Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1999 or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to _________.
Commission File Number: 0-19861
______________________
IMPAC MORTGAGE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Maryland 33-0675505
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1401 Dove Street, Newport Beach, California 92660
(Address of principal executive offices)
(949) 475-3600
(Registrant's telephone number, including area code)
________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock $0.01 par value American Stock Exchange
______________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [_]
On March 14, 2000, the aggregate market value of the voting stock held by non-
affiliates of the registrant was approximately $69.9 million, based on the
closing sales price of the Common Stock on the American Stock Exchange. For
purposes of the calculation only, in addition to affiliated companies, all
directors and executive officers of the registrant have been deemed affiliates.
The number of shares of Common Stock outstanding as of March 14, 2000 was
21,400,906.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy Statement issued in connection
with the 2000 Annual Meeting of Stockholders of the Registrant are incorporated
by reference into Part III.
IMPAC MORTGAGE HOLDINGS, INC.
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. BUSINESS....................................................................................... 3
ITEM 2. PROPERTIES..................................................................................... 30
ITEM 3. LEGAL PROCEEDINGS.............................................................................. 30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 30
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................... 31
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA........................................................... 32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 35
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................................... 55
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................... 62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........... 62
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................. 63
ITEM 11. EXECUTIVE COMPENSATION......................................................................... 63
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................. 63
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................. 63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................ 64
SIGNATURES.............................................................................................. 68
2
PART I
Certain information contained in this Report constitutes forward-looking
statements under the Securities Act and the Exchange Act. These forward-looking
statements can be identified by the use of forward-looking terminology
including, but not limited to, "may," "will," "expect," "intend," "should,"
"anticipate," "estimate," or "believe" or comparable terminology. The Company's
actual results may differ materially from those contained in the forward-looking
statements. Factors that might cause such differences include, but are not
limited to, those discussed in "Item 1. Business--Risk Factors" as well as those
discussed elsewhere in this Report.
ITEM 1. BUSINESS
Impac Mortgage Holdings, Inc. was incorporated in Maryland in August 1995.
References to the "Company" refer to Impac Mortgage Holdings, Inc. ("IMH") and
its subsidiaries, IMH Assets Corporation ("IMH Assets"), Impac Warehouse Lending
Group, Inc. ("IWLG"), and Impac Funding Corporation, (together with its wholly-
owned subsidiary Impac Secured Assets Corporation, ("IFC")). References to IMH
refer to Impac Mortgage Holdings, Inc. as a separate entity from IMH Assets,
IWLG and IFC.
General
Impac Mortgage Holdings, Inc. is a mortgage real estate investment trust
("REIT"), which, together with its subsidiaries and related companies, primarily
operates three businesses: (1) the Long-Term Investment Operations, (2) the
Conduit Operations, and (3) the Warehouse Lending Operations. The Long-Term
Investment Operations invests primarily in non-conforming residential mortgage
loans and securities backed by such loans. The Conduit Operations purchases and
sells and securitizes primarily non-conforming mortgage loans. The Warehouse
Lending Operations provides warehouse and repurchase financing to originators of
mortgage loans. The Company elects to be taxed as a REIT for federal income tax
purposes, which generally allows the Company to pass through income to
stockholders without payment of federal income tax at the corporate level.
Long-Term Investment Operations
The Long-Term Investment Operations, conducted by IMH and IMH Assets (a
wholly-owned specialty purpose entity through which IMH conducts its CMO
borrowings), invests primarily in non-conforming residential mortgage loans and
mortgage-backed securities secured by or representing interests in such loans
and, to a lesser extent, in second mortgage loans. Non-conforming residential
mortgage loans are residential mortgages that generally do not qualify for
purchase by government-sponsored agencies such as the Federal National Mortgage
Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation
("Freddie Mac"). The principal differences between conforming loans and non-
conforming loans include applicable loan-to-value ratios, credit and income
histories of the mortgagors, documentation required for approval of the
mortgagors, type of properties securing the mortgage loans, loan sizes, and the
mortgagors' occupancy status with respect to the mortgaged properties. Second
mortgage loans are mortgage loans secured by a second lien on the property and
made to borrowers owning single-family homes for the purpose of debt
consolidation, home improvements, education and a variety of other purposes.
Income is earned primarily from net interest income received by IMH on
mortgage loans and mortgage-backed and other collateralized securities acquired
and held in its portfolio. Mortgage loans and mortgage-backed and other
collateralized securities are financed with capital, borrowings provided from
Collateralized Mortgage Obligations ("CMOs"), warehouse facilities, which are
referred to as reverse repurchase agreements, and borrowings secured by
mortgage-backed securities. IFC supports the investment objectives of the Long-
Term Investment Operations by supplying the Long-Term Investment Operations
mortgage loans and mortgage-backed securities at prices that are comparable to
those available through investment bankers and other third parties.
Mortgage Loans Held in the Portfolio
The Company originates loans through its network of conduit sellers and
invests a substantial portion of its portfolio in non-conforming mortgage loans
and, to a lesser extent, second mortgage loans. The Company also
3
purchases such loans from third parties for long-term investment and for resale.
Management believes that non-conforming mortgage loans provide an attractive net
earnings profile and produce higher yields without commensurately higher credit
risks when compared with conforming mortgage loans. A portion of the long-term
investment portfolio consists of "A-," "B," "C," and "D" grade mortgage loans,
(collectively, "B/C Loans"). The Company believes that a structural change in
the mortgage banking industry has occurred which has increased demand for higher
yielding non-conforming mortgage loans. This change has been caused by a number
of factors, including: (1) investors' demand for higher-yielding assets due to
historically low interest rates over the past few years, (2) increased
securitization of high-yielding non-conforming mortgage loans by the investment
banking industry, (3) quantification and development of standardized credit
criteria by credit rating agencies for securities backed by non-conforming
mortgage loans, and (4) increased competition in the securitization industry,
which has reduced borrower interest rates and fees, thereby making non-
conforming mortgage loans more affordable.
Investments in Mortgage-Backed and Other Collateralized Securities
The Company also acquires mortgage-backed securities and other
collateralized securities generated through its own securitization efforts and
those generated by third parties. In connection with the issuance of mortgage-
backed securities by IFC in the form of real estate mortgage investment conduits
("REMICs"), IMH has and may retain senior or subordinated securities as regular
interests on a short-term or long-term basis. Such securities or investments may
subject the Company to credit, interest rate and/or prepayment risks. In
general, subordinated classes of a particular series of securities bear all
losses prior to the related senior classes. Losses in excess of expected losses
at the time such securities are purchased would adversely affect the Company's
yield on such securities and could result in the failure of the Company to
recoup its initial investment. The Company may also acquire REMIC or CMO
residual interests created through its own securitizations or those of third
parties. See "--Conduit Operations--Securitization and Sale Process," and "--
Risk Factors--Value of Our Portfolio of Mortgage-Backed Securities May be
Adversely Affected."
Financing
The Long-Term Investment Operations are primarily financed through the
issuance of CMOs, short-term borrowings under reverse repurchase agreements,
borrowings secured by mortgage-backed securities, and proceeds from the sale of
capital stock. Refer to "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of OperationsLiquidity and Capital Resources"
for more information regarding the Company's financing arrangements.
Collateralized Mortgage Obligations. As the Long-Term Investment Operations
accumulates mortgage loans in its long-term investment portfolio, the Company
may issue CMOs secured by such loans as a means of financing its Long-Term
Investment Operations. The decision to issue CMOs is based on the Company's
current and future investment needs, market conditions and other factors. For
accounting and tax purposes, the mortgage loans financed through the issuance of
CMOs are treated as assets of the Company, and the CMOs are treated as debt of
the Company, when for accounting purposes the CMO qualifies as a financing
arrangement. Each issue of CMOs is fully payable from the principal and interest
payments on the underlying mortgage loans collateralizing such debt, any cash or
other collateral required to be pledged as a condition to receiving the desired
rating on the debt, and any investment income on such collateral. The Long-Term
Investment Operations earns the net interest spread between the interest income
on the mortgage loans securing the CMOs and the interest and other expenses
associated with the CMO financing. The net interest spread may be directly
impacted by the levels of prepayment of the underlying mortgage loans and, to
the extent each CMO class has variable rates of interest, may be affected by
changes in short-term interest rates.
When the Company issues CMOs for financing purposes, it seeks an investment
grade rating for such CMOs by a nationally recognized rating agency. To secure
such a rating, 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
enhancements such as additional mortgage loan 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 the capacity
of the Company to raise additional funds through short-term secured borrowings
or additional CMOs, and diminishes the potential expansion of its investment
portfolio. As a result, the Company's objective is to pledge additional
collateral for CMOs only in the amount required to obtain an investment grade
rating for the CMOs by a
4
nationally recognized rating agency. Total loss exposure to the Company is
limited to the equity invested in the CMOs at any point in time.
The Company believes that under prevailing market conditions an issuance of
CMOs receiving other than an investment grade rating would require payment of an
excessive yield to attract investors. The Company's CMOs typically are
structured as one-month London interbank offered rate ("LIBOR") "floaters" and
fixed-rate securities with interest payable monthly. Interest rates on
adjustable rate CMOs generally range from 0.18% to 8.50% over one-month LIBOR
and from 6.65% to 18.25% on fixed rate CMOs depending on the class of the CMOs
issued. The CMOs are guaranteed for the holders by a mortgage loan insurer,
giving the CMOs the highest rating established by a nationally recognized rating
agency.
Reverse Repurchase Agreements. The Company has reverse repurchase
agreements at interest rates that are consistent with the Company's financing
objectives. A reverse repurchase agreement, although structured as a sale and
repurchase obligation, acts as a financing vehicle under which the Company
effectively pledges its mortgage loans and mortgage securities as collateral to
secure a short-term loan. Generally, the other party to the agreement makes the
loan in an amount equal to a percentage of the market value of the pledged
collateral. At the maturity of the reverse repurchase agreement, the Company is
required to repay the loan and correspondingly receives back its collateral.
Under reverse repurchase agreements, the Company retains the instruments of
beneficial ownership, including the right to distributions on the collateral and
the right to vote on matters as to which certificate holders vote. Upon a
payment default under such agreements, the lending party may liquidate the
collateral.
The Company's borrowing agreements require the Company to pledge cash,
additional mortgage loans or additional securities backed by mortgage loans in
the event the market value of existing collateral declines. The Company may be
required to sell assets to reduce its borrowings to the extent that cash
reserves are insufficient to cover such deficiencies in collateral. To reduce
its exposure to the credit risk of reverse repurchase agreement lenders, the
Company enters into such agreements with several different parties and follows
its own credit exposure procedures. The Company monitors the financial condition
of its reverse repurchase agreement lenders on a regular basis, including the
percentage of mortgage loans that are the subject of reverse repurchase
agreements with a single lender. See "--Risk Factors--Inability to Generate
Liquidity May Adversely Affect Our Operations."
Borrowings Secured by Mortgage-Backed Securities. The Company finances a
portion of its mortgage-backed securities portfolio with principal only notes.
The notes represent senior or subordinated interests in trust funds primarily
consisting of a pool of mortgage loans. The notes represent non-recourse
obligations of the Company.
Other Mortgage-Backed Securities. As an additional alternative for the
financing of its Long-Term Investment Operations, the Company may issue other
mortgage-backed securities. The Company may issue mortgage pass-through
certificates representing an undivided interest in pools of mortgage loans. The
holders of mortgage pass-through certificates receive their pro rata share of
the principal payments made on a pool of mortgage loans and interest at a pass-
through interest rate that are fixed at the time of offering. The Company may
retain up to a 100% undivided interest in a significant number of the pools of
mortgage loans underlying such pass-through certificates. The retained interest,
if any, may also be subordinated so that, in the event of a loss, payments to
certificate holders will be made before the Company receives its payments.
Unlike the issuance of CMOs, the issuance of mortgage pass-through certificates
will not create an obligation of the Company to security holders in the event of
borrower default. However, as in the case of CMOs, the Company may be required
to obtain various forms of credit enhancements in order to obtain an investment
grade rating for issues of mortgage pass-through certificates by a nationally
recognized rating agency.
Conduit Operations
The Conduit Operations, conducted by IFC, purchases primarily non-
conforming mortgage loans and, to a lesser extent, second mortgage loans from
its network of third party correspondents and other sellers. IFC subsequently
securitizes and sells loans to permanent investors, including the Long-Term
Investment Operations. All mortgage loans originated or purchased by IFC will be
made available for sale to IMH at prices that are comparable to those available
through third parties at the date of sale and subsequent transfer to IMH. IMH
owns all of the preferred stock of, and 99% of the economic interest in, IFC,
while Joseph R. Tomkinson, Chairman and Chief Executive Officer, William S.
5
Ashmore, President and Chief Operating Officer, and Richard J. Johnson,
Executive Vice President and Chief Financial Officer, are the holders of all of
the outstanding voting stock of, and 1% of the economic interest in, IFC.
As of February 8, 2000, IFC maintained relationships with 263
correspondents. Correspondents originate and close mortgage loans under IFC's
mortgage loan programs on a flow (loan-by-loan) basis or through bulk sale
commitments. Correspondents include savings and loan associations, commercial
banks, mortgage bankers and mortgage brokers. IFC can compete effectively with
other non-conforming mortgage loan conduits through its efficient loan
purchasing process, flexible purchase commitment options and competitive pricing
and by designing non-conforming mortgage loans to suit the needs of its
correspondent loan originators and their borrowers, which are intended to
provide sufficient credit quality to its investors. In addition to earnings
generated from ongoing securitizations and sales to third-party investors, IFC
supports the Long-Term Investment Operations of the Company by supplying IMH
with non-conforming mortgage loans and securities backed by such loans.
As a non-conforming mortgage loan conduit, IFC acts as an intermediary
between the originators of mortgage loans that do not currently meet the
guidelines for purchase by government-sponsored entities that guarantee
mortgage-backed securities (i.e. Fannie Mae and Freddie Mac) and permanent
investors in mortgage-backed securities secured by or representing an ownership
interest in such mortgage loans. IFC also acts as a bulk purchaser of primarily
non-conforming mortgage loans. The Company believes that non-conforming mortgage
loans provide an attractive net earnings profile, producing higher yields
without commensurately higher credit risks when compared to mortgage loans that
qualify for purchase by Fannie Mae or Freddie Mac. In addition, based on the
Company's experience in the mortgage banking industry and in the mortgage
conduit business, the Company believes it provides mortgage loan sellers with an
expanded and competitively priced array of non-conforming and, to a lesser
extent, B/C Loan products, timely purchasing of loans, mandatory, best efforts
and optional rate-lock commitments, and flexible master commitments. See
"--Purchase Commitment Process and Pricing."
Marketing and Production
Marketing Strategy. The Company's competitive strategy is to be a low-cost
national acquirer of mortgage loans to be held for long-term investment, sold in
the secondary market as whole loans or securitized as mortgage-backed
securities. A key feature of this approach is the use of a large national
network of correspondent originators. This allows the Company to shift the high
fixed costs of interfacing with the homeowner to the correspondents. The
marketing strategy for the Conduit Operations is designed to accomplish three
objectives: (1) attract a geographically diverse group of both large and small
correspondent loan originators, (2) establish relationships with such
correspondents and facilitate their ability to offer a variety of loan products
designed by IFC, and (3) purchase loans and securitize and sell them in the
secondary market or to IMH. In order to accomplish these objectives, IFC designs
and offers loan products that are attractive to potential non-conforming
borrowers and to end-investors in non-conforming mortgage loans and mortgage-
backed securities.
IFC has historically emphasized and continues to emphasize flexibility in
its mortgage loan product mix as part of its strategy to attract correspondents
and establish relationships. IFC also maintains relationships with numerous end-
investors so that it may develop products that they may be interested in as
market conditions change, which in turn may be offered through the correspondent
network. As a consequence, IFC is less dependent on acquiring conforming
mortgage loans and has acquired significant volumes of non-conforming loans.
In response to the needs of its non-conforming mortgage loan
correspondents, and as part of its strategy to facilitate the sale of its loans
through the Conduit Operations, IFC's marketing strategy offers efficient
response time in the purchase process, direct and frequent contact with its
correspondents through a trained sales force and flexible commitment programs.
Finally, due to the price sensitivity of most homebuyers, IFC is competitive in
pricing its products in order to attract sufficient numbers of borrowers.
The Progressive Series Loan Program. The underwriting guidelines utilized
in the Progressive Series Loan Program ("Progressive Series"), as developed by
IFC, are intended to assess the borrower's ability and willingness to repay the
mortgage loan obligation and to assess the adequacy of the mortgaged property as
collateral for the mortgage loan. Progressive Series is designed to meet the
needs of borrowers with excellent credit, as well as those with credit that has
been adversely affected. Progressive Series consists of six mortgage loan
programs. Each program has
6
different credit criteria, reserve requirements, qualifying ratios and loan-to-
value ratio ("LTV") restrictions. Series I is designed with credit history and
income requirements typical of "A" credit borrowers. In the event a borrower
does not fit the series I criteria, the borrower's mortgage loan is placed into
either series II, III, III+, IV, V or VI, depending on which series' mortgage
loan parameters meets the borrower's unique credit profile. Series II, III,
III+, IV, V or VI allow for less restrictive standards because of certain
compensating or offsetting factors such as a lower LTV, verified liquid assets,
job stability, pride of ownership and, in the case of refinance mortgage loans,
length of time owning the mortgaged property. The philosophy of Progressive
Series is that no single borrower characteristic should automatically determine
whether an application for a mortgage loan should be approved or disapproved.
Lending decisions are based on a risk analysis assessment after the review of
the entire mortgage loan file. Each mortgage loan is individually underwritten
with emphasis placed on the overall quality of the mortgage loan. Progressive
Series I utilizes an average annual salary to calculate the debt service-to-
income ratio. Salaried borrowers are evaluated based on a 12-month salary
history while self-employed and commission borrowers are evaluated on a 24-month
basis. The debt service-to-income ratio for series I borrowers is required to be
within the range of 36% to 50%. Progressive Series II, III, III+, IV, V and VI
borrowers are required to have debt service-to-income ratios within the range of
45% to 60% (calculated on the basis of monthly income), depending on the LTV of
the mortgage loan.
The Progressive Express Loan Program. In July 1996, IFC developed an
additional program to the Progressive Series, called the Progressive Express
Loan Program ("Progressive Express"). The concept of Progressive Express is to
underwrite loans focusing on the borrower's Fair Isaac Credit Score ("FICO"),
the borrower's ability and willingness to repay the mortgage loan obligation,
and assessment of the adequacy of the mortgage property as collateral for the
loan. The FICO was developed by Fair Isaac Co., Inc. of San Rafael, California.
It is an electronic evaluation of past and present credit accounts on the
borrower's credit bureau report. This includes all reported accounts as well as
public records and inquiries. Progressive Express offers six levels of mortgage
loan programs. Progressive Express has a minimum FICO that must be met by the
borrower's primary wage earner and does not allow for exceptions to the FICO
requirement. The FICO requirement is as follows: Progressive Express I - above
680, Progressive Express II - 680-620, Progressive Express III - 619-601,
Progressive Express IV - 600-581, Progressive Express V - 580-551, and
Progressive IV - 550-500. Each Progressive Express program has different FICO
requirements, credit criteria, reserve requirements, and LTV restrictions.
Progressive Express I is designed for credit history and income requirements
typical of "A+" credit borrowers. In the event a borrower does not fit the
Progressive Express I criteria, the borrower's mortgage loan is placed into
either Progressive Express II, III, IV, V, VI, depending on which series'
mortgage loan parameters meets the borrowers unique credit profile.
Impac Lending Group ("ILG"). ILG began operations in January 1999 and
markets, underwrites, processes and funds mortgage loans for both of the
Company's wholesale and retail customers. Through the wholesale division, ILG
allows mortgage brokers to work directly with the Company to originate,
underwrite and fund their mortgage loans. Many of the Company's wholesale
customers cannot conduct business with the Conduit Operations as correspondent
sellers because they do not meet the higher net worth requirements. Through the
retail division, ILG markets mortgage loans directly to the public. Both the
wholesale and retail divisions offer all of the loan programs, including
Progressive Series and Progressive Express, that are offered by the Conduit
Operations.
Mortgage Loans Acquired. A majority of mortgage loans purchased by the
Conduit Operations are non-conforming mortgage loans. Currently, the maximum
principal balance for a conforming loan is $252,700. Loans that exceed such
maximum principal balance are referred to as "jumbo loans." Non-conforming
mortgage loans generally consist of jumbo loans or other loans that are
originated in accordance with underwriting or product guidelines that differ
from those applied by Fannie Mae and Freddie Mac. Non-conforming loans may
involve greater risk as a result of different underwriting and product
guidelines. A portion of the mortgage loans purchased through the Conduit
Operations are B/C Loans, as described below, which may entail greater credit
risks than other non-conforming loans. IFC generally does not acquire mortgage
loans with principal balances above $750,000 for "A" quality loans, and $500,000
for B/C Loans. Non-conforming loans purchased by IFC pursuant to its
underwriting programs typically differ from those purchased pursuant to the
guidelines established by Fannie Mae and Freddie Mac primarily with respect to
required documentation, LTV ratios, borrower income or credit history, interest
rates, borrower occupancy of the mortgaged property, and/or property types. To
the extent that these programs reflect underwriting standards different from
those of Fannie Mae and Freddie Mac, the performance of loans made may reflect
higher delinquency rates and/or credit losses.
7
IFC's focus on the acquisition of non-conforming mortgage loans may affect
the Company's financial performance. For example, the purchase market of non-
conforming loans has typically provided for higher interest rates in order to
compensate for the lower liquidity of such loans, thereby potentially enhancing
the interest income earned by the Company during the accumulation phase for
loans held-for-sale and during the holding period for loans held-for-investment.
In addition, due to the lower level of liquidity in the non-conforming loan
market, the Company may realize higher returns upon securitization of such loans
than would be realized upon securitization of conforming loans. On the other
hand, such lower levels of liquidity may from time to time cause the Company to
hold such loans or other mortgage-related assets supported by such loans. In
addition, by retaining for investment either the loans or other mortgage-related
assets supported by such loans, the Company assumes the potential risk of any
increased delinquency rates and/or credit losses as well as interest rate risk.
Mortgage loans acquired by IFC are generally secured by first liens and, to
a lesser extent, second liens on single (one-to-four) family residential
properties with either fixed or adjustable interest rates. Fixed rate mortgage
loans ("FRMs") have a constant interest rate over the life of the loan, which is
generally 15 or 30 years. The interest rate on adjustable rate mortgage loans
("ARMs") are typically tied to an index, such as six-month LIBOR or the one-year
constant maturity Treasury index ("CMT Index") and are adjustable periodically
at various intervals. ARMs are typically subject to lifetime interest rate caps
and periodic interest rate and/or payment caps. The interest rates on ARMs are
typically lower than the average comparable fixed rate loan initially, but may
be higher than average comparable fixed rate loans over the life of the loan.
Currently, IFC purchases (1) FRMs that have original terms to maturity ranging
from 10 to 30 years, (2) ARMs that adjust based on LIBOR or the CMT Index, and
(3) 2-year and 3-year FRMs that adjust to six-month ARMs approximately two to
three years following origination at an interest rate based upon a defined index
plus a spread. Substantially all mortgage loans purchased by IFC fully amortize
over their remaining terms. However, IFC may purchase mortgage loans with other
interest rate and maturity characteristics.
The credit quality of the loans purchased by IFC varies depending upon the
specific program under which such loans are purchased. For example, a principal
credit risk inherent in adjustable rate mortgage loans is the potential "payment
shock" experienced by the borrower as rates rise, which could result in
increased delinquencies and credit losses. In the case of negative amortization
mortgage loans, a portion of the interest due accrues to the underlying
principal balance of the loan, thereby increasing the LTV ratio of the mortgage
loans. As a general rule, mortgage loans with higher LTV ratios are vulnerable
to higher delinquency rates given the borrower's lower equity investment in the
underlying property. Limited documentation mortgage loans, by contrast, must
meet more rigorous criteria for borrower credit quality in order to compensate
for the reduced level of lender review with respect to the borrower's earnings
history and capacity.
8
The following table summarizes IFC's mortgage loan acquisitions by type of
loan, including net premiums, for the periods shown:
Year ended Year ended
December 31, 1999 December 31, 1998
----------------- -----------------
(dollars in millions,
except for average loan size)
Non-conforming Loans:
Volume of loans.......................................................... $ 1,669.4 $ 2,234.7
------------ ------------
Percent of total volume.................................................. 99.9% 99.4%
Conforming Loans:
Volume of loans.......................................................... $ 2.3 $ 13.9
------------ ------------
Percent of total volume.................................................. 0.1% 0.6%
------------ ------------
Total Mortgage Loan Acquisitions........................................... $ 1,671.7 $ 2,248.6
============ ============
Fixed Rate Loans:
Volume of loans.......................................................... $ 1,037.0 $ 1,893.2
------------ ------------
Percent of total volume.................................................. 62.0% 84.2%
Adjustable Rate Loans:
Volume of loans.......................................................... 634.7 355.4
------------ ------------
Percent of total volume.................................................. 38.0% 15.8%
------------ ------------
Total Mortgage Loan Acquisitions........................................... $ 1,671.7 $ 2,248.6
============ ============
Average Loan Size......................................................... $ 156,000 $ 128,000
============ ============
IFC's loan purchase activities are expected to continue to focus on those
regions of the country where higher volumes of non-conforming mortgage loans are
originated, including California, Florida, New Jersey, New York, Colorado,
Nevada, Texas, Georgia, Maryland and Hawaii. The highest concentration of non-
conforming mortgage loans purchased by IFC relates to properties located in
California and Florida because of generally higher property values and mortgage
loan balances. During the years ended December 31, 1999 and 1998, mortgage loans
secured by California and Florida properties accounted for approximately 44% and
11%, respectively, and 42% and 8%, respectively, of mortgage loan acquisitions.
Of the $1.7 billion in mortgage loans acquired during the year ended December
31, 1999, $880.7 million, or 53%, were acquired from IFC's top ten sellers.
During the year ended December 31, 1999, Occidental Mortgage Corporation
accounted for $181.7 million, or 11%, of mortgage loans acquired by IFC. No
other sellers accounted for more than 10% of the total mortgage loans acquired
by IFC during the year ended December 31, 1999. In addition, IFC acquired $5.4
million, or 0.3%, of mortgage loans from Walsh Securities, Inc. ("WSI") and
$89.2 million, or 5%, of mortgage loans from ILG, affiliates of the Company.
James Walsh, Executive Vice President of WSI, is a Director of the Company.
During 1999, ILG operated under the business license of WSI. No sellers other
than WSI and ILG are affiliates of the Company.
A portion of the mortgage loans acquired by IFC are comprised of B/C Loans,
as defined by the Company. For the year ended December 31, 1999, such loans
accounted for 10% of IFC's total loan acquisitions as compared to 23% of IFC's
total loan acquisitions during 1998. In general, B/C Loans are residential
mortgage loans made to borrowers with lower credit ratings than borrowers of
higher quality, or so called "A" grade mortgage loans, and are normally subject
to higher rates of loss and delinquency than other non-conforming loans
purchased by IFC. As a result, B/C Loans normally bear a higher rate of interest
and are typically subject to higher fees (including greater prepayment fees and
late payment penalties) than non-conforming loans of "A" quality. In general,
greater emphasis is placed upon the value of the mortgaged property and,
consequently, the quality of appraisals, and less upon the credit history of the
borrower in underwriting B/C Loans than in underwriting "A" grade loans. In
addition, B/C Loans are generally subject to lower LTV ratios than "A" grade
loans. Under IFC's B/C Loan program, underwriting authority is delegated only to
correspondents who meet strict underwriting guidelines established by IFC, see
"--underwriting and Quality Control."
9
High Loan-to-Value Loans. High loan-to-value loans ("125 Loans") consist of
second mortgage loans to qualified borrowers who have limited access to
traditional mortgage-related financing generally because of a lack of equity in
their homes. The loans are typically closed-end (usually 15 years), fixed rate,
fully-amortizing loans secured by a first or second lien on the borrower's
primary residence, and are typically used by consumers to pay-off credit card
and other unsecured indebtedness. Almost all of these loans are made in excess
of the value of the underlying collateral available to secure such loans, up to
a maximum of 125% of the property's LTV ratio. During 1997, IFC purchased $576.1
million of 125 Loans from Preferred Credit Corporation, of which the majority of
125 Loans were subsequently sold and securitized. As of December 31, 1999, IFC
had outstanding 125 Loans held-for-sale of $193,000.
Purchase Commitment Process and Pricing
Master Commitments. As part of its marketing strategy, IFC has established
mortgage loan purchase commitments ("Master Commitments") with sellers that,
subject to certain conditions, entitle the seller to sell and obligate IFC to
purchase a specified dollar amount of non-conforming mortgage loans over a
period generally ranging from six months to one year. The terms of each Master
Commitment specify whether a seller may sell loans to IFC on a mandatory, best
efforts or optional rate-lock basis. Master Commitments do not generally
obligate IFC to purchase loans at a specific price, but rather provide the
seller with a future outlet for the sale of its originated loans based on IFC's
quoted prices at the time of purchase. Master Commitments specify the types of
mortgage loans the seller is entitled to sell to IFC and generally range from $2
million to $50 million in aggregate committed principal amount. The provisions
of IFC's Seller/Servicer Guide are incorporated in each of the Conduit
Operations' Master Commitments and may be modified by negotiations between the
parties. In addition, there are individualized Master Commitment options
available to sellers, which include alternative pricing structures or
specialized loan products. In order to obtain a Master Commitment, a seller may
be asked to pay a non-refundable up-front or non-delivery fee, or both, to the
Company. As of December 31, 1999, IFC had outstanding Master Commitments with 88
sellers to purchase mortgage loans in the aggregate principal amount of $1.9
billion over periods ranging from six months to one year, of which $747.5
million had been purchased or committed to be purchased pursuant to rate-locks.
Sellers who have entered into Master Commitments may sell mortgage loans to
the Conduit Operations by executing individual, bulk or other rate-locks (each,
a "rate-lock"). Each rate-lock, in conjunction with the related Master
Commitment, specifies the terms of the related sale, including the quantity and
price of the mortgage loans or the formula by which the price will be
determined, the rate-lock type and the delivery requirements. Historically, the
up-front fee paid by a seller to IFC to obtain a Master Commitment on a
mandatory delivery basis is often refunded pro rata as the seller delivers loans
pursuant to rate-locks. Any remaining fee after the Master Commitment expires is
retained by the Conduit Operations.
Following the issuance of a specific rate-lock, IFC is subject to the risk
of interest rate fluctuations and enters into hedging transactions to diminish
such risk. Hedging transactions may include mandatory or optional forward sales
of mortgage loans or mortgage-backed securities, interest rate caps, floors and
swaps, mandatory forward sales, mandatory or optional sales of futures, and
other financial futures transactions. The nature and quantity of hedging
transactions are determined by the management of IFC based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
Deferred hedging gains and losses are presented on IFC's balance sheet in
mortgage loans held-for-sale. These deferred amounts are recognized upon the
sale or securitization of the related mortgage loans. As of December 31, 1999
and 1998, IFC had $792,000 and $263,000, respectively, of deferred hedging
losses included in mortgage loans held-for-sale.
Bulk and Other Rate-Locks. IFC also acquires mortgage loans from sellers
that are not purchased pursuant to Master Commitments. These purchases may be
made on an individual rate-lock basis. Bulk rate-locks obligate the seller to
sell and IFC to purchase a specific group of loans, generally ranging from $1
million to $125 million in aggregate committed principal amount, at set prices
on specific dates. Bulk rate-locks enable IFC to acquire substantial quantities
of loans on a more immediate basis. The specific pricing, delivery and program
requirements of these purchases are determined by negotiation between the
parties but are generally in accordance with the provisions of IFC's
Seller/Servicer Guide. Due to the active presence of investment banks and other
substantial investors in this area, bulk pricing is extremely competitive. Loans
are also purchased from individual sellers (typically smaller originators of
mortgage loans) who do not wish to sell pursuant to either a Master Commitment
or bulk rate-lock. The terms of these individual purchases are based primarily
on IFC's Seller/Servicer Guide and standard pricing provisions.
10
Mandatory, Best-Efforts and Optional Rate-Locks. Mandatory rate-locks
require the seller to deliver a specified quantity of loans to IFC over a
specified period of time regardless of whether the loans are actually originated
by the seller or whether circumstances beyond the seller's control prevent
delivery. IFC is required to purchase all loans covered by the rate-lock at
prices established at the time of rate-lock. If the seller is unable to deliver
the specified loans, it may instead deliver comparable loans approved by IFC
within the specified delivery time. Failure to deliver the specified mortgage
loans or acceptable substitute loans under a mandatory rate-lock obligates the
seller to pay IFC a penalty, and, if IFC's mortgage loan yield requirements have
declined, the present value of the difference in yield IFC would have obtained
on the mortgage loans that the seller agreed to deliver and the yield available
on similar mortgage loans subject to mandatory rate-lock issued at the time of
such failure to deliver. In contrast, mortgage loans sold on a best-efforts
basis must be delivered to IFC only if they are actually originated by the
seller. The best-efforts rate-lock provides sellers with an effective way to
sell loans during the origination process without any penalty for failure to
deliver. Optional rate-locks give the seller the option to deliver mortgage
loans to IFC at a fixed price on a future date and requires the payment of up-
front fees to IFC. Any up-front fees paid in connection with optional rate-locks
are retained by IFC if the loans are not delivered.
Pricing. IFC sets purchase prices at least once every business day for
mortgage loans it acquires for its Conduit Operations based on prevailing market
conditions. Different prices are established for the various types of loans,
rate-lock periods and types of rate-locks (mandatory or best-efforts). IFC's
standard pricing is based on the anticipated price it receives upon sale or
securitization of the loans, the anticipated interest spread realized during the
accumulation period, the targeted profit margin and the anticipated issuance,
credit enhancement, and ongoing administrative costs associated with such sale
or securitization. The credit enhancement cost component of IFC's pricing is
established for individual mortgage loans or pools of mortgage loans based upon
the characteristics of such loans or loan pools. As the characteristics of the
loans or loan pools vary, this cost component is correspondingly adjusted upward
or downward to reflect the variation. IFC's adjustments are reviewed
periodically by management to reflect changes in the costs of credit
enhancement. Adjustments to IFC's standard pricing may also be negotiated on an
individual basis under Master Commitments or bulk or individual rate-locks with
sellers. See "--Securitization and Sale Process."
Purchase Guidelines, Underwriting Methods, Seller Eligibility and Quality
Control
Purchase Guidelines. IFC has developed comprehensive purchase guidelines
for the acquisition of mortgage loans by the Conduit Operations. Each loan
underwritten assesses the borrower's FICO, ability and willingness to repay the
mortgage loan obligation and the adequacy of the mortgaged property as
collateral for the mortgage loan. Subject to certain exceptions and the type of
loan product, each purchased loan must conform to the loan parameters and
eligibility requirements specified in IFC's Seller/Servicer Guide with respect
to, among other things, loan amount, type of property, LTV ratio, mortgage
insurance, credit history, debt service-to-income ratio, appraisal and loan
documentation. IFC also performs a full legal documentation review prior to the
purchase of all loans. All mortgage loans originated under IFC's loan programs
are underwritten either by employees of IFC or by contracted mortgage insurance
companies or delegated conduit sellers.
Underwriting Methods. Under all of IFC's underwriting methods, loan
documentation requirements for verifying the borrower's income and assets vary
according to LTV ratios and other factors. Generally, as the standards for
required documentation are lowered, the borrowers' down payment requirements are
increased and the required LTV ratios are decreased. The borrower is also
required to have a stronger credit history, larger cash reserves and an
appraisal of the property that is validated by an enhanced desk and field
review. Lending decisions are based on a risk analysis assessment after the
review of the entire mortgage loan file. Each mortgage loan is individually
underwritten with emphasis placed on the overall quality of the mortgage loan.
Under the Progressive Series program, IFC underwrites one-to-four family
mortgage loans with LTV ratios at origination of up to 95% of the property's
appraised value, depending on, among other things, a borrower's credit history,
repayment ability and debt service-to-income ratio, as well as the type and use
of the mortgaged property. Second lien financing of the mortgaged properties
may be provided by lender's other than IFC at origination, however, the combined
LTV ratio generally may not exceed 95% of the property's appraised value.
Progressive Express has a minimum FICO that must be met by the borrower's
primary wage earner and does not allow for exceptions to the FICO requirement.
Each Progressive Express program has different FICO requirements, credit
criteria, reserve requirements, and LTV ratio restrictions. Under the
Progressive Express program, IFC underwrites single family dwellings with LTV
11
ratios at origination of up to 95% of the property's appraised value. In order
for the property to be eligible for the Progressive Express, it must be a single
family residence (1 unit only), condominium, and/or planned unit development.
Under Progressive Express, the borrower must disclose employment and assets on
the application, however there is no verification of the information.
IFC uses the program parameters as guidelines only. On a case-by-case
basis, IFC may determine that the prospective mortgagor warrants an exception
outside the standard program guidelines. An exception may be allowed if the loan
application reflects certain compensating factors, including (1) the prospective
mortgagor has demonstrated an ability to save and devote a greater portion of
income to basic housing needs, (2) the prospective mortgagor may have a
potential for increased earnings and advancement because of education or special
job training, even if the prospective mortgagor has just entered the job market,
(3) the prospective mortgagor has demonstrated an ability to maintain a debt
free position, (4) the prospective mortgagor may have short term income that is
verifiable but could not be counted as stable income because it does not meet
the remaining term requirements, and (5) the prospective mortgagor's net worth
is substantial enough to suggest that repayment of the loan is within the
prospective mortgagor's ability.
IFC does not publish an approved appraiser list for its correspondent
sellers. Conduit sellers may select any appraiser of choice, regardless of the
LTV ratio of the related loan, from the seller's approved appraiser list. At the
discretion of the underwriter, a full appraisal, an enhanced desk review
appraisal, or a field review appraisal may be required.
Seller Eligibility Requirements. Mortgage loans acquired by the Conduit
Operations are originated by various sellers, including savings and loan
associations, banks, mortgage bankers and other mortgage brokers. Sellers are
required to meet certain regulatory, financial, insurance and performance
requirements established by IFC before they are eligible to participate in its
mortgage loan purchase program, and must submit to periodic reviews by IFC to
ensure continued compliance with these requirements. IFC's current criteria for
seller participation generally includes a minimum tangible net worth requirement
of $300,000, approval as a Fannie Mae or Freddie Mac Seller/Servicer in good
standing, a Housing and Urban Development approved mortgagee in good standing or
a financial institution that is insured by the Federal Deposit Insurance
Corporation ("FDIC") or comparable federal or state agency, and that the seller
is examined by a federal or state authority. In addition, sellers are required
to have comprehensive loan origination quality control procedures. In connection
with its qualification, each seller enters into an agreement that generally
provides for recourse by IFC against the seller in the event of a breach of
representations or warranties made by the seller with respect to mortgage loans
sold to IFC, which includes but is not limited to any fraud or misrepresentation
during the mortgage loan origination process or upon early payment default on
such loans.
The underwriting program consists of three separate subprograms. IFC's
principal delegated underwriting subprogram is a fully delegated program
designed for loan sellers that meet higher financial and performance criteria
than those applicable to sellers generally. Generally, qualifying sellers have
tangible net worth of at least $1.5 million and are granted delegated
underwriting authority to a maximum loan amount of $500,000 for all mortgage
products under this subprogram. The second subprogram is a delegated program
pursuant to which sellers have tangible net worth of $500,000 to $1.5 million
and are granted delegated underwriting authority to a maximum loan amount of
$300,000. The third program is for sellers with tangible net worth of $300,000
to $500,000 in which sellers are under IFC's non-delegated underwriting program.
IFC has established a delegated underwriting program, which is similar in
concept to the delegated underwriting programs established by Fannie Mae and
Freddie Mac. Under this program, qualified sellers are required to underwrite
loans in compliance with IFC's underwriting guidelines as set forth in IFC's
Seller/Servicer Guide and by individual Master Commitment. In order to determine
a seller's eligibility to perform under its delegated underwriting program, an
internal review is undertaken by IFC's loan committee. In connection with its
approval, the seller must represent and warrant to IFC that all mortgage loans
sold to IFC will comply with IFC's underwriting guidelines. The current
financial, historical loan quality and other criteria for seller participation
in this program generally include a minimum net worth requirement and
verification of the seller's good standing, including the seller's experience
and demonstrated performance, with Fannie Mae and Freddie Mac. IFC periodically
reviews the sellers participating in its delegated underwriting program and will
retain those sellers that it believes are productive.
12
Mortgage loans acquired under IFC's non-delegated underwriting program are
either fully underwritten by IFC's underwriting staff or involve the use of
contract underwriters. IFC has contracted with several national mortgage
insurance firms that conduct contract underwriting for mortgage loan
acquisitions by IFC. Under these contracts, IFC relies on the credit review and
analysis of the contract underwriter, as well as its own pre-purchase
eligibility review to ensure that the loan meets program acceptance, its own
follow-up quality control procedures, and the representations and warranties of
the contract underwriter. Loans that are not acquired under either delegated or
contract underwriter methods are fully underwritten by IFC's underwriting staff.
In such cases, IFC performs a full credit review and analysis to ensure
compliance with its loan eligibility requirements. This review specifically
includes, among other things, an analysis of the underlying property and
associated appraisal, and an examination of the credit, employment and income
history of the borrower. Under all of these methods, loans are purchased only
after completion of a legal documentation and eligibility criteria review.
Quality Control. IFC performs a post-closing quality control review on a
minimum of 25% of the mortgage loans originated or acquired under the
Progressive Series and Progressive Express programs for complete re-verification
of employment, income and liquid assets used to qualify for such mortgage loans.
Such reviews also include procedures intended to detect evidence of fraudulent
documentation and/or imprudent activity during the processing, funding,
servicing or selling of the mortgage loans. Verification of occupancy and
applicable information is made by regular mail.
Securitization and Sale Process
General. The Conduit Operations primarily utilizes warehouse lines of
credit and equity to finance the acquisition of mortgage loans from
correspondents. When a sufficient volume of mortgage loans with similar
characteristics has been accumulated, generally $100 million to $350 million,
IFC will securitize them through the issuance of mortgage-backed securities in
the form of REMICs or resell them as bulk whole loan sales. The period between
the time IFC commits to purchase mortgage loans and the time it sells or
securitizes such mortgage loans generally ranges from 10 to 90 days, depending
on certain factors including the length of the purchase commitment period, the
loan volume by product type and the securitization process.
Any decision by IFC to issue REMICs or to sell the loans in bulk is
influenced by a variety of factors. REMIC transactions are generally accounted
for as sales of the mortgage loans and can eliminate or minimize any long-term
residual investment in such loans. REMIC securities consist of one or more
classes of "regular interests" and a single class of "residual interest." The
regular interests are tailored to the needs of investors and may be issued in
multiple classes with varying maturities, average lives and interest rates.
