# **UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

## **FORM 10-Q**

 
| **ý**                                            | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES**  |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------|
| **EXCHANGE ACT OF 1934**                              |
|                                                  |       |                                                                     |
| **For the quarterly  period ended March 31, 2006 or** |
|                                                  |       |                                                                     |
| **o**                                                 | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES** |
| **EXCHANGE ACT OF 1934**                              |

 

**For the transitionperiod from               to               .**

 

**CommissionFile Number: 1-14100**

 

**IMPACMORTGAGE HOLDINGS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Maryland**                    | ** ** | **33-0675505**      |
|---------------------------------|------------|---------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer    |
| incorporation or organization)  |       | Identification No.) |

 

**1401 DoveStreet, Newport Beach, California 92660**

**(Address of principal executiveoffices)**

 

**(949)475-3600**

**(Registrant’s telephone number,including area code)**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.    Yes  ý    No  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ý  Accelerated filer o  Non-accelerated filer o

 

Indicate bycheck mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2)    Yes o No ý

 

There were76,112,963 shares of common stock outstanding as of April 28, 2006.

 

 

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**IMPAC MORTGAGE HOLDINGS, INC.**

 

### **FORM10-Q QUARTERLY REPORT**

 

**TABLE OF CONTENTS**

 
| **PART I. FINANCIAL INFORMATION** | ** **                                                                                                            |
|-----------------------------------|-----------------------------------------------------------------------------------------------------------------------|
|                              |                                                                                                                  |   |
| ITEM 1.                           | **CONSOLIDATED FINANCIAL STATEMENTS**                                                                                 | ** ** |
|                              | Consolidated  Balance Sheets as of March 31, 2006 and December 31, 2005                                               |   |
|                              | Consolidated Statements of Operations and Comprehensive Earnings for  the Three Months Ended  March 31, 2006 and 2005 |   |
|                              | Consolidated Statements of Cash Flows for the Three Months Ended  March 31, 2006 and 2005                             |   |
|                              | Notes to Consolidated Financial Statements                                                                            |   |
|                              |                                                                                                                  |   |
| ITEM 2.                           | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                       |   |
|                              | Forward-Looking  Statements                                                                                           |   |
|                              | General  Overview                                                                                                     |   |
|                              | Critical Accounting Policies                                                                                          |   |
|                              | Financial Highlights for the First Quarter  of 2006                                                                   |   |
|                              | First Quarter 2006 Taxable Income                                                                                     |   |
|                              | Financial Condition and Results of Operations                                                                         |   |
|                              | Liquidity and Capital Resources                                                                                       |   |
|                              |                                                                                                                  |   |
| ITEM  3.                          | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                       |   |
|                              |                                                                                                                  |   |
| ITEM 4.                           | CONTROLS AND  PROCEDURES                                                                                              |   |
|                              |                                                                                                                  |   |
| **PART II. OTHER  INFORMATION**   | ** **                                                                                                            |
|                              |                                                                                                                  |   |
| ITEM 1.                           | LEGAL  PROCEEDINGS                                                                                                    |   |
|                              |                                                                                                                  |   |
| ITEM 1A.                          | RISK  FACTORS                                                                                                         |   |
|                              |                                                                                                                  |   |
| ITEM  2.                          | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                          |   |
|                              |                                                                                                                  |   |
| ITEM  3.                          | DEFAULTS  UPON SENIOR SECURITIES                                                                                      |   |
|                              |                                                                                                                  |   |
| ITEM  4.                          | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                  |   |
|                              |                                                                                                                  |   |
| ITEM 5.                           | OTHER INFORMATION                                                                                                     |   |
|                              |                                                                                                                  |   |
| ITEM 6.                           | EXHIBITS                                                                                                              |   |
|                              |                                                                                                                  |   |
|                              | SIGNATURES                                                                                                            |   |
|                              |                                                                                                                  |   |
|                              | CERTIFICATIONS                                                                                                        | ** ** |
|                                   |                                                                                                                       |  |  |

 

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#### **PART I. FINANCIALINFORMATION**

 

**ITEM 1.**          CONSOLIDATEDFINANCIAL STATEMENTS

 

**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

**(dollar amounts in thousands, exceptshare data)**

 
| ** **                                                                                                                                                                                                                                         | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                         | ** ** | **(Unaudited)**     | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                         | ** ** | ** **          | ** ** | ** **             | ** ** |
| Cash and cash equivalents                                                                                                                                                                                                                          |       | $                   | 234,777    |                   | $          | 146,621 |   |
| Restricted cash                                                                                                                                                                                                                                    |       | 943                 |       | 698                    |       |
| Securitized mortgage collateral                                                                                                                                                                                                                    |       | 22,957,394          |       | 24,494,290             |       |
| Finance receivables                                                                                                                                                                                                                                |       | 291,950             |       | 350,217                |       |
| Mortgages held-for-investment                                                                                                                                                                                                                      |       | 20,932              |       | 160,070                |       |
| Allowance for loan losses                                                                                                                                                                                                                          |       | (74,258             | )          | (78,514                | )          |
| Mortgages held-for-sale                                                                                                                                                                                                                            |       | 801,098             |       | 2,052,694              |       |
| Accrued interest receivable                                                                                                                                                                                                                        |       | 111,519             |       | 123,565                |       |
| Derivatives                                                                                                                                                                                                                                        |       | 300,090             |       | 250,368                |       |
| Other assets                                                                                                                                                                                                                                       |       | 197,853             |       | 220,370                |       |
| Total assets                                                                                                                                                                                                                                       |       | $                   | 24,842,298 |                   | $          | 27,720,379 |   |
|                                                                                                                                                                                                                                               |       |                |       |                   |       |
| **LIABILITIES**                                                                                                                                                                                                                                    | ** ** | ** **          | ** ** | ** **             | ** ** |
| Securitized mortgage borrowings                                                                                                                                                                                                                    |       | $                   | 22,488,155 |                   | $          | 23,990,430 |   |
| Reverse repurchase agreements                                                                                                                                                                                                                      |       | 992,528             |       | 2,430,075              |       |
| Trust preferred securities                                                                                                                                                                                                                         |       | 96,992              |       | 96,750                 |       |
| Other liabilities                                                                                                                                                                                                                                  |       | 49,702              |       | 36,177                 |       |
| Total liabilities                                                                                                                                                                                                                                  |       | 23,627,377          |       | 26,553,432             |       |
|                                                                                                                                                                                                                                               |       |                |       |                   |       |
| Commitments and contingencies                                                                                                                                                                                                                      |       |                |       |                   |       |
|                                                                                                                                                                                                                                               |       |                |       |                   |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                                     | ** ** | ** **          | ** ** | ** **             | ** ** |
| Series-A junior participating preferred  stock, $0.01 par value; 2,500,000 shares authorized; none issued and  outstanding as of March 31, 2006 and December 31, 2005, respectively                                                                |       | —              |       | —                 |       |
| Series-B 9.375% cumulative redeemable  preferred stock, $0.01 par value; liquidation value $50,000; 2,000,000 shares  authorized, 2,000,000 shares issued and outstanding as of March 31, 2006 and  December 31, 2005, respectively                |       | 20                  |       | 20                     |       |
| Series-C 9.125% cumulative redeemable  preferred stock, $0.01 par value; liquidation value $109,280; 5,500,000  shares authorized; 4,383,900 shares and 4,371,200 issued and outstanding as  of March 31, 2006 and December 31, 2005, respectively |       | 44                  |       | 44                     |       |
| Common stock, $0.01 par value; 200,000,000  shares authorized; 76,112,963 shares issued and outstanding as of March 31,  2006 and December 31, 2005, respectively                                                                                  |       | 761                 |       | 761                    |       |
| Additional paid-in capital                                                                                                                                                                                                                         |       | 1,167,978           |       | 1,167,059              |       |
| Accumulated other comprehensive income                                                                                                                                                                                                             |       | 717                 |       | 1,305                  |       |
| Net accumulated deficit:                                                                                                                                                                                                                           |       |                |       |                   |       |
| Cumulative dividends declared                                                                                                                                                                                                                      |       | (713,296            | )          | (675,373               | )          |
| Retained earnings                                                                                                                                                                                                                                  |       | 758,697             |       | 673,131                |       |
| Net accumulated earnings (deficit)                                                                                                                                                                                                                 |       | 45,401              |       | (2,242                 | )          |
| Total stockholders’ equity                                                                                                                                                                                                                    |       | 1,214,921           |       | 1,166,947              |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                    |       | $                   | 24,842,298 |                   | $          | 27,720,379 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

1

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**AND COMPREHENSIVE EARNINGS**

**(in thousands, except per share data)**

**(unaudited)**

 
| ** **                                                   | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| **INTEREST INCOME:**                                         | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Mortgage assets                                              |       | $                                         | 333,376    |   | $ | 276,021 |   |
| Other                                                        |       | 1,828                                     |       | 1,359 |   |
| Total interest income                                        |       | 335,204                                   |       | 277,380 |   |
|                                                         |       |                                      |       |   |   |
| **INTEREST EXPENSE:**                                        | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings                              |       | 295,475                                   |       | 179,467 |   |
| Reverse repurchase agreements                                |       | 25,873                                    |       | 16,762 |   |
| Other borrowings                                             |       | 2,382                                     |       | 45 |   |
| Total interest expense                                       |       | 323,730                                   |       | 196,274 |   |
|                                                         |       |                                      |       |   |   |
| Net interest income                                          |       | 11,474                                    |       | 81,106 |   |
| Provision for loan losses                                    |       | 150                                       |       | 6,074 |   |
| Net interest income after provision for  loan losses         |       | 11,324                                    |       | 75,032 |   |
|                                                         |       |                                      |       |   |   |
| **NON-INTEREST INCOME:**                                     | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Realized gain (loss) from derivative  instruments            |       | 40,136                                    |       | (13,727 | ) |
| Change in fair value of derivative  instruments              |       | 51,429                                    |       | 131,318 |   |
| Gain on sale of loans                                        |       | 7,353                                     |       | 9,137 |   |
| Other income                                                 |       | 8,821                                     |       | 5,078 |   |
| Total non-interest income                                    |       | 107,739                                   |       | 131,806 |   |
|                                                         |       |                                      |       |   |   |
| **NON-INTEREST EXPENSE:**                                    | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Personnel expense                                            |       | 18,621                                    |       | 18,880 |   |
| General and administrative and other  expense                |       | 5,073                                     |       | 4,913 |   |
| Amortization of deferred charge                              |       | 5,096                                     |       | 5,803 |   |
| Professional services                                        |       | 2,317                                     |       | 3,419 |   |
| Equipment expense                                            |       | 1,510                                     |       | 1,147 |   |
| Occupancy expense                                            |       | 1,368                                     |       | 1,145 |   |
| Data processing expense                                      |       | 1,366                                     |       | 943 |   |
| Amortization and impairment of mortgage  servicing rights    |       | 351                                       |       | 289 |   |
| Gain on sale of other real estate owned                      |       | (354                                      | )          | (848 | ) |
| Total non-interest expense                                   |       | 35,348                                    |       | 35,691 |   |
| Net earnings before income taxes                             |       | 83,715                                    |       | 171,147 |   |
| Income tax benefit                                           |       | (1,851                                    | )          | (2,463 | ) |
| Net earnings                                                 |       | 85,566                                    |       | 173,610 |   |
| Cash dividends on cumulative redeemable  preferred stock     |       | (3,672                                    | )          | (3,624 | ) |
| Net earnings available to common  stockholders               |       | $                                         | 81,894     |   | $ | 169,986 |   |
| Net earnings                                                 |       | $                                         | 85,566     |   | $ | 173,610 |   |
| Net unrealized gains (losses) on securities  :               |       |                                      |       |   |   |
| Unrealized holding gains arising during  year                |       | 264                                       |       | 264 |   |
| Reclassification of gains (losses) included  in net earnings |       | (853                                      | )          | — |   |
| Net unrealized (losses) gains                                |       | (589                                      | )          | 264 |   |
| Comprehensive earnings                                       |       | $                                         | 84,977     |   | $ | 173,874 |   |
|                                                         |       |                                      |       |   |   |
| Net earnings per share:                                      |       |                                      |       |   |   |
| Basic                                                        |       | $                                         | 1.08       |   | $ | 2.26 |   |
| Diluted                                                      |       | $                                         | 1.07       |   | $ | 2.23 |   |
| Dividends declared per common share                          |       | $                                         | 0.25       |   | $ | 0.75 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

