SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 1
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2004
2005 or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period fromto.
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 incorporation or organization) | (I.R.S. Employer Identification No.) |
1401 Dove Street, Newport Beach, California 92660
(Address of principal executive offices)
(949) 475-3600
(Registrant’s telephone number, including area code)
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. Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yesx No¨
There were 70,605,69475,732,094 shares of common stock outstanding as of August 12, 2004.4, 2005.
IMPAC MORTGAGE HOLDINGS, INC.
QUARTERLY REPORT on2005 FORM 10-Q/A QUARTERLY REPORT
EXPLANATORY NOTE
This Amendment No. 1 reflects the following:
The consolidated financial statements in this document include restatements and reclassifications as previously filed in our original Form 10-Q for the quarter ended June 30, 2004, Form 10-Q/A for the quarter ended March 31, 2004 and Form 10-K/A for the year ended December 31, 2003. The restatements were necessary to conform with accounting principles generally accepted in the United States of America (“GAAP”) as follows:
Although these corrections have an effect on net earnings, these corrections and reclassifications have no effect on taxable income, which is an important factor in determining the amount of dividends paid to our stockholders. In addition, beginning and ending cash and cash equivalents for all reporting periods remain unchanged.
This report on Form 10-Q/A for the quarterquarterly period ended June 30, 2004 reflects2005 is being filed to make various corrections reclassificationsin Items 1, 2, 3 and restatements4 of the following unaudited financial statements: (a) consolidated balance sheets asPart I and to include information and exhibits under Items 5 and 6 of June 30, 2004, March 31, 2004 and December 31, 2003 and 2002; (b) consolidated statements of operations for the six months
ended June 30, 2004 and for the three and six months ended June 30, 2003; (c) consolidated statements of comprehensive earnings for the three and six months ended June 30, 2003; (d) consolidated statements of operations and comprehensive earnings for the three months ended March 31, 2004 and 2003, for the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002 and 2001; and (e) consolidated statements of cash flows for the six months ended June 30, 2004 and 2003, for the three months ended March 31, 2004 and 2003 and for the years ended December 31, 2003, 2002 and 2001. For a more detailed description of the restatements and reclassifications, see “Note A.2.—Restatement of Consolidated Financial Statements” to the accompanying notes to the consolidated financial statements and “Restatement of Consolidated Financial Statements” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” containedPart II. Other items in this report on Form 10-Q/A. This report on Form 10-Q/A restates certain financial information for the applicable periods set forth in notes to consolidated financial statements, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 3. “Quantitative and Qualitative Disclosures About Market Risk” and Item 4. “Controls and Procedures.” Other items included in this report of Form 10-Q/A are not affected by the restatements and reclassifications and appear unchanged from our original Form 10-Q for the quarterly period ended June 30, 2004. The consolidated statement of operations and related financial information for the six months ended June 30, 2004 contained in our prior Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 should no longer be relied upon. We will not amend any Annual Reports on Form 10-K for fiscal years prior to December 31, 2003 or Quarterly Reports on Form 10-Q for quarterly periods prior to the three months ended March 31, 2004.
amended.
FORM 10-Q/A QUARTERLY REPORT
Page | ||||
PART I. FINANCIAL INFORMATION | ||||
ITEM 1. | CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) | |||
Consolidated Balance Sheets as of June 30, | 1 | |||
2 | ||||
3 | ||||
Consolidated Statements of Cash Flows | 4 | |||
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | |||
| ||||
Risk Factors Related to Our Business Arising in the Quarterly Period Ended June 30, 2005 | ||||
40 | ||||
ITEM 3. | ||||
ITEM 4. | ||||
PART II. OTHER INFORMATION | ||||
ITEM 1. | ||||
ITEM 2. |
| |||
ITEM 3. | ||||
ITEM 4. | ||||
ITEM 5. | ||||
ITEM 6. | ||||
PART I. FINANCIAL INFORMATION
ITEM 1. | CONSOLIDATED FINANCIAL STATEMENTS |
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
(dollar amounts in thousands, except per share data)
(unaudited)
June 30, 2004 | December 31, 2003 | |||||||||||||||
(as restated) | June 30, 2005 | December 31, 2004 | ||||||||||||||
ASSETS | ||||||||||||||||
Cash and cash equivalents | $ | 252,305 | $ | 127,381 | $ | 245,254 | $ | 324,351 | ||||||||
Restricted cash | 403 | 253,360 | ||||||||||||||
CMO collateral | 14,816,077 | 8,639,014 | 23,980,050 | 21,308,906 | ||||||||||||
Finance receivables | 382,900 | 471,820 | ||||||||||||||
Mortgages held-for-investment | 853,513 | 652,814 | 232,019 | 586,686 | ||||||||||||
Finance receivables | 579,672 | 630,030 | ||||||||||||||
Allowance for loan losses | (60,249 | ) | (38,596 | ) | (69,826 | ) | (63,955 | ) | ||||||||
Mortgages held-for-sale | 326,661 | 397,618 | 1,281,125 | 587,745 | ||||||||||||
Accrued interest receivable | 62,672 | 39,347 | 109,135 | 97,617 | ||||||||||||
Other assets | 425,203 | 130,349 | 337,750 | 249,237 | ||||||||||||
Total assets | $ | 17,255,854 | $ | 10,577,957 | $ | 26,498,810 | $ | 23,815,767 | ||||||||
LIABILITIES | ||||||||||||||||
CMO borrowings | $ | 14,749,602 | $ | 8,489,853 | $ | 23,544,517 | $ | 21,206,373 | ||||||||
Reverse repurchase agreements | 1,561,780 | 1,568,807 | ||||||||||||||
Accumulated dividends payable | 52,642 | — | ||||||||||||||
Reverse repurchase agreements/warehouse borrowings | 1,732,266 | 1,527,558 | ||||||||||||||
Trust preferred securities | 76,202 | — | ||||||||||||||
Accrued dividends payable | 56,747 | — | ||||||||||||||
Other liabilities | 62,963 | 46,510 | 41,069 | 37,761 | ||||||||||||
Total liabilities | 16,426,987 | 10,105,170 | 25,450,801 | 22,771,692 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
STOCKHOLDERS’ EQUITY | ||||||||||||||||
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares authorized; none outstanding as of June 30, 2004 and December 31, 2003 | — | — | ||||||||||||||
Series B 9.375% cumulative redeemable preferred stock, $0.01 par value; liquidation value $50,000,000; 7,500,000 shares authorized; 2,000,000 shares and none issued and outstanding as of June 30, 2004 and December 31, 2003, respectively | 20 | — | ||||||||||||||
Common stock, $0.01 par value; 200,000,000 shares authorized and 69,613,694 and 56,368,368 shares issued and outstanding as of June 30, 2004 and December 31, 2003, respectively | 696 | 564 | ||||||||||||||
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares authorized; none issued and outstanding as of June 30, 2005 and December 31, 2004 | — | — | ||||||||||||||
Series B 9.375% cumulative redeemable preferred stock, $0.01 par value; liquidation value $50,000; 2,000,000 shares authorized, issued and outstanding as of June 30, 2005 and December 31, 2004 | 20 | 20 | ||||||||||||||
Series C 9.125% cumulative redeemable preferred stock, $0.01 par value; liquidation value $107,500; 5,500,000 shares authorized; 4,300,000 shares issued and outstanding as of June 30, 2005 and December 31, 2004 | 43 | 43 | ||||||||||||||
Common stock, $0.01 par value; 200,000,000 shares authorized; 75,663,094 and 75,153,926 shares issued and outstanding as of June 30, 2005 and December 31, 2004, respectively | 757 | 752 | ||||||||||||||
Additional paid-in capital | 930,290 | 629,662 | 1,158,482 | 1,152,861 | ||||||||||||
Accumulated other comprehensive gain | 878 | 4,356 | ||||||||||||||
Accumulated other comprehensive income | 1,420 | 979 | ||||||||||||||
Net accumulated deficit: | ||||||||||||||||
Cumulative dividends declared | (400,839 | ) | (307,031 | ) | (634,196 | ) | (513,453 | ) | ||||||||
Retained earnings | 297,822 | 145,236 | 521,483 | 402,873 | ||||||||||||
Net accumulated deficit | (103,017 | ) | (161,795 | ) | (112,713 | ) | (110,580 | ) | ||||||||
Total stockholders’ equity | 828,867 | 472,787 | 1,048,009 | 1,044,075 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 17,255,854 | $ | 10,577,957 | $ | 26,498,810 | $ | 23,815,767 | ||||||||
See accompanying notes to consolidated financial statements.
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||
(as restated) | (as restated) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
INTEREST INCOME: | ||||||||||||||||||||||||||||||||
Mortgage assets | $ | 160,246 | $ | 89,289 | $ | 294,513 | $ | 171,505 | $ | 308,339 | $ | 160,372 | $ | 584,360 | $ | 294,187 | ||||||||||||||||
Other interest income | 438 | 378 | 878 | 532 | 1,446 | 347 | 2,804 | 669 | ||||||||||||||||||||||||
Total interest income | 160,684 | 89,667 | 295,391 | 172,037 | 309,785 | 160,719 | 587,164 | 294,856 | ||||||||||||||||||||||||
INTEREST EXPENSE: | ||||||||||||||||||||||||||||||||
CMO borrowings | 65,187 | 45,615 | 117,181 | 83,908 | 216,255 | 65,187 | 395,722 | 117,181 | ||||||||||||||||||||||||
Reverse repurchase agreements | 10,062 | 7,305 | 19,615 | 14,096 | 25,982 | 10,062 | 42,744 | 19,615 | ||||||||||||||||||||||||
Borrowings secured by investment securities | — | 852 | — | 1,484 | ||||||||||||||||||||||||||||
Other borrowings | 20 | — | 87 | — | 1,395 | 20 | 1,439 | 87 | ||||||||||||||||||||||||
Total interest expense | 75,269 | 53,772 | 136,883 | 99,488 | 243,632 | 75,269 | 439,905 | 136,883 | ||||||||||||||||||||||||
Net interest income | 85,415 | 35,895 | 158,508 | 72,549 | 66,153 | 85,450 | 147,259 | 157,973 | ||||||||||||||||||||||||
Provision for loan losses | 15,282 | 7,059 | 25,007 | 13,543 | 5,711 | 15,282 | 11,785 | 25,007 | ||||||||||||||||||||||||
Net interest income after provision for loan losses | 70,133 | 28,836 | 133,501 | 59,006 | 60,442 | 70,168 | 135,474 | 132,966 | ||||||||||||||||||||||||
NON-INTEREST INCOME: | ||||||||||||||||||||||||||||||||
Gain (loss) on derivative instruments | (99,135 | ) | 77,881 | 18,456 | 41,251 | |||||||||||||||||||||||||||
Gain on sale of loans | 11,973 | — | 14,476 | 1,613 | 19,094 | 11,973 | 31,945 | 14,476 | ||||||||||||||||||||||||
Equity in net earnings of Impac Funding Corporation | — | 10,244 | — | 11,537 | ||||||||||||||||||||||||||||
Gain on sale of investment securities | 5,183 | 1,958 | 5,474 | 2,081 | — | 5,183 | — | 5,474 | ||||||||||||||||||||||||
Mark-to-market gain (loss) – derivative instruments | 77,881 | (7,750 | ) | 41,251 | (14,868 | ) | ||||||||||||||||||||||||||
Other income | 4,092 | 638 | 4,115 | 1,210 | 2,307 | 3,231 | 7,384 | 3,149 | ||||||||||||||||||||||||
Total non-interest income | 99,129 | 5,090 | 65,316 | 1,573 | (77,734 | ) | 98,268 | 57,785 | 64,350 | |||||||||||||||||||||||
NON-INTEREST EXPENSE: | ||||||||||||||||||||||||||||||||
Personnel expense | 16,346 | 790 | 30,014 | 1,476 | 20,810 | 16,346 | 39,690 | 30,014 | ||||||||||||||||||||||||
Amortization of deferred tax charge | 6,792 | 4,486 | 12,595 | 8,684 | ||||||||||||||||||||||||||||
General and administrative and other expense | 4,309 | 474 | 7,483 | 909 | 6,560 | 4,309 | 11,473 | 7,482 | ||||||||||||||||||||||||
Provision for repurchases | 1,640 | — | 457 | — | 1,650 | 1,640 | 5,364 | 457 | ||||||||||||||||||||||||
Amortization and impairment of mortgage servicing rights | 1,396 | — | 2,477 | — | 736 | 570 | 1,026 | 976 | ||||||||||||||||||||||||
Data processing expense | 972 | 114 | 1,777 | 223 | 836 | 972 | 1,779 | 1,777 | ||||||||||||||||||||||||
Occupancy expense | 857 | 59 | 1,698 | 120 | 1,171 | 857 | 2,315 | 1,698 | ||||||||||||||||||||||||
Equipment expense | 830 | 67 | 1,614 | 146 | 1,236 | 830 | 2,383 | 1,614 | ||||||||||||||||||||||||
Professional services | 331 | 797 | 2,162 | 1,182 | 2,021 | 331 | 5,440 | 2,162 | ||||||||||||||||||||||||
Gain on disposition of other real estate owned | (2,247 | ) | (523 | ) | (2,750 | ) | (434 | ) | ||||||||||||||||||||||||
Gain (loss) on sale of other real estate owned | 20 | (2,247 | ) | (829 | ) | (2,750 | ) | |||||||||||||||||||||||||
Total non-interest expense | 24,434 | 1,778 | 44,932 | 3,622 | 41,832 | 28,094 | 81,236 | 52,114 | ||||||||||||||||||||||||
Net earnings before income taxes | 144,828 | 32,148 | 153,885 | 56,957 | ||||||||||||||||||||||||||||
Income taxes | 1,614 | — | 1,299 | — | ||||||||||||||||||||||||||||
Net (loss) earnings before income taxes | (59,124 | ) | 140,342 | 112,023 | 145,202 | |||||||||||||||||||||||||||
Income tax benefit | (4,124 | ) | (2,872 | ) | (6,587 | ) | (7,384 | ) | ||||||||||||||||||||||||
Net earnings | 143,214 | 32,148 | 152,586 | 56,957 | ||||||||||||||||||||||||||||
Net (loss) earnings | (55,000 | ) | 143,214 | 118,610 | 152,586 | |||||||||||||||||||||||||||
Cash dividends on cumulative redeemable preferred stock | (443 | ) | — | (443 | ) | — | (3,624 | ) | (443 | ) | (7,248 | ) | (443 | ) | ||||||||||||||||||
Net earnings available to common stockholders | $ | 142,771 | $ | 32,148 | $ | 152,143 | $ | 56,957 | ||||||||||||||||||||||||
Net (loss) earnings available to common stockholders | $ | (58,624 | ) | $ | 142,771 | $ | 111,362 | $ | 152,143 | |||||||||||||||||||||||
NET EARNINGS PER SHARE: | ||||||||||||||||||||||||||||||||
NET (LOSS) EARNINGS PER SHARE: | ||||||||||||||||||||||||||||||||
Basic | $ | 2.20 | $ | 0.64 | $ | 2.44 | $ | 1.17 | $ | (0.78 | ) | $ | 2.20 | $ | 1.48 | $ | 2.44 | |||||||||||||||
Diluted | $ | 2.17 | $ | 0.63 | $ | 2.40 | $ | 1.15 | $ | (0.78 | ) | $ | 2.17 | $ | 1.46 | $ | 2.40 | |||||||||||||||
DIVIDENDS PER COMMON SHARE | $ | 0.75 | $ | 0.50 | $ | 1.40 | $ | 1.00 | $ | 0.75 | $ | 0.75 | $ | 1.50 | $ | 1.40 | ||||||||||||||||
See accompanying notes to consolidated financial statements.
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(in thousands)
(unaudited)
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
(as restated) | (as restated) | |||||||||||||||
Net earnings | $ | 143,214 | $ | 32,148 | $ | 152,586 | $ | 56,957 | ||||||||
Unrealized holding losses on securities arising during period | (154 | ) | (1,545 | ) | (293 | ) | (960 | ) | ||||||||
Less: Reclassification of gains included in net earnings | (3,185 | ) | — | (3,185 | ) | — | ||||||||||
Net unrealized losses arising during period | (3,339 | ) | (1,545 | ) | (3,478 | ) | (960 | ) | ||||||||
Comprehensive earnings | $ | 139,875 | $ | 30,603 | $ | 149,108 | $ | 55,997 | ||||||||
For the Three Months Ended June 30, | For the Six Months Ended June 30, | ||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||
Net (loss) earnings | $ | (55,000 | ) | $ | 143,214 | $ | 118,610 | $ | 152,586 | ||||||
Net unrealized gains (losses) arising during period: | |||||||||||||||
Unrealized holding losses on securities | 177 | (154 | ) | 441 | (293 | ) | |||||||||
Reclassification of losses included in net earnings | — | (3,185 | ) | — | (3,185 | ) | |||||||||
Net unrealized gains (losses) | 177 | (3,339 | ) | 441 | (3,478 | ) | |||||||||
Comprehensive (loss) earnings | $ | (54,823 | ) | $ | 139,875 | $ | 119,051 | $ | 149,108 | ||||||
See accompanying notes to consolidated financial statements.
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Six Months Ended June 30, | ||||||||||||||||
2004 | 2003 | For the Six Months Ended June 30, | ||||||||||||||
(as restated) | 2005 | 2004 | ||||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||||||
Net earnings | $ | 152,586 | $ | 56,957 | $ | 118,610 | $ | 152,586 | ||||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||||||
Equity in net earnings of Impac Funding Corporation | — | (11,537 | ) | |||||||||||||
Provision for loan losses | 25,007 | 13,543 | 11,785 | 25,007 | ||||||||||||
Amortization of CMO premiums and deferred securitization costs | 58,648 | 30,648 | ||||||||||||||
Amortization of premiums and deferred securitization costs | 138,600 | 60,602 | ||||||||||||||
Gain on sale of other real estate owned | (2,750 | ) | (434 | ) | (829 | ) | (2,750 | ) | ||||||||
Gain on sale of loans | (14,476 | ) | — | (31,945 | ) | (14,476 | ) | |||||||||
Unrealized mark-to-market gain – derivative instruments | (76,996 | ) | (8,139 | ) | ||||||||||||
Net change in investment in and advances to Impac Funding Corporation | — | 52,085 | ||||||||||||||
Unrealized (gain) loss on derivative instruments | (33,639 | ) | (67,995 | ) | ||||||||||||
Purchase of mortgages held-for-sale | (8,919,807 | ) | — | (10,127,623 | ) | (8,919,807 | ) | |||||||||
Sale and principal reductions on mortgages held-for-sale | 9,002,646 | — | 9,462,381 | 9,000,141 | ||||||||||||
Net change in deferred taxes | (19,705 | ) | — | (1,990 | ) | (2,134 | ) | |||||||||
Gain on sale of investment securities available-for-sale | (5,474 | ) | (2,081 | ) | — | (5,474 | ) | |||||||||
Change in deferred tax charge | 154 | (17,570 | ) | |||||||||||||
Depreciation and amortization | 1,549 | — | 2,229 | 1,549 | ||||||||||||
Amortization and impairment of mortgage servicing rights | 2,477 | — | 1,026 | 976 | ||||||||||||
Net change in accrued interest receivable | (23,325 | ) | (3,674 | ) | (11,518 | ) | (23,325 | ) | ||||||||
Net change in restricted cash | 252,957 | (598 | ) | |||||||||||||
Net change in other assets and liabilities | (177,877 | ) | 1,350 | (3,407 | ) | (187,222 | ) | |||||||||
Net cash provided by operating activities | 2,503 | 128,718 | ||||||||||||||
Net cash used in operating activities | (223,209 | ) | ( 490 | ) | ||||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||||||
Net change in CMO collateral | (6,237,471 | ) | (1,421,304 | ) | (2,814,965 | ) | (6,242,246 | ) | ||||||||
Net change in finance receivables | 50,358 | (245,346 | ) | 88,920 | 50,358 | |||||||||||
Purchase of premises and equipment | (3,889 | ) | — | (3,892 | ) | (3,889 | ) | |||||||||
Net change in mortgages held-for-investment | (205,606 | ) | (81,226 | ) | 344,288 | (206,058 | ) | |||||||||
Sale of investment securities available-for-sale | 1,710 | — | — | 4,510 | ||||||||||||
Purchase of investment securities available-for-sale | (3,920 | ) | — | (28,868 | ) | (3,920 | ) | |||||||||
Dividend from Impac Funding Corporation | — | 11,385 | ||||||||||||||
Net change in mortgage servicing rights | (2,741 | ) | — | (711 | ) | 2,033 | ||||||||||
Purchase of deferred investments | (2,485 | ) | (809 | ) | ||||||||||||
Net principal reductions on investment securities available-for-sale | 6,039 | 4,320 | 1,748 | 6,086 | ||||||||||||
Proceeds from the sale of other real estate owned, net | 20,181 | 15,806 | 25,107 | 20,181 | ||||||||||||
Net cash used in investing activities | (6,375,339 | ) | (1,716,365 | ) | (2,390,858 | ) | (6,373,754 | ) | ||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||||||
Net change in reverse repurchase agreements and other borrowings | (7,027 | ) | 223,956 | 204,708 | (7,027 | ) | ||||||||||
Proceeds from CMO borrowings | 8,224,275 | 2,346,668 | 7,109,346 | 8,212,970 | ||||||||||||
Repayment of CMO borrowings | (1,978,573 | ) | (989,589 | ) | (4,796,916 | ) | (1,967,268 | ) | ||||||||
Dividends paid on common and preferred stock | (41,166 | ) | (46,352 | ) | ||||||||||||
Issuance of trust preferred | 76,202 | — | ||||||||||||||
Dividends paid common | (56,748 | ) | (41,166 | ) | ||||||||||||
Dividends paid preferred | (7,248 | ) | — | |||||||||||||
Proceeds from sale of common stock | 138,523 | 37,777 | — | 138,523 | ||||||||||||
Proceeds from sale of common stock via equity distribution agreement | 112,518 | 24,462 | — | 112,518 | ||||||||||||
Proceeds from sale of cumulative redeemable preferred stock | 48,285 | — | — | 48,285 | ||||||||||||
Proceeds from exercise of stock options | 925 | 1,025 | 5,626 | 925 | ||||||||||||
Net cash provided by financing activities | 6,497,760 | 1,597,947 | 2,534,970 | 6,497,760 | ||||||||||||
Net change in cash and cash equivalents | 124,924 | 10,300 | (79,097 | ) | 123,516 | |||||||||||
Cash and cash equivalents at beginning of period | 127,381 | 113,345 | 324,351 | 125,153 | ||||||||||||
Cash and cash equivalents at end of period | $ | 252,305 | $ | 123,645 | $ | 245,254 | $ | 248,669 | ||||||||
SUPPLEMENTARY INFORMATION: | ||||||||||||||||
Interest paid | $ | 378,362 | $ | 121,307 | ||||||||||||
Taxes paid | 17,759 | 9,395 | ||||||||||||||
NON-CASH TRANSACTIONS: | ||||||||||||||||
Transfer of mortgages to other real estate owned | $ | 35,478 | $ | 18,238 | ||||||||||||
Dividends declared and unpaid | 56,747 | 52,642 | ||||||||||||||
Net change in other comprehensive earnings | 441 | (3,478 | ) |
See accompanying notes to consolidated financial statements.
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(unaudited)
For the Six Months Ended June 30, | ||||||||
2004 | 2003 | |||||||
(as restated) | ||||||||
SUPPLEMENTARY INFORMATION: | ||||||||
Interest paid | $ | 171,398 | $ | 104,408 | ||||
Taxes paid | 9,395 | — | ||||||
NON-CASH TRANSACTIONS: | ||||||||
Transfer of mortgages to other real estate owned | $ | 18,238 | $ | 17,746 | ||||
Dividends declared and unpaid | 52,642 | 25,352 | ||||||
Net change in other comprehensive earnings | (3,478 | ) | (960 | ) |
See accompanying notes to consolidated financial statements.
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share data or as otherwise indicated)
(unaudited)
Note A—Summary of Business and Significant Accounting Policies
1. | Business Summary and Financial Statement Presentation |
Unless the context otherwise requires, the terms “Company,” “we,” “us,” and “our” refer to Impac Mortgage Holdings, Inc. (IMH), a Maryland corporation incorporated in August 1995, and its subsidiaries, IMH Assets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG), Impac Multifamily Capital Corporation (IMCC) and Impac Funding Corporation (IFC), together with its wholly-owned subsidiaries Impac Secured Assets Corp. (ISAC) and Novelle Financial Services, Inc. (Novelle).
We are a mortgage real estate investment trust, or “REIT,” that is a nationwide acquirer, originator, seller and investor of non-conforming Alt-A mortgages, or “Alt-A mortgages,” and to a lesser extent, small-balance, multi-family mortgages, or “multi-family mortgages” and sub-prime, or “B/C mortgages.” We also provide warehouse financing to originators of mortgages.
We operate three core businesses:
The long-term investment operations primarily invest in adjustable rate and, to a lesser extent, fixed rate Alt-A mortgages that are acquired and originated by our mortgage operations and small-balance multi-family 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.
The mortgage operations acquire, originate, sell and securitize primarily adjustable rate and fixed rate Alt-A mortgages and, to a lesser extent, B/C mortgages. The mortgage operations generate income by securitizing and selling mortgages to permanent investors, including the long-term investment operations. This business also earns revenue from fees associated with master servicing agreements and interest income earned on mortgages held for sale. The 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 our mortgage operations, by funding mortgages from their closing or acquisition date until sale 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.
The accompanying unaudited consolidated financial statements of IMH and our subsidiaries (as defined above) 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 six-month period ended June 30, 20042005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
The results of operations for the three and six months ended June 30, 2004 reflect the consolidation of IFC on July 1, 2003. On July 1, 2003, IMH entered into a stock purchase agreement with Joseph R. Tomkinson, our Chairman, Chief Executive Officer and a director, William S. Ashmore, our Chief Operating Officer, President and a director, and the Johnson Revocable Living Trust, of which Richard J. Johnson, our Executive Vice President and Chief Financial Officer is trustee, whereby IMH purchased all of the outstanding shares of voting common stock of IFC for aggregate consideration of $750 thousand. Messr’s. Tomkinson and Ashmore and the Johnson Revocable Living Trust each owned one-third of the outstanding common stock of IFC. Mr. Tomkinson elected to receive $125 thousand worth of his consideration for the sale of his IFC shares of common stock in the form of 7,687 shares of IMH common stock. The fairness opinion related to the purchase price of IFC, as rendered by an independent financial advisor, and the subsequent transaction was approved by our board of directors. As a result of acquiring 100% of IFC’s common stock on July 1, 2003, IMH owns all of the common stock and preferred stock of IFC and began to consolidate IFC as of that date. As such, the consolidated financial statements for the three and six months ended June 30, 2004 (consolidation periods) reflect the results of operations of IFC on a consolidated basis. The consolidated financial statements for the three and six months ended June 30, 2003 (non-consolidation periods) include the results of operations of IFC as equity in net earnings of IFC. The presentation of prior periods’ consolidated financial statements conform to the restatements referred to in Note A.2. “Restatement of Consolidated Financial Statements” below.2005.
All significant inter-company balances and transactions have been eliminated in consolidation or under the equity method of accounting regarding transactions involving the mortgage operations prior to its consolidation. CertainIn addition, certain amounts in the prior periods’ consolidated financial statements have been reclassified to conform to the current year presentation.
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with GAAP. Management’s estimates and assumptions include allowance for loan losses, valuation of derivative financial instruments and repurchase liabilities related to sold loans, and the amortization of various loan premiums and discounts due to prepayment estimates. Actual results could differ from those estimates.
We are a mortgage real estate investment trust (REIT) that is a nationwide acquirer, originator, seller and securitizer of non-conforming Alt-A mortgages (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:
We operate three core businesses:
The long-term investment operations primarily invest in adjustable rate and fixed rate Alt-A mortgages that are acquired and originated by the mortgage operations. The long-term investment operations also originate small-balance, multi-family residential mortgages (multi-family mortgages). Mortgage balances generally range from $250 thousand to $3.0 million. Multi-family mortgages have interest rate floors, which is the initial start rate, and prepayment penalty periods of 3, 5 and 7 years. Multi-family mortgages provide greater asset diversification on our balance sheet as multi-family mortgage borrowers typically have higher credit scores and multi-family mortgages generally have lower loan-to-value ratios (LTV ratios) and longer lives than Alt-A mortgages. This business primarily generates net interest income on mortgages held-for-investment and mortgages held as CMO collateral (long-term mortgage portfolio). Investment in Alt-A and multi-family mortgages is financed with collateralized mortgage obligations (CMO) financing, warehouse facilities and proceeds from the sale of capital stock.
The mortgage operations, a taxable REIT subsidiary (TRS), acquire, originate, sell and securitize primarily adjustable rate and fixed rate Alt-A mortgages and, to a lesser extent, sub-prime mortgages (B/C mortgages) from correspondents, mortgage brokers and retail customers. The mortgage operations acquire Alt-A mortgages from its network of third party correspondents (Impac Alt-A mortgages). Correspondents originate and close mortgages under its mortgage programs on a flow (loan-by-loan) basis or through bulk sale commitments. Correspondents include savings and loan associations, commercial banks and mortgage bankers. The mortgage operations acts as an intermediary between the originators of mortgages that do not meet the guidelines for purchase by Fannie Mae and Freddie Mac and permanent investors in mortgage-backed securities secured by or representing an ownership interest in mortgages. The mortgage operations also acquire non-conforming Alt-A mortgages on a bulk basis that are underwritten to guidelines substantially similar, but not specific, to those of the mortgage operations (non-Impac Alt-A mortgages). Non-Impac mortgage borrowers generally have higher credit scores than Impac Alt-A mortgage borrowers. The mortgage operations generate income by securitizing and selling mortgages to permanent investors. This business also earns revenue from fees associated with mortgage servicing rights (MSR), master servicing agreements and interest income earned on mortgages held-for-sale. The 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.
2. |
The unaudited consolidated balance sheets as of March 31, 2004 and December 31, 2003 and 2002, the unaudited consolidated statements of operations and unaudited consolidated statements of comprehensive earnings for the three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002, and 2001 and the unaudited consolidated statements of cash flows for the three months ended March 31, 2004 and 2003, six months ended June 30, 2003 and for the years ended December 31, 2003, 2002 and 2001 were restated. The effect of this restatement on net earnings (loss) for the three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002 and 2001 was an increase (decrease) of $(36.7) million, $(0.7) million, $2.4 million, $1.7 million, $11.2 million, $12.8 million, $21.7 million, $(34.6) million and $(35.4) million, respectively. Additionally, basic and diluted earnings per share (“EPS”) for the six months ended June 30, 2004 was corrected to $2.44 and $2.40, respectively, from $2.30 and $2.27, respectively. The following are the principal reasons for the correction and reclassifications:
the reclassification of derivative financial instruments (“derivatives”) in other assets and other liabilities on our consolidated balance sheet. Previously, we included the fair value of derivatives, including cash and cash equivalents in margin accounts, in various balance sheet items including CMO collateral, mortgages held-for-sale, derivative assets, other assets and other liabilities. We now include positive fair values of derivatives
in other assets and negative fair values of derivatives in other liabilities on our consolidated balance sheet; and
The consolidated financial statements in this document include restatements and reclassifications as previously filed in our original Form 10-Q for the quarter ended June 30, 2004, Form 10-Q/A for the quarter ended March 31, 2004 and Form 10-K/A for the year ended December 31, 2003. The restatements were necessary to conform with accounting principles generally accepted in the United States of America (“GAAP”) as follows:
Change our classification of certain interest rate derivative gains and losses to non-interest income as opposed to an adjustment to the interest yield on mortgages held for long-term investment as a result of the elimination of cash flow hedging, as stated above. We purchase derivatives to manage our exposure to the variability of one-
month LIBOR, which is the underlying index of our adjustable rate CMO and warehouse borrowings, as changing interest rates affect cash flows on CMO and warehouse borrowings. Historically, cash payments received and made on derivatives were recorded as an adjustment to the interest yield on mortgages held for long-term investment on the consolidated financial statements. Due to the restatement discussed above relating to derivatives, rather than the Company reclassifying cash payments received and made on derivatives as an adjustment to the interest yield on CMO and warehouse borrowings, we have now recorded the total change in fair value of the derivatives (cash payments plus unrealized gains and losses) as mark-to-market gains (losses) - derivative instruments in the statements of operations; and
A summary of the impact of the restatements on net earnings follows:
For the three months ended March 31, 2004 | For the years ended December 31, | |||||||||||||||
2003 | 2002 | 2001 | ||||||||||||||
Net earnings, as previously reported | $ | 46,046 | $ | 127,231 | $ | 74,917 | $ | 33,178 | ||||||||
Restatement for sale of mortgage servicing rights when the mortgage loans are retained | (12,116 | ) | (14,192 | ) | (14,270 | ) | (7,309 | ) | ||||||||
Restatement for derivatives and cessation of cash flow hedge accounting | (24,558 | ) | 35,940 | (20,300 | ) | (28,051 | ) | |||||||||
Net earnings, as restated | $ | 9,372 | $ | 148,979 | $ | 40,347 | $ | (2,182 | ) | |||||||
The aforementioned restatement adjustments have been tax affected to the extent attributable to activities of the taxable REIT subsidiary. Note B. “Reconciliation of Net Earnings Per Share,” Note C. “Segment Reporting,” Note D. “Mortgages Held-for-Sale,” Note E. “CMO Collateral” and Note F. “CMO Borrowings” have been amended for the impact of the aforementioned restatements.
