UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FLAGSTAR BANCORP, INC.

(Exact name of registrant as specified in its charter)

Michigan		38-3150651
(State or other jurisdiction of Incorporation or organization)		(I.R.S. Employer Identification No.)
5151 Corporate Drive		48098
(Address of principal executive offices)		(Zip 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 þ No o.

          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer o                                                   Accelerated filer þ                                              Non-accelerated filer o

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ.

          As of October 31, 2006, 63,587,477 shares of the registrant’s common stock, $0.01 par value, were issued and outstanding.

 

 

FORWARD–LOOKING STATEMENTS

          This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Flagstar Bancorp, Inc. (“Flagstar” or the “Company”) and these statements are subject to risk and uncertainty. Forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, include those using words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions.

          There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed under the heading “Risk Factors” in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, including: (1) competitive pressures among depository institutions increase significantly; (2) changes in the interest rate environment reduce interest margins; (3) the Company’s estimates of prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions differ materially from actual results; (4) general economic conditions, either national or in the states in which the Company does business, are less favorable than expected; (5) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions adversely affect the businesses in which the Company is engaged; (7) changes and trends in the securities markets result in an adverse effect to the Company; (8) a delayed or incomplete resolution of regulatory issues; (9) the impact of reputational risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity; and (10) the outcome of regulatory and legal investigations and proceedings.

          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.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
The unaudited condensed consolidated financial statements of the Company are as follows:
Consolidated Statements of Financial Condition — September 30, 2006 (unaudited) and December 31, 2005.
Unaudited Consolidated Statements of Earnings — For the three and nine months ended September 30, 2006 and 2005.
Consolidated Statements of Stockholders’ Equity and Comprehensive Income — For the nine months ended September 30, 2006 (unaudited) and for the year ended December 31, 2005.
Unaudited Consolidated Statements of Cash Flows — For the nine months ended September 30, 2006 and 2005.
Unaudited Notes to Consolidated Financial Statements.
Statement regarding Computation of Net Earnings per Share
Section 302 Certification of Chief Executive Officer
Section 302 Certification of Chief Financial Officer
Section 906 Certification of Chief Executive Officer
Section 906 Certification of Chief Financial Officer

Flagstar Bancorp, Inc.

		At September 30,				At December 31,
		2006				2005
		(Unaudited)
Assets
Cash and cash equivalents		$	346,774			$	201,163
Mortgage-backed securities held to maturity (fair value $1.6 billion and $1.4 billion at September 30, 2006 and December 31, 2005, respectively)			1,552,040				1,414,986
Securities available for sale			32,295				26,148
Other investments			25,074				21,957
Loans available for sale			3,286,263				1,773,394
Loans held for investment			8,924,181				10,576,471
Less: allowance for loan losses			(42,744	)			(39,140	)
Loans held for investment, net			8,881,437				10,537,331
Total earning assets			13,777,109				13,773,816
Accrued interest receivable			53,136				48,399
Repossessed assets, net			71,514				47,724
Federal Home Loan Bank stock			274,507				292,118
Premises and equipment, net			212,795				200,789
Mortgage servicing rights, net			150,663				315,678
Other assets			233,527				195,743
Total assets		$	15,120,025			$	15,075,430
Liabilities and Stockholders’ Equity Liabilities
Deposits		$	8,212,773			$	7,979,000
Federal Home Loan Bank advances			4,517,308				4,225,000
Security repurchase agreements			734,495				1,060,097
Long term debt			207,472				207,497
Total interest-bearing liabilities			13,672,048				13,471,594
Accrued interest payable			48,329				41,288
Undisbursed payments on loans serviced for others			208,629				407,104
Escrow accounts			230,316				219,028
Liability for checks issued			19,323				23,222
Federal income taxes payable			51,655				75,271
Secondary market reserve			23,900				17,550
Other liabilities			50,813				48,490
Total liabilities			14,305,013				14,303,547
Commitments and Contingencies			—				—
Stockholders’ Equity
Common stock — $.01 par value, 150,000,000 shares authorized; 63,571,427 and 63,208,038 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively			636				632
Additional paid in capital			62,559				57,304
Accumulated other comprehensive income			5,984				7,834
Retained earnings			745,833				706,113
Total stockholders’ equity			815,012				771,883
Total liabilities and stockholders’ equity		$	15,120,025			$	15,075,430

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

Flagstar Bancorp, Inc.