2

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                                                     | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                      | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net earnings                                                                                   |       | $                                         | 85,566     |   | $ | 173,610 |   |
| Adjustments to reconcile net earnings to  net cash provided by (used in) operating activities: |       |                                      |       |   |   |
| Provision for loan losses                                                                      |       | 150                                       |       | 6,074 |   |
| Amortization of deferred charge, net                                                           |       | 5,096                                     |       | (1,958 | ) |
| Amortization of premiums, securitization  costs and debt issuance costs                        |       | 58,371                                    |       | 65,062 |   |
| Gain on sale of other real estate owned                                                        |       | (354                                      | )          | (848 | ) |
| Gain on sale of loans                                                                          |       | (7,353                                    | )          | (9,137 | ) |
| Change in fair value of derivative instruments                                                 |       | (51,429                                   | )          | (131,318 | ) |
| Purchase of mortgages held-for-sale                                                            |       | (2,104,134                                | )          | (4,664,116 | ) |
| Sale and principal reductions on mortgages  held-for-sale                                      |       | 3,362,930                                 |       | 4,188,867 |   |
| Net change in deferred taxes                                                                   |       | 84                                        |       | (1,990 | ) |
| Share based compensation                                                                       |       | 666                                       |       | — |   |
| Depreciation and amortization                                                                  |       | 1,319                                     |       | 1,053 |   |
| Amortization and impairment of mortgage  servicing rights                                      |       | 351                                       |       | 289 |   |
| Net change in accrued interest receivable                                                      |       | 12,046                                    |       | (6,949 | ) |
| Net change in restricted cash                                                                  |       | (245                                      | )          | 251,581 |   |
| Net change in other assets and liabilities                                                     |       | 20,924                                    |       | 26,293 |   |
| Net cash provided by (used in) operating  activities                                           |       | 1,383,988                                 |       | (103,487 | ) |
|                                                                                           |       |                                      |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                      | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net change in securitized mortgage  collateral                                                 |       | 1,458,964                                 |       | (1,138,912 | ) |
| Net change in finance receivables                                                              |       | 58,267                                    |       | 35,936 |   |
| Purchase of premises and equipment                                                             |       | (980                                      | )          | (2,324 | ) |
| Net change in mortgages held-for-investment                                                    |       | 137,607                                   |       | (572,795 | ) |
| Purchase of investment securities  available-for-sale                                          |       | 5,022                                     |       | — |   |
| Net change in mortgage servicing rights                                                        |       | —                                    |       | (1,161 | ) |
| Purchase of investments for deferred  compensation plan                                        |       | —                                    |       | (207 | ) |
| Net principal reductions on investment  securities available-for-sale                          |       | (638                                      | )          | 446 |   |
| Proceeds from the sale of other real estate  owned                                             |       | 16,838                                    |       | 9,904 |   |
| Net cash provided by (used in) investing  activities                                           |       | 1,675,080                                 |       | (1,669,113 | ) |
|                                                                                           |       |                                      |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                      | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net change in reverse repurchase agreements                                                    |       | (1,437,547                                | )          | 905,996 |   |
| Proceeds from securitized mortgage  borrowings                                                 |       | 905,942                                   |       | 2,557,477 |   |
| Repayment of securitized mortgage  borrowings                                                  |       | (2,420,682                                | )          | (1,784,370 | ) |
| Common stock dividends paid                                                                    |       | (15,225                                   | )          | — |   |
| Preferred stock dividends paid                                                                 |       | (3,672                                    | )          | (3,624 | ) |
| Proceeds from sale of cumulative redeemable  preferred stock                                   |       | 272                                       |       | — |   |
| Proceeds from exercise of stock options                                                        |       | —                                    |       | 1,231 |   |
| Net cash (used in) provided by financing  activities                                           |       | (2,970,912                                | )          | 1,676,710 |   |
|                                                                                           |       |                                      |       |   |   |
| Net change in cash and cash equivalents                                                        |       | 88,156                                    |       | (95,890 | ) |
| Cash and cash equivalents at beginning of period                                               |       | 146,621                                   |       | 324,351 |   |
| Cash and cash equivalents at end of period                                                     |       | $                                         | 234,777    |   | $ | 228,461 |   |
|                                                                                           |       |                                      |       |   |   |
| **SUPPLEMENTARY INFORMATION:**                                                                 | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Interest paid                                                                                  |       | $                                         | 202,787    |   | $ | 176,560 |   |
| Taxes paid                                                                                     |       | 32                                        |       | 1,546 |   |
|                                                                                           |       |                                      |       |   |   |
| **NON-CASH TRANSACTIONS:**                                                                     | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Accumulated other comprehensive gain (loss)                                                    |       | $                                         | (589       | ) | $ | 264 |   |
| Transfer of mortgages to other real estate  owned                                              |       | 29,690                                    |       | 15,178 |   |
| Dividends declared but unpaid                                                                  |       | 19,028                                    |       | 56,448 |   |

 

See accompanying notes to consolidated financial statements.

 

3

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**Note A—Summary of Business and Significant Accounting Policies**

 

**1.****     BusinessSummary and Financial Statement Presentation**

 

***Business Summary***

 

Unless thecontext otherwise requires, the terms “Company,” “we,” “us,” and “our” refer toImpac Mortgage Holdings, Inc. (IMH), a Maryland corporation incorporated inAugust 1995, and its subsidiaries, IMH Assets Corp. (IMH Assets), ImpacWarehouse Lending Group, Inc. (IWLG), Impac Commercial Capital Corporation(ICCC) formerly known as Impac Multi-family Capital Corporation (IMCC) andImpac Funding Corporation (IFC), together with its wholly-owned subsidiaryImpac Secured Assets Corp. (ISAC) .

 

We are amortgage real estate investment trust, or “REIT,” that is a nationwideacquirer, originator, seller and investor of non-conforming Alt-A residentialmortgages or “Alt-A mortgages” and to a lesser extent, small-balance commercialmortgages or “commercial mortgages” and sub-prime residential mortgages. Wealso provide warehouse financing to originators of mortgages.

 

We operatefour core businesses:

 

•      thelong-term investment operations that is conducted by IMH and IMH Assets;

 

•      themortgage operations that is conducted by IFC and ISAC;

 

•      thewarehouse lending operations that is conducted by IWLG; and

 

•      thecommercial operations that is conducted by ICCC.

 

The long-terminvestment operations generate earnings primarily from net interest incomeearned on mortgages held as securitized mortgage collateral and mortgagesheld-for-investment (long-term mortgage portfolio). The long-term mortgageportfolio as reported on our consolidated balance sheets consists of mortgagesheld as securitized mortgage collateral and mortgages held-for-investment.Investments in Alt-A mortgages and commercial mortgages are initially financedwith short-term borrowings under reverse repurchase agreements, which aresubsequently converted to long-term financing in the form of  securitized mortgage borrowings. Cash flowsfrom the long-term mortgage portfolio and proceeds from the sale of capitalstock also finance the acquisition of new Alt-A and commercial mortgages.

 

The mortgageoperations acquire, originate, sell and securitize primarily Alt-A adjustablerate mortgages (ARMs) and fixed rate mortgages (FRMs) and, to a lesser extent, subprimeresidential mortgages from correspondents, mortgage brokers and retailcustomers. Correspondents originate and close mortgages under their mortgageprograms and then sell the closed loans to the mortgage operations on a flow(loan-by-loan) basis or through bulk sale commitments. Correspondents includesavings and loan associations, commercial banks and mortgage bankers. Themortgage operations generate income by securitizing and selling mortgages topermanent investors, including the long-term investment operations. Thisbusiness also earns revenue from fees associated with mortgage servicingrights, master servicing agreements and interest income earned on mortgagesheld-for-sale. The mortgage operations use facilities provided by the warehouselending operations to finance the acquisition and origination of mortgages.

 

The warehouselending operations provide repurchase financing to mortgage loan originators,including the mortgage and commercial operations, by funding mortgages fromtheir closing date until sale to pre-approved investors. This business earnsfees from each transaction as well as net interest income from the differencebetween its cost of borrowings and the interest earned on repurchase advances.

 

OnJanuary 1, 2006, we elected to convert Impac Commercial CapitalCorporation “ICCC” from a qualified REIT subsidiary to a taxable REITsubsidiary.  Beginning in 2006, weexpanded our product guidelines to include other commercial loan products. Theprior loan portfolio remains as part of the REIT assets while the commercialorigination operations, ICCC, is now subject to state and federal income taxes.

 

The commercialoperations originate commercial mortgages, that are primarily adjustable ratemortgages with initial fixed interest rate periods of two-, three-, five-,seven- and ten-years that subsequently adjust to adjustable rate mortgages, or “hybridARMs,” with balances that generally range from $500,000 to$5.0 million.  Commercial mortgageshave interest rate

 

4

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floors, which is the initialstart rate, in some circumstances have lock out periods, and prepayment penaltyperiods of three-,five-, seven- andten-years. These mortgages provide greater asset diversification on our balancesheet as commercial mortgage borrowers typically have higher credit scores andtypically have lower loan-to-value ratios, or “LTV ratios,” and the mortgageshave longer average lives than residential mortgages.

 

The Companysecuritizes mortgages in the form of collateralized mortgage obligations (CMOs)and real estate mortgage investment conduits (REMICs). The typical CMOsecuritization is designed so that the transferee (securitization trust) is nota qualifying special purpose entity (QSPE) and thus as the sole residualinterest holder, the Company consolidates such variable interest entity.Amounts consolidated are classified as securitized mortgage collateral andsecuritized mortgage borrowings in the consolidated balance sheets. Generally,the typical REMIC securitization qualifies for sales accounting treatment andthe securitization trust is a QSPE and thus not consolidated by the Company. Inthe event that a REMIC securitization trust does not meet sale accounting andQSPE criteria, the securitization is treated as a secured borrowing andconsolidation is assessed pursuant to FIN 46R.

 

In 2005 and2006, we completed ISAC REMIC 2005-2 and ISAC REMIC 2006-1 securitizationswhich were treated as sales for tax purposes but treated as secured borrowingsfor generally accepted accounting principles (GAAP) purposes and consolidatedin the financial statements. The associated collateral and borrowings have beencombined with CMO’s and included in securitized mortgage collateral andborrowings, respectively, for reporting purposes. Hence, reference to “securitizedmortgage collateral” or “securitized mortgage borrowings” includes the REMIC2005-2 and 2006-1 securitized collateral and borrowings, respectively.

 

InJanuary 2006, we combined our Alt-A wholesale and subprime residentialmortgage product offerings under one platform. Our subprime residentialmortgage products previously marketed under Novelle FinancialServices, Inc., are now offered by our Alt-A wholesale operations, ImpacLending Group (ILG), a division of IFC.

 

***Financial Statement Presentation***

 

Theaccompanying unaudited consolidated financial statements of IMH and oursubsidiaries (as defined above) have been prepared in accordance with GAAP forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnotes required by GAAP forcomplete financial statements.  In the opinionof management, all adjustments, consisting of normal recurring adjustmentsconsidered necessary for a fair presentation, have been included.  Operating results for the three-month periodended March 31, 2006 are not necessarily indicative of the results that may beexpected for the year ending December 31, 2006.

 

All significantinter-company balances and transactions have been eliminated inconsolidation.  In addition, certainamounts in the prior periods’ consolidated financial statements have beenreclassified to conform to the current year presentation.

 

Management hasmade a number of estimates and assumptions relating to the reporting of assetsand liabilities, the disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period to prepare these financial statements inconformity with GAAP.  The items effectedby management’s estimates and assumptions include allowance for loan losses,valuation of derivative financial instruments, repurchase liabilities relatedto sold loans and the amortization of various loan premiums and discounts dueto prepayment estimates. Actual results could differ from those estimates.

 

Premiums,discounts and securitization costs associated with the securitized mortgagecollateral and securitized mortgage borrowing are amortized or accreted intointerest income/expense over the projected lives of the securitized mortgagecollateral and securitized mortgage borrowings using the interest method.  Our policy for estimating prepayment speedsfor calculating the effective yield is to evaluate historical performance,market prepayment speeds, and current conditions.  If our estimate of prepayments is incorrect,we may be required to make an adjustment to the amortization or accretion ofpremiums and discounts that would have an impact on future income.

 

**2.****     StockOptions**

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 123 (revised 2004), “Share-BasedPayment,” ** **(“SFAS 123R”). ThisStatement requires companies to expense the estimated fair value of stockoptions and similar equity instruments issued to employees over the requisiteservice period. SFAS 123R eliminates the alternative to use the intrinsicmethod of accounting provided for in Accounting Principles Board OpinionNo. 25, Accounting for Stock Issued to Employees (“APB 25”), whichgenerally resulted in no

 

5

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compensationexpense recorded in the financial statements related to the grant of stockoptions to employees if certain conditions were met.   The future impact of adoption of SFAS 123Rcannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had we adopted SFAS 123Rin prior periods, the impact of SFAS 123R would have approximated the impact ofSFAS 123 as described in the disclosure of pro forma net earnings per share.

 

Effective for the first quarterof fiscal 2006, we adopted SFAS 123R using the modified prospective method,which requires us to record compensation expense for all awards granted afterthe date of adoption, and for the unvested portion of previously granted awardsthat remain outstanding at the date of adoption. Accordingly, prior periodamounts presented herein have not been restated to reflect the adoption of SFAS123R.  As required, the pro forma impactfrom recognition of the estimated fair value of stock options granted toemployees has been disclosed for previous periods.

 

The fair value concepts werenot changed significantly in SFAS 123R; however, in adopting SFAS 123R,companies must choose among alternative valuation models and amortizationassumptions. After assessing alternative valuation models and amortizationassumptions, we will continue using both the Black-Scholes-Mertonoption-pricing formula and straight-line amortization of compensation expenseover the requisite service period of the grant. We will reconsider use of theBlack-Scholes-Merton model if additional information becomes available in thefuture that indicates another model would be more appropriate for the Company,or if grants issued in future periods have characteristics that cannot bereasonably estimated using this model. Under SFAS No. 123, “Accounting forStock Based Compensation” (“SFAS 123”), we were not required to estimateforfeitures in our expense calculation for the stock compensation pro formafootnote disclosure; however, SFAS 123R requires an estimate of forfeitures andupon adoption we changed our methodology to include an estimate of forfeitures.The adoption of SFAS 123R had no effect on cash flows from financingactivities.

 

The following table illustratesthe impact as if the Company had elected to use the fair value approach toaccount for its employee stock-based compensation plan at March 31, 2005:

 

| ** **                                                            | ** ** | **For the Three Months  Ended March 31, 2005** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------|------------|
| Net earnings available to common  stockholders                        |       | $                                              | 169,986    |   |
| Less: Total stock-based employee expense  using the fair value method |       | (546                                           | )          |
| Pro forma net earnings                                                |       | $                                              | 169,440    |   |
|                                                                  |       |                                           |       |
| Net earnings per share as reported:                                   |       |                                           |       |
| Basic                                                                 |       | $                                              | 2.26       |   |
| Diluted                                                               |       | $                                              | 2.23       |   |
|                                                                  |       |                                           |       |
| Pro forma net earnings per share:                                     |       |                                           |       |
| Basic                                                                 |       | $                                              | 2.25       |   |
| Diluted                                                               |       | $                                              | 2.23       |   |

 

The fair value of optionsgranted, which is amortized to expense over the option vesting period, isestimated on the date of grant using the Black-Scholes-Merton optionpricing model with the following weighted average assumptions:

 
| ** **                             | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| Risk-free interest rate                |       | 3.90%-4.26%                               |       | 2.16%-4.50% |   |
| Expected lives (in years)              |       | 3                                         |       | 3 - 4 |   |
| Expected volatility (1)                |       | 34.75%                                    |       | 42.26% |   |
| Expected dividend yield                |       | 10.00%                                    |       | 10.00% |   |
| Grant date fair value of share options |       | $1.79                                     |       | $3.71 |   |

 

----

(1)        Expected volatilities are based on the historicalvolatility of the Company’s stock over the expected option life.

