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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 31, 2003 the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $791.7 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 53,084,405 shares of common stock outstanding as of October 31, 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 September 30, 2003 and
December 31, 2002 ......................................... 1
Consolidated Statements of Operations and Comprehensive
Earnings, For the Three and Nine Months Ended September 30,
2003 and 2002 ............................................. 2
Consolidated Statements of Cash Flows, For the Nine Months
Ended September 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 ................................... 15
Financial Highlights for the Third Quarter of 2003 ........... 15
General and Business Operations .............................. 16
Available Information ........................................ 17
Critical Accounting Policies ................................. 17
Results of Operations--Impac Mortgage Holdings, Inc.--
For the Three Months Ended September 30, 2003 .......... 18
Results of Operations--Impac Mortgage Holdings, Inc. --
For the Nine Months Ended September 30, 2003 ........... 29
Liquidity and Capital Resources .............................. 34
Risk Factors ................................................. 38
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ...... 52
ITEM 4. CONTROLS AND PROCEDURES ......................................... 54
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ............................................... 54
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ....................... 54
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................. 55
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............. 55
ITEM 5. OTHER INFORMATION ............................................... 55
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................ 55
SIGNATURES ...................................................... 56
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)
September 30, December 31,
2003 2002
------------- -------------
ASSETS
Cash and cash equivalents ........................................................ $ 117,759 $ 113,345
CMO collateral ................................................................... 7,429,061 5,149,680
Finance receivables .............................................................. 650,991 1,140,248
Mortgages held-for-sale .......................................................... 571,939 --
Mortgages held-for-investment .................................................... 152,063 57,536
Allowance for loan losses ........................................................ (39,122) (26,602)
Accrued interest receivable ...................................................... 32,499 28,287
Derivative assets ................................................................ 17,919 14,931
Investment in Impac Funding Corporation .......................................... -- 20,787
Due from affiliates .............................................................. -- 14,500
Other assets ..................................................................... 93,036 39,061
------------- -------------
Total assets ................................................................ $ 9,026,145 $ 6,551,773
============= =============
LIABILITIES
CMO borrowings ................................................................... $ 7,261,703 $ 5,041,751
Reverse repurchase agreements .................................................... 1,236,007 1,168,029
Accumulated dividends payable .................................................... 26,535 21,754
Other liabilities ................................................................ 71,766 16,751
------------- -------------
Total liabilities ........................................................... 8,596,011 6,248,285
------------- -------------
STOCKHOLDERS' EQUITY
Preferred stock; $0.01 par value; 7,500,000 shares authorized; none outstanding at
September 30, 2003 and December 31, 2002 ...................................... -- --
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares
authorized; none outstanding at September 30, 2003 and December 31, 2002 ...... -- --
Common stock; $0.01 par value; 200,000,000 shares authorized; 53,069,072 and
45,320,517 shares outstanding at September 30, 2003 and December 31, 2002,
respectively .................................................................. 531 453
Additional paid-in capital ....................................................... 575,436 479,298
Accumulated other comprehensive loss ............................................. (23,486) (41,721)
Net accumulated deficit:
Cumulative dividends declared ................................................. (277,439) (200,954)
Retained earnings ............................................................. 155,092 66,412
------------- -------------
Net accumulated deficit ...................................................... (122,347) (134,542)
------------- -------------
Total stockholders' equity .................................................. 430,134 303,488
------------- -------------
Total liabilities and stockholders' equity .................................. $ 9,026,145 $ 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 Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
INTEREST INCOME:
Mortgage assets ........................................... $ 86,325 $ 59,736 $ 244,569 $ 150,438
Other interest income ..................................... 349 1,963 1,808 3,558
---------- ---------- ---------- ----------
Total interest income .................................. 86,674 61,699 246,377 153,996
---------- ---------- ---------- ----------
INTEREST EXPENSE:
CMO borrowings ............................................ 45,567 31,091 135,950 79,021
Reverse repurchase agreements ............................. 8,971 6,086 23,066 15,724
Other borrowings .......................................... 891 1,413 2,705 2,942
---------- ---------- ---------- ----------
Total interest expense ................................. 55,429 38,590 161,721 97,687
---------- ---------- ---------- ----------
Net interest income ....................................... 31,245 23,109 84,656 56,309
Provision for loan losses .............................. 7,820 5,361 21,363 13,302
---------- ---------- ---------- ----------
Net interest income after provision for loan losses ....... 23,425 17,748 63,293 43,007
NON-INTEREST INCOME:
Gain on sale of loans ..................................... 33,900 -- 35,514 --
Gain on sale of securities ............................... 3,545 -- 3,545 --
Equity in net earnings of Impac Funding Corporation ....... -- 2,755 16,698 12,816
Loan servicing expense .................................... (1,278) -- (1,299) --
Other income .............................................. 749 1,222 2,906 3,219
---------- ---------- ---------- ----------
Total non-interest income .............................. 36,916 3,977 57,364 16,035
NON-INTEREST EXPENSE:
Personnel expense ......................................... 10,551 534 12,045 1,326
General and administrative expense ........................ 5,057 533 7,657 1,099
Professional services ..................................... 1,461 708 2,854 2,649
Amortization of mortgage servicing rights ................. 1,203 -- 1,203 --
Provision for repurchases ................................. 586 -- 586 --
Mark-to-market loss on derivative instruments ............. 156 -- 156 --
(Gain) loss on disposition of other real estate owned ..... (642) 514 (1,076) 120
Write-down of investment securities available-for-sale .... 180 2 180 1,040
---------- ---------- ---------- ----------
Total non-interest expense ............................. 18,552 2,291 23,605 6,234
---------- ---------- ---------- ----------
Net earnings before taxes ................................. 41,789 19,434 97,052 52,808
Income taxes ........................................... 8,372 -- 8,372 --
---------- ---------- ---------- ----------
Net earnings after taxes .................................. 33,417 19,434 88,680 52,808
---------- ---------- ---------- ----------
OTHER COMPREHENSIVE EARNINGS:
Unrealized holding gains (losses) on securities arising
during period ........................................... 1,602 (487) (528) (1,041)
Unrealized holding gains (losses) on hedging instruments
arising during period ................................... 12,252 (13,818) 19,506 (23,112)
Reclassification of gains included in net earnings ........ (1,832) (28) (743) (185)
---------- ---------- ---------- ----------
Net unrealized gains (losses) arising during period .. 12,022 (14,333) 18,235 (24,338)
---------- ---------- ---------- ----------
Other comprehensive earnings .............................. $ 45,439 $ 5,101 $ 106,915 $ 28,470
========== ========== ========== ==========
NET EARNINGS PER SHARE:
Basic ..................................................... $ 0.64 $ 0.47 $ 1.78 $ 1.36
========== ========== ========== ==========
Diluted ................................................... $ 0.63 $ 0.47 $ 1.75 $ 1.34
========== ========== ========== ==========
DIVIDENDS PER COMMON SHARE ................................... $ 0.50 $ 0.45 $ 1.50 $ 1.28
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
2
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Nine Months
Ended September 30,
--------------------------
2003 2002
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ...................................................................... $ 88,680 $ 52,808
Adjustments to reconcile net earnings to net cash provided by operating activities:
Equity in net earnings of Impac Funding Corporation ............................ (16,698) (12,816)
Provision for loan losses ...................................................... 21,363 13,302
Amortization of loan premiums and securitization costs ......................... 48,359 26,185
Depreciation and amortization .................................................. 666 --
Gain on disposition of other real estate owned ................................. 1,076 (120)
Gain on sale of investment securities available-for-sale ....................... (3,545) --
Write-down of investment securities available-for-sale ......................... 180 1,040
Impairment of mortgage servicing rights ........................................ 1,203 --
Gain on sale of loans .......................................................... 35,514 --
Purchase of mortgages-held-for sale ............................................ (2,782,609) --
Sale and principal reductions on mortgages held-for-sale ....................... 2,626,588 --
Net change in accrued interest receivable ...................................... (4,375) (8,383)
Net change in deferred revenue ................................................. (6,365) --
Net change in deferred taxes ................................................... 10,417 --
Net change in other assets and liabilities ..................................... 6,865 (1,994)
----------- -----------
Net cash provided by operating activities .................................... 27,319 70,022
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in CMO collateral ...................................................... (2,328,266) (1,835,450)
Net change in finance receivables ................................................. 34,408 (449,790)
Net change in mortgages held-for-investment ....................................... (108,412) (258,888)
Cash received from acquisition of Impac Funding Corporation ....................... 23,510 --
Purchase of premises and equipment ................................................ (301) --
Sale of investment securities available-for-sale .................................. 5,232 --
Proceeds from sale of other real estate owned, net ................................ 22,961 8,295
Dividend from Impac Funding Corporation ........................................... 11,385 9,900
Net principal reductions on investment securities available-for-sale .............. 6,206 5,480
----------- -----------
Net cash used in investing activities ........................................ (2,489,298) (2,520,453)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in reverse repurchase agreements and other borrowings .................. 67,651 693,583
Proceeds from CMO borrowings ...................................................... 3,971,993 2,433,254
Repayments of CMO borrowings ...................................................... (1,752,041) (666,154)
Dividends paid .................................................................... (71,704) (47,020)
Proceeds from sale of common stock ................................................ 37,776 83,957
Proceeds from sale of common stock via equity distribution agreement .............. 54,613 9,310
Additions to master servicing rights and mortgages servicing rights ............... (1,618) --
Proceeds from exercise of stock options ........................................... 3,702 754
Reductions on notes receivable-common stock ....................................... -- 920
----------- -----------
Net cash provided by financing activities .................................... 2,310,372 2,508,604
----------- -----------
Net change in cash and cash equivalents ........................................... 4,414 58,173
Cash and cash equivalents at beginning of period .................................. 113,345 51,887
----------- -----------
Cash and cash equivalents at end of period ........................................ $ 117,759 $ 110,060
=========== ===========
See accompanying notes to consolidated financial statements.
3
IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(unaudited)
For the Nine Months
Ended September 30,
--------------------------
2003 2002
----------- -----------
SUPPLEMENTARY INFORMATION:
Interest paid .................................................. $ 160,898 $ 96,398
NON-CASH TRANSACTIONS:
Transfer of mortgages held-for-investment to CMO collateral .... $3,999,457 $ 2,449,994
Transfer of mortgages to other real estate owned ............... 26,678 11,219
Dividends declared and unpaid .................................. 26,535 19,309
Net unrealized gains (losses) .................................. 18,235 (24,338)
Issuance of shares for the purchase of Impac Funding Corporation 125 --
The following table presents the acquisition of the assets and liabilities
of Impac Funding Corporation as of July 1, 2003 (in thousands):
ASSETS ACQUIRED
Cash and cash equivalents ....................................... $ 24,135
Mortgages held-for-sale ......................................... 451,432
Accrued interest receivable ..................................... 564
Goodwill ........................................................ 486
Other assets .................................................... 71,377
--------
Total assets ............................................ $547,994
========
LIABILITIES ASSUMED
Warehouse borrowings ............................................ 447,951
Other liabilities ............................................... 73,206
--------
Total liabilities .......................................... 521,157
--------
Total stockholders' equity ................................. 26,837
--------
Total liabilities and stockholders' equity .............. $547,994
========
Net Assets Acquired:
Investment in Impac Funding Corporation ...................... $ 26,087
Cash paid for common stock ................................... 625
Shares issued for common stock ............................... 125
--------
$ 26,837
========
See accompanying notes to consolidated financial statements.
4
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 nine-month periods
ended September 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.
On July 1, 2003, IMH purchased all of the outstanding shares of voting
common stock of Impac Funding Corp (IFC), which represents 1% of the economic
interest of IFC, from Joseph R. Tomkinson, the Company's Chairman, Chief
Executive Officer and director, William S. Ashmore, the Company's President,
Chief Operating Officer and director and the Johnson Revocable Living Trust, of
which Richard J. Johnson, the Company's Executive Vice President and Chief
Financial Officer, is trustee. Each of Messer's. Tomkinson and Ashmore and the
Johnson Revocable Living Trust owned one-third of the outstanding common stock
of IFC. The purchase of IFC's common stock combined with the Company's existing
ownership of all of IFC's preferred stock, which represents 99% of IFC's
economic interest, resulted in the Company consolidating IFC as of July 1, 2003.
Prior to July 1, 2003, the Company accounted for its investment in IFC using the
equity method of accounting.
The Company's results of operations for the three-months ended September
30, 2003 include the financial results of its wholly-owned subsidiaries, which
are IFC, IMH Assets Corporation (IMH Assets), Impac Warehouse Lending Group
(IWLG) and Impac Multifamily Capital Corporation (IMCC). The Company's results
of operations for the nine-months ended September 30, 2003 include the financial
results of IFC for the six-months ended June 30, 2003 as "Equity in net earnings
of Impac Funding Corporation," and the consolidation of IFC's results of
operations for the three-months ended September 30, 2003 along with the
financial results of IMH Assets, IWLG and IMCC, as stand alone entities, for the
nine-months ended September 30, 2003.
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. Certain amounts in the prior periods'
consolidated financial statements have been reclassified to conform to the
current presentation.
Note 2--Business Summary
IMH is a mortgage real estate investment trust (REIT). Together with its
subsidiaries the Company is primarily a nationwide acquirer and originator of
non-conforming Alt-A mortgage loans (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.
The Company operates three core businesses:
o long-term investment operations;
o mortgage operations; and
o warehouse lending operations.
The long-term investment operations, conducted by IMH, IMH Assets and
IMCC, invest primarily in adjustable and fixed rate Alt-A mortgages that are
acquired and originated by the mortgage operations and small balance,
multi-family mortgages (multi-family mortgages) originated by IMCC. This
business primarily generates net interest income from
5
mortgages held for long-term investment. Investments in Alt-A mortgages and
multi-family mortgages are financed with collateralized mortgage obligations
(CMO) financing, warehouse facilities, proceeds from the sale of capital stock
and cash.
