United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
|X| Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarterly period ended September 30, 2002.
OR
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from _______________ to
______________.
Commission File Number: 1-14100
Impac Mortgage Holdings, Inc.
(Exact name of registrant as specified in its charter)
Maryland 33-0675505
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1401 Dove Street
Newport Beach, CA 92660
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (949) 475-3600
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
------------------------------- ------------------------
Common Stock $0.01 par value American Stock Exchange
Preferred Share Purchase Rights American Stock Exchange
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 90 days. Yes |X| No |_|
On November 11, 2002, the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $451.7 million, based on
the closing sales price of the common stock on the American Stock Exchange. For
purposes of the calculation only, in addition to affiliated companies, all
directors and executive officers of the registrant have been deemed affiliates.
The number of shares of common stock outstanding as of November 11, 2002 was
43,477,853.
IMPAC MORTGAGE HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS -
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001........................... 3
Consolidated Statements of Operations and Comprehensive Earnings (Loss), For the Three and Nine
Months Ended September 30, 2002 and 2001............................................................. 4
Consolidated Statements of Cash Flows, For the Nine Months Ended September 30, 2002 and 2001......... 5
Notes to Consolidated Financial Statements........................................................... 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................................................ 17
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................... 45
Item 4. CONTROLS AND PROCEDURES.............................................................................. 47
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.................................................................................... 48
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................................................ 48
Item 3. DEFAULTS UPON SENIOR SECURITIES...................................................................... 48
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................. 48
Item 5. OTHER INFORMATION.................................................................................... 48
Item 6. EXHIBITS AND REPORTS ON FORM 8-K..................................................................... 48
SIGNATURES........................................................................................... 49
CERTIFICATIONS....................................................................................... 50
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
(unaudited)
September 30, December 31,
2002 2001
------------- ------------
ASSETS
Cash and cash equivalents .......................................................... $ 110,060 $ 51,887
Investment securities available-for-sale ........................................... 27,494 32,989
Loans Receivable:
CMO collateral ................................................................... 4,006,065 2,229,168
Finance receivables .............................................................. 916,439 466,649
Mortgage loans held-for-investment ............................................... 274,138 20,078
Allowance for loan losses ........................................................ (21,564) (11,692)
----------- -----------
Net loans receivable .......................................................... 5,175,078 2,704,203
Accrued interest receivable ........................................................ 22,948 14,565
Investment in Impac Funding Corporation ............................................ 19,226 19,126
Due from affiliates ................................................................ 14,500 14,500
Other real estate owned ............................................................ 11,181 8,137
Derivative assets .................................................................. 13,535 5,128
Other assets ....................................................................... 2,235 4,199
----------- -----------
Total assets .................................................................. $ 5,396,257 $ 2,854,734
=========== ===========
LIABILITIES
CMO borrowings ..................................................................... $ 3,918,500 $ 2,151,400
Reverse repurchase agreements ...................................................... 1,167,680 469,491
Borrowings secured by investment securities available-for-sale ..................... 8,391 12,997
Accumulated dividends payable ...................................................... 19,309 14,081
Other liabilities .................................................................. 7,849 3,400
----------- -----------
Total liabilities ............................................................. 5,121,729 2,651,369
STOCKHOLDERS' EQUITY
Preferred stock; $0.01 par value; 7,500,000 and 6,300,00 shares authorized; none
outstanding at September 30, 2002 and December 31, 2001, respectively ............ -- --
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares
authorized; none outstanding at September 30, 2002 and December 31, 2001 ......... -- --
Series C 10.5% cumulative convertible preferred stock, $0.01 par value; none and
1,200,000 shares authorized; none outstanding at September 30, 2002 and
December 31, 2001, respectively .................................................. -- --
Common stock; $0.01 par value; 200,000,000 shares authorized; 42,908,092 and
32,001,997 shares outstanding at September 30, 2002 and December 31, 2001,
respectively ..................................................................... 429 320
Additional paid-in capital ......................................................... 453,191 359,279
Accumulated other comprehensive loss ............................................... (44,195) (19,857)
Notes receivable from common stock sales ........................................... -- (920)
Net accumulated deficit:
Cumulative dividends declared .................................................... (179,200) (126,952)
Retained earnings (accumulated deficit) .......................................... 44,303 (8,505)
----------- -----------
Net accumulated deficit ......................................................... (134,897) (135,457)
----------- -----------
Total stockholders' equity .................................................... 274,528 203,365
----------- -----------
Total liabilities and stockholders' equity .................................... $ 5,396,257 $ 2,854,734
=========== ===========
See accompanying notes to consolidated financial statements.
3
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
and COMPREHENSIVE EARNINGS (LOSS)
(in thousands, except earnings per share data)
(unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------- ------------------------
2002 2001 2002 2001
-------- -------- --------- ---------
INTEREST INCOME:
Mortgage assets ......................................... $ 59,736 $ 38,355 $ 150,438 $ 114,157
Other interest income ................................... 1,963 613 3,558 1,875
-------- -------- --------- ---------
Total interest income ................................. 61,699 38,968 153,996 116,032
-------- -------- --------- ---------
INTEREST EXPENSE:
CMO borrowings .......................................... 31,091 19,249 79,021 57,016
Reverse repurchase agreements ........................... 6,086 7,688 15,724 25,485
Borrowings secured by investment securities ............. 431 620 1,455 1,958
Other borrowings ........................................ 982 24 1,487 743
-------- -------- --------- ---------
Total interest expense ................................ 38,590 27,581 97,687 85,202
-------- -------- --------- ---------
Net interest income ..................................... 23,109 11,387 56,309 30,830
Provision for loan losses ............................. 5,361 2,615 13,302 10,559
-------- -------- --------- ---------
Net interest income after provision for loan losses ..... 17,748 8,772 43,007 20,271
NON-INTEREST INCOME:
Equity in net earnings of Impac Funding Corporation ..... 2,755 3,039 12,816 7,857
Loan servicing fees ..................................... 28 228 145 809
Other income ............................................ 1,194 1,094 3,074 2,610
-------- -------- --------- ---------
Total non-interest income ............................. 3,977 4,361 16,035 11,276
NON-INTEREST EXPENSE:
Professional services ................................... 708 646 2,649 1,728
General and administrative and other expense ............ 533 415 1,099 1,339
Personnel expense ....................................... 534 290 1,326 866
Loss (gain) on disposition of other real estate owned ... 514 (619) 120 (1,584)
Write-down on investment securities ..................... 2 1,841 1,040 1,949
Mark-to-market loss on derivative instruments ........... -- 2,269 -- 3,713
-------- -------- --------- ---------
Total non-interest expense ............................ 2,291 4,842 6,234 8,011
-------- -------- --------- ---------
Earnings before extraordinary item and cumulative
effect of change in accounting principle ................ 19,434 8,291 52,808 23,536
Extraordinary item .................................... -- -- -- (1,006)
Cumulative effect of change in accounting principle ... -- -- -- (4,313)
-------- -------- --------- ---------
Net earnings ............................................ 19,434 8,291 52,808 18,217
Less: Cash dividends on 10.5% cumulative convertible
preferred stock ..................................... -- -- -- (1,575)
-------- -------- --------- ---------
Net earnings available to common stockholders ........... 19,434 8,291 52,808 16,642
Comprehensive earnings (loss):
Unrealized losses on securities arising during period:
Unrealized holding gains (losses) on investment
securities available-for-sale ....................... (487) 10,724 (1,041) 12,624
Unrealized holding losses on derivative instruments ... (13,818) (23,496) (23,112) (23,740)
Less: Reclassification of realized losses included
in net earnings ..................................... (28) (123) (185) (924)
-------- -------- --------- ---------
Net unrealized losses arising during period ........ (14,333) (12,895) (24,338) (12,040)
-------- -------- --------- ---------
Comprehensive earnings (loss) ........................... $ 5,101 $ (4,604) $ 28,470 $ 6,177
======== ======== ========= =========
See accompanying notes to consolidated financial statements.
4
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
and COMPREHENSIVE EARNINGS (LOSS) - continued
(in thousands, except per share data)
(unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
Earnings per share before extraordinary item and
cumulative effect of change in accounting principle:
Basic .............................................. $ 0.47 $ 0.37 $ 1.36 $ 0.97
======== ======== ======== ========
Diluted ............................................ $ 0.47 $ 0.31 $ 1.34 $ 0.87
======== ======== ======== ========
Net earnings per share:
Basic .............................................. $ 0.47 $ 0.37 $ 1.36 $ 0.74
======== ======== ======== ========
Diluted ............................................ $ 0.47 $ 0.31 $ 1.34 $ 0.68
======== ======== ======== ========
Dividends declared per common share ................... $ 0.45 $ 0.25 $ 1.28 $ 0.25
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
5
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Nine Months
Ended September 30,
--------------------------
2002 2001
----------- ---------
Cash flows from operating activities:
Net earnings ......................................................................... $ 52,808 $ 22,530
Adjustments to reconcile net earnings to net cash provided by operating activities:
Cumulative effect of change in accounting principle ................................ -- (4,313)
Equity in net earnings of Impac Funding Corporation ................................ (12,816) (7,857)
Provision for loan losses .......................................................... 13,302 10,559
Amortization of loan premiums and securitization costs ............................. 26,185 9,949
Gain on disposition of other real estate owned ..................................... (120) (1,584)
Write-down of investment securities available-for-sale ............................. 1,040 1,949
Write-off of securitization costs from senior subordinated debentures .............. -- 1,006
Gain on sale of investment securities available-for-sale ........................... -- (159)
Net change in accrued interest receivable .......................................... (8,383) 42
Net change in other assets and liabilities ......................................... (1,994) (26,066)
----------- ---------
Net cash provided by operating activities ........................................ 70,022 6,056
----------- ---------
Cash flows from investing activities:
Net change in CMO collateral ......................................................... (1,835,450) (315,015)
Net change in finance receivables .................................................... (449,790) (59,671)
Net change in mortgage loans held-for-investment ..................................... (258,888) (143,976)
Proceeds from sale of other real estate owned, net ................................... 8,295 7,980
Dividend from Impac Funding Corporation .............................................. 9,900 6,419
Sale of investment securities available-for-sale ..................................... -- 5,154
Net principal reductions on investment securities available-for-sale ................. 5,480 2,660
----------- ---------
Net cash used in investing activities ............................................ (2,520,453) (496,449)
----------- ---------
Cash flows from financing activities:
Net change in reverse repurchase agreements and other borrowings ..................... 693,583 193,469
Proceeds from CMO borrowings ......................................................... 2,433,254 758,296
Repayments of CMO borrowings ......................................................... (666,154) (451,644)
Dividends paid ....................................................................... (47,020) (2,363)
Retirement of senior subordinated debentures ......................................... -- (7,747)
Proceeds from sale of common stock ................................................... 83,957 --
Proceeds from sale of common stock via Sales Agency Agreement ........................ 9,310 --
Proceeds from exercise of stock options .............................................. 754 337
Reductions (advances) on notes receivable-common stock ............................... 920 (28)
----------- ---------
Net cash provided by financing activities ........................................ 2,508,604 490,320
----------- ---------
Net change in cash and cash equivalents .............................................. 58,173 (73)
Cash and cash equivalents at beginning of period ..................................... 51,887 17,944
----------- ---------
Cash and cash equivalents at end of period ........................................... $ 110,060 $ 17,871
=========== =========
Supplementary information:
Interest paid ........................................................................ $ 96,398 $ 86,592
Non-cash transactions:
Transfer of mortgage loans held-for-investment to CMO collateral ..................... $ 2,449,994 $ 763,123
Dividends declared and unpaid ........................................................ 19,309 6,708
Accumulated other comprehensive loss ................................................. (24,338) (12,040)
Loans transferred to other real estate owned ......................................... 11,219 7,793
Redemption of preferred stock into common stock ...................................... -- 28,658
See accompanying notes to consolidated financial statements.
6
1. Basis of Financial Statement Presentation
The accompanying consolidated financial statements of Impac Mortgage
Holdings, Inc. and subsidiaries (the Company) have been prepared in accordance
with accounting principles generally accepted in the United States of America
(GAAP) for interim financial information and with the instructions to Form 10-Q
and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments, consisting of normal recurring
adjustments, considered necessary for a fair presentation have been included.
Operating results for the three-and nine-month periods ended September 30, 2002
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. The accompanying consolidated financial statements
should be read in conjunction with the consolidated financial statements and
related notes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
References to the Company refers to Impac Mortgage Holdings, Inc., a
Maryland corporation incorporated in August 1995, and its subsidiaries, IMH
Assets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG) and, its
affiliate, Impac Funding Corporation (IFC), together with its wholly-owned
subsidiaries Impac Secured Assets Corp. and Novelle Financial Services, Inc.
(NFS). References to Impac Mortgage Holdings, Inc. (IMH) are made to
differentiate IMH, the publicly traded company, as a separate entity from IMH
Assets, IWLG and IFC. IMH is organized as a real estate investment trust (REIT)
for federal income tax purposes, which generally allows it to pass through
income to stockholders without federal income tax at the corporate level.
The Company's results of operations have been presented in the
consolidated financial statements for the three- and nine- months ended
September 30, 2002 and 2001 and include the financial results of IMH's equity
interest in net earnings of IFC, the mortgage operations. The results of
operations of IFC, of which 100% of IFC's preferred stock and 99% of its
economic interest is owned by IMH, are included in the results of operations as
"Equity in net earnings of Impac Funding Corporation." Additionally, the
Company's results of operations include the financial results of IMH Assets and
IWLG as stand-alone entities.
2. Organization
The Company acquires, originates, securitizes and invests primarily in
non-conforming Alt-A mortgage loans (Alt-A). Alt-A mortgage loans consist
primarily of mortgage loans that are first lien mortgage loans made to borrowers
whose credit is generally within typical Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)
guidelines, but that have loan characteristics that make them non-conforming
under those guidelines. For instance, the loans may have higher loan-to-value
(LTV) ratios than allowable under those guidelines or they may have been
originated without certain documentation or verifications required under those
guidelines. Therefore, in making credit decisions, the Company is more reliant
upon the borrower's credit score and the adequacy of the underlying collateral.
Management believes that Alt-A mortgage loans provide an attractive net earnings
profile by producing higher yields without commensurately higher credit losses
than other types of mortgage loans. Since 1999, the Company has acquired and
originated primarily Alt-A mortgage loans. The Company also provides warehouse
and repurchase financing to originators of mortgage loans. Our ultimate goal is
to generate consistent and reliable income for distribution to our stockholders
primarily from the earnings of our long-term investment operations.
The Company primarily operates three core businesses: the long-term
investment operations, the mortgage operations and the warehouse lending
operations.
The long-term investment operations, conducted by IMH and IMH Assets,
invest primarily in Alt-A mortgage loans acquired from IFC. This business
primarily generates net interest income on its mortgage loan investment
portfolio and, to a lesser extent, its investment securities portfolio. Alt-A
mortgage loans are financed with collateralized mortgage obligations (CMO),
reverse repurchase agreements and proceeds from the sale of capital stock.
The mortgage operations, conducted by IFC, acquire, originate, sell and
securitize primarily Alt-A mortgage loans and, to a lesser extent, sub-prime
mortgage loans (B/C loans). The mortgage operations generate income by
securitizing and selling loans to permanent investors, including the long-term
investment operations. This business also earns revenues from fees associated
with mortgage servicing rights, master servicing agreements and interest
7
income earned on loans held for sale. The mortgage operations primarily use
warehouse lines of credit to finance the acquisition and origination of mortgage
loans.
The warehouse lending operations, conducted by IWLG, provide short-term
financing to mortgage loan originators by funding mortgage loans from their
closing date until they are sold to pre-approved investors. The warehouse
lending operations earn fees, as well as a spread, from the difference between
its cost of borrowings and the interest earned on advances. Generally, the
Company seeks to acquire Alt-A mortgage loans funded with warehouse facilities
provided by the warehouse lending operations which provides synergies with the
long-term investment operations and mortgage operations.
3. Summary of Significant Accounting Policies
Method of Accounting
The consolidated financial statements are prepared on the accrual basis of
accounting in accordance with GAAP. The preparation of financial statements in
conformity with GAAP requires management to make significant estimates and
assumptions that affect the reported amounts of assets, liabilities and
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results may
differ materially from those estimates. Significant estimates made by management
include accounting for derivative instruments, hedging activities and loan loss
provisions.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets," (SFAS 142). SFAS 142 applies to all acquired intangible assets whether
acquired singularly, as part of a group, or in a business combination. SFAS 142
supersedes Accounting Principles Bulletin (APB) Opinion No. 17, "Intangible
Assets," and carries forward provisions in APB Opinion No. 17 related to
internally developed intangible assets. SFAS 142 changes the accounting for
goodwill from an amortization method to an impairment-only approach. Goodwill
should no longer be amortized, but instead tested for impairment at least
annually at the reporting unit level. The accounting provisions are effective
for fiscal years beginning after December 31, 2001. As of September 30, 2002,
the Company's intangible assets and goodwill are not significant. The financial
impact of adopting this statement did not have a material impact on the
Company's financial condition and results of operations.
SFAS No. 143, "Accounting for Asset Retirement Obligations," (SFAS 143),
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. SFAS 143 is effective for financial statements issued for fiscal years
beginning after June 15, 2002. Management anticipates that the financial impact
of SFAS 143 will not have a material effect on the Company's financial condition
and results of operations.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," (SFAS 144), addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a business segment. SFAS 144 also
eliminates the exception to consolidation for a subsidiary for which control is
likely to be temporary. The provisions of SFAS 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal years. The provisions of SFAS 144 generally are to
be applied prospectively. Management anticipates that the financial impact of
SFAS 144 will not have a material effect on the Company's financial condition
and results of operations.
SFAS No. 145, "Rescission of SFAS Statements No. 4, 44, and 64, Amendment
of SFAS Statement No. 13, and Technical Corrections," (SFAS 145), updates,
clarifies and simplifies existing accounting pronouncements. SFAS 145 rescinds
SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." SFAS 145
amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency
between the required accounting for sale-leaseback transactions and the required
accounting for eleven certain lease modifications that have economic effects
that are similar to sale-leaseback transactions. The provisions of SFAS 145
related to SFAS No. 4 and SFAS No. 13 are effective for fiscal years beginning
and transactions occurring after May 15, 2002, respectively. Management
8
anticipates that the financial impact of SFAS 145 will not have a material
effect on the Company's financial condition and results of operations.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," (SFAS 146), requires the recognition of costs associated with exit
or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 replaces Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The provisions of SFAS 146 are to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. Management anticipates that the financial impact of SFAS 145 will not
have a material effect on the Company's financial condition and results of
operations.