 

6

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The following table summarizesactivity, pricing and other information for the Company’s stock options for thethree-month period ended March31, 2006:

 
| ** **                               | ** ** | **For the quarter ended March 31,** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|
| ** **                               | ** ** | **Number of  Shares**               | ** ** | **Weighted-  Average  Exercise  Price $** | ** ** | **Weighted-  Average  Remaining Life  (Years)** | ** ** | **Aggregate  Intrinsic  Value (1)  (in thousands)** | ** ** |
| Options outstanding at beginning of year |       | 5,266,544                           |       | 14.55 |   |   |   |   |   |
| Options granted                          |       | —                              |       | — |   |   |   |   |   |
| Options exercised                        |       | —                              |       | — |   |   |   |   |   |
| Options forfeited / cancelled            |       | (259,168                            | )          | 16.39 |   |   |   |   |   |
| Options outstanding at end of period     |       | 5,007,376                           |       | 14.46 |   | 2.73 |   | $ | 3,967.9 |   |
| Options exercisable at end of period     |       | 2,325,351                           |       | 12.04 |   | 2.72 |   | $ | 3,967.9 |   |

 

----

(1)        The intrinsic value of a stock option is the amount by which the fairvalue of the underlying stock exceeds the exercise price of the option.

 

The aggregate intrinsic valuein the preceding table represents the total pretax intrinsic value, based onthe Company’s closing stock price of $9.64 as of March 31, 2006, which wouldhave been received by the option holders had all option holders exercised theiroptions as of that date.

 

Additional informationregarding stock options outstanding as of March 31, 2006, is as follows:

 
| ** **                          | ** ** | **Stock Options Outstanding** | ** ** | **Options Exercisable**                                                 | ** ** |
|-------------------------------------|------------|-------------------------------|------------|-------------------------------------------------------------------------|------------|
| **Exercise  Price  Range ($)** | ** ** | **Number  Outstanding**       | ** ** | **Weighted-  Average  Remaining  Contractual  Life in Years** | ** ** | **Weighted-  Average  Exercise  Price ($)** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise  Price ($)** | ** ** |
| 3.85                                |       | 22,500                        |       | 4.84                                                                    |       | 3.85 |   | 22,500 |   | 3.85 |   |
| 4.18                                |       | 652,500                       |       | 4.99                                                                    |       | 4.18 |   | 652,500 |   | 4.18 |   |
| 4.44 - 9.42                         |       | 121,250                       |       | 5.42                                                                    |       | 7.37 |   | 121,250 |   | 7.37 |   |
| 10.54                               |       | 20,000                        |       | 0.08                                                                    |       | 10.54 |   | 20,000 |   | 10.54 |   |
| 10.95                               |       | 408,622                       |       | 0.33                                                                    |       | 10.95 |   | 408,622 |   | 10.95 |   |
| 13.76                               |       | 1,455,500                     |       | 3.37                                                                    |       | 13.76 |   | — |   | — |   |
| 14.27                               |       | 1,079,838                     |       | 1.33                                                                    |       | 14.27 |   | 646,658 |   | 14.27 |   |
| 21.77                               |       | 40,000                        |       | 8.23                                                                    |       | 21.77 |   | 40,000 |   | 21.77 |   |
| 22.83                               |       | 685,500                       |       | 2.33                                                                    |       | 22.83 |   | 228,827 |   | 22.83 |   |
| 23.10                               |       | 521,666                       |       | 2.34                                                                    |       | 23.10 |   | 184,994 |   | 23.10 |   |
| 3.85 - 23.10                        |       | 5,007,376                     |       | 2.73                                                                    |       | 14.46 |   | 2,325,351 |   | 12.04 |   |

 

**3.****     RecentAccounting Pronouncements**

 

In February 2006, the FASBissued SFAS No. 155, *“Accounting for CertainHybrid Financial Instruments”, an amendment of FASB Statements No. 133 and SFASNo. 140* (“SFAS 155”). This statement permits fair valueremeasurement for any hybrid financial instrument that contains an embeddedderivative that otherwise would require bifurcation. It also clarifies whichinterest-only strips and principal-only strips are not subject to FASBStatement No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS 133”). The statement also establishes a requirement toevaluate interests in securitized financial assets to identify interests thatare freestanding derivatives or hybrid financial instruments that contain anembedded derivative requiring bifurcation. The statement also clarifies thatconcentration of credit risks in the form of subordination are not embedded derivatives,and it also amends SFAS 140 to eliminate the prohibition on a QSPE from holdinga derivative financial instrument that pertains to a beneficial interest otherthan another derivative financial instrument. SFAS 155 is effective for allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal

 

7

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year thatbegins after September 15, 2006. The adoption of this statement by the companywill not have a significant effect on the financial results of operations.

 

In March 2006, the FASB issuedSFAS No. 156, *“Accounting for Servicing of FinancialAssets”-an amendment of FASB Statement No. 140* (“SFAS 156”). Thisstatement requires an entity to recognize a servicing asset or servicingliability each time it undertakes an obligation to service a financial asset byentering into a servicing contract in any of the following situations; whenevera transfer of the servicer’s financial assets that meets the requirements forsale accounting, a transfer of the servicer’s financial assets to a qualifyingspecial-purpose entity in a guaranteed mortgage securitization in which thetransferor retains all of the resulting securities and classifies them aseither available-for-sale securities or trading securities in accordance withFASB Statement No. 115, Accounting for Certain Investments in Debt and EquitySecurities, an acquisition or assumption of an obligation to service afinancial asset that does not relate to financial assets of the servicer or itsconsolidated affiliates. This statement requires all separately recognizedservicing assets and servicing liabilities to be initially measured at fairvalue, if practicable. This statement permits an entity to choose either of theamortizations method or the fair value measurement methods for each class ofseparately recognized servicing assets and servicing liabilities. Thisstatement at its initial adoption, permits a one-time reclassification ofavailable-for-sale securities to trading securities by entities with recognizedservicing rights, without calling into question the treatment of otheravailable-for-sale securities under Statement 115, provided that theavailable-for-sale securities are identified in some manner as offsetting theentity’s exposure to changes in fair value of servicing assets or servicingliabilities that a servicer elects to subsequently measure at fair value. Thisstatement also requires separate presentation of servicing assets and servicingliabilities subsequently measured at fair value in the statement of financialposition and additional disclosures for all separately recognized servicingassets and servicing liabilities. An entity should adopt this statement as ofthe beginning of its first fiscal year that begins after September 15, 2006.The adoption of this statement by the company will not have a significanteffect on the financial results of operations.

 

**4.****     LegalProceedings**

 

The Company is party tolitigation and claims which are normal in the course of our operations.  While the results of such litigation andclaims can not be predicted with certainty, the Company believes the finaloutcome of such matters will not have a material adverse effect on ourfinancial condition or results of operations.

 

**Note B—Reconciliationof Earnings Per Share**

 

The following table presentsthe computation of basic and diluted net earnings per share including thedilutive effect of stock options and cumulative redeemable preferred stockoutstanding for the periods indicated:

 

8

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| ** **                                                                      | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                  | ** ** | **2005** | ** ** |
| **Numerator for basic earnings per share:**                                     | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Net earnings                                                                    |       | $                                         | 85,566     |   | $ | 173,610 |   |
| Less: Cash dividends on cumulative  redeemable preferred stock                  |       | (3,672                                    | )          | (3,624 | ) |
| Net earnings available to common  stockholders                                  |       | $                                         | 81,894     |   | $ | 169,986 |   |
| **Denominator for basic earnings per share:**                                   | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Basic weighted average number of common  shares outstanding during the period   |       | 76,113                                    |       | 75,206 |   |
| **Denominator for diluted earnings per share:**                                 | ** ** | ** **                                | ** ** | ** ** | ** ** |
| Diluted weighted average number of common  shares outstanding during the period |       | 76,113                                    |       | 75,206 |   |
| Net effect of dilutive stock options                                            |       | 266                                       |       | 1,039 |   |
| Diluted weighted average common shares                                          |       | 76,379                                    |       | 76,245 |   |
|                                                                            |       |                                      |       |   |   |
| Net earnings per share:                                                         |       |                                      |       |   |   |
| Basic                                                                           |       | $                                         | 1.08       |   | $ | 2.26 |   |
| Diluted                                                                         |       | $                                         | 1.07       |   | $ | 2.23 |   |

 

For the three month periodsended March 31, 2006 and 2005, stock options to purchase 4.4 million and 1.4million shares, respectively, were outstanding but not included in the aboveweighted average calculations because they were anti-dilutive.

 

**NoteC—Segment Reporting**

 

The following tables present reporting segments for the three monthperiods ended March 31, 2006 and 2005:

 
| ** **                                                         | ** ** | **Reporting Segments as of and for the Three Months  Ended March 31, 2006** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Long-Term  Investment  Operations**                                       | ** ** | **Warehouse  Lending  Operations** | ** ** | **Mortgage  Operations  (IFC)** | ** ** | **Commercial  Operations** | ** ** | **Inter-  Company (1)** | ** ** | **Consolidated** | ** ** |
| **Balance Sheet Items:**                                           | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage collateral and mortgages  held-for-investment |       | $                                                                           | 23,106,162 |   | $ | — |   | $ | — |   | $ | 120 |   | $ | (127,956 | ) | $ | 22,978,326 |   |
| Mortgages held-for-sale                                            |       | —                                                                      |       | — |   | 712,632 |   | 88,466 |   | — |   | 801,098 |   |
| Finance receivables                                                |       | —                                                                      |       | 1,063,883 |   | — |   | — |   | (771,933 | ) | 291,950 |   |
| Total assets                                                       |       | 23,384,829                                                                  |       | 1,193,782 |   | 837,754 |   | 92,607 |   | (666,674 | ) | 24,842,298 |   |
| Total stockholders’ equity                                    |       | 1,030,473                                                                   |       | 225,023 |   | 107,464 |   | 1,385 |   | (149,424 | ) | 1,214,921 |   |
|                                                               |       |                                                                        |       |   |   |   |   |   |   |   |   |   |   |
| **Income Statement Items:**                                        | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest income                                                |       | $                                                                           | (12,088    | ) | $ | 7,691 |   | $ | 1,277 |   | $ | 134 |   | $ | 14,460 |   | $ | 11,474 |   |
| Provision for loan losses                                          |       | 150                                                                         |       | — |   | — |   | — |   | — |   | 150 |   |
| Realized gain from derivatives                                     |       | 40,136                                                                      |       | — |   | — |   | — |   | — |   | 40,136 |   |
| Change in fair value of derivatives                                |       | 46,963                                                                      |       | — |   | 3,625 |   | 841 |   | — |   | 51,429 |   |
| Other non-interest income                                          |       | (264                                                                        | )          | 797 |   | 21,165 |   | 1,036 |   | (6,560 | ) | 16,174 |   |
| Non-interest expense and income taxes                              |       | 4,038                                                                       |       | 1,874 |   | 23,814 |   | 2,410 |   | 1,361 |   | 33,497 |   |
| Net earnings (loss)                                                |       | $                                                                           | 70,559     |   | $ | 6,614 |   | $ | 2,253 |   | $ | (399 | ) | $ | 6,539 |   | $ | 85,566 |   |

 

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(1)        Income statement items include inter-company loan sale transactions andthe elimination of related gains. Corporate overhead expenses are allocated to the segments based onpercentage of time devoted to the segment.

 

9

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| ** **                                                         | ** ** | **Reporting Segments as of and for the Three Months  Ended March 31, 2005** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Long-Term  Investment  Operations**                                       | ** ** | **Warehouse  Lending  Operations** | ** ** | **Mortgage  Operations  (IFC)** | ** ** | **Inter-  Company (1)** | ** ** | **Consolidated** | ** ** |
| **Balance Sheet Items:**                                           | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage collateral and  mortgages held-for-investment |       | $                                                                           | 23,666,532 |   | $ | — |   | $ | — |   | $ | (130,347 | ) | $ | 23,536,185 |   |
| Mortgages held-for-sale                                            |       | —                                                                      |       | 758 |   | 1,064,298 |   | — |   | 1,065,056 |   |
| Finance receivables                                                |       | —                                                                      |       | 2,595,401 |   | — |   | (2,159,517 | ) | 435,884 |   |
| Total assets                                                       |       | 23,996,537                                                                  |       | 2,607,680 |   | 1,165,122 |   | (2,082,667 | ) | 25,686,672 |   |
| Total stockholders’ equity                                    |       | 1,010,170                                                                   |       | 173,452 |   | 46,872 |   | (71,392 | ) | 1,159,102 |   |
|                                                               |       |                                                                        |       |   |   |   |   |   |   |   |   |
| **Income Statement Items:**                                        | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest income                                                |       | $                                                                           | 52,119     |   | $ | 11,341 |   | $ | 1,974 |   | $ | 15,672 |   | $ | 81,106 |   |
| Provision for loan losses                                          |       | 6,074                                                                       |       | — |   | — |   | — |   | 6,074 |   |
| Realized from derivatives                                          |       | (13,727                                                                     | )          | — |   | — |   | — |   | (13,727 | ) |
| Change in fair value of derivatives                                |       | 128,878                                                                     |       | — |   | 2,440 |   | — |   | 131,318 |   |
| Other non-interest income                                          |       | (157                                                                        | )          | 2,027 |   | 43,519 |   | (31,174 | ) | 14,215 |   |
| Non-interest expense and income taxes                              |       | 2,693                                                                       |       | 2,085 |   | 31,767 |   | (3,317 | ) | 33,228 |   |
| Net earnings (loss)                                                |       | $                                                                           | 158,346    |   | $ | 11,283 |   | $ | 16,166 |   | $ | (12,185 | ) | $ | 173,610 |   |

 

----

(1)        Income statement items include inter-company loan sale transactions andthe elimination of related gains. Corporate overhead expenses are allocated to the segments based onpercentage of time devoted to the segment.

 

**NoteD—Mortgages Held-for-Sale**

 

Mortgages held-for-sale for theperiods indicated consisted of the following:

 

| ** **                                             | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| Mortgages held-for-sale - residential                  |       | $                      | 702,885    |                      | $          | 2,027,194 |   |
| Mortgages held-for-sale - commercial                   |       | 87,773                 |       | —                    |       |
| Change in fair value of mortgages  held-for-sale       |       | (969                   | )     | (4,465                    | )          |
| Net premiums on mortgages held-for-sale -  residential |       | 10,716                 |       | 29,965                    |       |
| Net premiums on mortgages held-for-sale -  commercial  |       | 693                    |       | —                    |       |
| Total mortgages held-for-sale                          |       | $                      | 801,098    |                      | $          | 2,052,694 |   |

 

The provision for loanrepurchases and gains and losses on repurchases are recorded against the gainon mortgages held-for-sale. Included in other liabilities as of March 31,2006 and December 31, 2005, was a liability for mortgage repurchases of$18.3 million and $10.4 million, respectively. The liability formortgage repurchases is maintained for the purpose of  providing for estimated losses fromrepurchasing previously sold mortgages for various reasons, including earlypayment defaults or breach of representations or warranties, which may be subsequentlysold at a loss. In determining the adequacy of the liability for mortgagerepurchases, management considers such factors as specific requests forrepurchase, known problem loans, underlying collateral values, recent salesactivity of similar loans and other appropriate information. In the opinion ofmanagement, the potential exposure related to these representations andwarranties will not have a material adverse effect on our financial conditionand results of operations.

