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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003 or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission File Number: 1-14100
IMPAC MORTGAGE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Maryland 33-0675505
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1401 Dove Street, Newport Beach, California 92660
(Address of principal executive offices)
(949) 475-3600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $0.01 par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes |X| No |_|
As of July 31, 2003 the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $698.5 million, based on the
closing sales price of common stock on the New York Stock Exchange on that date.
For purposes of the calculation only, in addition to affiliated companies, all
directors and executive officers of the registrant have been deemed affiliates.
There were 51,497,651 shares of common stock outstanding as of August 1, 2003.
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IMPAC MORTGAGE HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 ........................... 1
Consolidated Statements of Operations and Comprehensive Earnings, For the Three and Six Months
Ended June 30, 2003 and 2002 ................................................................. 2
Consolidated Statements of Cash Flows, For the Six Months Ended June 30, 2003 and 2002 .......... 3
Notes to Consolidated Financial Statements ...................................................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements ...................................................................... 13
Financial Highlights for the Second Quarter of 2003 ............................................. 13
General and Business Operations ................................................................. 14
Available Information ........................................................................... 15
Corporate Governance ............................................................................ 15
Critical Accounting Policies .................................................................... 15
Results of Operations--Impac Mortgage Holdings, Inc.--For the Three Months Ended June 30, 2003 .. 16
Results of Operations--Impac Mortgage Holdings, Inc. --For the Six Months Ended June 30, 2003 ... 29
Liquidity and Capital Resources ................................................................. 35
Risk Factors .................................................................................... 39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......................................... 53
ITEM 4. CONTROLS AND PROCEDURES ............................................................................ 55
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS .................................................................................. 55
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS .......................................................... 55
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .................................................................... 55
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ................................................ 55
ITEM 5. OTHER INFORMATION .................................................................................. 56
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................................................... 56
SIGNATURES ......................................................................................... 57
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
June 30, December 31,
2003 2002
----------- ------------
ASSETS
Cash and cash equivalents ............................................................... $ 123,645 $ 113,345
Investment securities available-for-sale ................................................ 22,867 26,065
Loans Receivable:
CMO collateral ....................................................................... 6,563,868 5,149,680
Finance receivables .................................................................. 1,319,830 1,140,248
Mortgages held-for-investment ........................................................ 129,542 57,536
Allowance for loan losses ............................................................ (33,384) (26,602)
----------- -----------
Net loans receivable ............................................................... 7,979,856 6,320,862
----------- -----------
Accrued interest receivable ............................................................. 31,804 28,287
Investment in Impac Funding Corporation ................................................. 26,087 20,787
Derivative assets ....................................................................... 18,558 14,931
Due from affiliates ..................................................................... 14,500 14,500
Other real estate owned ................................................................. 13,490 11,116
Other assets ............................................................................ 882 1,880
----------- -----------
Total assets ....................................................................... $ 8,231,689 $ 6,551,773
=========== ===========
LIABILITIES
CMO borrowings .......................................................................... $ 6,421,943 $ 5,041,751
Reverse repurchase agreements ........................................................... 1,396,684 1,168,029
Borrowings secured by investment securities available-for-sale .......................... 2,435 7,134
Accumulated dividends payable ........................................................... 25,352 21,754
Other liabilities ....................................................................... 6,997 9,617
----------- -----------
Total liabilities .................................................................. 7,853,411 6,248,285
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock; $0.01 par value; 7,500,000 shares authorized; none outstanding at
June 30, 2003 and December 31, 2002, respectively .................................... -- --
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares
authorized; none outstanding at June 30, 2003 and December 31, 2002 .................. -- --
Common stock; $0.01 par value; 200,000,000 shares authorized; 50,704,064 and
45,320,517 shares outstanding at June 30, 2003 and December 31, 2002, respectively ... 507 453
Additional paid-in capital .............................................................. 542,508 479,298
Accumulated other comprehensive loss .................................................... (35,508) (41,721)
Net accumulated deficit:
Cumulative dividends declared ........................................................ (250,904) (200,954)
Retained earnings .................................................................... 121,675 66,412
----------- -----------
Net accumulated deficit ............................................................. (129,229) (134,542)
----------- -----------
Total stockholders' equity ......................................................... 378,278 303,488
----------- -----------
Total liabilities and stockholders' equity ......................................... $ 8,231,689 $ 6,551,773
=========== ===========
See accompanying notes to consolidated financial statements.
1
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
and COMPREHENSIVE EARNINGS
(in thousands, except earnings per share data)
(unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
--------------------- ----------------------
2003 2002 2003 2002
-------- -------- --------- --------
INTEREST INCOME:
Mortgage assets ............................................ $ 82,766 $ 48,277 $ 158,245 $ 90,703
Other interest income ...................................... 778 952 1,459 1,594
-------- -------- --------- --------
Total interest income ................................... 83,544 49,229 159,704 92,297
-------- -------- --------- --------
INTEREST EXPENSE:
CMO borrowings ............................................. 48,699 25,524 90,383 47,930
Reverse repurchase agreements .............................. 7,305 5,348 14,096 9,638
Borrowings secured by investment securities ................ 852 475 1,484 1,024
Other borrowings ........................................... 79 328 330 504
-------- -------- --------- --------
Total interest expense .................................. 56,935 31,675 106,293 59,096
-------- -------- --------- --------
Net interest income ........................................ 26,609 17,554 53,411 33,201
Provision for loan losses ............................... 7,059 4,234 13,543 7,941
-------- -------- --------- --------
Net interest income after provision for loan losses ........ 19,550 13,320 39,868 25,260
NON-INTEREST INCOME:
Equity in net earnings of Impac Funding Corporation ........ 11,532 5,453 16,698 10,062
Other income ............................................... 1,106 954 3,750 1,996
-------- -------- --------- --------
Total non-interest income ............................... 12,638 6,407 20,448 12,058
NON-INTEREST EXPENSE:
Professional services ...................................... 1,420 1,080 2,457 1,940
Personnel expense .......................................... 802 391 1,494 792
General and administrative expense ......................... 771 489 1,536 567
Loss (gain) on disposition of other real estate owned ...... (523) 42 (434) (394)
Write-down on investment securities ........................ -- -- -- 1,039
-------- -------- --------- --------
Total non-interest expense .............................. 2,470 2,002 5,053 3,944
-------- -------- --------- --------
Net earnings ............................................... 29,718 17,725 55,263 33,374
OTHER COMPREHENSIVE EARNINGS:
Unrealized holding gains (losses) on securities
arising during period .................................... (1,563) 678 (1,041) (552)
Unrealized holding gains (losses) on hedging instruments
arising during period .................................... 3,665 (19,700) 7,254 (9,294)
Reclassification of (gains) losses included
in net earnings .......................................... -- 65 -- (159)
-------- -------- --------- --------
Net unrealized gains (losses) arising during period ... 2,102 (18,957) 6,213 (10,005)
-------- -------- --------- --------
Other comprehensive earnings (loss) ........................ $ 31,820 $ (1,232) $ 61,476 $ 23,369
======== ======== ========= ========
NET EARNINGS PER SHARE:
Basic ...................................................... $ 0.60 $ 0.45 $ 1.14 $ 0.88
======== ======== ========= ========
Diluted .................................................... $ 0.58 $ 0.44 $ 1.12 $ 0.87
======== ======== ========= ========
DIVIDENDS PER COMMON SHARE .................................... $ 0.50 $ 0.43 $ 1.00 $ 0.83
======== ======== ========= ========
See accompanying notes to consolidated financial statements.
2
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Six Months
Ended June 30,
---------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings .......................................................................... $ 55,263 $ 33,374
Adjustments to reconcile net earnings to net cash provided by operating activities:
Equity in net earnings of Impac Funding Corporation ................................ (16,698) (10,062)
Provision for loan losses .......................................................... 13,543 7,941
Amortization of loan premiums and securitization costs ............................. 30,648 15,619
Gain on disposition of other real estate owned ..................................... 434 394
Write-down of investment securities available-for-sale ............................. -- 1,039
Net change in accrued interest receivable .......................................... (3,517) (4,260)
Net change in other assets and liabilities ......................................... (5,249) (132,879)
----------- -----------
Net cash provided by (used in) operating activities .............................. 74,424 (88,834)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in CMO collateral .......................................................... (1,452,860) (1,238,180)
Net change in finance receivables ..................................................... (179,673) (102,662)
Net change in mortgages held-for-investment ........................................... (81,226) 5,428
Proceeds from sale of other real estate owned, net .................................... 14,938 5,554
Dividend from Impac Funding Corporation ............................................... 11,385 5,693
Net principal reductions on investment securities available-for-sale .................. 2,252 3,056
----------- -----------
Net cash used in investing activities ............................................ (1,685,184) (1,321,111)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in reverse repurchase agreements and other borrowings ...................... 223,956 43,333
Proceeds from CMO borrowings .......................................................... 2,346,668 1,736,750
Repayments of CMO borrowings .......................................................... (966,476) (414,131)
Dividends paid ........................................................................ (46,352) (29,849)
Proceeds from sale of common stock .................................................... 37,776 56,968
Proceeds from sale of common stock via Equity Distribution Agreement .................. 24,463 5,486
Proceeds from exercise of stock options ............................................... 1,025 141
Reductions on notes receivable-common stock ........................................... -- 920
----------- -----------
Net cash provided by financing activities ........................................ 1,621,060 1,399,618
----------- -----------
Net change in cash and cash equivalents ............................................... 10,300 (10,327)
Cash and cash equivalents at beginning of period ...................................... 113,345 51,887
----------- -----------
Cash and cash equivalents at end of period ............................................ $ 123,645 $ 41,560
=========== ===========
SUPPLEMENTARY INFORMATION:
Interest paid ......................................................................... $ 104,408 $ 59,013
NON-CASH TRANSACTIONS:
Transfer of mortgages held-for-investment to CMO collateral ........................... $ 2,338,700 $ 1,617,530
Transfer of mortgages to other real estate owned ...................................... 17,746 7,282
Dividends declared and unpaid ......................................................... 25,352 17,171
Other comprehensive earnings .......................................................... 6,213 (10,005)
See accompanying notes to consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--Basis of Financial Statement Presentation
The accompanying consolidated financial statements of Impac Mortgage
Holdings, Inc. (IMH) and subsidiaries, collectively, (the Company), have been
prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP) for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring adjustments, considered necessary for a fair presentation
have been included. Operating results for the three- and six-month periods ended
June 30, 2003 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2003. The accompanying consolidated financial
statements should be read in conjunction with the consolidated financial
statements and related notes thereto included in the Company's annual report on
Form 10-K for the year ended December 31, 2002.
The consolidated financial statements are prepared on the accrual basis of
accounting in accordance with GAAP. The preparation of financial statements in
conformity with GAAP requires management to make significant estimates and
assumptions that affect the reported amounts of assets, liabilities and
contingent liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results may
differ materially from those estimates.
The Company's results of operations have been presented in the
consolidated financial statements for the three- and six-months ended June 30,
2003 and 2002 and include the financial results of equity interest in net
earnings of Impac Funding Corporation (IFC). The results of operations of IFC,
of which 100% of IFC's preferred stock and 99% of its economic interest is owned
by IMH, are included in the results of operations as "Equity in net earnings of
Impac Funding Corporation." Additionally, the Company's results of operations
include the financial results of its subsidiaries, which are IMH Assets
Corporation (IMH Assets), Impac Warehouse Lending Group (IWLG) and Impac
Multifamily Capital Corporation (IMCC).
Note 2--Earnings Per Share
The following table presents the computation of basic and diluted net
earnings per share as if all stock options were outstanding for the periods
indicated (in thousands, except net earnings per share):
For the Three Months
Ended June 30,
--------------------
2003 2002
------- -------
Numerator for earnings per share:
Net earnings ...................................................... $29,718 $17,725
======= =======
Denominator for earnings per share:
Basic weighted average number of common shares outstanding ........ 49,856 39,522
Net effect of dilutive stock options .............................. 1,058 715
------- -------
Diluted weighted average common and common equivalent shares ... 50,914 40,237
======= =======
Net earnings per share:
Basic ............................................................. $ 0.60 $ 0.45
======= =======
Diluted ........................................................... $ 0.58 $ 0.44
======= =======
The Company had 20,000 and no stock options outstanding during the three
months ended June 30, 2003 and 2002, respectively, that were not considered in
the calculation of diluted weighted average common and common equivalent shares.
4
For the Six Months
Ended June 30,
------------------
2003 2002
------- -------
Numerator for earnings per share:
Net earnings ...................................................... $55,263 $33,374
======= =======
Denominator for earnings per share:
Basic weighted average number of common shares outstanding ........ 48,516 37,752
Net effect of dilutive stock options .............................. 958 611
------- -------
Diluted weighted average common and common equivalent shares ... 49,474 38,363
======= =======
Net earnings per share:
Basic ............................................................. $ 1.14 $ 0.88
======= =======
Diluted ........................................................... $ 1.12 $ 0.87
======= =======
The Company had 20,000 and 17,127 stock options outstanding during the six
months ended June 30, 2003 and 2002, respectively, that were not considered in
the calculation of diluted weighted average common and common equivalent shares.
Note 3--Stock Options
Stock options and awards may be granted to the directors, officers and
employees of the Company. The exercise price for any non-qualified stock option
(NQSO) or incentive stock option (ISO) granted may not be less than 100% (or
110% in the case of ISOs granted to an employee who is deemed to own in excess
of 10% of the outstanding common stock) of the fair market value of the shares
of common stock at the time the NQSO or ISO is granted. Grants under stock
option plans are made and administered by the board of directors. IMH currently
has a 1995 Stock Option, Deferred Stock and Restricted Stock Plan (1995 Plan).
During 2001 the board of directors and stockholders approved a new Stock Option,
Deferred Stock and Restricted Stock Plan (2001 Plan). The 1995 Plan and the 2001
Plan shall collectively be referred to as the Stock Option Plans. Each Stock
Option Plan provides for the grant of qualified incentive stock options (ISOs),
options not qualified (NQSOs), deferred stock, and restricted stock, and, in the
case of the 2001 Plan, dividend equivalent rights and, in the case of the 1995
Plan, stock appreciation rights and limited stock appreciation rights awards
(Awards). To enable IMH to deduct, in full, all amounts of ordinary income
recognized by its executive officers in connection with the exercise of
non-qualified stock options granted in the future, stockholders approved an
amendment to the 2001 stock option plan in June 2003 that limits the maximum
number of shares for which stock options may be granted to any eligible employee
in any fiscal year to 1,500,000 shares.
In December 2002 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148), an amendment to FASB
Statement No. 123, "Accounting for Stock-Based Compensation," (SFAS 123). SFAS
148 amends SFAS 123 to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS
123 to require prominent disclosures in both annual and interim financial
statements. On December 15, 2002 IMH adopted the disclosure requirements of SFAS
148. SFAS 123 established financial accounting standards for stock-based
employee compensation plans, which permits management to choose either a fair
value based method or an intrinsic value based method of accounting for its
stock-based compensation arrangements in accordance with APB Opinion No. 25 (APB
25). SFAS 123 requires pro forma disclosures of net earnings (loss) computed as
if the fair value based method had been applied in financial statements of
companies that continue to follow the intrinsic value method in accounting for
such arrangements under APB 25. SFAS 123 applies to all stock-based employee
compensation plans in which an employer grants shares of its stock or other
equity instruments to employees except for employee stock ownership plans. SFAS
123 also applies to plans in which the employer incurs liabilities to employees
in amounts based on the price of the employer's stock, i.e., stock option plans,
stock purchase plans, restricted stock plans and stock appreciation rights. The
statement also specifies the accounting for transactions in which a company
issues stock options or other equity instruments for services provided by
non-employees or to acquire goods or services from outside suppliers or vendors.
As of June 30, 2003 the Company had fixed stock option plans, which it
accounted for using the intrinsic value method in accordance with APB 25 and
which did not require the recognition of compensation cost. However, if
compensation cost for stock-based compensation plans had been recognized using
the fair value based method consistent
5
with SFAS 123, as amended by SFAS 148, net earnings and earnings per share would
have been reduced to the pro forma amounts indicated below (in thousands, except
per share amounts):
For the Three Months
Ended June 30,
--------------------
2003 2002
------- -------
Net earnings as reported ............................................. $29,718 $17,725
Less: Total stock-based employee compensation expense using the
fair value method ................................................. (136) (84)
------- -------
Pro forma net earnings ............................................ $29,582 $17,641
======= =======
Net earnings per share as reported:
Basic ............................................................. $ 0.60 $ 0.45
======= =======
Diluted ........................................................... $ 0.58 $ 0.44
======= =======
Pro forma net earnings:
Basic ............................................................. $ 0.59 $ 0.45
======= =======
Diluted ........................................................... $ 0.58 $ 0.44
======= =======
For the Six Months
Ended June 30,
------------------
2003 2002
------- -------
Net earnings as reported ............................................. $55,263 $33,374
Less: Total stock-based employee compensation expense using the
fair value method ................................................. (272) (161)
------- -------
Pro forma net earnings ............................................ $54,991 $33,213
======= =======
Net earnings per share as reported:
Basic ............................................................. $ 1.14 $ 0.88
======= =======
Diluted ........................................................... $ 1.12 $ 0.87
======= =======
Pro forma net earnings:
Basic ............................................................. $ 1.13 $ 0.88
======= =======
Diluted ........................................................... $ 1.11 $ 0.87
======= =======
There were no stock options granted during the second quarter of 2003,
therefore, pro forma net earnings and net earnings per share reflect the
amortization of previously granted stock options which are amortized as expense
over the stock option life in determining the pro forma impact. The derived fair
value of stock options granted during the second quarter of 2002 was
approximately $1.14 per stock option, which is derived based on the stock option
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions:
-----------------
For the Three and
Six Months Ended
June 30, 2002
-----------------
Risk-free interest rate ................ 1.45%
Expected lives (in years) .............. 3-10
Expected volatility .................... 35.07%
Expected dividend yield ................ 10.00%
Note 4--Segment Reporting
The Company internally reviews and analyzes its operating segments as
follows:
o the long-term investment operations, conducted by IMH, IMH Assets
and IMCC, invest primarily in non-conforming Alt-A residential
mortgages (Alt-A mortgages) acquired from the mortgage operations,
small-balance multi-family mortgages originated by IMCC and, to a
lesser extent, mortgage-backed securities secured by or representing
interests in mortgages;
6
o the warehouse lending operations, conducted by IWLG, provides
warehouse financing to affiliated companies and to approved mortgage
bankers, some of which are correspondents of IFC, to finance
mortgages; and
o the mortgage operations, conducted by IFC, acquires and originates
primarily Alt-A mortgages and, to a lesser extent, sub-prime
mortgages and second mortgages from its network of third party
correspondents, mortgage brokers and retail customers.
The following table presents business segments as of and for the six
months ended June 30, 2003 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
---------- ---------- ---------------- ------------
Balance Sheet Items:
CMO collateral and mortgages held-for-investment ... $6,693,410 $ -- $ -- $6,693,410
Finance receivables ................................ -- 1,430,703 (110,873) 1,319,830
Total assets ....................................... 7,155,167 1,503,032 (426,510) 8,231,689
Total stockholders' equity ......................... 590,013 103,372 (315,107) 378,278
Income Statement Items:
Net interest income ................................ $ 40,407 $ 13,004 $ -- $ 53,411
Provision for loan losses .......................... 12,351 1,192 -- 13,543
Non-interest income ................................ 1,051 2,699 16,698 20,448
Non-interest expense ............................... 2,653 2,400 -- 5,053
---------- ---------- --------- ----------
Net earnings ....................................... $ 26,454 $ 12,111 $ 16,698 $ 55,263
========== ========== ========= ==========
The following table presents business segments for the three months ended
June 30, 2003 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
---------- ---------- ---------------- ------------
Income Statement Items:
Net interest income ................................ $ 19,675 $ 6,934 $ -- $ 26,609
Provision for loan losses .......................... 6,462 597 -- 7,059
Non-interest income (expense) ...................... (232) 1,338 11,532 12,638
Non-interest expense ............................... 1,168 1,302 -- 2,470
---------- ---------- --------- ----------
Net earnings ....................................... $ 11,813 $ 6,373 $ 11,532 $ 29,718
========== ========== ========= ==========
The following table presents business segments as of and for the six
months ended June 30, 2002 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
---------- ---------- ---------------- ------------
Balance Sheet Items:
CMO collateral and mortgages held-for-investment ... $3,448,735 $ -- $ -- $3,448,735
Finance receivables ................................ -- 569,419 (108) 569,311
Total assets ....................................... 3,901,136 600,493 (219,715) 4,281,914
Total stockholders' equity ......................... 397,210 79,706 (219,606) 257,310
Income Statement Items:
Net interest income ................................ $ 26,062 $ 7,139 $ -- $ 33,201
Provision for loan losses .......................... 7,402 539 -- 7,941
Non-interest income ................................ 41 1,955 10,062 12,058
Non-interest expense ............................... 2,332 1,612 -- 3,944
---------- ---------- --------- ----------
Net earnings ....................................... $ 16,369 $ 6,943 $ 10,062 $ 33,374
========== ========== ========= ==========
7
The following table presents business segments for the three months ended
June 30, 2002 (in thousands):
Long-Term Warehouse Inter-
Investment Lending Company
Operations Operations Eliminations (1) Consolidated
---------- ---------- ---------------- ------------
Income Statement Items:
Net interest income ................................ $ 13,588 $ 3,966 $ -- $ 17,554
Provision for loan losses .......................... 3,964 270 -- 4,234
Non-interest income (expense) ...................... (24) 978 5,453 6,407
Non-interest expense ............................... 1,154 848 -- 2,002
---------- ---------- --------- ----------
Net earnings ....................................... $ 8,446 $ 3,826 $ 5,453 $ 17,725
========== ========== ========= ==========
(1) Elimination of inter-company balance sheet and income statement items.
Note 5--Allowance for Loan Losses
A provision is recorded for losses on mortgages held-for-investment,
mortgages held as CMO collateral and finance receivables at an amount that
management believes is sufficient to provide adequate protection against
estimated inherent losses in the mortgage loan investment portfolio. The
allowance for loan losses is reduced by losses incurred for loans deemed to be
uncollectible. Subsequent recoveries on mortgages previously charged off are
credited back to the allowance. The provision for estimated loan losses is
primarily based on historical loss statistics, including cumulative loss
percentages and loss severity, of similar mortgages in our mortgage loan
investment portfolio. The loss percentage is used to determine the estimated
inherent losses in the mortgage loan investment portfolio. The provision for
loan losses is also determined based on the following:
o management's judgment of the net loss potential of mortgages in our
mortgage loan investment portfolio based on prior loan loss
experience;
o changes in the nature and volume of the mortgage loan investment
portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
The following table presents activity for allowance for loan losses for
the periods shown (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
--------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
Beginning balance ............... $ 29,761 $ 14,764 $ 26,602 $ 11,692
Provision for loan losses ....... 7,059 4,234 13,543 7,941
Charge-offs, net of recoveries .. (3,436) (2,064) (6,761) (2,699)
-------- -------- -------- --------
Ending balance ............... $ 33,384 $ 16,934 $ 33,384 $ 16,934
======== ======== ======== ========
Note 6--Derivative Instruments and Hedging Activities
Management follows a hedging program intended to limit its exposure to
changes in interest rates primarily associated with cash flows on CMO
borrowings. Management's primary objective is to hedge exposure to the
variability in future cash flows attributable to the variability of one-month
LIBOR, which is the underlying index of adjustable rate CMO borrowings.