		For the three months ended								For the nine months ended
		September 30,								September 30,
		2006				2005				2006				2005
		(Unaudited)
Interest Income
Loans		$	184,328			$	180,698			$	526,222			$	509,004
Mortgage-backed securities held to maturity			19,878				4,502				58,177				5,055
Other			1,351				191				5,104				569
Total interest income			205,557				185,391				589,503				514,628
Interest Expense
Deposits			87,054				67,819				244,326				182,478
FHLB advances			48,677				51,593				131,147				133,783
Security repurchase agreements			13,161				—				39,707				—
Other			3,037				5,205				11,282				13,941
Total interest expense			151,929				124,617				426,462				330,202
Net interest income			53,628				60,774				163,041				184,426
Provision for loan losses			7,291				3,690				17,213				12,840
Net interest income after provision for loan losses			46,337				57,084				145,828				171,586
Non-Interest Income
Loan fees and charges			2,146				3,587				4,996				9,422
Deposit fees and charges			5,080				4,356				15,584				12,333
Loan administration			7,766				(1,913	)			12,430				5,701
Net gain (loss) on loan sales			(8,197	)			3,426				18,538				45,351
Net gain on sales of mortgage servicing rights			45,202				492				88,719				7,002
Net loss on securities available for sale			(2,144	)			—				(5,701	)			—
Other fees and charges			4,485				10,819				23,966				31,388
Total non-interest income			54,338				20,767				158,532				111,197
Non-Interest Expense
Compensation and benefits			37,518				30,275				108,735				92,613
Occupancy and equipment			17,726				16,122				51,335				50,568
Communication			1,108				2,573				3,295				5,688
Other taxes			(21	)			1,797				(1,652	)			6,327
General and administrative			12,522				12,461				37,564				38,829
Total non-interest expense			68,853				63,228				199,277				194,025
Earnings before federal income taxes			31,822				14,623				105,083				88,758
Provision for federal income taxes			11,070				5,163				36,780				31,720
Net Earnings		$	20,752			$	9,460			$	68,303			$	57,038
Net earnings per share — basic		$	0.33			$	0.15			$	1.08			$	0.92
Net earnings per share — diluted		$	0.32			$	0.15			$	1.06			$	0.89

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

Flagstar Bancorp, Inc.

										Accumulated
						Additional				Other								Total
		Common				Paid in				Comprehensive				Retained				Stockholders’
		Stock				Capital				Income				Earnings				Equity
Balance at January 1, 2005		$	614			$	40,754			$	5,343			$	682,243			$	728,954
Net earnings			—				—				—				79,865				79,865
Reclassification of gain on swap extinguishment – net of tax			—				—				(1,335	)			—				(1,335	)
Net unrealized gain on swaps used in cash flow hedges – net of tax			—				—				3,328				—				3,328
Net unrealized gain on securities available for sale – net of tax			—				—				498				—				498
Total comprehensive income			—				—				—				—				82,356
Stock options exercised and grants issued, net			18				8,171				—				—				8,189
Tax benefit from stock-based compensation			—				8,379				—				—				8,379
Dividends paid ($0.90 per share)			—				—				—				(55,995	)			(55,995	)
Balance at December 31, 2005 (Unaudited)			632				57,304				7,834				706,113				771,883
Net earnings			—				—				—				68,303				68,303
Reclassification of gain on swap extinguishment – net of tax			—				—				(1,001	)			—				(1,001	)
Net unrealized loss on swaps used in cash flow hedges – net of tax			—				—				(1,253	)			—				(1,253	)
Net unrealized gain on securities available for sale – net of tax			—				—				404				—				404
Total comprehensive income			—				—				—				—				66,453
Stock options exercised and grants issued, net			4				4,350				—				—				4,354
Tax benefit from stock-based compensation			—				905				—				—				905
Dividends paid ($0.45 per share)			—				—				—				(28,583	)			(28,583	)
Balance at September 30, 2006		$	636			$	62,559			$	5,984			$	745,833			$	815,012

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

Flagstar Bancorp, Inc.

		For the nine months ended
		September 30,
		2006				2005
		(Unaudited)
Operating Activities
Net earnings		$	68,303			$	57,038
Adjustments to net earnings to net cash used in operating activities
Provision for loan losses			17,213				12,840
Depreciation and amortization			80,129				89,264
FHLB stock dividends			—				(5,035	)
Net gain on the sale of assets			(2,010	)			(1,449	)
Net gain on loan sales			(18,538	)			(45,351	)
Net gain on sales of mortgage servicing rights			(88,719	)			(7,002	)
Net loss on securities available for sale			5,701				—
Proceeds from sales of loans available for sale			11,903,799				18,325,046
Originations and repurchase of mortgage loans available for sale, net of principal repayments			(12,401,103	)			(19,139,818	)
Increase in accrued interest receivable			(4,737	)			(12,904	)
(Increase) decrease in other assets			(39,682	)			102,766
Increase in accrued interest payable			7,041				9,879
(Decrease) increase in the liability for checks issued			(3,899	)			3,830
Net tax benefit for stock grants issued			(905	)			—
(Decrease) increase in federal income taxes payable			(22,667	)			30,670
Increase (decrease) in other liabilities			8,673				(9,460	)
Net cash used in operating activities			(491,401	)			(589,686	)
Investing Activities
Net change in other investments			(3,117	)			(2,908	)
Repayments of mortgage-backed securities held to maturity			300,543				9,650
Origination of portfolio loans, net of principal repayments			125,386				(1,295,941	)
Redemption (purchase) of Federal Home Loan Bank stock			17,611				(47,788	)
Investment in unconsolidated subsidiaries			—				3,095
Proceeds from the disposition of repossessed assets			42,068				31,952
Acquisitions of premises and equipment, net of proceeds for sales			(32,032	)			(35,430	)
Capitalization of mortgage servicing rights			(175,141	)			(261,612	)
Proceeds from the sale of mortgage servicing rights			371,751				36,732
Net cash provided by (used in) investing activities			647,069				(1,562,250	)
Financing Activities
Net increase in deposit accounts			233,773				781,760
Net decrease in security repurchase agreements			(325,602	)			—
Issuance of junior subordinated debt			—				100,000
Net increase in Federal Home Loan Bank advances			292,308				1,283,279
Payment on other long term debt			(25	)			(25	)
Net disbursement of payments of loans serviced for others			(198,475	)			(29,266	)
Net receipt of escrow payments			11,288				121,093
Proceeds from the exercise of stock options			4,354				4,934
Net tax benefit for stock grants issued			905				—
Dividends paid to stockholders			(28,583	)			(46,513	)
Net cash (used in) provided by financing activities			(10,057	)			2,215,262
Net increase in cash and cash equivalents			145,611				63,326
Beginning cash and cash equivalents			201,163				168,442
Ending cash and cash equivalents		$	346,774			$	231,768

