FLAGSTAR BANCORP INC – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 Operating Segments                                           58           Banking Operation                                            58           Home Lending Operation                                       58           Summary of Operation                                         59           Results of Operations                                        xx           Net Interest Income                                          59           Rate/Volume Analysis                                         62           Provision for Loan Losses                                    63           Non-Interest Income                                          64           Non-Interest Expense                                         69           Provision (Benefit) for Federal Income Taxes                 73           Analysis of Items on Statement of Financial Condition        73           Assets                                                       73           Interest-Earning Deposits                                    73           Securities Classified as Trading                             73           Securities Classified as Available-For-Sale                  74           Other Investments Restricted                                 74           Loans Held-For-Sale                                          74           Loans Repurchased with Government Guarantees                 75           Loans Held-For-Investment                                    75           Quality of Earning Assets                                    77           Troubled Debt Restructurings                                 79           Allowance For Loan Losses                                    82           Allowance For Unfunded Lending Commitments                   86           Accrued Interest Receivable                                  87           Repossessed Assets                                           87           FHLB Stock                                                   87           Premises and Equipment                                       87           Mortgage Servicing Rights                                    87           Derivatives                                                  89           Liabilities                                                  89           Deposits                                                     89           FHLB Advances                                                90           Security Repurchase Agreements                               91           Long-Term Debt                                               91           Accrued Interest Payable                                     92           Federal Income Taxes Payable (Receivable)                    92           Representation and Warranty Reserve                          92           Interest Rate Swaps                                          93           Other Liabilities                                            93           Contractual Obligations and Commitments                      95           Capital Resources and Liquidity                              95           Impact of Off-Balance Sheet Arrangements                     99           Impact of Inflation and Changing Prices                      99           Accounting and Reporting Developments                        99           Critical Accounting Policies                                 99           Fair Value Measurements                                     100           Allowance for Loan Losses                                   102           Representation and Warranty Reserve                         103           Use of Non-GAAP Financial Measurements                      103                                            57 

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Operating Segments

  Our business is comprised of two operating segments - banking and home lending. Our banking operation currently offers a line of consumer and commercial financial products and services to individuals, small and middle market businesses and large corporate borrowers. Our home lending operation originates, acquires, sells and services mortgage loans on one-to-four family residences. Each operating segment supports and complements the operations of the other, with funding for the home lending operation primarily provided by deposits and borrowings obtained through banking operations. For financial information regarding our two operating segments, see Note 31 of the Notes to Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, herein. A discussion of our two operating segments is set forth below.  Banking Operation. We provide a full range of banking services to consumers and small businesses throughout Michigan. During the fourth quarter 2011, we completed the sale or lease of 27 banking centers in Georgia to PNC and 22 banking centers in Indiana to First Financial. Our banking operation involves the gathering of deposits and investing those deposits in duration-matched assets consisting primarily of mortgage loans originated by our home lending operation. The banking operation holds these loans in its loans held-for-investment portfolio to earn income based on the difference, or "spread," between the interest earned on loans and investments and the interest paid for deposits and other borrowed funds. At December 31, 2011, we operated a network of 113 banking centers and provided banking services to approximately 94,000 households.  Home Lending Operation. Our home lending operation originates, acquires, sells and services one-to-four family residential first mortgage loans. The home lending operation also services mortgage loans on a fee basis for others and periodically sells mortgage servicing rights into the secondary market. Funding for our home lending operation is provided primarily by deposits and borrowings obtained by our banking operation.  The following tables present certain financial information concerning the results of operations of our banking operation and home lending operation during the past three years.                                 BANKING OPERATION                                           At or for the Years Ended December 31,                                       2011              2010              2009                                                (Dollars in thousands)        Net interest income        $    144,781      $    124,521      $    127,117        Net gain on sale revenue         22,676             6,689             8,556        Other income                     32,169            47,522            85,757        Loss before taxes              (211,514 )        (589,396 )        (596,521 )        Identifiable assets          11,445,959        11,269,376        12,629,589                                HOME LENDING OPERATION                                          At or for the Years Ended December 31,                                        2011              2010            2009                                               (Dollars in thousands)        Net interest income        $      100,592      $    86,142     $    91,950        Net gain on sale revenue          313,974          366,517         503,225        Other income (loss)                16,697           32,952         (74,252 )        Earnings before taxes              30,792          216,687         154,851        Identifiable assets             5,011,514        5,399,128       4,233,742                                            58 

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Summary of Operations

  Our net loss applicable to common stockholders for 2011 of $198.9 million (loss of $0.36 per diluted share) represents a decrease from the loss of $393.6 million (loss of $2.44 per diluted share) we incurred in 2010. The net loss during 2011 in comparison to 2010 was affected by the following factors:   

• Net interest margin improved to 2.07 percent from 1.67 percent for the year

         ended December 31, 2010;         •   Net interest income increased by $34.7 million to $245.4 million for the

year ended December 31, 2011, primarily due to a decline in our cost of

         funds;         •   Provision for loan losses decreased by 58.5 percent from the year ended

December 31, 2010, to $176.9 million, primarily due to a lower level of

        charge-offs of residential first mortgage loans;    

• Net loan administration income (including the off-balance sheet hedges of

mortgage servicing rights) and gain (loss) on trading securities (including

the on-balance sheet hedges of mortgage servicing rights), increased $81.9

million from the year ended December 31, 2010, to $94.6 million, primarily

due to servicing fees, ancillary income, and charges on our residential

        first mortgage servicing from an increase in the average balance in the         portfolio of loans serviced for others, slower than expected levels of         prepayments, and effective hedge performance;    

• Asset resolution expense related to non-performing residential first

mortgage and commercial loans decreased by 20.5 percent, to $128.3 million,

primarily due to a decrease in our provision for losses on real estate

         owned;         •   Restructured $1.0 billion in FHLB advances resulting in lower interest

        rates; and    

• Representation and warranty reserve - change in estimate increased $88.5

million to $150.1 million for the year ended December 31, 2011, due to a

change in estimates of expected repurchases in response to changes in the

pattern of repurchase requests made principally by the GSEs and Ginnie Mae.