The following table presents the consolidated statements of operations for the six months ended June 30, 2004 that was affected by the correction:
Consolidated Statements of Operations
For the Six Months Ended June 30, 2004 | ||||||
As Restated | As Previously Reported | |||||
Net earnings per share: | ||||||
Basic | $ | 2.44 | $ | 2.30 | ||
Diluted | 2.40 | 2.27 |
The following table presents the consolidated balance sheet as of June 30, 2004 that was affected by the reclassifications:
Consolidated Balance Sheets
As of June 30, 2004 | ||||||
As Restated | As Previously Reported | |||||
Mortgages held-for-sale | $ | 326,661 | $ | 326,727 | ||
Derivative assets | — | 22,124 | ||||
Other assets | 425,203 | 329,090 | ||||
Total assets | 17,255,854 | 17,181,931 | ||||
CMO borrowings | 14,749,602 | 14,676,479 | ||||
Other liabilities | 62,963 | 62,163 | ||||
Total liabilities | 16,426,987 | 16,353,064 | ||||
Total liabilities and stockholders’ equity | 17,255,854 | 17,181,931 |
The following tables present the consolidated balance sheets as of December 31, 2003 and 2002 and the consolidated statements of operations and comprehensive earnings and statements of cash flows for the years ended December 31, 2003, 2002 and 2001 that were affected by the correction and reclassification entries:
Consolidated Balance Sheets
As of December 31, 2003 | As of December 31, 2002 | |||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | |||||||||||||
CMO collateral | $ | 8,639,014 | $ | 8,735,434 | $ | 5,119,908 | $ | 5,149,680 | ||||||||
Investment in and advances to IFC | — | — | 531,032 | 20,787 | ||||||||||||
Finance receivables | 630,030 | 630,030 | 664,021 | 1,140,248 | ||||||||||||
Mortgages held-for-sale | 397,618 | 395,090 | — | — | ||||||||||||
Accrued interest receivable | 39,347 | 39,347 | 27,219 | 28,287 | ||||||||||||
Other assets | 130,349 | 109,678 | 53,880 | 39,061 | ||||||||||||
Total assets | 10,577,957 | 10,674,657 | 6,540,339 | 6,551,773 | ||||||||||||
CMO borrowings | 8,489,853 | 8,526,838 | 5,019,934 | 5,041,751 | ||||||||||||
Other liabilities | 46,510 | 70,522 | 47,097 | 16,751 | ||||||||||||
Total liabilities | 10,105,170 | 10,166,167 | 6,256,814 | 6,248,285 | ||||||||||||
Accumulated other comprehensive loss | 4,356 | (8,348 | ) | 8,471 | (41,721 | ) | ||||||||||
Retained earnings | 145,236 | 193,643 | (3,743 | ) | 66,412 | |||||||||||
Net accumulated deficit | (161,795 | ) | (113,388 | ) | (204,697 | ) | (134,542 | ) | ||||||||
Total stockholders’ equity | 472,787 | 508,490 | 283,525 | 303,488 | ||||||||||||
Total liabilities and stockholders’ equity | 10,577,957 | 10,674,657 | 6,540,339 | 6,551,773 |
Consolidated Statements of Operations
For the year ended December 31, | |||||||||||||||||||||||
2003 | 2002 | 2001 | |||||||||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | As Restated | As Previously Reported | ||||||||||||||||||
Interest on mortgage assets | $ | 385,523 | $ | 338,680 | $ | 228,444 | $ | 221,978 | $ | 140,399 | $ | 153,951 | |||||||||||
Total interest income | 386,741 | 340,827 | 230,267 | 226,416 | 141,563 | 156,615 | |||||||||||||||||
Interest on CMO borrowings | 174,199 | 185,791 | 102,366 | 117,756 | 74,235 | 77,813 | |||||||||||||||||
Interest on reverse repurchase agreements | 32,382 | 32,381 | 23,583 | 23,584 | 30,829 | 33,370 | |||||||||||||||||
Interest on other borrowings | 2,428 | 2,759 | 1,852 | 3,467 | 3,119 | 829 | |||||||||||||||||
Total interest expense | 209,009 | 220,931 | 127,801 | 144,807 | 108,183 | 112,012 | |||||||||||||||||
Net interest income | 177,732 | 119,896 | 102,466 | 81,609 | 33,380 | 44,603 | |||||||||||||||||
Net interest income after provision for loan losses | 152,879 | 95,043 | 82,618 | 61,761 | 16,567 | 27,790 | |||||||||||||||||
Gain on sale of loans | 39,022 | 66,053 | — | — | — | — | |||||||||||||||||
Equity in net earnings of IFC | 11,537 | 16,698 | 11,299 | 17,073 | 19,499 | 10,912 | |||||||||||||||||
Unrealized mark-to-market loss – derivative instruments | (16,021 | ) | (3,901 | ) | (50,502 | ) | — | (33,391 | ) | (3,821 | ) |
Other income Total non-interest income Personnel expense General and administrative and other Professional services Data processing expense Total non-interest expense Earnings before extraordinary item and cumulative effect of change in accounting principle Cumulative effect of change in accounting principle Net earnings before income taxes Income taxes Net earnings Comprehensive earnings Earnings per share before extraordinary item and effect of change in accounting principle: Net earnings per share – basic Net earnings per share – diluted Net earnings (loss) per share: Net earnings per share – basic Net earnings per share – diluted 9,995 1,845 2,864 4,509 5,295 6,155 44,533 93,674 (36,339 ) 21,582 (8,597 ) 17,379 25,250 25,267 1,856 1,868 1,192 1,211 7,660 7,661 985 983 1,669 1,668 4,785 6,061 1,389 3,649 1,218 2,747 1,829 1,966 162 386 159 326 44,172 49,504 5,932 8,426 4,833 10,368 153,240 139,213 40,347 74,917 3,137 �� 34,801 — — — — (4,313 ) (617 ) 153,240 139,213 40,347 74,917 (2,182 ) 33,178 4,261 11,982 — — — — 148,979 127,231 40,347 74,917 (2,182 ) 33,178 144,864 160,604 40,624 53,053 6,580 13,889 2.94 2.51 1.01 1.87 0.07 1.41 2.88 2.46 0.99 1.84 0.11 1.25 2.94 2.51 1.01 1.87 (0.16 ) 1.34 2.88 2.46 0.99 1.84 (0.16 ) 1.19
Consolidated Cash Flows
For the year ended December 31, | ||||||||||||||||||||||||
2003 | 2002 | 2001 | ||||||||||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | As Restated | As Previously Reported | |||||||||||||||||||
Net earnings | $ | 148,979 | $ | 127,231 | $ | 40,347 | $ | 74,917 | $ | (2,182 | ) | $ | 33,795 | |||||||||||
Equity in net earnings of IFC | (11,537 | ) | (16,698 | ) | (11,299 | ) | (17,073 | ) | (19,499 | ) | (10,912 | ) | ||||||||||||
Net change in accrued int. receivable | (12,128 | ) | (11,223 | ) | (12,932 | ) | (13,722 | ) | (3,416 | ) | (1,577 | ) | ||||||||||||
Gain on sale of loans | (39,022 | ) | (66,053 | ) | — | — | — | — | ||||||||||||||||
Sale and principle reductions on mortgages held-for-sale | 6,053,514 | 6,083,040 | — | — | — | — | ||||||||||||||||||
Impairment of securitization costs | — | — | — | — | (1,006 | ) | 1,006 | |||||||||||||||||
Net change in other assets and liabilities | (42,887 | ) | (11,337 | ) | 8,598 | (1,267 | ) | 17,009 | (1,858 | ) | ||||||||||||||
Net cash provided by (used in) operating activities | 263,682 | 232,369 | (188,267 | ) | 101,841 | 156,793 | 51,597 | |||||||||||||||||
Net change in CMO collateral | (3,561,981 | ) | (3,646,626 | ) | (2,952,209 | ) | (2,994,039 | ) | (869,825 | ) | (907,189 | ) | ||||||||||||
Net change in finance receivables | 33,991 | 55,369 | (363,450 | ) | (673,599 | ) | (162,771 | ) | (61,817 | ) | ||||||||||||||
Net change in mortgages held-for-investment | (595,278 | ) | (613,913 | ) | (44,235 | ) | (44,235 | ) | (16,091 | ) | (16,091 | ) | ||||||||||||
Principal reductions on investment securities available-for-sale | (7,961 | ) | 12,212 | 6,162 | 8,704 | 6,888 | 5,542 | |||||||||||||||||
Net cash used in investing activities | (4,064,661 | ) | (4,120,770 | ) | (3,328,715 | ) | (3,678,152 | ) | (1,019,420 | ) | (957,176 | ) | ||||||||||||
Net change in reverse repurchase agreements and other borrowings | 400,778 | 400,451 | 692,675 | 692,675 | 62,473 | 62,824 | ||||||||||||||||||
Repayment of CMO borrowings | (2,574,336 | ) | (2,480,967 | ) | (1,044,986 | ) | (985,657 | ) | (683,406 | ) | (640,805 | ) | ||||||||||||
Net cash provided by financing | 3,815,015 | 3,902,437 | 3,578,440 | 3,637,769 | 896,570 | 939,522 | ||||||||||||||||||
Net change in other comprehensive earnings | (4,115 | ) | 33,373 | 277 | (21,864 | ) | 8,762 | (19,289 | ) |
The following tables present the consolidated balance sheets as of March 31, 2004 and the consolidated statements of operations and comprehensive earnings and cash flows for the three months ended March 31, 2004 and 2003 that were affected by the correction and reclassification entries:
Consolidated Balance Sheets
As of March 31, 2004 | ||||||||
As Restated | As Previously Reported | |||||||
CMO collateral | $ | 11,158,627 | $ | 11,252,373 | ||||
Mortgages held-for-sale | 611,072 | 611,068 | ||||||
Other assets | 308,341 | 280,960 | ||||||
Total assets | 12,936,321 | 13,024,809 | ||||||
CMO borrowings | 11,139,069 | 11,183,583 | ||||||
Other liabilities | 77,010 | 73,789 | ||||||
Total liabilities | 12,374,746 | 12,416,039 | ||||||
Accumulated other comprehensive gain (loss) | 4,216 | (33,670 | ) | |||||
Retained earnings | 154,608 | 239,689 | ||||||
Net accumulated deficit | (193,146 | ) | (108,065 | ) | ||||
Total stockholders’ equity | 561,575 | 608,770 | ||||||
Total liabilities and stockholders’ equity | 12,936,321 | 13,024,809 |
Consolidated Statements of Operations
For the Three Months Ended March 31, | |||||||||||||||
2004 | 2003 | ||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | ||||||||||||
Interest on mortgage assets | $ | 134,267 | $ | 115,833 | $ | 82,216 | $ | 75,478 | |||||||
Total interest income | 134,707 | 116,273 | 82,370 | 76,159 | |||||||||||
Interest on CMO borrowings | 51,994 | 54,060 | 38,294 | 41,684 | |||||||||||
Interest on other borrowings | 66 | 66 | 632 | 883 | |||||||||||
Total interest expense | 61,614 | 63,680 | 45,716 | 49,357 | |||||||||||
Net interest income | 73,093 | 52,593 | 36,654 | 26,802 | |||||||||||
Net interest income after provision for loan losses | 63,368 | 42,868 | 30,170 | 20,318 | |||||||||||
Gain on sale of loans | 2,502 | 31,138 | 1,616 | 1,616 | |||||||||||
Equity in net earnings of IFC | — | — | 1,293 | 5,167 | |||||||||||
Mark-to-market loss – derivative instruments | (36,630 | ) | (1,280 | ) | (7,118 | ) | — | ||||||||
Other income | 315 | 315 | 692 | 1,027 | |||||||||||
Total non-interest income | (33,813 | ) | 31,453 | (3,517 | ) | 7,810 | |||||||||
Personnel expense | 13,668 | 13,668 | 686 | 692 | |||||||||||
General and administrative and other expense | 3,175 | 3,173 | 434 | 435 | |||||||||||
Professional services | 1,831 | 1,831 | 385 | 1,037 | |||||||||||
Data processing expense | 805 | 805 | 109 | 189 | |||||||||||
Total non-interest expense | 20,498 | 21,776 | 1,844 | 2,583 | |||||||||||
Net earnings before income taxes | 9,057 | 52,545 | 24,809 | 25,545 | |||||||||||
Income taxes | (315 | ) | 6,499 | — | — | ||||||||||
Net earnings | 9,372 | 46,046 | 24,809 | 25,545 | |||||||||||
Comprehensive earnings | 9,232 | 20,724 | 25,395 | 29,656 | |||||||||||
Net earnings per share: | |||||||||||||||
Net earnings per share – basic | 0.16 | 0.77 | 0.53 | 0.54 | |||||||||||
Net earnings per share – diluted | 0.15 | 0.76 | 0.52 | 0.53 |
Consolidated Cash Flows
For the Three Months Ended March 31, | ||||||||||||||||
2004 | 2003 | |||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | |||||||||||||
Net earnings | $ | 9,372 | $ | 46,046 | $ | 24,809 | $ | 25,545 | ||||||||
Equity in net earnings of IFC | — | — | (1,293 | ) | (5,167 | ) | ||||||||||
Gain on sale of loans | (2,502 | ) | (31,138 | ) | (1,616 | ) | (1,616 | ) | ||||||||
Sale and principal reductions on mortgages held-for-sale | 3,258,130 | 3,283,978 | — | — | ||||||||||||
Unrealized mark-to-market loss – derivative instruments | 24,308 | — | (3,525 | ) | — | |||||||||||
Net change in investment in and advances to IFC | — | — | 155,050 | — | ||||||||||||
Net change deferred taxes | (6,814 | ) | 1,030 | — | — | |||||||||||
Net change in accrued interest receivable | (8,492 | ) | (8,492 | ) | (1,478 | ) | (1,168 | ) | ||||||||
Net change in other assets and other liabilities | (129,039 | ) | (166,962 | ) | (25,509 | ) | (40,431 | ) | ||||||||
Net cash provided by (used in) operating activities | (288,298 | ) | (309,799 | ) | 167,189 | (2,086 | ) | |||||||||
Net change in CMO collateral | (2,545,512 | ) | (2,574,835 | ) | (1,100,439 | ) | (1,117,985 | ) | ||||||||
Net change in finance receivables | 103,634 | 103,634 | 148,787 | 308,622 | ||||||||||||
Dividend from IFC | — | — | — | 4,455 | ||||||||||||
Net principal reductions on investment securities | 627 | 627 | 1,562 | 1,673 | ||||||||||||
Proceeds from the sale of other real estate owned, net | 9,737 | 9,737 | 5,319 | 5,410 | ||||||||||||
Net cash used in investing activities | (1,918,512 | ) | (1,947,835 | ) | (962,126 | ) | (815,180 | ) | ||||||||
Repayment of CMO borrowings | (751,003 | ) | (700,179 | ) | (396,637 | ) | (374,308 | ) | ||||||||
Net cash provided by financing activities | 2,273,067 | 2,323,891 | 795,124 | 817,453 | ||||||||||||
Net change in other comprehensive earnings | (140 | ) | (25,322 | ) | 586 | 4,111 |
The following tables present the consolidated statements of operations and comprehensive earnings for the three- and six months ended June 30, 2003 and consolidated statements of cash flows for the six months ended June 30, 2003 that were affected by the correction and reclassification entries:
Consolidated Statements of Operations
For the Three Months Ended June 30, 2003 | For the Six Months Ended June 30, 2003 | |||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | |||||||||||
Interest income on mortgage assets | $ | 89,289 | $ | 82,766 | $ | 171,505 | $ | 158,245 | ||||||
Total interest income | 89,667 | 83,544 | 172,037 | 159,704 | ||||||||||
Interest expense on CMO borrowings | 45,615 | 48,699 | 83,908 | 90,383 | ||||||||||
Interest expense on reverse repurchase agreements | 7,305 | 7,305 | 14,096 | 14,096 | ||||||||||
Interest expense on other borrowings | — | 79 | — | 330 | ||||||||||
Total interest expense | 53,772 | 56,935 | 99,488 | 106,293 | ||||||||||
Net interest income | 35,895 | 26,609 | 72,549 | 53,411 | ||||||||||
Net interest income after provision for loan losses | 28,836 | 19,550 | 59,006 | 39,868 | ||||||||||
Other income | 638 | 1,106 | 1,210 | 3,750 | ||||||||||
Equity in net earnings of IFC | 10,244 | 11,532 | 11,537 | 16,698 | ||||||||||
Mark-to-market loss – derivative instruments | (7,750 | ) | — | (14,868 | ) | — | ||||||||
Total non-interest income | 5,090 | 12,638 | 1,573 | 20,448 | ||||||||||
Total non-interest expense | 1,778 | 2,470 | 3,622 | 5,053 | ||||||||||
Net earnings before income taxes | 32,148 | 29,718 | 56,957 | 55,263 | ||||||||||
Net earnings | 32,148 | 29,718 | 56,957 | 55,263 | ||||||||||
Comprehensive earnings | 30,603 | 31,820 | 55,997 | 61,476 | ||||||||||
Net earnings per share: | ||||||||||||||
Net earnings per share – basic | 0.64 | 0.60 | 1.17 | 1.14 | ||||||||||
Net earnings per share – diluted | 0.63 | 0.58 | 1.15 | 1.12 |
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2003 | ||||||||
As Restated | As Previously Reported | |||||||
Net earnings | $ | 56,957 | $ | 55,263 | ||||
Equity in net earnings of IFC | (11,537 | ) | (16,698 | ) | ||||
Unrealized mark-to-market gain – derivative instruments | (8,139 | ) | — | |||||
Net change in investment in and advances to IFC | 52,085 | — | ||||||
Gain on sale of investment securities available-for-sale | (2,081 | ) | — | |||||
Net change in accrued interest receivable | — | (3,517 | ) | |||||
Net change in other assets and other liabilities | 1,350 | (5,249 | ) | |||||
Net cash provided by operating activities | 128,718 | 74,424 | ||||||
Net change in CMO collateral | (1,421,304 | ) | (1,452,860 | ) | ||||
Net change in finance receivables | (245,346 | ) | (179,673 | ) | ||||
Principal reductions on investment securities available-for-sale | 4,320 | 2,252 | ||||||
Proceeds from the sale of other real estate owned, net | 15,806 | 14,938 | ||||||
Net cash used in investing activities | (1,716,365 | ) | (1,685,184 | ) | ||||
Repayment of CMO borrowings | (989,589 | ) | (966,476 | ) | ||||
Proceeds from sale of common stock | 37,777 | 37,776 | ||||||
Proceeds from sale of common stock via equity distribution agreement | 24,462 | 24,463 | ||||||
Net cash provided by financing activities | 1,597,947 | 1,621,060 |
The following tables present the consolidated statements of operations and comprehensive earnings for the three- and nine months ended September 30, 2003 that were affected by the correction and reclassification entries:
Consolidated Statements of Operations
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
As Restated | As Previously Reported | As Restated | As Previously Reported | |||||||||||||
Interest on mortgage assets | $ | 101,057 | $ | 86,325 | $ | 272,563 | $ | 244,569 | ||||||||
Total interest income | 101,405 | 86,674 | 273,442 | 246,377 | ||||||||||||
Interest on CMO borrowings | 42,834 | 45,567 | 126,742 | 135,950 | ||||||||||||
Interest on reverse repurchase agreements | 8,970 | 8,971 | 23,066 | 23,066 | ||||||||||||
Interest on other borrowings | 891 | 891 | 2,375 | 2,705 | ||||||||||||
Total interest expense | 52,695 | 55,429 | 152,183 | 161,721 | ||||||||||||
Net interest income | 48,710 | 31,245 | 121,259 | 84,656 | ||||||||||||
Net interest income after provision for loan losses | 40,890 | 23,425 | 99,896 | 63,293 | ||||||||||||
Gain on sale of loans | 23,602 | 33,900 | 25,216 | 35,514 | ||||||||||||
Other income | (529 | ) | (529 | ) | 680 | 1,607 | ||||||||||
Equity in net earnings of IFC | — | — | 11,537 | 16,698 | ||||||||||||
Mark-to-market loss – derivative instruments | (150 | ) | (156 | ) | (15,018 | ) | (156 | ) | ||||||||
Total non-interest income | 27,922 | 36,916 | 29,495 | 57,364 | ||||||||||||
Personnel expense | — | — | 12,027 | 12,045 | ||||||||||||
General and administrative and other expense | — | — | 3,792 | 4,994 | ||||||||||||
Professional services | — | — | 2,643 | 2,854 | ||||||||||||
Total non-interest expense | 18,396 | 18,552 | 22,018 | 23,605 | ||||||||||||
Net earnings before income taxes | 50,416 | 41,789 | 107,372 | 97,052 | ||||||||||||
Income taxes | 5,844 | 8,372 | 5,843 | 8,372 | ||||||||||||
Net earnings | 44,572 | 33,417 | 101,529 | 88,680 | ||||||||||||
Comprehensive earnings | 45,159 | 45,439 | 98,745 | 106,915 | ||||||||||||
Net earnings per share: | ||||||||||||||||
Net earnings per share – basic | 0.86 | 0.64 | 2.04 | 1.78 | ||||||||||||
Net earnings per share – diluted | 0.84 | 0.63 | 2.00 | 1.75 |
For purposes of the consolidated statements of cash flows, cash and cash equivalents consist of cash and money market mutual funds. Investments with maturities of three months or less at date of acquisition are considered to be cash equivalents.
Investment securities are classified as held-to-maturity, available-for-sale, and/or trading securities. Held-to-maturity investment securities are reported at amortized cost, available-for-sale securities are reported at fair value with unrealized gains and losses as a separate component of stockholders’ equity and trading securities are reported at fair value with unrealized gains and losses reported in earnings. Gains and losses recorded on sale of investment securities available-for-sale are based on the specific identification method. Premiums or discounts obtained on investment securities are accreted or amortized to interest income over the estimated life of the investment securities using the interest method. Investments securities may be subject to credit, interest rate and/or prepayment risk. As of June 30, 2004 and December 31, 2003, investment securities available-for-sale were $11.6 million and $13.4 million, respectively. Gross realized gains from the sale of investment securities available-for-sale were $5.1 million during the three and six months ended June 30, 2004. In addition, during the three and six months ended June 30, 2004, we received $98 thousand and $389 thousand of recoveries on investment securities available-for-sale that were written-off in prior periods.
Mortgages held for sale consist primarily of Alt-A mortgages, which are secured by one-to-four family residential real estate located throughout the United States. The mortgage operations acquire and originate mortgages generally with the intent to sell them in the secondary market or to the long-term investment operations. Mortgages held for sale are carried at the lower of aggregate cost, net of purchase discounts or premiums and deferred fees. We determine the fair value of mortgages held for sale using current secondary market prices for loans with similar coupons, maturities and credit quality.
SFAS 140 requires that a transfer of financial assets in which we surrender control over the assets be accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. SFAS 140 requires a “true sale” analysis of the treatment of the transfer under law as if the Company was a debtor under the bankruptcy code. A “true sale” legal analysis includes several legally relevant factors, such as the nature and level of recourse to the transferor and the nature of retained servicing rights. Once the legal isolation test has been met under SFAS 140, other factors concerning the nature and extent of the transferor’s control over the transferred assets are taken into account in order to determine whether de-recognition of assets is warranted, including whether the special-purpose entity (SPE) has complied with rules concerning qualifying special-purpose entities.
A legal opinion regarding legal isolation for each securitization has been obtained by the Company. The “true sale” opinion provides reasonable assurance the purchased assets would not be characterized as the property of the transferring Company’s receivership or conservatorship estate in the event of insolvency and also states the transferor would not be required to substantively consolidate the assets and liabilities of the purchaser SPE with those of the transferor upon such event.
The securitization process involves the sale of the loans to one of our wholly-owned bankruptcy remote special-purpose entities which then sells the loans to a separate, transaction-specific securitization trust in exchange for cash and certain trust interests that we retain. The securitization trust issues and sells undivided interests to third party investors that entitle the investors to specified cash flows generated from the securitized loans. These undivided interests are usually represented by certificates with varying interest rates, and are secured by the payments on the loans acquired by the trust, and commonly include senior and subordinated classes. The senior class securities are usually rated “AAA” by at least two of the major independent rating agencies and have priority over the subordinated classes in the receipt of payments. We have no obligation to provide funding support to either the third party investors or the securitization trusts. The third party investors or the securitization trusts generally have no recourse to our assets or us and have no ability to require us to repurchase their securities other than the standard representations and warranties. We do make certain representations and warranties concerning the loans, such as lien status or mortgage insurance coverage, and if we are found to have breached a representation or warranty we may be required to repurchase the loan from the securitization trust. We do not guarantee any certificates issued by the securitization trusts. The securitization trusts represent “qualified special-purpose entities” under SFAS 140, and are therefore not consolidated for financial reporting purposes.
In addition to the cash the securitization trust pays for the loans, we may have retained certain interests in the securitization trust as part of the trust’s payment to us for the loans. These retained interests may include subordinated classes of securities, interest-only securities, residual securities and master servicing rights. These retained interests are included in securities available for sale and other assets on the consolidated balance sheets. Transaction costs associated with the securitizations are recognized as a component of the gain or loss at the time of sale.
Our recognition of gain or loss on the sale of loans from REMIC securitizations is accounted for in accordance with SFAS 140. At the closing of each securitization, mortgages held-for-sale are removed from the consolidated balance sheets and cash received and a portion of the mortgages retained from the securitizations (retained interests) is added to the balance sheet. The carrying value of the mortgages sold is allocated between the loans sold and the retained interests based on their relative fair values.
Master servicing rights on mortgages that we sell are generally retained and master servicing rights are retained on sales of mortgage serving rights, when the mortgage loans are retained. Master servicing fees receivable represent the present value of the difference between (1) the interest rate on mortgages acquired or originated, and (2) the interest rate received by investors who purchase the securities backed by such loans in excess of the normal loan servicing fees charged by either the mortgage operations on loans acquired “servicing released” or correspondents who sold mortgages to the mortgage operations with “servicing retained.” Master servicing fees receivable have characteristics similar to interest-only securities. Accordingly, master servicing fees receivable have many of the same risks inherent in interest-only securities, including the risk that they will lose a substantial portion of their value as a result of rapid prepayments occasioned by declining interest rates. Accordingly, if the mortgage operations had to sell these receivables, the value received may be at or above the values at which the mortgage operations carried them on the balance sheet. In determining present value of future cash flows, management uses a market discount rate. Prepayment assumptions are based on recent evaluations of the actual prepayments of the mortgage operations servicing portfolio or on market prepayment rates on new portfolios and the interest rate environment at the time the master servicing fees receivable are created. We subcontract substantially all servicing obligations to independent third parties pursuant to sub-servicing agreements. However, master servicing rights on substantially all mortgage acquisitions and originations are retained. Master servicing fees are generally 0.03% per annum on the declining principal balances of the mortgages serviced. The value of master servicing fees is subject to prepayment and interest rate risks on the transferred financial assets.
The long-term investment operations invest in primarily adjustable rate and, to a lesser extent, fixed rate Alt-A mortgages to be held for long-term investment. CMO collateral and mortgages held-for-investment are recorded at cost, including adjustments for derivative gain or loss during the commitment period, as of the date of purchase. CMO collateral is recorded in IMH Assets, a special purpose financing subsidiary which is used to issue CMO financing. CMO collateral and mortgages held-for-investment include various types of adjustable rate and fixed rate mortgages secured by single-family residential real estate properties acquired and originated by the mortgage operations, multi-family residential real estate properties originated by IMCC and, to a lesser extent, fixed rate second trust deeds secured by single-family residential real estate properties. Any premiums and discounts, which may result from the acquisition of mortgages, derivative gain or loss during the commitment period or the sale of MSRs when the mortgages are retained, are amortized to interest income over their estimated lives using the interest method as an adjustment to the yield of the mortgage. CMO collateral and mortgages held-for-investment are continually evaluated for collectibility and, if appropriate, the mortgage may be placed on non-accrual status, generally when the mortgage is 90 days past due, and previously accrued interest is reversed from income.
Finance receivables represent transactions with customers, including affiliated companies, involving residential real estate lending. As a warehouse lender, the warehouse lending operations is a secured creditor of the mortgage bankers and brokers to which it extends credit and is subject to the risks inherent in that status including, the risk of borrower fraud, default and bankruptcy. Any claim of the warehouse lending operations as a secured lender in a bankruptcy proceeding may be subject to adjustment and delay. Finance receivables represent warehouse lines of credit with mortgage bankers that are collateralized by mortgages on single-family residential real estate. Finance receivables are stated at the principal balance outstanding. Interest income is recorded on the accrual basis in accordance with the terms of the mortgages.
An allowance is maintained for losses on mortgages held-for-investment, mortgages held as CMO collateral and finance receivables (loans provided for) at an amount that management believes provides for losses inherent in those loan portfolios. We have implemented a methodology designed to analyze the performance of various loan portfolios, based upon the relatively homogeneous nature within these loan portfolios. The allowance for losses is also analyzed using the following factors:
In evaluating the adequacy of the allowance for loan losses, a detailed analysis of historical loan performance data is accumulated and reviewed. This data is analyzed for loss performance and prepayment performance by product type, origination year and securitization issuance. The results of that analysis are then applied to the current mortgage portfolio and an estimate is created. We believe that pooling of mortgages with similar characteristics is an appropriate methodology in which to evaluate the allowance for loan losses. In addition, management provides an allowance for loan losses for Alt-A mortgages that are retained for long-term investment and which are not underwritten to our specific underwriting guidelines. These mortgages are acquired on a bulk basis by the mortgage operations from other mortgage originators that underwrite mortgages substantially similar, but not specific, to our mortgage underwriting guidelines, or “non-Impac mortgages.” Management also recognizes that there are qualitative factors that must be taken into consideration when evaluating and measuring inherent loss in our loan portfolios. These items include, but are not limited to, economic indicators that may affect the borrower’s ability to pay, changes in value of collateral, political factors and industry statistics.
Additions to the allowance are provided through a charge to earnings. Specific valuation allowances may be established for loans that are deemed impaired, if default by the borrower is deemed probable, and if the fair value of the loan or the collateral is estimated to be less than the gross carrying value of the loan. Actual losses on loans are recorded as a reduction to the allowance through charge-offs. Subsequent recoveries of amounts previously charged off are credited to the allowance.
For loans on non-accrual status, cash receipts are applied, and interest income is recognized, on a cash basis. For all other impaired loans, cash receipts are applied to principal and interest in accordance with the contractual terms of the loan and interest income is recognized on the accrual basis. Generally, a loan may be returned to accrual status when all delinquent principal and interest are brought current in accordance with the terms of the loan agreement.
Premises and equipment are stated at cost, less accumulated depreciation or amortization. Depreciation on premises and equipment is recorded using the straight-line method over the estimated useful lives of individual assets, typically, three to twenty years.
The decision to issue CMOs is based on our current and future investment needs, market conditions and other factors. CMOs, which are primarily secured by Alt-A mortgages on single-family and multi-family residential real properties, are issued as a means of financing our long-term mortgage portfolio. CMOs are carried at their outstanding principal balances, including accrued interest on such obligations. For accounting purposes, mortgages financed through the issuance of CMOs are treated as assets and the CMOs are treated as debt when the CMO qualifies as a financing arrangement. Each issue of CMOs is fully payable from the principal and interest payments on the underlying mortgages collateralizing such debt. CMOs typically are structured as one-month London Interbank Offered Rate (LIBOR) “floaters” and fixed rate securities
with interest payable monthly. The maturity of each class of CMO is directly affected by the rate of principal prepayments on the related CMO collateral. Each CMO series is also subject to redemption according to specific terms of the respective indentures (clean-up calls). As a result, the actual maturity of any class of a CMO series is likely to occur earlier than the stated maturities of the underlying mortgages.
When we issue CMOs for financing purposes, we seek an investment grade rating for our CMOs by nationally recognized rating agencies. To secure such ratings, it is often necessary to pledge collateral in excess of the principal amount of the CMOs to be issued, or to obtain other forms of credit enhancement such as additional mortgage insurance. The need for additional collateral or other credit enhancements depends upon factors such as the type of collateral provided, the interest rates paid, the geographic concentration of the mortgaged property securing the collateral and other criteria established by the rating agencies. The pledge of additional collateral reduces our capacity to raise additional funds through short-term secured borrowings or additional CMOs and diminishes the potential expansion of our long-term mortgage portfolio. Our total loss exposure is limited to the net economic investment in CMOs at any point in time.
Certain CMO borrowings are guaranteed to certificate holders by a mortgage loan insurer, which give the CMOs the highest rating established by nationally recognized rating agencies. Each issue of CMOs is fully payable from the principal and interest payments on the underlying mortgages collateralizing such debt. Cash or other collateral is required to be pledged as a condition to receiving the desired rating on the debt. CMOs typically are structured as adjustable rate securities, which primarily are indexed to one-month LIBOR, and fixed rate securities with interest payable to certificate holders monthly.
The long-term investment operations structures CMO securitizations as financing arrangements and recognizes no gain or loss on the transfer of mortgage assets. At the date of CMO securitizations, the mortgage operations sells the MSRs to third parties while IMH retains the mortgages on the balance sheet. Gains or losses on the sale of MSRs are recognized after allocating the previous carrying value of the mortgage between the MSRs sold and the mortgages retained by IMH, based on their relative fair values.
We operate 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. The remaining balance may extend until timely filing of our tax return in the subsequent taxable year. Qualifying distributions of taxable income are deductible by a REIT in computing taxable income. If in any tax year IMH should not qualify as a REIT, we would be taxed as a corporation and distributions to stockholders would not be deductible in computing taxable income. If IMH were to fail to qualify as a REIT in any tax year, we would not be permitted to qualify for that year and the succeeding four years. As of December 31, 2003, we had estimated federal and state net operating loss tax carry-forwards of $18.7 million that are available to offset future taxable income through 2020. We expect to file our 2003 federal and state tax returns in September of 2004 at which time federal and state net operating loss carry-forwards, if any, will be determined.