The mortgage operations, conducted by IFC, acquire, originate, sell and
securitize primarily adjustable and fixed rate Alt-A mortgages and, to a lesser
extent, sub-prime mortgages (B/C mortgages). B/C mortgages are residential
mortgages made to borrowers with lower credit ratings than borrowers of Alt-A
mortgages and are normally subject to higher rates of loss and delinquency than
Alt-A mortgages. The mortgage operations generate income by securitizing and
selling loans to permanent investors, including the long-term investment
operations, and, to a lesser extent, revenue from fees associated with mortgage
servicing rights, master servicing agreements and interest income earned on
mortgages held-for-sale. The mortgage operations use warehouse facilities
provided by the warehouse lending operations, conducted by IWLG, to finance the
acquisition and origination of mortgages.
The warehouse lending operations provide short-term financing to mortgage
loan originators, including the mortgage operations, by funding mortgages from
their closing date until they are sold to pre-approved investors. This business
earns fees from warehouse transactions as well as net interest income from the
difference between its cost of borrowings and the interest earned on warehouse
advances.
Note 3--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 For the Nine Months
Ended September 30, Ended September 30,
--------------------- ---------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Numerator for earnings per share:
Net earnings ............................................... $ 33,417 $ 19,434 $ 88,680 $ 52,808
========= ========= ========= =========
Denominator for earnings per share:
Basic weighted average number of common shares outstanding . 52,008 41,010 49,707 38,850
Net effect of dilutive stock options ....................... 1,135 766 1,003 662
--------- --------- --------- ---------
Diluted weighted average of common and common
equivalent shares ....................................... 53,143 41,766 50,710 39,512
========= ========= ========= =========
Net earnings per share:
Basic ...................................................... $ 0.64 $ 0.47 $ 1.78 $ 1.36
========= ========= ========= =========
Diluted .................................................... $ 0.63 $ 0.47 $ 1.75 $ 1.34
========= ========= ========= =========
The Company had zero and 424 stock options outstanding during the three
months ended September 30, 2003 and 2002, respectively, and 363,136 and 229,694
stock options outstanding during the nine months ended September 30, 2003 and
2002, respectively, that were not considered in the calculation of diluted
weighted average common and common equivalent shares because their effect was
antidilutive.
Note 4--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
maintains 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
of the Stock Option Plans provide for the grant of qualified incentive stock
options (ISOs), non-qualified stock options (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
6
the 2001 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 September 30, 2003, the Company had fixed stock option plans that it
accounted for using the intrinsic value method in accordance with APB 25 and
which did not require the recognition of compensation expense. However, if
compensation expense for stock-based compensation plans had been recognized
using the fair value based method consistent with SFAS 123, as amended by SFAS
148, net earnings and earnings per share would have been reduced to the pro
forma amounts indicated below (in thousands, except per share amounts):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------- --------- --------- ---------
2003 2002 2003 2002
--------- --------- --------- ---------
Net earnings as reported ................................ $ 33,417 $ 19,434 $ 88,680 $ 52,808
Total stock-based employee compensation expense using the
fair value method .................................... (346) (324) (618) (485)
--------- --------- --------- ---------
Pro forma net earnings .................................. $ 33,071 $ 19,110 $ 88,062 $ 52,323
========= ========= ========= =========
Net earnings per share as reported:
Basic ................................................... $ 0.64 $ 0.47 $ 1.78 $ 1.36
========= ========= ========= =========
Diluted ................................................. $ 0.63 $ 0.47 $ 1.75 $ 1.34
========= ========= ========= =========
Pro forma net earnings:
Basic ................................................... $ 0.64 $ 0.47 $ 1.77 $ 1.35
========= ========= ========= =========
Diluted ................................................. $ 0.62 $ 0.46 $ 1.74 $ 1.32
========= ========= ========= =========
The derived fair value of stock options granted during the third quarter
of 2003 and 2002 was approximately $1.09 and $1.21, respectively, 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 For the Three and
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
-------------------- ---------------------
Risk-free interest rate............. 1.22% 1.45%
Expected lives (in years)........... 4 3-10
Expected volatility................. 28.83% 35.07%
Expected dividend yield............. 10.00% 10.00%
7
Note 5--Segment Reporting
The Company internally reviews and analyzes its operating segments as
follows:
o the long-term investment operations invest primarily in Alt-A
mortgages acquired by the mortgage operations and multi-family
mortgages originated by IMCC;
o the warehouse lending operations provide warehouse financing to
affiliated companies and to non-affiliated customers, some of which
are correspondents of the mortgage operations, to finance mortgages;
and
o the mortgage operations acquire and originate primarily Alt-A
mortgages and, to a lesser extent, B/C mortgages and second
mortgages from its network of third party correspondents, mortgage
brokers and retail customers.
The following table presents business segment information for the periods
indicated (in thousands):
Long-Term Warehouse Inter-
Investment Lending Mortgage Company
Operations Operations Operations (1) Consolidated
------------ ------------ ------------ ------------ ------------
Balance Sheet Items as of
September 30, 2003:
- -------------------------------------
CMO collateral and mortgages
held-for-investment $ 7,581,124 $ -- $ -- $ -- $ 7,581,124
Loans held-for-sale -- -- 571,939 -- 571,939
Finance receivables -- 1,288,972 -- (637,981) 650,991
Total assets 8,065,715 1,347,623 692,548 (1,079,741) 9,026,145
Total stockholders' equity $ 670,001 $ 110,886 $ 27,043 $ (377,796) $ 430,134
Income Statement Items for the Three
Months Ended September 30, 2003:
- ------------------------------------
Net interest income $ 18,933 $ 8,073 $ 4,239 $ -- $ 31,245
Provision for loan losses 7,072 748 -- -- 7,820
Non-interest income 3,831 1,536 31,549 -- 36,916
Non-interest expense 1,252 1,348 24,324 -- 26,924
------------ ------------ ------------ ------------ ------------
Net earnings $ 14,440 $ 7,513 $ 11,464 $ -- $ 33,417
============ ============ ============ ============ ============
Income Statement Items for the Nine
Months Ended September 30, 2003:
- ------------------------------------
Net interest income $ 59,340 $ 21,078 $ 10,430 $ (6,192) $ 84,656
Provision for loan losses 19,423 1,940 -- -- 21,363
Non-interest income (2) 4,882 4,235 82,271 (34,024) 57,364
Non-interest expense 3,905 3,749 64,370 (40,047) 31,977
------------ ------------ ------------ ------------ ------------
Net earnings $ 40,894 $ 19,624 $ 28,331 $ (169) $ 88,680
============ ============ ============ ============ ============
- ---------------------
(1) Elimination of inter-company balance sheet and income statement items.
(2) Includes 99% of earnings from the mortgage operations as equity in net
earnings of IFC for the first six months of 2003.
8
The following table presents business segment information for the periods
indicated (in thousands):
Long-Term Warehouse
Investment Lending Inter-
Operations Operations Company Consolidated
------------ ------------ ------------ ------------
Balance Sheet Items as of September 30, 2002:
- ------------------------------------------------
CMO collateral and mortgages held-for-investment $ 4,280,203 $ -- $ -- $ 4,280,203
Finance receivables ............................ -- 916,439 -- 916,439
Total assets ................................... 4,636,313 1,258,645 (498,701) 5,396,257
Total stockholders' equity ..................... $ 423,361 $ 85,320 $ (234,153) $ 274,528
Income Statement Items for the Three Months
Ended September 30, 2002:
- ------------------------------------------------
Net interest income ............................ $ 17,556 $ 5,553 $ -- $ 23,109
Provision for loan losses ...................... 5,016 345 -- 5,361
Non-interest income (3) ........................ (174) 1,396 2,755 3,977
Non-interest expense ........................... 1,300 991 -- 2,291
------------ ------------ ------------ ------------
Net earnings ................................... $ 11,066 $ 5,613 $ 2,755 $ 19,434
============ ============ ============ ============
Income Statement Items for the Nine Months
Ended September 30, 2002:
- ------------------------------------------------
Net interest income ............................ $ 43,618 $ 12,691 $ -- $ 56,309
Provision for loan losses ...................... 12,418 884 -- 13,302
Non-interest income (3) ........................ (132) 3,351 12,816 16,035
Non-interest expense ........................... 3,633 2,601 -- 6,234
------------ ------------ ------------ ------------
Net earnings ................................... $ 27,435 $ 12,557 $ 12,816 $ 52,808
============ ============ ============ ============
- ------------
(3) Includes 99% of earnings from the mortgage operations as equity in net
earnings of IFC.
Note 6--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 for the subsequent twelve-month period in accordance
with GAAP. The Company provides for loan losses by maintaining a ratio of
allowance for loan losses to mortgages held as CMO collateral, finance
receivables and mortgages held-for-investment within a range of 40 basis points
to 45 basis points. As of September 30, 2003, the ratio of allowance for loan
losses to mortgages provided for was 47 basis points as allowance for loan
losses increased to $39.1 million.
The allowance for loan losses is reduced by losses incurred for mortgages
deemed to be uncollectible, delinquent mortgages sold at a loss and the
write-down of mortgages to the fair market value of real estate acquired through
foreclosure proceedings. 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. The provision for loan
losses is also determined based on the following:
o management's judgment of the net loss potential of mortgages based
on prior loan loss experience;
o changes in the nature and volume of the mortgage portfolio;
o value of the underlying collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
9
The following table presents activity for allowance for loan losses for
the periods shown (in thousands):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Beginning balance .............. $ 33,384 $ 16,934 $ 26,602 $ 11,692
Provision for loan losses ...... 7,820 5,361 21,363 13,302
Charge-offs, net of recoveries . (2,082) (731) (8,843) (3,430)
--------- --------- --------- ---------
Ending balance .............. $ 39,122 $ 21,564 $ 39,122 $ 21,564
========= ========= ========= =========
As of September 30,
--------------------
2003 2002
-------- --------
Allowance for loan losses as a percentage of mortgages held as CMO collateral, finance receivables and
mortgages held for investment ..................................................................... 0.47% 0.45%(1)
(1) Recalculation of prior period percentage to reflect exclusion of
affiliated finance receivables upon consolidation of IFC.
Note 7--Derivative Instruments and Hedging Activities
The Company follows a hedging program intended to limit its exposure to
changes in interest rates primarily associated with cash flows on CMO borrowings
and also enters into forward commitments and derivative instruments to mitigate
changes in the value of its "locked pipeline" of fixed rate mortgages. The
locked pipeline are mortgages that have not yet been acquired, however, the
mortgage operations has committed to acquire the mortgages in the future at
pre-determined rates through rate-lock commitments. The Company seeks to hedge
exposure to the variability in future cash flows attributable to the variability
of one-month London Interbank Offered Rate (LIBOR), which is the underlying
index of adjustable rate CMO borrowings. The Company also monitors on an ongoing
basis the prepayment risks that arise in fluctuating interest rate environments.
The Company'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;
o basis risk; and
o mismatched interest rate adjustment periods between mortgages held
as CMO collateral and CMO borrowings.
The Company primarily acquires for long-term investment six-month LIBOR
adjustable rate mortgages (ARMs) and hybrid ARMs. Six-month LIBOR ARMs are
generally subject to periodic and lifetime interest rate caps. This means that
the interest rate of each ARM is limited to upwards or downwards movements on
its periodic interest rate adjustment date, generally six months, or over the
life of the mortgage loan. Periodic caps limit the maximum interest rate change,
which can occur on any interest rate change date to generally a maximum of 1%
per semiannual adjustment. Also, each ARM has a maximum lifetime interest rate
cap. Generally, borrowings are not subject to the same periodic or lifetime
interest rate limitations. During a period of rapidly increasing or decreasing
interest rates, financing costs would increase or decrease at a faster rate than
the periodic interest rate adjustments on mortgages would allow, which could
effect 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.
Basis risk results as the basis, or interest rate index, of mortgages and
borrowings are tied to different interest indices. For instance, six-month LIBOR
ARMs are indexed to six-month LIBOR while CMO and reverse repurchase borrowings
are indexed to one-month LIBOR. Therefore, the Company receives interest income
based on six-month LIBOR plus a spread but pays interest expense based on
one-month LIBOR plus a spread. These indices typically move in unison but may
vary in unequal amounts.
Cash flows are subject to risk from the mismatched nature of interest rate
adjustment periods on mortgages and interest rates on the related borrowings.
Six-month LIBOR mortgages can adjust upwards or downwards every six months,
subject to periodic cap limitations, while adjustable rate CMO borrowings adjust
every month. Additionally, the Company has hybrid ARMs, which have an initial
fixed interest rate period generally ranging from two to three years, and to a
lesser extent five years, which subsequently convert to six-month LIBOR ARMs.
Again, during a rapidly increasing or
10
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.
To mitigate exposure to the effect of changing interest rates on cash
flows on CMO borrowings, the Company purchases or sells financial instruments
primarily in the form of interest rate swap agreements (swaps) and, to a lesser
extent, interest rate cap agreements (caps) and interest rate floor agreements
(floors), collectively referred to as (derivatives). 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 mortgages and, as a result, can reduce the interest rate
variability of borrowings. A purchase or sale of a cap or floor is a contractual
agreement for which the Company may pay or receive a fee. If prevailing interest
rates reach levels specified in the cap or floor agreement, the Company may
either receive or pay cash. The Company'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.
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
derivatives that are deposited into a CMO trust must have AAA credit ratings
while counter-parties on derivatives 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 derivatives, including
a number of derivatives embedded in other contracts and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If specific conditions are met, a derivative may be specifically
designated as (1) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment; (2) a hedge of
the exposure to variable cash flows of a forecasted transaction; or (3) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security or a
foreign-currency-denominated forecasted transaction. 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,
the Company assessed the hedging effectiveness of its caps utilizing only the
intrinsic value of the caps. DIG G20 allows the Company 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. The Company 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, the Company 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.
11
The mortgage operations records the fair market value of its locked
pipeline of fixed rate mortgages as it qualifies as a derivative under the
provisions of SFAS 133, however, it does not qualify for hedging treatment.