 

During the quarter ended March31, 2006 and 2005, the provision for loan repurchases was $10.3 million and$3.7 million respectively. The loss on sale of repurchased and re-pricedmortgages for the quarter ended March 31, 2006 and 2005, was $184 thousandand $846 thousand, respectively.

 

10

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**NoteE—****SecuritizedMortgage Collateral**

 

Securitized mortgage collateralconsisted of the following:

 

| ** **                                                  | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| Mortgages secured by single-family  residential real estate |       | $                      | 21,250,208 |                      | $          | 22,986,632 |   |
| Mortgages secured by commercial real estate                 |       | 1,422,854              |       | 1,195,541                 |       |
| Net unamortized premiums on mortgages -  residential        |       | 269,624                |       | 301,709                   |       |
| Net unamortized premiums on mortgages -  commercial         |       | 14,708                 |       | 10,408                    |       |
| Total securitized mortgage collateral                       |       | $                      | 22,957,394 |                      | $          | 24,494,290 |   |

 

**NoteF—Allowance for Loan Losses**

 

The allowance for loan loss iscomprised of the following:

 

| ** **                                                         | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| Securitized mortgage collateral and  mortgages held-for-investment |       | $                      | 53,716     |                      | $          | 55,007 |   |
| Specific reserve for finance receivables                           |       | 10,683                 |       | 10,683                    |       |
| Specific reserve for estimated hurricane  losses                   |       | 9,859                  |       | 12,824                    |       |
| Total allowance for loan losses                                    |       | $                      | 74,258     |                      | $          | 78,514 |   |

 

Activity for allowance for loanlosses for the periods indicated was as follows:

 

| ** **                      | ** ** | **At March 31,** | ** ** | **At March 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **2006**                   | ** ** | **2005**                   | ** ** |
| Beginning balance               |       | $                          | 78,514     |                       | $          | 63,955 |   |
| Provision for loan losses       |       | 150                        |       | 6,074                      |       |
| Charge-offs, net of recoveries  |       | (4,406                     | )          | (3,240                     | )          |
| Total allowance for loan losses |       | $                          | 74,258     |                       | $          | 66,789 |   |

 

11

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**NoteG—Other Assets**

 

Other assets for the periodsindicated consisted of the following:

 
| ** **                                 | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|--------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| Real estate owned                          |       | $                      | 59,557     |                      | $          | 46,351 |   |
| Deferred charge                            |       | 46,770                 |       | 47,406                    |       |
| Investment securities available-for-sale   |       | 35,245                 |       | 40,227                    |       |
| Prepaid and other assets                   |       | 20,527                 |       | 34,422                    |       |
| Deferred income taxes                      |       | 12,076                 |       | 12,160                    |       |
| Premises and equipment , net               |       | 11,983                 |       | 12,312                    |       |
| Investment in Impac Capital Trusts         |       | 2,821                  |       | 2,884                     |       |
| Cash margin balances                       |       | 8,874                  |       | 16,567                    |       |
| Investments for deferred compensation plan |       | —                 |       | 8,041                     |       |
| Total other assets                         |       | $                      | 197,853    |                      | $          | 220,370 |   |

 

**Note H— Securitized Mortgage Borrowings**

 

Selected information onsecuritized mortgage borrowings for the periods indicated consisted of thefollowing (dollars in millions):

 
| ** **                               | ** ** | ** **                     | ** ** | **Securitized mortgage borrowings  outstanding as of** | ** ** | **Range of Percentages:** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|--------------------------------------------------------|------------|---------------------------|------------|
| **Year of Issuance**                     | ** ** | **Original  Issuance  Amount** | ** ** | **3/31/2006**                                          | ** ** | **12/31/2005**            | ** ** | **Fixed Interest  Rates** | ** ** | **Interest Rate  Margins over  One-Month  LIBOR (1)** | ** ** | **Interest Rate  Margins after  Adjustment  Date (2)** | ** ** |
| 2002                                     |       | $                              | 3,876.1    |                                                   | $          | 98.8                      |       | $ | 219.8 |   | 5.25 - 12.00 |   | 0.27 - 2.75 |   | 0.54 - 3.68 |   |
| 2003                                     |       | 5,966.1                        |       | 1,437.6                                                |       | 1,723.0                   |       | 4.34 - 12.75 |   | 0.27 - 3.00 |   | 0.54 - 4.50 |   |
| 2004                                     |       | 17,710.7                       |       | 8,931.4                                                |       | 10,191.9                  |       | 3.58 - 5.56 |   | 0.25 - 2.50 |   | 0.50 - 3.75 |   |
| 2005                                     |       | 13,387.7                       |       | 11,136.9                                               |       | 11,902.9                  |       | — |   | 0.24 - 2.90 |   | 0.48 - 4.35 |   |
| 2006                                     |       | 923.0                          |       | 923.0                                                  |       | —                    |       | 6.25 |   | 0.10 - 1.40 |   | 0.20 - 2.10 |   |
| Subtotal securitized mortgage borrowings |       |                           |       | 22,527.7                                               |       | 24,037.6                  |       |   |   |   |   |   |   |
| Accrued interest expense                 |       |                           |       | 18.2                                                   |       | 18.1                      |       |   |   |   |   |   |   |
| Unamortized securitization costs         |       |                           |       | (57.7                                                  | )          | (65.3                     | )          |   |   |   |   |   |   |
| Total securitized mortgage borrowings    |       |                           |       | $                                                      | 22,488.2   |                      | $          | 23,990.4 |   |   |   |   |   |   |   |
|                                          |            |                                |            |                                                        |            |                           |            |  |  |  |  |  |  |  |  |  |

 

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(1)        One-month LIBOR was 4.83%as of March 31, 2006.

 

(2)        Interest rate margins aregenerally adjusted when the unpaid principal balance is reduced to less than10-20% of the original issuance amount.

 

**NoteI—Reverse Repurchase Agreements**

 

Reverse repurchase agreementsare entered into to finance our warehouse lending operations and to fund andpurchase mortgages by the mortgage operations. These facilities consist of uncommitted lines, which may be withdrawn atany time by the lender, and committed lines. At March 31, 2006, the Company was in compliance with the financialcovenants associated with the reverse repurchase agreements.  During the first quarter of 2006, thesefacilities amounted to $4.4 billion, of which $992.5 million was outstanding atMarch 31, 2006.

 

12

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| **ITEM 2:** | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|------------------|------------|-------------------------------------------------------------------------------------------------|

 

Unless the context otherwiserequires, the terms “Company,” “we,” “us,” and “our” refer to Impac MortgageHoldings, Inc. (IMH), a Maryland corporation incorporated in August 1995, andits subsidiaries, IMH Assets Corp. (IMH Assets), Impac Warehouse Lending Group,Inc. (IWLG), Impac Commercial Capital Corporation (ICCC) formerly known asImpac Multi-family Capital Corporation (IMCC) and Impac Funding Corporation(IFC), together with its wholly-owned subsidiary Impac Secured Assets Corp.(ISAC) .

 

**Forward-Looking Statements**

 

This report on Form 10-Qcontains certain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934. Forward-looking statements, some of which are based on variousassumptions and events that are beyond our control, may be identified byreference to a future period or periods or by the use of forward-looking terminology, such as “may,” “will,”“believe,” “expect,” “likely,” “should,” “anticipate,” or similar terms orvariations on those terms or the negative of those terms. The forward-looking statements arebased on current management expectations. Actual results may differ materiallyas a result of several factors, including, but not limited to, failure toachieve projected earnings levels; unexpected increases in credit and bondspreads; the ability to generate sufficient liquidity; the ability to accessthe equity markets; increased operating expenses and mortgage origination orpurchase expenses that reduce current liquidity position more than anticipated;continued increase in price competition; risks of delays in raising, or theinability to raise, additional capital, either through equity offerings, linesof credit or otherwise; the ability to generate taxable income and to paydividends; interest rate fluctuations on our assets that differ from those onour liabilities; unanticipated interest rate fluctuations; changes inexpectations of future interest rates; unexpected increase in prepayment rateson our mortgages; changes in assumptions regarding estimated loan losses or anincrease in loan losses; continued ability to access the securitization marketsor other funding sources, the availability of financing and, if available, theterms of any financing; changes in markets which the Company serves, such asmortgage refinancing activity and housing price appreciation; and other generalmarket and economic conditions.

 

For a discussion of these andother risks and uncertainties that could cause actual results to differ fromthose contained in the forward-looking statements, see “Risk Factors” and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthe Company’s Annual Report on Form 10-K for the period ended December 31,2005, the other reports we file under the Securities and Exchange Act of 1934,and the additional risk factors set forth below in this quarterly report. Thisdocument speaks only as of its date and we do not undertake, and specificallydisclaim any obligation, to publicly release the results of any revisions thatmay be made to any forward-looking statements to reflect the occurrence of anticipatedor unanticipated events or circumstances after the date of such statements.

 

**TheMortgage Banking Industry and Discussion of Relevant Fiscal Periods**

 

The mortgage banking industryis continually subject to current events that occur in the financial servicesindustry. Such events include changes in economic indicators, interest rates,price competition, geographic shifts, disposable income, market anticipation,customer perception as well as others. The factors that effect the industrychange rapidly.

 

In this environment, mortgagebanking companies generally anticipate the future marketplace, engage inhedging activities and continuously reassess business plans and strategies toeffectively position themselves in the marketplace.

 

As a result, current events candiminish the relevance of “quarter over quarter” and “year-to-date overyear-to-date” comparisons of financial information. In such instances, theCompany intends to present financial information in its Management Discussionand Analysis that is the most relevant to its financial information.

 

**General Overview**

 

We are a mortgage real estateinvestment trust, or “REIT,” that is a nationwide acquirer, originator, sellerand investor of non-conforming Alt-A residential mortgages, or “Alt-A mortgages,”and to a lesser extent, small-balance, commercial mortgages, or “commercialmortgages” and sub-prime residential mortgages. We also provide warehouse financing to originators of mortgages.

 

13

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We operate four corebusinesses:

 

•      thelong-term investment operations that is conducted by IMH and IMH Assets;

 

•      themortgage operations that is conducted by IFC and ISAC;

 

•      thewarehouse lending operations that is conducted by IWLG; and

 

•      thecommercial operations that is conducted by ICCC.

 

The long-term investmentoperations primarily invest in adjustable rate and, to a lesser extent, fixedrate Alt-A mortgages and commercial mortgages that are acquired and originatedby our mortgage and commercial operations. Alt-A mortgages are primarily firstlien mortgages made to borrowers whose credit is generally within typicalFannie Mae and Freddie Mac guidelines, but have loan characteristics that makethem non-conforming under those guidelines. Some of the principal differencesbetween mortgages purchased by Fannie Mae and Freddie Mac and Alt-A mortgagesare as follows:

 

•      creditand income histories of the mortgagor;

 

•      underwritingguidelines for debt and income ratios;

 

•      documentationrequired for approval of the mortgagor; and

 

•      loanbalances in excess of maximum Fannie Mae and Freddie Mac lending limits.

 

For instance, Alt-A mortgagesmay not have certain documentation or verifications that are required by FannieMae and Freddie Mac and, therefore, in making our credit decisions, we are morereliant upon the borrower’s credit score and the adequacy of the underlyingcollateral. We believe that Alt-A mortgages provide an attractive net earningsprofile by producing higher yields without commensurately higher credit lossesthan other types of mortgages.

 

The long-term investmentoperations also invest in commercial mortgages that are primarily adjustablerate mortgages with initial fixed interest rate periods of two-, three-, five-,seven- and ten-years that subsequently convert to adjustable rate mortgages, or“hybrid ARMs,” with balances that generally range from $500,000 to $5.0million. Commercial mortgages have interest rate floors, which are the initialstart rate, in some circumstances lock out periods and prepayment penaltyperiods of three-, five-, seven- and ten-years. Commercial mortgages providegreater asset diversification on our balance sheet as borrowers of commercialmortgages typically have higher credit scores and commercial mortgages typicallyhave lower loan-to-value ratios, or “LTV ratios,” and longer average life topayoff than Alt-A mortgages.

 

The long-term investmentoperations generate earnings primarily from net interest income earned onmortgages held for long-term investment, or (long-term mortgageportfolio).  The long-term mortgageportfolio as reported on our consolidated balance sheet consists of mortgagesheld as securitized mortgage collateral and mortgages held-for-investment.Investments in Alt-A mortgages and commercial mortgages are initially financedwith short-term borrowings under reverse repurchase agreements that aresubsequently converted to long-term financing in the form of securitizedmortgage borrowings. Cash flows from the long-term mortgage portfolio, proceedsfrom the sale of capital stock and issuance of trust preferred securities alsofinance new Alt-A and commercial mortgages.

 

In 2005 and 2006, we completedISAC REMIC 2005-2 and ISAC REMIC 2006-1 securitizations which were treated assales for tax purposes but treated as secured borrowings for generally acceptedaccounting principles (GAAP) purposes and consolidated in the financialstatements. The associated collateral and borrowings have been combined withincluded in securitized mortgage collateral and borrowings, respectively, forreporting purposes. Reference to “securitized mortgage collateral” or “securitizedmortgage borrowings” includes the REMIC 2005-2 and 2006-1 securitizedcollateral and borrowings, respectively.

 

The mortgage operationsacquire, originate, sell and securitize primarily adjustable rate and fixedrate Alt-A mortgages and, to a lesser extent, subprime residential mortgages.The mortgage operations generate income by securitizing and selling mortgagesto permanent investors, including the long-term investment operations. Thisbusiness also earns revenue from fees associated with mortgage servicingrights, master servicing agreements and interest income earned on mortgagesheld for sale. The mortgage operations use warehouse facilities provided by thewarehouse lending operations to finance the acquisition and origination ofmortgages.

 

The warehouse lendingoperations provide short-term financing to mortgage loan originators, includingour mortgage operations, by funding mortgages from their closing date untilsale to pre-approved investors. This business earns fees from

 

14

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warehousetransactions as well as net interest income from the difference between itscost of borrowings and the interest earned on warehouse advances.