IFC is a taxable REIT subsidiary and is therefore subject to corporate income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Basic net earnings per share are computed on the basis of the weighted average number of shares outstanding for the year divided into net earnings available to common stockholders for the year. Diluted net earnings per share are computed on the basis of the weighted average number of shares and dilutive common equivalent shares outstanding for the year divided by net earnings available to common stockholders for the year.
Stock Options |
Stock options andNo compensation cost has been recognized for stock-based awards may be granted to employees as the directors, officers and key employees. Thestock option exercise price for any qualified incentive stock options (ISOs) and non-qualified stock options (NQSOs) granted under our stock option plans may not be less than 100% (or 110% in the case of ISOs grantedis equal 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 ofunderlying common stock atas of the time the NQSO or ISO is granted. Grants under stock option plansgrant date. Summarized below are made and administered by the board of directors. We currently have a 1995 Stock Option, Deferred Stock and Restricted Stock Plan (1995 plan) and during 2001 the board of directors and stockholders approved a new Stock Option, Deferred Stock and Restricted Stock Plan (2001 plan), collectively, (the stock plans). Each stock plan provides for the grant of ISOs, 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 SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148), an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” (FASB 123). SFAS 148 amends FASB 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 January 1, 2003, IMH adopted the disclosure requirements of SFAS 148. In November 1995, the FASB issued SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). This statement establishes financial accounting standards for stock-based employee compensation plans. SFAS 123 permits management to choose either a new fair value based method or the current APB 25 intrinsic value based method of accounting for its stock-based compensation arrangements. 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 current practice 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.
The Company applies APB Opinion No. 25 in accounting for our stock plans. If compensation cost for our stock-based compensation plans had been determined consistent with SFAS 123, our net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
(as restated) | (as restated) | |||||||||||||||
Net earnings as reported | $ | 142,771 | $ | 32,148 | $ | 152,143 | $ | 56,957 | ||||||||
Less: Total stock-based employee compensation expense using the fair value method | (289 | ) | (290 | ) | (579 | ) | (579 | ) | ||||||||
Pro forma net earnings | $ | 142,482 | $ | 31,858 | $ | 151,564 | $ | 56,378 | ||||||||
Net earnings per share as reported: | ||||||||||||||||
Basic | $ | 2.20 | $ | 0.64 | $ | 2.44 | $ | 1.17 | ||||||||
Diluted | $ | 2.17 | $ | 0.63 | $ | 2.40 | $ | 1.15 | ||||||||
Pro forma net earnings: | ||||||||||||||||
Basic | $ | 2.20 | $ | 0.64 | $ | 2.43 | $ | 1.16 | ||||||||
Diluted | $ | 2.16 | $ | 0.63 | $ | 2.39 | $ | 1.14 | ||||||||
During the periods in which the mortgage operations was accounted for under the equity method, grants of stock options by IMH to IFC employees were not accounted for under APB Opinion No. 25 but were accounted for consistent with the provisions specified under SFAS 123.
There were no stock options granted during the second quarter of 2004 and 2003. Therefore, pro formaeffects on net earnings and net earnings per share reflectas if the amortization of previously granted stock options, which are amortized as expense overCompany had elected to use the stock option life in determining the pro forma impact.fair value approach to account for its employee stock-based compensation plans:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net earnings (loss) available to common stockholders | $ | (58,624 | ) | $ | 142,771 | $ | 111,362 | $ | 152,143 | |||||||
Less: Total stock-based employee compensation expense using the fair value method | (532 | ) | (289 | ) | (1,078 | ) | (579 | ) | ||||||||
Pro forma net earnings (loss) | $ | (59,156 | ) | $ | 142,482 | $ | 110,284 | $ | 151,564 | |||||||
Net earnings (loss) per share as reported: | ||||||||||||||||
Basic | $ | (0.78 | ) | $ | 2.20 | $ | 1.48 | $ | 2.44 | |||||||
Diluted | $ | (0.78 | ) | $ | 2.17 | $ | 1.46 | $ | 2.40 | |||||||
Pro forma net earnings (loss): | ||||||||||||||||
Basic | $ | (0.78 | ) | $ | 2.20 | $ | 1.46 | $ | 2.43 | |||||||
Diluted | $ | (0.78 | ) | $ | 2.16 | $ | 1.44 | $ | 2.39 | |||||||
In June 1998, FASB issued SFAS 133 as amended by SFAS No. 137 and SFAS No. 138, collectively, (SFAS 133). SFAS 133, subsequently amended by SFAS 149, establishes accounting and reporting standards for derivative instruments, including a number of derivative instruments embedded in other contracts 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. For derivatives that are accounted for as free standing derivatives, any change in fair value is recorded as expense or income in the current period.
Our primary objective is to limit the exposure to the variability in future cash flows attributable to the variability of one-month LIBOR, which is the underlying index of adjustable rate CMO and warehouse borrowings. We also monitor on an ongoing basis the prepayment risks that arise in fluctuating interest rate environments. Our interest rate risk management policies are formulated with the intent to offset the potential adverse effects of changing interest rates on CMO and warehouse borrowings.
To mitigate exposure to the effect of changing interest rates on cash flows on CMO and warehouse borrowings, we purchase derivative instruments 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 we may receive or pay a fee. If prevailing interest rates reach levels specified in the cap or floor agreement, we 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 debt and, as a result, can reduce the interest rate variability of borrowings. Our objective is to lock in a reliable stream of cash flows when interest rates fall below or rise above certain levels. For instance, when interest rates rise, borrowing costs may increase at greater speeds than the underlying collateral supporting the borrowings. These derivative instruments limit exposure to the variability of forecasted cash flows attributable to CMO and warehouse borrowings and protect net interest income by providing cash flows at certain triggers during changing interest rate environments. In all interest rate-hedging transactions, counter-parties must have a highly-rated credit rating as determined by various credit rating agencies.
Under SFAS 133, an entity that elects to apply hedge accounting is required to identify the hedged transaction and the hedging instrument and establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging relationships and the measurement and approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity’s approach to managing interest rate risk. This statement was effective for all fiscal quarters of fiscal years beginning after June 15, 2000. We can expect high effectiveness of hedging relationships since the hedged items, CMO and warehouse borrowings, and the hedging derivative instrument are based on one-month LIBOR. As both instruments are tied to the same index, the hedge is expected to be highly effective at the time the hedge is designated and on an ongoing basis. While these relationships have not been formally documented as cash flow hedging relationships and, consequently, the derivatives have been accounted for as free-standing derivatives for accounting purposes, we believe that they are economic hedges that effectively manage interest rate risks associated with our borrowing costs. These derivatives are recorded at the fair value with changes in fair value reported as mark-to-market gain (loss) – derivative instruments on the consolidated financial statements. The determination to treat these hedges as free-standing derivatives as opposed to cash flow hedges is primarily based upon the stringent documentation burden placed upon us to maintain cash flow hedge accounting. The accounting treatment has no effect on taxable income which is how we determine our dividend policy. In future periods we may choose to comply with such standards in order to achieve hedge accounting treatment.
We enter into commitments to make loans whereby the interest rate on the loan is set prior to funding (rate lock commitments). We also enter into commitments to purchase mortgage loans through our correspondent channel (purchase commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. In addition, purchase commitments for mortgage loans that are intended to be sold and those that will be held for investment
purposes can qualify as derivatives. Both types of commitments to purchase loans are evaluated under the definition of a derivative to determine whether SFAS. 133 is applicable. Rate lock and purchase commitments that are considered to be derivatives are recorded, at fair value, on the consolidated statements of financial condition with changes in fair value recorded in mark-to-market gain (loss)-derivative instruments on the consolidated statements of operations. In measuring the fair value of rate lock and purchase commitments, the amount of the expected servicing rights is not included in the valuation. This value is calculated and adjusted using an anticipated fallout factor for loan commitments that are not expected to be funded. This policy of recognizing the value of the derivative has the effect of recognizing a gain or loss on the related mortgage loans based on changes in the interest rate environment before the mortgage loans are funded and sold. As such, both rate lock and purchase commitments expose us to interest rate risk. We manage that risk by entering into various interest rate contracts that are also recorded at fair value with changes in fair value reported in mark-to-market gain (loss)-derivative instruments.
The mortgage operations also enter into forward commitments and derivative transactions to lock in the forecasted sale profitability of fixed rate mortgages held-for-sale. The mortgage operations generally sells calls or buys put options or enters into mandatory commitments on U.S. Treasury bonds and mortgage-backed securities to hedge against adverse movements of interest rates affecting the value of mortgages held-for-sale. The risk in writing a call option is that the mortgage operations give up the opportunity for profit if the market price of the mortgage increases and the option is exercised. The mortgage operation also has the additional risk of not being able to enter into a closing transaction if a liquid secondary market for the mortgage loan does not exist. The risk of buying a put option is limited to the premium paid for the put option. These economic hedges are treated as free-standing derivatives under the provisions of SFAS 133 with the entire change in fair value of the hedges recorded through mark-to-market gain (loss)-derivative instruments in current earnings.
Included in other assets on the consolidated balance sheets as of June 30, 2004 and December 31, 2003 are $100.9 million and $33.6 million of derivative assets, respectively. Derivative assets include cash margin balances placed with third parties of $15.3 million as June 30, 2004 and December 31, 2003. Included in other liabilities on the consolidated balance sheets as of June 30, 2004 and December 31, 2003 are $1.2 million and $14.7 million of derivative liabilities, respectively.
Recent Accounting Pronouncements |
In December 2004, the FASB Interpretation 46 (revised December 2003)issued Statement No. 123(R), “Consolidation of Variable Interest Entities” (FIN 46R),“Share-Based Payment” (SFAS 123R). It requires a variable interest entityall public companies to be consolidated by a company if that company is subject to a majorityreport share-based compensation expense at fair value at the grant date of the risk of loss fromrelated share-based awards. The Company is required to adopt the variable interest entity’s activities or is entitled to receive a majorityprovisions of the entity’s residual returns or both. Prior to FIN 46R, a company included another entity in its consolidated financial statements only ifSFAS 123R effective for annual periods beginning after June 15, 2005. The impact of adoption of SFAS 125R cannot be predicted at this time because it controlled the entity through voting interests. FIN 46R also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. The consolidated requirementswill depend on levels of FIN 46R apply to all variable interest entities (VIEs) by the end of the first reporting period that ends after December 15, 2003. The provisions of FIN 46R for interests held by public entities in VIEs that are not qualified special purpose entities are required to be applied by the first reporting period that ends after March 15, 2004. In connection with our CMO transactions, mortgages are transferred into trusts that are classified as VIEs and are consolidated with the financial results of IMH and its subsidiaries.
Staff Accounting Bulletin No. 105, “Application of Accounting Principles to Loan Commitments,” (SAB 105), clarifies the SEC’s position on the accounting and valuation for commitments to originate mortgage loans held-for-sale. Consistent with SFAS 149, SAB 105 states that loan commitments are treated as derivative instruments. SAB 105 requires that in valuing these loan commitments entities not include cash flows associated with servicing as to do so would resultshare-based payments granted in the recognitionfuture. However, had we adopted SFAS 123R in prior periods, the impact of servicing assets prior toSFAS 123R would have approximated the saleimpact of SFAS 123 as described in the disclosure of pro forma net earnings per share in Note A.2. Stock Options.
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or securitization of funded loans. This valuation methodology limits a company’s ability to record an asset for its mortgage pipeline at the transaction date even when the total fair value may include servicing-related acquisition premium. Prior to the issuance of SAB 105, each reporting period the mortgage operations recorded the fair value of its mortgage pipeline, inclusive of changes in benchmark interest rates and acquisition premiums. Subsequent to SAB 105, as of April 1, 2004 we record the fair value change of the mortgage pipeline based solely on interest rate fluctuations from the date of rate-lock to the applicable reporting date.otherwise indicated)
(unaudited)
Note B—Reconciliation of Earnings perPer Share
The following table presents the computation of basic and diluted net earnings (loss) per share as if allincluding the dilutive effect of stock options wereand cumulative redeemable preferred stock outstanding for the periods indicated:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||
(as restated) | (as restated) | |||||||||||||||||||||||||||||
Numerator for earnings per share: | ||||||||||||||||||||||||||||||
Net earnings | $ | 143,214 | $ | 32,148 | $ | 152,586 | $ | 56,957 | ||||||||||||||||||||||
Numerator for earnings (loss) per share: | ||||||||||||||||||||||||||||||
Net earnings (loss) | $ | (55,000 | ) | $ | 143,214 | $ | 118,610 | $ | 152,586 | |||||||||||||||||||||
Less: Cash dividends on cumulative redeemable preferred stock | (443 | ) | — | (443 | ) | — | (3,624 | ) | (443 | ) | (7,248 | ) | (443 | ) | ||||||||||||||||
Net earnings available to common stockholders | $ | 142,771 | $ | 32,148 | 152,143 | 56,957 | ||||||||||||||||||||||||
Net earnings (loss) available to common stockholders | $ | (58,624 | ) | $ | 142,771 | $ | 111,362 | $ | 152,143 | |||||||||||||||||||||
Denominator for earnings per share: | ||||||||||||||||||||||||||||||
Denominator for basic net earnings (loss) per share: | ||||||||||||||||||||||||||||||
Basic weighted average number of common shares outstanding | 75,387 | 64,888 | 75,297 | 62,284 | ||||||||||||||||||||||||||
Denominator for earnings (loss) per share: | ||||||||||||||||||||||||||||||
Basic weighted average number of common shares outstanding | 64,888 | 49,856 | 62,284 | 48,516 | 75,387 | 64,888 | 75,297 | 62,284 | ||||||||||||||||||||||
Net effect of dilutive stock options | 1,051 | 1,058 | 1,086 | 958 | — | 1,051 | 938 | 1,086 | ||||||||||||||||||||||
Diluted weighted average common and common equivalent shares | 65,939 | 50,914 | 63,370 | 49,474 | 75,387 | 65,939 | 76,235 | 63,370 | ||||||||||||||||||||||
Net earnings per share: | ||||||||||||||||||||||||||||||
Net earnings (loss) per share: | ||||||||||||||||||||||||||||||
Basic | $ | 2.20 | $ | 0.64 | $ | 2.44 | $ | 1.17 | $ | (0.78 | ) | $ | 2.20 | $ | 1.48 | $ | 2.44 | |||||||||||||
Diluted | $ | 2.17 | $ | 0.63 | $ | 2.40 | $ | 1.15 | $ | (0.78 | ) | $ | 2.17 | $ | 1.46 | $ | 2.40 | |||||||||||||
We had none and 20,0001.4 million stock options outstanding during the three and six months ended June 30, 2005, and no stock options outstanding during the three and six months ended June 30, 2004, and 2003, respectively, that were not consideredincluded in the calculation of dilutedabove weighted average common and common equivalent sharescalculations because they were anti-dilutive.
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as the exercise price of the stock options were greater than the average market price during the periods.otherwise indicated)
(unaudited)
Note C—Segment Reporting
Management internally reviews and analyzes its operatingThe following table presents reporting segments as follows:of and for the six months ended June 30, 2005:
Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter- Company (1) | Consolidated | ||||||||||||
Balance Sheet Items: | ||||||||||||||||
CMO collateral and mortgages | $ | 24,338,258 | $ | — | $ | — | $ | (126,189 | ) | $ | 24,212,069 | |||||
Mortgages held-for-sale | — | 401 | 1,280,724 | — | 1,281,125 | |||||||||||
Finance receivables | — | 1,809,901 | — | (1,427,001 | ) | 382,900 | ||||||||||
Total assets | 24,670,806 | 1,920,374 | 1,346,352 | (1,438,722 | ) | 26,498,810 | ||||||||||
Total stockholders’ equity | 901,594 | 187,551 | 24,955 | (66,091 | ) | 1,048,009 | ||||||||||
Income Statement Items: | ||||||||||||||||
Net interest income | $ | 81,027 | $ | 24,980 | $ | 6,659 | $ | 34,593 | $ | 147,259 | ||||||
Provision for loan losses | 11,785 | — | — | — | 11,785 | |||||||||||
Non-interest income | 23,805 | 4,257 | 75,396 | (45,673 | ) | 57,785 | ||||||||||
Non-interest expense and income taxes | 7,000 | 3,855 | 66,632 | (2,838 | ) | 74,649 | ||||||||||
Net earnings (loss) | $ | 86,047 | $ | 25,382 | $ | 15,423 | $ | (8,242 | ) | $ | 118,610 | |||||
(1) | Income statement items include inter-company loan sales transactions and the elimination of related gains. |
The following table presents reporting segments for the mortgage operations, to finance mortgages; and
Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter- Company (1) | Consolidated | |||||||||||||||
Income Statement Items: | |||||||||||||||||||
Net interest income | $ | 28,908 | $ | 13,638 | $ | 4,685 | $ | 18,922 | $ | 66,153 | |||||||||
Provision for loan losses | 5,711 | — | — | — | 5,711 | ||||||||||||||
Non-interest income | (91,188 | ) | 2,230 | 25,723 | (14,499 | ) | (77,734 | ) | |||||||||||
Non-interest expense and income taxes | 4,307 | 1,770 | 31,151 | 480 | 37,708 | ||||||||||||||
Net earnings (loss) | $ | (72,298 | ) | $ | 14,098 | $ | (743 | ) | $ | 3,943 | $ | (55,000 | ) | ||||||
(1) | Income statement items include inter-company loan sales transactions and the elimination of related gains. |
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
The following table presents business segments as of and for the six months ended June 30, 2004 (in thousands):2004:
Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter - Company(1) | Consolidated | |||||||||||||
Balance Sheet Items (as restated): | |||||||||||||||||
CMO collateral and mortgages held-for-investment | $ | 15,779,651 | $ | — | $ | — | $ | (110,061 | ) | $ | 15,669,590 | ||||||
Mortgages held-for-sale | — | — | 326,661 | — | 326,661 | ||||||||||||
Finance receivables | — | 1,698,668 | — | (1,118,996 | ) | 579,672 | |||||||||||
Total assets | 16,912,640 | 1,693,796 | 472,061 | (1,822,643 | ) | 17,255,854 | |||||||||||
Total stockholders’ equity | 1,344,505 | 131,383 | (25,266 | ) | (621,755 | ) | 828,867 | ||||||||||
Income Statement Items: | |||||||||||||||||
Net interest income | $ | 112,070 | $ | 17,966 | $ | 8,045 | $ | 20,427 | $ | 158,508 | |||||||
Provision for loan losses | 18,132 | 6,875 | — | — | 25,007 | ||||||||||||
Non-interest income | 45,428 | 4,764 | 35,551 | (20,427 | ) | 65,316 | |||||||||||
Non-interest expense and income taxes | 1,710 | 3,202 | 41,319 | — | 46,231 | ||||||||||||
Net earnings | $ | 137,656 | $ | 12,653 | $ | 2,277 | $ | — | $ | 152,586 | |||||||
The following table presents business segments for the three months ended June 30, 2004 (in thousands):
Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter - Company (1) | Consolidated | |||||||||||||
Income Statement Items: | |||||||||||||||||
Net interest income | $ | 60,713 | $ | 9,549 | $ | 2,903 | $ | 12,250 | $ | 85,415 | |||||||
Provision for loan losses | 13,847 | 1,435 | — | — | 15,282 | ||||||||||||
Non-interest income | 84,473 | 2,806 | 24,100 | (12,250 | ) | 99,129 | |||||||||||
Non-interest expense and income taxes | (35 | ) | 1,681 | 24,402 | — | 26,048 | |||||||||||
Net earnings | $ | 131,374 | $ | 9,239 | $ | 2,601 | $ | — | $ | 143,214 | |||||||
The following table presents business segments as of and for the six months ended June 30, 2003 (as restated, in thousands):
Long-Term Investment Operations | Warehouse Lending Operations | Inter - Company (1) | Consolidated | Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter- Company (1) | Consolidated | ||||||||||||||||||||||
Balance Sheet Items: | ||||||||||||||||||||||||||||||
CMO collateral and mortgages held-for-investment | $ | 6,696,229 | $ | — | $ | (52,371 | ) | $ | 6,643,858 | $ | 15,779,651 | $ | — | $ | — | $ | (101,723 | ) | $ | 15,677,928 | ||||||||||
Mortgages held-for-sale | — | — | 326,727 | — | 326,727 | |||||||||||||||||||||||||
Finance receivables | — | 1,430,703 | (521,427 | ) | 909,276 | — | 1,698,668 | — | (1,118,996 | ) | 579,672 | |||||||||||||||||||
Total assets | 7,158,954 | 1,503,031 | (452,919 | ) | 8,209,066 | 16,264,572 | 1,693,796 | 424,461 | (1,126,975 | ) | 17,255,854 | |||||||||||||||||||
Total stockholders’ equity | 590,979 | 103,373 | (341,516 | ) | 352,836 | 696,437 | 131,383 | 40,257 | (39,210 | ) | 828,867 | |||||||||||||||||||
Income Statement Items: | ||||||||||||||||||||||||||||||
Net interest income | $ | 61,332 | $ | 13,005 | $ | (1,788 | ) | $ | 72,549 | $ | 113,037 | $ | 17,966 | $ | 8,045 | $ | 18,925 | $ | 157,973 | |||||||||||
Provision for loan losses | 12,351 | 1,192 | — | 13,543 | 18,132 | 6,875 | — | — | 25,007 | |||||||||||||||||||||
Non-interest income(2) | (11,735 | ) | 2,698 | 10,610 | 1,573 | |||||||||||||||||||||||||
Non-interest expense | 2,653 | 2,400 | (1,431 | ) | 3,622 | |||||||||||||||||||||||||
Non-interest income | 44,461 | 4,764 | 77,173 | (62,048 | ) | 64,350 | ||||||||||||||||||||||||
Non-interest expense and income taxes | 1,710 | 3,202 | 58,890 | (19,072 | ) | 44,730 | ||||||||||||||||||||||||
Net earnings | $ | 34,593 | $ | 12,111 | $ | 10,253 | $ | 56,957 | $ | 137,656 | $ | 12,653 | $ | 26,328 | $ | (24,051 | ) | $ | 152,586 | |||||||||||
(1) | Income statement items include inter-company loan sales transactions and the elimination of related gains. |
The following table presents business segments for the three months ended June 30, 2003 (as restated, in thousands):2004:
Long- Term Investment Operations | Warehouse Lending Operations | Inter - Company (1) | Consolidated | Long-Term Investment Operations | Warehouse Lending Operations | Mortgage Operations | Inter- Company (1) | Consolidated | |||||||||||||||||||||||
Income Statement Items: | |||||||||||||||||||||||||||||||
Net interest income | $ | 30,081 | $ | 6,934 | $ | (1,120 | ) | $ | 35,895 | $ | 61,575 | $ | 9,548 | $ | 2,903 | $ | 11,424 | $ | 85,450 | ||||||||||||
Provision for loan losses | 6,462 | 597 | — | 7,059 | 13,847 | 1,435 | — | — | 15,282 | ||||||||||||||||||||||
Non-interest income | (6,023 | ) | 1,338 | 9,775 | 5,090 | 83,612 | 2,807 | 45,195 | (33,346 | ) | 98,268 | ||||||||||||||||||||
Non-interest expense | 1,168 | 1,302 | (692 | ) | 1,778 | ||||||||||||||||||||||||||
Non-interest expense and income taxes | (34 | ) | 1,681 | 33,307 | (9,732 | ) | 25,222 | ||||||||||||||||||||||||
Net earnings | $ | 16,428 | $ | 6,373 | $ | 9,347 | $ | 32,148 | $ | 131,374 | $ | 9,239 | $ | 14,791 | $ | (12,190 | ) | $ | 143,214 | ||||||||||||
(1) |
Note D—Mortgages Held-for-Sale
Mortgages held-for-sale are primarily adjustable rate and fixed rate Impac Alt-A and non-Impac Alt-A mortgages and, to a lesser extent, B/C mortgages acquired and originated byfor the mortgage operations and secured by first and second liens on single-family residential real estate properties. As of June 30, 2004 and December 31, 2003, approximately 63% and 61%, respectively, of mortgages held-for-sale was collateralized by properties located in California. Mortgages held-for-saleperiods indicated consisted of the following:
At June 30, | At December 31, 2003 | |||||||||||
(as restated) | At June 30, 2005 | At December 31, 2004 | ||||||||||
Mortgages held-for-sale | $ | 303,580 | $ | 385,108 | $ | 1,255,602 | $ | 576,777 | ||||
Unamortized net premiums on mortgages held-for-sale | 23,081 | 12,510 | ||||||||||
Net premiums on mortgages held-for-sale | 25,523 | 10,968 | ||||||||||
Total mortgages held-for-sale | $ | 326,661 | $ | 397,618 | $ | 1,281,125 | $ | 587,745 | ||||
Included in other liabilities as of June 30, 20042005 and December 31, 20032004 was an allowance for mortgage repurchases of $2.5$7.5 million and $2.3$2.2 million, respectively. The allowance for mortgage repurchases is maintained
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
for the purpose of purchasing previously sold mortgages for various reasons, including early payment defaults or breach of representations or warranties, which may be subsequently sold at a loss. In determining the opinionadequacy of the liability for mortgage repurchases, management considers such factors as specific requests for repurchase, known problem loans, underlying collateral values, recent sales activity of similar loans and other appropriate information. In 2005, gains or losses from the potential exposure relatedsubsequent sale of repurchased loans were recorded as gain (loss) on sale of loans. In 2004, losses from the subsequent sale of repurchased loans were $77,000 and $273,000 for the three and six months ended June 30, 2004 and are shown as an offset to these representations and warranties will not have a material adverse effect on our financial condition and results of operations.provision for loan repurchases in the following table. Activity for the allowance for repurchases for the periods indicated was as follows:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||
Beginning balance | $ | 5,897 | $ | 948 | $ | 2,183 | $ | 2,327 | ||||
Provision for loan repurchases | 1,650 | 1,563 | 5,364 | 184 | ||||||||
Total allowance for repurchases | $ | 7,547 | $ | 2,511 | $ | 7,547 | $ | 2,511 | ||||
Note E—CMO Collateral
CMO collateral includes various types of adjustable rate and fixed rate Impac Alt-A and non-Impac Alt-A mortgages secured by single-family residential and multi-family residential real estate properties and, to a lesser extent, fixed rate second trust deeds secured by single-family residential real estate properties. The long-term investment operations earns the net interest spread between interest income on mortgages securing CMOs and interest and other expenses associated with CMO financing. The net interest spread on CMOs may be directly impacted by mortgage prepayment levels and, to the extent each CMO class has variable rates of interest, by changes in short-term interest rates. CMO collateral for the periods indicated consisted of the following (as restated):following:
At June 30, 2004 | At December 31, 2003 | |||||
(as restated) | ||||||
Adjustable- and fixed rate mortgages secured by single-family residential real estate | $ | 14,183,373 | $ | 8,357,085 | ||
Adjustable rate mortgages secured by multi-family residential real estate | 354,691 | 200,427 | ||||
Fixed rate second trust deeds secured by single-family residential real estate | 118,628 | 9,798 | ||||
Unamortized net premiums on mortgages | 159,385 | 71,704 | ||||
Total CMO collateral | $ | 14,816,077 | $ | 8,639,014 | ||
At June 30, 2005 | At December 31, 2004 | |||||
Mortgages secured by single-family residential real estate | $ | 22,853,017 | $ | 20,428,144 | ||
Mortgages secured by multi-family residential real estate | 815,078 | 604,934 | ||||
Net premiums on mortgages | 311,955 | 275,828 | ||||
Total CMO collateral | $ | 23,980,050 | $ | 21,308,906 | ||
Note F—Allowance for Loan Losses
Activity for allowance for loan losses for the periods indicated was as follows (in thousands):follows:
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||||||||||||||
(as restated) | (as restated) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||
Beginning balance | $ | 46,299 | $ | 29,761 | $ | 38,596 | $ | 26,602 | $ | 66,789 | $ | 46,299 | $ | 63,955 | $ | 38,596 | ||||||||||||||||
Provision for loan losses | 15,282 | 7,059 | 25,007 | 13,543 | 5,711 | 15,282 | 11,785 | 25,007 | ||||||||||||||||||||||||
Charge-offs, net of recoveries | (1,332 | ) | (3,436 | ) | (3,354 | ) | (6,761 | ) | (2,674 | ) | (1,332 | ) | (5,914 | ) | (3,354 | ) | ||||||||||||||||
Total allowance for loan losses | $ | 60,249 | $ | 33,384 | $ | 60,249 | $ | 33,384 | ||||||||||||||||||||||||
Total allowance for loan losses (1) | $ | 69,826 | $ | 60,249 | $ | 69,826 | $ | 60,249 | ||||||||||||||||||||||||
(1) | The three and six months ended June 30, 2004 include specific impairment on warehouse advances of |
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
Note G—Other Assets
Other assets for the periods indicated consisted of the following:
At June 30, 2005 | At December 31, 2004 | |||||
Derivative assets | $ | 159,906 | $ | 103,290 | ||
Investment securities available-for-sale | 52,988 | 25,427 | ||||
Deferred tax charge | 48,057 | 48,211 | ||||
Real estate owned | 29,477 | 18,277 | ||||
Prepaid and other assets | 20,225 | 35,423 | ||||
Premises and equipment | 10,755 | 9,092 | ||||
Deferred income taxes | 7,318 | 5,328 | ||||
Investment in Impac Capital Trust | 2,350 | — | ||||
Deferred compensation | 6,674 | 4,189 | ||||
Total other assets | $ | 337,750 | $ | 249,237 | ||
Note H—CMO Borrowings
Selected information on CMO borrowings for the periods indicated consisted of the following (dollars in millions):
Year of Issuance | Original Issuance Amount | CMOs Outstanding as of | Range of Fixed Interest Rates (%) | Range of Interest Rate Margins Over One-Month LIBOR (%) | Range of Interest Rate Margins After Adjustment Date (%)(1)(2) | ||||||||||||
6/30/05 | 12/31/04 | ||||||||||||||||
2002 | $ | 3,876.1 | $ | 306.3 | $ | 1,237.3 | 5.25 - 12.00 | 0.27 - 2.75 | 0.54 - 3.68 | ||||||||
2003 | 5,966.1 | 2,654.0 | 3,615.8 | 4.34 - 12.75 | 0.27 - 3.00 | 0.54 - 4.50 | |||||||||||
2004 | 17,710.7 | 13,695.9 | 16,407.5 | 3.58 - 5.56 | 0.25 - 2.50 | 0.50 - 3.75 | |||||||||||
2005 | 7,137.5 | 6,944.9 | — | N/A | 0.26 - 2.90 | 0.52 - 4.35 | |||||||||||
Sub-total CMO borrowings | 23,601.1 | 21,260.6 | |||||||||||||||
Accrued interest expense | 13.0 | 12.9 | |||||||||||||||
Unamortized issuance costs | (69.6 | ) | (67.1 | ) | |||||||||||||
Total CMO borrowings | $ | 23,544.5 | $ | 21,206.4 | |||||||||||||
(1) | One-month LIBOR was 3.32% as of the last reset date on CMO borrowings prior to June 30, 2005. |
(2) | Interest rate margins over one-month LIBOR are generally increased when the unpaid principal balance is 20%-25% of the original issuance amount. |
At the end of the first quarter of 2004, we discovered that one client of theNote I—Reverse Repurchase Agreements
We enter into reverse repurchase agreements to finance our warehouse lending operations and certainthe funding and purchase of mortgages by the client’s officers had perpetrated a fraud pursuant tomortgage operations. Reverse repurchase agreements consist of uncommitted lines, which they defraudedmay be withdrawn at any time by the warehouse lending operations into making advances pursuant to a warehouse line of credit. As of the date the fraud was discovered, an aggregate of $12.6 million of fraudulent loan advances were outstanding. We immediately terminated the warehouse line of creditlender, and have been cooperating with federal investigators in their ongoing investigation of the defrauding parties.
We retained an independent consultant to investigate the matter; the investigator reported that no principals of the warehouse lending operations had knowingly participated in the fraud. As a result of the fraud, during the first quarter of 2004 we established a specific allowance for loan losses in the amount of $6.0 million to provide for probable losses on the fraudulent warehouse advances as we have deemed this amount to be non-collectible.committed lines. During the second quarter of 2004, we increased the specific allowance for loan losses to $8.0 million as a result of a re-evaluation of the under lying collateral. Based on available information, we believe we will be able to recover the remaining $4.6 million of related warehouse advances. To the extent that we believe that the actual losses will exceed the $8.0 million allowance, we will make an additional allowance for loan losses when, or if, we determine it is appropriate to do so as events2005 and circumstances dictate. However, we believe that this specific allowance is adequate to provide for probable loan losses based on currently available information.
In the opinion of management and in accordance with the loan loss allowance methodology, the present allowance for loan losses is considered adequate to provide for losses inherent in the loan portfolios.
Note G—CMO Borrowings
Certain CMO borrowings are guaranteed to certificate holders by a mortgage loan insurer, which give the CMOs the highest rating established by nationally recognized rating agencies. Each issue of CMOs is fully payable from the principal and interest payments on the underlying mortgages collateralizing such debt, any cash or other collateral required to be pledged as a condition to receiving the desired rating on the debt. CMOs typically are structured as adjustable rate securities, which primarily are indexed to one-month LIBOR, and fixed rate CMOs with interest payable to certificate holders monthly.
