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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Mark One

For the quarterly period ended September 30, 2003

OR

Commission File No.: 0-22353

FLAGSTAR BANCORP, INC.

Registrant’s telephone number, including area 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 x No o.

     As of November 6, 2003, 60,453,569 shares of the registrant’s Common Stock, $0.01 par value, were issued and outstanding.

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o.

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CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS

When used in this Form 10-Q or future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or stockholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “would be”, “will allow”, “intends to”, “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, or similar expressions are intended to identify “forward looking statement” within the meaning of the Private Securities Litigation Reform Act of 1995.

The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, substantial changes in levels of market interest rates, credit and other risks of lending and investment activities and competitive and regulatory factors, could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected.

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.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

     Consolidated Statements of Financial Condition - September 30, 2003 (unaudited) and December 31, 2002.

     Unaudited Consolidated Statements of Earnings - For the three and nine months ended September 30, 2003 and 2002.

     Consolidated Statements of Stockholders Equity - September 30, 2003 (unaudited) and December 31, 2002.

     Unaudited Consolidated Statements of Cash Flows - For the nine months ended September 30, 2003 and 2002.

     Condensed Notes to Consolidated Financial Statements.

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Flagstar Bancorp, Inc.
Consolidated Statements of Financial Condition
(in thousands)

The accompanying notes are an integral part of these statements.

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Flagstar Bancorp, Inc.
Unaudited Consolidated Statements of Earnings
(in thousands, except per share data)

The accompanying notes are an integral part of these statements.

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Flagstar Bancorp, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands, except per share data)

The accompanying notes are an integral part of these statements.

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

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

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Flagstar Bancorp, Inc.
Notes to Consolidated Financial Statements

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. Flagstar’s primary business consists of attracting deposits from the general public, small businesses, and local government agencies. The Company strategically invests those funds in duration-matched residential, consumer, and commercial loans that are individually underwritten by the Company. The Company also originates or acquires conforming residential mortgage loans on an individual basis that are resold on a servicing retained basis to the secondary market in bulk. The Company also sells the retained servicing rights in bulk transactions in the secondary market. The Company also acquires funds on a wholesale basis from a variety of sources and services a significant volume of loans for others.

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 Savings Association Insurance Fund (“SAIF”).

Note 2. Basis of Presentation

The accompanying consolidated unaudited financial statements of Flagstar Bancorp, Inc. (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, 2003.

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Note 3. Critical Accounting Policies

The Company has established various accounting policies that govern the application of generally accepted accounting principles in the preparation of the financial statements. Application of these accounting policies involves judgments and assumptions by management that has a material impact on the carrying value of certain assets and liabilities. The judgments and assumptions are based on historical experience and other factors that are believed to be reasonable under the circumstances.

The Company believes that the following topics involve critical areas of the Company’s operations and the accounting policies associated with these areas requires the most significant judgments, assumptions and estimates.

Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of credit losses inherent in the Company’s investment loan portfolio at the reporting date. The estimate is a composite of a variety of factors including past experience, collateral value, and the general economy. The allowance includes a specific portion, a formula driven portion, and a general nonspecific portion. The collection and ultimate recovery of the book value of the collateral, in most cases, is beyond the Company’s control.

Mortgage Servicing Rights. Determining the fair value of mortgage servicing rights involves a calculation of the present value of a set of market driven and MSR specific cash flows. The Company is required to make assumptions about future market conditions including interest rates in order to complete the analysis. The model calculates a fair value based upon variables, but does not, and can not take into account the actual price the specific MSR could be sold at in a fair exchange. The Company does have the portfolio valued by an outside valuation expert not less than annually, but interim valuations could fail to reflect any valuation changes created by a dynamic interest rate environment.

Derivative Accounting. In its mortgage banking operation, the Company enters into commitments to originate loans at certain prices and rates. The Company also sells forward mortgage-backed securities into the secondary market. In accordance with FASB 133, the Company carries these commitments at market value. The process of recording these commitments at fair value has the effect of recording the eventual gain or loss on the sale of these loans before it actually happens. This estimation process may be prone to error and therefore could misstate the Company’s true position.