SFAS No. 147, "Acquisitions of Certain Financial Institutions," (SFAS
147), is an amendment of FASB Statements No. 72 and 144 and FASB Interpretation
No. 9 and addresses the financial accounting and reporting for the acquisition
of all or part of a financial institution, except for a transaction between two
or more mutual enterprises. SFAS 147 removes acquisitions of financial
institutions, other than transactions between two or more mutual enterprises,
from the scope of SFAS No. 72, "Accounting for Certain Acquisitions of Banking
or Thrift Institutions," (SFAS 72), and FASB Interpretation No. 9, "Applying APB
Opinions No. 16 and 17." The provisions of SFAS 147 are to be applied on October
1, 2002. Management anticipates that the financial impact of SFAS 147 will not
have a material effect on the Company's financial condition and results of
operations.
4. Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No.
138, collectively, (SFAS 133). SFAS 133 establishes accounting and reporting
standards for derivative instruments, including a number of derivative
instruments embedded in other contracts, collectively referred to as
derivatives, and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If specific conditions are
met, a derivative may be specifically designated as (1) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment; (2) a hedge of the exposure to variable cash flows
of a forecasted transaction; or (3) a hedge of the foreign currency exposure of
a net investment in a foreign operation, an unrecognized firm commitment, an
available for sale security or a foreign-currency-denominated forecasted
transaction.
On January 1, 2001, the Company adopted SFAS 133 and the fair market value
of derivative instruments are reflected on the Company's financial statements.
On August 10, 2001, the Derivatives Implementation Group (DIG) of the FASB
published DIG G20, which further interpreted SFAS 133. On October 1, 2001, the
Company adopted the provisions of DIG G20 and net income and accumulated other
comprehensive income were adjusted by the amount needed to reflect the
cumulative impact of adopting the provisions of DIG G20.
9
The following table presents certain information related to derivative
instruments and hedging activities as of September 30, 2002 (in thousands):
Related
Fair Amount in Related Related
Value Other Unamortized Amount in Amount
of Comprehensive Derivative Derivative in CMO
Derivatives Index Income Instruments Asset Account Collateral
----------------------------------------------------------------------------------------------
Caps and collars not 1 mo.
associated with CMOs ..... $(10,426) LIBOR $(13,001) $ 2,574 $(10,427) $ --
Cash in margin account ..... 23,962 N/A -- -- 23,962 --
Caps, collars and swaps 1 mo.
associated with CMOs ..... (25,362) LIBOR (36,276) 10,914 -- (25,362)
99% OCI activity at IFC .... -- FNMA (1,291) -- -- --
-------- -------- ------- -------- --------
Totals ..................... $(11,826) $(50,568) $13,488 $ 13,535 $(25,362)
======== ======== ======= ======== ========
The following table presents certain information related to derivative
instruments and hedging activities as of December 31, 2001 (dollars in
thousands):
Related
Fair Amount in Related Related
Value Other Unamortized Amount in Amount
of Comprehensive Derivative Derivative in CMO
Derivatives Index Income Instruments Asset Account Collateral
----------------------------------------------------------------------------------------------
Caps and collars not 1 mo.
associated with CMOs ..... $(13,659) LIBOR $(15,240) $ 1,581 $(13,659) $ --
Cash in margin account ..... 18,787 N/A -- -- 18,787 --
Caps, collars and swaps 1 mo.
associated with CMOs ..... (4,372) LIBOR (12,722) 8,350 -- (4,372)
99% OCI activity at IFC .... (158) FNMA (90) -- -- --
-------- -------- ------- -------- --------
Totals ..................... $ 598 $(28,052) $ 9,931 $ 5,128 $ (4,372)
======== ======== ======= ======== ========
5. Reconciliation of Net Earnings per Share
The following table presents the computation of basic and diluted net
earnings per share as if all stock options were outstanding for the periods
indicated and 10.5% cumulative convertible preferred stock (Preferred Stock) was
outstanding during the three months ending September 30, 2001 (in thousands,
except earnings per share):
For the Three Months
Ended September 30,
--------------------
2002 2001
------- -------
Numerator for earnings per share:
Net earnings available to common stockholders .................... $19,434 $ 8,291
======= =======
Denominator for earnings per share:
Basic weighted average number of common shares outstanding ....... 41,010 22,687
======= =======
Diluted weighted average number of common shares outstanding ..... 41,010 26,823
Net effect of dilutive stock options ............................. 766 361
------- -------
Diluted weighted average common and common equivalent shares .. 41,776 27,184
======= =======
Net earnings per share:
Basic ......................................................... $ 0.47 $ 0.37
======= =======
Diluted ....................................................... $ 0.47 $ 0.31
======= =======
The Company had 424 and 560,978 stock options during the three months
ended September 30, 2002 and September 30, 2001, respectively, that were not
considered in the dilutive calculation of earnings per share as the exercise
price was greater than the average market price during the period. In August
2001, 1,200,000 shares of preferred stock were converted into 6,355,932 shares
of common stock.
10
The following table presents the computation of basic and diluted net
earnings per share as if all stock options were outstanding for the periods
indicated and Preferred Stock was outstanding during the nine months ending
September 30, 2001 (in thousands, except earnings per share):
For the Nine Months
Ended September 30,
---------------------
2002 2001
------- --------
Numerator for earnings per share:
Earnings before extraordinary item and cumulative effect of change in
accounting principle ..................................................... $52,808 $ 23,536
Extraordinary item ...................................................... -- (1,006)
Cumulative effect of change in accounting principle ..................... -- (4,313)
------- --------
Earnings after extraordinary item and cumulative effect of change in
accounting principle ..................................................... 52,808 18,217
Less: Dividends paid to preferred stockholders ......................... -- (1,575)
------- --------
Net earnings available to common stockholders .............................. $52,808 $ 16,642
======= ========
Denominator for earnings per share:
Basic weighted average number of common shares outstanding ................. 38,850 22,573
======= ========
Diluted weighted average number of common shares outstanding ............... 38,850 26,793
Net effect of dilutive stock options ....................................... 662 174
------- --------
Diluted weighted average common and common equivalent shares ............ 39,512 26,967
======= ========
Net earnings per share before extraordinary item and cumulative effect of
change in accounting principle:
Basic ................................................................... $ 1.36 $ 0.97
======= ========
Diluted ................................................................. $ 1.34 $ 0.87
======= ========
Net earnings per share:
Basic ................................................................... $ 1.36 $ 0.74
======= ========
Diluted ................................................................. $ 1.34 $ 0.68
======= ========
The Company had 229,694 and 195,277 stock options during the nine months
ended September 30, 2002 and September 30, 2001, respectively, that were not
considered in the dilutive calculation of earnings per share as the exercise
price was greater than the average market price during the period.
11
6. Mortgage Assets
Mortgage assets consist of investment securities available-for-sale,
mortgage loans held-for-investment, CMO collateral and finance receivables. As
of September 30, 2002 and December 31, 2001, mortgage assets consisted of the
following (in thousands):
September 30, December 31,
2002 2001
------------- ------------
Investment securities available-for-sale:
Subordinated securities collateralized by mortgages ........... $ 21,147 $ 26,661
Net unrealized gain (1) ....................................... 6,347 6,328
----------- -----------
Carrying value of investment securities available-for-sale .. 27,494 32,989
----------- -----------
Loans Receivable:
CMO collateral--
CMO collateral, unpaid principal balance ...................... 3,959,957 2,186,561
Unamortized net premiums on loans ............................. 55,153 35,397
Securitization expenses ....................................... 16,317 11,582
Fair value of derivative instruments .......................... (25,362) (4,372)
----------- -----------
Carrying value of CMO collateral ............................ 4,006,065 2,229,168
Finance receivables, net of pledge balances (2)--
Due from affiliates ........................................... 439,742 166,078
Due from other mortgage banking companies ..................... 476,697 300,571
----------- -----------
Carrying value of finance receivables ....................... 916,439 466,649
Mortgage loans held-for-investment--
Mortgage loans held-for-investment, unpaid principal balance .. 270,073 20,086
Unamortized net premiums (discounts) on loans ................. 4,065 (8)
----------- -----------
Carrying value of mortgage loans held-for-investment ........ 274,138 20,078
Carrying value of gross loans receivable ......................... 5,196,642 2,715,895
Allowance for loan losses ..................................... (21,564) (11,692)
----------- -----------
Carrying value of net loans receivable ...................... 5,175,078 2,704,203
----------- -----------
Total carrying value of mortgage assets ....................... $ 5,202,572 $ 2,737,192
=========== ===========
(1) Unrealized gains on investment securities available-for-sale is a
component of accumulated other comprehensive loss in stockholders' equity.
(2) Outstanding advances on warehouse lines that the warehouse lending
operations makes to affiliates and external customers.
7. Allowance for Loan Losses
The Company makes a monthly provision for estimated loan losses on its
long-term investment portfolio as an increase to allowance for loan losses. The
provision for estimated loan losses is primarily based on a migration analysis
based on historical loss statistics, including cumulative loss percentages and
loss severity, of similar loans in the Company's long-term investment portfolio.
The loss percentage is used to determine the estimated inherent losses in the
investment portfolio. Provision for loan losses is also based on management's
judgment of net loss potential, including specific allowances for known impaired
loans, changes in the nature and volume of the portfolio, the value of the
collateral and current economic conditions that may affect the borrowers'
ability to pay.
The adequacy of the allowance for loan losses is evaluated on a monthly
basis by management to maintain the allowance at levels sufficient to provide
for inherent losses. The migration system analyzes historical migration of
mortgage loans from original current status to 30-, 60- and 90-day delinquency,
foreclosure, and other real estate owned and liquidated. The principal balance
of all loans currently in the long-term investment portfolio are included in the
migration analysis until the principal balance of loans either become real
estate owned or are paid in full. The statistics generated by the migration
analysis are used to establish the general valuation for loan losses.
12
The following tables present activity for allowance for loan losses for
the periods shown (in thousands):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------- -----------------------
2002 2001 2002 2001
-------- ------- -------- --------
Balance, beginning of period ...... $ 16,934 $ 7,817 $ 11,692 $ 5,090
Provision for loan losses ......... 5,361 2,615 13,302 10,558
Charge-offs, net of recoveries .... (731) (2,490) (3,430) (7,706)
-------- ------- -------- --------
Balance, end of period ............ $ 21,564 $ 7,942 $ 21,564 $ 7,942
======== ======= ======== ========
8. Segment Reporting
The Company internally reviews and analyzes its operating segments as
follows:
o the long-term investment operations, conducted by IMH and IMH Assets,
invests primarily in non-conforming Alt-A residential mortgage loans
acquired from the mortgage operations and mortgage-backed securities
secured by or representing interests in such loans and in second mortgage
loans;
o the warehouse lending operations, conducted by IWLG, provides warehouse
and repurchase financing to affiliated companies and to approved mortgage
bankers, a majority of which are correspondents of IFC, to finance
mortgage loans; and
o the mortgage operations, conducted by IFC, Impac Lending Group (ILG), a
division of IFC, and NFS, a subsidiary of IFC, purchases and originates
primarily non-conforming Alt-A mortgage loans, and, to a lesser extent,
B/C mortgage loans and second mortgage loans from its network of third
party correspondent sellers, mortgage brokers and retail customers. IFC is
an unconsolidated taxable REIT subsidiary of IMH and its results of
operations are shown as "Equity interest in net earnings of IFC."
The following table shows reporting segments as of and for the nine months
ended September 30, 2002 (in thousands):
Long-Term Warehouse (a)
Investment Lending Eliminations
Operations Operations and Others Consolidated
---------- ---------- ------------ ------------
Balance Sheet Items
CMO collateral $4,006,065 $ -- $ -- $4,006,065
Total assets 4,636,313 1,258,645 (498,701) 5,396,257
Total stockholders' equity 423,361 85,320 (234,153) 274,528
Income Statement Items
Interest income $ 127,306 $ 28,956 $ (2,266) $ 153,996
Interest expense 83,689 16,264 (2,266) 97,687
Equity interest in net earnings
of IFC (b) -- -- 12,816 12,816
Net earnings 27,435 12,557 12,816 52,808
The following table shows reporting segments for the three months ended
September 30, 2002 (in thousands):
Income Statement Items
Interest income $ 51,316 $ 11,699 $ (1,316) $ 61,699
Interest expense 33,760 6,146 (1,316) 38,590
Equity interest in net earnings
of IFC (b) -- -- 2,755 2,755
Net earnings 11,066 5,613 2,755 19,434
13
The following table shows reporting segments as of and for the nine months
ended September 30, 2001 (in thousands):
Long-Term Warehouse (a)
Investment Lending Eliminations
Operations Operations and Others Consolidated
---------- ---------- ------------ ------------
Balance Sheet Items
CMO collateral $1,672,581 $ -- $ -- $1,672,581
Total assets 2,020,644 669,628 (293,530) 2,396,742
Total stockholders' equity 264,164 70,065 (157,638) 176,591
Income Statement Items
Interest income $ 89,380 $ 34,266 $ (7,614) $ 116,032
Interest expense 67,260 25,556 (7,614) 85,202
Equity interest in net earnings
of IFC (b) -- -- 7,857 7,857
Net earnings 2,591 7,769 7,857 18,217
The following table shows reporting segments for the three months ended September 30, 2001 (in thousands):
Income Statement Items
Interest income $ 30,975 $ 11,003 $ (3,010) $ 38,968
Interest expense 22,899 7,692 (3,010) 27,581
Equity interest in net earnings
of IFC (b) -- -- 3,039 3,039
Net earnings 2,339 2,913 3,039 8,291
(a) Elimination of inter-segment balance sheet and income statement items.
(b) The mortgage operations is accounted for using the equity method and is an
unconsolidated qualified REIT subsidiary of the Company.
9. Investment in Impac Funding Corporation
The Company is entitled to 99% of the earnings or losses of IFC through
its ownership of 100% of the non-voting preferred stock of IFC. As such, the
Company records its investment in IFC using the equity method. Under this
method, original investments are recorded at cost and adjusted by the Company's
share of earnings or losses.
14
The following tables present consolidated financial information for Impac
Funding Corporation for the periods presented (in thousands):
BALANCE SHEETS
September 30, December 31,
2002 2001
------------- ------------
ASSETS
Cash $ 19,251 $ 28,612
Investment securities available-for-sale 186 3,394
Mortgage loans held-for-sale 456,640 174,172
Mortgage servicing rights 10,023 8,468
Premises and equipment, net 5,303 5,333
Accrued interest receivable 335 130
Other assets 40,897 19,693
--------- ---------
Total assets $ 532,635 $ 239,802
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Borrowings from IWLG $ 454,083 $ 174,136
Due to affiliates 14,500 14,500
Deferred revenue 6,147 4,479
Accrued interest expense 763 453
Other liabilities 37,722 26,914
--------- ---------
Total liabilities 513,215 220,482
--------- ---------
Shareholders' Equity:
Preferred stock 18,053 18,053
Common stock 182 182
Retained earnings 21,669 8,722
Cumulative dividends declared (18,984) (8,984)
Accumulated other comprehensive gain (loss) (1,500) 1,347
--------- ---------
Total shareholders' equity 19,420 19,320
--------- ---------
Total liabilities and shareholders' equity $ 532,635 $ 239,802
========= =========
STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- -----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Interest income $ 8,072 $ 5,569 $ 22,644 $ 18,314
Interest expense 5,991 4,629 16,882 16,601
-------- -------- -------- --------
Net interest income 2,081 940 5,762 1,713
Gain on sale of loans 13,656 12,423 49,387 32,947
Loan servicing income (expense) (473) 507 (1,221) 2,308
Other non-interest income 9 210 2,089 319
-------- -------- -------- --------
Total non-interest income 13,192 13,140 50,255 35,574
Personnel expense 6,575 4,138 18,418 10,776
General and administrative and other expense 4,549 2,844 13,006 8,500
Provision for repurchases 1,324 501 2,154 515
Amortization of mortgage servicing rights 1,037 1,313 3,529 3,757
Mark-to-market gain on derivative instruments (2,937) (62) (3,393) (45)
-------- -------- -------- --------
Total non-interest expense 10,548 8,734 33,714 23,503
Earnings before income taxes and cumulative effect
of change in accounting principle 4,725 5,346 22,303 13,784
Income taxes 1,942 2,257 9,357 5,865
-------- -------- -------- --------
Earnings before cumulative effect of change in
accounting principle 2,783 3,089 12,946 7,919
Cumulative effect of change in accounting principle -- -- -- 17
-------- -------- -------- --------
Net earnings 2,783 3,089 12,946 7,936
Less: Cash dividends on preferred stock (4,208) (2,000) (9,900) (6,419)
-------- -------- -------- --------
Net earnings available to common stockholders $ (1,425) $ 1,089 $ 3,046 $ 1,517
======== ======== ======== ========
15
10. Stockholders' Equity
During the nine months ended September 30, 2002 accumulated other
comprehensive loss increased by $24.3 million due to a $22.5 million increase in
unrealized loss on derivative instruments and a $1.8 million increase in
unrealized gain on investment securities available-for-sale.
During the nine months ended September 30, 2002 the Company issued
approximately 9.9 million shares of common stock and received net proceeds of
$84.0 million (excluding issuance of shares from the exercise of stock options
and shares sold under the Sales Agency Agreement).
During the nine months ended September 30, 2002 the Company sold 854,600
shares of common stock pursuant to its Sales Agency Agreement and received net
proceeds of $9.3 million.
On September 24, 2002 the Company declared a third quarter cash dividend
of $0.45 per common share, or $19.3 million, which was paid on October 9, 2002
to common stockholders of record on October 2, 2002.
On June 25, 2002 the Company declared a second quarter cash dividend of
$0.43 per common share, or $17.2 million, which was paid on July 12, 2002 to
common stockholders of record on July 3, 2002.
On March 26, 2002 the Company declared a first quarter cash dividend of
$0.40 per common share, or $15.8 million, which was paid on April 16, 2002 to
common stockholders of record on April 3, 2002.