Interest rates on adjustable rate CMOs range from a low of 0.25% over one-month LIBOR, or 1.62% as of June 30, 2004, on “AAA” credit rated bonds to a high of 4.50% over one-month LIBOR, or 5.87% as of June 30, 2004, on “BBB” credit rated bonds. Interest rates on fixed rate CMOs range from 4.34% to 12.75%, depending on the class of CMOs issued. We completed $8.2 billion and $2.1 billion in CMOs during the six months ended June 30, 20042005, we added an additional $750 million and 2003, respectively,$1.2 billion to financeexisting warehouse facilities resulting in total warehouse facilities of $4.3 billion at June 30, 2005.
IMPAC MORTGAGE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
Note J—Junior Subordinated Debt and Trust Preferred Securities
During the retentionsecond quarter of $8.3 billion and $2.2 billion, respectively,2005, the Company formed three wholly-owned trust subsidiaries (Trusts) for the purpose of mortgages acquired and originatedissuing an aggregate of $76.3 million of trust preferred securities (the Trust Preferred Securities). The proceeds from the sale thereof were invested in junior subordinated debt issued by the mortgage operations. ForCompany. All proceeds from the six months ended June 30, 2004sale of the Trust Preferred Securities and 2003 interest expensethe common securities issued by the Trusts are invested in junior subordinated notes (Notes), which are the sole assets of the Trusts. The Trusts pay dividends on CMO borrowings was $117.2 million and $83.9 million, respectively.the Trust Preferred Securities at the same rate as the distributions paid by the Company on the junior subordinated notes held by the Trusts.
The following table presents CMOsshows the Trust Preferred Securities issued CMOsduring the second quarter 2005:
Trust Preferred Securities | Common Securities | Junior Subordinated Debt | Stated Maturity Date | Optional Redemption Date | |||||||||||
Impac Capital Trust #1 (1) | $ | 25,000 | $ | 780 | $ | 25,780 | 3/30/2035 | 3/30/2010 | (4) | ||||||
Impac Capital Trust #2 (2) | 25,000 | 774 | 25,774 | 4/30/2035 | 4/30/2010 | (5) | |||||||||
Impac Capital Trust #3 (3) | 26,250 | 820 | 27,070 | 6/30/2035 | 6/30/2010 | (4) | |||||||||
Sub-total | $ | 76,250 | $ | 2,374 | $ | 78,624 | |||||||||
Unamortized Debt Issuance Costs | (2,422 | ) | |||||||||||||
Total | $ | 76,202 | |||||||||||||
(1) | Requires quarterly distributions initially at a fixed rate of 8.01% per annum through March 30, 2010 and thereafter at a variable rate of three-month LIBOR plus 3.75% per annum. Distributions are cumulative but after March 2006 may be deferred for a period of up to four consecutive quarterly interest payment periods if the Company exercises its right to defer the payment of interest on the Notes (Extension Period). |
(2) | Requires quarterly distributions initially at a fixed rate of 8.065% per annum through April 30, 2010 and thereafter at a variable rate of three-month LIBOR plus 3.75% per annum. Distributions are cumulative but after April 2006 may be deferred for a period of up to four consecutive quarterly interest payment periods if the Company exercises its right to defer the payment of interest on the Notes. |
(3) | Requires quarterly distributions initially at a fixed rate of 8.01% per annum through June 30, 2010 and thereafter at a variable rate of three-month LIBOR plus 3.75% per annum. Distributions are cumulative but after May 2006 may be deferred for a period of up to four consecutive quarterly interest payment periods if the Company exercises its right to defer the payment of interest on the Notes (Extension Period). |
(4) | Redeemable at par at any time after the date indicated. |
(5) | Redeemable at par at any time after the date indicated and before that date, under certain events, at a premium of 7.5% of the outstanding amount. |
During any Extension Period, the Company may not declare or pay dividends on its capital stock. If an event of default occurs (such as a payment default that is outstanding for 30 days, a default in performance, a breach of any covenant or representation, bankruptcy or insolvency of the periods indicatedCompany or liquidation or dissolution of the Trust) either the trustee of the Notes or the holders of at least 25% of the aggregate principal amount of the outstanding Notes may declare the principal amount of, and certainall accrued interest rate information on, CMOs by yearall the Notes to be due and payable immediately, or if the holders of issuance as indicated (dollarsthe Notes fail to make such declaration, the holders of at least 25% in millions):aggregate liquidation amount of the Preferred Securities outstanding shall have a right to make such declaration.
Original | CMOs Outstanding As of | Range of Interest Rates (%) | Range of One-Month LIBOR (%) | Range of Interest Rate Margins After Adjustment Date (%) | |||||||||||||
Year of Issuance | 06/30/04 | 12/31/03 | |||||||||||||||
(as restated) | |||||||||||||||||
1998 | $ | 583.0 | $ | — | $ | — | 6.65 -7.25 | N/A | N/A | ||||||||
2000 | 943.6 | — | — | N/A | 0.26 –2.40 | 0.52 -3.60 | |||||||||||
2001 | 1,500.9 | 178.4 | 444.9 | N/A | 0.28 –2.30 | 0.56 -3.45 | |||||||||||
2002 | 3,876.1 | 1,815.3 | 2,491.0 | 5.25 -12.00 | 0.27 –2.75 | 0.54 -3.68 | |||||||||||
2003 | 5,966.1 | 4,769.9 | 5,583.5 | 4.34 -12.75 | 0.27 -3.00 | 0.54 -4.50 | |||||||||||
2004 | 8,224.3 | 8,030.7 | 3.58 – 5.56 | 0.25 -2.50 | 0.50 –3.75 | ||||||||||||
Sub-total CMOs | 21,094.0 | 14,794.3 | 8,519.4 | ||||||||||||||
Accrued interest | — | 9.3 | 7.4 | ||||||||||||||
Capitalized securitization costs | — | (54.0 | ) | (36.9 | ) | ||||||||||||
Total CMOs | $ | 21,094.0 | $ | 14,749.6 | $ | 8,489.9 | |||||||||||
In December 2003, the FASB modified and reissued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46R). FIN 46R requires the deconsolidation of trust preferred entities since the Company
IMPAC MORTGAGE HOLDINGS, INC.
Note H—Issuance of Series B Preferred StockNOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share data or as otherwise indicated)
(unaudited)
On May 28, 2004, we completeddoes not have a significant variable interest in the saletrust. Therefore, the Company records its investment in the trust preferred entities in other assets and accounts for such under the equity method of 2,000,000 shares of 9.375% Series B Cumulative Redeemable Preferred Stock, par value $0.01 per share, liquidation preference $25.00 per share, oraccounting and reflects a liability for the “Series B Preferred Stock.” Dividends on the Series B Preferred Stock are payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year. The shares of Series B Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory
redemption and are not convertible into any other securities. Upon liquidation, dissolution or winding upissuance of the Company, the Series B Preferred Stock have the right to receive the sum of $25.00 per share, a premium ranging from $0.50 to $2.00 until May 2009, and accrued and unpaid dividends (whether or not declared)junior subordinated notes to the date of payment, before any payments are made to holders of common stock. Holders of shares of Series B Preferred Stock generally have no voting rights, but will have limited voting rights if we fail to pay dividends for six or more quarters andtrust preferred entities. The interest expense on such notes is recorded in certain Interest Expense—other events. We may not redeem the Series B Preferred Stock until May 28, 2009 except in limited circumstances to preserve our status as a REIT. On or after May 28, 2009, we may, at our option, redeem the Series B Preferred Stock in whole or in part, at any time and from time to time, for cash at $25.00 per share, plus accrued and unpaid dividends (whether or not declared), if any, to and including the redemption date. On June 30, 2004, we paid a dividendborrowings in the aggregatestatement of $443,000 to preferred stockholders.operations.
ITEM | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Unless the context otherwise requires, the terms “Company,” “we,” “us,” and “our” refer to Impac Mortgage Holdings, Inc. (“IMH”), a Maryland corporation incorporated in August 1995, and its wholly-owned subsidiaries, IMH Assets Corp., or “IMH Assets,” Impac Warehouse Lending Group, Inc., or “IWLG,” Impac Multifamily Capital Corporation, or “IMCC,” and Impac Funding Corporation, or “IFC,” together with its wholly-owned subsidiaries Impac Secured Assets Corp., or “ISAC,” and Novelle Financial Services, Inc., or “Novelle.”
This report on Form 10-Q/A contains certain forward-looking statements within the meaningThe Mortgage Banking Industry and Discussion 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 due to a number of factors, including, but not limited to, failure to achieve projected earnings levels, the ability to generate sufficient liquidity, the ability to access the capital markets, the size, frequency and manner of our securitizations, the ability to generate taxable income and pay dividends, risks related to restatement of our financial statements, interest rate fluctuations, frauds committed upon us, unknown weaknesses in our internal controls, natural disaster, interruption in our management information systems, new regulatory laws, increase in prepayment rates on our mortgage assets, changes in assumptions regarding estimated loan losses or fair value amounts, changes in expectations of future interest rates, the availability of financing and, if available, the terms of any financing, changes in origination and resale pricing of mortgages, changes in markets which we serve and changes in general market and economic conditions. For a discussion of these and other risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see “Risk Factors” and Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this 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.
Restatement of Consolidated Financial StatementsRelevant Fiscal Periods
The unaudited consolidated balance sheets as of March 31, 2004 and December 31, 2003 and 2002, the unaudited consolidated statements of operations and unaudited consolidated statements of comprehensive earnings for the three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002, and 2001 and the unaudited consolidated statements of cash flows for the three months ended March 31, 2004 and 2003, six months ended June 30, 2003 and for the years ended December 31, 2003, 2002 and 2001 were restated. The effect of this restatement on net earnings (loss) for the three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002 and 2001 was an increase (decrease) of $(36.7) million, $(0.7) million, $2.4 million, $1.7 million, $11.2 million, $12.8 million, $21.7 million, $(34.6) million and $(35.4) million, respectively. Additionally, basic and diluted earnings per share (“EPS”) for the six months ended June 30, 2004 was correctedmortgage banking industry is continually subject to $2.44 and $2.40, respectively, from $2.30 and $2.27, respectively. The following are the principal reasons for the correction and reclassifications:
The consolidated financial statements in this document include restatements and reclassifications as previously filed in our original Form 10-Q for the quarter ended June 30, 2004, Form 10-Q/A for the quarter ended March 31, 2004 and Form 10-K/A for the year ended December 31, 2003. The restatements were necessary to conform with accounting principles generally accepted in the United States of America (“GAAP”) as follows:
In this environment, mortgage banking companies regularly anticipate the reclassification of certain derivative gainsfuture marketplace, engage in hedging activities and lossescontinuously reassess business plans and strategies to mark-to-market gain (loss) – derivative instruments as opposed to an adjustment toeffectively position themselves in the yield on mortgage assets asmarketplace.
As a result, current events can diminish the relevance of separate comparisons of “quarter over quarter” and “year-to date over year-to date” comparisons of financial information. In such instances, the elimination of cash flow hedge accounting, as stated above; and
Although these corrections have an effect on net earnings, these corrections and reclassifications have no effect on taxable income, which is an important factor in determining the amount of dividends paid to our stockholders. In addition, beginning and ending cash and cash equivalents for all reporting periods remain unchanged.
For a further discussion of the corrections and restatements, see “Explanatory Note” at the beginning of this Form 10-Q/A and “Note A.2.—Restatement of Consolidated Financial Statements” in the accompanying notes to consolidated financial statements. The effect of the restatement of the consolidated financial statements is reflected in “Management’sManagement Discussion and Analysis of Financial Condition and Results of Operations” below.
We currently estimate that fees for professional services relatedis the most relevant to the reclassifications and restatements of ourits financial statements will be approximately $500,000.
The results of operations for the three and six months ended June 30, 2004 reflect the consolidation of IFC on July 1, 2003. On July 1, 2003, IMH entered into a stock purchase agreement with Joseph R. Tomkinson, our Chairman, Chief Executive Officer and a director, William S. Ashmore, our Chief Operating Officer, President and a director, and the Johnson Revocable Living Trust, of which Richard J. Johnson, our Executive Vice President and Chief Financial Officer is trustee, whereby IMH purchased all of the outstanding shares of voting common stock of IFC for aggregate consideration of $750,000. Each of Messr’s. Tomkinson and Ashmore and the Johnson Revocable Living Trust owned one-third of the outstanding common stock of IFC. Mr. Tomkinson elected to receive $125,000 worth of his consideration for the sale of his IFC shares of common stock in the form of 7,687 shares of IMH common stock. The fairness opinion related to the purchase price of IFC, as rendered by an independent financial advisor, and the subsequent transaction was approved by our board of directors. As a result of acquiring 100% of IFC’s common stock on July 1, 2003, IMH owns all of the common stock and prefered stock of IFC and began to consolidate IFC as of that date. As such, the consolidated financial statements for the three and six months ended June 30, 2004, or “consolidation period,” reflect the results of operations of
IFC on a consolidated basis. The consolidated financial statements for the three and six months ended June 30, 2003, or “non-consolidation period,” include the results of operations of IFC as equity in net earnings of IFC.information.
General and Business OperationsOverview
We are a mortgage real estate investment trust, or “REIT,” that is a nationwide acquirer, originator, seller and investor of non-conforming Alt-A mortgages, or “Alt-A mortgages,” and to a lesser extent, small-balance, multi-family mortgages, or “multi-family mortgages” and sub-prime, or “B/C mortgages.” We also provide warehouse and repurchase financing to originators of mortgages.
We operate three core businesses:
The long-term investment operations primarily invest in adjustable rate and, to a lesser extent, fixed rate Alt-A mortgages that are acquired and originated by our mortgage operations. 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:
For instance, Alt-A mortgages may not have certain documentation or verifications that are required by Fannie Mae and Freddie Mac and, 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 credit losses than other types of mortgages.
The long-term investment operations also originate and invest in multi-family mortgages that are primarily hybridadjustable rate mortgages with initial fixed interest rate periods of two-, three-, five-, seven- and ten-years that subsequently adjust to adjustable rate mortgages, or “hybrid ARMs,” with initial fixed interest rate periods of three, five and seven yearsbalances that subsequently adjust to adjustable rate mortgages. Mortgage balances generally range from $250,000$500,000 to $3.0$5.0 million. Multi-family mortgages have interest rate floors, which is the initial start rate, and prepayment penalty periods of 3, 5three-, five-, seven- and 7 years.ten-years. Multi-family mortgages provide greater asset diversification on our balance sheet as borrowers of multi-family mortgages typically have higher credit scores and multi-family mortgages typically have lower loan-to-value ratios, or “LTV ratios,” and longer average termlife to payoff than Alt-A mortgages.
As of June 30, 2005, we had no multi-family mortgages held as CMO collateral and held-for–investment on our consolidated financial statements that were delinquent. The long-term investment operations generate earnings primarily from net interest income earned on mortgages held for long-term investment, or “long-term mortgage portfolio.” The long-term mortgage portfolio as reported on our consolidated balance sheet consists of mortgages held as CMO collateralcollateralized mortgage obligations, or “CMO’s,” and mortgages held for investment on our balance sheet.held-for-investment. Investments in Alt-A mortgages and multi-family mortgages are initially financed with short-term borrowings under reverse repurchase agreements whichthat are subsequently converted to long-term financing in the form of collateralized mortgage obligations, or “CMO,”CMO financing. Cash flow from the long-term mortgage portfolio, and proceeds from the sale of capital stock and issuance of trust preferred securities also finance new Alt-A and multi-family 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 sale to pre-approved investors. This business earns net interest income from the difference between its cost of borrowings and the interest earned on warehouse advances as well as fees from warehouse transactions.
The mortgage operations acquire, originate, sell and originatesecuritize primarily adjustable rate and fixed rate Alt-A mortgages and, to a lesser extent, B/C mortgages as follows:
mortgages. The mortgage operations generate income by securitizing and selling mortgages to permanent investors, including the long-term investment operations. This business also earns revenue from interest income on mortgages held-for-sale and fees associated with mortgage acquisitions and originations, mortgage servicing rights, and master servicing agreements.agreements and interest income earned on mortgages held for sale. The mortgage operations use warehouse facilities provided by the warehouse lending operations to finance the acquisition and origination of mortgages.
Our goal isThe warehouse lending operations provide short-term financing to generate consistent reliablemortgage loan originators, including our mortgage operations, by funding mortgages from their closing date until sale to pre-approved investors. This business earns fees from warehouse transactions as well as net interest income for distribution to our stockholders primarily from earnings generated by our core operating businesses.the difference between its cost of borrowings and the interest earned on warehouse advances.
We define critical accounting policies as those that are important to the portrayal of our financial condition and results of operations and may 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 include the following:
Allowance for loan losses. We provide an allowance for loan losses for mortgages held as CMO collateral, finance receivables and mortgages held-for-investment, or “loans provided for.” 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. This data is analyzed for loss performance and prepayment performance by product type, origination year and securitization issuance. The results of that analysis are then applied to the current mortgage portfolio and an estimate is created. We believe that pooling of mortgages with similar characteristics is an appropriate methodology in which to evaluate the allowance for loan losses. In addition, management provides an allowance for loan losses for Alt-A mortgages that are retained for long-term investment and which are not underwritten to our specific underwriting guidelines. These mortgages are acquired on a bulk basis by the mortgage operations from other mortgage originators that underwrite mortgages substantially similar, but not specific, to our mortgage underwriting guidelines, or “non-Impac mortgages.” Management also recognizes that there are qualitative factors that must be taken into consideration when evaluating and measuring inherent loss in our loan portfolios. These items include, but are not limited to, economic indicators that may affect the borrower’s ability to pay, changes in value of collateral, political factors and industry statistics. Specific valuation allowances may be established for loans that are deemed impaired, if default by the borrower is deemed probable, and if the fair value of the loan or the collateral is estimated to be less than the gross carrying value of the loan. Actual losses on loans are recorded as a reduction to the allowance through charge-offs. Subsequent recoveries of amounts previously charged off are credited to the allowance. For additional information regarding allowance for loan losses refer to “Results of Operations and Financial Condition.”
Derivative financial instruments. The mortgage operations acquire derivatives to mitigate changes in the value of its mortgage pipeline. The mortgage pipeline consists of mortgages that have not yet been acquired, however, the mortgage operations has committed to acquire the mortgages in the future at pre-determined interest rates through rate-lock commitments. On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan Commitments,” or “SAB 105,” which clarifies the SEC’s position on the accounting and valuation for commitments to originate mortgage loans held-for-sale. Consistent with SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” or “SFAS 149,” SAB 105 states that loan commitments are treated as derivatives.
Prior to the issuance of SAB 105, the mortgage operations recorded the fair value of its mortgage pipeline, inclusive of changes in benchmark interest rates and acquisition premiums, as it qualifies as a derivative under the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities, or “SFAS 133.” Therefore, the mortgage pipeline and the fair value of derivatives were marked to market each reporting period. SAB 105 requires that in valuing these loan commitments entities not include cash flows associated with servicing as to do so would result in the recognition of servicing assets prior to the sale or securitization of funded loans. This valuation methodology limits a company’s ability to record an asset for its mortgage pipeline as of the applicable reporting date even when the total fair value may include servicing-related acquisition premium. Subsequent to SAB 105, as of April 1, 2004 we record the fair value change of the mortgage pipeline based solely on interest rate fluctuations from the date of rate-lock to the applicable reporting date. Other derivatives, as accounted for under SFAS 133 and which principally reduce exposure to interest rate risk associated with specific liabilities, are also carried at fair value with changes in fair value reflected in earnings.
Securitization of financial assets as financing versus sale. The mortgage operations recognize gains or losses on the sale of mortgages when the sales transaction settles or upon the securitization of the mortgages when the risks of ownership have passed to the purchasing party. Gains and losses may be increased or decreased by the amount of any servicing related premiums received and costs associated with the acquisition or origination of mortgages. A transfer of financial assets in which control is surrendered is accounted for as a sale to the extent that consideration other than a beneficial interest in the transferred assets is received in the exchange. The long-term investment operations structure CMO securitizations as financing arrangements and recognize no gain or loss on the transfer of mortgage assets. The CMO securitization trusts do not meet criteria within SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (SFAS 140), to be qualifying special purpose entities, and further, are considered variable interest entities under FASB Interpretation No. 46R and, therefore, are consolidated by the long-term investment operations as the entities’ primary beneficiary. The mortgage operations structure REMIC securitizations as sales, and gains and losses are recognized. Liabilities and derivatives incurred or obtained at the transfer of financial assets are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the transferred assets must be measured by allocating the previous carrying value between the asset sold and the interest retained, if any, based on their relative fair values at the date of transfer. To determine the value of the securities and retained interest, management estimates future rates of prepayments, prepayment penalties to be received, delinquencies, defaults and default loss severity and their impact on estimated cash flows.
Financial Highlights for the Second Quarter of 20042005
Financial Highlights for the First Six Months of 2005
Financial Highlights for the First Six Months of 2004
Second Quarter and Year to Date 2005 Taxable Income
After adjusting for our estimates of the differences between net earnings and taxable income, estimated taxable income was $58.0 million, or $0.88 per diluted share, for the second quarter of 2004 as compared to $28.6 million, or $0.56 per diluted share, for the second quarter of 2003. 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. As an example, to calculate taxable income we deduct actual loan losses as compared to the determination of net earnings that require a deduction of loan loss provisions, which are determined based on estimated losses inherent in our loan portfolios or fair value adjustments are recorded as an expense or revenue for GAAP, but are not included in the calculation of taxable income. To maintain our 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. As such, we believe that the disclosure of estimated taxable income available to common stockholders, which is a non-generally accepted accounting principle, or “GAAP,” financial measurement, is useful information for our investors. Of estimated taxable income of $58.0 million, we declared total regular cash dividends of $52.6 million during the second quarter of 2004. Upon the filing of our 2002 tax return, we had federal and state net operating tax loss carry-forwards of $18.7 million that may or may not be used to offset taxable income through 2020. We expect to file our 2003 federal and state tax returns on or about September of 2004 at which time federal and state net operating loss carry-forwards, if any, will be determined.
The following table presents a reconciliation of net earnings (GAAP) to estimated taxable income available to common stockholders for the periods indicated (dollars in(in thousands, except per share amounts):
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2005 (1) | 2004 (1) | 2005 (1) | 2004 (1) | |||||||||||||
Net (loss) earnings | $ | (55,000 | ) | $ | 143,214 | $ | 118,610 | $ | 152,586 | |||||||
Adjustments to GAAP earnings (loss) (6): | ||||||||||||||||
Loan loss provision | 5,711 | 15,282 | 11,785 | 25,007 | ||||||||||||
Tax deduction for actual loan losses | (2,674 | ) | (1,332 | ) | (5,914 | ) | (3,354 | ) | ||||||||
Anticipated partial worthlessness deduction on warehouse advances | — | (2,000 | ) | — | (8,000 | ) | ||||||||||
Fair value of derivatives (2) | 90,871 | (102,026 | ) | (38,008 | ) | (75,380 | ) | |||||||||
Dividends on preferred stock | (3,624 | ) | (443 | ) | (7,248 | ) | (443 | ) | ||||||||
Net (earnings) loss of IFC (3) | 743 | (14,791 | ) | (15,423 | ) | (26,328 | ) | |||||||||
Dividend from IFC | 9,000 | 7,500 | 25,850 | 15,000 | ||||||||||||
Elimination of inter-company loan sales transactions (4) | (3,943 | ) | 12,190 | 8,242 | 24,051 | |||||||||||
Estimated taxable income available to common stockholders (5) | $ | 41,084 | $ | 57,594 | $ | 97,894 | $ | 103,139 | ||||||||
Estimated taxable income per diluted share (5) | $ | 0.54 | $ | 0.87 | $ | 1.28 | $ | 1.63 | ||||||||
Diluted weighted average shares outstanding | 75,387 | 65,939 | 76,235 | 63,370 | ||||||||||||
Net earnings available to common stockholders Adjustments to GAAP earnings: Loan loss provision Dividend from IFC Fair value of free-standing derivative(1) Tax deduction for actual loan losses Anticipated partial worthlessness deduction on warehouse advances(2) Net earnings of IFC(3) Estimated taxable income(4) Estimated taxable income per diluted share Estimated taxable income per outstanding shareExplanatory Footnotes For the Three Months
Ended June 30, For the Six Months
Ended June 30, 2004 2003 2004 2003 (as restated) (as restated) $ 142,771 $ 32,148 $ 152,143 $ 56,957 15,282 7,059 25,007 13,543 7,500 6,930 15,000 11,385 (102,027 ) (4,615 ) (75,380 ) (8,139 ) (1,332 ) (3,436 ) (3,354 ) (6,761 ) (2,000 ) — (8,000 ) — (2,600 ) (9,441 ) (2,277 ) (10,356 ) $ 57,594 $ 28,645 $ 103,139 $ 56,629 $ 0.87 $ 0.56 $ 1.63 $ 1.14 $ 0.83 $ 0.56 $ 1.48 $ 1.12
(1) | Estimated taxable income includes estimates of book to tax adjustments and can differ from actual taxable income as calculated when we file our annual corporate tax return. Since estimated taxable income is a non-GAAP financial measurement, the reconciliation of estimated taxable income available to common stockholders to net earnings meets the requirement of Regulation G as promulgated by the SEC for the presentation of non-GAAP financial measurements. |
(2) | The mark-to-market change for the valuation of |
Represents |
(4) | Includes the effects to taxable income associated with the elimination of gains from intercompany loan sales between IFC and IMH, net of tax and the related amortization of the deferred charge. |
(5) | Excludes the deduction for dividends paid and the availability of a deduction attributable to net operating loss carry-forwards. Federal net operating tax loss carry-forwards of $18.7 million are expected to be utilized prior to its expiration in the year 2020. |
(6) | 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. As an example, to calculate estimated taxable income we deduct actual loan losses as compared to the determination of net earnings which requires a deduction for estimated losses inherent in our mortgage portfolios in the form of a provision for loan losses. To maintain our REIT status, we are required to distribute a minimum of 90% of our annual taxable income to our stockholders. |
Issuance of Series B Preferred Stock
On May 28, 2004, we completed the sale of 2,000,000 shares of 9.375% Series B Cumulative Redeemable Preferred Stock, par value $0.01 per share, liquidation preference $25.00 per share, or the “Series B Preferred Stock.” Dividends on the Series B Preferred Stock is payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year. The shares of Series B Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory redemption and are not convertible into any other securities. Upon liquidation, dissolution or winding up of the Company, the Series B Preferred Stock have the right to receive the sum of $25.00 per share, a premium ranging from $0.50 to $2.00 until May 2009, and accrued and unpaid dividends (whether or not declared) to the date of payment, before any payments are made to holders of common stock. Holders of shares of Series B Preferred Stock generally have no voting rights, but will have limited voting rights if we fail to pay dividends for six or more quarters and in certain other events. We may not redeem the Series B Preferred Stock until May 28, 2009 except in limited circumstances to preserve our status as a REIT. On or after May 28, 2009, we may, at our option, redeem the Series B Preferred Stock in whole or in part, at any time and from time to time, for cash at $25.00 per share, plus accrued and unpaid dividends (whether or not declared), if any, to and including the redemption date. On June 30, 2004, we paid a dividend in the aggregate of $443,000 to preferred shareholders of record on June 1, 2004.
Results of Operations and Financial Condition
Results of Operations —
For the Three Months Ended June 30, 2004 compared to the Three Months Ended June 30, 2003First Quarter 2005 vs. Second Quarter 2005
Net earnings increasedEstimated taxable income decreased $0.21 to $143.2 million, or $2.17$0.54 per diluted common share for the second quarter of 20042005 as compared to $32.1 million, or $0.63$0.75 per diluted common share for the first quarter 2005. The decline in estimated taxable income per share was mainly attributable to both a decline in adjusted net interest margins on mortgage assets and a reduction in the cash dividend from IFC during the second quarter of 2003. The quarter-over-quarter increase in net earnings of $111.1 million was primarily due to the following:
These variances are discussed in further detail below.
Mark-to-Market Gain (Loss) – Derivative Instruments
During the three months ended June 30, 2004, mark –to-market gain (loss) - derivative instruments increased to a gain of $77.9 million2005 as compared to a loss of $7.8 million for the same period in the previous year. The increase in mark–to-market gain (loss) - derivative instruments was the result of a sharp increase in the one month forward LIBOR curve as a result of the Federal Reserve Bank’s statement that they intended to raise short term interest rates at a measured pace. This resulted in an adjustment to future expectations of short term rates which affected the value of our derivative instruments. We enter into derivative contracts to manage the various risks associated with certain specific liabilities. On the date we enter into various derivative contracts, the derivatives were designated as an economic hedge of the variability in expected future cash flows associated with a financing obligation or future liability. In our consolidated financial statements, we now record a market valuation adjustment for economic hedges and any subsequent cash payments paid or received on these derivatives as a current period expense or revenue in mark-to-market loss – derivative instruments on the consolidated financial statements. In addition, we account for certain forward purchase commitments on mortgage loans, or “mortgage pipeline,” as free-standing derivatives, and record the change in fair value of such instruments and the related derivatives used to hedge the mortgage pipeline as a current period expense or revenue.first quarter 2005.
Net Interest Income
We earn interest income primarily on mortgage assets which include CMO collateral, mortgages held-for-investment, mortgages held-for-sale, finance receivables and investment securities available-for-sale, or collectively, “mortgage assets,” and,With respect to a lesser extent, interest income earned on cash and cash equivalents. 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. For additional information on derivative instruments and their effect on net interest income during changing interest rate environments, refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk.”
Net interest income increased to $85.4 million for the second quarter of 2004 compared to $35.9 million for the second quarter of 2003. The quarter-over-quarter increasedecrease in net interest income was primarily due to an increase in average mortgage assets, which increased to $14.3 billion for the second quarter of 2004 compared to $7.1 billion for the second quarter of 2003 as the long-term investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter of 2003. We primarily retain Alt-A mortgages that are acquired and originated by the mortgage operations and multi-family mortgages originated by IMCC that fit within our investment criteria. Alt-A and multi-family mortgages are ARMs and FRMs with good credit profiles with mortgage insurance enhancements, when required, that generally have prepayment penalty features and are primarily purchase money transactions.
The following table summarizes the principal balance of Alt-A mortgages acquired by the long-term investment operations from the mortgage operations and multi-family mortgages originated by IMCC by loan characteristic for the periods indicated (in thousands):
For the Three Months Ended June 30, | ||||||||||
2004 | 2003 | |||||||||
Principal Balance | % | Principal Balance | % | |||||||
Volume by Type: | ||||||||||
Adjustable rate | $ | 4,819,450 | 89 | $ | 802,719 | 100 | ||||
Fixed rate | 569,468 | 11 | 3,868 | 0 | ||||||
Total Mortgage Acquisitions | $ | 5,388,918 | 100 | $ | 806,587 | 100 | ||||
Volume by Product: | ||||||||||
Primarily six-month LIBOR indexed ARMs(1) | $ | 817,504 | 15 | $ | 346,456 | 43 | ||||
Primarily six-month LIBOR indexed hybrids(1) (2) | 3,885,458 | 72 | 382,181 | 47 | ||||||
Fixed rate first trust deeds | 449,675 | 9 | 473 | 0 | ||||||
Fixed rate second trust deeds | 119,793 | 2 | 3,395 | 1 | ||||||
Multi-family mortgages(3) | 116,488 | 2 | 74,082 | 9 | ||||||
Total Mortgage Acquisitions | $ | 5,388,918 | 100 | $ | 806,587 | 100 | ||||
Volume by Credit Quality: Alt-A loans B/C loans(4) Total Mortgage Acquisitions Volume by Purpose: Purchase Refinance Total Mortgage Acquisitions Volume by Prepayment Penalty: With prepayment penalty Without prepayment penalty Total Mortgage Acquisitions $ 5,376,346 100 $ 801,156 99 12,572 0 5,431 1 $ 5,388,918 100 $ 806,587 100 $ 3,167,942 59 $ 474,493 59 2,220,976 41 332,094 41 $ 5,388,918 100 $ 806,587 100 $ 3,708,620 69 $ 706,658 88 1,680,298 31 99,929 12 $ 5,388,918 100 $ 806,587 100
The increase in net interest income was also due to an increase inadjusted net interest margins on mortgage assets which increasedis a non-GAAP financial measure and excludes the amortization of loan discounts and includes the net cash payments or receipts on derivative instruments, the second quarter decreased 14 basis points to 2.38%0.67% as compared to 0.81% for the first quarter 2005. The 14 basis point decline in adjusted net interest margins on average mortgage asset balances for the second quarter of 2004 as compared$26.2 billion equates to 2.01%a decline in net earnings of approximately $9.2 million or $0.12 per diluted common share for the second quarter.
