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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 March 31, 2003 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, California 92660
(Address of principal executive offices)
(949) 475-3600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on 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 |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes |X| No |_|
As of April 30, 2003 the aggregate market value of the voting stock held
by non-affiliates of the registrant was approximately $647.7 million, based on
the closing sales price of common stock on the American Stock Exchange on that
date. For purposes of the calculation only, in addition to affiliated companies,
all directors and executive officers of the registrant have been deemed
affiliates. There were 49,196,734 shares of Common Stock outstanding as of April
30, 2003.
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IMPAC MORTGAGE HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002............................................ 1
Consolidated Statements of Operations and Comprehensive
Earnings, For the Three Months Ended March 31, 2003
and 2002..................................................... 2
Consolidated Statements of Cash Flows, For the Three
Months Ended March 31, 2003 and 2002......................... 3
Notes to Consolidated Financial Statements..................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................. 12
Forward-Looking Statements..................................... 12
Available Information.......................................... 12
General and Business Operations................................ 12
Critical Accounting Policies................................... 13
Financial Highlights for the First Quarter of 2003............. 14
Results of Operations--Impac Mortgage Holdings, Inc............ 14
Results of Operations--Impac Funding Corporation............... 22
Liquidity and Capital Resources................................ 24
Risk Factors................................................... 28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........ 42
ITEM 4. CONTROLS AND PROCEDURES........................................... 44
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................. 44
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......................... 44
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................... 44
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............... 44
ITEM 5. OTHER INFORMATION................................................. 44
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................................. 44
SIGNATURES........................................................ 46
CERTIFICATIONS.................................................... 47
2
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)
March 31, December 31,
2003 2002
----------- ------------
ASSETS
Cash and cash equivalents ........................................................ $ 113,532 $ 113,345
Investment securities available-for-sale ......................................... 25,211 26,065
Loans Receivable:
CMO collateral ................................................................. 6,248,796 5,149,680
Finance receivables ............................................................ 831,535 1,140,248
Mortgages held-for-investment .................................................. 72,932 57,536
Allowance for loan losses ...................................................... (29,761) (26,602)
----------- -----------
Net loans receivable ........................................................ 7,123,502 6,320,862
----------- -----------
Accrued interest receivable ...................................................... 29,455 28,287
Investment in Impac Funding Corporation .......................................... 21,388 20,787
Derivative assets ................................................................ 19,232 14,931
Due from affiliates .............................................................. 14,500 14,500
Other real estate owned .......................................................... 14,052 11,116
Other assets ..................................................................... 34,622 1,880
----------- -----------
Total assets ................................................................ $ 7,395,494 $ 6,551,773
=========== ===========
LIABILITIES
CMO borrowings ................................................................... $ 6,151,048 $ 5,041,751
Reverse repurchase agreements .................................................... 857,638 1,168,029
Borrowings secured by investment securities available-for-sale ................... 5,132 7,134
Accumulated dividends payable .................................................... 24,598 21,754
Other liabilities ................................................................ 6,229 9,617
----------- -----------
Total liabilities ........................................................... 7,044,645 6,248,285
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; $0.01 par value; 7,500,000 shares authorized; none outstanding at
March 31, 2003 and December 31, 2002, respectively ............................. -- --
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares
authorized; none outstanding at March 31, 2003 and December 31, 2002 ........... -- --
Common stock; $0.01 par value; 200,000,000 shares authorized; 49,196,734 and
45,320,517 shares outstanding at March 31, 2003 and December 31, 2002,
respectively ................................................................... 492 453
Additional paid-in capital ....................................................... 521,562 479,298
Accumulated other comprehensive loss ............................................. (37,610) (41,721)
Net accumulated deficit:
Cumulative dividends declared .................................................. (225,552) (200,954)
Retained earnings .............................................................. 91,957 66,412
----------- -----------
Net accumulated deficit ....................................................... (133,595) (134,542)
----------- -----------
Total stockholders' equity .................................................. 350,849 303,488
----------- -----------
Total liabilities and stockholders' equity .................................. $ 7,395,494 $ 6,551,773
=========== ===========
See accompanying notes to consolidated financial statements.
1
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE EARNINGS
(in thousands, except earnings per share data)
(unaudited)
For the Three Months
Ended March 31,
---------------------
2003 2002
--------- ---------
INTEREST INCOME:
Mortgage Assets ..................................................... $ 75,478 $ 42,426
Other interest income ............................................... 681 642
--------- ---------
Total interest income ............................................. 76,159 43,068
INTEREST EXPENSE:
CMO borrowings ...................................................... 41,684 22,406
Reverse repurchase agreements ....................................... 6,790 4,290
Borrowings secured by investment securities available-for-sale ...... 632 549
Other borrowings .................................................... 251 176
--------- ---------
Total interest expense ............................................ 49,357 27,421
--------- ---------
Net interest income ................................................. 26,802 15,647
Provision for loan losses ......................................... 6,484 3,707
--------- ---------
Net interest income after provision for loan losses ................. 20,318 11,940
NON-INTEREST INCOME:
Equity in net earnings of Impac Funding Corporation ................. 5,167 4,609
Other income ........................................................ 2,643 1,043
--------- ---------
Total non-interest income ......................................... 7,810 5,652
NON-INTEREST EXPENSE:
Professional services ............................................... 1,037 860
General and administrative expense .................................. 764 79
Personnel expense ................................................... 692 401
Loss (gain) on disposition of other real estate owned ............... 90 (436)
Write-down on investment securities available-for-sale .............. -- 1,039
--------- ---------
Total non-interest expense ........................................ 2,583 1,943
--------- ---------
Net earnings ........................................................ 25,545 15,649
OTHER COMPREHENSIVE EARNINGS:
Unrealized holding losses on securities arising during period ....... -- (1,230)
Unrealized holding gains on hedging instruments arising during period 3,589 10,407
Reclassification of (gains) losses included in net earnings ........ 522 (224)
--------- ---------
Net unrealized gains arising during period ........................ 4,111 8,953
--------- ---------
Other comprehensive earnings ................................... $ 29,656 $ 24,602
========= =========
NET EARNINGS PER SHARE:
Basic ............................................................... $ 0.54 $ 0.44
========= =========
Diluted ............................................................. $ 0.53 $ 0.43
========= =========
DIVIDENDS DECLARED PER COMMON SHARE .................................... $ 0.50 $ 0.40
========= =========
See accompanying notes to consolidated financial statements.
2
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Three Months
Ended March 31,
--------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ...................................................................... $ 25,545 $ 15,649
Adjustments to reconcile net earnings to net cash provided by operating activities:
Equity in net earnings of Impac Funding Corporation ............................. (5,167) (4,609)
Provision for loan losses ....................................................... 6,484 3,707
Amortization of loan premiums and securitization costs .......................... 14,299 7,306
Gain (loss) on disposition of other real estate owned ........................... (90) 436
Write-down of investment securities available-for-sale .......................... -- 1,039
Net change in accrued interest receivable ....................................... (1,168) (1,634)
Net change in other assets and liabilities ...................................... (40,431) (1,299)
----------- -----------
Net cash (used in) provided by operating activities ........................... (528) 20,595
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in CMO collateral ...................................................... (1,117,985) (330,518)
Net change in finance receivables ................................................. 308,622 (172,840)
Net change in mortgage loans held-for-investment .................................. (18,971) 10,126
Proceeds from sale of other real estate owned, net ................................ 5,590 2,200
Dividend from Impac Funding Corporation ........................................... 4,455 1,980
Net principal reductions on investment securities available-for-sale .............. 1,551 1,347
----------- -----------
Net cash used in investing activities ......................................... (816,738) (487,705)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in reverse repurchase agreements and other borrowings .................. (312,393) 104,866
Proceeds from CMO borrowings ...................................................... 1,483,605 495,000
Repayments of CMO borrowings ...................................................... (374,308) (175,674)
Dividends paid .................................................................... (21,754) (14,081)
Proceeds from sale of common stock ................................................ 37,778 56,968
Proceeds from sale of common stock via Sales Agency Agreement ..................... 4,083 --
Proceeds from exercise of stock options ........................................... 442 51
Reductions on notes receivable-common stock ....................................... -- 920
----------- -----------
Net cash provided by financing activities ..................................... 817,453 468,050
----------- -----------
Net change in cash and cash equivalents ........................................... 187 940
Cash and cash equivalents at beginning of period .................................. 113,345 51,887
----------- -----------
Cash and cash equivalents at end of period ........................................ $ 113,532 $ 52,827
=========== ===========
SUPPLEMENTARY INFORMATION:
Interest paid ..................................................................... $ 48,485 $ 27,534
NON-CASH TRANSACTIONS:
Transfer of mortgages held-for-investment to CMO collateral ....................... $ 1,436,221 $ 499,996
Transfer of mortgages to other real estate owned .................................. 8,436 1,488
Dividends declared and unpaid ..................................................... 24,598 15,766
Other comprehensive earnings ...................................................... 4,111 8,953
See accompanying notes to consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--Basis of Financial Statement Presentation
The accompanying consolidated financial statements of Impac Mortgage
Holdings, Inc. (IMH) and subsidiaries, collectively, (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-month period ended March 31,
2003 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2003. 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, 2002.
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.
The Company's results of operations have been presented in the
consolidated financial statements for the three-months ended March 31, 2003 and
2002 and include the financial results of equity interest in net earnings of
Impac Funding Corporation (IFC). 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 its subsidiaries, which are IMH Assets Corporation (IMH
Assets), Impac Warehouse Lending Group (IWLG) and Impac Multifamily Capital
Corporation (IMCC).
Note 2--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 (in thousands, except net earnings per share):
For the Three Months
Ended March 31,
---------------------
2003 2002
--------- ---------
Numerator for earnings per share:
Net earnings ................................................. $ 25,545 $ 15,649
========= =========
Denominator for earnings per share:
Basic weighted average number of common shares outstanding ... 47,069 35,926
Net effect of dilutive stock options ......................... 827 473
--------- ---------
Diluted weighted average common and common equivalent shares 47,896 36,399
========= =========
Net earnings per share:
Basic ........................................................ $ 0.54 $ 0.44
========= =========
Diluted ...................................................... $ 0.53 $ 0.43
========= =========
The Company had 20,000 and 1,500 stock options during the three months
ended March 31, 2003 and 2002, respectively, that were not considered in the
calculation of diluted weighted average common and common equivalent shares as
the exercise price of the stock options were greater than the average market
price during the periods.
4
Note 3--Stock Options
Stock options and awards may be granted to the directors, officers and key
employees of the Company. The exercise price for any non-qualified stock option
(NQSO) or incentive stock option (ISO) granted may not be less than 100% (or
110% in the case of ISOs granted to an employee who is deemed to own in excess
of 10% of the outstanding common stock) of the fair market value of the shares
of common stock at the time the NQSO or ISO is granted. Grants under stock
option plans are made and administered by the board of directors. IMH currently
has a 1995 Stock Option, Deferred Stock and Restricted Stock Plan (1995 Plan).
During 2001 the board of directors and stockholders approved a new Stock Option,
Deferred Stock and Restricted Stock Plan (2001 Plan), collectively, (the Stock
Option Plans). Each Stock Option Plan provides for the grant of qualified
incentive stock options (ISOs), options not qualified (NQSOs), deferred stock,
and restricted stock, and, in the case of the 2001 Plan, dividend equivalent
rights and, in the case of the 1995 Plan, stock appreciation rights and limited
stock appreciation rights awards (Awards).
In December 2002 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148), an amendment of FASB
Statement No. 123, "Accounting for Stock-Based Compensation," (SFAS 123). SFAS
148 amends SFAS 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS
123 to require prominent disclosures in both annual and interim financial
statements. On December 15, 2002 IMH adopted the disclosure requirements of SFAS
148. SFAS No. 123 established financial accounting standards for stock-based
employee compensation plans, which permits management to choose either a fair
value based method or an intrinsic value based method of accounting for its
stock-based compensation arrangements in accordance with APB Opinion No. 25 (APB
25). SFAS 123 requires pro forma disclosures of net earnings (loss) computed as
if the fair value based method had been applied in financial statements of
companies that continue to follow the intrinsic value method in accounting for
such arrangements under APB 25. SFAS 123 applies to all stock-based employee
compensation plans in which an employer grants shares of its stock or other
equity instruments to employees except for employee stock ownership plans. SFAS
123 also applies to plans in which the employer incurs liabilities to employees
in amounts based on the price of the employer's stock, i.e., stock option plans,
stock purchase plans, restricted stock plans and stock appreciation rights. The
statement also specifies the accounting for transactions in which a company
issues stock options or other equity instruments for services provided by
non-employees or to acquire goods or services from outside suppliers or vendors.