Management also monitors on an ongoing basis the prepayment risks that arise in
fluctuating interest rate environments. Management's hedging program is
formulated with the intent to offset the potential adverse effects of changing
interest rates on cash flows on CMO borrowings resulting from the following:
o interest rate adjustment limitations on CMO collateral due to
periodic and lifetime interest rate cap features; and
8
o mismatched interest rate adjustment periods between mortgages held
as CMO collateral and CMO borrowings.
To mitigate exposure to the effect of changing interest rates on cash
flows on CMO borrowings, IMH purchases or sells derivatives in the form of
interest rate cap agreements (Caps), interest rate floor agreements (Floors) and
interest rate swap agreements (Swaps). A purchase or sale of a Cap or Floor is a
contractual agreement for which IMH may pay or receive a fee. If prevailing
interest rates reach levels specified in the Cap or Floor agreement, IMH may
either receive or pay cash. A Swap is generally a contractual agreement that
obligates one party to receive or make cash payments based on an adjustable rate
index and the other party to receive or make cash payments based on a fixed
rate. Swaps have the effect of fixing borrowing costs on a similar amount of
Swaps and, as a result, can reduce the interest rate variability of borrowings.
Management's objective is to lock in a reliable stream of cash flows when
interest rates fall below or rise above certain levels. For instance, when
interest rates rise, borrowing costs may increase at greater speeds than the
underlying collateral supporting the borrowings. These derivatives hedge the
variability of forecasted cash flows attributable to CMO borrowings and protect
net interest income by providing cash flows at certain triggers during changing
interest rate environments. Counter-parties on hedging instruments that are
deposited into a CMO trust must have AAA credit ratings while counter-parties on
hedging instruments that are not deposited into a CMO trust generally have an A
or above credit rating as determined by various credit rating agencies.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 137 and SFAS No. 138, collectively, (SFAS
133), established accounting and reporting standards for derivative instruments,
including a number of derivative instruments embedded in other contracts,
collectively referred to as derivatives, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
specific conditions are met, a derivative may be specifically designated as (1)
a hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment; (2) a hedge of the exposure to
variable cash flows of a forecasted transaction; or (3) a hedge of the foreign
currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available for sale security or a
foreign-currency-denominated forecasted transaction.
On January 1, 2001 IMH adopted SFAS 133 and the fair value of derivatives
were reflected in financial condition and results of operations. On August 10,
2001 the Derivatives Implementation Group (DIG) of the FASB published DIG G20,
which further interpreted SFAS 133. On October 1, 2001 IMH adopted the
provisions of DIG G20 and net income and accumulated other comprehensive income
were adjusted by the amount needed to reflect the cumulative impact of adopting
the provisions of DIG G20.
Caps qualify as derivatives under provisions of SFAS 133. The hedging
instrument is the specific LIBOR Cap that is hedging the LIBOR based CMO
borrowings. The nature of the risk being hedged is the variability of the cash
flows associated with the LIBOR borrowings. Prior to the adoption of DIG G20
management assessed the hedging effectiveness of its Caps utilizing only the
intrinsic value of the Caps. DIG G20 allows management to utilize the terminal
value of the Caps to assess effectiveness. DIG G20 also allows for amortization
of the initial fair value of the Caps over the life of the Caps based on the
maturity date of the individual caplets. Upon adoption of DIG G20 net income and
accumulated other comprehensive income were adjusted by the amount needed to
reflect the cumulative impact of adopting the provisions of DIG G20. Subsequent
to the adoption of DIG G20 Caps are considered effective hedges and are marked
to market each reporting period with the entire change in market value being
recognized in accumulated other comprehensive income.
Floors and Swaps qualify as cash flow hedges under the provisions of SFAS
133. The hedging instrument is the specific LIBOR Floor or Swap that is hedging
the LIBOR based CMO borrowings. The nature of the risk being hedged is the
variability of the cash flows associated with the LIBOR borrowings. Prior to DIG
G20 these derivatives were marked to market with the entire change in the market
value of the intrinsic component recognized in accumulated other comprehensive
income each reporting period. The time value component of these agreements were
marked to market and recognized in non-interest expense in the statement of
operations. Subsequent to the adoption of DIG G20 these derivatives are marked
to market with the entire change in the market value recognized in accumulated
other comprehensive income. Effectiveness of derivatives is measured by the fact
that the hedged item, CMO borrowings, and the derivative are based on one-month
LIBOR. As both instruments are tied to the same index, the hedge is expected to
be highly effective both at inception and on an ongoing basis. Management
assesses the effectiveness and ineffectiveness of the hedging instruments at the
inception of the hedge and at each reporting period. Based on the fact that, at
inception, the critical terms of the hedges and forecasted CMO borrowings are
the same, management has concluded that the changes in cash flows attributable
to the risk being hedged are expected to be substantially offset by the
derivatives, subject to subsequent assessments that the critical terms have not
changed.
9
The following table presents certain information related to derivatives
and the related component in the financial statements as of June 30, 2003 (in
thousands):
Fair Related Related
Value Related Unamortized Amount in Amount
of Amount in Derivative Derivative in CMO
Derivatives Index OCI Instruments Asset Account Collateral
----------- ----------- --------- ----------- ------------- ----------
Derivatives not associated with
CMOs ............................ $ (7,807) 1 mo. LIBOR $ (4,296) $(3,511) $ (7,807) $ --
Cash in margin account ............ 26,365 N/A -- -- 26,365 --
Derivatives associated with
CMOs ............................ (31,861) 1 mo. LIBOR (37,576) 5,715 -- (31,861)
99% OCI activity at IFC ........... -- Fannie Mae (1,148) -- -- --
-------- -------- ------- -------- --------
Totals ......................... $(13,303) $(43,020) $ 2,204 $ 18,558 $(31,861)
======== ======== ======= ======== ========
The following table presents certain information related to derivatives
and the related component in the financial statements as of December 31, 2002
(in thousands):
Fair Related Related
Value Related Unamortized Amount in Amount
of Amount in Derivative Derivative in CMO
Derivatives Index OCI Instruments Asset Account Collateral
----------- ----------- --------- ----------- ------------- ----------
Derivatives not associated with
CMOs ............................ $(15,515) 1 mo. LIBOR $ (9,693) $(5,822) $(15,515) $ --
Cash in margin account ............ 30,446 N/A -- -- 30,446 --
Derivatives associated with
CMOs ............................ (30,332) 1 mo. LIBOR (39,464) 9,132 -- (30,332)
99% of OCI activity at IFC ........ -- Fannie Mae (1,035) -- -- --
-------- -------- ------- -------- --------
Totals ......................... $(15,401) $(50,192) $ 3,310 $ 14,931 $(30,332)
======== ======== ======= ======== ========
Note 7--Income Taxes
The Company operates so as to qualify as a REIT under the requirements of
the Internal Revenue Code (the Code). Requirements for qualification as a REIT
include various restrictions on ownership of IMH's stock, requirements
concerning distribution of taxable income and certain restrictions on the nature
of assets and sources of income. A REIT must distribute at least 90% of its
taxable income to its stockholders of which 85% must be distributed within the
taxable year in order to avoid the imposition of an excise tax and the remaining
balance may extend until timely filing of its tax return in its subsequent
taxable year. Qualifying distributions of its taxable income are deductible by a
REIT in computing its taxable income. If in any tax year the Company should not
qualify as a REIT, it would be taxed as a corporation and distributions to the
stockholders would not be deductible in computing taxable income. If the Company
were to fail to qualify as a REIT in any tax year, it would not be permitted to
qualify for that year and the succeeding four years. As of December 31, 2002,
the Company had estimated federal and state net operating loss tax
carry-forwards of approximately $17.4 million, which expire in the year 2020,
that are available to offset future taxable income.
Note 8--Investment in Impac Funding Corporation
The Company is entitled to 99% of the earnings or losses of IFC through
its ownership of 100% of the non-voting preferred stock of IFC. As such, the
Company records its investment in IFC using the equity method. Under this
method, original investments are recorded at cost and adjusted by the Company's
share of earnings or losses. On July 1, 2003 IMH entered into a Stock Purchase
Agreement with Joseph R. Tomkinson, William S. Ashmore and the Johnson Revocable
Living Trust, of which Richard J. Johnson is trustee, whereby IMH purchased all
of the outstanding shares of voting common stock of IFC for aggregate
consideration of $750,000. The fairness opinion of IFC, as rendered by an
independent financial advisor, and subsequent transaction was approved by the
board of directors. The common stock of IFC represents 1% of the economic
interest in IFC. As a result of acquiring 100% of IFC's common stock, IMH will
consolidate IFC's financial results beginning in the third quarter of 2003. The
following tables present unaudited consolidated financial information for
interim periods and audited consolidated financial information as of December
31, 2002 for Impac Funding Corporation (in thousands):
10
BALANCE SHEETS
June 30, December 31,
2003 2002
--------- -----------
ASSETS
Cash and cash equivalents ........................................ $ 24,135 $ 22,773
Securities available-for-sale .................................... 125 129
Mortgages held-for-sale .......................................... 451,432 495,877
Mortgage and master servicing rights ............................. 7,555 8,274
Premises and equipment, net ...................................... 5,959 4,948
Accrued interest receivable ...................................... 564 430
Deferred taxes ................................................... 24,504 18,829
Other assets ..................................................... 33,234 24,326
--------- ---------
Total assets ................................................ $ 547,508 $ 575,586
========= =========
LIABILITIES
Borrowings from IWLG ............................................. $ 447,951 $ 491,383
Due to affiliates ................................................ 14,500 14,500
Deferred revenue ................................................. 6,365 5,088
Accrued interest expense ......................................... 911 1,068
Other liabilities ................................................ 51,430 42,550
--------- ---------
Total liabilities ........................................... 521,157 554,589
--------- ---------
SHAREHOLDERS' EQUITY
Preferred stock .................................................. 18,053 18,053
Common stock ..................................................... 182 182
Retained earnings ................................................ 42,835 25,968
Cumulative dividends declared .................................... (33,484) (21,984)
Accumulated other comprehensive loss ............................. (1,235) (1,222)
--------- ---------
Total shareholders' equity .................................. 26,351 20,997
--------- ---------
Total liabilities and shareholders' equity .................. $ 547,508 $ 575,586
========= =========
STATEMENTS OF OPERATIONS
For the Three Months For the Six Months
Ended June 30, Ended June 30,
--------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net interest income:
Total interest income ............................. $ 9,580 $ 7,926 $ 18,345 $ 14,572
Total interest expense ............................ 6,577 5,916 12,152 10,891
-------- -------- -------- --------
Net interest income ............................ 3,003 2,010 6,193 3,681
Non-interest income:
Gain on sale of loans ............................. 28,706 19,574 50,740 35,732
Loan servicing income (expense) ................... 185 (391) (449) (748)
Other non-interest income ......................... 412 346 431 2,080
-------- -------- -------- --------
Total non-interest income ...................... 29,303 19,529 50,722 37,064
Non-interest expense:
Personnel expense ................................. 8,582 6,270 16,645 11,843
General and administrative expense ................ 5,417 4,368 10,743 8,457
Amortization and impairment of servicing rights ... 1,108 993 3,105 2,493
Provision for repurchases ......................... 531 395 887 830
Mark-to-market gain - SFAS 133 .................... (3,619) (8) (3,784) (456)
-------- -------- -------- --------
Total non-interest expense ..................... 12,019 12,018 27,596 23,167
Net earnings before income taxes ..................... 20,287 9,521 29,319 17,578
Income taxes ...................................... 8,639 4,013 12,452 7,415
-------- -------- -------- --------
Net earnings ......................................... 11,648 5,508 16,867 10,163
Less: Cash dividends on preferred stock ........... (6,930) (3,713) (11,385) (5,693)
-------- -------- -------- --------
Net earnings available to common shareholders ........ $ 4,718 $ 1,795 $ 5,482 $ 4,470
======== ======== ======== ========
11
Note 9--Recent Accounting Pronouncements
In November 2002 the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statements No.
5, 57 and 107 and a rescission of FASB Interpretation No. 34 (FIN 45). FIN 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 are applicable to
guarantees issued or modified after December 31, 2002 and are not expected to
have a material effect on the Company's financial statements. The disclosure
requirements are effective for financial statements of interim or annual periods
ending after December 15, 2002.
In December 2002 the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" (SFAS 148), an amendment of SFAS No.
123 "Accounting for Stock-Based Compensation," (SFAS 123). SFAS 148 amends SFAS
123 to provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements. Certain
portions of the disclosure modifications are required for fiscal years ending
after December 15, 2002 and are included in the notes to these consolidated
financial statements. The Company has adopted the disclosure requirement of SFAS
148 and will continue to account for stock options using the intrinsic value
method.
In January 2003 the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" (FIN 46). FIN 46
addresses the consolidation by business enterprises of variable interest
entities as defined in FIN 46. FIN 46 applies immediately to variable interests
in variable interest entities created after January 31, 2003 and to variable
interests in variable interest entities obtained after January 31, 2003. For
non-public enterprises, such as IFC, with a variable interest in a variable
interest entity created before February 1, 2003 FIN 46 is applied to the
enterprise no later than the end of the first reporting period beginning after
June 15, 2003. IMH is subject to a majority of the risk of loss from IFC and
will therefore need to be included as a consolidated entity upon adoption of FIN
46. The result of this consolidation would be the elimination of certain
inter-company balances and certain gains or losses. On July 1, 2003 IMH
purchased all of the outstanding shares of voting common stock of IFC. As a
result of acquiring 100% of IFC's common stock, IMH will consolidate IFC's
financial results beginning in the third quarter of 2003.
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" (SFAS 149), clarifies and amends financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS 133. In
general, SFAS 149 is effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. It is
anticipated that the financial impact of SFAS 149 will not have a material
effect on the Company.
SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" (SFAS 150), establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity that have been
presented either entirely as equity or between the liabilities section and the
equity section of the statement of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is anticipated that the financial impact of SFAS 150 will not have
a material effect on the Company.
Note 10--Subsequent Events
On July 1, 2003 IMH entered into a Stock Purchase Agreement with Joseph R.
Tomkinson, William S. Ashmore and the Johnson Revocable Living Trust, of which
Richard J. Johnson is trustee, whereby IMH purchased all of the outstanding
shares of voting common stock of IFC, IMH's mortgage operations, for aggregate
consideration of $750,000. The fairness opinion of IFC, as rendered by an
independent financial advisor, and subsequent transaction was approved by the
board of directors. The common stock of IFC represents 1% of the economic
interest in IFC. IMH currently owns all of the outstanding non-voting preferred
stock of IFC, which represents 99% of the economic interest in IFC. Each of
Messer's. Tomkinson and Ashmore and the Johnson Revocable Living Trust owned
one-third of the outstanding common stock of IFC. As a result of acquiring 100%
of IFC's common stock, IMH will consolidate IFC's financial results in the third
quarter of 2003.
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
This quarterly report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. Forward-looking statements,
some of which are based on various assumptions and events that are beyond our
control, may be identified by reference to a future period or periods or by the
use of forward-looking terminology, such as "may," "will," "believe," "expect,"
"plan," "anticipate," "continue," or similar terms or variations on those terms
or the negative of those terms. Actual results could differ materially from
those set forth in forward-looking statements, including, among other things,
failure to achieve projected earning levels, the timely and successful
implementation of strategic initiatives, the ability to generate sufficient
liquidity, the ability to access the capital markets, interest rate fluctuations
on our assets that differ from those on our liabilities, changes in prepayment
rates on our mortgage assets, changes in assumptions regarding estimated loan
losses or interest rates, the availability of financing and, if available, the
terms of any financing, changes in estimations of acquisition and origination
and resale pricing of mortgages, changes in markets which we serve, including
the market for Alt-A mortgages, changes in general market and economic
conditions and other factors described in this quarterly report. For a
discussion of the risks and uncertainties that could cause actual results to
differ from those contained in the forward-looking statements see "Risk Factors"
in this quarterly report. We do not undertake, and specifically disclaim any
obligation, to publicly release the results of any revisions that may be made to
any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Financial Highlights for the Second Quarter of 2003
o Earnings per share increased to $0.58 compared to $0.53 for the
first quarter of 2003 and $0.44 for the second quarter of 2002;
o Estimated taxable income per share was $0.56 compared to $0.58 for
the first quarter of 2003 and $0.45 for the second quarter of 2002
(refer to reconciliation of net earnings to estimated taxable income
below);
o Cash dividends declared per share were $0.50 for the first and
second quarters of 2003 and $0.43 for the second quarter of 2002;
o Total assets increased to $8.2 billion as of June 30, 2003 compared
to $6.6 billion as of December 31, 2002 and $4.3 billion as of June
30, 2002;
o Book value per share increased to $7.46 as of June 30, 2003 compared
to $6.70 as of December 31, 2002 and $6.44 as of June 30, 2002;
o Total market capitalization increased to $846.3 million as of June
30, 2003 compared to $521.2 million as of December 31, 2002 and
$538.2 million as of June 30, 2002;
o Dividend yield as of June 30, 2003 was 11.98%, based on an
annualized second quarter cash dividend of $0.50 per share and
closing stock price of $16.69 per share;
o Return on average assets and equity was 1.52% and 34.48% as compared
to 1.48% and 31.69% for the first quarter of 2003 and 1.88% and
27.00% during the second quarter of 2002;
o IFC, the mortgage operations, acquired and originated $1.9 billion
of primarily Alt-A mortgages compared to $1.8 billion during the
first quarter of 2003 and $1.4 billion during the second quarter of
2002;
o The long-term investment operations acquired $806.6 million of
primarily Alt-A mortgages from IFC compared to $1.4 billion during
the first quarter of 2003 and $1.1 billion during the second quarter
of 2002; and
o IMCC originated and retained for long-term investment $74.1 million
of multi-family mortgages compared to $42.1 million during the first
quarter of 2003 and $25.8 million during the fourth quarter of 2002.
IMCC was formed in July of 2002.
13
General and Business Operations
Unless the context otherwise requires, the terms "we," "us," and "our"
refer to Impac Mortgage Holdings, Inc., a Maryland corporation incorporated in
August 1995, and its subsidiaries, IMH Assets Corp., or "IMH Assets," Impac
Warehouse Lending Group, Inc., or "IWLG," Impac Multifamily Capital Corporation,
or "IMCC," and its affiliate Impac Funding Corporation, or "IFC." IFC became a
wholly-owned subsidiary of IMH in July 2003. For further information regarding
IFC, refer to "Results of Operations--Consolidation of IFC" below. References to
Impac Mortgage Holdings, Inc., or "IMH," are made to differentiate IMH, the
publicly traded company, as a separate entity from IMH Assets, IWLG, IMCC and
IFC.
We are a mortgage real estate investment trust, or "REIT." Together with
our subsidiaries and affiliate we are a nationwide acquirer and originator of
non-conforming Alt-A mortgages, or "Alt-A mortgages." Alt-A mortgages are
primarily first lien mortgages made to borrowers whose credit is generally
within typical Fannie Mae and Freddie Mac guidelines, but have loan
characteristics that make them non-conforming under those guidelines. Some of
the principal differences between mortgages purchased by Fannie Mae and Freddie
Mac and Alt-A mortgages are as follows:
o credit and income histories of the mortgagor;
o documentation and/or verification required for approval of the
mortgagor;
o applicable debt-to-income ratios; and
o applicable loan-to-value ratios.
For instance, Alt-A mortgages that we acquire may have higher
loan-to-value, or "LTV," ratios than allowable under Fannie Mae or Freddie Mac
guidelines, although, some Alt-A mortgages that we acquire may include private
mortgage insurance when appropriate. Furthermore, Alt-A mortgages that we
acquire and originate may not have certain documentation or verifications that
are required by Fannie Mae and Freddie Mac. In addition, the borrower's debt to
income ratio, if calculated at all, may be higher than those allowed by Fannie
Mae or Freddie Mac. Therefore, in making our credit decisions, we are more
reliant upon the borrower's credit score and the adequacy of the underlying
collateral. We believe that Alt-A mortgages provide an attractive net earnings
profile by producing higher yields without commensurately higher credit losses
than other types of mortgages. Since 1999 we have acquired and originated
primarily Alt-A mortgages. We also provide warehouse and repurchase financing to
originators of mortgages. Our goal is to generate consistent reliable income for
distribution to our stockholders primarily from earnings generated by our
mortgage loan investment portfolio. We operate the following core businesses:
o long-term investment operations;
o mortgage operations; and
o warehouse lending operations.
The long-term investment operations invest in adjustable and fixed rate
Alt-A mortgages that are acquired and originated by our mortgage operations and
small-balance multi-family mortgages originated by IMCC. This business primarily
generates net interest income from its mortgage loan investment portfolio and,
to a lesser extent, its investment securities portfolio. Our investment in Alt-A
mortgages and small-balance multi-family mortgages, or "multi-family mortgages,"
is financed with cash flow from the mortgage loan investment portfolio,
collateralized mortgage obligations, or "CMO," financing, short-term borrowings
under reverse repurchase agreements and proceeds from the sale of capital stock.
The mortgage operations acquire, originate, sell and securitize adjustable
and fixed rate Alt-A mortgages. Our mortgage operations generate income by
securitizing and selling loans to permanent investors, including our long-term
investment operations. This business also earns revenue from fees associated
with mortgage servicing rights, master servicing agreements and net interest
income earned on mortgages held-for-sale. Our mortgage operations use warehouse
facilities provided by the warehouse lending operations to finance the
acquisition and origination of mortgages.
14
The warehouse lending operations provide short-term financing to mortgage
loan originators, including the mortgage operations, by funding mortgages from
their closing date until they are sold to pre-approved investors. This business
earns fees from warehouse transactions as well as net interest income from the
difference between its cost of borrowings and interest earned on warehouse
advances.
Available Information
Our Internet website address is www.impaccompanies.com. We make our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K
and proxy statement for our annual shareholders' meetings, as well as any
amendments to those reports, available free of charge through our website as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the Securities and Exchange Commission, or "SEC." You can
learn more about us by reviewing our SEC filings on our website by clicking on
"Investor Relations" located on our home page. The SEC also maintains a website
at www.sec.gov that contains reports, proxy statements and other information
regarding SEC registrants, including IMH.