Therefore, the locked pipeline and the related fair market value of derivatives
is marked to market each reporting period along with a corresponding entry to
non-interest expense. The mortgage operations also enter into forward
commitments and derivatives to lock in the forecasted sale profitability of
fixed rate mortgages held-for-sale. The mortgage operations generally sells
mortgage back securities, call or buys put options on U.S. Treasury bonds and
mortgage-backed securities and swaps to hedge against adverse movements of
interest rates affecting the value of mortgages held-for-sale. The risk in
writing a call option is that the mortgage operations give up the opportunity
for profit if the market price of the mortgage increases and the option is
exercised. The mortgage operations has the additional risk of not being able to
enter into a closing transaction if a liquid secondary market does not exist.
The risk of buying a put option is limited to the premium paid for the put
option. These hedges are treated as cash flow hedges under the provisions of
SFAS 133 to hedge forecasted transactions with the entire change in market value
of the hedges recorded through accumulated other comprehensive income.
The following tables present certain information related to derivatives
and the related component in the financial statements as of September 30, 2003
(in thousands):
Related Related
Fair Related Unamortized Amount in Amount
Value of Amount in Derivative Derivative in CMO
Derivatives Index OCI Premiums Asset Account Collateral
------------ ------------ ------------ ------------ ------------ ------------
Derivatives not associated with CMOs .. $ (10,906) 1 mo. LIBOR $ (9,309) $ (1,318) $ (10,906) $ --
Cash in margin account ................ 28,825 N/A -- -- 28,825 --
Derivatives associated with CMOs....... (15,792) 1 mo. LIBOR (18,875) 3,083 -- (15,792)
Fannie Mae forward
commitments hedging
mortgages held-for-sale ............. (1,707) N/A (990) -- -- --
Fannie Mae forward commitments hedging
pipeline ............................ (3,862) N/A -- -- -- --
Value of locked pipeline .............. 8,862 N/A -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Totals ............................. $ 5,420 $ (29,174) $ 1,765 $ 17,919 $ (15,792)
============ ============ ============ ============ ============
Related Related
Amount in Amount in Amount in
Amount in Deferred Loans Other Assets/
Earnings Taxes Held for Sale Liabilities
------------ ------------ ------------- -------------
Fannie Mae forward commitments hedging
mortgages held-for-sale ..................... -- 717 (1,707) --
Fannie Mae forward commitments hedging pipeline (3,644) -- -- (3,862)
Value of locked pipeline ...................... 3,488 -- -- 8,862
------------ ------------ ------------- -------------
Totals ..................................... $ (156) $ 717 $ (1,707) $ 5,000
============ ============ ============= =============
The following table presents certain information related to derivatives
and the related component in the financial statements as of December 31, 2002
(in thousands):
Related Related
Fair Related Unamortized Amount in Amount
Value of Amount in Derivative Derivative in CMO
Derivatives Index OCI Premiums 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)
============ ============ ============ ============ ============
12
Note 8--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. The Company has federal and
state net operating loss tax carry-forwards of $18.7 million, which expire in
the year 2020, that are available to offset 2003 and future taxable income.
Deferred tax assets and liabilities of the mortgage operations are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax base. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Note 9--Gain on Sale of Loans
The Company recognizes gains or losses on the sale of mortgages when the
sales transaction settles or upon the securitization of mortgages when the risks
of ownership have passed to the purchasing party. Gains and losses may be
increased or decreased by the amount of any servicing released premiums received
and costs associated with the acquisition or origination of mortgages. Gains on
the sale of loans or securities by the mortgage operations to the long-term
investment operations are eliminated in consolidation. A transfer of financial
assets in which control is surrendered is accounted for as a sale to the extent
that consideration other than a beneficial interest in the transferred assets is
received in the exchange. Liabilities and derivatives incurred or obtained by
the transfer of financial assets are required to be measured at fair value, if
practicable. Also, servicing assets and other retained interests in the
transferred assets must be measured by allocating the previous carrying value
between the asset sold and the interest retained, if any, based on their
relative fair values at the date of transfer. To determine the value of the
securities, the Company estimates future rates of prepayments, prepayment
penalties to be received, delinquencies, defaults and default loss severity and
their impact on estimated cash flows.
Note 10--Acquisitions
On July 1, 2003, IMH purchased from Joseph R. Tomkinson, IMH's Chairman,
Chief Executive Officer and a director, William S. Ashmore, IMH's Chief
Operating Officer, President and a director, and the Johnson Revocable Living
Trust, of which Richard J. Johnson, IMH's Executive Vice President and Chief
Financial Officer, all of the outstanding shares of common stock of IFC for
aggregate consideration of $750,000 which resulted in goodwill of approximately
$486,000. The fairness opinion related to the purchase of IFC, as rendered by an
independent financial advisor, and the 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 common and preferred
stock of IFC, which represents 100% of the 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, as of July 1, 2003 IMH consolidates IFC. The Company will not
reclassify prior periods' financial statements to conform to the current
presentation.
13
Note 11--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. 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,
as of July 1, 2003 IMH consolidates IFC. The Company will not reclassify prior
periods' financial statements to conform to the current presentation.
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
September 30, 2003 and for hedging relationships designated after September 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 12--Subsequent Events
Recently, there have been a large number of fires in certain areas of
California. Although, we have a large percentage of loans secured by properties
in California, we do not anticipate the fires to have a material impact on our
results of operations.
14
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, 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 Third Quarter of 2003
o Earnings per diluted share increased to $0.63 compared to $0.58 for
the second quarter of 2003 and $0.47 for the third quarter of 2002;
o Estimated taxable income per diluted share was $0.61 compared to
$0.56 for the second quarter of 2003 and $0.61 for the third 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 second and
third quarters of 2003 compared to $0.45 for the third quarter of
2002 and we expect to declare and pay at least a $0.50 cash dividend
during the fourth quarter of 2003;
o Total assets increased to $9.0 billion as of September 30, 2003
compared to $6.6 billion as of December 31, 2002 and $5.4 billion as
of September 30, 2002;
o Book value per share increased 21% to $8.11 as of September 30, 2003
compared to $6.70 as of December 31, 2002 and $6.40 as of September
30, 2002;
o Total market capitalization increased to $859.2 million as of
September 30, 2003 compared to $521.2 million as of December 31,
2002 and $478.4 million as of September 30, 2002;
o Dividend yield as of September 30, 2003 was 12.35%, based on an
annualized third quarter cash dividend of $0.50 per share and
closing stock price of $16.19 per share as of September 30, 2003;
o Return on average assets and equity was 1.56% and 34.82% compared to
1.52% and 34.48% for the second quarter of 2003 and 1.64% and 29.27%
for the third quarter of 2002;
o The mortgage operations, acquired and originated $2.7 billion of
primarily non-conforming Alt-A mortgages, or "Alt-A mortgages,"
compared to $1.9 billion for the second quarter of 2003 and $1.7
billion for the third quarter of 2002;
o The long-term investment operations retained $1.4 billion of
primarily Alt-A mortgages compared to $806.6 million for the second
quarter of 2003 and $1.1 billion for the third quarter of 2002;
15
o Novelle Financial Services, Inc., an originator of sub-prime, or
"B/C mortgages," and an operating unit of the mortgage operations,
originated $138.7 million of B/C mortgages compared to $105.7
million for the second quarter of 2003 and $126.0 million for the
third quarter of 2002;
o Impac Multifamily Capital Corporation originated $90.0 million of
small balance, multi-family mortgages, or "multi-family mortgages,"
compared to $74.1 million for the second quarter of 2003 and $42.1
million for the first quarter of 2003; and
o Average short-term warehouse advances made by the warehouse lending
operations to non-affiliated customers increased to $666.8 million
compared to $551.8 million for the second quarter of 2003 and $347.7
million for the third quarter of 2002.
General and Business Operations
Unless the context otherwise requires, the terms "we," "us," and "our"
refer to Impac Mortgage Holdings, Inc., or "IMH," 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 Impac Funding Corporation, or "IFC." IFC
became a wholly-owned subsidiary of IMH in July 2003. References to 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 we are primarily a nationwide acquirer and originator of Alt-A
mortgages and, to a lesser extent, an originator of multi-family mortgages and
B/C 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; and
o applicable debt-to-income ratios.
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.
B/C mortgages that we originate are residential mortgages made to
borrowers with lower credit ratings than borrowers of higher credit quality
mortgages and are normally subject to higher rates of loss and delinquency than
Alt-A mortgages. As a result, B/C mortgages normally bear a higher rate of
interest and are typically subject to higher fees, including greater prepayment
fees and late payment penalties, than Alt-A mortgages. In general, greater
emphasis is placed upon the value of the mortgaged property and, consequently,
the quality of appraisals and less upon the credit history of the borrower in
underwriting B/C 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 assets. We
operate the following core businesses:
o long-term investment operations;
o mortgage operations; and
o warehouse lending operations.
16
The long-term investment operations invest in adjustable and fixed rate
Alt-A mortgages originated by our mortgage operations and, to a lesser extent,
multi-family mortgages originated by IMCC. This business primarily generates net
interest income from mortgages held for long-term investment. Our investment in
mortgages is financed with collateralized mortgage obligations, or "CMO,"
financing, short-term borrowings under reverse repurchase agreements, proceeds
from the sale of capital stock and cash.
The mortgage operations acquire, originate, sell and securitize adjustable
and fixed rate Alt-A mortgages and, to a lesser extent, B/C mortgages. Our
mortgage operations generate income by securitizing and selling loans to
permanent investors, including our long-term investment operations, and, to a
lesser extent, revenue from net interest income earned on mortgages
held-for-sale, fees associated with mortgage servicing rights and master
servicing agreements. Our mortgage operations use warehouse facilities provided
by the warehouse lending operations to finance the acquisition and origination
of mortgages.
The warehouse lending operations provide short-term financing to mortgage
loan originators, including the mortgage operations, by funding mortgages from
their closing date until they are sold to pre-approved investors. This business
earns fees from warehouse transactions as well as net interest income from the
difference between its cost of borrowings and interest earned on warehouse
advances.
Consolidation of IFC
On July 1, 2003, we entered into a Stock Purchase Agreement with Joseph R.
Tomkinson, our Chairman, Chief Executive Officer and a director, William S.
Ashmore, our Chief Operating Officer, President and a director, and the Johnson
Revocable Living Trust, of which Richard J. Johnson, our Executive Vice
President and Chief Financial Officer, is trustee, whereby we purchased all of
the outstanding shares of voting common stock of IFC for aggregate consideration
of $750,000. The fairness opinion related to the purchase price of IFC, as
rendered by an independent financial advisor, and the subsequent transaction was
approved by our board of directors. The common stock of IFC represents 1% of the
economic interest in IFC. We currently own 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, as of July 1, 2003 IMH consolidates IFC. The Company
will not reclassify prior periods' financial statements to conform to the
current presentation.
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 stockholders' 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.
Critical Accounting Policies
We define critical accounting policies as those that are important to the
portrayal of our financial condition and results of operations and require
estimates and assumptions based on our judgment of changing market conditions
and the performance of our assets and liabilities at any given time. In
determining which accounting policies meet this definition, we considered our
policies with respect to the valuation of our assets and liabilities and
estimates and assumptions used in determining those valuations. We believe the
most critical accounting issues that require the most complex and difficult
judgments and that are particularly susceptible to significant change to our
financial condition and results of operations including the following:
o allowance for loan losses; and
o derivative instruments.
Allowance for loan losses. We provide an allowance for loan losses for
mortgages held as CMO collateral, finance receivables and mortgages
held-for-investment. In evaluating the adequacy of the allowance for loan losses
management
17
takes several items into consideration. For instance, a detailed analysis of
historical loan performance data is accumulated and reviewed. This data is
analyzed for loss performance and prepayment performance by product type,
origination year and securitization issuance. The results of that analysis are
then applied to the current mortgage portfolio and an estimate is created. 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
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 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. For additional
information regarding provision for loan losses refer to "Results of Operations"
below.
Derivative instruments. The mortgage operations enter into forward
commitments and derivative transactions to mitigate changes in the value of its
"locked pipeline" of fixed rate mortgages. The locked pipeline are mortgages
that have not yet been acquired, however, the mortgage operations has committed
to acquire the mortgages in the future at pre-determined rates through rate-lock
commitments. The mortgage operations records the fair market value of its locked
pipeline as it qualifies as a derivative instrument under the provisions of SFAS
133, however, it does not qualify for hedging treatment. Therefore, the locked
pipeline and the related fair market value of derivative instruments are marked
to market each reporting period along with a corresponding entry to non-interest
expense.
Results of Operations and Financial Condition
Results of Operations - For the Three Months Ended September 30, 2003 as
compared to the Three Months Ended September 30, 2002
Net earnings increased 72% to $33.4 million, or $0.63 per diluted share,
for the third quarter of 2003 compared to $19.4 million, or $0.47 per diluted
share, for the third quarter of 2002. The third quarter-over-quarter increase in
net earnings of $14.0 million was primarily due to the following:
o $8.1 million increase in net interest income; and
o $8.7 million increase in net earnings of the mortgage operations;
o which were partially offset by a $2.5 million increase in provision
for loan losses.
Taxable Income
Estimated taxable income was $32.5 million, or $0.61 per diluted share,
for the third quarter of 2003 compared to $25.5 million, or $0.61 per diluted
share, for the third quarter of 2002. 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. We believe that the disclosure of estimated taxable income, which is a
non-GAAP financial measurement, is useful information for our investors.
18
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 Three Months
Ended September 30,
------------------------
2003 2002
--------- ---------
Net earnings ................................................................... $ 33,417 $ 19,434
Adjustments to net earnings:
Provision for loan losses ................................................... 7,820 5,361
Dividend from the mortgage operations ....................................... 11,000 4,208
Tax deduction for actual loan losses ........................................ (2,082) (731)
Tax loss on sale of investment securities available-for-sale ................ (1,180) --
Recovery of previously charged-off investment securities available-for-sale . (4,999) --
Net earnings of the mortgage operations ..................................... (11,464) --
Equity in net earnings of IFC ............................................... -- (2,755)
--------- ---------
Estimated taxable income (1) ................................................... $ 32,512 $ 25,517
========= =========
Estimated taxable income per diluted share (1) ................................. $ 0.61 $ 0.61
========= =========
- ---------
(1) Excludes the deduction for dividends paid and the availability of a
deduction attributable to net operating tax loss carry-forwards, if any.