16
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
This quarterly report contains forward-looking statements including
statements relating to the expected performance of the Company's businesses and
dividend and earnings expectations. The forward-looking statements are based on
current management expectations. Actual results may differ materially as a
result of several factors, including, among other things, failure to achieve
projected earning levels, the timely and successful implementation of strategic
initiatives, the ability to generate sufficient liquidity, the size and
frequency of our securitizations and the amount of interest we earn on our
mortgage loans, interest rate fluctuations on our assets that differ from those
on our liabilities, changes in the difference between short-term and long-term
interest rates, increases in prepayment rates on our mortgage assets, changes in
assumptions regarding estimated loan losses, changes in assumptions regarding
estimated fair value amounts, the availability of financing and, if available,
the terms of any financing, changes in origination and resale pricing of
mortgage loans, growth in markets which the Company serves, changes in general
market and economic conditions and other factors described in this report and
under "Risk Factors." Caution must be exercised in relying on these and other
forward-looking statements. Due to known and unknown risks and other factors not
presently identified, the Company's results may differ materially from its
expectations and projections. We may update and revise our estimates based on
actual conditions experienced, however, it is not practicable to publish all
revisions and as a result, no one should assume that results projected in or
contemplated by the forward-looking statements included above may continue to be
accurate in the future.
The terms "Company," "we," "us," and "our" refer to Impac Mortgage
Holdings, Inc., a Maryland corporation incorporated in August 1995, and its
subsidiaries, IMH Assets Corp., or "IMH Assets," Impac Warehouse Lending Group,
Inc., or "IWLG," and its affiliate, Impac Funding Corporation, or "IFC,"
together with its wholly-owned subsidiaries Impac Secured Assets Corp. and
Novelle Financial Services, Inc., or "NFS."
Together with our subsidiaries and affiliates we acquire, originate,
securitize and invest nationwide primarily in non-conforming Alt-A mortgage
loans, or "Alt-A." Alt-A mortgage loans consist primarily of mortgage loans that
are first lien mortgage loans made to borrowers whose credit is generally within
typical Federal National Mortgage Association, or "Fannie Mae," and the Federal
Home Loan Mortgage Corporation, or "Freddie Mac," guidelines, but that have loan
characteristics that make them non-conforming under those guidelines. For
instance, Alt-A mortgage loans may have higher loan-to-value LTV ratios than
allowable under those guidelines or they may have been originated without
certain documentation or verifications required under those guidelines.
Therefore, in making credit decisions, we are more reliant upon the borrower's
credit score and the adequacy of the underlying collateral. Alt-A credit quality
loans generally have a credit score of 600 or better while "A" credit quality
loans generally have a credit score of 640 or better.
We believe that the non-conforming Alt-A mortgage market is expanding
because this market niche provides mortgage borrowers with valuable financing
alternatives to Fannie Mae, Freddie Mac and sub-prime lenders. We also believe
that Alt-A mortgage loans provide an attractive net earnings profile by
producing higher yields without commensurately higher credit losses than other
types of mortgage loans. Since 1999, we have acquired and originated primarily
Alt-A mortgage loans. We also provide warehouse and repurchase financing to
originators of mortgage loans. Our ultimate goal is to generate consistent and
reliable income for distribution to our stockholders primarily from the earnings
of our long-term investment operations.
Critical Accounting Policies
Certain accounting policies require us to make significant estimates and
assumptions, which materially affect the carrying value of certain assets and
liabilities, and we consider these to be critical accounting policies. The
estimates and assumptions we use are based on historical experience and other
factors, which we believe to be reasonable under the circumstances. Actual
results could differ significantly from these estimates and assumptions which
could materially affect the carrying value of assets and liabilities at the
balance sheet dates and our results of operations for the reporting periods. We
believe the following are critical accounting policies that require the most
significant estimates and assumptions that are particularly susceptible to
significant change in the preparation of our financial statements:
o Allowance for losses on loans. For further information, see note 7 on
pages 12 and 13 of notes to consolidated financial statements and
pages 21 and 26 of this section; and
17
o Accounting for Derivative Instruments and Hedging Activities. For
further information, see note 4 on pages 9 and 10 of notes to
consolidated financial statements and "Item 3. Quantitative and
Qualitative Disclosures About Market Risk" on page 45.
Operating Segments
We primarily operate three core businesses: the long-term investment
operations, the mortgage operations, and the warehouse lending operations.
Long-Term Investment Operations
The long-term investment operations, conducted by IMH and IMH Assets,
primarily invest in Alt-A mortgage loans acquired and originated by the mortgage
operations. In addition, during the third quarter of 2002 the Company began
operations of a new subsidiary called Impac Multi-Family Capital Corporation, or
"IMCC," which intends to originate mortgage loans on multi-family properties
with loan balances between $250,000 and $1.5 million. These businesses primarily
generate net interest income on its mortgage investment portfolio and, to a
lesser extent, its investment securities portfolio. Alt-A mortgage loans are
financed with collateralized mortgage obligations, or "CMOs," reverse repurchase
agreements and proceeds from the sale of capital stock.
During the first nine months of 2002 the long-term investment operations
acquired $2.5 billion of primarily Alt-A adjustable-rate mortgages, or "ARMs,"
and $200.9 million of fixed-rate mortgages, or "FRMs." Of the mortgages acquired
during the first nine months of 2002, 93% were ARMs, of which 65% were indexed
to six-month London Interbank Offered Rate, or "LIBOR," 62% were purchase money
transactions and 77% had prepayment penalty features. Mortgages acquired during
the first nine months of 2002 had a weighted average coupon of 6.60% and a
weighted average credit score of 686.
As of September 30, 2002, the long-term mortgage investment portfolio was
$4.3 billion of which approximately 91% were ARMs and 9% were FRMs. The
long-term mortgage investment portfolio had a weighted average coupon of 6.84%,
a weighted average margin of 3.07% (mainly LIBOR based) and an original weighted
average credit score of 680. 97% of the long-term mortgage investment portfolio
were Alt-A mortgages, 71% had prepayment penalty features with a weighted
average prepayment expiration period of approximately 22 months, 48% were
six-month LIBOR indexed ARMs, or "six month ARMs," and 42% were six-month LIBOR
indexed hybrid loans, or "six month hybrids." Six months hybrids have initial
fixed interest rate periods of two to five years, which subsequently adjust to
ARMs, and had an average interest rate adjustment period of approximately 14
months as of September 30, 2002.
Mortgage Operations
The mortgage operations, conducted by IFC, acquire, originate, sell and
securitize primarily Alt-A mortgage loans and, to a lesser extent, sub-prime
mortgage loans, or "B/C loans." The mortgage operations primarily generate
income by securitizing and selling loans to permanent investors, including the
long-term investment operations. This business also earns revenues from fees
associated with mortgage servicing rights, master servicing agreements and
interest income earned on loans held for sale. The mortgage operations primarily
use warehouse lines of credit to finance the acquisition and origination of
mortgage loans.
Loan acquisitions and originations during the first nine months of 2002,
excluding premiums, were $4.3 billion. Of mortgages acquired or originated
during the first nine months of 2002, 93% were Alt-A, 77% had prepayment penalty
features, 68% were ARMs and 58% were purchase money transactions. During the
first nine months of 2002 the mortgage operations sold $2.7 billion of mortgage
loans to the long-term investment operations, issued real estate mortgage
investment conduits, or "REMICs," totaling $594.7 million and sold $680.4
million of mortgage loans to third party investors.
As of September 30, 2002 the master servicing portfolio was $7.9 billion
and the loan delinquency rate of mortgages in the master servicing portfolio
which were 60 or more days past due, inclusive of foreclosures and delinquent
bankruptcies, was 4.45%.
18
Warehouse Lending Operations
The warehouse lending operations, conducted by IWLG, provide short-term
financing to mortgage loan originators by funding mortgage loans from their
closing date until they are sold to pre-approved investors. The warehouse
lending operations earn fees, as well as a spread, from the difference between
its cost of borrowings and the interest earned on advances.
As of September 30, 2002 the warehouse lending operations had extended
$564.0 million of short-term warehouse lines of credit available to 60
non-affiliated customers, of which $476.7 million was outstanding.
Results of Operations--Impac Mortgage Holdings, Inc.
For the Three Months Ended September. 30, 2002 as compared to the Three Months
Ended September 30, 2001
Net earnings for the third quarter of 2002 increased to $19.4 million, or
$0.47 per diluted share, as compared to net earnings of $8.3 million, or $0.31
per diluted share, for the third quarter of 2001 primarily due to an $11.7
million increase in net interest income. Return on average assets and equity was
1.64% and 29.27%, respectively, during the third quarter of 2002 as compared to
1.45% and 17.16%, respectively, during the third quarter of 2001.
Book value per outstanding common share was $6.40 at quarter-end as
compared to $6.44 per outstanding common share as of June 30, 2002. Book value
decreased during the third quarter primarily due to a $14.9 million increase in
accumulated other comprehensive loss, which offset the incremental increase in
book value from the issuance of new shares. The increase in other comprehensive
loss was the result of fair market adjustments on derivative instruments, in
accordance with Statement of Financial Accounting Standards No. 133, or "SFAS
133," "Accounting for Derivative Instruments and Hedging Activities."
Estimated taxable income for the third quarter was $25.5 million, or $0.61
per diluted share, as compared to $7.4 million, or $0.27 per diluted share,
during the third quarter of 2001. Estimated taxable income during the third
quarter of 2002 was greater than net earnings as excess provision for loan
losses cannot be deducted from taxable income. In addition, estimated taxable
income for the third quarter of 2002 reflects a $4.2 million dividend from IFC.
After filing its 2001 tax returns, the Company had a federal net operating loss
carryforward of $29.3 million, which expires in the year 2020, and a state net
operating loss carryforward of $29.3 million, which expires in the year 2010,
that are available to offset future taxable income.
The following table summarizes the calculation of estimated taxable income
and a reconciliation of estimated taxable income to net earnings for the periods
shown (in thousands, except earnings per share amounts):
For the Three Months
Ended September 30,
--------------------------
2002 (2) 2001 (3)
-------- --------
Net earnings ................................... $ 19,434 $ 8,291
Adjustments to net earnings:
Loan loss provision ......................... 5,361 2,615
Dividends from IFC .......................... 4,208 2,000
Tax deduction for actual loan losses ........ (731) (2,491)
Equity in net earnings of IFC ............... (2,755) (3,039)
-------- -------
Estimate taxable income (1) .................... $ 25,517 $ 7,376
======== =======
Estimated taxable income per share ............. $ 0.61 $ 0.27
======== =======
(1) Estimated taxable income includes estimates of book to tax adjustments and
can differ from actual taxable income as calculated when the Company files
its annual tax return.
(2) Excludes deduction for dividends paid and the availability of a deduction
attributable to a net operating loss carryforward.
(3) Excludes deduction for dividends paid, the availability of a deduction
attributable to a net operation loss carryforward and quarterly tax
deductions of approximately $2.7 million for amortization of the
termination of the Company's management agreement.
19
Net interest income increased 103% to $23.1 million during the third
quarter of 2002 as compared to $11.4 million during the third quarter of 2001 as
average mortgage assets rose. Average mortgage assets increased as mortgage
rates declined to historic lows during 2002 which contributed to record mortgage
acquisitions and originations by the mortgage operations. Although, in the near
term, we believe that mortgage demand for both fixed and adjustable rate
mortgages will remain high, we are mindful that this may not always be the case.
Therefore, we believe that we must take advantage of this market opportunity and
continue the growth of our balance sheet, which increased 26% to $5.4 billion as
of quarter-end as compared to $4.3 billion as of June 30, 2002.
Total assets increased as the long-term investment operations acquired
$1.1 billion of mortgages from the mortgage operations, which included $200.0
million of FRMs. The FRMs were securitized as our first fixed rate CMO since
1998. The fixed rate CMO utilizes matched fixed rate borrowings that provides a
locked-in interest spread over the life of the mortgage loans which, we believe,
will have a longer life than adjustable rate assets. The fixed rate CMO had a
weighted average fixed borrowing cost of 4.98%. We also completed one variable
rate CMO during the third quarter for $497.5 million that had a weighted average
adjustable borrowing cost of one-month LIBOR plus 49 basis points. By acquiring
and securitizing FRMs, in addition to acquiring and securitizing ARMs, we
believe that we can generate more consistent revenue from our mortgage loan
investment portfolio as opposed to revenue generated from gain on sale of loans,
which are more susceptible to fluctuations in mortgage activity. In the future,
we expect to acquire as much as 50% of the mortgage operations' fixed rate
acquisitions and originations.
To sustain our strategy of growing the balance sheet, it has become
apparent that we need to raise capital more quickly through the block sale of
common shares as opposed to raising capital strictly through the sale of common
shares via our Sales Agency Agreement. Therefore, during the third quarter we
completed the sale of approximately 2.5 million common shares at a public
offering price of $11.25 per share. We expect to continue to access the capital
markets through our Sales Agency Agreement or periodically issue shares from our
shelf registration as the market, economics and sound business practice
dictates.
In addition to issuing common shares to finance our growth, we utilized
new reverse repurchase agreements to provide financing for the acquisition of
mortgages during the third quarter. New reverse repurchase agreements of $650.0
million were secured with various investment banks during the year. The new
reverse repurchase agreements provide us with a higher aggregate credit limit to
fund the acquisition and origination of mortgage loans at terms comparable to
those we have received in the past and the flexibility of having financial
relationships with a larger cross-section of financial institutions. However, we
continue to securitize or sell mortgage loans every 30 to 45 days to limit our
exposure to possible margin calls on our financing facilities.
We believe that we effectively manage interest rate risk by purchasing
interest rate hedging instruments that result in reliable and consistent net
interest margins in changing interest rate environments. Net interest margins on
mortgage assets decreased 4 basis points to 1.92% during the third quarter of
2002 as compared to 1.96% during the third quarter of 2001. As short-term
interest rates and mortgage rates declined, yields on mortgage assets decreased
178 basis points during the third quarter of 2002 to 5.18% as compared to 6.96%
during the third quarter of 2001. Borrowing costs on mortgage assets also
declined as yields dropped 192 basis points to 3.37% during the third quarter of
2002 as compared to 5.29% during the third quarter of 2001. We believe that our
interest rate hedging strategy will continue to provide reliable and consistent
net interest margins in a changing interest rate environment.
20
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the third
quarters of 2002 and 2001 and includes interest income on Mortgage Assets and
interest expense related to borrowings on Mortgage Assets only (dollars in
thousands):
For the Three Months For the Three Months
Ended September 30, 2002 Ended September 30, 2001
-------------------------------- --------------------------------
Average Wtd. Avg Average Wtd. Avg
Balance Interest Yield Balance Interest Yield
-------------------------------- --------------------------------
Mortgage Assets
Securities collateralized by mortgages $ 28,442 $ 362 5.09% $ 33,491 $ 679 8.11%
Loans receivable: -- -- --
CMO collateral (1) 3,725,003 48,286 5.19 1,515,450 27,219 7.18
Mortgage loans held-for-investment (1) 131,267 1,665 5.07 195,891 2,529 5.16
Finance receivables:
Affiliated 377,922 4,358 4.61 251,140 4,027 6.41
Non-affiliated 347,691 5,065 5.83 208,164 3,901 7.50
--------------------- ---------------------
Total finance receivables 725,613 9,423 5.19 459,304 7,928 6.90
--------------------- ---------------------
Total loans receivable 4,581,883 59,374 5.18 2,170,645 37,676 6.94
--------------------- ---------------------
Total Mortgage Assets $4,610,325 $59,736 5.18% $2,204,136 $38,355 6.96%
===================== =====================
Borrowings on Mortgage Assets
CMO borrowings (2) $3,635,351 $31,091 3.42% $1,435,864 $19,249 5.36%
Reverse repurchase agreements - mortgages 816,923 6,086 2.98 633,248 7,688 4.86
Borrowings secured by investment securities 9,255 431 18.63 16,183 620 15.32
--------------------- ---------------------
Total Borrowings on Mortgage Assets $4,461,529 $37,608 3.37% $2,085,295 $27,557 5.29%
===================== =====================
Net Interest Spread (3) 1.81% 1.67%
Net Interest Margin (4) 1.92% 1.96%
(1) Interest income includes amortization of acquisition costs.
(2) Interest expense includes amortization of securitization costs.
(3) Net interest spread is calculated by subtracting the weighted average
yield on total borrowings on Mortgage Assets from the weighted average
yield on total Mortgage Assets.
(4) Net interest margin is calculated by subtracting interest expense on total
borrowings on Mortgage Assets from interest income on total Mortgage
Assets and then dividing by the total average balance for Mortgage Assets.
Mortgage loans acquired from the mortgage operations with prepayment
penalty features help to mitigate Constant Prepayment Rate, or "CPR," and
corresponding premium and securitization cost amortization as a result of
refinancing activity. Loan premiums paid for acquiring mortgage loans and
securitization costs for obtaining financing are amortized to interest income
and interest expense over the estimated lives of the mortgage loans or related
borrowings. Prepayments on a pool of mortgage loans are commonly measured
relative to a CPR that represents an annual rate at which prepayments occur each
month relative to the then outstanding balance of the pool of mortgage loans.
The prepayment experience for our mortgage assets for the third quarter of 2002
equaled 24% CPR, which represents an improvement over the third quarter of 2001,
a period for which prepayment experience equaled 36% CPR. Additionally, the
acquisition of mortgage loans at current market rates during the third quarter
also contributed to a decline in CPR.
We believe that we mitigate loan losses and a potential increase in
foreclosure rates by maintaining an adequate allowance for loan loss, by
acquiring mortgage loans with favorable credit profiles and by acquiring
mortgage loans with conservative loan-to-value ratios with mortgage insurance
enhancements, which reduces our effective loan-to-value ratio. Allowance for
loan losses increased 85% to $21.6 million at quarter-end, or 0.41% of total
loans receivable, which includes CMO collateral, mortgage loans
held-for-investment and finance receivables, as compared to $11.7 million, or
0.43% of total loans receivable, as of December 31, 2001. During the third
quarter of 2002 provision for loan losses was $5.4 million on mortgage
acquisitions of $1.1 billion as compared to $2.6 million and $360.9 million,
respectively, for the third quarter of 2001.
As of September 30, 2002 total non-performing assets were $105.6 million,
or 1.96% of total assets, as compared to $69.3 million, or 2.43% of total
assets, as of December 31, 2001. Mortgage loans that were 60 or more days
21
delinquent, including foreclosures and delinquent bankruptcies, was 2.92% of the
long-term mortgage investment portfolio as of September 30, 2002 as compared to
3.84% as of December 31, 2001.