Flagstar Bancorp, Inc.
Consolidated Statements of Cash Flows – Continued
(In thousands)

		For the nine months ended
		September 30,
		2006				2005
		(Unaudited)
Supplemental disclosure of cash flow information:
Loans held for investment transferred to repossessed assets		$	77,322			$	38,351
Total interest payments made on deposits and other borrowings		$	419,421			$	320,323
Federal income taxes paid		$	61,253			$	—
Mortgage loans available for sale transferred to held for investment		$	247,771			$	735,907
Mortgage loans held for investment transferred to available for sale		$	1,256,646			$	—
Recharacterization of loans held for investment to mortgage-backed securities held to maturity		$	440,707			$	834,848

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

Flagstar Bancorp, Inc.

Note 1. Nature of Business

          Flagstar Bancorp, Inc. (“Flagstar” or the “Company”) is a New York Stock Exchange – listed company (NYSE: FBC) headquartered in Troy, Michigan, which serves as the holding company for Flagstar Bank, FSB (the “Bank”), a federally chartered stock savings bank founded in 1987. With $15.1 billion in assets at September 30, 2006, Flagstar is the largest publicly traded savings bank headquartered in the Midwest.

          The Company’s principal business is investing in various types of loans using funds obtained in the form of deposits and borrowings. The acquisition or origination of single-family mortgage loans is the Company’s primary lending activity. The Company also originates consumer loans, commercial real estate loans, and non-real estate commercial loans.

          The Company sells or securitizes most of the mortgage loans that it originates, and it generally retains the right to service the mortgage loans it sells. These mortgage servicing rights (“MSRs”) generate loan administration income for the Company before amortization and are periodically sold by the Company as the related loans are originated (“flow basis”) or after a sufficient amount of MSRs have been accumulated (“bulk basis”) in transactions separate from the sale of the underlying mortgages. The Company may also retain loans for its own portfolio as part of its asset growth and retail bank strategies and to receive the interest spread between interest-earning assets and interest-paying liabilities.

          The Bank is a member of the Federal Home Loan Bank of Indianapolis (“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 up to the applicable limits.

          On May 30, 2006, the Company formed Flagstar Capital Markets Corporation (“FCMC”) as a wholly-owned subsidiary of the Bank. FCMC performs functions that were previously handled by the Bank’s capital markets group, which were transferred to FCMC at the time of its creation. These functions include maintaining investment loans on the balance sheet, the purchase of securities, the sale and securitization of mortgage loans, the maintenance and sale of mortgage servicing rights, the development of new loan products, the establishment of pricing for mortgage loans to be acquired, providing for lock-in support, and the management of the interest rate risk associated with these activities.

Note 2. Basis of Presentation

          The accompanying unaudited consolidated financial statements include the accounts of the Company and its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated. In accordance with current accounting principles, the Company’s trust subsidiaries are not consolidated. In addition, certain prior period amounts have been reclassified to conform to the current period presentation.

          The unaudited consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. The accompanying interim financial statements are unaudited; however, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the three and nine month periods ended September 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, you should refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The Form 10-K can be found on the Company’s Investor Relations web page, at www.flagstar.com, and on the website of the Securities and Exchange Commission, at www.sec.gov.

Note 3. Recent Accounting Developments

Servicing of Financial Assets

     In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140.” SFAS No. 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. It requires all separately recognized servicing assets and servicing liabilities to be initially

measured at fair value. SFAS No. 156 permits an entity to choose either an amortization or fair value measurement method for each class of separately recognized servicing assets and servicing liabilities. It also permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights. Lastly, it requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value and additional disclosures for all separately recognized servicing assets and servicing liabilities. The Company early-adopted SFAS No. 156 and elected to retain the amortization method for all classes of servicing assets. Had the Company elected the fair value method on January 1, 2006, the Company’s retained earnings would have increased by approximately $68 million, net of tax.

Accounting for Uncertainty in Income Taxes

     In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109,” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The standard is required to be adopted by the Company on January 1, 2007. Management is currently analyzing the impact of this interpretation on the Company’s financial condition, results of operation and liquidity.