The following table presents dividends declared and paid in 2003 that will
be applied to taxable income for 2003:
Per Share
Stockholder Dividend
Period Covered Record Date Amount
- ------------------------------------------------ --------------- ----------
Quarter ended December 31, 2002 ................ January 2, 2003 $ 0.48
Quarter ended March 31, 2003 ................... April 4, 2003 $ 0.50
Quarter ended June 30, 2003 .................... July 3, 2003 $ 0.50
Quarter ended September 30, 2003 ............... October 3, 2003 $ 0.50
In addition, we expect to declare and pay at least a dividend distribution
of $0.50 per share during the fourth quarter of 2003 which combined with the
dividends previously declared and paid during 2003 should be sufficient to meet
REIT taxable income distribution requirements for the year. Upon filing our 2002
tax return, we had federal and state net operating loss tax carry-forwards of
$18.7 million, which may or may not offset taxable income in 2003 or in
subsequent years.
The increase in third quarter-over-quarter net earnings was driven by
record mortgage acquisitions and originations. During the third quarter of 2003,
the mortgage operations acquired and originated $2.7 billion of mortgages
compared to $1.7 billion during the third quarter of 2002. An additional $90.0
million of multi-family mortgages were originated by IMCC during the third
quarter of 2003. Mortgages acquired through correspondents as bulk acquisitions,
which are generally not underwritten through our proprietary automated
underwriting system, were $932.2 million, or 34% of total mortgage acquisitions
and originations, during the third quarter of 2003 compared to $237.3 million,
or 14% of total mortgage acquisitions and originations, during the third quarter
of 2002.
19
The following table summarizes the principal balance of mortgage
acquisitions and originations by the mortgage operations by loan characteristic
for the periods indicated (in thousands):
For the Three Months Ended September 30,
----------------------------------------
2003 2002
---------------- ----------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
By Loan Type:
Fixed rate first trust deed .............................. $1,244,444 45 $ 552,751 33
Fixed rate second trust deed ............................. 45,417 2 24,032 1
Adjustable rate:
Six-month London Interbank Offered Rate ("LIBOR") ARMs . 452,924 17 724,101 43
Six-month LIBOR hybrids (1) ............................ 993,623 36 379,102 23
---------- --- ---------- ---
Total adjustable rate ............................... 1,446,547 53 1,103,203 66
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ........ $2,736,408 100 $1,679,986 100
========== === ========== ===
By Production Channel:
Correspondent acquisitions:
Flow ................................................... $1,270,677 46 $1,021,222 61
Bulk ................................................... 932,187 35 237,263 14
---------- --- ---------- ---
Total correspondent acquisitions .................... 2,202,864 81 1,258,485 75
---------- --- ---------- ---
Wholesale and retail originations ...................... 394,884 14 295,518 18
Novelle Financial Services, Inc. ....................... 138,660 5 125,983 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ........ $2,736,408 100 $1,679,986 100
========== === ========== ===
By Credit Quality:
Alt-A mortgages .......................................... $2,589,974 95 $1,545,239 92
B/C mortgages (2) ........................................ 146,434 5 134,747 8
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ........ $2,736,408 100 $1,679,986 100
========== === ========== ===
By Purpose:
Purchase ................................................. $1,260,247 46 $ 985,755 59
Refinance ................................................ 1,476,161 54 694,231 41
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ........ $2,736,408 100 $1,679,986 100
========== === ========== ===
By Prepayment Penalty:
With prepayment penalty .................................. $1,867,746 68 $1,372,735 82
Without prepayment penalty ............................... 868,662 32 307,251 18
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations ........ $2,736,408 100 $1,679,986 100
========== === ========== ===
- ------------
(1) Mortgages are fixed rate for initial two to ten year periods and
subsequently adjust to the indicated index plus a margin.
(2) The third quarter of 2003 and 2002 includes $138.7 million and $126.0
million, respectively, of B/C mortgages originated by Novelle Financial
Services, Inc., that are subsequently held-for-sale or sold to third party
investors for cash gains.
As a result of record mortgage acquisitions and originations, we retained
$1.4 billion of mortgages during the third quarter of 2003 compared to $1.1
billion during the third quarter of 2002. The increase in mortgage acquisitions
by the long-term investment operations and the growth of our warehouse lending
operations resulted in significant growth of our mortgage portfolio. The
mortgage portfolio grew 69% to $8.8 billion as of September 30, 2003 compared to
$5.2 billion as of September 30, 2002, which in turn generated higher levels of
net interest income.
20
The following table summarizes the principal balance of mortgages acquired
from the mortgage operations and originated by the long-term investment
operations by loan characteristic for the periods indicated (in thousands):
For the Three Months Ended
September 30,
-----------------------------------
2003 2002
---------------- ----------------
Principal Principal
Balance % Balance %
------- - ------- -
Volume by Type:
Adjustable rate ................ $1,326,364 92 $ 892,092 82
Fixed rate ..................... 108,679 8 200,004 18
---------- ----------
Total Mortgage Acquisitions . $1,435,043 100 $1,092,096 100
========== ==========
Volume by Product:
Six-month LIBOR ARMs ........... $ 357,636 25 $ 619,225 57
Six-month LIBOR hybrids (1) .... 968,728 67 272,867 25
Fixed rate first trust deeds ... 108,679 8 200,004 18
Fixed rate second trust deeds .. -- 0 -- 0
---------- ----------
Total Mortgage Acquisitions . $1,435,043 100 $1,092,096 100
========== ==========
Volume by Credit Quality:
Alt-A mortgages ................ $1,339,512 94 $1,086,719 100
Multi-family mortgages ......... 90,022 6 -- 0
B/C mortgages .................. 5,509 0 5,377 0
---------- ----------
Total Mortgage Acquisitions . $1,435,043 100 $1,092,096 100
========== ==========
Volume by Purpose:
Purchase ....................... $ 839,870 59 $ 681,739 62
Refinance ...................... 595,173 41 410,357 38
---------- ----------
Total Mortgage Acquisitions . $1,435,043 100 $1,092,096 100
========== ==========
Volume by Prepayment Penalty:
With prepayment penalty ........ $1,087,377 76 $ 913,959 84
Without prepayment penalty ..... 347,666 24 178,137 16
---------- ----------
Total Mortgage Acquisitions . $1,435,043 100 $1,092,096 100
========== ==========
- ------------
(1) Mortgages are fixed rate for initial two to ten year periods and
subsequently adjust to the indicated index plus a margin.
Net interest income increased by $8.1 million to $31.2 million for the
third quarter of 2003 compared to $23.1 million for the third quarter of 2002.
The third quarter-over-quarter increase in net interest income was primarily due
to a $3.8 billion increase in average Mortgage Assets, which increased to $8.4
billion for the third quarter of 2003 compared to $4.6 billion for the third
quarter of 2002 as the long-term investment operations retained $4.8 billion of
primarily Alt-A mortgages from the mortgage operations and $207.4 million of
multi-family mortgages since the end of the third quarter of 2002. We retain
mortgages acquired and originated by the mortgage operations and multi-family
mortgages originated by IMCC that fit within our criteria, which are generally
ARMs and fixed rate mortgages ("FRMs") with good credit profiles, insurance
enhancements, when we require, and prepayment penalty features. Growth of the
warehouse lending operations also contributed to an increase in net interest
income for the third quarter of 2003 as average finance receivables to
non-affiliated customers increased 92% to $666.8 million compared to $347.7
million for the third quarter of 2002.
We earn interest income primarily on Mortgage Assets, which includes CMO
collateral, mortgages held-for-investment, mortgages held-for-sale, finance
receivables and investment securities available-for-sale, 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.
21
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the third
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 September 30, 2003 Ended September 30, 2002
--------------------------------- -------------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ------- ---------- -------- -------
MORTGAGE ASSETS
Investment securities available-for-sale (1) .. $ 18,148 $ 2,804 61.80% $ 28,442 $ 362 5.09%
CMO collateral (2) ............................ 6,682,380 60,976 3.65 3,725,003 48,286 5.19
Mortgages held-for-sale (3) ................... 648,698 10,621 6.55 -- -- --
Mortgages held-for-investment (4) ............. 348,028 3,591 4.13 131,267 1,665 5.07
Finance receivables:
Affiliated (5) ............................. -- -- -- 377,922 4,358 4.61
Non-affiliated ............................. 666,771 8,333 5.00 347,691 5,065 5.83
---------- -------- ---------- --------
Total finance receivables ................. 666,771 8,333 5.00 725,613 9,423 5.19
---------- -------- ---------- --------
Total Mortgage Assets ................... $8,364,025 $ 86,325 4.13% $4,610,325 $ 59,736 5.18%
========== ======== ========== ========
BORROWINGS
CMO borrowings ................................ $6,544,740 $ 45,567 2.78% $3,635,351 $ 31,091 3.42%
Reverse repurchase agreements ................. 1,555,992 8,972 2.31 816,923 6,086 2.98
Borrowings secured by investment securities (6) 794 832 419.1 9,255 431 18.63
---------- -------- ---------- --------
Total borrowings on Mortgage Assets ..... $8,101,526 $ 55,371 2.73% $4,461,529 $ 37,608 3.37%
========== ======== ========== ========
Net interest spread (7) ....................... 1.40% 1.81%
Net interest margin (8) ....................... 1.48% 1.92%
- ---------------------
(1) Principal recovery on previously charged-off investment securities
inflated the yield during the third quarter of 2003.
(2) Includes amortization of acquisition costs and net cash payments on
derivative instruments allocated to specific CMOs.
(3) Mortgages held-for-sale were acquired via the acquisition of Impac Funding
Corporation on July 1, 2003.
(4) Includes amortization of acquisition costs and net cash payments on
derivative instruments not allocated to specific CMOs.
(5) Advances to subsidiaries and affiliates have been eliminated during the
third quarter of 2003 due to the consolidation of the mortgage operations.
(6) 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.
These borrowings were paid off during the third quarter of 2003. The yield
reflects discount and securitization costs that were recorded as interest
expense upon repayment of borrowings.
(7) 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.
(8) 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.
The increase in net interest income was offset, in part, by a decrease in
net interest margins on Mortgage Assets, which declined 44 basis points to 1.48%
for the third quarter of 2003 compared to 1.92% for the third quarter of 2002.
Although net interest margins declined third quarter-over-quarter, net interest
margins improved from 1.36% during the second quarter of 2003. The overall
decrease in net interest margins during the third quarter of 2003 as compared to
the third quarter of 2002 was primarily the result of a decline in net interest
margins on CMO collateral, which declined 93 basis points to 0.92% for the third
quarter of 2003 as compared to 1.85% for the third 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.
22
Interest rate resets on mortgages. At the time mortgages were retained for
long-term investment, six-month 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. Six-month LIBOR hybrids
acquired for long-term investment during the first nine months 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 nine months of 2003. Additionally,
the decline in interest rates during 2003 and 2002 resulted in record
refinancing activity, which in turn resulted in increased mortgage prepayments.
We reinvested the proceeds from mortgage prepayments in lower yielding Mortgage
Assets. 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 5.71% as of September 30, 2003 compared to 6.88% as of September
30, 2002.
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
third quarter of 2003 compared to the third quarter of 2002, in part, because we
acquired and retained more FRMs for long-term investment. As of September 30,
2003 18% of mortgages held as CMO collateral were FRMs compared to 9% of FRMs
held as CMO collateral as of September 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 retention of $4.8
billion of mortgages by the long-term investment operations since the end of the
third 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 changing
interest rates. As a result, net cash payments and amortization from derivative
instruments was $14.1 million for the third quarter of 2003 compared to $6.3
million for the third 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 changing 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 change from current levels.
In addition to the positive contribution of net interest income to
consolidated net earnings, net earnings from the mortgage operations increased
$8.7 million to $11.5 million during the third quarter of 2003 compared to $2.8
million during the third quarter of 2002. This increase was primarily due to an
increase in gain on sale of loans, which was the result of an increase in loan
sales volume combined with greater profitability per loan sold. The sale of
Alt-A mortgages and multi-family mortgages to third party investors and the
completion of CMOs during the third quarter of 2003 resulted in gain on sale of
loans of $33.9 million compared to gain on sale of loans of $13.7 million for
the third quarter of 2002. Of the $2.7 billion of mortgage acquisitions and
originations during the third quarter of 2003, the mortgage operations sold $1.3
billion of mortgages to third party investors and $1.3 billion to the long-term
investment. This compares to $371.8 million of mortgages sold to third party
investors and $1.1 billion of mortgages sold to the long-term investment
operations during the third quarter of 2002. The long-term investment operations
also completed $1.6 billion of CMOs during the third quarter of 2003 as compared
to $696.5 million of CMOs completed during the third quarter of 2002. Gain on
sale of loans was 127 basis points on total loan sales volume of $2.7 billion
for the third quarter of 2003 compared to 93 basis points on total loan sales
volume of $1.5 billion for the third quarter of 2002.
Gain on sale of loans includes the difference between the price we acquire
and originate mortgages and the price we receive upon the sale or securitization
of mortgages plus or minus direct mortgage origination revenue and costs, i.e.
loan and underwriting fees, commissions, appraisal review fees, document
expense, etc. Gain on sale of loans acquired and originated by the mortgage
operations also includes a premium for the sale of mortgage servicing rights
upon the sale or
23
securitization of mortgages. All mortgages sold or securitized during the third
quarter of 2003 were done so on a servicing released basis, which results in
substantially all cash gains. 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 mortgages sold for
the periods indicated (in thousands):
For the Three Months
Ended September 30,
-----------------------
2003 2002
---------- ----------
Real estate mortgage investment conduits ("REMICs") $ 400,000 $ --
Whole loan sales to third party investors .......... 931,160 371,834
Loan sales to the long-term investment operations .. 1,345,021 1,092,096
---------- ----------
Total sales ..................................... $2,676,181 $1,463,930
========== ==========
Non-interest expense increased to $18.6 million for the third quarter of
2003 compared to $2.3 million for the third quarter of 2002 as non-interest
expense of the mortgage operations was consolidated during the third quarter of
2003. However, for comparative purposes, when including non-interest expense of
the mortgage operations for the third quarter of 2002, consolidated non-interest
expense was $12.8 million. The $5.8 million increase in non-interest expense
includes the following:
o $4.2 million increase in operating expense, which includes personnel
expense, professional services and general and administrative
expense; and
o $3.1 million decrease in mark-to-market gain on derivative
instruments;
which were partially offset by the following:
o $1.2 million decrease in loss on disposition of other real estate
owned; and
o $738,000 decrease in provision for repurchases.