We make monthly provisions for estimated loan losses on our long-term
investment portfolio as an increase to allowance for loan losses. The provision
for estimated loan losses is primarily based on a migration analysis based on
historical loss statistics, including cumulative loss percentages and loss
severity, of similar loans in our long-term investment portfolio. The loss
percentage is used to determine the estimated inherent losses in the investment
portfolio. Provision for loan losses is also based on management's judgment of
net loss potential, including specific allowances for known impaired loans,
changes in the nature and volume of the portfolio, the value of the collateral
and current economic conditions that may affect the borrowers' ability to pay.
We acquire mortgage loans from the mortgage operations that fit within our
criteria, which are primarily non-conforming Alt-A ARMs and, to a lesser extent,
FRMs with good credit profiles, with insurance enhancements (when required),
prepayment penalty features and purchase money transactions. The following table
summarizes mortgage loan acquisitions for the periods indicated (in thousands):
LOAN ACQUISITION SUMMARY (1)
For the Three Months
Ended September 30,
-----------------------------------
2002 2001
----------------- --------------
Balance % Balance %
------- --- ------- ---
Volume by Type:
Adjustable rate ....................... $ 892,092 82 $353,290 98
Fixed rate ............................ 200,004 18 7,608 2
---------- --------
Total Loan Acquisitions ............. $1,092,096 $360,898
========== ========
Volume by Product:
Six month LIBOR indexed ARMs .......... $ 619,225 57 $ 92,925 26
Six month LIBOR indexed hybrids (2) ... 272,867 25 260,365 72
Fixed first trust deeds ............... 200,004 18 0 0
Fixed second trust deeds .............. 0 0 7,608 2
---------- --------
Total Loan Acquisitions ............. $1,092,096 $360,898
========== ========
Volume by Credit Quality:
Alt-A loans ........................... $1,086,719 100 $358,492 99
B/C loans ............................. 5,377 0 2,406 1
---------- --------
Total Loan Acquisitions ............. $1,092,096 $360,898
========== ========
Volume by Purpose:
Purchase .............................. $ 681,739 62 $253,224 70
Refinance ............................. 410,357 38 107,674 30
---------- --------
Total Loan Acquisitions ............. $1,092,096 $360,898
========== ========
Volume by Prepayment Penalty:
With prepayment penalty ............... $ 913,959 84 $194,697 54
Without prepayment penalty ............ 178,137 16 166,201 46
---------- --------
Total Loan Acquisitions ............. $1,092,096 $360,898
========== ========
(1) Excludes premiums paid upon acquiring mortgages.
(2) Mortgage loans are fixed rate for initial two to five year periods and
subsequently adjust to the indicated index plus a margin.
Equity in net earnings of IFC decreased 7% to $2.8 million during the
third quarter as compared to $3.0 million during the third quarter of 2001.
However, net earnings of IFC would have been higher during the third quarter of
2002 if IFC had sold $200.0 million of FRMs to non-affiliated investors as whole
loan sales or as REMICs instead of selling FRMs to the long-term investment
operations. Sale of mortgage loans to the long-term investment operations
results in a deferral of the gain over the life of the mortgage loans. These
FRMs were securitized as our first fixed rate CMO since 1998 and should provide
positive cash flows over the life of the loans. Refer to "Results of
Operations--Impac Funding Corporation" for more information on the operating
results of IFC.
22
Results of Operations--Impac Funding Corporation
For the Three Months Ended September 30, 2002 as compared to the Three Months
Ended September 30, 2001
Net earnings decreased 10% to $2.8 million during the third quarter of
2002 as compared to $3.1 million during the third quarter of 2001. The decrease
in net earnings was primarily due to the sale of $200.0 million of FRMs to the
long-term investment operations during the third quarter of 2002 as compared to
the sale of FRMs to non-affiliated investors or as REMICs during the third
quarter of 2001. Sale of mortgage loans to the long-term investment operations
results in a deferral of the gain over the life of the mortgage loans. The sale
of $200.0 million of FRMs to the long-term investment operations should provide
positive cash flows over the life of the mortgage assets as opposed to one-time
cash gain on sale of loans.
Net interest income increased to $2.1 million during the third quarter of
2002 as compared to $940,000 during the third quarter of 2001 as average loans
held for sale increased and net interest margins widened. Average loans held for
sale increased to $396.2 million during the third quarter of 2002 as compared to
$263.0 million during the third quarter of 2001 as a result of higher loan
acquisitions and originations. Net interest margins increased to 2.42% during
the third quarter of 2002 as compared to 2.04% during the third quarter of 2001
as interest rate spreads widened.
Gain on sale of loans increased to $13.7 million on loan sales of $1.5
billion during the third quarter of 2002 as compared to gain on sale of loans of
$12.4 million on loan sales of $769.9 million during the third quarter of 2001.
The mortgage operation sells or securitizes loans between 30 and 45 days from
the date of acquisition and origination. Frequent sale or securitization of
mortgage loans requires less capital, maintains higher liquidity and provides
less interest rate and price volatility during the mortgage loan accumulation
period.
Excluding mark-to-market gain on derivative instruments, total
non-interest expense increased to $13.5 million during the third quarter of 2002
as compared to $8.8 million during the third quarter of 2001. The increase in
total non-interest expense during the third quarter of 2002 was primarily due to
$1.4 million of operating expenses from NFS, which began operations during the
fourth quarter of 2001. In addition, staff and operating expenses were higher as
staff was hired to meet greater correspondent loan acquisition and wholesale
origination volumes during the third quarter of 2002.
Although non-interest expense increased during the third quarter of 2002,
fully loaded costs to acquire and originate an Alt-A mortgage loan at IFC
declined to 69 basis points during the third quarter of 2002 as compared to 97
basis points during the third quarter of 2001. Fully loaded costs to acquire and
originate a B/C mortgage loan at NFS was 198 basis points during the third
quarter of 2002. Fully loaded expense includes both direct costs incurred to
acquire and originate mortgage loans, which includes loan origination and sales
and marketing costs, and indirect costs, which includes accounting,
administration, legal and information technology costs.
Mortgage loan acquisitions and originations increased 109% to $1.7 billion
during the third quarter of 2002 as compared to $815.5 million during the third
quarter of 2001. The following table summarizes mortgage loan acquisitions and
originations for the periods indicated (in thousands):
23
LOAN PRODUCTION SUMMARY (1)
For the Three Months
Ended September 30,
-----------------------------------
2002 2001
----------------- --------------
Balance % Balance %
------- --- ------- ---
Volume by Type:
Fixed rate first trust deeds .......... $ 552,751 33 $335,257 41
Fixed rate second trust deeds ......... 24,032 1 10,083 1
Adjustable rate:
Six month LIBOR ARMs ................ 724,101 133,557
Six month LIBOR hybrids ............. 379,102 336,618
---------- --------
Total adjustable rate ................. 1,103,203 66 470,175 58
---------- --------
Total Loan Production ............... $1,679,986 $815,515
========== ========
Volume by Channel:
Correspondent acquisitions ............ $1,258,485 75 $606,905 74
Wholesale and retail originations ..... 295,518 18 188,629 23
Novelle Financial Services, Inc. ...... 125,983 7 19,981 3
---------- --------
Total Loan Production ............... $1,679,986 $815,515
========== ========
Volume by Credit Quality:
Alt-A loans ........................... $1,545,239 92 $791,037 97
B/C loans ............................. 134,747 8 24,478 3
---------- --------
Total Loan Production ............... $1,679,986 $815,515
========== ========
Volume by Purpose:
Purchase .............................. $ 985,755 59 $531,935 65
Refinance ............................. 694,231 41 283,580 35
---------- --------
Total Loan Production ............... $1,679,986 $815,515
========== ========
Volume by Prepayment Penalty:
With prepayment penalty ............... $1,372,735 82 $515,814 63
Without prepayment penalty ............ 307,251 18 299,701 37
---------- --------
Total Loan Production ............... $1,679,986 $815,515
========== ========
(1) Excludes premiums paid upon acquiring and originating mortgages.
Results of Operations--Impac Mortgage Holdings, Inc.
For the Nine Months Ended September 30, 2002 as compared to the Nine Months
Ended September 30, 2001
Net earnings for the first nine months of 2002 were $52.8 million, or
$1.34 per diluted share, as compared to net earnings of $18.2 million, or $0.68
per diluted share, for the same period of 2001. Net earnings rose as net
interest income increased by $25.5 million, equity in net earnings of IFC
increased by $5.0 million and mark-to-market loss on derivative instruments and
cumulative effect of change in accounting policy decreased by $8.0 million.
Return on average assets and equity was 1.82% and 27.72%, respectively, during
the first nine months of 2002 as compared to 1.16% and 13.13%, respectively,
during the same period of 2001.
Estimated taxable income for the first nine months of 2002 was $59.8
million, or $1.51 per diluted share, as compared to $19.6 million, or $0.73 per
diluted share, during the same period of 2001. Estimated taxable income during
the first nine months of 2002 was greater than net earnings as excess provision
for loan losses cannot be deducted from taxable earnings. During the first nine
months of 2002 provision for loan losses of $13.3 million were in excess of
actual loan charge-offs, net of recoveries, of $3.4 million. In addition,
estimated taxable income for the first nine months of 2002 reflects dividends of
$9.9 million from IFC.
24
The following table summarizes the calculation of estimated taxable income
and a reconciliation of estimated taxable income to net earnings for the periods
shown (in thousands, except earnings per share amounts):
For the Nine Months
Ended September 30,
--------------------------
2002 (2) 2001 (3)
-------- --------
Net earnings .................................. $ 52,808 $ 18,217
Adjustments to net earnings:
Loan loss provision ........................ 13,302 10,559
Dividends from IFC ......................... 9,900 6,419
Tax deduction for actual loan losses ....... (3,430) (7,707)
Equity in net earnings of IFC .............. (12,816) (7,857)
-------- --------
Estimate taxable income (1) ................... $ 59,764 $ 19,631
======== ========
Estimated taxable income per share ............ $ 1.51 $ 0.73
======== ========
(1) Estimated taxable income includes estimates of book to tax adjustments and
can differ from actual taxable income as calculated when the Company files
its annual tax return.
(2) Excludes deduction for dividends paid and the availability of a deduction
attributable to a net operating loss carryforward.
(3) Excludes deduction for dividends paid, the availability of a deduction
attributable to a net operating loss carryforward and tax deductions of
approximately $8.1 million for amortization of the termination of the
Company's management agreement.
Net interest income increased 83% to $56.3 million during the first nine
months of 2002 as compared to $30.8 million during the same period of 2001 as
total average mortgage assets rose. Total average mortgage assets increased 90%
to $3.8 billion during the first nine months of 2002 as compared to $2.0 billion
during the same period of 2001 as the long-term investment operations acquired
$2.7 billion of mortgage loans during the first nine months of 2002. Net
interest margins on mortgage assets decreased 3 basis points to 1.92% during the
first nine months of 2002 as compared to 1.95% during the same period of 2001.
As short-term interest rates and mortgage rates declined, yields on mortgage
assets decreased 218 basis points during the first nine months of 2002 to 5.32%
as compared to 7.50% during the same period of 2001. Borrowing costs on mortgage
assets also declined as yields dropped 236 basis points to 3.55% during the
first nine months of 2002 as compared to 5.91% during the same period of 2001.
25
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the first
nine months of 2002 and 2001 and includes interest income on Mortgage Assets and
interest expense related to borrowings on Mortgage Assets only (dollars in
thousands):
For the Nine Months For the Nine Months
Ended September 30, 2002 Ended September 30, 2001
-------------------------------- --------------------------------
Average Wtd. Avg Average Wtd. Avg
Balance Interest Yield Balance Interest Yield
-------------------------------- --------------------------------
Mortgage Assets
Securities collateralized by mortgages $ 29,806 $ 1,449 6.48% $ 34,181 $ 2,997 11.69%
Loans receivable:
CMO collateral 2,981,957 120,487 5.39 1,387,641 77,540 7.45
Mortgage loans held-for-investment 81,195 2,865 4.70 154,678 7,115 6.13
Finance receivables:
Affiliated 397,980 13,542 4.54 262,002 14,809 7.54
Non-affiliated 279,273 12,095 5.77 191,563 11,696 8.14
---------------------- ----------------------
Total finance receivables 677,253 25,637 5.05 453,565 26,505 7.79
---------------------- ----------------------
Total loans receivable 3,740,405 148,989 5.31 1,995,884 111,160 7.43
---------------------- ----------------------
Total Mortgage Assets $3,770,211 $150,438 5.32% $2,030,065 $114,157 7.50%
====================== ======================
Borrowings on Mortgage Assets
CMO borrowings $2,894,017 $79,021 3.64% $1,309,069 $57,016 5.81%
Reverse repurchase agreements - mortgages 706,696 15,724 2.97 578,021 25,485 5.88
Borrowings secured by investment securities 10,760 1,455 18.03 18,219 1,958 14.33
---------------------- ----------------------
Total Borrowings on Mortgage Assets $3,611,473 $96,200 3.55% $1,905,309 $84,459 5.91%
====================== ======================
Net Interest Spread 1.77% 1.59%
Net Interest Margin 1.92% 1.95%
During the first nine months of 2002 and 2001 provision for loan losses
was $13.3 million and $10.6 million, respectively, while actual loan losses, net
of recoveries, during the first nine months of 2002 and 2001 were $3.4 million
and $7.7 million, respectively. Provision for loan losses increased during the
first nine months of 2002 as the long-term investment operations acquired $2.7
billion of mortgage loans for long-term investment as compared to $907.8 million
during the same period of 2001. Allowance for loan losses increased 85% to $21.6
million at quarter-end as compared to $11.7 million as of December 31, 2001.
26
The following table summarizes mortgage loan acquisitions for the periods
indicated (in thousands):
LOAN ACQUISITION SUMMARY (1)
For the Nine Months
Ended September 30,
-----------------------------------
2002 2001
----------------- --------------
Balance % Balance %
------- --- ------- ---
Volume by Type:
Adjustable rate ....................... $2,479,017 93 $894,506 99
Fixed rate ............................ 200,871 7 13,287 1
---------- --------
Total Loan Acquisitions ............. $2,679,888 $907,793
========== ========
Volume by Product:
Six month LIBOR indexed ARMs .......... $1,727,198 65 $116,975 13
Six month LIBOR indexed hybrids (2) ... 751,819 28 777,531 86
Fixed first trust deeds ............... 200,560 7 0 0
Fixed second trust deeds .............. 311 0 13,287 1
---------- --------
Total Loan Acquisitions ............. $2,679,888 $907,793
========== ========
Volume by Credit Quality:
Alt-A loans ........................... $2,667,877 100 $901,229 99
B/C loans ............................. 12,011 0 6,564 1
---------- --------
Total Loan Acquisitions ............. $2,679,888 $907,793
========== ========
Volume by Purpose:
Purchase .............................. $1,652,564 62 $614,116 68
Refinance ............................. 1,027,324 38 293,677 32
---------- --------
Total Loan Acquisitions ............. $2,679,888 $907,793
========== ========
Volume by Prepayment Penalty:
With prepayment penalty ............... $2,050,608 77 $533,987 59
Without prepayment penalty ............ 629,280 23 373,806 41
---------- --------
Total Loan Acquisitions ............. $2,679,888 $907,793
========== ========
(1) Excludes premiums paid upon acquiring mortgages.
(2) Mortgage loans are fixed rate for initial two to five year periods and
subsequently adjust to the indicated index plus a margin.
Equity in net earnings of IFC increased to $12.8 million during the first
nine months of 2002 as compared to $7.9 million during the same period of 2001
primarily as loan acquisitions and originations and corresponding sales volume
increased. The increase in loan production during the first nine months of 2002
resulted in a corresponding increase in loan sales which contributed to gain on
sale of loans of $49.4 million as compared to $32.9 million during the same
period of 2001. Refer to "Results of Operations--Impac Funding Corporation" for
more information on the operating results of IFC.
Mark-to-market loss on derivative instruments and cumulative effect of
change in accounting principle, which was the transition adjustment upon
adoption of SFAS 133 on January 1, 2001, decreased to zero during the first nine
months of 2002 as compared to $8.0 million during the same period of 2001. On
January 1, 2001, the Company adopted SFAS 133 and the fair market value of
derivative instruments during the first nine months of 2001 was reflected on the
Company's financial statements as a decrease to net earnings. On August 10,
2001, the Derivatives Implementation Group, or "DIG," of the Financial
Accounting Standards Board published DIG G20, which further interpreted SFAS
133. On October 1, 2001, the Company adopted the provisions of DIG G20 and net
income and accumulated other comprehensive income were adjusted by the amount
needed to reflect the cumulative impact of adopting the provisions of DIG G20.
Results of Operations-- Impac Funding Corporation
For the Nine Months Ended September 30, 2002 as compared to the Nine Months
Ended September 30, 2001
Net earnings increased 63% to $12.9 million during the first nine months
of 2002 as compared to $7.9 million during the same period of 2001 primarily due
a $16.4 million increase in gain on sale of loans and a $4.0 million increase in
net interest income which was partially offset by a $10.2 million increase in
operating expense.
27
Gain on sale of loans increased to $49.4 million on loan sales of $4.0
billion during the first nine months of 2002 as compared to gain on sale of
loans of $32.9 million on loan sales of $2.2 billion during the same period of
2001. Additionally, profit margins on mortgage loans sold during the first nine
months of 2002 were more favorable as compared to profit margins on mortgage
loans sold during the same period of 2001.
Net interest income increased to $5.8 million during the first nine months
of 2002 as compared to $1.7 million during the same period of 2001 as average
loans held for sale increased and net interest margins widened. Average loans
held for sale increased to $412.3 million during the first nine months of 2002
as compared to $269.9 million during the same period of 2001 as a result of
higher loan acquisitions and originations. Net interest margins increased to
2.14% during the first nine months of 2002 as compared to 1.22% during the same
period of 2001 as interest rate spreads widened.
Excluding mark-to-market gain on derivative instruments, total
non-interest expense increased to $37.1 million during the first nine months of
2002 as compared to $23.5 million during the third quarter of 2001. The increase
in total non-interest expense during the first nine months of 2002 was primarily
due to $6.1 million of operating expenses from NFS, which began operations
during the fourth quarter of 2001. In addition, staff and operating expenses
increased as staff was hired to meet greater correspondent loan acquisition and
wholesale origination volumes during the first nine months of 2002. Although
non-interest expense increased during the first nine months of 2002, fully
loaded costs to acquire and originate an Alt-A mortgage loan at IFC declined to
74 basis points during the first nine months of 2002 as compared to 100 basis
points during the same period of 2001. Fully loaded costs to acquire and
originate a B/C mortgage loan at NFS was 235 basis points during the first nine
months of 2002.