   Net Interest Income  On June 30, 2011, we implemented a reclassification in the treatment of amounts due from Federal Housing Administration ("FHA") relating to the servicing of delinquent FHA loans to recognize the accrued credit from FHA as interest income. Previously, income from FHA was applied as an offset to non-interest expense (asset resolution expense) relating to the servicing of delinquent FHA loans, and recorded on a net basis as asset resolution expense. The impact of the reclassification on the year ended December 31, 2010, was an increase in net interest income of $35.0 million, with an offsetting increase to asset resolution expense and an increase in net interest margin of 11 basis points.  Net interest income is primarily the dollar value of the average yield we earn on the average balances of our interest-earning assets, less the dollar value of the average cost of funds we incur on the average balances of our interest-bearing liabilities. Interest income recorded on loans is reduced by the amortization net premiums and net deferred loan origination costs.  2011. Net interest income represented 38.9 percent of our total revenue in 2011 as compared to 31.7 percent in 2010. For the year ended December 31, 2011, we had an average balance of $11.8 billion of interest-earning assets, of which $9.9 billion were loans receivable. The decline in average interest-earning assets reflects a $1.0 billion decline in average loans held-for-investment. Average-interest bearing liabilities totaled $10.5 billion for the year ended December 31, 2011, as compared to $11.4 billion for the year ended December 31, 2010. The decline of $0.9 billion reflects a $585.7 million decrease in average deposits and a $229.5 million decrease in average FHLB advances for the year ended December 31, 2011, as compared to the year ended December 31, 2010.  The decrease in interest income was due to the fact that our residential first mortgage loans held-for-investment continue to run-off, and was only partially offset by new originations in loan portfolios.                                           59  -------------------------------------------------------------------------------- Interest expense decreased for the year ended December 31, 2011 compared to the year ended December 31, 2010. We continue to replace maturing retail certificates of deposit with core money market and savings accounts and lower yielding certificates of deposits. The average cost of interest-bearing liabilities decreased 73 basis points from 2.82 percent for the year ended December 31, 2010 to 2.09 percent for the year ended December 31, 2011, while the average yield on interest-earning assets decreased 31 basis points (7.3 percent), from 4.25 percent for the year ended December 31, 2010 to 3.94 percent for the year ended December 31, 2011. As a result, our interest rate spread was 1.85 percent for the year ended December 31, 2011, as compared to 1.43 percent for the year ended December 31, 2010. Net interest margin for the year ended December 31, 2011 increased to 2.07 percent, as compared to 1.67 percent the year ended December 31, 2010. The Bank recorded a net interest margin of 2.13 percent for the year ended December 31, 2011, as compared to 1.75 percent for the year ended December 31, 2010.  2010. Net interest income decreased in 2010 compared to 2009. Net interest income represented 31.7 percent of our total revenue in 2010 as compared to 29.5 percent in 2009. For the year ended December 31, 2010, we had an average balance of $12.5 billion of interest-earning assets, of which $10.5 billion were loans receivable. Average-interest bearing liabilities totaled $11.4 billion for the year ended December 31, 2010, as compared to $13.5 billion for the year ended December 31, 2009.  Interest income decreased in 2010, compared to 2009 and offsetting the decrease in interest income was a decrease in our cost of funds. Our interest income also includes the amount of negative amortization (i.e., capitalized interest) arising from our option ARM loans. For more information see Item 1. - Business - Operating Segments - Home Lending Operation - Underwriting. The amount of negative amortization included in our interest income during the years ended December 31, 2010 and 2009 was $2.1 million and $4.3 million, respectively. The average cost of interest-bearing liabilities decreased 71 basis points (20.1 percent) from 3.53 percent during 2009 to 2.82 percent in 2010, while the average yield on interest-earning assets decreased 79 basis points (15.7 percent) from 5.04 percent during 2009 to 4.25 percent in 2010. As a result, our interest rate spread during 2010 was 1.43 percent at year-end. The decrease of our interest rate spread during the year, together with a decrease in non-performing loans of $753.2 million, from $1.1 billion in 2009 as compared to $318.4 million in 2010 positively impacted our consolidated net interest margin, resulting in an increase for 2010 to 1.67 percent from 1.58 percent for 2009. The Bank recorded a net interest margin of 1.75 percent in 2010, as compared to 1.68 percent in 2009.  The following tables present on a consolidated basis (rather than on a Bank-only basis) 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 recorded on our loans is adjusted by the amortization of net premiums, net deferred loan origination costs and the amount of negative amortization (i.e., capitalized interest) arising from our option ARM loans. Interest income from earning assets was reduced by $1.0 million, $0.9 million and $5.9 million of amortization of net premiums and net deferred loan origination costs in 2011, 2010 and 2009, respectively. Non-accruing loans were included in the average loans outstanding. The amount of                                           60

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net negative amortization included in our interest income during 2011, 2010 and 2009 were $2.2 million, $2.1 million and $4.3 million, respectively.

                                                                                               For the Years Ended December 31,                                                           2011                                            2010                                            2009                                                                          Average                                         Average                                         Average                                           Average                         Yield/          Average                         Yield/          Average                         Yield/                                           Balance         Interest         Rate           Balance         Interest         Rate           Balance         Interest         Rate                                                                                                  (Dollars in thousands) Interest-Earning Assets: Loans held-for-sale                     $  1,928,339      $  83,025         

4.31 % $ 1,945,913$ 91,321 4.69 % $ 2,743,218

   $ 142,229          5.18 % Loans repurchased with government guarantees                                 1,784,927         56,916          3.19 %        1,307,070         35,045          2.68 %          215,345          7,527          3.50 % Loans held-for-investment Consumer loans(3)                          4,830,127        221,006          4.58 %        5,776,292        279,370          4.84 %        6,745,808        351,041          5.20 % Commercial loans(3)                        1,373,566         66,075          4.74 %        1,466,241         69,034          4.64 %        1,742,846         86,169          4.88 %  Loans held-for-investment                  6,203,693        287,081          4.61 %        7,242,533        348,404          4.80 %        8,488,654        437,210          5.14 % Securities classified as available-for- sale or trading               752,871         35,602         

4.73 % 1,076,610 55,832 5.19 % 2,048,748

     107,486          5.25 % Interest-bearing deposits and other        1,133,840          2,785         

0.25 % 950,513 2,179 0.23 % 303,396

2,413 0.80 %

  Total interest-earning assets             11,803,670      $ 465,409          3.94 %       12,522,639      $ 532,781          4.25 %       13,799,361      $ 696,865          5.04 % Other assets                               1,544,924                                       1,507,533                                       2,068,550  Total assets                            $ 13,348,594                                    $ 14,030,172                                    $ 15,867,911  Interest-Bearing Liabilities: Deposits Demand deposits                         $    397,988      $   1,319          0.33 %     $    382,195      $   1,928          0.50 %     $    303,256      $   1,491          0.49 % Savings deposits                           1,236,105          9,952          0.81 %          761,416          6,999          0.92 %          557,109          7,748          1.39 % Money market deposits                        561,943          3,905          0.69 %          560,237          5,157          0.92 %          702,120         12,193          1.74 % Certificate of deposits                    3,001,586         52,433          1.75 %        3,355,041         90,952          2.71 %        3,950,717        145,454          3.68 %  Total retail deposits                      5,197,622         67,609          1.30 %        5,058,889        105,036          2.08 %        5,513,202        166,886          3.03 % Demand deposits                               77,702            417          0.54 %          264,473            995          0.38 %          117,264            589          0.50 % Savings deposits                             414,394          2,647          0.64 %          158,493          1,025          0.65 %           86,241            665          0.77 % Certificate of deposits                      296,830          1,841          0.62 %          309,051          2,607          0.84 %          611,453          9,737          1.59 %  Total government deposits                    788,926          4,905          0.62 %          732,017          4,627          0.63 %          814,958         10,991          1.35 % Wholesale deposits                           674,856         23,032          3.41 %        1,456,221         45,029          3.09 %        1,791,999         63,630          3.55 %  Total deposits                             6,661,404         95,546          1.43 %        7,247,127        154,692          2.13 %        8,120,159        241,507          2.97 % FHLB advances                              3,620,368        117,963          3.26 %        3,849,897        154,964          4.03 %        5,039,779        218,231          4.33 % Security repurchase agreements                     -              -             -             79,053          2,750          3.48 %          108,000          4,676          4.33 % Other                                        248,597          6,527          2.63 %          261,333          9,712          3.72 %          274,774         13,384          4.87 % 