As of March 31, 2003 the Company had fixed stock option plans, which it
accounted for using the intrinsic value method in accordance with APB 25 and
which did not require the recognition of compensation cost. However, if
compensation cost for stock-based compensation plans had been recognized using
the fair value based method consistent with SFAS 123, as amended by SFAS 148,
net earnings and earnings per share would have been reduced to the pro forma
amounts indicated below (in thousands of dollars, except per share amounts):
For the Three Months
Ended March 31,
---------------------
2003 2002
--------- ---------
Net earnings as reported ........................................................ $ 25,545 $ 15,649
Less: Total stock-based employee compensation expense using the fair value method (136) (77)
--------- ---------
Pro forma net earnings ....................................................... $ 25,409 $ 15,572
========= =========
Net earnings per share as reported:
Basic ........................................................................ $ 0.54 $ 0.44
========= =========
Diluted ...................................................................... $ 0.53 $ 0.43
========= =========
Pro forma net earnings:
Basic ........................................................................ $ 0.54 $ 0.43
========= =========
Diluted ...................................................................... $ 0.53 $ 0.43
========= =========
5
There were no stock options granted during the first quarter of 2003,
therefore, pro forma net earnings and net earnings per share reflect the
amortization of previously granted stock options which are amortized as expense
over the stock option life in determining the pro forma impact. The derived fair
value of stock options granted during the first quarter of 2002 was
approximately $0.70 per stock option, which is derived based on the stock option
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions:
-------------------
For the Three
Months Ended
March 31, 2002
-------------------
Risk-free interest rate........................ 1.45%
Expected lives (in years)...................... 3-10
Expected volatility............................ 35.07%
Expected dividend yield........................ 10.00%
Note 4--Segment Reporting
The Company internally reviews and analyzes its operating segments as
follows:
o the long-term investment operations, conducted by IMH, IMH Assets
and IMCC, invests primarily in non-conforming Alt-A residential
mortgages (Alt-A mortgages) acquired from the mortgage operations,
small-balance multi-family mortgages originated by IMCC and
mortgage-backed securities secured by or representing interests in
mortgages;
o the warehouse lending operations, conducted by IWLG, provides
warehouse financing to affiliated companies and to approved mortgage
bankers, some of which are correspondents of IFC, to finance
mortgages; and
o the mortgage operations, conducted by IFC, acquires and originates
primarily Alt-A mortgages and, to a lesser extent, sub-prime
mortgages and second mortgages from its network of third party
correspondents, mortgage brokers and retail customers.
The following table presents business segments as of and for the three
months ended March 31, 2003 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
------------ ------------ ---------------- ------------
Balance Sheet Items:
CMO collateral and mortgages held-for-investment $ 6,321,728 $ -- $ -- $ 6,321,728
Finance receivables ............................ -- 893,907 (62,372) 831,535
Total assets ................................... 6,800,997 957,636 (363,139) 7,395,494
Total stockholders' equity ..................... 554,507 96,999 (300,657) 350,849
Income Statement Items:
Net interest income ............................ $ 20,732 $ 6,070 $ -- $ 26,802
Provision for loan losses ...................... 5,889 595 -- 6,484
Non-interest income (2) ........................ 1,283 1,360 5,167 7,810
Non-interest expense ........................... 1,485 1,098 -- 2,583
------------ ------------ ------------ ------------
Net earnings ................................... $ 14,641 $ 5,737 $ 5,167 $ 25,545
============ ============ ============ ============
6
The following table presents business segments as of and for the three
months ended March 31, 2002 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
----------- ----------- ---------------- -----------
Balance Sheet Items:
CMO collateral and mortgages held-for-investment $ 2,572,380 $ 123 $ -- $ 2,572,503
Finance receivables ............................ -- 639,489 -- 639,489
Total assets ................................... 2,885,218 655,436 (191,426) 3,349,228
Total stockholders' equity ..................... 385,686 75,880 (191,426) 270,140
Income Statement Items:
Net interest income ............................ $ 12,475 $ 3,172 $ -- $ 15,647
Provision for loan losses ...................... 3,438 269 -- 3,707
Non-interest income (2) ........................ 66 977 4,609 5,652
Non-interest expense ........................... 1,180 763 -- 1,943
----------- ----------- ----------- -----------
Net earnings ................................... $ 7,923 $ 3,117 $ 4,609 $ 15,649
=========== =========== =========== ===========
(1) Elimination of inter-company balance sheet and income statement items.
(2) Non-interest income in the inter-company eliminations column is equity in
net earnings of IFC, which is an unconsolidated qualified REIT subsidiary
of IMH and is accounted for using the equity method.
Note 5--Allowance for Loan Losses
An allowance is maintained for losses on mortgages held-for-investment,
mortgages held as CMO collateral and finance receivables at an amount that
management believes is sufficient to provide adequate protection against
inherent losses in the mortgage loan investment portfolio. A provision is
recorded for loans deemed to be uncollectible thereby increasing the allowance
for loan losses. Subsequent recoveries on mortgages previously charged off are
credited back to the allowance. 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 mortgages in
our mortgage loan investment portfolio. The loss percentage is used to determine
the estimated inherent losses in the mortgage loan investment portfolio.
Provision for loan losses is also determined based on the following:
o management's judgment of the net loss potential of mortgages in our
mortgage loan investment portfolio based on prior loan loss
experience;
o changes in the nature and volume of the mortgage loan investment
portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
The following table presents activity for allowance for loan losses for
the periods shown (in thousands):
For the Three Months Ended
-------------------------------
March 31, December 31,
2003 2002
------------- -------------
Beginning balance .......................... $ 26,602 $ 21,564
Provision for loan losses .................. 6,484 6,546
Charge-offs, net of recoveries ............. (3,325) (1,508)
------------- -------------
Ending balance ........................... $ 29,761 $ 26,602
============= =============
Note 6--Derivative Instruments and Hedging Activities
Management follows a hedging program intended to limit its exposure to
changes in interest rates primarily associated with cash flows on CMO
borrowings. Management's primary objective is to hedge exposure to the
variability in future
7
cash flows attributable to the variability of one-month LIBOR, which is the
underlying index of adjustable rate CMO borrowings. Management also monitors on
an ongoing basis the prepayment risks that arise in fluctuating interest rate
environments. Management's hedging program is formulated with the intent to
offset the potential adverse effects of changing interest rates on cash flows on
CMO borrowings resulting from the following:
o interest rate adjustment limitations on CMO collateral due to periodic and
lifetime interest rate cap features; and
o mismatched interest rate adjustment periods between mortgages held as CMO
collateral and CMO borrowings.
To mitigate exposure to the effect of changing interest rates on cash
flows on CMO borrowings, IMH purchases derivatives in the form of interest rate
cap agreements (Caps) interest rate floor agreements (Floors) and interest rate
swap agreements (Swaps). A Cap or Floor is a contractual agreement for which IMH
pays a fee. If prevailing interest rates reach levels specified in the Cap or
Floor agreement IMH may either receive or pay cash. A 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 receive or make cash
payments based on a fixed rate. Swaps have the effect of fixing borrowing costs
on a similar amount of Swaps and, as a result, can reduce the interest rate
variability of borrowings. Management's 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 may increase at
greater speeds than the underlying collateral supporting the borrowings. These
derivatives hedge the variability of forecasted cash flows attributable to CMO
borrowings and protect net interest income by providing cash flows at certain
triggers during changing interest rate environments. In all hedging transactions
counter-parties must have a highly rated credit rating as determined by various
credit rating agencies.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 137 and SFAS No. 138, collectively, (SFAS
133), established 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 IMH adopted SFAS 133 and the fair value of derivatives
were reflected in financial condition and results of operations. On August 10,
2001 the Derivatives Implementation Group (DIG) of the FASB published DIG G20,
which further interpreted SFAS 133. On October 1, 2001 IMH 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.
Caps qualify as derivatives 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
management assessed the hedging effectiveness of its Caps utilizing only the
intrinsic value of the Caps. DIG G20 allows management to utilize the terminal
value of the Caps to assess effectiveness. DIG G20 also allows for amortization
of 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 accumulated other comprehensive income.
Floors and Swaps qualify as cash flow hedges under the provisions of SFAS
133. The hedging instrument is the specific LIBOR Floor or Swap 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 accumulated other comprehensive
income each reporting period. The time value component of these agreements were
marked to market and recognized in non-interest expense in 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 accumulated
other comprehensive income.
8
Effectiveness of derivatives is measured by the fact that the hedged item,
CMO borrowings, and the derivative 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. Management assesses 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,
management has concluded that the changes in cash flows attributable to the risk
being hedged are expected to be completely offset by the derivatives, subject to
subsequent assessments that the critical terms have not changed.
The following table presents certain information related to derivatives
and the related component in the financial statements as of March 31, 2003
(dollars in thousands):
Fair Related Related
Value Related Unamortized Amount in Amount
of Amount in Derivative Derivative in CMO
Derivatives Index OCI Instruments Asset Account Collateral
------------- ------------- ------------- ------------- ------------- -------------
Derivatives not associated with
CMOs ........................ $ (10,875) 1 mo. LIBOR $ (6,193) $ (4,682) $ (10,875) $ --
Cash in margin account ........ 30,107 N/A -- -- 30,107 --
Derivatives associated with
CMOs ........................ (31,951) 1 mo. LIBOR (39,343) 7,392 -- (31,951)
99% OCI activity at IFC ....... -- Fannie Mae (1,131) -- -- --
------------- ------------- ------------- ------------- ------------- -------------
Totals ..................... $ (12,719) $ (46,667) $ 2,710 $ 19,232 $ (31,951)
============= ============= ============= ============= =============
The following table presents certain information related to derivatives and
the related component in the financial statements as of December 31, 2002
(dollars in thousands):
Fair Related Related
Value Related Unamortized Amount in Amount
of Amount in Derivative Derivative in CMO
Derivatives Index OCI Instruments Asset Account Collateral
------------- ------------- ------------- ------------- ------------- -------------
Derivatives not associated with
CMOs ........................ $ (15,515) 1 mo. LIBOR $ (9,693) $ (5,822) $ (15,515) $ --
Cash in margin account ........ 30,446 N/A -- -- 30,446 --
Derivatives associated with CMOs. (30,332) 1 mo. LIBOR (39,464) 9,132 -- (30,332)
99% of OCI activity at IFC .... -- Fannie Mae (1,035) -- -- --
------------- ------------- ------------- ------------- ------------- -------------
Totals ..................... $ (15,401) $ (50,192) $ 3,310 $ 14,931 $ (30,332)
============= ============= ============= ============= =============
Note 7--Income Taxes
The Company operates so as to qualify as a REIT under the requirements of
the Internal Revenue Code (the Code). Requirements for qualification as a REIT
include various restrictions on ownership of IMH's stock, requirements
concerning distribution of taxable income and certain restrictions on the nature
of assets and sources of income. A REIT must distribute at least 90% of its
taxable income to its stockholders of which 85% must be distributed within the
taxable year in order to avoid the imposition of an excise tax and the remaining
balance may extend until timely filing of its tax return in its subsequent
taxable year. Qualifying distributions of its taxable income are deductible by a
REIT in computing its taxable income. If in any tax year the Company should not
qualify as a REIT, it would be taxed as a corporation and distributions to the
stockholders would not be deductible in computing taxable income. If the Company
were to fail to qualify as a REIT in any tax year, it would not be permitted to
qualify for that year and the succeeding four years. As of December 31, 2002 the
Company had estimated federal and state net operating loss tax carry-forwards of
approximately $16.7 million, which expire in the year 2020 and 2010,
respectively, that are available to offset future taxable income.