Establishing Standards on Measuring Fair Value

     In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP, and expands disclosures about fair value measurements. The statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date. The statement emphasizes that fair value is a market-based measurement and not an entity-specific measurement. It also establishes a fair value hierarchy used in fair value measurements and expands the required disclosures of assets and liabilities measured at fair value. Management will be required to adopt this statement beginning in 2008. The adoption of this standard is not expected to have a material impact on the Company’s financial condition, results of operation or liquidity.

Accounting for Defined Benefit Pension and Other Postretirement Plans

     In September 2006, the FASB issued SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 amends SFAS statements No. 87, 88, 106 and 132(R). SFAS No. 158 requires employers to recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. Secondly, it requires employers to measure the plans assets and obligations that determine its funded status as of the end of the fiscal year. Lastly, employers are required to recognize changes in the funded status of a defined benefit postretirement plan in the year that the changes occur with the changes reported in comprehensive income. The standard is required to be adopted by entities having fiscal years ending after December 15, 2006. Because the Company does not have any defined benefit plans or other post retirement plans, this standard is not expected to have an impact on the Company’s financial condition, results of operation or liquidity.

Quantifying Financial Statement Misstatements

     In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 expresses the views of the SEC regarding the process of quantifying financial statement misstatements to determine if any restatement of prior financial statements is required. The statement addresses the two techniques commonly used in practice in accumulating and quantifying misstatements, and requires that the technique with the most severe result be used in determining whether a misstatement is material. The standard is required to be adopted by the Company on January 1, 2007. The adoption of this standard is not expected to have a material impact on the Company’s financial condition, results of operation or liquidity.

Note 4. Stock-Based Compensation

          On May 26, 2006, the Company’s shareholders approved the Flagstar Bancorp, Inc. 2006 Equity Incentive Plan (the “2006 Plan”). The 2006 Plan consolidates, amends and restates the Company’s 1997 Employees and Directors Stock Option Plan, its 2000 Stock Incentive Plan, and its 1997 Incentive Compensation Plan (each, a “Prior Plan”). Awards still outstanding under any of the Prior Plans will continue to be governed by their respective terms. Under the 2006 Plan, key employees, officers, directors and others expected to provide significant services to the Company and its affiliates are eligible to receive

10

awards. Awards that may be granted under the 2006 Plan include stock options, incentive stock options, cash-settled stock appreciation rights, restricted stock units, performance shares and performance units and other awards.

          Under the 2006 Plan, the exercise price of any option granted must be at least equal to the fair market value of the Company’s common stock on the date of grant. Non-qualified stock options granted to directors expire five years from the date of grant. Grants other than non-qualified stock options have term limits set by the Board in the applicable agreement. Stock appreciation rights expire seven years from the date of grant.

          In December 2004, the FASB issued SFAS No. 123R (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which requires that compensation costs related to share-based payment transactions be recognized in financial statements. SFAS No. 123R eliminated the alternative to use the intrinsic method of accounting previously allowed under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” which generally did not require any compensation expense to be recognized in the financial statements for the grant of stock options to employees if certain conditions were met . Only certain pro forma disclosures of share-based payments were required.

          On January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective method. SFAS No. 123R requires all share-based payment to employees, including grants of employee stock options, to be recognized as expense in the consolidated statement of earnings based on their fair values. The amount of compensation expense is determined based on the fair value of the options when granted and is expensed over the required service period, which is normally the vesting period of the options. SFAS No. 123R applies to awards granted or modified on or after January 1, 2006, and to any unvested awards that were outstanding at December 31, 2005. Consequently, compensation expense is recorded for prior option grants that vest on or after January 1, 2006, the date of adoption.

          Prior to the adoption of SFAS No. 123R, the Company accounted for its Prior Plan under the recognition and measurement principles of APB Opinion No. 25. The Company reported all tax benefits resulting from the exercise of stock options as financing cash flows in the consolidated statements of cash flows. In accordance with SFAS No. 123R, for the period beginning January 1, 2006, only the excess tax benefits from the exercise of stock options are presented as financing cash flows. The excess tax benefits totaled $0.1 million and $0.9 million for the three and nine months ended September 30, 2006, respectively.

          The fair value concepts were not changed significantly in SFAS No. 123R; however, in adopting this standard, companies must choose among alternative valuation models and amortization assumptions. The Company has elected to continue to use both the Black-Scholes option pricing model and the straight-line method of amortization of compensation expense over the requisite service period of the grant. The Company will reconsider use of the Black-Scholes model if additional information in the future indicates another model would be more appropriate at that time, or if grants issued in future periods have characteristics that could not be reasonably estimated using this model.

          The Company used the following weighted average assumptions in applying the Black-Scholes model to determine the fair value of options it issued during the year ended December 31, 2005: dividend yield of 4.80%; expected volatility of 45.28%; a risk-free rate of 3.80%; and an expected life of five years. There were no options granted during the nine-month period ending September 30, 2006.