Corporate Governance
Pursuant to the requirements of the Sarbanes-Oxley Act of 2002, we have
addressed the following issues regarding corporate governance:
o established a formal internal audit function to enhance our internal
controls and procedures. The internal audit plan provides executive
management and our audit committee, which is comprised of
independent members of our board of directors, the ability to ensure
that appropriate controls and procedures are in place to identify
financial or operational concerns;
o established separate external and internal audit functions between
our certified public accountants who are responsible for external
auditing and financial review and a firm independent of our
certified public accountants who are responsible for review of
internal controls and procedures;
o established a Disclosure Committee which is comprised of our
Chairman and Chief Executive Officer, President and Chief Operating
Officer, Executive Vice President and Chief Financial Officer,
General Counsel and other senior officers to review and approve the
dissemination of all public disclosures and to ensure accuracy of
those disclosures;
o adopted a code of business conduct and ethics and corporate
governance guidelines that apply to all of our directors, executive
officers and employees to maintain the highest standards of ethics
and conduct in all of our business relationships;
o established an insider trading policy that is designed to prohibit
any of our directors, executive officers or employees from using
material non-public information and to prohibit providing material
non-public information to others; and
o ensuring that our board of directors consists of a majority of
independent directors and that members of the audit, nominating,
corporate governance and compensation committees are comprised
exclusively of independent directors.
Critical Accounting Policies
We define critical accounting policies as those that are important to the
portrayal of our financial condition and results of operations and require
estimates and assumptions based on our judgment of changing market conditions
and the performance of our assets and liabilities at any given time. In
determining which accounting policies meet this definition, we considered our
policies with respect to the valuation of our assets and liabilities and
estimates and assumptions used in determining those valuations. We believe the
most critical accounting issues that require the most complex and difficult
judgments and that are particularly susceptible to significant change to our
financial condition and results of operations including the following:
o allowance for loan losses; and
15
o investment securities.
Allowance for loan losses. In evaluating the adequacy of the allowance for
loan losses management takes several items into consideration. For instance, a
detailed analysis of historical loan performance data is accumulated and
reviewed. This data is analyzed for loss performance and prepayment performance
by product type, origination year and securitization issuance. The results of
that analysis are then applied to the current mortgage loan investment portfolio
and an estimate is created. In accordance with Statement of Financial Accounting
Standards No. 5, management believes that pooling of mortgages with similar
characteristics is an appropriate methodology in which to evaluate the allowance
for loan losses. In addition, management acknowledges that there are mortgages
in the mortgage loan investment portfolio that were acquired and not
underwritten to our specific underwriting guidelines.
Management also recognizes that there are qualitative factors that must be
taken into consideration when evaluating and measuring potential impairment in
the mortgage loan investment portfolio. These items include, but are not limited
to, economic indicators that may affect the borrower's ability to pay, changes
in value of collateral, political factors and industry statistics. From an
industry standpoint, there is a wide range of allowance for loan loss levels
that are maintained by our competitors. For additional information regarding
provision for loan losses refer to "Results of Operations--Impac Mortgage
Holdings, Inc.--Provision for Loan Losses" below.
Investment securities. Investment securities consist primarily of
subordinated mortgage-backed securities that are classified as
available-for-sale and are therefore recorded at fair value. Any changes in the
fair market value of these investment securities are reported as a component of
accumulated other comprehensive income in stockholders' equity. To determine the
fair value of investment securities available-for-sale, management must estimate
future rates of mortgage prepayments, prepayment penalties to be received,
delinquency rates, constant default rates and default loss severity and their
impact on estimated cash flows. Estimates are based on historical loss data for
comparable mortgages. Management estimates mortgage prepayments by evaluating
historical prepayment performance of comparable mortgages and trends in the
industry. Management determines the estimated fair value of the residuals by
discounting the expected cash flows using a discount rate which it believes is
commensurate with the risks involved. If management's estimates and assumptions
used in determining future cash flows on mortgage-backed securities vary
significantly from actual cash flows, we may be required to record impairment on
the mortgage-backed securities, which would require us to write-down the
carrying amount of the mortgage-backed securities through earnings.
Results of Operations--Impac Mortgage Holdings, Inc.
For the Three Months Ended June 30, 2003 as compared to the Three Months Ended
June 30, 2002
Net Earnings
Net earnings increased 68% to $29.7 million, or $0.58 per diluted share,
for the second quarter of 2003 compared to $17.7 million, or $0.44 per diluted
share, for the second quarter of 2002. The quarter-over-quarter increase in net
earnings of $12.0 million was primarily due to the following:
o $9.1 million increase in net interest income;
o $6.1 million increase in equity in net earnings of IFC; and
o partially offset by a $2.8 million increase in provision for loan
losses.
The 2003 quarter-over-quarter variances are discussed in further detail
below.
During the second quarter of 2003 net earnings generated by the long-term
investment operations and warehouse lending operations accounted for 61% of
consolidated net earnings for the second quarter of 2003 compared to 69% for the
second quarter of 2002 and 80% for the first quarter of 2003. Conversely, net
earnings generated by IFC, the mortgage operations, accounted for 39% of
consolidated net earnings, which is reflected in equity in net earnings of IFC
on our consolidated income statements, compared to 31% for the second quarter of
2002 and 20% for the first quarter of 2003.
The lower relative contribution to consolidated net earnings by the
long-term investment and warehouse lending operations was primarily due to a
compression of net interest margins on mortgage assets, which includes CMO
collateral, mortgages held-for-investment, finance receivables and investment
securities available-for-sale, or collectively, "Mortgage
16
Assets." Net interest margins on Mortgage Assets declined to 1.36% for the
second quarter of 2003 compared to 1.85% for the second quarter of 2002 and
1.57% for the first quarter of 2003. A number of factors contributed to the
decline in net interest margins on Mortgage Assets during the second quarter of
2003 and are provided in further detail below in our discussion of "Net Interest
Income." Conversely, the higher relative contribution to consolidated net
earnings by the mortgage operations during the second quarter of 2003 was
primarily due to an increase in gain on sale of loans which more than offset the
decline in net interest margins on Mortgage Assets. Refer to our discussion of
"Non-Interest Income" below for further details regarding the results of
operations of IFC. Our operating structure, which includes multiple operating
businesses, i.e. long-term investor in Alt-A mortgages, warehouse lender and
mortgage acquirer and originator, provides a flexible strategy to maintain
consistent and reliable earnings.
With continued strong loan demand nationwide for both purchase and
refinance mortgages during the second quarter of 2003 the mortgage operations
experienced a significant increase in its rate-locked pipeline of mortgages in
process, or "mortgage pipeline." The increase in the mortgage pipeline resulted
in a $3.6 million mark-to-market gain - SFAS 133 recorded by IFC which is
reflected in equity in net earnings of IFC on our consolidated income
statements. The mark-to-market gain was due to a fair market valuation of the
mortgage pipeline and derivative instruments acquired to hedge interest rates on
the mortgage pipeline until the close and eventual sale or securitization of the
mortgages. The mortgage pipeline was $501.3 million as of June 30, 2003 compared
to $281.7 million as of March 31, 2003. On an after-tax basis, the
mark-to-market gain on the mortgage pipeline represented approximately $0.04 of
our diluted earnings per share for the second quarter of 2003.
Consolidation of IFC
On July 1, 2003 IMH entered into a Stock Purchase Agreement with Joseph R.
Tomkinson, William S. Ashmore and the Johnson Revocable Living Trust, of which
Richard J. Johnson is trustee, whereby IMH purchased all of the outstanding
shares of voting common stock of IFC, IMH's mortgage operations, for aggregate
consideration of $750,000. The fairness opinion of IFC, as rendered by an
independent financial advisor, and subsequent transaction was approved by the
board of directors. The common stock of IFC represents 1% of the economic
interest in IFC. IMH currently owns all of the outstanding non-voting preferred
stock of IFC, which represents 99% of the economic interest in IFC. Joseph R.
Tomkinson is IMH's Chairman, Chief Executive Officer and a director, William S.
Ashmore is IMH's Chief Operating Officer, President and a director, and Richard
J. Johnson is IMH's Executive Vice President and Chief Financial Officer. Each
of Messer's. Tomkinson and Ashmore and the Johnson Revocable Living Trust owned
one-third of the outstanding common stock of IFC. Mr. Tomkinson elected to
receive $125,000 worth of his consideration for the sale of his IFC shares of
common stock in the form of 7,687 shares of IMH common stock. The remainder of
the consideration was paid in cash. As a result of acquiring 100% of IFC's
common stock, IMH will consolidate IFC's financial results in the third quarter
of 2003 and will be entitled to 100% of IFC's consolidated net earnings.
Taxable Income
When we file our annual tax returns there are certain adjustments that we
make to net earnings and taxable income due to differences in the nature and
extent that revenues and expenses are recognized under the two methods. For
instance, to calculate taxable income we can only deduct loan loss provisions to
the extent that we incurred actual loan losses as compared to net earnings,
which require a deduction of loan loss provisions to derive net earnings. To
maintain REIT status, we are required to distribute a minimum of 90% of our
annual taxable income to our stockholders. Because we pay dividends based on
taxable income, dividends may be more or less than net earnings. Therefore,
management believes that the disclosure of estimated taxable income, which is a
non-GAAP financial measurement, is useful information for our investors.
After adjusting for our estimates of the differences between net earnings
and taxable income, estimated taxable income was $28.7 million, or $0.56 per
diluted share, for the second quarter of 2003 compared to $18.2 million, or
$0.45 per diluted share, for the second quarter of 2002 and $0.58 per diluted
share for the first quarter of 2003. We declared cash dividends of $0.50 per
share for the first and second quarters of 2003. We expect to maintain this as a
minimum level of dividend distributions for the remainder of 2003. As of
December 31, 2002, the Company had estimated federal and state net operating
loss tax carry-forwards of approximately $17.4 million, which expire in the year
2020, that are available to offset future taxable income. However, actual net
operating tax loss carry-forwards, which may be used to offset future taxable
income, will be not be determined until we file our 2002 tax return in September
of this year.
The following table presents a reconciliation of net earnings to estimated
taxable income for the periods indicated (in thousands, except per share
amounts):
17
For the Three Months
Ended June 30,
---------------------
2003 2002
-------- --------
Net earnings ......................................... $ 29,718 $ 17,725
Adjustments to net earnings:
Provision for loan losses ......................... 7,059 4,234
Dividend from IFC ................................. 6,930 3,713
Tax deduction for actual loan losses .............. (3,436) (2,064)
Equity in net earnings of IFC ..................... (11,532) (5,453)
-------- --------
Estimated taxable income (1) ......................... $ 28,739 $ 18,155
======== ========
Estimated taxable income per diluted share (1) ....... $ 0.56 $ 0.45
======== ========
- ----------
(1) Excludes the deduction for dividends paid and the availability of a
deduction attributable to net operating tax loss carry-forwards, if any.
New Tax Law Guidance. On May 28, 2003, President Bush signed into law the
Jobs and Growth Tax Relief Reconciliation Act of 2003, or the "Act." The Act
reduces tax rates on dividends and capital gains, increases and extends bonus
depreciation provisions, increases Section 179 expensing, and accelerates
reductions in individual income tax rates. Under the Act, the current-law top
individual rate on adjusted net capital gain of 20% (10% for taxpayers in the
10% and 15% brackets) would be reduced to 15% (5% for taxpayers in the lower
brackets). These lower rates apply to both the regular tax and the alternative
minimum tax. The lower rates apply to assets held more than one year. The
capital gains changes apply to sales and exchanges (and payments received) on or
after May 6, 2003, and before January 1, 2009. In the case of a pass-through
entity, the determination of when gains or losses are properly taken into
account is made at the entity level. Under the Act, dividends received by an
individual shareholder from domestic corporations and "qualified foreign
corporations" will be treated as net capital gain for purposes of applying the
capital gain tax rates for purposes of both the regular tax and the alternative
minimum tax. Thus, dividends will be taxed at a rate of 15% (5% for taxpayers in
the lower brackets; zero for these taxpayers in 2008). Ordinary dividends
received from REITs generally qualify for the reduced rates only to the extent
of (i) qualifying dividends the REIT receives from other corporations (e.g., a
Taxable REIT Subsidiary) during the tax year and (ii) the sum of REIT taxable
income (after the dividends paid deduction) and built-in gain subject to tax
under Section 337(d), for the prior tax year, in each case reduced (not below
zero) by federal income tax paid thereon.
Therefore, the pro-rata share of dividend distributions of IMH's taxable
income paid by IMH to our stockholders that are attributable to qualifying
dividends IMH receives from IFC, a qualified taxable REIT subsidiary of IMH,
after May 6, 2003 will be subject to a 15% tax rate. The pro-rata share of
dividend distributions paid by IMH to our stockholders that are attributable to
taxable income generated by non-taxable subsidiaries would continue to be taxed
at ordinary income tax rates. If, for example, we assume a dividend distribution
paid to an IMH stockholder of $1,000 during the second quarter of 2003, taxes
owed on the dividend distribution before and after the Act would be as follows:
Before the Act:
Maximum individual tax rate .................................................... 38.6%
Tax owed ($1,000 x 0.386) ...................................................... $386
====
After the Act:
Tax Owed on Taxable Income Attributable to IFC:
Percent of dividend allocation ($6,930 divided by $28,739) .................. 24%
Dividend allocation ($1,000 times 0.24) ..................................... $ 240
Tax owed at 15% maximum tax rate on dividend allocation ($240 times 0.15) ... $ 36
Tax Owed on Taxable Income Attributable to Non-Taxable Entities:
Percent of dividend allocation ($28,739 minus $6,930 divided by $28,739) .... 76%
Dividend allocation ($1,000 times 0.76) ..................................... $ 760
Tax owed at 35% maximum individual tax rate ($760 times 0.35) ............... $266
----
Total tax owed ............................................................ $302
====
Effective tax rate ($302 divided by $1,000) ................................. 30.2%
Tax savings per $1,000 dividend distribution ................................... $ 84
18
Net Interest Income
We earn interest income primarily on Mortgage Assets and, to a lesser
extent, interest income earned on cash and cash equivalents and due from
affiliates. Interest expense is primarily interest paid on borrowings on
Mortgage Assets, which include CMO borrowings, reverse repurchase agreements and
borrowings on investment securities available-for-sale, and, to a lesser extent,
interest expense paid on due to affiliates. We also receive or make cash
payments on derivative instruments as an adjustment to the yield on Mortgage
Assets or borrowings on Mortgage Assets depending on whether certain specified
contractual interest rate levels are reached.
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the
second quarters of 2003 and 2002 and include interest income on Mortgage Assets
and interest expense related to borrowings on Mortgage Assets only (in
thousands):
For the Three Months For the Three Months
Ended June 30, 2003 Ended June 30, 2002
------------------------------- -------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ----- ---------- -------- -----
MORTGAGE ASSETS
Investment securities available-for-sale (1) ...... $ 24,254 $ 2,569 42.37% $ 28,655 $ 655 9.14%
Loans Receivable:
CMO collateral (2) .............................. 6,339,709 64,812 4.09 2,865,465 37,750 5.27
Mortgages held-for-investment (3) ............... 139,396 2,527 7.25 96,062 1,231 5.13
Finance receivables:
Affiliated ..................................... 571,664 5,827 4.08 430,283 4,895 4.55
Non-affiliated ................................. 551,770 7,031 5.10 249,362 3,746 6.01
---------- ------- ---------- -------
Total finance receivables .................... 1,123,434 12,858 4.58 679,645 8,641 5.09
---------- ------- ---------- -------
Total Loans Receivable ...................... 7,602,539 80,197 4.22 3,641,172 47,622 5.23
---------- ------- ---------- -------
Total Mortgage Assets .......................... $7,626,793 $82,766 4.34% $3,669,827 $48,277 5.26%
========== ======= ========== =======
BORROWINGS
CMO borrowings .................................... $6,201,601 $48,699 3.14% $2,769,705 $25,524 3.69%
Reverse repurchase agreements ..................... 1,235,403 7,305 2.37 719,328 5,348 2.97
Borrowings secured by investment securities (4) ... 3,898 852 87.43 10,714 475 17.73
---------- ------- ---------- -------
Total borrowings on Mortgage Assets ............ $7,440,902 $56,856 3.06% $3,499,747 $31,347 3.58%
========== ======= ========== =======
Net Interest Spread (5) ........................... 1.28% 1.68%
Net Interest Margin (6) ........................... 1.36% 1.85%
- ----------
(1) The receipt of an unanticipated recovery on a previously charged-off
security inflated the yield during the second quarter of 2003.
(2) Includes amortization of acquisition costs and net cash payments on
derivative instruments allocated to specific CMOs.
(3) Includes amortization of acquisition costs and net cash payments on
derivative instruments not allocated to specific CMOs.
(4) Payments and excess cash flows received from the investment securities
collateralizing this loan are used to pay down the outstanding borrowings.
The payments are received from a collateral base that is in excess of the
borrowings. Therefore, while the payment amounts should remain relatively
stable, the average balance of the borrowings will continue to decrease.
(5) Net interest spread is calculated by subtracting the weighted average
yield on total borrowings on Mortgage Assets from the weighted average
yield on total Mortgage Assets.
(6) Net interest margin is calculated by subtracting interest expense on total
borrowings on Mortgage Assets from interest income on total Mortgage
Assets and then dividing by the total average balance for Mortgage Assets.
Net interest income was $26.6 million for the second quarter of 2003
compared to $17.6 million for the second quarter of 2002. The
quarter-over-quarter increase in net interest income was primarily due to a $3.9
billion increase in average Mortgage Assets, which increased to $7.6 billion for
the second quarter of 2003 compared to $3.7 billion for the second quarter of
2002 as the long-term investment operations acquired $4.5 billion of primarily
Alt-A mortgages from the mortgage operations and originated $142.0 million of
multi-family mortgages since the end of the second quarter of 2002. We acquire
mortgage loans from the mortgage operations that fit within our criteria, which
are Alt-A ARMs and FRMs with good credit profiles, insurance enhancements, when
required, and prepayment penalty features.
The following table summarizes the principal balance of mortgages acquired
by the long-term investment operations from the mortgage operations by loan
characteristic for the periods indicated (in thousands):
19
For the Three Months Ended June 30,
------------------------------------
2003 2002
--------------- -----------------
Principal Principal
Balance % Balance %
------- - ------- -
Volume by Type:
Adjustable rate ..................... $802,719 100 $1,095,144 100
Fixed rate .......................... 3,868 0 867 0
-------- ----------
Total Mortgage Acquisitions ...... $806,587 100 $1,096,011 100
======== ==========
Volume by Product:
Six-month LIBOR ARMs ................ $348,698 43 $ 785,040 72
Six-month LIBOR hybrids (1) ......... 454,021 56 310,104 28
Fixed rate first trust deeds ........ 473 0 556 0
Fixed rate second trust deeds ....... 3,395 1 311 0
-------- ----------
Total Mortgage Acquisitions ...... $806,587 100 $1,096,011 100
======== ==========
Volume by Credit Quality:
Alt-A loans ......................... $801,156 99 $1,091,232 100
B/C loans ........................... 5,431 1 4,779 0
-------- ----------
Total Mortgage Acquisitions ...... $806,587 100 $1,096,011 100
======== ==========
Volume by Purpose:
Purchase ............................ $474,493 59 $ 680,806 62
Refinance ........................... 332,094 41 415,205 38
-------- ----------
Total Mortgage Acquisitions ...... $806,587 100 $1,096,011 100
======== ==========
Volume by Prepayment Penalty:
With prepayment penalty ............. $706,658 88 $ 835,124 76
Without prepayment penalty .......... 99,929 12 260,887 24
-------- ----------
Total Mortgage Acquisitions ...... $806,587 100 $1,096,011 100
======== ==========
- ----------
(1) Mortgages are fixed rate for initial two to seven year periods and
subsequently adjust to the indicated index plus a margin.
The increase in net interest income was offset, in part, by a decrease in
net interest margins on Mortgage Assets, which declined 49 basis points to 1.36%
for the second quarter of 2003 compared to 1.85% for the second quarter of 2002.
The overall decrease in net interest margins was primarily the result of a
decline in net interest margins on CMO collateral, which declined 69 basis
points to 1.02% for the second quarter of 2003 as compared to 1.71% for the
second quarter of 2002. This decline was due to a number of factors as follows:
o interest rate resets on mortgages;
o higher composition of FRMs; and
o net cash payments on derivative instruments.
Interest rate resets on mortgages. At the time mortgages were acquired and
retained for long-term investment, six-month LIBOR ARMs had initial coupons
above the fully-indexed rate, which is the margin on the mortgage plus the
index. Upon the mortgage interest rate reset date, interest rates on six-month
LIBOR ARMs adjusted downward to the fully-indexed rate. The reset to lower
coupons on these mortgages during low interest rate environments is consistent
with our strategy to mitigate the borrower's propensity to refinance their
mortgage, which we believe will extend the duration of the mortgages.
Secondarily, during the second quarter of 2003 the average six-month LIBOR
interest rate was lower than, or inverted to, the average one-month LIBOR
interest rate which meant that coupons on six-month LIBOR ARMs were indexed to a
lower interest rate than interest rates on adjustable rate CMO borrowings, which
are indexed to one-month LIBOR. The result was that coupons on six-month LIBOR
ARMs adjusted downward further in relation to interest rates on adjustable rate
CMO borrowings during the second quarter of 2003. Lastly, six-month LIBOR
hybrids acquired for long-term investment during the first half of 2001 with
initial fixed interest rate periods of two years subsequently converted to
six-month LIBOR ARMs, which resulted in those mortgages resetting to lower
adjustable interest rates during the first half of 2003. As a result of the
combination of these factors, the interest rate spread differential between
six-month LIBOR ARMs and adjustable rate CMO borrowings compressed. The weighted
average coupon of mortgages held as CMO collateral was 5.98% as of June 30, 2003
compared to 7.12% as of June 30, 2002.
20
Higher composition of FRMs. We generally earn smaller net interest margins
on FRMs financed with fixed rate CMO borrowings than on ARMs financed with
adjustable rate CMO borrowings. In order to compensate CMO bondholders for
investing in fixed rate CMOs, which generally have longer lives than adjustable
rate CMOs and are fixed over the life of the investment, we must pay a higher
yield on the bonds in much the same way that long-term certificates of deposit
generally have higher yields than short-term certificates of deposit. In other
words, we are compensating fixed rate CMO bondholders for the risk that market
interest rates may rise while interest rates on the CMO bonds will remain fixed.
Therefore, overall net interest margins on CMO collateral declined during the
second quarter of 2003 compared to the second quarter of 2002, in part, because
we acquired and retained more FRMs for long-term investment, which were financed
with fixed rate CMO financing. As of June 30, 2003 19% of mortgages held as CMO
collateral were FRMs compared to 5% of FRMs held as CMO collateral as of June
30, 2002. However, we believe that FRMs generally have longer lives than ARMs,
generate cash flows over a longer time horizon and produce a comparable return
on average equity as on ARMs.
Net cash payments on derivative instruments. The notional amount of
derivative instruments rose as we acquired derivative instruments as interest
rate hedges for CMO borrowings, which were used to finance the acquisition and
origination of $4.7 billion of mortgages by the long-term investment operations
since the end of the second quarter of 2002. The increase in the notional amount
of derivative instruments combined with the decline of short-term interest rates
increased net cash payments made on derivative instruments. We acquire
derivative instruments to offset possible increased CMO borrowing costs
resulting from rising interest rates. As a result, net cash payments and
amortization from derivative instruments was $12.4 million for the second
quarter of 2003 compared to $6.5 million for the second quarter of 2002. The
goal of our interest rate hedging policy is to provide stable net interest
margins and cash flows to our investors in various interest rate environments.