Note 8--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. The following tables present unaudited consolidated
financial information for interim periods and audited consolidated financial
information as of December 31, 2002 for Impac Funding Corporation (in
thousands):
9
BALANCE SHEETS
March 31, December 31,
2003 2002
------------- -------------
ASSETS
Cash and cash equivalents ............................ $ 30,303 $ 22,773
Securities available-for-sale ........................ 127 129
Mortgages held-for-sale .............................. 344,987 495,877
Mortgage and master servicing rights ................. 7,811 8,274
Premises and equipment, net .......................... 5,271 4,948
Accrued interest receivable .......................... 875 430
Other assets ......................................... 41,245 43,155
------------- -------------
Total assets .................................... $ 430,619 $ 575,586
============= =============
LIABILITIES
Borrowings from IWLG ................................. $ 339,962 $ 491,383
Due to affiliates .................................... 14,500 14,500
Deferred revenue ..................................... 6,713 5,088
Accrued interest expense ............................. 758 1,068
Other liabilities .................................... 47,081 42,550
------------- -------------
Total liabilities ............................... 409,014 554,589
------------- -------------
SHAREHOLDERS' EQUITY
Preferred stock ...................................... 18,053 18,053
Common stock ......................................... 182 182
Retained earnings .................................... 31,187 25,968
Cumulative dividends declared ........................ (26,484) (21,984)
Accumulated other comprehensive loss ................. (1,333) (1,222)
------------- -------------
Total shareholders' equity ...................... 21,605 20,997
------------- -------------
Total liabilities and shareholders' equity ...... $ 430,619 $ 575,586
============= =============
STATEMENTS OF OPERATIONS
For the Three Months
Ended March 31,
-------------------------------
2003 2002
------------- -------------
Net interest income:
Total interest income ............................. $ 8,764 $ 6,646
Total interest expense ............................ 5,575 4,975
------------- -------------
Net interest income ............................. 3,189 1,671
Non-interest income:
Gain on sale of loans ............................. 22,033 16,158
Loan servicing expense ............................ (634) (357)
Other non-interest income ......................... 19 1,735
------------- -------------
Total non-interest income ....................... 21,418 17,536
Non-interest expense:
Personnel expense ................................. 8,063 5,573
General and administrative expense ................ 5,324 4,090
Amortization and impairment of mortgage and master
servicing rights ................................ 1,997 1,499
Provision for repurchases ......................... 356 435
Mark-to-market gain - SFAS 133 .................... (165) (448)
------------- -------------
Total non-interest expense ...................... 15,575 11,149
------------- -------------
Net earnings before income taxes ..................... 9,032 8,058
Income taxes ...................................... 3,813 3,403
------------- -------------
Net earnings ......................................... 5,219 4,655
Less: Cash dividends on preferred stock ........... (4,455) (1,980)
------------- -------------
Net earnings available to common shareholders ........ $ 764 $ 2,675
============= =============
10
Note 9--Recent Accounting Pronouncements
In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143), which requires the Company to record the
fair value of an asset retirement obligation as a liability in the period in
which it incurs as a legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition, construction, development,
and/or normal use of the assets. The Company also records a corresponding asset
that is depreciated over the life of the asset. Subsequent to the initial
measurement of the asset retirement obligation, the obligation will be adjusted
at the end of each period to reflect the passage of time and changes in the
estimated future cash flows underlying the obligation. The Company was required
to adopt SFAS No. 143 on January 1, 2003. The adoption of SFAS 143 did not have
a material effect on the Company's financial statements.
In April 2002 the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections"
(SFAS 145). SFAS 145 amends existing guidance on reporting gains and losses on
the extinguishment of debt to prohibit the classification of the gain or loss as
extraordinary, as the use of such extinguishments have become part of the risk
management strategy of many companies. SFAS 145 also amends SFAS No. 13 to
require sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The provisions of SFAS
145 related to the rescission of SFAS 4 was applied in fiscal years beginning
after May 15, 2002. Earlier application of these provisions is encouraged. The
provisions of SFAS 145 related to SFAS 13 were effective for transactions
occurring after May 15, 2002, with early application encouraged. The adoption of
SFAS 145 did not have a material effect on the Company's financial statements.
In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS 146). SFAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002 with early application
encouraged. The adoption of SFAS 146 did not have a material effect on the
Company's financial statements.
In November 2002 the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34 (FIN 45). FIN 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 are applicable to
guarantees issued or modified after December 31, 2002 and are not expected to
have a material effect on the Company's financial statements. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002.
In December 2002 the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148), an amendment of SFAS No.
123 "Accounting for Stock-Based Compensation," (SFAS 123). SFAS 148 amends SFAS
123 to provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements. Certain
portions of the disclosure modifications are required for fiscal years ending
after December 15, 2002 and are included in the notes to these consolidated
financial statements. The Company has adopted the disclosure requirement of SFAS
148 and will continue to account for stock options using the intrinsic value
method.
In January 2003 the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" (FIN 46). FIN 46
addresses the consolidation by business enterprises of variable interest
entities as defined in FIN 46. FIN 46 applies immediately to variable interests
in variable interest entities created after January 31, 2003 and to variable
interests in variable interest entities obtained after January 31, 2003. For
nonpublic enterprises, such as IFC, with a variable interest in a variable
interest entity created before February 1, 2003 FIN 46 is applied to the
enterprise no later than the end of the first reporting period beginning after
June 15, 2003. IMH is subject to a majority of the risk of loss from IFC and
will therefore need to be included as a consolidated entity upon adoption of FIN
46. The result of this consolidation would be the elimination of certain
inter-company balances and certain gains or losses. The adoption of FIN 46 will
likely be immaterial on the results of operations of the Company as 99% of the
earnings or losses of IFC are currently included in the Company's financial
statements through its ownership of all of the non-voting preferred stock of
IFC. However, the Company's balance sheet will reflect IFC's assets, net of
inter-company eliminations, when consolidated.
11
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
This quarterly report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. Forward-looking statements,
some of which are based on various assumptions and events that are beyond our
control, may be identified by reference to a future period or periods or by the
use of forward-looking terminology, such as "may," "will," "believe," "expect,"
"plan," "anticipate," "continue," or similar terms or variations on those terms
or the negative of those terms. Actual results could differ materially from
those set forth in forward-looking statements, 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 ability to access the capital markets, interest rate fluctuations
on our assets that differ from those on our liabilities, increase in prepayment
rates on our mortgage assets, changes in assumptions regarding estimated loan
losses or interest rates, the availability of financing and, if available, the
terms of any financing, changes in estimations of acquisition and origination
and resale pricing of mortgages, changes in markets which we serve, including
the market for Alt-A mortgages, changes in general market and economic
conditions and other factors described in this quarterly report. For a
discussion of the risks and uncertainties that could cause actual results to
differ from those contained in the forward-looking statements see "Risk Factors"
in this quarterly report. We do not undertake, and specifically disclaim any
obligation, to publicly release the results of any revisions that may be made to
any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Available Information
Our Internet website address is www.impaccompanies.com. We make our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K
and proxy statement for our annual shareholders' meetings, as well as any
amendments to those reports, available free of charge through our website as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the Securities and Exchange Commission, or "SEC." You can
learn more about us by reviewing our SEC filings on our website by clicking on
"Investor Relations" located on our home page. The SEC also maintains a website
at www.sec.gov that contains reports, proxy statements and other information
regarding SEC registrants, including the Company.
General and Business Operations
Unless the context otherwise requires, the terms "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," Impac Multifamily Capital Corporation,
or "IMCC," and its affiliate Impac Funding Corporation, or "IFC." References to
Impac Mortgage Holdings, Inc., or "IMH," are made to differentiate IMH, the
publicly traded company, as a separate entity from IMH Assets, IWLG, IMCC and
IFC.
We are a mortgage real estate investment trust, or "REIT." Together with
our subsidiaries and affiliate we are a nationwide acquirer and originator of
non-conforming Alt-A mortgages, or "Alt-A mortgages." Alt-A mortgages are
primarily first lien mortgages made to borrowers whose credit is generally
within typical Fannie Mae and Freddie Mac guidelines, but have loan
characteristics that make them non-conforming under those guidelines. Some of
the principal differences between mortgages purchased by Fannie Mae and Freddie
Mac and Alt-A mortgages are as follows:
o credit and income histories of the mortgagor;
o documentation required for approval of the mortgagor; and
o applicable loan-to-value ratios.
For instance, Alt-A mortgages that we acquire may have higher
loan-to-value, or "LTV," ratios than allowable under Fannie Mae or Freddie Mac
guidelines, although, some Alt-A mortgages that we acquire may include private
mortgage insurance when appropriate. Furthermore, Alt-A mortgages that we
acquire and originate may not have certain documentation or verifications that
are required by Fannie Mae and Freddie Mac. Therefore, in making our credit
decisions, we are more reliant upon the borrower's credit score and the adequacy
of the underlying collateral. We believe that Alt-A mortgages provide an
attractive net earnings profile by producing higher yields without
commensurately higher
12
credit losses than other types of mortgages. Since 1999 we have acquired and
originated primarily Alt-A mortgages. We also provide warehouse and repurchase
financing to originators of mortgages. Our goal is to generate consistent
reliable income for distribution to our stockholders primarily from earnings
generated by our mortgage loan investment portfolio. We operate the following
core businesses:
o long-term investment operations;
o mortgage operations; and
o warehouse lending operations.
The long-term investment operations invest primarily in adjustable and
fixed rate Alt-A mortgages that are acquired and originated by our mortgage
operations and small-balance multi-family mortgages originated by IMCC. This
business primarily generates net interest income from its mortgage loan
investment portfolio and, to a lesser extent, its investment securities
portfolio. Our investment in Alt-A mortgages and small-balance multi-family
mortgages, or "multi-family mortgages," is financed with cash flow from the
mortgage loan investment portfolio, collateralized mortgage obligations, or
"CMO," financing, short-term borrowings under reverse repurchase agreements and
proceeds from the sale of capital stock.
The mortgage operations acquire, originate, sell and securitize primarily
adjustable and fixed rate Alt-A mortgages. Our mortgage operations generate
income by securitizing and selling loans to permanent investors, including our
long-term investment operations. This business also earns revenue from fees
associated with mortgage servicing rights, master servicing agreements and
interest income earned on mortgages held-for-sale. Our mortgage operations use
warehouse facilities provided by the warehouse lending operations to finance the
acquisition and origination of mortgages.
The warehouse lending operations provide short-term financing to mortgage
loan originators, including the mortgage operations, by funding mortgages from
their closing date until they are sold to pre-approved investors. This business
earns fees from warehouse transactions as well as net interest income from the
difference between its cost of borrowings and the interest earned on warehouse
advances.
Critical Accounting Policies
We define critical accounting policies as those that are important to the
portrayal of our financial condition and results of operations and require
estimates and assumptions based on our judgment of changing market conditions
and the performance of our assets and liabilities at any given time. In
determining which accounting policies meet this definition, we considered our
policies with respect to the valuation of our assets and liabilities and
estimates and assumptions used in determining those valuations. We believe the
most critical accounting issues that require the most complex and difficult
judgments and that are particularly susceptible to significant change to our
financial condition and results of operations including the following:
o allowance for loan losses; and
o investment securities.
Allowance for loan losses. In evaluating the adequacy of the allowance for
loan losses management takes several items into consideration. For instance, a
detailed analysis of historical loan performance data is accumulated and
reviewed. It is analyzed for loss performance and prepayment performance by
product type, origination year and securitization deal. The results of that
analysis are then applied to the current mortgage loan investment portfolio and
an estimate is created. In accordance with Statement of Financial Accounting
Standards No. 5, management believes that pooling of mortgages with similar
characteristics is an appropriate methodology in which to evaluate the allowance
for loan losses. In addition, management acknowledges that there are mortgages
in the mortgage loan investment portfolio that were acquired and not
underwritten within the mortgage operations specific guidelines. As such,
management does not have historical loss performance data in which to capture
and make a specific allowance for those mortgages. Therefore, management must
include an additional allowance for loan losses for those mortgages not
underwritten to our specific guidelines.
Management also recognizes that there are qualitative factors that must be
taken into consideration when evaluating and measuring potential impairment in
the mortgage loan investment portfolio. These items include, but are not limited
to, economic indicators that may affect the borrower's ability to pay, political
factors and industry statistics. From an industry
13
standpoint, there is a wide range of allowance for loan loss levels that are
maintained by our competitors. For additional information regarding provision
for loan losses refer to "Results of Operations--Impac Mortgage Holdings,
Inc.--Provision for Loan Losses" below.
Investment securities. Investment securities consist primarily of
subordinated mortgage-backed securities that are classified as
available-for-sale and are therefore recorded at fair value. Any changes in the
fair market value of these investment securities are reported as a component of
accumulated other comprehensive income in stockholders' equity. To determine the
fair value of investment securities available-for-sale, management must estimate
future rates of mortgage prepayments, prepayment penalties to be received,
delinquency rates, constant default rates and default loss severity and their
impact on estimated cash flows. Estimates are based on historical loss data for
comparable mortgages. Management estimates mortgage prepayments by evaluating
historical prepayment performance of comparable mortgages and trends in the
industry. Management determines the estimated fair value of the residuals by
discounting the expected cash flows using a discount rate, which it believes is
commensurate with the risks involved. If management's estimates and assumptions
used in determining future cash flows on mortgage-backed securities vary
significantly from actual cash flows, we may be required to record impairment on
the mortgage-backed securities, which would require us to write-down the
carrying amount of the mortgage-backed securities through earnings.
Financial Highlights for the First Quarter of 2003
o Earnings per share increased to $0.53 compared to $0.50 for the
fourth quarter of 2002 and $0.43 for the first quarter of 2002;
o Estimated taxable income per share was $0.58 compared to $0.58 for
the fourth quarter of 2002 and $0.44 for the first quarter of 2002;
o Cash dividends declared per share increased to $0.50 compared to
$0.48 for the fourth quarter of 2002 and $0.40 for the first quarter
of 2002;
o Total assets increased to $7.4 billion as of March 31, 2003 from
$6.6 billion as of December 31, 2002 and $3.3 billion as of March
31, 2002;
o Book value per share increased to $7.13 as of March 31, 2003
compared to $6.70 as of December 31, 2002 and $6.85 as of March 31,
2002;
o Total market capitalization increased to $639.1 million as of March
31, 2003 compared to $521.2 million as of December 31, 2002 and
$371.4 million as of March 31, 2002;
o Dividend yield as of March 31, 2003 was 15.40%, based on annualized
first quarter cash dividend of $0.50 per share and closing stock
price of $12.99 per share;
o Return on average assets and equity was 1.48% and 31.69% as compared
to 1.49% and 31.37% for the fourth quarter of 2002 and 2.02% and
26.72% during the first quarter of 2002;
o IFC, the mortgage operations, acquired and originated $1.8 billion
of primarily Alt-A mortgages compared to $1.7 billion during the
fourth quarter of 2002 and $1.2 billion during the first quarter of
2002;
o The long-term investment operations acquired $1.4 billion of
primarily Alt-A mortgages from IFC compared to $1.2 billion during
the fourth quarter of 2002 and $491.8 million during the first
quarter of 2002; and
o IMCC originated and retained for long-term investment $42.1 million
of multi-family mortgages compared to $25.8 million during the
fourth quarter of 2002.