The following table summarizes mortgage loan acquisitions and originations
for the periods indicated (in thousands):
LOAN PRODUCTION SUMMARY (1)
For the Nine Months
Ended September 30,
------------------------------------
2002 2001
---------------- ----------------
Balance % Balance %
------- --- ------- ---
Volume by Type:
Fixed rate first trust deeds ......... $1,319,446 31 $1,169,007 54
Fixed rate second trust deeds ........ 61,719 1 29,879 1
Adjustable rate:
Six month LIBOR ARMs ............... 1,875,105 158,880
Six month LIBOR hybrids ............ 995,520 819,786
---------- ----------
Total adjustable rate ................ 2,870,625 68 978,666 45
---------- ----------
Total Loan Production .............. $4,251,790 $2,177,552
========== ==========
Volume by Channel:
Correspondent acquisitions ........... $3,172,698 75 $1,667,374 77
Wholesale and retail originations .... 787,317 18 490,197 22
Novelle Financial Services, Inc. ..... 291,775 7 19,981 1
---------- ----------
Total Loan Production .............. $4,251,790 $2,177,552
========== ==========
Volume by Credit Quality:
Alt-A loans .......................... $3,940,267 93 $2,143,632 98
B/C loans ............................ 311,523 7 33,920 2
---------- ----------
Total Loan Production .............. $4,251,790 $2,177,552
========== ==========
Volume by Purpose:
Purchase ............................. $2,473,125 58 $1,373,171 63
Refinance ............................ 1,778,665 42 804,381 37
---------- ----------
Total Loan Production .............. $4,251,790 $2,177,552
========== ==========
Volume by Prepayment Penalty:
With prepayment penalty .............. $3,291,851 77 $1,407,519 65
Without prepayment penalty ........... 959,939 23 770,033 35
---------- ----------
Total Loan Production .............. $4,251,790 $2,177,552
========== ==========
(1) Excludes premiums paid upon acquiring and originating mortgages.
28
Liquidity and Capital Resources
We recognize the need to have funds available for our operating businesses
and our customer's demands for obtaining short-term warehouse financing until
the settlement or sale of mortgage loans with us or with other investors. It is
our policy to have adequate liquidity at all times to cover normal cyclical
swings in funding availability and loan demand and to allow us to meet abnormal
and unexpected funding requirements. We plan to meet liquidity through normal
operations with the goal of avoiding unplanned sales of assets or emergency
borrowing of funds.
Toward this goal, our asset and liability committee, or "ALCO," is
responsible for monitoring our liquidity position and funding needs. ALCO is
comprised of the senior executives of the Company. ALCO meets on a weekly basis
to review current and projected sources and uses of funds. ALCO monitors the
composition of the balance sheet for changes in the liquidity of our assets in
adverse market conditions. Our liquidity consists of cash and cash equivalents,
short-term and marketable investment securities rated AAA through BBB and
mortgage loans temporarily funded in cash and maturing mortgage loans, or
"liquid assets."
Sources of Liquidity
Our business operations are primarily funded as follows:
o monthly interest and principal payments from our mortgage loan and
investment securities portfolios;
o CMO and reverse repurchase agreements secured by mortgage loans and
mortgage-backed securities;
o proceeds from securitization and whole loan sale of mortgage loans;
and
o cash from the issuance of securities.
We use CMO borrowings and reverse repurchase agreements to fund
substantially all of our mortgage loan and mortgage-backed securities
portfolios. As we accumulate mortgage loans for long-term investment, we issue
CMOs secured by the mortgage loans as a means of providing long-term financing
and repaying short-term repurchase advances. The use of CMOs provides the
following benefits:
o allows us to lock in our financing cost over the life of the
mortgage loans securing the CMO borrowings; and
o eliminates margin calls on the borrowings that are converted from
reverse repurchase agreements to CMO financing.
Terms of CMO borrowings require that an independent third party custodian
hold mortgage loans as collateral. The maturity of each CMO bond class is
directly affected by the rate of early principal payments on the related
collateral. As of September 30, 2002 interest rates on adjustable rate CMOs
range from a low of 0.26% over one-month LIBOR to a high of 2.40% over one-month
LIBOR, or from 2.07% to 4.75% depending on the class of CMOs issued. Interest
rates on fixed rate CMOs range from 4.88% to 7.75% depending on the class of
CMOs issued. Equity in the CMOs is established at the time CMOs are issued at
levels sufficient to achieve desired credit ratings on the securities from
rating agencies. We also determine the amount of equity invested in CMOs based
upon the anticipated return on equity as compared to estimated proceeds from
additional debt issuance. Total credit loss exposure is limited to the equity
invested in the CMOs at any point in time.
During the first nine months of 2002 we issued $2.4 billion of CMOs to
provide long-term financing for mortgage loans securing CMOs. Because of the
credit profile, historical loss performance and prepayment characteristics of
our non-conforming Alt-A mortgages, we have been able to borrow a higher
percentage against mortgage loans securing CMOs, which means that we have to
provide less capital at the time mortgage loans are securitized. By decreasing
the amount of capital we have to invest in our CMOs, we have been able to
efficiently utilize our available capital.
Before the issuance of CMOs, we finance the acquisition of mortgage loans
primarily through borrowings on reverse repurchase agreements with third party
lenders. When we have accumulated a sufficient amount of mortgage loans, we
issue CMOs and convert short-term advances under reverse repurchase agreements
to long-term CMO financing. Since 1995 we have had an uncommitted repurchase
facility with a major investment bank to finance the acquisition of mortgage
loans as needed. In order to give us more flexibility in our borrowing
arrangements and to reduce our reliance on one lender, we entered into
additional uncommitted repurchase facilities of $650.0 million with
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various investment banks during 2002. As of quarter-end the long-term investment
operations and warehouse lending operations had $1.6 billion of uncommitted
repurchase facilities of which $1.2 billion was outstanding.
Terms of the reverse repurchase agreements require that mortgage loans be
held by an independent third party custodian, which gives us the ability to
borrow against a percentage of the outstanding principal balance of the mortgage
loans. The borrowing rates vary from 70 basis points to 150 basis points,
depending on the type of collateral provided, over one-month LIBOR or the Euro
dollar. The advance rates on the reverse repurchase agreements is based on the
type of mortgage collateral provided and generally range from 70% to 98% of the
fair market value of the collateral.
Our reverse repurchase agreements contain customary covenants including
limitation on transactions with affiliates and prohibition of certain mergers,
consolidations and sale of assets. One of our reverse repurchase agreements also
contains covenants regarding minimum liquidity, net worth requirements and a
minimum ratio of indebtedness to tangible net worth. If we fail to comply with
any of these covenants or otherwise default under a reverse repurchase facility,
the buyer has the right to terminate the facility and require immediate
repurchase of the mortgage loans which may require us to sell assets at less
than optimal terms. In addition, if we default under one facility, it would
generally trigger a default under our other facilities.
The mortgage operations currently has warehouse line agreements with the
warehouse lending operations to obtain financing of up to $870.0 million to
provide interim mortgage loan financing during the period that the mortgage
operations accumulates mortgage loans until the mortgage loans are securitized
or sold. As of September 30, 2002 $454.1 million was outstanding under the
warehouse lines. The interest rates on the borrowings are indexed to prime minus
0.50%. Prime was 4.75% at September 30, 2002.
We expect to continue to use short-term warehouse facilities to fund the
acquisition of mortgage loans. If we cannot renew or replace maturing
borrowings, we may have to sell, on a whole loan basis, the loans securing these
facilities which, depending upon market conditions, may result in substantial
losses. Additionally, if for any reason the market value of our mortgage loans
securing warehouse facilities decline, our lenders may require us to provide
them with additional equity or collateral to secure our borrowings, which may
require us to sell mortgage loans at substantial losses.
When the mortgage operations accumulates a sufficient amount of mortgage
loans, generally from 30 to 45 days, it sells or securitizes its mortgage loans.
During the first nine months of 2002 the mortgage operations securitized $594.7
million of mortgage loans as REMICs and sold $2.7 billion, in unpaid principal
balance, of mortgage loans to the long-term investment operations. In addition,
the mortgage operations sold $680.4 million, in unpaid principal balance, of
mortgage loans to other investors. The mortgage operations sold mortgage
servicing rights on all sales and securitizations completed during 2002, which
generated 100% cash gains. Cash from the sale of mortgage servicing rights was
deployed in the mortgage operations and used to acquire and originate additional
mortgage loans.
In order to mitigate interest rate and market risk, we attempt to
securitize our mortgage loans more frequently. Although securitizing mortgage
loans more frequently adds operating and securitization costs, we believe the
added cost is offset as less capital is required and more liquidity is provided
with less interest rate and price volatility, as the accumulation and holding
period of mortgage loans is shortened. The mortgage operations currently has
agreements in place for the sale of mortgage loans and mortgage servicing rights
with an investment bank and large mortgage loan servicer, respectively. This
allows the mortgage operations to forward price its REMIC and CMO transactions
on a servicing released basis and achieve greater stability in the execution of
its securitizations.
On December 1, 2001 we filed a registration statement with the SEC, which
allows us to sell up to $300.0 million of securities, including common stock,
preferred stock, debt securities and warrants. This type of registration
statement is commonly referred to as a "shelf" registration process. In
conjunction with the filing of the shelf, we have completed the sale of an
aggregate of approximately 9.9 million shares of common stock during the first
nine months of 2002, which provided net proceeds of $84.0 million.
On May 22, 2002 we entered into a Sales Agency Agreement with UBS Warburg
LLC, or "the Agent," to sell up to 3,594,082 shares of common stock. In
conjunction with the Sales Agency Agreement, we completed the sale of 854,600
shares of common stock during 2002, of which 365,300 shares were sold during the
three months ended September 30, 2002. We received net proceeds of $9.3 million,
of which $3.8 million was received during the three months ended September 30,
2002. The Agent receives a commission of 3% based on the gross sales price per
share
30
of the shares sold under the Sales Agency Agreement. During the third quarter
the Agent received an aggregate of $118,000.
Uses of Liquidity
Our business operations primarily use funds as follows:
o acquisition and origination of mortgage loans;
o provide short-term warehouse financing; and
o pay common stock dividends.
During the first nine months of 2002 we acquired and originated $4.3
billion of mortgage loans of which we retained $2.7 billion for long-term
investment. Our equity investment in mortgage loans is outstanding until we sell
or securitize our mortgage loans, which is one of the reasons we attempt to
securitize our mortgage loans frequently. When we complete CMOs our average
equity investment generally ranges from approximately 2 1/2% to 3 1/2% of the
outstanding principal balance of mortgage loans, depending on our premium costs,
securitization costs, interest rate hedge acquisition costs and the capital
investment required. Since we rely significantly upon securitizations to
generate cash proceeds to repay borrowings and to create credit availability,
any disruption in our ability to complete securitizations may require us to
utilize other sources of financing, which, if available at all, may be on
unfavorable terms. In addition, delays in closing securitizations of our
mortgage loans increase our risk by exposing us to credit and interest rate
risks for this extended period of time. Furthermore, gains on sales from our
securitizations represent a significant portion of our earnings.
We utilize our uncommitted warehouse lines to provide short-term warehouse
financing to affiliates and external customers of the warehouse lending
operations. The mortgage operations has a $870.0 million warehouse facility with
the warehouse lending operations to fund the acquisition and origination of
mortgage loans until sale or securitization. The warehouse lending operations
provides financing to affiliates at prime minus 0.50%. As of September 30, 2002
affiliates had $439.7 million outstanding on the warehouse line with the
warehouse lending operations.
The warehouse lending operations also provides financing to non-affiliates
at prime plus a spread. Non-affiliates can generally finance between 95% and 98%
of the fair market value of the mortgage loans. As of September 30, 2002 the
warehouse lending operations had $564.0 million of approved warehouse lines
available to its non-affiliate customers of which $476.7 million was
outstanding. Our ability to meet liquidity requirements and the financing need
of our customers is subject to the renewal of our credit and repurchase
facilities or obtaining other sources of financing, if required, including
additional debt or equity from time to time. Any decision our lenders or
investors make to provide available financing to us in the future will depend
upon a number of factors, including:
o our compliance with the terms of our existing credit arrangements;
o our financial performance;
o industry and market trends in our various businesses;
o the general availability of and rates applicable to financing and
investments;
o our lenders or investors resources and policies concerning loans and
investments; and
o the relative attractiveness of alternative investment or lending
opportunities.
During the first quarter of 2002 we declared a common stock dividend of
$0.40 per common share, or $15.8 million, which was paid on April 16, 2002.
During the second quarter of 2002 we declared a common stock dividend of
$0.43 per common share, or $17.2 million, which was paid on July 12, 2002.
During the third quarter of 2002 we declared a common stock dividend of
$0.45 per common share, or $19.3 million, which was paid on October 9, 2002.
Cash Flows
Operating Activities - During the first nine months of 2002 net cash
provided by operating activities was $70.0 million, which was primarily the
result of net earnings of $52.8 million.
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Investing Activities - During the first nine months of 2002 net cash used
in investing activities was $2.5 billion. Net cash flows of $2.1 billion,
including principal repayments, was used in investing activities to acquire and
originate mortgage loans and $449.8 million was used to provide short-term
advances warehouse advances to affiliates and external customers.
Financing Activities - During the first nine months of 2002 net cash
provided by financing activities was $2.5 billion. Net cash flows of $1.8
billion was provided by proceeds from CMO borrowings, net of repayment of CMO
borrowings, $693.6 million was provided by advances on warehouse lines and $93.3
million was provided by the issuance of common stock.
Inflation
The consolidated financial statements and corresponding notes to the
consolidated financial statements have been prepared in accordance with GAAP,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased costs of our operations. Unlike industrial companies,
nearly all of our assets and liabilities are monetary in nature. As a result,
interest rates have a greater impact on our performance than do the effects of
general levels of inflation. Inflation affects our operations primarily through
its effect on interest rates, since interest rates normally increase during
periods of high inflation and decrease during periods of low inflation. During
periods of increasing interest rates, demand for mortgage loans and a borrower's
ability to qualify for mortgage financing in a purchase transaction may be
adversely affected. During periods of decreasing interest rates, borrowers may
prepay their mortgages, which in turn may adversely affect our yield and
subsequently the value of our portfolio of mortgage assets.
Risk Factors
A prolonged economic downturn or recession would likely result in a reduction of
our mortgage origination activity which would adversely affect our financial
results.
The United States economy has recently undergone and may in the future,
undergo, a period of slowdown, which some observers view as a recession. An
economic downturn or a recession may have a significant adverse impact on our
operations and our financial condition. For example, a reduction in new
mortgages will adversely affect our ability to expand our mortgage portfolio,
our principal means of increasing our earnings. In addition, a decline in new
mortgage activity will likely result in reduced activity for our warehouse
lending operations and our long-term investment operations. In the case of our
mortgage operations, a decline in mortgage activity may result in fewer loans
that meet its criteria for purchase and securitization, thus resulting in a
reduction in interest income and fees and gain on sale of loans. We may also
experience larger than previously reported losses on our investment portfolio
due to a higher level of defaults or foreclosures on our mortgage loans.
If we are unable to generate sufficient liquidity we will be unable to conduct
our operations as planned.
If we cannot generate sufficient liquidity, we will be unable to continue
to grow our operations, grow our asset base, maintain our current hedging policy
and pay dividends. We have traditionally derived our liquidity from four primary
sources:
o financing facilities provided to us by others to acquire or
originate mortgage assets;
o whole loan sales and securitizations of acquired or originated
mortgage loans;
o our issuance of equity and debt securities; and
o earnings from operations.
We cannot assure you that any of these alternatives will be available to
us, or if available, that we will be able to negotiate favorable terms. Our
ability to meet our long-term liquidity requirements is subject to the renewal
of our credit and repurchase facilities and/or obtaining other sources of
financing, including additional debt or equity from time to time. Any decision
by our lenders and/or investors to make additional funds available to us in the
future will depend upon a number of factors, such as our compliance with the
terms of our existing credit arrangements, our financial performance, industry
and market trends in our various businesses, the lenders' and/or investors' own
resources and policies concerning loans and investments, and the relative
attractiveness of alternative investment or lending opportunities. If we cannot
raise cash by selling debt or equity securities, we may be forced to sell our
assets
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at unfavorable prices or discontinue various business activities. Our inability
to access the capital markets could have a negative impact on our earnings and
hence, our ability to pay dividends.
Any significant margin calls under our financing facilities would adversely
affect our liquidity and may adversely affect our financial results.
Prior to the fourth quarter of 1998, we generally had no difficulty in
obtaining favorable financing facilities or in selling acquired mortgage loans.
However, during the fourth quarter of 1998, the mortgage industry experienced
substantial turmoil as a result of a lack of liquidity in the secondary markets.
At that time, investors expressed unwillingness to purchase interests in
securitizations due, in part, to:
o the lack of financing to acquire these securitization interests;
o the widening of returns expected by institutional investors on
securitization interests over the prevailing Treasury rate; and
o market uncertainty.
As a result, many mortgage loan originators, including our company, were
unable to access the securitization market on favorable terms. This resulted in
some companies declaring bankruptcy. Originators, like our company, were
required to sell loans on a whole loan basis and liquidate holdings of
mortgage-backed securities to repay short-term borrowings. However, the large
amount of loans available for sale on a whole loan basis affected the pricing
offered for these loans, which in turn reduced the value of the collateral
underlying the financing facilities. Therefore, many providers of financing
facilities initiated margin calls. Margin calls resulted when our lenders
evaluated the market value of the collateral securing our financing facilities
and required us to provide them with additional equity or collateral to secure
our borrowings.
Our financing facilities were short-term borrowings and due to the turmoil
in the mortgage industry during the latter part of 1998 many traditional
providers of financing facilities were unwilling to provide facilities on
favorable terms, or at all. Our current financing facilities continue to be
short-term borrowings and we expect this to continue. If we cannot renew or
replace maturing borrowings, we may have to sell, on a whole loan basis, the
loans securing these facilities which, depending upon market conditions, may
result in substantial losses.
We incurred losses for fiscal years 1997, 1998 and 2000 and may incur losses in
the future.