These regular interests are predominantly senior securities but, in conjunction
with providing credit enhancement, may be subordinated to the rights of other
regular interests. The residual interest represents the remainder of the cash
flows from the mortgage loans (including, in some instances, reinvestment
income) over the amounts required to be distributed to the regular interests. In
some cases, the regular interests may be structured so that there is no
significant residual cash flow, thereby allowing IFC to sell its entire interest
in the mortgage loans. As a result, in some cases, all of the capital originally
invested in the mortgage loans by the Company is redeployed in the Conduit
Operations.
Each series of mortgage-backed securities is typically fully payable from
the mortgage assets underlying such series, and the recourse of investors is
limited to such assets and any associated credit enhancement features, such as
senior/subordinated structures. To the extent the Company holds subordinated
securities, the Company generally bears all losses prior to the related senior
security holders. Generally, any losses in excess of the credit enhancement
obtained are borne by the security holders. Except in the case of a breach of
the standard representations and warranties made by the Company when mortgage
loans are securitized, such securities are non-recourse to the Company.
Typically, the Company has recourse to the sellers of loans for any such
breaches, but there are no assurances of the sellers' abilities to honor their
respective obligations.
Credit Enhancement. REMICs created by the Conduit Operations are structured
so that one or more of the classes of such securities are rated investment grade
by at least one nationally recognized rating agency. In contrast to Agency
Certificates (pass-through certificates guaranteed by Fannie Mae or Freddie Mac)
in which the principal and interest payments are guaranteed by the U.S.
government or one of its agencies, securities created by the Conduit Operations
do not benefit from any such guarantee. The ratings for the Conduit Operations'
REMICs are based upon the perceived
13
credit risk by the applicable rating agency of the underlying mortgage loans,
the structure of the securities and the associated level of credit enhancement.
Credit enhancement is designed to provide protection to the security holders in
the event of borrower defaults and other losses including those associated with
fraud or reductions in the principal balances or interest rates on mortgage
loans as required by law or a bankruptcy court.
The Conduit Operations can utilize multiple forms of credit enhancement,
including special hazard insurance, private mortgage insurance reserve funds,
letters of credit, surety bonds, over-collateralization and subordination or any
combination of the foregoing. In determining whether to provide credit
enhancement through subordination or other credit enhancement methods, the
Conduit Operations takes into consideration the costs associated with each
method. Ratings of mortgage-backed securities are based primarily upon the
characteristics of the pool of underlying mortgage loans and associated credit
enhancement. A decline in the credit quality of such pools (including
delinquencies and/or credit losses above initial expectations), or of any third-
party credit enhancer, or adverse developments in general economic trends
affecting real estate values or the mortgage industry, could result in
downgrades of such ratings.
In connection with the securitization of B/C Loans, the levels of
subordination required as credit enhancement for the more senior classes of
securities issued are higher than those with respect to its "A" grade non-
conforming loans. Similarly, in connection with the securitization of mortgage
loans secured by second liens, the levels of subordination required as credit
enhancement for the more senior classes of securities issued are higher than
those with respect to its mortgage loans secured by first liens. Thus, to the
extent that the Company retains any of the subordinated securities created in
connection with such securitizations and losses with respect to such pools of
B/C Loans or mortgage loans secured by second liens are higher than expected,
the Company's future earnings could be adversely affected.
Master Servicing and Servicing
Master Servicing
General. IFC generally performs the function of master servicer with
respect to mortgage loans it sells and securitizes. The master servicer's
function includes collecting loan payments from servicers of loans and remitting
loan payments, less master servicing fees receivable and other fees, to a
trustee or other purchaser for each series of mortgage-backed securities or
loans master serviced. In addition, as master servicer, IFC monitors compliance
with its servicing guidelines and is required to perform, or to contract with a
third party to perform, all obligations not adequately performed by any
servicer. A master servicer typically employs servicers to carry out servicing
functions. Servicers typically perform servicing functions for the master
servicer as independent contractors. In addition, IFC acts as the master
servicer for all loans acquired by the Long-Term Investment Operations. With
respect to its function as a master servicer for loans owned by IMH, IFC and IMH
have entered into agreements having terms substantially similar to those
described below for servicing agreements. Master servicing fees range from 0.01%
per annum to 0.03% per annum on the declining principal balances of the loans
serviced. As of December 31, 1999 and 1998, IFC's master servicing portfolio was
$2.9 billion and $3.7 billion, respectively.
IFC offers its sellers of mortgage loans the right to retain servicing.
However, in connection with its warehouse line from IWLG, any such servicers of
the mortgage loans would have to be approved by IWLG. In the case of servicing
retained mortgage loans, the Company will enter into servicing agreements with
the sellers of mortgage loans to service the mortgage loans they sell to the
Company. Each servicing agreement will require the servicer to service the
Company's mortgage loans in a manner generally consistent with Fannie Mae and
Freddie Mac guidelines and procedures and with any servicing guidelines
promulgated by the Company. Each servicer will collect and remit principal and
interest payments, administer mortgage escrow accounts, submit and pursue
insurance claims, and initiate and supervise foreclosure proceedings on the
mortgage loans serviced. Each servicer will also provide accounting and
reporting services required by the Company for such loans. The servicer will be
required to follow such collection procedures as are customary in the industry.
The servicer may, at its discretion, arrange with a defaulting borrower a
schedule for the liquidation of delinquencies, provided primary mortgage
insurance coverage is not adversely affected. Each servicing agreement will
provide that the servicer may not assign any of its obligations with respect to
the mortgage loans serviced for the Company, except with the Company's consent.
14
The following table summarizes delinquency statistics for IFC's master
servicing portfolio based on principal balance for the periods shown (dollars in
millions):
At December 31, 1999 At December 31, 1998
-------------------------------- ----------------------------
Principal % of Master Principal % of Master
Balance Servicing Balance Servicing
of Loans Portfolio of Loans Portfolio
-------------- --------------- -------------- -----------
Loans delinquent for:
30-59 days...................................................... $ 128.4 4.46% $ 172.7 4.65%
60-89 days...................................................... 30.8 1.07 46.7 1.26
90 days......................................................... 21.1 0.73 51.5 1.39
-------------- ------------- -------------- -----------
180.3 6.26 270.9 7.30
Foreclosures pending.............................................. 47.0 1.64 54.7 1.47
Bankruptcies pending.............................................. 26.9 0.93 25.9 0.70
-------------- ------------- -------------- -----------
Total delinquencies, foreclosures and bankruptcies.............. $ 254.2 8.83% $ 351.5 9.47%
============== ============= ============== ===========
Master Servicing Fees. The Company expects from time to time to retain master
servicing fees receivable. Master servicing fees receivable have characteristics
similar to "interest-only" securities; accordingly, they 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. Master servicing fees receivable
represent the present value of the difference between the interest rate on
mortgage loans purchased by the Conduit Operations and 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 (1) the Conduit
Operations on loans acquired "servicing released" or (2) correspondents who sold
loans to the Conduit Operations with "servicing retained" (the "Excess Servicing
Fees"). At December 31, 1999 and 1998, the Company had no master servicing fees
receivable.
To the extent that servicing fees on a mortgage loan exceed an adequate
compensation (typically ranging from 0.25% to 0.50% per annum of the mortgage
loan principal amount), the Conduit Operations will generate master servicing
fees receivable as an asset that represents an estimated present value of those
excess fees assuming a certain prepayment rate on the mortgage loan. In
determining present value of future cash flows, the Conduit Operations will use
a market discount rate. Prepayment assumptions will be based on recent
evaluations of the actual prepayments of the Conduit Operations' servicing
portfolio or on market prepayment rates on new portfolios on which the Conduit
Operations has no experience and the interest rate environment at the time the
master servicing fees receivable are created. Management of the Company believes
that, depending upon the level of interest rates from time to time, investments
in current coupon master servicing fees receivable may be prudent, and if
interest rates rise, these investments will mitigate declines in income that may
occur in the Conduit Operations. IFC intends to hold the master servicing fees
receivable for investment. Currently, the secondary market for master servicing
fees receivable is limited. Accordingly, if IFC had to sell these receivables,
the value received may or may not be at or above the values at which IFC carried
them on its balance sheet.
Servicing
General. IFC subcontracts all of its servicing obligations under such loans to
independent third parties pursuant to sub-servicing agreements. IFC believes
that the selection of third-party sub-servicers is more effective than
establishing a servicing department within the Company. However, part of IFC's
responsibility is to continually monitor the performance of the sub-servicers
through monthly performance reviews and regular site visits. Depending on these
sub-servicer reviews, the Company may in the future rely on its internal
collection group to take an ever more active role to assist the sub-servicer in
the servicing of these loans. Servicing includes collecting and remitting loan
payments, making required advances, accounting for principal and interest,
holding escrow or impound funds for payment of taxes and insurance, if
applicable, making required inspections of the mortgaged property, contacting
delinquent borrowers, and supervising foreclosures and property dispositions in
the event of unremedied defaults in accordance with the Company's guidelines.
Servicing fees range from 0.25% per annum for FRMs to 0.50% per annum for B/C
Loans and ARMs on the declining principal balances of loans serviced.
15
IFC generally acquires substantially all of its loans on a "servicing
released" basis, particularly in the case of the acquisition of B/C Loans due to
its belief that control over the servicing and collection functions with respect
to B/C Loans is important to the realization of a satisfactory return, and
thereby acquires the servicing rights. To the extent IFC finances the
acquisition of such loans with its warehouse line with IWLG, IFC pledges such
loans and the related servicing rights to IWLG as collateral. As a result, IWLG
has an absolute right to control the servicing of such loans (including the
right to collect payments on the underlying mortgage loans) and to foreclose
upon the underlying real property in the case of default. Typically, IWLG
delegates its right to service the mortgage loans securing the warehouse line to
IFC.
The following table summarizes certain information regarding IFC's
servicing portfolio of mortgage loans for the periods shown (dollars in
millions, except average loan size):
Year ended Year ended
December 31, 1999 December 31, 1998
------------------ -------------------
Beginning servicing portfolio..................................... $ 3,714.0 $ 3,028.6
Add: Loan acquisitions........................................... 1,647.7 2,198.3
Less: Servicing transferred (1)................................... (2,270.8) --
Principal paydowns (2)........................................ (697.5) (1,512.9)
----------------- ------------------
Ending servicing portfolio........................................ $ 2,393.4 $ 3,714.0
================= ==================
Number of loans serviced.......................................... 22,096 33,414
Average loan size................................................. $ 108,000 $ 111,000
Weighted average interest rate.................................... 9.43% 9.47%
______________
(1) Includes loan sales on a servicing released basis of $1.5 billion and the
sale of servicing rights on the unpaid principal balance of $784.3 million.
When loans are sold from the servicing portfolio on a servicing released
basis, the Company generally sub-services such loans from the sales
contract date to the transfer date. When servicing rights on loans are
sold, the Company generally retains its function as master servicer.
(2) Includes normal principal runoff and principal prepayments.
Mortgage Servicing Rights. When the Conduit Operations purchases loans
which include the associated servicing rights, the allocated price paid for the
servicing rights is reflected on its financial statements as Mortgage Servicing
Rights ("MSRs"). MSRs differ from master servicing fees receivable primarily by
the required amount of servicing to be performed, the loss exposure to the owner
of the instrument, and the financial liquidity of the instrument. In contrast to
MSRs, where the owner of the instrument acts as the servicer, master servicing
fees receivable do not require the owner of the instrument to service the
underlying mortgage loan. In addition, master servicing fees receivable subject
their owners to greater loss exposure from delinquencies or foreclosure on the
underlying mortgage loans than MSRs because a master servicer stands behind the
servicer (or sub-servicer) and potentially the owner of the mortgage loan in
priority of payment. Both MSRs and master servicing fees receivable are
purchased and sold in the secondary markets. However, MSRs are generally more
liquid and can be sold at less of a discount as compared to master servicing
fees receivable. During periods of declining interest rates, prepayments of
mortgage loans increase as homeowners look to refinance at lower rates,
resulting in a decrease in the value of the Company's MSRs. Mortgage loans with
higher interest rates are more likely to result in prepayments. At December 31,
1999 and 1998, IFC had $15.6 million and $14.1 million, respectively, of MSRs.
Warehouse Lending Operations
The Warehouse Lending Operations, conducted by IWLG, provides warehouse and
repurchase financing to affiliated companies and to approved mortgage banks,
most of which are correspondents of IFC, to finance mortgage loans during the
time from the closing of the loans to their sale or other settlement with pre-
approved investors. Generally, the non-conforming mortgage loans funded with
such warehouse lines of credit are acquired by IFC. IWLG's warehouse lines are
non-recourse and IWLG can only look to the sale or liquidation of the mortgage
loans as a source of repayment. Any claim of IWLG as a secured lender in a
bankruptcy proceeding may be subject to adjustment and delay. Borrowings under
the warehouse facilities are presented on the Company's balance sheets as
finance receivables. IFC's outstanding warehouse line balances on IWLG's balance
sheet are structured to qualify under REIT asset tests and to generate income
qualifying under the 75% gross income test. Terms of affiliated warehouse lines
are
16
based on Bank of America's prime rate with advance rates between 90% and 98%
of the fair value of the mortgage loans outstanding. Outstanding warehouse line
balances to non-affiliates on IWLG's balance sheet do not qualify under REIT
asset tests and do not generate income qualifying under the 75% gross income
test. Terms of non-affiliated warehouse lines, including the commitment amount,
are determined based upon the financial strength, historical performance and
other qualifications of the borrower. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources--Conduit Operations" for a more detailed discussion of IWLG's
warehouse line to IFC.
Regulation
The rules and regulations applicable to the Conduit Operations, among other
things, prohibit discrimination and establish underwriting guidelines that
include provisions for inspections and appraisals, require credit reports on
prospective borrowers, and fix maximum loan amounts. Mortgage loan acquisition
activities are subject to, among other laws, the Equal Credit Opportunity Act,
Federal Truth-in-Lending Act and the Real Estate Settlement Procedures Act and
the regulations promulgated that prohibit discrimination and require the
disclosure of certain basic information to mortgagors concerning credit terms
and settlement costs. IFC is an approved Fannie Mae and Freddie Mac
seller/servicer. IFC is subject to the rules and regulations of Fannie Mae and
Freddie Mac with respect to acquiring, processing, selling and servicing
conforming mortgage loans. In addition, IFC is required annually to submit to
Fannie Mae and Freddie Mac audited financial statements, and each regulatory
entity has its own financial requirements for sellers/servicers. For any
conforming mortgage loan activities, IFC's affairs are also subject to
examination by Fannie Mae and Freddie Mac at any time to assure compliance with
the applicable regulations, policies and procedures. Additionally, there are
various state and local laws and regulations affecting the Conduit Operations.
Mortgage operations also may be subject to applicable state usury statutes. The
Company is presently in material compliance with all material rules and
regulations to which it is subject.
Competition
In purchasing non-conforming mortgage loans and issuing securities backed by
such loans, the Company competes with established mortgage conduit programs,
investment banking firms, savings and loan associations, banks, thrift and loan
associations, finance companies, mortgage bankers, insurance companies, other
lenders and other entities purchasing mortgage assets. The continued
consolidation in the mortgage banking industry may also reduce the number of
current sellers available to the Conduit Operations, thus reducing the Company's
potential customer base, resulting in IFC's purchasing a larger percentage of
mortgage loans from a smaller number of sellers. Such changes could negatively
impact the Conduit Operations. Mortgage-backed securities issued by the Conduit
Operations and the Long-Term Investment Operations face competition from other
investment opportunities available to prospective investors. The Company faces
competition in its Conduit Operations and Warehouse Lending Operations from
other financial institutions, including but not limited to banks and investment
banks. Many of the institutions with which the Company competes in its Conduit
Operations and Warehouse Lending Operations have significantly greater financial
resources than the Company. However, IFC can compete effectively with other non-
conforming mortgage loan conduits through its efficient loan purchasing process,
flexible purchase commitment options and competitive pricing and by designing
non-conforming mortgage loans to suit the needs of its correspondent loan
originators and their borrowers, while providing sufficient credit quality to
its investors.
Employees
As of December 31, 1999, the Company had 185 employees, 13 of which were
employed by IWLG. Employees and operating management of the Long-Term Investment
Operations and Conduit Operations are employed by IFC. As of December 31, 1999,
IFC had 172 employees. The Company believes that relations with its employees
are good. The Company is not a party to any collective bargaining agreement.
Risk Factors
In addition to the other information in this Form 10-K, the following factors
should be considered in evaluating the Company and its business.
17
Inability to Generate Liquidity May Adversely Affect Our Operations
We must access liquidity to continue our operations, grow our asset base and
pay dividends. We have traditionally derived our liquidity from three sources:
. financing facilities provided to us by others to acquire mortgage
assets;
. whole loan sales and securitizations of acquired mortgage loans; and
. sale of equity securities.
Margin Calls on Financing Facilities May Adversely Affect Our Operations
Prior to the fourth quarter of 1998, we generally had no difficulty in
obtaining favorable financing facilities or in selling acquired mortgage loans.
However, during the fourth quarter of 1998 the mortgage industry experienced
substantial turmoil as a result of a lack of liquidity in the secondary markets.
At that time, investors expressed unwillingness to purchase interests in
securitizations due in part to:
. higher than expected credit losses on many companies' securitization
interests, and
. the widening of returns expected by institutional investors on
securitization interests over the prevailing Treasury rate.
As a result, many mortgage loan originators, including our company, were
unable to access the securitization market on favorable terms, which resulted in
some companies declaring bankruptcy. Originators, like our company, were
required to sell loans on a whole loan basis and liquidate holdings of mortgage-
backed securities to repay financing facilities. However, the large influx of
loans available for sale on a whole loan basis affected the pricing offered for
these loans which in turn reduced the value of the collateral underlying the
financing facilities. Therefore, many providers of financing facilities
initiated margin calls. Margin calls resulted when our lenders evaluated the
market value of the collateral securing our financing facilities and required us
to provide them with additional equity or collateral to secure our borrowings.
Our financing facilities are 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. 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.
Dependence on Securitizations for Liquidity
We rely significantly upon securitizations to generate cash proceeds to repay
borrowings and to create credit availability. Any reduction in our ability to
complete securitizations may require us to utilize other sources of financing,
which may be on less than favorable terms. In addition, gains on sales from our
securitizations represent a significant portion of our earnings. Several factors
could affect our ability to complete securitizations of our mortgages,
including:
. conditions in the securities markets;
. the credit quality of the mortgage loans originated or purchased by our
Conduit Operations;
. the volume of our mortgage loan originations and purchases; and
. our ability to obtain credit enhancement.
If we are unable to profitably securitize a significant number of our mortgage
loans in a particular financial reporting period, then it could result in lower
income or a loss for that period. As a result of turmoil in the securitization
market during the latter part of 1998, many mortgage lenders, including our
company, were required to sell mortgage loans on a whole loan basis under
adverse market conditions in order to generate liquidity. Many of these sales
were made at prices lower than our carrying value of the mortgage loans and we
experienced losses. We cannot assure you that we will be able to continue to
profitably sell our loans on a whole loan basis, or at all.
18
Gains on sales from our securitizations have historically represented a
substantial portion of our earnings. Our ability to complete securitizations is
dependent upon general conditions in the securities and secondary markets and
the credit quality of the mortgage loans. In addition, delays in closing sales
of our loans increases our risk by increasing the warehousing period for the
loans, further exposing our company to credit risk.
The market for first loss risk securities (securities that first take a loss
when mortgages are not paid by the borrowers) is generally limited. In
connections with our securitizations, we will endeavor to sell all securities
subjecting us to a first loss risk. If we cannot sell these securities, then we
may be required to hold them for an extended period, subjecting us to a first
loss risk.
Inability to Access Capital Markets May Adversely Affect Our Liquidity and
Operations
Although we believe our current operating cash flows are sufficient to fund
our lending activities and the growth of our mortgage assets, to repay our
financing facilities and to pay cash dividends, we continue to explore
alternatives for increasing our liquidity through additional asset sales and
capital raising efforts. However, 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. If we cannot raise cash by selling debt and equity
securities, we may be forced to sell our assets at unfavorable prices or
discontinue various business activities. Our inability to access the capital
markets could have a negative impact on our earnings and ability to pay
dividends.
REIT provisions of the Internal Revenue Code require us to distribute to our
stockholders substantially all of our taxable income. These provisions restrict
our ability to retain earnings and renew capital for our business activities. We
may decide in future periods not to be treated as a REIT, which would cause us
to be taxed at the corporate level and to cease paying regular dividends. Also,
to date a large portion of our dividends to stockholders consisted of
distributions by our Conduit Operations subsidiary to our Long-Term Investment
Operations entity. However, our Conduit Operations was not, and is not, required
under the REIT provisions to make these distributions. Since we are trying to
retain earnings for future growth, we may not cause our Conduit Operations
subsidiary to make these distributions in the future. This would materially
affect the amount of dividends, if any, paid by us to our stockholders.
Our Prior History is Not Reflective of Future Performance
Our historical financial performance is of limited relevance in predicting our
future performance. We began our operations in November 1995. Our future
operating results will depend largely upon our ability to expand our long-term
investment operations, our conduit operations and our warehouse lending
operations. We cannot assure you that we will be able to successfully grow or
that our operations will be profitable in the future. We cannot assure you that
any prior rates of growth can be sustained or that they are indicative of future
results. It is unlikely that any of our future dividends will be equal to or
more than those dividends we have paid in the past.
The loans we purchased to date and included in our securitizations have been
outstanding for a relatively short period of time and our delinquency and loss
experience to date may not be indicative of future results. It is unlikely that
we will be able to maintain our delinquency and loan loss ratios at their
present levels as our portfolio becomes more seasoned.
Our Borrowings and Substantial Leverage May Cause Losses
Risks of Use of Collateralized Mortgage Obligations
To grow our investment portfolio, we borrow a substantial portion of the
market value of substantially all of our investments in mortgage loans and
mortgage-backed securities. We currently prefer to use collateralized mortgage
obligations as financing vehicles to increase our leverage, since mortgage loans
held for collateralized mortgage obligation collateral are retained for
investment rather than sold in a secondary market transaction. Retaining
mortgage loans as collateralized mortgage obligation collateral exposes our
operations to greater credit losses than the use of securitization techniques
that are treated as sales. In creating a collateralized mortgage obligation, we
make a cash equity investment to fund collateral in excess of the amount of the
securities issued. If we experience credit losses on
19
the pool of loans subject to the collateralized mortgage obligation greater than
we expected, the value of our equity investment decreases and we would have to
adjust the value of the investment in our financial statements.
Cost of Borrowings May Exceed Return on Assets
The cost of borrowings under our financing facilities corresponds to a
referenced interest rate plus or minus a margin. The margin varies depending on
factors such as the nature and liquidity of the underlying collateral and the
availability of financing in the market. We will experience net interest losses
if the returns on our assets financed with borrowed funds fail to cover the cost
of our borrowings.
Default Risks Under Financing Facilities
If we default under our collateralized borrowings, our lenders could force us
to liquidate the collateral. If the value of the collateral is less than the
amount borrowed, we would be required to pay the difference in cash. 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.
Risk of Lack of Return of Investment on Liquidation
We have pledged a substantial portion of our assets to secure the repayment of
collateralized mortgage obligations issued in securitizations, our financing
facilities or other borrowings. We will also pledge substantially all of our
current and future mortgage loans to secure borrowings pending their
securitization or sale. The cash flows we receive from our investments that have
not yet been distributed, pledged or used to acquire mortgage loans or other
investments may be the only unpledged assets available to our unsecured
creditors and you if our company were liquidated.
Interest Rate Fluctuations May Adversely Affect Our Operating Results
Our operations, each as a mortgage loan originator and warehouse lender, may
be adversely affected by rising and falling interest rates. Higher interest
rates may discourage potential borrowers from refinancing mortgages, borrowing
to purchase homes or seeking second mortgages. This may decrease the amount of
mortgages available to be acquired by our conduit operations and decrease the
demand for warehouse financing provided by our warehouse lending operations to
originators of mortgage loans. 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 mortgage loans at lower long-term interest
rates. Increased loan prepayments could lead to a reduction in the number of
loans we service, the fees we receive for loan servicing and our loan servicing
income.
We are subject to the risk of rising mortgage interest rates between the time
we commit to purchase mortgages at a fixed price 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 yet sold or securitized.
Risks of Repricing of Assets and Liabilities
Our principal source of revenue is net interest income or net interest spread,
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 significant risk of loss.
20
Additionally, the rates paid on our borrowings and the rates received on our
assets may be based upon different indices (i.e., LIBOR, U.S. Treasuries, etc.).
If the index used to determine the rate on our borrowings increases faster than
the index used to determine the rate on our assets, we will experience a
declining net interest spread which will have a negative impact on our
profitability and may result in losses.
Risks of Adjustable Rate Mortgages
A significant portion of the mortgage assets held by our long-term investment
operations are adjustable rate mortgages or bear interest based upon short-term
interest rate indices. We generally fund these mortgage assets with borrowings.
To the extent that there is a difference between the interest rate index used to
determine the interest rate on our adjustable rate mortgage assets and the
interest rate index used to determine the borrowing rate for our related
financing, our business may be negatively impacted.
Interest Rate Caps
Adjustable rate mortgages typically have interest rate caps which limit
interest rates charged to the borrower during any given period. Our borrowings
are not subject to similar restrictions. In a period of rapidly increasing
interest rates, the interest rates we pay on our borrowings could increase
without limitation, while the interest rates we earn on our adjustable rate
mortgage assets would be capped. If this occurs, our net earnings could be
significantly reduced or we could suffer a net interest loss.
Payment Caps
Some of our adjustable rate mortgages may be subject to payment caps meaning
some portion of the interest accruing on the mortgage is deferred and added to
the principal outstanding. Our borrowings do not have similar provisions. This
could cause us to receive less cash on our adjustable rate assets than the
interest due on our related borrowings. Also, the increased principal amount
outstanding as a result of interest deferral may result in a higher rate of
defaults on these loans.
Our Quarterly Operating Results May Fluctuate
Our results of operations, and more specifically our earnings, may
significantly fluctuate from quarter to quarter based on several factors,
including:
. changes in the amount of loans we originate;
. differences between our cost of funds on borrowings and the average
interest rates earned on our loans;
. inability or decisions not to complete significant bulk whole loan sales
or securitizations in a particular quarter; and
. problems generally affecting the mortgage loan industry.
A delay in closing a particular mortgage loan sale or securitization would
also increase our exposure to interest rate fluctuations by lengthening the
period during which our variable rate borrowings under our warehouse facilities
are outstanding. If we were unable to sell a sufficient number of mortgage loans
at a premium during a particular reporting period, our revenues for that period
would decline, which could have a material adverse affect on our operations. As
a result, our stock price could also fluctuate.
21
Our Share Prices Have Been and May Continue to be Highly Volatile
Historically, the market price of our common stock has been extremely
volatile. During the fourth quarter of 1998 our stock reached a high of $13.50
and a low of $2.75. On December 31, 1999, the closing sale price was $4.13. The
market price of our common stock is likely to continue to be highly volatile and
could be significantly affected by factors including:
. availability of liquidity;
. volatility in the securitization market;
. whole loan sale pricing;
. margin calls by warehouse lenders;
. actual or anticipated fluctuations in our operating results;
. interest rates;
. prepayments on mortgages;
. valuations of securitization related assets;
. cost of funds; and
. general market conditions.
In addition, significant price and volume fluctuations in the stock market
have particularly affected the market prices for the common stocks of specialty
finance companies such as ours. These broad market fluctuations have adversely
affected and may continue to adversely affect the market price of our common
stock. If our results of operations fail to meet the expectations of securities
analysts or investors in a future quarter, the market price of our common stock
could also be materially adversely affected.
Prepayments of Mortgage Loans May Adversely Affect Our Operations
Mortgage prepayments generally increase when fixed mortgage interest rates
fall below the then-current interest rates on outstanding adjustable rate
mortgage loans. Prepayments on mortgage loans are also affected by the terms and
credit grades of the loans and general economic conditions. Most of our
adjustable rate mortgages and those backing mortgage-backed securities are
originated within six months of the time we purchased the mortgages and
generally bear initial interest rates which are lower than their "fully-indexed"
amount (the applicable index plus the margin). If we acquire these mortgages at
a premium and they are prepaid prior to or soon after the time of adjustment to
a fully-indexed rate, we would not have received interest at the fully-indexed
rate during such period. This means we would lose the opportunity to earn
interest at that rate over the expected life of the mortgage. Also, if
prepayments on our adjustable rate mortgage loans increase when interest rates
are declining, our net interest income may decrease if we cannot reinvest the
prepayments in mortgage assets bearing comparable rates.
We currently 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 any
mortgage loans that we acquired at a premium are prepaid, generally accepted
accounting principles require us to immediately write-off any remaining
capitalized premium amount, which would decrease our interest income.
Value of Our Portfolio of Mortgage-Backed Securities May be Adversely Affected
We invest in mortgage-backed securities known as "interest-only," "principal-
only," residual interest and subordinated securities. These securities are
either created through our own securitizations or those of third parties.
Investments in residual interest and subordinated securities are much riskier
than investments in senior mortgage-backed securities because these subordinated
securities bear all credit losses prior to the related senior securities. On a
percentage basis, the risk associated with holding residual interest and
subordinated securities is greater than holding the underlying mortgage loans
directly due to the concentration of losses in the subordinated securities.
We estimate future cash flows from these securities and value them utilizing
assumptions based in part on projected discount rates, mortgage loan prepayments
and credit losses. If our actual experience differs from our assumptions we
would be required to reduce the value of these securities. The market for our
asset-backed securities is extremely
22
limited and we cannot assure you that we could sell these securities at their
reported value or at all or that we could recoup our initial investment.
We also bear the risk of loss on any mortgage-backed securities we purchase in
the secondary mortgage market. If third parties have been contracted to insure
against these types of losses, we would be dependent in part upon the
creditworthiness and claims paying ability of the insurer and the timeliness of
reimbursement in the event of a default on the underlying obligations. The
insurance coverage for various types of losses is limited, and we bear the risk
of any losses in excess of the limitation or outside of the insurance coverage.
In addition, we may not obtain our anticipated yield or we may incur losses if
the credit support available within certain mortgage-backed securities is
inadequate due to unanticipated levels of losses, or due to difficulties
experienced by the credit support provider. Delays or difficulties encountered
in servicing mortgage-backed securities may cause greater losses and, therefore,
greater resort to credit support than was originally anticipated, and may cause
a rating agency to downgrade certain classes of our securities.
We Undertake Additional Risks by Acquiring and Investing in Mortgage Loans
Risk of Failure to Obtain Credit Enhancements
We do not obtain credit enhancements such as mortgage pool or special hazard
insurance for all of our mortgage loans and investments. Borrowers may obtain
private mortgage insurance, but we only require this insurance in limited
circumstances. During the time we hold mortgage loans for investment, we are
subject to risks of borrower defaults and bankruptcies and special hazard losses
that are not covered by standard hazard insurance (such as losses occurring from
earthquakes or floods). If a borrower defaults on a mortgage loan that we hold,
we bear the risk of loss of principal to the extent there is any deficiency
between the value of the related mortgaged property and the amount owing on the
mortgage loan. In addition, since defaulted mortgage loans are not considered
eligible collateral under our borrowing arrangements, we bear the risk of being
required to finance these loans with funds other than borrowed funds until they
are ultimately liquidated.
Greater Credit Risks from Non-Conforming Mortgage Loans
Non-conforming residential mortgage loans are residential mortgages that do
not qualify for purchase by government sponsored agencies such as the Fannie Mae
and Freddie Mac. Our operations may be negatively affected due to our
investments in non-conforming loans or securities evidencing interests in such
loans. Credit risks associated with non-conforming mortgage loans are greater
than conforming mortgage loans. The interest rates we charge on non-conforming
loans are often higher than those charged for conforming loans. 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.
Second Mortgages Entail Greater Risks
Our security interest in the property securing second mortgages is
subordinated to the interest of the first mortgage holder. 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, all or a portion of
our second mortgage loan will not be repaid.
Geographic Concentration of Mortgage Loans Has Higher Risks
We do not set limitations on the percentage of our mortgage asset portfolio
composed of properties located in any one area (whether by state, zip code or
other geographic measure). Concentration in any one area increases our exposure
to the economic and natural hazard risks associated with that area. We estimate
that a high concentration of the loans included in securitizations in which we
hold subordinated interests are secured by properties in California. Certain
parts of California have experienced an economic downturn in past years and have
suffered the effects of certain natural hazards.
23
Potential Losses Related to Recourse Obligations
Mortgage-backed securities issued in connection with our securitizations have
been non-recourse to us, except in the case of a breach of standard
representations and warranties made by us when the loans are securitized. While
we have recourse against the sellers of mortgage loans, we cannot assure you
that they will honor their obligations. We also engaged in bulk whole loan sales
pursuant to agreements that provide for recourse by the purchaser against us. In
some cases, the remedies available to a purchaser of mortgage loans from us are
broader than those available to us against those who sell us these loans. If a
purchaser exercises its rights against us, we may not always be able to enforce
whatever remedies we may have against our sellers.
We Undertake Additional Risks 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 banks,
including the risks of fraud, borrower default and bankruptcy, any of which
could result in credit losses for us. Our claims as a secured lender in a
bankruptcy proceeding may be subject to adjustment and delay.
Value of our Mortgage Servicing Rights is Subject to Adjustment
When we purchase loans that include the associated servicing rights, the
allocated cost of the servicing rights is reflected on our financial statements
as mortgage servicing rights. To determine the fair value of these servicing
rights, we use assumptions to estimate future net servicing income including
projected discount rates, mortgage loan prepayments and credit losses. If actual
prepayments or defaults with respect to loans serviced occur more quickly than
we originally assumed, we would have to reduce the carrying value of our
mortgage servicing rights. We do not know if our assumptions will prove correct.
Our Operating Results Will be Affected by the Results of Our Hedging Activities
To offset the risks associated with our conduit operations, we enter into
transactions designed to hedge our interest rate risks. To offset the risks
associated with our long-term investment operations, we attempt to match the
interest rate sensitivities of our adjustable rate mortgage assets held for
investment with the associated financing liabilities. Our management determines
the nature and quantity of the hedging transactions based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
We do not limit management's use of certain instruments in such hedging
transactions. Although our hedging program currently qualifies for hedge
accounting under generally accepted accounting principles, we cannot assure you
that our hedging transactions will offset our risks of loss, and we could incur
significant losses.
Reduction in Demand for Residential Mortgage Loans and Our Non-Conforming Loan
Products May Adversely Affect Our Operations
The availability of sufficient mortgage loans meeting our criteria is
dependent in part upon the size and level of activity in the residential real
estate lending market and, in particular, the demand for non-conforming mortgage
loans, which is affected by:
. interest rates;
. regional and national economic conditions;
. fluctuations in residential property values; and
. general regulatory and tax developments.
24
If our mortgage loan purchases decrease, we will have:
. decreased economies of scale;
. higher origination costs per loan;
. reduced fee income;
. smaller gains on the sale of non-conforming mortgage loans; and
. an insufficient volume of loans to effect securitizations which requires
us to accumulate loans over a longer period.
Our Delinquency Ratios and Our Performance May be Adversely Affected by the
Performance of Parties Who Sub-Service our Loans
We contract with third-party sub-servicers for the sub-servicing of all our
loans, including those in our securitizations, and our operations are subject to
risks associated with inadequate or untimely servicing. Poor performance by a
sub-servicer may result in greater than expected delinquencies and losses on our
loans. A substantial increase in our delinquency or foreclosure rate could
adversely affect our ability to access the capital and secondary markets for our
financing needs. Also, with respect to loans subject to a securitization,
greater delinquencies would adversely impact the value of any "interest-only,"
"principal-only" and subordinated securities we hold in connection with that
securitization.
In a securitization, relevant agreements permit us to be terminated as
servicer under specific conditions described in these agreements, such as the
failure of a sub-servicer to perform certain functions within specific time
periods. If, as a result of a sub-servicer's failure to perform adequately, we
were terminated as servicer of a securitization, the value of any servicing
rights held by us would be adversely impacted.
Intense Competition for Mortgage Loans May Adversely Affect Our Operations
We compete in purchasing non-conforming mortgage loans and issuing mortgage-
backed securities with:
. other mortgage conduit programs;
. investment banking firms;
. savings and loan associations;
. banks;
. thrift and loan associations;
. finance companies;
. mortgage bankers;
. insurance companies;
. other lenders; and
. other entities purchasing mortgage assets.
Continued consolidation in the mortgage banking industry may adversely affect
us by reducing the number of current sellers to our conduit operations and our
potential customer base. As a result, we may have to purchase a larger
percentage of mortgage loans from a smaller number of sellers which could cause
us to have to pay higher premiums for loans.
If We Fail to Maintain Our REIT Status We May be Subject to Taxation as a
Regular Corporation
Consequences if We Fail to Qualify as a REIT
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.
25
You should be aware that opinions of counsel are not binding on the IRS or any
court. 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. Both the validity of the opinion of counsel
and 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 could be
subject to the Federal alternative minimum tax. Unless we are entitled to relief
under specific statutory provisions, we could not elect to be taxed as a REIT
for four taxable years following the year during which we were disqualified.
Therefore, if we lose our REIT status, the funds available for distribution to
you would be reduced substantially for each of the years involved.
Effect of Distribution Requirements
As a REIT, we are subject to annual distribution requirements, which limit the
amount of cash we have available for other business purposes, including amounts
to fund our growth.
Other Tax Liabilities
Even if we qualify as a REIT, we may be subject to certain Federal, state, and
local taxes on our income, property and operations that could reduce operating
cash flow.
Recent Developments
The Tax Relief Extension Act of 1999 was recently enacted and it contains
several tax provisions regarding REITs. It includes a provision which reduces
the annual distribution requirement for REIT taxable income from 95% to 90%. It
also changes the 10% voting securities test under current law to a 10% vote or
value test. Thus, subject to certain exceptions, a REIT will no longer be
allowed to own more than 10% of the vote or value of the outstanding securities
of any issuer, other than a qualified REIT subsidiary or another REIT. One
exception to this new test, which is also an exception to the 5% asset test
under current law, allows a REIT to own any or all of the securities of a
"taxable REIT subsidiary." A taxable REIT subsidiary can perform non-customary
services as well as engage in non-real estate activities. A taxable REIT
subsidiary will be taxed as a regular C corporation but will be subject to
earnings stripping limitations on the deductibility of interest paid to its
REIT. In addition, the REIT will be subject to a 100% excise tax to the extent
any transaction between the taxable REIT subsidiary and the REIT is not
conducted on an arm's length basis securities of a taxable REIT subsidiary will
constitute non-real-estate assets for purposes of determining whether at least
75% of a REIT's assets consist of real estate assets. In addition, no more that
20% of a REIT's total assets can consist of securities of taxable REIT
subsidiaries. These new tax provisions are not effective until January 1, 2001.
In addition, grandfather protection is provided with respect to the 10% value
test for securities of a corporation held by a REIT on July 12, 1999, but such
protection ceases to apply after the corporation engages in a substantial new
line of business or acquires any substantial asset and also ceases to apply
after the acquisition of additional securities of the corporation by the REIT
after July 12, 1999.
Because we currently own more than 10% of the value of IFC, we may have to
restructure the ownership of IFC or have it elect to be a taxable REIT
subsidiary of the Company in 2001.
26
Potential Characterization of Distributions or Gain on Sale as Unrelated
Business Taxable Income to Tax-Exempt Investors
If (1) we are subject to the rules relating to taxable mortgage pools or we
are a "pension-held REIT," or (2) a tax-exempt stockholder has incurred debt to
purchase or hold our common stock is not exempt from Federal income taxation
under certain special sections of the Internal Revenue Code, or (3) the residual
REMIC interests we buy generate "excess inclusion income," then distributions to
and, in the case of a stockholder described in (2), 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 to Increased Taxation
If we have borrowings with two or more maturities and, (1) are secured by
mortgage loans or mortgage-backed securities and, (2) the payments made on the
borrowings are related to the payments received on the underlying assets, then
the borrowings may be classified as a "taxable mortgage pool" under the Internal
Revenue Code. If any part of our company was treated as a taxable mortgage pool,
then our REIT status would not be impaired, but a portion of the taxable income
we generated may, under regulations to be issued by the Treasury Department, be
characterized as "excess inclusion" income and allocated to our stockholders.
Any excess inclusion income would:
. not be allowed to be offset by a stockholder's net operating losses;
. be subject to a tax as unrelated business income if a stockholder were a
tax-exempt stockholder;
. be subject to the application of federal income tax withholding at the
maximum rate (without reduction for any otherwise applicable income tax
treaty) with respect to amounts allocable to foreign stockholders; and
. be taxable (at the highest corporate tax rate) to us, rather than to our
stockholders, to the extent the excess inclusion income relates to stock
held by disqualified organizations (generally, tax-exempt companies not
subject to tax on unrelated business income, including governmental
organizations).
We take the position that our existing financing arrangements do not create a
taxable mortgage pool. However, the IRS may successfully maintain that our
financing arrangements do qualify as a taxable mortgage pool. In addition, we
may enter into arrangements creating excess inclusion income in the future.
Our Operations May be Adversely Affected if We are Subject to the Investment
Company Act
We intend to conduct our business at all times so as not to become regulated
as an investment company under the Investment Company Act. The Investment
Company Act exempts entities that are primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate. In order to qualify for this exemption we must maintain at least
55% of our assets directly in mortgage loans, qualifying pass-through
certificates and certain other qualifying interests in real estate. Our
ownership of certain mortgage assets may be limited by the provisions of the
Investment Company Act. If the Securities and Exchange Commission adopts a
contrary interpretation with respect to these securities or otherwise believes
we do not satisfy the above exception, we could be required to restructure our
activities or sell certain of our assets. To insure that we continue to qualify
for the exemption we may be required at times to adopt less efficient methods of
financing certain of our mortgage assets and we may be precluded from acquiring
certain types of higher-yielding mortgage assets. The net effect of these
factors will be to lower at times our net interest income. If we fail to qualify
for exemption from registration as an investment company, our ability to use
leverage would be substantially reduced, and we would not be able to conduct our
business as described. Our business will be materially and adversely affected if
we fail to qualify for this exemption.
27
Future Revisions in Policies and Strategies at the Discretion of Our Board of
Directors May be Affected Without Stockholder Consent
Our board of directors, including a majority of our unaffiliated directors,
has established our investment and operating policies and strategies. We may:
. invest in the securities of other REITs for the purpose of exercising
control;
. offer securities in exchange for property; and
. offer to repurchase or otherwise reacquire our shares or other
securities in the future.