Results of Operations--Impac Mortgage Holdings, Inc.
Net Earnings
Net earnings increased 63% to $25.5 million, or $0.53 per diluted share,
for the first quarter of 2003 compared to $15.6 million, or $0.43 per diluted
share, for the first quarter of 2002. The quarter-over-quarter increase in net
earnings of $9.9 million was primarily due to the following:
o $11.2 million increase in net interest income;
14
o $558,000 increase in equity in net earnings of IFC; and
o partially offset by a $2.8 million increase in provision for loan
losses.
The 2003 quarter-over-quarter variances are discussed in further detail
below.
Taxable Income
When we file our annual tax returns there are certain adjustments that we
make to net earnings and taxable income due to differences in the nature and
extent that revenues and expenses are recognized under the two methods. For
instance, to calculate taxable income we can only deduct loan loss provisions to
the extent that we incurred actual loan losses as compared to net earnings,
which allows for a complete deduction of loan loss provisions to derive net
earnings. To maintain REIT status, we are required to distribute a minimum of
90% of our annual taxable income to our stockholders. Because we pay dividends
based on taxable income, dividends may be more or less than net earnings.
Therefore, management believes that the disclosure of taxable income, which is a
non-GAAP financial measurement, is useful information for our investors.
After adjusting for our estimates of the differences between net earnings
and taxable income, estimated taxable income was $28.0 million, or $0.58 per
diluted share, for the first quarter of 2003 compared to $16.1 million, or $0.44
per diluted share, for the first quarter of 2002. We declared cash dividends of
$0.50 per share for the first quarter of 2003. As of December 31, 2002 estimated
federal and state net operating tax loss carry-forwards were approximately $16.7
million, which expire in the year 2020 and 2010, respectively, that are
available to offset future taxable income. Actual net operating tax loss
carry-forwards, which may be used to offset future taxable income, will be
determined when we file our 2002 tax return.
The following table presents a reconciliation of net earnings to estimated
taxable income for the periods indicated (dollars in thousands, except per share
amounts):
For the Three Months
Ended March 31,
-------------------------------
2003 2002
------------- -------------
Net earnings ......................................... $ 25,545 $ 15,649
Adjustments to net earnings:
Provision for loan losses .......................... 6,484 3,707
Dividend from IFC .................................. 4,455 1,980
Tax deduction for actual loan losses ............... (3,325) (635)
Equity in net earnings of IFC ...................... (5,167) (4,609)
------------- -------------
Estimated taxable income (1) ......................... $ 27,992 $ 16,092
============= =============
Estimated taxable income per diluted share (1) ....... $ 0.58 $ 0.44
============= =============
- ---------
(1) Excludes the deduction for dividends paid and the availability of a
deduction attributable to net operating tax loss carry-forwards.
Net Interest Income
We earn interest income primarily on mortgage assets, which include CMO
collateral, mortgages held-for-investment, finance receivables and investment
securities available-for-sale, or collectively, "Mortgage Assets," and, to a
lesser extent, interest income earned on cash and cash equivalents and due from
affiliates. Interest expense is primarily interest paid on borrowings on
Mortgage Assets, which include CMO borrowings, reverse repurchase agreements and
borrowings on investment securities available-for-sale, and, to a lesser extent,
interest expense paid on due to affiliates. We also receive or make cash
payments on derivative instruments as an adjustment to the yield on Mortgage
Assets or borrowings on Mortgage Assets depending on whether certain specified
contractual interest rate levels are reached.
15
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the first
quarters of 2003 and 2002 and include 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 March 31, 2003 Ended March 31, 2002
---------------------------------- -----------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- ---------- ---------- ---------- ---------- ----------
MORTGAGE ASSETS
Investment securities available-for-sale ...... $ 25,536 $ 753 11.80% $ 32,364 $ 433 5.35%
Loans Receivable:
CMO collateral .............................. 5,533,475 60,051 4.34 2,340,187 34,451 5.89
Mortgages held-for-investment (1) ........... 180,912 3,251 7.19 14,979 (31) (0.83)
Finance receivables:
Affiliated ................................. 464,636 4,685 4.03 385,813 4,290 4.45
Non-affiliated ............................. 523,182 6,738 5.15 239,579 3,283 5.48
---------- ---------- ---------- ----------
Total finance receivables ................. 987,818 11,423 4.63 625,392 7,573 4.84
---------- ---------- ---------- ----------
Total Loans Receivable ................... 6,702,205 74,725 4.46 2,980,558 41,993 5.64
---------- ---------- ---------- ----------
Total Mortgage Assets ....................... $6,727,741 $ 75,478 4.49% $3,012,922 $ 42,426 5.63%
========== ========== ========== ==========
BORROWINGS
CMO borrowings ................................ $5,417,690 $ 41,684 3.08% $2,261,902 $ 22,406 3.96%
Reverse repurchase agreements ................. 1,129,251 6,790 2.41 581,247 4,290 2.95
Borrowings secured by investment securities (2) 6,233 632 40.56 12,345 549 17.79
---------- ---------- ---------- ----------
Total borrowings on Mortgage Assets ......... $6,553,174 $ 49,106 3.00% $2,855,494 $ 27,245 3.82%
========== ========== ========== ==========
Net Interest Spread (3) ....................... 1.49% 1.82%
Net Interest Margin (4) ....................... 1.57% 2.02%
- -------------
(1) Interest income includes amortization of acquisition costs and net cash
payments or receipts on derivative instruments not allocated to specific
CMOs.
(2) Payments and excess cash flows received from the securities
collateralizing this loan are used to pay down the outstanding borrowings.
The payments are received from a collateral base that is in excess of the
borrowings. Therefore, while the payment amounts should remain relatively
stable the average balance of the borrowings will continue to decrease.
(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.
Net interest income was $26.8 million for the first quarter of 2003
compared to $15.6 million for the first quarter of 2002. The
quarter-over-quarter increase in net interest income was primarily due to an
increase in average Mortgage Assets, which increased to $6.7 billion for the
first quarter of 2003 compared to $3.0 billion for the first quarter of 2002 as
the long-term investment operations acquired $4.8 billion of primarily Alt-A
mortgages from the mortgage operations and originated $66.9 million of
multi-family mortgages since the end of the first quarter of 2002. We acquire
mortgage loans from the mortgage operations that fit within our criteria, which
are primarily Alt-A ARMs and FRMs with good credit profiles, with insurance
enhancements, when required, prepayment penalty features and purchase money
transactions.
The following table summarizes the principal balance of mortgages acquired
by the long-term investment operations from the mortgage operations by loan
characteristic for the periods indicated (in thousands):
16
For the Three Months
Ended March 31,
--------------------------------
2003 2002
--------------- ---------------
Principal Principal
Balance % Balance %
------- - ------- -
Volume by Type:
Adjustable rate ..................... $ 866,253 60 $ 491,781 100
Fixed rate .......................... 567,986 40 -- 0
---------- ----------
Total Mortgage Acquisitions ....... $1,434,239 $ 491,781
========== ==========
Volume by Product:
Six-month LIBOR indexed ARMs ........ $ 491,241 34 $ 322,933 66
Six-month LIBOR indexed hybrids (1) . 375,011 26 168,848 34
Fixed rate first trust deeds ........ 564,639 39 -- 0
Fixed rate second trust deeds ....... 3,348 1 -- 0
---------- ----------
Total Mortgage Acquisitions ....... $1,434,239 $ 491,781
========== ==========
Volume by Credit Quality:
Alt-A loans ......................... $1,427,484 100 $ 489,927 100
B/C loans ........................... 6,755 0 1,854 0
---------- ----------
Total Mortgage Acquisitions ....... $1,434,239 $ 491,781
========== ==========
Volume by Purpose:
Purchase ............................ $ 611,529 43 $ 290,019 59
Refinance ........................... 822,710 57 201,762 41
---------- ----------
Total Mortgage Acquisitions ....... $1,434,239 $ 491,781
========== ==========
Volume by Prepayment Penalty:
With prepayment penalty ............. $1,163,745 81 $ 301,525 61
Without prepayment penalty .......... 270,494 19 190,256 39
---------- ----------
Total Mortgage Acquisitions ....... $1,434,239 $ 491,781
========== ==========
- ----------
(1) Mortgages are fixed rate for initial two to five year periods and
subsequently adjust to the indicated index plus a margin.
The increase in net interest income due to an increase in average Mortgage
Assets was offset, in part, by a decrease in net interest margins on Mortgage
Assets, which declined to 1.57% for the first quarter of 2003 compared to 2.02%
for the first quarter of 2002. The overall decrease in net interest margins was
primarily the result of a decline in net interest margins on CMO collateral,
which declined 67 basis points to 1.26% for the first quarter of 2003 as
compared to 1.93% for the first quarter of 2002. This decline was due to a
number of factors, some of which were affected by a decrease in short-term
interest rates since the end of the first quarter of 2002, as follows:
o interest rate adjustments on mortgages;
o early principal prepayment of higher coupon mortgages;
o net cash payments on derivative instruments; and
o higher composition of FRMs.
Interest rate adjustments on mortgages. Interest rates on seasoned LIBOR
ARMs, which secure adjustable rate CMO borrowings and are subject to periodic
interest rate caps, have reset lower over the last year as a result of
short-term interest rate reductions by the Federal Reserve Bank since the end of
the first quarter of 2002 which have, in effect, "caught up" to interest rate
reductions on adjustable rate CMO borrowings, which are not subject to periodic
interest rate caps. The result is that the interest rate spread differential
between LIBOR ARMs, which are primarily indexed to six-month LIBOR, and
adjustable rate CMO borrowings, which are primarily indexed to one-month LIBOR,
has narrowed or compressed. In addition, many seasoned hybrid ARMs with initial
fixed interest rate periods subsequently converted to LIBOR ARMs, which are
primarily indexed to six-month LIBOR. This resulted in those mortgages resetting
to lower adjustable interest rates.
17
Early principal prepayment of higher coupon mortgages. Record refinancing
activity during 2002, which continued during the first quarter of 2003, resulted
in the early principal payment of mortgages with higher interest rates than
interest rates on new mortgages that were acquired by the long-term investment
operations. As a result of interest rate resets and the early principal
prepayment of higher coupon mortgages, the weighted average coupon of mortgages
held as CMO collateral was 6.29% as of March 31, 2003 compared to 7.53% as of
March 31, 2002. However, we believe that the high concentration of mortgages
held as CMO collateral with prepayment penalty features helps to mitigate future
mortgage prepayments. As of March 31, 2003, 78% of mortgages held as CMO
collateral had active prepayment penalty features compared to 52% as of March
31, 2002.
Net cash payments on derivative instruments. The notional amount of
derivative instruments rose as we acquired derivative instruments as interest
rate hedges for CMO borrowings, which were used to finance the acquisition and
origination of $4.8 billion of mortgages by the long-term investment operations
since the end of the first quarter of 2002. The increase in the notional amount
of derivative instruments combined with the decline of short-term interest rates
during the first quarter of 2003 increased net cash payments made on derivative
instruments. We acquire derivative instruments to offset possible increased CMO
borrowing costs from rising interest rates. However, as short-term interest
rates decline, net interest margin compression may occur as the interest rate
spread differential between the interest rate index, i.e. one-month LIBOR, and
the contractual interest rate level, or strike price, which one-month LIBOR
needs to reach in order for us to receive cash payments, widens. As a result of
these factors, net cash payments on derivative instruments were $11.8 million
for the first quarter of 2003 compared to $6.5 million for the first quarter of
2002. Excluding the impact of derivative instruments, net interest margins on
Mortgage Assets would have been 2.20% for the first quarter of 2003 as compared
to 2.90% for the first quarter of 2002. The goal of our interest rate hedging
policy is to provide stable net interest margins and cash flows to our investors
in various interest rate environments. We believe that our interest rate hedging
policy is sound and net interest margins will remain relatively stable when and
if interest rates rise.