Our interest rate hedging strategy is designed to protect net interest margins
and net earnings from rising interest rates, which, absent interest rate hedging
instruments, would in all likelihood have an adverse effect on both. We believe
that our interest rate hedging policy is sound and net interest margins will
remain relatively stable even if interest rates rise from current levels.
Provision for Loan Losses
Provision for loan losses were $7.1 million for the second quarter of 2003
compared to $4.2 million for the second quarter of 2002. The provision for
estimated loan losses are primarily based on historical loss statistics,
including cumulative loss percentages and loss severity, of similar mortgages in
our mortgage loan investment portfolio. The loss percentage is used to determine
the estimated inherent losses in the mortgage loan investment portfolio. The
provision for loan losses is also determined based on the following:
o management's judgment of the net loss potential of mortgages in our
mortgage loan investment portfolio based on prior loan loss
experience;
o changes in the nature and volume of the mortgage loan investment
portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
For additional information regarding delinquencies of mortgages in our
mortgage loan investment portfolio refer to "Financial Condition" below.
Non-Interest Income
Non-interest income primarily consists of equity in net earnings of IFC,
net warehouse fees from warehouse advances made by IWLG and other revenue.
Equity in net earnings of IFC results as IMH records 99% of the earnings or
losses from IFC due to IMH's ownership of 100% of IFC's preferred stock, which
represents 99% of the economic interest in IFC. As a result of acquiring 100% of
IFC's common stock on July 1, 2003, IMH will consolidate IFC's financial results
in the third quarter of 2003 and will be entitled to 100% of IFC's consolidated
net earnings. Non-interest income increased to $12.6 million for the second
quarter of 2003 as compared to $6.4 million for the second quarter of 2002. The
quarter-
21
over-quarter increase in non-interest income of $6.2 million was primarily due
to a $6.1 million increase in net earnings of IFC as discussed in further detail
below.
Results of Operations--IFC-- For the Three Months Ended June 30, 2003 as
compared to the Three Months Ended June 30, 2002. IFC's net earnings increased
to $11.6 million compared to $5.5 million for the second quarter of 2002. The
quarter-over-quarter increase of $6.1 million was primarily due to the
following:
o $9.8 million increase in non-interest income;
o $3.6 million increase in mark-to-market gain - SFAS 133;
o $1.0 million increase in net interest income; and
o offset by an $8.0 million increase in operating costs and income
taxes.
IFC's net interest income was $3.0 million for the second quarter of 2003
compared to $2.0 million for the second quarter of 2002. The
quarter-over-quarter increase in net interest income was primarily due to an
increase in average mortgages held-for-sale, which increased to $600.2 million
for the second quarter of 2003 compared to $450.4 million for the second quarter
of 2002 as the mortgage operations acquired and originated $1.9 billion of
primarily Alt-A mortgages during the second quarter of 2003. The increase in
IFC's net interest income was also due to an increase in net interest margins on
mortgages held-for-sale, which rose to 2.25% for the second quarter of 2003
compared to 2.09% for the second quarter of 2002. Net interest margins improved
for the second quarter of 2003 as the mortgage operations acquired a higher
percentage of FRMs and six-month LIBOR hybrids, which generally have higher
interest rates than interest rates on six-month LIBOR ARMs.
22
The following table summarizes the principal balance of IFC's mortgage
acquisitions and originations by loan characteristic for the periods indicated
(in thousands):
For the Three Months Ended June 30,
--------------------------------------
2003 2002
----------------- -----------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
By Loan Type:
Fixed rate first trust deed ......................... $ 991,450 52 $ 404,007 29
Fixed rate second trust deed ........................ 24,910 1 24,191 2
Adjustable rate:
Six-month LIBOR ARMs .............................. 422,752 22 624,123 45
Six-month LIBOR hybrids (1) ....................... 461,333 25 335,098 24
---------- --- ---------- ---
Total adjustable rate .......................... 884,085 47 959,221 69
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $1,900,445 100 $1,387,419 100
========== === ========== ===
By Production Channel:
Correspondent acquisitions:
Flow .............................................. $1,086,622 57 $ 865,472 63
Bulk .............................................. 346,036 18 171,000 12
---------- --- ---------- ---
Total correspondent acquisitions ............... 1,432,658 75 1,036,472 75
---------- --- ---------- ---
Wholesale and retail originations ................. 362,097 19 256,381 18
Novelle Financial Services, Inc. .................. 105,690 6 94,566 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $1,900,445 100 $1,387,419 100
========== === ========== ===
By Credit Quality:
Alt-A ............................................... $1,784,432 94 $1,287,377 93
B/C (2) ............................................. 116,013 6 100,042 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $1,900,445 100 $1,387,419 100
========== === ========== ===
By Purpose:
Purchase ............................................ $ 862,368 45 $ 839,140 60
Refinance ........................................... 1,038,077 55 548,279 40
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $1,900,445 100 $1,387,419 100
========== === ========== ===
By Prepayment Penalty:
With prepayment penalty ............................. $1,558,725 82 $1,101,865 79
Without prepayment penalty .......................... 341,720 18 285,554 21
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $1,900,445 100 $1,387,419 100
========== === ========== ===
- ----------
(1) Mortgages are fixed rate for initial two to seven year periods and
subsequently adjust to the indicated index plus a margin.
(2) The second quarter of 2003 and 2002 includes $105.7 million and $94.6
million, respectively, of B/C mortgages originated by Novelle Financial
Services, Inc., a subsidiary of IFC, that are subsequently sold or
held-for-sale to third party investors for cash gains.
IFC exceeded acquisition and origination goals during the second quarter
of 2003 as both the national mortgage purchase and refinance indexes reached
record levels. We expect our mortgage activity to remain at record levels for
the remainder of this year as we expect interest rates to remain near historical
lows. The Mortgage Banker's Association has recently revised nationwide
estimates of total 1-4 family originations from a 28% decline in projected
originations for 2003 over 2002 at the beginning of this year to an estimate of
a 37% increase in 2003 originations over 2002.
IFC's non-interest income was $29.3 million for the second quarter of 2003
compared to $19.5 million for the second quarter of 2002. The
quarter-over-quarter increase was primarily due to a $9.1 million increase in
gain on sale of loans. Gain on sale of loans increased to $28.7 million during
the second quarter of 2003 compared to gain on sale of loans of $19.6 million
during the second quarter of 2002. Gain on sale of loans includes the difference
between the price we acquire and originate mortgages and the price we receive on
loan sale or securitization and direct mortgage origination revenue and cost,
i.e. loan and underwriting fees, commissions, appraisal review fees, document
expense, etc. Gain on sale of loans was 160 basis points on total loan sales
volume of $1.8 billion for the second quarter of 2003 compared to 128
23
basis points on total loan sales volume of $1.5 billion for the second quarter
of 2002. All mortgages were sold by the mortgage operations on a servicing
released basis during the second quarters of 2003 and 2002, which results in
substantially all cash gains upon sale or securitization. In order to minimize
risks associated with the accumulation of our mortgages, we seek to securitize
or sell our mortgages more frequently by creating smaller transactions, thereby
reducing our exposure to interest rate risk and price volatility during the
accumulation period of mortgages.
The following table summarizes the principal balance of IFC's mortgage
sales for the periods indicated (in thousands):
For the Three Months
Ended June 30,
------------------------
2003 2002
---------- ----------
REMIC .............................................. $ 200,000 $ 206,571
Whole loan sales to third party investors .......... 786,158 224,383
Loan sales to the long-term investment operations .. 806,588 1,096,011
---------- ----------
Total sales ..................................... $1,792,746 $1,526,965
========== ==========
IFC's non-interest expense and income taxes was $20.7 million for the
second quarter of 2003 compared to $16.0 million for the second quarter of 2002.
The quarter-over-quarter increase of $4.7 million was primarily due to the
following:
o $3.4 million increase in operating costs;
o $4.6 million increase in income taxes; and
o offset by a $3.6 million increase in mark-to-market gain - SFAS 133.
The $3.4 million increase in operating costs, which includes personnel
expense, professional services, equipment expense, occupancy expense, data
processing expense and general and administrative expense, was primarily due to
loan production growth. Operating costs increased 32% to $14.0 million for the
second quarter of 2003 compared to $10.6 million for the second quarter of 2002,
while mortgage acquisition and origination growth increased 37%
quarter-over-quarter. We believe that our efficient centralized operating
structure and our web-based automated underwriting system, iDASLg2, allows us to
maintain our position as a low cost nationwide acquirer and originator of Alt-A
mortgages.
The following table summarizes IFC's fully-loaded mortgage production
costs to acquire or originate a single mortgage by production channel for the
periods indicated (in basis points of mortgage acquisition or origination):
For the Three Months
Ended June 30,
--------------------
Production Channel Company 2003 2002
- ------------------------------ -------------------------------- ------ ------
Correspondent acquisitions Impac Funding Corporation 64.94 69.32
Wholesale/retail originations Impac Lending Group 93.69 100.84
B/C originations Novelle Financial Services, Inc. 266.26 242.62
------ ------
Total Weighted Average Cost .................................... 77.93 86.95
====== ======
Fully-loaded cost to acquire or originate a single mortgage is based on
mortgage production costs, including sales commissions which are a component of
gain on sale of loans in the financial statements, and corporate administrative
costs, including human resources, accounting, management information systems,
corporate administration and marketing. Mortgage production costs exclude other
non-production related expenses, including amortization and impairment of
mortgage servicing rights, mark-to-market gain (loss) from SFAS 133 and
write-down of investment securities.
The $3.6 million increase in mark-to-market gain - SFAS 133 was due to a
fair market valuation of the mortgage pipeline and derivative instruments
acquired to hedge interest rates on those mortgages until close and eventual
sale or securitization. The mortgage pipeline was $501.3 million as of June 30,
2003 as compared to $281.7 million as of March 31, 2003.
24
Non-Interest Expense
Non-interest expense was $2.5 million for the second quarter of 2003
compared to $2.0 million for the second quarter of 2002. The
quarter-over-quarter increase in non-interest expense of $500,000 was primarily
due to the following:
o $1.0 million increase in operating expenses; and
o offset by a $565,000 decrease in loss on disposition of other real
estate owned.
Operating expenses, which includes professional services, general and
administrative expense and personnel expense, increased 50% to $3.0 million for
the second quarter of 2003 as compared to $2.0 million for the second quarter of
2002 primarily due to the growth of our operating businesses, which resulted in
a 91% increase in total assets since June 30, 2002. For additional information
and detail regarding our operating businesses refer to "Financial Condition"
below.
The $565,000 decrease in loss on disposition of other real estate owned
for the second quarter of 2003 was the result of write-downs on foreclosed
property to a percentage of appraised value or a real estate broker's price
opinion that was in excess of ultimate loss incurred upon the sale of the
foreclosed property. The difference between the initial write-down on foreclosed
property and ultimate loss upon disposition of foreclosed property resulted in a
gain on disposition of other real estate owned. During the second quarter of
2002 write-downs on foreclosed property was in line with ultimate loss incurred
upon the sale of the foreclosed property resulting in a slight loss on
disposition of other real estate owned. We monitor the relationship between the
appraised value or broker's price opinion and the sales price of other real
estate owned in the context of current market conditions, including changes in
real estate values. The percentage write-down of newly acquired real estate to
appraised value or broker's price opinion is adjusted accordingly based on the
past sales performance of real estate dispositions.
Financial Condition
The following table presents selected financial data for the periods
indicated (in thousands, except per share data):
As of and For the Quarter Ended,
------------------------------------
June 30, December 31, June 30,
2002 2002 2003
-------- ------------ --------
Book value per share ............................................ $ 7.46 $ 6.70 $ 6.44
Return on average assets ........................................ 1.52% 1.49% 1.88%
Return on average equity ........................................ 34.48% 31.37% 27.00%
Assets to equity ratio .......................................... 21.76:1 21.59:1 16.64:1
Debt to equity ratio ............................................ 20.68:1 20.48:1 15.54:1
Allowance for loan losses as a percentage of Loans Receivable ... 0.42% 0.42% 0.42%
Mortgages 90+ days delinquent and other real estate owned ....... $172,900 $130,614 $ 88,094
Mortgages 90+ days delinquent and other real estate owned
to total assets .............................................. 2.10% 1.99% 2.06%
Mortgages owned 60+ days delinquent ............................. $206,307 $161,260 $102,607
60+ day delinquency of mortgages owned .......................... 3.28% 3.22% 3.10%
Total assets grew 24% to $8.2 billion as of June 30, 2003 compared to $6.6
billion as of December 31, 2002 as the long-term investment operations acquired
adjustable and fixed rate Alt-A mortgages from the mortgage operations and
retained multi-family mortgages originated by IMCC. Additionally, the warehouse
lending operations increased advances on short-term warehouse lines, or finance
receivables, as of quarter-end. The acquisition and retention of $2.2 billion of
Alt-A mortgages by the long-term investment operations from the mortgage
operations and $116.2 million of multi-family mortgages originated by IMCC
increased CMO collateral and mortgages held-for-investment to $6.7 billion as of
June 30, 2003 as compared to $5.2 billion as of December 31, 2002. Finance
receivables increased to $1.3 billion as of June 30, 2003 compared to $1.1
billion as of December 31, 2002 as warehouse activity with both affiliates and
non-affiliates increased. Total average finance receivables increased to $1.1
billion for the second quarter of 2003 as compared to $987.8 million for the
first quarter of 2003 while average finance receivables to non-affiliates
increased to $551.8 million compared to $523.2 million, respectively. As of June
30, 2003 the warehouse lending operations had approved warehouse lines available
to borrowers of $1.8 billion as compared to $1.5 billion as of December 31,
2002. The investment securities portfolio declined to $22.9 million, or 0.28% of
total assets, as of June 30, 2003, including positive mark-to-market fair value
adjustments of $7.6 million, as compared to $26.1 million as of December 31,
2002, including positive mark-to-
25
market fair value adjustments of $8.4 million. We acquired no investment
securities since 1999 and it has been our investment policy to only consider the
acquisition of investment securities that are collateralized by mortgages
underwritten by our mortgage operations.
The following table presents detail on Mortgage Assets for the periods
indicated (in thousands):
June 30, December 31,
2003 2002
----------- ------------
Investment securities available-for-sale:
Subordinated securities collateralized by mortgages ............. $ 15,279 $ 17,710
Net unrealized gain (1) ......................................... 7,588 8,355
----------- -----------
Carrying value of investment securities available-for-sale ... 22,867 26,065
Loans Receivable:
CMO collateral--
CMO collateral, unpaid principal balance ........................ 6,465,962 5,082,208
Unamortized net premiums on loans ............................... 100,725 75,987
Securitization expenses ......................................... 29,042 21,817
Fair value of derivative instruments ............................ (31,861) (30,332)
----------- -----------
Carrying value of CMO collateral ............................. 6,563,868 5,149,680
Finance receivables, net of pledge balances (2)--
Due from affiliates ............................................. 410,554 476,227
Due from other mortgage banking companies ....................... 909,276 664,021
----------- -----------
Carrying value of finance receivables ........................ 1,319,830 1,140,248
Mortgage loans held-for-investment--
Mortgage loans held-for-investment, unpaid principal balance .... 128,858 56,898
Unamortized net premiums on loans ............................... 461 566
Deferred costs .................................................. 223 72
----------- -----------
Carrying value of mortgage loans held-for-investment ......... 129,542 57,536
----------- -----------
Carrying value of gross Loans Receivable ........................... 8,013,240 6,347,464
Allowance for loan losses ....................................... (33,384) (26,602)
----------- -----------
Carrying value of net Loans Receivable ............................. 7,979,856 6,320,862
----------- -----------
Carrying value of Mortgage Assets .................................. $ 8,002,723 $ 6,346,927
=========== ===========
- ----------
(1) Unrealized gains on investment securities available-for-sale is a
component of accumulated other comprehensive loss in stockholders' equity.
(2) Outstanding advances on warehouse lines that the warehouse lending
operations makes to affiliates and external customers.
During the remainder of 2003, we intend to liquidate or call some, if not
all, of our remaining investment securities available-for-sale portfolio that
were acquired prior to 1999. Some of the investment securities will be called,
or collapsed, as certain call provisions of the securities have been met. The
call provisions of each security become effective when the current unpaid
principal balance of underlying mortgages securing the individual security are
less than a required percentage, generally 10% or 20%, of the original unpaid
principal balance of the mortgage pool. When we collapse these investment
securities in July 2003, we will acquire ownership of approximately $103.2
million of FRMs, which are being resecuritized in the form of a new fixed rate
CMO. The sale of the remaining investment securities available-for-sale that are
not called or collapsed may result in significant realized gains, after
deduction of related expenses. Most of the investment securities
available-for-sale which we intend to collapse or sell were resecuritized in
1999 and used as collateral for long-term financing that provided needed cash
subsequent to the liquidity crisis that occurred in 1998. Prior to any collapse
or sale of these individual securities, we will repay the remaining borrowings
secured by these investment securities. The borrowings secured by investment
securities was $3.2 million, net of discounts and prepaid securitization costs
of $769,000, as of June 30, 2003. All remaining discounts and prepaid
securitization expenses on the borrowings will be written-off during the third
quarter of 2003.
26
The following table presents additional selected information about
mortgages held as CMO collateral for the periods indicated:
As of and For the Quarter Ended,
--------------------------------
June 30, December 31, June 30,
2002 2002 2003
-------- ------------ --------
Percent of Alt-A mortgages ..................................... 99 99 99
Percent of six-month LIBOR ARMs and six-month LIBOR hybrids .... 81 85 95
Percent of FRMs ................................................ 19 15 5
Percent of six-month LIBOR hybrids ............................. 33 35 50
Weighted average coupon ........................................ 5.98 6.57 7.12
Weighted average margin ........................................ 3.00 3.01 3.14
Weighted average original LTV .................................. 80 82 83
Weighted average original credit score ......................... 689 683 677
Percent with active prepayment penalty ......................... 81 76 65
Percent of mortgages in California ............................. 63 63 64
Percent of purchase transactions ............................... 57 62 65
Percent of owner occupied ...................................... 90 93 94
Percent of first lien .......................................... 99 99 99
We believe that in order for us to generate positive cash flows and
earnings we must successfully manage the following primary operational and
market risks:
o credit risk;
o prepayment risk;
o liquidity risk; and
o interest rate risk.
Credit Risk. We manage credit risk by acquiring for long-term investment
high credit quality Alt-A mortgages that are acquired and originated by our
mortgage operations, adequately providing for loan losses and actively managing
delinquencies and defaults. We believe that by improving the overall credit
quality of our mortgage loan investment portfolio, we can consistently generate
stable future cash flow and earnings for our stockholders. During the second
quarter of 2003, we acquired adjustable and fixed rate Alt-A mortgages from the
mortgage operations with an original weighted average credit score of 695 and an
original weighted average LTV ratio of 79%. Alt-A mortgages are primarily first
lien mortgages made to borrowers whose credit is generally within typical Fannie
Mae and Freddie Mac guidelines, but that have loan characteristics that make
them non-conforming under those guidelines. We primarily acquire non-conforming
"A" or "A-" credit quality mortgages, collectively, Alt-A mortgages. As defined
by us, A credit quality mortgages generally have a credit score of 640 or better
and A- credit quality mortgages generally have a credit score of between 600 and
639. As a comparison, Fannie Mae and Freddie Mac generally purchase conforming
mortgages with credit scores greater than 620. As of June 30, 2003, the original
weighted average credit score of mortgages held as CMO collateral was 689 and
the original weighted average LTV ratio was 80%.
In addition to acquiring mortgages from our mortgage operations, the
long-term investment operations originated $116.2 million of multi-family
mortgages through IMCC during the first half of 2003. IMCC was formed to
primarily originate adjustable rate multi-family mortgages with high credit
quality, conservative debt service ratios and low LTV ratios with balances
generally ranging from $250,000 to $2.0 million. Multi-family mortgages provide
greater asset diversification on our balance sheet as multi-family mortgages
typically have higher interest rate spreads and longer lives than residential
mortgages. All multi-family mortgages originated during the second quarter of
2003 had interest rate floors with prepayment penalty periods ranging from three
to five years.
We believe that we adequately provide for loan losses by maintaining a
ratio of allowance for loan losses to total loans receivable, which includes CMO
collateral, finance receivables, and mortgages held-for-investment, within a
range of 40 basis points to 45 basis points. As of June 30, 2003, the ratio of
allowance for loan losses to total loans receivable was 42 basis points as
allowance for loan losses increased to $33.4 million. However, as mortgages held
as CMO collateral season, there is generally a historical upward curve whereby
some mortgages will move through the delinquency cycle with
27
the expectation that some of the delinquent mortgages will eventually be
acquired through foreclosure proceedings and sold at a gain or loss. Actual loan
losses increased to $3.4 million for the second quarter of 2003 compared to $2.1
for the second quarter of 2002 as mortgages acquired during 2001 and 2000
reflect the movement of mortgages through the delinquency cycle to acquisition
via foreclosure proceedings and eventual disposition of other real estate owned.
Mortgages held as CMO collateral acquired during 2003 and 2002 are unseasoned
mortgages and have not experienced material losses as of June 30, 2003. CMOs
issued prior to 2000 include seasoned mortgages and have not experienced
significant increases in losses.
We monitor our sub-servicers to make sure that they perform loss
mitigation, foreclosure and collection functions according to our servicing
guidelines. This includes an effective and aggressive collection effort in order
to minimize the proportion of mortgages which become seriously delinquent.
However, when resolving delinquent mortgages, sub-servicers are required to take
timely and aggressive action. The sub-servicer is required to determine payment
collection under various circumstances, which will result in maximum financial
benefit. This is accomplished by either working with the borrower to bring the
mortgage current or by foreclosing and liquidating the property. We perform
ongoing review of mortgages that display weaknesses and believe that we maintain
adequate loss allowance on the mortgages. When a borrower fails to make required
payments on a mortgage and does not cure the delinquency within 60 days, we
generally record a notice of default and commence foreclosure proceedings. If
the mortgage is not reinstated within the time permitted by law for
reinstatement, the property may then be sold at a foreclosure sale. In
foreclosure sales, we generally acquire title to the property. As of June 30,
2003 our mortgage loan investment portfolio included 3.28% of mortgages that
were 60 days or more delinquent compared to 3.22% as of December 31, 2002.
The following table summarizes mortgages in our long-term mortgage loan
investment portfolio that were 60 or more days delinquent for the periods
indicated (in thousands):
At June 30, At December 31,
2003 2002
----------- ---------------
60-89 days delinquent .......................... $ 46,897 $ 41,762
90 or more days delinquent ..................... 43,717 33,822
Foreclosures ................................... 106,959 74,597
Delinquent bankruptcies ........................ 8,734 11,079
-------- --------
Total 60 or more days delinquent ............ $206,307 $161,260
======== ========
Seriously delinquent assets consist of mortgages that are 90 days or more
delinquent, including loans in foreclosure and delinquent bankruptcies. When
real estate is acquired in settlement of loans, referred to as other real estate
owned, the mortgage is written-down to a percentage of the property's appraised
value or broker's price opinion. As of June 30, 2003, seriously delinquent
assets and other real estate owned as a percentage of total assets was 2.10%
compared to 1.99% as of December 31, 2002.