In October 1998, we adopted a repurchase plan to repurchase up to $5.0 million
of our common stock in the open market. In September 1999, the board of
directors approved common stock repurchases up to an additional $5.0 million, or
a total of $10.0 million. As of December 31, 1999, we had repurchased 2.0
million shares for $9.9 million. We may also underwrite the securities of other
issuers, although we have no present intention to do so. Any of the policies,
strategies and activities may be modified or waived by our board of directors,
subject in certain cases to approval by a majority of our unaffiliated
directors, without stockholder consent.
Effect of Future Offerings May Adversely Affect Market Price of Our Securities
We intend to increase our capital resources by making additional private or
public offerings of securities in the future. We do not know:
. the actual or perceived effect of these offerings;
. the timing of these offerings;
. the 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.
Risk Relating to Common Stock
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.
Risk Relating to Preferred Stock
Our charter authorizes our board of directors to issue shares of preferred
stock and to classify or reclassify any unissued shares of common stock or
preferred stock into one or more classes or series of stock. The preferred stock
may be issued from time to time with terms as determined by our board of
directors. Our preferred stock is available for our possible future financing of
acquisitions and for our general corporate purposes without further stockholder
authorization. In October 1998, our board announced a dividend to all common
stockholders of rights for certain shares of our Series A Junior Preferred
Stock. Our Series A Junior Preferred Stock has terms and conditions which could
have the effect of delaying, deferring or preventing a hostile change in control
of our company. Our board could authorize the issuance of shares of another
class or series of preferred stock with terms and conditions which could also
have the effect of delaying, deferring or preventing a change in control of our
company which could involve a premium price for holders of common stock or
otherwise be in their best interest. The preferred stock, if issued, may have a
preference on dividend payments, which could reduce the assets we have available
to make distributions to our common stockholders.
Maryland Business Combination Statute
The Maryland General Corporation Law establishes special requirements for
"business combinations" between a Maryland corporation and "interested
stockholders" unless exemptions are applicable. An interested stockholder is any
person who beneficially owns 10% or more of the voting power of our then-
outstanding voting stock. Among other things, the law prohibits for a period of
five years a merger and other similar transactions between our company and an
interested stockholder unless the board of directors approved the transaction
prior to the party becoming an interested stockholder. The five-year period runs
from the most recent date on which the interested stockholder became an
28
interested stockholder. The law also requires a supermajority stockholder vote
for such transactions after the end of the five-year period. This means that the
transaction must be approved by at least:
. 80% of the votes entitled to be cast by holders of outstanding voting
shares,
. 66% of the votes entitled to be cast by holders of outstanding voting
shares other than shares held by the interested stockholder with whom
the business combination is to be effected.
The business combination statute could have the effect of discouraging offers
to acquire us and of increasing the difficulty of consummating any such offers,
even if our acquisition would be in our stockholders' best interests.
Maryland Control Share Acquisition Statute
Maryland law provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a stockholder vote. Two-thirds of the shares eligible to vote must
vote in favor of granting the "control shares" voting rights. "Control shares"
are shares of stock that, taken together with all other shares of stock the
acquirer previously acquired, would entitle the acquirer to exercise at least
20% of the voting power in electing directors. Control shares do not include
shares of stock the acquiring person is entitled to vote as a result of having
previously obtained stockholder approval. A "control share acquisition" means
the acquisition of control shares, subject to certain exceptions.
If a person who has made (or proposes to make) a control share acquisition
satisfies certain conditions (including agreeing to pay expenses), he may compel
our board of directors to call a special meeting of stockholders to be held
within 50 days to consider the voting rights of the shares. If such a person
makes no request for a meeting, we have the option to present the question at
any stockholders' meeting.
If voting rights are not approved at a meeting of stockholders then we may
redeem any or all of the control shares (except those for which voting rights
have previously been approved) for fair value. We will determine the fair value
of the shares, without regard to voting rights, as of the date of either:
. the last control share acquisition, or
. any meeting where stockholders considered and did not approve voting
rights of the control shares.
If voting rights for control shares are approved at a stockholders' meeting
and the acquirer becomes entitled to vote a majority of the shares of stock
entitled to vote, all other stockholders may exercise appraisal rights. This
means that you would be able to force us to redeem your stock for fair value.
Under Maryland law, the fair value may not be less than the highest price per
share paid in the control share acquisition. Furthermore, certain limitations
otherwise applicable to the exercise of dissenters' rights would not apply in
the context of a control share acquisition. The control share acquisition
statute would not apply to shares acquired in a merger, consolidation or share
exchange if we were a party to the transaction. The control share acquisition
statute could have the effect of discouraging offers to acquire us and of
increasing the difficulty of consummating any such offers, even if our
acquisition would be in our stockholders' best interests.
29
Possible Adverse Consequences of Limits on Ownership of Shares
Our Charter limits ownership of our capital stock by any single stockholder to
9.5% of our outstanding shares. 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 50% or more 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:
. will consider the transfer to be null and void;
. will not reflect the transaction on our books;
. may institute legal action to enjoin the transaction;
. will not pay dividends or other distributions with respect to those
shares;
. will not recognize any voting rights for those shares;
. will consider the shares held in trust for the benefit of our Company;
and
. will either direct the affected person to sell the shares and turn over
any profit to us, or we will redeem the shares. If we redeem the shares,
it will be at a price equal to the lesser of:
(a) the price paid by the transferee of the shares, or
(b) the average of the last reported sales prices on the American
Stock Exchange on the ten trading days immediately preceding the
date fixed for redemption by our board of directors.
An individual who acquires shares that violate the above rules bears the risk
that (1) he may lose control over the power to dispose of his shares, (2) he may
not recognize profit from the sale of his shares if the market price of the
shares increases and (3) he may be required to recognize a loss from the sale of
his shares if the market price decreases.
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.
ITEM 2. PROPERTIES
The primary executive and administrative offices of the Company are located in
Newport Beach, California. The Company has entered into a 10-year lease to use
approximately 74,000 square feet of office space at a rate of $149,000 per
month. The Company believes that these facilities will adequately provide for
the Company's future growth needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to litigation and claims which are normal in the
course of its operations. While the results of such litigation and claims cannot
be predicted with certainty, the Company believes the final outcome of such
matters will not have a materially adverse effect on its results of operations
or consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the security holders to be voted on during the
fourth quarter of 1999.
30
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the American Stock Exchange ("AMEX")
under the symbol IMH. The following table summarizes the high, low and closing
sales prices for IMH's Common Stock as reported by the AMEX for the periods
indicated:
1999 1998
------------------------------- --------------------------------
High Low Close High Low Close
-------- -------- --------- -------- -------- ---------
First Quarter......................................... $ 6.19 $ 4.00 $ 5.00 $ 18.25 $ 15.88 $ 17.06
Second Quarter........................................ 6.13 4.38 5.06 17.75 14.00 15.56
Third Quarter......................................... 6.13 3.88 4.63 16.88 10.00 13.50
Fourth Quarter........................................ 4.81 3.38 4.13 13.50 2.75 4.56
On March 14, 2000, the last reported sale price of the Common Stock on the
AMEX was $3.31 per share. As of March 14, 2000, there were 671 holders of record
(including holders who are nominees for an undetermined number of beneficial
owners) of the Company's Common Stock.
Dividend Reinvestment and Stock Purchase Plan. Pursuant to IMH's Dividend
Reinvestment and Stock Purchase Plan ("DRSPP" or the "Plan"), stockholders can
acquire additional shares of IMH Common Stock by reinvesting their cash
dividends at a 0% to 5% discount of the average high and low market prices as
reported on the AMEX on the Investment Date (as described in the Plan) to the
extent shares are issued by IMH. Stockholders may also purchase additional
shares of IMH Common Stock through the cash investment option at a 0% to 5%
discount of the average high and low market prices as reported on the AMEX
during the three trading days preceding the Investment Date. In July 1999, the
Company suspended its DRSPP.
Share Repurchase Program. During 1999, the Company's Board of Directors
authorized the Company to repurchase up to $10.0 million of the Company's Common
Stock, $.01 par value, in open market purchases from time to time at the
discretion of the Company's management; the timing and extent of the repurchases
will depend on market conditions. The Company intends to effect such
repurchases, if any, in compliance with the Rule 10b-18 under the Securities
Exchange Act of 1934. For the year ended December 31, 1999, the Company
repurchased 2.0 million shares of its Common Stock for $9.9 million. The
acquired shares were canceled.
Stockholder Rights Plan. On October 7, 1998, the Company's Board of
Directors adopted a Stockholder Rights Plan in which Preferred Stock Purchase
Rights were distributed as a dividend at the rate of one Right for each
outstanding share of Common Stock. The dividend distribution was made on October
19, 1998 payable to stockholders of record on that date. The Rights are attached
to the Company's Common Stock. The Rights will be exercisable and trade
separately only in the event that a person or group acquires or announces the
intent to acquire 10 percent or more of the Company's Common Stock. Each Right
will entitle stockholders to buy one-hundredth of a share of a new series of
junior participating Preferred Stock at an exercise price of $30.00. If the
Company is acquired in a merger or other transaction after a person has acquired
10 percent or more of Company outstanding Common Stock, each Right will entitle
the stockholder to purchase, at the Right's then-current exercise price, a
number of the acquiring Company's common shares having a market value of twice
such price. In addition, if a person or group acquires 10 percent or more of the
Company's Common Stock, each Right will entitle the stockholder (other than the
acquiring person) to purchase, at the Right's then-current exercise price, a
number of shares of the Company's Common Stock having a market value of twice
such price. Following the acquisition by a person of 10 percent or more of the
Company's Common Stock and before an acquisition of 50 percent or more of the
Common Stock, the Board of Directors may exchange the Rights (other than the
Rights owned by such person) at an exchange ratio of one share of Common Stock
per Right. Before a person or group acquires beneficial ownership of 10 percent
or more of the Company's Common Stock, the Rights are redeemable for $.0001 per
right at the option of the Board of Directors. The Rights will expire on October
19, 2008. The Rights distribution is not taxable to stockholders. The Rights are
intended to enable all the Company stockholders to realize the long-term value
of their investment in the Company.
31
Dividends
To maintain its qualification as a REIT, IMH intends to make annual
distributions to stockholders of at least 95% of its taxable income, which may
not necessarily equal net income as calculated in accordance with generally
accepted accounting principles ("GAAP"), determined without regard to the
deduction for dividends paid and excluding any net capital gains. Any taxable
income remaining after the distribution of the regular quarterly or other
dividends will be distributed annually on or prior to the date of the first
regular quarterly dividend payment date of the following taxable year. The
dividend policy is subject to revision at the discretion of the Board of
Directors. All distributions in excess of those required for IMH to maintain
REIT status will be made by IMH at the discretion of the Board of Directors and
will depend on the taxable earnings of IMH, the financial condition of IMH, and
such other factors as the Board of Directors deems relevant. The Board of
Directors has not established a minimum distribution level.
Distributions to stockholders will generally be taxable as ordinary income,
although a portion of such distributions may be designated by IMH as capital
gain or may constitute a tax-free return of capital. IMH annually furnishes to
each of its stockholders a statement setting forth distributions paid during the
preceding year and their characterization as ordinary income, capital gains or
return of capital. Of the total dividends paid during 1999 and 1998,
approximately $4.8 million and $8.9 million, respectively, represented a tax-
free return of capital.
The following table summarizes dividends paid or declared by IMH:
Per Share
Stockholder Dividend
Period Covered Record Date Amount (1)
- ------------------------------------------------------------------------- ---------------------- ---------------
Quarter ended March 31, 1998............................................. April 9, 1998 $0.48
Quarter ended June 30, 1998.............................................. July 1, 1998 $0.49
Quarter ended September 30, 1998 (1)..................................... October 9, 1998 $0.49
Quarter ended March 31, 1999............................................. April 9, 1999 $0.10
Quarter ended June 30, 1999.............................................. June 30, 1999 $0.12
Quarter ended September 30, 1999......................................... September 30, 1999 $0.13
Quarter ended December 31, 1999.......................................... January 3, 2000 $0.13
_____________
(1) On September 28, 1998, the Company declared a third quarter dividend of
$0.49 per share payable on October 26, 1998 to stockholders of record on
October 9, 1998. However, on October 8, 1998 the Company announced that the
third quarter dividend would be delayed and paid on January 6, 1999. The
Company paid interest in the form of an additional cash dividend at a rate
of 4% per annum for the period from the previously announced payment date
through January 6, 1999. The total amount of interest paid was $96,300, or
$0.004 per share.
The Company did not declare a dividend for the quarter ended December 31,
1998. See "Item 1. Business--Risk Factors--Inability to Generate Liquidity May
Adversely Affect Our Operations."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated statements of operations data for each
of the years in the five-year period ended December 31, 1999, and the
consolidated balance sheet data for the five-year period ended December 31, 1999
were derived from the Company's and IFC's financial statements audited by KPMG
LLP ("KPMG"), independent auditors, whose reports appear on pages F-2 and F-32,
respectively. Such selected financial data should be read in conjunction with
the consolidated financial statements and the notes to the consolidated
financial statements starting on page F-1 and with Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
32
IMPAC MORTGAGE HOLDINGS, INC.
(dollar amounts in thousands, except per share data)
Year Ended December 31,
----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
Statement of Operations Data:
Net interest income:
Total interest income.............................. $ 119,458 $ 163,658 $ 109,533 $ 63,673 $ 2,851
Total interest expense............................. 89,795 121,695 76,577 44,144 1,715
----------- ------------ ------------ ------------ ------------
Net interest income............................... 29,663 41,963 32,956 19,529 1,136
Provision for loan losses....................... 5,547 4,361 6,843 4,350 488
Net interest income after loan loss provision..... 24,116 37,602 26,113 15,179 648
Non-interest income:
Equity in net earnings (loss) of IFC............... 4,292 (13,876) 8,316 903 1,489
Equity in net loss of ICH.......................... -- (998) (239) -- --
Loss on sale of mortgage loans..................... -- (3,111) -- -- --
Gain on sale of securities......................... 93 427 648 -- --
Other income....................................... 2,517 4,019 1,601 593 244
----------- ------------ ------------ ------------ ------------
Total non-interest income......................... 6,902 (13,539) 10,326 1,496 1,733
----------- ------------ ------------ ------------ ------------
Non-interest expense:
Write-down on securities available-for-sale........ 2,037 14,132 -- -- --
Loss on equity investment of ICH................... -- 9,076 -- -- --
General and administrative and other operating
expense........................................... 6,664 6,788 1,851 1,449 209
Advisory fees...................................... -- -- 6,242 3,347 38
Termination agreement expense...................... -- -- 44,375 -- --
----------- ------------ ------------ ------------ ------------
Total non-interest expense........................ 8,701 29,996 52,468 4,796 247
----------- ------------ ------------ ------------ ------------
Earnings (loss) before income taxes............... 22,317 (5,933) (16,029) 11,879 2,134
Income taxes (benefit)............................. -- -- -- -- 76
----------- ------------ ------------ ------------ ------------
Net earnings (loss)............................... $ 22,317 $ (5,933) $ (16,029) $ 11,879 $ 2,058
=========== ============ ============ ============ ============
Net earnings (loss) per share-- basic............. $ 0.83 $ (0.25) $ (0.99) $ 1.34 $ 0.05
=========== ============ ============ ============ ============
Net earnings (loss) per share-- diluted........... $ 0.76 $ (0.25) $ (0.99) $ 1.32 $ 0.05
=========== ============ ============ ============ ============
Dividends declared per share...................... $ 0.48 $ 1.46 $ 1.68 $ 1.61 $ --
=========== ============ ============ ============ ============
Net earnings (loss) per share before
Management termination expense (1).............. $ 0.76 $ (0.25) $ 1.74 $ 1.32 $ 0.05
=========== ============ ============ ============ ============
(1) Per share amounts exclude the effect of expenses related to the termination
in December 1997 (the "Termination Agreement Expense") of the Company's
Management Agreement with Imperial Credit Advisors, Inc. ("ICAI"), an
affiliate of ICII.
At December 31,
--------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ------------- ------------ ----------- ------------
Balance Sheet Data:
Investment securities available-for-sale.......... $ 93,206 $ 93,486 $ 67,011 $ 63,506 $ 2,284
Mortgage loans held-for-investment and
CMO collateral.................................. 1,313,112 1,181,847 1,052,610 502,658 --
Finance receivables............................... 197,119 311,571 533,101 362,312 583,021
Investment in Impac Funding Corporation........... 17,372 13,246 27,122 9,896 866
Investment in Impac Commercial Holdings, Inc...... -- -- 17,985 -- --
Total assets...................................... 1,675,430 1,665,504 1,752,812 972,355 613,688
CMO borrowings.................................... 850,817 1,072,316 741,907 474,513 --
Reverse repurchase agreements..................... 539,687 323,625 755,559 357,716 567,727
Total liabilities................................. 1,436,586 1,413,898 1,523,782 843,165 568,452
Total stockholders' equity........................ 238,844 251,606 229,030 129,190 45,236
33
IMPAC FUNDING CORPORATION
(dollar amounts in thousands, except Operating Data)
Year Ended December 31,
-------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- ---------- ---------- -----------
Statement of Operations Data:
Net interest income:
Total interest income............................. $ 21,225 $ 48,510 $ 48,020 $ 32,799 $ 1,249
Total interest expense............................ 20,953 40,743 41,628 31,751 1,785
----------- ----------- ---------- ---------- -----------
Net interest income (expense).................... 272 7,767 6,392 1,048 (536)
Non-interest income:
Gain (loss) on sale of loans...................... 27,098 (11,663) 19,414 7,747 4,135
Mark-to-market loss on investment securities...... -- (805) -- -- --
Gain (loss) on sale of investment securities...... -- (706) 550 -- --
Loan servicing income............................. 5,221 7,071 4,109 1,250 5,159
Gain on sale of servicing rights.................. -- -- -- -- 370
Other income...................................... 979 420 93 -- --
----------- ----------- ---------- ---------- -----------
Total non-interest income........................ 33,298 (5,683) 24,166 8,997 9,664
----------- ----------- ---------- ---------- -----------
Non-interest expense:
General and administrative and other operating
expense.......................................... 14,965 14,385 10,047 7,154 3,663
Amortization of mortgage servicing rights......... 5,331 6,361 2,827 613 2,892
Write down of securities available-for-sale....... 4,252 -- -- -- --
Impairment of mortgage servicing rights........... 1,078 3,722 -- -- --
Provision for repurchases......................... 385 367 3,148 687 --
----------- ----------- ---------- ---------- -----------
Total non-interest expense....................... 26,011 24,835 16,022 8,454 6,555
----------- ----------- ---------- ---------- -----------
Earnings (loss) before income taxes.............. 7,559 (22,751) 14,536 1,591 2,573
Income taxes (benefit)............................ 3,227 (8,738) 6,136 679 1,069
----------- ----------- ---------- ---------- -----------
Net earnings (loss).............................. $ 4,332 $ (14,013) $ 8,400 $ 912 $ 1,504
=========== =========== ========== ========== ===========
At December 31,
-------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- ----------- ----------- ----------- -----------
Balance Sheet Data:
Residual interests in securitizations............ $ -- $ -- $ -- $ 46,949 $ --
Mortgage loans held-for-sale..................... 68,084 252,568 620,549 334,104 544,275
Mortgage servicing rights........................ 15,621 14,062 15,568 8,785 --
Total assets..................................... 116,246 313,872 656,944 399,171 552,631
Borrowings from IWLG............................. 66,125 192,900 454,840 327,422 550,291
Other borrowings................................. 181 67,058 148,307 -- --
Due to affiliates................................ 14,500 24,382 6,198 54,803 --
Total liabilities................................ 98,698 301,009 629,548 389,175 551,757
Total shareholders' equity....................... 17,548 12,863 27,396 9,996 874
Operating Data (in millions):
Mortgage loan acquisitions (volume).............. $ 1,672 $ 2,249 $ 2,571 $ 1,542 $ 1,133
Master servicing portfolio at period-end......... 2,879 3,714 3,029 1,550 512
Servicing portfolio at period-end................ 2,393 3,714 3,029 1,550 512
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain information contained in the following Management's Discussion and
Analysis of Financial Condition and Results of Operations constitute forward-
looking statements within the meaning of the Securities Act of 1933 and the
Exchange Act of 1934 which can be identified by the use of forward-looking
terminology such as "may," "will," "expect," "intend," "should," "anticipate,"
"estimate," or "believe" or comparable terminology. The Company's actual results
may differ materially from those contained in the forward-looking statements.
Factors which may cause such differences to occur are discussed in "Item 1.
Business--Risk Factors" as well as those factors discussed below.
General
Impac Mortgage Holdings, Inc. was incorporated in Maryland in August 1995. The
Company, together with its subsidiaries and related companies, primarily
operates three businesses: (1) the Long-Term Investment Operations, (2) the
Conduit Operations, and (3) the Warehouse Lending Operations. The Long-Term
Investment Operations invests primarily in non-conforming residential mortgage
loans and securities backed by such loans. The Conduit Operations purchases and
sells and securitizes primarily non-conforming mortgage loans. The Warehouse
Lending Operations provides warehouse and repurchase financing to originators of
mortgage loans.
The Company is entitled to 99% of the earnings or losses of IFC through its
ownership of all of the non-voting preferred stock of IFC. As such, the Company
records its investment in IFC using the equity method. Under this method,
original investments are recorded at cost and adjusted by the Company's share of
earnings or losses. The Company is a mortgage REIT that elects to be taxed at
the corporate level as a REIT for federal income tax purposes, which generally
allows the Company to pass through income to stockholders without payment of
federal income tax at the corporate level.
Relationships with Impac Entities
On May 5, 1999, Impac Commercial Holdings, Inc. ("ICH") executed a stock
purchase agreement pursuant to which it issued to Fortress Partners LP
("Fortress") $12.0 million of series B convertible preferred stock of ICH. In
addition, FIC Management Inc. ("FIC"), an affiliate of Fortress, entered into a
definitive agreement with RAI Advisors, LLC ("RAI") for the assignment of RAI's
rights and interests in the management agreement with ICH. In connection with
these transactions, the submanagement agreement among RAI, IMH and IFC was
terminated and a new submanagement agreement was entered into among FIC, IMH and
IFC and the right of first refusal agreement among RAI, ICH, ICCC, IMH and IFC
was terminated. Under the new submanagement agreement, IMH and IFC provide
various services including, accounting, data processing and secondary marketing
to ICH, as Fortress deems necessary. Messrs. Joseph R. Tomkinson, Chairman and
Chief Executive Officer of IMH, and Frank P. Filipps, an unaffiliated director
of IMH, remain on the board of directors of ICH.
Many of the officers and directors of the Company are officers, directors and
owners of IFC. The Company owns all of the preferred stock of, and 99% of the
economic interest in, IFC, while Joseph R. Tomkinson, William S. Ashmore,
President and Chief Operating Officer, and Richard J. Johnson, Executive Vice
President and Chief Financial Officer, are the holders of all of the outstanding
voting stock of, and 1% of the economic interest in, IFC.
Significant Transactions
Common Stock Exchange Offering
In March 1999, certain stockholders of the Company exchanged 1,359,507 shares
of their Common Stock, at an average price of $5.70 per share, for 11% senior
subordinated debentures due to mature on February 15, 2004. The debentures are
unsecured obligations of the Company subordinated to all indebtedness of the
Company's subsidiaries. The debentures bear interest at 11% per annum from their
date of issuance, payable quarterly, commencing May 15, 1999, until the
debentures are paid in full. The debentures mature on February 15, 2004, at
which the date may be extended once by the Company to a date not later than May
15, 2004, provided that the Company satisfies certain conditions. Commencing on
February 15, 2001, the debentures are redeemable, at the Company's option, in
whole at
35
any time or in part from time to time, at the principal amount to be redeemed
plus accrued and unpaid interest thereon to the redemption date.
Exchange of Series B Cumulative Convertible Preferred Stock for Series C
Cumulative Convertible Preferred Stock
In February 2000, all shares of Series B 10.5% Cumulative Convertible
Preferred Stock ("Series B Preferred Stock") was exchanged for Series C 10.5%
Cumulative Convertible Preferred Stock ("Series C Preferred Stock") and the
conversion rate was adjusted to $4.72 per share convertible into 5.29661 shares
of Common Stock or an aggregate of 6,355,932 shares of Common Stock. Other than
the foregoing, the Series C Preferred Stock has the same rights, preferences and
privileges as the Series B Preferred Stock.
Collateralized Mortgage Obligations ("CMOs")
The Company issued two CMOs during the year ended December 31, 1999. The first
CMO was issued in February 1999 for $183.1 million and was collateralized by
$120.8 million of adjustable rate mortgages and $77.8 million of residential
loans secured by second trust deeds. The second CMO was issued in June 1999 for
$115.0 million and was collateralized by $117.6 million of primarily adjustable
rate mortgages. The issuance of CMOs provides the Company with immediate
liquidity, a locked-in net interest rate spread and eliminates the Company's
exposure to margin calls on such loans.
Real Estate Mortgage Investment Conduits ("REMICs")
The Company issued two REMICs during the year ended December 31, 1999. The
first REMIC was issued in September 1999 for $133.2 million and was
collateralized by $137.3 million of adjustable rate mortgages. The second REMIC
was issued in December 1999 for $226.9 million and was collateralized by $230.1
million of fixed rate mortgages. The REMICs were accounted for as sales of the
mortgage loans, which resulted in a gain of $6.5 million.
Definitive Agreement to Acquire a California Thrift and Loan
During the first quarter of 1999, the Company completed a definitive agreement
to acquire a California Thrift and Loan ("Bank"). As provided for in the
agreement, the Company submitted its application in the second quarter of 1999
for a change of control to the state and federal regulatory agencies for their
approval. During the process of reviewing the application, the federal agency
raised certain issues. The Company was not able to give the federal agency
sufficient comfort with respect to those issues without modifying its proposal.
The Company submitted a new application to state and federal regulatory agencies
in the first quarter of 2000. The new application was modified from the previous
application in several key areas and to more clearly define the Bank as a stand-
alone operation that is not reliant upon the Company for its success. It is
anticipated that the Bank will market its own unique loan products, which will
include mortgages, consumer equity loans and loans on small commercial and
multi-family properties. However, there are no assurances that the new
application for change of control will be received favorably by either of the
state or federal regulatory agencies. In the event that the Company is
unsuccessful in its efforts to obtain the Bank charter, management believes that
it will have no adverse impact on the future profitability of the Company.
Advance to Impac Funding Corporation
During the second quarter of 1999, IMH advanced to IFC $14.5 million in cash,
in exchange for an interest only note at an interest rate of 9.50% with a
maturity of June 30, 2004, in anticipation of the initial capitalization of the
Bank and to fund the operations of IFC and other strategic opportunities deemed
appropriate by IFC.
Business Operations
Business Strategy: During 1999, the Company restructured its balance sheet in
order to increase book value per common share, generate additional liquidity and
improve overall credit quality of its investment portfolio. The following
transactions were completed during 1999: (1) the exchange of 1.4 million shares
of Common Stock for 11.0% senior subordinated debt due 2/15/2004, (2) a stock
repurchase program to repurchase up 10.0 million shares of outstanding Common
Stock and (3) the re-securitization of a portion of its investment securities
portfolio. In addition,
36
the Long-Term Investment Operations acquired from IFC $349.8 million, in unpaid
principal balance, of adjustable rate mortgages to be held for long-term
investment during the fourth quarter of 1999. During January 2000, the Company
completed the issuance of a $460.0 million CMO that was primarily collateralized
by the adjustable rate mortgages acquired from IFC during the fourth quarter of
1999.
The exchange of Common Stock for 11.0% senior subordinated debt and the
repurchase of outstanding Common Stock during 1999 was accretive to book value
by $0.65, or 7%. Book value at December 31, 1999 was $9.76 (calculated assuming
liquidation value of the Company's Series B Cumulative Convertible Preferred
Stock) as compared to $9.11 on a pro-forma basis. Overall, book value increased
8% to $9.76 at December 31, 1999 as compared to $9.02 at December 31, 1998.
Based on the Company's business plan for 2000 and the retention of reported
earnings in excess of minimum distribution requirements, the Company expects to
increase its book value per share in the future.
The Company completed a re-securitization of a portion of its investment
securities available-for-sale in October 1999, which raised additional liquidity
for the Company of approximately $23.4 million after repaying short-term
borrowings secured by the investment securities portfolio. The cash proceeds
were used to acquire mortgages from IFC, increase outstanding lending by the
Warehouse Lending Operations, repurchase Common Stock and other business
expansion. The Company reduced its reliance on reverse repurchase agreements to
finance its investment securities to zero at December 31, 1999 as compared to
$24.1 million at December 31, 1998. The Company continued to maintain reduced
leverage and strong liquidity levels during the fourth quarter of 1999. The
Company's debt-to-equity ratio increased to 6.0:1 at December 31, 1999 as
compared to 5.6:1 at December 31, 1998, which was well within the Company's
target range.
Throughout 1999, the Company acquired an aggregate of $638.3 million of
mortgages from IFC for its Long-Term Investment Operations. These mortgages
consisted of $506.6 million, or 79%, of A quality, non-conforming mortgages. Of
the $638.3 million of mortgages acquired, $539.7 million, or 85%, were
adjustable rate mortgages. In addition, $222.9 million, or 35%, of mortgages
acquired during 1999 for long-term investment had prepayment penalties as
compared to $147.6 million, or 18%, of mortgages with prepayment penalties
acquired during 1998. The Company expects that the higher percentage of
mortgages acquired for long-term investment with prepayment penalties will lead
to a reduction in overall prepayments. Constant prepayment rates ("CPR") on the
Company's CMO portfolio during the fourth quarter of 1999 decreased to 28% CPR
as compared to 34% CPR during the fourth quarter of 1998. The loan delinquency
rate of mortgages held for long-term investment which were 60 or more days past
due, inclusive of foreclosures and delinquent bankruptcies, decreased to 5.43%
at December 31, 1999 as compared to 7.58% at December 31, 1998.
The Company's Board of Directors announced a dividend policy for 2000 that
allows the Company to expand its business operations and focus on rebuilding the
Company's balance sheet without the diluted effect of offering additional shares
of Common Stock at current market levels. During 2000, the Company plans to only
distribute 100% of taxable earnings. During 1999, the Company paid dividends in
excess of taxable earnings, which represented a return of capital to its
stockholders, of approximately $4.8 million over minimum distribution
requirements. Of the total dividend distributions paid to common stockholders
during 1999, 39% represented ordinary income and 61% represented a return of
capital.
Long-Term Investment Operations: During the year ended December 31, 1999, the
Long-Term Investment Operations, conducted by IMH and IMH Assets, acquired
$638.3 million of mortgages from IFC as compared to $866.7 million acquired
during 1998. Mortgages purchased by the Long-Term Investment Operations during
1999 consisted of $262,000 of FRMs and $545.2 million of ARMs secured by first
liens on residential property and $92.8 million of fixed rate second trust deeds
secured by residential property. IMH Assets issued CMOs totaling $298.1 million,
which were collateralized by $316.2 million of mortgage loans, during 1999 as
compared to CMOs totaling $768.0 million, which were collateralized by $788.2
million of mortgage loans, during 1998. As of December 31, 1999, the Long-Term
Investment Operations' portfolio of mortgage loans consisted of $949.7 million
of mortgage loans held in trust as collateral for CMOs and $363.4 million of
mortgage loans held-for-investment, of which approximately 34% were FRMs and 66%
were ARMs. The weighted average coupon of the Long-Term Investment Operations
portfolio of mortgage loans was 9.26% at December 31, 1999 with a weighted
average margin of 4.37%. The portfolio of mortgage loans included 77% of "A"
credit quality, non-conforming mortgage loans and 23% of B/C Loans, as defined
by the Company. The Long-Term Investment Operations sold $10.8 million, in
unpaid principal balance, of mortgage loans to
37
IFC and none to third party investors as compared to no loan sales to IFC and
$73.2 million of loans sold to third party investors during 1998. During 1999,
the Long-Term Investment Operations acquired $22.0 million of securities created
by IFC through the issuance of REMICs as compared to $60.6 million during 1998.
In addition, the Long-Term Investment Operations had outstanding finance
receivables of $197.1 million and investment securities available-for-sale of
$93.2 million at December 31, 1999. Of the $93.2 million of investment
securities available-for-sale, $56.8 million were subordinated securities
collateralized by mortgages, $30.8 million were "interest only" securities, and
$5.6 million were subordinated securities collateralized by other loans.
Conduit Operations: The Conduit Operations, conducted by IFC, supports the
Long-Term Investment Operations of the Company by supplying IMH and IMH Assets
with mortgages for IMH's long-term investment portfolio. As such, IFC sold
$638.3 million, in unpaid principal balance, of mortgages to IMH as compared to
$866.7 million, in unpaid principal balance, of loans sold during 1998. IFC's
mortgage acquisitions decreased 23% to $1.7 billion during 1999 as compared to
$2.2 billion of mortgages acquired during 1998. After excluding bulk
acquisitions, IFC's acquisitions decreased 11% to $1.6 billion during 1999 as
compared to $1.8 billion during 1998. During 1999, IFC securitized $360.1
million, in unpaid principal balance, of mortgages and sold whole loans to third
party investors totaling $824.1 million, in unpaid principal balance, of
mortgages. This compares to loan securitizations of $907.5 million, in unpaid
principal balance, of mortgages and whole loan sales to third party investors of
$856.2 million, in unpaid principal balance, of mortgages during 1998. Loan
securitizations and sales during 1999 resulted in gain on sale of loans of $27.1
million as compared to loss on sale of loans of $11.7 million during 1998. IFC
had deferred revenue of $7.6 million at December 31, 1999 as compared to $10.6
million at December 31, 1998. IFC's master servicing portfolio decreased 22% to
$2.9 billion at December 31, 1999 as compared to $3.7 billion at December 31,
1998. Of the $2.9 billion of mortgage loans master serviced by IFC at December
31, 1999, IFC is the master servicer for $1.4 billion of loans collateralizing
REMIC securities and $885.2 million of mortgage loans collateralizing CMOs. In
addition, of the $2.6 billion of loans master serviced by IFC, IFC owns
servicing rights on $2.4 billion in unpaid principal balance of mortgages.
Mortgages collateralized by properties located in California represented 40% of
IFC's master servicing portfolio at December 31, 1999 and 1998. The loan
delinquency rate of mortgages in IFC's master servicing portfolio which were 60
or more days past due, inclusive of foreclosures and delinquent bankruptcies,
was 4.37% and 4.82% at December 31, 1999 and 1998, respectively.
Warehouse Lending Operations: At December 31, 1999, the Company, conducted by
IWLG, had $1.4 billion of warehouse lines of credit available to 49 borrowers
(including IFC), of which $197.1 million was outstanding, including $66.1
million outstanding to IFC, $1.2 million outstanding to ILG and $48,000
outstanding to WSI. James Walsh, Executive Vice President of WSI, is also a
Director of IMH.
RESULTS OF OPERATIONS--
IMPAC MORTGAGE HOLDINGS, INC.
Year Ended December 31, 1999 as compared to Year Ended December 31, 1998
Net Earnings (Loss)
Net earnings for the year ended December 31, 1999 of $22.3 million, or $0.76
per diluted common share, compared to a net loss of $(5.9) million, or $(0.25)
per diluted common share, for 1998. The loss for 1998 was primarily due to a
global liquidity crisis in the mortgage-backed securitization market, which
occurred during the latter half of 1998. The deterioration of the mortgage-
backed securitization market created liquidity problems as the Company's lenders
made margin calls on their repurchase agreements. In order to meet margin calls
and reduce borrowings on its outstanding reverse repurchase agreements, the
Company sold mortgage loans and mortgage-backed securities at significant
losses. In addition, the Company recorded impairment charges on its investment
securities available-for-sale and recorded a loss on the sale of its equity
investment in ICH. However, as the mortgage-backed securitization market
stabilized during 1999, the Company returned to overall profitability, which in
large part was due to the profitability on the sale of its mortgage loans at
IFC.
38
Net Interest Income
Net interest income decreased 29% to $29.7 million during 1999 as compared to
$42.0 million during 1998. Interest income is primarily interest earned on
Mortgage Assets and includes interest income earned on cash and cash equivalents
and due from affiliates. Interest expense is primarily interest paid on
borrowings on Mortgage Assets and includes interest expense paid on due to
affiliates and senior subordinated debt. Mortgage Assets include CMO collateral,
mortgage loans held-for-investment, finance receivables and investment
securities available-for-sale. Borrowings on Mortgage Assets include CMO
financing, reverse repurchase agreements and borrowings on investment securities
available-for-sale. The decrease in net interest income during 1999 as compared
to 1998 was primarily the result of lower average Mortgage Assets, which
decreased 20% to $1.6 billion during 1999 as compared to $2.0 billion during
1998. Average Mortgage Assets decreased during 1999 as compared to 1998
principally due to the sale of mortgage loans during the fourth quarter of 1998
in order to increase liquidity and meet margin calls. The Company continued to
raise liquidity and reduce leverage throughout 1999 as IFC completed monthly
whole loan sales on a servicing released basis. As such, the Long-Term
Investment Operations' loan acquisitions from IFC decreased 26% to $638.3
million as compared to $866.7 million acquired during 1998. Additionally, due to
IFC's decreased loan production and the shorter accumulation and holding period
between monthly whole loan sales, average finance receivables to affiliates
(primarily IFC) decreased 42% to $232.7 million during 1999 as compared to
$403.9 million during 1998. Net interest income also decreased as the net
interest margin on Mortgage Assets decreased to 1.84% during 1999 as compared to
2.14% during 1998. The decrease in net interest margin on Mortgage Assets was
primarily the result of a decrease in the net interest margin on CMO collateral
to 0.79% during 1999 as compared to 1.26% during 1998. The decrease in the net
interest margin on CMO collateral during 1999 was primarily due to an increase
in amortization of net premiums as a result of higher loan prepayments. CMO
collateral significantly affects changes in net interest income as it represents
the largest percentage of total Mortgage Assets. Average CMO collateral
accounted for 71% of total average Mortgage Assets during 1999 and 63% of total
average Mortgage Assets during 1998.
39
The following table summarizes average balance, interest and weighted average
yield on Mortgage Assets and borrowings for the years ended December 31, 1999
and 1998 and includes interest income on Mortgage Assets and interest expense
related to borrowings on Mortgage Assets only (dollars in thousands):
For the year ended December 31, 1999 For the year ended December 31, 1998
---------------------------------------------- ------------------------------------------------
Weighted Weighted
Average Avg. % of Average Avg. % of
Balance Interest Yield Portfolio Balance Interest Yield Portfolio
----------- --------- ---------- ----------- ----------- --------- ---------- -----------
MORTGAGE ASSETS
- ---------------
Subordinated securities
collateralized by mortgages $ 87,107 $ 12,604 14.47% 5.56 $ 88,544 $ 11,219 12.67% 4.47
Subordinated securities
collateralized by other loans 7,433 834 11.22 0.47 5,364 709 13.22 0.27
----------- --------- ----------- ---------
Total investment securities
available-for-sale 94,540 13,438 14.21 6.03 93,908 11,928 12.70 4.74
----------- --------- ----------- ---------
Loan receivables:
CMO collateral 1,119,813 74,096 6.62 71.48 1,244,458 92,011 7.39 62.87
Mortgage loans held-for-investment 34,767 2,345 6.74 2.22 149,131 14,373 9.64 7.54
Finance receivables:
Affiliated 232,741 19,566 8.41 14.86 403,935 34,166 8.46 20.41
Non-affiliated 84,783 7,779 9.18 5.41 87,855 8,242 9.38 4.44
----------- --------- ----------- ---------
Total finance receivables 317,524 27,345 8.61 20.27 491,790 42,408 8.62 24.85
----------- --------- ----------- ---------
Total Loan Receivables 1,472,104 103,786 7.05 93.97 1,885,379 148,792 7.89 95.26
----------- --------- ----------- ---------
Total Mortgage Assets $ 1,566,644 $ 117,224 7.48% 100.00 $ 1,979,287 $ 160,720 8.12% 100.00
=========== ========= =========== =========
BORROWINGS
- ----------
CMO borrowings $ 1,017,992 $ 65,212 6.41% 74.25% $ 1,153,985 $ 76,309 6.61% 64.63%
Reverse repurchase
agreements-mortgages 331,179 21,545 6.51 24.16 605,486 40,439 6.68 33.91
Borrowings secured by securities
available-for-sale 6,445 686 10.64 0.47 -- -- -- --
Reverse repurchase
agreements-securities 15,377 998 6.49 1.12 26,051 1,700 6.53 1.46
----------- --------- ----------- ---------
Total Borrowings on
Mortgage Assets $ 1,370,993 $ 88,441 6.45% 100.00 $ 1,785,522 $ 118,448 6.63% 100.00
=========== ========= =========== =========
Net Interest Spread (1) 1.03% 1.49%
Net Interest Margin (2) 1.84% 2.14%
______________
(1) Calculated by subtracting the yield on total borrowings on Mortgage Assets
from the yield on total Mortgage Assets.
(2) Calculated by subtracting interest on total borrowings on Mortgage Assets
from interest on total Mortgage Assets and dividing the result by the
average balance of total Mortgage Assets.
Interest income on Mortgage Assets: Interest income on CMO collateral
decreased 19% to $74.1 million during 1999 as compared to $92.0 million during
1998 as average CMO collateral decreased 8% to $1.1 billion as compared to $1.2
billion, respectively. Average CMO collateral decreased as the Long-Term
Investment Operations issued CMOs totaling $298.1 million during 1999, which
were collateralized by $316.2 million of mortgages, as compared to CMOs totaling
$768.0 million, which were collateralized by $788.2 million of mortgages, during
1998. Average CMO collateral also decreased due to higher mortgage loan
prepayments, which increased 16% to $490.0 million during 1999 as compared to
$424.1 million during 1998. CPR on CMO collateral was 37% CPR during 1999 as
compared to 30% CPR during 1998. However, $222.9 million, or 35%, of mortgages
acquired during 1999 by the Long-Term Investment Operations, had prepayment
penalties as compared to $147.6 million, or 18%, of mortgages acquired with
prepayment penalties during 1998. The Company expects that the higher percentage
of mortgages acquired for long-term investment with prepayment penalties will
lead to a reduction in overall prepayments.
40
A decrease in the weighted average yield on CMO collateral also contributed to
an overall decrease in interest income on CMO collateral during 1999 as compared
to 1998. The weighted average yield on CMO collateral decreased to 6.62% during
1999 as compared to 7.39% during 1998. The decrease in yield on CMO collateral
during 1999 was primarily due to amortization of net premiums paid in acquiring
the mortgage loans held as CMO collateral and a decrease in short-term interest
rates, which are used as an index to determine interest rate adjustments on
adjustable rate CMO collateral. During 1999, the Company amortized net premiums
on CMO collateral of $14.4 million as compared to $11.7 million during 1998.