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Note 4. Stock-Based Compensation

The Company has two stock incentive plans, the 1997 Stock Option Plan and the 2000 Stock Incentive Plan (collectively, the “Plans”), which provide for the granting of non-qualified stock options, incentive stock options, restricted stock awards, performance stock awards, stock bonuses and other awards to our employees (including officers and directors). Awards are granted at the average market price of our stock on the grant date, vest over varying periods generally beginning at least one year from the date of grant, and expire ten years from the date of grant.

As permitted by SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the Company continues to measure and recognize compensation expense using the intrinsic value method specified in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). As required under the provisions of SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” the following table discloses the pro forma net income and pro forma basic and diluted earnings per share had the fair value method been applied to all stock awards for the three and nine months ended September 30, 2003 and 2002:

In addition, during the three and nine months ended September 30, 2003, the Company recognized compensation expense of $119 thousand ($77 thousand, net of taxes) and $833 thousand ($541 thousand, net of taxes), respectively, related to restricted stock awards. During the three and nine months ended September 30, 2002, the Company recognized compensation expense of $154 thousand ($100 thousand, net of taxes) and $463 thousand ($301 thousand, net of taxes), respectively, related to restricted stock awards. These expenses were included in net earnings as reported.

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Note 5. Significant Events

1.		On April 23, 2003, the Company announced a 2 for 1 split of its common stock. The split was completed on May 15, 2003. All share information on the financial statements of the Company has been adjusted accordingly.
2.		On June 30, 2003, Flagstar Capital Corporation (“ Flagstar Capital”) redeemed all of its 8.50% Series A Preferred stock.

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Selected Financial Ratios ( in thousands, except per share data )

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

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. Flagstar’s primary business consists of attracting deposits from the general public, small businesses, and local government agencies. The Company strategically invests those funds in duration-matched residential, consumer, and commercial loans that are for the most part individually underwritten by the Company. The Company also originates or acquires conforming residential mortgage loans on an individual basis that are resold on a servicing retained basis to the secondary market in bulk. The Company also sells the retained servicing rights in bulk transactions in the secondary market. The Company also acquires funds on a wholesale basis from a variety of sources and services a significant volume of loans for others.

Net Earnings

During the three and nine month periods ended September 30, 2003, the Company recorded record net earnings due to the interest rate environment prevalent during the periods. The lower and falling interest rates experienced in the first half of 2003 have positively affected the Company’s mortgage banking operation. Along with the record revenues recorded by the mortgage banking operation, the expanding retail banking operation has continued to provide additional earnings for the Company.

     Three months

Net earnings for the three months ended September 30, 2003 were $90.8 million ($1.42 per share-diluted), a $64.2 million increase from the $26.6 million ($0.43 per share-diluted) reported in 2002. The increase resulted from a $104.9 million increase in non-interest income, a $7.6 million increase in net interest income and a $1.9 million decrease in the provision for losses, which was offset by a $15.7 million increase in operating expenses and a $34.5 million increase in the provision for federal income taxes.

During September of 2002, the Company recorded a one-time after-tax adjustment to its financial statements for its adoption and implementation of the Financial Accounting Standards Board’s Statement 133 Implementation Issue No. C13. This one time adjustment increased net earnings in the quarter ended September 30, 2002 $0.30 to $0.73 per share-diluted. This adjustment is not included in net earnings for comparative purposes.

     Nine months

Net earnings for the nine months ended September 30, 2003 were $217.7 million ($3.42 per share-diluted), a $139.1 million increase from the $78.6 million ($1.27 per share-diluted) reported in 2002. The increase resulted from a $231.3 million increase in non-interest income and a $16.5 million increase in net interest income which was offset by a $29.7 million increase in operating expenses, a $74.7 million increase in the provision for federal income taxes, and a $4.3 million increase in the provision for losses.

During September of 2002, the Company recorded a one-time after-tax adjustment to its financial statements for its adoption and implementation of the Financial Accounting Standards Board’s Statement 133 Implementation Issue No. C13. This one time adjustment increased net earnings for the nine months ended September 30, 2002 $0.30 to $1.57 per share-diluted. This adjustment is not included in net earnings for comparative purposes.

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Segment reporting

Although the Company operates and reports its net earnings as one entity, the Company’s operations have been segregated as two distinct operations for this document. The operations have been classified into a retail banking segment and mortgage banking segment.