The following table summarizes mortgages in our long-term mortgage loan
investment portfolio that were seriously delinquent and other real estate owned
for the periods indicated (in thousands):
At June 30, At December 31,
2003 2002
----------- ---------------
90 or more days delinquent ..................... $159,410 $119,498
Other real estate owned ........................ 13,490 11,116
-------- --------
Total ....................................... $172,900 $130,614
======== ========
Prepayment Risk. 88% of Alt-A mortgages acquired from the mortgage
operations during the second quarter of 2003 had prepayment penalty features
ranging from one to five years and as of June 30, 2003, 81% of mortgages held as
CMO collateral had active prepayment penalties compared to 65% as of June 30,
2002. In addition, our six-month LIBOR ARMs do not have specified interest rate
floors and in declining interest rate environments coupons on mortgages may
decline to levels that do not give the borrower an incentive to refinance.
During the second quarter of 2003 constant prepayment rates of mortgages held as
CMO collateral was 27% compared to 26% during the second quarter of 2002.
Liquidity Risk. We employ a leveraging strategy to increase assets by
financing our mortgage loan investment portfolio primarily with CMO borrowings,
reverse repurchase agreements and capital and then using cash proceeds to
acquire additional Mortgage Assets. We acquire adjustable and fixed rate
mortgages from the mortgage operations and finance the acquisition of those
mortgages with reverse repurchase agreements, which is referred to as the
accumulation period. After
28
accumulating a pool of adjustable and fixed rate mortgages, generally between
$200 million and $600 million, we securitize the mortgages in the form of CMOs.
Our strategy is to securitize our mortgages every 30 to 45 days in order to
reduce the accumulation period that mortgages are outstanding on short-term
warehouse or reverse repurchase facilities, thereby reducing our exposure to
margin calls on these facilities. CMOs are classes of bonds that are sold to
investors in mortgage-backed securities and as such are not subject to margin
calls. In addition, CMOs generally require a smaller initial cash investment as
a percentage of mortgages financed than does interim warehouse and reverse
repurchase financing.
Because of the historically favorable prepayment and loss rates of our
high credit quality Alt-A mortgages, we have received favorable credit ratings
on our CMOs from credit rating agencies, which has reduced our required initial
capital investment as a percentage of mortgages securing CMO financing. The
ratio of total assets to total equity, or "leverage ratio," was 21.76 to 1 as of
June 30, 2003 compared to 21.59 to 1 as of December 31, 2002. With increased
leverage, we have been able to grow our balance sheet by efficiently using
available capital. We monitor our leverage ratio and liquidity levels to insure
that we are adequately protected against adverse changes in market conditions.
For additional information regarding liquidity refer to "Liquidity and Capital
Resources" below.
Interest Rate Risk. Refer to Item 3. "Quantitative and Qualitative
Disclosures About Market Risk."
Results of Operations--Impac Mortgage Holdings, Inc.
For the Six Months Ended June 30, 2003 as compared to the Six Months Ended June
30, 2002
Net Earnings
Net earnings increased 66% to $55.3 million, or $1.12 per diluted share,
for the first six months of 2003 compared to $33.4 million, or $0.87 per diluted
share, for the first six months of 2002. The period-over-period increase in net
earnings of $21.9 million was primarily due to the following:
o $20.2 million increase in net interest income;
o $6.6 million increase in equity in net earnings of IFC; and
o partially offset by a $5.6 million increase in provision for loan
losses.
The 2003 period-over-period variances are discussed in further detail
below.
Taxable Income
After adjusting for our estimates of the differences between net earnings
and taxable income, estimated taxable income was $56.7 million, or $1.15 per
diluted share, for the first six months of 2003 compared to $34.2 million, or
$0.89 per diluted share, for the first six months of 2002. We declared cash
dividends of $1.00 per share for the first six months of 2003. The following
table presents a reconciliation of net earnings to estimated taxable income for
the periods indicated (in thousands, except per share amounts):
For the Six Months
Ended June 30,
-----------------------
2003 2002
-------- --------
Net earnings ..................................... $ 55,263 $ 33,374
Adjustments to net earnings:
Provision for loan losses ..................... 13,543 7,941
Dividend from IFC ............................. 11,385 5,693
Tax deduction for actual loan losses .......... (6,761) (2,699)
Equity in net earnings of IFC ................. (16,698) (10,062)
-------- --------
Estimated taxable income (1) ..................... $ 56,732 $ 34,247
======== ========
Estimated taxable income per diluted share (1) ... $ 1.15 $ 0.89
======== ========
- ----------
(1) Excludes the deduction for dividends paid and the availability of a
deduction attributable to net operating tax loss carry-forwards, if any.
29
Net Interest Income
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the first
six months of 2003 and 2002 and includes interest income on Mortgage Assets and
interest expense related to borrowings on Mortgage Assets only (in thousands):
For the Six Months For the Six Months
Ended June 30, 2003 Ended June 30, 2002
------------------------------- -------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ----- ---------- -------- -----
MORTGAGE ASSETS
Investment securities available-for-sale (1) ...... $ 24,891 $ 3,322 26.69% $ 30,500 $ 1,088 7.13%
Loans Receivable:
CMO collateral (2) .............................. 5,938,819 124,863 4.20 2,604,277 72,201 5.54
Mortgages held-for-investment (3) ............... 160,040 5,779 7.22 55,745 1,200 4.31
Finance receivables:
Affiliated ..................................... 518,445 10,513 4.06 408,175 9,185 4.50
Non-affiliated ................................. 537,555 13,768 5.12 244,498 7,029 5.75
---------- -------- ---------- -------
Total finance receivables .................... 1,056,000 24,281 4.60 652,673 16,214 4.97
---------- -------- ---------- -------
Total Loans Receivable ...................... 7,154,859 154,923 4.33 3,312,695 89,615 5.41
---------- -------- ---------- -------
Total Mortgage Assets .......................... $7,179,750 $158,245 4.41% $3,343,195 $90,703 5.43%
========== ======== ========== =======
BORROWINGS
CMO borrowings .................................... $5,811,811 $90,383 3.11% $2,517,207 $47,930 3.81%
Reverse repurchase agreements ..................... 1,182,620 14,096 2.38 650,669 9,638 2.96
Borrowings secured by investment securities (4) ... 5,059 1,484 58.67 11,525 1,024 17.77
---------- -------- ---------- -------
Total borrowings on Mortgage Assets ............ $6,999,490 $105,963 3.03% $3,179,401 $58,592 3.69%
========== ======== ========== =======
Net Interest Spread (5) ........................... 1.38% 1.74%
Net Interest Margin (6) ........................... 1.46% 1.92%
- ----------
(1) The receipt of an unanticipated recovery on a previously charged-off
security inflated the yield during 2003.
(2) Includes amortization of acquisition costs and net cash payments on
derivative instruments allocated to specific CMOs.
(3) Includes amortization of acquisition costs and net cash payments on
derivative instruments not allocated to specific CMOs.
(4) Payments and excess cash flows received from the investment securities
collateralizing this loan are used to pay down the outstanding borrowings.
The payments are received from a collateral base that is in excess of the
borrowings. Therefore, while the payment amounts should remain relatively
stable, the average balance of the borrowings will continue to decrease.
(5) Net interest spread is calculated by subtracting the weighted average
yield on total borrowings on Mortgage Assets from the weighted average
yield on total Mortgage Assets.
(6) Net interest margin is calculated by subtracting interest expense on total
borrowings on Mortgage Assets from interest income on total Mortgage
Assets and then dividing by the total average balance for Mortgage Assets.
Net interest income was $53.4 million for the first six months of 2003
compared to $33.2 million for the first six months of 2002. The
period-over-period increase in net interest income was primarily due to an
increase in average Mortgage Assets, which increased to $7.2 billion for the
first six months of 2003 compared to $3.3 billion for the first six months of
2002 as the long-term investment operations acquired $4.5 billion of primarily
Alt-A mortgages from the mortgage operations and originated $142.0 million of
multi-family mortgages since the end of the second quarter of 2002.
30
The following table summarizes the principal balance of mortgages acquired
by the long-term investment operations from the mortgage operations by loan
characteristic for the periods indicated (in thousands):
For the Six Months Ended June 30,
--------------------------------------
2003 2002
----------------- -----------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
Volume by Type:
Adjustable rate .................. $1,668,971 74 $1,586,925 100
Fixed rate ....................... 571,855 26 867 0
---------- ----------
Total Mortgage Acquisitions ... $2,240,826 100 $1,587,792 100
========== ==========
Volume by Product:
Six-month LIBOR ARMs ............. $ 839,939 38 $1,107,973 70
Six-month LIBOR hybrids (1) ...... 829,033 37 478,952 30
Fixed rate first trust deeds ..... 565,111 25 556 0
Fixed rate second trust deeds .... 6,743 0 311 0
---------- ----------
Total Mortgage Acquisitions ... $2,240,826 100 $1,587,792 100
========== ==========
Volume by Credit Quality:
Alt-A loans ...................... $2,228,641 99 $1,581,158 100
B/C loans ........................ 12,185 1 6,634 0
---------- ----------
Total Mortgage Acquisitions ... $2,240,826 100 $1,587,792 100
========== ==========
Volume by Purpose:
Purchase ......................... $1,086,022 48 $ 970,825 61
Refinance ........................ 1,154,804 52 616,967 39
---------- ----------
Total Mortgage Acquisitions ... $2,240,826 100 $1,587,792 100
========== ==========
Volume by Prepayment Penalty:
With prepayment penalty .......... $1,870,491 83 $1,136,649 72
Without prepayment penalty ....... 370,335 17 451,143 28
---------- ----------
Total Mortgage Acquisitions ... $2,240,826 100 $1,587,792 100
========== ==========
- ----------
(1) Mortgages are fixed rate for initial two to seven year periods and
subsequently adjust to the indicated index plus a margin.
The increase in net interest income was offset, in part, by a decrease in
net interest margins on Mortgage Assets, which declined 46 basis points to 1.46%
for the first six months of 2003 compared to 1.92% for the first six months of
2002. The overall decrease in net interest margins on Mortgage Assets was
primarily the result of a decline in net interest margins on CMO collateral,
which declined 70 basis points to 1.16% for the first six months of 2003 as
compared to 1.86% for the first six months of 2002. This decline was due to a
number of factors as follows:
o interest rate resets on mortgages;
o higher composition of FRMs; and
o net cash payments on derivative instruments.
For detailed information regarding the effect of these factors on net
interest margins on Mortgage Assets refer to the same discussion in "Results of
Operations--Impac Mortgage Holdings, Inc.--For the Three Months Ended June 30,
2003 as compared to the Three Months Ended June 30, 2002--Net Interest Income"
as the discussion also applies to the first six months of 2003.
Provision for Loan Losses
Provision for loan losses were $13.5 million for the first six months of
2003 compared to $7.9 million for the first six months of 2002. The provision
for estimated loan losses are primarily based on historical loss statistics,
including cumulative loss percentages and loss severity, of similar mortgages in
our mortgage loan investment portfolio. The loss percentage is used to determine
the estimated inherent losses in the mortgage loan investment portfolio. The
provision for loan losses is also determined based on the following:
31
o management's judgment of the net loss potential of mortgages in our
mortgage loan investment portfolio based on prior loan loss
experience;
o changes in the nature and volume of the mortgage loan investment
portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
Non-Interest Income
Non-interest income increased to $20.4 million for the first six months of
2003 as compared to $12.1 million for the first six months of 2002. The
period-over-period increase in non-interest income of $8.3 million was primarily
due a $6.7 million increase in net earnings of IFC as discussed in further
detail below.
Results of Operations--IFC-- For the Six Months Ended June 30, 2003 as
compared to the Six Months Ended June 30, 2002. Net earnings of IFC increased
for the first six months of 2003 to $16.9 million compared to $10.2 million for
the first six months of 2002. The period-over-period increase of $6.7 million
was primarily due to the following:
o $13.7 million increase in non-interest income;
o $2.5 million increase in net interest income;
o $3.3 million increase in mark-to-market gain - SFAS 133; and
o offset by a $12.1 million increase in operating costs and income
taxes.
IFC's net interest income was $6.2 million for the first six months of
2003 compared to $3.7 million for the first six months of 2002. The
period-over-period increase in net interest income was primarily due to an
increase in average mortgages held-for-sale, which increased to $545.1 million
for the first six months of 2003 compared to $420.5 million for the first six
months of 2002 as the mortgage operations acquired and originated $3.7 billion
of primarily Alt-A mortgages during the first six months of 2003. The increase
in IFC's net interest income was also due to an increase in net interest margins
on mortgages held-for-sale, which rose to 2.53% for the first six months of 2003
compared to 2.00% for the first six months of 2002. Net interest margins
improved for the first six months of 2003 as the mortgage operations acquired a
higher percentage of FRMs and six-month LIBOR hybrids, which generally have
higher interest rates than interest rates on six-month LIBOR ARMs.
32
The following table summarizes the principal balance of IFC's mortgage
acquisitions and originations by loan characteristic for the periods indicated
(in thousands):
For the Six Months Ended June 30,
--------------------------------------
2003 2002
----------------- -----------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
By Loan Type:
Fixed rate first trust deed ......................... $1,885,593 51 $ 767,040 30
Fixed rate second trust deed ........................ 53,807 2 37,686 1
Adjustable rate:
Six-month LIBOR ARMs .............................. 923,102 25 1,147,628 45
Six-month LIBOR hybrids (1) ....................... 809,298 22 619,450 24
---------- --- ---------- ---
Total adjustable rate .......................... 1,732,400 47 1,767,078 69
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $3,671,800 100 $2,571,804 100
========== === ========== ===
By Production Channel:
Correspondent acquisitions:
Flow .............................................. $2,128,928 58 $1,697,650 66
Bulk .............................................. 663,445 18 216,564 8
---------- --- ---------- ---
Total correspondent acquisitions ............... 2,792,373 76 1,914,214 74
---------- --- ---------- ---
Wholesale and retail originations ................. 667,187 18 491,798 19
Novelle Financial Services, Inc. .................. 212,240 6 165,792 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $3,671,800 100 $2,571,804 100
========== === ========== ===
By Credit Quality:
Alt-A ............................................... $3,441,339 94 $2,395,028 93
B/C (2) ............................................. 230,461 6 176,776 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $3,671,800 100 $2,571,804 100
========== === ========== ===
By Purpose:
Purchase ............................................ $1,626,400 44 $1,487,370 58
Refinance ........................................... 2,045,400 56 1,084,434 42
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $3,671,800 100 $2,571,804 100
========== === ========== ===
By Prepayment Penalty:
With prepayment penalty ............................. $3,029,803 83 $1,919,212 75
Without prepayment penalty .......................... 641,997 17 652,592 25
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ... $3,671,800 100 $2,571,804 100
========== === ========== ===
- ----------
(1) Mortgages are fixed rate for initial two to seven year periods and
subsequently adjust to the indicated index plus a margin.
(2) The first six months of 2003 and 2002 includes $212.2 million and $165.8
million, respectively, of B/C mortgages originated by Novelle Financial
Services, Inc., a subsidiary of IFC, which are subsequently sold or
held-for-sale to third party investors for cash gains.
IFC's non-interest income was $50.7 million for the first six months of
2003 compared to $37.1 million for the first six months of 2002. The
period-over-period increase was primarily due to a $15.0 million increase in
gain on sale of loans, which increased to $50.7 million during the first six
months of 2003 compared to gain on sale of loans of $35.7 million during the
first six months of 2002. Gain on sale of loans includes the difference between
the price we acquire and originate mortgages and the price we receive on loan
sale or securitization and direct mortgage origination revenue and cost, i.e.
loan and underwriting fees, commissions, appraisal review fees, document
expense, etc. Gain on sale of loans was 136 basis points on total loan sales
volume of $3.7 billion for the first six months of 2003 compared to 143 basis
points on total loan sales volume of $2.5 billion for the first six months of
2002. All mortgages were sold by the mortgage operations on a servicing released
basis during the first six months of 2003 and 2002, which results in
substantially all cash gains upon sale or securitization.
33
The following table summarizes the principal balance of IFC's mortgage
sales for the periods indicated (in thousands):
For the Six Months
Ended June 30,
------------------------
2003 2002
---------- ----------
REMIC ............................................... $ 487,500 $ 599,952
Whole loan sales to third party investors ........... 1,001,090 308,588
Loan sales to the long-term investment operations ... 2,240,826 1,587,792
---------- ----------
Total sales ...................................... $3,729,416 $2,496,332
========== ==========
IFC's non-interest expense and income taxes was $40.0 million for the
first six months of 2003 compared to $30.6 million for the first six months of
2002. The period-over-period increase of $9.4 million was primarily due to the
following:
o $7.1 million increase in operating costs;
o $5.0 million increase in income taxes; and
o partially offset by a $3.3 million increase in mark-to-market gain -
SFAS 133.
The $7.1 million increase in operating costs, which includes personnel
expense, professional services, equipment expense, occupancy expense, data
processing expense and general and administrative expense, was primarily due to
loan production growth. Operating costs increased 35% to $27.4 million for the
first six months of 2003 compared to $20.3 million for the first six months of
2002 while mortgage acquisition and origination growth increased 43%
period-over-period. We believe that our efficient centralized operating
structure and our web-based automated underwriting system, iDASLg2, allows us to
maintain our position as a low cost nationwide acquirer and originator of Alt-A
mortgages.
The following table summarizes IFC's fully-loaded mortgage production
costs to acquire or originate a single mortgage by production channel for the
periods indicated (in basis points of mortgage acquisition or origination):
For the Six Months
Ended June 30,
------------------
Production Channel Company 2003 2002
- ------------------------------ ----------------------------------- ------ ------
Correspondent acquisitions Impac Funding Corporation 65.21 70.35
Wholesale/retail originations Impac Lending Group 99.23 102.09
B/C originations Novelle Financial Services, Inc. 262.11 264.14
------ ------
Total Weighted Average Cost ........................................ 82.78 88.91
====== ======
Fully-loaded cost to acquire or originate a single mortgage is based on
mortgage production costs, including sales commissions which are a component of
gain on sale of loans in the financial statements, and corporate administrative
costs, including human resources, accounting, management information systems,
corporate administration and marketing. Mortgage production costs exclude other
non-production related expenses, including amortization and impairment of
mortgage servicing rights, mark-to-marked gain (loss) from SFAS 133 and
write-down of investment securities.
The $3.3 million increase in mark-to-market gain - SFAS 133 was due to a
fair market valuation of the mortgage pipeline and derivative instruments
acquired to hedge interest rates on those mortgages until close and eventual
sale or securitization. The mortgage pipeline was $501.3 million as of June 30,
2003 as compared to $326.9 million as of December 31, 2002.
Non-Interest Expense
Non-interest expense was $5.1 million for the first six months of 2003
compared to $3.9 million for the first six months of 2002. The
period-over-period increase in non-interest expense of $1.2 million was
primarily due to the following:
o $2.2 million increase in operating expenses; and
o offset by a $1.0 decrease in write-down on investment securities.
34
Operating expenses, which includes professional services, general and
administrative expense and personnel expense, increased 67% to $5.5 million
during the first six months of 2003 as compared to $3.3 million during the first
six months of 2002 primarily due to the growth of our operating businesses,
which resulted in a 91% increase in total assets since June 30, 2002.
The $1.0 million decrease in write-down of investment securities
available-for-sale was due to write-downs recorded during the first quarter of
2002 to reflect current market conditions, including prepayment experience and
loss expectations, of mortgage-backed securities in our investment securities
portfolio. Write-downs on investment securities recorded during the first
quarter of 2002 were primarily taken on investment securities secured by
mortgages not underwritten and created by our mortgage operations. However,
since 1998 our investment strategy has been to only acquire or invest in
securities underwritten and created by our mortgage operations.
Liquidity and Capital Resources
We recognize the need to have funds available for our operating businesses
and our customers' demands for obtaining short-term warehouse financing until
the settlement or sale of mortgages with us or with other investors. It is our
policy to have adequate liquidity at all times to cover normal cyclical swings
in funding availability and mortgage demand and to allow us to meet abnormal and
unexpected funding requirements. We plan to meet liquidity needs through normal
operations with the goal of avoiding unplanned sales of assets or emergency
borrowing of funds. Toward this goal, our Asset/Liability Committee, or "ALCO,"
is responsible for monitoring our liquidity position and funding needs.
ALCO is comprised of executive and senior officers of the mortgage
operations and warehouse lending operations. ALCO generally meets on a weekly
basis to review current and projected sources and uses of funds. ALCO monitors
the composition of our balance sheet for changes in the liquidity of our assets.
Our liquidity consists of cash and cash equivalents, short-term marketable
investment securities rated AAA through BBB and maturing mortgages, or "liquid
assets." Our policy is to maintain a liquidity threshold of 5% of liquid assets
to warehouse borrowings, reverse repurchase agreements, dividends payable and
other short-term liabilities.
We believe that current liquidity levels, available financing facilities
and liquidity provided by operating activities will adequately provide for our
projected funding needs and asset growth. However, any future margin calls and,
depending upon the state of the mortgage industry, terms of any sale of mortgage
assets may adversely affect our ability to maintain adequate liquidity levels or
may subject us to future losses. Our operating businesses primarily use
available funds as follows:
o acquisition and origination of mortgages;
o provide short-term warehouse advances to affiliates and
non-affiliates; and
o pay common stock dividends.
Acquisition and origination of mortgages. During the first six months of
2003 the mortgage operations acquired and originated $3.7 billion of primarily
Alt-A mortgages. Initial capital invested in mortgages includes premiums paid
when mortgages are acquired and originated. The mortgage operations paid
weighted average premiums of 2.02% on the principal balance of mortgages
acquired during the first six months of 2003. Capital invested in mortgages is
outstanding until we sell or securitize mortgages, which is one of the reasons
we attempt to sell or securitize mortgages every 30 to 45 days.
The long-term investment operations acquired $2.2 billion of primarily
Alt-A mortgages from the mortgage operations and originated $116.2 million of
multi-family mortgages for long-term investment. Initial capital invested in
mortgages includes premiums paid upon acquisition of mortgages and the equity
required to finance mortgages with short-term reverse repurchase agreements.
Equity requirements to finance Alt-A mortgages with reverse repurchase
agreements generally range from between 2% and 5% of the principal balance of
the mortgage depending on the collateral provided. Equity requirements to
finance multi-family mortgages with reverse repurchase agreements is
approximately 16.75% of the principal balance of the mortgage depending on the
collateral provided. Multi-family mortgages are financed with a $125.0 million
warehouse facility that expires in September 2003. When the long-term investment
operations accumulates a pool of mortgages, generally ranging from $200.0
million to $600.0 million, the mortgages are financed through the issuance of
CMOs. When we complete CMOs, our total initial capital investment in CMOs ranges
from approximately 3% to 5% of
35
the principal balance of Alt-A mortgages and 8% to 15% for multi-family
mortgages, depending on premiums paid upon acquisition of mortgages, costs paid
for completion of CMOs, costs to acquire derivative instruments and initial
capital investment in CMOs required to achieve desired credit ratings.