Amortization of net premiums on CMO collateral increased during 1999 as compared
to 1998 primarily due to the increase in the CPR, as previously mentioned.
However, during 1999 IFC limited premiums paid on loans without prepayment
penalties. During 1999, IFC acquired mortgage loans at a weighted average price
paid of 101.5 as compared to a weighted average price paid of 102.3 during 1998.
As of December 31, 1999, net premiums on CMO collateral was $28.8 million as
compared to $39.4 million at December 31, 1998.
Interest income on mortgage loans held-for-investment decreased 84% to $2.3
million during 1999 as compared to $14.4 million during 1998 as average mortgage
loans held-for-investment decreased 77% to $34.8 million as compared to $149.1
million, respectively. Average mortgage loans held-for-investment decreased due
to a decrease in mortgage loan acquisitions by the Long-Term Investment
Operations during 1999 as compared to 1998. Mortgage loans acquired from IFC by
the Long-Term Investment Operations decreased 26% to $638.3 million as compared
to $866.7 million acquired during 1998. As the Company focused on increased
liquidity and reduced leverage during 1999, the Long-Term Investment Operations
reduced its acquisition of mortgage loans to be held for long-term investment
and concentrated on selling mortgage loans at IFC. Additionally, the decrease in
the weighted average yield on mortgage loans held-for-investment during 1999 as
compared to 1998 contributed to the decrease in interest income. The weighted
average yield decreased to 6.74% during 1999 as compared to 9.64% during 1998.
The decrease in the yield on mortgage loans held-for-investment during 1999 was
primarily due to the sale of high-yielding 125 Loans by the Long-Term Investment
Operations to IFC in December of 1998 and a decrease in mortgage rates during
1999. The majority of 125 Loans that were held by the Long-Term Investment
Operations were sold to IFC. Interest income on mortgage loans held-for-
investment includes the effect of amortization of net premiums paid in acquiring
the mortgage loans. As of December 31, 1999, net premiums on mortgage loans
held-for-investment was $2.0 million as compared to $482,000 as of December 31,
1998.
Interest income on finance receivables decreased 36% to $27.3 million during
1999 as compared to $42.4 million during 1998 as average finance receivables
decreased 35% to $317.5 million as compared to $491.8 million, respectively. The
decrease in interest income on finance receivables during 1999 was primarily the
result of monthly whole loan sales by IFC as compared to quarterly
securitizations during 1998 and a decrease in loan acquisitions during 1999 as
compared to 1998. IFC's loan accumulation and holding period shortened during
1999 as the Company sought to minimize interest rate and market risk exposure on
its mortgage loans held-for-sale and maintain strong liquidity levels through
monthly whole loan sales. In addition, IFC's loan acquisitions decreased to $1.7
billion during 1999 as compared to $2.2 billion during 1998. As such, average
outstanding finance receivables to affiliates (primarily IFC) decreased to
$232.7 million during 1999 as compared to $403.9 million during 1998, which
resulted in a decrease in interest income to $19.6 million as compared to $34.2
million, respectively. The weighted average yield on affiliated finance
receivables decreased to 8.41% during 1999 as compared to 8.46% during 1998 as
the average prime rate, which is the index the Company uses to determine
interest rates on finance receivables, was lower during 1999 as compared to
1998. Interest income on finance receivables to non-affiliates decreased 5% to
$7.8 million during 1999 as compared to $8.2 million during 1998 as average
outstanding finance receivables to non-affiliates decreased to $84.8 million as
compared to $87.9 million, respectively. Interest income on finance receivables
to non-affiliates also decreased as the weighted average yield decreased to
9.18% during 1999 as compared to 9.38% during 1998 as the average prime rate was
lower in 1999 as compared to 1998.
Interest income on investment securities available-for-sale increased 13% to
$13.4 million during 1999 as compared to $11.9 million during 1998 as average
investment securities increased 1% to $94.5 million as compared to $93.9
million, respectively. Interest income on investment securities primarily
increased during 1999 as the weighted average yield on investment securities
increased to 14.21% during 1999 as compared to 12.70% during 1998. The yield on
investment securities increased during 1999 as compared to 1998 as the Long-Term
Investment Operations acquired $18.3 million of securities from IFC that had a
higher weighted average yield than the weighted average yield of the total
investment securities portfolio and also due to a change in yield estimates on
the remaining securities portfolio.
41
Interest expense on borrowings: Interest expense on CMO borrowings decreased
15% to $65.2 million during 1999 as compared to $76.3 million during 1998 as
average borrowings on CMO collateral decreased 17% to $1.0 billion as compared
to $1.2 billion, respectively. Average CMO borrowings decreased as the Long-Term
Investment Operations issued CMOs totaling $298.1 million during 1999 as
compared to CMOs totaling $768.0 million during 1998. The increase in loan
prepayments also contributed to the overall decrease in average CMO borrowings
during 1999 as compared to 1998. The weighted average yield of CMO borrowings
decreased to 6.41% during 1999 as compared to 6.61% during 1998 as average one-
month LIBOR, which is the index used to determine rates on adjustable rate CMO
borrowings, was lower during 1999 as compared to 1998. In addition, interest
expense on CMO borrowings is affected by the amortization of securitization
costs. Securitization costs are incurred when a CMO is issued and securitization
costs are capitalized and amortized over the life of the CMO borrowings as an
adjustment to the yield. During 1999, the Company amortized securitization costs
of $4.2 million as compared to $2.6 million during 1998 due to an increase in
loan prepayments during 1999 as compared to 1998. As of December 31, 1999,
unamortized securitization costs were $11.9 million as compared to unamortized
securitization costs of $12.3 million at December 31, 1998.
Interest expense on reverse repurchase borrowings, which are used to fund the
acquisition of mortgage loans and finance receivables, decreased 47% to $21.5
million during 1999 as compared to $40.4 million during 1998 as average reverse
repurchase agreements decreased 45% to $331.2 million as compared to $605.5
million, respectively. The decrease in average finance receivables was primarily
related to the previously discussed decrease in average finance receivables to
IFC. The Warehouse Lending Operations uses reverse repurchase agreements with
investment banks to fund its short-term loans to affiliates (primarily IFC) and
non-affiliates. As IFC shortened the accumulation and holding period on its
mortgage loans held-for-sale and acquired fewer loans during 1999 as compared to
1998, IFC required lower borrowing levels during 1999. The weighted average
yield of reverse repurchase agreements collateralized by mortgage loans
decreased to 6.51% during 1999 as compared to 6.68% during 1998 as average one-
month LIBOR, which is the index used by the Company's lenders to determine
interest rates on reverse repurchase borrowings, decreased during 1999 as
compared to 1998.
During most of 1999, the Company used investment securities available-for-sale
as collateral to borrow under reverse repurchase agreements to fund the purchase
of mortgage-backed securities and to act as an additional source of liquidity
for the Company's operations. During October 1999, the Company issued notes
collateralized by its investment securities available-for-sale to provide a more
stable financing source for these assets. Therefore, combined interest expense
on reverse repurchase agreements and borrowings secured by investment securities
available-for-sale remained unchanged at $1.7 million during 1999 and 1998. The
combined average balance on reverse repurchase agreements and borrowings secured
by investment securities available-for-sale decreased 16% to $21.8 million as
compared to $26.1 million, respectively. The weighted average yield on these
combined borrowings increased to 7.72% during 1999 as compared to 6.53% during
1998.
Non-Interest Income
Non-interest income increased to $6.9 million during 1999 as compared to
$(13.5) million during 1998. Non-interest income increased primarily due to an
increase in equity in net earnings (loss) of IFC. Equity in net earnings (loss)
of IFC improved during 1999 as compared to 1998 due to increased profitability
from the sale of mortgage loans. In addition, IFC recorded non-cash write-downs
on MSRs and investment securities held-for-sale during the fourth quarter of
1998. As discussed previously, loss on loan sales and asset write-downs were due
to a deterioration of the mortgage-backed securitization market, which occurred
during the latter part of 1998. As the mortgage market stabilized during 1999,
IFC returned to overall profitability, which in large part was due to
profitability on loan sales.
Equity in Net Earnings (Loss) of IFC
Equity in net earnings (loss) of IFC increased to $4.3 million during 1999 as
compared to $(13.9) million during 1998. The Company records 99% of the earnings
or losses from IFC, as the Company owns 100% of IFC's preferred stock, which
represents 99% of the economic interest in IFC. For more information on the
results of operations of IFC, refer to "--Results of Operations--Impac Funding
Corporation."
42
Equity in Net Loss of ICH
The Company's equity in net loss of ICH decreased to zero for 1999 as compared
to a loss of $(998,000) for 1998. The Company recorded no earnings or loss from
ICH during 1999 as the Company sold its holdings of ICH Common Stock during the
fourth quarter of 1998. Prior to the fourth quarter of 1998, the Company
recorded equity in net earnings (loss) in ICH by virtue of the Company's
ownership of 9.8% of ICH's voting Common Stock and 100% of Class A non-voting
Common Stock.
Non-Interest Expense
Non-interest expense decreased to $8.7 million during 1999 as compared to
$30.0 million during 1998. Non-interest expense decreased primarily due to a
decrease in write-down of investment securities available-for-sale, loss on
equity investment and general and administrative and other expense.
Write-down of Investment Securities Available-for-Sale
Write-down of investment securities available-for-sale decreased to $2.0
million during 1999 as compared to $14.1 million during 1998 as the mortgage
market recovered from the problems that occurred during the latter half of 1998.
Loss on Equity Investment
Loss on equity investment decreased to zero during 1999 as compared to $9.1
million during 1998 as the Company sold 100% of its Common Stock investment in
ICH at a loss during the fourth quarter of 1998.
General and Administrative and Other Expense
General and administrative and other expense decreased to $1.3 million during
1999 as compared to $2.3 million during 1998 as the Company sold its remaining
50% ownership interest in a commercial office building, where the Company
maintains its current headquarters, to ICH during the fourth quarter of 1998.
Expenses related to the 50% ownership interest in the property decreased to none
during 1999 as compared to $622,000 during 1998.
Credit Exposures
Non-performing Assets. Non-performing assets consist of loans that are 90 days
or more delinquent ("non-accrual loans"), including loans in foreclosure and
delinquent bankruptcies, and real estate acquired in settlement of loans, or
other real estate owned. It is the Company's policy to place a mortgage loan on
non-accrual status when a loan becomes 90 days delinquent. Any previously
accrued interest will be reversed from income. Non-accrual loans are included in
mortgage loans held-for-sale at IFC and mortgage loans held-for-investment and
CMO collateral at IMH. The outstanding unpaid principal balance of non-
performing assets totaled $63.3 million at December 31, 1999 as compared to
$80.7 million at December 31, 1998. The decrease in non-performing assets was
primarily due to the sale of delinquent mortgage loans held-for-sale at IFC. Of
the total non-performing assets at December 31, 1999 and 1998, other real estate
owned represented $9.7 million and $9.2 million, respectively, in unpaid
principal balance. The carrying amount of other real estate owned, after writing
down the mortgage loan to the broker's price opinion or appraised value, was
$8.8 million and $8.5 million at December 31, 1999 and 1998, respectively. The
Company recorded losses on the disposition of other real estate owned of $2.2
million and $1.7 million during 1999 and 1998, respectively.
The Company monitors its sub-servicers to make sure that they perform loss
mitigation, foreclosure and collection functions according to the Company's
written policies. This includes an effective and aggressive collection effort in
order to minimize mortgage loans from becoming non-performing assets. However,
when resolving non-performing assets, the Company's sub-servicers are required
to take timely and aggressive action. The sub-servicer is required to determine
collectibility under various circumstances, which will result in maximum
financial benefit to the Company. This is accomplished by either working with
the borrower to bring the loan current or by foreclosing and liquidating the
43
property. The Company performs ongoing reviews of loans that display weaknesses
and believes it maintains adequate loss allowances on the mortgage loans.
The following table summarizes the unpaid principal balance of the Company's
non-performing assets included in its mortgage loan portfolios for the periods
shown (in thousands):
At December 31,
-----------------------------------
1999 1998
-------------- --------------
Mortgage Loans Held-for-Sale:
Non-accrual..................................................... $ 2,572 $ 15,328
Other real estate owned......................................... -- --
-------------- --------------
Total mortgage loans held-for-sale............................. 2,572 15,328
-------------- --------------
Mortgage Loans Held-for-Investment:
Non-accrual..................................................... 8,229 6,870
In process foreclosures......................................... 306 1,437
-------------- --------------
Total mortgage loans held-for-investment....................... 8,535 8,307
-------------- --------------
CMO collateral:
Non-accrual..................................................... 42,792 49,305
Other real estate owned......................................... 9,411 7,739
-------------- --------------
Total CMO collateral........................................... 52,203 57,044
-------------- --------------
Total mortgage loan portfolios............................... $ 63,310 $ 80,679
============== ==============
Delinquent Loans. When a borrower fails to make required payments on a loan
and does not cure the delinquency within 60 days, the Company generally records
a notice of default and commences foreclosure proceedings. If the loan is not
reinstated within the time permitted by law for reinstatement, the property may
then be sold at a foreclosure sale. In foreclosure sales, the Company generally
acquires title to the property. At December 31, 1999, loans that were delinquent
30 days or more, as a percentage of the outstanding servicing balance of the
mortgage loan portfolios, was 10.98% as compared to 12.80% at December 31, 1998.
The following table summarizes the unpaid principal balance of the Company's
delinquent mortgage loans included in its mortgage loan portfolios for the
periods shown (in thousands):
At December 31,
-----------------------------------
1999 1998
-------------- --------------
Mortgage Loans Held-for-Sale:
30-59 days delinquent........................................... $ 9,140 $ 6,976
60-89 days delinquent........................................... 1,838 1,448
90 or more days delinquent (1).................................. 2,572 15,328
-------------- --------------
Total mortgage loans held-for-sale............................. 13,550 23,752
-------------- --------------
Mortgage Loans Held-for-Investment:
30-59 days delinquent........................................... 7,029 2,384
60-89 days delinquent........................................... 1,453 271
90 or more days delinquent (1).................................. 8,229 6,870
-------------- --------------
Total mortgage loans held-for-investment....................... 16,711 9,525
-------------- --------------
CMO collateral:
30-59 days delinquent........................................... 50,822 63,953
60-89 days delinquent........................................... 12,398 18,695
90 or more days delinquent (1).................................. 42,792 49,305
-------------- --------------
Total CMO collateral........................................... 106,012 131,953
-------------- --------------
Total mortgage loan portfolios............................... $ 136,273 $ 165,230
============== ==============
______________
(1) Includes loans in foreclosure and delinquent bankruptcies.
Provision for Loan Losses. The Company's total allowance for loan losses
expressed as a percentage of Gross Loan Receivables which includes loans held-
for-investment, CMO collateral and finance receivables, decreased to
44
0.27% at December 31, 1999 as compared to 0.47% at December 31, 1998. The
Company recorded net loan loss provisions of $5.5 million during 1999 as
compared to $4.4 million during 1998. The amount provided for loan losses during
1999 increased primarily due to an increase in foreclosures and the subsequent
disposition of other real estate owned. The allowance for loan losses is
determined primarily on the basis of management's judgment of net loss potential
including specific allowances for known impaired loans, changes in the nature
and volume of the portfolio, value of the collateral and current economic
conditions that may affect the borrowers' ability to pay.
Year Ended December 31, 1998 as compared to Year Ended December 31, 1997
Net Earnings (Loss)
The Company recorded a net loss of $(5.9) million, or $(0.25) per basic and
diluted common share, during the year ended December 31, 1998 as compared to a
net loss of $(16.0) million, or $(0.99) per basic and diluted common share, for
the year ended December 31, 1997. The Company's net loss for 1998 was primarily
the result of a tax adjusted loss of $7.3 million on the sale of mortgage loans
held-for-sale at IFC and a tax adjusted non-cash charge of $2.9 million on the
write-down of IFC's MSRs and investment securities available-for-sale. In
addition, the Company's 1998 earnings were negatively affected by a $9.1 million
loss on the sale of its equity investment in ICH, which reflects the price the
Company received on the sale of its ICH common stock on October 19, 1998, an
impairment charge of $14.1 million on investment securities available-for-sale,
a loss on sale of mortgage loans of $3.1 million, and a loss on disposition of
real estate owned of $1.7 million. Excluding the consolidated tax adjusted
losses on mortgage loan sales of $10.4 million, consolidated tax adjusted non-
cash charges of $17.0 million, and the loss on sale of equity investment in ICH
of $9.1 million, the Company's earnings for the year ended December 31, 1998
would have been $30.6 million, or $1.28 per basic and diluted common share, as
compared to earnings of $28.3 million, or $1.74 per basic and diluted common
share, for the same period of 1997, after excluding a non-cash charge of $44.4
million for the Company's buyout of its management agreement. Earnings per share
for 1998, including the adjustments described above, were lower as compared to
earnings per share for 1997 due to an increase in the number of common shares
outstanding during 1998.
The loss on the sale of mortgage loans and the write-down of mortgage assets
by the Company and IFC was precipitated by the deterioration of the mortgage-
backed securitization market during the third and fourth quarters of 1998. The
deterioration of the mortgage-backed securitization market in 1998 created
liquidity problems for the Company as the Company's lenders made margin calls on
their reverse repurchase facilities. These margin calls resulted in the Company
delaying its third quarter dividend, which was paid on January 6, 1999, and
selling mortgage loans and mortgage-backed securities at losses in order to
reduce outstanding borrowings on these facilities. Although a loss was recorded
for 1998, the Company was successful in improving liquidity and protecting
stockholder value by selling out of its mortgage loan positions rather than
continuing to expose the Company to further market risk while accumulating these
loans for securitization.
Net Interest Income
Net interest income increased 27% to $42.0 million during 1998 as compared to
$33.0 million during 1997. Interest income is primarily interest earned on
Mortgage Assets and includes interest income earned on cash and cash equivalents
and due from affiliates. Interest expense is primarily interest paid on
borrowings on Mortgage Assets and includes interest expense paid on due to
affiliates. Mortgage Assets include CMO collateral, mortgage loans held-for-
investment, finance receivables and investment securities available-for-sale.
Borrowings on Mortgage Assets include CMO borrowings and reverse repurchase
agreements. The increase in net interest income during 1998 as compared to 1997
was primarily the result of higher average Mortgage Assets, which increased 54%
to $2.0 billion during 1998 as compared to $1.3 billion during 1997. The net
interest spread on Mortgage Assets decreased to 1.49% during 1998 as compared to
1.89% during 1997. The decrease in net interest spread on Mortgage Assets was
primarily the result of a decrease in the net interest spread on CMO collateral,
which represents the largest portion of Mortgage Assets on a weighted-average
basis. The net interest spread on CMO collateral was 0.78% during 1998 as
compared to 1.40% during 1997. The decrease in net interest spread on CMO
collateral during 1998 was primarily due to higher rates of mortgage loan
prepayments and correspondingly higher rates of premium amortization expense as
compared to 1997.
45
The following table summarizes average balance, interest and weighted-average
yield on Mortgage Assets and borrowings for the years ended December 31, 1998
and 1997 and includes interest income on Mortgage Assets and interest expense
related to borrowings on Mortgage Assets only (dollars in thousands):
For the year ended December 31, 1998 For the year ended December 31, 1997
-------------------------------------------------- -------------------------------------------------
Weighted Weighted
Average Avg. % of Average Avg. % of
Balance Interest Yield Portfolio Balance Interest Yield Portfolio
--------- ------------- -------- ------------ ----------- ------------ ------- -------------
MORTGAGE ASSETS
- ---------------
Subordinated securities
collateralized by mortgages $ 88,544 $ 11,219 12.67% 4.47 $ 58,956 $ 7,519 12.75% 4.51
Subordinated securities
collateralized by other loans 5,364 709 13.22 0.27 5,980 1,028 17.19 0.46
----------- --------- ----------- ---------
Total investment securities
available-for-sale 93,908 11,928 12.70 4.74 64,936 8,547 13.16 4.97
----------- --------- ----------- ---------
Loan receivables:
CMO collateral 1,244,458 92,011 7.39 62.87 626,831 47,967 7.65 47.93
Mortgage loans
held-for-investment 149,131 14,373 9.64 7.54 182,215 14,535 7.98 13.93
Finance receivables:
Affiliated 403,935 34,166 8.46 20.41 403,931 34,299 8.49 30.88
Non-affiliated 87,855 8,242 9.38 4.44 29,963 2,991 9.98 2.29
----------- --------- ----------- ---------
Total finance receivables 491,790 42,408 8.62 24.85 433,894 37,290 8.59 33.17
----------- --------- ----------- ---------
Total Loan Receivables 1,885,379 148,792 7.89 95.26 1,242,940 99,792 8.03 95.03
----------- --------- ----------- ---------
Total Mortgage Assets $ 1,979,287 $ 160,720 8.12% 100.0 $ 1,307,876 $ 108,339 8.28% 100.00
=========== ========= =========== =========
BORROWINGS
- ----------
CMO borrowings $ 1,153,985 $ 76,309 6.61% 64.63 $ 586,463 $ 36,665 6.25% 49.06
Reverse repurchase
agreements-mortgages 605,486 40,439 6.68 33.91 580,908 37,881 6.52 48.59
Reverse repurchase
agreements-securities 26,051 1,700 6.53 1.46 28,109 1,836 6.53 2.35
----------- --------- ----------- ---------
Total Borrowings on
Mortgage Assets $ 1,785,522 $ 118,448 6.63% 100.00 $ 1,195,480 $ 76,382 6.39% 100.00
=========== ========= ============ =========
Net Interest Spread 1.49% 1.89%
Net Interest Margin 2.14% 2.44%
Interest income on Mortgage Assets: Interest income on CMO collateral
increased 92% to $92.0 million during 1998 as compared to $48.0 million during
1997 as average CMO collateral increased 91% to $1.2 billion as compared to
$626.8 million, respectively. Average CMO collateral increased as the Long-Term
Investment Operations issued CMOs totaling $768.0 million during 1998, which
were collateralized by $788.2 million of mortgages held by the Long-Term
Investment Operations. The weighted average yield on CMO collateral decreased to
7.39% during 1998 as compared to 7.65% during 1997. The decrease in the yield on
CMO collateral during 1998 was primarily due to higher rates of mortgage loan
prepayments and correspondingly higher rates of premium amortization expense as
compared to 1997. Interest income on CMO collateral includes the effect of
amortization of net premiums paid in acquiring the mortgage loans. As of
December 31, 1998, net premiums on CMO collateral was $39.4 million.
Interest income on mortgage loans held-for-investment decreased 1% to $14.4
million during 1998 as compared to $14.5 million during 1997 as average mortgage
loans held-for-investment decreased 18% to $149.1 million as compared to $182.2
million, respectively. The weighted average yield on mortgage loans held-for-
investment increased to 9.64% during 1998 as compared to 7.98% during 1997. The
increase in the yield on mortgage loans held-for-investment during 1998 was
primarily due to higher average balance of 125 Loans outstanding and held in
portfolio during 1998 as compared to 1997. Most of the 125 Loans that were held
by the Long-Term Investment Operations were sold to IFC in December 1998.
Interest income on mortgage loans held-for-investment includes the effect of
46
amortization of net premiums paid in acquiring the mortgage loans. As of
December 31, 1998, net premiums on mortgage loans held-for-investment was
$482,000.
Interest income on finance receivables increased 14% to $42.4 million during
1998 as compared to $37.3 million during 1997 as average finance receivables
increased 13% to $491.8 million as compared to $433.9 million, respectively. The
increase in interest income on finance receivables was primarily the result of
an increase of 193% in average finance receivables to non-affiliated mortgage
banking companies to $87.9 million during 1998 as compared to $30.0 million
during 1997. Interest income on finance receivables to non-affiliates increased
173% to $8.2 million during 1998 as compared to $3.0 million during 1997. The
weighted average yield on non-affiliated finance receivables decreased to 9.38%
during 1998 as compared to 9.98% during 1997. Average finance receivables
outstanding to affiliates was constant at $403.9 million during 1998 and 1997.
Interest income on finance receivables to affiliates decreased to $34.2 million
during 1998 as compared to $34.3 million during 1997. The weighted average yield
on affiliated finance receivables decreased to 8.46% during 1998 as compared to
8.49% during 1997. The overall weighted average yield on finance receivables
increased to 8.62% during 1998 as compared to 8.59% during 1997.
Interest income on investment securities available-for-sale increased 40% to
$11.9 million during 1998 as compared to $8.5 million during 1997 as average
investment securities available-for-sale increased 45% to $93.9 million as
compared to $64.9 million, respectively. The increase in average securities
available-for-sale during 1998 was the result of the Long-Term Investment
Operations purchasing and retaining mortgage-backed securities of $60.6 million
that were issued by IFC as REMICs. The weighted average yield on investment
securities available-for-sale decreased to 12.70% during 1998 as compared to
13.16% during 1997 due to the purchase of lower-yielding securities during 1998.
Interest expense on borrowings: Interest expense on CMO borrowings increased
108% to $76.3 million during 1998 as compared to $36.7 million during 1997 as
average borrowings on CMO collateral increased 105% to $1.2 billion as compared
to $586.5 million, respectively. Average CMO borrowings increased as the Long-
Term Investment Operations issued CMOs totaling $768.0 million during 1998. The
weighted average yield of CMO borrowings increased to 6.61% during 1998 as
compared to 6.25% during 1997. This increase was the result of the Company
issuing fixed-rate CMOs totaling $583.0 million during 1998 at higher interest
rates than the initial interest rates on variable-rate CMOs the Company issued
prior to 1998. Although borrowing rates on the fixed-rate CMOs are generally
higher than the initial interest rates on variable-rate CMOs, the Company
receives a comparable interest rate spread on fixed-rate CMOs as it does on its
variable-rate CMOs.
Interest expense on reverse repurchase borrowings used to fund the acquisition
of mortgage loans and finance receivables increased 7% to $40.4 million during
1998 as compared to $37.9 million during 1997 as the average balance of reverse
repurchase agreements increased 4% to $605.5 million during 1998 as compared to
$580.9 million during 1997. The increase in average finance receivables was
primarily related to an increase in finance receivables made to non-affiliates
of the Company and to the longer time period IFC's mortgage loans were
outstanding on IWLG's warehouse facilities during 1998. As the market for
mortgage-backed securitizations and whole loan sales deteriorated during the
latter half of 1998 and made it more difficult for IFC to securitize or sell
mortgage loans, the average number of days that IFC warehoused its mortgage
loans with IWLG increased during 1998 as compared to 1997. The weighted average
yield of reverse repurchase agreements collateralized by mortgage loans
increased to 6.68% during 1998 as compared 6.52% during 1997.
The Company also uses mortgage-backed securities as collateral to borrow under
reverse repurchase agreements to fund the purchase of mortgage-backed securities
and to act as an additional source of liquidity for the Company's operations.
Interest expense on these reverse repurchase agreements decreased 6% to $1.7
million during 1998 as compared to $1.8 million during 1997 as the average
balance on these reverse repurchase agreements decreased 7% to $26.1 million as
compared to $28.1 million, respectively. The weighted average yield of reverse
repurchase agreements collateralized by mortgage-backed securities remained
constant at 6.53% during 1998 and 1997.
47
Non-Interest Income
Equity in Net Earnings (loss) of IFC
The Company's equity in net loss of IFC decreased to a loss of $(13.9) million
for 1998 as compared to earnings of $8.3 million for 1997. The decrease in
equity in net earnings (loss) of IFC during 1998 was primarily the result of net
losses on sale of mortgage loans and non-cash charges for the write-down of MSRs
and investment securities available-for-sale. The net loss on sale of mortgage
loans and the non-cash charges were due to the deterioration of the mortgage-
backed securitization market, as previously discussed. The Company records 99%
of the earnings or losses from IFC as the Company owns 100% of IFC's preferred
stock, which represents 99% of the economic interest in IFC. For more
information on the results of operations of IFC, refer to "Results of
OperationsImpac Funding Corporation."
Equity in Net Loss of ICH
The Company's equity in net loss of ICH increased to a loss of $(998,000) for
1998 as compared to a loss of $(239,000) for 1997. The increase in equity in net
loss of ICH during 1998 was primarily the result of a deficit in equity in net
earnings (loss) of ICCC of $(19.2), which ICH records on its consolidated
financial statements, and an impairment charge of $1.7 million that ICH recorded
on its residual interest in securitization held-for-trading. ICH records 95% of
the earnings or losses from ICCC as ICH owns 100% of ICCC's preferred stock,
which represents 95% of the economic interest in ICCC. Prior to October 19,
1998, the Company recorded equity in net loss in ICH by virtue of the Company's
ownership of 9.8% of ICH's voting Common Stock and 100% of Class A non-voting
Common Stock. On October 19, 1998, ICH repurchased from IMH 937,084 shares of
ICH Common Stock and 456,916 shares of ICH Class A Common Stock, which
represented all ICH Common Stock that IMH owned, and eliminating any recognition
of earnings or losses from ICH. For more information on the results of
operations of ICH, refer to Impac Commercial Holdings, Inc.'s Annual Report on
Form 10-K filed with the Securities and Exchange Commission on February 26,
1999.
Non-Interest Expense
General and Administrative and Other Expense
General and administrative and other expense increased to $2.3 million during
1998 as compared to $836,000 during 1997. The increase in general and
administrative and other expense was primarily related to property expense on a
commercial office building in which the Company had a 50% ownership interest,
which was sold to ICH in October 1998. Property expense increased to $623,000
during 1998 as compared to $109,000 during 1997.
Professional Services
Professional services increased to $2.2 million during 1998 as compared to
$1.1 million during 1997. Professional services primarily includes intercompany
allocations of MIS, accounting and executive management services from IFC which
increased to $968,000 during 1998 as compared to $385,000 during 1997.
Professional services also includes outside legal, accounting and tax work
performed for the Company.
Advisory Fees
Earnings were positively affected by a reduction in advisory fees resulting
from the Company's buyout of its management agreement with ICAI in December
1997. As a result of the buyout, there were no advisory fees paid by IMH during
1998 as compared to $6.2 million in advisory fees paid by IMH during 1997.
Provision for Loan Losses
The Company recorded loan loss provisions of $4.4 million during 1998 as
compared to $6.8 million during 1997. The amount provided for loan losses during
1998 decreased primarily due to a reduction in exposure to future losses through
the sale of delinquent loans and the transfer of certain loans from the held-
for-investment to the held-for-sale portfolio (as explained below).
48
Credit Exposures
Non-performing Assets. The outstanding unpaid principal balance of non-
performing assets totaled $80.7 million at December 31, 1998 as compared to
$50.1 million at December 31, 1997. The increase in non-performing assets was
primarily due to delinquent mortgage loans with high loan-to-value ratios, which
were purchased in 1997, and the seasoning of mortgage loans held for long-term
investment. Of the total non-performing assets at December 31, 1998 and 1997,
other real estate owned represented $9.2 million and $5.7 million, respectively,
in unpaid principal balance. The carrying amount of other real estate owned,
after writing down the mortgage loan to the broker's price opinion or appraised
value, was $8.5 million and $5.7 million at December 31, 1998 and 1997,
respectively. The Company recorded losses on the disposition of other real
estate owned of $1.7 million during 1998 as compared to gains on disposition of
other real estate owned of $433,000 during 1997.
The following table summarizes the unpaid principal balance of the Company's
non-performing assets included in its mortgage loan portfolios for the periods
shown (in thousands):
At December 31,
----------------------------------
1998 1997
-------------- ---------------
Mortgage Loans Held-for-Sale:
Non-accrual.......................................................................... $ 15,328 $ 5,740
Other real estate owned.............................................................. -- --
Total mortgage loans held-for-sale.................................................. 15,328 5,740
-------------- ---------------
Mortgage Loans Held-for-Investment:
Non-accrual.......................................................................... 6,870 7,627
Other real estate owned.............................................................. 1,437 1,415
-------------- ---------------
Total mortgage loans held-for-investment............................................ 8,307 9,042
-------------- ---------------
CMO collateral:
Non-accrual.......................................................................... 49,305 31,056
Other real estate owned.............................................................. 7,739 4,247
-------------- ---------------
Total CMO collateral................................................................ 57,044 35,303
-------------- ---------------
Total mortgage loan portfolios.................................................... $ 80,679 $ 50,085
============== ===============
Delinquencies. At December 31, 1998, loans that were delinquent 30 days or
more, as a percentage of the outstanding servicing balance of the mortgage loan
portfolios, was 10.98% as compared to 9.81% at December 31, 1997. The following
table summarizes the unpaid principal balance of the Company's delinquent
mortgage loans included in its mortgage loan portfolios for the periods shown
(in thousands):
At December 31,
----------------------------------
1998 1997
---------------- --------------
Mortgage Loans Held-for-Sale:
30-59 days delinquent................................................................ $ 6,976 $ 21,309
60-89 days delinquent.............................................................. 1,448 3,395
90 or more days delinquent (1)....................................................... 15,328 5,740
-------------- --------------
Total mortgage loans held-for-sale.................................................. 23,752 30,444
-------------- --------------
Mortgage Loans Held-for-Investment:
30-59 days delinquent................................................................ 2,384 2,999
60-89 days delinquent................................................................ 271 3,375
90 or more days delinquent (1)....................................................... 6,870 7,627
-------------- --------------
Total mortgage loans held-for-investment............................................ 9,525 14,001
-------------- --------------
CMO collateral:
30-59 days delinquent................................................................ 63,953 59,223
60-89 days delinquent................................................................ 18,695 16,034
90 or more days delinquent (1)....................................................... 49,305 31,056
-------------- --------------
Total CMO collateral................................................................ 131,953 106,313
-------------- --------------
Total mortgage loan portfolios.................................................... $ 165,230 $ 150,758
============== ==============
- ------------
(1) Includes loans in foreclosure and delinquent bankruptcies.
49
Provision for Loan Losses. The Company's total allowance for loan losses
expressed as a percentage of Gross Loan Receivables which includes loans held-
for-investment, CMO collateral and finance receivables, increased to 0.47% at
December 31, 1998 as compared to 0.32% at December 31, 1997. The Company
recorded net loan loss provisions of $4.4 million during 1998 as compared to
$6.8 million during 1997. The amount provided for loan losses during 1998
decreased primarily due to a reduction in exposure to future losses through the
sale of delinquent loans and the transfer of certain loans from the held-for-
investment to the held-for-sale portfolio, which resulted in a mark-to-market
adjustment. The allowance for loan losses is determined primarily on the basis
of management's judgment of net loss potential including specific allowances for
known impaired loans, changes in the nature and volume of the portfolio, value
of the collateral and current economic conditions that may affect the borrowers'
ability to pay.
RESULTS OF OPERATIONS--
IMPAC FUNDING CORPORATION
Year Ended December 31, 1999 as compared to Year Ended December 31, 1998
Net Earnings (Loss)
IFC recorded net earnings of $4.3 million during 1999 as compared to a net
loss of $(14.0) million during 1998. Earnings increased during 1999 as compared
to 1998 primarily as the mortgage market stabilized and recovered from the
liquidity crisis, which occurred during the latter part of 1998. As the mortgage
market recovered during 1999, IFC returned to overall profitability, which in
large part was due to the profitability on the sale of its mortgage loans.
During 1998, IFC sold loans at significant losses to meet margin calls and raise
liquidity. In addition, IFC recorded non-cash write-down on MSRs and investment
securities available-for-sale.
Net Interest Income
Net interest income decreased to $272,000 during 1999 as compared to $7.8
million during 1998 as average mortgage loans held-for-sale decreased 50% to
$240.1 million as compared to $476.1 million, respectively. Average mortgage
loans held-for-sale decreased due to the shorter accumulation and holding period
of mortgage loans held-for-sale and a decrease in mortgage loan acquisitions.
During 1999, IFC primarily sold loans monthly on a whole loan basis as opposed
to quarterly securitizations, which occurred during 1998. Monthly whole loan
sales were completed during 1999 in order to reduce interest rate and market
risk exposures and to maintain strong liquidity levels. In addition, mortgage
loan acquisitions decreased 23% to $1.7 billion during 1999 as compared to
mortgage loan acquisitions of $2.2 billion during 1998. Mortgage loan
acquisitions decreased during 1999 as compared to 1998 due to the residual
effects of the deterioration of the mortgage-backed securitization market, which
occurred during the latter part of 1998. In response to the liquidity crisis,
IFC raised interest rates on its loan programs and decreased the amount of
premiums paid on its loan acquisitions, which caused some of IFC's correspondent
sellers to use other sources for the funding of their mortgage loans. During
1999, IFC continued to rebuild its mortgage loan acquisitions to previous levels
by offering its sellers competitive and flexible mortgage products. As such,
mortgage loan acquisitions increased 48% to $548.2 million during the fourth
quarter of 1999 as compared to $370.5 million during the fourth quarter of 1998.
Non-Interest Income
Non-interest income increased to $33.3 million during 1999 as compared to
$(5.7) million during 1998 as gain on sale of loans increased to $27.1 million
during 1999 as compared to $(11.7) million during 1998. In line with the
Company's overall strategy to reduce interest rate and market risk exposure and
to maintain strong liquidity levels, IFC sold mortgage loans on a whole loan
basis for cash during 1999, as opposed to sales through asset-backed
securitizations for non-cash gains, which occurred during 1998. During 1999, IFC
sold mortgages totaling $824.1 million, on a servicing released basis, to third
party investors as compared to loan sales of $856.2 million during 1998. The
sale of loans on a servicing released basis during 1999 reduced IFC's exposure
to further prepayment risk. IFC also securitized $360.1 million in REMICs during
1999 as compared to $907.5 million in REMICs during 1998. The increase in gain
on sale of loans was partially offset by a decrease in loan servicing income
during 1999 as compared to 1998. Loan servicing income decreased to $5.2 million
during 1999 as compared to $7.1 million during 1998 as IFC sold MSRs and
completed loan sales on a servicing released basis. Total unpaid principal
balance of mortgage loans at the time MSRs were sold was $2.3 billion.
50
Non-Interest Expense
Non-interest expense increased 5% to $26.0 million during 1999 as compared to
$24.8 million during 1998. Non-interest expense during 1999 was positively
affected by decreases in personnel expense and impairment and amortization of
MSRs. Personnel expense decreased 18% to $7.3 million as compared to $8.9
million during 1998. Personnel expense decreased primarily due to a reduction in
staff which occurred during the fourth quarter of 1998 and carried into 1999.
During the fourth quarter of 1998, IFC reduced staff in anticipation of
decreased loan acquisitions due to the deterioration of the mortgage-backed
securitization market. The reduction in staff also contributed to increased
liquidity from operating activities. Impairment of MSRs decreased to $1.1
million during 1999 as compared to $3.7 million during 1998 as the mortgage
market recovered during 1999. Impairment of MSRs recorded in 1998 was primarily
due to the deterioration of the mortgage-backed securitization market.
Amortization of MSRs decreased to $5.3 million as compared to $6.4 million as
IFC sold MSRs and completed whole loan sales on a servicing released basis.
The decreases in personnel expense and impairment and amortization of MSRs
were offset by increases in write-down on securities available-for-sale and
general and administrative and other expense. Write-down on securities
available-for-sale increased to $4.3 million during 1999 as compared to zero
during 1998. The write-down on securities available-for-sale was due to the
complete write-off of an investment security deemed to have no value. The
increase in general and administrative and other expense during 1999 was
primarily due to costs associated with the operation of the wholesale and retail
origination division, which began operations in 1999, and costs associated with
the application of the Bank charter.
Year Ended December 31, 1998 as compared to Year Ended December 31, 1997
Net Earnings (Loss)
IFC recorded a net loss of $(14.0) million for the year ended December 31,
1998 as compared to net earnings of $8.4 million for the same period in 1997.
Earnings decreased for the year ended December 31, 1998 as compared to the same
period in 1997 primarily as a result of net losses on sale of mortgage loans and
non-cash charges for the write-down of MSRs and investment securities available-
for-sale. The net loss on sale of mortgage loans and non-cash charges was due to
the deterioration of the mortgage-backed securitization market, as previously
discussed. In addition, earnings for the year ended December 31, 1998 were
negatively affected by increases in personnel expense, amortization of MSRs and
general and administrative and other expense.
Net Interest Income
Net interest income increased 22% to $7.8 million during 1998 as compared to
$6.4 million during 1997. Although mortgage loan acquisitions decreased 15% to
$2.2 billion during 1998 as compared to $2.6 billion during 1997, IFC had higher
average mortgage loan balances outstanding as the mortgage-backed securitization
and whole loan sales market deteriorated during the latter half of 1998 and made
it more difficult for IFC to securitize or sell mortgage loans. Average mortgage
loans held-for-sale increased 5% to $476.1 million during 1998 as compared to
$455.3 million during 1997. The weighted average yield on mortgage loans held-
for-sale increased to 9.47% during 1998 as compared to 9.31% during 1997.
In addition, IFC's total net interest spread increased to 1.29% during 1998 as
compared to 1.10% during 1997. The increase in total net interest spread was
primarily due to a reduction of borrowings on residual interests in securities,
which occurred in December of 1997. These borrowings were paid off as part of
the Company's termination of its management agreement with ICAI. Total interest
expense on these borrowings was $3.7 million during 1997 with a yield of 11.81%.
Non-Interest Income
Non-interest income decreased to $(5.7) million during 1998 as compared to
$24.2 million during 1997. Non-interest income decreased primarily due to a
reduction of $31.1 million in gain on sale of loans, a mark-to-market loss
51
of $805,000 on investment securities available-for-sale, and a decrease of $1.3
million on gain on sale of investment securities.
During 1998, IFC securitized $907.5 million of mortgages and sold whole loans
to third party investors totaling $856.2 million, resulting in net loss on sale
of loans of $11.7 million, during 1998. This compares to securitizations of
$878.0 million and whole loan sales to third parties of $501.7 million,
resulting in net gain on sale of loans of $19.4 million, during 1997. The
increase in loan sales to third parties during 1998 as compared to 1997 was the
result of IFC selling mortgage loans to reduce its outstanding borrowings on its
reverse repurchase facilities in order to meet margin calls from its lenders.
The loss on loans sold during 1998 as compared to gain on loans sold during 1997
was the result of lower prices IFC received on its loans. The Company felt it
was important to protect shareholder value and increase liquidity by selling out
of its mortgage loan positions at losses rather than take additional interest
rate and market risk by retaining the loans for securitization.
Loan servicing income increased 73% to $7.1 million for 1998 as compared to
$4.1 million for 1997 due to the continued increase in IFC's servicing
portfolio. IFC continues to build its loan servicing portfolio as IFC generally
retains loan servicing rights on mortgage loans acquired. Total loans serviced
at December 31, 1998 were 33,414, or $3.7 billion in principal balance of
mortgages, as compared to 28,494, or $3.0 billion in principal balance of
mortgages, at December 31, 1997.