          The following table summarizes the activity that occurred in the nine month period ended September 30, 2006, and the year ended December 31, 2005:

		Number of Shares
		September 30,				December 31,
		2006				2005
		(Unaudited)
Options outstanding, beginning of period			3,417,366				4,961,529
Options granted			—				372,792
Options exercised			(326,340	)			(1,788,354	)
Options canceled, forfeited and expired			(23,234	)			(128,601	)
Options outstanding, end of period			3,067,792				3,417,366
Options exercisable, end of period			2,920,342				2,861,884

		Weighted Average Exercise Price
		September 30,				December 31,
		2006				2005
		(Unaudited)
Options outstanding, beginning of period		$	13.20			$	9.34
Options granted			—				20.50
Options exercised			6.11				4.17
Options canceled, forfeited and expired			17.27				15.64
Options outstanding, end of period			13.73				13.20
Options exercisable, end of period			13.79				13.20

          The following information pertains to the stock options under the Prior Plans, and now contained in the 2006 Plan, that were not exercised at September 30, 2006 (unaudited):

		Options Outstanding												Options Exercisable
						Weighted
		Number of				Average				Weighted				Number of				Weighted
		Options				Remaining				Average				Options				Average
		Outstanding at				Contractual				Exercise				Exercisable at				Exercise
Range of Grant Price		September 30, 2006				Life (Years)				Price				September 30, 2006				Price
$   1.76			130,149				3.76			$	1.76				130,149			$	1.76
1.96 – 4.77			28,050				2.44				3.49				28,050				3.49
5.01			94,738				4.64				5.01				94,738				5.01
5.29 – 6.06			108,401				2.72				5.34				108,401				2.72
11.80			1,120,831				4.35				11.80				1,120,831				11.80
12.27 – 15.23			771,149				4.83				12.31				623,699				12.27
19.35 – 20.06			36,429				5.82				19.70				36,429				19.70
20.73			339,863				6.84				20.73				339,863				20.73
22.68			287,456				7.28				22.68				287,456				22.68
24.72			150,726				6.70				24.72				150,726				24.72
			3,067,792							$	13.73				2,920,342			$	13.79

At September 30, 2006, the number of options available for future grants was 2,293,514.

          The Company used the following weighted average assumptions in applying the Black-Scholes model to determine the fair value of the cash-settled stock appreciation rights it issued during the nine months ended September 30, 2006: dividend yield of 3.68%; expected volatility of 21.98%; a risk-free rate of 4.99%; and an expected life of five years.

          The following table presents the status and changes in cash-settled stock appreciation rights issued under the 2006 Plan:

						Weighted Average
Stock Appreciation Rights Awarded:		Shares				Fair Value
Non-vested balance at December 31, 2005			—
Granted			328,873			$	2.10
Vested			—
Forfeited			—
Non-vested balance at September 30, 2006			328,873

          The following table illustrates the effect on net earnings and earnings per share as of and for the three and nine months ended September 30, 2005 as if the Company had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation (in thousands, except per share data):

		For the three				For the nine
		months ended				months ended
		September 30, 2005				September 30, 2005
Net earnings, as reported		$	9,460			$	57,038
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(654	)			(1,962	)
Pro forma net earnings		$	8,806			$	55,076
Basic earnings per share
As reported		$	0.15			$	0.92
Pro forma		$	0.14			$	0.89
Diluted earnings per share
As reported		$	0.15			$	0.89
Pro forma		$	0.14			$	0.86

          For the three and nine months ended September 30, 2006, the Company recorded stock-based compensation expense of $0.4 million ($0.3 million net of tax) and $1.8 million ($1.2 million net of tax), respectively or less than $0.01 per share and $0.02 per share, diluted. The future effect of SFAS No. 123R on results of operations will depend on the level of future grants, the vesting period of those grants, the fair value of the options granted at such date and the fair value of the cash-settled stock appreciation rights. Consequently, the current effects on the Company’s results as a result of adopting FASB No. 123R in 2006 are not necessarily representative of effects for future periods.

Note 5. Securities Available for Sale

          The Company recorded $26.1 million in residual interests as of December 31, 2005, as a result of its non-agency securitization of $600 million in home equity line of credit loans (the “HELOC Securitization”). In addition, each month, draws on the home equity lines of credit in the trust established in the HELOC Securitization are purchased from the Company by the trust, resulting in additional residual interests to the Company. These residual interests are recorded as securities available for sale and are therefore recorded at fair value. Any gains or losses realized on the sale of such securities or any unrealized losses that are deemed to be other-than-temporarily impaired (“OTTI”) are reported in the consolidated statement of earnings. All unrealized gains or losses that are deemed to be temporary are reported in the consolidated statement of stockholders’ equity and comprehensive income under accumulated other comprehensive income.

          At September 30, 2006, key assumptions used in determining the fair value of residual interests resulting from the securitization completed in December 2005 were a prepayment speed of 52%, projected credit losses of 1.25% and a discount rate of 15%.