Total interest-bearing liabilities 10,530,369 220,036

 2.09 %       11,437,410        322,118          2.82 %       13,542,712        477,798          3.53 % Other liabilities                          1,632,494                                       1,518,191                                       1,507,951 Stockholders' equity                       1,185,731                                       1,074,571                                         817,248  Total liabilities and stockholders equity                                  $ 13,348,594                                    $ 14,030,172                                    $ 15,867,911  Net interest-earning assets             $  1,273,301                                    $  1,085,229                                    $    256,649  Net interest income                                       $ 245,373                                       $ 210,663                                       $ 219,067  Interest rate spread(1)                                                      1.85 %                                          1.43 %                                          1.51 %  Net interest margin(2)                                                       2.07 %                                          1.67 %                                          1.58 %  Ratio of average interest-earning assets to interest- bearing liabilities                                                                 112.1 %                                         109.5 %                                         101.9 %     

(1) Interest rate spread is the difference between rates of interest earned on

    interest-earning assets and rates of interest paid on interest-bearing     liabilities.    

(2) Net interest margin is net interest income divided by average

    interest-earning assets.                                            61 

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(3) Consumer loans include: residential first mortgage, second mortgage,

construction, warehouse lending, HELOC and other consumer loans. Commercial

loans include: commercial real estate, commercial and industrial, and

commercial lease financing loans.

Rate/Volume Analysis

  The following table presents the dollar amount of changes in interest income and interest expense for the components of interest-earning assets and interest-bearing liabilities that are presented in the preceding table. The table below distinguishes between the changes related to average outstanding balances (changes in volume while holding the initial rate constant) and the changes related to average interest rates (changes in average rates while holding the initial balance constant). Changes attributable to both a change in volume and a change in rates were included as changes in rate.                                                                 For the Years Ended December 31,                                          2011 Versus 2010 Increase                      2010 Versus 2009 Increase                                              (Decrease) Due to:                            (Decrease) Due to:                                     Rate          Volume          Total           Rate           Volume          Total                                                                    (Dollars in thousands) Interest-Earning Assets: Loans held-for-sale               $  (7,471 )    $    (825 )    $   (8,296 )    $  (9,570 )    $  (41,338 )    $  (50,908 ) Loans repurchased with government guarantees                 9,059         12,812          21,871        (10,693 )        38,211          27,518 Loans held-for-investment Consumer loans(1)                   (12,603 )      (45,761 )       (58,364 )      (20,858 )       (50,813 )       (71,671 ) Commercial loans(1)                   1,345         (4,304 )        (2,959 )       (3,636 )       (13,499 )       (17,135 )  Total Loans held-for-investment     (11,258 )      (50,065 )       (61,323 )      (24,494 )       (64,312 )       (88,806 ) Securities classified as available-for-sale or trading        (3,441 )      (16,789 )       (20,230 )         (651 )       (51,003 )       (51,654 ) Interest-earning deposits and other                                   186            420             606         (6,270 )         6,036            (234 )  

Total interest-earning assets $ (12,925 ) $ (54,447 ) $ (67,372 ) $ (51,678 ) $ (112,406 ) $ (164,084 )

  Interest-Bearing Liabilities: Demand deposits                   $    (689 )    $      80      $     (609 )    $      49      $      388      $      437 Savings deposits                     (1,410 )        4,363           2,953         (3,591 )         2,842            (749 ) Money market deposits                (1,268 )           16          (1,252 )       (4,572 )        (2,464 )        (7,036 ) Certificate of deposits             (28,937 )       (9,582 )       (38,519 )      (32,571 )       (21,931 )       (54,502 )  Total retail deposits               (32,304 )       (5,123 )       (37,427 )      (40,685 )       (21,165 )       (61,850 ) Demand deposits                         124           (702 )          (578 )         (334 )           740             406 Savings deposits                        (33 )        1,655           1,622           (197 )           557             360 Certificate of deposits                (663 )         (103 )          (766 

) (2,314 ) (4,816 ) (7,130 )

  Total government deposits              (572 )          850             278         (2,845 )        (3,519 )        (6,364 ) Wholesale deposits                    2,164        (24,161 )       (21,997 )       (6,678 )       (11,923 )       (18,601 )  Total deposits                      (30,712 )      (28,434 )       (59,146 )      (50,208 )       (36,607 )       (86,815 ) FHLB advances                       (27,762 )       (9,239 )       (37,001 )      (11,753 )       (51,514 )       (63,267 ) Security repurchase agreements            -         (2,750 )        (2,750 )         (516 )        (1,410 )        (1,926 ) Other                                (2,712 )         (473 )        (3,185 )       (3,198 )          (474 )        (3,672 )  Total interest-bearing liabilities                       $ (61,186 )    $ (40,896 )    $ (102,082

) $ (65,675 ) $ (90,005 ) $ (155,680 )

Change in net interest income $ 48,261 $ (13,551 ) $ 34,710

    $  13,997      $  (22,401 )    $   (8,404 )                                             62 