Non-Interest Expense
Non-interest expense increased to $24.8 million during 1998 as compared to
$16.0 million during 1997. The increase in expense was primarily the result of
increases in personnel expense of $2.1 million, amortization of MSRs of $3.5
million and a non-cash impairment charge on MSRs of $3.7 million.
Personnel expense increased 31% to $8.9 million during 1998 as compared to
$6.8 million during 1997 primarily due to an increase in staff and incentive
compensation during the first nine months of 1998 as IFC's production volumes
increased. However, in October of 1998 IFC reduced staff by approximately 25% as
production volumes decreased during the fourth quarter of 1998 due to interest
rate and purchase price adjustments IFC made on its loan programs.
Amortization of MSRs increased to $6.4 million during 1998 as compared to $2.8
million during 1997 due to continued growth of IFC's servicing portfolio. Since
December 31, 1997, the Company has securitized $907.5 million in principal
balance of mortgage loans and, accordingly, has capitalized MSRs related to
those securitizations which are amortized in proportion to, and over the period
of expected net servicing income. In addition, during 1998 IFC recorded an
impairment charge of $3.7 million on its MSRs as a result of a decrease in their
value.
Liquidity and Capital Resources
Overview
Historically, the Company's business operations are primarily funded from
monthly interest and principal payments from its mortgage loan and investment
securities portfolios, adjustable- and fixed-rate CMO financing, reverse
repurchase agreements secured by mortgage loans, borrowings secured by mortgage-
backed securities, proceeds from the sale of mortgage loans and the issuance of
REMICs and proceeds from the issuance of Common Stock through secondary stock
offerings, DRSPP, and its structured equity shelf program ("SES Program"). The
acquisition of mortgage loans and mortgage-backed securities by the Long-Term
Investment Operations are primarily funded from monthly principal and interest
payments, reverse repurchase agreements, CMO financing, and proceeds from the
sale of Common Stock. The acquisition of mortgage loans by the Conduit
Operations are funded from reverse repurchase agreements, the sale of mortgage
loans and mortgage-backed securities and the issuance of REMICs. Short-term
warehouse financing, finance receivables, provided by the Warehouse Lending
Operations are primarily funded from reverse repurchase agreements. During 1999,
the Company issued no new shares of Common Stock through stock offerings or
through its SES Program and issued only minimal shares of Common Stock through
its DRSPP. In addition, during 1999 the Company suspended the issuance of any
new shares of Common Stock under the DRSPP.
52
The Company's ability to meet its long-term liquidity requirements is subject
to the renewal of its credit and repurchase facilities and/or obtaining other
sources of financing, including additional debt or equity from time to time.
Any decision by the Company's lenders and/or investors to make additional funds
available to the Company in the future will depend upon a number of factors,
such as the Company's compliance with the terms of its existing credit
arrangements, the Company's financial performance, industry and market trends in
the Company's various businesses, the general availability of and rates
applicable to financing and investments, such lenders' and/or investors' own
resources and policies concerning loans and investments, and the relative
attractiveness of alternative investment or lending opportunities.
Results of Liquidity during 1999
The deterioration of the mortgage-backed securitization market during the
latter half of 1998 created a lack of liquidity for the Company as the Company's
lenders made margin calls on their reverse repurchase agreements. Margin calls
result from the Company's lenders evaluating the market value of underlying
collateral securing the reverse repurchase agreements and requiring additional
equity or collateral on the reverse repurchase agreements. These margin calls
resulted in the Company delaying its third quarter dividend, which was paid on
January 6, 1999, and selling mortgage loans and mortgage-backed securities,
during the fourth quarter of 1998, at significant losses. During the fourth
quarter of 1998, the Company completed the sale of $250.4 million of mortgage
loans and $8.9 million of mortgage-backed securities, which increased the
Company's liquidity by $13.6 million, at the time of sale, after paying down
related reverse repurchase agreements. By selling mortgage loans and paying down
outstanding borrowings on reverse repurchase facilities, the Company reduced its
exposure to future margin calls.
However, the market disruptions during 1998 caused several public companies to
file for protection from their creditors under the U.S. Bankruptcy Code. This
had the effect of causing reduced investor confidence with certain sectors of
the financial services industry, particularly REITs, which in turn caused stock
prices to fall sharply. As a result of this decline in stock prices, the Company
suspended any purchases of its Common Stock through its DRSPP and was unable to
access the capital markets and raise additional cash. In response to these
market conditions and availability of capital, the Company increased the pricing
of its loans and limited the amount of premiums paid in acquiring mortgage
loans. In anticipation of reduced production from increased loan rates and
decreased loan pricing, the Company reduced staffing levels, thereby increasing
liquidity from operating activities.
As the mortgage market stabilized during 1999, the Company restructured its
balance sheet and generated cash internally to meet its funding needs. IFC
completed monthly whole loan sales on a servicing released basis, which provided
liquidity throughout 1999 to acquire mortgage loans and fund operations. The
Company also completed a re-securitization of a portion of its investment
securities available-for-sale in October 1999, which raised additional cash of
approximately $23.4 million after repaying short-term borrowings secured by the
investment securities. The cash proceeds were used to acquire mortgages from
IFC, increase outstanding lending by the Warehouse Lending Operations,
repurchase Common Stock and other business expansion. The Company successfully
repurchased 2.0 million shares of Common Stock for $9.9 million with the cash
generated by the re-securitization and reduced its reliance on reverse
repurchase agreements. Reverse repurchase agreements to finance its investment
securities decreased to zero at December 31, 1999 as compared to $24.1 million
at December 31, 1998. The Company continued to maintain reduced leverage and
strong liquidity levels during 1999. The Company's debt-to-equity ratio
increased slightly to 6.0:1 at December 31, 1999 as compared to 5.6:1 at
December 31, 1998, which was well within the Company's target range. This
compares to a debt-to-equity ratio of 7.9:1 at September 30, 1998, which was
prior to the deterioration of the mortgage-backed securitization market during
the fourth quarter of 1998. During 1999, the Company experienced no margin calls
on its reverse repurchase facilities.
The Company believes that current liquidity levels, available financing
facilities and additional liquidity provided by operating activities, as
projected for 2000, will adequately provide for the Company's projected funding
needs, asset growth and the payment of dividends. As such, the Board of
Directors has announced a dividend policy for 2000 that allows the Company to
expand its business operations and focus on rebuilding the Company's balance
sheet without the diluted effect of offering additional shares of Common Stock
at current market levels. During 2000, the Company plans to distribute 100% of
taxable earnings. However, any future margin calls and, depending upon the state
of the mortgage industry, terms of any sale of Mortgage Assets may adversely
affect the Company's ability to pay dividends in future periods or subject the
Company to future losses.
53
Definitive Agreement to Acquire Thrift and Loan Charter. During the first
quarter of 1999, the Company completed a definitive agreement to acquire a Bank.
As provided for in the agreement, the Company submitted its application in the
second quarter of 1999 for a change of control to the state and federal
regulatory agencies for their approval. During the process of reviewing the
application, the federal agency raised certain issues. The Company was not able
to give the federal agency sufficient comfort with respect to those issues
without modifying its proposal. The Company submitted a new application to state
and federal regulatory agencies in the first quarter of 2000. The new
application was modified from the previous application in several key areas and
to more clearly define the Bank as a stand-alone operation that is not reliant
upon the Company for its success. It is anticipated that the Bank will market
its own unique loan products, which will include mortgages, consumer equity
loans and loans on small commercial and multi-family properties. However, there
are no assurances that the new application for change of control will be
received favorably by either of the state or federal regulatory agencies. In the
event that the Company is unsuccessful in its efforts to obtain the Bank
charter, management believes that it will have no adverse impact on the future
profitability of the Company.
Sources of Liquidity
Long-Term Investment Operations: The Long-Term Investment Operations uses CMO
borrowings to finance substantially all of its mortgage loan portfolio. Terms of
the CMO borrowings require that an independent third party custodian hold the
mortgages. The maturity of each class is directly affected by the rate of
principal prepayments on the related collateral. Equity in the CMOs is
established at the time the CMOs are issued at levels sufficient to achieve
desired credit ratings on the securities from rating agencies. The amount of
equity invested in CMOs by the Long-Term Investment Operations is also
determined by the Company based upon the anticipated return on equity as
compared to the estimated proceeds from additional debt issuance. Total credit
loss exposure is limited to the equity invested in the CMOs at any point in
time. At December 31, 1999, the Long-Term Investment Operations had $850.8
million of CMO borrowings used to finance $949.7 million of CMO collateral.
Prior to October 1999, the Long-Term Investment Operations pledged mortgage-
backed securities as collateral to borrow funds under reverse repurchase
agreements. The terms under these reverse repurchase agreements were generally
for 30 days with interest rates ranging from one-month LIBOR plus 0.45% to 2.00%
depending on the type of collateral provided. However, during October 1999, the
Company re-securitized a portion of its mortgage-backed securities portfolio
with notes. As of December 31, 1999, the Long-Term Investment Operations had
$31.3 million outstanding under these notes, which were secured by $49.6 million
in fair market value of mortgage-backed securities. The Company still has the
ability to borrow funds under the reverse repurchase agreements.
During 1999, the Company raised capital of $1.0 million from the sale of
216,156 shares of Common Stock issued through its DRSPP.
Conduit Operations: The Conduit Operations has entered into warehouse line
agreements to obtain financing of up to $600.0 million from the Warehouse
Lending Operations to provide IFC mortgage loan financing during the period that
IFC accumulates mortgage loans until the mortgage loans are securitized or sold.
The margins on IFC's reverse repurchase agreements are based on the type of
collateral provided and generally range from 95% to 98% of the fair market value
of the collateral. The interest rates on the borrowings are indexed to prime,
which was 8.50% at December 31, 1999. As of December 31, 1999, the Conduit
Operations had $66.1 million outstanding under the warehouse line agreements.
IFC also has an uncommitted warehouse line agreement to obtain financing from a
major investment bank. As of December 31, 1999 and 1998, there was $181,000 and
$25.0 million outstanding under the warehouse line.
During 1999, the Conduit Operations securitized $360.1 million of mortgage
loans as REMICs and sold $824.1 million, in unpaid principal balance, of
mortgage loans to third party investors. In addition, IFC sold $638.3 million,
in unpaid principal balance, of mortgage loans to the Long-Term Investment
Operations during 1999.
Warehouse Lending Operations: The Warehouse Lending Operations finances the
acquisition of mortgage loans by the Long-Term Investment Operations and Conduit
Operations primarily through borrowings on reverse repurchase agreements with
third party lenders. IWLG has an uncommitted repurchase facility with a major
investment bank to finance the Warehouse Lending Operations as needed. Terms of
the reverse repurchase agreement requires that the mortgages be held by an
independent third party custodian giving the Warehouse Lending Operations the
ability to
54
borrow against the collateral as a percentage of the outstanding principal
balance. The borrowing rates vary from 85 basis points to 200 basis points over
one-month LIBOR, depending on the type of collateral provided. The margins on
the reverse repurchase agreement is based on the type of mortgage collateral
provided and generally range from 70% to 98% of the fair market value of the
collateral. At December 31, 1999, the Warehouse Lending Operations had $539.7
million outstanding on the reverse repurchase facility.
Cash Flows
Operating Activities - During 1999, net cash provided by operating activities
was $55.8 million. Cash provided by operating activities was primarily from net
earnings of $22.3 million.
Investing Activities - During 1999, net cash used in investing activities was
$64.1 million. Cash used in investing activities was primarily due to the
acquisition of mortgage loans from IFC. Cash used to acquire mortgage loans was
partially offset by cash provided from repayment of CMO collateral and finance
receivables.
Financing Activities - During 1999, net cash used in financing activities was
$5.5 million. Cash used in financing activities was primarily due to repayments
of CMOs, payment of cash dividends and repurchase of Common Stock. Cash used in
financing activities was offset by cash provided from increased borrowings on
reverse repurchase agreements and from the issuance of new CMOs.
Inflation
The Consolidated Financial Statements and Notes 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 the Company's
operations. Unlike industrial companies, nearly all of the assets and
liabilities of the Company's operations are monetary in nature. As a result,
interest rates have a greater impact on the Company's operations' performance
than do the effects of general levels of inflation. Inflation affects the
Company's operations primarily through its effect on interest rates, since
interest rates normally increase during periods of high inflation and decrease
during periods of low inflation. During periods of increasing interest rates,
demand for mortgage loans and a borrower's ability to qualify for mortgage
financing in a purchase transaction may be adversely affected. During periods of
decreasing interest rates, borrowers may prepay their mortgages, which in turn
may adversely affect the Company's yield and subsequently the value of its
portfolio of Mortgage Assets.
Year 2000 Compliance
After completing all phases of its Year 2000 Project Plan, the Company
experienced no problems as a result of Year 2000 issues. Both in-house
information technology systems and non-information technology systems functioned
according to the Company's internal Year 2000 Project Plan. In addition, the
Company's vendors, who provide the Company with both integrated and non-
integrated systems data, functioned without any Year 2000 related problems as
well. Even though the Company does not expect any "residual" Year 2000 issues to
affect the Company's operations, there can be no assurance that the Company will
not be affected in the future. The Company paid a total of $273,000 to an
outside vendor for Year 2000 project work during the year ended December 31,
1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General
A significant portion of the Company's revenues and earnings are derived from
net interest income and, accordingly, the Company strives to manage its
interest-earning assets and interest-bearing liabilities to generate what
management believes to be an appropriate contribution from net interest income.
When interest rates fluctuate, the Company can be adversely affected by changes
in the fair market value of its assets and liabilities and by the interest
spread the Company earns on interest-earning assets and interest-bearing
liabilities. The Company derives income from the differential spread between
interest earned on interest-earning assets and interest paid on interest-bearing
liabilities.
55
Any change in interest rates affect both income received and income paid from
these assets in varying and typically in unequal amounts and may compress the
Company's interest rate spread and adversely affect overall earnings.
Therefore, the Company seeks to control the volatility of the Company's
performance due to changes in interest rates through asset/liability management.
The Company attempts to achieve an appropriate relationship between interest
rate sensitive assets and interest rate sensitive liabilities. Although the
Company manages other risks, such as credit, operational and liquidity risk in
the normal course of business, management considers interest rate risk to be a
significant market risk which could potentially have the largest material effect
on the Company's financial condition and results of operations. As the Company
has only invested or borrowed in U.S. dollar denominated financial instruments,
the Company is not subject to foreign currency exchange risk.
As part of its asset/liability management process, the Company performs
various interest rate simulations that calculate the affect of potential changes
in interest rates on its interest-earning assets and interest-bearing
liabilities and their affect on overall earnings. This analysis assumes
instantaneous parallel shifts in the yield curve and to what degree those shifts
affect net interest income. In addition, various modeling techniques are used to
value interest sensitive mortgage-backed securities, including interest-only
securities. The value of mortgage-backed securities is determined using a
discounted cash flow model using prepayment rate, discount rate and credit loss
assumptions.
Interest Rate Sensitive Assets and Liabilities
Interest rate risk management is the responsibility of the Company's Asset and
Liability Committee ("ALCO"), which reports to the Company's Board of Director's
on a monthly basis. ALCO establishes policies that monitor and coordinate the
Company's sources, uses and pricing of its 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.
The matching of assets and liabilities may be analyzed by examining the extent
to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period. The interest rate sensitivity
gap is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of interest-
bearing liabilities maturing or repricing within that time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
that amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. During a period of falling interest rates, the
net earnings of an institution with a positive gap, theoretically, may be
adversely affected due to its interest-earning assets repricing to a greater
extent than its interest-bearing liabilities. Conversely, during a period of
rising interest rates, theoretically, the net earnings of an institution with a
positive gap position may increase as it is able to invest in higher yielding
interest-earning assets at a more rapid rate than its interest-bearing
liabilities reprice. However, the gap analysis does not take into consideration
constraints on the repricing of interest rates of ARM assets in a given period
resulting from periodic and lifetime cap features, the behavior of various
indexes applicable to the Company's assets and liabilities or the affects of
off-balance sheet financial instruments, particularly interest rate caps, on net
interest income, see "Changes in Interest Rates."
The Company manages its interest rate risk by (1) retaining adjustable-rate
mortgages to be held for long-term investment, (2) selling fixed-rate mortgages
on a whole-loan basis, (3) securitizing both adjustable- and fixed-rate
mortgages through the issuance of CMOs, and (4) the purchase of LIBOR interest
rate caps, see "Hedging." The Company retains adjustable-rate mortgages, which
are generally indexed to six-month LIBOR and reprice every six months, to be
held for investment or as CMO collateral. The Company also securitizes both
variable- and fixed-rate mortgages as CMOs to reduce its interest rate risk as
CMOs provide a net interest spread between the interest income on the mortgages
and the interest and other expenses associated with the CMO financing. In
addition, the Company purchases LIBOR interest rate caps to provide some
protection against any resulting basis risk shortfall on the related
liabilities. The interest rate caps purchased are based upon the principal
balance that would result under an assumed prepayment speed.
The Company does not currently maintain a securities trading portfolio. As a
result, the Company is not exposed to market risk as it relates to trading
activities. The Company's investment securities portfolio is available-for-sale,
which requires the Company to perform market valuations of the portfolio in
order to properly record the portfolio at the
56
lower of cost or market. Therefore, the Company continually monitors the
interest rates of its investment securities portfolio as compared to prevalent
interest rates in the market.
The following table summarizes the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1999 (dollar amounts in
thousands), which are anticipated by the Company to reprice or mature in each of
the future time periods shown. The amount of assets and liabilities shown which
reprice or mature during a particular period were determined in accordance with
the earlier of term to repricing or the contractual term of the asset or
liability as adjusted for scheduled and unscheduled repayments. Unscheduled
prepayment rates are assumed on substantially all of the Company's mortgage-
backed security and loan portfolios and are based on historic loan prepayment
experience and anticipated future prepayments. The table does not include assets
and liabilities that are not interest rate sensitive such as interest
receivables and payables, prepaid expenses and accrued expenses.
Over 5 Fair
2000 2001 2002 2003 2004 Years (4) Total Value
--------- -------- -------- -------- -------- --------- --------- ----------
Interest sensitive assets:
Cash equivalents 20,152 -- -- -- -- -- 20,152 20,152
Average interest rate 4.28% --% --% --% --% --% 4.28%
Investment securities (1) 11,942 8,384 9,514 10,487 10,786 42,093 93,206 93,206
Average interest rate 13.79% 13.79% 13.79% 13.79% 13.79% 13.79% 13.79%
Finance receivables 197,119 -- -- -- -- -- 197,119 197,119
Average interest rate 8.97% --% --% --% --% --% 8.97%
CMO collateral (2) 409,262 108,720 56,424 48,092 41,164 286,015 949,677 938,784
Average interest rate 8.11% 8.38% 8.51% 8.54% 8.58% 7.54% 8.03%
Loans held-for-investment (3) 32,212 47,941 24,235 30,585 20,551 207,911 363,435 366,066
Average interest rate 7.89% 8.30% 8.76% 8.75% 8.75% 7.16% 7.70%
Due from affiliates 14,500 -- -- -- -- -- 14,500 14,500
Average interest rate 8.33% --% --% --% --% --% 8.33% --
--------- -------- -------- -------- -------- --------- --------- ----------
Total interest-sensitive assets 685,187 165,045 90,173 89,164 72,501 536,019 1,638,089 1,629,827
--------- -------- -------- -------- -------- --------- --------- ----------
Average interest rate 8.34% 8.63% 9.14% 9.23% 9.40% 7.88% 8.36%
Interest sensitive liabilities:
CMO borrowings 591,144 36,296 31,276 26,944 23,207 140,453 849,320 844,852
Average interest rate 7.15% 7.15% 7.15% 7.15% 7.15% 7.15% 7.15%
Reverse repurchase agreements 539,687 -- -- -- -- -- 539,687 539,687
Average interest rate 6.41% --% --% --% --% --% 6.41%
Borrowings secured by 9,178 6,505 4,607 3,261 2,306 5,476 31,333 34,393
Securities available-for-sale
Average interest rate 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% 13.00% --
Senior subordinated debt -- -- -- -- -- 6,691 6,198
Average interest rate --% --% --% --% 6,691% --% 11.00% --
Due to affiliates 2,945 -- -- -- -- -- 2,945 2,945
Average interest rate 8.00% --% --% --% --% --% 8.00%
--------- -------- -------- -------- -------- --------- --------- ----------
Total interest-sensitive liabilities 1,142,954 42,801 35,883 30,205 32,204 145,929 1,429,976 1,428,075
--------- -------- -------- -------- -------- --------- --------- ----------
Average interest rate 6.85% 8.04% 7.90% 7.78% 8.37% 7.37% 7.02%
Interest rate sensitivity gap (5) (457,767) 122,244 54,290 58,959 40,297 390,090 208,113
Cumulative interest rate
Sensitivity gap (457,767) (335,523) (281,233) (222,274) (181,977) 208,113
Cumulative gap ratio % (27.95)% (20.48)% (17.17)% (13.57)% (11.11)% 12.70%
________________
(1) The over 5 year category includes "interest-only" securities of $30.8
million.
(2) Includes unamortized net premiums and unamortized securitization costs
of $28.8 million and $11.9 million and $11.9 million respectively.
(3) Includes unamortized net premium of $2.0 million.
(4) CMO collateral and loans held-for-investment include non-accrual loans of
$42.8 million and $8.3 million, respectively.
(5) Interest rate sensitivity gap represents the difference between
interest-earning assets and interest-bearing liabilities.
57
As the Company's estimated interest rate sensitivity gap is negative during
2000, net interest income could be negatively affected by an increase in
interest rates as more interest-bearing liabilities could reprice upwards during
2000 than interest-bearing assets. Conversely, a decrease in interest rates
could have a positive affect on net interest income during 2000 as more
interest-bearing liabilities could reprice downwards during 2000 than interest-
bearing assets. The estimated cumulative negative gap during 2000 of $457.8
million compares to an estimated cumulative positive gap for 1999 of $303.6
million. The shift from an estimated cumulative positive gap in 1999 to an
estimated cumulative negative gap in 2000 is primarily the result of the Company
retaining $321.6 million of mortgage loans, during the fourth quarter of 1999,
that have fixed interest rates for initial two-, three-, and five-year periods,
which subsequently change to adjustable interest rates thereafter. Since these
estimates are based upon numerous assumptions, such as the expected maturities
of the Company's interest-earning assets and interest-bearing liabilities, the
Company's actual sensitivity to interest rate changes could vary significantly
if actual experience differs from those assumptions used in making the
calculations. In addition, the estimated impacts of parallel shifts in interest
rates and the resulting effect on net interest income does consider increases or
decreases in premium amortization and securitization expenses due to possible
increases or decreases in loan prepayments, which could also vary if actual
experience differs from the prepayment assumptions used.
Changes in Interest Rates
Although the static gap methodology is widely accepted in identifying
interest rate risk, it does not take into consideration changes that may occur
in investment and financing strategies, changes in the yield curve, changes in
hedging strategy, changes in prepayment speeds and changes in business volumes.
Therefore, in addition to measuring interest rate risk via a gap analysis, the
Company measures the sensitivity of its net interest income to changes in
interest rates affecting interest sensitive assets and liabilities using
simulations. The simulations consider the affect of interest rate changes on
interest sensitive assets and liabilities as well as interest rate caps (off-
balance sheet items). Changes in interest rates are defined as instantaneous and
sustained movements in interest rates in 100 basis point increments. The Company
estimates its net interest income for the next twelve months assuming no changes
in interest rates from those at period end. Once the base case has been
estimated, calculations are made for each of the defined changes in interest
rates, to include any associated differences in the anticipated prepayment speed
of loans. Those results are then compared against the base case to determine the
estimated change to net interest income.
The following table (dollar amounts in millions) estimates the financial
impact to net interest income from various instantaneous and parallel shifts in
interest rates based on the Company's on- and off-balance sheet structure as of
December 31, 1999 and 1998. Since, these estimates are based upon numerous
assumptions, such as expected prepayment rates and the shape of the yield curve,
the Company's actual sensitivity to interest rate changes could differ
significantly as compared to actual results.
2000 1999
--------------------------- ---------------------------
Changes in Interest Rates Change in Net Change in Net
(In Basis Points) Interest Income (1) Interest Income (1)
--------------------------- ---------------------------
($) (%) ($) (%)
+200.................................................... (9.2) (25) (1.9) (6)
+100.................................................... (4.2) (12) (4.4) (14)
-100.................................................... 2.6 7 2.1 7
-200.................................................... 1.0 3 4.9 16
______________
(1) The dollar and percentage changes represent net interest income, for the
next twelve months, in a stable interest rate environment versus the change
in net interest income in the various instantaneous, parallel rate change
simulations.
The estimated decreases in net interest income in an increasing rate
environment during 2000 as compared to 1999 is primarily due to (1) an estimated
negative gap during year 2000 of $457.8 million, as shown in the static gap
table above, and (2) the lag in the repricing of the indices to which the
Company's adjustable rate loans and mortgage-backed securities are tied as
compared to the borrowings that fund these assets. As interest rates increase,
an estimated $1.1 billion of the Company's interest rate sensitive liabilities
contractually mature or reprice during 2000 as compared to $685.2 million of
interest rate sensitive assets that are estimated to contractually mature or
reprice during 2000. As of
58
December 31, 1999, mortgage loans held-for-investment, of which approximately
$350.0 million were retained during the fourth quarter of 1999, were financed by
reverse repurchase agreements, which are subject to daily repricing based on
one-month LIBOR plus a spread. Therefore, as of December 31, 1999, loans held-
for-investment with primarily two- to five-year repricing dates were matched
against (financed with) liabilities with daily repricing characteristics.
However, during January 2000, these loans were used as collateral for CMOs that
have lower financing costs than reverse repurchase agreements but were not
reflected in the gap analysis or the calculations of changes in net interest
income as the CMO was completed subsequent to year-end. Additionally, because
the Company's adjustable rate CMO collateral is tied to various indices,
primarily six-month LIBOR, and the corresponding CMO financing is primarily tied
to one-month LIBOR, the Company's interest rate sensitive liabilities reprice
faster than its interest rate sensitive assets, which could create negative
results in net interest income over the near term (12-month horizon) during
periods of increasing interest rates.
The following table presents the extent to which changes in interest rates
and changes in the volume of interest rate sensitive assets and interest rate
sensitive liabilities have affected the Company's interest income and interest
expense during the periods indicated. Information is provided on Mortgage Assets
and borrowings on Mortgage Assets, only, with respect to (1) changes
attributable to changes in volume (changes in volume multiplied by prior rate),
(2) changes attributable to changes in rate (changes in rate multiplied by prior
volume), (3) changes in interest due to both rate and volume, and (4) the net
change.
Year Ended December 31,
1999 over 1998
----------------------------------------------------------------
Rate/ Net
Volume Rate Volume Change
------------- ------------- ------------ ------------
(in thousands)
Increase/(decrease) in:
Subordinated securities collateralized by mortgages......... (182) 1,593 (26) 1,385
Subordinated securities collateralized by other loans....... 274 (107) (42) 125
--------- ---------- --------- ----------
Total investment securities available-for-sale............. 92 1,486 (68) 1,510
Loan receivables:
CMO collateral.............................................. (9,211) (9,621) 917 (17,915)
Mortgage loans held-for-investment.......................... (11,025) (4,317) 3,314 (12,028)
Finance receivables:
Affiliated................................................. (14,483) (215) 98 (14,600)
Non-affiliated............................................. (288) (180) 5 (463)
--------- ---------- --------- ----------
Total finance receivables................................. (14,771) (395) 103 (15,063)
--------- ---------- --------- ----------
Total Loan Receivables..................................... (35,007) (14,333) 4,334 (45,006)
--------- ---------- --------- ----------
Change in interest income on Mortgage Assets.............. (34,915) (12,847) 4,266 (43,496)
--------- ---------- --------- ----------
CMO borrowings.............................................. (8,989) (2,355) 247 (11,097)
Reverse repurchase agreements-mortgages..................... (18,324) (1,056) 486 (18,894)
Borrowings on secured by securities available-for-sale...... -- -- 686 686
Reverse repurchase agreements-securities.................... (697) (10) 5 (702)
--------- ---------- --------- ----------
Change in interest expense on borrowings on
Mortgage Assets........................................... (28,010) (3,421) 1,424 (30,007)
--------- ---------- --------- ----------
Change in net interest income............................ (6,905) (9,426) 2,842 (13,489)
========= ========== ========= ==========
59
Year Ended December 31,
1998 over 1997
---------------------------------------------------------------
Rate/ Net
Volume Rate Volume Change
------------ ------------ ------------ ------------
(in thousands)
Increase/(decrease) in:
Subordinated securities collateralized by mortgages............ 3,772 (47) (25) 3,700
Subordinated securities collateralized by other loans.......... (106) (237) 24 (319)
--------- --------- -------- ---------
Total investment securities available-for-sale................ 3,666 (284) (1) 3,381
Loan receivables:
CMO collateral................................................. 47,248 (1,630) (1,574) 44,044
Mortgage loans held-for-investment............................. (2,640) 3,025 (547) (162)
Finance receivables:
Affiliated.................................................... -- (121) (12) (133)
Non-affiliated................................................ 5,778 (180) (347) 5,251
--------- --------- -------- ---------
Total finance receivables.................................... 5,778 (301) (359) 5,118
--------- --------- -------- ---------
Total Loan Receivables........................................ 50,386 1,094 (2,480) 49,000
--------- --------- -------- ---------
Change in interest income on Mortgage Assets................. 54,052 810 (2,481) 52,381
--------- --------- -------- ---------
CMO borrowings................................................. 35,470 2,111 2,063 39,644
Reverse repurchase agreements-mortgages........................ 1,602 929 27 2,558
Reverse repurchase agreements-securities....................... (134) -- (2) (136)
--------- --------- -------- ---------
Change in interest expense on borrowings on
Mortgage Assets.............................................. 36,938 3,040 2,088 42,066
--------- --------- -------- ---------
Change in net interest income............................... 17,114 (2,230) (4,569) 10,315
========= ========= ======== =========
Hedging
The Company conducts certain hedging activities in connection with both its
Long-Term Investment Operations and its Conduit Operations.
Long-Term Investment Operations. To the extent consistent with IMH's
election to qualify as a REIT, the Company follows a hedging program intended to
protect against interest rate changes and to enable the Company to earn net
interest income in periods of generally rising, as well as declining or static,
interest rates. Specifically, the Company's hedging program is formulated with
the intent to offset the potential adverse effects resulting from (1) interest
rate adjustment limitations on its mortgage loans and securities backed by
mortgage loans, and (2) the differences between the interest rate adjustment
indices and interest rate adjustment periods of its adjustable rate mortgage
loans and mortgage-backed securities secured by such loans and related
borrowings. As part of its hedging program, the Company also monitors on an
ongoing basis the prepayment risks that arise in fluctuating interest rate
environments.
The Company's hedging program encompasses a number of procedures. First,
the Company structures its commitments so that the mortgage loans purchased will
have interest rate adjustment indices and adjustment periods that, on an
aggregate basis, correspond as closely as practicable to the interest rate
adjustment indices and interest rate adjustment periods of the anticipated
financing source. In addition, the Company structures its borrowing agreements
to have a range of different maturities (although substantially all have
maturities of less than one year). As a result, the Company adjusts the average
maturity of its borrowings on an ongoing basis by changing the mix of maturities
as borrowings come due and are renewed. In this way, the Company minimizes any
differences between interest rate adjustment periods of mortgage loans and
related borrowings that may occur due to prepayments of mortgage loans or other
factors.
The Company, based on market conditions, may purchase interest rate caps to
limit or partially offset adverse changes in interest rates associated with its
borrowings. In a typical interest rate cap agreement, the cap purchaser
60
makes an initial lump sum cash payment to the cap seller in exchange for the
seller's promise to make cash payments to the purchaser on fixed dates during
the contract term if prevailing interest rates exceed the rate specified in the
contract. In this way, the Company generally hedges as much of the interest rate
risk arising from lifetime rate caps on its mortgage loans and from periodic
rate and/or payment caps as the Company determines is in the best interest of
the Company, given the cost of such hedging transactions and the need to
maintain IMH's status as a REIT. Such periodic caps on the Company's mortgage
loans may also be hedged by the purchase of mortgage derivative securities.
Mortgage derivative securities can be effective hedging instruments in certain
situations as the value and yields of some of these instruments tend to increase
as interest rates rise and tend to decrease in value and yields as interest
rates decline, while the experience for others is the converse. The Company
intends to limit its purchases of mortgage derivative securities to investments
that qualify as Qualified REIT Assets or Qualified Hedges so that income from
such investments will constitute qualifying income for purposes of the 95% and
75% gross income tests. To a lesser extent, the Company, through its Conduit
Operations, may enter into interest rate swap agreements, buy and sell financial
futures contracts and options on financial futures contracts and trade forward
contracts as a hedge against future interest rate changes; however, the Company
will not invest in these instruments unless the Company is exempt from the
registration requirements of the Commodity Exchange Act or otherwise comply with
the provisions of that Act. The REIT provisions of the Internal Revenue Code of
1986, as amended (the "Code"), may restrict the Company's ability to purchase
certain instruments and may severely restrict the Company's ability to employ
other strategies. In all it's hedging transactions, the Company intends to deal
only with counterparties that the Company believes are sound credit risks. At
December 31, 1999 and 1998, the Company had $422.0 million and none, in notional
amount, of interest rate caps and interest rate swaps, respectively.
Conduit Operations. In conducting its Conduit Operations, IFC is subject to
the risk of rising mortgage interest rates between the time it commits to
purchase mortgage loans at a fixed price and the time it sells or securitizes
those mortgage loans. To mitigate this risk, IFC enters into transactions
designed to hedge interest rate risks, which may include mandatory and optional
forward selling of mortgage loans or mortgage-backed securities, interest rate
caps, floors and swaps, and buying and selling of futures and options on
futures. The nature and quantity of these hedging transactions are determined by
the management of IFC based on various factors, including market conditions and
the expected volume of mortgage loan purchases.
Forward Contracts
IFC sells mortgage-backed securities through forward delivery contracts
with major dealers in such securities. At December 31, 1999 and 1998, IFC had
$110.0 million and $46.0 million, respectively, in outstanding commitments to
sell mortgage loans through mortgage-backed securities. These commitments allow
IFC to enter into mandatory commitments when IFC notifies the investor of its
intent to exercise a portion of the forward delivery contracts. IFC was not
obligated under mandatory commitments to deliver loans to such investors at
December 31, 1999 and 1998. The credit risk of forward contracts relates to the
counterparties' ability to perform under the contract. IFC evaluates
counterparties based on their ability to perform prior to entering into any
agreements.
Futures Contracts
IFC sells future contracts against five and ten-year Treasury notes with
major dealers in such securities. At December 31, 1999 and 1998, IFC had $10.0
million and none, respectively, in outstanding commitments to sell Treasury
notes which expire within 90 days.
Options
In order to protect against changes in the value of mortgage loans held for
sale, IFC may sell call or buy put options on U.S. Treasury bonds and mortgage-
backed securities. IFC generally sells call or buys put options to hedge against
adverse movements of interest rates affecting the value of its mortgage loans
held for sale. The risk in writing a call option is that IFC gives up the
opportunity for profit if the market price of the mortgage loans increases and
the option is exercised. IFC also has the additional risk of not being able to
enter into a closing transaction if a liquid secondary market does not exist.
The risk of buying a put option is limited to the premium IFC paid for the put
option. IFC had written option contracts with an outstanding principal balance
of $20.0 million and $25.0 million at December 31, 1999 and 1998, respectively.
61
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item 8 is incorporated by reference to
Impac Mortgage Holdings, Inc.'s Consolidated Financial Statements and
Independent Auditors' Report beginning at page F-1 of this Form 10-K.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
62
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is hereby incorporated by
reference to Impac Mortgage Holdings, Inc.'s definitive proxy statement, to be
filed pursuant to Regulation 14A within 120 days after the end of Impac Mortgage
Holdings, Inc.'s 1999 fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is hereby incorporated by
reference to Impac Mortgage Holdings, Inc.'s definitive proxy statement, to be
filed pursuant to Regulation 14A within 120 days after the end of Impac Mortgage
Holdings, Inc.'s 1999 fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is hereby incorporated by
reference to Impac Mortgage Holdings, Inc.'s definitive proxy statement, to be
filed pursuant to Regulation 14A within 120 days after the end of Impac Mortgage
Holdings, Inc.'s 1999 fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is hereby incorporated by
reference to Impac Mortgage Holdings, Inc.'s definitive proxy statement, to be
filed pursuant to Regulation 14A within 120 days after the end of Impac Mortgage
Holdings, Inc.'s 1999 fiscal year.
63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) All schedules have been omitted because they are either not applicable,
not required or the information required has been disclosed in the
Consolidated Financial Statements and related Notes to Consolidated
Financial Statements at page F-1, or otherwise included in this Form
10-K.
(b) Reports on Form 8-K--None
(c) Exhibits
Exhibit
Number Description
- ------ -----------
3.1 Charter of the Registrant (incorporated by reference to the
corresponding exhibit number to the Registrant's Registration
Statement on Form S-11, as amended (File No. 33-96670), filed with
the Securities and Exchange Commission on September 7, 1995).
3.1(a) Certificate of correction of the Registrant (incorporated by
reference to exhibit 3.1(a) of the Registrant's 10-K for the year
ended December 31, 1998).
3.1(b) Articles of Amendment of the Registrant (incorporated by reference
to exhibit 3.1(b) of the Registrant's 10-K for the year ended
December 31, 1998).
3.1(c) Articles of Amendment for change of name to Charter of the
Registrant (incorporated by reference to exhibit number 3.1(a) of
the Registrant's Current Report on Form 8-K, filed February 11,
1998).
3.1(d) Articles Supplementary and Certificate of Correction for Series A
Junior Participating Preferred Stock of the Registrant
(incorporated by reference to exhibit 3.1(d) of the Registrant's
10-K for the year ended December 31, 1998).
3.1(e) Articles Supplementary for Series B 10.5% Cumulative Convertible
Preferred Stock of the Registrant (incorporated by reference to
exhibit 3.1b of the Registrant's Current Report on Form 8-K, filed
December 23, 1998).
3.1(f) Articles Supplementary for Series C 10.5% Cumulative Convertible
Preferred Stock of the Registrant.
3.1(g) Certificate of Correction for Series C Preferred Stock of the
Registrant.
3.2 Bylaws of the Registrant, as amended and restated (incorporated by
reference to the corresponding exhibit number of the Registrant's
Quarterly Report on Form 10-Q for the period ending March 31,
1998).
4.1 Form of Stock Certificate of the Company (incorporated by reference
to the corresponding exhibit number to the Registrant's
Registration Statement on Form S-11, as amended (File No. 33-
96670), filed with the Securities and Exchange Commission on
September 7, 1995).
4.2 Rights Agreement between the Registrant and BankBoston, N.A.
(incorporated by reference to exhibit 4.2 of the Registrant's
Registration Statement on Form 8-A as filed with the Securities and
Exchange Commission on October 14, 1998).
4.2(a) Amendment No. 1 to Rights Agreement between the Registrant and
BankBoston, N.A. (incorporated by reference to exhibit 4.2(a) of
the Registrant's Registration Statement on Form 8-A/A as filed with
the Securities and Exchange Commission on December 23, 1998).
64
4.3 Form of Series B 10.5% Cumulative Convertible Preferred Stock
Certificate (incorporated by reference to exhibit 4.9 of the
Registrant's Current Report on Form 8-K, filed December 23, 1998).
4.4 Form of Series C 10.5% Cumulative Convertible Preferred Stock
Certificate.
4.5 Indenture between the Registrant and IBJ Whitehall Bank & Trust
Company, dated March 29, 1999 (incorporated by reference to exhibit
a(11) of the Registrant's Form 8-K filed on April 9, 1999).
4.6 First Supplemental Indenture to Indenture between the Registrant
and IBJ Whitehall Bank & Trust Company, dated March 29, 1999
(incorporated by reference to exhibit a(12) of the Registrant's
Form 8-K filed on April 9, 1999).
10.1 1995 Stock Option, Deferred Stock and Restricted Stock Plan, as
amended and restated (incorporated by reference to exhibit 10.1 of
the Registrant's Quarterly Report on Form 10-Q for the period
ending March 31, 1998).
10.2 Form of Indemnity Agreement between the Registrant and its
Directors and Officers (incorporated by reference to exhibit 10.4
to the Registrant's Registration Statement on Form S-11, as amended
(File No. 33-96670), filed with the Securities and Exchange
Commission on September 7, 1995).
10.3 Form of Tax Agreement between the Registrant and Imperial Credit
Industries, Inc. (incorporated by reference to exhibit 10.5 to the
Registrant's Registration Statement on Form S-11, as amended (File
No. 33-96670), filed with the Securities and Exchange Commission on
September 7, 1995).
10.4(a) Sublease, dated February 12, 1997, between the Registrant and
Imperial Credit Industries, Inc. regarding Santa Ana Heights
facility (incorporated by reference to exhibit 10.5(a) of the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1997).
10.4(b) Sublease Amendment, dated July 24, 1997, between the Registrant and
Imperial Credit Industries, Inc. (incorporated by reference to
exhibit 10.5(b) of the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997).
10.4(c) Sublease Amendment, dated February 6, 1998, between the Registrant
and Imperial Credit Industries, Inc. (incorporated by reference to
exhibit 10.5(c) of the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997).
10.5 Form of Amended and Restated Employment Agreement with ICI Funding
Corporation (incorporated by reference to exhibit 10.8 to the
Registrant's Quarterly Report on Form 10-Q, as amended, for the
quarter ended June 30, 1998).
10.5(a) List of Officers and terms relating to Form of Amended and Restated
Employment Agreement (incorporated by reference to exhibit 10.8(a)
to the Registrant's Quarterly Report on Form 10-Q, as amended, for
the quarter ended June 30, 1998).
10.5(b) Form of Amendment No. 1 to Amended and Restated Employment
Agreement with Impac Funding Corporation (incorporated by reference
to exhibit 10.1(a) of the Registrant's Current Report on Form 8-K,
filed June 2, 1998).
10.5(c) List of Officers and terms relating to Form of Amendment No. 1 to
the Amended and Restated Employment Agreement with Impac Funding
Corporation (incorporated by reference to exhibit 10.1(b) of the
Registrant's Current Report of Form 8-K, filed June 2, 1998).
65
10.6 Form of Loan Purchase and Administrative Services Agreement between
the Registrant and Impac Funding Corporation (incorporated by
reference to exhibit 10.9 to the Registrant's Registration
Statement on Form S-11, as amended (File No. 33-96670), filed with
the Securities and Exchange Commission on September 7, 1995).