Therefore, we also attempt to securitize our mortgages through CMO financing
every 30 to 45 days as total capital invested in CMOs is generally less than
cash required for reverse repurchase financing and is not subject to margin
calls.
Provide short-term warehouse advances to affiliates and non-affiliates. We
utilize uncommitted warehouse facilities with various lenders to provide
short-term warehouse financing to affiliates and non-affiliated customers of the
warehouse lending operations. The warehouse lending operations provide
short-term financing to non-affiliated customers from the closing of the
mortgages to their sale or other settlement with investors. The warehouse
lending operations generally finances between 90% and 98% of the lesser of the
unpaid principal balance or fair market value of mortgages, which equates to a
cash requirement of between 2% and 10%, at prime rate plus or minus a spread. As
of June 30, 2003 the warehouse lending operations had $909.3 million in
outstanding warehouse advances to non-affiliates of which $856.0 million were
advanced via approved warehouse lines with the remainder advanced under
temporary approved warehouse line limits. Due to a heavy volume of originations
at the end of June 2003 some non-affiliates were granted temporary increases in
their warehouse facilities, most of which expired in July 2003.
Affiliates had $27.9 million in pledge accounts with the warehouse lending
operations as of June 30, 2003, which allows them to finance approximately 100%
of the fair market value of their mortgages at prime minus 0.50%. The mortgage
operations has uncommitted warehouse line agreements to obtain financing of up
to $600.0 million from the warehouse lending operations to provide interim
mortgage financing during the period that the mortgage operations accumulates
mortgages until the mortgages are securitized or sold. As of June 30, 2003 the
warehouse lending operations had $448.0 million in outstanding warehouse
advances to the mortgage operations, excluding pledge balances.
Our ability to meet liquidity requirements and the financing needs of our
customers is subject to the renewal of our credit and repurchase facilities or
obtaining other sources of financing, if required, including additional debt or
equity from time to time. Any decision our lenders or investors make to provide
available financing or capital to us in the future will depend upon a number of
factors, including:
o our compliance with the terms of our existing credit arrangements;
o our financial performance;
o industry and market trends in our various businesses;
o the general availability of and rates applicable to financing and
investments;
o our lenders or investors resources and policies concerning loans and
investments; and
o the relative attractiveness of alternative investment or lending
opportunities.
Pay common stock dividends. We made common stock dividend payments of
$46.4 million during the first six months of 2003.
Our operating businesses are primarily funded as follows:
o CMO borrowings and reverse repurchase agreements;
o cash flows from our mortgage loan investment portfolio;
o sale and securitization of mortgages; and
o cash proceeds from the issuance of securities.
CMO borrowings and reverse repurchase agreements. We use reverse
repurchase agreements and CMO borrowings to fund substantially all of our
warehouse advances to affiliates and non-affiliates, the acquisition of
mortgages to be held for long-term investment and, prior to 1999, the
acquisition of investment securities. Since 1999 we have not acquired any
investment securities.
36
As we accumulate mortgages for long-term investment, we finance the
acquisition of mortgages primarily through borrowings on reverse repurchase
agreements with third party lenders. Since 1995 we have primarily used an
uncommitted repurchase facility with a major investment bank to finance
substantially all warehouse advances to affiliates and non-affiliates and
mortgages acquired for long-term investment, as needed. However, during 2002 and
2003 we added $750.0 million of new warehouse facilities with other lenders to
finance asset growth, which includes $75.0 million of committed warehouse
facilities and $50.0 million of uncommitted warehouse facilities to fund
multi-family mortgages. The new warehouse facilities provide us with a higher
aggregate credit limit to fund the acquisition and origination of mortgages at
terms comparable to those we have received in the past and the flexibility of
having financial relationships with a larger cross-section of financial
institutions. As of June 30, 2003 the warehouse lending operations had $1.4
billion outstanding on warehouse facilities with various lenders.
We expect to continue to use short-term warehouse facilities to fund the
acquisition of mortgages. If we cannot renew or replace maturing borrowings, we
may have to sell, on a whole loan basis, the mortgages securing these
facilities, which, depending upon market conditions, may result in substantial
losses. Additionally, if for any reason the market value of our mortgages
securing warehouse facilities decline, our lenders may require us to provide
them with additional equity or collateral to secure our borrowings, which may
require us to sell mortgages at substantial losses.
In order to mitigate the liquidity risk associated with reverse repurchase
agreements, we attempt to securitize or sell our mortgages between 30 and 45
days and extend only short-term interim financing to non-affiliated customers.
Although securitizing mortgages more frequently adds operating and
securitization costs, we believe the added cost is offset as more liquidity is
provided with less interest rate and price volatility, as the accumulation and
holding period of mortgages is shortened. When we have accumulated a sufficient
amount of mortgages, we issue CMOs and convert short-term advances under reverse
repurchase agreements to long-term CMO borrowings. The use of CMOs provides the
following benefits:
o allows us to lock in our financing cost over the life of the
mortgages securing the CMO borrowings;
o eliminates margin calls on the borrowings that are converted from
reverse repurchase agreements to CMO financing; and
o limits losses associated with collateral securing CMOs to our equity
investment.
During the first six months of 2003 we completed $2.3 billion of CMOs, of
which $1.8 billion was adjustable rate CMOs and $561.9 million was fixed rate
CMOs, to provide long-term financing for the acquisition and origination of $2.2
billion of Alt-A and multi-family mortgages. Because of the credit profile,
historical loss performance and prepayment characteristics of our mortgages, we
have been able to borrow a higher percentage against mortgages held as CMO
collateral, which means that we have to provide less initial capital upon
completion of CMOs. Equity in CMOs is established at the time CMOs are issued at
levels sufficient to achieve desired credit ratings on the securities from
credit rating agencies. Total credit loss exposure is limited to the capital
invested in the CMOs at any point in time. As of June 30, 2003 total equity
invested in mortgages held as CMO collateral was $62.8 million. We also
determine the amount of equity invested in CMOs based upon the anticipated
return on equity as compared to estimated proceeds from additional debt
issuance. By decreasing the amount of equity we are required to invest in our
CMOs to maintain desired credit ratings, we have been able to effectively
utilize available cash to acquire additional mortgage assets.
Cash flows from our mortgage loan investment portfolio. During the first
six months of 2003 mortgages held as CMO collateral, which is the majority of
the mortgage loan investment portfolio, generated excess principal and interest
cash flows of $62.3 million. We receive excess principal and interest cash flows
on mortgages held as CMO collateral after distributions are made to investors in
CMOs to the extent cash or other collateral required to maintain desired credit
ratings on the CMOs is fulfilled. Excess principal and interest cash flows
represent the difference between principal and interest payments on the
mortgages less the following:
o interest paid to bondholders;
o pro-rata early principal prepayments paid to bondholders;
o servicing fees paid to mortgage servicers;
o premiums paid to mortgage insurers; and
37
o actual losses incurred on disposition of real estate acquired in
settlement of mortgages.
Sale and securitization of mortgages. When the mortgage operations
accumulates a sufficient amount of mortgages, generally between $200.0 million
and $600.0 million, it sells or securitizes the mortgages. The mortgage
operations sold $2.2 billion of mortgages to the long-term investment operations
during the first six months of 2003, $1.0 billion of mortgages to third party
investors and $487.5 million was securitized as REMICs. The mortgage operations
sold mortgage servicing rights on substantially all mortgages during the first
six months of 2003. The sale of mortgage servicing rights generated
substantially all cash gains, which was used to acquire and originate additional
mortgages. In order to mitigate interest rate and market risk, the mortgage
operations attempts to sell and securitize mortgages between 30 and 45 days.
Since we rely significantly upon sales and securitizations to generate cash
proceeds to repay borrowings and to create credit availability, any disruption
in our ability to complete sales and securitizations may require us to utilize
other sources of financing, which, if available at all, may be on unfavorable
terms. In addition, delays in closing sales and securitizations of our mortgages
increase our risk by exposing us to credit and interest rate risk for this
extended period of time.
Cash proceeds from the issuance of securities. In December 2001, we filed
with the SEC a shelf registration statement that allows us to sell up to $300.0
million of securities, including common stock, preferred stock, debt securities
and warrants. During the six months ended June 30, 2003 we issued approximately
3.5 million shares of common stock from our shelf registration statement, in the
form of a public offering, and received net cash proceeds of approximately $37.8
million. Pursuant to an equity distribution agreement with UBS Securities, LLC,
we also sold 1.8 million shares of common stock from our shelf registration
statement during the six months ended June 30, 2003 and received net proceeds of
approximately $24.5 million. We also sold 1.4 million shares of common stock
from our shelf registration statement during the three months ended June 30,
2003 and received net proceeds of approximately $20.4 million. During the six
months ended June 30, 2003 UBS Securities, LLC received a commission of 3% of
the gross sales price per share of the shares of common stock sold pursuant to
the equity distribution agreement, which amounted to an aggregate commission of
$757,000. As of June 30, 2003, approximately $108.7 million in securities were
available for issuance under our shelf registration statement. By issuing new
shares periodically throughout the year we believe that we were able to utilize
new capital more efficiently and profitably.
Cash Flows
Operating Activities - Net cash provided by operating activities was $74.4
million during the first six months of 2003 compared to net cash used in
operating activities of $88.8 million during the same period of 2002. Net
earnings of $55.3 million provided most of the cash flows from operating
activities during the first six months of 2003.
Investing Activities - Net cash used in investing activities was $1.7
billion during the first six months of 2003 compared to $1.3 billion during the
same period of 2002. Net cash flows of $1.5 billion were used in investing
activities to acquire and originate mortgages, net of mortgage principal
repayments.
Financing Activities - Net cash provided by financing activities was $1.6
billion during the first six months of 2003 compared to $1.4 billion during the
same period of 2002. CMO financing provided net cash flows of $1.4 billion, net
of debt reduction, from financing activities.
Inflation
The consolidated financial statements and corresponding notes to the
consolidated financial statements have been prepared in accordance with GAAP,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased costs of our operations. Unlike industrial companies,
nearly all of our assets and liabilities are monetary in nature. As a result,
interest rates have a greater impact on our performance than do the effects of
general levels of inflation. Inflation affects our operations primarily through
its effect on interest rates, since interest rates normally increase during
periods of high inflation and decrease during periods of low inflation. During
periods of increasing interest rates, demand for mortgages and a borrower's
ability to qualify for mortgage financing in a purchase transaction may be
adversely affected. During periods of decreasing interest rates, borrowers may
prepay their mortgages, which in turn may adversely affect our yield and
subsequently the value of our portfolio of mortgage assets.
38
Risk Factors
A prolonged economic downturn or recession would likely result in a reduction of
our mortgage origination activity which would adversely affect our financial
results.
The United States economy has recently undergone and may in the future,
undergo, a period of slowdown, which some observers view as a recession. An
economic downturn or a recession may have a significant adverse impact on our
operations and our financial condition. For example, a reduction in new
mortgages will adversely affect our ability to expand our mortgage portfolio,
our principal means of increasing our earnings. In addition, a decline in new
mortgage activity will likely result in reduced activity for our warehouse
lending operations and our long-term investment operations. In the case of our
mortgage operations, a decline in mortgage activity may result in fewer loans
that meet its criteria for purchase and securitization or sale, thus resulting
in a reduction in interest income and fees and gain on sale of loans. We may
also experience larger than previously reported losses on our investment
portfolio due to a higher level of defaults or foreclosures on our mortgages.
Terrorist attacks or military action may adversely affect our financial results.
The effects that terrorist attacks in the United States or other incidents
and related military action may have on the mortgage operations' ability to
acquire or originate mortgages, the performance of the mortgages held by the
long-term investment operations or on the values of mortgaged properties cannot
be determined at this time. As a result of terrorist activity or military
action, there may be a reduction in new mortgages, which will adversely affect
our ability to expand our mortgage portfolio. In addition, a decline in new
mortgage activity will likely result in reduced activity for our warehouse
lending operations and our long-term investment operations. Mortgages held by
our long-term investment operations may experience higher rates of delinquency,
default and prepayment. These potential consequences of terrorist attacks or
military action will have an adverse affect on our financial results. Federal
agencies and non-government lenders have, and may continue to, defer, reduce or
forgive payments and delay foreclosure proceedings in respect of loans to
borrowers affected in some way be recent and possible future events. In
addition, activation of a substantial number of U.S. military reservists or
members of the National Guard may significantly increase the proportion of
mortgages whose mortgage rates are reduced by application of the Soldiers' and
Sailors' Civil Relief Act of 1940 or similar state laws, and neither the master
servicers nor the servicers will be required to advance for any interest
shortfall caused by any such reduction. Interest payable to senior and
subordinate certificate holders will be reduced on a pro rata basis by any
reductions in the amount of interest collectible as a result of application of
the Soldiers' and Sailors' Civil Relief Act of 1940 or similar state laws.
If we are unable to generate sufficient liquidity we will be unable to conduct
our operations as planned.
If we cannot generate sufficient liquidity, we will be unable to continue
to grow our operations, grow our asset base, maintain our current hedging policy
and pay dividends. We have traditionally derived our liquidity from four primary
sources:
o financing facilities provided to us by others to acquire or
originate mortgage assets;
o whole loan sales and securitizations of acquired or originated
mortgages;
o our issuance of equity and debt securities; and
o earnings from operations.
We cannot assure you that any of these alternatives will be available to
us, or if available, that we will be able to negotiate favorable terms. Our
ability to meet our long-term liquidity requirements is subject to the renewal
of our credit and repurchase facilities and/or obtaining other sources of
financing, including additional debt or equity from time to time. Any decision
by our lenders and/or investors to make additional funds available to us in the
future will depend upon a number of factors, such as our compliance with the
terms of our existing credit arrangements, our financial performance, industry
and market trends in our various businesses, the lenders' and/or investors' own
resources and policies concerning loans and investments, and the relative
attractiveness of alternative investment or lending opportunities. If we cannot
raise cash by selling debt or equity securities, we may be forced to sell our
assets at unfavorable prices or discontinue various business activities. Our
inability to access the capital markets could have a negative impact on our
earnings growth and also our ability to pay dividends.
39
Any significant margin calls under our financing facilities would adversely
affect our liquidity and may adversely affect our financial results.
Prior to the fourth quarter of 1998, we generally had no difficulty in
obtaining favorable financing facilities or in selling acquired mortgages.
However, during the fourth quarter of 1998, the mortgage industry experienced
substantial turmoil as a result of a lack of liquidity in the secondary markets.
At that time, investors expressed unwillingness to purchase interests in
securitizations due, in part, to:
o the lack of financing to acquire these securitization interests;
o the widening of returns expected by institutional investors on
securitization interests over the prevailing Treasury rate; and
o market uncertainty.
As a result, many mortgage originators, including us, were unable to
access the securitization market on favorable terms. This resulted in some
companies declaring bankruptcy. Originators, like us, were required to sell
loans on a whole loan basis and liquidate holdings of mortgage-backed securities
to repay short-term borrowings. However, the large amount of mortgages available
for sale on a whole loan basis affected the pricing offered for these mortgages,
which in turn reduced the value of the collateral underlying the financing
facilities. Therefore, many providers of financing facilities initiated margin
calls. Margin calls resulted when our lenders evaluated the market value of the
collateral securing our financing facilities and required us to provide them
with additional equity or collateral to secure our borrowings.
Our financing facilities were short-term borrowings and due to the turmoil
in the mortgage industry during the latter part of 1998 many traditional
providers of financing facilities were unwilling to provide facilities on
favorable terms, or at all. Our current financing facilities continue to be
short-term borrowings and we expect this to continue. If we cannot renew or
replace maturing borrowings, we may have to sell, on a whole loan basis, the
loans securing these facilities, which, depending upon market conditions, may
result in substantial losses.
We incurred losses for fiscal years 1997, 1998 and 2000 and may incur losses in
the future.
During the year ended December 31, 2000 we experienced a net loss of $54.2
million. The net loss incurred during 2000 included accounting charges of $68.9
million. The accounting charges were the result of write-downs of non-performing
investment securities secured by mortgages and additional increases in the
provision for loan losses to provide for the deterioration of the performance of
collateral supporting specific investment securities. During the year ended
December 31, 1998 we experienced a net loss of $5.9 million primarily as the
mortgage industry experienced substantial turmoil as a result of a lack of
liquidity in the secondary markets which caused us to sell mortgages at losses
to meet margin calls on our warehouse facilities. During the year ended December
31, 1997 we experienced a net loss of $16.0 million. The net loss incurred
during 1997 included an accounting charge of $44.4 million that was the result
of expenses related to the termination and buyout of our management agreement
with Imperial Credit Advisors, Inc. We cannot be certain that revenues will
remain at current levels or improve or that we will be profitable in the future,
which could prevent us from effectuating our business strategy.
If we are unable to complete securitizations, we would face a liquidity shortage
which would adversely affect our operating results.
We rely significantly upon securitizations to generate cash proceeds to
repay borrowings and replenish our borrowing capacity. Any reduction in our
ability to complete securitizations may require us to utilize other sources of
financing, which, if available at all, may be on unfavorable terms. In addition,
delays in closing securitizations of our mortgages increase our risk by exposing
us to credit and interest rate risks for this extended period of time.
Furthermore, gains on sales from certain of our securitizations represent a
significant portion of our earnings. Several factors could affect our ability to
complete securitizations of our mortgages, including:
o conditions in the securities and secondary markets;
o credit quality of the mortgages acquired or originated through our
mortgage operations;
40
o volume of our mortgage loan acquisitions and originations;
o our ability to obtain credit enhancements; and
o lack of investors purchasing higher risk components of the
securities.
If we are unable to profitably securitize a significant number of our
mortgages in a particular financial reporting period, then we could experience
lower income or a loss for that period. As a result of turmoil in the
securitization market during the latter part of 1998, many mortgage lenders,
including us, were required to sell mortgages on a whole loan basis under
adverse market conditions in order to generate liquidity. Many of these sales
were made at prices lower than our carrying value of the mortgages and we
experienced substantial losses. We cannot assure you that we will be able to
continue to profitably securitize or sell our loans on a whole loan basis, or at
all.
The market for first loss risk securities, which are securities that take
the first loss when mortgages are not paid by the borrowers, is generally
limited. In connection with our REMIC securitizations, we endeavor to sell all
securities subjecting us to a first loss risk. If we cannot sell these
securities, we may be required to hold them for an extended period, subjecting
us to a first loss risk.
Our borrowings and use of substantial leverage may cause losses.
Our use of collateralized mortgage obligations may expose our operations
to credit losses.
To grow our investment portfolio, we borrow a substantial portion of the
market value of substantially all of our investments in mortgages in the form of
CMOs. Historically, we have borrowed approximately 98% of the market value of
such investments. There are no limitations on the amount we may borrow, other
than the aggregate value of the underlying mortgages. We currently use CMOs as
financing vehicles to increase our leverage, since mortgages held for CMO
collateral are retained for investment rather than sold in a secondary market
transaction.
Retaining mortgages as collateral for CMOs exposes our operations to
greater credit losses than does the use of other securitization techniques that
are treated as sales because as the equity holder in the security, we are
allocated losses from the liquidation of defaulted loans first prior to any
other security holder. Although our liability under a collateralized mortgage
obligation is limited to the collateral used to create the collateralized
mortgage obligation, we generally are required to make a cash equity investment
to fund collateral in excess of the amount of the securities issued in order to
obtain the appropriate credit ratings for the securities being sold, and
therefore obtain the lowest interest rate available, on the CMOs. If we
experience greater credit losses than expected on the pool of loans subject to
the CMO, the value of our equity investment will decrease and we would have to
increase the allowance for loan losses on our financial statements.
The cost of our borrowings may exceed the return on our assets.
The cost of borrowings under our financing facilities corresponds to a
referenced interest rate plus or minus a margin. The margin varies depending on
factors such as the nature and liquidity of the underlying collateral and the
availability of financing in the market. We will experience net interest losses
if the returns on our assets financed with borrowed funds fail to cover the cost
of our borrowings, and we did not implement offsetting financial hedges.
If we default under our financing facilities, we may be forced to
liquidate the collateral at prices less than the amount borrowed.
If we default under our financing facilities, our lenders could force us
to liquidate the collateral. If the value of the collateral is less than the
amount borrowed, we could be required to pay the difference in cash.
Furthermore, if we default under one facility, it would generally cause a
default under our other facilities. If we were to declare bankruptcy, some of
our reverse repurchase agreements may obtain special treatment and our creditors
would then be allowed to liquidate the collateral without any delay. On the
other hand, if a lender with whom we have a reverse repurchase agreement
declares bankruptcy, we might experience difficulty repurchasing our collateral,
or enforcing our claim for damages, and it is possible that our claim could be
repudiated and we could be treated as an unsecured creditor. If this occurs, our
claims would be subject to significant delay and we may receive substantially
less than our actual damages or nothing at all.
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If we are forced to liquidate we may have few unpledged assets for
distribution to unsecured creditors.
We have pledged a substantial portion of our assets to secure the
repayment of CMOs issued in securitizations, our financing facilities and our
other borrowings. We will also pledge substantially all of our current and
future mortgages to secure borrowings pending their securitization or sale. The
cash flows we receive from our investments that have not yet been distributed or
pledged or used to acquire mortgages or other investments may be the only
unpledged assets available to our unsecured creditors if we were liquidated.
Interest rate fluctuations may adversely affect our operating results.
Our operations, as a mortgage loan acquirer and originator or a warehouse
lender, may be adversely affected by rising and falling interest rates. Higher
interest rates may discourage potential borrowers from refinancing mortgages,
borrowing to purchase homes or seeking second mortgages. This may decrease the
amount of mortgages available to be acquired or originated by our mortgage
operations and decrease the demand for warehouse financing provided by our
warehouse lending operations. If short-term interest rates exceed long-term
interest rates, there is a higher risk of increased loan prepayments, as
borrowers may seek to refinance their fixed and adjustable rate mortgages at
lower long-term fixed interest rates. Increased loan prepayments could lead to a
reduction in the number of loans in our investment portfolio and reduce our net
interest income.
We are subject to the risk of rising mortgage interest rates between the
time we commit to purchase mortgages at a fixed price through the issuance of
individual, bulk or other rate-locks and the time we sell or securitize those
mortgages. An increase in interest rates will generally result in a decrease in
the market value of mortgages that we have committed to purchase at a fixed
price, but have not been sold or securitized or have not been properly hedged.
As a result, we may record a smaller gain, or even a loss, upon the sale or
securitization of those mortgages.
We may experience losses if our liabilities re-price at different rates than our
assets.