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Provision for Loan Losses

  The provisions reflect our estimates to maintain the allowance for loan losses at a level to cover probable losses inherent in the portfolio for each of the respective periods.  2011. The decrease in the provision during the year ended December 31, 2011, which increased the allowance for loan losses to $318.0 million at December 31, 2011 from $274.0 million at December 31, 2010, parallels a decrease in net charge-offs both as a dollar amount and as a percentage of the loans held-for-investment over 2010. Net charge-offs decreased for year ended December 31, 2011 as compared to the same period in 2010, primarily due to a lower level of charge-offs of residential first mortgage loans resulting from the sale of $80.3 million of non-performing loans completed in the first quarter of 2011 in comparison to the sale of $474.0 million in non-performing residential first mortgage loans completed during the fourth quarter of 2010. As a percentage of the average loans held-for-investment, net charge-offs for the year ended December 31, 2011 decreased to 2.14 percent from 9.34 percent in 2010.  Loan delinquencies include all loans that were delinquent for at least 30 days when a borrower fails to make a payment and or such payments is received after the first day of the month following the month of the missed payment. Total delinquent loans increased to $633.5 million at December 31, 2011, of which $488.4 million were greater than 90 days delinquent, as compared to $505.6 million at December 31, 2010, of which $318.4 million were greater than 90 days delinquent. During the year ended December 31, 2011, the increase in delinquencies primarily resulted from residential first mortgage loans as other categories of loans within the held-for-investment portfolio showed improvement including commercial real estate, commercial and industrial, second mortgage and HELOC loans. The overall delinquency rate on residential first mortgage loans increased to 12.9 percent at December 31, 2011 from 6.8 percent at December 31, 2010. This increase reflects the expected migration of current loans into delinquency status following the sale of non-performing loans during the fourth quarter 2010, which temporarily reduced the overall delinquency rate. The overall delinquency rate on commercial real estate loans decreased to 9.6 percent at December 31, 2011 from 16.9 percent at December 31, 2010, due in large part to the charge-down or movement of impaired commercial real estate to real estate owned coupled with a sale of several impaired commercial real estate loans during 2011.  2010. The decrease in the provision during 2010 compared to 2009, reflects the increase in net charge-offs both as a dollar amount and as a percentage of the loans held-for-investment, which is offset by a decrease in overall loan delinquencies and severity of loss (i.e., loans at least 30 days past due) in 2010. In the fourth quarter of 2010, we sold or transferred to held-for-sale $578.0 million of non-performing residential first mortgages. The decrease in delinquencies was primarily due to the continued elevated level of charge-offs and the sale of non-performing loans. Net charge-offs in 2010 totaled $676.4 million as compared to $356.4 million in 2009. Approximately $327.3 million of the current year charge-offs related to the sale or transfer to held-for-sale of certain non-performing residential loans. As a percentage of the average loans held-for-investment, net charge-offs in 2010 increased to 9.3 percent from 4.2 percent in 2009. At the same time, overall loan delinquencies decreased to 8.0 percent of total loans held-for-investment at December 31, 2010 from 16.9 percent at December 31, 2009.  Loan delinquencies include all loans that were delinquent for at least 30 days. Total delinquent loans decreased to $0.5 billion at December 31, 2010, of which $0.3 billion were over 90 days delinquent and non-accruing, as compared to $1.3 billion at December 31, 2009, of which $1.1 billion were over 90 days delinquent and non-accruing. In 2010, the decrease in delinquencies impacted all categories of loans within the held-for-investment portfolio, with the exception of commercial non-real estate and HELOCs. The overall delinquency rate on residential mortgage loans decreased to 6.8 percent at December 31, 2010 from 16.7 percent at December 31, 2009, largely due to the sale of non-performing residential mortgages in the fourth quarter of 2010. The overall delinquency rate on commercial real estate loans decreased to 16.9 percent at December 31, 2010 from 26.3 percent at December 31, 2009, due in large part to the charge-down or movement of impaired commercial real estate to real estate owned.  

See "Allowance for Loan Losses" in this discussion for further analysis of the provision for loan losses.

                                           63  

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Non-Interest Income

The following table sets forth the components of our non-interest income.

                                                             For the Years Ended December 31,                                                         2011             2010            2009  Loan fees and charges                                $    77,843       $  89,535       $ 125,168 Deposit fees and charges                                  29,629          32,181          32,429 Loan administration                                       94,604          12,679           7,167 Net gain on trading securities                            21,088          76,526           5,861 Loss on residual and transferors' interest                (5,673 )        (7,847 )       (82,867 ) Net gain on loan sales                                   300,789         296,965         501,250 Net loss on sales of mortgage servicing rights            (7,903 )        (6,977 )        (3,886 ) Net gain on securities available-for-sale                      -           6,689           8,556 Net gain on sale of assets                                22,676               -               - Total other-than-temporary (impairment) recovery         (30,456 )        43,600         (67,799 ) (Loss) gain recognized in other comprehensive income before taxes                                        6,417         

(48,591 ) 47,052

  Net impairment losses recognized in earnings             (24,039 )        (4,991 )       (20,747 ) Representation and warranty reserve - change in estimate                                                (150,055 )       (61,523 )       (75,627 ) Other fees and charges                                    26,557          20,440          25,982  Total non-interest income                            $   385,516       $ 453,680       $ 523,286    During the year ended December 31, 2011, total non-interest income decreased from 2010, primarily due to an increase in the representation and warranty reserve, decreases in net gain on trading securities, an increase in net impairment losses and decreases in loan fees and charges, partially offset by an increase in loan administration income and an increase in gain on sale of assets. Factors affecting the comparability of the primary components of non-interest income are discussed in the following paragraphs.  Loan fees and charges. Our lending operation and banking operation both earn loan origination fees and collect other charges in connection with originating residential first mortgages, commercial loans and other consumer loans. During 2011, the decrease in gross loan fees and charges reflects the decline in the volume of loans originated during 2011, compared to 2010 and 2009. Commercial loan origination fees are capitalized and added as an adjustment to the basis of the individual loans originated. These fees are accreted into income as an adjustment to the loan yield over the life of the loan or when the loan is sold. We account for substantially all residential first mortgage originations as held-for-sale using the fair value method and no longer apply deferral of non-refundable fees and costs to those loans.  Deposit fees and charges. Our banking operation collects deposit fees and other charges such as fees for non-sufficient funds checks, cashier check fees, ATM fees, overdraft protection, and other account fees for services we provide to our banking customers.  Total deposit fees and charges decreased 7.9 percent during 2011 to $29.6 million, compared to $32.2 million in 2010 and $32.4 million in 2009. Our non-sufficient funds fees decreased to $19.7 million in 2011 from $22.1 million in 2010. The primary reason for these decreases in deposit fees and charges was the result of changes to Regulation E, implemented in the third quarter 2010, requiring financial institutions to provide customers with the right to "opt-in" to overdraft services for ATM and one-time, non-recurring debit card transactions. Even with the changes to Regulation E, our 2011 debit card fee income increased by 2.8 percent to $6.3 million from $6.1 million in 2010 and $5.0 million in 2009. This is attributable to the 6.8 percent increase in transaction volume from 9.4 million in 2010 to 10.0 million during 2011. The Federal Reserve final ruling regarding interchange fees had a negative impact on debit card fee income beginning October 1, 2011, with the average fee per transaction dropping from 57 cents in the first three quarters of 2011 to 24 cents in the fourth quarter. The divestiture of the Georgia and Indiana branches in December also had a negative impact on total deposit fees of approximately $500,000.                                           64 

-------------------------------------------------------------------------------- Loan administration.  When our home lending operation sells mortgage loans in the secondary market, it usually retains the right to continue to service these loans and earn a servicing fee, also referred to herein as loan administration income. Our MSRs are accounted for on the fair value method. See Note 15 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.  

The following table summarizes net loan administration income (loss).