          On April 28, 2006, the Company completed a guaranteed mortgage securitization transaction of approximately $400 million of fixed second mortgage loans that the Company held at the time in its investment portfolio (the “Second Mortgage Securitization”). The transaction was treated as a recharacterization of loans held for investment to mortgage-backed securities held to maturity, and therefore no gain on sale was recorded. The securitization resulted in the Company recording a residual interest of approximately $9.9 million that is carried as a security available for sale. At September 30, 2006, key assumptions used in determining the value of residual interests resulting from this securitization were a prepayment speed of 25%, projected credit losses of 1.50% and a discount rate of 15%.

          The table below sets forth key economic assumptions and the hypothetical sensitivity of the fair value of residual interests to an immediate adverse change in any single key assumption. Changes in fair value based on 10% and 20% variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The effect of a variation in a particular assumption on the fair value of the residual interest is calculated without changing any other assumptions. In practice, changes in one factor may result in changes in other factors, such as increases in market interest rates, that may magnify or counteract sensitivities.

		Assumptions
						Prepayment				Projected				Discount
HELOC Securitization		Fair Value				Speed				Credit Losses				Rate
		(Dollars in thousands)
Residual asset as of September 30, 2006		$	20,938				52	%			1.25	%			15	%
Impact on fair value of 10% adverse change in assumption						$	1,443			$	388			$	509
Impact on fair value of 20% adverse change in assumption						$	2,597			$	776			$	999

		Assumptions
Second Mortgage						Prepayment				Projected				Discount
Securitization		Fair Value				Speed				Credit Losses				Rate
		(Dollars in thousands)
Residual asset as of September 30, 2006		$	11,357				25	%			1.50	%			15	%
Impact on fair value in 10% adverse change in assumption						$	56			$	409			$	583
Impact on fair value in 20% adverse change in assumption						$	117			$	818			$	1,126

Note 6. Segment Information

          The Company’s operations are comprised of two business segments: banking and home lending. Each business operates under the same banking charter and is complementary to the other, but is reported on a segmented basis for this report.

          The banking operation includes the gathering of deposits and investing those deposits in duration-matched assets, such as loans and securities. It holds these loans in the investment portfolio in order to earn income based on the difference, or “spread,” between the interest earned on loans and the interest paid for deposits and other borrowed funds. All of the non-bank consolidated subsidiaries are included in the banking operation.

          The home lending operation involves the origination, packaging and sale of loans in order to receive transaction income. The lending operation also services mortgage loans for others and sells the related MSRs in the secondary market. Funding for the lending operation is provided by deposits garnered and borrowings incurred by the banking group, as well as proceeds from loan sales and MSR sales generated by the home lending group.

          Following is a presentation of financial information by segment for the periods indicated (in thousands):

		For the three months ended September 30, 2006
		Banking				Home Lending
2006:		Operation				Operation				Elimination				Combined
Net interest income		$	42,111			$	11,517			$	—			$	53,628
Gain on sale revenue			—				37,005				—				37,005
Other income			4,159				13,174				—				17,333
Total net interest income and non-interest income			46,270				61,696				—				107,966
Earnings before federal income taxes			14,378				17,444				—				31,822
Depreciation and amortization			2,492				15,173				—				17,665
Capital expenditures			7,407				1,641				—				9,048
Identifiable assets			14,416,661				3,753,364				(3,050,000	)			15,120,025
Inter-segment income (expense)			22,875				(22,875	)			—				—

		For the nine months ended September 30, 2006
		Banking				Home Lending
		Operation				Operation				Elimination				Combined
Net interest income		$	124,798			$	38,243			$	—			$	163,041
Gain on sale revenue			—				107,257				—				107,257
Other income			18,410				32,865				—				51,275
Total net interest income and non-interest income			143,208				178,365				—				321,573
Earnings before federal income taxes			47,589				57,494				—				105,083
Depreciation and amortization			7,209				72,920				—				80,129
Capital expenditures			29,504				2,382				—				31,886
Identifiable assets			14,416,661				3,753,364				(3,050,000	)			15,120,025
Inter-segment income (expense)			57,300				(57,300	)			—				—

		For the three months ended September 30, 2005
		Banking				Home Lending
2005:		Operation				Operation				Elimination				Combined
Net interest income		$	44,162			$	16,612			$	—			$	60,774
Gain on sale revenue			—				3,918				—				3,918
Other income			15,982				867				—				16,849
Total net interest income and non-interest income			60,144				21,397				—				81,541
Earnings before federal income taxes			33,559				(18,936	)			—				14,623
Depreciation and amortization			2,384				34,844				—				37,228
Capital expenditures			4,901				5,918				—				10,819
Identifiable assets			14,442,011				2,215,034				(1,200,000	)			15,457,045
Inter-segment income (expense)			9,000				(9,000	)			—				—

		For the nine months ended September 30, 2005
		Banking				Home Lending
		Operation				Operation				Elimination				Combined
Net interest income		$	136,708			$	47,718			$	—			$	184,426
Gain on sale revenue			—				52,353				—				52,353
Other income			40,392				18,452				—				58,844
Total net interest income and non-interest income			177,100				118,523				—				295,623
Earnings before federal income taxes			91,657				(2,899	)			—				88,758
Depreciation and amortization			7,455				81,809				—				89,264
Capital expenditures			24,498				10,889				—				35,387
Identifiable assets			14,442,011				2,215,034				(1,200,000	)			15,457,045
Inter-segment income (expense)			31,275				(31,275	)			—				—

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

          Where we say “we,” “us,” or “our,” we usually mean Flagstar Bancorp, Inc. In some cases, a reference to “we,” “us,” or “our” will include our wholly-owned subsidiary Flagstar Bank, FSB, and FCMC, its wholly-owned subsidiary, which we collectively refer to as the “Bank.”