 

On January 1, 2006, weelected to convert the commercial operations from a qualified REIT subsidiaryto a taxable REIT subsidiary. Beginning in 2006, we expanded our productguidelines to include commercial loan products. The prior loan portfolioremains as part of the REIT assets while the commercial origination operations,ICCC, is now subject to state and federal income taxes.

 

The commercial operationsoriginate commercial mortgages that are primarily adjustable rate mortgageswith initial fixed interest rate periods of two-, three-, five-, seven- and ten-years that subsequently adjustto adjustable rate mortgages, or “hybrid ARMs,” with balances that generallyrange from $500,000 to $5.0 million. Commercial mortgages have interest rate floors, which is the initialstart rate,in some circumstances have lockouts and prepayment penalty periodsof three-, five-,seven- and ten-years.These mortgages provide greater asset diversification on our balance sheet ascommercial mortgage borrowers typically have higher credit scores and typicallyhave lower loan-to-value ratios, or “LTV ratios,” and the mortgages have longeraverage lives than residential mortgages.

 

*OfficerReappointments. *EffectiveMay 1, 2006, the Company appointed Richard J. Johnson as Executive VicePresident, Chief Operating Officer and Gretchen D. Verdugo as Executive VicePresident, Chief Financial Officer. In conjunction with the appointments,Mr. Johnson surrendered his title and duties as Executive Vice President,Chief Financial Officer, Ms. Verdugo surrendered her title as ChiefAccounting Officer, and William S. Ashmore surrendered his title and duties asChief Operating Officer, but remains President and a director of the Company.

 

**Critical Accounting Policies**

 

We define critical accountingpolicies as those that are important to the portrayal of our financialcondition and results of operations and may require estimates and assumptionsbased on our judgment of changing market conditions and the performance of ourassets and liabilities at any given time. In determining which accountingpolicies meet this definition, we considered our policies with respect to thevaluation of our assets and liabilities and estimates and assumptions used indetermining those valuations. We believe the most critical accounting issuesthat require the most complex and difficult judgments and that are particularlysusceptible to significant change to our financial condition and results ofoperations include allowance for loan losses, derivative financial instrumentsand securitization of financial assets as financing versus sale.

 

**Financial Highlights for the First Quarter of2006**

 

•      Estimatedtaxable income per diluted share was $0.36 compared to $0.19 for the fourthquarter of 2005 and $0.75 for the first quarter of 2005;

 

•      Cashdividends declared per common share were $0.25 for the first quarter of 2006compared to $0.20 for the fourth quarter of 2005 and $0.75 for the firstquarter of 2005;

 

•      Totalassets were $24.8 billion as of March 31, 2006 compared to $27.7 billion as ofDecember 31, 2005 and $25.7 billion as of March 31, 2005;

 

•      Bookvalue per common share was $13.87 as of March 31, 2006 compared to $13.24 as ofDecember 31, 2005 and $13.31 as of March 31, 2005;

 

•      Themortgage operations acquired and originated $2.1 billion of primarily Alt-Amortgages compared to $6.0 billion for the fourth quarter of 2005 and $4.7billion for the first quarter of 2005;

 

•      Thelong-term investment operations retained for investment $579.7 million ofprimarily Alt-A mortgages and $114.7 million of commercial mortgages comparedto $2.6 billion of primarily Alt-A mortgages and $206.6 million of commercialmortgages for the fourth quarter of 2005 and $3.3 billion of primarily Alt-Amortgages and $165.3 million of commercial mortgages for the first quarter of2005; and

 

•      Thecommercial mortgage operations originated $202.8 million of commercialmortgages compared to $206.6 million for the fourth quarter of 2005 and $165.3million for the first quarter of 2005.

 

15

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**First Quarter 2006 and 2005 Taxable Income**

 

Because dividend payments arebased on estimated taxable income, dividends may be more or less than netearnings. As such, we believe that the disclosure of estimated taxable incomeavailable to common stockholders, which is a non-generally accepted accountingprinciple, or “non-GAAP,” financial measurement, is useful information for ourinvestors.

 

The following table presents areconciliation of net earnings (GAAP) to estimated taxable income available tocommon stockholders for the periods indicated (in thousands, except per shareamounts):

 
| ** **                                                     | ** ** | **For the Three Months  Ended March 31, (1)** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                     | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| Net earnings                                                   |       | $                                             | 85,566     |   | $ | 173,610 |   |
| Adjustments to net earnings: (2)                               |       |                                          |       |   |   |
| Loan loss provision (4)                                        |       | 150                                           |       | 6,074 |   |
| REMIC income (3)                                               |       | 4,721                                         |       | — |   |
| Tax deduction for actual loan losses (4)                       |       | (4,406                                        | )          | (3,240 | ) |
| Change in fair value of derivatives (5)                        |       | (46,963                                       | )          | (128,878 | ) |
| Dividends on preferred stock                                   |       | (3,672                                        | )          | (3,624 | ) |
| Net earnings of taxable REIT subsidiaries  (6)                 |       | (1,854                                        | )          | (16,166 | ) |
| Dividend from taxable REIT subsidiaries (7)                    |       | —                                        |       | 16,850 |   |
| Elimination of inter-company loan sales  transactions (8)      |       | (6,539                                        | )          | 12,184 |   |
| Miscellaneous adjustments                                      |       | 120                                           |       | — |   |
| Estimated taxable income available to  common stockholders (9) |       | $                                             | 27,123     |   | $ | 56,810 |   |
| Estimated taxable income per diluted common  share (9)         |       | $                                             | 0.36       |   | $ | 0.75 |   |
| Diluted weighted average common shares  outstanding            |       | 76,379                                        |       | 76,245 |   |

 

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(1)        Estimatedtaxable income includes estimates of book to tax adjustments and can differfrom actual taxable income as calculated when we file our annual corporate taxreturn. Since estimated taxable income is a non-GAAP financial measurement, thereconciliation of estimated taxable income available to common stockholders tonet earnings is intended to meet the requirements of Regulation G aspromulgated by the SEC for the presentation of non-GAAP financial measurements.To maintain our REIT status, we are required to distribute a minimum of 90% ofour annual taxable income to our stockholders.

(2)        Certainadjustments are made to net earnings in order to calculate taxable income dueto differences in the way revenues and expenses are recognized under the twomethods.

(3)        IncludesGAAP to Tax Differences related to the ISAC REMIC 2005-2 and ISAC REMIC 2006-1securitizations, which were treated as secured borrowings for GAAP purposes andsales for tax purposes.

(4)        Tocalculate estimated taxable income, actual loan losses are deducted. For thecalculation of net earnings, GAAP requires a deduction for estimated lossesinherent in our mortgage portfolios in the form of a provision for loan losses,which are not deductible for tax purposes. Therefore, as the estimated lossesprovided for GAAP are actually realized, the losses will negatively and maymaterially impact future taxable income.

(5)        Themark-to-market change for the valuation of derivatives at IMH is income orexpense for GAAP financial reporting but is not included as an addition ordeduction for taxable income calculations.

(6)        Representsnet earnings of IFC and ICCC, our taxable REIT subsidiaries (TRSs), which maynot necessarily equal taxable income. Starting January 1, 2006, the Company elected to convert ICCC from aqualified REIT subsidiary to a TRS. Therefore, the three months ended March 31, 2005 does not includeany  net earnings or losses of ICCC.

(7)        Anydividends paid to IMH by the TRSs in excess of their cumulative undistributedtaxable income would be recognized as return of capital by IMH to the extent ofIMH’s capital investment in the TRSs. Distributions from the TRSs to IMH maynot equal the TRS’s net earnings, however, IMH can only recognize dividenddistributions received from the TRSs as taxable income to the extent that theTRS’s distributions are from current or prior period undistributed taxableincome. Any distributions by the TRS’s in excess of IMH’s capital investment inthe TRSs would be taxed as capital gains. The three months ended March 31, 2005 does not include any  net earnings or losses of ICCC

(8)        Includesthe effects to taxable income associated with the elimination of gains frominter-company loan sales and other intercompany transactions between IFC,ICCC,  and IMH, net of tax and therelated amortization of the deferred charge.

(9)        Excludesthe deduction for common stock dividends paid and the availability of adeduction attributable to net operating loss carry-forwards. As of December 31,2005, the Company has estimated Federal net operating loss carry-forwards of$18.1 million that are expected to be utilized prior to their expiration in theyear 2020.

 

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***First Quarter 2006 vs. Fourth Quarter 2005***

 

Estimated taxable incomeincreased $12.4 million to $27.1 million, or $0.36 per diluted common share,for the first quarter 2006, compared to $14.7 million or $0.19 per dilutedcommon share, for the fourth quarter 2005. The increase in estimated taxable income was mainly attributable to anincrease in adjusted net interest margin at IMH and taxable income fromREMICs  issued beginning in the fourthquarter of 2005.  The $8.9 millionincrease in adjusted net interest margin at IMH was the result of a $34.1million decline in interest income, offset by a decrease in borrowing costs of$28.7 million and an increase in the realized gain from derivative instrumentsof $14.3 million.  The taxable incomefrom REMICs of $4.7 million was primarily related to the taxable yield from theresiduals retained.

 

**Financial Condition and Results of Operations**

 

*Financial Condition*

Condensed Balance Sheet Data

(dollars in thousands)

 
| ** **                                          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
|-----------------------------------------------------|------------|---------------------|------------|------------------------|------------|--------------------------|------------|---------------|------------|
| Cash and cash equivalents                           |       | $                   | 234,777    |                   | $          | 146,621                  |       | $             | 88,156     |   | 60 | % |
| Restricted cash                                     |       | 943                 |       | 698                    |       | 245                      |       | 35            |       |
| Securitized mortgage collateral                     |       | 22,957,394          |       | 24,494,290             |       | (1,536,896               | )          | (6            | )          |
| Mortgages held-for-investment                       |       | 20,932              |       | 160,070                |       | (139,138                 | )          | (87           | )          |
| Finance receivables                                 |       | 291,950             |       | 350,217                |       | (58,267                  | )          | (17           | )          |
| Allowance for loan losses                           |       | (74,258             | )          | (78,514                | )          | (4,256                   | )          | (5            | )          |
| Mortgages held-for-sale                             |       | 801,098             |       | 2,052,694              |       | (1,251,596               | )          | (61           | )          |
| Derivatives                                         |       | 300,090             |       | 250,368                |       | 49,722                   |       | 20            |       |
| Accrued interest receivable                         |       | 111,519             |       | 123,565                |       | (12,046                  | )          | (10           | )          |
| Other assets                                        |       | 197,853             |       | 220,370                |       | (22,517                  | )          | (10           | )          |
| **Total assets**                                    |       | $                   | 24,842,298 |                   | $          | 27,720,379               |       | $             | (2,878,081 | ) | (10 | )% |
|                                                |       |                |       |                   |       |                     |       |          |       |
| Securitized mortgage borrowings                     |       | $                   | 22,488,155 |                   | $          | 23,990,430               |       | $             | (1,502,275 | ) | (6 | )% |
| Reverse repurchase agreements                       |       | 992,528             |       | 2,430,075              |       | (1,437,547               | )          | (59           | )          |
| Other liabilities                                   |       | 146,694             |       | 132,927                |       | 13,767                   |       | 10            |       |
| Total liabilities                                   |       | 23,627,377          |       | 26,553,432             |       | (2,926,055               | )          | (11           | )          |
| Total stockholder’s equity                     |       | 1,214,921           |       | 1,166,947              |       | 47,974                   |       | 4             |       |
| **Total liabilities and stockholder’s equity** |       | $                   | 24,842,298 |                   | $          | 27,720,379               |       | $             | (2,878,081 | ) | (10 | )% |

 

Total assets were$24.8 billion as of March 31, 2006 as compared to $27.7 billionas of December 31, 2005, as the long-term investment operations retained $579.7million of primarily Alt-A mortgages and $114.7 million of commercial mortgagesoffset by $2.8 billion in whole loan sales and $2.3 billion in total principalpay downs.

 

The following table presentsselected information about mortgages held as securitized mortgage collateral asof the dates indicated:

 

17

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| ** **                                    | ** ** | **Residential  As of** | ** ** | **Commercial  As of**  | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **March 31,  2006**    | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
| Percent of Alt-A mortgages                    |       | 99                     |       | 99                     |       | 99 |   | N/A |   | N/A |   | N/A |   |
| Percent of ARMs                               |       | 87                     |       | 89                     |       | 90 |   | 100 |   | 100 |   | 100 |   |
| Percent of FRMs                               |       | 13                     |       | 11                     |       | 10 |   | 0 |   | 0 |   | 0 |   |
| Percent of hybrid ARMs                        |       | 75                     |       | 75                     |       | 71 |   | 97 |   | 96 |   | 92 |   |
| Percent of interest-only                      |       | 72                     |       | 71                     |       | 64 |   | 12 |   | 11 |   | 0 |   |
| Weighted average coupon                       |       | 6.19                   |       | 6.10                   |       | 5.70 |   | 5.79 |   | 5.62 |   | 5.28 |   |
| Weighted average margin                       |       | 3.80                   |       | 3.79                   |       | 3.66 |   | 2.69 |   | 2.69 |   | 2.84 |   |
| Weighted average original LTV                 |       | 75                     |       | 76                     |       | 76 |   | 67 |   | 67 |   | 66 |   |
| Weighted average original credit score        |       | 696                    |       | 695                    |       | 696 |   | 730 |   | 728 |   | 725 |   |
| Percent with active prepayment penalty        |       | 75                     |       | 75                     |       | 76 |   | 100 |   | 100 |   | 100 |   |
| Prior 3-month constant prepayment rate        |       | 36                     |       | 38                     |       | 28 |   | 8 |   | 9 |   | 7 |   |
| Prior 12-month prepayment rate                |       | 39                     |       | 37                     |       | 28 |   | 9 |   | 9 |   | 6 |   |
| Lifetime prepayment rate                      |       | 26                     |       | 25                     |       | 22 |   | 5 |   | 5 |   | 3 |   |
| Weighted average debt service coverage  ratio |       | N/A                    |       | N/A                    |       | N/A |   | 1.24 |   | 1.22 |   | 1.28 |   |
| Percent of mortgages in California            |       | 54                     |       | 55                     |       | 61 |   | 66 |   | 71 |   | 86 |   |
| Percent of purchase transactions              |       | 60                     |       | 60                     |       | 59 |   | 52 |   | 52 |   | 49 |   |
| Percent of owner occupied                     |       | 80                     |       | 81                     |       | 83 |   | N/A |   | N/A |   | N/A |   |
| Percent of first lien                         |       | 99                     |       | 99                     |       | 99 |   | 100 |   | 100 |   | 100 |   |

 

The following table presentsselected financial data as of the dates indicated (dollars in thousands, exceptper share data):

 

| ** **                             | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **March 31,  2006**               | ** ** | **December 31,  2005** | ** ** | **March 31,  2005** | ** ** |
| Book value per share                   |       | $                                 | 13.87      |   | $ | 13.24 |   | $ | 13.31 |   |
| Return on average assets               |       | 1.30                              | %          | 1.01 | % | 2.81 | % |
| Return on average equity               |       | 29.18                             | %          | 24.13 | % | 65.06 | % |
| Assets to equity ratio                 |       | 20.45:1                           |       | 23.75:1 |   | 22.16:1 |   |
| Debt to equity ratio                   |       | 19.41:1                           |       | 22.72:1 |   | 21.07:1 |   |
| Mortgages owned 60+ days delinquent    |       | $                                 | 769,503    |   | $ | 733,348 |   | $ | 437,088 |   |
| 60+ day delinquency of mortgages owned |       | 3.39                              | %          | 3.12 | % | 1.94 | % |

 

We believe that in order for usto generate positive cash flows and earnings we must successfully manage thefollowing primary operational and market risks:

 

•      credit risk;

 

•      prepayment risk;

 

•      liquidity risk; and

 

•      interest rate risk.