                                                           For the Years Ended December 31,                                                      2011              2010             2009                                                               (Dollars in thousands) Servicing income (loss) on consumer mortgage servicing: Servicing fees, ancillary income and charges      $      211        $    3,197        $   5,570 Amortization expense - consumer                            -              (949 )         (2,420 ) Impairment (loss) recovery - consumer                      -              

(960 ) (3,808 )

  Total net loan administration income (loss), consumer                                                 211             1,288             (658 ) Servicing income (loss) on residential mortgage servicing: Servicing fees, ancillary income and charges         169,885           151,145          152,732 Fair value adjustments                              (235,820 )        (172,267 )        (74,254 ) Gain (loss) on hedging activity                      160,328            

32,513 (70,653 )

  Total net loan administration income - residential(1)                                        94,393            11,391            7,825  Total loan administration income                  $   94,604        $   12,679        $   7,167     

(1) Loan administration income does not include the impact of mortgage-backed

securities deployed as economic hedges of the MSR assets. These positions,

recorded as securities-trading, provided $21.1 million, $76.5 million and

$5.9 million in gains and contributed an estimated $3.9 million,

$16.0 million and $53.5 million of net interest income for the years ended

December 31, 2011, 2010 and 2009, respectively.

   2011. Loan administration income increase was primarily due to servicing fees, ancillary income, and charges on our residential first mortgage servicing from an increase in the average balance in the portfolio of loans serviced for others, slower than expected levels of prepayments, and effective hedge performance during the year ended December 31, 2011, compared to 2010. The total unpaid principal balance of loans serviced for others for the years ended December 30, 2011 was $63.8 billion compared to $56.0 billion at December 31, 2010.  Loan administration income does not include $21.1 million of gains in securities that were held as economic hedges of our MSR asset during the year ended December 31, 2011. These gains are required to be recorded separately as gains on trading securities within our Consolidated Statements of Operations.  2010. Loan administration income increased as a result of servicing fees, ancillary income, and charges on our residential mortgage servicing decreased during 2010 compared to 2009, primarily as a result of decreases in the average balance of the loans serviced for others portfolio due to lower loan origination volume and continued run-off of serviced loans originated in prior periods. The total unpaid principal balance of loans serviced for others was $56.0 billion at December 31, 2010, versus $56.5 billion at December 31, 2009.  The loan administration income of $12.7 million does not include $76.5 million of gains in mortgage backed securities that were held on our Consolidated Statements of Financial Condition as economic hedges of our MSR asset during the year ended December 31, 2010. These gains are required to be recorded separately as gains on trading securities within our Consolidated Statements of Operations.  For consumer mortgage servicing, the decrease in the servicing fees, ancillary income and charges for the year ended December 31, 2010 versus 2009 was due to the transfer of servicing to a third party servicer in the fourth quarter. At December 31, 2010, the total unpaid principal balance of consumer loans serviced for others was zero (due to the transfer of such servicing pursuant to the applicable servicing agreements) versus $0.9 billion serviced at December 31, 2009.                                           65 

-------------------------------------------------------------------------------- Gain on trading securities. Securities classified as trading are comprised of U.S. Treasury bonds and Agency securities. U.S. Treasury bonds held in trading are distinguished from available-for-sale based upon the intent of management to use them as an economic hedge against changes in the valuation of the MSR portfolio, however, these do not qualify as an accounting hedge as defined in current accounting guidance for derivatives and hedges.  We recorded a gain of $21.1 million for the year ended December 31, 2011, all of which was related to an unrealized gain on U.S. Treasury bonds held at December 31, 2011. We recorded a gain of $76.5 million for the year ended December 31, 2010 on U.S. government sponsored agency mortgage-backed securities held, of which $3.9 million related to an unrealized gain on agency mortgage-backed securities held at December 31, 2010.  Loss on residual interests and transferor interests. Losses on residual interests classified as trading and transferor's interest are a result of a reduction in the estimated fair value of our beneficial interests resulting from private securitizations. The losses during the years ended December 31, 2011 and 2010 are primarily due to continued increases in expected credit losses on the assets underlying the securitizations. We have not engaged in any private-label securitization activity since 2007. At December 31, 2011, we no longer held a residual interest in any of our securitizations. For further information on the securitizations see Note 11 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data herein.  For the year ended December 31, 2011, we recognized a loss of $5.7 million all of which was related to a reduction in the transferor's interest related to our HELOC securitizations. We recognized a loss of $7.8 million for the year ended December 31, 2010. In 2010, $2.1 million was related to a reduction in the residual valuation and $5.7 million was related to a reduction in the transferor's interest related to our HELOC securitizations.  Net gain on loan sales. Our home lending operation records the transaction fee income it generates from the origination, securitization and sale of mortgage loans in the secondary market. The amount of net gain on loan sales recognized is a function of the volume of mortgage loans originated for sale and the fair value of these loans, net of related selling expenses. Net gain on loan sales is increased or decreased by any mark to market pricing adjustments on loan commitments and forward sales commitments, increases to the representation and warranty reserve (formerly known as secondary market reserve) related to loans sold during the period, and related administrative expenses. The volatility in the gain on sale spread is attributable to market pricing, which changes with demand and the general level of interest rates. Historically, pricing competition on mortgage loans is lower in periods of low or decreasing interest rates, due to higher consumer demand as usually evidenced by higher loan origination levels, resulting in higher spreads on origination. Conversely, pricing competition increases when interest rates rise, which generally reduce consumer demand, thus decreasing spreads on origination and compressing gain on sale. During 2010 and 2011, the net gain was also affected by increasing spreads available from securities sold that are guaranteed by Fannie Mae and Freddie Mac and by a combination of a significant decline in residential mortgage lenders and a significant shift in loan demand for Fannie Mae and Freddie Mac conforming residential mortgage loans and FHA insured loans, which have provided more favorable loan pricing opportunities for conventional residential mortgage products.  

The following table provides information on our net gain on loan sales reported in our consolidated financial statements and loans sold within the period.

                                              For the Years Ended December 31,                                        2011              2010              2009                                                  (Dollars in thousands)

Net gain on loan sales $ 300,789$ 296,965$ 501,250

Loans sold and securitized $ 27,451,362$ 26,506,672$ 32,326,643

      Net margin on loan sales             1.10 %            1.12 %        

1.55 %

2011. Net gain on loan sales increased for the year ended December 31, 2011, from 2010, which was a result of increased residential first mortgage originations and continued strong margins on sales of the