     Retail banking operation

The Company provides a full range of banking services to consumers and small businesses in southern Michigan and Indiana. At September 30, 2003, the Bank operated a network of 98 banking centers.

This operation is considered the growth portion of the Company. Ten years ago, the Company had only one banking center located in the lobby of its headquarters building. During the nine months ended September 30, 2003, the Company opened eleven new banking centers.

Earnings from the Retail Banking Operation (“RBO”) primarily consist of net interest income generated from loans held for investment funded by deposits and long-term borrowings. Earnings also consist of fees collected from depositors and fees earned on consumer and commercial loan originations. All single-family mortgage origination data is included in the earnings related to the mortgage banking operation. Management believes that because of its duration-matching program, the RBO’s earnings are more stable and less volatile than the earnings contributed from the mortgage banking operation.

Each quarter the RBO contributes a larger amount of revenue and net earnings to the totals recorded by the Company. During the three months ended September 30, 2003, the RBO was responsible for approximately $20.3 million, or 22.3% of net earnings. That compares positively to the $13.2 million reported for the comparable 2002 period and the $16.8 million reported in the second quarter of 2003. During the nine months ended September 30, 2003, the RBO was responsible for approximately $53.3 million of net earnings compared to the $42.8 million reported in the comparable 2002 period.

In each period, the portion of the total earnings of the Company that the RBO earnings contributes varies widely. In the three months ended September 30, 2003, RBO earnings constituted 22.3% of total earnings versus 24.5%, 49.2%, and 54.1% reported for the nine months ended September 30, 2003, and the three and nine months ended September 30, 2002, respectively. The volatility in the percentage of total income is a product of the fluctuation in the earnings provided by the mortgage banking operation as discussed below.

In each successive period, the retail banking operation has expanded its deposit portfolio and the number of banking centers. Each new banking center has been opened on a de novo basis. The result has been that each year revenues and expenses related to this operation have increased. During the three months ended September 30, 2003, attributable earnings increased an annualized 216.2% versus the same period in 2002 and an annualized 82.1% versus the three months ended June 30, 2003. These increases are tied to the expansion of the banking center network. Further expansion of the deposit branch network is planned. During 2002, the Company opened 16 banking centers. During the remainder of 2003, the Company has plans to open an additional three banking centers.

Upon opening these new facilities, we do not expect that we will have an immediate increase in retail deposits. Nonetheless, we believe that the growth in deposits will occur over time, with FHLB advances and other sources providing sufficient funding in the interim.

At September 30, 2003, the Company operated 35 banking centers under its in-store program. Thirty-two of these banking centers are located in Wal-Mart superstores. While 14 of the in-store branches were located in Indiana, 21 were located in Michigan communities. The first of the Wal-Mart banking centers was placed in operation in June 2000. The Company expects to open two more Wal-Mart facilities in 2004.

Sixty-four of the Company’s retail banking centers were opened within the past three years. Fourteen of the banking centers in Indiana were opened under the Wal-Mart in-store program during the past three

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years. The Wal-Mart banking centers had an average deposit portfolio of $14.8 million compared with the Company average of $28.7 million. Of the 98 branches, 24 branches had deposits of less than $10.0 million. Banking centers opened in 2000, 2001, 2002, and 2003 had average balances of $44.0 million, $21.2 million, $16.2 million, and $6.7 million, respectively. Banking centers opened under the in-store program opened in 2000, 2001, 2002, and 2003 had average balances of $17.9 million, $15.2 million, $8.8 million, and $5.8 million, respectively.

Each of the in-store banking centers offer the same products and services to our customers as are available at our free-standing banking centers without any significant difference in operating costs. By relying upon in-store banking centers to expand our retail branch network, we avoid the significant building costs of free-standing banking centers while obtaining marketing exposure in a high customer traffic area. The customers using our in-store banking centers are substantially the same as the customers using our free-standing banking centers.

It is the Company’s intent to continue to grow the retail banking operation. Since September 30, 2003, the Company has opened two more banking centers.