 

*Credit Risk.*We manage credit risk by acquiring for long-term investment high credit qualityAlt-A and commercial mortgages from our customers, adequately providing forloan losses and actively managing delinquencies and defaults.  Alt-A mortgages are primarily first lienmortgages made to borrowers whose credit is generally within typical Fannie Maeand Freddie Mac guidelines, but that have loan characteristics that make themnon-conforming under those guidelines.

 

As of March 31, 2006, theoriginal weighted average credit score of mortgages held as residential andcommercial securitized mortgage collateral was 696 and 730, respectively, andthe original weighted average LTV ratio was 75% and

 

18

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67%respectively.  During the first quarterof 2006, the long-term investment operations retained $694.4 million ofprimarily adjustable and fixed rate Alt-A and commercial mortgages that wereacquired or originated by the mortgage and commercial operations with anoriginal weighted average credit score of 699 and an original weighted averageLTV ratio of 73%.  ICCC also originated$202.8 million of commercial mortgages with a weighted average credit score of732, a weighted average debt service cover ratio of 1.24 and an originalweighted average LTV of 68%.

 

We monitor our sub-servicers tomake sure that they perform loss mitigation, foreclosure and collectionfunctions according to our servicing guide. This includes an effective and aggressive collection effort in order tominimize the number of mortgages becoming seriously delinquent.  When resolving delinquent mortgages,sub-servicers are required to take timely and aggressive action.  The sub-servicer is required to determinepayment collection under various circumstances, which will result in maximumfinancial benefit.  We accomplish this byeither working with the borrower to bring the mortgage current or byforeclosing and liquidating the property. We perform ongoing reviews of mortgages that display weaknesses andbelieve that we maintain an adequate loss allowance on the mortgages.  When a borrower fails to make requiredpayments on a mortgage and does not cure the delinquency within 60 days, wegenerally record a notice of default and commence foreclosure proceedings.  If the mortgage is not reinstated within thetime period permitted by law for reinstatement, the property may then be soldat a foreclosure sale.  At foreclosuresales, we generally acquire title to the property.  As of March 31, 2006, our long-term mortgageportfolio included 3.39% of mortgages that were 60 days or more delinquentcompared to 3.12% as of December 31, 2005.

 

The following table summarizesmortgages that we own, including securitized mortgage collateral, mortgagesheld for long-term investment and mortgages held-for-sale, that were 60 or moredays delinquent for the periods indicated (in thousands):

 

| ** **                       | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|----------------------------------|------------|------------------------|------------|---------------------------|------------|
| 60 - 89 days delinquent          |       | $                      | 251,602    |                      | $          | 300,039 |   |
| 90 or more days delinquent       |       | 245,568                |       | 221,581                   |       |
| Foreclosures                     |       | 230,340                |       | 161,414                   |       |
| Delinquent bankruptcies          |       | 41,993                 |       | 50,314                    |       |
| Total 60 or more days delinquent |       | $                      | 769,503    |                      | $          | 733,348 |   |

 

Non-performing assets consistof mortgages that are 90 days or more delinquent, including loans inforeclosure and delinquent bankruptcies. It is our policy to place a mortgageon non-accrual status when it becomes 90 days delinquent and anypreviously accrued interest will be reversed from revenue. When real estate isacquired in settlement of loans, or other real estate owned, the mortgage iswritten-down to a percentage of the property’s appraised value or broker’sprice opinion less anticipated selling costs. As of March 31, 2006,non-performing assets as a percentage of total assets was 2.32% compared to1.73% as of December 31, 2005.

 

The following table summarizesmortgages that we own, including securitized mortgage collateral, mortgagesheld for long-term investment and mortgages held-for-sale, that werenon-performing for the periods indicated (in thousands):

 

| ** **                                                            | ** ** | **At March 31,  2006** | ** ** | **At December 31,  2005** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| 90 or more days delinquent, foreclosures and  delinquent bankruptcies |       | $                      | 517,901    |                      | $          | 433,309 |   |
| Other real estate owned                                               |       | 59,557                 |       | 46,351                    |       |
| Total non-performing assets                                           |       | $                      | 577,458    |                      | $          | 479,660 |   |

 

*PrepaymentRisk.*The Company uses prepayment penalties as amethod of partially mitigating prepayment risk. Mortgage industry evidence suggests that the increase in homeappreciation rates and lower payment option mortgage products over the lastthree years was a significant factor affecting borrowers refinancing decisionsthrough 2005.  As a result, mortgageprepayment rates accelerated during 2005 as it appeared that borrowers werewilling to pay prepayment penalties in order to cash out or obtain lowermonthly payments by refinancing into other mortgage products.  More recent

 

19

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behavior inour securitized mortgage collateral reflects some degree of reduced prepaymentswith the three-month constant prepayment rate (CPR) declining to 36% from 38%as of December 31, 2005.

 

During the quarter ended March31, 2006, 82% of Alt-A mortgages acquired by the long-term investmentoperations from the mortgage operations had prepayment penalty features rangingfrom six-months to five years.  As ofMarch 31, 2006, 75% and 100% of mortgages held as residential andcommercial securitized mortgage collateral had prepayment penalties,respectively.  As of March 31, 2006,the twelve-monthCPR of mortgages held as securitized mortgage collateral was 39% as compared toa 28% twelve-month CPRas of March 31, 2005.  Prepaymentpenalties are charged to borrowers for mortgages that are paid early andrecorded as interest income on our consolidated financial statements. Interestincome from prepayment penalties helps offset amortization of loan premiums andsecuritization costs. During the first quarter of 2006 prepayment penaltiesreceived from borrowers was recorded as interest income and increased the yieldon average mortgage assets by 19 basis points as compared to 9 basis points forthe same period in 2005.

 

*LiquidityRisk. *We employa leverage strategy to increase assets by financing our long-term mortgageportfolio primarily with securitized mortgage borrowings, reverse repurchaseagreements and capital, then using cash proceeds to acquire additional mortgageassets. We retain ARMs and FRMs that are acquired and originated fromthe mortgage and commercial operations and finance the acquisition of thosemortgages, during this accumulation period, with reverse repurchase agreements.After accumulating a pool of mortgages we securitize the mortgages in the formof securitized mortgage collateral. Our strategy is to sell or securitize ourmortgages within 90 days in order to reduce the accumulation period thatmortgages are outstanding on short-term reverse repurchase facilities, whichreduces our exposure to margin calls on these facilities. Securitized mortgageborrowings are classes of bonds that are sold to investors of mortgage-backed securities and assuch are not subject to margin calls. In addition, the securitized mortgageborrowings generally require a smaller initial cash investment as a percentageof mortgages financed than does interim reverse repurchase financing. Wecontinually monitor our leverage ratio and liquidity levels to insure that weare adequately protected against adverse changes in market conditions. Foradditional information regarding liquidity refer to “—Liquidity and CapitalResources.”

 

*Interest RateRisk.*Refer to Item 3. “Quantitative and QualitativeDisclosures About Market Risk.”

 

*Results of Operations*

 

*For the Three Months Ended March 31, 2006 compared to the Three MonthsEnded March 31, 2005*

 

Condensed Statements of Operations Data

(dollars in thousands, except share data)

 
| ** **                                           | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Interest income                                      |       | $                                        | 335,204    |   | $ | 277,380 |   | $ | 57,824 |   | 21 | % |
| Interest expense                                     |       | 323,730                                  |       | 196,274 |   | 127,456 |   | 65 |   |
| Net interest income                                  |       | 11,474                                   |       | 81,106 |   | (69,632 | ) | (86 | ) |
| Provision for loan losses                            |       | 150                                      |       | 6,074 |   | (5,924 | ) | (98 | ) |
| Net interest income after provision for  loan losses |       | 11,324                                   |       | 75,032 |   | (63,708 | ) | (85 | ) |
| Total non-interest income                            |       | 107,739                                  |       | 131,806 |   | (24,067 | ) | (18 | ) |
| Total non-interest expense                           |       | 35,348                                   |       | 35,691 |   | (343 | ) | (1 | ) |
| Income tax benefit                                   |       | (1,851                                   | )          | (2,463 | ) | 612 |   | 25 |   |
|                                                 |       | $                                        | 85,566     |   | $ | 173,610 |   | $ | (88,044 | ) | (51 | )% |
| Net earnings                                         |       |                                     |       |   |   |   |   |   |   |
|                                                 |       |                                     |       |   |   |   |   |   |   |
| Net earnings per share - diluted                     |       | $                                        | 1.07       |   | $ | 2.23 |   | $ | (1.16 | ) | (52 | )% |
| Dividends declared per common share                  |       | $                                        | 0.25       |   | $ | 0.75 |   | $ | (0.50 | ) | (67 | )% |

 

*NetInterest Income*

 

We earn interest incomeprimarily on mortgage assets which include securitized mortgage collateral,mortgages held-for-investment, mortgages held-for-sale, finance receivables andinvestment securities available-for-sale, or collectively,

 

20

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“mortgageassets,” and, to a lesser extent, interest income earned on cash and cashequivalents. Interest expense is primarily interest paid on borrowings onmortgage assets, which include securitized mortgage borrowings and reverserepurchase agreements.

 

The following table summarizesaverage balance, interest and weighted average yield on mortgage assets andborrowings on mortgage assets for the periods indicated (dollars in thousands):

 
| ** **                                                            | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                 | ** ** | **2005** | ** ** |
| ** **                                                            | ** ** | **Average  Balance**                     | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                                   | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Subordinated securities collateralized by  mortgages                  |       | $                                        | 40,159     |   | $ | 720 |   | 7.17 | % | $ | 25,193 |   | $ | 331 |   | 5.26 | % |
| Securitized mortgage collateral (1)                                   |       | 23,507,250                               |       | 297,509 |   | 5.06 | % | 22,042,801 |   | 244,375 |   | 4.43 | % |
| Mortgages held-for-investment and  held-for-sale                      |       | 1,776,874                                |       | 30,372 |   | 6.84 | % | 1,682,170 |   | 26,228 |   | 6.24 | % |
| Finance receivables                                                   |       | 301,009                                  |       | 4,775 |   | 6.35 | % | 384,166 |   | 5,087 |   | 5.30 | % |
| Total mortgage assets\ interest income                                |       | $                                        | 25,625,292 |   | $ | 333,376 |   | 5.20 | % | $ | 24,134,330 |   | $ | 276,021 |   | 4.57 | % |
|                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                        | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings                                       |       | $                                        | 23,015,890 |   | $ | 295,475 |   | 5.14 | % | $ | 21,742,654 |   | $ | 179,467 |   | 3.30 | % |
| Reverse repurchase agreements                                         |       | 1,919,992                                |       | 25,873 |   | 5.39 | % | 1,872,872 |   | 16,762 |   | 3.58 | % |
| Total borrowings on mortgage assets\  interest expense                |       | $                                        | 24,935,882 |   | $ | 321,348 |   | 5.15 | % | $ | 23,615,526 |   | $ | 196,229 |   | 3.32 | % |
|                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest Spread (2)                                               |       |                                     |       |   |   | 0.05 | % |   |   |   |   | 1.25 | % |
| Net Interest Margin (3)                                               |       |                                     |       |   |   | 0.19 | % |   |   |   |   | 1.32 | % |
|                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest Income on Mortgage Assets                                |       |                                     |       | $ | 12,028 |   | 0.19 | % |   |   | $ | 79,792 |   | 1.32 | % |
| Less: Accretion of loan discounts (4)                            |       |                                     |       | (15,920 | ) | (0.25 | ) |   |   | (17,032 | ) | (0.28 | ) |
| Adjusted by net cash receipts (payments) on  derivatives (5)          |       |                                     |       | 40,136 |   | 0.63 |   |   |   | (13,727 | ) | (0.23 | ) |
| Adjusted Net Interest Margin (6)                                      |       |                                     |       | $ | 36,244 |   | 0.57 | % |   |   | $ | 49,033 |   | 0.81 | % |
|                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization of loan premiums and  securitization costs (7) |       |                                     |       | $ | 62,499 |   | -0.98 | % |   |   | $ | 65,062 |   | -1.08 | % |

 

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(1)        Interestincludes amortization of acquisition cost on mortgages acquired from themortgage operations and accretion of loan discounts.

(2)        Netinterest spread on mortgage assets is calculated by subtracting the weightedaverage yield on total borrowings on mortgage assets from the weighted averageyield on total mortgage assets.

(3)        Netinterest margin on mortgage assets is calculated by subtracting interestexpense on total borrowings on mortgage assets from interest income on totalmortgage assets and then dividing by total mortgage assets.

(4)        Yieldrepresents income from the accretion of loan discounts, as defined in (1),divided by total average mortgage assets.

(5)        Yieldrepresents net cash (payments) receipts on derivatives divided by total averagemortgage assets.