During the year ended December 31, 2000, we experienced a net loss of
$54.2 million. The net loss incurred during 2000 included non-cash accounting
charges of $68.9 million. The non-cash accounting charges were the result of
write-downs of non-performing investment securities secured by mortgages and
additional increases in the provision for loan losses to provide for the
deterioration of the performance of collateral supporting specific investment
securities. During the year ended December 31, 1998, we experienced a net loss
of $5.9 million. During the year ended December 31, 1997, we experienced a net
loss of $16.0 million. The net loss incurred during 1997 included a non-cash
accounting charge of $44.4 million that was the result of expenses related to
the termination and buyout of our management agreement with Imperial Credit
Advisors, Inc. We cannot be certain that revenues will remain at current levels
or improve or that we will be profitable in the future, which could prevent us
from effectuating our business strategy.
If we are unable to complete securitizations, we would face a liquidity shortage
which would adversely affect our operating results.
We rely significantly upon securitizations to generate cash proceeds to
repay borrowings and to create credit availability. Any reduction in our ability
to complete securitizations may require us to utilize other sources of
financing, which, if available at all, may be on unfavorable terms. In addition,
delays in closing securitizations of our mortgage loans increase our risk by
exposing our company to credit and interest rate risks for this extended period
of time. Furthermore, gains on sales from our securitizations represent a
significant portion of our earnings. Several factors could affect our ability to
complete securitizations of our mortgages, including:
o conditions in the securities and secondary markets;
o credit quality of the mortgage loans acquired or originated through
our mortgage operations;
o volume of our mortgage loan acquisitions and originations;
o our ability to obtain credit enhancements; and
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o lack of investors purchasing higher risk components of the
securities.
If we are unable to profitably securitize a significant number of our
mortgage loans in a particular financial reporting period, then we could
experience lower income or a loss for that period. As a result of turmoil in the
securitization market during the latter part of 1998, many mortgage lenders,
including our company, were required to sell mortgage loans on a whole loan
basis under adverse market conditions in order to generate liquidity. Many of
these sales were made at prices lower than our carrying value of the mortgage
loans and we experienced substantial losses. We cannot assure you that we will
be able to continue to profitably securitize or sell our loans on a whole loan
basis, or at all.
The market for first loss risk securities, which are securities that take
the first loss when mortgages are not paid by the borrowers, is generally
limited. In connection with our REMIC securitizations, we endeavor to sell all
securities subjecting us to a first loss risk. If we cannot sell these
securities, we may be required to hold them for an extended period, subjecting
us to a first loss risk.
Our borrowings and use of substantial leverage may cause losses.
Our use of collateralized mortgage obligations may expose our operations
to credit losses.
To grow our investment portfolio, we borrow a substantial portion of the
market value of substantially all of our investments in mortgage loans in the
form of CMOs. Historically, we have borrowed approximately 98% of the market
value of such investments. There are no limitations on the amount we may borrow,
other than the aggregate value of the underlying mortgage loans. We currently
use CMOs as financing vehicles to increase our leverage, since mortgage loans
held for CMO collateral are retained for investment rather than sold in a
secondary market transaction. Retaining mortgage loans as collateral for CMOs
exposes our operations to greater credit losses than does the use of other
securitization techniques that are treated as sales because as the equity holder
in the security, we are allocated losses from the liquidation of defaulted loans
first prior to any other security holder. Although our liability under a
collateralized mortgage obligation is limited to the collateral used to create
the collateralized mortgage obligation, we generally are required to make a cash
equity investment to fund collateral in excess of the amount of the securities
issued in order to obtain the appropriate credit ratings for the securities
being sold, and therefore obtain the lowest interest rate available, on the
CMOs. If we experience greater credit losses than expected on the pool of loans
subject to the CMO, the value of our equity investment will decrease and we
would have to increase the allowance for loan losses on our financial
statements.
The cost of our borrowings may exceed the return on our assets.
The cost of borrowings under our financing facilities corresponds to a
referenced interest rate plus or minus a margin. The margin varies depending on
factors such as the nature and liquidity of the underlying collateral and the
availability of financing in the market. We will experience net interest losses
if the returns on our assets financed with borrowed funds fail to cover the cost
of our borrowings, and we did not implement any applicable financial hedges.
If we default under our financing facilities, we may be forced to
liquidate the collateral at prices less than the amount borrowed.
If we default under our financing facilities, our lenders could force us
to liquidate the collateral. If the value of the collateral is less than the
amount borrowed, we could be required to pay the difference in cash.
Furthermore, if we default under one facility, it would generally cause a
default under our other facilities. If we were to declare bankruptcy, some of
our reverse repurchase agreements may obtain special treatment and our creditors
would then be allowed to liquidate the collateral without any delay. On the
other hand, if a lender with whom we have a reverse repurchase agreement
declares bankruptcy, we might experience difficulty repurchasing our collateral,
or enforcing our claim for damages, and it is possible that our claim could be
repudiated and we could be treated as an unsecured creditor. If this occurs, our
claims would be subject to significant delay and we may receive substantially
less than our actual damages or nothing at all.
If we are forced to liquidate we may have few unpledged assets for
distribution to unsecured creditors.
We have pledged a substantial portion of our assets to secure the
repayment of CMOs issued in securitizations, our financing facilities and our
other borrowings. We will also pledge substantially all of our current and
future mortgage
34
loans to secure borrowings pending their securitization or sale. The cash flows
we receive from our investments that have not yet been distributed, pledged or
used to acquire mortgage loans or other investments may be the only unpledged
assets available to our unsecured creditors and you if our company was
liquidated.
Interest rate fluctuations may adversely affect our operating results.
Our operations, as a mortgage loan acquirer and originator or a warehouse
lender, may be adversely affected by rising and falling interest rates. Higher
interest rates may discourage potential borrowers from refinancing mortgages,
borrowing to purchase homes or seeking second mortgages. This may decrease the
amount of mortgages available to be acquired or originated by our mortgage
operations and decrease the demand for warehouse financing provided by our
warehouse lending operations. If short-term interest rates exceed long-term
interest rates, there is a higher risk of increased loan prepayments, as
borrowers may seek to refinance their fixed and adjustable rate mortgage loans
at lower long-term fixed interest rates. Increased loan prepayments could lead
to a reduction in the number of loans in our investment portfolio and reduce our
net interest income.
We are subject to the risk of rising mortgage interest rates between the
time we commit to purchase mortgages at a fixed price through the issuance of
individual, bulk or other rate-locks and the time we sell or securitize those
mortgages. An increase in interest rates will generally result in a decrease in
the market value of mortgages that we have committed to purchase at a fixed
price, but have not been sold or securitized or have not been properly hedged.
As a result, we may record a smaller gain, or even a loss, upon the sale or
securitization of those mortgage loans.
We may experience losses if our liabilities re-price at different rates than our
assets.
Our principal source of revenue is net interest income or net interest
spread from our investment portfolio, which is the difference between the
interest we earn on our interest earning assets and the interest we pay on our
interest bearing liabilities. The rates we pay on our borrowings are independent
of the rates we earn on our assets and may be subject to more frequent periodic
rate adjustments. Therefore, we could experience a decrease in net interest
income or a net interest loss because the interest rates on our borrowings could
increase faster than the interest rates on our assets. If our net interest
spread becomes negative, we will be paying more interest on our borrowings than
we will be earning on our assets and we will be exposed to a risk of loss.
Additionally, the rates paid on our borrowings and the rates received on
our assets may be based upon different indices. If the index used to determine
the rate on our borrowings, typically one-month LIBOR, increases faster than the
indices used to determine the rates on our assets, such as six-month LIBOR,
one-year CMT, or the prime rate, we will experience a declining net interest
spread, which will have a negative effect on our profitability, and may result
in losses.
An increase in our adjustable interest rate borrowings may decrease the net
interest margin on our adjustable rate mortgages.
Our long-term investment portfolio includes mortgage loans that are
hybrids ARMs. These are mortgages with fixed interest rates for an initial
period of time, after which they begin bearing interest based upon short-term
interest rate indices. We generally fund mortgages with adjustable interest rate
borrowings having interest rates that are indexed to short-term interest rates
and adjust periodically at various intervals. To the extent that there is an
increase in the interest rate index used to determine our adjustable interest
rate borrowings and that increase is not offset by a corresponding increase in
the rates at which interest accrues on our assets or by various interest rate
hedges that we have in place at any given time, our net interest margin will
decrease or become negative. We may suffer a net interest loss on our adjustable
rate mortgages that have interest rate caps if the interest rates on our related
borrowings increase.
Adjustable rate mortgages typically have interest rate caps, which limit
interest rates charged to the borrower during any given period. Our borrowings
are not subject to similar restrictions. As a result, in a period of rapidly
increasing interest rates, the interest rates we pay on our borrowings could
increase without limitation, while the interest rates we earn on our adjustable
rate mortgage assets would be capped. If this occurs, our net interest spread
could be significantly reduced or we could suffer a net interest loss.
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Increased levels of prepayments of our adjustable rate mortgage loans may
accelerate our expenses and decrease our net income.
Mortgage prepayments generally increase on our adjustable rate mortgages
when fixed mortgage interest rates fall below the then-current interest rates on
outstanding adjustable rate mortgage loans. Prepayments on mortgage loans are
also affected by the terms and credit grades of the loans, conditions in the
housing and financial markets and general economic conditions. Most of the
adjustable rate mortgages that we acquire are originated within three months of
the time we purchased the mortgages and generally bear initial interest rates
that are lower than their fully-indexed amount (the applicable index plus the
margin). If we acquire these mortgages at a premium and they are repaid prior to
or soon after the time of adjustment to a fully-indexed rate without payment of
any prepay penalty, we would not have received interest at the fully-indexed
rate during such period and we must expense the unamortized premium that was
paid for the loan at the time of the prepayment. This means we would lose the
opportunity to earn interest at that rate over the expected life of the
mortgage. Also, if prepayments on our adjustable rate mortgage loans increase
when interest rates are declining, our net interest income may decrease if we
cannot reinvest the prepayments in mortgage assets bearing comparable rates.
Prepayments on fixed rate mortgages will also decrease our net interest income
when interest rates are declining.
We generally acquire mortgages on a servicing released basis, meaning we
acquire both the mortgages and the rights to service them. This strategy
requires us to pay a higher purchase price or premium for the mortgages. If the
mortgage loans that we acquire at a premium prepay faster than originally
projected, generally accepted accounting principles require us to write down the
remaining capitalized premium amounts at a faster speed than was originally
projected, which would decrease our current net interest income.
The value of our portfolio of mortgage-backed securities may be adversely
affected by unforeseen events.
Our prior investments in residual interest and subordinated debt
investments exposed us to greater risks as compared to those associated with
senior mortgage-backed securities.
Prior to 1998, we invested in mortgage-backed securities known as
interest-only, principal-only, residual interest or other subordinated
securities. Investments in residual interest and subordinated securities are
much riskier than investments in senior mortgage-backed securities because these
subordinated securities bear all credit losses prior to the related senior
securities. The risk associated with holding residual interest and subordinated
securities is greater than that associated with holding the underlying mortgage
loans directly due to the concentration of losses attributed to the subordinated
securities.
If the projected value of our portfolio of residual interest and
subordinated debt instruments is incorrect we would have to write down the value
of these securities.
We estimate future cash flows from these securities and value them
utilizing assumptions based in part on projected discount rates, mortgage loan
prepayments and credit losses. If our actual experience differs from our
assumptions, we would be required to reduce the value of these securities. The
market for our asset-backed securities is extremely limited and we cannot assure
you that we could sell these securities at their reported value, or at any value
or that we could recoup our initial investment.
In addition, we may not obtain our anticipated yield or we may incur
losses if the credit support available within certain mortgage-backed securities
is inadequate due to unanticipated levels of losses, or due to difficulties
experienced by the credit support provider. Delays or difficulties encountered
in servicing the mortgages in mortgage-backed securities may cause greater
losses and, therefore, greater resort to credit support than was originally
anticipated, and may cause a rating agency to downgrade certain classes of our
mortgage-backed securities, which might then equate to a reduction of the value
of the security.
We undertake additional risks by acquiring and investing in mortgage loans.
We may be subject to losses on mortgage loans for which we do not obtain
credit enhancements.
We do not obtain credit enhancements such as mortgage pool or special
hazard insurance for all of our mortgage loans and investments. Generally, we
require mortgage insurance on any loan with a loan-to-value ratio greater than
80%. During the time we hold mortgage loans for investment, we are subject to
risks of borrower defaults and
36
bankruptcies and special hazard losses that are not covered by standard hazard
insurance. If a borrower defaults on a mortgage loan that we hold, we bear the
risk of loss of principal to the extent there is any deficiency between the
value of the related mortgaged property and the amount owing on the mortgage
loan and any insurance proceeds available to us through the mortgage insurer. In
addition, since defaulted mortgage loans, which under our financing arrangements
are mortgage loans that are generally 60 to 90 days delinquent in payments, may
be considered negligible collateral under our borrowing arrangements, we could
bear the risk of being required to own these loans without the use of borrowed
funds until they are ultimately liquidated or possibly sold at a loss.
Non-conforming Alt-A mortgage loans expose us to greater credit risks
We are an acquirer and originator of non-conforming Alt-A residential
mortgage loans. These are residential mortgages that do not qualify for purchase
by government sponsored agencies such as the Federal National Mortgage
Association and the Federal Home Loan Mortgage Corporation. Our operations may
be negatively affected due to our investments in non-conforming Alt-A mortgage
loans. Credit risks associated with non-conforming Alt-A mortgage loans are
greater than those associated with conforming mortgage loans. The interest rates
we charge on non-conforming Alt-A loans are often higher than those charged for
conforming loans in order to compensate for the higher risk and lower liquidity.
Lower levels of liquidity may cause us to hold loans or other mortgage-related
assets supported by these loans that we otherwise would not hold. By doing this,
we assume the potential risk of increased delinquency rates and/or credit losses
as well as interest rate risk. Additionally, the combination of different
underwriting criteria and higher rates of interest leads to greater risk,
including higher prepayment rates and higher delinquency rates and/or credit
losses.
Lending to non-conforming Alt-A borrowers may expose us to a higher risk
of delinquencies, foreclosures and losses.
As a lender of non-conforming Alt-A mortgage loans, our market includes
borrowers who may be unable to obtain mortgage financing from conventional
mortgage sources. Loans made to such non-conforming Alt-A borrowers generally
entail a higher risk of delinquency and higher losses than loans made to
borrowers who utilize conventional mortgage sources. Delinquency, foreclosures
and losses generally increase during economic slowdowns or recessions. The
actual risk of delinquencies, foreclosures and losses on loans made to
non-conforming Alt-A borrowers could be higher under adverse economic conditions
than those currently experienced in the mortgage lending industry in general.
Further, any material decline in real estate values increases the loan-to-value
ratios of loans previously made by us, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of a borrower default. Any
sustained period of increased delinquencies, foreclosures or losses after the
loans are sold could adversely affect the pricing of our future loan sales and
our ability to sell or securitize our loans in the future. In the past, certain
of these factors have caused revenues and net income of many participants in the
mortgage industry, including us, to fluctuate from quarter to quarter.
Our use of second mortgages exposes us to greater credit risks.
Our security interest in the property securing second mortgages is
subordinated to the interest of the first mortgage holder and the second
mortgages have a higher combined loan-to-value ratio than does the first
mortgage. If the value of the property is equal to or less than the amount
needed to repay the borrower's obligation to the first mortgage holder upon
foreclosure, our second mortgage loan will not be repaid.
The geographic concentration of our mortgage loans increases our exposure
to risks in those areas.
We do not set limitations on the percentage of our mortgage asset
portfolio composed of properties located in any one area (whether by state, zip
code or other geographic measure). Concentration in any one area increases our
exposure to the economic and natural hazard risks associated with that area.
Historically, a majority of our mortgage loan acquisitions and originations by
the mortgage operations and mortgage loans held for investment by our long term
investment operations were secured by properties in California and, to a lesser
extent, Florida. For instance, certain parts of California have experienced an
economic downturn in past years and California and Florida have suffered the
effects of certain natural hazards. Declines in those residential real estate
markets may reduce the values of the properties collateralizing the mortgage
loans, increase foreclosures and losses and have material adverse effect on our
results of operations or financial condition. Furthermore, if borrowers are not
insured for natural disasters, which are typically not covered by standard
hazard insurance policies, then they may not be able to repair the property or
may stop paying their mortgage loans if the property is damaged. This would
cause increased
37
foreclosures and decrease our ability to recover losses on properties affected
by such disasters. This would have a material adverse effect on our results of
operations or financial condition.
Representations and warranties made by us in our loan sales and securitizations
may subject us to liability.
In connection with our securitizations, we transfer loans acquired or
originated by us into a trust in exchange for cash and, in the case of a CMO,
residual certificates issued by the trust. The trustee will have recourse to us
with respect to the breach of the standard representations and warranties made
by us at the time such loans are transferred. While we generally have recourse
to our customers for any such breaches, there can be no assurance of our
customers' abilities to honor their respective obligations. Also, we engage in
bulk whole loan sales pursuant to agreements that generally provide for recourse
by the purchaser against us in the event of a breach of one of our
representations or warranties, any fraud or misrepresentation during the
mortgage loan origination process, or upon early default on such mortgage loan.
We generally limit the potential remedies of such purchasers to the potential
remedies we receive from the people from whom we acquired or originated the
mortgage loans. However, in some cases, the remedies available to a purchaser of
mortgage loans from us may be broader than those available to us against the
sellers of the loans and should a purchaser enforce its remedies against us, we
may not always be able to enforce whatever remedies we have against our
customers. Furthermore, if we discover, prior to the sale or transfer of a loan,
that there is any fraud or misrepresentation with respect to the loan and the
originator fails to repurchase the loan, then we may not be able to sell the
loan or we may have to sell the loan only at a discount.
In the ordinary course of our business, we are subject to claims made
against us by borrowers and trustees in our securitizations arising from, among
other things, losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of our employees, officers and agents (including our appraisers),
incomplete documentation and our failure to comply with various laws and
regulations applicable to our business. Any claims asserted against us may
result in legal expenses or liabilities that could have a material adverse
effect on our results of operations or financial condition.
We face conflicts of interests based on the ownership of the voting stock of
Impac Funding Corporation by certain officers and directors of Impac Mortgage
Holdings, Inc.
We are subject to conflicts of interest arising from our relationship with
Impac Mortgage Holdings, Inc., our long-term investment operations, Impac
Funding Corporation, our mortgage operations, and their officers and directors.
Our long-term investment operations acquires non-confirming Alt-A mortgage loans
from our mortgage operations. Impac Mortgage Holdings, Inc. owns all of the
preferred stock, and 99% of the economic interest in, Impac Funding Corporation.
Joseph R. Tomkinson, our Chairman and Chief Executive Officer, William S.