Operating expense increased 33% to $17.1 million for the third quarter of
2003 compared to $12.9 million for the third quarter of 2002. This increase was
primarily due to a 59% increase in mortgage acquisitions and originations by the
mortgage operations to $2.7 billion for the third quarter of 2003 compared to
$1.7 billion for the third quarter of 2002, which resulted in an increase in
staff levels. However, operational efficiencies created by IDASL combined with
the higher level of correspondent bulk acquisitions during the third quarter of
2003 resulted in lower per loan correspondent acquisition costs as compared to
the third quarter of 2002. Bulk mortgage acquisitions generally require less
staffing and corresponding personnel expense and other operating expense than
mortgages acquired on a flow, or loan-by-loan basis.
The following table summarizes the mortgage operations weighted average
fully-loaded production cost 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 September 30,
---------------------
Production Channel Company/Division 2003 2002
- ----------------------------------------- ----------------------------------- --------- ---------
Correspondent acquisitions Impac Funding Corporation 42.96 77.53
Wholesale/retail originations Impac Lending Group 92.82 95.59
B/C originations Novelle Financial Services, Inc. 205.06 197.65
--------- ---------
Total Weighted Average Production Cost....................................... 58.37 78.77
========= =========
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 on derivative instruments and
write-down of investment securities.
24
The mark-to-market gain on derivative instruments 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 $3.1 million decrease in mark-to-market gain on derivative
instruments was due to a $239.9 million decrease in the mortgage operations'
locked pipeline of fixed rate mortgages, which declined to $261.4 million as of
September 30, 2003 compared to $501.3 million as of June 30, 2003.
Gain on disposition of other real estate owned was $642,000 for the third
quarter of 2003 compared to a loss on disposition of other real estate owned of
$514,000 for the third quarter of 2002. When we acquire real estate through
foreclosure proceedings we record a write-down on foreclosed property to a
percentage of appraised value or a real estate broker's price opinion. Gain or
loss on disposition of other real estate owned results when there is a
difference between the initial write-down on foreclosed property and the
ultimate proceeds received upon disposition of foreclosed property. During the
third quarter of 2003 the initial write-downs on foreclosed property were in
excess of the proceeds received on the sale of real estate owned, which resulted
in a gain. The opposite occurred on real estate disposition during the third
quarter of 2002. 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.
Provision for loan losses were $7.8 million for the third quarter of 2003
compared to $5.4 million for the third 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 portfolio. The loss percentage is used to determine the estimated
inherent losses in the mortgage portfolio. The provision for loan losses is also
determined based on the following:
o management's judgment of the net loss potential of mortgages based
on prior loan loss experience;
o changes in the nature and volume of the mortgage portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
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,
--------------------------------------------------
September 30, December 31, September 30,
2003 2002 2002
------------- ------------- -------------
Book value per share ........................................................ $ 8.11 $ 6.70 $ 6.40
Return on average assets .................................................... 1.56% 1.49% 1.64%
Return on average equity .................................................... 34.82% 31.37% 29.27%
Assets to equity ratio ...................................................... 20.98:1 21.59:1 19.66:1
Debt to equity ratio ........................................................ 19.76:1 20.48:1 18.56:1
Allowance for loan losses as a percentage of mortgages held as CMO
collateral, finance receivables and mortgages held for investment(1) ..... 0.47% 0.45% 0.45%
Mortgages 90+ days delinquent and other real estate owned ................... $ 194,086 $ 130,614 $ 105,610
Mortgages 90+ days delinquent and other real estate owned as a
percentage of total assets ............................................... 2.14% 1.99% 1.96%
Mortgages owned 60+ days delinquent ......................................... $ 231,153 $ 161,260 $ 120,078
60+ day delinquency of mortgages owned ...................................... 2.88% 3.22% 2.92%
- ------------
(1) Recalculation of prior period percentage to reflect exclusion of
affiliated finance receivables upon consolidation of IFC.
Total assets grew 36% to $9.0 billion as of September 30, 2003 compared to
$6.6 billion as of December 31, 2002 as the long-term investment operations
retained $3.6 billion of adjustable and fixed rate Alt-A mortgages and $206.2
million of multi-family mortgages during the first nine months of 2003. Due to
the retention and subsequent securitization of $4.0
25
billion of CMOs during the first nine months of 2003, CMO collateral increased
to $7.4 billion as of September 30, 2003 compared to $5.1 billion as of December
31, 2002.
The warehouse lending operations also grew as average finance receivables
to non-affiliated customers increased 92% to $666.8 million for the third
quarter of 2003 compared to $347.7 million for the third quarter of 2002. As of
September 30, 2003 the warehouse lending operations had approved warehouse lines
available to non-affiliated customers of $956.0 million representing 64 clients
compared to $665.0 million in approved warehouse lines to 61 clients as of
December 31, 2002.
Due to record mortgage acquisitions and originations for the third quarter
of 2003, average mortgages held for sale increased 63% to $647.5 million for the
third quarter of 2003 compared to $396.2 for the third quarter of 2002. The
mortgage operations had a locked pipeline of fixed rate mortgages in process of
$261.4 million as of September 30, 2003 compared to $501.3 million as of June
30, 2003. We anticipate the majority of the locked pipeline will close during
the fourth quarter of 2003.
During the third quarter of 2003, we exercised our right to call some of
our investment securities that we subsequently sold for a $3.5 million gain. In
addition, we used the proceeds from the sale of investment securities that
secured higher yielding borrowings to repay those borrowings.
The following table presents detail on Mortgage Assets for the periods
indicated (in thousands):
September 30, December 31,
2003 2002
------------- -------------
Investment securities available-for-sale--
Subordinated securities collateralized by mortgages ......... $ 9,641 $ 17,710
Net unrealized gain (1) ..................................... 5,705 8,355
------------- -------------
Carrying value of investment securities available-for-sale 15,346 26,065
Mortgages held-for-sale--
Mortgages held-for-sale ................................... 567,725 --
Unamortized net premiums on mortgages ..................... 4,214 --
------------- -------------
Carrying value of mortgages held-for-sale .............. 571,939 --
CMO collateral--
CMO collateral, unpaid principal balance .................... 7,301,516 5,082,208
Unamortized net premiums on mortgages ....................... 110,129 75,987
Securitization expenses ..................................... 33,208 21,817
Fair value of derivative instruments ........................ (15,792) (30,332)
------------- -------------
Carrying value of CMO collateral ......................... 7,429,061 5,149,680
Finance receivables (2)--
Due from affiliates (3) ..................................... -- 476,227
Due from non-affiliated customers ........................... 650,991 664,021
------------- -------------
Carrying value of finance receivables .................... 650,991 1,140,248
Mortgages held-for-investment--
Mortgages held-for-investment, unpaid principal balance ..... 150,126 56,898
Unamortized net premiums on mortgages ....................... 1,757 566
Deferred costs .............................................. 180 72
------------- -------------
Carrying value of mortgages held-for-investment .......... 152,063 57,536
Allowance for loan losses ................................... (39,122) (26,602)
------------- -------------
Carrying value of Mortgage Assets .............................. $ 8,780,278 $ 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 make to affiliates and non-affiliated customers.
(3) Advances to affiliates were eliminated as the financial results of the
mortgage operations consolidate as of July 1, 2003.
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:
26
o credit risk;
o prepayment risk;
o liquidity risk; and
o interest rate risk.
Credit Risk. We manage credit risk by investing in high credit quality
Alt-A mortgages that are acquired and originated by our mortgage operations and
multi-family mortgages originated by IMCC, adequately providing for loan losses
and actively managing delinquencies and defaults.
We believe that by improving the overall credit quality of our mortgage
portfolio, we can consistently generate stable future cash flow and earnings for
our stockholders. During the third quarter of 2003, we retained adjustable and
fixed rate Alt-A mortgages from the mortgage operations with an original
weighted average credit score of 701 and an original weighted average LTV ratio
of 77%. 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 while B/C
mortgages generally have credit scores of 599 and below. As a comparison, Fannie
Mae and Freddie Mac generally purchase conforming mortgages with credit scores
greater than 620. As of September 30, 2003, the original weighted average credit
score of mortgages held as CMO collateral was 691 and the original weighted
average LTV ratio was 79%.
In addition to retaining mortgages from our mortgage operations, IMCC
originated $206.2 million of multi-family mortgages IMCC during the first nine
months 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 first nine months 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 mortgages held as CMO collateral, finance
receivables and mortgages held-for-investment within a range of 40 basis points
to 45 basis points. As of September 30, 2003, the ratio of allowance for loan
losses to mortgages provided for was 47 basis points as allowance for loan
losses increased to $39.1 million. However, as mortgages held as CMO collateral
season, there is generally a historical upward curve whereby some mortgages will
move through the delinquency cycle with the expectation that some of the
delinquent mortgages will eventually be acquired through foreclosure proceedings
and sold at a gain or loss. Mortgages acquired during 2001 and 2000 reflect this
pattern which resulted in an increase in actual loan losses to $2.1 million for
the third quarter of 2003 compared to $731,000 for the third quarter of 2002.
Mortgages held as CMO collateral acquired during 2003 and 2002 are unseasoned
mortgages and have not experienced material losses as of September 30, 2003.
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 September
30, 2003 our mortgage portfolio included 2.88% of mortgages that were 60 days or
more delinquent compared to 3.22% as of December 31, 2002.
27
The following table summarizes mortgages in our mortgage portfolio that
were 60 or more days delinquent for the periods indicated (in thousands):
At September 30, At December 31,
2003 2002
---------------- ----------------
60-89 days delinquent ............................ $ 50,921 $ 41,762
90 or more days delinquent ....................... 36,313 33,822
Foreclosures ..................................... 134,218 74,597
Delinquent bankruptcies .......................... 9,701 11,079
---------------- ----------------
Total 60 or more days delinquent .............. $ 231,153 $ 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 September 30, 2003, seriously delinquent
assets and other real estate owned as a percentage of total assets was 2.14%
compared to 1.99% as of December 31, 2002.
The following table summarizes mortgages in our mortgage portfolio that
were seriously delinquent and other real estate owned for the periods indicated
(in thousands):
At September 30, At December 31,
2003 2002
---------------- ----------------
90 or more days delinquent ....................... $ 180,232 $ 119,498
Other real estate owned .......................... 13,854 11,116
---------------- ----------------
Total ......................................... $ 194,086 $ 130,614
================ ================
Prepayment Risk. 74% of Alt-A mortgages retained by the long-term
investment operations during the third quarter of 2003 had prepayment penalty
features ranging from one to five years and as of September 30, 2003, 81% of
mortgages held as CMO collateral had active prepayment penalties compared to 70%
as of September 30, 2002. In addition, our six-month LIBOR ARMs do not have
specified interest rate floors. Therefore, in declining interest rate
environments, coupons on the mortgages may decline to levels that do not give
the borrower an incentive to refinance. During the third quarter of 2003
constant prepayment rates of mortgages held as CMO collateral was 29% compared
to 33% for the third quarter of 2002.
Liquidity Risk. We employ a leveraging strategy to increase assets by
financing our mortgage 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 multi-family mortgages from IMCC and finance the
acquisition of those mortgages with reverse repurchase agreements, which is
referred to as the accumulation period. After accumulating a pool of adjustable
and fixed rate mortgages, generally between $200 million and $1.0 billion, 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 20.98 to 1 as of
September 30, 2003 compared to 21.59 to 1 as of December 31, 2002 and 19.66 to 1
as of September 30, 2002. With increased leverage, we have been able to grow our
balance sheet by efficiently using available capital while maintaining adequate
levels of liquidity. 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."
28
Results of Operations
Results of Operations - For the Nine Months Ended September 30, 2003 as compared
to the Nine Months Ended September 30, 2002
Net earnings increased 68% to $88.7 million, or $1.75 per diluted share,
for the first nine months of 2003 compared to $52.8 million, or $1.34 per
diluted share, for the first nine months of 2002. The period-over-period
increase in net earnings of $35.9 million was primarily due to the following:
o $28.4 million increase in net interest income; and
o $15.4 million increase in net earnings of the mortgage operations;
o which were partially offset by an $8.1 million increase in provision
for loan losses.
Taxable Income
Estimated taxable income was $89.2 million, or $1.76 per diluted share,
for the first nine months of 2003 compared to $59.8 million, or $1.51 per
diluted share, for the first nine months of 2002.
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 Nine Months
Ended September 30,
--------------------
2003 2002
-------- --------
Net earnings ................................................................. $ 88,680 $ 52,808
Adjustments to net earnings:
Provision for loan losses ................................................. 21,363 13,302
Dividend from the mortgage operations ..................................... 22,385 9,900
Tax deduction for actual loan losses ...................................... (8,843) (3,430)
Tax loss on sale of investment securities available-for-sale .............. (1,180) --
Recovery of previously charged-off investment securities available-for-sale (4,999) --
Net earnings of the mortgage operations ................................... (11,464) --
Equity in net earnings of IFC ............................................. (16,698) (12,816)
-------- --------
Estimated taxable income (1) ................................................. $ 89,244 $ 59,764
======== ========
Estimated taxable income per diluted share (1) ............................... $ 1.76 $ 1.51
======== ========
- ----------------
(1) Excludes the deduction for dividends paid and the availability of a
deduction attributable to net operating tax loss carry-forwards, if any.