10.7 Dividend Reinvestment and Stock Purchase Plan (incorporated by
reference to Exhibit 4 to, and the prospectus included in, the
Registrant's Registration Statement on Form S-3/A (File No. 333-
52335), as filed with the Securities and Exchange Commission on
September 4, 1998).
10.8 Servicing Agreement effective November 11, 1995 between the
Registrant and Impac Funding Corporation (incorporated by reference
to exhibit 10.14 to the Registrant's Registration Statement on Form
S-11, as amended (File No. 333-04011), filed with the Securities
and Exchange Commission on May 17, 1996).
10.9 Impac Mortgage Holdings, Inc. 1996 Stock Option Loan Plan
(incorporated by reference to exhibit 10.15 to the Registrant's
Form 10-K for the year ended December 31, 1996).
10.10 Real Estate Purchase, Sale and Escrow Agreement by and between
TW/BRP Dove, LLC and IMH/ICH Dove Street, LLC, dated as of August
25, 1997 (incorporated by reference to exhibit 10.16 to the
Registrant's Quarterly Report on Form 10-Q, as amended, for the
quarter ended June 30, 1997).
10.10(a) Contract of Sale between the Registrant and Impac Commercial
Holdings, Inc. (incorporated by reference to exhibit 10.11(a) of
the Registrant's 10-K for the year ended December 31, 1998).
10.11 Termination Agreement, effective December 19, 1997, between the
Registrant, Impac Funding Corporation, Imperial Credit Industries,
Inc. and Imperial Credit Advisors, Inc. and Joseph R. Tomkinson,
William S. Ashmore and Richard J. Johnson (incorporated by
reference to exhibit 10.18 to the Registrant's Current Report on
Form 8-K, as amended, dated December 19, 1997).
10.12 Services Agreement, dated December 29, 1997, between the
Registrant, Impac Funding Corporation and Imperial Credit Advisors,
Inc. (incorporated by reference to exhibit 10.19 to the
Registrant's Current Report on Form 8-K, as amended, dated December
19, 1997).
10.13 Registration Rights Agreement, dated December 29, 1997, between
Registrant and Imperial Credit Advisors, Inc. (incorporated by
reference to exhibit 10.20 to the Registrant's Current Report on
Form 8- K, as amended, dated December 19, 1997).
10.14 Sales Agency Agreement between the Registrant and PaineWebber,
Incorporated, dated May 12, 1998 (incorporated by reference to
exhibit 1.1 of the Registrant's Current Report on Form 8-K, filed
June 2, 1998).
10.15 Lease dated June 1, 1998 regarding Dove Street facilities
(incorporated by reference to exhibit 10.17 of the Registrant's 10-
K for the year ended December 31, 1998).
10.16 Employment Letter between Impac Funding Corporation and Ronald
Morrison dated May 28, 1998 (incorporated by reference to exhibit
10.18 of the Registrant's 10-K for the year ended December 31,
1998).
10.17 Note dated June 30, 1999 between the Registrant and Impac Funding
Corporation.
21.1 Subsidiaries of the Registrant (incorporated by reference to
exhibit 21.1 of the Registrant's 10-K for the year ended December
31, 1998).
23.1 Consent of KPMG LLP regarding the Registrant.
23.2 Consent of KPMG LLP regarding Impac Funding Corporation.
66
24 Power of Attorney (included on signature page).
27 Financial Data Schedule.
67
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Newport
Beach, State of California, on the 17th day of March, 2000.
IMPAC MORTGAGE HOLDINGS, INC.
by /s/ Joseph R. Tomkinson
-----------------------
Joseph R. Tomkinson
Chairman of the Board
and Chief Executive Officer
We, the undersigned directors and officers of Impac Mortgage Holdings,
Inc., do hereby constitute and appoint Joseph R. Tomkinson and Richard J.
Johnson, or either of them, our true and lawful attorneys and agents, to do any
and all acts and things in our name and behalf in our capacities as directors
and officers and to execute any and all instruments for us and in our names in
the capacities indicated below, which said attorneys and agents, or either of
them, may deem necessary or advisable to enable said corporation to comply with
the Securities Exchange Act of 1934, as amended, and any rules, regulations, and
requirements of the Securities and Exchange Commission, in connections with this
report, including specifically, but without limitation, power and authority to
sign for us or any of us in our names and in the capacities indicated below, any
and all amendments to this report, and we do hereby ratify and confirm all that
the said attorneys and agents, or either of them, shall do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Joseph R. Tomkinson Chairman of the Board and March 17, 2000
- --------------------------
Joseph R. Tomkinson Chief Executive Officer
(Principal Executive Officer)
/s/ Richard J. Johnson Chief Financial Officer (Principal March 17, 2000
- --------------------------
Richard J. Johnson Financial and Accounting Officer)
/s/ James Walsh Director March 17, 2000
- --------------------------
James Walsh
/s/ Frank P. Filipps Director March 17, 2000
- --------------------------
Frank P. Filipps
/s/ Stephan R. Peers Director March 17, 2000
- --------------------------
Stephan R. Peers
/s/ William S. Ashmore Director March 17, 2000
- --------------------------
William S. Ashmore
68
INDEPENDENT AUDITORS' REPORT AND
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
Page
----
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
----------------------------------------------
Independent Auditors' Report................................................................... F-2
Consolidated Balance Sheets at December 31, 1999 and 1998...................................... F-3
Consolidated Statements of Operations and Comprehensive Earnings (Loss) for
the three years ended December 31, 1999, 1998 and 1997...................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the three
years ended December 31, 1999, 1998 and 1997................................................ F-5
Consolidated Statements of Cash Flows for the three years ended December 31,
1999, 1998 and 1997......................................................................... F-6
Notes to Consolidated Financial Statements..................................................... F-8
IMPAC FUNDING CORPORATION AND SUBSIDIARY
----------------------------------------
Independent Auditors' Report................................................................... F-32
Consolidated Balance Sheets at December 31, 1999 and 1998...................................... F-33
Consolidated Statements of Operations and Comprehensive Earnings (Loss) for
the three years ended December 31, 1999, 1998 and 1997.................................... F-34
Consolidated Statements of Changes in Shareholders' Equity for the
three years ended December 31, 1999, 1998 and 1997.......................................... F-35
Consolidated Statements of Cash Flows for the three years ended December 31,
1999, 1998 and 1997......................................................................... F-36
Notes to Consolidated Financial Statements..................................................... F-37
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Impac Mortgage Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of Impac
Mortgage Holdings, Inc. and subsidiaries as of December 31, 1999 and 1998, and
the related consolidated statements of operations and comprehensive earnings
(loss), changes in stockholders' equity and cash flows for each of the years in
the three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Impac Mortgage Holdings, Inc. and subsidiaries as of December 31, 1999 and 1998,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1999 in conformity with generally
accepted accounting principles.
KPMG LLP
Orange County, California
January 31, 2000, except as to Note
T to the consolidated financial statements,
which is as of February 29, 2000.
F-2
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollar amounts in thousands, except share data)
At December 31,
-----------------------------------
1999 1998
--------------- ---------------
ASSETS
------
Cash and cash equivalents................................................................. $ 20,152 $ 33,876
Investment securities available-for-sale.................................................. 93,206 93,486
Loan Receivables:
CMO collateral.......................................................................... 949,677 1,161,220
Finance receivables..................................................................... 197,119 311,571
Mortgage loans held-for-investment...................................................... 363,435 20,627
Allowance for loan losses............................................................... (4,029) (6,959)
--------------- ---------------
Net loan receivables................................................................. 1,506,202 1,486,459
Investment in Impac Funding Corporation................................................... 17,372 13,246
Due from affiliates....................................................................... 14,500 17,904
Accrued interest receivable............................................................... 11,209 10,039
Other real estate owned................................................................... 8,820 8,456
Other assets.............................................................................. 3,969 2,038
--------------- ---------------
Total assets......................................................................... $ 1,675,430 $ 1,665,504
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CMO borrowings............................................................................ $ 850,817 $ 1,072,316
Reverse repurchase agreements............................................................. 539,687 323,625
Borrowings secured by investment securities available-for-sale............................ 31,333 --
11% senior subordinated debentures........................................................ 6,691 --
Accrued dividends payable................................................................. 3,570 12,129
Due to affiliates......................................................................... 2,945 2,670
Other liabilities......................................................................... 1,543 3,158
--------------- ---------------
Total liabilities.................................................................... 1,436,586 1,413,898
--------------- ---------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 6,300,000 shares authorized; none issued and
outstanding at December 31, 1999 and 1998............................................... -- --
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares
authorized; none issued and outstanding at December 31, 1999 and 1998, respectively..... -- --
Series B 10.5% cumulative convertible preferred stock, $0.01 par value; liquidation
value $30,000; 1,200,000 shares authorized; and 1,200,000 issued and
outstanding at December 31, 1999 and 1998 respectively.................................. 12 12
Common stock, $0.01 par value; 50,000,000 shares authorized; 21,400,906 and
24,557,657 shares issued and outstanding at December 31, 1999 and 1998, respectively.... 214 246
Additional paid-in capital............................................................... 327,632 342,945
Accumulated other comprehensive loss..................................................... (7,579) (1,736)
Notes receivable from common stock sales................................................. (905) (918)
Net accumulated deficit:
Cumulative dividends declared........................................................... (93,080) (79,176)
Retained earnings (accumulated deficit)................................................. 12,550 (9,767)
--------------- ---------------
Net accumulated deficit............................................................... (80,530) (88,943)
--------------- ---------------
Total stockholders' equity........................................................... 238,844 251,606
--------------- ---------------
Total liabilities and stockholders' equity........................................... $ 1,675,430 $ 1,665,504
=============== ===============
See accompanying notes to consolidated financial statements.
F-3
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE EARNINGS (LOSS)
(in thousands, except per share data)
For the year ended December 31,
----------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
INTEREST INCOME:
Mortgage Assets............................................................ $ 117,224 $ 160,720 $ 108,339
Other interest income...................................................... 2,234 2,938 1,194
-------------- -------------- --------------
Total interest income..................................................... 119,458 163,658 109,533
INTEREST EXPENSE:
CMO borrowings............................................................. 65,212 76,309 36,665
Reverse repurchase agreements.............................................. 23,229 42,139 39,717
Other borrowings........................................................... 1,354 3,247 195
-------------- -------------- --------------
Total interest expense.................................................... 89,795 121,695 76,577
-------------- -------------- --------------
Net interest income........................................................ 29,663 41,963 32,956
Provision for loan losses................................................. 5,547 4,361 6,843
-------------- -------------- --------------
Net interest income after provision for loan losses........................ 24,116 37,602 26,113
NON-INTEREST INCOME:
Equity in net earnings (loss) of Impac Funding Corporation................. 4,292 (13,876) 8,316
Equity in net loss of Impac Commercial Holdings, Inc....................... -- (998) (239)
Loss on sale of loans...................................................... -- (3,111) --
Servicing fees............................................................. 1,370 1,929 980
Gain on sale of securities................................................. 93 427 648
Other income............................................................... 1,147 2,090 621
-------------- -------------- --------------
Total non-interest income................................................. 6,902 (13,539) 10,326
NON-INTEREST EXPENSE:
Professional services...................................................... 2,678 2,243 1,117
(Gain) loss on sale of other real estate owned............................. 2,159 1,707 (433)
Write-down on investment securities available-for-sale..................... 2,037 14,132 --
General and administrative and other expense............................... 1,343 2,320 836
Personnel expense.......................................................... 484 518 331
Loss on equity investment of Impac Commercial Holdings, Inc................ -- 9,076 --
Advisory fees.............................................................. -- -- 6,242
Termination agreement expense.............................................. -- -- 44,375
-------------- -------------- --------------
Total non-interest expense................................................ 8,701 29,996 52,468
-------------- -------------- --------------
Net earnings (loss)....................................................... 22,317 (5,933) (16,029)
Less: Cash dividends on cumulative convertible preferred stock............. (3,290) -- --
-------------- -------------- --------------
Net earnings available to common stockholders............................. 19,027 (5,933) (16,029)
-------------- -------------- --------------
Other comprehensive earnings (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period................... (5,538) 7,395 (2,657)
Less: Reclassification of losses included in income....................... (305) (4,015) --
-------------- -------------- --------------
Net unrealized gains (losses) arising during period..................... (5,843) 3,380 (2,657)
-------------- -------------- --------------
Comprehensive earnings (loss)............................................. $ 16,474 $ (2,553) $ (18,686)
============== ============== ==============
Net earnings (loss) per share--basic...................................... $ 0.83 $ (0.25) $ (0.99)
============== ============== ==============
Net earnings (loss) per share--diluted.................................... $ 0.76 $ (0.25) $ (0.99)
============== ============== ==============
See accompanying notes to consolidated financial statements.
F-4
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollar amounts in thousands, except share data)
Accumulated
Number of Number of Other
Preferred Common Additional Comprehensive
Shares Preferred Shares Common Paid-In Earnings
Outstanding Stock Outstanding Stock Capital (Loss)
------------- --------- ------------ -------- ------------ --------------
Balance, December 31, 1996................. -- $ -- 9,400,000 $ 94 $ 135,521 $ (2,459)
Dividends declared ($1.68 per share)....... -- -- -- -- -- --
Net proceeds from public stock offerings... -- -- 3,229,906 32 83,088 --
Proceeds from DRSPP........................ -- -- 1,062,844 11 24,678 --
Proceeds from exercise of stock options.... -- -- 72,966 1 935 --
Payments on notes receivable from
common stock sales........................ -- -- -- -- -- --
Stock issued for termination of
management agreement...................... -- -- 2,009,310 20 35,017 --
Gain on sale of ICH preferred stock........ -- -- -- -- 3,840 --
3-for-2 stock split........................ -- -- 6,770,638 67 (67) --
Net loss, 1997............................. -- -- -- -- -- --
Other comprehensive loss................... -- -- -- -- -- (2,657)
------------ --------- ------------ -------- ------------ --------------
Balance, December 31, 1997................. -- -- 22,545,664 225 283,012 (5,116)
Dividends declared ($1.46 per share)....... -- -- -- --
Net proceeds from preferred stock
offering.................................. 1,200,000 12 -- -- 28,758 --
Proceeds from DRSPP........................ -- -- 1,758,493 18 27,822 --
Proceeds from SES Program.................. -- -- 245,700 3 3,245 --
Proceeds from exercise of stock options.... -- -- 7,800 -- 108 --
Payments on notes receivable from
common stock sales........................ -- -- -- -- -- --
Net loss, 1998............................. -- -- -- -- -- --
Other comprehensive earnings............... -- -- -- -- -- 3,380
------------ --------- ------------ -------- ------------ --------------
Balance, December 31, 1998................. 1,200,000 12 24,557,657 246 342,945 (1,736)
Dividends declared ($0.48 per common
share).................................... -- -- -- -- -- --
Dividends declared on preferred shares..... -- -- -- -- -- --
Proceeds from DRSPP........................ -- -- 216,156 -- 946 --
Repurchase of common stock................. -- -- (2,013,400) (19) (9,841) --
Exchange of Common Stock for
senior subordinated debt................ -- -- (1,359,507) (13) (6,418) --
Payments on notes receivable from
common stock sales........................ -- -- -- -- -- --
Net earnings, 1999......................... -- -- -- -- -- --
Other comprehensive loss................... -- -- -- -- -- (5,843)
------------ --------- ------------ -------- ------------ --------------
Balance, December 31, 1999................. 1,200,000 $ 12 21,400,906 $ 214 $ 327,632 $ (7,579)
============ ========= ============ ======== ============ ==============
Notes
Receivable Retained
Common Cumulative Earnings Total
Stock Dividends (Accumulated Shareholders'
Sales Declared Deficit) Equity
----------- ----------- ------------- -------------
Balance, December 31, 1996................. $ (720) $ (15,441) $ 12,195 $ 129,190
Dividends declared ($1.68 per share)....... -- (28,486) -- (28,486)
Net proceeds from public stock offerings... -- -- -- 83,120
Proceeds from DRSPP........................ -- -- -- 24,689
Proceeds from exercise of stock options.... -- -- -- 936
Payments on notes receivable from
common stock sales........................ (610) -- -- (610)
Stock issued for termination of
management agreement...................... -- --
Gain on sale of ICH preferred stock........ -- -- -- 3,840
3-for-2 stock split........................ -- -- -- --
Net loss, 1997............................. -- -- (16,029) (16,029)
Other comprehensive loss................... -- -- -- (2,657)
----------- ----------- ------------- -------------
Balance, December 31, 1997................. (1,330) (43,927) (3,834) 229,030
Dividends declared ($1.46 per share)....... -- (35,249) -- (35,249)
Net proceeds from preferred stock
offering.................................. -- -- -- 28,770
Proceeds from DRSPP........................ -- -- -- 27,840
Proceeds from SES Program.................. -- -- -- 3,248
Proceeds from exercise of stock options.... -- -- -- 108
Payments on notes receivable from
common stock sales........................ 412 -- -- 412
Net loss, 1998............................. -- -- (5,933) (5,933)
Other comprehensive earnings............... -- -- -- 3,380
----------- ----------- ------------- -------------
Balance, December 31, 1998................. (918) (79,176) (9,767) 251,606
Dividends declared ($0.48 per common
share).................................... -- (10,614) -- (10,614)
Dividends declared on preferred shares..... -- (3,290) -- (3,290)
Proceeds from DRSPP........................ -- -- -- 946
Repurchase of common stock................. -- -- -- (9,860)
Exchange of Common Stock for
senior subordinated debt................ -- -- -- (6,431)
Payments on notes receivable from
common stock sales........................ 13 -- -- 13
Net earnings, 1999......................... -- -- 22,317 22,317
Other comprehensive loss................... -- -- -- (5,843)
----------- ----------- ------------- -------------
Balance, December 31, 1999................. $ (905) $ (93,080) $ 12,550 $ 238,844
=========== =========== ============= =============
F-5
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the year ended December 31,
---------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)...................................................... $ 22,317 $ (5,933) $ (16,029)
Adjustments to reconcile net earnings (loss) to net cash provided by
operating activities:
Equity in net (earnings) loss of Impac Funding Corporation.............. (4,292) 13,876 (8,316)
Equity in net loss of Impac Commercial Holdings, Inc.................... -- 998 239
Provision for loan losses............................................... 5,547 4,361 6,843
Buyout of management agreement.......................................... -- -- 44,375
Depreciation and amortization........................................... -- 355 75
Amortization of CMO premiums and deferred securitization costs.......... 18,593 14,358 7,105
Loss on sale of ICH common stock........................................ -- 9,076 --
Net change in accrued interest receivable............................... (1,170) 4,973 (7,749)
Write-down of investment securities available-for-sale.................. 2,037 14,132 --
Gain (loss) on sale of REO.............................................. (2,159) (1,707) 433
Gain on sale of investment securities available-for-sale................ (93) (427) (648)
Net change in other assets and liabilities.............................. 15,059 3,105 (10,707)
-------------- -------------- --------------
Net cash provided by operating activities............................. 55,839 57,167 15,621
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in CMO collateral............................................. 178,519 (385,568) (306,705)
Net change in finance receivables........................................ 113,969 221,100 (161,533)
Net change in mortgage loans held-for-investment......................... (352,603) 225,301 (269,681)
Purchase of investment securities available-for-sale..................... (18,295) (66,329) (12,555)
Sale of investment securities available-for-sale......................... 3,803 15,801 10,285
Issuance of note to IFC.................................................. (14,500) -- --
Principal reductions on investment securities available-for-sale......... 6,985 13,727 (3,244)
Purchase of equity in residual interests in securitizations from IFC..... -- -- (9,338)
Proceeds from sale of other real estate owned............................ 18,027 11,777 7,902
Purchase of premises and equipment....................................... -- (2,489) (3,941)
Contributions to Impac Funding Corporation............................... -- -- (8,910)
Contributions to Impac Commercial Holdings, Inc.......................... -- -- (15,123)
Dividends from investment in Impac Commercial Holdings, Inc.............. -- 1,812 739
-------------- -------------- --------------
Net cash provided by (used in) investing activities................... (64,095) 35,132 (772,104)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in reverse repurchase agreements.............................. 247,395 (431,934) 397,843
Proceeds from CMO borrowings............................................. 298,076 768,012 521,746
Repayment of CMO borrowings.............................................. (519,575) (437,602) (254,352)
Proceeds from preferred stock............................................ -- 28,770 --
Proceeds from public stock offerings, net................................ -- -- 83,120
Dividends paid........................................................... (22,463) (33,491) (23,285)
Repurchase of common stock............................................... (9,860) -- --
Proceeds from sale of common stock issued through DRSPP and SES.......... 946 31,088 24,689
Proceeds from exercise of stock options.................................. -- 108 936
Advances to purchase common stock........................................ 13 412 (610)
-------------- -------------- --------------
Net cash provided by (used in) financing activities................... (5,468) (74,637) 750,087
-------------- -------------- --------------
See accompanying notes to consolidated financial statements.
F-6
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(continued)
(in thousands)
Net change in cash and cash equivalents.................................. (13,724) 17,662 (6,396)
Cash and cash equivalents at beginning of year........................... 33,876 16,214 22,610
------------- -------------- --------------
Cash and cash equivalents at end of year................................. $ 20,152 $ 33,876 $ 16,214
============= ============== ==============
SUPPLEMENTARY INFORMATION:
Interest paid........................................................... $ 88,989 $ 122,904 $ 73,053
NON-CASH TRANSACTIONS:
Exchange of Common Stock for senior subordinated debt................... $ 6,431 $ -- $ --
Sale of Impac Commercial Holdings common stock.......................... -- 6,099 --
Sale of Dove St. building and other assets in exchange for debt......... -- 6,000 --
Accumulated other comprehensive gain (loss)............................. (5,843) 3,380 (2,657)
Gain on sale of subsidiary preferred stock.............................. -- -- 3,840
Issuance of stock to ICAI for termination of management agreement....... -- -- 35,037
Transfer of loans held-for-investment to other real estate owned........ 1,318 7,924 6,780
Transfer of CMO collateral to other real estate owned................... 14,431 4,883 6,451
Dividends declared and unpaid........................................... 3,570 12,129 10,371
See accompanying notes to consolidated financial statements.
F-7
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A--Summary of Business and Significant Accounting Policies
1. Financial Statement Presentation
The operations of the Company have been presented in the consolidated
financial statements for the three-year period ended December 31, 1999 and
include the financial results of Impac Mortgage Holdings, Inc. (IMH), IMH Assets
Corporation (IMH Assets) and Impac Warehouse Lending Group (IWLG) as stand-alone
entities and the financial results of IMH's equity interest in net earnings
(loss) in Impac Funding Corporation (IFC) as a stand-alone entity. The financial
results of IMH's equity interest in net loss in Impac Commercial Holdings, Inc.
(ICH) as a stand-alone entity are presented in the consolidated financial
statements for the two-year period ended December 31, 1998.
The Company is entitled to 99% of the earnings or losses of IFC through its
ownership of all of the non-voting preferred stock of IFC. As such, the Company
records its investment in IFC using the equity method. Under this method,
original investments are recorded at cost and adjusted by the Company's share of
earnings or losses. Certain officers and directors of the Company own all of the
common stock of IFC and are entitled to 1% of the earnings or losses of IFC.
Gain on the sale of loans or securities by IFC to IMH are deferred and accreted
for gain on sale over the estimated life of the loans or securities using the
interest method.
All significant intercompany balances and transactions with IMH's
consolidated subsidiaries have been eliminated in consolidation. Interest income
on affiliated short-term advances, due from affiliates, has been earned at the
rate of 8.00% per annum. Interest expense on affiliated short-term borrowings,
due to affiliates, has been incurred at the rate of 8.00% per annum. Costs and
expenses of affiliates have been charged to ICH in proportion to services
provided per the submanagement agreement between FIC Management Inc. (FIC), an
affiliate of Fortress Partners LP (Fortress), IMH and IFC, not to exceed an
annual fee of $250,000. Certain amounts in the prior periods' consolidated
financial statements have been reclassified to conform to the current
presentation.
Management of the Company 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 generally accepted
accounting principles. Actual results could differ from those estimates.
2. Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents consists of cash and money market mutual funds. The Company
considers investments with maturities of three months or less at date of
acquisition to be cash equivalents.
3. Investment Securities Available-for-Sale
The Company classifies investment and mortgage-backed securities as
held-to-maturity, available-for-sale, and/or trading securities. Held-to-
maturity investment and mortgage-backed 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. The Company's investment securities are held as available-for-sale,
reported at fair value with unrealized gains and losses reported as a separate
component of stockholders' equity. Gains and losses on sale of investment
securities available-for-sale are based on the specific identification method.
As the Company qualifies as a Real Estate Investment Trust (REIT), and no income
taxes are paid, the unrealized gains and losses are reported gross in
stockholders' equity. 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. Such investments may subject
the Company to credit, interest rate and/or prepayment risk.
F-8
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The Company determines the decline in fair value to be other than temporary
if the present value of estimated future cash flows discounted at a risk-free
rate is less than the amortized cost basis of the security. In that event, the
cost basis of the security is written down to fair value as a new cost basis and
the amount of the write down is included in earnings.
IMH purchases a large portion of the residuals created by IFC's
securitizations recorded at IFC as a result of the sale of mortgage loans
through securitizations. IFC sells a portfolio of mortgage loans to a special
purpose entity that has been established for the limited purpose of buying and
reselling the mortgage loans. IFC then transfers the same mortgage loans to a
special purpose entity or owners trust (the Trust). The Trust issues interest-
bearing asset-backed securities generally in an amount equal to the aggregate
principal balance of the mortgage loans. IFC typically sells these certificates
at face value and without recourse except that representations and warranties
customary to the mortgage banking industry are provided by IFC. IMH or other
investors purchase these certificates from the Trust and the proceeds from the
sale of the certificates are used as consideration to purchase the underlying
mortgage loans from the Company. In addition, IFC may provide a credit
enhancement for the benefit of the investors in the form of additional
collateral held by the Trust. The over-collateralization account is required to
be maintained at specified levels.
To determine the value of the securities, the Company must estimate future
rates of prepayments, prepayment penalties to be received by the Company,
delinquencies, defaults and default loss severity and their impact on estimated
cash flows. At December 31, 1999, the Company used a 0.50% to 9% constant
default rate estimate with a 1% to 20% severity resulting in loss estimates of
0% to 5%. These estimates are based on historical loss data for comparable
loans. The Company estimates prepayments by evaluating historical prepayment
performance of comparable mortgage loans and trends in the industry. At December
31, 1999, the Company used a constant prepayment assumption of 12% to 31% to
estimate the prepayment characteristics of the underlying collateral.
The Company determines the estimated fair value of the residuals by
discounting the expected cash flows using a discount rate, which it believes is
commensurate with the risks involved. At December 31, 1999, the Company used a
weighted average discount rate of approximately 12.7%.
4. CMO Collateral and Mortgage Loans Held-for-Investment
The Company purchases non-conforming mortgage loans to be held as long-term
investment or as Collateral Mortgage Obligations (CMOs) collateral. Mortgage
loans held-for-investment and CMO collateral are recorded at cost at the date of
purchase. Mortgage loans held-for-investment and CMO collateral include various
types of fixed and adjustable rate loans secured by mortgages on single-family
residential real estate properties and fixed rate loans secured by second trust
deeds on single-family residential real estate properties. Premiums and
discounts, which may result from the purchase or acquisition of mortgage loans
in excess of the outstanding principal balance, are amortized to interest income
over their estimated lives using the interest method as an adjustment to the
carrying amount of the loan. Prepaid securitization costs related to the
issuance of CMOs are amortized to interest expense over their estimated lives
using the interest method. Mortgage loans are continually evaluated for
collectibility and, if appropriate, the mortgage loans may be placed on non-
accrual status, generally when the mortgage is 90 days past due, and previously
accrued interest reversed from income. Other than temporary impairment in the
carrying value of mortgage loans held-for-investment, if any, will be recognized
as a reduction to current operations.
5. Finance Receivables
Finance receivables represent transactions with customers, including
affiliated companies, involving residential real estate lending. As a warehouse
lender, the Company 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 default and bankruptcy. Any claim of the Company
as a secured lender in a bankruptcy proceeding may be subject to adjustment
F-9
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
and delay. The Company's finance receivables represent warehouse lines of credit
with mortgage banking companies collateralized by mortgage loans on single
family residences. Finance receivables are stated at the principal balance
outstanding. Interest income is recorded on the accrual basis in accordance with
the terms of the loans. Finance receivables are continually evaluated for
collectibility and, if appropriate, the receivable is placed on non-accrual
status, generally when 90 days past due. Future collections of interest income
are included in interest income or applied to the loan balance based on an
assessment of the likelihood that the loans will be repaid.
6. Allowance for Loan Losses
The Company maintains an allowance for losses on mortgage loans held-for-
investment, collateral for CMOs, and finance receivables at an amount which it
believes is sufficient to provide adequate protection against future losses in
the mortgage loans portfolio. The allowance for losses is determined primarily
on management's judgment of net loss potential including specific allowances for
known impaired loans, changes in the nature and volume of the portfolio, value
of the collateral and current economic conditions that may affect the borrowers'
ability to pay. A provision is recorded for loans deemed to be uncollectible
thereby increasing the allowance for loan losses. Subsequent recoveries on
mortgage loans previously charged off are credited back to the allowance.
7. Premises and Equipment
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 (three
to twenty years).
8. CMO Borrowings
The Company issues CMOs, which are primarily secured by non-conforming
mortgage loans on single-family residential real property, as a means of
financing its Long-Term Investment Operations. CMOs are carried at their
outstanding principal balances including accrued interest on such obligations.
For accounting and tax purposes, mortgage loans financed through the issuance of
CMOs are treated as assets of the Company and the CMOs are treated as debt of
the Company. Each issue of CMOs is fully payable from the principal and interest
payments on the underlying mortgage loans collateralizing such debt and any
investment income on such collateral. The Company's 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. 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 mortgage loans.
9. Income Taxes
IMH operates so as to qualify as a REIT under the requirements of the
Internal Revenue Code (the Code). Requirements for qualification as a REIT
include various restrictions on ownership of IMH's stock, requirements
concerning distribution of taxable income and certain restrictions on the nature
of assets and sources of income. A REIT must distribute at least 95% of its
taxable income to its stockholders, the distribution of which 85% must be
distributed within the taxable year in order to avoid the imposition of an
excise tax and the remaining balance may extend until timely filing of its tax
return in its subsequent taxable year. Qualifying distributions of its taxable
income are deductible by a REIT in computing its taxable income. If in any tax
year IMH should not qualify as a REIT, it would be taxed as a corporation and
distributions to the stockholders would not be deductible in computing taxable
income. If IMH were to fail to qualify as a REIT in any tax year, it would not
be permitted to qualify for that year and the succeeding four years.
F-10
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
10. Net Earnings (Loss) per Share
Basic net earnings per share are computed on the basis of the weighted
average number of shares outstanding for the year divided by net earnings for
the year. Diluted net earnings per share are computed on the basis of the
weighted average number of shares and common equivalent shares outstanding for
the year divided by net earnings for the year.
11. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
133). SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognizes all derivatives as either assets or
liabilities in the statement of financial position and measures those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment, (b)
a hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) 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. This statement is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. SFAS 133
was amended by SFAS No. 137, which allows deferral of SFAS 133 for all fiscal
quarters of fiscal years beginning after July 15, 2000. Management is evaluating
the impact of implementation of SFAS 133 on the Company's financial position and
results of operations.
Note B--Investment Securities Available-for-Sale
The Company's mortgage-backed securities are primarily secured by
conventional, one-to-four family mortgage loans. The yield to maturity on each
security depends on, among other things, the rate and timing of principal
payments, including prepayments, repurchases, defaults and liquidations, the
pass-through rate, and interest rate fluctuations. The Company's interest in
these securities is subordinated so that, in the event of a loss, payments to
senior certificate holders will be made before the Company receives its
payments. At December 31, 1999 and 1998, the Company's investment securities
available-for-sale included $87.6 million and $88.1 million, respectively, of
subordinated securities collateralized by mortgages and $5.6 million and $5.4
million, respectively, of subordinated securities collateralized by other loans.
In connection with the issuance of REMICs by IFC during the years ended
December 31, 1999 and 1998 of $360.1 million and $907.5 million, respectively,
IMH purchased $18.3 million and $23.4 million, respectively, of securities as
regular interests and none and $37.2 million, respectively, of "interest-only"
securities. During 1999, the Company recorded $3.7 million in discounts, at the
time of purchase, in connection with the purchase of the mortgage-backed
securities. The amortized cost and estimated fair value of mortgage-backed
securities available-for-sale and other collateralized securities available-for-
sale are summarized as follows:
F-11
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gain Loss Fair Value
-------------- -------------- -------------- --------------
(in thousands)
At December 31, 1999:
Mortgage-backed securities..................................... $ 94,986 $ 1,235 $ 8,007 $ 88,214
Other collateralized securities................................ 5,633 -- 641 4,992
-------------- -------------- -------------- --------------
$ 100,619 $ 1,235 $ 8,648 $ 93,206
============== ============== ============== ==============
At December 31, 1998:
Mortgage-backed securities..................................... $ 89,825 $ 2,560 $ 4,296 $ 88,089
Other collateralized securities................................ 5,397 -- -- 5,397
-------------- -------------- -------------- --------------
$ 95,222 $ 2,560 $ 4,296 $ 93,486
============== ============== ============== ==============
Note C--Mortgage Loans Held-for-Investment
Mortgage loans held-for-investment include various types of adjustable rate
loans secured by mortgages on single-family residential real estate properties
and fixed rate loans secured by second trust deeds on single-family residential
real estate properties. During the years ended December 31, 1999 and 1998, IMH
purchased $638.3 million and $866.7 million, respectively, of mortgage loans
from IFC. At December 31, 1999 and 1998, approximately 64% and 39%,
respectively, of mortgage loans held-for-investment were collateralized by
properties located in California. Mortgage loans held-for-investment consisted
of the following:
At December 31,
------------------------------------
1999 1998
---------------- --------------
(in thousands)
Adjustable rate loans secured by single-family residential real estate............. $ 335,609 $ 20,145
Fixed rate loans secured by second trust deeds on single-family residential real
estate............................................................................ 25,785 --
Unamortized net premiums on mortgage loans......................................... 2,041 482
---------------- --------------
$ 363,435 $ 20,627
================ ==============
At December 31, 1999, 1998 and 1997, there were $8.3 million, $7.3 million
and $6.4 million, respectively, of mortgage loans held-for-investment which were
not accruing interest due to the delinquent nature of the mortgage loans. If
interest on such loans had been accrued for the years ended December 31, 1999,
1998 and 1997, interest income would have increased by $538,000, $724,000 and
$299,000, respectively.
Note D--CMO Collateral
CMO collateral includes various types of fixed and adjustable rate loans
secured by mortgages on single-family residential real estate properties and
fixed rate loans secured by second trust deeds on single-family residential real
estate properties. During the years ended December 31, 1999 and 1998, $298.1
million and $768.0 million, respectively, of CMOs were issued and collateralized
by $316.2 million and $788.2 million, respectively, of mortgage loans. At
December 31, 1999 and 1998, approximately 43% of CMO collateral was
collateralized by properties located in California. At December 31, 1999 and
1998, the underlying principal balance of mortgages supporting CMO borrowings of
$850.8 million and $1.1 billion, respectively, represented approximately $827.3
million and $1.1 billion, respectively, of adjustable and fixed rate mortgage
loans with varying grade quality and approximately $81.7 million and $24.2
million, respectively, of second mortgage loans. Collateral for CMOs consisted
of the following:
F-12
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
At December 31,
------------------------------------
1999 1998
---------------- -----------------
(in thousands)
Adjustable and fixed rate loans secured by single-family residential real estate... $ 827,268 $ 1,085,388
Fixed rate loans secured by second trust deeds on single-family residential real
estate............................................................................ 81,718 24,189
Unamortized net premiums on loans.................................................. 28,798 39,369
Securitization expenses............................................................ 11,893 12,274
---------------- -----------------
$ 949,677 $ 1,161,220
================ =================
Note E--Finance Receivables
The terms of IWLG's affiliated warehouse lines are based on Bank of America's
prime rate, which was 8.50% and 7.75% as of December 31, 1999 and 1998,
respectively, with advance rates between 90% and 98% of the fair value of the
mortgage loans outstanding. The terms of IWLG's non-affiliated warehouse lines,
including the maximum warehouse line amount and interest rate, are determined
based upon the financial strength, historical performance and other
qualifications of the borrower. The warehouse lines have maturities that range
from on-demand to one year and are generally collateralized by mortgages on
single-family residential real estate.
At December 31, 1999 and 1998, the Company had $1.4 billion and $813.1
million, respectively, of warehouse lines of credit available to 49 and 32
borrowers, respectively, of which $197.1 million and $311.6 million,
respectively, was outstanding. IWLG finances its Warehouse Lending Operations
through reverse repurchase agreements and equity. Finance receivables consisted
of the following:
At December 31,
------------------------------------
1999 1998
---------------- -----------------
(in thousands)
Due from IFC..................................................................... $ 66,125 $ 192,900
Due from Impac Commercial Capital Corporation.................................... -- 3,642
Due from Walsh Securities, Inc................................................... 48 1,544
Due from Impac Lending Group (ILG)............................................... 1,243 --
Due from other mortgage banking companies........................................ 129,703 113,485
---------------- -----------------
$ 197,119 $ 311,571
================ =================
Note F--Allowance for loan losses
Activity for allowance for loan losses was as follows:
For the year ended December 31,
1999 1998 1997
-------------- -------------- --------------
(in thousands)
Balance, beginning of year............................................ $ 6,959 $ 5,129 $ 4,384
Provision for loan losses............................................. 5,547 4,361 6,843
Charge-offs, net of recoveries........................................ (7,152) (1,711) (4,748)
Loss on sale of delinquent loans...................................... (1,325) (820) (1,350)
-------------- -------------- --------------
Balance, end of year.................................................. $ 4,029 $ 6,959 $ 5,129
============== ============== ==============
F-13
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Note G--Reverse repurchase agreements
The Company entered into reverse repurchase agreements with major brokerage
firms to finance its Warehouse Lending Operations and to fund the purchase of
mortgage loans and mortgage-backed securities. Mortgage loans and mortgage-
backed securities underlying reverse repurchase agreements are delivered to
dealers that arrange the transactions. The Company's reverse repurchase
agreements are uncommitted lines, which may be withdrawn at any time by the
lender, with interest rates that range from one-month LIBOR plus 0.85% to 2.00%
depending on the type of collateral provided.
Prior to October of 1999, the Company used reverse repurchase agreements to
fund the purchase of its mortgage-backed securities and to provide the Company
additional working capital. In October of 1999, the Company repaid its
borrowings of reverse repurchase agreements secured by mortgage-backed
securities with proceeds from the re-securitization of a portion of its
mortgage-backed securities portfolio (see Note I-Borrowings Secured by
Investment Securities Available-for-Sale). The Company's interest expense on
reverse repurchase agreements for the years ended December 31, 1999 and 1998 was
$22.5 million and $42.1 million, respectively. The following tables set forth
information regarding the Company's reverse repurchase agreements (in
thousands):
At December 31, 1999
-----------------------------------------------------------------------------------------------
Reverse
Type of Commitment Repurchase Underlying Maturity
Collateral Committed Amount Liability Collateral Date
-------------- ------------ ------------- -------------- ------------ -------------
Lender 1........................ Mortgages No $ 536,112 $ 536,112 $ 547,408 N/A
Lender 2........................ Mortgages No 3,575 3,575 3,956 N/A
------------- -------------- ------------
$ 539,687 $ 539,687 $ 551,364
============= ============== ============
At December 31, 1999
-----------------------------------------------------------------------------------------------
Reverse
Type of Commitment Repurchase Underlying Maturity
Collateral Committed Amount Liability Collateral Date
-------------- ------------ ------------- -------------- ------------ -------------
Lender 1........................ Mortgages No $ 299,567 $ 299,567 $ 313,338 N/A
Lender 2........................ Securities Yes 10,017 10,017 30,595 12/29/99
Lender 3........................ Securities Yes 7,876 7,876 18,578 1/21-3/26/99(1)
Lender 4........................ Securities Yes 3,632 3,632 12,189 1/05/99(1)
Lender 5........................ Securities Yes 2,533 2,533 8,715 1/15/99(1)
------------- -------------- ------------
$ 323,625 $ 323,625 $ 383,415
============= ============== ============
____________
(1) Upon expiration, these reverse repurchase agreements were renewed.
At December 31, 1999 and December 31, 1998, reverse repurchase agreements
includes accrued interest payable of $3.7 million and $2.0 million,
respectively. The following table presents certain information on reverse
repurchase agreements, excluding accrued interest payable:
For the year ended
December 31,
--------------------------------------
1999 1998
-------------------- --------------
(dollars in thousands)
Maximum month-end outstanding balance............................................. $ 569,862 $ 912,444
Average balance outstanding....................................................... 346,556 631,537
Weighted average rate............................................................. 6.51% 6.67%
F-14
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Note H--CMO Borrowings
The Company's CMOs are guaranteed for the holders by a mortgage loan insurer
giving the CMOs the highest rating established by a nationally recognized rating
agency. Each issue of CMOs is fully payable from the principal and interest
payments on the underlying mortgage loans collateralizing such debt, any cash or
other collateral required to be pledged as a condition to receiving the desired
rating on the debt, and any investment income on such collateral. The Long-Term
Investment Operations earns the net interest spread between the interest income
on the mortgage loans securing the CMOs and the interest and other expenses
associated with the CMO financing. Interest expense includes the amortization of
securitization costs. The net interest spread may be directly impacted by
prepayment levels of the underlying mortgage loans, and, to the extent each CMO
class has variable rates of interest, may be affected by changes in short-term
interest rates. Variable rate CMOs are typically structured as one-month LIBOR
"floaters." Interest on variable and fixed rate CMOs is payable to the
certificate holders monthly. For the years ended December 31, 1999, 1998 and
1997, interest expense on CMO borrowings was $65.2 million, $76.3 million $36.7
million, respectively. The following table sets forth CMOs issued by the
Company, CMOs outstanding as of December 31, 1999 and 1998, and certain interest
rate information (dollars in millions):
Range of Interest Range of
CMOs Range of Interest Rate Rate Interest Rate
Outstanding Fixed Margins Over Margin Margins After
Issue Issuance As of Interest One-Month Adjustment Adjustment
------------------------
Date Issuance Name Amount 12/31/99 12/31/98 Rates LIBOR Date Date
- -------- --------------------- ---------- ---------- ---------- -------- ------------- --------- -----------
4/22/96 Fund America Investors
Trust V............... $ 296.3 $ 41.7 $ 79.2 N/A 0.50% 6/2003 1.00%
8/27/96 Impac CMB
Trust Series 1996-1... 259.8 37.1 64.6 N/A 0.32% 10/2003 1.32%
5/22/97 Impac CMB
Trust Series 1997-1... 348.0 68.5 168.9 N/A 0.22% 7/2004 0.44%
12/10/97 Impac CMB 0.26% 0.52%
Trust Series 1997-2... 173.7 43.6 120.9 N/A to 1.30% 1/2005 to 2.60%
1/27/98 Impac CMB 6.65%
Trust Series 1998-1... 362.8 179.6 283.7 to 7.25% N/A N/A N/A
3/24/98 Impac CMB 6.70%
Trust Series 1998-2... 220.2 120.7 190.4 to 7.25% N/A N/A N/A
6/23/98 Impac CMB 0.18% 0.36%
Trust Series 1998-3... 185.0 94.8 161.6 N/A to 1.24% 7/2005 to 2.48%
2/23/99 Impac CMB 10.00% 2.88%
Trust Series 1999-1... 183.1 154.4 -- to 18.25% to 7.40% N/A N/A
6/24/99 Impac CMB 3.00%
Trust Series 1999-2... 115.0 108.3 -- N/A to 8.50% N/A N/A
-------- -------- ----------
2,143.9 848.7 1,069.3
Accrued interest...... -- 2.1 3.0
-------- --------- ----------
$2,143.9 $ 850.8 $ 1,072.3
======== ======== ==========
Note I--Borrowings Secured by Investment Securities Available-for-Sale
In October 1999, the Company completed a re-securitization of its investment
securities available-for-sale, which raised additional cash liquidity for the
Company of approximately $23.4 million after repaying reverse repurchase
agreements collateralized by the investment securities available-for-sale. As of
December 31, 1999, there was $31.3 million outstanding on the borrowings, which
were secured by $49.6 of mortgage-backed securities available-for-sale.