The dividend from IFC was reduced to $9.0 million for the second quarter of 2003. The following table summarizes average balance, interest and weighted average yield on mortgage assets and borrowings on mortgage assets2005 as compared to $16.8 million for the periods indicated (dollarsfirst quarter 2005. The decrease in thousands):
For the Three Months Ended June 30, | ||||||||||||||||||
2004 | 2003 | |||||||||||||||||
(as restated) | ||||||||||||||||||
Average Balance | Interest | Yield | Average Balance | Interest | Yield | |||||||||||||
MORTGAGE ASSETS | ||||||||||||||||||
Investment securities available-for-sale | $ | 13,064 | $ | 1,724 | 52.79 | % | $ | 24,254 | $ | 611 | 10.08 | % | ||||||
CMO collateral(1) | 12,329,664 | 132,595 | 4.30 | 6,343,063 | 79,694 | 5.03 | ||||||||||||
Mortgages held-for-investment and held-for-sale(2) | 1,474,636 | 19,499 | 5.29 | 139,396 | 1,953 | 5.60 | ||||||||||||
Finance receivables | 462,412 | 6,428 | 5.56 | 551,770 | 7,031 | 5.10 | ||||||||||||
Total Mortgage Assets | $ | 14,279,776 | $ | 160,246 | 4.49 | % | $ | 7,058,483 | $ | 89,289 | 5.06 | % | ||||||
BORROWINGS | ||||||||||||||||||
CMO borrowings(3) | $ | 12,099,866 | $ | 65,187 | 2.15 | % | $ | 6,204,955 | $ | 45,615 | 2.94 | % | ||||||
Reverse repurchase agreements | 1,841,645 | 10,062 | 2.19 | 1,235,403 | 7,305 | 2.37 | ||||||||||||
Borrowings secured by investment securities(4) | — | — | — | 3,898 | 852 | 87.43 | ||||||||||||
Total borrowings on Mortgage Assets | $ | 13,941,511 | $ | 75,249 | 2.16 | % | $ | 7,444,256 | $ | 53,772 | 2.89 | % | ||||||
Net Interest Spread(5) | 2.33 | % | 2.17 | % | ||||||||||||||
Net Interest Margin(6) | 2.38 | % | 2.01 | % | ||||||||||||||
Net Cash Payments on Derivatives(7) | $ | 23,422 | $ | 12,365 | ||||||||||||||
Net Interest Margin including Net Cash Payments on Derivatives(8) | 1.72 | % | 1.31 | % |
the dividend from IFC of $7.8 million represents a decrease in estimated taxable income of approximately $0.10 per diluted common share. The 37 basis point increasedecision to decrease the dividend from IFC was attributable to a decline in net interest marginsthe earnings and profits generated by IFC that can be distributed to IMH in the form of a taxable dividend. The decline in earnings and profits from IFC was primarily duethe result of a decrease in non-interest income and to a lesser extent differences in timing of servicing income recognized in the first quarter and tax deductions related to the following:
Consolidation of mortgages held by the mortgage operations. The consolidation of the mortgage operations contributed to a 16 basis point increase in net interest margins on mortgage assetsstock options during the second quarter of 2004 as mortgages held-for-sale were consolidated with total average mortgage assets. DuringIMH stock options by employees of IFC. The decrease in non-interest income was primarily the second quarterresult of 2003 mortgages held-for-sale were not consolidated with total average mortgage assets as IFC was a non-consolidating entity prior to July 1, 2003. Net interest marginsmark-to-market loss of $10.1 million on mortgages held-for-sale were favorable during the second quarterfair value of 2004 due to a steep yield curve as comparedderivatives related to the second quarter of 2003. The yield curve represents the mathematical difference between short-term interest rates and long-term interest rates. Because the mortgage operations establishes interest rates on its mortgages by indexing those interest rates to long-term market interest rates and finances mortgages with borrowings that are indexed to short-term interest rates, a steep yield curve benefits net interest margins.
Accretion of loan discount recognized on sale of MSRs.Net interest margins increased by 6 basis points during the second quarter of 2004 as accretion of loan discounts of $12.3 million, or 34 basis points of total average mortgage assets, was accreted as an adjustment to the yield on mortgage assets as compared to $5.0 million, or 28 basis points of total average mortgage assets, during the second quarter of 2003. Mortgage loan discounts result from the sale of mortgage servicing rights when the mortgage loans are retained. Such discount is measured using the relative fair value method to allocate the carrying value of the loan between the MSRs sold and the mortgage loans retained. The resulting discount is accreted into interest income as a yield adjustment on mortgage assets.
Non-Interest and Income Tax Expense
Non-interest and income tax expense increased to $26.0 million for the second quarter of 2004 as compared to $1.8 million for the second quarter of 2003. The quarter-over-quarter increase in non-interest and income tax expense of $24.2 million was primarily due to a $21.3 million increase in operating costs. The increase in operating costs was primarily due to the consolidation of the mortgage operations on July 1, 2003. Operating costs generated by the mortgage operations was reported on a consolidated basis for the consolidation period, however, for the non-consolidation period the financial results of IFC were reported as equity in net earnings of IFC on the consolidated financial statements. As such, operating costs increased to $23.6 million for the second quarter of 2004 as compared to $2.3 million for the second quarter of 2003. Operating costs include personnel expense, professional services, equipment expense, occupancy expense, data processing expense and general and administrative and other expense. Personnel expense, which primarily includes salary, wages and benefit costs, was $16.3 million, or 69% of total operating costs, during the second quarter of 2004 as compared to $790,000 during the second quarter of 2003. Personnel related costs are variable expenses and are primarily driven by mortgage acquisitions and originations. Mortgage acquisitions and originations increased to $5.5 billion during the second quarter of 2004 as compared to $1.9 billion during the second quarter of 2003. The following table summarizes the principal balance of mortgage acquisitions and originations by loan characteristic for the periods indicated (in thousands):
Principal Balance Principal Balance By Loan Type: Fixed rate first trust deed Fixed rate second trust deed Adjustable rate: Primarily six-month LIBOR indexed ARMs(1) Primarily six-month LIBOR indexed hybrids(2) Total adjustable rate Total Mortgage Acquisitions and Originations By Production Channel: Correspondent acquisitions: Flow Bulk, or Non-Impac mortgages Total correspondent acquisitions Wholesale and retail originations Novelle Financial Services, Inc. Total Mortgage Acquisitions and Originations By Credit Quality: Alt-A B/C(3) Total Mortgage Acquisitions and Originations By Purpose: Purchase Refinance Total Mortgage Acquisitions and Originations By Prepayment Penalty: With prepayment penalty Without prepayment penalty Total Mortgage Acquisitions and Originations For the Three Months Ended June 30, 2004 2003 % % $ 624,118 11 $ 991,450 52 169,361 3 24,910 1 798,749 15 422,752 22 3,858,497 71 461,333 25 4,657,246 86 884,085 47 $ 5,450,725 100 $ 1,900,445 100 $ 2,450,634 45 $ 1,086,622 57 2,257,131 41 346,036 18 4,707,765 86 1,432,658 75 546,941 10 362,097 19 196,019 4 105,690 6 $ 5,450,725 100 $ 1,900,445 100 $ 5,242,341 96 $ 1,784,432 94 208,384 4 116,013 6 $ 5,450,725 100 $ 1,900,445 100 $ 3,131,014 57 $ 862,368 45 2,319,711 43 1,038,077 55 $ 5,450,725 100 $ 1,900,445 100 $ 3,737,440 69 $ 1,558,725 82 1,713,285 31 341,720 18 $ 5,450,725 100 $ 1,900,445 100
Operating costs increasedpipeline at a lower incremental per loan rate relative to total mortgage acquisitions and originations as 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. In addition, a higher percentage of non-Impac mortgage acquisitions during the second quarter of 2004 contributed to lower per loan acquisition costs as compared to the second quarter of 2003. Non-Impac Alt-A mortgage acquisitions, which are acquired as bulk loan packages, generally require less staffing and corresponding operating costs than Impac Alt-A mortgages, which are acquired on a flow, or loan-by-loan basis. During the second quarter of 2004, non-Impac mortgages accounted for 41% of total mortgage acquisitions and originations compared to 18% during the second quarter of 2003.
Provision for Loan Losses
Provision for loan losses were $15.3 million for the second quarter of 2004 as compared to $7.1 million for the second quarter of 2003. The quarter-over-quarter increase in provision for loan losses was primarily due to an increase in our mortgage loan portfolio as the long-term investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter 2005 as compared to a gain on the fair value of 2003, which required a corresponding increase in allowance for loan losses.
In addition,derivatives of $9.4 million at the end of the first quarter of 2004, we discovered that one client2005. The after tax effect of the warehouse lending operations and certain of its officers had perpetrated a fraud pursuant to which they defrauded the warehouse lending operations into making advances pursuant to a warehouse line of credit. As of the date the fraud was discovered, an aggregate of $12.6
million of fraudulent loan advances were outstanding. We immediately terminated the warehouse line of credit and have been cooperating with federal investigators in their ongoing investigation of the defrauding parties. It appears that the defrauding parties had perpetrated a similar fraud on another warehouse lender. We retained an independent consultant to investigate the matter; the investigator reported that no principals of the warehouse lending operations had knowingly participated in the fraud and stated that it is not likely that any other client of the warehouse lending operations could duplicate the same fraud. With the aid of independent counsel, the audit committee of our board of directors reviewed the report and the scope of the investigation and concurs with the assessment set forth in the report. In response, we have taken steps to enhance procedures at our warehouse lending operations, including improvements of the application approval and funding processes of mortgage bankers and follow-up quality control checks. As a result of the fraud, during the first quarter of 2004 we established a specific allowance for loan losses in the amount of $6.0 million to provide for anticipated losses on the fraudulent warehouse advances as we have deemed this amount to be non-collectible. During the second quarter of 2004, we increased the specific allowance for loan losses by $2.0 million to $8.0 million as a result of the re-evaluation of the remaining collateral. Based on available information, we believe we will be able to recover the remaining $4.6 million of related warehouse advances. Because we deem $8.0 million of the total warehouse advances to be non-collectible and anticipate that it will result in a tax deduction upon the filing of our 2004 corporate income tax return, we reflected the $8.0 million as a reduction to estimated taxable income for the second quarter of 2004 as shown in the reconciliation of net earnings to estimated taxable income above. To the extent that we believe that the actual losses will exceed the $8.0 million allowance, we will make an additional allowance for loan losses when, or if, we determine it is appropriate to do so as events and circumstances dictate. However, we believe that this specific allowance is adequate to provide for anticipated loan losses based on currently available information.
Results of Operations by Business Segment-
For the Three Months Ended June 30, 2004 compared to the Three Months Ended June 30, 2003
Long-Term Investment Operations
Net earnings from the long-term investment operations was $131.4 million for the second quarter of 2004 as compared to $16.4 million for the second quarter of 2003. The increase in net earnings of $115.0 million was primarily due to the following:
Mark-to-market loss—derivative instruments. Mark-to-market loss—derivative instruments decreased by $86.4 million to a gain of $78.6 million for the second quarter of 2004 as compared to a loss of $7.8 million for the second quarter of 2003. Mark-to-market loss—derivative instruments declined as future expectations of short-term rates positively affected the value of derivatives.
Net interest income. Net interest income rose by $30.6 million to $60.7 million for the second quarter of 2004 as compared to $30.1 million for the second quarter of 2003 primarily due to an increase in total average mortgage assets. Mortgage assests increased as the investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter of 2003, which in turn led to an increase in average CMO collateral and mortgages held-for-investment as shown in the comparative yield table above. Refer to Note C. “Segment Reporting” in the notes to consolidated financial statements for additional detail.
Mortgage Operations
Net earnings from the mortgage operations include its results of operations for the consolidation period on a consolidated basis, see “Consolidation of IFC” above. Prior to the consolidation of IFC, its results of operations were included in equity in net earnings of IFC on the consolidated financial statements. Equity in net earnings of IFC is reflected in the Inter-company segment for purposes of segment reporting as shown in Note C. “Segment Reporting” in the notes to consolidated financial statements. As such, net earnings from the mortgage operations was $2.6 million during the consolidation period while equity in net earnings of IFC during the non-consolidation period was $10.2 million.
Warehouse Lending Operations
Net earnings from the warehouse lending operations was $9.2 million for the second quarter of 2004 as compared to $6.4 million for the second quarter of 2003. The increase in net earnings of $2.8 million was primarily due to an increase in net interest income. Net interest income increased during the second quarter of 2004 as total average affiliate and non-affiliate finance receivables increased. Refer to Note C. “Segment Reporting” in the notes to consolidated financial statements for additional detail.
Results of Operations —
For the Six Months Ended June 30, 2004 compared to the Six Months Ended June 30, 2003
Net earnings increased to $152.6 million, or $2.40 per diluted share, for the first six months of 2004 compared to $57.0 million, or $1.15 per diluted share, for the first six months of 2003. The period-over-period increase in net earnings of $95.6 million was primarily due to the following:
These variances are discussed in further detail below.
Net Interest Income
We earn interest income primarily on mortgage assets which include CMO collateral, mortgages held-for-investment, mortgages held-for-sale, 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. 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. For additional information on derivative instruments and their effect on net interest income during changing interest rate environments, refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk.”
Net interest income increased to $158.5 million for the first six months of 2004 compared to $72.5 million for the first six months of 2003. The period-over-period increase in net interest income was primarily due to an increase in average mortgage assets, which increased 93% to $12.9 billion for the first six months of 2004 compared to $6.7 billion for the first six months of 2003 as the long-term investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter of 2003. We primarily retain Alt-A mortgages that are acquired and originated by the mortgage operations and multi-family mortgages originated by IMCC that fit within our investment criteria. Alt-A and multi-family mortgages are ARMs and FRMs with good credit profiles with mortgage insurance enhancements, when required, that generally have prepayment penalty features and are primarily purchase money transactions.
The following table summarizes the principal balance of Alt-A mortgages acquired by the long-term investment operations from the mortgage operations and multi-family mortgages originated by IMCC by loan characteristic for the periods indicated (in thousands):
For the Six Months Ended June 30, | ||||||||||
2004 | 2003 | |||||||||
Principal Balance | % | Principal Balance | % | |||||||
Volume by Type: | ||||||||||
Adjustable rate | $ | 7,515,917 | 90 | $ | 1,668,971 | 74 | ||||
Fixed rate | 819,426 | 10 | 571,855 | 26 | ||||||
Total Mortgage Acquisitions | $ | 8,335,343 | 100 | $ | 2,240,826 | 100 | ||||
Volume by Product: | ||||||||||
Primarily six-month LIBOR indexed ARMs(1) | $ | 1,487,562 | 18 | $ | 833,798 | 38 | ||||
Primarily six-month LIBOR indexed hybrids(1) (2) | 5,817,367 | 70 | 718,996 | 32 | ||||||
Multi-family mortgages(3) | 210,988 | 3 | 116,178 | 5 | ||||||
Fixed rate first trust deeds | 699,590 | 8 | 565,111 | 25 |
Fixed rate second trust deeds Total Mortgage Acquisitions Volume by Credit Quality: Alt-A loans B/C loans(4) Total Mortgage Acquisitions Volume by Purpose: Purchase Refinance Total Mortgage Acquisitions Volume by Prepayment Penalty: With prepayment penalty Without prepayment penalty Total Mortgage Acquisitions 119,836 1 6,743 0 $ 8,335,343 100 $ 2,240,826 100 $ 8,310,512 100 $ 2,228,641 99 24,831 0 12,185 1 $ 8,335,343 100 $ 2,240,826 100 $ 5,007,883 60 $ 1,086,022 48 3,327,460 40 1,154,804 52 $ 8,335,343 100 $ 2,240,826 100 $ 5,955,665 71 $ 1,870,491 83 2,379,678 29 370,335 17 $ 8,335,343 100 $ 2,240,826 100
The increase in net interest income was also due to an increase in net interest margins on mortgage assets which increased 29 basis points to 2.45% for the first six months of 2004 as compared to 2.16% for the first six months of 2003. The following table summarizes average balance, interest and weighted average yield on mortgage assets and borrowings on mortgage assets for the periods indicated (dollars in thousands):
For the Six Months Ended June 30, | ||||||||||||||||||
2004 | 2003 | |||||||||||||||||
(as restated) | ||||||||||||||||||
Average Balance | Interest | Yield | Average Balance | Interest | Yield | |||||||||||||
MORTGAGE ASSETS | ||||||||||||||||||
Investment securities available-for-sale | $ | 13,022 | $ | 2,631 | 40.41 | % | $ | 24,891 | $ | 1,241 | 9.97 | % | ||||||
CMO collateral(1) | 10,938,704 | 239,372 | 4.38 | 5,944,484 | 152,003 | 5.11 | ||||||||||||
Mortgages held-for-investment and held-for-sale(2) | 1,454,376 | 40,985 | 5.64 | 160,040 | 4,493 | 5.61 | ||||||||||||
Finance receivables | 449,349 | 11,525 | 5.13 | 537,555 | 13,768 | 5.12 | ||||||||||||
Total Mortgage Assets | $ | 12,855,451 | $ | 294,513 | 4.58 | % | $ | 6,666,970 | $ | 171,505 | 5.14 | % | ||||||
BORROWINGS | ||||||||||||||||||
CMO borrowings(3) | $ | 10,703,651 | $ | 117,181 | 2.19 | % | $ | 5,817,476 | $ | 83,908 | 2.88 | % | ||||||
Reverse repurchase agreements | 1,825,396 | 19,615 | 2.15 | 1,182,620 | 14,096 | 2.38 | ||||||||||||
Borrowings secured by investment securities(4) | — | — | 5,059 | 1,484 | 58.67 | |||||||||||||
Total borrowings on Mortgage Assets | $ | 12,529,047 | $ | 136,796 | 2.18 | % | $ | 7,005,155 | $ | 99,488 | 2.84 | % | ||||||
Net Interest Spread(5) | 2.40 | % | 2.30 | % | ||||||||||||||
Net Interest Margin(6) | 2.45 | % | 2.16 | % | ||||||||||||||
Net Cash Payments on Derivatives(7) | $ | 35,745 | $ | 23,007 | ||||||||||||||
Net Interest Margin including Net Cash Payments on Derivatives(8) | 1.90 | % | 1.47 | % |
The increase in net interest margins was primarily due to the consolidation of the mortgage operations on July 1, 2003. The consolidation of the mortgage operations contributed to a 21 basis point increase in net interest margins on mortgage assets during the first six months of 2004 as mortgages held-for-sale were consolidated with total average mortgage assets. During the first six months of 2003, mortgages held-for-sale were not consolidated with total average mortgage assets as IFC was a non-consolidated entity prior to July 1, 2003. Net interest margins on mortgages held-for-sale were favorable during the first six months of 2004 due to a steep yield curve as compared to the first six months of 2003. The yield curve represents the mathematical difference between short-term interest rates and long-term interest rates. Because the mortgage operations establishes interest rates on its mortgages by indexing those interest rates to long-term market interest rates and finances mortgages with borrowings that are indexed to short-term interest rates, a steep yield curve benefits net interest margins.
Mark to Market Gain (Loss) – Derivative Instruments
During the six months ended June 30, 2004, mark –to-market gain (loss) derivative instruments increased to a gain of $41.3 million as compared to a loss of $(14.9) million for the same period in the previous year. The increase in mark–to-market gain (loss) derivative instruments was the result of a sharp increase in the one month forward LIBOR curve as a result of the Federal Reserves statement that they intended to raise short term interest rates at a measured pace. This resulted in an adjustment to future expectations of short term rates which affected the value of our derivative instruments. We enter into derivative contracts to manage the various risks associated with certain specific liabilities. On the date we enter into various derivative contracts, the derivatives were designated as an economic hedge of the variability in expected future cash flows associated with a financing obligation or future liability. In our consolidated financial statements, we now record a market valuation adjustment for economic hedges and any subsequent cash payments paid or received on these derivatives as a current period expense or revenue in mark-to-market loss – derivative instruments on the consolidated financial statements. In addition, we account for certain forward purchase commitments on mortgage loans as free-standing derivatives, and record the change in fair value of such instruments and the related derivatives used to hedgemanage the interest rate risk on the mortgage loan pipeline as a current period expense or revenue.
Non-Interest and Income Tax Expense
Non-interest and income tax expense increased to $46.2 million forrepresents the first six months of 2004 as compared to $3.6 million for the first six months of 2003. The period-over-period increase in non-interest and income tax expense was primarily due to a $40.6 million increase in operating costs. The increase in operating costs was primarily due to the consolidationmajority of the mortgage operations on July 1, 2003. Operating costsdifference in the earnings and profits generated by the mortgage operations was reported on a consolidated basis for the consolidation period, however, for the non-consolidation period the financial results of IFC were reported as equity in net earnings of IFC on the consolidated financial statements. As such, operating costs increased to $44.7 million for the first six months of 2004 as compared to $4.1 million for the first six months of 2003. Operating costs include personnel expense, professional services, equipment expense, occupancy expense, data processing expense and general and administrative and other expense. Personnel expense, which primarily includes salary, wages and benefit costs, was $30.0 million, or 67% of total operating costs, during the second quarter of 2004 as compared to $1.5 million during the second quarter of 2003. Personnel related costs are variable expenses and are primarily driven by mortgage acquisitions and originations. Mortgage acquisitions and originations increased to $5.5 billion during the second quarter of 2004 as compared to $1.9 billion during the second quarter of 2003. The following table summarizes the principal balance of mortgage acquisitions and originations by loan characteristic for the periods indicated (in thousands):
By Loan Type: Fixed rate first trust deed Fixed rate second trust deed Adjustable rate: Primarily six-month LIBOR indexed ARMs (1) Primarily six-month LIBOR indexed hybrids (2) Total adjustable rate Total Mortgage Acquisitions and Originations By Production Channel: Correspondent acquisitions: Flow Bulk, or non-Impac mortgages Total correspondent acquisitions Wholesale and retail originations Novelle Financial Services, Inc. Total Mortgage Acquisitions and Originations By Credit Quality: Alt-A B/C (3) Total Mortgage Acquisitions and Originations By Purpose: Purchase Refinance Total Mortgage Acquisitions and Originations By Prepayment Penalty: With prepayment penalty Without prepayment penalty Total Mortgage Acquisitions and Originations For the Six Months Ended June 30, 2004 2003 Principal
Balance % Principal
Balance % $ 1,278,549 14 $ 1,885,593 51 280,762 3 53,807 2 1,433,056 16 923,102 25 5,927,440 67 809,298 22 7,360,496 83 1,732,400 47 $ 8,919,807 100 $ 3,671,800 100 $ 4,622,008 52 $ 2,128,928 58 3,039,927 34 663,445 18 7,661,935 86 2,792,373 76 918,519 10 667,187 18 339,353 4 212,240 6 $ 8,919,807 100 $ 3,671,800 100 $ 8,554,519 96 $ 3,441,339 94 365,288 4 230,461 6 $ 8,919,807 100 $ 3,671,800 100 $ 5,186,099 58 $ 1,626,400 44 3,733,708 42 2,045,400 56 $ 8,919,807 100 $ 3,671,800 100 $ 6,308,842 71 $ 3,029,803 83 2,610,965 29 641,997 17 $ 8,919,807 100 $ 3,671,800 100
Operating costs increased at a lower incremental per loan rate relative to mortgage acquisitions and originations as 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. In addition, a higher percentage of non-Impac mortgage acquisitions during the first six months of 2004 contributed to lower per loan acquisition costs2005 as compared to the first six months of 2003. Non-Impac Alt-A mortgage acquisitions, which are acquired as bulkquarter 2005. The remaining difference is represented by an adjustment related to loan packages, generally require less staffing and corresponding operating costs than Impac Alt-A mortgages, which are acquired on a flow, or loan-by-loan basis. During the first six months of 2004 non-Impac mortgages accounted for 34% of total mortgage acquisitions and originations compared to 18% during the first six months of 2003.
Provision for Loan Losses
Provision for loan losses were $25.0 million for the first six months of 2004 as compared to $13.5 million for the first six months of 2003. The period-over-period increaseservicing income in provision for loan losses was primarily due to an increase in our mortgage loan portfolio as the long-term investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter of 2003, which required a corresponding increase in allowance for loan losses.
In additions, at the end of the first quarter of 2004, we discovered$3.2 million that one client ofdid not occur during the warehouse lending operationssecond quarter and certain of its officers had perpetrated a fraud pursuant to which they defrauded the warehouse lending operations into making advances pursuant to a warehouse line of credit. As of the date the fraud was discovered, an aggregate of $12.6$4.7 million of fraudulent loan advances were outstanding. We immediately terminatedstock option expense that occurred during the warehouse line of credit and have been cooperating with federal investigators in their ongoing investigation of the defrauding parties. It appears that the defrauding parties had perpetrated a similar fraud on another warehouse lender. We retained an independent consultant to investigate the matter; the investigator reported thatsecond quarter when no principals of the warehouse lending operations had knowingly participated in the fraud and stated that it is not likely that any other client of the warehouse lending operations could duplicate the same fraud. With the aid of independent counsel, the audit committee of our board of directors reviewed the report and the scope of the investigation and concurs with the assessment set forth in the report. In response, we have taken steps to enhance procedures at our warehouse lending operations, including improvements of the application approval and funding processes of mortgage bankers and follow-up quality control checks. As a result of the fraud,such expense was incurred during the first quarter of 2004 we established2005. Historically, this taxable expense was spread out over a specific allowance for loan losses in the amountlonger period of $6.0 million to provide for anticipated losses on the fraudulent warehouse advances as we have deemed this amount to be non-collectible. During the second quarter of 2004 we increased the specific allowance for loan losses by $2.0 million to $8.0 milliontime, but as a result of the re-evaluation of the remaining collateral. Based on available information, we believe we will be able to recover the remaining $4.6 million of related warehouse advances. Because we deem $8.0 million of the total warehouse advances to be non-collectible and anticipate that it will result in a tax deduction upon thedelayed filing of our 2004 corporate income tax return, we reflected the $8.0 million as a reductionForm 10-K/A Amendment No. 2 to estimated taxable income for the second quarter of 2004 as shown in the reconciliation of net earnings to estimated taxable income above. To the extent that we believe that the actual losses will exceed the $8.0 million allowance, we will make an additional allowance for loan losses when, or if, we determine it is appropriate to do so as eventsinclude audited financial statements, employees were prohibited from exercising options.
Financial Condition and circumstances dictate. However, we believe that this specific allowance is adequate to provide for anticipated loan losses based on currently available information.
Results of Operations by Business Segment-
For the Six Months Ended June 30,, 2004 compared to the Six Months Ended June 30, 2003
Long-Term Investment Operations
Net earnings from the long-term investment operations was $137.7 million for the first six months of 2004 as compared to $34.6 million for the first six months of 2003. The increase in net earnings of $103.1 million was primarily due to the following:
Mark-to-market loss—derivative instruments. Mark-to-market loss—derivative instruments decreased by $54.5 million to a gain of $39.6 million for the first six months of 2004 as compared to a loss of $14.9 million for the first six months of 2003. Mark-to-market loss—derivative instruments declined as future expectations of short-term rates positively affected the value of derivatives.
Net interest income. Net interest income rose by $50.8 million to $112.1 million for the first six months of 2004 as compared to $61.3 million for the first six months of 2003 primarily as the long-term mortgage portfolio rose. The long-term investment operations retained $11.7 billion of primarily Alt-A mortgages from the mortgage operations and $385.3 million of multi-family mortgages originated by IMCC since the end of the second quarter of 2003, which in turn led to an increase in average CMO collateral and mortgages held-for-investment as shown in the comparative yield table above. Refer to Note C. “Segment Reporting” in the notes to consolidated financial statements for additional detail.
Mortgage Operations
Net earnings from the mortgage operations include its results of operations for the consolidation period on a consolidated basis, see “Consolidation of IFC” above. Prior to the consolidation of IFC, its results of operations were included in equity in net earnings of IFC on the consolidated financial statements. Equity in net earnings of IFC is reflected in the Inter-company segment for purposes of segment reporting as shown in Note C. “Segment Reporting” in the notes to consolidated financial statements. As such, net earnings from the mortgage operations was $2.3 million during the consolidation period while equity in net earnings of IFC during the non-consolidation period was $11.5 million.
Warehouse Lending Operations
Net earnings from the warehouse lending operations was $12.7 million for the first six months of 2004 as compared to $12.1 million for the first six months of 2003. The increase in net earnings was primarily due to an decrease in net interest income. Refer to Note C. “Segment Reporting” in the notes to consolidated financial statements for additional detail.
Financial Condition
Condensed Balance Sheet Data
(dollars in thousands)
June 30, 2005 | December 31, 2004 | Increase (Decrease) | % Change | |||||||||||
CMO collateral | $ | 23,980,050 | $ | 21,308,906 | 2,671,144 | 13 | % | |||||||
Mortgages held-for-investment | 232,019 | 586,686 | (354,667 | ) | (60 | ) | ||||||||
Finance receivables | 382,900 | 471,820 | (88,920 | ) | (19 | ) | ||||||||
Allowance for loan losses | (69,826 | ) | (63,955 | ) | (5,871 | ) | 9 | |||||||
Mortgages held-for-sale | 1,281,125 | 587,745 | 693,380 | 118 | ||||||||||
Other assets | 692,542 | 924,565 | (232,023 | ) | (25 | ) | ||||||||
Total assets | $ | 26,498,810 | $ | 23,815,767 | 2,683,043 | 11 | % | |||||||
CMO borrowings | $ | 23,544,517 | $ | 21,206,373 | 2,338,144 | 11 | ||||||||
Reverse repurchase agreements | 1,732,266 | 1,527,558 | 204,708 | 13 | ||||||||||
Other liabilities | 174,018 | 37,761 | 136,257 | 361 | ||||||||||
Total liabilities | 25,450,801 | 22,771,692 | 2,679,109 | 12 | ||||||||||
Total stockholders’ equity | 1,048,009 | 1,044,075 | 3,934 | 0 | ||||||||||
Total liabilities and stockholders’ equity | $ | 26,498,810 | $ | 23,815,767 | 2,683,043 | 11 | % | |||||||
Total assets grew 63%11% to $17.3$26.5 billion as of June 30, 20042005 as compared to $10.6$23.8 billion as of December 31, 20032004 as the long-term investment operations retained $8.3$6.4 billion of primarily adjustable rate and fixed rate Alt-A mortgages and multi-family mortgages during the first six months of 2004. The following table presents selected financial data as of the dates indicated (dollars in thousands, except per share data and master servicing portfolio):
As of and For the Quarter Ended, | ||||||||||||
June 30, 2004 | December 31, 2003 | June 30, 2003 | ||||||||||
Book value per share | $ | 11.19 | $ | 8.39 | 6.96 | |||||||
Return on average assets | 3.92 | % | 1.95 | % | 1.65 | % | ||||||
Return on average equity | 92.81 | % | 49.57 | % | 40.36 | % | ||||||
Assets to equity ratio | 20.73:1 | 22.35:1 | 23.27:1 | |||||||||
Debt to equity ratio | 19.59:1 | 21.28:1 | 22.17:1 | |||||||||
Mortgages owned 60+ days delinquent | $ | 238,660 | $ | 175,313 | $ | 206,307 | ||||||
60+ day delinquency of mortgages owned | 1.49 | % | 1.79 | % | 3.28 | % | ||||||
Mortgages owned 90+ days delinquent and other real estate owned | $ | 180,617 | $ | 140,369 | $ | 172,900 | ||||||
90+ days delinquency of mortgages owned and other real estate owned to total assets | 1.05 | % | 1.33 | % | 2.11 | % | ||||||
Master servicing portfolio (in billions) | $ | 20,129 | $ | 13,920 | $ | 10,444 |
2005. The retention of mortgages (less mortgage prepayments) during the first six monthssecond quarter of 20042005 resulted in a 72%13% increase in mortgages held as CMO collateral to $14.8$24.0 billion as of June 30, 20042005 as compared to $8.6$21.3 billion as of December 31, 2003. 2004.
The following table presents selected information about mortgages held as CMO collateral as of the dates indicated:
As of the Quarter Ended, | As of | |||||||||||
June 30, 2004 | December 31, 2003 | June 30, 2003 | June 30, 2005 | December 31, 2004 | June 30, 2004 | |||||||
Percent of Alt-A mortgages | 99 | 99 | 99 | 99 | 99 | 99 | ||||||
Percent of ARMs | 88 | 86 | 81 | 91 | 90 | 88 | ||||||
Percent of FRMs | 12 | 14 | 19 | 9 | 10 | 12 | ||||||
Percent of hybrid ARMs | 61 | 48 | 33 | 75 | 70 | 61 | ||||||
Percent of interest-only | 64 | 63 | 49 | |||||||||
Weighted average coupon | 5.45 | 5.56 | 5.98 | 5.80 | 5.62 | 5.45 | ||||||
Weighted average margin | 3.33 | 3.10 | 3.00 | 3.66 | 3.61 | 3.33 | ||||||
Weighted average original LTV | 77 | 79 | 80 | 75 | 76 | 77 | ||||||
Weighted average original credit score | 698 | 694 | 689 | 697 | 696 | 698 | ||||||
Percent with active prepayment penalty | 76 | 76 | 76 | |||||||||
Prior 3-month CPR | 34 | 31 | 27 | 33 | 29 | 34 | ||||||
Prior 12-month CPR | 31 | 28 | 25 | 28 | 29 | 31 | ||||||
Percent with active prepayment penalty | 76 | 81 | 81 | |||||||||
Lifetime prepayment rate | 20 | 21 | 28 | |||||||||
Percent of mortgages in California | 64 | 64 | 63 | 59 | 62 | 64 | ||||||
Percent of purchase transactions | 58 | 57 | 57 | 59 | 60 | 58 | ||||||
Percent of owner occupied | 85 | 87 | 90 | 79 | 81 | 85 | ||||||
Percent of first lien | 99 | 99 | 99 | 99 | 99 | 99 |
The following table presents selected financial data as of the dates indicated (dollars in thousands, except per share data):
As of and Year to Date Ended, | ||||||||||||
June 30, 2005 | December 31, 2004 | June 30, 2004 | ||||||||||
Book value per share | $ | 11.77 | $ | 11.80 | $ | 11.19 | ||||||
Return on average assets | 0.92 | % | 1.51 | % | 2.32 | % | ||||||
Return on average equity | 21.24 | % | 35.62 | % | 54.13 | % | ||||||
Assets to equity ratio | 25.28:1 | 22.81:1 | 20.82:1 | |||||||||
Debt to equity ratio | 24.12:1 | 21.77:1 | 19.68:1 | |||||||||
Mortgages owned 60+ days delinquent | $ | 461,360 | $ | 381,290 | $ | 238,660 | ||||||
60+ day delinquency of mortgages owned | 2.01 | % | 1.74 | % | 1.49 | % |
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:
Credit Risk. We manage credit risk by retainingacquiring for long-term investment high credit quality Alt-A and multi-family mortgages from our customers, adequately providing for loan losses and actively managing delinquencies and defaults. Alt-A mortgages are primarily first lien mortgages made to borrowers whose credit is generally within typical Fannie Mae and Freddie Mac guidelines, but that have loan characteristics that make them non-conforming under those guidelines.
