its primary business objective is to ensure the availability of sufficient cash flows to meet the obligations mandated by the Series A Preferred Shares. In managing its investments, the Company accepts a certain credit risk posture and assumes some interest rate risk.

Interest rate risk generally refers to the potential volatility in net interest income resulting from changes in interest rates. The Company’s risk occurs when it must replace amortized principal balances with new Mortgage Loans. These new Mortgage Loans are chosen in a manner to maintain an interest rate risk posture similar to the initial portfolio of Mortgage Loans. The Company must monitor the ratio of fixed costs (the Series A Preferred Shares’ dividends, advisory fees, and servicing costs) to the interest income potential of the Mortgage Loans and mortgage securities. When, in management’s opinion, the coverage ratio is at risk of being depleted, the Company must look to its parent company, IHC, for support or utilize the investment powers of the Company.

The Company will record higher levels of interest income in a rising interest rate environment and will experience declining interest income during periods of falling interest rates. This happens because the Company’s assets reprice while the Series A Preferred Shares have a fixed cost of 8.5%.

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PART II — OTHER INFORMATION

	(a)		Exhibits
			Exhibit 11
	(b)		Reports on Form 8-K
			None

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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