                                       66  -------------------------------------------------------------------------------- originations, as well as a reduction in overall hedging costs. Overall mortgage rate-lock commitments for the year ended December 31, 2011 were $27.5 billion, compared to $26.5 billion for the comparable 2010 period. We had mortgage loan origination volume of $26.6 billion in the year ended December 31, 2011, compared to $26.6 billion in the comparable 2010 period. There was an overall modest decline on sale spreads (110 basis points in the year ended December 31, 2011, compared to 112 basis points in the comparable 2010 period).  Our calculation of net gain on loan sales reflects adoption of fair value accounting for the majority of mortgage loans held-for-sale beginning January 1, 2009. The change of method was made on a prospective basis; therefore, only mortgage loans held-for-sale that were originated after 2009 have been affected. In addition, we also had changes in amounts related to derivatives, lower of cost or market adjustments on loans transferred to held-for-investment and provisions to representation and warranty reserve. Changes in amounts related to loan commitments and forward sales commitments amounted to a loss of $(22.2) million for the year ended December 31, 2011, compared to a gain of $12.4 million for the year ended December 30, 2010, respectively. Lower of cost or market adjustments amounted to less than $0.1 million and $0.3 million for years ended December 31, 2011 and 2010, respectively. Provisions to our representation and warranty reserve representing our initial estimate of losses on probable mortgage repurchases amounted to $9.0 million and $35.2 million, for years ended December 30, 2011 and 2010, respectively. Also included in net gain on loan sales is the initial capitalized value of our MSRs, which totaled $254.8 million and $239.4 million for the years ended December 31, 2011 and 2010, respectively.  2010. For the year ended December 31, 2010, net gain on loan sales decreased from 2009 period. The 2010 period reflects the sale of $26.5 billion in loans versus $32.3 billion sold in the 2009 period. Management believes changes in market conditions during the 2010 period resulted in decreased mortgage loan origination volume ($26.6 billion in the 2010 period versus $32.4 billion in the 2009 period) and an overall decrease on sale spread (112 basis points in the 2010 versus 155 basis points in the 2009 period).  We had changes in amounts related to derivatives, lower of cost or market adjustments on loans transferred to held-for-investment and provisions to the representation and warranty reserve. Changes in amounts related to loan commitments and forward sales commitments amounted to $12.4 million and $20.5 million for the years ended December 31, 2010 and 2009, respectively. Lower of cost or market adjustments amounted to $0.3 million and $0.1 million for the years ended December 31, 2010 and 2009, respectively. Provisions to the representation and warranty reserve representing our initial estimate of losses on probable mortgage repurchases amounted to $35.2 million and $26.5 million, for the years ended December 31, 2010 and 2009, respectively. Also included in net gain on loan sales is the capitalized value of our MSRs, which totaled $239.4 million and $336.2 million for the years ended December 31, 2010 and 2009, respectively.  Net (loss) gain on sales of mortgage servicing rights. As part of our business model, we occasionally sells MSRs in transactions separate from the sale of the underlying loans. Because we carry our MSRs at fair value, we would not expect to realize significant gains or losses at the time of the sale. Instead, our income or loss on changes in the valuation of MSRs would be recorded through our loan administration income.  2011. We recorded a loss on sales of MSRs for the year ended December 31, 2011 of $7.9 million. During the year ended December 31, 2011, we sold servicing rights on a bulk basis associated with underlying mortgage loans totaling $9.2 billion and on a servicing released sale as to underlying mortgage loans totaling $1.0 million. We had no sales on a flow basis in 2011.  2010. During 2010, we recorded a loss on sales of MSRs of $7.0 million. Of the 2010 loss, $5.7 million represented the estimated costs of the transactions, which include hold back reserves for missing documents, payoff reserves, broker fees and recording fees, and $1.3 million was due to the transfer of the servicing rights on two private second mortgage loan securitizations. During 2010, we sold servicing rights related to $13.4 billion of loans serviced for others on a bulk basis and $1.8 billion on a servicing released basis. We had no sales on a flow basis in 2010.                                           67

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Net gain (loss) on securities available-for-sale. Securities classified as available-for-sale are comprised of U.S. government sponsored agency mortgage-backed securities and collateralized mortgage obligations ("CMOs").

  Gains 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 Bank, are reported within net gain on loan sales. Securities in U.S. government sponsored agency mortgage-backed securities available-for-sale typically have remained in the portfolio less than 90 days before sale. Gain on sales for all other available-for-sale securities types are reported in net gain on sale on sale of available-for-sale securities.  

2011. There were $13.9 million in sales of U.S. government sponsored agency mortgage-backed securities with underlying mortgage products originated by the Bank during the year ended December 31, 2011, resulting in a gain of $0.1 million. During the year ended December 31, 2011, there were no sales of purchased U.S. government sponsored agency mortgage-backed securities and non-U.S. government sponsored agency mortgage-backed securities available-for-sale.

  2010. During 2010, sales of agency securities with underlying mortgage products recently originated by the Bank were $187.7 million resulting in $1.2 million of net gain on loan sales. Gain on sales for all other available-for-sale security types are reported in net gain on sale of available-for-sale securities. During the year ended December 31, 2010, we sold $251.0 million in purchased agency and non-agency securities available-for-sale generating a net gain on sale of $6.7 million.  Net impairment losses recognized through earnings. We recognize OTTI related to credit losses through operations with any remainder recognized through other comprehensive income (loss) and a cumulative adjustment increasing retained earnings and other comprehensive loss by the non-credit portion of other-than-temporary impairment. See Stockholder's Equity in Note 23 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.  Generally, an investment impairment analysis is performed every three months. We also review the general market conditions for the specific type of underlying collateral for each security; in this case, the mortgage market in general has suffered from significant losses in value. With the assistance of third party experts, as deemed necessary, we model the expected cash flows of the underlying mortgage assets using historical factors such as default rates and current delinquency and estimated factors such as prepayment speed, default speed and severity speed. Next, the cash flows are modeled through the appropriate waterfall for each CMO tranche owned; the level of credit support provided by subordinated tranches is included in the waterfall analysis. The resulting cash flow of principal and interest is then utilized by management to determine the amount of credit losses by security.  The credit losses on the CMO portfolio have been created by the economic conditions present in the United States over the course of the last two years. This includes high mortgage defaults, declines in collateral values and changes in homeowner behavior, such as intentionally defaulting on a note due to a home value worth less than the outstanding debt on the home (so-called "strategic defaults").  2011. For the year ended December 31, 2011, there were $24.0 million of additional credit losses recognized with respect to the CMOs, as the result of forecasted continued depreciation in home values which serve as collateral for these securities. At December 31, 2011, the cumulative amount of OTTI expense incurred due to credit losses on the CMOs totaled $59.4 million.  2010. In the year ended December 31, 2010, additional credit losses on CMO's totaled $5.0 million, which was recognized in current operations. At December 31, 2010, the cumulative amount of other-than temporary impairment due to credit losses totaled $40.0 million.                                           68  -------------------------------------------------------------------------------- Representation and warranty reserve - change in estimate. We maintain a representation and warranty reserve to account for the expected losses related to loans we might be required to repurchase (or the indemnity payments we may have to make to purchasers), as well as adjustments to our previous estimates of expected losses on loans sold. The provision in the representation and warranty reserve reduces our net gain on loans sales and the representation and warranty reserve - change in estimate takes into account adjustments to our previous estimates of expected losses on loans sold. These estimates, recorded in representation and warranty reserve - change in estimate, are based on our most recent data regarding loan repurchases and actual credit losses on repurchased loans.  2011. The $88.5 million increase from the year ended December 31, 2010, is consistent with recent industry trends, as the GSEs (a term generally used to refer collectively or singularly to Fannie Mae and Freddie Mac) continue to be more aggressive in the number of pre-2009 loan files being reviewed and their interpretation of their rights under the related representations and warranties.  2010. The $14.1 million decrease from the year ended December 31, 2009, was primarily due to our change in estimate of expected losses from probable repurchase obligations related to loans sold in prior periods. In addition, during 2010, we recorded an expense of $61.5 million for the increase in our representation and warranty reserve due to our change in estimate of expected losses from probable repurchase obligations related to loans sold in prior periods, which decreased from the $75.6 million recorded in 2009.  Other fees and charges. Other fees and charges include certain miscellaneous fees, including dividends received on FHLB stock and income generated by our subsidiaries Flagstar Reinsurance Company ("FRC"), Douglas Insurance Agency, Inc. and Paperless Office Solutions, Inc.  2011. During the year ended December 31, 2011, we recorded $8.3 million in dividends on an average outstanding balance of FHLB stock of $316.5 million, as compared to $7.0 million in dividends on an average balance of FHLB stock outstanding of $367.4 million in 2010. During the year ended December 31, 2011, FRC had no earned fees, compared to $1.4 million in 2010. During the third quarter 2010, FRC terminated its reinsurance agreement with the last of the four mortgage insurance companies and as a result FRC will no longer earn any fees.  2010. During 2010, we recorded $7.0 million in dividends on an average outstanding balance of FHLB stock of $367.4 million, as compared to $6.2 million in dividends on an average balance of FHLB stock outstanding of $373.4 million in 2009. During 2010, FRC earned fees of $1.4 million versus $9.4 million in 2009. The amount of fees earned by FRC varies with the volume of loans that were insured during the respective periods.  