The following table presents certain financial information concerning the results of Flagstar’s retail banking operation:

     Mortgage banking operation

Flagstar’s mortgage banking activities involve the origination of mortgage loans and the purchase of mortgage loans from the originating lender. Company personnel originate loans and conduct business from its 98 banking centers and its 114 loan origination centers. Flagstar purchases mortgage loans on a wholesale basis through a network of correspondents consisting of other banks, thrifts, mortgage companies, and mortgage brokers. The mortgage loans, the majority of which are subsequently sold in the secondary mortgage market, primarily conform to the underwriting standards of Freddie Mac, Fannie Mae, or Ginnie Mae.

Earnings recorded in the Mortgage Banking Operation (“MBO”) is generated by the revenue received from the sale of loans and mortgage servicing rights, the net interest income received on loans held for sale, loan servicing fees received, and certain loan origination fees, offset by the costs required to perform those tasks. The earnings and revenues recorded by the MBO are substantially dependent on the general economy and the interest rate environment, which is outside the Company’s control. Historically, originations are at their peak when interest rates are low and the general outlook for the economy is positive.

The mortgage banking operation is a much more volatile source of earnings. The earnings volatility inherent in the mortgage banking operation is visually apparent in the revenues and pre-tax earnings of the operation shown below. The results show that during the three and nine months ended September 30, 2003, pre-tax earnings increased 419.3% and 354.8% versus the comparable periods in 2002, respectively. The primary cause for these large swings is the mortgage loan production completed during the periods. The future revenue, earnings, and profitability of this operation are dependent on production volumes and the interest rate environment.

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During the three months ended September 30, 2003, the MBO was responsible for approximately 77.7% of net earnings. Net earnings for the MBO are up 2.5% on a sequential quarter basis. Loan production in the current quarter has decreased 8.6% on a sequential quarter basis but is up 46.8% on a comparable quarter basis.

During the nine months ended September 30, 2003, the MBO was responsible for approximately 75.5% of net earnings. Net earnings for the MBO are up 358.7% on a comparable period basis. Loan production for the nine months ended September 30, 2003 is up 76.1% on a comparable period basis.

Management believes that the earnings of the MBO will continue to fluctuate with its ability to originate and sell mortgage loans and mortgage servicing rights. Management also believes the severity of the swings and the effect those swings will have on the net earnings of the Company will be mitigated to a significant extent by the increased earnings expected from the continued growth of the RBO.

The following table presents certain financial information concerning the results of Flagstar’s mortgage banking operation:

Net Interest Income

     Three months

Net interest income continued to rise and in this quarter increased $7.6 million, or 16.4%, to $53.7 million compared to the $46.1 million recorded for the 2002 period. Although there was a 19.4%, or $22.0 million, increase in interest income, there was a $14.4 million, or 21.5%, increase in interest expense. In this period of lower interest rates, the asset sensitivity of the balance sheet was evident. This repricing is shown in the 142 basis point decrease in the asset yield while liability costs only decreased 69 basis points. This decrease caused the 73 basis point decrease in the interest rate spread during the period and the 63 basis point decrease in the interest margin when compared to the 2002 period.

On a sequential quarter basis, the reported spread and margin decreased 9 basis points and 14 basis points, respectively. This decrease was the result of a 19 basis point decrease in the yield on the earning asset portfolio, offset by a 10 basis point decrease in the rate paid on liabilities. The small decreases in the spread and margin are reflective of the stabling interest rate environment.

Management expects to increase the size of the earning asset portfolio in the coming quarters. This growth will be accomplished using duration matched assets and liabilities. Although management will utilize the most cost effective source of funds available, there is no guarantee that management will be able to maintain these spreads and margins.

     Nine months

In comparing the net interest income reported for the nine months ended September 30, 2003 to the net interest income reported for the nine months ended September 30, 2002, the variance is similar to that seen in the three-month analysis. The Company recorded an increase of $16.5 million in net interest income. This increase includes a $49.2 million increase in interest income and a $32.7 million increase in interest expense.

In comparison, despite a 62 basis point reduction in the rates paid on the Company’s liabilities, there was a 132 basis point reduction in the yield on earning assets that eliminated the savings in interest costs.

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AVERAGE YIELDS EARNED AND RATES PAID

The following tables present interest income from average earning assets, expressed in dollars and yields, and interest expense on average interest-bearing liabilities, expressed in dollars and rates. Interest income from earning assets includes the amortization of net premiums and the amortization of net deferred loan origination costs. Nonaccruing loans were included in the average loan amounts outstanding.