F-15
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The outstanding borrowings are principal only notes issued at a discount. The
notes represent senior or subordinated interests in trust funds primarily
consisting of a pool of mortgage loans and are non-recourse obligations of the
Company. The terms of the notes are dependent on the cash flows from the
underlying certificates.
Note J--Senior Subordinated Debentures
In March 1999, certain stockholders of the Company exchanged 1,359,507 shares
of their common stock, at an average price of $5.70 per share, for 11% senior
subordinated debentures due to mature on February 15, 2004. The debentures are
unsecured obligations of the Company subordinated to all indebtedness of the
Company's subsidiaries. The debentures bear interest at 11% per annum from their
date of issuance, payable quarterly, commencing May 15, 1999, until the
debentures are paid in full. The debentures mature on February 15, 2004, at
which the date may be extended once by the Company to a date not later than May
15, 2004, provided that the Company satisfies certain conditions. Commencing on
February 15, 2001, the debentures are redeemable, at the Company's option, in
whole at any time or in part from time to time, at the principal amount to be
redeemed plus accrued and unpaid interest thereon to the redemption date.
Note K--Segment Reporting
The basis for the Company's segments is to separate its entities as follows:
segments that derive income from investment in long-term Mortgage Assets,
segments that derive income by providing short-term financing and segments that
derive income from the purchase and sale or securitization of mortgage loans.
The Company internally reviews and analyzes its segments as follows:
. The Long-Term Investment Operations, conducted by IMH and IMH Assets,
invests primarily in non-conforming residential mortgage loans and
mortgage-backed securities secured by or representing interests in
such loans and in second mortgage loans.
. The Warehouse Lending Operations, conducted by IWLG, provides
warehouse and repurchase financing to affiliated companies and to
approved mortgage banks, most of which are correspondents of IFC, to
finance mortgage loans.
. The Conduit Operations, conducted by IFC, purchases non-conforming
mortgage loans and second mortgage loans from its network of third
party correspondents and other sellers.
The following table shows the Company's reporting segments as of and for the
year ended December 31, 1999 (in thousands):
Long-Term Warehouse
Investment Lending (b) (c)
Operations Operations Other Eliminations Consolidated
-------------- -------------- ------------ ---------------- ----------------
Balance Sheet Items:
- --------------------
CMO collateral $ 949,677 $ -- $ -- $ -- $ 949,677
Total assets 1,545,283 588,448 2,945 (461,246) 1,675,430
Total stockholders' equity 294,852 48,684 -- (104,692) 238,844
Income Statement Items:
- -----------------------
Interest income 91,965 31,998 21 (4,526) 119,458
Interest expense 72,704 21,612 5 (4,526) 89,795
Equity in IFC (a) 4,292 -- -- -- 4,292
Net earnings 6,828 9,939 41 5,509 22,317
F-16
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The following table shows the Company's reporting segments as of and for
the year ended December 31, 1998 (in thousands):
Long-Term Warehouse
Investment Lending (b) (c)
Operations Operations Other Eliminations Consolidated
------------ ---------- -------- ------------ ------------
Balance Sheet Items:
- -------------------
CMO collateral $ 1,161,220 $ -- $ -- $ -- $ 1,161,220
Total assets 1,410,019 338,365 3,418 (86,298) 1,665,504
Total stockholders' equity 277,868 38,745 615 (65,622) 251,606
Income Statement Items:
- ----------------------
Interest income 121,271 57,500 358 (15,471) 163,658
Interest expense 95,095 41,903 168 (15,471) 121,695
Depreciation and amortization 11 -- 344 -- 355
Equity in IFC (a) (13,876) -- -- -- (13,876)
Net earnings (loss) (6,369) 15,057 560 (15,181) (5,933)
The following table shows the Company's reporting segments as of and for
the year ended December 31, 1997 (in thousands):
Long-Term Warehouse
Investment Lending (b) (c)
Operations Operations Other Eliminations Consolidated
------------ ---------- -------- ------------ ------------
Balance Sheet Items:
- -------------------
CMO collateral $ 794,893 $ -- $ -- $ -- $ 794,893
Total assets 1,287,200 766,844 19,872 (321,104) 1,752,812
Total stockholders' equity 255,729 23,688 3,889 (54,276) 229,030
Income Statement Items:
- ----------------------
Interest income 72,092 52,643 -- (15,202) 109,533
Interest expense 53,607 38,172 -- (15,202) 76,577
Depreciation and amortization 10 -- 65 -- 75
Equity in IFC (a) 8,316 -- -- -- 8,316
Net earnings (loss) (38,279) 14,527 27 7,696 (16,029)
________________
(a) The Conduit Operations is accounted for using the equity method and is
an unconsolidated subsidiary of the Company.
(b) Primarily includes the operations of Dove, of which the Company owned
a 50% interest, and account reclassifications.
(c) Elimination of intersegment balance sheet and income statement items.
Note L--Fair Value of Financial Instruments
The estimated fair value amounts have been determined by IMH using
available market information and appropriate valuation methodologies, however,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented are
not necessarily indicative of the amounts IMH could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
F-17
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
December 31, 1999 December 31, 1998
-------------------------------- ---------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------------- ------------- -------------- --------------
Assets (in thousands)
------
Cash and cash equivalents................................... $ 20,152 $ 20,152 $ 33,876 $ 33,876
Investment securities available-for-sale.................... 93,206 93,206 93,486 93,486
CMO collateral.............................................. 949,677 938,784 1,161,220 1,185,188
Finance receivables......................................... 197,119 197,119 311,571 311,571
Mortgage loans held-for-investment.......................... 363,435 366,066 20,627 20,627
Due from affiliates......................................... 14,500 14,500 17,904 17,904
Interest rate caps.......................................... 1,925 2,091 -- --
Liabilities
-----------
CMO borrowings, excluding accrued interest.................. 848,756 844,852 1,069,323 1,071,375
Reverse-repurchase agreements, excluding accrued interest... 535,990 535,990 321,667 321,667
Borrowings secured by investment securities
available-for-sale...................................... 31,333 34,393 -- --
Senior subordinated debentures.............................. 6,691 6,198 -- --
Due to affiliates........................................... 2,945 2,945 2,670 2,670
Short-term commitments to extend credit..................... -- -- -- --
The fair value estimates as of December 31, 1999 and 1998 are based on
pertinent information available to management as of that date. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these consolidated financial statements since those
dates and, therefore, current estimates of fair value may differ significantly
from the amounts presented.
The following describes the methods and assumptions used by IMH in
estimating fair values:
Cash and Cash Equivalents
Fair value approximates carrying amounts as these instruments are demand
deposits and money market mutual funds and do not present unanticipated interest
rate or credit concerns.
Investment Securities Available-for-Sale
Fair value is estimated using a bond model, which incorporates certain
assumptions such as prepayment, yield and losses.
CMO Collateral
Fair value is estimated based on quoted market prices from dealers and
brokers for similar types of mortgage loans.
Finance Receivables
Fair value approximates carrying amounts due to the short-term nature of
the assets and do not present unanticipated interest rate or credit concerns.
F-18
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Mortgage Loans Held-for-Investment
Fair value is estimated based on estimates of proceeds the Company would
receive from the sale of the underlying collateral of each loan.
Due From / To Affiliates
Fair value approximates carrying amount because of the short-term maturity
of the liabilities and does not present unanticipated interest rate or credit
concerns.
CMO Borrowings
Fair value of fixed rate borrowings is estimated based on the use of a bond
model, which incorporates certain assumptions such as prepayment, yield and
losses. Fair value of variable rate borrowings approximate carrying amount
because of the variable interest rate nature of the borrowings.
Reverse Repurchase Agreements
Fair value approximates carrying amounts due to the short-term nature of
the liabilities and do not present unanticipated interest rate or credit
concerns.
Borrowings Secured by Investment Securities Available-for-Sale
Fair value is estimated based on quoted market prices from dealers or
brokers.
Senior Subordinated Debt
Fair value is estimated based on quoted market price from dealers or
brokers.
Interest Rate Caps
Fair value is estimated based on quoted market prices from dealers or
brokers.
Short-term Commitments to Extend Credit
The Company does not collect fees associated with its warehouse lines of
credit. Accordingly, these commitments do not have an estimated fair value.
Note M--Employee Benefit Plans
Profit Sharing and 401(k) Plan
The Company does not have its own 401(K) or profit sharing plan. As such,
employees of the Company participate in Imperial Credit Industries, Inc's.
(ICII) 401(K) plan. Under ICII's 401(K) plan, employees of the Company may
contribute up to 14% of their salaries. The Company will match 50% of the first
4% of employee contributions. Additional Company contributions may be made at
the discretion of the Company. The Company's matching and discretionary
contributions were not material for any period presented.
F-19
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Note N--Related Party Transactions
Related Party Cost Allocations
In 1995, IMH entered into a services agreement with ICII under which ICII
provided various services to the Company, including data processing, human
resource administration, general ledger accounts, check processing, remittance
processing and payment of accounts payable. ICII charged fees for each of the
services based upon usage. As part of the services provided, ICII provided the
Company with insurance coverage and self-insurance programs, including health
insurance. This services agreement was replaced with a new ICAI services
agreement in December 1997, in connection with termination of the Company's
management agreement with ICAI. Pursuant to the services agreement with ICAI,
ICAI provides the Company certain human resource administration and data and
phone communication services. The charge to the Company for insurance coverage
is based upon a pro rata portion of the costs to ICII for its various policies.
Total charges to the Company for the years ended December 31, 1999, 1998 and
1997 were $11,000, $13,000, and $8,000, respectively.
During 1999 and 1998, IMH and IWLG were allocated data processing,
executive and operations management, and accounting services that IFC incurred
during the normal course of business per the Company's submanagement agreement
with RAI Advisors Inc. (RAI). IFC, through RAI, charged IMH and IWLG for
management and operating services based upon usage which management believes was
reasonable. In May 1999, the submanagement agreement with RAI was terminated and
IFC entered into a new submanagement agreement with FIC Management, Inc.,
pursuant to which IFC provides services to Impac Commercial Holdings, Inc.
(ICH). Prior to the submanagement agreement with RAI and after RAI was
terminated, IMH and IWLG were allocated data processing, executive and
operations management, and accounting services that IFC incurred during the
normal course of business. IFC charged IMH and IWLG for management and operating
services based upon usage which management believes was reasonable. Total cost
allocations charged by IFC to IMH and IWLG for the years ended December 31,
1999, 1998 and 1997 were $1.2 million, $968,000 and $385,000, respectively.
Lease Agreement: IMH and IFC entered into with ICH a premises operating
sublease agreement (see Note O--Commitments and Contingencies) to rent
approximately 74,000 square feet of office space in Newport Beach, California,
for a ten-year term, which expires in May 2008. IMH and IFC pay monthly rental
expenses and allocate the cost to subsidiaries and affiliated companies on the
basis of square footage occupied.
The majority of occupancy charges incurred were paid by IFC as most of the
Company's employees are employed by the Conduit Operations. Total rental expense
for the years ended December 31, 1999, 1998 and 1997 were $1.1 million, $1.3
million and $396,000, of which $1.0 million, $1.2 million and $385,000 was paid
by IFC, respectively.
Credit Arrangements - Current
IWLG maintains a warehouse financing facility with IFC. Advances under such
warehouse facilities bear interest at Bank of America's prime rate. As of
December 31, 1999 and 1998, finance receivables outstanding to IFC were $66.1
million and $192.9 million, respectively. Interest income recorded by IWLG
related to finance receivables due from IFC for the years ended December 31,
1999, 1998, and 1997, was $18.4 million, $32.7 million, and $33.5 million,
respectively.
IWLG maintains a warehouse financing facility with ILG. Advances under such
warehouse facilities bear interest at prime plus 1.50% rate. As of December 31,
1999, amounts outstanding on ILG's warehouse line with IWLG were $1.2 million.
Interest expense recorded by ILG related to warehouse lines with IWLG for the
year ended December 31, 1999 was $293,000. There were no borrowings prior to
1999.
F-20
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
IWLG maintains a warehouse financing facility with WSI, a firm affiliated
with James Walsh, a Director of the Company. Advances under the line of credit
bear interest at a rate determined at the time of each advance. As of December
31, 1999, 1998 and 1997, finance receivables outstanding to WSI were $48,000,
$798,000 and $5.9 million, respectively. Interest income recorded by IWLG
related to finance receivables due from WSI for the years ended December 31,
1999, 1998 and 1997 was $729,000, $699,000 and $255,000, respectively.
During the normal course of business, the Company may advance or borrow
funds on a short-term basis with affiliated companies. Advances to affiliates
are reflected as "Due from affiliates", while borrowings are reflected as "Due
to affiliates" on the Company's balance sheet. These short-term advances and
borrowings bear interest at a fixed rate of 8.00% per annum. As of December 31,
1999 and 1998, due from affiliates was none and $17.9 million, respectively.
Interest income recorded by the Company related to short-term advances due from
affiliates for the years ended December 31, 1999 and 1998 was $835,000 and $2.4
million, respectively. As of December 31, 1999 and 1998, due to affiliates was
$2.9 million and $2.7 million, respectively. Interest expense recorded by the
Company related to short-term borrowings due to affiliates for the years ended
December 31, 1999 and 1998 was $399,000 and $2.7 million, respectively.
Indebtedness of Management. In connection with the exercise of stock
options by certain directors and employees of the Company, the Company made
loans secured by the related stock. The loans were made for a five-year term
with a current interest rate of 5.63%. Interest on the loans is payable
quarterly upon receipt of the dividend payment and the interest rate is set
annually by the compensation committee. At each dividend payment date, 50% of
excess quarterly stock dividends, after applying the dividend payment to
interest due, is required to reduce the principal balance outstanding on the
loans. The interest rate on these loans adjusts annually at the discretion of
the Board of Directors. As of December 31, 1999 and 1998, total notes receivable
from common stock sales was $905,000 and $918,000, respectively. Interest income
recorded by the Company related to the loans for the years ended December 31,
1999, 1998 and 1997 was $41,000, $60,000 and $68,000, respectively.
Credit Arrangements - Expired
IMH maintained an uncommitted warehouse line agreement with ICCC. The
margins on the warehouse line agreement were at 8% of the fair market value of
the collateral provided. Advances under such warehouse facilities bore interest
at Bank of America's prime rate. As of December 31, 1999 and 1998, finance
receivables outstanding to ICCC were none and $3.6 million, respectively.
Interest income recorded by IMH related to finance receivables due from ICCC for
the years ended December 31, 1999 and 1998 was $93,000 and $785,000,
respectively.
IMH entered into a revolving credit arrangement with a commercial bank
which was an affiliate of ICII, whereby IMH could borrow up to maximum amount of
$10.0 million for general working capital needs. The revolving credit agreement
was converted to a reverse repurchase agreement in October 1998. Advances under
the reverse repurchase agreement were at an interest rate of LIBOR plus 2.00%,
with interest paid monthly. As of December 31, 1999 and 1998, IMH's outstanding
borrowings under the reverse repurchase arrangement were none and $10.0 million,
respectively. Interest expense recorded by IMH for the year ended December 31,
1999 and 1998 related to such advances was $348,000 and $202,000, respectively.
During 1997, IWLG extended loans of $5.1 million to WSI at rates ranging
from prime plus 2% per annum to prime plus 4% per annum. As of December 31, 1999
and 1998, WSI had an aggregate of none and $746,000, respectively, outstanding
on the loans. Interest income recorded by IWLG related to loans due from WSI for
the years ended December 31, 1999 and 1998 was $20,000 and $254,000,
respectively.
Termination of Management Agreement: As part of the Company's termination
agreement of its Management Agreement with ICAI, the Company purchased the
equity in residual interests in securitizations from IFC for $9.0 million and
simultaneously retired IFC's borrowings with the Company for the equity in
residual interests in
F-21
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
securitizations for $9.0 million. No gain or loss on the sale of residual
interests in securitizations was recorded by the Company or IFC.
Transactions with IFC
Purchase of Mortgage-Backed Securities: During the years ended December 31,
1999 and 1998, the Company purchased $22.0 million and $60.6 million,
respectively, of mortgage-backed securities issued by IFC for $18.3 million and
$56.1 million, respectively, net of discounts of $3.7 million and $4.5 million,
respectively. IFC issued mortgage-backed securities during 1999 and 1998 in
connection with its REMIC securitizations.
Purchase of Mortgage Loans: During the years ended December 31, 1999 and
1998, the Company purchased from IFC mortgage loans having a principal balance
of $637.4 million and $842.9 million, respectively. The loans were purchased
with premiums of $877,000 and $23.9 million, respectively. Servicing rights on
all mortgages purchased by IMH were retained by IFC.
Sale of Mortgage Loans: During the year ended December 31, 1999 and 1998,
the Company sold to IFC mortgage loans having a principal balance of $10.8
million and $170.4 million, respectively, with premiums of $294,000 and $7.7
million, respectively.
Sale of Franchise Loans Receivables: In April 1998, IMH sold the beneficial
interest in the Class A Trust Certificate for the Franchisee Loan Receivables
Trust 1995-B Franchise Loans Receivables and the beneficial interest in the
Class E Trust Certificate for the Franchisee Loan Receivables Trust 1996-B to
IFC at carrying value which approximated fair value. No gain or loss was
recorded on the sale and IMH was under no obligation to sell the securities.
Sub-Servicing Agreement: IFC acts as a servicer of mortgage loans acquired
on a "servicing-released" basis by the Company in its Long-Term Investment
Operations pursuant to the terms of a Servicing Agreement, which became
effective on November 20, 1995. IFC subcontracts all of its servicing
obligations under such loans to independent third parties pursuant to sub-
servicing agreements.
Advances: During 1999, IMH advanced $14.5 million in cash to IFC at an
interest rate of 9.50% per annum due June 30, 2004, in exchange for an interest
only note in anticipation of the initial capitalization of the Bank and to fund
the operations of IFC and other strategic opportunities deemed appropriate by
IFC. Interest income recorded by IMH related to this note was $696,000.
Transactions with ICH and ICCC
Sale of Commercial Office Building: On October 27, 1998, the Company sold
to ICH its remaining 50% ownership interest in a commercial office building
located in Newport Beach, California for $6.0 million. After the sale of the 50%
ownership interest to ICH, the Company has no ownership interest in the
commercial office building.
Sale of ICH Common Stock: On October 21, 1998, ICH repurchased from IMH
937,084 shares of ICH Common Stock and 456,916 shares of ICH Class A Common
Stock at a per share price of $4.375, based upon the closing sales price of the
Common Stock on the AMEX on October 19, 1998, for a total repurchase of $6.1
million. The Company recorded a loss on the sale of ICH Common Stock of $9.1
million. The sale of ICH Common Stock represented 100% of IMH's ownership of ICH
Common Stock.
F-22
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Transactions with ICII and ICAI
Redemption of Senior Notes: On January 24, 1997, IMH redeemed ICII senior
note obligations for $5.2 million, resulting in a gain of $648,000.
Termination of Management Agreement: Effective December 19, 1997, the
Company terminated its Management Agreement with ICAI. A termination fee in the
aggregate of $44.0 million was paid with 2,009,310 shares of the Company's
common stock representing a value of $35.0 million in addition to equity in
IFC's residual interest in securitizations. In connection with the Termination
Agreement, the Company entered into a Registration Rights Agreement with ICAI
with regards to the 2,009,310 shares of Common Stock. IMH purchased the equity
in residual interests in securitizations from IFC for $9.0 million and
simultaneously retired IFC's borrowings with IMH for the equity in residual
interest in securitizations of $9.0 million. No gain or loss on the sale of
residual interests in securitizations was recorded by IMH or IFC. For financial
accounting purposes, the termination fee was treated as a non-recurring, non-
cash expense and resulted in a charge of $44.4 million to the Company's fourth
quarter income.
Non-Compete Agreement and Right of First Refusal Agreement
Pursuant to the Non-Compete Agreement executed on the date of the ICH
initial public offering, IFC will not acquire any commercial mortgages for a
period of the earlier of nine months from the closing of the ICH initial public
offering or the date upon which ICH and/or ICCC accumulates (for investment or
sale) $300.0 million of commercial mortgages or commercial mortgage-backed
securities. This agreement expired in March 1998.
Pursuant to a Right of First Refusal Agreement by and among IMH, IFC, ICH,
ICCC and RAI, pursuant to which, in part, RAI agreed that any mortgage loan or
mortgage-backed security investment opportunity which is offered to it on behalf
of either ICH, IMH any affiliated REIT will first be offered to that entity
whose initial primary business as described in its initial public offering
documentation most closely aligns with such investment opportunity. The Right of
First Refusal Agreement was terminated in May 1999.
Note O--Commitments and Contingencies
Financial Instruments with Off-Balance-Sheet Risk
IMH is a party to financial instruments with off-balance sheet risk in the
normal course of business. Such instruments include short-term commitments to
extend credit to borrowers under warehouse lines of credit, which involve
elements of credit risk, lease commitments, interest rate cap agreements, and
exposure to credit loss in the event of nonperformance by the counterparties to
the various agreements associated with loan purchases. Unless noted otherwise,
IMH does not require collateral or other security to support such commitments.
The Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. The contract or
notional amounts of interest rate cap agreements and forward contracts do not
represent exposure to credit loss. The Company controls the credit risk of its
interest rate cap agreements and forward contracts through credit approvals,
limits and monitoring procedures.
Short-Term Loan Commitments
IWLG's warehouse lending program provides secured short-term non-recourse
revolving financing to small-and medium-size mortgage originators and affiliated
companies to finance mortgages from the closing of the loans until sold to
permanent investors. As of December 31, 1999 and 1998, the Company had 49 and 32
committed lines of credit, respectively, extended in the aggregate principal
amount of $1.4 billion and $813.1 million, respectively, of which $67.4 million
and $198.1 million, respectively, was outstanding with affiliated companies. The
Company's warehouse lines are non-recourse and IWLG can only look to the sale or
liquidation of the mortgages as a source of repayment.
F-23
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Lease Commitments
The Company entered into a premises operating lease for approximately
74,000 square feet of office space in Newport Beach, California which expires in
May 2008. Minimum premises rental commitments under non-cancelable leases are as
follows (in thousands):
Year 2000........................................... 1,812
Year 2001........................................... 1,856
Year 2002........................................... 1,901
Year 2003........................................... 1,946
Year 2004........................................... 1,990
Year 2005 and thereafter............................ 7,132
-------------
Total Lease Commitments.......................... $ 16,637
=============
Rent expense associated with the premises operating lease is allocated
between IMH, IWLG and IFC based on square footage. IMH and IWLG's combined
portion of premises rental expense for the years ended December 31, 1999, 1998,
and 1997 was $100,000, $65,000, and $11,000, respectively.
Interest Rate Cap Agreements
The Company purchases and sells, from time to time, interest rate
agreements in the form of interest rate caps, interest rate floors, and other
interest rate futures to attempt to mitigate interest and related risks. The
Company also may use such instruments to modify the characteristics of its CMO
issuance or to hedge the anticipated issuance of future liabilities or the
market value of certain assets. The Company intends generally to hedge as much
of the interest rate risk based on the cost of such hedging transaction and the
need to maintain the Company's status as a REIT. At December 31, 1999 and 1998,
the Company had $422.0 million and none, in notional amount, of interest rate
caps, respectively. The carrying value of the interest rate caps was $1.9
million.
Loan Purchase Commitments
In the ordinary course of business, IFC is exposed to liability under
representations and warranties made to purchasers and insurers of mortgage loans
and the purchasers of servicing rights. Under certain circumstances, IFC is
required to repurchase mortgage loans if there had been a breach of
representations or warranties. IMH has guaranteed the performance obligation of
IFC under such representation and warranties related to loans included in
securitizations. However, IMH does not anticipate nonperformance by such
borrowers or counterparties.
Note P--Management Contract
Effective December 19, 1997, the Company terminated its Management
Agreement with ICAI. The termination fee of $44.0 million was paid with
2,009,310 shares of the Company's Common Stock in addition to other assets.
During the year ended December 31, 1997, the Company paid fees to ICAI of $6.2
million.
Note Q--Stock Option Plan
The Company adopted a Stock Option, Deferred Stock and Restricted Stock
Plan (the Stock Option Plan) which provides for the grant of qualified incentive
stock options (ISOs), options not qualified (NQSOs) and deferred stock,
restricted stock, stock appreciation, dividend equivalent rights and limited
stock appreciation rights awards (Awards). The Stock Option Plan is administered
by a committee of directors appointed by the Board of Directors (the
Administrator). ISOs may be granted to the officers and key employees of the
Company. NQSOs and Awards may be granted to the directors, officers and key
employees of the Company or any of its subsidiaries, to the directors, officers
F-24
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
and key employees of IFC. The exercise price for any NQSO or ISO granted under
the Stock Option Plan may not be less than 100% (or 110% in the case of ISOs
granted to an employee who is deemed to own in excess of 10% of the outstanding
Common Stock) of the fair market value of the shares of Common Stock at the time
the NQSO or ISO is granted. Unless previously terminated by the Board of
Directors, no options or Awards may be granted under the Stock Option Plan after
August 31, 2005.
Options granted under the Stock Option Plan will become exercisable in
accordance with the terms of the grant made by the Administrator. Awards will be
subject to the terms and restrictions of the award made by the Administrator.
The Administrator has discretionary authority to select participants from among
eligible persons and to determine at the time an option or Award is granted and,
in the case of options, whether it is intended to be an ISO or a NQSO, and when
and in what increments shares covered by the option may be purchased. As of
December 31, 1999 and 1998, options to purchase 592,098 shares and 562,500
shares, respectively, were exercisable and 525,109 shares and 462,219 shares,
respectively, were reserved for future grants under the Stock Option Plan.
Option transactions for the periods shown are summarized as follows:
For the year ended December 31,
----------------------------------------------------------------------------------
1999 1998 1997
------------------------- ------------------------- -------------------------
Weighted- Weighted- Weighted-
Number Average Number Average Number Average
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
---------- ------------ ---------- ------------ ---------- ------------
Options outstanding at beginning of year.. 737,781 $ 10.06 724,675 $ 12.56 548,250 $ 9.47
Options granted........................... 35,500 4.92 195,781 5.68 325,125 16.73
Options exercised......................... -- -- (7,800) 13.75 (103,700) 8.77
Options forfeited/cancelled............... (98,390) 9.45 (174,875) 15.34 (45,000) 13.75
---------- ---------- ----------
Options outstanding at end of year........ 674,891 $ 9.89 737,781 $ 10.06 724,675 $ 12.56
========== ========== ==========
As of December 31, 1999 and 1998, total notes receivable from Common Stock
sales were $905,000 and $918,000, respectively. Interest on all loans secured by
the Company's Common Stock is payable quarterly upon receipt of the Company's
dividend payment. At each dividend payment date, 50% of excess quarterly stock
dividends, after applying the dividend payment to interest due, is required to
reduce the principal balance outstanding on the loans. The interest rate on
these loans adjusts annually and is set at the discretion of the Board of
Directors.
During 1998, the Company made one loan totaling $30,000 to an employee of
the Company that is secured by the related Common Stock in connection with the
exercise of stock options under the Stock Option Plan. There were no loans made
in 1999.
F-25
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The following table sets forth information about fixed stock options
outstanding at December 31, 1999:
Stock Options Outstanding Options Exercisable
------------------------------------------------------ ---------------------------------
Weighted-
Average Remaining Weighted- Weighted-
Exercise Number Contractual Life average Number Average
Prices Outstanding (mos.) exercise price ($) Exercisable exercise price ($)
-------- ----------- ----------------- ------------------ ----------- ------------------
$ 4.44 144,391 3.94 $ 4.44 97,098 $ 4.44
4.56 2,500 2.72 4.56 -- --
4.69 25,000 4.65 4.69 -- --
5.75 5,500 2.15 5.75 -- --
5.81 2,500 2.57 5.81 -- --
7.50 255,000 5.66 7.50 255,000 7.50
15.42 127,500 7.08 15.42 127,500 15.42
17.58 112,500 3.81 17.58 112,500 17.58
----------- -----------
674,891 5.16 9.89 592,098 10.62
=========== ===========
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 the
Company to choose either a new fair value based method or the current APB
Opinion 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 Opinion 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 nonemployees or to acquire goods or services from
outside suppliers or vendors.
The Company elected to continue to apply APB Opinion 25 in accounting for
its Plan and, accordingly, no compensation cost has been recognized for its
stock options in the financial statements. If the Company determined its
compensation cost based on the fair value, at the grant date of the stock
options exercisable under SFAS 123, the Company's net earnings (loss) and net
earnings (loss) per share would have decreased to the pro forma amounts
indicated below (dollars in thousands, except per share data):
For the year ended December 31,
----------------------------------------
1999 1998 1997
---------- ---------- -----------
Net earnings (loss) as reported............................... $ 22,317 $ (5,933) $ (16,029)
========== ========== ===========
Pro forma net earnings (loss)................................. $ 22,308 $ (6,038) $ (16,581)
========== ========== ===========
Basic earnings (loss) per share as reported................... $ 0.83 $ (0.25) $ (0.99)
========== ========== ===========
Diluted earnings (loss) per share as reported................. $ 0.76 $ (0.25) $ (0.99)
========== ========== ===========
Basic pro forma earnings (loss) per share..................... $ 0.83 $ (0.25) $ (1.02)
========== ========== ===========
Diluted pro forma earnings (loss) per share................... $ 0.76 $ (0.25) $ (1.02)
========== ========== ===========
The derived fair value of the options granted during 1999, 1998 and 1997
was approximately $1.35, $0.54 and $1.70, respectively. The fair value of
options granted, which is amortized to expenses over the option vesting period
in
F-26
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
determining the pro forma impact, is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
For the years ended December 31,
----------------------------------
1999 1998 1997
---------- ---------- ----------
Risk-Free Interest Rate................... 4.98% 5.09% 5.84%
Expected Lives (in years)................. 3-5 3-10 3-10
Expected Volatility....................... 0.60% 29.90% 28.50%
Expected Dividend Yield................... 9.50% 11.50% 9.70%
Note R--Stockholders' Equity
Pursuant to IMH's Dividend Reinvestment and Stock Purchase Plan (DRSPP or
the Plan), stockholders can acquire additional shares of IMH Common Stock by
reinvesting their cash dividends at a 0% to 5% discount of the average high and
low market prices as reported on the AMEX on the Investment Date (as described
in the Plan) to the extent shares are issued by IMH. Stockholders may also
purchase additional shares of IMH Common Stock through the cash investment
option at a 0% to 5% discount of the average high and low market prices as
reported on the AMEX during the three trading days preceding the Investment
Date. During 1999, 1998 and 1997, the Company raised capital of $946,000, $3.1
million and $24.7 million, respectively, as 216,156, 1.8 million and 1.6 million
shares, respectively, of Common Stock were purchased under the Company's DRSPP.
Proceeds from the sale of securities were used for working capital needs. In
July of 1999, the Company suspended its DRSPP.
During 1999, the Company's Board of Directors authorized the Company to
repurchase up to $10.0 million of the Company's Common Stock, $.01 par value, in
open market purchases from time to time at the discretion of the Company's
management; the timing and extent of the repurchases will depend on market
conditions. For the year ended December 31, 1999, the Company repurchased 2.0
million shares of its Common Stock for $9.9 million. The acquired shares were
canceled.
During 1999, certain stockholders of the Company exchanged 1,359,507 shares
of their Common Stock for 11% senior subordinated debentures due February 15,
2004. The Debentures are unsecured obligations of the Company subordinated and
subject in right of payment to all existing and future senior indebtedness of
the Company and effectively subordinated to all indebtedness of the Company's
subsidiaries. The Debentures bear interest at 11% per annum from their date of
issuance, payable quarterly, commencing May 15, 1999, until the debentures are
paid in full. The debentures mature on February 15, 2004, which date may be
extended once by the Company to a date not later than May 15, 2004, provided
that the Company satisfies certain conditions. Commencing on February 15, 2001,
the debentures will be redeemable, at the Company's option, in whole at any time
or in part from time to time, at the principal amount to be redeemed plus
accrued and unpaid interest to the redemption date.
On December 22, 1998, the Company completed the sale of 1,200,000 shares of
Series B 10.5% Cumulative Convertible Preferred Stock (Series B Preferred Stock)
at $25.00 per share. The Series B Preferred Stock was convertible into shares of
the Company's Common Stock at a conversion price of $4.95 per share.
Accordingly, each share of Series B Preferred Stock was convertible into
5.050505 shares of the Company's Common Stock. The terms of the acquisition
provided for a downward adjustment of the conversion price if, among other
things, certain earnings levels were not attained by the Company through June
30, 1999. In February 2000, the Series B Preferred Stock was exchanged for
Series C 10.5% Cumulative Convertible Preferred Stock (Series C Preferred Stock)
and the conversion rate was adjusted to $4.72 per share convertible into 5.29661
shares of Common Stock or an aggregate of 6,355,932 shares of Common Stock.
Dividends on the Preferred Stock accumulate from the date of issuance and are
paid quarterly, in cash or the Company's Common Stock, starting April 27, 1999.
The dividend rate per share is the greater of $0.65625 or the quarterly cash
dividend declared on the number of shares of Common Stock into which a share of
Preferred Stock is convertible. The Company is authorized to issue shares of
Preferred Stock designated in one or more
F-27
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
classes or series. The Preferred Stock may be issued from time to time with such
designations, rights and preferences as shall be determined by the Board of
Directors. The Preferred Stock has a preference on dividend payments, takes
priority over dividend distributions to the common stockholders.
On October 7, 1998, the Company's Board of Directors adopted a Stockholder
Rights Plan in which Preferred Stock Purchase Rights were distributed as a
dividend at the rate of one Right for each outstanding share of Common Stock.
The dividend distribution was made on October 19, 1998 payable to stockholders
of record on that date. The Rights are attached to the Company's Common Stock.
The Rights will be exercisable and trade separately only in the event that a
person or group acquires or announces the intent to acquire 10 percent or more
of the Company's Common Stock. Each Right will entitle stockholders to buy one-
hundredth of a share of a new series of junior participating Preferred Stock at
an exercise price of $30.00. If the Company is acquired in a merger or other
transaction after a person has acquired 10 percent or more of Company
outstanding Common Stock, each Right will entitle the stockholder to purchase,
at the Right's then-current exercise price, a number of the acquiring Company's
common shares having a market value of twice such price. In addition, if a
person or group acquires 10 percent or more of the Company's Common Stock, each
Right will entitle the stockholder (other than the acquiring person) to
purchase, at the Right's then-current exercise price, a number of shares of the
Company's Common Stock having a market value of twice such price. Following the
acquisition by a person of 10 percent or more of the Company's Common Stock and
before an acquisition of 50 percent or more of the Common Stock, the Board of
Directors may exchange the Rights (other than the Rights owned by such person)
at an exchange ratio of one share of Common Stock per Right. Before a person or
group acquires beneficial ownership of 10 percent or more of the Company's
Common Stock, the Rights are redeemable for $.0001 per right at the option of
the Board of Directors. The Rights will expire on October 19, 2008. The Rights
distribution is not taxable to stockholders. The Rights are intended to enable
all the Company stockholders to realize the long-term value of their investment
in the Company.
Note S--Reconciliation of Earnings Per Share
The following table represents the computation of basic and diluted net
earnings (loss) per share for the periods presented, as if all stock options,
cumulative convertible preferred stock (Preferred Stock), and ICII's ownership
interest in IMH were outstanding for these periods (in thousands, except per
share data):
For the year ended December 31,
-----------------------------------------------------
1999 1998 1997
-------------- ------------- -------------
Numerator:
Numerator for basic earnings per share--
Net earnings (loss)......................................... $ 22,317 $ (5,933) $ (16,029)
Less: Dividends paid to preferred stockholders.............. (3,290) -- --
------------- ------------- -------------
Net earnings (loss) available to
common stockholders...................................... $ 19,027 $ (5,933) $ (16,029)
============= ============= =============
Denominator:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period............................. 22,824 23,914 16,267
Impact of assumed conversion of
Preferred Stock........................................... 6,356 -- --
Net effect of dilutive stock options........................ 16 -- --
------------- ------------- -------------
Denominator for diluted earnings per share................ 29,196 23,914 16,267
============= ============= =============
Net earnings (loss) per share--basic......................... $ 0.83 $ (0.25) $ (0.99)
============= ============= =============
Net earnings (loss) per share--diluted....................... $ 0.76 $ (0.25) $ (0.99)
============= ============= =============
F-28
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The antidilutive effects of stock options outstanding as of December 31,
1999, 1998 and 1997 was none, 137,105 and 210,110, respectively. The
antidilutive effects of outstanding Preferred Stock as of December 31, 1999,
1998 and 1997 was none, 6,060,606 and none, respectively. Terms of the Preferred
Stock acquisition provided for a downward adjustment of the conversion price if,
among other things, certain earnings levels were not attained by the Company
through June 30, 1999. The change in the Preferred Stock conversion price during
1999 from $5.05 per share resulted in 6,355,932 in Common Stock equivalent
shares outstanding at December 31, 1999 as compared to 6,060,606 Common Stock
equivalent shares outstanding at December 31, 1998
Note T--Subsequent Events
In February 2000, the Series B Preferred Stock was exchanged for Series C
Preferred Stock and the conversion rate was adjusted to $4.72 per share
convertible into 5.29661 shares of Common Stock or an aggregate of 6,355,932
shares of Common Stock.
Note U--Quarterly Financial Data (unaudited)
Selected quarterly financial data for 1999 follows (in thousands, except
per share data):
For the Three Months Ended,
---------------------------------------------------------------
December 31, September 30, June 30, March 31,
-------------- --------------- ----------- ------------
Net interest income............................................ $ 7,378 $ 5,876 $ 8,163 $ 8,246
Provision for loan losses...................................... 1,191 1,367 1,490 1,499
Non-interest income (loss)..................................... (611) 3,784 2,019 1,710
Non-interest expense........................................... 1,639 2,062 2,738 2,262
Net earnings................................................... 3,937 6,231 5,954 6,195
Net earnings per share - diluted (1)........................... 0.14 0.22 0.21 0.20
Dividends declared per share................................... 0.13 0.13 0.12 0.10
Selected quarterly financial data for 1998 follows (in thousands, except
per share data):
For the Three Months Ended,
---------------------------------------------------------------
December 31, September 30, June 30, March 31,
-------------- --------------- ----------- ------------
Net interest income............................................ $ 9,004 $ 11,676 $ 11,517 $ 9,766
Provision for loan losses...................................... 2,262 (292) 487 1,904
Non-interest income (loss)..................................... (10,654) (9,534) 3,287 3,362
Non-interest expense........................................... 4,187 23,050 2,639 120
Net earnings (loss)............................................ (8,099) (20,616) 11,678 11,104
Net earnings (loss) per share - diluted (1).................... (0.33) (0.85) 0.49 0.48
Dividends declared per share................................... -- 0.49 0.49 0.48
_______________
(1) Diluted earnings per share are computed independently for each of the
quarters presented. Therefore, the sum of the quarterly earnings per share
may not equal the total for the year.
F-29
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Note V--Impac Funding Corporation
The following condensed financial information summarizes the financial
condition and results of operations of Impac Funding Corporation:
Condensed Consolidated Balance Sheets
(in thousands)
At December 31,
-----------------------------------
1999 1998
-------------- --------------
ASSETS
------
Cash and cash equivalents.................................. $ 8,805 $ 422
Securities available-for-sale.............................. 1,887 5,965
Securities held-for-trading................................ -- 5,300
Mortgage loans held-for-sale............................... 68,084 252,568
Mortgage servicing rights.................................. 15,621 14,062
Due from affiliates........................................ 4,307 9,152
Premises and equipment, net................................ 3,575 1,978
Accrued interest receivable................................ 48 1,896
Other assets............................................... 13,919 22,529
-------------- --------------
$ 116,246 $ 313,872
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Borrowings from IWLG...................................... $ 66,125 $ 192,900
Other borrowings.......................................... 181 67,058
Due to affiliates......................................... 14,500 24,382
Deferred revenue.......................................... 7,635 10,605
Accrued interest expense.................................. 843 --
Other liabilities......................................... 9,414 6,064
-------------- --------------
Total liabilities...................................... 98,698 301,009
-------------- --------------
Shareholders' equity:
Preferred stock........................................ 18,053 18,053
Common stock........................................... 182 182
Accumulated deficit.................................... (520) (4,852)
Accumulated other comprehensive loss................... (167) (520)
-------------- --------------
Total shareholders' equity......................... 17,548 12,863
-------------- --------------
$ 116,246 $ 313,872
============== ==============
F-30
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
Condensed Consolidated Statements of Operations
(in thousands)
For the year ended December 31,
------------------------------------------------
1999 1998 1997
------------ ----------- ------------
Net interest income:
Total interest income............................. $ 21,225 $ 48,510 $ 48,020
Total interest expense............................ 20,953 40,743 41,628
------------ ----------- ------------
Net interest income............................. 272 7,767 6,392
Non-interest income:
Gain (loss) on sale of loans...................... 27,098 (11,663) 19,414
Loan servicing income............................. 5,221 7,071 4,109
Other income...................................... 979 (1,091) 643
------------ ----------- ------------
Total non-interest income....................... 33,298 (5,683) 24,166
------------ ----------- ------------
Non-interest expense:
Amortization of mortgage servicing rights......... 5,331 6,361 2,827
Write down of securities available-for-sale....... 4,252 -- --
Impairment of mortgage servicing rights........... 1,078 3,722 --
Provision for repurchases......................... 385 367 3,148
General and administrative and other expense...... 14,965 14,385 10,047
------------ ----------- ------------
Total non-interest expense...................... 26,011 24,835 16,022
------------ ----------- ------------
Earnings (loss) before income taxes............... 7,559 (22,751) 14,536
Income taxes (benefit)............................. 3,227 (8,738) 6,136
------------ ----------- ------------
Net earnings (loss)............................... $ 4,332 $ (14,013) $ 8,400
============ =========== ============
F-31
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Impac Funding Corporation:
We have audited the accompanying consolidated balance sheets of Impac
Funding Corporation and subsidiary as of December 31, 1999 and 1998, and the
related consolidated statements of operations and comprehensive earnings (loss),
changes in shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Impac Funding Corporation and subsidiary as of December 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1999 in conformity with generally
accepted accounting principles.