Non-Interest Expense

  The following table sets forth the components of our non-interest expense, along with the allocation of expenses related to loan originations that are deferred pursuant to accounting guidance for receivables, non-refundable fees and other costs. Mortgage loan fees and direct origination costs (principally compensation and benefits) are capitalized as an adjustment to the basis of the loans originated during the period and amortized to expense over the lives of the respective loans rather than immediately expensed. Other expenses associated with loan origination, however, are not required or allowed to be capitalized and are, therefore, expensed when incurred. We account for substantially all of our mortgage loans held-for-sale using the fair value method and, therefore, immediately recognize loan origination fees and direct origination costs in the period incurred rather than defer the cost.                                           69  --------------------------------------------------------------------------------

                             NON-INTEREST EXPENSES                                                             For the Years Ended December 31,                                                        2011             2010            2009                                                                (Dollars in thousands) Compensation and benefits                           $   225,083       $ 199,500       $ 223,394 Commissions                                              39,980          38,688          73,994 Occupancy and equipment                                  70,125          65,285          70,009 Asset resolution                                        128,313         161,326         104,119 Federal insurance premiums                               41,581          37,389          36,613 Other taxes                                               2,801           3,180          16,029 Warrant (income) expense                                 (6,889 )         4,189          23,338 Loss on extinguishment of debt                                -          20,826          16,446 General and administrative                              134,739          80,554         116,617  Total                                                   635,733         610,937         680,559 Less: capitalized direct costs of loan closings          (1,053 )          (238 )          (905 )  Total, net                                          $   634,680       $ 610,699       $ 679,654  Efficiency ratio(1)                                       100.6 %          91.9 %          91.6 %  Efficiency ratio (credit-adjusted)(2)                      64.8 %          61.9 %          70.4 %     

(1) Total operating and administrative expenses divided by the sum of net

    interest income and non-interest income.    

(2) Based on efficiency ratios as calculated, less representation and warranty

reserve - change in estimate and asset resolution expense, see "Use of

Non-GAAP Financial Measures."

   The 3.9 percent increase in non-interest expense during the year ended December 31, 2011 compared to the prior year was primarily due to an increase in compensation and benefits and general and administrative expenses (primarily litigation settlement expense and consulting fees), partially offset by a decrease in asset resolution expense, warrant expense, and loss on extinguishment of debt.  Compensation and benefits. 2011. The increase in gross compensation and benefits expense is primarily attributable to an increase in our salaried employees and a $14.2 million increase in incentive compensation paid or accrued during the year ended December 31, 2011, compared to a total of $8.6 million recorded for the year ended December 31, 2010 which included a $3.6 million reversal of a prior year incentive compensation accrual. Our full-time equivalent non-commissioned salaried employees increased by 162 employees from December 31, 2010 to a total of 2,839 at December 31, 2011.  2010. In 2010, full-time equivalent ("FTE") salaried employees decreased by 74 to 3,001 at December 31, 2010. The decrease in gross compensation and benefits expense was largely due to reductions in compensation incentives by $11.3 million and temporary help expense by $3.5 million.  Commissions. 2011. During both the years ended December 31, 2011 and 2010 commission expense equaled 15 basis points (0.15 percent) of total loan originations. The 3.3 percent increase in commissions is primarily due to the 2.7 percent increase in loan originations during the year ended December 31, 2011. Loan originations increased to $27.3 billion for the year ended December 31, 2011 from $26.6 billion in 2010.  2010. The decrease in commissions was largely due to the decrease in employment of commissioned loan officers and account executives in 2010. At December 31, 2010, the number of loan officers and account                                           70

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executives totaled 146 and 132, respectively, compared to 174 and 162, respectively, at December 31, 2009. Commission expense, a variable cost of production, equaled 15 basis points (0.15 percent) of total production at December 31, 2010 compared to 23 basis points (0.23 percent) at December 31, 2009.

  Asset resolution. Asset resolution expenses consist of foreclosure and other disposition and carrying costs, loss provisions, and gains and losses on the sale of real estate owned properties that we have obtained through foreclosure or other proceedings. On June 30, 2011, we implemented a reclassification in the financial reporting application of amounts due from FHA relating to the servicing of delinquent FHA loans to recognize the accrued credit from FHA as interest income. Previously, income from FHA was applied as an offset to non-interest expense (i.e. asset resolution expense) relating to the servicing of delinquent FHA loans, and recorded on a net basis as asset resolution expense. The impact of the reclassification on the years ended December 31, 2010 and 2009, was an increase in net interest income of $35.0 million and $7.5 million, respectively, and a corresponding increase to asset resolution expense. The discussion immediately below relates to the changes in asset resolution expense on a post-reclassification basis for the years ended December 31, 2011 and 2010.  2011. For the year ended December 31, 2011, asset resolution expenses decreased compared to 2010, primarily due to a $50.9 million reduction in provision for real estate owned loss which decreased from $97.7 million in 2010 to $47.6 million in 2011, net of any gain on real estate owned and recovery of related debt which totaled $0.8 million in 2011. The $50.9 million decrease in provision for real estate owned loss, net of any gain on real estate owned and recovery of related debt, was partially offset by an increase of $17.9 million in foreclosure and additional repurchase expenses which totaled $92.7 million for the year ended December 31, 2011, compared to $74.8 million for the year ended December 31, 2010.  2010. In 2010, asset resolution expenses increased from 2009, mainly due to costs related to real estate owned commercial properties. Foreclosure costs on real estate owned commercial properties of $6.2 million with a net of gain on sales and recoveries of $3.3 million and a loss provision of $39.2 million, totaled $42.1 million of asset resolution expenses. The increased level of loss provisions on real estate owned was primarily due to continuing depressed real estate markets.  Federal insurance premiums. 2011. Our FDIC insurance expense increased for the year ended December 31, 2011, as compared 2010, largely due to an increase in our assessment base due to a change in how the assessment base used for calculating deposit insurance is now determined as required by the Dodd-Frank Act. After March 31, 2011, our assessment base for deposit insurance was calculated based on our average consolidated total assets less average tangible equity during the assessment period, as opposed to our average reported deposits. During the year ended December 31, 2011, federal insurance premiums totaled $41.6 million, an increase of $4.2 million, compared to $37.4 million for the year ended December 31, 2010.  