Higher composition of FRMs. We generally earn smaller net interest margins
on FRMs financed with fixed rate CMOs than on ARMs financed with adjustable rate
CMOs. In order to compensate CMO bondholders for investing in fixed rate CMOs,
which generally have longer lives than adjustable rate CMOs and are fixed over
the life of the investment, we must pay a higher yield on the bonds in much the
same way that longer term certificates of deposit generally have higher yields
than shorter term certificates of deposit. In other words, we are compensating
fixed rate CMO bondholders for the risk that market interest rates may rise
while interest rates on the CMO bonds will remain fixed. Therefore, overall net
interest margins on CMO collateral declined during the first quarter of 2003
compared to the first quarter of 2002, in part, because we acquired and retained
more FRMs, which were financed with fixed rate CMO financing. As of March 31,
2003 21% of mortgages held as CMO collateral were FRMs compared to 8% of FRMs
held as CMO collateral as of March 31, 2002. However, we believe that FRMs,
which generally have longer lives than ARMs, may generate cash flows over a
longer time horizon and produce a comparable return on average equity over time
as average return on equity on ARMs.
Provision for Loan Losses
Provision for loan losses were $6.5 million for the first quarter of 2003
compared to $3.7 million for the first quarter of 2002. The provision for
estimated loan losses are primarily based on a migration analysis based on
historical loss statistics, including cumulative loss percentages and loss
severity, of similar mortgages in our mortgage loan investment portfolio. The
loss percentage is used to determine the estimated inherent losses in the
mortgage loan investment portfolio. Provision for loan losses is also determined
based on the following:
o management's judgment of the net loss potential of mortgages in our
mortgage loan investment portfolio based on prior loan loss
experience;
o changes in the nature and volume of the mortgage loan investment
portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
For additional information regarding actual loss rates and delinquencies
of mortgages in our mortgage loan investment portfolio refer to "Financial
Condition" below.
18
Non-Interest Income
Non-interest income primarily consists of equity in net earnings of IFC,
net warehouse fees from warehouse advances made by IWLG and other revenue.
Equity in net earnings of IFC results as IMH records 99% of the earnings or
losses from IFC due to IMH's ownership of 100% of IFC's preferred stock, which
represents 99% of the economic interest in IFC.
Non-interest income increased to $7.8 million for the first quarter of
2003 compared to $5.7 million for the first quarter of 2002. The
quarter-over-quarter increase of $2.1 million in non-interest income was
primarily due to a $1.6 million gain on sale of mortgages in addition to a
$558,000 increase in equity in net income of IFC during the first quarter of
2003. For additional information and detail regarding IFC's financial condition
and results of operations refer to "Results of Operations--Impac Funding
Corporation" below.
Non-Interest Expense
Non-interest expense was $2.6 million for the first quarter of 2003
compared to $1.9 million for the first quarter of 2002. The quarter-over-quarter
increase of $700,000 in non-interest expense was primarily due to the following:
o $1.2 million increase in operating expenses;
o $526,000 decrease in gain on disposition of other real estate owned;
and
o partially offset by a $1.0 million decrease in write-down on
investment securities available-for-sale.
The increase in operating expenses, which include professional services,
general and administrative expense and personnel expense, was primarily due to
the growth of our operating businesses, which resulted in a 124% increase in
total assets since the end of the first quarter of 2002. In addition, general
and administrative expense for the first quarter of 2002 reflects a $395,000 tax
refund of a previous alternative minimum tax payment. The $526,000 decrease in
gain on disposition of other real estate owned was the result of estimates of
write-downs on foreclosed property to a percentage of appraised value or a real
estate broker's price opinion which were more in line with actual results upon
the sale of the foreclosed property during the first quarter of 2003 than during
the first quarter of 2002. The $1.0 million decrease in write-down of investment
securities available-for-sale was due to write-downs recorded during the first
quarter of 2002 to reflect current market conditions, including prepayment
experience and loss expectations, of mortgage-backed securities that remain in
our investment securities portfolio. Write-downs on investment securities
recorded during the first quarter of 2002 were primarily taken on investment
securities secured by mortgages not underwritten and created by our mortgage
operations. However, since 1998 our investment strategy has been to only acquire
or invest in securities underwritten and created by our mortgage operations.
Financial Condition
Total assets grew 12% to $7.4 billion as of March 31, 2003 compared to
$6.6 billion as of December 31, 2002 as the long-term investment operations
acquired $1.4 billion of primarily adjustable and fixed rate Alt-A mortgages
from the mortgage operations and retained $42.1 million of multi-family
mortgages originated by IMCC during the first quarter of 2003. The acquisition
and retention of Alt-A mortgages increased CMO collateral and mortgages
held-for-investment to $6.3 billion as of March 31, 2003 compared to $5.2
billion as of December 31, 2002.
The following table presents selected information about mortgages held as
CMO collateral for the periods indicated:
19
As of and For the Quarter Ended,
----------------------------------------
March 31, December 31, March 31,
2003 2002 2002
--------- ------------ ---------
Percent of Alt-A mortgages................... 99 99 99
Percent of ARMs.............................. 79 85 92
Percent of hybrid ARMs....................... 31 35 61
Weighted average coupon...................... 6.29 6.57 7.53
Weighted average margin...................... 2.99 3.01 3.31
Weighted average original LTV................ 80 82 83
Weighted average original credit score....... 687 683 672
Percent with active prepayment penalty....... 78 76 52
Percent of mortgages in California........... 62 63 63
Percent of purchase transactions............. 57 62 66
Percent of owner occupied.................... 91 93 95
Percent of first lien........................ 99 99 99
Our investment securities portfolio was $25.2 million, or 0.34% of total
assets, as of March 31, 2003, which included positive mark-to-market fair value
adjustments of $8.8 million. Finance receivables declined to $831.5 million as
of March 31, 2003 compared to $1.1 billion as of December 31, 2002 as customer
mortgage inventory declined by quarter-end as a result of large bulk loan sales.
However, total average finance receivables increased to $987.8 million for the
first quarter of 2003 compared to $952.1 million for the fourth quarter of 2002.
The following table presents selected financial data for the periods
indicated (dollars in thousands, except per share data):
As of and For the Quarter Ended,
---------------------------------------------
March 31, December 31, March 31,
2003 2002 2002
------------- ------------- -------------
Book value per share ..................................................... $ 7.13 $ 6.70 $ 6.85
Return on average assets ................................................. 1.48% 1.49% 2.02%
Return on average equity ................................................. 31.69% 31.37% 26.72%
Assets to equity ratio ................................................... 21.07:1 21.59:1 12.40:1
Debt to equity ratio ..................................................... 19.98:1 20.48:1 11.32:1
Allowance for loan losses as a percentage of Loans Receivable ............ 0.42% 0.42% 0.46%
Mortgages 90+ days delinquent and other real estate owned ................ $ 155,597 $ 130,614 $ 80,403
Mortgages 90+ days delinquent and other real estate owned to total assets 2.10% 1.99% 2.40%
Mortgages owned 60+ days delinquent ...................................... $ 190,003 $ 161,260 $ 94,219
60+ day delinquency of mortgages owned ................................... 3.17% 3.22% 3.85%
We believe that in order for us to generate positive cash flows and
earnings we must successfully manage the following primary operational and
market risks:
o credit risk;
o prepayment risk;
o liquidity risk; and
o interest rate risk.
Credit Risk. We manage credit risk by acquiring for long-term investment
high credit quality Alt-A mortgages with conservative LTV ratios that are
acquired and originated by our mortgage operations, adequately providing for
loan losses and actively managing delinquencies and defaults. We believe that by
improving the overall credit quality of our mortgage loan investment portfolio
we can consistently generate stable future cash flow and earnings. During the
first quarter of 2003 we acquired primarily adjustable and fixed rate Alt-A
mortgages from the mortgage operations with an original weighted average credit
score of 701 and an original weighted average LTV ratio of 75%. Alt-A mortgages
are primarily first lien mortgages made to borrowers whose credit is generally
within typical Fannie Mae and Freddie Mac guidelines,
20
but that have loan characteristics that make them non-conforming under those
guidelines. We primarily acquire non-conforming "A" or "A-" credit quality
mortgages, collectively, Alt-A mortgages. As defined by us, A credit quality
mortgages generally have a credit score of 640 or better and A- credit quality
mortgages generally have a credit score of between 600 and 639. As a comparison,
Fannie Mae and Freddie Mac generally purchase conforming mortgages with credit
scores greater than 620. As of March 31, 2003 the original weighted average
credit score of mortgages held as CMO collateral was 687 and the original
weighted average LTV ratio was 80%.
In addition to acquiring mortgages from our mortgage operations, the
long-term investment operations originated $42.1 million of multi-family
mortgages through IMCC. IMCC was formed to primarily originate small balance
multi-family mortgages with high credit quality, conservative LTV ratios and
adjustable rate mortgages with balances ranging from $250,000 to $1.5 million.
Multi-family mortgages provide greater asset diversification on our balance
sheet as multi-family mortgages typically have higher interest rate spreads and
longer lives than residential mortgages. All multi-family mortgages originated
during the first quarter of 2003 had interest rate floors with prepayment
penalty periods ranging from three to five.
We believe that we have adequately provided for loan losses by maintaining
a ratio of allowance for loan losses to total loans receivable, which includes
CMO collateral, finance receivables, and mortgages held-for-investment, of 42
basis points as of March 31, 2003 as allowance for loan losses increased to
$29.8 million. However, as mortgages held as CMO collateral season, there is
generally a historical upward curve whereby some mortgages will move through the
delinquency cycle with the expectation that some of the delinquent mortgages
will eventually be acquired through foreclosure proceedings and sold at a gain
or loss. Although mortgage delinquency rates as a percentage of the mortgage
loan investment portfolio declined since the end of the first quarter of 2002,
actual loan losses increased to $3.3 million for the first quarter of 2003
compared to $635,000 for the first quarter of 2002 as mortgages acquired during
2001 and 2000 reflect the movement of mortgages through the delinquency cycle to
acquisition via foreclosure proceedings to eventual disposition. Mortgages held
as CMO collateral that were acquired during 2003 and 2002 are unseasoned
mortgages and have not experienced material losses as of March 31, 2003 while
CMOs issued prior to 2000 include seasoned mortgages, which have not experienced
a significant increase in losses.
We monitor our sub-servicers to make sure that they perform loss
mitigation, foreclosure and collection functions according to our servicing
guide. This includes an effective and aggressive collection effort in order to
minimize mortgages from becoming seriously delinquent. However, when resolving
delinquent mortgages, sub-servicers are required to take timely and aggressive
action. The sub-servicer is required to determine payment collection under
various circumstances, which will result in maximum financial benefit. This is
accomplished by either working with the borrower to bring the mortgage current
or by foreclosing and liquidating the property. We perform ongoing review of
mortgages that display weaknesses and believe that we maintain adequate loss
allowance on the mortgages. When a borrower fails to make required payments on a
mortgage and does not cure the delinquency within 60 days, we generally record a
notice of default and commence foreclosure proceedings. If the mortgage is not
reinstated within the time permitted by law for reinstatement, the property may
then be sold at a foreclosure sale. In foreclosure sales, we generally acquire
title to the property. As of March 31, 2003 our mortgage loan investment
portfolio included 3.17% of mortgages that were 60 days or more delinquent
compared to 3.22% as of December 31, 2002.
The following table summarizes mortgages in our long-term mortgage loan
investment portfolio that were 60 or more days delinquent for the periods
indicated (in thousands):
At March 31, At December 31,
2003 2002
---------------- ---------------
60-89 days delinquent........................ $ 48,458 $ 41,762
90 or more days delinquent................... 30,845 33,822
Foreclosures................................. 102,919 74,597
Delinquent bankruptcies...................... 7,781 11,079
---------------- --------------
Total 60 or more days delinquent.......... $ 190,003 $ 161,260
================ ==============
Seriously delinquent assets consist of mortgages that are 90 days or more
delinquent, including loans in foreclosure and delinquent bankruptcies. When
real estate is acquired in settlement of loans, referred to as other real estate
owned, the mortgage is written-down to a percentage of the property's appraised
value or broker's price opinion. As of March 31, 2003 seriously delinquent
assets and other real estate owned as a percentage of total assets was 2.10%
compared to 1.99% as of December 31, 2002.
21
The following table summarizes mortgages in our long-term mortgage loan
investment portfolio that were seriously delinquent and other real estate owned
for the periods indicated (in thousands):
At March 31, At December 31,
2003 2002
------------- ---------------
90 or more days delinquent................... 141,545 119,498
Other real estate owned...................... 14,052 11,116
------------- ---------------
Total..................................... $ 155,597 $ 130,614
============= ===============
Prepayment Risk. 81% of Alt-A mortgages acquired from the mortgage
operations during the first quarter of 2003 had prepayment penalty features
ranging from two to five years and as of March 31, 2003, 78% of mortgages held
as CMO collateral had active prepayment penalties compared to 52% as of March
31, 2002.
Liquidity Risk. We employ a leveraging strategy to increase assets by
financing our mortgage loan investment portfolio primarily with CMO borrowings,
reverse repurchase agreements and capital and then using cash proceeds to
acquire additional mortgage assets. We acquire adjustable and fixed rate
mortgages from the mortgage operations and finance the acquisition of those
mortgages, during this accumulation period, with reverse repurchase agreements.