KPMG LLP
Orange County, California
January 31, 2000
F-32
IMPAC FUNDING CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(dollar amounts in thousands)
At December 31,
---------------------------
1999 1998
----------- -----------
ASSETS
------
Cash and cash equivalents........................................................... $ 8,805 $ 422
Securities available-for-sale....................................................... 1,887 5,965
Securities held-for-trading......................................................... -- 5,300
Mortgage loans held-for-sale........................................................ 68,084 252,568
Mortgage servicing rights........................................................... 15,621 14,062
Due from affiliates................................................................. 4,307 9,152
Premises and equipment, net......................................................... 3,575 1,978
Accrued interest receivable......................................................... 48 1,896
Other assets........................................................................ 13,919 22,529
--------- ---------
Total assets.................................................................... $ 116,246 $ 313,872
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Borrowings from IWLG................................................................ $ 66,125 $ 192,900
Other borrowings.................................................................... 181 67,058
Due to affiliates................................................................... 14,500 24,382
Deferred revenue.................................................................... 7,635 10,605
Accrued interest expense............................................................ 843 --
Other liabilities................................................................... 9,414 6,064
--------- ---------
Total liabilities............................................................... 98,698 301,009
--------- ---------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value; 10,000 shares authorized; 10,000 shares issued and
outstanding at December 31, 1999 and 1998......................................... 18,053 18,053
Common stock, no par value; 10,000 shares authorized; 10,000 shares issued and
Outstanding at December 31, 1999 and 1998......................................... 182 182
Accumulated deficit................................................................ (520) (4,852)
Accumulated other comprehensive loss............................................... (167) (520)
--------- ---------
Total shareholders' equity........................................................ 17,548 12,863
--------- ---------
Total liabilities and shareholders' equity...................................... $ 116,246 $ 313,872
========= =========
See accompanying notes to consolidated financial statements.
F-33
IMPAC FUNDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE EARNINGS (LOSS)
(in thousands)
For the year ended December 31,
----------------------------------------
1999 1998 1997
-------- --------- --------
INTEREST INCOME:
Mortgage loans held-for-sale.......................................... $ 20,352 $ 45,070 $ 42,373
Other interest income................................................. 873 3,440 5,647
-------- --------- --------
Total interest income................................................ 21,225 48,510 48,020
INTEREST EXPENSE:
Borrowings from IWLG.................................................. 18,366 32,682 33,450
Other affiliated borrowings........................................... 1,673 2,020 4,618
Other borrowings...................................................... 914 6,041 3,560
-------- --------- --------
Total interest expense............................................... 20,953 40,743 41,628
-------- --------- --------
Net interest income.................................................. 272 7,767 6,392
NON-INTEREST INCOME:
Gain (loss) on sale of loans.......................................... 27,098 (11,663) 19,414
Mark-to-market loss on investment securities.......................... -- (805) --
Gain (loss) on sale of investment securities.......................... -- (706) 550
Loan servicing income................................................. 5,221 7,071 4,109
Other income.......................................................... 979 420 93
-------- --------- --------
Total non-interest income............................................ 33,298 (5,683) 24,166
NON-INTEREST EXPENSE:
Personnel expense..................................................... 7,299 8,901 6,760
Amortization of mortgage servicing rights............................. 5,331 6,361 2,827
Write down of securities available-for-sale........................... 4,252 -- --
General and administrative and other expense.......................... 3,417 2,516 2,228
Professional services................................................. 2,524 978 79
Occupancy expense..................................................... 1,095 1,391 408
Impairment of mortgage servicing rights............................... 1,078 3,722 --
Provision for repurchases............................................. 385 367 3,148
Data processing expense............................................... 337 387 311
Telephone and other communications.................................... 293 212 261
-------- --------- --------
Total non-interest expense........................................... 26,011 24,835 16,022
-------- --------- --------
Earnings (loss) before income taxes.................................. 7,559 (22,751) 14,536
Income taxes (benefit)................................................ 3,227 (8,738) 6,136
-------- --------- --------
Net earnings (loss).................................................. 4,332 (14,013) 8,400
Other comprehensive earnings (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period.............. 329 (520) --
Less: Reclassification of gains included in income................... 24 -- --
-------- --------- --------
Net unrealized gains (losses) arising during period................ 353 (520) --
-------- --------- --------
Comprehensive earnings (loss)........................................ $ 4,685 $ (14,533) $ 8,400
======== ========= ========
See accompanying notes to consolidated financial statements.
F-34
IMPAC FUNDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(dollar amounts in thousands)
Retained Accumulated
Number of Number of Earnings Other Total
Preferred Preferred Common Common (Accumulated Comprehensive Shareholders'
Shares Stock Shares Stock Deficit) Loss Equity
---------- --------- --------- ------ ------------ ----------- -----------
Balance, December 31, 1996..... 10,000 9,143 10,000 92 761 -- 9,996
Capital Contributions, 1997.... -- 8,910 -- 90 -- -- 9,000
Net earnings, 1997............. -- -- -- -- 8,400 -- 8,400
------- -------- ------- ------ ------ ------- -------
Balance, December 31, 1997..... 10,000 18,053 10,000 182 9,161 -- 27,396
Net loss, 1998................. -- -- -- -- (14,013) -- (14,013)
Other comprehensive loss....... -- -- -- -- -- (520) (520)
------- -------- ------- ------ ------ ------- -------
Balance, December 31, 1998..... 10,000 $ 18,053 10,000 $ 182 $ (4,852) $ (520) $ 12,863
Net earnings, 1999............. -- -- -- -- 4,332 -- 4,332
Other comprehensive income..... -- -- -- -- -- 353 353
------- -------- ------- ------ ------ ------- -------
Balance, December 31, 1999..... 10,000 18,053 10,000 182 (520) (167) 17,548
======= ======== ======= ====== ====== ======= =======
See accompanying notes to consolidated financial statements.
F-35
IMPAC FUNDING CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the year ended December 31,
---------------------------------------------------------
1999 1998 1997
--------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)............................................... $ 4,332 $ (14,013) $ 8,400
Adjustments to reconcile net earnings to net cash provided by
(used in) operating activities:
Provision for repurchases........................................ 385 367 3,148
Gain (loss) on sale of loans..................................... 27,098 -- --
Depreciation and amortization.................................... 6,453 7,141 3,371
Amortization of deferred revenue................................. (12,751) (8,157) (1,862)
Impairment of mortgage servicing rights.......................... 1,078 3,722 --
Net change in accrued interest receivable........................ 1,848 2,859 (2,910)
Net change in other assets and liabilities....................... (6,258) 1,806 (54,291)
Net change in deferred taxes..................................... -- (10,459) 3,172
Net change in deferred revenue................................... 9,781 11,714 7,517
Purchase of securities held-for-trading.......................... 5,300 (5,300) --
Write-down of investment securities.............................. 4,252 805 --
Net change in accrued interest expense........................... 843 (5,673) 1,382
-------------- -------------- --------------
Net cash provided by (used in) operating activities............ 42,361 (15,188) (32,073)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage loans held-for-sale.......................... (1,671,777) (2,248,586) (2,571,208)
Sale of and principal reductions on mortgage loans held-for-sale.. 1,827,638 2,616,170 2,284,763
Additions to mortgage servicing rights............................ (7,968) (8,577) (9,611)
Issuance of note from IMH......................................... 14,500 -- --
Sale of residual interests in securitizations..................... -- -- 47,925
Principal reductions on residual interests in securitizations..... -- -- (976)
Purchase of securities available-for-sale......................... (5,413) -- (28,646)
Sale of securities available-for-sale............................. 5,413 -- 22,953
Principal reductions on securities available-for-sale............. -- 403 (390)
Purchase of premises and equipment................................ (2,719) (970) (1,498)
-------------- -------------- --------------
Net cash provided by (used in) investing activities............ 159,674 358,440 (256,688)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in borrowings from IWLG................................ (126,775) (261,940) 127,418
Net change in other borrowings.................................... (66,877) (81,249) 148,307
Capital contributions............................................. -- -- 9,000
-------------- -------------- --------------
Net cash provided by (used in) financing activities............ (193,652) (343,189) 284,725
-------------- -------------- --------------
Net change in cash and cash equivalents............................ 8,383 63 (4,036)
Cash and cash equivalents at beginning of year..................... 422 359 4,395
-------------- -------------- --------------
Cash and cash equivalents at end of year........................... $ 8,805 $ 422 $ 359
============== ============== ==============
SUPPLEMENTARY INFORMATION:
Interest paid..................................................... $ 20,109 $ 44,806 $ 40,246
Taxes paid........................................................ 385 5,205 2,964
See accompanying notes to consolidated financial statements.
F-36
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDDTED FINANCIAL STATEMENTS
Note A--Summary of Business and Significant Accounting Policies
1. Business and Financial Statement Presentation
IFC is a mortgage loan conduit organization, which purchases primarily non-
conforming mortgage loans from a network of third party correspondent loan
originators and subsequently securitizes or sells such loans to permanent
investors or IMH. On March 31, 1997, ownership of all of the Common Stock of IFC
was transferred from ICII to Joseph R. Tomkinson, Chief Executive Officer of IMH
and IFC, William S. Ashmore, President of IMH and IFC, and Richard J. Johnson,
Chief Financial Officer of IMH and IFC, who are entitled to 1% of the earnings
or losses of IFC.
The consolidated financial statements include the operations of IFC and its
wholly owned subsidiary, Impac Secured Asset Corporation (collectively, IFC) and
have been prepared in conformity with generally accepted accounting principles
and prevailing practices within the mortgage banking industry.
All significant intercompany balances and transactions with IFC's
consolidated subsidiary have been eliminated in consolidation. Interest income
on affiliated short-term advances, due from affiliates, has been earned at the
rate of 8% per annum. Interest expense on affiliated short-term borrowings, due
to affiliates, has been incurred at the rate of 8% per annum. Certain amounts in
the prior period's consolidated financial statements have been reclassified to
conform to the current presentation.
Management of IFC 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 generally accepted accounting
principles. Actual results could differ from those estimates.
2. Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents consists of cash and money market mutual funds. IFC considers
investments with maturities of three months or less at date of acquisition to be
cash equivalents.
3. Gain on Sale of Loans
IFC recognizes gains or losses on the sale of loans when the sales
transaction settles or upon the securitzation of the mortgage loans 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 released premiums received
and costs associated with the origination of mortgage loans. Gain on sale of
loans or securities to IMH are deferred and accreted over the estimated life of
the loans or securities using the interest method.
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. Liabilities and
derivatives incurred or obtained by 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, IFC estimates future rates of
prepayments, prepayment penalties to be received by IFC, delinquencies, defaults
and default loss severity and their impact on estimated cash flows. At December
31, 1999, IFC used a 4.39% constant default rate estimate with a 73.78% severity
resulting in loss estimates of 2.08%. These estimates are based on historical
loss data for comparable loans. IFC estimates prepayments by
F-37
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
evaluating historical prepayment performance of comparable mortgage loans and
trends in the industry. At December 31, 1999, IFC used a constant prepayment
assumption of 1.37% to estimate the prepayment characteristics of the underlying
collateral. These assumptions may fluctuate depending on market conditions.
4. Securities Available-for-Sale and Securities Held-for-Trading
IFC classifies investment and mortgage-backed securities as held-to-
maturity, available-for-sale, and/or trading securities. Held-to-maturity
investment and mortgage-backed securities are reported at amortized cost,
available-for-sale securities are reported at fair value with unrealized gains
and losses, net of related income taxes, as a separate component of
shareholders' equity, and trading securities are reported at fair value with
unrealized gains and losses reported in operations. IFC's investment securities
are held as available-for-sale, reported at fair value with unrealized gains and
losses net of related income taxes reported as a separate component of
shareholders' equity. 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.
Residual interests in securitization of mortgage loans are recorded as a
result of the sale of mortgage loans through securitizations. IFC sells a
portfolio of mortgage loans to a special purpose entity that has been
established for the limited purpose of buying and reselling IFC's mortgage
loans. The special purpose entity then transfers the same mortgage loans to a
Real Estate Mortgage Investment Conduit or owners trust (the Trust). The Trust
issues interest-bearing asset-backed securities in an amount equal to the
aggregate principal balance of the mortgage loans. IFC typically sells these
certificates at face value and without recourse except that representations and
warranties customary to the mortgage banking industry are provided by IFC. IFC
may provide a credit enhancement for the benefit of the investors in the form of
additional collateral (over-collateralization) held by the Trust. The over-
collateralization account is required to be maintained at specified levels.
At the closing of each securitization, IFC removes from its consolidated
balance sheets the loans held-for-sale and adds to its consolidated balance
sheet the cash received, and the estimated fair value of the portion of the
mortgage loans retained from the securitizations (Residuals). The Residuals
consist of the over-collateralization account and the net interest receivables
which represent the estimated cash flows to be received by the Trust in the
future. The excess of the cash received and the assets retained by IFC over the
carrying value of the mortgage loans sold, less transaction costs, equals the
net gain on sale of mortgage loans recorded by IFC.
IFC allocates its basis in the mortgage loans between the portion of the
mortgage loans sold through the certificates and the portion retained based on
the relative fair values of those portions on the date of the sale. IFC may
recognize gains or losses attributable to the changes in the fair value of the
residuals, which are recorded at estimated fair value and accounted for as held-
for-trading securities at IFC. The market for the purchase or sale of residuals
is not considered liquid. IFC determines the estimated fair value of the
residuals by discounting the expected cash flows using a discount rate which IFC
believes is commensurate with the risks involved. At December 31, 1999, IFC used
a weighted average discount rate of approximately 16.8%. Most of the residual
interests generated by IFC are sold to IMH and accounted for as available-for-
sale securities at IMH.
The Company receives periodic servicing fees for the servicing and
collection of the mortgage loans as master servicer of the securitized loans.
The Company is also entitled to the cash flows from the residual that represent
collections on the mortgage loans in excess of the amounts required to pay the
certificate principal and interest, the servicing fees and certain other fees
such as trustee and custodial fees. At the end of each collection period, cash
collected from the mortgage loans are allocated to the base servicing and other
fees for the period, then to the certificate holders for interest at the pass-
through rate on the certificates plus principal as defined in the servicing
agreements. If the amount of cash required for the above allocations exceeds the
amount collected during the collection period, the shortfall is drawn from the
over-collateralization account. If the cash collected during the period exceeds
the amount necessary for the above allocations, and there is no shortfall in the
related over-collateralization account, the excess is
F-38
released to the Company. If the over-collateralization account balance is not at
the required credit enhancement level, the excess cash collected is retained in
the over-collateralization account until the specified level is achieved. The
cash and collateral in the over-collateralization account is restricted from use
by the Company. Pursuant to certain servicing agreements, cash held in the over-
collateralization accounts may be used to make accelerated principal paydowns on
the certificates to create additional excess collateral in the over-
collateralization account.
5. Mortgage Loans Held-for-Sale
Mortgage loans held-for-sale are stated at the lower of cost or market in
the aggregate as determined by outstanding commitments from investors or current
investor yield requirements. Interest is recognized as revenue when earned
according to the terms of the mortgage loans and when, in the opinion of
management, it is collectible. Nonrefundable fees and direct costs associated
with the origination or purchase of loans are deferred and recognized when the
loans are sold as gain or loss on sale of mortgage loans. It is the policy of
the Company to construct hedge positions, which will limit exposure to a rise or
decline of 25 basis points in yield or approximately a one-point change in price
of the benchmark instrument.
6. Premises and Equipment
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 (three
to seven years).
7. Mortgage Servicing Rights
The Company allocates a portion of the cost of acquiring a mortgage loan to
the mortgage loan servicing rights based on its fair value relative to the
components of the loan. To determine the fair value of the servicing rights
created, IFC uses a valuation model that calculates the present value of future
net servicing revenues to determine the fair value of the servicing rights. In
using this valuation method, IFC incorporates assumptions that it believes
market participants would use in estimating future net servicing, an inflation
rate, ancillary income per loan, a prepayment rate, a default rate and a
discount rate commensurate with the risk involved. MSRs are amortized in
proportion to, and over the period of expected net servicing income.
The mortgage servicing rights are considered impaired when the fair value
using a discounted cash flow analysis is less than the carrying value. In that
event, an impairment loss is recognized in the respective period.
As of December 31, 1999 and 1998, IFC is the master servicer for $1.4
billion and $1.5 billion of loans collateralizing REMIC securities and $885.2
million and $1.1 billion of mortgage loans collateralizing CMOs, respectively.
IFC recognizes gain or loss on the sale of servicing rights when the sales
contract has been executed and ownership is determined to have passed to the
purchasing party. Gains and losses are computed by deducting the basis in the
servicing rights and any other costs associated with the sale from the purchase
price.
8. 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.
F-39
9. Futures
To control risk, IFC uses future contracts on Treasury Bonds and Treasury
notes to hedge against interest rate fluctuations and options on futures. The
use of these instruments provides for increased liquidity, lower transaction
costs and more effective short-term coverage than cash and mortgage-backed
securities. However, IFC is vulnerable to the basis risk that is inherent in
cross-hedging transactions. IFC uses the buying and selling of futures contracts
on Treasury bonds and Treasury notes when the market is vulnerable to day to day
corrections. Executing hedges with these instruments allows IFC to more
effectively hedge the risks of corrections or reverses in the market without
committing mandatory sales on mortgage-backed securities or cash. IFC utilizes
these instruments on a short-term basis to fine-tune its overall hedge position
at a lower cost. The Company's policy is to defer hedging gains or losses until
the related asset is sold. The hedge is then recognized and applied against the
gain or loss on the sale.
10. Forward Contracts and Options
In order to hedge against a change in market value of the loans it
acquires, IFC sells mortgage-backed securities through forward delivery
contracts. Income or loss on these contracts is recorded at the time of sale of
the related contracts or loans as a component of the gain or loss on sale of the
loans. If any party to the contracts fails to completely perform, IFC would be
exposed to additional interest rate risk. IFC's principal hedging activity
consists of optional and mandatory commitments to deliver closed mortgage loans
to institutional investors, which do not require any collateral deposits.
Written options are stated at market value.
11. Servicing Income
Servicing income is reported as earned, principally on a cash basis when
the majority of the service process is completed.
12. Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS 133, which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as (a) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecasted transaction, or (c) 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. This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. SFAS 133 was amended by SFAS No. 137, which
allows deferral of SFAS 133 for all fiscal quarters of fiscal years beginning
after July 15, 2000. Management is evaluating the impact of implementation of
SFAS 133 on the Company's financial position and results of operations.
Note B--Mortgage Loans Held-for-Sale
Mortgage loans purchased by IFC are fixed and adjustable-rate non-
conforming mortgage loans secured by first and second liens on single-family
residential properties. During the years ended December 31, 1999 and 1998, IFC
acquired $1.7 billion and $2.2 billion, respectively, of mortgage loans and sold
$1.8 billion and $2.6 billion, respectively, of mortgage loans. Of the mortgage
loans sold by IFC during 1999 and 1998, $638.3 million and $866.7 million,
respectively, were sold to IMH including premiums of $877,000 and $23.8 million,
respectively. At December 31, 1999 and 1998, approximately 23% and 50%,
respectively, of mortgage loans held-for-sale were collateralized by properties
located in California. During 1999 and 1998, IFC acquired none and $54.4
million, respectively, of fixed-
F-40
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
rate mortgage loans secured by second liens on single family residential
properties with loan-to-value ratios of approximately 125%, of which $193,000 of
principal balance was outstanding at December 31, 1999. Mortgage loans held for
sale consisted of the following:
At December 31,
------------------------------------------
1999 1998
------------------ -----------------
(in thousands)
Mortgage loans held-for-sale..................................... $ 66,041 $ 247,079
Premium on loans................................................. 1,251 5,226
Deferred hedging................................................. 792 263
--------------- --------------
$ 68,084 $ 252,568
=============== ==============
Included in other liabilities at December 31, 1999 and 1998 is an allowance
for repurchases of $592,000 and $838,000, respectively.
Note C--Premises and Equipment
Premises and equipment consisted of the following:
At December 31,
----------------------------------------
1999 1998
--------------- --------------
(in thousands)
Premises and equipment........................................... $ 6,146 $ 3,463
Less accumulated depreciation.................................... (2,571) (1,485)
--------------- --------------
$ 3,575 $ 1,978
=============== ==============
Note D--Mortgage Servicing Rights
Activity for mortgage servicing rights was as follows:
For the year ended
December 31,
-------------------------------------------
1999 1998
------------------ -----------------
(in thousands)
Beginning Balance................................................ $ 14,062 $ 15,568
Additions........................................................ 7,968 8,577
Impairment of mortgage servicing rights.......................... (1,078) (3,722)
Amortization..................................................... (5,331) (6,361)
--------------- --------------
Ending balance................................................... $ 15,621 $ 14,062
=============== ==============
At December 31, 1999 and 1998, approximately $6.2 million and $5.6 million,
respectively, of mortgage servicing rights relates to $1.6 billion and $1.1
billion, respectively, of mortgage loans sold to IMH.
Note E--Other Borrowings
IFC enters into reverse repurchase agreements with major brokerage firms to
fund the purchase of mortgage loans. Mortgage loans underlying reverse
repurchase agreements are delivered to dealers that arrange the transactions.
IFC has entered into an uncommitted warehouse line agreement to obtain financing
up to $200.0 million from a major investment bank. The margins on the reverse
repurchase agreements are based on the type of collateral used and
F-41
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
generally range from 95% to 98% of the fair market value of the collateral. The
interest rates on the borrowings are indexed to LIBOR plus a spread of 85 basis
points to 125 basis points depending on the type of collateral used.
The following tables sets forth information regarding reverse repurchase
agreements (in thousands):
At December 31, 1999
---------------------------------------------------------------------------------------
Reverse
Type of Commitment Repurchase Underlying Maturity
Collateral Amount Liability Collateral Date
------------- ---------------- --------------- -------------- -------------
Lender 1............................. Mortgages $ 181 $ 181 $ 253 N/A
---------------- --------------- --------------
$ 181 $ 181 $ 253
================ =============== ==============
At December 31, 1998
---------------------------------------------------------------------------------------
Reverse
Type of Commitment Repurchase Underlying Maturity
Collateral Amount Liability Collateral Date
------------- ---------------- --------------- -------------- -------------
Lender 1............................. Mortgages $ 25,024 $ 25,024 $ 30,073 N/A
Lender 2............................. Mortgages 42,034 42,034 43,141 N/A
---------------- --------------- --------------
$ 67,058 $ 67,058 $ 73,214
================ =============== ==============
Note F--Income Taxes
IFC's income taxes (benefit) are as follows:
For the year ended December 31,
--------------------------------------------------------
1999 1998 1997
----------------- ---------------- ----------------
(in thousands)
Current income taxes:
Federal.................................................... $ 248 $ (3,673) $ 4,064
State...................................................... 2 -- 1,346
---------------- ---------------- ----------------
Total current income taxes................................ 250 (3,673) 5,410
---------------- ---------------- ----------------
Deferred income taxes:
Federal.................................................... 2,115 (3,533) 433
State...................................................... 862 (1,532) 293
---------------- ---------------- ----------------
Total deferred income taxes............................... 2,977 (5,065) 726
---------------- ---------------- ----------------
Total income taxes (benefit)............................ $ 3,227 $ (8,738) $ 6,136
================ ================ ================
The Company's effective income taxes (benefit) differ from the amount
determined by applying the statutory Federal rate of 34% for the years ended
December 31, 1999, 1998, and 1997 is as follows:
1999 1998 1997
----------------- ---------------- ----------------
(in thousands)
Income taxes (benefit) at Federal tax rate....................... $ 2,570 $ (7,735) $ 4,942
California franchise tax, net of Federal income tax (benefit).... 570 (1,011) 1,082
Other............................................................ 87 8 112
----------------- ---------------- ----------------
$ 3,227 $ (8,738) $ 6,136
================= ================ ================
F-42
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
The tax effected cumulative temporary differences that give rise to deferred
tax assets and liabilities as of December 31, 1999 and 1998 are as follows:
1999 1998
--------------- ---------------
(in thousands)
Deferred tax assets:
--------------------
Deferred revenue..................................................................... $ 3,142 $ 4,364
Forward commitments.................................................................. 14 368
Depreciation......................................................................... 28 19
Salary accruals...................................................................... 169 188
Other accruals....................................................................... 585 103
Loan mark-to-market.................................................................. -- 331
Non-accrual loans.................................................................... 91 685
Provision for repurchases............................................................ 244 345
Contribution carryover............................................................... -- 25
Minimum tax credit................................................................... 292 263
Net operating loss................................................................... 2,871 2,926
------------- ---------------
Total gross deferred tax assets.................................................. 7,436 9,617
------------- ---------------
Deferred tax liabilities:
-------------------------
Mortgage servicing rights............................................................ 6,168 5,412
Deferred gain........................................................................ 449 440
Mark to market....................................................................... 31 --
------------- ---------------
Total gross deferred tax liabilities............................................. 6,648 5,852
------------- ---------------
Net deferred tax (asset) liability............................................... $ (788) $ (3,765)
============= ===============
As of December 31, 1999, the Company has net operating loss carry-forwards for
federal and state income tax purposes of $6.8 million, which are available to
offset future taxable income, if any, through 2018 and 2004, respectively. In
addition, the Company has an alternative minimum tax credit carry-forward of
approximately $292,000 which is available to reduce future federal regular
income taxes, if any, over an indefinite period.
The Company believes that the deferred tax asset will more likely than not be
realized due to the reversal of the deferred tax liability and expected future
taxable income. In determining the possible future realization of deferred tax
assets, future taxable income from the following sources are taken into account:
(a) the reversal of taxable temporary differences, (b) future operations
exclusive of reversing temporary differences and (c) tax planning strategies
that, if necessary, would be implemented to accelerate taxable income into years
in which net operating losses might otherwise expire.
Note G--Disclosures About Fair Value of Financial Instruments
The estimated fair value amounts have been determined by IFC using available
market information and appropriate valuation methodologies, however,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented are
not necessarily indicative of the amounts IFC could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
F-43
IMPAC FUNDING CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS---(continued)
December 31, 1999 December 31, 1998
------------------------------- ----------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------- ----------- ------------ -----------
(in thousands)
Assets
------
Cash and cash equivalents................................ $ 8,805 $ 8,805 $ 422 $ 422
Securities available-for-sale............................ 1,887 1,887 5,965 5,965
Securities available-for-trading......................... -- -- 5,300 5,300
Mortgage loans held-for-sale............................. 68,084 68,084 252,568 252,568
Due from affiliates...................................... 4,307 4,307 9,152 9,152
Liabilities
-----------
Borrowings from IWLG..................................... 66,125 66,125 192,900 192,900
Other borrowings......................................... 181 181 67,058 67,058
Due to affiliates........................................ 14,500 14,500 24,382 24,382
Off-balance sheet loan commitments....................... -- 34 -- 895
December 31, 1999
--------------------------
Off-balance sheet items Notional Carrying Unrealized
----------------------- -------- -------- ----------
Amount Value Gain
------------ -------- -----------
Forward contracts ....................................... $ 110,000 $ -- $ 471
Futures contracts........................................ 10,000 -- 54
Option contracts......................................... 20,000 95 30
The fair value estimates as of December 31, 1999 and 1998 are based on
pertinent information available to management as of that date. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since those dates and,
therefore, current estimates of fair value may differ significantly from the
amounts presented. The fair value of off-balance sheet items for 1998 was not
deemed material.
The following describes the methods and assumptions used by IFC in estimating
fair values:
Cash and Cash Equivalents
Fair value approximates carrying amounts as these instruments are demand
deposits and do not present unanticipated interest rate or credit concerns.
Securities Available-for-Sale and Securities Held-for-Trading
To determine the value of the securities, the Company estimates future rates
of prepayments, prepayment penalties to be received by the Company,
delinquencies, defaults and default loss severity and their impact on estimated
cash flows.
Mortgage Loans Held-for-Sale
Fair value of mortgage loans held-for-sale is estimated based on quoted market
prices from dealers and brokers for similar types of mortgage loans.
Borrowings from IWLG
Fair value approximately carrying amounts because of the short-term maturity
of the liabilities.
Other Borrowings
Fair value approximates carrying amounts because of the short-term maturity of
the liabilities.
F-44
Due From / To Affiliates
Fair value approximates carrying amounts because of the short-term maturity of
the liabilities and does not present unanticipated interest rate or credit
concerns.
Off-Balance Sheet Items
Fair value of loan commitments, including hedging positions, is determined in
the aggregate based on current investor yield requirements.
Fair value of forward, futures and options contracts is based on broker
quotes.
Note H--Employee Benefit Plans
Profit Sharing and 401(k) Plan
IFC does not have its own 401(k) or profit sharing plan. As such, employees of
IFC participate in ICII's 401(k) plan. Under ICII's 401(k) plan, employees of
the Company may contribute up to 14% of their salaries. The Company will match
50% of the first 4% of employee contributions. An additional Company
contribution may be made at the discretion of IFC. The Company recorded
approximately $135,000, $340,000 and $204,000 for matching and discretionary
contributions during 1999, 1998 and 1997, respectively.
Note I--Related Party Transactions
Related Party Cost Allocations
In December 1999, IFC entered into a services agreement with ICAI, a
subsidiary of ICII, under which ICAI provides various services to IFC, including
data processing, human resource administration, general ledger accounts, check
processing, remittance processing and payment of accounts payable. ICAI charges
fees for each of the services based upon usage. The charge to IFC for coverage
is based upon a pro rata portion of costs ICAI incurred for its various
policies. Total allocation of expense for the years ended December 31, 1999,
1998 and 1997 was $180,000, $178,000 and $152,000, respectively.
During 1999 and 1998, IMH and IWLG were allocated data processing, executive
and operations management, and accounting services that IFC incurred during the
normal course of business per the Company's submanagement agreement with RAI
Advisors Inc. (RAI). IFC, through RAI, charged IMH and IWLG for management and
operating services based upon usage which management believes was reasonable. In
May 1999, the submanagement agreement with RAI was terminated and IFC entered
into a new submanagement agreement with FIC Management, Inc., pursuant to which
IFC provides services to ICH. Prior to the submanagement agreement with RAI and
after RAI was terminated, IMH and IWLG were allocated data processing, executive
and operations management, and accounting services that IFC incurred during the
normal course of business. IFC charged IMH and IWLG for management and operating
services based upon usage which management believes was reasonable. Total cost
allocations charged by IFC to IMH and IWLG for the year ended December 31, 1999,
1998 and 1997 were $1.2 million, $968,000 and $385,000, respectively.
Lease Agreement: IMH and IFC entered into a premises operating sublease
agreement (see Note J--Commitments and Contingencies) to rent approximately
74,000 square feet of office space in Newport Beach, California, for a ten-year
term, which expires in May 2008. IMH and IFC pay monthly rental expenses and
allocate the cost to subsidiaries and affiliated companies on the basis of
square footage occupied. The majority of occupancy charges incurred were paid by
IFC as most of the Company's employees are employed by the Conduit Operations.
Total rental expense for the years ended December 31, 1999 and 1998 were $1.1
million and $1.3 million, of which $1.0 million and $1.2 million was paid by
IFC.
F-45
Credit Arrangements - Current
IFC maintains a warehouse financing facility with IWLG. Advances under such
warehouse facilities bear interest at Bank of America's prime rate. As of
December 31, 1999 and 1998, amounts outstanding on IFC's warehouse line with
IWLG were $66.1 million and $192.9 million, respectively. Interest expense
recorded by IFC related to warehouse lines with IWLG for the years ended
December 31, 1999, 1998 and 1997 was $18.4 million, $32.7 million and $33.4
million, respectively.
During the normal course of business, IFC may advance or borrow funds on a
short-term basis with affiliated companies. Advances to affiliates are reflected
as "Due from affiliates", while borrowings are reflected as "Due to affiliates"
on IFC's balance sheet. These short-term advances and borrowings bear interest
at a fixed rate of 8.00% per annum. Interest income recorded by IFC related to
short-term advances due from affiliates for the years ended December 31, 1999,
1998 and 1997 was $463,000, $1.7 million and $500,000, respectively. Interest
expense recorded by IFC related to short-term advances due to affiliates for the
years ended December 31, 1999, 1998 and 1997 was $977,000, $2.0 million and
$688,000, respectively.
Transactions with IMH and IWLG
Purchase of Mortgage Loans: During the years ended December 31, 1999 and 1998,
IFC purchased from IMH mortgage loans having a principal balance of $10.8
million and $170.4 million, respectively, including premiums of $294,000 and
$7.7 million, respectively.
Advances: During 1999, IFC was advanced $14.5 million in cash from IMH at an
interest rate of 9.50% per annum in exchange for an interest only note due June
30, 2004, in anticipation of the initial capitalization of the Bank and to fund
the operations of IFC and other strategic opportunities deemed appropriate by
IFC. Interest expense recorded by IFC related to this note was $696,000.
Sale of Mortgage Loans: During the years ended December 31, 1999 and 1998, IFC
sold to IMH mortgage loans having a principal balance of $637.4 million and
$842.9 million, respectively. The loans were sold with premiums of $877,000 and
$23.9 million, respectively. Servicing rights on all mortgages purchased by IMH
were retained by IFC.
Purchases and Sales of Mortgage-Backed Securities: During the years ended
December 31, 1999 and 1998, IFC sold $22.0 million and $60.6 million,
respectively, of mortgage-backed securities to IMH for $18.3 million and $56.1
million, respectively, net of discounts of $3.7 million and $4.5 million,
respectively. During the years ended December 31, 1999 and 1998 IFC purchased
$7.5 million and none of mortgage-backed securities from IMH for $3.8 million
and none, respectively, net of discounts of $3.7 million and none, respectively.
IFC issued the mortgage-backed securities during 1999 and 1998 in connection
with its REMIC securitizations.
Transactions with WSI
Purchase of Mortgage Loans: During the years ended December 31, 1999 and 1998,
IFC acquired $5.4 million and $4.2 million of mortgage loans, respectively from
WSI, an affiliate of the Company. James Walsh, Executive Vice President of WSI,
is a Director of the Company.
Transactions with Impac Lending Group (ILG)
Purchase of Mortgage Loans: During the year ended December 31, 1999, IFC
acquired $89.2 million of mortgage loans from Impac Lending Group, an affiliate
of the Company.
F-46
Transactions with RAI
Submanagement Agreement: In 1997, IFC entered into a submanagement agreement
with RAI under which IMH and IFC provided various services to ICH as RAI deems
necessary, including facilities and costs associated therewith, technology,
human resources, management information systems, general ledger accounts, check
processing and accounts payable, plus a 15% service charge. RAI charges ICH for
these services based upon usage. Total cost allocations RAI charged to ICH for
the year ended December 31, 1998 were $521,000. In May 1999, the Submanagement
Agreement with RAI was terminated and IFC entered into a new submanagement
agreement with FIC Management, Inc. pursuant to which IFC provides service to
ICH.
Non-Compete Agreement and Right of First Refusal Agreement
Pursuant to the Non-Compete Agreement executed on the date of the ICH initial
public offering, IFC will not acquire any commercial mortgages for a period of
the earlier of nine months from the closing of the ICH initial public offering
or the date upon which ICH and/or ICCC accumulates (for investment or sale)
$300.0 million of commercial mortgages or commercial mortgage-backed securities.
This agreement expired in March 1998.
Pursuant to the Right of First Refusal Agreement by and among IFC, IMH, ICH,
ICCC and RAI, pursuant to which, in part, RAI will agree that any mortgage loan
or mortgage-backed security investment opportunity which is offered to it on
behalf of either ICH, IMH any affiliated REIT will first be offered to that
entity whose initial primary business as described in its initial public
offering documentation most closely aligns with such investment opportunity. The
Right of First Refusal Agreement was terminated in May 1999.
Note J--Commitments and Contingencies
Master Servicing
Properties securing mortgage loans in IFC's master servicing portfolio are
primarily located in California. As of December 31, 1999 and 1998, approximately
40% of mortgage loans in IFC's master servicing portfolio were located in
California. As of December 31, 1999 and 1998, IFC was master servicing loans
totaling approximately $2.9 billion and $3.7 billion, respectively, of which
$2.8 billion and $3.5 billion, respectively, were serviced for others. IFC is
the master servicer for $1.4 billion and $1.5 billion, respectively of loans
collateralizing fixed rate REMIC securities and $885.2 million and $1.1 billion,
respectively, of loans collateralizing CMOs. Related fiduciary funds are held in
trust for investors in non-interest bearing accounts. These funds are segregated
in special bank accounts and are held as deposits at Southern Pacific Bank.
Master Commitments
IFC establishes mortgage loan purchase commitments (Master Commitments) with
sellers that, subject to certain conditions, entitle the seller to sell and
obligate IFC to purchase a specified dollar amount of non-conforming mortgage
loans over a period generally ranging from six months to one year. The terms of
each Master Commitment specify whether a seller may sell loans to IFC on a
mandatory, best efforts or optional basis. Master commitments generally do not
obligate IFC to purchase loans at a specific price, but rather provide the
seller with a future outlet for the sale of its originated loans based on IFC's
quoted prices at the time of purchase. As of December 31, 1999 and 1998, IFC had
outstanding short term Master Commitments with 88 and 54 sellers, respectively,
to purchase mortgage loans in the aggregate principal amount of $1.9 billion and
$1.5 billion, respectively, over periods ranging from six months to one year, of
which $747.5 million and $522.3 million, respectively, had been purchased or
committed to be purchased pursuant to rate locks. These rate-locks were made
pursuant to Master Commitments, bulk rate-locks and other negotiated rate-locks.
There is no exposure to credit loss in this type of commitment until the loans
are funded, and
F-47
interest rate risk associated with the short-term commitments is mitigated by
the use of forward contracts to sell loans to investors.
Following the issuance of a specific rate-lock, IFC is subject to the risk of
interest rate fluctuations and enters into hedging transactions to diminish such
risk. Hedging transactions may include mandatory or optional forward sales of
mortgage loans or mortgage-backed securities, interest rate caps, floors and
swaps, mandatory forward sales, mandatory or optional sales of futures, and
other financial futures transactions. The nature and quantity of hedging
transactions are determined by the management of IFC based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
Deferred hedging gains and losses are presented on IFC's balance sheet in other
assets. These deferred amounts are recognized upon the sale or securitization of
the related mortgage loans. Deferred hedging gains and losses are presented on
IFC's balance sheet in mortgage loans held-for-sale. As of December 31, 1999 and
1998, IFC had $792,000 and $263,000, respectively, of deferred hedging losses
included in mortgage loans held-for-sale.
Forward Contracts
IFC sells mortgage-backed securities through forward delivery contracts with
major dealers in such securities. At December 31, 1999 and 1998, IFC had $110.0
million and $46.0 million, respectively, in outstanding commitments to sell
mortgage loans through mortgage-backed securities. These commitments allow IFC
to enter into mandatory commitments when IFC notifies the investor of its intent
to exercise a portion of the forward delivery contracts. IFC was not obligated
under mandatory commitments to deliver loans to such investors at December 31,
1999 and 1998. The credit risk of forward contracts relates to the
counterparties' ability to perform under the contract. IFC evaluates
counterparties based on their ability to perform prior to entering into any
agreements.
Futures Contracts
IFC sells futures contracts against five and ten-year Treasury notes with
major dealers in such securities. At December 31, 1999 and 1998, IFC had $10.0
million and none, respectively, in outstanding commitments to sell Treasury
notes which expire within 90 days.
Options
In order to protect against changes in the value of mortgage loans held for
sale, IFC may sell call or buy put options on U.S. Treasury bonds and mortgage-
backed securities. IFC generally sells call or buys put options to hedge against
adverse movements of interest rates affecting the value of its mortgage loans
held for sale. The risk in writing a call option is that IFC gives up the
opportunity for profit if the market price of the mortgage loans increases and
the option is exercised. IFC also has the additional risk of not being able to
enter into a closing transaction if a liquid secondary market does not exist.
The risk of buying a put option is limited to the premium IFC paid for the put
option. IFC had written option contracts with an outstanding principal balance
of $20.0 million and $25.0 million at December 31, 1999 and 1998, respectively.
IFC received approximately $95,000 and $134,000 in premiums on these options at
December 31, 1999 and 1998, respectively.
Sales of Loans and Servicing Rights
In the ordinary course of business, IFC is exposed to liability under
representations and warranties made to purchasers and insurers of mortgage loans
and the purchasers of servicing rights. Under certain circumstances, IFC is
required to repurchase mortgage loans if there has been a breach of
representations or warranties. In the opinion of management, the potential
exposure related to these representations and warranties will not have a
material adverse effect. At December 31, 1999 and 1998, included in other
liabilities are $592,000 and $838,000, respectively, in allowances for
repurchases related to possible off-balance sheet recourse and repurchase
agreement provisions.
F-48
Note K--Quarterly Financial Data (unaudited)
Selected quarterly financial data for 1999 follows (in thousands):
For the Three Months Ended,
----------------------------------------------------------------------
December 31, September 30, June 30, March 31,
---------------- ----------------- ------------ ------------
Net interest income........................................... $ (571) $ 392 $ 363 $ 88
Non-interest income........................................... 4,204 10,427 11,181 7,486
Non-interest expense (including income taxes)................. 4,873 7,771 10,121 6,473
Net earnings (loss)........................................... (1,240) 3,048 1,423 1,101
Selected quarterly financial data for 1998 follows (in thousands):
For the Three Months Ended,
----------------------------------------------------------------------
December 31, September 30, June 30, March 31,
---------------- ----------------- ------------ -----------
Net interest income..................................... $ 1,031 $ 1,387 $ 1,333 $ 4,016
Non-interest income..................................... (8,469) (9,103) 6,973 4,916
Non-interest expense (including income taxes)........... 2,627 224 6,491 6,755
Net earnings (loss)..................................... (10,065) (7,940) 1,815 2,177
F-49