Ashmore, our Chief Operating Officer, President and a director, and Richard J.
Johnson, our Executive Vice President and Chief Financial Officer, are holders
of all of the outstanding voting stock of, and 1% of the economic interest in,
Impac Funding Corporation. They have the right to elect all directors of Impac
Funding Corporation and the ability to control the outcome of all matters for
which the consent of the holders of the common stock of Impac Funding
Corporation is required. Messer's Tomkinson, Ashmore and Johnson are also the
sole directors of Impac Funding Corporation. Decisions made by these officers at
one company may be at conflict with and have an adverse affect on the operations
of the other.
A substantial interruption in our use of iDASLg2 may adversely affect our level
of mortgage loan acquisitions and originations.
We utilize the Internet in our business principally for the implementation
of our automated loan origination program, iDASLg2, which stands for the second
generation of Impac Direct Access System for Lending. iDASLg2 is not a lead
generator for mortgage brokers. iDASLg2 allows our customers to pre-qualify
borrowers for various loan programs based on criteria requested from the
borrower and renders an automated underwriting decision by issuing an approval
of the mortgage loan or a referral for further review or additional information.
All of our correspondents submit loans through iIDASLg2 and all wholesale loans
delivered by mortgage brokers are directly underwritten through the use of
iDASLg2. iDASLg2 may be interrupted if the Internet experiences periods of poor
performance, if our computer systems or the systems of our third-party service
providers contain defects, or if customers are reluctant to use or have
inadequate connectivity to the Internet. Increased government regulation of the
Internet could also adversely affect our use of the Internet in unanticipated
ways and discourage our customers from using our services. If our ability to use
the Internet in providing our services is impaired, our ability to originate or
acquire loans on an automated basis could be delayed or reduced. Furthermore, we
rely on a third party hosting company in connection
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with the use of iDASLg2. If the third party hosting company fails for any
reason, and adequate back-up is not implemented in a timely manner, it may delay
and reduce those mortgage loan acquisitions and originations done through
iDASLg2. Any substantial delay and reduction in our mortgage loan acquisitions
and originations will reduce our net earnings for the applicable period.
We are subject to risks of operational failure that are beyond our control.
Substantially all of our operations are located in Newport Beach,
California. Our systems and operations are vulnerable to damage and interruption
from fire, flood, telecommunications failure, break-ins, earthquake and similar
events. Our operations may also be interrupted by power disruptions, including
rolling black-outs implemented in California due to the state's continuing acute
power shortage. We do not maintain alternative power sources. Furthermore, our
security mechanisms may be inadequate to prevent security breaches to our
computer systems, including from computer viruses, electronic break-ins and
similar disruptions. Such security breaches or operational failures could expose
us to liability, impair our operations, result in losses, and harm our
reputation.
Competition for mortgage loans is intense and may adversely affect our
operations.
We compete in acquiring and originating non-conforming Alt-A mortgage
loans and issuing mortgage-backed securities with other mortgage conduit
programs, investment banking firms, savings and loan associations, banks, thrift
and loan associations, finance companies, mortgage bankers, insurance companies,
other lenders, and other entities purchasing mortgage assets.
We also face intense competition from Internet-based lending companies
where entry barriers are relatively low. Some of our competitors are much larger
than we are, have better name recognition than we do, and have far greater
financial and other resources. Government-sponsored entities, in particular
Fannie Mae and Freddie Mac, are also expanding their participation in the Alt-A
mortgage industry. These government-sponsored entities have a size and
cost-of-funds advantage over us that allows them to price loans at lower rates
than we are able to offer. This phenomenon may seriously destabilize the Alt-A
mortgage industry. In addition, if as a result of their less-conservative,
risk-adjusted pricing these government-sponsored entities experience
significantly higher-than-expected losses, it would likely adversely affect
overall investor perception of the Alt-A mortgage industry because the losses
would be made public due to the reporting obligations of these entities.
The intense competition in the Alt-A mortgage industry has also led to
rapid technological developments, evolving industry standards and frequent
releases of new products and enhancements. As mortgage products are offered more
widely through alternative distribution channels, such as the Internet, we may
be required to make significant changes to our current retail and wholesale
structure and information systems to compete effectively. Our inability to
continue enhancing our current Internet capabilities, or to adapt to other
technological changes in the industry, could have a material adverse effect on
our business, financial condition, liquidity and results of operations.
The need to maintain mortgage loan volume in this competitive environment
creates a risk of price competition in the Alt-A mortgage industry. Competition
in the industry can take many forms, including interest rates and costs of a
loan, less stringent underwriting standards, convenience in obtaining a loan,
customer service, amount and term of a loan and marketing and distribution
channels. Price competition would lower the interest rates that we are able to
charge borrowers, which would lower our interest income. Price-cutting or
discounting reduces profits and will depress earnings if sustained for any
length of time. If our competition uses less stringent underwriting standards we
will be pressured to do so as well, resulting in greater loan risk without being
able to price for that greater risk. Our competitors may lower their
underwriting standards to increase their market share. If we do not relax
underwriting standards in the face of competition, we may lose market share.
Increased competition may also reduce the volume of our loan originations and
acquisitions. Any increase in these pricing and credit pressures could have a
material adverse effect on our business, financial condition, liquidity and
results of operations.
We are exposed to potential credit losses in providing warehouse financing.
As a warehouse lender, we lend money to mortgage bankers on a secured
basis and we are subject to the risks associated with lending to mortgage
bankers, including the risks of fraud, borrower default and bankruptcy, any of
which could result in credit losses for us. Our claims as a secured lender in a
bankruptcy proceeding may be subject to adjustment and delay.
39
We may not pay dividends to stockholders.
REIT provisions of the Internal Revenue Code generally require that we
annually distribute to our stockholders at least 90% of all of our taxable
income. These provisions restrict our ability to retain earnings and thereby
renew capital for our business activities. We may decide at a future date to
terminate our REIT status, which would cause us to be taxed at the corporate
level, and cease paying regular dividends.
In addition, for any year that we do not generate taxable income, we are
not required to declare and pay dividends to maintain our REIT status. For
instance, due to losses incurred in 2000, we did not declare any dividends from
September 2000 until September 2001.
To date, a portion of our taxable income and cash flow has been
attributable to our receipt of dividend distributions from Impac Funding
Corporation, our mortgage operations affiliate. Impac Funding Corporation is not
a REIT and is not, therefore, subject to the above-described REIT distribution
requirements. Because Impac Funding Corporation is seeking to retain earnings to
fund the future growth of our mortgage operations business, its board may decide
that Impac Funding Corporation should cease making dividend distributions in the
future. This would materially reduce the amount of our taxable income and in
turn, would reduce the amount we would be required to distribute as dividends.
If we fail to maintain our REIT status, we may be subject to taxation as a
regular corporation.
We believe that we have operated and intend to continue to operate in a
manner that enables us to meet the requirements for qualification as a REIT for
federal income tax purposes. We have not requested, and do not plan to request,
a ruling from the Internal Revenue Service that we qualify as a REIT.
Moreover, no assurance can be given that legislation, new regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to qualification as a REIT or the federal income tax
consequences of such qualification. Our continued qualification as a REIT will
depend on our satisfaction of certain asset, income, organizational and
stockholder ownership requirements on a continuing basis.
If we fail to qualify as a REIT, we would not be allowed a deduction for
distributions to stockholders in computing our taxable income and would be
subject to federal income tax at regular corporate rates. We also may be subject
to the federal alternative minimum tax. Unless we are entitled to relief under
specific statutory provisions, we could not elect to be taxed as a REIT for four
taxable years following the year during which we were disqualified. Therefore,
if we lose our REIT status, the funds available for distribution to you would be
reduced substantially for each of the years involved. Failure to qualify as a
REIT could adversely affect the value of our common stock.
Delayed mortgage loan sales or securitization closings could have a material
adverse affect on our operations.
A delay in closing a particular mortgage loan sale or securitization would
increase our exposure to interest rate fluctuations by lengthening the period
during which our variable rate borrowings under our warehouse facilities are
outstanding. Any disruption in our ability to complete securitizations may
require us to utilize other sources of financing, which, if available at all,
may be on unfavorable terms. If we were unable to sell a sufficient number of
mortgage loans at a premium during a particular reporting period, our revenues
for that period would decline, which could have a material adverse affect on our
operations.
Our share prices have been and may continue to be volatile.
Historically, the market price of our common stock has been volatile. The
market price of our common stock is likely to continue to be highly volatile and
could be significantly affected by factors including:
o the amount of dividends paid;
o availability of liquidity in the securitization market;
o loan sale pricing;
o calls by warehouse lenders or changes in warehouse lending rates;
o unanticipated fluctuations in our operating results;
o prepayments on mortgages;
o valuations of securitization related assets;
40
o cost of funds; and
o general market conditions.
In addition, significant price and volume fluctuations in the stock market
have particularly affected the market prices for the common stock of mortgage
REIT companies such as ours. These broad market fluctuations have adversely
affected and may continue to adversely affect the market price of our common
stock. If our results of operations fail to meet the expectations of securities
analysts or investors in a future quarter, the market price of our common stock
could also be materially adversely affected and we may experience difficulty in
raising capital.
If actual prepayments or defaults with respect to mortgage loans serviced occurs
more quickly than originally assumed, the value of our mortgage servicing rights
would be subject to downward adjustment.
When we purchase loans that include the associated servicing rights, the
allocated cost of the servicing rights is reflected on our financial statements
as mortgage servicing rights. To determine the fair value of these servicing
rights, we use assumptions to estimate future net servicing income including
projected discount rates, mortgage loan prepayments and credit losses. If actual
prepayments or defaults with respect to loans serviced occur more quickly than
we originally assumed, we would have to reduce the carrying value of our
mortgage servicing rights. We do not know if our assumptions will prove correct.
Our operating results may be adversely affected by the results of our hedging
activities.
To offset the risks associated with our mortgage operations, we enter into
transactions designed to hedge our interest rate risks. To offset the risks
associated with our long-term investment operations, we attempt to match the
interest rate sensitivities of our adjustable rate mortgage assets held for
investment with the associated financing liabilities. Our management determines
the nature and quantity of the hedging transactions based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
We do not limit management's use of certain instruments in such hedging
transactions. While we believe that we properly hedge our interest rate risk, we
may not, and in some cases will not, be permitted to use hedge accounting as
established by FASB under the provisions of SFAS 133 to account for our hedging
activities. The effect of our hedging strategy may result in some volatility in
our quarterly earnings as interest rates go up or down. It is possible that
there will be periods during which we will incur losses after the accounting for
our hedging activities. In addition, if the counter parties to our hedging
transactions are unable to perform according to the terms of the contracts, we
may incur losses. While we believe we properly hedge our interest rate risk, we
cannot assure you that our hedging transactions will offset the risk of adverse
changes in net interest margins.
A reduction in the demand for residential mortgage loans and our non-conforming
Alt-A loan products may adversely affect our operations.
The availability of sufficient mortgage loans meeting our criteria is
dependent in part upon the size and level of activity in the residential real
estate lending market and, in particular, the demand for non-conforming Alt-A
mortgage loans, which is affected by:
o interest rates;
o national economic conditions;
o residential property values; and
o regulatory and tax developments.
o If our mortgage loan purchases decrease, we will have:
o decreased economies of scale;
o higher origination costs per loan;
o reduced fee income;
o smaller gains on the sale of non-conforming mortgage loans; and
o an insufficient volume of loans to generate securitizations which
thereby causes us to accumulate loans over a longer period.
41
Our delinquency ratios and our performance may be adversely affected by the
performance of parties who sub-service our loans.
We contract with third-party sub-servicers for the sub-servicing of all
the loans in which we retain servicing rights, including those in our
securitizations. Our operations are subject to risks associated with inadequate
or untimely servicing. Poor performance by a sub-servicer may result in greater
than expected delinquencies and losses on our loans. A substantial increase in
our delinquency or foreclosure rate could adversely affect our ability to access
the capital and secondary markets for our financing needs. Also, with respect to
loans subject to a securitization, greater delinquencies would adversely impact
the value of any interest-only, equity interest, principal-only and subordinated
securities we hold in connection with that securitization.
In a securitization, relevant agreements permit us to be terminated as
servicer or master servicer under specific conditions described in these
agreements, such as the failure of a sub-servicer to perform certain functions
within specific time periods. If, as a result of a sub-servicer's failure to
perform adequately, we were terminated as servicer of a securitization, the
value of any servicing rights held by us would be adversely affected.
Potential characterization of distributions or gain on sale as unrelated
business taxable income to tax-exempt investors.
If (1) all or a portion of our assets are subject to the rules relating to
taxable mortgage pools, (2) we are a "pension-held REIT," (3) a tax-exempt
stockholder has incurred debt to purchase or hold our common stock, or (4) the
residual REMIC interests we buy generate "excess inclusion income," then a
portion of the distributions to and, in the case of a stockholder described in
(3), gains realized on the sale of common stock by such tax-exempt stockholder
may be subject to Federal income tax as unrelated business taxable income under
the Internal Revenue Code.
Classification as a taxable mortgage pool could subject us or certain of our
shareholders to increased taxation.
If we have borrowings with two or more maturities and, (1) those
borrowings are secured by mortgage loans or mortgage-backed securities and, (2)
the payments made on the borrowings are related to the payments received on the
underlying assets, then the borrowings and the pool of mortgage loans or
mortgage backed securities to which such borrowings relate may be classified as
a taxable mortgage pool under the Internal Revenue Code. If any part of our
company were to be treated as a taxable mortgage pool, then our REIT status
would not be impaired, but a portion of the taxable income we recognize may,
under regulations to be issued by the Treasury Department, be characterized as
"excess inclusion" income and allocated among our stockholders to the extent of
and generally in proportion to the distributions we make to each stockholder.
Any excess inclusion income would:
o not be allowed to be offset by a stockholder's net operating losses;
o be subject to a tax as unrelated business income if a stockholder
were a tax-exempt stockholder;
o be subject to the application of federal income tax withholding at
the maximum rate (without reduction for any otherwise applicable
income tax treaty) with respect to amounts allocable to foreign
stockholders; and
o be taxable (at the highest corporate tax rate) to us, rather than to
our stockholders, to the extent the excess inclusion income relates
to stock held by disqualified organizations (generally, tax-exempt
companies not subject to tax on unrelated business income, including
governmental organizations).
Based on advice of our tax counsel, we take the position that our existing
financing arrangements do not create a taxable mortgage pool.
We may be subject to fines or other penalties based upon the conduct of our
independent brokers or correspondents.
The mortgage brokers and correspondents from which we obtain loans have
parallel and separate legal obligations to which they are subject. While these
laws may not explicitly hold the originating lenders responsible for the legal
violations of mortgage brokers, increasingly federal and state agencies have
sought to impose such liability. Recently, for example, the United States
Federal Trade Commission, or "FTC," entered into a settlement agreement with a
mortgage lender where the FTC characterized a broker that had placed all of its
loan production with a single lender as the "agent" of the lender; the FTC
imposed a fine on the lender in part because, as "principal," the lender was
legally responsible for the mortgage broker's unfair and deceptive acts and
practices. The United States Justice Department in the past has sought to hold a
subprime mortgage lender responsible for the pricing practices of its
42
mortgage brokers, alleging that the mortgage lender was directly responsible for
the total fees and charges paid by the borrower under the Fair Housing Act even
if the lender neither dictated what the mortgage broker could charge nor kept
the money for its own account. Accordingly, we may be subject to fines or other
penalties based upon the conduct of our independent mortgage brokers or
correspondents.
We are no longer able to rely on the Alternative Mortgage Transactions Parity
Act to preempt certain state law restrictions on prepayment penalties, which may
cause us to be unable to compete effectively with financial institutions that
are exempt from such restrictions on ARMs.
The value of a mortgage loan depends, in part, upon the expected period of
time that the mortgage loan will be outstanding. If a borrower pays off a
mortgage loan in advance of this expected period, the holder of the mortgage
loan does not realize the full value expected to be received from the loan. A
prepayment penalty payable by a borrower who repays a loan earlier than expected
helps discourage such a prepayment or helps offset the reduction in value
resulting from the early payoff. Prepayment penalties are an important feature
on the loans we originate.
Certain state laws restrict or prohibit prepayment penalties on mortgage
loans. We have historically relied on the federal Alternative Mortgage
Transactions Parity Act, or the "Parity Act", and related regulations issued by
the Office of Thrift Supervision, or "OTS," to preempt state limitations on
prepayment penalties on ARM loans. The Parity Act was enacted to extend to
financial institutions other than federally chartered depository institutions
the federal preemption which federally chartered depository institutions enjoy.
However, on September 25, 2002, the OTS issued final regulations that reduce the
scope of the Parity Act preemption such that we will no longer be able to rely
on the Parity Act to preempt state restrictions on prepayment penalties. The
elimination of this federal preemption could have a material adverse affect on
our ability to compete effectively with financial institutions that will
continue to enjoy federal preemption of state restrictions on prepayment
penalties on ARM loans.
Our operations may be adversely affected if we are subject to the Investment
Company Act.
We intend to conduct our business at all times so as not to become
regulated as an investment company under the Investment Company Act. The
Investment Company Act exempts entities that are primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate.
In order to qualify for this exemption we must maintain at least 55% of
our assets directly in mortgage loans, qualifying pass-through certificates and
certain other qualifying interests in real estate. Our ownership of certain
mortgage assets may be limited by the provisions of the Investment Company Act.
If the Securities and Exchange Commission adopts a contrary interpretation with
respect to these securities or otherwise believes we do not satisfy the above
exception, we could be required to restructure our activities or sell certain of
our assets. To insure that we continue to qualify for the exemption we may be
required at times to adopt less efficient methods of financing certain of our
mortgage assets and we may be precluded from acquiring certain types of
higher-yielding mortgage assets. The net effect of these factors will be to
lower at times our net interest income. If we fail to qualify for exemption from
registration as an investment company, our ability to use leverage would be
substantially reduced, and we would not be able to conduct our business as
described. Our business will be materially and adversely affected if we fail to
qualify for this exemption.
If we conduct future offerings the market price of our securities may be
adversely affected.
We may elect to increase our capital resources by making additional
private or public offerings of securities in the future. We do not know:
o the actual or perceived effect of these offerings;
o the timing of these offerings;
o the dilution of the book value or earnings per share of our
securities then outstanding; and
o the effect on the market price of our securities then outstanding.
Sales of additional common stock may adversely affect its market price.