After accumulating a pool of adjustable and fixed rate mortgages, generally
between $200 million and $600 million, we securitize the mortgages in the form
of CMOs. Our strategy is to securitize our mortgages every 30 to 45 days in
order to reduce the accumulation period that mortgages are outstanding on
short-term warehouse or reverse repurchase facilities, which reduces our
exposure to margin calls on these facilities. CMOs are classes of bonds that are
sold to investors in mortgage-backed securities and as such are not subject to
margin calls. In addition, CMOs generally require a smaller initial cash
investment as a percentage of mortgages financed than does interim warehouse and
reverse repurchase financing.
Because of the historically favorable prepayment and loss rates of our
high credit quality Alt-A mortgages, we have received favorable credit ratings
on our CMOs from credit rating agencies, which has reduced our required initial
capital investment as a percentage of mortgages securing CMO financing. The
ratio of total assets to total equity, or "leverage ratio," was 21.07 to 1 as of
March 31, 2003 compared to 12.40 to 1 as of March 31, 2002. However, after
excluding CMO collateral and CMO borrowings, leverage on all other assets was
4.53 to 1 as of March 31, 2003 compared to 4.43 to 1 as of March 31, 2002. With
increased leverage, we have been able to grow our balance sheet by efficiently
using available capital. We continually monitor our leverage ratio and liquidity
levels to insure that we are adequately protected against adverse changes in
market conditions. For additional information regarding liquidity refer to
"Liquidity and Capital Resources" below.
Interest Rate Risk. Refer to Item 3. "Quantitative and Qualitative
Disclosures About Market Risk."
Results of Operations--Impac Funding Corporation
Net earnings were $5.2 million for the first quarter of 2003 compared to
$4.7 million for the first quarter of 2002. The quarter-over-quarter increase
was primarily due to the following:
o $3.9 million increase in non-interest income;
o $1.5 million increase in net interest income; and
o partially offset by a $4.8 million increase in non-interest expense
and income taxes.
The 2003 quarter-over-quarter variances are discussed in further detail
below.
Net Interest Income
Net interest income was $3.2 million for the first quarter of 2003
compared to $1.7 million for the first quarter of 2002. The quarter-over-quarter
increase in net interest income was primarily due to an increase in average
mortgages held-for-sale, which increased to $489.4 million for the first quarter
of 2003 compared to $390.2 million for the first quarter of 2002 as the mortgage
operations acquired $1.8 billion of primarily Alt-A mortgages during the first
quarter of 2003. The increase in net interest income was also due to an increase
in net interest margins on mortgages held-for-sale, which rose to 2.89% for the
first quarter of 2003 compared to 1.90% for the first quarter of 2002. Net
interest margins improved for the
22
first quarter of 2003 as the mortgage operations acquired a higher percentage of
FRMs and six-month LIBOR hybrids, which generally have higher interest rates
than interest rates on six-month LIBOR ARMs.
The following table summarizes the principal balance of mortgage
acquisitions and originations by loan characteristic for the periods indicated
(in thousands):
For the Three Months Ended March 31,
--------------------------------------
2003 2002
----------------- -----------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
By Loan Type:
Fixed rate first trust deed ..................... $ 894,427 50 $ 362,806 31
Fixed rate second trust deed .................... 28,896 2 13,496 1
Adjustable rate:
Six-month LIBOR indexed ARMs ................. 500,067 523,731
Six-month LIBOR indexed hybrids (1) .......... 347,965 284,352
---------- ----------
Total adjustable rate ...................... 848,032 48 808,083 68
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations $1,771,355 100 $1,184,385 100
========== === ========== ===
By Production Channel:
Correspondent acquisitions:
Flow ......................................... $1,042,306 59 $ 832,177 70
Bulk ......................................... 317,409 18 45,565 4
---------- --- ---------- ---
Total correspondent acquisitions ........... 1,359,715 77 877,742 74
---------- --- ---------- ---
Wholesale and retail originations ............ 305,090 17 235,417 20
Novelle Financial Services, Inc. ............. 106,550 6 71,226 6
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations $1,771,355 100 $1,184,385 100
========== === ========== ===
By Credit Quality:
Alt-A ........................................... $1,656,908 94 $1,107,650 94
B/C (2) ......................................... 114,447 6 76,735 6
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations $1,771,355 100 $1,184,385 100
========== === ========== ===
By Purpose:
Purchase ........................................ $ 764,032 43 $ 648,230 55
Refinance ....................................... 1,007,323 57 536,155 45
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations $1,771,355 100 $1,184,385 100
========== === ========== ===
By Prepayment Penalty:
With prepayment penalty ......................... $1,471,904 83 $ 817,251 69
Without prepayment penalty ...................... 299,451 17 367,134 31
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations $1,771,355 100 $1,184,385 100
========== === ========== ===
- -----------
(1) Mortgages are fixed rate for initial two to five year periods and
subsequently adjust to the indicated index plus a margin.
(2) The first quarter of 2003 and 2002 includes $106.6 million and $71.2
million, respectively, of B/C mortgages originated by Novelle Financial
Services, Inc., a subsidiary of IFC, that are subsequently sold to third
party investors for cash gains.
Non-Interest Income
Non-interest income was $21.4 million for the first quarter of 2003
compared to $17.5 million for the first quarter of 2002. The
quarter-over-quarter increase was primarily due to a $5.8 million increase in
gain on sale of loans. Gain on sale of loans increased to $22.0 million during
the first quarter of 2003 compared to gain on sale of loans of $16.2 million
during the first quarter of 2002. Gain on sale of loans includes the difference
between the price we acquire and originate mortgages and the price we receive on
loan sale or securitization and direct mortgage origination revenue and cost,
i.e. loan and underwriting fees, commissions, appraisal review fees, document
expense, etc.
Gain on sale of loans was 114 basis points on total loan sales volume of
$1.9 billion for the first quarter of 2003 compared to 167 basis points on total
loan sales volume of $969.4 million for the first quarter of 2002. All mortgages
were sold by the mortgage operations on a servicing released basis during the
first quarters of 2003 and 2002, which results in 100% cash gains upon sale or
securitization. In order to minimize risks associated with the accumulation of
our mortgages,
23
we seek to securitize our mortgages more frequently by creating smaller
securitizations, thereby reducing our exposure to interest rate risk and price
volatility during the accumulation period of mortgages.
The following table summarizes the principal balance of mortgage sales by
the mortgage operations for the periods indicated:
For the Three Months
Ended March 31,
------------------------
2003 2002
---------- ----------
REMIC ........................................... $ 287,500 $ 393,381
Whole loan sales to third party investors ....... 214,932 84,206
Loan sales to the long-term investment operations 1,434,239 491,781
---------- ----------
Total sales .................................. $1,936,671 $ 969,368
========== ==========
Non-Interest Expense
Non-interest expense and income taxes was $19.4 million for the first
quarter of 2003 compared to $14.6 million for the first quarter of 2002. The
quarter-over-quarter increase in non-interest expense of $4.8 million was
primarily due to the following:
o $3.7 million increase in operating costs;
o $410,000 increase in income taxes; and
o $498,000 increase in amortization and impairment of mortgage and
master servicing rights.
The $3.7 million increase in operating costs, which include personnel
expense, professional services, equipment expense, occupancy expense, data
processing expense and general and administrative expense, was primarily due to
loan production growth. Operating costs increased 38% to $13.4 million for the
first quarter of 2003 compared to $9.7 million for the first quarter of 2002
while mortgage acquisition and origination growth increased 50%
quarter-over-quarter. We believe that our efficient centralized operating
structure and our web-based automated underwriting system, iDASLg2, allows us to
maintain our position as a low cost nationwide acquirer and originator of Alt-A
mortgages.
The following table summarizes fully-loaded mortgage production costs to
acquire or originate a single mortgage by production channel for the periods
indicated (in basis points of mortgage acquisition or origination):
For the Three Months
Ended March 31,
---------------------
Production Channel Company 2003 2002
- ------------------------------ ----------------------------- --------- ---------
Correspondent acquisitions Impac Funding Corporation 65.42 71.58
Wholesale/retail originations Impac Lending Group 105.80 103.44
B/C originations Novelle Financial Services, Inc. 258.00 292.71
--------- ---------
Total Weighted Average Cost........................................ 83.96 91.21
========= =========
Fully-loaded cost to acquire or originate a single mortgage is based on
mortgage production costs, including sales commissions which are a component of
gain on sale of loans in the financial statements, and corporate administrative
costs, including human resources, accounting, management information systems,
corporate administration and marketing. Mortgage production costs exclude other
non-production related expenses, including amortization and impairment of
mortgage servicing rights, mark-to-marked gain (loss) from SFAS 133 and
write-down of investment securities.
Liquidity and Capital Resources
We recognize the need to have funds available for our operating businesses
and our customers' demands for obtaining short-term warehouse financing until
the settlement or sale of mortgages 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 mortgage demand and to allow us to meet abnormal and
unexpected funding requirements. We plan to meet liquidity through normal
operations
24
with the goal of avoiding unplanned sales of assets or emergency borrowing of
funds. Toward this goal, our Asset/Liability Committee, or "ALCO," is
responsible for monitoring our liquidity position and funding needs.
ALCO is comprised of the senior executives of the mortgage operations and
warehouse lending operations. ALCO meets on a weekly basis to review current and
projected sources and uses of funds. ALCO monitors the composition of the
Company's balance sheet for changes in the liquidity of our assets. Our
liquidity consists of cash and cash equivalents, short-term and marketable
investment securities rated AAA through BBB and maturing mortgages, or "liquid
assets." Our policy is to maintain a liquidity threshold of 5% of liquid assets
to warehouse borrowings, reverse repurchase agreements, dividends payable and
other short-term liabilities. During the first quarter of 2003 we were in
compliance with this policy, which ALCO reports to the board of directors at
least quarterly.
We believe that current liquidity levels, available financing facilities
and liquidity provided by operating activities will adequately provide for our
projected funding needs and asset growth. However, any future margin calls and,
depending upon the state of the mortgage industry, terms of any sale of mortgage
assets may adversely affect our ability to maintain adequate liquidity levels or
may subject us to future losses. Our operating businesses primarily use
available funds as follows:
o acquisition and origination of mortgages;
o provide short-term warehouse advances to affiliates and
non-affiliates; and
o pay common stock dividends.
Acquisition and origination of mortgages. During the first quarter of 2003
the mortgage operations acquired and originated $1.8 billion of primarily Alt-A
mortgages. Initial capital invested in mortgages includes premiums paid when
mortgages are acquired and originated. The mortgage operations paid weighted
average premiums of 1.75% on the principal balance of mortgages acquired during
the first quarter of 2003. Capital invested in mortgages is outstanding until we
sell or securitize mortgages, which is one of the reasons we attempt to sell or
securitize mortgages every 30 to 45 days.
The long-term investment operations acquired $1.4 billion of primarily
Alt-A mortgages from the mortgage operations and originated $42.1 million of
multi-family mortgages for long-term investment. Initial capital invested in
mortgages includes premiums paid upon acquisition of mortgages and the equity
required to finance mortgages with short-term reverse repurchase agreements.
Equity requirements to finance Alt-A mortgages with reverse repurchase
agreements generally range from between 2% and 5% of the principal balance of
the mortgage depending on the collateral provided. Equity requirements to
finance multi-family mortgages with reverse repurchase agreements is
approximately 15% of the principal balance of the mortgage depending on the
collateral provided. When the long-term investment operations accumulate a pool
of mortgages, generally ranging from $200.0 million to $600.0 million, the
mortgages are financed through the issuance of CMOs. When we complete CMOs our
total initial capital investment in CMOs ranges from approximately 3% to 5% of
the principal balance of mortgages, depending on premiums paid upon acquisition
of mortgages, costs paid for completion of CMOs, costs to acquire derivative
instruments and initial capital investment in CMOs required to achieve desired
credit ratings. Therefore, we also attempt to securitize our mortgages through
CMO financing every 30 to 45 days as total capital invested in CMOs is generally
less than cash required for reverse repurchase financing.
Provide short-term warehouse advances to affiliates and non-affiliates. We
utilize uncommitted warehouse facilities with various lenders to provide
short-term warehouse financing to affiliates and external customers of the
warehouse lending operations. The warehouse lending operations provide
short-term financing to external customers from the closing of the mortgages to
their sale or other settlement with investors. The warehouse lending operations
finances between 95% and 98% of the fair market value of mortgages, which
equates to a cash requirement of between 2% and 5%, at prime rate plus a spread.
As of March 31, 2003 the warehouse lending operations had $638.0 million of
approved warehouse lines available to non-affiliates, of which $515.2 million
was outstanding.