General

          We have no significant business other than of the Bank. Operations of the Bank are categorized into two business segments: banking and home lending. Each segment operates under the same banking charter but is reported on a segmented basis for financial reporting purposes. For certain financial information concerning the results of operations of our banking and home lending operations, see Note 6 of the Notes to Consolidated Financial Statements, in Item 1, Financial Statements, herein.

          Banking Operation. We provide a full range of banking services to consumers and small businesses in Michigan, Indiana and Georgia. Our banking operation involves the gathering of deposits and the borrowing of funds and investing all these amounts in duration-matched assets consisting primarily of mortgages originated by our home lending operation. The banking operation holds these loans in its loans held for investment portfolio in order to earn income based on the difference, or “spread,” between the interest earned on loans and the interest paid for deposits and other borrowed funds. At September 30, 2006, we operated a branch network of 146 banking centers. We continue to focus on expanding our branch network to increase our access to retail deposit funding sources. During the first nine months of 2006, we opened 10 banking centers. During the remainder of 2006, we expect to open a total of five more banking centers in the Atlanta area.

          Home Lending Operation. Our home lending operation originates, packages and sells residential mortgage loans in order to generate transactional income. The home lending operation also services mortgage loans on a fee basis for others and sells MSRs in the secondary market. Funding for our home lending operation is provided by deposits obtained from our banking operations, other borrowings and proceeds from loan sales and MSR sales.

Critical Accounting Policies

          Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, we have identified four policies that, due to the judgment, estimates and assumptions inherent in those policies, are critical to an understanding of our consolidated financial statements. These policies relate to: (a) the determination of our allowance for loan losses; (b) the valuation of our MSRs; (c) the valuation of our derivatives; and (d) the determination of our secondary market reserve. We believe that the judgment, estimates and assumptions used in the preparation of our consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. For further information on our critical accounting policies, please refer to our Annual Report on Form 10-K for the year ended December 31, 2005, which is available on our website, www.flagstar.com, under the Investor Relations section, or on the website of the SEC, at www.sec.gov.

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

		For the three months ended								For the nine months ended
		September 30,								September 30,
		2006				2005				2006				2005
Return on average assets			0.55	%			0.25	%			0.60	%			0.52	%
Return on average equity			10.10	%			5.03	%			12.23	%			10.19	%
Efficiency ratio			63.8	%			77.5	%			62.0	%			65.6	%
Equity/assets ratio (average for the period)			5.46	%			4.95	%			4.93	%			5.14	%
Mortgage loans originated or purchased		$	4,633,986			$	8,306,439			$	13,882,989			$	22,623,153
Other loans originated or purchased		$	200,161			$	489,665			$	885,158			$	1,274,541
Mortgage loans sold		$	4,045,915			$	6,983,384			$	11,904,611			$	18,312,923
Interest rate spread – Bank only 1			1.44	%			1.63	%			1.44	%			1.69	%
Net interest margin – Bank only 2			1.67	%			1.84	%			1.65	%			1.90	%
Interest rate spread – Consolidated 1			1.47	%			1.68	%			1.48	%			1.74	%
Net interest margin – Consolidated 2			1.54	%			1.72	%			1.57	%			1.85	%
Average common shares outstanding (000’s)			63,548				62,288				63,475				61,945
Average fully diluted shares outstanding (000’s)			64,304				64,186				64,323				64,118
Charge-offs to average investment loans (annualized)			0.18	%			0.16	%			0.19	%			0.18	%

		September 30,				June 30,				December 31,				September 30,
		2006				2006				2005				2005
Equity-to-assets ratio			5.39	%			5.28	%			5.12	%			4.83	%
Core capital ratio 3			6.52	%			6.39	%			6.26	%			5.99	%
Total risk-based capital ratio 3			11.52	%			11.15	%			11.09	%			10.44	%
Book value per share		$	12.82			$	12.65			$	12.21			$	11.96
Number of common shares outstanding			63,571				63,529				63,208				62,368
Mortgage loans serviced for others		$	14,829,396			$	22,379,937			$	29,648,088			$	31,282,929
Capitalized value of mortgage servicing rights			1.02	%			1.03	%			1.06	%			1.13	%
Ratio of allowance to non-performing loans			77.1	%			79.2	%			60.7	%			69.6	%
Ratio of allowance to loans held for investment			0.48	%			0.42	%			0.37	%			0.31	%
Ratio of non-performing assets to total assets			1.05	%			0.99	%			0.98	%			0.86	%
Number of banking centers			146				145				137				129
Number of home lending centers			85				87				101				105
Number of salaried employees			2,559				2,548				2,405				2,414
Number of commissioned employees			491	4			530	4			689				790

RESULTS OF OPERATIONS

Net Earnings

          Three months. Net earnings for the three months ended September 30, 2006 was $20.8 million ($0.32 per share-diluted), an $11.3 million increase from the $9.5 million ($0.15 per share-diluted) reported in the comparable 2005 period. The overall increase resulted from a $33.6 million increase in non-interest income offset in part by a $5.6 million increase in non-interest expense, a $10.8 million decrease in net interest income after provision for loan losses and a $5.9 million increase in federal income tax expense.