The increase in period-over-period net earnings was driven by record
mortgage acquisitions and originations. During the first nine months of 2003 the
mortgage operations acquired and originated $6.4 billion of mortgages compared
to $4.3 billion during the first nine months of 2002. An additional $206.2
million of multi-family mortgages were originated by IMCC during the first nine
months of 2003 compared to none during the first nine months of 2002 as IMCC was
formed in July 2002. Mortgages acquired through our correspondent channel as
bulk acquisitions, which are generally not underwritten through IDASL, were $1.6
billion, or 25% of total mortgage acquisitions and originations, during the
first nine months of 2003 compared to $453.8 million, or 11% of total mortgage
acquisitions and originations, during the first nine months of 2002.
29
The following table summarizes the principal balance of mortgage
acquisitions and originations by the mortgage operations by loan characteristic
for the periods indicated (in thousands):
For the Nine Months Ended September 30,
--------------------------------------------
2003 2002
------------------- -------------------
Principal Principal
Balance % Balance %
---------- --- ---------- ---
By Loan Type:
Fixed rate first trust deed ....................... $3,130,037 49 $1,319,446 31
Fixed rate second trust deed ...................... 99,224 1 61,719 1
Adjustable rate:
Six-month LIBOR ARMs ............................ 1,376,026 22 1,875,105 44
Six-month LIBOR hybrids (1) ..................... 1,802,921 28 995,520 24
---------- --- ---------- ---
Total adjustable rate ........................ 3,178,947 50 2,870,625 68
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations . $6,408,208 100 $4,251,790 100
========== === ========== ===
By Production Channel:
Correspondent acquisitions:
Flow ............................................ $3,399,605 53 $2,718,871 64
Bulk ............................................ 1,595,632 25 453,827 11
---------- --- ---------- ---
Total correspondent acquisitions ............. 4,995,237 78 3,172,698 75
---------- --- ---------- ---
Wholesale and retail originations ............... 1,062,071 17 787,317 18
Novelle Financial Services, Inc. ................ 350,900 5 291,775 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations . $6,408,208 100 $4,251,790 100
========== === ========== ===
By Credit Quality:
Alt-A mortgages ................................... $6,031,313 94 $3,940,267 93
B/C mortgages (2) ................................. 376,895 6 311,523 7
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations . $6,408,208 100 $4,251,790 100
========== === ========== ===
By Purpose:
Purchase .......................................... $2,886,647 45 $2,473,125 58
Refinance ......................................... 3,521,561 55 1,778,665 42
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations . $6,408,208 100 $4,251,790 100
========== === ========== ===
By Prepayment Penalty:
With prepayment penalty ........................... $4,897,549 76 $3,291,851 77
Without prepayment penalty ........................ 1,510,659 24 959,939 23
---------- --- ---------- ---
Total Mortgage Acquisitions and Originations . $6,408,208 100 $4,251,790 100
========== === ========== ===
- -----------
(1) Mortgages are fixed rate for initial two to ten year periods and
subsequently adjust to the indicated index plus a margin.
(2) The first nine months of 2003 and 2002 includes $350.9 million and $291.8
million, respectively, of B/C mortgages originated by Novelle Financial
Services, Inc., which are subsequently held-for-sale or sold to third
party investors for cash gains.
As a result of record mortgage acquisitions and originations, we retained
$3.8 billion of mortgages during the first nine months of 2003 compared to $2.7
billion during the first nine months of 2002. The increase in mortgage
acquisitions by the long-term investment operations and the growth of our
warehouse lending operations resulted in significant growth of our mortgage
portfolio. The mortgage portfolio grew 69% to $8.8 billion as of September 30,
2003 compared to $5.2 billion as of September 30, 2002, which in turn generated
higher levels of net interest income.
30
The following table summarizes the principal balance of mortgages acquired
from the mortgage operations and originated by the long-term investment
operations by loan characteristic for the periods indicated (in thousands):
For the Nine Months Ended
September 30,
--------------------------------------------
2003 2002
------------------- -------------------
Principal Principal
Balance % Balance %
------- - ------- -
Volume by Type:
Adjustable rate ................. $3,111,514 82 $2,479,017 93
Fixed rate ...................... 680,535 18 200,871 7
---------- ----------
Total Mortgage Acquisitions .. $3,792,049 100 $2,679,888 100
========== ==========
Volume by Product:
Six-month LIBOR ARMs ............ $1,203,717 32 $1,727,198 65
Six-month LIBOR hybrids (1) ..... 1,907,798 50 751,819 28
Fixed rate first trust deeds .... 673,791 18 200,560 7
Fixed rate second trust deeds ... 6,743 0 311 0
---------- ----------
Total Mortgage Acquisitions .. $3,792,049 100 $2,679,888 100
========== ==========
Volume by Credit Quality:
Alt-A mortgages ................. $3,568,153 95 $2,667,877 100
Multi-family mortgages .......... 206,201 5 -- 0
B/C mortgages ................... 17,695 0 12,011 0
---------- ----------
Total Mortgage Acquisitions .. $3,792,049 100 $2,679,888 100
========== ==========
Volume by Purpose:
Purchase ........................ $1,986,152 52 $1,652,564 62
Refinance ....................... 1,805,897 48 1,027,324 38
---------- ----------
Total Mortgage Acquisitions .. $3,792,049 100 $2,679,888 100
========== ==========
Volume by Prepayment Penalty:
With prepayment penalty ......... $3,074,048 81 $2,050,608 77
Without prepayment penalty ...... 718,001 19 629,280 23
---------- ----------
Total Mortgage Acquisitions .. $3,792,049 100 $2,679,888 100
========== ==========
- ----------
(1) Mortgages are fixed rate for initial two to ten year periods and
subsequently adjust to the indicated index plus a margin.
Net interest income increased by $28.4 million to $84.7 million for the
first nine months of 2003 compared to $56.3 million for the first nine months of
2002. The period-over-period increase in net interest income was primarily due
to a $3.8 billion increase in average Mortgage Assets, which increased to $7.6
billion for the first nine months of 2003 compared to $3.8 billion for the first
nine months of 2002 as the long-term investment operations retained $4.8 billion
of primarily Alt-A mortgages from the mortgage operations and $207.4 million of
multi-family mortgages since the end of the third quarter of 2002. We retain
Alt-A mortgages acquired and originated by the mortgage operations and
multi-family mortgages originated by IMCC that fit within our criteria, which
are generally ARMs and FRMs with good credit profiles, insurance enhancements,
when we require, and prepayment penalty features. Growth of the warehouse
lending operations also contributed to an increase in net interest income for
the first nine months of 2003 as average finance receivables to non-affiliated
customers increased 108% to $581.1 million compared to $279.3 million for the
first nine months of 2002.
31
The following table summarizes average balance, interest and weighted
average yield on Mortgage Assets and borrowings on Mortgage Assets for the first
nine months of 2003 and 2002 and includes interest income on Mortgage Assets and
interest expense related to borrowings on Mortgage Assets only (in thousands):
For the Nine Months For the Nine Months
Ended September 30, 2003 Ended September 30, 2002
------------------------------- -----------------------------
Average Average
Balance Interest Yield Balance Interest Yield
---------- -------- ----- ---------- -------- -----
MORTGAGE ASSETS
Investment securities available-for-sale (1) .. $ 22,703 $ 6,126 35.98% $ 29,806 $ 1,449 6.48%
CMO collateral (2) ............................ 6,189,396 185,839 4.00 2,981,957 120,487 5.39
Mortgages held-for-sale (3) ................... 218,158 10,621 6.49 -- -- --
Mortgages held-for-investment (4) ............. 237,585 9,369 5.26 81,195 2,865 4.70
Finance receivables:
Affiliated (5) ............................. 345,255 10,513 4.06 397,980 13,542 4.54
Non-affiliated ............................. 581,100 22,101 5.07 279,273 12,095 5.77
---------- -------- ---------- --------
Total finance receivables ................ 926,355 32,614 4.69 677,253 25,637 5.05
---------- -------- ---------- --------
Total Mortgage Assets ...................... $7,594,197 $244,569 4.29% $3,770,211 $150,438 5.32%
========== ======== ========== ========
BORROWINGS
CMO borrowings ................................ $6,058,805 $135,950 2.99% $2,894,017 $ 79,021 3.64%
Reverse repurchase agreements ................. 1,290,996 23,066 2.39 706,696 15,724 2.97
Borrowings secured by investment securities (6) 3,622 2,316 85.26 10,760 1,455 18.03
---------- -------- ---------- --------
Total borrowings on Mortgage Assets ........ $7,353,423 $161,332 2.93% $3,611,473 $ 96,200 3.55%
========== ======== ========== ========
Net interest spread (7) ....................... 1.36% 1.77%
Net interest margin (8) ....................... 1.46% 1.92%
- ---------------
(1) Principal 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) Mortgages held-for-sale were acquired via the acquisition of Impac Funding
Corporation on July 1, 2003.
(4) Includes amortization of acquisition costs and net cash payments on
derivative instruments not allocated to specific CMOs.
(5) Advances to subsidiaries and affiliates have been eliminated during the
third quarter of 2003 due to the consolidation of the mortgage operations.
(6) 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.
These borrowings were paid off during the third quarter of 2003. The yield
reflects discount and securitization costs that were recorded as interest
expense upon repayment of borrowings.
(7) 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.
(8) 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.
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 nine months of 2003 compared to 1.92% for the first nine months of
2002. The overall decrease in net interest margins during the first nine months
of 2003 as compared to the first nine months of 2002 was primarily the result of
a decline in net interest margins on CMO collateral, which declined 44 basis
points to 0.60% for the first nine months of 2003 as compared to 1.04% for the
first nine 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.
32
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--For the Three Months Ended September 30, 2003 as compared to the
Three Months Ended September 30, 2002" as the discussion also applies to the
first nine months of 2003 compared to the first nine months of 2002.
In addition to the positive contribution of net interest income to
consolidated net earnings, net earnings from the mortgage operations increased
$15.4 million to $28.3 million during the first nine months of 2003 compared to
$12.9 million during the first nine months of 2002. This increase was primarily
due to an increase in gain on sale of loans, which was the result of an increase
in loan sales volume combined with greater profitability per loan sold. The sale
of Alt-A mortgages and multi-family mortgages to third party investors and the
completion of CMOs during the first nine months of 2003 resulted in gain on sale
of loans of $86.3 million compared to gain on sale of loans of $49.4 million for
the first nine months of 2002. Of the $6.4 billion of mortgage acquisitions and
originations during the first nine months of 2003, the mortgage operations sold
$2.8 billion of mortgages to third party investors and $3.6 billion was sold to
the long-term investment operations. This compares to $1.3 billion of mortgages
sold to third party investors and $2.7 billion of mortgages sold to the
long-term investment operations during the first nine months of 2002. The
long-term investment operations also completed $4.0 billion of CMOs during the
first nine months of 2003 as compared to $2.4 billion of CMOs completed during
the first nine months of 2002. Gain on sale of loans was 135 basis points on
total loan sales volume of $6.4 billion for the first nine months of 2003
compared to 125 basis points on total loan sales volume of $4.0 billion for the
first nine months of 2002.
Gain on sale of loans includes the difference between the price we acquire
and originate mortgages and the price we receive upon the sale or securitization
of mortgages plus or minus direct mortgage origination revenue and costs, i.e.
loan and underwriting fees, commissions, appraisal review fees, document
expense, etc. Gain on sale of loans acquired and originated by the mortgage
operations also includes a premium for the sale of mortgage servicing rights
upon the sale or securitization of mortgages. All mortgages sold or securitized
during the third quarter of 2003 were done so on a servicing released basis,
which results in substantially all cash gains. 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 mortgages sold for
the periods indicated (in thousands):
For the Nine Months
Ended September 30,
-----------------------
2003 2002
---------- ----------
REMICs ............................................... $ 887,500 $ 599,952
Whole loan sales to third party investors ............ 1,933,008 680,422
Loan sales to the long-term investment operations .... 3,585,848 2,679,888
---------- ----------
Total sales ....................................... $6,406,356 $3,960,262
========== ==========
Non-interest expense increased to $23.6 million for the first nine months
of 2003 compared to $6.2 million during the first nine months of 2002. However,
for comparative purposes, when including non-interest expense of the mortgage
operations for the first nine months of 2002, non-interest expense was $51.2
million for the first nine months of 2003 compared to $39.9 million for the
first nine months of 2002. The $11.3 million increase in non-interest expense
includes the following:
o $13.4 million increase in operating expense, including personnel
expense, professional services and general and administrative
expense; and
o $779,000 increase in amortization of MSR's;
which was partially offset by the following:
o $1.2 million decrease in loss on disposition of other real estate
owned;
o $860,000 decrease in write-down on investment securities; and
o $681,000 decrease in provision for repurchases.
33
Operating expense increased 37% to $49.9 million for the first nine months
of 2003 compared to $36.5 million for the first nine months of 2002. This
increase was primarily due to a 49% increase in mortgage acquisitions and
originations by the mortgage operations to $6.4 billion for the first nine
months of 2003 compared to $4.3 billion for the first nine months of 2002 that
resulted in an increase in staff levels. However, operational efficiencies
created by IDASL combined with the higher level of correspondent bulk
acquisitions during the first nine months of 2003 resulted in lower per loan
correspondent acquisition costs as compared to the first nine months of 2002.
Bulk mortgage acquisitions generally require less staffing and corresponding
personnel expense and other operating expense than mortgages acquired on a flow,
or loan-by-loan basis.
The following table summarizes the mortgage operations weighted average
fully-loaded production cost to acquire or originate a single mortgage by
production channel for the periods indicated (in basis points of mortgage
acquisition or origination):
For the Nine Months
Ended September 30,
------------------------
Production Channel Company/Division 2003 2002
- --------------------------------- -------------------------------------------- ------ ------
Correspondent acquisitions Impac Funding Corporation 55.40 78.64
Wholesale/retail originations Impac Lending Group 96.84 99.65
B/C originations Novelle Financial Services, Inc. 239.57 235.43
------ ------
Total Weighted Average Production Cost........................................ 72.35 84.90
====== ======
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.