Affiliates had $21.0 million in pledge accounts with the warehouse lending
operations as of March 31, 2003, which allows them to finance 100% of the fair
market value of their mortgages at prime minus 0.50%. The mortgage operations
has uncommitted warehouse line agreements to obtain financing of up to $600.0
million from the warehouse lending operations to provide interim mortgage
financing during the period that the mortgage operations accumulates mortgages
until the mortgages are securitized or sold. As of March 31, 2003 the warehouse
lending operations had $340.0 million in outstanding warehouse advances to the
mortgage operations, excluding pledge balances.
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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.
Pay common stock dividends. We made common stock dividend payments of
$21.8 million during the first quarter of 2003.
Our operating businesses are primarily funded as follows:
o CMO borrowings and reverse repurchase agreements;
o cash flows from our mortgage loan investment portfolio;
o sale and securitization of mortgages; and
o cash proceeds from the issuance of securities.
CMO borrowings and reverse repurchase agreements. We use reverse
repurchase agreements and CMO borrowings to fund substantially all of our
warehouse advances to affiliates and non-affiliates, the acquisition of
mortgages to be held for long-term investment and, prior to 1999, the
acquisition of investment securities. Since 1999 we have not acquired any
investment securities.
As we accumulate mortgages for long-term investment, we finance the
acquisition of mortgages primarily through borrowings on reverse repurchase
agreements with third party lenders. Since 1995 we have primarily used an
uncommitted repurchase facility with a major investment bank to finance
substantially all warehouse advances to affiliates and non-affiliates and
mortgages acquired for long-term investment, as needed. However, during 2002 we
added $650.0 million of new uncommitted warehouse facilities with other lenders
to finance asset growth. The new warehouse facilities provide us with a higher
aggregate credit limit to fund the acquisition and origination of mortgages 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. As of March 31, 2003 the warehouse lending operations had $857.6
million outstanding on warehouse facilities with various lenders.
We expect to continue to use short-term warehouse facilities to fund the
acquisition of mortgages. If we cannot renew or replace maturing borrowings, we
may have to sell, on a whole loan basis, the mortgages securing these
facilities, which, depending upon market conditions, may result in substantial
losses. Additionally, if for any reason the market value of our mortgages
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 mortgages at substantial losses.
In order to mitigate the liquidity risk associated with reverse repurchase
agreements, we attempt to securitize our mortgages between 30 and 45 days.
Although securitizing mortgages more frequently adds operating and
securitization costs, we believe the added cost is offset as more liquidity is
provided with less interest rate and price volatility, as the accumulation and
holding period of mortgages is shortened. When we have accumulated a sufficient
amount of mortgages, we issue CMOs and convert short-term advances under reverse
repurchase agreements to long-term CMO borrowings. The use of CMOs provides the
following benefits:
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o allows us to lock in our financing cost over the life of the
mortgages securing the CMO borrowings; and
o eliminates margin calls on the borrowings that are converted from
reverse repurchase agreements to CMO financing.
During the first quarter of 2003 we completed $1.5 billion of CMOs, of
which $921.7 million was adjustable rate CMOs and $561.9 million was fixed rate
CMOs, to provide long-term financing for the acquisition and origination of $1.5
billion of Alt-A and multi-family mortgages. Because of the credit profile,
historical loss performance and prepayment characteristics of our mortgages, we
have been able to borrow a higher percentage against mortgages held as CMO
collateral, which means that we have to provide less initial capital upon
completion of CMOs. Equity in the CMOs is established at the time CMOs are
issued at levels sufficient to achieve desired credit ratings on the securities
from credit rating agencies. Total credit loss exposure is limited to the
capital invested in the CMOs at any point in time. As of March 31, 2003 total
equity invested in mortgages held as CMO collateral was $129.7 million, which
includes premiums paid when mortgages are acquired from the mortgage operations,
costs incurred to complete CMO borrowings, costs incurred to acquire derivative
instruments and the required initial capital investment in CMOs. 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. By decreasing the amount of capital we are required to invest in our
CMOs to maintain desired credit ratings, we have been able to effectively
utilize available cash to acquire additional mortgage assets.
Cash flows from our mortgage loan investment portfolio. During the first
quarter of 2003 mortgages held as CMO collateral, which is the majority of the
mortgage loan investment portfolio, generated excess principal and interest cash
flows of $34.2 million. We receive excess principal and interest cash flows on
mortgages held as CMO collateral after distributions are made to investors in
CMOs to the extent cash or other collateral required to maintain desired credit
ratings on the CMOs is fulfilled. Excess principal and interest cash flows
represent the difference between principal and interest payments on the
mortgages less the following:
o interest paid to bondholders;
o pro-rata early principal prepayments paid to bondholders;
o servicing fees paid to mortgage servicers;
o premiums paid to mortgage insurers; and
o actual losses incurred on disposition of real estate acquired in
settlement of mortgages.
Sale and securitization of mortgages. When the mortgage operations
accumulates a sufficient amount of mortgages, generally between $100.0 million
and $300.0 million, it sells or securitizes the mortgages. The mortgage
operations sold $1.4 billion of mortgages to the long-term investment operations
during the first quarter of 2003, $214.9 million of mortgages to third party
investors and $287.5 million was securitized as REMICs. The mortgage operations
sold mortgage servicing rights on substantially all mortgages during the first
quarter of 2003. The sale of mortgage servicing rights generated substantially
all cash gains, which was used to acquire and originate additional mortgages. In
order to mitigate interest rate and market risk, the mortgage operations
attempts to sell and securitize mortgages between 30 and 45 days. Since we rely
significantly upon sales and securitizations to generate cash proceeds to repay
borrowings and to create credit availability, any disruption in our ability to
complete sales and 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 sales and securitizations of our mortgages increase our risk
by exposing us to credit and interest rate risk for this extended period of
time.
Cash proceeds from the issuance of securities. In December 2001, we filed
with the SEC a shelf registration statement that allows us to sell up to $300.0
million of securities, including common stock, preferred stock, debt securities
and warrants. During the three months ended March 31, 2003 we issued
approximately 3.4 million shares of common stock from our shelf registration
statement, in the form of a public offering, and received net cash proceeds of
approximately $37.8 million. Pursuant to an amended and restated equity
distribution with UBS Warburg, LLC, we also sold 358,386 shares of common stock
from our shelf registration statement during the three months ended March 31,
2003 and received net proceeds of approximately $4.1 million. During the three
months ended March 31, 2003 UBS Warburg, LLC received a commission of 3% of the
gross sales price per share of the shares of common stock sold pursuant to the
amended and restated equity distribution agreement, which amounted to an
aggregate commission of $126,000. As of March 31, 2003,
27
approximately $129.7 million in securities were available for issuance under our
shelf registration statement. By issuing new shares periodically throughout the
year we believe that we were able to utilize new capital more efficiently and
profitably.
Cash Flows
Operating Activities - Net cash used in operating activities was $528,000
during the first quarter of 2003 compared to net cash provided by operating
activities of $20.6 million during the first quarter of 2002. Net earnings of
$25.5 million provided most of the cash flows from operating activities during
the first quarter of 2003.
Investing Activities - Net cash used in investing activities was $816.7
million during the first quarter of 2003 compared to $487.7 million during the
first quarter of 2002. Net cash flows of $809.4 million were used in investing
activities to acquire and originate mortgages, net of mortgage principal
repayments.
Financing Activities - Net cash provided by financing activities was
$817.5 million during the first quarter of 2003 compared to $468.1 million
during the first quarter of 2002. Net cash flows of $1.1 billion provided by CMO
financing, net of debt reduction, was primarily provided by financing
activities.
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 mortgages 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 mortgages.
Terrorist attacks or military action may adversely affect our financial results.
The effects that terrorist attacks in the United States or other incidents
and related military action may have on the mortgage operations' ability to
acquire or originate mortgages, the performance of the mortgages held by the
long-term investment operations or on the values of mortgaged properties cannot
be determined at this time. As a result of terrorist activity or military
action, there may be a reduction in new mortgages, which will adversely affect
our ability to expand our mortgage portfolio. 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. Mortgages held by
our long-term investment operations may experience higher rates of delinquency,
default and prepayment. These potential consequences of terrorist attacks or
military action will have an adverse affect on our financial results. Federal
agencies and non-government lenders have, and may continue to, defer, reduce or
forgive payments and delay foreclosure proceedings in respect of loans to
borrowers affected in some way be recent and possible future events. In
addition, activation of a substantial number of U.S. military
28
reservists or members of the National Guard may significantly increase the
proposition of mortgages whose mortgage rates are reduced by application of the
Soldiers' and Sailors' Civil Relief Act of 1940 or similar state laws, and
neither the master servicers nor the servicers will be required to advance for
any interest shortfall caused by any such reduction. Interest payable to senior
and subordinate certificate holders will be reduced on a pro rata basis by any
reductions in the amount of interest collectible as a result of application of
the Soldiers' and Sailors' Civil Relief Act of 1940 or similar state laws.
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
mortgages;
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 at unfavorable prices or discontinue various business activities. Our
inability to access the capital markets could have a negative impact on our
earnings growth and also 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 mortgages.
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 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
mortgages available for sale on a whole loan basis affected the pricing offered
for these mortgages, 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
29
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 accounting charges of $68.9
million. The 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 primarily as the
mortgage industry experienced substantial turmoil as a result of a lack of
liquidity in the secondary markets which caused us to sell mortgages at losses
to meet margin calls on our warehouse facilities. During the year ended December
31, 1997 we experienced a net loss of $16.0 million. The net loss incurred
during 1997 included an 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 mortgages 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 mortgages acquired or originated through our
mortgage operations;
o volume of our mortgage loan acquisitions and originations;
o our ability to obtain credit enhancements; and
o lack of investors purchasing higher risk components of the
securities.
If we are unable to profitably securitize a significant number of our
mortgages 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 mortgages 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 mortgages 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 mortgages 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
30
mortgages. We currently use CMOs as financing vehicles to increase our leverage,
since mortgages held for CMO collateral are retained for investment rather than
sold in a secondary market transaction.
Retaining mortgages 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 mortgages 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 mortgages 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 mortgages 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 mortgages.
We may experience losses if our liabilities re-price at different rates than our
assets.
31
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 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 mortgages that are hybrid
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 and adjust periodically. 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.
Increased levels of prepayments of our adjustable rate mortgages 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 mortgages. Prepayments on mortgages are also
affected by the terms and credit grades of the mortgages, conditions in the
housing and financial markets and general economic conditions. If we acquire
mortgages at a premium and they are subsequently repaid, we must expense the
unamortized premium at the time of the prepayment. We could possibly lose the
opportunity to earn interest at a higher rate over the expected life of the
mortgage. Also, if prepayments on our adjustable rate mortgages 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
mortgages 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
32
securities. The risk associated with holding residual interest and subordinated
securities is greater than that associated with holding the underlying mortgages
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 adversely 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 mortgages securing mortgage-backed securities may cause greater
losses than anticipated and, therefore, we may have a higher rate of mortgage
insurance claims than were originally anticipated. This may cause a rating
agency to downgrade certain classes of our mortgage-backed securities and cause
a reduction of the value of the security.
We undertake additional risks by acquiring and investing in mortgages.
We may be subject to losses on mortgages 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 mortgages and investments. Generally, we require
mortgage insurance on any mortgage with a loan-to-value ratio greater than 80%.
During the time we hold mortgages for investment, we are subject to risks of
borrower defaults and bankruptcies and special hazard losses that are not
covered by standard hazard insurance. If a borrower defaults on a mortgage 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 mortgages, which under our
financing arrangements are mortgages 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.
Alt-A mortgages expose us to greater credit risks.
We are an acquirer and originator of Alt-A mortgages. These are
residential mortgages that do not qualify for purchase by government sponsored
agencies such as Fannie Mae and Freddie Mac. Our operations may be negatively
affected due to our investments in Alt-A mortgages. Credit risks associated with
Alt-A mortgages are greater than those associated with conforming mortgages. The
interest rates we charge on 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 Alt-A borrowers may expose us to a higher risk of
delinquencies, foreclosures and losses.
As a lender of Alt-A mortgages, our market includes borrowers who may be
unable to obtain mortgage financing from conventional mortgage sources.
Mortgages made to such Alt-A borrowers generally entail a higher risk of
delinquency and higher losses than mortgages 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 mortgages made to 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 mortgages 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 mortgages are sold could adversely affect the
33
pricing of our future loan sales and our ability to sell or securitize our
mortgages 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 mortgages 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 acquisitions and originations by the
mortgage operations and mortgages 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 mortgages,
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 mortgages if the
property is damaged. This would cause increased 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 mortgages acquired and
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 mortgages 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 origination process, or upon early default on such mortgage. 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
mortgages. However, in some cases, the remedies available to a purchaser of
mortgages from us may be broader than those available to us against the sellers
of the mortgages 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 mortgage and the
originator fails to repurchase the mortgage, then we may not be able to sell the
mortgage or we may have to sell the mortgage 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 Alt-A mortgages from our mortgage
operations. Impac Mortgage Holdings, Inc. owns
34
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. We are currently negotiating with management to
purchase the common shares of Impac Funding Corporation, however, we cannot
assure you that terms will be agreed upon or that a transaction will be
completed.