(6)        Adjustednet interest margin on mortgage assets is calculated by subtracting interestexpense on total borrowings on mortgage assets, accretion of loan discounts andnet cash (payments) receipts on derivatives from interest income on totalmortgage assets and dividing by total average mortgage assets. Net cash(payments) receipts on derivatives are a component of realized gain (loss) onderivatives on the consolidated statements of operations. Adjusted net interestmargins on mortgage assets is a non-GAAP financial measurement, however, thereconciliation provided in this table is intended to meet the requirements ofRegulation G as promulgated by the SEC for the presentation of non-GAAPfinancial measurements. We believe that the presentation of adjusted netinterest margin on mortgage assets is useful information for our investors asit more closely reflects the true economics of net interest margins on mortgageassets.

 

21

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(7)        Theamortization of loan premiums and securitization costs are components ofinterest income and interest expense, respectively. Yield represents the costof amortization of net loan premiums and securitization costs divided by totalaverage mortgage assets.

 

Decreases in net interestincome were primarily due to a decline in net interest margins on mortgageassets primarily caused by the following:

 

•      increase in one-monthLIBOR rate underlying borrowings only partially offset by realized gain (loss)from derivative instruments;

 

•      differences in interestrate adjustment periods;

 

•      prepayments of higheryielding mortgages; and

 

•      a more challengingcompetitive environment.

 

Net interest income for thefirst quarter of 2006 decreased to $11.5 million as compared to$81.1 million for 2005. The quarter-over-quarter decrease in net interestincome of $69.6 million was primarily due to net interest margins onmortgage assets declining by 113 basis points to 0.19% for 2006 as compared to1.32% for 2005. Net interest margin on mortgage assets declined as one-monthLIBOR, which is the interest rate index used to price borrowing costs onsecuritized mortgage and reverse repurchase borrowings, rose approximately 200basis points since the first quarter of 2005 while mortgage assets over thesame period did not re-price upward as quickly. This resulted in an increase ininterest expense of 65% to $323.7 billion as of March 31, 2006 as comparedto $196.3 million as of March 31, 2005. Adjusted net interest margins on mortgage assets, as defined in theyield table above, declined by 24 basis points to 0.57% during the firstquarter of 2006 as compared to 0.81% during the first quarter of 2005. Thedecrease in adjusted net interest margins on mortgage assets was primarily dueto (1) an increase in short-term interest rates, (2)  theamortization of loan premiums, securitization costs and bond discounts as aresult of higher mortgage prepayments and, to a lesser extent, (3) higherleverage and lower net interest margins on certain securitized mortgageborrowings completed during 2005.

 

Since the first quarter of2005, the Federal Reserve raised short-term interest rates, which effectedmovements in one-month LIBOR, approximately 200 basis points. This causedborrowing costs on adjustable rate securitized mortgage borrowings, which aretied to one-month LIBOR and re-price monthly without limitation, to rise at afaster pace than coupons on LIBOR ARMs securing securitized mortgageborrowings, which generally re-price every six months with limitation. LIBORARMs held in our long-term investment portfolio are subject to thefollowing interest rate risks:

 

•      interest rate adjustmentlimitations on mortgages held for long-term investment due to periodic andlifetime interest rate cap features as compared to borrowings which are notsubject to adjustment limitations;

 

•      mismatched interest ratere-pricing periods between mortgages held for long-term investment, whichgenerally re-price every six months, and borrowings, which re-price every monthin regards to securitized mortgage borrowings and daily in regardsto reverse repurchase agreements; and

 

•      uneven and unequalmovements in the interest rate indices used to re-price mortgages held forlong-term investment, which are generally indexed to one-, three- and six-month LIBOR and one-year LIBOR, andborrowings, which are generally indexed to one-month LIBOR.

 

Along with an increase inshort-term interest rates, our expectation, based on past experience, was thatwe would see a corresponding decline in mortgage prepayment speeds. However,mortgage prepayment speeds continued at heightened levels during 2005. There ismortgage industry evidence that documents a substantial increase in homeappreciation rates over the last three years which has been a significantfactor affecting prepayment patterns of residential borrowers. Borrowers appearwilling to use home equity to pay loan prepayment penalties in order to obtainlower monthly payments by refinancing into other mortgage products, such asinterest-only and other alternative mortgage products.  More recent behavior in our securitizedmortgage collateral reflects some degree of reduced prepayments with thethree-month CPR rate declining to 36% as of March 31, 2006 from 38% as ofDecember 31, 2005.

 

Amortization of loan premiumsand securitization expenses decreased by 10 basis points to 0.98% of averagemortgage assets during the first quarter of 2006 as compared to 1.08% ofaverage mortgage assets during the same period in 2005. A substantial portionof our long-term mortgage investment portfolio consists of mortgages withprepayment penalty features that are primarily designed to help minimize therate of early mortgage prepayments. However, if borrowers do prepay on mortgages, a prepayment penalty ischarged which helps partially offset additional amortization of loan premiumsand

 

22

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securitizationcosts related to the prepaid mortgages. During the first quarter of 2006,prepayment penalties received from borrowers was recorded as interest incomeand increased 10 basis points to 19 basis points of mortgage assets as comparedto 9 basis points of mortgage assets in the first quarter of 2005.

 

Additionally, the net interest margin continues to be impacted by thedifficult competitive environment facing mortgage portfolio lenders. As aresult, net interest margins continue to tighten on newly originated loans.Furthermore, a rise in short-term rates and a decline in long term rates hasresulted in a flattening of the yield curve, adding pressure to mortgagelending profitability.

 

During the first quarter of2006, adjusted net interest margins on mortgage assets, which is a non-GAAPfinancial measurement as indicated in the yield table above, decreased by 24basis points as compared to a decline of 113 basis points on net interestmargin on mortgage assets.  Adjusted netinterest margin on mortgage assets did not decline as much as net interestmargin on mortgage assets primarily due to an 86 basis point increase inrealized gain (loss) from derivative instruments relative to total averagemortgage assets. Realized gains from derivative instruments partially offsetthe decline in adjusted net interest margins on mortgage assets which wascaused by the factors described above.

 

Adjusted net interest margins were also affected by the followingduring the first quarter of 2006:

 

•      our interest rate riskmanagement policies include the employment of balance guarantees that limit ourderivatives to no more than 100% coverage of the principal amount outstandingon securitized mortgage borrowings at any given time;and

 

•      actual mortgageprepayments and the corresponding repayment of securitized mortgage borrowingsexceeded the pre-determined amortization schedule of the notional amount ofderivative instruments.

 

Our interest rate riskmanagement policies are formulated with the intent to offset the potential adverseeffects of changing interest rates primarily associated with cash flows onadjustable rate securitized mortgage borrowings. However, as a result of thecombination of the factors listed above, the interest rate spread differentialbetween ARMs and adjustable rate securitized mortgage borrowingscompressed, which compressed net interest margins on mortgage assets. Bydesign, our current interest rate risk management program provides 20% to 25%coverage of the outstanding principal balance of our six month LIBORARMs and 85% to 98% coverage of the outstanding principal balance ofintermediate, or hybrid, ARMs at the point in time that we securitize themortgages.

 

For further information on ourinterest rate risk management policies refer to Item 3. “Quantitative andQualitative Disclosures About Market Risk.”

 

*Provisionfor Loan Losses*

 

The Company provides for loanlosses in accordance with its policies that include a detailed analysis ofhistorical loan performance data which is analyzed for loss performance andprepayment performance by product type, origination year and securitizationissuance. The results of that analysis are then applied to the current mortgageportfolio and an estimate is created. The Company’s general allowance for loanlosses reflects the expectation that losses inherent in the portfolio willexceed the level of annualized losses we are currently experiencing.

 

During the first quarter 2006,the provision for loan losses decreased to $150 thousand as compared to $6.1million for same period in 2005.  Thedecrease in provision was primarily due to 1) the result of a $3.0 millionreduction in specific reserves for loans secured by properties affected byHurricanes Katrina, Rita and Wilma; and 2) a decrease in the Company’s loan portfolio for the quarter ended March31, 2006 as compared to an increase in the size of the portfolio during thequarter ended March 31, 2005 primarily as the Company retained 79% fewerloans  as compared to the same periodending March 31, 2005.

 

The Company has reserved forloans secured by properties affected by Hurricanes Katrina, Rita andWilma.  Based on current propertyinspections, the specific reserves were reduced to $9.8 million at March 31,2006 from $12.8 million at December 31, 2005.  The Company is still evaluating the affect of the hurricanes and theamount of the provision may be adjusted as more information becomes available.

 

Total allowance for loan losseswas $74.3 million at March 31, 2006 as compared to $66.8 million at March 31,2005. Actual losses on mortgages increased to $4.4 million during the quarterended March 31, 2006 from $3.2 million for the quarter ended March 31, 2005,primarily due to seasoning of our securitized mortgage collateral portfolio.

 

23

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For further information ondelinquencies in our long-term investment portfolio and non-performing assetsrefer to “Financial Condition—Credit Risk.”

 

*Non-Interest Income (Quarterly)*

 

*For the Three Months Ended March 31, 2006 compared to the Three MonthsEnded March 31, 2005:*

 

Changes in Non-Interest Income

(dollars in thousands)

 
| ** **                                        | ** ** | **For the Three Months Ended March 31,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Realized gain (loss) from derivative  instruments |       | $                                        | 40,136     |   | $ | (13,727 | ) | $ | 53,863 |   | 392 | % |
| Change in fair value of derivative  instruments   |       | 51,429                                   |       | 131,318 |   | (79,889 | ) | (61 | ) |
| Gain on sale of loans                             |       | 7,353                                    |       | 9,137 |   | (1,784 | ) | (20 | ) |
| Other income                                      |       | 8,821                                    |       | 5,078 |   | 3,743 |   | 74 |   |
| Total non-interest income                         |       | $                                        | 107,739    |   | $ | 131,806 |   | $ | (24,067 | ) | (18 | )% |

 

*Realized Gain(Loss) from Derivative Instruments*. Realized gain(loss) from derivatives increased to $40.1 million during the first quarter of2006 as compared to $(13.7) million during the first quarter of 2005, or 63basis points of total average mortgage assets during the first quarter of 2006as compared to (23) basis points of total average mortgage assets during thefirst quarter of 2005.  The increase inrealized gain (loss) from derivatives is due to the approximately 200 basispoint increase in one-month LIBOR from the end of the first quarter 2005, whichhas caused the floating rate payment received on swaps to increase above thefixed payment made.  Realized gain (loss)from derivatives are recorded as current period expense or revenue on ourconsolidated financial statements and are included in the calculation oftaxable income.

 

*Change inFair Value of Derivative Instruments.* The change in fair value of derivativeinstruments decreased to $51.4 million during the first quarter of 2006 ascompared to $131.3 million during the first quarter of 2005.  Theamount of market valuation adjustment is the result of changes in theexpectation of future interest rates.  We primarily enter into derivative contractsto offset changes in cash flows associated with securitized mortgageborrowings. In our consolidated financial statements, we record a marketvaluation adjustment for these derivatives, as well as other derivatives usedby the mortgage operations to hedge our loan pipeline and mortgage loans heldfor sale, as current period expense or revenue. The change in fair value of derivatives at IMH is excluded for purposesof calculating taxable income as shown in the reconciliation table of net earningsto estimated taxable income in the “Taxable Income” table.

 

24

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*Non-Interest Expense*

 

Changes in Non-Interest Expense

(dollars in thousands)

 
| ** **                                                | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Personnel expense                                         |       | $                                        | 18,621     |   | $ | 18,880 |   | $ | (259 | ) | (1 | )% |
| General and administrative and other  expense             |       | 5,073                                    |       | 4,913 |   | 160 |   | 3 |   |
| Professional services                                     |       | 2,317                                    |       | 3,419 |   | (1,102 | ) | (32 | ) |
| Equipment expense                                         |       | 1,510                                    |       | 1,147 |   | 363 |   | 32 |   |
| Occupancy expense                                         |       | 1,368                                    |       | 1,145 |   | 223 |   | 19 |   |
| Data processing expense                                   |       | 1,366                                    |       | 943 |   | 423 |   | 45 |   |
| Total operating expense (1)                               |       | 30,255                                   |       | 30,447 |   | (192 | ) | (1 | ) |
| Amortization of deferred charge                           |       | 5,096                                    |       | 5,803 |   | (707 | ) | (12 | ) |
| Amortization and impairment of mortgage  servicing rights |       | 351                                      |       | 289 |   | 62 |   | 21 |   |
| (Gain) loss on sale of other real estate  owned           |       | (354                                     | )          | (848 | ) | 494 |   | 58 |   |
| Total non-operating expense (2)                           |       | 5,093                                    |       | 5,244 |   | (151 | ) | (3 | ) |
| Total non-interest expense                                |       | $                                        | 35,348     |   | $ | 35,691 |   | $ | (343 | ) | (1 | )% |

 

----

(1)        Operatingexpenses are primarily related to the mortgage operations personnel, whichgenerally fluctuates in conjunction with increases or decreases in mortgageacquisition and origination volumes.

(2)        Non-operatingexpenses generally relate to existing assets and liabilities and are generallynot a function of increases or decreases in mortgage acquisition or originationvolumes.

 

*Operating Expense.* The decrease in operatingexpense was primarily due to the following:

 

•      decrease in professionalservices; and

 

•      decrease in personnelexpenses.

 

*2006 to2005 Quarterly Comparative*

 

Total operating expensesremained substantially unchanged decreasing 1% on a quarter-over-quarter basisas accounting and auditing fees decreased to $1.1 million during the firstquarter of 2006 as compared to $2.1 million for the same period in 2005. Thedecrease is mainly attributable to a decrease in SOX related expenditures madeduring the first quarter of 2005. Additionally, legal fees decreased to $717.5thousand as compared to $1.1 million for the first quarter of 2005.

 

Personnel expense decreased 1%on a quarter-over-quarter basis as bonus and incentives decreased 41% to $2.9million as compared to $5.0 million for the first quarter of 2005. The decreasein bonus and incentives was partially offset by a 21% increase in employeebenefits to $4.1 million as compared to $3.4 million for the first quarter of2005.