Gain on disposition of other real estate owned was $1.1 million for the
first nine months of 2003 compared to a loss on disposition of other real estate
owned of $120,000 for the first nine months of 2002. When we acquire real estate
through foreclosure proceedings we record a write-down on foreclosed property to
a percentage of appraised value or a real estate broker's price opinion. Gain or
loss on disposition of other real estate owned results when there is a
difference between the initial write-down on foreclosed property and the
ultimate proceeds received upon disposition of foreclosed property. During the
first nine months of 2003 the initial write-downs on foreclosed property were in
excess of the proceeds received on the sale of real estate owned, which resulted
in a gain. The opposite occurred on real estate disposition during the first
nine months of 2002.
Provision for loan losses were $21.4 million for the first nine months of
2003 compared to $13.3 million for the first nine 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 portfolio. The loss percentage is used to determine the estimated
inherent losses in the mortgage portfolio. The provision for loan losses is also
determined based on the following:
o management's judgment of the net loss potential of mortgages based
on prior loan loss experience;
o changes in the nature and volume of the mortgage portfolio;
o value of the collateral;
o delinquency trends; and
o current economic conditions that may affect the borrowers' ability
to pay.
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
34
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.
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 nine months of
2003 the mortgage operations acquired and originated $6.4 billion of primarily
Alt-A mortgages. Initial capital invested in Alt-A 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 nine 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 retained $3.6 billion of primarily
Alt-A mortgages from the mortgage operations and originated $206.2 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 13% 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 April 2004. When the long-term investment operations
accumulates a pool of mortgages, generally ranging from $200.0 million to $1.0
billion, the mortgages are financed through the issuance of CMOs. When we
complete CMOs, our total initial capital investment in CMOs ranges from
approximately 3% to 5% of the principal balance of Alt-A mortgages and
approximately 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 September 30, 2003, the warehouse lending operations had $956.0 million in
approved warehouse lines available to non-affiliated customers of which $651.0
million was outstanding. Due to a heavy volume of originations at the end of
September 2003 some non-affiliates were granted temporary increases in their
warehouse facilities, most of which expire in November 2003.
Affiliates had $29.4 million in pledge accounts with the warehouse lending
operations as of September 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 September 30, 2003 the warehouse lending operations had $572.4 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
35
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.
Our operating businesses are primarily funded as follows:
o CMO borrowings and reverse repurchase agreements;
o sale and securitization of mortgages;
o cash proceeds from the issuance of securities; and
o cash flows from our CMO portfolio.
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-affiliated customers and the
acquisition of mortgages to be held for long-term investment.
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 September 30, 2003 the warehouse lending operations had $1.2
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
36
o limits losses associated with collateral securing CMOs to our equity
investment.
During the first nine months of 2003 we completed $4.0 billion of CMOs, of
which $3.3 billion was adjustable rate CMOs and $656.8 million was fixed rate
CMOs, to provide long-term financing for the acquisition and origination of $3.8
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. 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.
Sale and securitization of mortgages. When the mortgage operations
accumulates a sufficient amount of mortgages, generally between $200.0 million
and $1.0 billion, it sells or securitizes its mortgages. The mortgage operations
sold $3.6 billion of mortgages to the long-term investment operations during the
first nine months of 2003, $1.9 billion of mortgages to third party investors
and $888.0 million was securitized as REMICs. The mortgage operations sold
mortgage servicing rights on substantially all mortgages during the first nine
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
a shelf registration statement with the SEC that allows us to sell up to $300.0
million of securities, including common stock, preferred stock, debt securities
and warrants. During the nine months ended September 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 2.1 million and 3.9 million shares and received net proceeds of
approximately $30.1 million and $54.6 million of common stock from our shelf
registration statement during the three and nine months ended September 30,
2003, respectively. During each of the three and nine months ended September 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 $933,000 and $1.7
million, respectively.
As of September 30, 2003, approximately $77.7 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 from our CMO portfolio. During the first nine months of 2003
mortgages held as CMO collateral, which was the majority of our mortgage
portfolio, generated excess principal and interest cash flows of $96.4 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.
Cash Flows
Operating Activities - Net cash provided by operating activities was $27.3
million during the first nine months of 2003 compared to net cash provided by
operating activities of $70.0 million during the same period of 2002. Net
earnings of $88.7 million provided most of the cash flows from operating
activities during the first nine months of 2003.
Investing Activities - Net cash used in investing activities was $2.5
billion during the first nine months of 2003 compared to $2.5 billion during the
same period of 2002. Net cash flows of $2.3 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 $2.3
billion during the first nine months of 2003 compared to $2.5 billion during the
same period of 2002. CMO financing provided net cash flows of $2.2 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.
Risk Factors
Risks Related To Our Businesses
A prolonged economic downturn or recession would likely result in a reduction of
our mortgage origination activity which would adversely affect our financial
results.
The United States economy has undergone and may in the future, undergo, a
period of slowdown, which some observers view as a recession. An economic
downturn or a recession may have a significant adverse 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.
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;
38
o excess cash flow from our CMO portfolio; and
o earnings from operations.
We cannot assure you that any of these alternatives will be available to
us, or if available, that we will be able to negotiate favorable terms. Our
ability to meet our long-term liquidity requirements is subject to the renewal
of our credit and repurchase facilities and/or obtaining other sources of
financing, including additional debt or equity from time to time. Any decision
by our lenders and/or investors to make additional funds available to us in the
future will depend upon a number of factors, such as our compliance with the
terms of our existing credit arrangements, our financial performance, industry
and market trends in our various businesses, the lenders' and/or investors' own
resources and policies concerning loans and investments, and the relative
attractiveness of alternative investment or lending opportunities. If we cannot
raise cash by selling debt or equity securities, we may be forced to sell our
assets at unfavorable prices or discontinue various business activities. Our
inability to access the capital markets could have a negative impact on our
earnings growth and also our ability to pay dividends.
Any significant margin calls under our financing facilities would adversely
affect our liquidity and may adversely affect our financial results.
Prior to the fourth quarter of 1998, we generally had no difficulty in
obtaining favorable financing facilities or in selling acquired mortgages.
However, during the fourth quarter of 1998, the mortgage industry experienced
substantial turmoil as a result of a lack of liquidity in the secondary markets.
At that time, investors expressed unwillingness to purchase interests in
securitizations due, in part, to:
o the lack of financing to acquire these securitization interests;
o the widening of returns expected by institutional investors on
securitization interests over the prevailing Treasury rate; and
o market uncertainty.
As a result, many mortgage originators, including 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 financing facilities. During the year ended December
31, 1997 we experienced a net loss of $16.0 million. The net loss incurred
during 1997 included an accounting charge of $44.4 million that was the result
of expenses related to the termination and buyout of our management agreement
with Imperial Credit Advisors, Inc. We cannot be certain that revenues will
remain at current levels or improve or that we will be profitable in the future,
which could prevent us from effectuating our business strategy.
39
If we are unable to complete securitizations or if we experience delayed
mortgage loan sales or securitization closings, we could face a liquidity
shortage which would adversely affect our operating results.
We rely significantly upon securitizations to generate cash proceeds to
repay borrowings and replenish our borrowing capacity. If there is a delay in a
securitization closing or any reduction in our ability to complete
securitizations we may be required to utilize other sources of financing, which,
if available at all, may be on unfavorable terms. In addition, delays in closing
a mortgage sales or securitizations of our mortgages increase our risk by
exposing us to credit and interest rate risks for this extended period of time.
Furthermore, gains on sales from certain of our securitizations represent a
significant portion of our earnings. Several factors could affect our ability to
complete securitizations of our mortgages, including:
o conditions in the securities and secondary markets;
o credit quality of the mortgages acquired or originated through our
mortgage operations;
o volume of our mortgage loan acquisitions and originations;
o our ability to obtain credit enhancements; and
o lack of investors purchasing higher risk components of the
securities.
If we are unable to sell a sufficient number of mortgages at a premium or
profitably securitize a significant number of our mortgages in a particular
financial reporting period, then we could experience lower income or a loss for
that period, which could have a material adverse affect on our operations. We
cannot assure you that we will be able to continue to profitably securitize or
sell our loans on a whole loan basis, or at all.
The market for first loss risk securities, which are securities that take
the first loss when mortgages are not paid by the borrowers, is generally
limited. In connection with our REMIC securitizations, we endeavor to sell all
securities subjecting us to a first loss risk. If we cannot sell these
securities, we may be required to hold them for an extended period, subjecting
us to a first loss risk.
Our borrowings and use of substantial leverage may cause losses.
Our use of 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.
If we default under our financing facilities or if the value of collateral
is less than the amount borrowed, 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
40
collateral without any delay. On the other hand, if a lender with whom we have a
reverse repurchase agreement declares bankruptcy, we might experience difficulty
repurchasing our collateral, or enforcing our claim for damages, and it is
possible that our claim could be repudiated and we could be treated as an
unsecured creditor. If this occurs, our claims would be subject to significant
delay and we may receive substantially less than our actual damages or nothing
at all.
If we are forced to liquidate, we may have few unpledged assets for
distribution to unsecured creditors.
We have pledged a substantial portion of our assets to secure the
repayment of CMOs issued in securitizations and our financing facilities. We
will also pledge substantially all of our current and future mortgages to secure
borrowings pending their securitization or sale. The cash flows we receive from
our investments that have not yet been distributed or pledged or used to acquire
mortgages or other investments may be the only unpledged assets available to our
unsecured creditors if we were liquidated.
Interest rate fluctuations may adversely affect our operating results.
Our operations, as a mortgage loan acquirer and originator or a warehouse
lender, may be adversely affected by rising and falling interest rates. Interest
rates have been low over the past few years; however any increase in interest
rates may discourage potential borrowers from refinancing mortgages, borrowing
to purchase homes or seeking second mortgages. This may decrease the amount of
mortgages available to be acquired or originated by our mortgage operations and
decrease the demand for warehouse financing provided by our warehouse lending
operations, which could adversely affect our operating results. If short-term
interest rates exceed long-term interest rates, there is a higher risk of
increased loan prepayments, as borrowers may seek to refinance their fixed and
adjustable rate mortgages at lower long-term fixed interest rates. Increased
loan prepayments could lead to a reduction in the number of loans in our
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 mortgage 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.
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Adjustable rate mortgages typically have interest rate caps, which limit
interest rates charged to the borrower during any given period. Our borrowings
are not subject to similar restrictions. As a result, in a period of rapidly
increasing interest rates, the interest rates we pay on our borrowings could
increase without limitation, while the interest rates we earn on our adjustable
rate mortgage assets would be capped. If this occurs, our net interest spread
could be significantly reduced or we could suffer a net interest loss.
Increased levels of 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.
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.
Our mortgage products expose us to greater credit risks.
We are an acquirer and originator of Alt-A mortgages, B/C mortgages and
multi-family mortgages. These are mortgages that generally may not qualify for
purchase by government-sponsored agencies such as Fannie Mae and Freddie Mac.
Our operations may be negatively affected due to our investments in these
mortgages. Credit risks associated with these mortgages may be greater than
those associated with conforming mortgages. The interest rates we charge on
these mortgages are often higher than those charged for conforming loans in
order to compensate for the higher risk and lower liquidity. Lower levels of
liquidity may cause us to hold loans or other mortgage-related assets supported
by these loans that we otherwise would not hold. By doing this, we assume the
potential risk of increased delinquency rates and/or credit losses as well as
interest rate risk. Additionally, the combination of different underwriting
criteria and higher rates of interest leads to greater risk, including higher
prepayment rates and higher delinquency rates and/or credit losses.
Lending to our type of borrowers may expose us to a higher risk of
delinquencies, foreclosures and losses.
Our market includes borrowers who may be unable to obtain mortgage
financing from conventional mortgage sources. Mortgages made to such borrowers
generally entail a higher risk of delinquency and higher losses than mortgages
made to borrowers who utilize conventional mortgage sources. Delinquency,
foreclosures and losses generally increase during economic slowdowns or
recessions. The actual risk of delinquencies, foreclosures and losses on
mortgages made to our borrowers could be higher under adverse economic
conditions than those currently experienced in the mortgage lending industry in
general.
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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 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.
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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, B/C and multi-family
mortgages and issuing mortgage-backed securities with other mortgage conduit
programs, investment banking firms, savings and loan associations, banks, thrift
and loan associations, finance companies, mortgage bankers, insurance companies,
other lenders, and other entities purchasing mortgage assets.
We also face intense competition from Internet-based lending companies
where entry barriers are relatively low. Some of our competitors are much larger
than we are, have better name recognition than we do, and have far greater
financial and other resources. Government-sponsored entities, in particular
Fannie Mae and Freddie Mac, are also expanding their participation in the Alt-A
mortgage industry. These government-sponsored entities have a size and
cost-of-funds advantage over us that allows them to price mortgages at lower
rates than we are able to offer. This phenomenon may seriously destabilize the
Alt-A mortgage industry. In addition, if as a result of what may be
less-conservative, risk-adjusted pricing, these government-sponsored entities
experience significantly higher-than-expected losses, it would likely adversely
affect overall investor perception of the Alt-A 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
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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.
If actual prepayments or defaults with respect to mortgages serviced occurs more
quickly than originally assumed, the value of our mortgage servicing rights
would be subject to downward adjustment.
When we purchase mortgages that include the associated servicing rights,
the allocated cost of the servicing rights is reflected on our financial
statements as mortgage servicing rights. To determine the fair value of these
servicing rights, we use assumptions to estimate future net servicing income
including projected discount rates, mortgage loan prepayments and credit losses.
If actual prepayments or defaults with respect to loans serviced occur more
quickly than we originally assumed, we would have to reduce the carrying value
of our mortgage servicing rights. We do not know if our assumptions will prove
correct.
Our operating results may be adversely affected by the results of our hedging
activities.
To offset the risks associated with our mortgage operations, we enter into
transactions designed to hedge our interest rate risks. To offset the risks
associated with our long-term investment operations, we attempt to match the
interest rate sensitivities of our adjustable rate mortgage assets held for
investment with the associated financing liabilities. Our management determines
the nature and quantity of the hedging transactions based on various factors,
including market conditions and the expected volume of mortgage loan purchases.