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 mortgage origination program, iDASLg2, which stands for the
second generation of Impac Direct Access System for Lending. iDASLg2 allows our
customers to pre-qualify borrowers for various mortgage 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. Substantially, all of our correspondents
submit mortgages through iDASLg2 and all wholesale mortgages 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
mortgages on an automated basis could be delayed or reduced. Furthermore, we
rely on a third party hosting company in connection 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
acquisitions and originations done through iDASLg2. Any substantial delay and
reduction in our mortgage 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 and San Diego, 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 power shortages. 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 mortgages is intense and may adversely affect our operations.
We compete in acquiring and originating Alt-A mortgages 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 mortgages 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
35
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.
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
levels 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 IFC. IFC is not a
REIT and is not, therefore, subject to the above-described REIT distribution
requirements. Because IFC is seeking to retain earnings to fund the future
growth of our mortgage operations business, its board of directors may decide
that IFC 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.
36
Delayed mortgage loan sales or securitization closings could have a material
adverse affect on our operations.
A delay in closing a particular mortgage 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
mortgages 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;
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 mortgages serviced occurs more
quickly than originally assumed, the value of our mortgage servicing rights
would be subject to downward adjustment.
When we purchase mortgages 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
37
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 mortgages and our Alt-A loan products
may adversely affect our operations.
The availability of sufficient mortgages 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 Alt-A mortgages, which is
affected by:
o interest rates;
o national economic conditions;
o residential property values; and
o regulatory and tax developments.
If our mortgage 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 mortgages; and
o an insufficient volume of loans to generate securitizations which
thereby causes us to accumulate mortgages over a longer period.
Our delinquency ratios and our performance may be adversely affected by the
performance of parties who sub-service our mortgages.
We contract with third-party sub-servicers for the sub-servicing of all
the mortgages 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 mortgages. 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 mortgages 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.
38
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 mortgages 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 mortgages 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. Previously, 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
sub-prime mortgage lender responsible for the pricing practices of its 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.
After July 1, 2003 we may no longer be 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 depends, in part, upon the expected period of time
that the mortgage will be outstanding. If a borrower pays off a mortgage in
advance of this expected period, the holder of the mortgage does not realize the
full value expected to be received from the mortgage. A prepayment penalty
payable by a borrower who repays a mortgage 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
mortgages we acquire or originate.
Certain state laws restrict or prohibit prepayment penalties on mortgages.
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 ARMs. 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. The OTS subsequently delayed the effective date of
the final regulations until July 1, 2003. The National Home Equity Mortgage
Association has filed a lawsuit against the OTS challenging the OTS's authority
to issue the regulations. Unless the court determines prior to July 1, 2003 that
the regulations were not validly issued on that date, we will no longer be able
to rely on the Parity Act to preempt state restrictions on prepayment penalties.
39
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 ARMs.
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 mortgages, 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 public
or private 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 securities
and warrants. As of March 31, 2003, we have sold approximately $170.3 million
(gross proceeds) worth of common stock from our shelf registration statement and
we may sell additional securities worth approximately $129.7 million (gross
proceeds) from our shelf registration statement in the future. 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, and pursuant to
the terms of the plan, approved an increase of 1,500,000 authorized shares,
which we plan to register. As of March 31, 2003, our 1995 Stock Option, Deferred
Stock and Restricted Stock Plan had 67,390 shares reserved and available for
issuance and that were registered. 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.
New regulatory laws affecting the mortgage industry may increase our costs and
decrease our mortgage origination and acquisition.
The regulatory environments in which we operate have an impact on the
activities in which we may engage, how the activities may be carried out, and
the profitability of those activities. Therefore, changes to laws, regulations
or regulatory policies can affect whether and to what extent we are able to
operate profitably. For example, proposed state and federal legislation targeted
at predatory lending could have the unintended consequence of raising the cost
or otherwise reducing the availability of mortgage credit for those potential
borrowers with less than prime- quality credit histories, thereby resulting in a
reduction of otherwise legitimate Alt-A lending opportunities. We cannot provide
any assurance that these proposed laws, rules and regulations, or other similar
laws, rules or regulations, will not be adopted in the future. Adoption
40
of these laws and regulations could have a material adverse impact on our
business by substantially increasing the costs of compliance with a variety of
inconsistent federal, state and local rules, or by restricting our ability to
charge rates and fees adequate to compensate us for the risk associated with
certain loans.
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, (including an action that was dismissed but there has been a
notice of an appeal) 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 mortgages 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 mortgages, 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 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.
41
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We focus on effectively managing the various operational and market risks
associated with our businesses. We believe that the most critical of those risks
are:
o credit risk;
o prepayment risk;
o liquidity risk; and
o interest rate risk.
We manage credit risk by acquiring high-credit quality Alt-A mortgages
from the mortgage operations with favorable credit profiles and by acquiring
mortgages with conservative loan-to-value ratios with mortgage insurance
enhancements, when required, which reduces our effective loan-to-value ratio.
Our belief is that high-credit quality Alt-A mortgages will result in favorable
foreclosure rates and conservative loan-to-value ratios will result in favorable
loss rates. We also believe that we maintain an adequate allowance for loan
losses to provide for future loan losses. We manage mortgage prepayment risk by
acquiring Alt-A mortgages from the mortgage operations with prepayment penalty
features. We manage liquidity risk by frequently securitizing or selling our
mortgages. We securitize mortgages through the issuance of CMOs and REMICs every
30 to 45 days. By frequently securitizing our mortgages, we reduce the volume of
mortgages that are financed with short-term reverse repurchase agreements at any
given time. The issuance of CMOs convert short-term reverse repurchase
borrowings, which are subject to margin calls if the value of the mortgages
collateralizing reverse repurchase borrowings decline, to long-term CMO
financing that are not subject to margin calls. By securitizing mortgages as
REMICs or selling mortgages as whole loan sales, ownership of the mortgages
transfers to the trust in the case of REMICs and to the buyer in the case of
whole loan sales. For additional information regarding these risks refer to Item
2. "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Although we manage credit, 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. Since 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 in unequal amounts. Changing interest rates may compress
our interest rate margins and adversely affect overall earnings.
Interest rate risk management is the responsibility of ALCO, which reports
results of interest rate risk analysis to the board of directors on a quarterly
basis. ALCO establishes policies that monitor and coordinate sources, uses and
pricing of funds. ALCO also attempts to reduce the volatility in net interest
income by managing the relationship of interest rate sensitive assets to
interest rate sensitive liabilities. In addition, various modeling techniques
are used to value interest sensitive mortgage-backed securities, including
interest-only securities. The value of mortgage-backed securities is determined
using a discounted cash flow model using prepayment rate, discount rate and
credit loss assumptions. Our investment securities portfolio is
available-for-sale, which requires us to perform market valuations of the
securities in order to properly record the portfolio. We continually monitor
interest rates of our investment securities portfolio as compared to prevalent
interest rates in the market. We do not currently maintain a securities trading
portfolio and are not exposed to market risk as it relates to trading
activities.
ALCO follows an interest rate hedge program intended to limit our exposure
to changes in interest rates primarily associated with cash flows on our
adjustable rate 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 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 interest rate hedge program is
formulated with the intent to offset the potential adverse effects of changing
interest rates on cash flows on adjustable rate CMO borrowings resulting from
the following:
42
o interest rate adjustment limitations on mortgages held as CMO
collateral due to periodic and lifetime interest rate cap features;
and
o mismatched interest rate adjustment periods between mortgages held
as CMO collateral and CMO borrowings.
We acquire for long-term investment six-month LIBOR ARMs and hybrid ARMs.
Six-month LIBOR 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. 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
mortgages would allow, which could affect net interest income. In addition, if
market rates were to exceed the maximum interest rates of our ARMs, borrowing
costs would increase while interest rates on ARMs would remain constant.
We also acquire hybrid ARMs that have initial fixed interest rate periods
generally ranging from two to three years and, to a lesser extent, five years,
which subsequently convert to six-month LIBOR ARMs. During a rapidly increasing
or decreasing interest rate environment financing costs would increase or
decrease more rapidly than would interest rates on mortgages, which would remain
fixed until their next interest rate adjustment date. In order to provide some
protection against any resulting basis risk shortfall on the related
liabilities, we purchase derivative instruments. Derivative instruments are
based upon the principal balance that would result under assumed prepayment
speeds.
We measure the sensitivity of our net interest income to changes in
interest rates affecting interest sensitive assets and liabilities using
simulations. As part of various interest rate simulations, we calculate the
effect of potential changes in interest rates on our interest-earning assets and
interest-bearing liabilities and their affect on overall earnings. The
simulations assume instantaneous and parallel shifts in interest rates and to
what degree those shifts affect net interest income. First, we estimate our net
interest income for the next twelve months using period-end balance sheet data
and 12-month projections of the following:
o future interest rates using forward yield curves, which are market
consensus estimates of future interest rates;
o acquisition of derivative instruments;
o mortgage prepayment rate assumptions; and
o mortgage acquisitions.
We refer to this 12-month projection of net interest income as the "base
case." Once the base case has been established, we "shock" the base case with
instantaneous and parallel shifts in interest rates in 100 basis point
increments upward and downward. Calculations are made for each of the defined
instantaneous and parallel shifts in interest rates over or under the forward
yield curve used to determine the base case and include any associated changes
in projected mortgage prepayment rates caused by changes in interest rates. The
results of each 100 basis point change in interest rates are then compared
against the base case to determine the estimated change to net interest income.
The simulations consider the affect of interest rate changes on interest
sensitive assets and liabilities as well as derivative instruments. The
simulations also consider the impact that instantaneous and parallel shift in
interest rates has on prepayment rates and the resulting affect of accelerating
or decelerating amortization rates of premium and securitization costs on net
interest income.
The use of derivative instruments to hedge changes in interest rates is an
integral part of our strategy to limit interest rate risk. Therefore, net
interest income may be significantly impacted by cash payments we are required
to make or cash payments we receive on derivative instruments. The amount of
cash payments or cash receipts on derivative instruments is determined by (1)
the notional amount of the derivative instrument and (2) current interest rate
levels in relation to the various strike prices of derivative instruments during
a particular time period.
We believe our quantitative risk has not materially changed since our
disclosures under Item 7A. "Quantitative and Qualitative Disclosures About
Market Risk" in our annual report on Form 10-K for the year ended December 31,
2002.
43
ITEM 4: CONTROLS AND PROCEDURES
As of March 31, 2003 the Chief Executive Officer, or "CEO," and Chief
Financial Officer, or "CFO," performed an evaluation of the effectiveness and
the 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 March 31, 2003. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to March 31, 2003.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
With respect to the complaint captioned Deborah Searcy, Shirley Walker, et
al. vs. Impac Funding Corporation, Impac Mortgage Holdings, Inc. et. al., which
is described in IMH's annual report on Form 10-K for the year ended December 31,
2002, in March 2003, the plaintiffs filed an amended complaint adding certain
defendants, including an Impac-related entity, and dropping others, including
certain Impac-related entities, and we have been served with the amended
complaint. Please refer to IMH's annual report on Form 10-K for the year ended
December 31, 2002 regarding the Searcy action. The Company believes that it has
meritorious defenses to this complaint and intends to defend it vigorously.
Nevertheless, litigation is uncertain and the Company may not prevail in the
lawsuit and can express no opinion as to its ultimate outcome.
The Company is a party to other litigation and claims, which are normal in
the course of its operations. While the results of such other litigation and
claims cannot be predicted with certainty, the Company believes the final
outcome of such other matters will not have a material adverse effect on the
Company.
Please refer to IMH's annual report on Form 10-K for the year ended
December 31, 2002 regarding other litigation and claims.
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:
99.1 Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
IMH filed a Current Report on Form 8-K, dated January 29, 2003, reporting
Items 5, 7 and 9, relating to the issuance of a press release announcing
fourth quarter 2002 results.
IMH filed a Current Report on Form 8-K, dated February 19, 2003, reporting
Items 5 and 7, relating to the Company's Consolidated Statements of Cash
Flows for the year ended December 31, 2002.
44
IMH filed a Current Report on Form 8-K, dated February 20, 2003, reporting
Items 5 and 7, relating to the Company entering into an underwriting
agreement for the sale of 3,000,000 shares of its common stock.
IMH filed a Current Report on Form 8-K, dated February 28, 2003, reporting
item 9, relating to a monthly fact sheet.
45
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: May 2, 2003
46
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 officer's 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 functions):
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
May 2, 2003
47
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 officer's 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 functions):
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
May 2, 2003
48
Exhibit 99.1
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 ended March 31, 2003 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
May 2, 2003
/s/ Richard J. Johnson
Richard J. Johnson
Chief Financial Officer
May 2, 2003
A signed original of this written statement required by Section 906 has
been provided to Impac Mortgage Holdings, Inc. and will be retained by Impac
Mortgage Holdings, Inc. and furnished to the Securities and Exchange Commission
or its staff upon request.