We believe that by improving the overall credit quality of our long-term mortgage portfolio we can consistently generate stable future cash flow and taxable income. As of June 30, 2004,2005, the original weighted average credit score of mortgages held as CMO collateral was 698697 and the original weighted average LTV ratio was 77%75%.
During the first six monthssecond quarter of 2004, we retained $8.12005, the long-term investment operations acquired $3.1 billion of primarily adjustable rate and fixed rate Alt-A mortgages that were acquired or originated by the mortgage operations with an original weighted average credit score of 699 and an original weighted average LTV ratio of 77%76%. OfIn addition, during the $8.1second quarter of 2005, the long-term investment operations acquired $2.0 billion of mortgages retained during the first six months of 2004, $3.0 billion were non-Impac mortgages that were acquired on a bulk basis by the mortgage operations with an original weighted average credit score of 700694 and an original weighted average LTV ratio of 77%78%. IMCC also originated $211.0$214.6 million of multi-family mortgages with a weighted average credit score of 722742 and an original weighted average LTV of 65%66%.
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 the number of 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. InAt foreclosure sales, we generally acquire title to the property. As of June 30, 2004,2005, our long-term mortgage portfolio included 1.49%2.01% of mortgages that were 60 days or more delinquent compared to 1.79%1.74% as of December 31, 2003.2004.
The following table summarizes mortgages in our long-term mortgage portfolio that were 60 or more days delinquent for the periods indicated (in thousands):
At June 30, 2004 | At December 31, 2003 | At June 30, 2005 | At December 31, 2004 | |||||||||
60-89 days delinquent | $ | 75,079 | $ | 51,173 | $ | 178,877 | $ | 139,872 | ||||
90 or more days delinquent | 43,864 | 52,080 | 135,687 | 68,877 | ||||||||
Foreclosures | 107,980 | 66,767 | 108,390 | 157,867 | ||||||||
Delinquent bankruptcies | 11,737 | 5,293 | 38,406 | 14,674 | ||||||||
Total 60 or more days delinquent | $ | 238,660 | $ | 175,313 | $ | 461,360 | $ | 381,290 | ||||
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, or “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 June 30, 2004,2005, seriously delinquent assets and other real estate owned as a percentage of total assets was 1.05%1.18% as compared to 1.33%1.09% as of December 31, 2003.
2004. The following table summarizes mortgages in our long-term mortgage portfolio that were seriously delinquent and other real estate owned for the periods indicated (in thousands):
At June 30, 2004 | At December 31, 2003 | |||||
90 or more days delinquent | $ | 163,581 | $ | 124,140 | ||
Other real estate owned | 17,036 | 16,229 | ||||
Total | $ | 180,617 | $ | 140,369 | ||
Additionally, an allowance is maintained for losses on mortgages held-for-investment, mortgages held as CMO collateral and finance receivables (loans provided for) at an amount that management believes provides for losses inherent in those loan portfolios. We have implemented a methodology designed to analyze the performance of various loan portfolios, based upon the relatively homogeneous nature within these loan portfolios. The allowance for losses is also analyzed using the following factors:
At June 30, 2005 | At December 31, 2004 | |||||
90 or more days delinquent | $ | 282,483 | $ | 241,418 | ||
Other real estate owned | 29,477 | 18,277 | ||||
Total | $ | 311,960 | $ | 259,695 | ||
The Company’s loan portfolio increased 147% to $21.3 billion for the year ended December 31, 2004 and increased 13% to $23.98 billion during the six-month period ended June 30, 2005. During 2005, the Company increased the amount of sales to third party investors and retained less new loan production than in the past which results in a larger proportion of the net loss potential of mortgages in the long-term mortgage portfolio based on prior loan loss experience;
In evaluating the adequacy of the allowance for loan losses, a detailed analysis of historical loan performance data is accumulated and reviewed. This data is analyzed for loss performance and prepayment performance by product type, origination year and securitization issuance. The results of that analysis are then applied to the current mortgage portfolio and an estimate is created. We believe that pooling of mortgages with similar characteristics is an appropriate methodology in which to evaluate the allowance for loan losses. In addition, management provides an allowance for loan losses for Alt-A mortgages that are retained for long-term investment and which are not underwritten to our specific underwriting guidelines. These mortgages are acquired on a bulk basis by the mortgage operations from other mortgage originators that underwrite mortgages substantially similar, but not specific, to our mortgage underwriting guidelines, or “non-Impac mortgages.” Management also recognizes that there are qualitative factors that must be taken into consideration when evaluating and measuring inherent loss in our loan portfolios. These items include, but are not limited to, economic indicators that may affect the borrower’s ability to pay, changes in value of collateral, political factors and industry statistics.
Additions to the allowance are provided through a charge to earnings. Specific valuation allowances may be established fornewly originated loans that are deemed impaired, if defaultcurrent. The seasoned loans with higher expected delinquency rates are not being offset by the borrower is deemed probable, and if the fair value of the loan or the collateral is estimated to be less than the gross carrying value of the loan. Actual losses on loans are recorded as a reduction to the allowance through charge-offs. Subsequent recoveries of amounts previously charged off are credited to the allowance. For loans on non-accrual status, cash receipts are applied, and interest income is recognized, on a cash basis. For all other impaired loans, cash receipts are applied to principal and interest in accordance with the contractual terms of the loan and interest income is recognized on the accrual basis. Generally, a loan may be returned to accrual status when all delinquent principal and interest are broughtmuch newly originated current in accordance with the terms of the loan agreement.
As of June 30, 2004, allowance for loan losses increased to $60.2 million as compared to $38.6 million as of December 31, 2003 as we retained $8.3 billion of mortgages year-to-date and increased allowance for loan losses accordingly. In addition, we established a specific allowance for loan losses in the amount of $8.0 million to provide for anticipated losses on the fraudulent warehouse advances, as discussed above, as we have deemed this amount to be non-collectible. In our opinion and in accordance with our loan loss allowance methodology, we believe that the present allowance for loan losses is adequate to provide for losses inherent in our loan portfolios.production.
Prepayment Risk. As of June 30, 2004,2005, 76% of mortgages held as CMO collateral had prepayment penalty features as compared to 81%76% as of December 31, 2003. 71%2004. 70% of Alt-A mortgages retainedacquired by the long-term investment operations during the first six months of 20042005 had prepayment penalty features ranging from two to seven years as compared to 83%71% during the first six months of 2003.2004. Additionally, 100% of Multi-family mortgages originated have prepayment penalty features ranging from three to ten years. Mortgages held as CMO collateral had a 28% 12-month CPR of 31% as of June 30, 20042005 as compared to a29% 12-month CPR of 25% as of June 30, 2003.2004.
Liquidity Risk.We employ a leveragingleverage strategy to increase assets by financing our long-term mortgage portfolio primarily with CMO borrowings, reverse repurchase agreements and capital and then using cash proceeds to acquire additional mortgage assets. We retainThe long-term investment operations acquires ARMs and FRMs that are acquired and originated by the mortgage operations and financefinances the acquisition of those mortgages, during this accumulation period, with reverse repurchase agreements. After
accumulating a pool of mortgages, generally between $200 million and $2.0 billion, we securitize the mortgages in the form of CMOs. Our strategy is to securitize our mortgages every 15 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 prepayment and loss rates of our 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. However, the ratio of total assets to total equity, or “leverage ratio,” declined to 20.73 to 1 as of June 30, 2004 compared to 22.35 to 1 as of December 31, 2003 as capital that was raised during the second quarter of 2004 was not fully deployed in the acquisition of mortgage assets as of quarter-end. We continually
monitor our leverage ratioratios 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
For the Three Months Ended June 30, 2005 compared to the Three Months Ended June 30, 2004
Condensed Statements of Operations Data
(dollars in thousands, except share data)
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||||
Interest income | $ | 309,785 | $ | 160,719 | $ | 149,066 | 93 | % | |||||||
Interest expense | 243,632 | 75,269 | 168,363 | 244 | |||||||||||
Net interest income | 66,153 | 85,450 | (19,297 | ) | (23 | ) | |||||||||
Provision for loan losses | 5,711 | 15,282 | (9,571 | ) | (63 | ) | |||||||||
Net interest income after provision for loan losses | 60,442 | 70,168 | (9,726 | ) | (14 | ) | |||||||||
Total non-interest income | (77,734 | ) | 98,268 | (176,002 | ) | (179 | ) | ||||||||
Total non-interest expense | 41,832 | 28,094 | 13,738 | 49 | |||||||||||
Income taxes | (4,124 | ) | (2,872 | ) | (1,252 | ) | 44 | ||||||||
Net earnings (loss) | $ | (55,000 | ) | $ | 143,214 | $ | (198,214 | ) | (138 | )% | |||||
Net earnings per share—diluted | $ | (0.78 | ) | $ | 2.17 | $ | (2.95 | ) | (136 | )% | |||||
Dividends declared per common share | $ | 0.75 | $ | 0.75 | $ | — | — | % |
For the Six Months Ended June 30, 2005 compared to the Six Months Ended June 30, 2004
Condensed Statements of Operations Data
(dollars in thousands, except share data)
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||||
Interest income | $ | 587,164 | $ | 294,856 | $ | 292,308 | 99 | % | |||||||
Interest expense | 439,905 | 136,883 | 303,022 | 221 | |||||||||||
Net interest income | 147,259 | 157,973 | (10,714 | ) | (7 | ) | |||||||||
Provision for loan losses | 11,785 | 25,007 | (13,222 | ) | (53 | ) | |||||||||
Net interest income after provision for loan losses | 135,474 | 132,966 | 2,508 | 2 | |||||||||||
Total non-interest income | 57,785 | 64,350 | (6,565 | ) | (10 | ) | |||||||||
Total non-interest expense | 81,236 | 52,114 | 29,122 | 56 | |||||||||||
Income taxes | (6,587 | ) | (7,384 | ) | 797 | (11 | ) | ||||||||
Net earnings | $ | 118,610 | $ | 152,586 | $ | (33,976 | ) | (22 | )% | ||||||
Net earnings per share—diluted | $ | 1.46 | $ | 2.40 | $ | (0.94 | ) | (39 | )% | ||||||
Dividends declared per common share | $ | 1.50 | $ | 1.40 | $ | 0.10 | 7 | % |
Net Interest Income
We earn interest income primarily on mortgage assets which include CMO collateral, mortgages held-for-investment, mortgages held-for-sale, 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. Interest expense is primarily interest paid on borrowings on mortgage assets, which include CMO borrowings and reverse repurchase agreements. The following table summarizes average balance, interest and weighted average yield on mortgage assets and borrowings on mortgage assets for the periods indicated (dollars in thousands):
For the Three Months Ended June 30, | ||||||||||||||||||||
2005 | 2004 | |||||||||||||||||||
Average Balance | Interest | Yield | Average Balance | Interest | Yield | |||||||||||||||
MORTGAGE ASSETS | ||||||||||||||||||||
CMO collateral (1) | $ | 23,440,857 | $ | 264,359 | 4.51 | % | $ | 12,329,669 | $ | 132,630 | 4.30 | % | ||||||||
Mortgages held-for-investment and mortgages held-for-sale | 2,397,955 | 38,907 | 6.49 | 1,474,639 | 19,499 | 5.29 | ||||||||||||||
Finance receivables | 341,905 | 4,752 | 5.56 | 462,412 | 6,428 | 5.56 | ||||||||||||||
Investment securities available-for-sale | 25,245 | 320 | 5.07 | 28,381 | 1,815 | 25.58 | ||||||||||||||
Total mortgage assets | $ | 26,205,962 | $ | 308,338 | 4.71 | % | $ | 14,295,101 | $ | 160,372 | 4.49 | % | ||||||||
BORROWINGS | ||||||||||||||||||||
CMO borrowings | $ | 23,024,518 | $ | 216,255 | 3.76 | % | $ | 12,067,093 | $ | 65,187 | 2.16 | % | ||||||||
Reverse repurchase agreements | 2,541,772 | 25,982 | 4.09 | 1,841,645 | 10,062 | 2.19 | ||||||||||||||
Total borrowings on mortgage assets | $ | 25,566,290 | $ | 242,237 | 3.79 | % | $ | 13,908,738 | $ | 75,249 | 2.16 | % | ||||||||
Net interest spread (2) | 0.92 | % | 2.33 | % | ||||||||||||||||
Net interest margin (3) | 1.01 | % | 2.38 | % | ||||||||||||||||
Net interest income on mortgage assets | $ | 66,101 | 1.01 | % | $ | 85,123 | 2.38 | % | ||||||||||||
Less: Accretion of loan discounts (4) | (20,553 | ) | (0.31 | ) | (12,250 | ) | (0.34 | ) | ||||||||||||
Less: Net cash payments on derivatives (5) | (1,456 | ) | (0.02 | ) | (23,422 | ) | (0.66 | ) | ||||||||||||
Adjusted net interest margin (6) | $ | 44,092 | 0.67 | % | $ | 49,451 | 1.38 | % | ||||||||||||
Effect of amortization of loan premiums and CMO securitization costs (7) | $ | 73,536 | 1.12 | % | $ | 35,695 | 1.00 | % |
CMO collateral (1) Mortgages held-for-investment and mortgages held-for-sale Finance receivables Investment securities available-for-sale Total mortgage assets CMO borrowings Reverse repurchase agreements Total borrowings on mortgage assets Net interest spread (2) Net interest margin (3) Net interest income on mortgage assets Less: Accretion of loan discounts (4) Less: Net cash payments on derivatives (5) Adjusted net interest margin (6) Effect of amortization of loan premiums and CMO securitization costs (7) For the Six Months Ended June 30, 2005 2004 Average
Balance Interest Yield Average
Balance Interest Yield MORTGAGE ASSETS $ 22,745,368 $ 508,734 4.47 % $ 10,938,808 $ 238,837 4.37 % 2,042,039 65,135 6.38 1,455,628 40,985 5.63 363,242 9,839 5.42 449,349 11,525 5.13 25,219 652 5.17 29,305 2,841 19.39 $ 25,175,868 $ 584,360 4.64 % $ 12,873,090 $ 294,188 4.57 % BORROWINGS $ 22,387,127 $ 395,722 3.54 % $ 10,684,259 $ 117,181 2.19 % 2,209,170 42,744 3.87 1,825,396 19,616 2.15 $ 24,596,297 $ 438,466 3.57 % $ 12,509,655 $ 136,797 2.19 % 1.07 % 2.38 % 1.16 % 2.45 % $ 145,894 1.16 % $ 157,391 2.45 % (37,585 ) (0.30 ) (20,427 ) (0.32 ) (15,183 ) (0.12 ) (35,745 ) (0.56 ) $ 93,126 0.74 % $ 101,219 1.57 % $ 138,599 1.10 % $ 60,602 0.94 %
(1) | Interest includes amortization of acquisition cost on mortgages acquired from the mortgage operations and accretion of loan discounts, which primarily represents the amount allocated to MSRs when MSRs are sold to third parties and mortgages are transferred from the mortgage operations to the long-term investment operations and retained for long-term investment. |
(2) | Net interest spread on mortgage assets is calculated by subtracting the weighted average yield on total borrowings on mortgage assets from the weighted average yield on total mortgage assets. |
(3) | Net interest margin on mortgage assets is calculated by subtracting interest expense on total borrowings on mortgage assets from interest income on total mortgage assets and then dividing by total mortgage assets. |
(4) | Yield represents income from the accretion of loan discounts, as defined in (1), divided by total average mortgage assets. |
(5) | Yield represents net cash payments on derivatives divided by total average mortgage assets. |
(6) | Adjusted net interest margin on mortgage assets is calculated by subtracting interest expense on total borrowings on mortgage assets, accretion of loan discounts and net cash payments on derivatives from interest income on total mortgage assets and dividing by total average mortgage assets. Net cash payments on derivatives are a component of gain (loss) on derivatives on the consolidated statements of operations. Adjusted net interest margins on mortgage assets is a non-GAAP financial measurement, however, the reconciliation provided in this table meets the requirements of Regulation G as promulgated by the SEC for the presentation of non-GAAP financial measurements. We believe that the presentation of adjusted net interest margin on mortgage assets is useful information for our investors as it more closely reflects the true economics of net interest margins on mortgage assets. |
(7) | The amortization of loan premiums and CMO securitization costs are components of interest income and interest expense, respectively. Yield represents the cost of amortization of net loan premiums and CMO securitization costs divided by total average mortgage assets. |
Comparatively, decreases in net interest income were primarily due to a decline in net interest margins on mortgage assets primarily caused by the following:
Second Quarter 2005 vs. Second Quarter 2004
Net interest margins on mortgage assets declined by 137 basis points to 1.01% for the second quarter of 2005 as compared to 2.38% for the second quarter of 2004. Net interest margin on mortgage assets declined as one-month LIBOR, which is the interest rate index used to price borrowing costs on CMO and reverse repurchase borrowings, rose approximately 200 basis points since the end of the second quarter of 2004 while mortgage assets over the same period did not re-price upward as quickly. Net interest margin on mortgage assets are more susceptible to changes in interest rates due to differences in interest rate adjustments between mortgage assets and borrowings on mortgage assets as follows:
Examples of interest rate differences include the following:
Due to higher mortgage prepayments during the second quarter of 2005, amortization of mortgage premiums and CMO securitization cost increased by 12 basis points to 112 basis points of total average mortgage assets as compared to 100 basis points of total average mortgage assets during the second quarter of 2004. Along with an increase in short-term interest rates, our expectation was that a corresponding decline in mortgage prepayment rates would follow. However, mortgage prepayment rates accelerated during the latter part of 2004 and continued through the second quarter of 2005. There is mortgage industry evidence which suggests that the increase in home appreciation rates over the last three years was a significant factor affecting Alt-A borrowers refinance decisions during 2004 and 2005. Borrowers appear willing to use equity to pay a loan prepayment penalty in order to obtain lower monthly payments by refinancing into other mortgage products. We collected prepayment penalty charges of $8.6 million, or 13 basis points of total average mortgage assets, during the second quarter of 2005 as compared to $2.3 million, or 6 basis points of total average mortgage assets, during the second quarter of 2004 which partially offset the increase in amortization costs caused by the prepayment of mortgages.
Because of the uncertainty surrounding our ability to raise capital last year during the process of restating our consolidated financial statements, we utilized CMO structures during the second half of 2004 which allowed
us to preserve existing capital through the use of higher leverage. Higher leverage CMOs were structured to require a lower level of initial capital investment than for CMOs completed prior to July 2004. Capital invested in higher leverage CMOs have been, and will continue to be, deposited into those specified CMO trusts from monthly excess cash flows on mortgages securing the CMOs until the required level of capital investment is attained. The use of higher leverage CMOs contributed to the decrease in net interest margins on total mortgage assets.
Net interest margin continues to be impacted by the difficult competitive environment facing mortgage portfolio lenders. As a result, spreads continue to tighten on newly originated loans. Furthermore, a rise in short-term rates and decline in long term rates has resulted in a flattening of the yield curve, adding pressure to mortgage lending profitability. Net interest margins on mortgage assets, which are based upon weighted average yield, declined to 101 basis points during the second quarter of 2005 as compared to 238 basis points in 2004. However, the adjusted net interest margins did not decline as much as net interest margins on mortgage assets primarily due to a 64 basis point decline in cash payments on derivatives relative to total average mortgage assets. Lower derivative costs relative to total average mortgage assets partially offset the decline in adjusted net interest margins on mortgage assets which was caused by the factors described above.
During the second quarter of 2005, adjusted net interest margins on mortgage assets declined to 67 basis points from 138 basis points in the 2004 period. Our interest rate risk management policies are formulated with the intent to partially offset the potential adverse effects of changing interest rates on mortgage assets and borrowings on mortgage assets which may result in variability in net interest margins.
First Half 2005 vs First Half 2004
During the 2005 six months period net interest income was impacted by a decline in net interest margins on mortgage assets. Net interest margins on mortgage assets declined by 129 basis points to 1.16% for the first six months of 2005 as compared to 2.45% for the same period in the previous year. Net interest margins on mortgage assets declined as one month LIBOR, which is the interest rate index used to price borrowing costs on CMO and reverse repurchase borrowings, rose approximately 200 basis points since the end of the second quarter of 2004 while mortgage assets over the same period did not re-price upward as quickly. Net interest margins on mortgage assets are susceptible to changes in interest rates due to differences in interest rate adjustments between mortgage assets and borrowings on mortgage assets as follows:
Examples of differences in interest rate indices adjustment periods include the following (addressed in the same order as above):
Due to higher mortgage prepayments during the first six months of 2005, amortization of mortgage premiums and CMO securitization costs increased by 16 basis points to 110 basis points of total average mortgage assets as compared to 94 basis points of total average mortgage assets during the first six months of 2004. Along with an increase in short-term interest rates, our expectation, based on past experience, was that a corresponding decline in mortgage prepayment rates would follow. However, mortgage prepayment rates accelerated during the latter part of 2004 and during the first six months of 2005. There is mortgage industry evidence which indicates that the increase in home appreciation rates over the last three years was a significant factor affecting Alt-A borrowers’ refinance decisions during 2004. Borrowers appear willing to use equity to pay a loan prepayment penalty in order to obtain lower monthly payments by refinancing into other mortgage products, including interest-only and high loan-to-value mortgage products. However, we collected prepayment penalty charges of $13.9 million, or 11 basis points of total average mortgage assets, during the first six months of 2005 as compared to $3.4 million, or 5 basis points of total average mortgage assets, during the first six months of 2004 which partially offset the increase in amortization costs caused by the prepayment of mortgages.
Because of the uncertainty surrounding our ability to raise capital last year during the process of restating our consolidated financial statements, we utilized CMO structures during the second half of 2004 which allowed us to preserve existing capital through the use of higher leverage and lower net interest margins. Higher leverage CMOs were structured to require a lower level of initial capital investment than for CMOs completed prior to July 2004. Capital invested in higher leverage CMOs have been, and will continue to be, deposited into those specific CMO trusts from monthly excess cash flows on mortgages securing the CMOs until the required level of capital investment is attained. The use of higher leverage CMOs contributed to compressed net interest margins on total mortgage assets.
Additionally, the net interest margin continues to be impacted by the difficult competitive environment facing mortgage portfolio lenders. As a result, spreads continue to tighten on newly originated loans. Furthermore, a rise in short-term rates and decline in long term rates has resulted in a flattening of the yield curve, adding pressure to mortgage lending profitability.
During the six months ended June 30, 2005, adjusted net interest margins on mortgage assets, which is a non-GAAP financial measurement as indicated in the yield table above, decreased by 83 basis points as compared to a decline of 129 basis points on net interest margin on mortgage assets. Adjusted net interest margin on mortgage assets did not decline as much net interest margin on mortgage assets primarily due to a 44 basis point decline in cash payments on derivatives relative to total average mortgage assets. Lower derivative costs relative to total average mortgage assets partially offset the decline in adjusted net interest margins on mortgage assets which was caused by the factors described above. Our interest rate risk management policies are formulated with the intent to partially offset the potential adverse effects of changing interest rates on mortgage assets and borrowings on mortgage assets which may result in variability in adjusted net interest margin.
For further information on our interest rate risk management policies refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk.”
Provision for Loan Losses
The Company’s loan portfolio increased 147% to $21.3 billion for the year ended December 31, 2004 and increased 13% to $23.98 billion during the six-month period ended June 30, 2005. During 2005, the Company increased the amount of sales to third party investors and retained less new loan production as in the past which results in a larger proportion of the mortgage portfolio as seasoned loans and a smaller proportion of newly originated loans that are current. The seasoned loans with higher expected delinquency rates are not being offset by as much newly originated current production.
The Company provides for loan losses in accordance with its policies that include a detailed analysis of historical loan performance data which is analyzed for loss performance and prepayment performance by product
type, origination year and securitization issuance. The results of that analysis are then applied to the current mortgage portfolio and an estimate is created. As the loan portfolio grew more rapidly in 2004 as compared to 2005, the Company correspondingly recorded more provision for loans losses in 2004 as compared to 2005.
During the second quarter of 2004, a $2.0 million specific impairment was included in the provision for loan losses for warehouse advances that were deemed to be permanently impaired as compared to no specific impairments during the second quarter of 2005. As a result, the provision decreased to $5.7 million for the second quarter of 2005 as compared to $15.3 million for same period in 2004. Actual losses on mortgages were $2.7 million and $1.3 million for the second quarter of 2005 and 2004, respectively. The Company does not expect a percentage change or increasing trend with respect to delinquencies/loan losses due to the credit quality of its portfolio.
As a result of slower growth in the Company’s asset portfolio, loan loss provisions will tend to reflect dollar increase when compared to prior periods. Such variances would level out in the event that the portfolio was continuously maintained on a flat growth basis for the periods presented. The Company does not expect a percentage change or increasing trend with respect to delinquencies/loan losses due to the credit quality of its portfolio. Provision for loan losses decreased to $11.8 million during the first six months of 2005 as compared to $25.0 million during the same period in the previous year. However, provision for loan losses during the first six months of 2004 includes a $8 million specific impairment that was recorded for warehouse advances that were deemed to be permanently impaired as compared to no specific impairments during the first six months of 2005. Actual losses on mortgages deemed to be non-collectible were $5.9 million and $3.4 million for the first six months of 2005 and 2004, respectively. For further information on delinquencies in our long-term investment portfolio and non-performing assets refer to “Financial Condition—Credit Risk.”
Non-Interest Income (Quarterly)
Changes in Non-Interest Income
(dollars in thousands)
For the Three Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | |||||||||||
Gain (loss) on derivative instruments | $ | (99,135 | ) | $ | 77,881 | $ | (177,016 | ) | (227 | )% | ||||
Gain on sale of loans | 19,094 | 11,973 | 7,121 | 59 | ||||||||||
Gain on sale of investment securities | — | 5,183 | (5,183 | ) | (100 | ) | ||||||||
Other income | 2,307 | 3,231 | (924 | ) | (29 | ) | ||||||||
Total non-interest income (expense) | $ | (77,734 | ) | $ | 98,268 | $ | (176,002 | ) | (179 | )% | ||||
Gain (Loss) on Derivative Instruments. Gain (loss) on derivative instruments includes unrealized mark-to-market gain or loss on derivative instruments and net cash payments or receipts on derivatives. Unrealized mark-to-market gain (loss) on derivative instruments decreased to $(97.7) million during the second quarter of 2005 as compared to $101.3 million during the second quarter of 2004 while the cash derivative payments decreased to $1.5 million in second quarter of 2005 as compared to $23.4 million for second quarter of 2004. The decrease in market valuation adjustment was the result of changes in the expectation of future interest rates, which negatively impacted the fair value of derivatives during the second quarter of 2005 as compared to the second quarter of 2004. In addition, we had a greater notional amount of derivatives outstanding as of June 30, 2005 that were negatively impacted and caused a significant market valuation adjustment as compared to June 30, 2004. We enter into derivative contracts to offset the various risks associated with certain specific CMO liabilities. In our consolidated financial statements, we record a market valuation adjustment for derivatives, including certain forward purchase commitments on mortgages, as current period expense or revenue. Unrealized mark-to-market gain or loss on derivatives at IMH is not included as an addition or deduction for purposes of calculating taxable income as shown in the reconciliation table of net earnings to estimated taxable income in the “Taxable Income”
table. Cash payments on derivatives decreased to $1.5 million during the second quarter of 2005 as compared to $23.4 million during the second quarter of 2004. However, cash payments on derivatives declined to 2 basis points of total average mortgage assets during the second quarter of 2005 as compared to 66 basis points of total average mortgage assets during the second quarter of 2004. Cash payments on derivatives are recorded as current period expense or revenue on our consolidated financial statements and are included in the calculation of taxable income.
Gain on Sale of Loans.The quarter-over-quarter increase in gain on sale of loans was primarily due to an increase in the sales volume. The mortgage operations sold $2.3 billion of loans to third party investors during the second quarter of 2005 as compared to $439.5 million of mortgages sold to third party investors during the second quarter of 2004. Additionally, we use derivatives to protect the market value of mortgages when we have established a rate-lock commitment on a particular mortgage prior to its close and eventual sale or securitization. Any changes in interest rates on mortgages that we have committed to acquire at a particular rate until we sell or securitize the mortgage generally results in an increase or decrease in the market value of that mortgage. During the second quarter of 2005, the value of these derivatives resulted in a $8.2 million loss as compared to a gain of $7.0 million during the second quarter of 2004.
Non-Interest Income (Six Month Periods)
Changes in Non-Interest Income
(dollars in thousands)
For the Six Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||
Gain on derivative instruments | $ | 18,456 | $ | 41,251 | $ | (22,795 | ) | (55 | )% | ||||
Gain on sale of loans | 31,945 | 14,476 | 17,469 | 121 | |||||||||
Gain on sale of investment securities | — | 5,474 | (5,474 | ) | (100 | ) | |||||||
Other income | 7,384 | 3,149 | 4,235 | 134 | |||||||||
Total non-interest income (expense) | $ | 57,785 | $ | 64,350 | $ | (6,565 | ) | (10 | )% | ||||
Gain on Derivative Instruments. Mark-to-market gain on derivatives includes unrealized mark-to-market gain or loss on derivative instruments and net cash payments or receipts on derivatives. Unrealized mark-to-market gain (loss) on derivative instruments decreased to $33.6 million during the first six months of 2005 as compared to $77.0 million for the same period in the previous year while the cash derivative payments decreased to $15.2 million for the six months ended June 30, 2005 as compared to $35.7 million for the same period in the previous year. The decrease in market valuation adjustment was the result of changes in the expectation of future interest rates, which negatively impacted the fair value of derivatives during the first six months of 2005 as compared to the first six months of 2004. In addition, we had a greater notional amount of derivatives outstanding as of June 30, 2005 that were negatively impacted and caused a significant market valuation adjustment as compared to June 30, 2004. We enter into derivative contracts to offset the various risks associated with certain specific CMO liabilities. In our consolidated financial statements, we record a market valuation adjustment for derivatives, including certain forward purchase commitments on mortgages, as current period expense or revenue. Unrealized mark-to-market gain or loss on derivatives at IMH is not included as an addition or deduction for purposes of calculating taxable income as shown in the reconciliation table of net earnings to estimated taxable income in the “Taxable Income” table. Cash payments on derivatives decreased during the first six months of 2005 as compared to the first six months of 2004. However, cash payments on derivatives declined to 12 basis points of total average mortgage assets during the first six months of 2005 as compared to 56 basis points of total average mortgage assets during the first six months of 2004. Cash payments on derivatives are recorded as current period expense or revenue on our consolidated financial statements and are included in the calculation of taxable income.
Gain on Sale of Loans.The increase in gain on sale of loans was primarily due to an increase in loan sale volume. Additionally, we use derivatives to protect the market value of mortgages when we have established a rate-lock commitment on a particular mortgage prior to its close and eventual sale or securitization. Any changes in interest rates on mortgages that we have committed to acquire at a particular rate until we sell or securitize the mortgage generally results in an increase or decrease in the market value of that mortgage. During the six months ended June 30, 2005, the change in value of these derivatives resulted in a $2.9 million loss as compared to a $2.3 million loss during the same period in the prior year. The mortgage operations sold $3.1 billion of loans to third party investors during the first six months of 2005 as compared to $1.1 billion of mortgages sold to third party investors for the same period in the previous year. All inter-company loan sales between the mortgage operations and the long-term investment operations are eliminated on our consolidated financial statements.
Non-Interest Expense
Changes in Non-Interest Expense
(dollars in thousands)
For the Three Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | |||||||||||
Personnel expense | $ | 20,810 | $ | 16,346 | $ | 4,464 | ||||||||
General and administrative and other expense | 6,560 | 4,309 | 2,251 | |||||||||||
Professional services | 2,021 | 331 | 1,690 | |||||||||||
Equipment expense | 1,236 | 830 | 406 | |||||||||||
Occupancy expense | 1,171 | 857 | 314 | |||||||||||
Data processing expense | 836 | 972 | (136 | ) | ||||||||||
Total operating expense (1) | 32,634 | 23,645 | 8,989 | 38 | % | |||||||||
Amortization of deferred tax charge | 6,792 | 4,486 | 2,306 | |||||||||||
Provision for repurchases | 1,650 | 1,640 | 10 | |||||||||||
Amortization and impairment of mortgage servicing rights | 736 | 570 | 166 | |||||||||||
(Gain) loss on sale of other real estate owned | 20 | (2,247 | ) | 2,267 | ||||||||||
Total non-operating expense (2) | 9,198 | 4,449 | 4,749 | 107 | % | |||||||||
Total non-interest expense | $ | 41,832 | $ | 28,094 | $ | 13,738 | 49 | % | ||||||
Changes in Non-Interest Expense
(dollars in thousands)
For the Six Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | �� | ||||||||||
Personnel expense | $ | 39,690 | $ | 30,014 | $ | 9,676 | ||||||||
General and administrative and other expense | 11,473 | 7,482 | 3,991 | |||||||||||
Professional services | 5,440 | 2,162 | 3,278 | |||||||||||
Equipment expense | 2,383 | 1,614 | 769 | |||||||||||
Occupancy expense | 2,315 | 1,698 | 617 | |||||||||||
Data processing expense | 1,779 | 1,777 | 2 | |||||||||||
Total operating expense (1) | 63,080 | 44,747 | 18,333 | 41 | % | |||||||||
Amortization of deferred tax charge | 12,595 | 8,684 | 3,911 | |||||||||||
Provision for repurchases | 5,364 | 457 | 4,907 | |||||||||||
Amortization and impairment of mortgage servicing rights | 1,026 | 976 | 50 | |||||||||||
Gain on sale of other real estate owned | (829 | ) | (2,750 | ) | 1,921 | |||||||||
Total non-operating expense (2) | 18,156 | 7,367 | 10,789 | 146 | % | |||||||||
Total non-interest expense | $ | 81,236 | $ | 52,114 | $ | 29,122 | 56 | % | ||||||
(1) | Operating expenses are primarily related to the mortgage operations personnel, which fluctuates in conjunction with increases or decreases in mortgage acquisition and origination volumes. |
(2) | Non-operating expenses generally relate to existing assets and liabilities and are generally not a function of increases or decreases in mortgage acquisition or origination volumes. |
Operating Expense. The increase in operating expense was primarily due to the following:
2005 to 2004 Quarterly Comparative
Total operating expense increased on a quarter-over-quarter basis even though acquisitions and originations from the mortgage operations were $5.5 billion during each of the second quarter of 2005 and 2004. Multi-family originations increased 84% to $214.6 million for the second quarter of 2005 as compared to $116.5 million during the second quarter of 2004. The Company increased personnel to manage the higher level of multi-family originations and to maintain the current level of mortgage acquisition and originations. Operating costs also increased during the second quarter of 2005 due to the expansion of our wholesale mortgage operations into the Midwest and East Coast including the hiring of mortgage professionals and the assumption of certain premises and operating leases. The expansion of our wholesale mortgage operations gives us penetration into areas of the country where we were not generating a significant volume of mortgage originations during 2004. Additionally, we continued to upgrade and expand the staffs of our Internal Audit and Information Technology departments.