To sustain our growth strategy we intend to raise capital through the sale
of equity. The sale or the proposed sale of substantial amounts of our common
stock in the public market could materially adversely affect the market price of
our common stock or other outstanding securities. In December 2001, we filed a
shelf registration statement with the SEC, which allows us to sell up to $300.0
million of securities, including common stock, preferred stock, debt
43
securities and warrants. In connection with the shelf registration statement, we
have entered into a sales agency agreement to sell up to 3,594,082 shares of
common stock. We have also registered an aggregate of 2,120,069 shares of common
stock in connection with our 2001 Stock Option, Deferred Stock and Restricted
Stock Plan. The sale of a large amount of shares or the perception that such
sales may occur, could adversely affect the market price for our common stock or
other outstanding securities.
We are a defendant in purported class actions and may not prevail in these
matters.
Class action lawsuits and regulatory actions alleging improper marketing
practices, abusive loan terms and fees, disclosure violations, improper yield
spread premiums and other matters are risks faced by all mortgage originators,
particularly those in the Alt-A market. We are a defendant in four purported
class actions pending in four different states. All, allege generally that the
loan originator improperly charged fees in violation of various state lending or
consumer protection laws in connection with mortgage loans that we acquired.
Although the suits are not identical, they generally seek unspecified
compensatory damages, punitive damages, pre- and post-judgment interest, costs
and expenses and rescission of the loans, as well as a return of any improperly
collected fees. These actions are in the early stages of litigation and,
accordingly, it is difficult to predict the outcome of these matters. We believe
we have meritorious defenses to the actions and intend to defend against them
vigorously; however, an adverse judgment in any of these matters could have a
material adverse effect on us.
We may be subject to possible adverse consequences as a result of limits on
ownership of our shares.
Our charter limits ownership of our capital stock by any single
stockholder to 9.5% of our outstanding shares unless waived by the board of
directors. Our board of directors may increase the 9.5% ownership limit. In
addition, to the extent consistent with the REIT provisions of the Internal
Revenue Code, our board of directors may, pursuant to our articles of
incorporation, waive the 9.5% ownership limit for a stockholder or purchaser of
our stock. In order to waive the 9.5% ownership limit our board of directors
must require the stockholder requesting the waiver to provide certain
representations to the Company to ensure compliance with the REIT provisions of
the Internal Revenue Code. Our charter also prohibits anyone from buying shares
if the purchase would result in us losing our REIT status. This could happen if
a share transaction results in fewer than 100 persons owning all of our shares
or in five or fewer persons, applying certain broad attribution rules of the
Internal Revenue Code, owning more than 50% (by value) of our shares. If you or
anyone else acquires shares in excess of the ownership limit or in violation of
the ownership requirements of the Internal Revenue Code for REITs, we:
o will consider the transfer to be null and void;
o will not reflect the transaction on our books;
o may institute legal action to enjoin the transaction;
o will not pay dividends or other distributions with respect to those
shares;
o will not recognize any voting rights for those shares;
o may redeem the shares; and
o will consider the shares held in trust for the benefit of a
charitable beneficiary as designated by us.
The trustee shall sell the shares held in trust and the owner of the
excess shares will be entitled to the lesser of:
(a) the price paid by the owner;
(b) if the owner did not purchase for the excess shares, the closing
price for the shares on the national securities exchange on which
the company is listed on the day of the event causing the shares to
be held in trust; or
(c) the price received by the trustee from the sale of the shares.
Limitations on acquisition and change in control ownership limit.
The 9.5% ownership limit discussed above may have the effect of precluding
acquisition of control of our company by a third party without consent of our
board of directors.
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Item 3: Quantitative and Qualitative Disclosures about Market Risk
A significant portion of our revenues and earnings are derived from net
interest income. We strive to manage our interest-earning assets and
interest-bearing liabilities to generate what we believe to be an appropriate
contribution from net interest income. When interest rates fluctuate,
profitability can be adversely affected by changes in the fair market value of
our assets and liabilities and by the interest spread earned on interest-earning
assets and interest-bearing liabilities. We derive income from the differential
spread between interest earned on interest-earning assets and interest paid on
interest-bearing liabilities. Any change in interest rates affects income
received and income paid from assets and liabilities in varying and typically
unequal amounts. Changing interest rates may compress our interest rate margins
and adversely affect overall earnings.
Therefore, we seek to control the volatility of profitability due to
changes in interest rates through asset/liability management. We attempt to
achieve an appropriate relationship between interest rate sensitive assets and
interest rate sensitive liabilities. Although we manage other risks, such as
credit, operational, prepayment and liquidity risk in the normal course of
business, we consider interest rate risk to be a significant market risk which
could potentially have the largest material effect on our financial condition
and results of operations. As we only invest or borrow in U.S. dollar
denominated financial instruments, we are not subject to foreign currency
exchange risk.
We follow a hedging program intended to limit our exposure to changes in
interest rates primarily associated with our CMO borrowings. Our primary
objective is to hedge our exposure to the variability in future cash flows
attributable to the variability of one-month LIBOR, which is generally the
underlying index of our adjustable rate CMO borrowings. We also monitor on an
ongoing basis the prepayment risks that arise in fluctuating interest rate
environments. Our hedging program is formulated with the intent to offset the
potential adverse effects of changing interest rates on CMO borrowings resulting
from the following: interest rate adjustment limitations on mortgage loans due
to periodic and lifetime interest rate cap features and mismatched interest rate
adjustment periods of mortgage loans and CMO borrowings.
We primarily acquire for long-term investment six-month ARMs and six month
hybrids. Six-month ARMs are generally subject to periodic and lifetime interest
rate caps. This means that the interest rate of each ARM is limited to upwards
or downwards movements on its periodic interest rate adjustment date, generally
six months, or over the life of the mortgage loan. Periodic caps limit the
maximum interest rate change, which can occur on any interest rate change date
to generally a maximum of 1% per semiannual adjustment. Also, each ARM has a
maximum lifetime interest rate cap. Generally, borrowings are not subject to the
same periodic or lifetime interest rate limitations. During a period of rapidly
increasing or decreasing interest rates, financing costs would increase or
decrease at a faster rate than the periodic interest rate adjustments on
mortgage loans would allow, which could effect net interest income. In addition,
if the change in market rates were to exceed the maximum interest rates
permitted change in the ARM rate, borrowing costs would increase while interest
rates on ARMs would remain constant.
Our mortgage loan portfolio is also subject to risk from the mismatched
nature of interest rate adjustment periods on mortgage loans and interest rates
on the related borrowings. Six-month ARMs can adjust upwards or downwards every
six months, subject to periodic cap limitations, while adjustable rate CMO
borrowings adjust every month. Additionally, hybrid ARMs have an initial fixed
interest rate period generally ranging from two to three years, and to a lesser
extent five years, which subsequently convert to six-month ARMs. Again, during a
rapidly increasing or decreasing interest rate environment, financing costs
would increase or decrease more rapidly than would interest rates on mortgage
loans, which would remain fixed until their next interest rate adjustment date.
To mitigate exposure from the effect of changing interest rates on CMO
borrowings, we purchase and sell derivative instruments in the form of interest
rate cap agreements, or caps, interest rate floor agreements, or floors, and
interest rate swap agreements, or swaps. We also simultaneously purchase or sell
caps and floors, which are referred to as collars. These derivative instruments
are referred to collectively as derivatives. An interest rate cap or floor is a
contractual agreement. If prevailing interest rates reach levels specified in
the cap or floor agreement, we may either receive or pay cash. An interest rate
swap is generally a contractual agreement that obligates one party to receive or
make cash payments based on an adjustable rate index and the other party to make
or receive cash payments based on a fixed rate. Swap agreements have the effect
of fixing borrowing costs on a similar amount of swaps and, as a result, we can
reduce the interest rate variability of borrowings. Our objective is to lock in
a reliable stream of cash flows when interest rates fall below or rise above
certain levels. For instance, when interest rates rise, borrowing costs increase
at greater speeds than the underlying collateral supporting the borrowings.
These derivative instruments hedge the variability of forecasted cash flows
attributable to CMO borrowings and protect net interest
45
income by providing cash flows at certain triggers during changing interest rate
environments. In all hedging transactions, counterparties must have at least a
single "A" credit rating as determined by various credit rating agencies.
Caps qualify as derivative instruments under provisions of SFAS 133. The
hedging instrument is the specific LIBOR cap that is hedging the LIBOR based CMO
borrowings. The nature of the risk being hedged is the variability of the cash
flows associated with the LIBOR borrowings. Prior to the adoption of DIG G20, we
assessed the hedging effectiveness of our caps utilizing only the intrinsic
value of the caps. DIG G20 allows us to utilize the terminal value of the caps
to assess effectiveness. DIG G20 also allows us to amortize the initial fair
value of the caps over the life of the caps based on the maturity date of the
individual caplets. Upon adoption of DIG G20, net income and accumulated other
comprehensive income were adjusted by the amount needed to reflect the
cumulative impact of adopting the provisions of DIG G20. Subsequent to the
adoption of DIG G20, caps are considered effective hedges and are marked to
market each reporting period with the entire change in market value being
recognized in other comprehensive income on the balance sheet.
Floors, swaps and collars qualify as cash flow hedges under the provisions
of SFAS 133. The hedging instrument is the specific LIBOR floor, swap or collar
that is hedging the LIBOR based CMO borrowings. The nature of the risk being
hedged is the variability of the cash flows associated with the LIBOR
borrowings. Prior to DIG G20, these derivatives were marked to market with the
entire change in the market value of the intrinsic component recognized in other
comprehensive income on the balance sheet each reporting period. The time value
component of these agreements were marked to market and recognized in
non-interest expense on the statement of operations. Subsequent to the adoption
of DIG G20, these derivatives are marked to market with the entire change in the
market value recognized in other comprehensive income on the balance sheet.
Measuring the effectiveness of derivatives is straightforward since the
hedged item, CMO borrowings, and the hedging instrument is based on one-month
LIBOR. As both instruments are tied to the same index, the hedge is expected to
be highly effective both at inception and on an ongoing basis. We assess the
effectiveness and ineffectiveness of the hedging instruments at the inception of
the hedge and at each reporting period. Based on the fact that, at inception,
the critical terms of the hedges and forecasted CMO borrowings are the same, we
have concluded that the changes in cash flows attributable to the risk being
hedged are expected to be completely offset by the hedging derivatives, subject
to subsequent assessments that the critical terms have not changed.
At September 30, 2002 caps had a remaining notional balance of $1.5
billion. Pursuant to the terms of the caps, we will receive cash payments if
one-month LIBOR reaches certain strike prices, ranging from 1.75% to 10.25%,
with a weighted average strike price of 4.32% over the life of the caps. Collars
had a remaining notional balance of $1.2 billion. Pursuant to the terms of the
collars, we will receive cash payments if one-month LIBOR reaches strike prices
ranging from 2.07% to 6.53% with a weighted average strike price of 4.39% over
the life of the collars. We will make cash payments if one-month LIBOR reaches
strike prices ranging from 1.75% to 5.88% with a weighted average strike price
of 3.55%. Swaps had a remaining notional balance of $438.2 million. Pursuant to
the terms of the swaps, we will receive cash payments based on one-month LIBOR
and make cash payments at fixed rates ranging from 2.28% to 5.18%, with a
weighted average fixed rate of 2.74% over the life of the swaps.
The notional amounts of caps, collars and swaps are amortized according to
projected prepayment rates on CMO borrowings. However, regarding the floor
component of the collar, the notional amount equals the actual principal balance
of the CMO borrowings. As of September 30, 2002 the fair market value of the
allocated caps, collars and swaps was an unrecognized loss of $49.3 million.
These derivatives are marked to market each reporting period with the entire
change in market value being recognized in other comprehensive income on the
balance sheet.
During 2001 we purchased a collar at strike prices tied to the one-month
LIBOR forward yield curve to protect cash flows on CMO borrowings, which are
secured by hybrid ARMs with remaining fixed terms. As of September 30, 2002 the
collar had a notional amount of $531.8 million with a one-month LIBOR cap strike
price ranging from 4.87% to 5.42% and a weighted average strike price of 5.15%
over the life of the cap. The collar has a one-month LIBOR floor strike price
ranging from 4.41% to 4.94% and a weighted average strike price of 4.63% over
the life of the floor. The collar matures on March 25, 2004. The notional amount
of the collar is amortized according to projected prepayment rates reflected in
CMO borrowings. As of September 30, 2002 the fair market value of the collar was
an unrecognized loss of $15.4 million. The collar is marked to market each
reporting period with the entire change in market value being recognized in
accumulated other comprehensive income on the balance sheet.
46
During the second quarter of 2002, we purchased a portfolio of interest
floors at strike prices tied to the prevailing one-month LIBOR forward curve to
protect hedged cash flows from the effects of continued interest rate declines
consistent with a weakening economy. As of September 30, 2002 the floors had a
notional amount of $531.8 million with one-month LIBOR floor strike prices
ranging from 2.31% to 4.75% and a weighted average strike price of 3.41% over
the life of the floor. The floor matures on March 25, 2004. The notional amount
of the floor is amortized according to projected prepayment rates reflected in
CMO borrowings. As of September 30, 2002, the fair market value of the floor was
an unrecognized gain of $9.0 million. The floor is marked to market each
reporting period with the entire change in market value being recognized in
accumulated other comprehensive income on the balance sheet.
The most significant variable in the determination of gain on sale in a
securitization is the spread between the weighted average coupon on the
securitized loans and the pass-through interest rate. In the interim period
between loan origination or purchase and securitization or sale of such loans,
we are exposed to interest rate risk. Most of the loans are securitized or sold
within 30 to 45 days of origination of purchase. However, a portion of the loans
are held-for-sale or securitization for as long as 12 months (or longer, in very
limited circumstances) prior to securitization or sale. If interest rates rise
during the period that the mortgage loans are held, in the case of a
securitization, the spread between the weighted average interest rate on the
loans to be securitized and the pass-through interest rates on the securities to
be sold (the latter having increased as a result of market rate movements) would
narrow. Upon securitization or sale, this would result in a reduction of our
related gain or an increase in our loss on sale.
We had interest- and principal-only strips of $2.5 million and $4.9
million outstanding at September 30, 2002 and December 31, 2001, respectively.
These instruments are carried at market value at September 30, 2002 and December
31, 2001. We value these assets based on the present value of future cash flow
streams net of expenses using various assumptions. These assets are subject to
risk of accelerated mortgage prepayment or losses in excess of assumptions used
in valuation. Ultimate cash flows realized from these assets would be reduced
should prepayments or losses exceed assumptions used in the valuation.
Conversely, cash flows realized would be greater should prepayments or losses be
below expectations.
We believe our quantitative risk has not materially changed since our
disclosures under "Quantitative and Qualitative Disclosures About Market Risk"
in our Annual Report on Form 10-K for the year ended December 31, 2001.
Item 4: Controls and Procedures
As of September 30, 2002 the Chief Executive Officer, or "CEO," and Chief
Financial Officer, or "CFO," performed an evaluation of the effectiveness and
the and operation of the Company's disclosure controls and procedures as defined
in Rule 13a - 14c under the Securities Exchange Act of 1934, as amended. Based
on that evaluation, the CEO and CFO concluded that the Company's disclosure
controls and procedures were effective as of September 30, 2002. There have been
no significant changes in the Company's internal controls or in other factors
that could significantly affect internal controls subsequent to September 30,
2002.
47
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
The following lawsuits, as each relates to the Company, were dismissed:
James and Jill Baker et. al. vs. Century Financial Group, Inc. et. al. on March
21, 2002; Frazier, et. al. vs. Preferred Credit et. al. on July 31, 2002; Mattie
L. Street vs. PSB Lending Corp. et. al. on July 31, 2002; and Sumner N. Doxie
vs. Impac Funding Corp. on October 11, 2002. With respect to each of the Frazier
and Street actions, the plaintiffs filed a motion for reconsideration on August
15, 2002. All of the above lawsuits were previously described in our annul
report on Form 10-K for the year ended December 31, 2001.
Item 2: Changes in Securities and Use of Proceeds
None.
Item 3: Defaults Upon Senior Securities
None.
Item 4: Submission of Matters to a Vote of Security Holders
None.
Item 5: Other Information
None.
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1 Underwriting Agreement, dated August 22, 2002, among JMP Securities LLC,
Sandler O'Neill & Partners, L.P. and Impac Mortgage Holdings, Inc.
(incorporated by reference to exhibit 1.1 of the Registrant's Form 8-K
dated August 22, 2002)
21.1 Subsidiaries of the Registrant
(b) Reports on Form 8-K:
1. On August 23, 2002, the Company filed a current report on Form 8-K dated
August 22, 2002 reporting Items 5 and 7 and relating to the execution of
an underwriting agreement and the sale of 2,200,000 shares of common
stock.
2. On August 30, 2002, the Company filed a current report on Form 8-K dated
August 30, 2002 reporting Item 9 and relating to the Company's monthly
fact sheet.
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMPAC MORTGAGE HOLDINGS, INC.
/s/ Richard J. Johnson
by: Richard J. Johnson
Executive Vice President
and Chief Financial Officer
(authorized officer of registrant and principal financial officer)
Date: November 14, 2002
49
CERTIFICATION
I, Joseph R. Tomkinson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Impac Mortgage
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Joseph R. Tomkinson
Joseph R. Tomkinson
Chief Executive Officer
November 14, 2002
50
CERTIFICATION
I, Richard J. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Impac Mortgage
Holdings, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Richard J. Johnson
Richard J. Johnson
Chief Financial Officer
November 14, 2002
51
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Impac Mortgage Holdings, Inc.
(the "Company") on Form 10-Q for the period ending September 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
each of the undersigned, in the capacities and on the dates indicated below,
hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ Joseph R. Tomkinson
Joseph R. Tomkinson
Chief Executive Officer
November 14, 2002
/s/ Richard J. Johnson
Richard J. Johnson
Chief Financial Officer
November 14, 2002
52
Exhibit 21.1
Subsidiaries of the Registrant
Name of Subsidiary State of Incorporation
- ------------------ ----------------------
Impac Warehouse Lending Group, Inc. California
Impac Funding Corporation California
100% of the non-voting preferred stock is owned by
Impac Mortgage Holdings, Inc. Impac Funding Corporation
owns 100% of the Common Stock of Impac Secured Assets
Corporation, a California corporation, and Novelle
Financial Services, Inc., a Delaware corporation. Impac
Funding Corporation does business in various states
under the following names: Impac Lending Group, Impac
Home Loans, and Novelle Financial Services.
IMH Assets Corp. California
Impac Multifamily Capital Corporation California