Our principal source of revenue is net interest income or net interest
spread from our investment portfolio, which is the difference between the
interest we earn on our interest earning assets and the interest we pay on our
interest bearing liabilities. The rates we pay on our borrowings are independent
of the rates we earn on our assets and may be subject to more frequent periodic
rate adjustments. Therefore, we could experience a decrease in net interest
income or a net interest loss because the interest rates on our borrowings could
increase faster than the interest rates on our assets. If our net interest
spread becomes negative, we will be paying more interest on our borrowings than
we will be earning on our assets and we will be exposed to a risk of loss.
Additionally, the rates paid on our borrowings and the rates received on
our assets may be based upon different indices. If the index used to determine
the rate on our borrowings, typically one-month LIBOR, increases faster than the
indices used to determine the rates on our assets, such as six-month LIBOR or
the prime rate, we will experience a declining net interest spread, which will
have a negative effect on our profitability, and may result in losses.
An increase in our adjustable interest rate borrowings may decrease the net
interest margin on our adjustable rate mortgages.
Our long-term investment portfolio includes mortgages that are six-month
LIBOR hybrids. These are mortgages with fixed interest rates for an initial
period of time, after which they begin bearing interest based upon short-term
interest rate indices and adjust periodically. We generally fund mortgages with
adjustable interest rate borrowings having interest rates that are indexed to
short-term interest rates and adjust periodically at various intervals. To the
extent that there is an increase in the interest rate index used to determine
our adjustable interest rate borrowings and that increase is not offset by a
corresponding increase in the rates at which interest accrues on our assets or
by various interest rate hedges that we have in place at any given time, our net
interest margin will decrease or become negative. We may suffer a net interest
loss on our adjustable rate mortgages that have interest rate caps if the
interest rates on our related borrowings increase.
Adjustable rate mortgages typically have interest rate caps, which limit
interest rates charged to the borrower during any given period. Our borrowings
are not subject to similar restrictions. As a result, in a period of rapidly
increasing interest rates, the interest rates we pay on our borrowings could
increase without limitation, while the interest rates we earn on our adjustable
rate mortgage assets would be capped. If this occurs, our net interest spread
could be significantly reduced or we could suffer a net interest loss.
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Increased levels of early prepayments of mortgages may accelerate our expenses
and decrease our net income.
Mortgage prepayments generally increase on our adjustable rate mortgages
when fixed mortgage interest rates fall below the then-current interest rates on
outstanding adjustable rate mortgages. Prepayments on mortgages are also
affected by the terms and credit grades of the mortgages, conditions in the
housing and financial markets and general economic conditions. If we acquire
mortgages at a premium and they are subsequently repaid, we must expense the
unamortized premium at the time of the prepayment. We could possibly lose the
opportunity to earn interest at a higher rate over the expected life of the
mortgage. Also, if prepayments on mortgages increase when interest rates are
declining, our net interest income may decrease if we cannot reinvest the
prepayments in mortgage assets bearing comparable rates.
We generally acquire mortgages on a servicing released basis, meaning we
acquire both the mortgages and the rights to service them. This strategy
requires us to pay a higher purchase price or premium for the mortgages. If the
mortgages that we acquire at a premium prepay faster than originally projected,
generally accepted accounting principles require us to write down the remaining
capitalized premium amounts at a faster speed than was originally projected,
which would decrease our current net interest income.
The value of our portfolio of mortgage-backed securities may be adversely
affected by unforeseen events.
Our prior investments in residual interest and subordinated debt
investments exposed us to greater risks as compared to those associated
with senior mortgage-backed securities.
Prior to 1998, we invested in mortgage-backed securities known as
interest-only, principal-only, residual interest or other subordinated
securities. Investments in these securities are much riskier than investments in
senior mortgage-backed securities because these subordinated securities may bear
all credit losses prior to the related senior securities. The risk associated
with holding residual interest and subordinated securities is greater than that
associated with holding the underlying mortgages directly due to the
concentration of losses and uncertainty regarding the timing and amount of cash
flows attributed to the subordinated securities.
If the projected value of our portfolio of residual interest and
subordinated debt instruments is incorrect we would have to write down the
value of these securities.
We estimate future cash flows from these securities and value them
utilizing assumptions based in part on projected discount rates, mortgage loan
prepayments and credit losses. If our actual experience adversely differs from
our assumptions, we would be required to reduce the value of these securities.
The market for our asset-backed securities is extremely limited and we cannot
assure you that we could sell these securities at their reported value, or at
any value or that we could recoup our initial investment.
In addition, we may not obtain our anticipated yield or we may incur
losses if the credit support available within certain mortgage-backed securities
is inadequate due to unanticipated levels of losses, or due to difficulties
experienced by the credit support provider. Delays or difficulties encountered
in servicing mortgages securing mortgage-backed securities may cause greater
losses than anticipated and, therefore, we may have a higher rate of mortgage
insurance claims than were originally anticipated. This may cause a rating
agency to downgrade certain classes of our mortgage-backed securities and cause
a reduction of the value of the security.
We undertake additional risks by acquiring and investing in mortgages.
We may be subject to losses on mortgages for which we do not obtain credit
enhancements.
We do not obtain credit enhancements such as mortgage pool or special
hazard insurance for all of our mortgages and investments. Generally, we require
mortgage insurance on any mortgage with a loan-to-value ratio greater than 80%.
During the time we hold mortgages for investment, we are subject to risks of
borrower defaults and bankruptcies and special hazard losses that are not
covered by standard hazard insurance. If a borrower defaults on a mortgage that
we hold, we bear the risk of loss of principal to the extent there is any
deficiency between the value of the related mortgaged property and the amount
owing on the mortgage loan and any insurance proceeds available to us through
the mortgage insurer. In addition, since defaulted mortgages, which under our
financing arrangements are mortgages that are generally 60 to 90 days delinquent
in payments, may be considered negligible collateral under our borrowing
arrangements, we could bear the risk of being required to own these loans
without the use of borrowed funds until they are ultimately liquidated or
possibly sold at a loss.
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Alt-A mortgages expose us to greater credit risks.
We are an acquirer and originator of Alt-A mortgages. These are
residential mortgages that generally may not qualify for purchase by
government-sponsored agencies such as Fannie Mae and Freddie Mac. Our operations
may be negatively affected due to our investments in Alt-A mortgages. Credit
risks associated with Alt-A mortgages may be greater than those associated with
conforming mortgages. The interest rates we charge on Alt-A loans are often
higher than those charged for conforming loans in order to compensate for the
higher risk and lower liquidity. Lower levels of liquidity may cause us to hold
loans or other mortgage-related assets supported by these loans that we
otherwise would not hold. By doing this, we assume the potential risk of
increased delinquency rates and/or credit losses as well as interest rate risk.
Additionally, the combination of different underwriting criteria and higher
rates of interest leads to greater risk, including higher prepayment rates and
higher delinquency rates and/or credit losses.
Lending to Alt-A borrowers may expose us to a higher risk of
delinquencies, foreclosures and losses.
As a lender of Alt-A mortgages, our market includes borrowers who may be
unable to obtain mortgage financing from conventional mortgage sources.
Mortgages made to such Alt-A borrowers generally entail a higher risk of
delinquency and higher losses than mortgages made to borrowers who utilize
conventional mortgage sources. Delinquency, foreclosures and losses generally
increase during economic slowdowns or recessions. The actual risk of
delinquencies, foreclosures and losses on mortgages made to Alt-A borrowers
could be higher under adverse economic conditions than those currently
experienced in the mortgage lending industry in general.
Further, any material decline in real estate values increases the
loan-to-value ratios of mortgages previously made by us, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of a
borrower default. Any sustained period of increased delinquencies, foreclosures
or losses after the mortgages are sold could adversely affect the pricing of our
future loan sales and our ability to sell or securitize our mortgages in the
future. In the past, certain of these factors have caused revenues and net
income of many participants in the mortgage industry, including us, to fluctuate
from quarter to quarter.
Our use of second mortgages exposes us to greater credit risks.
Our security interest in the property securing second mortgages is
subordinated to the interest of the first mortgage holder and the second
mortgages have a higher combined loan-to-value ratio than does the first
mortgage. If the value of the property is equal to or less than the amount
needed to repay the borrower's obligation to the first mortgage holder upon
foreclosure, our second mortgage loan will not be repaid.
The geographic concentration of our mortgages increases our exposure to
risks in those areas.
We do not set limitations on the percentage of our mortgage asset
portfolio composed of properties located in any one area (whether by state, zip
code or other geographic measure). Concentration in any one area increases our
exposure to the economic and natural hazard risks associated with that area.
Historically, a majority of our mortgage acquisitions and originations by the
mortgage operations, mortgages held for investment by our long term investment
operations and loans financed by our warehouse lending operations were secured
by properties in California and, to a lesser extent, Florida. For instance,
certain parts of California have experienced an economic downturn in past years
and California and Florida have suffered the effects of certain natural hazards.
Declines in those residential real estate markets may reduce the values of the
properties collateralizing the mortgages, increase foreclosures and losses and
have material adverse effect on our results of operations or financial
condition.
Furthermore, if borrowers are not insured for natural disasters, which are
typically not covered by standard hazard insurance policies, then they may not
be able to repair the property or may stop paying their mortgages if the
property is damaged. This would cause increased foreclosures and decrease our
ability to recover losses on properties affected by such disasters. This would
have a material adverse effect on our results of operations or financial
condition.
Representations and warranties made by us in our loan sales and securitizations
may subject us to liability.
In connection with our securitizations, we transfer mortgages acquired and
originated by us into a trust in exchange for cash and, in the case of a CMO,
residual certificates issued by the trust. The trustee will have recourse to us
with respect to the breach of the standard representations and warranties made
by us at the time such mortgages are transferred. While we
44
generally have recourse to our customers for any such breaches, there can be no
assurance of our customers' abilities to honor their respective obligations.
Also, we engage in bulk whole loan sales pursuant to agreements that generally
provide for recourse by the purchaser against us in the event of a breach of one
of our representations or warranties, any fraud or misrepresentation during the
mortgage origination process, or upon early default on such mortgage. We
generally limit the potential remedies of such purchasers to the potential
remedies we receive from the customers from whom we acquired or originated the
mortgages. However, in some cases, the remedies available to a purchaser of
mortgages from us may be broader than those available to us against the sellers
of the mortgages and should a purchaser enforce its remedies against us, we may
not always be able to enforce whatever remedies we have against our customers.
Furthermore, if we discover, prior to the sale or transfer of a loan, that there
is any fraud or misrepresentation with respect to the mortgage and the
originator fails to repurchase the mortgage, then we may not be able to sell the
mortgage or we may have to sell the mortgage at a discount.
In the ordinary course of our business, we are subject to claims made
against us by borrowers and trustees in our securitizations arising from, among
other things, losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of our employees, officers and agents (including our appraisers),
incomplete documentation and our failure to comply with various laws and
regulations applicable to our business. Any claims asserted against us may
result in legal expenses or liabilities that could have a material adverse
effect on our results of operations or financial condition.
A substantial interruption in our use of iDASLg2 may adversely affect our level
of mortgage loan acquisitions and originations.
We utilize the Internet in our business principally for the implementation
of our automated mortgage origination program, iDASLg2, which stands for the
second generation of Impac Direct Access System for Lending. iDASLg2 allows our
customers to pre-qualify borrowers for various mortgage programs based on
criteria requested from the borrower and renders an automated underwriting
decision by issuing an approval of the mortgage loan or a referral for further
review or additional information. Substantially, all of our correspondents
submit mortgages through iDASLg2 and all wholesale mortgages delivered by
mortgage brokers are directly underwritten through the use of iDASLg2. iDASLg2
may be interrupted if the Internet experiences periods of poor performance, if
our computer systems or the systems of our third-party service providers contain
defects, or if customers are reluctant to use or have inadequate connectivity to
the Internet. Increased government regulation of the Internet could also
adversely affect our use of the Internet in unanticipated ways and discourage
our customers from using our services. If our ability to use the Internet in
providing our services is impaired, our ability to originate or acquire
mortgages on an automated basis could be delayed or reduced. Furthermore, we
rely on a third party hosting company in connection with the use of iDASLg2. If
the third party hosting company fails for any reason, and adequate back-up is
not implemented in a timely manner, it may delay and reduce those mortgage
acquisitions and originations done through iDASLg2. Any substantial delay and
reduction in our mortgage acquisitions and originations will reduce our net
earnings for the applicable period.
We are subject to risks of operational failure that are beyond our control.
Substantially all of our operations are located in Newport Beach,
California and San Diego, California. Our systems and operations are vulnerable
to damage and interruption from fire, flood, telecommunications failure,
break-ins, earthquake and similar events. Our operations may also be interrupted
by power disruptions, including rolling black-outs implemented in California due
to power shortages. We do not maintain alternative power sources. Furthermore,
our security mechanisms may be inadequate to prevent security breaches to our
computer systems, including from computer viruses, electronic break-ins and
similar disruptions. Such security breaches or operational failures could expose
us to liability, impair our operations, result in losses, and harm our
reputation.
Competition for mortgages is intense and may adversely affect our operations.
We compete in acquiring and originating Alt-A mortgages and issuing
mortgage-backed securities with other mortgage conduit programs, investment
banking firms, savings and loan associations, banks, thrift and loan
associations, finance companies, mortgage bankers, insurance companies, other
lenders, and other entities purchasing mortgage assets.
We also face intense competition from Internet-based lending companies
where entry barriers are relatively low. Some of our competitors are much larger
than we are, have better name recognition than we do, and have far greater
financial and other resources. Government-sponsored entities, in particular
Fannie Mae and Freddie Mac, are also expanding their participation in the Alt-A
mortgage industry. These government-sponsored entities have a size and
cost-of-funds advantage
45
over us that allows them to price mortgages at lower rates than we are able to
offer. This phenomenon may seriously destabilize the Alt-A mortgage industry. In
addition, if as a result of what may be less-conservative, risk-adjusted
pricing, these government-sponsored entities experience significantly
higher-than-expected losses, it would likely adversely affect overall investor
perception of the Alt-A mortgage industry because the losses would be made
public due to the reporting obligations of these entities.
The intense competition in the Alt-A mortgage industry has also led to
rapid technological developments, evolving industry standards and frequent
releases of new products and enhancements. As mortgage products are offered more
widely through alternative distribution channels, such as the Internet, we may
be required to make significant changes to our current retail and wholesale
structure and information systems to compete effectively. Our inability to
continue enhancing our current Internet capabilities, or to adapt to other
technological changes in the industry, could have a material adverse effect on
our business, financial condition, liquidity and results of operations.
The need to maintain mortgage loan volume in this competitive environment
creates a risk of price competition in the Alt-A mortgage industry. Competition
in the industry can take many forms, including interest rates and costs of a
loan, less stringent underwriting standards, convenience in obtaining a loan,
customer service, amount and term of a loan and marketing and distribution
channels. Price competition would lower the interest rates that we are able to
charge borrowers, which would lower our interest income. Price-cutting or
discounting reduces profits and will depress earnings if sustained for any
length of time. If our competition uses less stringent underwriting standards we
will be pressured to do so as well, resulting in greater loan risk without being
able to price for that greater risk. Our competitors may lower their
underwriting standards to increase their market share. If we do not relax
underwriting standards in the face of competition, we may lose market share.
Increased competition may also reduce the volume of our loan originations and
acquisitions. Any increase in these pricing and credit pressures could have a
material adverse effect on our business, financial condition, liquidity and
results of operations.
We are exposed to potential credit losses in providing warehouse financing.
As a warehouse lender, we lend money to mortgage bankers on a secured
basis and we are subject to the risks associated with lending to mortgage
bankers, including the risks of fraud, borrower default and bankruptcy, any of
which could result in credit losses for us. Our claims as a secured lender in a
bankruptcy proceeding may be subject to adjustment and delay.
We may not pay dividends to stockholders.
REIT provisions of the Internal Revenue Code generally require that we
annually distribute to our stockholders at least 90% of all of our taxable
income. These provisions restrict our ability to retain earnings and thereby
renew capital for our business activities. We may decide at a future date to
terminate our REIT status, which would cause us to be taxed at the corporate
levels and cease paying regular dividends.
In addition, for any year that we do not generate taxable income, we are
not required to declare and pay dividends to maintain our REIT status. For
instance, due to losses incurred in 2000, we did not declare any dividends from
September 2000 until September 2001.
To date, a portion of our taxable income and cash flow has been
attributable to our receipt of dividend distributions from IFC. IFC is not a
REIT and is not, therefore, subject to the above-described REIT distribution
requirements. Because IFC is seeking to retain earnings to fund the future
growth of our mortgage operations business, its board of directors may decide
that IFC should cease making dividend distributions in the future. This would
materially reduce the amount of our taxable income and in turn, would reduce the
amount we would be required to distribute as dividends.
If we fail to maintain our REIT status, we may be subject to taxation as a
regular corporation.
We believe that we have operated and intend to continue to operate in a
manner that enables us to meet the requirements for qualification as a REIT for
federal income tax purposes. We have not requested, and do not plan to request,
a ruling from the Internal Revenue Service that we qualify as a REIT.
Moreover, no assurance can be given that legislation, new regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to qualification as a REIT or the federal income tax
consequences of
46
such qualification. Our continued qualification as a REIT will depend on our
satisfaction of certain asset, income, organizational and stockholder ownership
requirements on a continuing basis.
If we fail to qualify as a REIT, we would not be allowed a deduction for
distributions to stockholders in computing our taxable income and would be
subject to federal income tax at regular corporate rates. We also may be subject
to the federal alternative minimum tax. Unless we are entitled to relief under
specific statutory provisions, we could not elect to be taxed as a REIT for four
taxable years following the year during which we were disqualified. Therefore,
if we lose our REIT status, the funds available for distribution to you would be
reduced substantially for each of the years involved. Failure to qualify as a
REIT could adversely affect the value of our common stock.
Delayed mortgage loan sales or securitization closings could have a material
adverse affect on our operations.
A delay in closing a particular mortgage sale or securitization would
increase our exposure to interest rate fluctuations by lengthening the period
during which our variable rate borrowings under our warehouse facilities are
outstanding. Any disruption in our ability to complete securitizations may
require us to utilize other sources of financing, which, if available at all,
may be on unfavorable terms. If we were unable to sell a sufficient number of
mortgages at a premium during a particular reporting period, our revenues for
that period would decline, which could have a material adverse affect on our
operations.
Our share prices have been and may continue to be volatile.
Historically, the market price of our common stock has been volatile. The
market price of our common stock is likely to continue to be highly volatile and
could be significantly affected by factors including:
o the amount of dividends paid;
o availability of liquidity in the securitization market;
o loan sale pricing;
o margin calls by warehouse lenders or changes in warehouse lending
rates;
o unanticipated fluctuations in our operating results;
o prepayments on mortgages;
o valuations of securitization related assets;
o cost of funds; and
o general market conditions.
In addition, significant price and volume fluctuations in the stock market
have particularly affected the market prices for the common stock of mortgage
REIT companies such as ours. These broad market fluctuations have adversely
affected and may continue to adversely affect the market price of our common
stock. If our results of operations fail to meet the expectations of securities
analysts or investors in a future quarter, the market price of our common stock
could also be materially adversely affected and we may experience difficulty in
raising capital.
If actual prepayments or defaults with respect to mortgages serviced occurs more
quickly than originally assumed, the value of our mortgage servicing rights
would be subject to downward adjustment.
When we purchase mortgages that include the associated servicing rights,
the allocated cost of the servicing rights is reflected on our financial
statements as mortgage servicing rights. To determine the fair value of these
servicing rights, we use assumptions to estimate future net servicing income
including projected discount rates, mortgage loan prepayments and credit losses.
If actual prepayments or defaults with respect to loans serviced occur more
quickly than we originally assumed, we would have to reduce the carrying value
of our mortgage servicing rights. We do not know if our assumptions will prove
correct.
47
Our operating results may be adversely affected by the results of our hedging
activities.
To offset the risks associated with our mortgage operations, we enter into
transactions designed to hedge our interest rate risks. To offset the risks
associated with our long-term investment operations, we attempt to match the
interest rate sensitivities of our adjustable rate mortgage assets held for
investment with the associated financing liabilities. Our management determines
the nature and quantity of the hedging transactions based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
We do not limit management's use of certain instruments in such hedging
transactions. While we believe that we properly hedge our interest rate risk, we
may not, and in some cases will not, be permitted to use hedge accounting as
established by FASB under the provisions of SFAS 133 to account for our hedging
activities. The effect of our hedging strategy may result in some volatility in
our quarterly earnings as interest rates go up or down. It is possible that
there will be periods during which we will incur losses on hedging activities.
In addition, if the counter parties to our hedging transactions are unable to
perform according to the terms of the contracts, we may incur losses. While we
believe we prudently hedge our interest rate risk, our hedging transactions may
not offset the risk of adverse changes in net interest margins.
A reduction in the demand for residential mortgages and our Alt-A loan products
may adversely affect our operations.
The availability of sufficient mortgages meeting our criteria is dependent
in part upon the size and level of activity in the residential real estate
lending market and, in particular, the demand for Alt-A mortgages, which is
affected by:
o interest rates;
o national economic conditions;
o residential property values; and
o regulatory and tax developments.
If our mortgage purchases decrease, we will have:
o decreased economies of scale;
o higher origination costs per loan;
o reduced fee income;
o smaller gains on the sale of non-conforming mortgages; and
o an insufficient volume of loans to generate securitizations which
thereby causes us to accumulate mortgages over a longer period.
Our delinquency ratios and our performance may be adversely affected by the
performance of parties who sub-service our mortgages.
We contract with third-party sub-servicers for the sub-servicing of all
the mortgages in which we retain servicing rights, including those in our
securitizations. Our operations are subject to risks associated with inadequate
or untimely servicing. Poor performance by a sub-servicer may result in greater
than expected delinquencies and losses on our mortgages. A substantial increase
in our delinquency or foreclosure rate could adversely affect our ability to
access the capital and secondary markets for our financing needs. Also, with
respect to mortgages subject to a securitization, greater delinquencies would
adversely impact the value of any interest-only, equity interest, principal-only
and subordinated securities we hold in connection with that securitization.
In a securitization, relevant agreements permit us to be terminated as
servicer or master servicer under specific conditions described in these
agreements, such as the failure of a sub-servicer to perform certain functions
within specific time periods. If, as a result of a sub-servicer's failure to
perform adequately, we were terminated as servicer of a securitization, the
value of any servicing rights held by us would be adversely affected.
48
Potential characterization of distributions or gain on sale as unrelated
business taxable income to tax-exempt investors.
If (1) all or a portion of our assets are subject to the rules relating to
taxable mortgage pools, (2) we are a "pension-held REIT," (3) a tax-exempt
stockholder has incurred debt to purchase or hold our common stock, or (4) the
residual REMIC interests we buy generate "excess inclusion income," then a
portion of the distributions to and, in the case of a stockholder described in
(3), gains realized on the sale of common stock by such tax-exempt stockholder
may be subject to Federal income tax as unrelated business taxable income under
the Internal Revenue Code.
Classification as a taxable mortgage pool could subject us or certain of our
shareholders to increased taxation.