2005 to 2004 Six Month Comparative
Total operating expense increased as acquisitions and originations from the mortgage operations increased 13% to $10.1 billion during the first six months of 2005 as compared to $8.9 billion during the first six months of 2004. In addition, originations of multi-family mortgages increased 80% to $379.9 million for the first six months of 2005 as compared to $211.0 million for the same period in the previous year. The increase in acquisitions and originations resulted in an increase in personnel, which were hired to manage the growth of our operations, and personnel-related costs.
Operating costs also increased for the first six months of 2005 due to the expansion of our wholesale mortgage operations into the Midwest and East Coast including the hiring of mortgage professionals and the assumption of certain premises and operating leases. The expansion of our wholesale mortgage operations gives us penetration into areas of the country where we were not generating a significant volume of mortgage originations during 2004. Additionally, we continued to upgrade and expand the staffs of our Internal Audit and Information Technology departments.
The following table summarizes the principal balance of mortgage acquisitions and originations for the periods indicated (in thousands):
For the Three Months Ended June 30, | ||||||||||||
2005 | 2004 | |||||||||||
Principal Balance | % | Principal Balance | % | |||||||||
By Production Channel: | ||||||||||||
Correspondent acquisitions: | ||||||||||||
Flow | $ | 1,912,770 | 34 | % | $ | 2,450,634 | 44 | % | ||||
Bulk | 2,911,775 | 51 | 2,257,131 | 41 | ||||||||
Total correspondent acquisitions | 4,824,545 | 85 | % | 4,707,765 | 85 | % | ||||||
Wholesale and retail originations | 499,344 | 9 | 546,941 | 10 | ||||||||
Novelle Financial Services, Inc. | 139,617 | 2 | 196,019 | 3 | ||||||||
Total mortgage operations acquisitions and originations | 5,463,506 | 96 | % | 5,450,725 | 98 | % | ||||||
Impac Multifamily Capital Corporation | 214,597 | 4 | 116,488 | 2 | ||||||||
Total acquisitions and originations | $ | 5,678,103 | 100 | % | $ | 5,567,213 | 100 | % | ||||
For the Six Months Ended June 30, | ||||||||||||
2005 | 2004 | |||||||||||
Principal Balance | % | Principal Balance | % | |||||||||
By Production Channel: | ||||||||||||
Correspondent acquisitions: | ||||||||||||
Flow | $ | 4,290,170 | 41 | % | $ | 4,622,008 | 51 | % | ||||
Bulk | 4,588,709 | 44 | 3,039,927 | 33 | ||||||||
Total correspondent acquisitions | 8,878,879 | 85 | % | 7,661,935 | 84 | % | ||||||
Wholesale and retail originations | 988,252 | 9 | 918,519 | 10 | ||||||||
Novelle Financial Services, Inc. | 260,492 | 2 | 339,353 | 4 | ||||||||
Total mortgage operations acquisitions and originations | 10,127,623 | 96 | % | 8,919,807 | 98 | % | ||||||
Impac Multifamily Capital Corporation | 379,901 | 4 | 210,988 | 2 | ||||||||
Total acquisitions and originations | $ | 10,507,524 | 100 | % | $ | 9,130,795 | 100 | % | ||||
Results of Operations by Business Segment
Long-Term Investment Operations
For the Three Months Ended June 30,:
Condensed Statements of Operations Data
(dollars in thousands)
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||||
Net interest income | $ | 28,908 | $ | 61,575 | $ | (32,667 | ) | (53 | )% | ||||||
Provision for loan losses | 5,711 | 13,847 | (8,136 | ) | (59 | ) | |||||||||
Non-interest income | (91,188 | ) | 83,612 | (174,800 | ) | (209 | ) | ||||||||
Non-interest expense and income taxes | 4,307 | (34 | ) | 4,341 | 12,768 | ||||||||||
Net earnings (loss) | $ | (72,298 | ) | $ | 131,374 | $ | (203,672 | ) | (155 | )% | |||||
The quarter-over-quarter decrease in net earnings was primarily due to a decrease in unrealized mark-to-market gain (loss) on derivatives which was $(90.9) million for the second quarter of 2005 as compared to $102.0 million for the second quarter of 2004. Mark-to-market gain (loss) on derivatives was partially offset by a decrease in cash payments on derivatives to $(1.5) million for the second quarter of 2005 compared to $(23.4) for the second quarter of 2004. The change in the unrealized mark-to-market gain (loss) on derivatives was primarily due to a decline in the pace and magnitude of expected future rate increases combined with accelerated prepayment speeds. Additionally, increased borrowing costs have contributed to the decline in Net Interest Income. Income taxes in the 2005 period include 2005 forecast earnings and applicable adjustments for expected taxes payable when the 2004 returns are filed.
For the Six Months Ended June 30,:
Condensed Statements of Operations Data
(dollars in thousands)
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||
Net interest income | $ | 81,027 | $ | 113,037 | $ | (32,010 | ) | (28 | )% | ||||
Provision for loan losses | 11,785 | 18,132 | (6,347 | ) | (35 | ) | |||||||
Non-interest income | 23,805 | 44,461 | (20,656 | ) | (46 | ) | |||||||
Non-interest expense and income taxes | 7,000 | 1,710 | 5,290 | 309 | |||||||||
Net earnings | $ | 86,047 | $ | 137,656 | $ | (51,609 | ) | (37 | )% | ||||
The decrease in net earnings was primarily due to a decrease in unrealized mark-to-market gain (loss) on derivatives which decreased to $38.0 million for the first six months of 2005 as compared to $75.4 million for the first six months of 2004. Unrealized mark-to-market gain (loss) on derivatives decreased primarily due to a decline in the pace and magnitude of interest rate increases. Fluctuations in Non-Interest and provision for loan losses are explained in the discussions of the current quarter ended June 30, 2005 combined with accelerated prepayment speeds. Additionally, increased borrowing costs have contributed to the decline in Net Interest Income. Income taxes in the 2005 period include 2005 forecast earnings and applicable adjustments for expected taxes payable when the 2004 returns are filed.
Mortgage Operations
For the Three Months Ended June 30,:
Condensed Statements of Operations Data
(dollars in thousands)
2005 | 2004 | Increase (Decrease) | % Change | |||||||||||
Net interest income | $ | 4,685 | $ | 2,903 | $ | 1,782 | 61 | % | ||||||
Non-interest income | 25,723 | 45,195 | (19,472 | ) | (43 | ) | ||||||||
Non-interest expense and income taxes | 31,151 | 33,307 | (2,156 | ) | (6 | ) | ||||||||
Net earnings (loss) | $ | (743 | ) | $ | 14,791 | $ | (15,534 | ) | (105 | )% | ||||
The quarter-over-quarter decrease in net earnings was primarily due to a decrease in non-interest income. The decrease in non-interest income was mainly attributed to a decline in the unrealized mark-to-market gain (loss) and to a lesser extent the gain on sales to IMH and third party investors from 104 bps to 58 bps, or $31.5 million for the second quarter of 2005 as compared to $44.2 million for the second quarter of 2004. During the second quarter of 2005 the mortgage operations sold $3.1 billion of mortgages to the long-term investment operations and $2.3 billion of mortgages to third party investors as compared to $5.3 billion and $439.5 million, respectively, during the second quarter of 2004. The unrealized mark-to-market gain (loss) on derivatives decreased to $(6.8) million for the second quarter of 2005 as compared to $(0.7) million for the second quarter of 2004. The mortgage operations use derivatives to protect the market value of mortgages when it establishes a rate-lock commitment on a particular mortgage prior to its close and sale or securitization. Any changes in interest rates on mortgages that the mortgage operations has committed to acquire at a particular rate to the time it sells or securitizes the mortgage generally results in an increase or decrease in the market value of that mortgage. The mortgage operations are reflected as a stand-alone entity for segment financial reporting purposes, however, on the consolidated financial statements inter-company loan sales and related gains are eliminated.
Condensed Statements of Operations Data
(dollars in thousands)
For the Six Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||
Net interest income | $ | 6,659 | $ | 8,045 | $ | (1,386 | ) | (17 | )% | ||||
Non-interest income | 75,396 | 77,173 | (1,777 | ) | (2 | ) | |||||||
Non-interest expense and income taxes | 66,632 | 58,890 | 7,742 | 13 | |||||||||
Net earnings | $ | 15,423 | $ | 26,328 | $ | (10,905 | ) | 41 | % | ||||
The decrease in net earnings was primarily due to an increase in non-interest expense which increased 52% to $60.8 million for the six months ended June 30, 2005 as compared to $40.0 for the six months ended June 30, 2004. The majority of the increase in non-interest expense was due to an increase in personnel expense and provision for repurchases. The increase in personnel expense was primarily due to an increase in acquisitions and originations, as well as the addition of mortgage professionals to expand our sales force, accounting, finance internal audit and information technology departments. The increase in provision for repurchases was due to an increase in our sales volume to third party investors. The increase in non-interest expense was partially offset by a 69% decline in income taxes to $5.9 million for the six months ended June 30, 2005 as compared to $18.9 million for the six months ended June 30, 2004. Additionally, during the first six months of 2005 the mortgage operations sold $6.4 billion of mortgages to the long-term investment operations and $3.1 billion of mortgage to third party investors as compared to $8.1 billion and $1.1 billion, respectively, during the second quarter of 2004.
Warehouse Lending Operations
Condensed Statements of Operations Data
(dollars in thousands)
For the Three Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||
Net interest income | $ | 13,638 | $ | 9,548 | $ | 4,090 | 43 | % | |||||
Provision for loan losses | — | 1,435 | (1,435 | ) | (100 | ) | |||||||
Non-interest income | 2,230 | 2,807 | (577 | ) | (21 | ) | |||||||
Non-interest expense and income taxes | 1,770 | 1,681 | 89 | 5 | |||||||||
Net earnings | $ | 14,098 | $ | 9,239 | $ | 4,859 | 53 | % | |||||
The quarter-over-quarter increase in net earnings was primarily due to a decrease in provision for loan losses and an increase in net interest income. Provision for loan losses declined as the warehouse lending operations discovered fraudulent mortgages during the first quarter of 2004 that were deemed to be permanently impaired which required a corresponding increase in allowance for loan losses as compared to no specific provision for loan losses required during the second quarter of 2005. The increase in net interest income was the result of an increase in average finance receivables which rose to $2.7 billion during the second quarter of 2005 as compared to $1.9 billion during the second quarter of 2004 as the mortgage operations acquired and originated higher mortgage volumes. The warehouse lending operations is reflected as a stand-alone entity for segment financial reporting purposes. However, on the consolidated financial statements inter-company finance receivables and borrowings are eliminated.
Condensed Statements of Operations Data
(dollars in thousands)
For the Six Months Ended June 30,:
2005 | 2004 | Increase (Decrease) | % Change | ||||||||||
Net interest income | $ | 24,980 | $ | 17,966 | $ | 7,014 | 39 | % | |||||
Provision for loan losses | — | 6,875 | (6,875 | ) | (100 | ) | |||||||
Non-interest income | 4,257 | 4,764 | (507 | ) | 11 | ||||||||
Non-interest expense and income taxes | 3,855 | 3,202 | 653 | 20 | |||||||||
Net earnings | $ | 25,382 | $ | 12,653 | $ | 12,729 | 101 | % | |||||
The increase in net earnings was primarily due to a decrease in provision for loan losses and an increase in net interest income. Provision for loan losses declined as the warehouse lending operations discovered fraudulent mortgages of $8 million during the first six months of 2004 that were deemed to be permanently impaired which required a corresponding increase in allowance for loan losses as compared to no specific provision for loan losses required during the first six months of 2005. The increase in net interest income was the result of an increase in average finance receivables which rose to $2.3 billion during the first six months of 2005 as compared to $1.9 billion during the first six months of 2004 as the mortgage operations acquired and originated higher mortgage volumes. The warehouse lending operations is reflected as a stand-alone entity for segment financial reporting purposes. However, on the consolidated financial statements inter-company finance receivables and borrowings are eliminated.
Liquidity and Capital Resources
We recognize the need to have funds available for our operating businesses and our customer’s demands for obtaining short-term warehouse financing until the settlement or sale of 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 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 ofparticipants include 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 balance sheet for changes in the liquidity of our assets. Our primary liquidity consists of cash and cash equivalents and maturing mortgages, or “liquid assets.”
We believe that current cash balances, currently available financing facilities, capital raising capabilities and excess cash flows generated from our long-term mortgage portfolio will adequately provide for projected funding needs and asset growth. However, if we are unable to raise capital in the future, we may not be able to grow as planned. Refer to “Risk Factors” for additional information regarding risks that could adversely affect our liquidity.
Our operating businesses primarily use available funds as follows:
Acquisition and origination of mortgages by the mortgage and long-term investment operations. During the first six monthssecond quarter of 2004,2005, the mortgage operations acquired $8.9$5.5 billion of primarily Alt-A mortgages. The acquisition and originationmortgages, of mortgages are initially financed with warehouse borrowings which require an initial capital$3.1 billion was acquired by the long-term investment of generally between 2% to 5% of the outstanding principal balance of the mortgages, or “haircut,” depending on the collateral provided. In addition to the haircut, initial capital invested in mortgages includes premiums paid when mortgages are acquired and originated. During the first six months of 2004, the mortgage operations paid weighted average premiums of 2.31% of the principal balance of mortgages acquired and originated.for long-term investment. 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 between 15 to 45 days of acquisition or origination.
In addition, IMCC originated $211.0 million of multi-family mortgages which were initially financed with short-term warehouse financing that generally require a 10% to 15% haircut. Multi-family mortgages are either sold as whole loan sales or are financed with CMO borrowings at lower OC requirements than haircut requirements for warehouse financing.
Investment in mortgages. The long-term investment operations retained $8.1 billion of primarily Alt-A mortgages that were acquired from the mortgage operations during the first six months of 2004. The retention of mortgages are initially
financed with warehouse borrowings which require an initial haircut between 2% to 5% of the outstanding principal balance of the mortgages. In addition to the haircut, initial Initial capital invested in mortgages includes premiums paid when mortgages are acquired and originated and our capital investment, or “haircut,” required upon financing, which is generally determined by the type of collateral provided. The mortgage operations acquired and originated mortgages at a weighted average price of 102.1 during the second quarter of 2005, which were financed with warehouse borrowings from the warehouse lending operations at a haircut generally between 2% to 10% of the outstanding principal balance of the mortgages. In addition, IMCC originated $214.6 million of multi-family mortgages at a weighted average price of 100.1 which were initially financed with short-term warehouse financing from the warehouse lending operations at a haircut of generally 3% of the outstanding principal balance of the mortgages.
Long-term investment in mortgages by the long-term investment operations. The long-term investment operations acquires primarily Alt-A mortgages from the mortgage operations. Capital invested in mortgages is outstanding until we securitize mortgages as CMOsoperations and repayfinances them with warehouse borrowings and recoup our 2% to 5% haircut.from the warehouse lending operations at substantially the same terms as the mortgage operations. When the long-term investment operations finances mortgages with long-term CMO borrowings, short-term warehouse financing is repaid. Then, depending on credit ratings from national credit rating agencies on our CMOs, we are generally required to provide an over-collateralization, or “OC,” of 0.50%0.35% to 1% of the principal balance of mortgages securing CMO financing as compared to a haircut of 2% to 5%10% of the principal balance of mortgages securing short-term warehouse financing. Our total capital investment in CMOs generally rangeranges from approximately 3%2% to 5% of the principal balance of mortgages securing CMO borrowings which includes premiums paid upon acquisition of mortgages from the mortgage operations, costs paid for completion of CMOs, costs to acquire derivative instrumentsderivatives and OC required to achieve desired credit ratings. Multi-family mortgages are financed on a long-term basis with CMO borrowings at substantially the same rates and terms as Alt-A mortgages.
Provide short-term warehouse advances to affiliates and non-affiliates.by the warehouse lending operations.We utilize committed and uncommitted warehouse facilities with various lenders to provide short-term warehouse financing to affiliates and non-affiliated clients of the warehouse lending operations. The warehouse lending operations provides short-term financing to the mortgage operations, long-term investment operations and non-affiliated clients from the closing of mortgages to their sale or other settlement with investors. The warehouse lending operations generally finances between 95%90% and 98% of the fair market value of the principal balance of mortgages, which equates to a haircut requirement of between 2% and 5%10%, at prime rateone-month LIBOR, plus a spread. The mortgage operations hasand long-term investment operations have uncommitted warehouse line agreements to obtain financing of up to $800.0 million from the warehouse lending operations at prime minus 0.50%one-month LIBOR plus a spread during the period that the mortgage and long-
term investment operations accumulates mortgages until the mortgages are securitized or sold. As of June 30, 2005, the mortgage and long-term investment operations had $1.2 billion and $222.4 million, respectively, of warehouse advances outstanding with the warehouse lending operations. In addition, as of June 30, 2004,2005, the warehouse lending operations had $867.8$610.5 million of approved warehouse lines available to non-affiliated clients, of which $579.7$382.9 million was outstanding.
Our ability to meet liquidity requirements and the financing needs 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:
PayDistribute common and preferred stock dividends. We paid common stock dividends of $41.2 million and preferred stock dividends of $443,000 during the first six months of 2004. We are required to distribute a minimum of 90% of our taxable income to our stockholders in order to maintain our REIT status, exclusive of the application of any tax loss carry forwards that may be used to offset current period taxable income. Because we pay dividends based on taxable income, dividends may be more or less than net earnings. As such, weWe declared cash dividends of $1.40$0.75 per outstanding common share during the second quarter of 2005 on estimated taxable income of $0.54 per diluted common share. In addition, we paid cash dividends of $7.2 million on preferred stock during the first six months of 2004 on net earnings of $2.40 per diluted share. 2005.
A portion of dividends paid to IMH’s common stockholders come from dividend distributions from the mortgage operations, our taxable REIT subsidiary, to IMH. During the first six months of 2004,2005, the mortgage operations provided a dividend distribution of $15.0$25.9 million to IMH. However, becauseIMH which was related to estimated taxable income earned during the first six months of 2005. As a result of the reduction in taxable income from $0.75 per diluted share in the first quarter to $0.54 per diluted share in the second quarter on June 30, 2005, the company announced it will re-evaluate the dividend policy. Because the mortgage operations may seek to retain earnings to fund the acquisition and origination of mortgages or to expand the mortgage operations, the board of directors of the mortgage operations may decide that the mortgage operations should cease making dividend distributions in the future. This could reduce the amount of taxable income that would be distributed to IMH stockholders in the form of dividends.dividend payment amounts.
Our operating businesses are primarily funded as follows:
CMO borrowings and reverse repurchase agreements.warehouse facilities.We use CMO borrowings and reverse repurchase agreements to fund substantially all warehouse financing to affiliates and non-affiliated clients and for the acquisition and origination of Alt-A and multi-family mortgages. As we accumulate mortgages, we finance the acquisition of mortgages primarily through borrowings
on reverse repurchase agreementswarehouse facilities with third party lenders. We primarily use committeduncommitted and uncommitted repurchasecommitted facilities with major investment banks to finance substantially all warehouse financing, as needed. During the first six months of 2005 we added an additional $1.2 billion to an existing warehouse facility 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. These reverse repurchase agreementswarehouse facilities may have certain covenant tests which we continue to satisfy. During 2005 we received waivers from our lenders for the delay in issuing our 2004 audited financial statements, which our lenders previously required. Audited consolidated financial statements for 2004 were filed with the SEC on May 16, 2005 and were provided to our lenders. As of June 30, 2004,2005, the warehouse lending operations had $2.15$4.3 billion of committeduncommitted and uncommitted repurchasecommitted facilities with various lenders of which $1.56$1.7 billion was outstanding. Of total repurchase facilities, oneFrom time to time, we may also receive additional uncommitted interim financing from our lenders in excess of our lenders provides financing of up to $200.0 millionpermanent borrowing limits to finance mortgages during the origination of multi-family mortgages of which a substantial portion is committed.accumulation phase and prior to securitizations or whole loan sales.
From time to time, we may also utilize term reverse repurchase financing provided to us by an underwriterunderwriters who underwritesunderwrite some of our securitizations. The term reverse repurchase financing funds mortgages that are specifically allocated to securitization transactions, which allows us to reduce overall borrowings outstanding on reverse repurchase agreements with other lenders during the period immediately prior to the settlement of the securitization. Terms and interest rates on the term reverse repurchase facilities are similar togenerally lower than on other reverse repurchase agreements. Term reverse repurchase financing are generally repaid withwithin 30 days from the date funds are advanced. During the first six months of 2004, average balances outstanding on term reverse repurchases were $190.5 million and $30.2 million was outstanding on term reverse repurchase agreements as of June 30, 2004.
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 sell or securitize our mortgages between 15 to 45 days from acquisition or origination. Although securitizing mortgages more frequently adds operating and securitization costs, we believe the added cost is offset as liquidity is provided more frequently 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 seek to issue CMOs and convert short-term advances under reverse repurchase agreements to long-term CMO borrowings. The use of CMO borrowings provides the following benefits:
During the first six monthssecond quarter of 2004,2005 we completed $8.2$4.6 billion of CMOs, of which $7.6 billion were adjustable rate CMOs and $599.0 million were fixed rate CMOs to provide long-term financing for the retention of primarily Alt-A mortgages and the origination of multi-family mortgages. Because of the credit profile, historical loss performance and prepayment characteristics of our Alt-A mortgages, we have been able to borrow a higher percentage against the principal balance of mortgages held as CMO collateral, which means that we have to provide less initial capital upon completion of CMOs. Capital investment 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.
Excess cash flows from our long-term mortgage portfolio.portfolio. We receive excess cash flows on mortgages held as CMO collateral after distributions are made to investors in CMOson CMO borrowings to the extent cash or other collateral required to maintain desired credit ratings on the CMOs is fulfilled.fulfilled and can be used to provide funding
for some of the long-term investment operations’ activities. Excess cash flows represent the difference between principal and interest payments on the underlying mortgages less the following (in order of priority paid):following:
Sale and securitization of mortgages.When the mortgage operations accumulatesaccumulate a sufficient amount of mortgages that are intended to be deposited into a CMO, it sells the mortgages to the long-term investment operations. When selling mortgages on a whole loan basis, the mortgage operations or towill accumulate mortgages and enter into sales transactions with third party investors as whole loan sales or securitizeson a monthly basis. When the mortgage operations enter into a Real Estate Mortgage Investment Company (REMIC) securitization it accumulates mortgages as REMICs.and sells these loans on a monthly basis.
The mortgage operations sold $8.1$6.4 billion of mortgages to the long-term investment operations during the first six months of 20042005 and sold $1.1$3.1 billion of mortgages as whole loan sales and REMICs. The mortgage operations sold mortgage servicing rights on substantially all mortgages sold during the first six months of 2004.2005. The sale of mortgage servicing rights generated substantially all cash, which was used to acquire and originate additional mortgage assets.
In order to mitigate interest rate and market risk, the mortgage operations attempts to sell and securitize mortgages between 15 and 45 days from acquisition and origination. 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 unfavorableless favorable 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 2003, we filed with the SEC a shelf registration statement that allows us to sell up to $500.0 million of securities, including common stock, preferred stock, debt securities and warrants. In February 2004, we raised $106.5 million in net proceeds from the issuance of 5,750,000 new shares of common stock and in May and June of 2004 we raised $32.3 million in net proceeds from the issuance of 1,725,000 shares of common stock. In May 2004 we also raised $48.4 million in net proceeds from the issuance of 2,000,000 shares of 9.375% Series B Cumulative Redeemable Preferred Stock. In addition, pursuant to an equity distribution agreement entered into in May of 2004 with UBS Securities, LLC (“UBS”), we sold 5,208,000 shares of common stock and received net proceeds of $101.8 million during the second quarter of 2004. UBS Securities, LLC received a commission of 3% of the gross sales price per share of the shares of common stock sold pursuant to the equity distribution agreement, which amounted to an aggregate commission of $3.1 million. From July 1 to July 8, 2004, the remaining 992,000 shares of common stock were sold pursuant to the equity distribution agreement with net proceeds to us of $21.2 million and $654,000 in aggregate commissions to UBS. With the sale of the 6,200,000 shares, there are no shares of common stock remaining to be sold pursuant to the equity distribution agreement. By issuing new shares periodically throughout the year, we believe that we were able to utilize new capital more efficiently and profitably.
Cash FlowsInflation/Deflation
Operating Activities - Net cash provided by operating activities was $2.5 million for the first six months of 2004 as compared to $128.7 million for the first six months of 2003. Net cash flows of $82.8 million was used in operating activities to primarily acquire and originate mortgages, net of loan sales.
Investing Activities - Net cash used in investing activities was $6.4 billion for the first six months of 2004 as compared to $1.7 billion for the first six months of 2003. Net cash flows of $6.2 billion was used in investing activities to primarily invest in mortgages, net of principal repayments.
Financing Activities - Net cash provided by financing activities was $6.5 billion for the first six months of 2004 as compared to $1.6 billion for the first six months of 2003. Net cash flows of $6.2 billion was provided by financing activities primarily from CMO financing, net of principal repayments.
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 and housing price appreciation, 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 Related to Our Business Arising in the Quarterly Period Ended June 30, 2005
Our Mortgage Products Expose Us to Greater Credit Risk
We have loan programs that allow a borrower to pay only the interest attributable to his loan for a set period of time. If there is a decline in real estate values borrowers may default on these types of loans since they have not reduced their principal balances, which, therefore, could exceed the value of their property. In addition a reduction in property values would also cause an increase in the loan to value for that loan which could have the effect of reducing the value of that loan.
New Criteria May Effect the Value or Marketability of Certain of Our Loan Products
The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration (none of whom regulate IMH) jointly issued guidance to promote sound credit risk management practices. The guidance cautions lenders to consider all relevant risk factors when establishing underwriting guidelines, including a borrower’s income and debt levels, credit score as well as the loan size, collateral value, lien position and property type and location. It stresses that prudently underwritten home equity loans should include an evaluation of a borrower’s capacity to adequately service the debt, and that reliance on a credit score is insufficient because it relies on historical financial performance not present capacity to pay. While not specifically applicable to IMH, the guidance is instructive of the regulatory climate covering low and no documentation loans, which IMH does acquire and originate, and hence it may affect our ability to sell these loans to third parties, should we elect to sell them.
Risk FactorsForward-Looking Statements
SomeThis report on Form 10-Q/A contains certain forward-looking statements within the meaning of Section 27A of the followingSecurities 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,” “likely,” “should,” “anticipate,” or similar terms or variations on those terms or the negative of those terms. The forward-looking statements are based on current management expectations. Actual results may differ materially as a result of several factors, including, but not limited to, failure to achieve projected earnings levels; the ability to generate sufficient liquidity and conduct our operations as planned; the ability to access the equity markets; delays in raising, or the inability to raise, additional capital, either through equity offerings, lines of credit or otherwise as a result of, among other things, market conditions; the ability to generate taxable income and to pay dividends; interest rate fluctuations and changes in expectations of future interest rates; changes in prepayment rates or effectiveness of prepayment penalties on our mortgages; the availability of financing and, if available, the terms of any financing; continued ability to access the securitization markets or other funding sources; risks related to our ability to maintain an effective system of internal control over financial reporting and disclosure controls and procedures due to reported, or potential, material weaknesses and the ability to remediate any material weaknesses; changes in markets which the Company serves; the effectiveness of risk factors relate tomanagement strategies; and changes in other general market and economic conditions. For a discussion of our assets. For additional information on our asset categories referthese and other risks and uncertainties that could cause actual results to Item 2.differ from those contained in the forward-looking statements, see “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Note D—Mortgages Held-for-Sale,” “Note E— CMO Collateral” and “Note G—CMO Borrowings”Operations” in this quarterly report, the accompanying notes to the consolidated financial statements.
Risks Related To Our Businesses
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 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 impactCompany’s Annual Report on our operations and our financial condition. For example, a reduction in new mortgages will adversely affect our ability to expand our long-term 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 or sale, 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 long-term mortgage portfolio due to a higher level of defaults or foreclosures on our mortgages.
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 interest rate risk management policies and pay dividends. We have traditionally derived our liquidity from the following primary sources:
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 growth of taxable income 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, too:
As a result, during this period many mortgage originators, including us, were unable to access the securitization market on favorable terms. This resulted in some companies declaring bankruptcy. Originators, like us, 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 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 face risks related to our recent accounting restatements.
On July 22, 2004, we publicly announced that we had discovered accounting inaccuracies in previously reported financial statements. As a result, following consultation with our auditors, we decided to restate our financial statementsForm 10-K, Amendment No. 2, for the three monthsperiod ended December 31, 2004, the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for each of the years ended December 31, 2003, 2002 and 2001. The restatements relate to a correction to our revenue recognition policy with respect to the cash sales of mortgage servicing rights to unrelated third parties when the mortgage loans are retained, our accounting for derivatives and interest rate risk management activities, the accounting for loan purchase commitments as derivatives and selected elimination entries to consolidate IFC with that of IMH. The effect of this restatement on net earnings (loss) for the three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2003, the three and nine months ended September 30, 2003 and for the years ended December 31, 2003, 2002 and 2001 was an increase (decrease) of $(36.7) million, $(0.7) million, $2.4 million, $1.7 million, $11.2 million, $12.8 million, $21.7 million, $(34.6) million and $(35.4) million, respectively. Additionally, basic and diluted earnings per share (“EPS”) for the six months ended June 30, 2004 was corrected to $2.44 and $2.40, respectively, from $2.30 and $2.27, respectively.
The restatement of these financial statements may lead to litigation claims and/or regulatory proceedings against us. The defense of any such claims or proceedings may cause the diversion of management’s attention and resources, and we may be required to pay damages if any such claims or proceedings are not resolved in our favor. Any litigation or regulatory proceeding, even if resolved in our favor, could cause us to incur significant legal2005 and other expenses. We also may have difficulty raising equity capital or obtaining other financing, suchreports we file under the Securities and Exchange Act of 1934. This document speaks only as lines of credit or otherwise. We may not be able to effectuate our current operating strategy, including the ability to originate, acquire or securitize mortgages loans for retention or sale at projected levels. We may be subject to resignation of our current external auditors which may, among other things, cause a delay in the preparation of our financial statementsits date and increase expenditures related to the retention of new external auditors and the lead time required to become familiar with our operations. The process of retaining new external auditors may limit our access to the capital markets for an extended period of time. Moreover, we may be the
subject of negative publicity focusing on the financial statement inaccuracies and resulting restatement and negative reactions from our stockholders, creditors or others with which we do business. The occurrence of any of the foregoing could harm our business and reputation and cause the price of our securities to decline and could result in a delisting of our securities from the New York Stock Exchange.
If we fail to maintain an effective system of internal and disclosure controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders could lose confidence in our financial reporting which would harm our business and the trading price of our securities.
Effective internal and disclosure controls are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We have in the past discovered, and may in the future discover, areas of our disclosure and internal controls that need improvement. As a result after a review of our June 30, 2004 operating results, we identified certain deficiencies in some of our disclosure controls and procedures which we believe require remediation.
Furthermore, in planning and performing its audit of our restated consolidated financial statements, our external auditors also noted in a letter to management and the audit committee dated August 16, 2004 certain matters involving internal controls and operations that they consider to be a material weakness, as defined by the Public Company Accounting Oversight Board (“PCAOB”). According to the letter, we need to improve the evaluation and documentation of accounting policies and procedures for complex transactions, such as transfers of financial assets, derivatives and hedge accounting and allowance for credit losses, and we currently do not have a sufficient amount or type of staff in the financial reporting and accounting departments, including the lack of a Controller. Furthermore, our auditors also noted significant deficiencies, as defined by the PCAOB, for our consideration stating that our internal audit function does not provide an adequate or effective monitoring of our controls and we need to evaluate whether we have appropriate internal resources to manage and monitor work performed by our outsourced tax compliance function. We are currently taking steps to address these conditions, but we may be hampered in this regard by our current staffing.
We cannot be certain that our efforts to improve our internal and disclosure controls will be successful or that we will be able to maintain adequate controls over our financial processes and reporting in the future. Any failure to develop or maintain effective controls or difficulties encountered in their implementation or other effective improvement of our internal and disclosure controls could harm our operating results or cause us to fail to meet our reporting obligations. If we are unable to adequately establish or improve our internal controls over financial reporting, our external auditors will not be able to issue an unqualified opinion on the effectiveness of our internal controls. Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our securities and could result in regulatory proceedings against us by, among others, the SEC.