          Nine months. Net earnings for the nine months ended September 30, 2006 was $68.3 million ($1.06 per share-diluted), an $11.3 million increase from the $57.0 million ($0.89 per share-diluted) reported in the comparable 2005 period. On a period-to-period comparison basis, there was a $47.3 million increase in non-interest income, offset by a $5.2 million increase in non-interest expense in the 2006 period, a $25.7 million decrease in net interest income after provision for loan losses and a $5.1 million increase in federal income tax expense.

Net Interest Income

          Three months. We recorded $53.6 million in net interest income for the three months ended September 30, 2006, an 11.8% decline from $60.8 million recorded for the comparable 2005 period. The decline reflects a $20.2 million increase in interest income offset by a $27.3 million increase in interest expense, primarily as a result of rates paid on deposits, FHLB advances and security repurchase agreements that increased more than the increase in yields earned on loans and mortgage-backed securities. In the three months ended September 30, 2006, as compared to the same period in 2005, we decreased our average interest-earning assets by $0.2 billion and our average interest-paying liabilities by $0.3 billion.

          Average interest-earning assets as a whole repriced up 67 basis points during the three months ended September 30, 2006, while average interest-bearing liabilities repriced up 88 basis points during the same period, resulting in the decrease in our net interest spread of 21 basis points to 1.47% for the three months ended September 30, 2006, from 1.68% for the comparable 2005 period.

          Nine months. We recorded $163.0 million in net interest income for the nine months ended September 30, 2006, an 11.6% decline from the $184.4 million recorded for the comparable 2005 period. The decline reflects a $74.9 million increase in interest income offset by a $96.3 million increase in interest expense, primarily as a result of rates paid on deposits, FHLB advances and security repurchase agreements that increased to a greater extent than the increase in yields earned on loans and mortgage-backed securities. In this same period, our average paying liabilities increased by $0.1 billion more than the increase in our average interest-earning assets. This caused a decline in the ratio of average interest-earning assets to average interest-bearing liabilities for the nine months ended September 30, 2006 to 102% from 103% for the nine months ended September 30, 2005. Together, the effect of these rate and volume changes resulted in the reduction in the net interest margin, to 1.57% for the third quarter of 2006 from 1.85% for the third quarter of 2005.

          Average interest-earning assets as a whole repriced up 51 basis points during the nine months ended September 30, 2006 while average interest-bearing liabilities repriced up 77 basis points during the same period, resulting in the decrease in our net interest spread of 26 basis points to 1.48% for the nine months ended September 30, 2006 from 1.74% for the comparable 2005 period.

     Average Yields Earned and Rates Paid. The following table presents interest income from average interest-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 net deferred loan origination costs of $6.0 million and $7.4 million for the three months ended September 30, 2006 and 2005, respectively. For both the nine months ended September 30, 2006 and 2005, interest income from earning assets included $21.2 million of amortization of net premiums and net deferred loan origination costs. Non-accruing loans were included in the average loan amounts outstanding.

		Three months ended September 30,
		2006												2005
		(Dollars in thousands)
		Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Loans receivable, net		$	12,137,127			$	184,328				6.07	%		$	13,739,838			$	180,698				5.26	%
Mortgage-backed securities-held to maturity			1,621,748				19,878				4.90				286,238				4,502				6.29
Other			55,822				1,351				9.67				27,022				191				2.84
Total interest-earning assets			13,814,697			$	205,557				5.95	%			14,053,098			$	185,391				5.28	%
Other assets			1,232,581												1,162,432
Total assets		$	15,047,278											$	15,215,530
Interest-bearing liabilities:
Deposits		$	8,040,584			$	87,054				4.30	%		$	8,220,828			$	67,819				3.27	%
FHLB advances			4,236,896				48,677				4.56				5,098,832				51,593				4.01
Security repurchase agreements			975,901				13,161				5.35				—				—				—
Other			207,751				3,037				5.85				409,200				5,205				5.09
Total interest-bearing liabilities			13,461,132			$	151,929				4.48	%			13,728,860			$	124,617				3.60	%
Other liabilities			764,447												734,062
Stockholders’ equity			821,699												752,608
Total liabilities and stockholders’ equity		$	15,047,278											$	15,215,530
Net interest-earning assets		$	353,565											$	324,238
Net interest income						$	53,628											$	60,774
Interest rate spread1											1.47	%											1.68	%
Net interest margin2											1.54	%											1.72	%
Ratio of average interest-earning assets to average interest-bearing liabilities											103	%											102	%