We do not limit management's use of certain instruments in such hedging
transactions. While we believe that we properly hedge our interest rate risk, we
may not, and in some cases 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 our loan products may adversely affect our
operations.
The availability of sufficient mortgages meeting our criteria is dependent
in part upon the size and level of activity in the residential real estate
lending market and, in particular, the demand for 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;
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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.
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 six purported
class actions, (including an action that was dismissed but there has been a
notice of an appeal) pending in six different states. Five of which allege
generally that the loan originator improperly charged fees in violation of
various state lending or consumer protection laws in connection with mortgages
that we acquired. Although the suits are not identical, they generally seek
unspecified compensatory damages, punitive damages, pre- and post-judgment
interest, costs and expenses and rescission of the mortgages, as well as a
return of any improperly collected fees. The other purported class action claims
damages for sending out unsolicited faxes and seek statutory and treble damages.
These actions are in the early stages of litigation and, accordingly, it is
difficult to predict the outcome of these matters. We believe we have
meritorious defenses to the actions and intend to defend against them
vigorously; however, an adverse judgment in any of these matters could have a
material adverse effect on us.
Regulatory Risks
We may be subject to fines or other penalties based upon the conduct of our
independent brokers or correspondents.
The mortgage brokers and correspondents from which we obtain 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
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than expected helps discourage such a prepayment or helps offset the reduction
in value resulting from the early payoff. Prepayment penalties are an important
feature on the mortgages we acquire or originate.
Certain state laws restrict or prohibit prepayment penalties on mortgages.
Until July 1, 2003, we had historically relied on the federal Alternative
Mortgage Transactions Parity Act, or the "Parity Act," and related regulations
issued by the Office of Thrift Supervision, or "OTS," to preempt state
limitations on prepayment penalties on ARMs. The Parity Act was enacted to
extend to financial institutions other than federally chartered depository
institutions the federal preemption which federally chartered depository
institutions enjoy. However, on September 25, 2002, the OTS issued final
regulations that reduce the scope of the Parity Act preemption. The OTS
subsequently delayed the effective date of the final regulations until July 1,
2003. The National Home Equity Mortgage Association has filed a lawsuit against
the OTS challenging the OTS's authority to issue the regulations. The court held
in favor of the OTS's authority. NHEMA has appealed this decision. However,
pending the appeal, we may not rely on the Parity Act to preempt state
restrictions on prepayment penalties. It is possible any appellate decision may
again find in favor of the OTS, in which case we will not be able to rely on the
Parity Act to preempt state restrictions on prepayment penalties. The
elimination of this federal preemption could have a material adverse affect on
our ability to compete effectively with financial institutions that will
continue to enjoy federal preemption of state restrictions on prepayment
penalties on ARMs.
Violation of various federal and state laws may result in losses on our loans.
o Applicable state laws generally regulate interest rates and other
charges, require certain disclosure, and require licensing of the
lender. In addition, other state laws, public policy and general
principles of equity relating to the protection of consumers, unfair
and deceptive practices and debt collection practices may apply to
the origination, servicing and collection of our loans. Mortgage
loans are also subject to federal laws, including:
o the Federal Truth-in-Lending Act and Regulation Z promulgated
thereunder, which require certain disclosures to the borrowers
regarding the terms of the loans;
o the Equal Credit Opportunity Act and Regulation B promulgated
thereunder, which prohibit discrimination on the basis of age, race,
color, sex, religion, marital status, national origin, receipt of
public assistance or the exercise of any right under the Consumer
Credit Protection Act, in the extension of credit;
o the Fair Credit Reporting Act, which regulates the use and reporting
of information related to the borrower's credit experience;
o the Depository Institutions Deregulation and Monetary Control Act of
1980, which preempts certain state usury laws; and
o the Alternative Mortgage Transaction Parity Act of 1982, which
preempts certain state lending laws which regulate alternative
mortgage transactions.
Violations of certain provisions of these federal and state laws may limit
our ability to collect all or part of the principal of or interest on the loans
and in addition could subject us trust to damages and administrative enforcement
and could result in the mortgagors rescinding the loans whether held by us or
subsequent holders of the loans.
Our operations may be adversely affected if we are subject to the Investment
Company Act.
We intend to conduct our business at all times so as not to become
regulated as an investment company under the Investment Company Act. The
Investment Company Act exempts entities that are primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate.
In order to qualify for this exemption we must maintain at least 55% of
our assets directly in mortgages, qualifying pass-through certificates and
certain other qualifying interests in real estate. Our ownership of certain
mortgage assets may be limited by the provisions of the Investment Company Act.
If the 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
47
leverage would be substantially reduced, and we would not be able to conduct our
business as described. Our business will be materially and adversely affected if
we fail to qualify for this exemption.
New regulatory laws affecting the mortgage industry may increase our costs and
decrease our mortgage origination and acquisition.
The regulatory environments in which we operate have an impact on the
activities in which we may engage, how the activities may be carried out, and
the profitability of those activities. Therefore, changes to laws, regulations
or regulatory policies can affect whether and to what extent we are able to
operate profitably. For example, , recently enacted and proposed local, state
and federal legislation targeted at predatory lending could have the unintended
consequence of raising the cost or otherwise reducing the availability of
mortgage credit for those potential borrowers with less than prime-quality
credit histories, thereby resulting in a reduction of otherwise legitimate Alt-A
lending opportunities. Similarly, recently enacted and proposed local, state and
federal privacy laws and laws prohibiting or limiting marketing by telephone,
facsimile, email and the Internet may limit our ability to cross market and our
ability to access potential loan applicants. We cannot provide any assurance
that the proposed laws, rules and regulations, or other similar laws, rules or
regulations, will not be adopted in the future. Adoption of these laws and
regulations could have a material adverse impact on our business by
substantially increasing the costs of compliance with a variety of inconsistent
federal, state and local rules, or by restricting our ability to charge rates
and fees adequate to compensate us for the risk associated with certain loans.
Some states have enacted, or may enact, laws or regulations that prohibit
inclusion of some provisions in mortgage loans that have mortgage rates or
origination costs in excess of prescribed levels, and require that borrowers be
given certain disclosures prior to the consummation of such mortgage loans. Our
failure to comply with these laws could subject us to monetary penalties and
could result in the borrowers rescinding the mortgage loans, whether held by us
or subsequent holders. Lawsuits have been brought in various states making
claims against assignees of these loans for violations of state law.
Risks Related To Our Status As a REIT
We may not pay dividends to stockholders.
REIT provisions of the Internal Revenue Code generally require that we
annually distribute to our stockholders at least 90% of all of our taxable
income. 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 the mortgage
operations. The mortgage operations is not a REIT and is not, therefore, subject
to the above-described REIT distribution requirements. Because the mortgage
operations is seeking to retain earnings to fund the future growth of our
mortgage operations business, its board of directors may decide that the
mortgage operations should cease making dividend distributions in the future.
This would materially reduce the amount of our taxable income and in turn, would
reduce the amount we would be required to distribute as dividends.
If we fail to maintain our REIT status, we may be subject to taxation as a
regular corporation.
We believe that we have operated and intend to continue to operate in a
manner that enables us to meet the requirements for qualification as a REIT for
federal income tax purposes. We have not requested, and do not plan to request,
a ruling from the Internal Revenue Service that we qualify as a REIT.
Moreover, no assurance can be given that legislation, new regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to qualification as a REIT or the federal income tax
consequences of such qualification. Our continued qualification as a REIT will
depend on our satisfaction of certain asset, income, organizational and
stockholder ownership requirements on a continuing basis.
If we fail to qualify as a REIT, we would not be allowed a deduction for
distributions to stockholders in computing our taxable income and would be
subject to federal income tax at regular corporate rates. We also may be subject
to the federal alternative minimum tax. Unless we are entitled to relief under
specific statutory provisions, we could not elect to be taxed
48
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.
Potential characterization of distributions or gain on sale as unrelated
business taxable income to tax-exempt investors.
If (1) all or a portion of our assets are subject to the rules relating to
taxable mortgage pools, (2) we are a "pension-held REIT," (3) a tax-exempt
stockholder has incurred debt to purchase or hold our common stock, or (4) the
residual REMIC interests we buy generate "excess inclusion income," then a
portion of the distributions to and, in the case of a stockholder described in
(3), gains realized on the sale of common stock by such tax-exempt stockholder
may be subject to Federal income tax as unrelated business taxable income under
the Internal Revenue Code.
Classification as a taxable mortgage pool could subject us or certain of our
stockholders to increased taxation.
If we have borrowings with two or more maturities and, (1) those
borrowings are secured by mortgages or mortgage-backed securities and, (2) the
payments made on the borrowings are related to the payments received on the
underlying assets, then the borrowings and the pool of mortgages or
mortgage-backed securities to which such borrowings relate may be classified as
a taxable mortgage pool under the Internal Revenue Code. If any part of our
Company were to be treated as a taxable mortgage pool, then our REIT status
would not be impaired, but a portion of the taxable income we recognize may,
under regulations to be issued by the Treasury Department, be characterized as
"excess inclusion" income and allocated among our stockholder 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 stockholders
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 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;
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o will not recognize any voting rights for those shares;
o may redeem the shares; and
o will consider the shares held in trust for the benefit of a
charitable beneficiary as designated by us.
The trustee shall sell the shares held in trust and the owner of the
excess shares will be entitled to the lesser of:
(a) the price paid by the owner;
(b) if the owner did not purchase the excess shares, the closing price
for the shares on the national securities exchange on which 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.
Limitations on acquisition and change in control ownership limit.
The 9.5% ownership limit discussed above may have the effect of precluding
acquisition of control of our Company by a third party without consent of our
board of directors.
Risks Related To Ownership Of Our Common Stock
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.
Sales of additional common stock may adversely affect its market price.
To sustain our growth strategy we intend to raise capital through the sale
of equity. The sale or the proposed sale of substantial amounts of our common
stock in the public market could materially adversely affect the market price of
our common stock or other outstanding securities. We do not know the actual or
perceived effect of these offerings, the timing of these offerings, the dilution
of the book value or earnings per share of our securities then outstanding; and
the effect on
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the market price of our securities then outstanding. 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 September 30, 2003, we have sold approximately $222.3
million (gross proceeds) worth of common stock from our shelf registration
statement and we may sell additional securities worth approximately $77.7
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 September 30, 2003, our 1995 Stock Option, Deferred Stock and Restricted
Stock Plan had 383,212 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.
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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 in certain
circumstances by acquiring mortgages with mortgage insurance enhancements, as we
deem appropriate, 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 which we attempt to
do 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 is comprised of the senior executives of the mortgage operations and
warehouse lending operations. 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:
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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 nine 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.
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ITEM 4: CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of September 30, 2003, our 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 Rules 13a
- - 15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Based on that evaluation, the CEO and CFO concluded that our
disclosure controls and procedures were effective as of September 30, 2003.
Changes in Internal Controls
There have been no changes in our internal control over financial
reporting identified in connection with the evaluation required by paragraph (d)
Rule 13a-15 or 15d-15 under the Exchange Act that occurred during the quarter
ended September 30, 2003 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On October 14, 2003, an action was filed in the Circuit Court of Cook
County, Illinois as Case No. 03 CH17085 entitled Fast Forward Solutions, LLC v.
Novelle Financial Services, Inc. The complaint contains allegations of a class
action and alleges that the defendant sent out unsolicited faxes in violation of
the Telephone Consumer Protection Act, the Illinois Consumer Fraud Act, and
Illinois Common Law. The plaintiff is seeking statutory and treble damages.
With respect to the complaint captioned Frazier, et al. v. Preferred
Credit, et al, which had been pending in the U.S. District Court for the Western
District of Tennessee, Case No. CT004762-01, until it was dismissed on July 31,
2002, with a motion for reconsideration denied on March 7, 2003, as described in
IMH's annual report on Form 10-K for the year ended December 31, 2002, on July
31, 2003 the plaintiffs filed a new complaint captioned, Frazier, et al v. Impac
Funding Corp., et al, Case No. 03-2565 DP, in the same court. The causes of
action in the new action are materially identical to the causes of action stated
in the 2001 action, though the number of defendants is reduced.
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. 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 these complaints and we
intend to defend the claims vigorously. Nevertheless, litigation is uncertain
and we may not prevail in the lawsuits and can express no opinion as to their
ultimate outcome. Please refer to our annual report on Form 10-K for the year
ended December 31, 2002 and our subsequent quarterly reports on form 10-Q
regarding other litigation and claims.
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.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) Not applicable.
(c) On July 1, 2003, IMH purchased from Joseph R. Tomkinson, William S.
Ashmore and the Johnson Revocable Living Trust all of the
outstanding shares of voting common stock of IFC, for aggregate
consideration of $750,000. Each of Messers. Tomkinson and Ashmore
and the Johnson Revocable Living Trust owned one-third
54
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.
Exemption from the registration is claimed under the Securities Act
of 1933, as amended (the "Securities Act") in reliance on Section
4(2) of the Securities Act or Rule 506 of Regulation D promulgated
thereunder. The purchaser represented his intention to acquire the
securities for investment only and not with a view to, or for the
sale in connection with, any distribution thereof and an appropriate
legend was affixed to the certificate evidencing the securities in
such transaction. No brokers or dealers were involved in the
transaction and no commissions were paid. The purchaser had adequate
access to information about us.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Item 601(b)(31)
of Regulation S-K, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Item 601(b)(31)
of Regulation S-K, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
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:
Current Report on Form 8-K, dated July 15, 2003, reporting Items 5 and 7,
relating to the purchase of IFC common stock and new employment agreements
entered into with certain executive officers.
Current Report on Form 8-K, dated August 4, 2003, reporting Items 7 and
12, relating to a press release reporting financial results for the
quarter ended June 30, 2003.
Current Report on Form 8-K, dated August 29, 2003, reporting Item 9
relating to the posting of our unaudited Monthly Fact Sheet.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
IMPAC MORTGAGE HOLDINGS, INC.
/s/ Richard J. Johnson
by: Richard J. Johnson
Executive Vice President
and Chief Financial Officer
(authorized officer of registrant and principal financial officer)
Date: November 5, 2003
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