We incurred losses for fiscal years 1997, 1998, 2000 and 2001 and may incur losses in the future.
During the years ended December 31, 2001 and 2000, we experienced a net loss of $2.2 million and $54.5 million. The 2001 loss was related to the mark-to-market loss on derivatives and the 2000 loss was 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 for 2000. 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 financing 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 or generate taxable income for distribution to our stockholders in the future, which could prevent us from effectuating our business strategy.
If we are unable to complete securitizations or if we experience delayed mortgage loan sales or securitization closings, we could face a liquidity shortage which would adversely affect our operating results.
We rely significantly upon securitizations to generate cash proceeds to repay borrowings and replenish our borrowing capacity. If there is a delay in a securitization closing or any reduction in our ability to complete securitizations we may be required to utilize other sources of financing, which, if available at all, may be on unfavorable terms. In addition, delays in closing mortgage sales or securitizations of our mortgages increase our risk by exposing us to credit and interest rate risks
for this extended period of time. Furthermore, gains on sales from certain of our securitizations represent a significant portion of our taxable income. Several factors could affect our ability to complete securitizations of our mortgages, including:
If we are unable to sell a sufficient number of mortgages at a premium or 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, which could have a material adverse affect on our operations. 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 CMOs may expose our operations to credit losses.
To grow our long-term mortgage portfolio, we borrow a substantial portion of the market value of substantially all of our investments in mortgages in the form of CMOs. There are no limitations on the amount of CMO financing we may incur, other than the aggregate value of the underlying 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 may have to increase the allowance for loan losses on our financial statements.
If we default under our financing facilities, we may be forced to liquidate collateral.
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 and our financing facilities. 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 or pledged or used to acquire mortgages or other investments may be the only unpledged assets available to our unsecured creditors if we were 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. Interest rates have been low over the past few years; however any increase in 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, which could adversely affect our operating results. 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 long-term mortgage portfolio and reduce our net interest income. Rising interest rates may also increase delinquencies, foreclosures and losses on our adjustable rate mortgages.
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.
Our principal source of revenue is net interest income or net interest spread from our long-term mortgage 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 mortgage portfolio includes mortgages that are six-month LIBOR 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 ARMs that have interest rate caps if the interest rates on our related borrowings increase.
ARMs 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 ARMs 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 early prepayments of mortgages may accelerate our expenses and decrease our net income.
Mortgage prepayments generally increase on our ARMs when fixed mortgage interest rates fall below the then-current interest rates on outstanding ARMs. 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 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.
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, or “GAAP,” 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.
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 mortgagesundertake, and investments. Generally, we require mortgage insurance onspecifically disclaim any mortgage with an LTV 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.
Our mortgage products expose us to greater credit risks.
We are an acquirer and originator of Alt-A mortgages, and to a lesser extent, multi-family and B/C mortgages. These are mortgages that generally may 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 these mortgages. Credit risks associated with these mortgages may be greater than those associated with conforming mortgages. The interest rates we charge on these mortgages 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 our type of borrowers may expose us to a higher risk of delinquencies, foreclosures and losses.
Our market includes borrowers who may be unable to obtain mortgage financing from conventional mortgage sources. Mortgages made to such 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 our 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 LTV 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 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 multi-family mortgages expose us to increased lending risks.
Generally, we consider multi-family mortgages to involve a higher degree of risk compared to first mortgages on one- to four-family, owner occupied residential properties. These mortgages have higher risks than mortgages secured by residential real estate because repayment of the mortgages often depends on the successful operations and the income stream of the borrowers. Furthermore, multi-family mortgages typically involve larger mortgage balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgages.
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 LTV 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 long-term mortgage 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, long-term mortgage portfolio and finance receivables 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 customers 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 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.
A substantial interruption in our use of iDASLg2 may adversely affect our level of mortgage acquisitions and originations.
We utilize the Internet in our business principally for the implementation of our automated mortgage origination program, iDASLg2. 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 bankers and 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 taxable income 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, B/C and multi-family 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 and brokers, 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 what may be 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 and B/C mortgage industry because the losses would be made public due to the reporting obligations of these entities.
The intense competition in the Alt-A, B/C and multi-family mortgage industry has also led to rapid technological developments, evolving industry standards and frequent releases of new products and enhancements. As mortgage products are offered more widely through alternative distribution channels, such as the Internet, we may be required to make significant changes to our current retail and wholesale structure and information systems to compete effectively. Our inability to continue enhancing our current Internet capabilities, or to adapt to other technological changes in the industry, could have a material adverse effect on our business, financial condition, liquidity and results of operations.
The need to maintain mortgage loan volume in this competitive environment creates a risk of price competition in the Alt-A, B/C and multi-family 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. Fraud risk may include the financing of nonexistent loans or fictitious mortgage loan transactions that could result in the loss of all sums we have advanced to the borrower. Also, our claims as a secured lender in a bankruptcy proceeding may be subject to adjustment and delay.
Our operating results will be affected bypublicly release the results of our interest rate risk management activities.
To offset the risks associated with our mortgage operations, we enter into transactions designed to limit our exposure to interest rate risks. To offset the risks associated with adjustable rate borrowings, we attempt to match the interest rate sensitivities of our ARMs with the associated financing liabilities. Management determines the nature and quantity of derivative transactions based on various factors, including market conditions and the expected volume of mortgage acquisitions. While we believe that we properly manage our interest rate risk on an economic and tax basis, we are not able to apply hedge accounting, as established by the Financial Accounting Standards Board, or FASB,” under the provisions of Statement of Financial Accounting Standards No. 133, or “SFAS 133,” for our interest rate risk management activities in our financial statements. The effect of not applying hedge accounting means that our interest rate risk management activities may result in significant 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 on derivative transactions that may result in net losses, as was the case in 2001 after the restatement of our consolidated financial statements. In addition, if the counter parties to our derivative transactions are unable to perform according to the terms of the contracts, we may incur losses. While we believe we prudently manage interest rate risk, our derivative transactions may not offset the risk of adverse changes in net interest margins.
A reduction in the demand for our 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 residential mortgages, which is affected by:
If our mortgage acquisitions and originations decline, we may have:
Our delinquency ratios and our performance may be adversely affected by the performance of parties who service or sub-service our mortgages.
We sell or contract with third-parties for the servicing of all mortgages, including those in our securitizations. Our operations are subject to risks associated with inadequate or untimely servicing. Poor performance by a 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 our equity interest, if any 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. If, as a result of a servicer or sub-servicer’s failure to perform adequately, we were terminated as master servicer of a securitization, the value of any master servicing rights held by us would be adversely affected.
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 and B/C market. We are a defendant in purported class actions pending in different states. The class actions 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. The other purported class action claims damages for sending out unsolicited faxes and seeks statutory and treble damages. 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.
Regulatory Risks
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 mortgages 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 bankers and 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 bankers and 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 banker 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 bankers and brokers or correspondents.
Violation of various federal, state and local laws may result in losses on our loans.
Applicable state and local laws generally regulate interest rates and other charges, require certain disclosure, and require licensing of the lender. In addition, other state and local laws, public policy and general principles of equity relating to the protection of consumers, unfair and deceptive practices and debt collection practices may apply to the origination, servicing and collection of our loans. Mortgage loans are also subject to federal laws, including:
Violations of certain provisions of these federal and state laws may limit our ability to collect all or part of the principal of or interest on the loans and in addition could subject us trust to damages and administrative enforcement and could result in the mortgagors rescinding the loans whether held by us or subsequent holders of the loans.
Our operations may be adversely affected if we are subject to the Investment Company Act.
We intend to conduct our business at all times so as not to become regulated as an investment company under the Investment Company Act. The Investment Company Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.
In order to qualify for this exemption we must maintain at least 55% of our assets directly in 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 SEC 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 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.
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, recently enacted and proposed local, 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 or B/C lending opportunities. Similarly, recently enacted and proposed local, state and federal privacy laws and laws prohibiting or limiting marketing by telephone, facsimile, email and the Internet may limit our ability to market and our ability to access potential loan applicants. For example, the recently enacted Can Spam Act of 2003 establishes the first national standards for the sending of commercial email allowing, among other things, unsolicited commercial email provided it contains certain information and an opt-out mechanism. We cannot provide any assurance that the proposed laws, rules and regulations, or other similar laws, rules or regulations, will not be adopted in the future. Adoption 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.
Some states and local governments have enacted, or may enact, laws or regulations that prohibit inclusion of some provisions in mortgage loans that have mortgage rates or origination costs in excess of prescribed levels, and require that borrowers be given certain disclosures prior to the consummation of such mortgage loans. Our failure to comply with these laws could subject us to monetary penalties and could result in the borrowers rescinding the mortgage loans, whether held by us or subsequent holders. Lawsuits have been brought in various states making claims against assignees of these loans for violations of state law.
Risks Related To Our Status As A REIT
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, exclusive of the application of any tax loss carry forwardsrevisions that may be usedmade to offset current period taxable income. These provisions restrict our abilityany forward-looking statements to retain earnings and thereby generate capital from our operating activities. We may decide at a futurereflect the occurrence of anticipated or unanticipated events or circumstances after the 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 the mortgage operations. The mortgage operations is not a REIT and is not, therefore, subject to the above-described REIT distribution requirements. Because the mortgage operations is seeking to retain earnings to fund the future growth of our mortgage operations business, its board of directors may decide that the mortgage operations 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 stockholders would be reduced substantially for each of the years involved. Failure to qualify as a REIT could adversely affect the value of our securities.
Potential characterization of distributions or gain on sale as unrelated business taxable income to tax-exempt investors.
If (1) all or a portion of our assets are subject to the rules relating to taxable mortgage pools, (2) we are a “pension-held REIT,” (3) a tax-exempt stockholder has incurred debt to purchase or hold our common stock, or (4) the residual REMIC interests we buy generate “excess inclusion income,” then a portion of the distributions to and, in the case of a stockholder described in (3), gains realized on the sale of common stock by such tax-exempt stockholder may be subject to Federal income tax as unrelated business taxable income under the Internal Revenue Code.
Classification as a taxable mortgage pool could subject us or certain of our stockholders 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:
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 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:
Notwithstanding the above, we recently amended our charter so that nothing in the charter will preclude the settlement of transactions entered into through the facilities of the New York Stock Exchange (“NYSE”).
The trustee shall sell the shares held in trust and the owner of the excess shares will be entitled to the lesser of:
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.
Risks Related To Ownership of Our Securitiesstatements.
Our share prices have been and may continue to be volatile.
Historically, the market price of our securities has been volatile. The market price of our securities is likely to continue to be highly volatile and could be significantly affected by factors including:
In addition, significant price and volume fluctuations in the stock market have particularly affected the market prices for the securities 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 securities could also be materially adversely affected and we may experience difficulty in raising capital.
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. We do not know the actual or perceived effect of these offerings, the timing of these offerings, the potential dilution of the book value or earnings per share of our securities then outstanding and the effect on the market price of our securities then outstanding. In December 2003, we filed a shelf registration statement for a total of $500.0 million, which may be used in connection with offerings of debt securities, common stock, preferred stock, warrants, and/or units for general corporate purposes. In May and June 2004, we issued 1,725,000 shares of common stock and 2,000,000 shares of Series B Preferred Stock from this shelf. We may currently sell additional securities worth approximately $177.1 million (gross proceeds) from this shelf registration statement in the future. We also have shares reserved for future issuance under our stock plans. 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.
ITEM 3: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
General Overview
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 impact 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 net earnings.
Interest rate risk management is the responsibility of ALCO, which reports results of interest rate risk analysis to the board of directors on at least 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 investment securities available-for-sale 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.
Changes in Interest Rates
ALCO follows an interestInterest rate hedging programrisk management policies 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 hedgelimit 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 hedging program isrisk management policies are formulated with the intent to offset the potential adverse effects of changing interest rates on cash flows on our adjustable rate CMO borrowings.
We primarily acquire for long-term investment ARMs and hybrid ARMs and, to a lesser extent, FRMs. ARMs are generally subject to periodic and lifetime interest rate caps. This means that the interest rate of each ARM is limited to upwardupwards or downwarddownwards 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 could 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 ratesrate limits of our ARMs, borrowing costs could 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 seven years which subsequently convert to 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 anypotential 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.derivatives.
We measure the sensitivity of our net interest income to changes in interest rates affecting interest sensitive assets and liabilities using various simulations. These simulations take into consideration changes that may occur in investment and financing strategies, changes in the forward yield curve, changes in interest rate hedging strategy, changes inrisk management strategies, mortgage prepayment speeds and changes in the volume of mortgage acquisitions and originations.
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
We estimate net interest income along with net cash flows on derivatives for the next twelve months using balance sheet data and the notional amount of derivatives as of the applicable date withApril 30, 2005 and 12-month projections of the following:following primary drivers affecting net interest income:
We refer to the 12-month projection of net interest income along with the 12-month projection of net cash flows on derivatives as the “base case.” For financial reporting purposes, net cash flows on derivative instruments are included in mark-to-market loss –gain (loss) on derivative instruments on the consolidated financial statements. However, for purposes of interest rate risk analysis we include net cash flows on derivatives in our base case simulations as we acquire derivatives to offset the effect that changes in interest rates have on variable borrowing costs, such as CMO and warehouse borrowings. We believe that including net cash flows on derivatives in our interest rate risk analysis presents a more useful simulation of the effect of changing interest rates on net cash flows generated by our long-term mortgage portfolio.
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 includinginclude 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 dollar and percentage change to base case. The simulations consider the affect of interest rate changes on interest sensitive assets and liabilities as well as derivatives. The simulations also consider the impact that instantaneous and parallel shift in interest rates have on prepayment rates and the resulting affect of accelerating or decelerating amortization rates of premium and securitization costs.
In the following table, the up 100 basis point scenario as of April 30, 2005 represents our projection of the net change from base case net interest income, which is derived from assumptions as previously discussed, if market interest rates were to immediately rise by 100 basis points. This means that we increase interest rates at all data points along our projected forward yield curve by 100 basis points and recalculate our projection of net interest income over the next 12 months. In addition, based on changes in interest rates, or changes in our forward yield curve, our model adjusts mortgage prepayment rates and recalculates amortization of acquisition and securitization costs and net cash receipts or payments on derivatives as part of the calculation of net interest income. Thus, if a 100 basis point interest rate increase occurred, the projected volatility to net interest income is negatively impacted by $9.5 million, or a decrease of 3% relative to projected base case net interest income.
Over the past year, the interest rate risk profile of our balance sheet increased. Higher liability sensitivity occurred as part of a deliberate and long-term optimization strategy as mortgages having marginally longer duration than that of CMO borrowings were added to our balance sheet during 2004 and the first six months of
2005. Other factors contributing to the shift in the interest rate risk profile include the increase in the overall level of interest rates, the flattening of the yield curve and slower expected future prepayment behavior. However, since our estimates are based upon numerous assumptions, actual sensitivity to interest rate changes could vary if actual experience differs from the assumptions used.
The following table estimates the financial impact to base case, including net cash flowsflow from derivatives, from various instantaneous and parallel shifts in interest rates based on both our on-on-balance sheet structure and off-balance sheet structure, which refers to the notional amount of derivatives that are not recorded on our balance sheet as of the period indicated:April 30, 2005 (dollar amounts in millions):
Changes in base case as of June 30, 2004 (1) | Changes in base case as of April 30, 2005 (1) | |||||||||||||||||||||||||||||
Base case, excluding net cashflow on derivatives | Net cash flow on derivatives | Base case, including net cash flow on derivatives | Base case, excluding net cashflow on derivatives | Net cashflow on derivatives | Base case, including net cashflow on derivatives | |||||||||||||||||||||||||
($) | (%) | ($) | ($) | (%) | ($) | (%) | ($) | ($) | (%) | |||||||||||||||||||||
Instantaneous and Parallel Change in Interest Rates (2) | ||||||||||||||||||||||||||||||
Up 300 basis points, or 3% | (206.7 | ) | (62 | ) | 170.8 | (35.9 | ) | (12 | ) | (415.5 | ) | (175 | ) | 364.8 | (50.7 | ) | (18 | ) | ||||||||||||
Up 200 basis points, or 2% | (121.7 | ) | (37 | ) | 125.6 | 3.9 | 1 | (277.7 | ) | (117 | ) | 243.2 | (34.5 | ) | (12 | ) | ||||||||||||||
Up 100 basis points, or 1% | (62.4 | ) | (19 | ) | (56.9 | ) | (5.4 | ) | (2 | ) | (131.1 | ) | (55 | ) | 121.6 | (9.5 | ) | (3 | ) | |||||||||||
Down 100 basis points, or 1% | 60.9 | 18 | (56.9 | ) | 3.9 | 1 | 130.3 | 55 | (121.6 | ) | 8.7 | 3 | ||||||||||||||||||
Down 200 basis points, or 2% | n/a | n/a | n/a | n/a | n/a | 341.7 | 144 | (311.4 | ) | 30.3 | 11 | |||||||||||||||||||
Down 300 basis points, or 3% | n/a | n/a | n/a | n/a | n/a |
(1) | The dollar and percentage changes represent base case for the next twelve months versus the change in base case |
(2) | Instantaneous and parallel interest rate changes over and under the projected forward yield curve. |
(3) |
The use of derivatives to manage risk associated with changes in interest rates is an integral part of our strategy to limit interest rate risk.strategy. The amount of cash payments or cash receipts on derivatives is determined by (1) the notional amount of the derivative and (2) current interest rate levels in relation to the various strike pricesstrikes or coupons of derivatives during a particular time period. As of June 30, 2005 and December 31, 2004, we had notional balances of interest rate swaps, caps, and floors of $19.7 billion and $15.1 billion, respectively, with unrealized mark-to-market gains of $130.5 million and $92.5 million, respectively. By using derivatives, we attempt to minimize the effect of both upward and downward interest rate changes on our long-term mortgage portfolio. Our goal is to minimize significant changes to base case net interest income, including net cash flows from derivatives, as interest rates change. We primarily acquire swaps to essentially convert our adjustable rate CMO borrowings into fixed rate borrowings. For instance, we receive one-month LIBOR on swaps, which offsets interest expense on adjustable rate CMO borrowings, and we pay a fixed interest rate.
ITEM 4: | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is properly recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include processes to accumulate and
communicate relevant information to management, including our Chief Executive Officer (“CEO”)CEO and Chief Financial Officer (“CFO”),CFO, as appropriate, to allow for timely decisions regarding required disclosures.
Under the supervision
As of June 30, 2005, our CEO and CFO, with the participation of ourother management including our CEO and CFO, we conducted an evaluationof the Company, evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) or 15(d)-15(e) promulgated under the Exchange Act, as of June 30, 2004. Based on theirand based upon that evaluation, our managementCEO and CFO concluded that ourthese disclosure controls and procedures were ineffective.not effective.
SubsequentMaterial Weaknesses
The Company’s management identified the following material weaknesses in internal control over financial reporting as of December 31, 2004:
1) | The Company’s internal controls intended to ensure the proper accounting and reporting for certain complex transactions and financial reporting matters were not designed or operating effectively. For these purposes, complex transactions and financial reporting matters include those relating to the transfer of financial assets, derivative financial instruments, state income tax exposure items, and the income tax effect of intercompany transfers of financial assets between taxable and non-taxable operating segments. Specifically, as previously disclosed in our 2004 Form 10-K/A, the Company did not employ an adequate number of personnel in its accounting and finance departments with appropriate skills and expertise to ensure that the accounting and reporting for certain complex transactions and financial reporting matters included in the Company’s financial statements were in accordance with U.S. generally accepted accounting principles. As a result of these ineffective controls, the Company had previously incorrectly recorded gains on sales of mortgage servicing rights when the related mortgage loans were sold to its parent company, the REIT. These gains on sales of mortgage servicing rights should have been recorded as an adjustment to the carrying value of the retained mortgage loans and recognized as a yield adjustment over the remaining term of the loans. In addition, the Company previously did not identify certain loan purchase commitments as derivative financial instruments. Lastly, the Company did not prepare and maintain sufficient documentation of certain derivative financial instrument transactions to support hedge accounting. As a result, the Company did not previously reflect fluctuations in the estimated fair value of these derivative financial instruments in earnings in the period of change, as required by U.S. generally accepted accounting principles. The Company restated its financial statements in 2004 to correct these material errors in accounting for the years ended December 31, 2003, 2002 and 2001, and three months ended March 31, 2004 and 2003, the three and six months ended June 30, 2004 and 2003, and the three and nine months ended September 30, 2003. |
2) | The Company’s internal control over financial reporting intended to ensure adequate access and change control over end-user computing spreadsheets were not designed properly. In addition, the information technology general controls related to access and program changes were deficient, resulting in a potential lack of reliability and integrity of the financial information which is used in these spreadsheets. As a result, although no actual misstatement was identified, there is a more than remote likelihood that financial statements and related footnote disclosures could be materially misstated. Specifically, there is the potential that an error could be reflected in the financial reporting and related disclosure of the allowance for loan losses, asset sales and securitizations and related yield adjustments on retained interests, and mortgage loan characteristics tables as a result of this material weakness in internal control over financial reporting. |
Internal Control Over Financial Reporting
Changes to filing our original annual report on Form 10-K and in connection with the preparation and review of our financial statements forInternal Control Over Financial Reporting
During the quarter ended June 30, 2004, management identified errors that led2005, the Company continued its remediation efforts in regard to a decision to restate our financial statements for the quarters ended Marchtwo December 31, 2004 and 2003 and formaterial weaknesses in Internal Control Over Financial Reporting as discussed below in the years ended December 31, 2003, 2002 and 2001. The restatements and reclassifications are further discussed“Remediation Efforts Related to the Material Weaknesses in Note A.2. – “RestatementInternal Control over Financial Reporting” section of Consolidatedthis report.
Remediation Efforts Related to the Material Weakness in Internal Control Over Financial Statements” in our Notes to Consolidated Financial Statements.Reporting
Subsequent to management’s identification of the errors in our financial statements and after reporting the error to our independent registered public accounting firm, KPMG LLP (“KPMG”), we noted certain matters regarding financial reporting and the interpretation of financial accounting standards in accordance with generally acceptable accounting principles to be a material weakness in internal controls as defined under standards established by the American Institute of Certified Public Accountants. A material weakness is a reportable condition in which the design or operation of one or more internal control components does not reduce to a relatively low level the risk that errors or fraud in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. Inadequate controls and procedures in the accounting and financial reporting departments for appropriately interpreting and applying accounting principles in order to prevent or detect misstatements of accounting information was a material weakness that was identified.
Furthermore, in planning and performing its audit of our restated consolidated financial statements, our external auditors also noted in a letter to management and the audit committee dated August 16,During 2004, certain matters involving internal controls and operations that they consider to be a material weakness, as defined by the PCAOB. According to the letter, we need to improve the evaluation and documentation of accounting policies and procedures for complex transactions, such as transfers of financial assets, derivatives and hedge accounting and allowance for credit losses, and we currently do not have a sufficient amount or type of staff in the financial reporting and accounting departments, including the lack of a Controller. Furthermore, our auditors also noted significant deficiencies, as defined by the PCAOB, for our consideration stating that our internal audit function does not provide an adequate or effective monitoring of our controls and we need to evaluate whether we have appropriate internal resources to manage and monitor work performed by our outsourced tax compliance function.
In connection with restating our financial statements as provided in this report, our CEO and CFO, with the participation of other management, evaluated the effectiveness of our disclosure controls and procedures for the quarter ended June 30, 2004 and based on the evaluation by our CEO and CFO, they concluded that, as of the quarter ended June 30, 2004, there were certain deficiencies in some of our disclosure controls and procedures, which has resulted in a conclusion that such disclosure controls were ineffective.
As a result of the findings described above and in addition to our obligations under Section 404 of the Sarbanes-Oxley Act of 2002, we began implementing the following actions:actions to address the two identified material weaknesses which have assisted us in our remediation efforts throughout the first six months of 2005:
We anticipate expenditures
We believe that our disclosure controlspolicies and procedures including our internal control over financial reporting, have improved duewith respect to authorization and monitoring of user access and with respect to the scrutiny of such matters by our managementauthorization and Audit Committee, and other consultants we have engaged to assist us in assessing and improving our controls and procedures. We believe our controls and procedures will continue to improve as we complete the implementation of the actions described above. We note, however, that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving it stated goals under all potential future conditions. Over time, our control systems as we develop them may become inadequate because ofdocumentation requirements for program changes in conditions, ororder to ensure the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Based in part upon these changes, our CEO and CFO believe that as of the filing date of this report on Form 10-Q/A, our disclosure controls and procedures are effective and are designed to provide reasonable assurance that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. The Company has not yet evaluated or tested the operating effectiveness of the matters listed above that have been and are being implemented to correct the referenced material weakness and significant deficiencies.
Changes in Internal Controls
During the first quarter of 2005, we took the following actions:
During the second quarter of 2004 (specifically in August 2004), 2005, we took the following actions:
PART II. OTHER INFORMATION
ITEM 1: | LEGAL PROCEEDINGS |
With respectPlease refer to the complaint captionedGarry Lee Skinner and Judy Cooper Skinner, et al. v. Preferred Credit, et al., which is described in IMH’s annual report on Form 10-K10-K/A Amendment No. 2 for the year ended December 31, 2003, a motion to dismiss the complaint was granted by an order of the court dated June 9, 2004. The plaintiffs have noticed an appeal.
With respect to the complaints captionedMichael and Amber Stallings v. Empire Funding Home Loan Owner Trust 1997-3; U.S. Bank, National Association; and Wilmington Trust Company, which is described in IMH’s annual report on Form 10-K for the year ended December 31, 2003, on April 5, 2004 the court conducted a status conference and agreed to administratively close the case pending the outcome of an appeal of a similar case before Sixth Circuit. Although the court
has not yet issued its order administratively closing the case, the court’s intent to issue such an order is indicated in the minutes of the status conference contained in the court’s docket.
With respect to the complaint captionedFrazier, et al v. Impac Funding Corp., et al., which is described in IMH’s annual report on Form 10-K for the year ended December 31, 2003, on April 5, 2004, the court conducted a status conference and agreed to administratively close the case pending the outcome of an appeal of a similar case before Sixth Circuit. On April 29, 2004, the court issued its order administratively closingFrazier.
On April 14, 2004, an action was filed in the Circuit Court of DuPage County, Illinois as Case No. 04 L 391 entitledSally Sengpiel v. GMAC Mortgage Corporation, Impac Funding Corp. d/b/a Impac Leasing Group. The complaint contains allegation of a class action and alleges that the defendants required prepayment penalties on notes, which exceed an annual percentage rate of 8% per annum in violation of Illinois law. The plaintiff is seeking actual and statutory damages and injunctive relief. On June 28, 2004, we filed a motion to dismiss the complaint.
We are a party to otherregarding litigation and claims which are normal in the course of our operations. While the results of such other litigation and claims cannot be predicted with certainty, we believe the final outcome of such other matters will not have a material adverse effect on our financial condition or results of operations.claims.
ITEM 2: |
None.
ITEM 3: | DEFAULTS UPON SENIOR SECURITIES |
None.
ITEM 4: | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
On May 25, 2004,June 28, 2005, we held our annual meeting of stockholders. Of 62,650,69675,263,432 shares eligible to vote, 59,597,212,71,749,939, or 95.1%95.3%, votes were returned, formulating a quorum. At the annual stockholders meeting, the following matters were submitted to stockholders for vote: (1) Proposal I - I—Election of Directors and (2) Proposal II – Amendment to IMH’s Charter.
Directors. The voting did not consist of any broker non-votes.
Proposal I - I—Election of Directors
The results of voting on these proposals are as follows:
Director | For | Against | Elected | For | Against | Elected | ||||||
Joseph R. Tomkinson | 58,894,764 | 702,448 | Yes | 71,172,251 | 577,688 | Yes | ||||||
William S. Ashmore | 59,023,464 | 573,748 | Yes | 71,153,361 | 596,578 | Yes | ||||||
James Walsh | 58,032,619 | 1,564,593 | Yes | 71,037,505 | 712,434 | Yes | ||||||
Frank P. Filipps | 58,000,219 | 1,596,993 | Yes | 70,791,777 | 958,162 | Yes | ||||||
Stephan R. Peers | 55,409,603 | 4,187,609 | Yes | 70,825,207 | 924,732 | Yes | ||||||
William E. Rose | 58,945,557 | 651,655 | Yes | 71,242,630 | 507,309 | Yes | ||||||
Leigh J. Abrams | 59,067,919 | 529,293 | Yes | 71,167,173 | 582,766 | Yes |
All directors are elected at our annual stockholders meeting.
Proposal II - Amendment to IMH’s charter
Proposal II was approved with 58,773,158 shares voted for, 475,649 voted against and 348,402 abstained from voting, thereby, amending and reinstating Article VII of our charter so that nothing in the charter will preclude the settlement of transactions entered into through the facilities of the NYSE.
ITEM 5: | OTHER INFORMATION |
None.On August 12, 2005, Gretchen Verdugo and Impac Funding Corporation (“IFC”) executed an employment agreement, which is effective as of February 1, 2005. The employment agreement, unless terminated earlier, expires on January 31, 2008.
Guaranty. Because IMH will receive direct and indirect benefits from the performance of Ms. Verdugo under the employment agreement, IMH executed a guaranty, executed as of August 12, 2005 and effective as of February 1, 2005, in favor of Ms. Verdugo. Under the terms of the guaranty, IMH promises to pay any and all obligations owed to Ms. Verdugo in the event of default by IFC.
Base and Other Compensation. Pursuant to the terms of the employment agreement, Ms. Verdugo receives an annual base salary of $400,000, which is not subject to any annual adjustment. Ms. Verdugo also receives other benefits, such as a monthly car allowance, health benefits, and accrued vacation. Additionally, Ms. Verdugo is eligible for tuition reimbursement for up to $67,000 for the costs associated with obtaining her MBA degree. Ms. Verdugo is prohibited, without prior approval of the board of directors, from receiving compensation, directly or indirectly from any companies with whom IFC or any of its affiliates has any financial, business or affiliated relationship.
Bonus Incentive Compensation. Ms. Verdugo is eligible to receive bonus incentive compensation consisting of a discretionary bonus of up to 50% of her base salary paid during the fiscal year. Such bonus incentive compensation is based upon management objectives established each year, which currently relate to support, and assistance in the implementation, of management initiatives, successful overview of compliance with regulatory requirements and continuation of professional education.
Severance Compensation. If Ms. Verdugo’s employment is terminated for any reason, other than without cause or good reason, Ms. Verdugo will receive her base salary, bonus incentive compensation and accrued vacation benefits prorated through the termination date. Termination with cause includes conviction of a crime of dishonesty or a felony with certain penalties, substantial failure to perform duties after notice, willful misconduct or gross negligence or material breach by IFC of the employment agreement. Good reason includes material changes to employee’s duties, relocation of the company’s business by more than 65 miles without employee’s consent, the company’s material breach of the employment agreement or, in the event of a change of control, the acquiring company fails to assume the agreement. If Ms. Verdugo is terminated without cause or if she resigns with good reason, Ms. Verdugo will receive, in addition to the above, the following:
(a) | an additional 18 months of base salary to be paid proportionally over the 18 month period following execution of a waiver and release agreement; |
(b) | health benefits paid over the 18 month period following the termination date, provided certain conditions are met; and |
(c) | the continued vesting for a period of 18 months of stock options, but no new grants of stock options. |
In the event that Ms. Verdugo voluntary terminates the employment agreement 30 days prior to the end of 2005, she will receive the severance payments detailed above, except the continued vesting of her stock options.
Ms. Verdugo has also agreed not to compete with IFC throughout the term of her employment or during the 18 months that severance payments are made to her Verdugo, provided that the agreement not to compete during such 18 month period will be waived if Ms. Verdugo forgoes the severance compensation.
Change of Control. The employment agreement will not be terminated by merger, an acquisition by another entity, or by transferring of all or substantially all of IFC’s assets. In the event of any such change of control, the surviving entity or transferee, will be bound by the employment agreement.
ITEM 6: | EXHIBITS |
(a) Exhibits:
(a) | Exhibits: |
10.1 | ||
10.2 | Guaranty, effective February 1, 2005, granted by Impac Mortgage Holdings, Inc. in favor of Gretchen D. Verdugo. | |
31.1 | Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
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. |
* | This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings. |
(b) Reports on Form 8-K:
Current Report on Form 8-K, dated May 4, 2004, furnished to the SEC reporting Item 12, relating to a press release issued by the Company on January 29, 2004 reporting financial results for the quarter ended March 31, 2004.
Current Report on Form 8-K, dated May 7, 2004, furnished to the SEC reporting Items 5 and 7, relating to the execution of an underwriting agreement with UBS Securities LLC, Friedman, RBC Capital Markets Corporation and Roth Capital Partners LLC.
Current Report on Form 8-K, dated May 12, 2004, furnished to the SEC reporting Items 5 and 7, relating to the execution of an equity distribution agreement with UBS Securities LLC.
Current Report on Form 8-K, dated May 25, 2004, furnished to the SEC reporting Items 5 and 7, relating to the execution of an underwriting agreement with Bear, Stearns & Co. Inc., Stifel, Nicolaus & Company, Incorporated, JMP Securities LLC, RBC Dain Rauscher Inc., Advest, Inc., and Flagstone Securities, LLC.
Current Report on Form 8-K, dated June 30, 2004, furnished to the SEC reporting Item 9, relating to the posting of the Company’s unaudited monthly fact sheet.
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. | ||
by: | /s/ RICHARD J. JOHNSON | |
Richard J. Johnson | ||
Executive Vice President and (authorized officer of registrant and principal financial officer) |
Date: October 22, 2004August 15, 2005
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