2010. During the year ended December 31, 2010, federal insurance premiums totaled $37.4 million, a 2.1 percent increase of $0.8 million, compared to $36.6 million for the year ended December 31, 2009.

  Warrant expense. 2011. For the year ended December 31, 2011, warrant income increased $11.1 million compared to 2010. In November of 2010, 5.5 million shares additional warrants were issued to certain investors of the May 2008 private placement in full satisfaction of obligations under anti-dilution provisions applicable to such investors. At December 31, 2011, total of shares underlying warrants stood at 6.9 million and were fair valued at $2.4 million, compared to $9.3 million at December 31, 2010. The overall increase in warrant income is attributable to the decline in market price of our common stock since December 31, 2010.  2010. The decrease in warrant expense from 2009, was largely due to reclassification of U.S. Treasury warrants during 2009 from a liability to equity. The warrants were issued to the U.S. Treasury as part of the TARP Capital Purchase Program. The decrease in warrant expense was offset in part by a net $4.2 million increase in the valuation of warrants and the issuance of additional warrants to certain investors in May 2008 private placement in full satisfaction of obligations under anti-dilution provisions applicable to such investors. At December 31, 2010, the                                           71  -------------------------------------------------------------------------------- net total of shares underlying warrants stood at 6.9 million and the valuation of warrants increased to $9.3 million from $5.1 million at December 31, 2009. The overall increase in warrant income is attributable to the issuance of additional warrants, offset by the decline in market price of our common stock since December 31, 2009.  General and administrative. 2011. For the year ended December 31, 2011 general and administrative expense increased from 2010 (which included a $20.8 million loss on the extinguishment of debt).  Commercial loan expenses increased $5.3 million to $4.8 million for the year ended December 31, 2011 from income of $0.5 million for the year ended December 31, 2010. The increase is primarily due to a $5.3 million increase in commercial lines of credit expense to $4.5 million for the year ended December 31, 2011 from income of $0.8 million for the year ended December 31, 2010.  Residential loan expenses increased $4.0 million to $11.4 million for the year ended December 31, 2011 from $7.4 million for the year ended December 31, 2010. The increase was largely due to a $5.8 million change in loss mitigation administrative expense from $5.4 million in income for the year ended December 31, 2010 to an expense of $0.4 million for the year ended December 31, 2011. The increase in loss mitigation administrative expense was offset by a $2.7 million decrease in servicing outsource expense.  General and administrative expense consist of our outside consulting, audit, legal and other operating expenses, which increased $50.8 million from $14.7 million for the year ended December 31, 2010 to $65.5 million for the year ended December 31, 2011. The $50.8 million increase was primarily due to the $33.3 million litigation settlement as a result of the agreement with the U.S. Department of Justice.  The overall increase in general and administrative expense was offset in part by decreases in the following expenses. Advertising expense decreased 25.2 percent to <money>$7.7 million for the year ended December 31, 2011, compared to $10.3 million for the year ended December 31, 2010. During the year ended December 31, 2011 there was no net reinsurance expense compared to $1.4 million for the year ended December 31, 2010. Documentation expense for loans decreased by $1.0 million to $14.1 million for the year ended December 31, 2011, compared to $15.1 million during the year ended December 31, 2010. In addition, other general business and corporate expenses decreased $1.4 million to $22.1 million for the year ended December 31, 2011 from $23.5 million during the year ended December 31, 2010.  2010. For the year ended December 31, 2010 general and administrative expense, including the loss on extinguishment of debt, decreased $31.7 million. During the year ended December 31, 2010, loss on extinguishment of debt totaled $20.8 million, of which $19.7 million represented prepayment penalties related to the early retirement of $500.0 million in FHLB advances. Excluding the loss on extinguishment of debt, the net change for the year ended December 31, 2010 compared to 2009 was a decrease of $36.0 million.  Commercial loan expenses decreased $8.7 million for the year ended December 31, 2010 to income of $0.5 million, compared to an expense of $8.2 million for the year ended December 31, 2009. The decrease is primarily due to a decrease in commercial lines of credit expense to income of $0.8 million for the year ended December 31, 2010, from an expense of $7.9 million for the year ended December 31, 2009.  Residential loan expenses increased $1.3 million to $7.4 million for the year ended December 31, 2010 from $6.1 million for the year ended December 31, 2009. The increase was largely due to a combined increase of $6.4 million resulting from increases in miscellaneous loan and servicing related expenses and servicing outsource expense which totaled $11.3 million for the year ended December 31, 2010 from $4.9 million for the year ended December 31, 2009. The increase in residential loan expense was offset by the change in loss mitigation administrative expense to income of $5.4 million for the year ended December 31, 2010 from zero for the year ended December 31, 2009.  

Our outside consulting, audit and legal expenses decreased 35.8 percent, a decrease of $8.2 million from $22.9 million for the year ended December 31, 2009 to $14.7 million for the year ended December 31, 2010.

                                       72  -------------------------------------------------------------------------------- The decrease in general and administrative expense was primarily due to a $21.4 million decrease in net reinsurance expense to $1.4 million for the year ended December 31, 2010, compared to $22.8 million for the year ended December 31, 2009, which included a $32.5 million charge in reinsurance loss reserve partially offset by a $12.0 million change in premium deficiency. In addition, advertising expense decreased by $2.0 million from $12.3 million for the year ended December 31, 2009 to $10.3 million for the year ended December 31, 2010, and loan documentation expense decreased by $4.7 million to $15.1 million for the year ended December 31, 2010, compared to $19.8 million for the year ended December 31, 2009.  

Provision (Benefit) for Federal Income Taxes

  For the years ended December 31, 2011 and 2010, our provision for federal income taxes as a percentage of pretax loss was 0.6 percent, compared to a benefit on pretax losses of 12.5 percent for the year ended December 31, 2009. For each year, the provision (benefit) for federal income taxes varies from statutory rates primarily because of an addition to our valuation allowance for net deferred tax assets.  Deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, a deferred tax asset is recorded for net operating loss carry forwards and unused tax credits. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.  We periodically review the carrying amount of our deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, it is more likely than not that all or a portion of our deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.  In evaluating this available evidence, we consider historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. Our evaluation is based on current tax laws as well as our expectations of future performance.  We recorded a $383.8 million valuation allowance against deferred tax assets as of December 31, 2011. See Note 27 of the Notes to the Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, herein.