If we have borrowings with two or more maturities and, (1) those
borrowings are secured by mortgages or mortgage-backed securities and, (2) the
payments made on the borrowings are related to the payments received on the
underlying assets, then the borrowings and the pool of mortgages or
mortgage-backed securities to which such borrowings relate may be classified as
a taxable mortgage pool under the Internal Revenue Code. If any part of our
Company were to be treated as a taxable mortgage pool, then our REIT status
would not be impaired, but a portion of the taxable income we recognize may,
under regulations to be issued by the Treasury Department, be characterized as
"excess inclusion" income and allocated among our stockholders to the extent of
and generally in proportion to the distributions we make to each stockholder.
Any excess inclusion income would:
o not be allowed to be offset by a stockholder's net operating losses;
o be subject to a tax as unrelated business income if a stockholder
were a tax-exempt stockholder;
o be subject to the application of federal income tax withholding at
the maximum rate (without reduction for any otherwise applicable
income tax treaty) with respect to amounts allocable to foreign
stockholders; and
o be taxable (at the highest corporate tax rate) to us, rather than to
our stockholders, to the extent the excess inclusion income relates
to stock held by disqualified organizations (generally, tax-exempt
companies not subject to tax on unrelated business income, including
governmental organizations).
Based on advice of our tax counsel, we take the position that our existing
financing arrangements do not create a taxable mortgage pool.
We may be subject to fines or other penalties based upon the conduct of our
independent brokers or correspondents.
The mortgage brokers and correspondents from which we obtain loans have
parallel and separate legal obligations to which they are subject. While these
laws may not explicitly hold the originating lenders responsible for the legal
violations of mortgage brokers, increasingly federal and state agencies have
sought to impose such liability. Previously, for example, the United States
Federal Trade Commission, or "FTC," entered into a settlement agreement with a
mortgage lender where the FTC characterized a broker that had placed all of its
loan production with a single lender as the "agent" of the lender; the FTC
imposed a fine on the lender in part because, as "principal," the lender was
legally responsible for the mortgage broker's unfair and deceptive acts and
practices. The United States Justice Department in the past has sought to hold a
sub-prime mortgage lender responsible for the pricing practices of its mortgage
brokers, alleging that the mortgage lender was directly responsible for the
total fees and charges paid by the borrower under the Fair Housing Act even if
the lender neither dictated what the mortgage broker could charge nor kept the
money for its own account. Accordingly, we may be subject to fines or other
penalties based upon the conduct of our independent mortgage brokers or
correspondents.
We are no longer able to rely on the Alternative Mortgage Transactions Parity
Act to preempt certain state law restrictions on prepayment penalties, which may
cause us to be unable to compete effectively with financial institutions that
are exempt from such restrictions on ARMs.
The value of a mortgage depends, in part, upon the expected period of time
that the mortgage will be outstanding. If a borrower pays off a mortgage in
advance of this expected period, the holder of the mortgage does not realize the
full value expected to be received from the mortgage. A prepayment penalty
payable by a borrower who repays a mortgage earlier than expected helps
discourage such a prepayment or helps offset the reduction in value resulting
from the early payoff. Prepayment penalties are an important feature on the
mortgages we acquire or originate.
49
Certain state laws restrict or prohibit prepayment penalties on mortgages.
We have historically relied on the federal Alternative Mortgage Transactions
Parity Act, or the "Parity Act," and related regulations issued by the Office of
Thrift Supervision, or "OTS," to preempt state limitations on prepayment
penalties on ARMs. The Parity Act was enacted to extend to financial
institutions other than federally chartered depository institutions the federal
preemption which federally chartered depository institutions enjoy. However, on
September 25, 2002, the OTS issued final regulations that reduce the scope of
the Parity Act preemption. The OTS subsequently delayed the effective date of
the final regulations until July 1, 2003. The National Home Equity Mortgage
Association has filed a lawsuit, which remains unresolved, against the OTS
challenging the OTS's authority to issue the regulations. As a result, we are no
longer able to rely on the Parity Act to preempt state restrictions on
prepayment penalties. The elimination of this federal preemption could have a
material adverse affect on our ability to compete effectively with financial
institutions that will continue to enjoy federal preemption of state
restrictions on prepayment penalties on ARMs.
Our operations may be adversely affected if we are subject to the Investment
Company Act.
We intend to conduct our business at all times so as not to become
regulated as an investment company under the Investment Company Act. The
Investment Company Act exempts entities that are primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate.
In order to qualify for this exemption we must maintain at least 55% of
our assets directly in mortgages, qualifying pass-through certificates and
certain other qualifying interests in real estate. Our ownership of certain
mortgage assets may be limited by the provisions of the Investment Company Act.
If the Securities and Exchange Commission adopts a contrary interpretation with
respect to these securities or otherwise believes we do not satisfy the above
exception, we could be required to restructure our activities or sell certain of
our assets. To insure that we continue to qualify for the exemption we may be
required at times to adopt less efficient methods of financing certain of our
mortgage assets and we may be precluded from acquiring certain types of
higher-yielding mortgage assets. The net effect of these factors will be to
lower our net interest income. If we fail to qualify for exemption from
registration as an investment company, our ability to use leverage would be
substantially reduced, and we would not be able to conduct our business as
described. Our business will be materially and adversely affected if we fail to
qualify for this exemption.
If we conduct future offerings the market price of our securities may be
adversely affected.
We may elect to increase our capital resources by making additional public
or private offerings of securities in the future. We do not know:
o the actual or perceived effect of these offerings;
o the timing of these offerings;
o the dilution of the book value or earnings per share of our
securities then outstanding; and
o the effect on the market price of our securities then outstanding.
Sales of additional common stock may adversely affect its market price.
To sustain our growth strategy we intend to raise capital through the sale
of equity. The sale or the proposed sale of substantial amounts of our common
stock in the public market could materially adversely affect the market price of
our common stock or other outstanding securities. In December 2001 we filed a
shelf registration statement with the SEC, which allows us to sell up to $300.0
million of securities, including common stock, preferred stock, debt securities
and warrants. As of June 30, 2003, we have sold approximately $191.3 million
(gross proceeds) worth of common stock from our shelf registration statement and
we may sell additional securities worth approximately $108.7 million (gross
proceeds) from this shelf registration statement in the future. We have also
registered an aggregate of 3,620,069 shares of common stock in connection with
our 2001 Stock Option, Deferred Stock and Restricted Stock Plan. As of June 30,
2003, our 1995 Stock Option, Deferred Stock and Restricted Stock Plan had
1,905,711 shares reserved and available for issuance and that were registered.
The sale of a large amount of shares or the perception that such sales may
occur, could adversely affect the market price for our common stock or other
outstanding securities.
50
New regulatory laws affecting the mortgage industry may increase our costs and
decrease our mortgage origination and acquisition.
The regulatory environments in which we operate have an impact on the
activities in which we may engage, how the activities may be carried out, and
the profitability of those activities. Therefore, changes to laws, regulations
or regulatory policies can affect whether and to what extent we are able to
operate profitably. For example, proposed state and federal legislation targeted
at predatory lending could have the unintended consequence of raising the cost
or otherwise reducing the availability of mortgage credit for those potential
borrowers with less than prime-quality credit histories, thereby resulting in a
reduction of otherwise legitimate Alt-A lending opportunities. We cannot provide
any assurance that these proposed laws, rules and regulations, or other similar
laws, rules or regulations, will not be adopted in the future. Adoption of these
laws and regulations could have a material adverse impact on our business by
substantially increasing the costs of compliance with a variety of inconsistent
federal, state and local rules, or by restricting our ability to charge rates
and fees adequate to compensate us for the risk associated with certain loans.
We are a defendant in purported class actions and may not prevail in these
matters.
Class action lawsuits and regulatory actions alleging improper marketing
practices, abusive loan terms and fees, disclosure violations, improper yield
spread premiums and other matters are risks faced by all mortgage originators,
particularly those in the Alt-A market. We are a defendant in four purported
class actions, (including an action that was dismissed but there has been a
notice of an appeal) pending in four different states. All allege generally that
the loan originator improperly charged fees in violation of various state
lending or consumer protection laws in connection with mortgages that we
acquired. Although the suits are not identical, they generally seek unspecified
compensatory damages, punitive damages, pre- and post-judgment interest, costs
and expenses and rescission of the mortgages, as well as a return of any
improperly collected fees. These actions are in the early stages of litigation
and, accordingly, it is difficult to predict the outcome of these matters. We
believe we have meritorious defenses to the actions and intend to defend against
them vigorously; however, an adverse judgment in any of these matters could have
a material adverse effect on us.
We may be subject to possible adverse consequences as a result of limits on
ownership of our shares.
Our charter limits ownership of our capital stock by any single
stockholder to 9.5% of our outstanding shares unless waived by the board of
directors. Our board of directors may increase the 9.5% ownership limit. In
addition, to the extent consistent with the REIT provisions of the Internal
Revenue Code, our board of directors may, pursuant to our articles of
incorporation, waive the 9.5% ownership limit for a stockholder or purchaser of
our stock. In order to waive the 9.5% ownership limit our board of directors
must require the stockholder requesting the waiver to provide certain
representations to the Company to ensure compliance with the REIT provisions of
the Internal Revenue Code. Our charter also prohibits anyone from buying shares
if the purchase would result in us losing our REIT status. This could happen if
a share transaction results in fewer than 100 persons owning all of our shares
or in five or fewer persons, applying certain broad attribution rules of the
Internal Revenue Code, owning more than 50% (by value) of our shares. If you or
anyone else acquires shares in excess of the ownership limit or in violation of
the ownership requirements of the Internal Revenue Code for REITs, we:
o will consider the transfer to be null and void;
o will not reflect the transaction on our books;
o may institute legal action to enjoin the transaction;
o will not pay dividends or other distributions with respect to those
shares;
o will not recognize any voting rights for those shares;
o may redeem the shares; and
o will consider the shares held in trust for the benefit of a
charitable beneficiary as designated by us.
The trustee shall sell the shares held in trust and the owner of the
excess shares will be entitled to the lesser of:
(a) the price paid by the owner;
51
(b) if the owner did not purchase the excess shares, the closing price
for the shares on the national securities exchange on which IMH is
listed on the day of the event causing the shares to be held in
trust; or
(c) the price received by the trustee from the sale of the shares.
Reduction in the rate at which individual stockholders are subject to tax on
dividends paid by regular C corporations to a maximum rate of 15%.
On May 28, 2003, President Bush signed the Act, which, among other things,
reduces the rate at which individual stockholders are subject to tax on
dividends paid by regular C corporations to a maximum rate of 15%. Generally,
REITs are tax advantaged relative to C corporations because, unlike C
corporations, REITs are allowed a deduction for dividends paid, which, in most
cases, allows a REIT to avoid paying corporate level federal income tax on its
earnings. The provisions of the Act reducing the rate at which individual
stockholders pay tax on dividend income from C corporations may serve to
mitigate this tax advantage and may cause individuals to view an investment in a
C corporation as more attractive than an investment in a REIT. This may
adversely affect the value of our common stock.
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.
52
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We focus on effectively managing the various operational and market risks
associated with our businesses. We believe that the most critical of those risks
are:
o credit risk;
o prepayment risk;
o liquidity risk; and
o interest rate risk.
We manage credit risk by acquiring high-credit quality Alt-A mortgages
from the mortgage operations with favorable credit profiles and by acquiring
mortgages with mortgage insurance enhancements, when required, which reduces our
effective loan-to-value ratio. Our belief is that high-credit quality Alt-A
mortgages will result in favorable foreclosure rates and will result in
favorable loss rates. We also believe that we maintain an adequate allowance for
loan losses to provide for future loan losses. We manage mortgage prepayment
risk by acquiring the majority of Alt-A mortgages from the mortgage operations
with prepayment penalty features. We manage liquidity risk by frequently
securitizing or selling our mortgages. We securitize mortgages through the
issuance of CMOs and REMICs every 30 to 45 days. By frequently securitizing our
mortgages, we reduce the volume of mortgages that are financed with short-term
reverse repurchase agreements at any given time. The issuance of CMOs convert
short-term reverse repurchase borrowings, which are subject to margin calls if
the value of the mortgages collateralizing reverse repurchase borrowings
decline, to long-term CMO financing that are not subject to margin calls. By
securitizing mortgages as REMICs or selling mortgages as whole loan sales,
ownership of the mortgages transfers to the trust in the case of REMICs and to
the buyer in the case of whole loan sales. For additional information regarding
these risks refer to Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Although we manage credit, prepayment and liquidity risk in the normal
course of business, we consider interest rate risk to be a significant market
risk, which could potentially have the largest material effect on our financial
condition and results of operations. Since a significant portion of our revenues
and earnings are derived from net interest income, we strive to manage our
interest-earning assets and interest-bearing liabilities to generate what we
believe to be an appropriate contribution from net interest income. When
interest rates fluctuate, profitability can be adversely affected by changes in
the fair market value of our assets and liabilities and by the interest spread
earned on interest-earning assets and interest-bearing liabilities. We derive
income from the differential spread between interest earned on interest-earning
assets and interest paid on interest-bearing liabilities. Any change in interest
rates affects income received and expense paid from assets and liabilities in
varying and typically in unequal amounts. Changing interest rates may compress
our interest rate margins and adversely affect overall earnings.
Interest rate risk management is the responsibility of ALCO, which reports
results of interest rate risk analysis to the board of directors on a quarterly
basis. ALCO establishes policies that monitor and coordinate sources, uses and
pricing of funds. ALCO also attempts to reduce the volatility in net interest
income by managing the relationship of interest rate sensitive assets to
interest rate sensitive liabilities. In addition, various modeling techniques
are used to value interest sensitive mortgage-backed securities, including
interest-only securities. The value of mortgage-backed securities is determined
using a discounted cash flow model using prepayment rate, discount rate and
credit loss assumptions. Our investment securities portfolio is
available-for-sale, which requires us to perform market valuations of the
securities in order to properly record the portfolio. We continually monitor
interest rates of our investment securities portfolio as compared to prevalent
interest rates in the market. We do not currently maintain a securities trading
portfolio and are not exposed to market risk as it relates to trading
activities.
ALCO follows an interest rate hedging program intended to limit our
exposure to changes in interest rates primarily associated with cash flows on
our adjustable rate CMO borrowings. Our primary objective is to hedge our
exposure to the variability in future cash flows attributable to the variability
of one-month LIBOR, which is the underlying index of our adjustable rate CMO
borrowings. We also monitor on an ongoing basis the prepayment risks that arise
in fluctuating interest rate environments. Our interest rate hedging program is
formulated with the intent to attempt to offset the potential adverse effects of
changing interest rates on cash flows on adjustable rate CMO borrowings
resulting from the following:
53
o interest rate adjustment limitations on mortgages held as CMO
collateral due to periodic and lifetime interest rate cap features;
and
o mismatched interest rate adjustment periods between mortgages held
as CMO collateral and CMO borrowings.
We acquire for long-term investment six-month LIBOR ARMs and six-month
LIBOR hybrids. Six-month LIBOR ARMs are generally subject to periodic and
lifetime interest rate caps. This means that the interest rate of each ARM is
limited to upwards or downwards movements on its periodic interest rate
adjustment date, generally six months, or over the life of the mortgage.
Periodic caps limit the maximum interest rate change, which can occur on any
interest rate change date to generally a maximum of 1% per semi-annual
adjustment. Also, each ARM has a maximum lifetime interest rate cap. Generally,
borrowings are not subject to the same periodic or lifetime interest rate
limitations. During a period of rapidly increasing or decreasing interest rates,
financing costs would increase or decrease at a faster rate than the periodic
interest rate adjustments on mortgages would allow, which could affect net
interest income. In addition, if market rates were to exceed the maximum
interest rates of our ARMs, borrowing costs would increase while interest rates
on ARMs would remain constant.
We also acquire hybrid ARMs that have initial fixed interest rate periods
generally ranging from two to three years and, to a lesser extent, five to seven
years, which subsequently convert to six-month LIBOR ARMs. During a rapidly
increasing or decreasing interest rate environment financing costs would
increase or decrease more rapidly than would interest rates on mortgages, which
would remain fixed until their next interest rate adjustment date. In order to
provide some protection against any resulting basis risk shortfall on the
related liabilities, we purchase derivative instruments. Derivative instruments
are based upon the principal balance that would result under assumed prepayment
speeds.
We measure the sensitivity of our net interest income to changes in
interest rates affecting interest sensitive assets and liabilities using
simulations. As part of various interest rate simulations, we calculate the
effect of potential changes in interest rates on our interest-earning assets and
interest-bearing liabilities and their affect on overall earnings. The
simulations assume instantaneous and parallel shifts in interest rates and to
what degree those shifts affect net interest income. First, we estimate our net
interest income for the next twelve months using period-end balance sheet data
and 12-month projections of the following:
o future interest rates using forward yield curves, which are market
consensus estimates of future interest rates;
o acquisition of derivative instruments;
o mortgage prepayment rate assumptions; and
o mortgage acquisitions.
We refer to this 12-month projection of net interest income as the "base
case." Once the base case has been established, we "shock" the base case with
instantaneous and parallel shifts in interest rates in 100 basis point
increments upward and downward to plus and minus 200 basis points. Calculations
are made for each of the defined instantaneous and parallel shifts in interest
rates over or under the forward yield curve used to determine the base case and
include any associated changes in projected mortgage prepayment rates caused by
changes in interest rates. The results of each 100 basis point change in
interest rates are then compared against the base case to determine the
estimated change to net interest income. The simulations consider the affect of
interest rate changes on interest sensitive assets and liabilities as well as
derivative instruments. The simulations also consider the impact that
instantaneous and parallel shifts in interest rates have on prepayment rates and
the resulting affect of accelerating or decelerating amortization rates of
premium and securitization costs on net interest income.
The use of derivative instruments to hedge changes in interest rates is an
integral part of our strategy to limit interest rate risk. Therefore, net
interest income may be significantly impacted by cash payments we are required
to make or cash payments we receive on derivative instruments. The amount of
cash payments or cash receipts on derivative instruments is determined by (1)
the notional amount of the derivative instrument and (2) current interest rate
levels in relation to the various strike prices of derivative instruments during
a particular time period.
We believe our quantitative risk has not materially changed since our
disclosures under Item 7A. "Quantitative and Qualitative Disclosures About
Market Risk" in our annual report on Form 10-K for the year ended December 31,
2002.
54
ITEM 4: CONTROLS AND PROCEDURES
As of June 30, 2003 the Chief Executive Officer, or "CEO," and Chief
Financial Officer, or "CFO," performed an evaluation of the effectiveness and
the operation of our disclosure controls and procedures as defined in Rule 13a -
14c under the Securities Exchange Act of 1934, as amended. Based on that
evaluation, the CEO and CFO concluded that our disclosure controls and
procedures were effective as of June 30, 2003. There have been no significant
changes in our internal controls or in other factors that could significantly
affect internal controls subsequent to June 30, 2003.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
With respect to the complaint captioned Deborah Searcy, Shirley Walker, et
al. vs. Impac Funding Corporation, Impac Mortgage Holdings, Inc. et. al., which
is described in IMH's annual report on Form 10-K for the year ended December 31,
2002, in March 2003, the plaintiffs filed an amended complaint adding certain
defendants, including an Impac-related entity, and dropping others, including
certain Impac-related entities, and we have been served with the amended
complaint. A motion to dismiss the amended complaint has been filed. This motion
is scheduled to be heard on September 5, 2003. Please refer to IMH's annual
report on Form 10-K for the year ended December 31, 2002 regarding the Searcy
action. We believe that we have meritorious defenses to this complaint and we
intend to defend IMH vigorously. Nevertheless, litigation is uncertain and we
may not prevail in the lawsuit and can express no opinion as to its ultimate
outcome. We are a party to other litigation and claims, which are normal in the
course of our operations. While the results of such other litigation and claims
cannot be predicted with certainty, we believe the final outcome of such other
matters will not have a material adverse effect on IMH. Please refer to our
annual report on Form 10-K for the year ended December 31, 2002 regarding other
litigation and claims.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 24, 2003, we held our annual meeting of stockholders. Of
49,196,734 shares eligible to vote, 46,447,456 votes were returned, or 94.4%,
formulating a quorum. At the annual stockholders meeting, the following matters
were submitted to stockholders for vote: Proposal I - Election of Directors,
Proposal II - Ratification of the appointment of KPMG LLP as our independent
auditors for the year ending December 31, 2003, Proposal III - Approval for
Section 162(m) purposes of an amendment to IMH's 2001 Stock Option Plan limiting
the maximum number of shares for which options may be granted to any eligible
employee in any fiscal year and Proposal IV - Approval for Section 162(m)
purposes of incentive compensation for Joseph R. Tomkinson, William S. Ashmore
and Richard J. Johnson.
Proposal I - Election of Directors.
The results of voting on these proposals are as follows:
Director For Against Elected
-------- --- ------- -------
Joseph R. Tomkinson 45,914,697 532,759 Yes
William S. Ashmore 46,003,597 443,859 Yes
James Walsh 45,433,407 1,014,049 Yes
Frank P. Filipps 45,433,407 1,014,049 Yes
Stephan R. Peers 46,002,597 444,859 Yes
William E. Rose 45,433,407 1,014,049 Yes
Leigh J. Abrams 46,003,597 443,859 Yes
55
All directors are elected at our annual stockholders meeting.
Proposal II - Ratification of the appointment of KPMG LLP as our independent
auditors for the year ending December 31, 2003.
Proposal II was approved with 45,759,325 shares voted for, 548,090 voted
against and 140,041 abstained from voting, thereby, ratifying the appointment of
KPMG LLP as our independent auditors for the year ending December 31, 2003.
Proposal III - Approval for Section 162(m) purposes of an amendment to IMH's
2001 Stock Option Plan limiting the maximum number of shares for which options
may be granted to any eligible employee in any fiscal year.
Proposal III was approved with 38,228,389 shares voted for, 8,012,542
voted against and 206,523 abstained from voting, thereby, approving for Section
162(m) purposes an amendment to IMH's 2001 Stock Option Plan limiting the
maximum number of shares for which options may be granted to any eligible
employee in any fiscal year.
Proposal IV - Approval for Section 162(m) purposes of incentive compensation for
Joseph R. Tomkinson, William S. Ashmore and Richard J. Johnson.
Proposal IV was approved with 43,093,127 shares voted for, 2,842,902 voted
against and 511,426 abstained from voting, thereby, approving for Section 162(m)
purposes incentive compensation for Joseph R. Tomkinson, William S. Ashmore and
Richard J. Johnson.
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
21.1 Subsidiaries of the Registrant.
31.1 Certifications of Chief Executive Officer pursuant to item
601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to item
601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
IMH filed a Current Report on Form 8-K, dated May 7, 2003, reporting Items
5 and 7, relating to an equity distribution agreement for the sale of up
to 4,862,965 shares of our common stock.
IMH filed a Current Report on Form 8-K, dated June 12, 2003, reporting
Items 5 and 7, relating to an announcement that our common stock will be
traded on the New York Stock Exchange.
56
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMPAC MORTGAGE HOLDINGS, INC.
/s/ Richard J. Johnson
by: Richard J. Johnson
Executive Vice President
and Chief Financial Officer
(authorized officer of registrant and principal financial officer)
Date: August 4, 2003
57