 

The following table summarizesthe principal balance of mortgage acquisitions and originations for the periodsindicated (in thousands):

 

25

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| ** **                             | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                 | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **Principal  Balance**                   | ** ** | **%** | ** ** | **Principal  Balance** | ** ** | **%** | ** ** |
| By Production Channel:                 |       |                                     |       |   |   |   |   |   |   |
| Correspondent acquisitions:            |       |                                     |       |   |   |   |   |   |   |
| Flow                                   |       | $                                        | 1,422,434  |   | 61 |   | $ | 2,377,608 |   | 49 |   |
| Bulk                                   |       | 132,151                                  |       | 6 |   | 1,676,726 |   | 35 |   |
| Total correspondent acquisitions       |       | 1,554,585                                |       | 67 |   | 4,054,334 |   | 84 |   |
| Wholesale and retail originations      |       | 549,549                                  |       | 24 |   | 609,782 |   | 13 |   |
| Total mortgage operations acquisitions |       | 2,104,134                                |       | 91 |   | 4,664,116 |   | 97 |   |
| Commercial Mortgage Operations         |       | 202,780                                  |       | 9 |   | 165,304 |   | 3 |   |
| Total acquisitions and originations    |       | $                                        | 2,306,914  |   | 100 |   | $ | 4,829,420 |   | 100 |   |

 

Thequarter-over-quarter decrease in acquisitions and originations was primarilythe result of an adjusted pricing methodology in a more competitivemarketplace. Total residential acquisitions and originations for the firstquarter decreased to $2.1 billion as compared to $4.7 billion for the firstquarter of 2005. The reduction in acquisitions and originations at the mortgageoperations was primarily related to a decrease in more price sensitive bulkacquisitions which decreased to 6% of our total correspondent acquisitions ascompared to approximately 35% during the first quarter of 2005. Given what webelieve to be increased credit risk in the market, we are averse to assumingmore layered risk and as a result have tightened our underwriting guidelinesand adjusted our pricing models based on risk.

 

***Results of Operations by Business Segment***

 

***Long-Term Investment Operations***

 

Condensed Statements of Operations Data

(dollars in thousands)

 
| ** **                                           | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Net interest income                                  |       | $                                        | (12,088    | ) | $ | 52,119 |   | $ | (64,207 | ) | (123 | )% |
| Provision for loan losses                            |       | 150                                      |       | 6,074 |   | (5,924 | ) | (98 | ) |
| Net interest income after provision for  loan losses |       | (12,238                                  | )          | 46,045 |   | (58,283 | ) | (127 | ) |
|                                                 |       |                                     |       |   |   |   |   |   |   |
| Realized gain (loss) from derivative  instruments    |       | 40,136                                   |       | (13,727 | ) | 53,863 |   | 392 |   |
| Change in fair value of derivative  instruments      |       | 46,963                                   |       | 128,878 |   | (81,915 | ) | (64 | ) |
| Other non-interest income                            |       | (264                                     | )          | (157 | ) | (107 | ) | (68 | ) |
| Total non-interest income                            |       | 86,835                                   |       | 114,994 |   | (28,159 | ) | (24 | ) |
|                                                 |       |                                     |       |   |   |   |   |   |   |
| Non-interest expense                                 |       | 4,038                                    |       | 2,693 |   | 1,345 |   | 50 |   |
| Net earnings                                         |       | $                                        | 70,559     |   | $ | 158,346 |   | $ | (87,787 | ) | (55 | )% |

 

The quarter-over-quarterdecrease in net earnings was primarily due to the change in fair value onderivative instruments which decreased to $47.0 million for the first quarterof 2006 as compared to $128.9 million for the first quarter of 2005. Themarket valuation adjustment is the result of changes in the expectation offuture interest rates. Additionally, net interest income declined to$(12.1) million compared to $52.1 million, primarily due to an increase inborrowing costs, which were only partially offset by realized gain (loss) fromderivatives which increased to $40.1 million for the first quarter of 2006compared to $(13.7) for the first quarter of 2005. Together, net interestincome and realized gain (loss) from derivative instruments declined 27% to$28.0 million for the three months ended March 31, 2006 compared to $38.4million for the three months ended March 31, 2005. This decline is primarilyattributable to the aforementioned net interest margin compression.

 

26

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***Mortgage Operations***

 

Condensed Statements of Operations Data

(dollars in thousands)

 
| ** **                            | ** ** | **For the Three Months Ended March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Net interest income                   |       | $                                        | 1,277      |   | $ | 1,974 |   | $ | (697 | ) | (35 | )% |
| Non-interest income                   |       | 24,790                                   |       | 45,959 |   | (21,169 | ) | (46 | ) |
| Non-interest expense and income taxes |       | 23,814                                   |       | 31,767 |   | (7,953 | ) | (25 | ) |
| Net earnings                          |       | $                                        | 2,253      |   | $ | 16,166 |   | $ | (13,913 | ) | (86 | )% |

 

The quarter-over-quarterdecrease in net earnings was primarily due to a decrease in non-interestincome. The decrease in non-interest income was mainly attributed to a decreasein gain (loss) on loans held for sale. Gain (loss) on loans sold decreased asthe long-term investment operations retained for investment purposes $579.7million as compared to $3.3 billion for the same period in 2005, reducing theassociated gains relating to the transfer of those loans by $25.5 million. Additionally,whole loan sales increased to $2.8 billion in the first quarter of 2006 ascompared to $887.8 million for the same period in 2005. The increase in wholeloans sales increased the provision for repurchase to $10.3 million as comparedto $3.7 million for the same period in 2005. The aforementioned losses werepartially offset by increases in net gains on whole loans sales to $21.9million for the first quarter of 2006 as compared to $8.2 million for the sameperiod in 2005. The decrease in non-interest income were partially offset by adecrease in non-interest expense which decreased to $22.4 million for the firstquarter of 2006 compared to $26.5 million for first quarter of 2005. Themortgage operations use derivatives to protect the market value of mortgageswhen it establishes a rate-lock commitment on a particular mortgage prior toits close and sale or securitization. During the first quarter of 2006, thevalue of these derivatives were $(3.1) million as compared to $5.1 million forthe first quarter of 2005. Any changes in interest rates on mortgages that themortgage operations has committed to acquire at a particular rate to the timeit sells or securitizes the mortgage generally results in an increase ordecrease in the market value of that mortgage. The mortgage operations arereflected as a stand-alone entity for segment financial reporting purposes;however, on the consolidated financial statements inter-company loan sales andrelated gains are eliminated.

 

***Warehouse Lending Operations***

 

Condensed Statements of Operations Data

(dollars in thousands)

 
| ** **                             | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Net interest  income                   |       | $                                        | 7,691      |   | $ | 11,341 |   | $ | (3,650 | ) | (32 | )% |
| Non-interest  income                   |       | 797                                      |       | 2,027 |   | (1,230 | ) | (61 | ) |
| Non-interest  expense and income taxes |       | 1,874                                    |       | 2,085 |   | (211 | ) | (10 | ) |
| Net earnings                           |       | $                                        | 6,614      |   | $ | 11,283 |   | $ | (4,669 | ) | (41 | )% |

 

The quarter-over-quarterdecrease in net earnings was primarily due to a decrease in net interest incomeas borrowing costs on mortgage assets increased to $25.5 million in the firstquarter of 2006 as compared to $16.7 million for the same period in 2005 asone-month LIBOR, which is tied to our borrowing costs, increased approximately200 basis points on a quarter-over-quarter basis. Additionally, loan feesdecreased $1.2 million decreasing non-interest income. For the three monthsended March 31, 2006 and March 31, 2005, no provision for loan loss wasrecorded. The warehouse lending operations is reflected as a stand-alone entityfor segment financial reporting purposes. However, on the consolidated financialstatements inter-company finance receivables and borrowings are eliminated.

 

27

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***Commercial Operations***

 

Condensed Statements of Operations Data

(dollars in thousands)

 

| ** **                             | **For the Three Months Ended  March 31, 2006** | ** ** |
|----------------------------------------|------------------------------------------------|------------|
| Net interest  income                   |                                           | $          | 134 |   |
| Provision  for loan losses             |                                           | —     |   |
| Non-interest  income                   |                                           | 1,877      |   |
| Non-interest  expense and income taxes |                                           | 2,410      |   |
| Net earnings                           |                                           | $          | (399 | ) |

 

On January 1, 2006, weelected to convert Impac Commercial Capital Corporation “ICCC” from a qualifiedREIT subsidiary to a taxable REIT subsidiary. Therefore, there is nocorresponding quarter over quarter comparison.

 

Net earnings for the commercialoperations were $(399) thousand for the first quarter of 2006. Non-interestincome was $1.9 million in the first quarter of 2006 due to the gain on sale ofloans of $1.0 million and the change in fair value of derivative instruments of$841 thousand. Offsetting non-interest income was non-interest expense of $2.4million due to the expansion of our commercial mortgage operations. Thecommercial operations are reflected as a stand-alone entity for segmentfinancial reporting purposes; however, on the consolidated financial statementsinter-company loan sales and related gains are eliminated.

 

**Liquidity and Capital Resources**

 

We recognize the need to havefunds available for our operating businesses and our customers’ demands forobtaining short-term warehouse financing until the settlement or sale ofmortgages with us or with other investors. It is our policy to have adequateliquidity at all times to cover normal cyclical swings in funding availabilityand mortgage demand and to allow us to meet abnormal and unexpected fundingrequirements. We plan to meet liquidity through normal operations with the goalof avoiding unplanned sales of assets or emergency borrowing of funds. Towardthis goal, our asset/liability committee, or “ALCO,” is responsible formonitoring our liquidity position and funding needs.

 

ALCO participants includesenior executives of the long-term investment operations, the mortgageoperations, the commercial operations, and warehouse lending operations. ALCOmeets on a weekly basis to review current and projected sources and uses offunds. ALCO monitors the composition of the balance sheet for changes in theliquidity of our assets. Our primary liquidity consists of cash and cashequivalents; short-term securities available for sale, and maturing mortgages,or “liquid assets.”

 

We believe that current cashbalances, short-term investments, currently available financing facilities,capital raising capabilities and excess cash flows generated from our long-termmortgage portfolio will adequately provide for projected funding needs andlimited asset growth.

 

Our operating businessesprimarily use available funds as follows:

 

•      acquisition and originationof mortgages by the mortgage, commercial, and long-term investment operations;

 

•      long-term investment inmortgages by the long-term investment operations;

 

•      provide short-term warehouseadvances by the warehouse lending operations;

 

•      pay interest on debt;

 

•      distribute common andpreferred stock dividends; and

 

•      pay operating andnon-operating expenses.

 

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*Acquisitionand origination of mortgages by the mortgage, commercial, and long-terminvestment operations*. During the first quarter of2006, the mortgage operations acquired $2.1 billion of primarily Alt-Amortgages, of which $694.4 million was acquired by the long-term investmentoperations for long-term investment. Capital invested in mortgages isoutstanding until we sell or securitize mortgages, which is one of the reasonswe attempt to sell or securitize mortgages within 90 days of acquisition ororigination. Initial capital invested in mortgages includes premiums paid whenmortgages are acquired and originated and our capital investment, or “haircut,”required upon financing, which is generally determined by the type ofcollateral provided. The mortgage operations acquired and originated mortgagesat a weighted average price of 101.54 during the first quarter of 2006, whichwere financed with warehouse borrowings from the warehouse lending operationsat a haircut generally between 2% to 10% of the outstanding principal balance ofthe mortgages. In addition, ICCC originated $202.8 million of commercialmortgages at a weighted average price of 100.04 which were initially financedwith short-term warehouse financing from the warehouse lending operations at ahaircut of generally 3% of the outstanding principal balance of the mortgages.

 

*Long-terminvestment in mortgages by the long-term investment operations*.The long-term investment operations acquires primarily Alt-A mortgages from themortgage operations and finances them with warehouse borrowings from thewarehouse lending operations at substantially the same terms as the mortgageoperations. When the long-term investment operations finances mortgages withlong-term securitized mortgage borrowings, short-term warehouse financing isrepaid. Then, depending on credit ratings from national credit rating agencieson our securitized mortgage borrowings, we are generally required to provide anover-collateralization, or “OC”, of 0.35% to 1% of the principal balance ofmortgages securing securitized mortgage borrowings as compared to a haircut of2% to 10% of the principal balance of mortgages securing short-term warehousefinancing. Our total capital investment in securitized mortgage collateral generallyranges from approximately 2% to 5% of the principal balance of mortgagessecuring securitized mortgage borrowings which includes premiums paid uponacquisition of mortgages from the mortgage operations, costs paid forcompletion of securitized mortgage borrowings, costs to acquire derivatives andOC required to achieve desired credit ratings. Commercial mortgages arefinanced on a long-term basis with securitized mortgage borrowings atsubstantially the same rates and terms as Alt-A mortgages.

 

*Provideshort-term warehouse advances by the warehouse lending operations.*Weutilize committed and uncommitted reverse repurchase facilities with variouslenders to provide short-term warehouse financing to affiliates andnon-affiliated clients of the warehouse lending operations. The warehouse lendingoperations provides short-term financing to the mortgage operations andnon-affiliated clients from the closing of mortgages to their sale or othersettlement with investors. The warehouse lending operations generally financesbetween 90% and 98% of the fair market value of the principal balance ofmortgages, which equates to a haircut requirement of between 10% and 2%,respectively, at one-month LIBOR, plus a spread. The mortgage operations haveuncommitted warehouse line agreements to obtain financing from the warehouselending operations at one-month LIBOR plus a spread during the period that themortgage operation accumulates mortgages until the mortgages are securitized orsold. As of March 31, 2006, the mortgage operations had $667.5 million of warehouseadvances outstanding with the warehouse lending operations. In addition, as ofMarch 31, 2006, the warehouse lending operations had $759.5 million of approvedwarehouse lines available to non-affiliated clients, of which $292.0 millionwas outstanding.

 

Our ability to meet liquidityrequirements and the financing needs of our customers is subject to the renewalof our credit and repurchase facilities or obtaining other sources offinancing, if required, including additional debt or equity from time to time.Any decision our lenders or investors make to provide available financing to usin the future will depend upon a number of factors, including:

 

•      our compliance with theterms of our existing credit arrangements;

 

•      our financial performance;

 

•      industry and market trendsin our various businesses;

 

•      the general availability of,and rates applicable to, financing and investments;

 

•      our lenders or investorsresources and policies concerning loans and investments; and

 

•      the relative attractivenessof alternative investment or lending opportunities.

 

*Distributecommon and preferred stock dividends*. We are requiredto distribute a minimum of 90% of our taxable income to our stockholders inorder to maintain our REIT status, exclusive of the application of any tax losscarry forwards

 

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that may beused to offset current period taxable income. Because we pay dividends based ontaxable income, dividends may be more or less than net earnings. We declared cashdividends of $0.25 per outstanding common share for the first quarter of 2006on estimated taxable income of $0.36 per diluted common share and paid cashdividends of $0.20 per outstanding common share for the fourth quarter of 2005and paid during the first quarter of 2006. In addition, we paid cash dividendsof $3.7 million on preferred stock during the first quarter of 2006.

 

A portion of dividends paid toIMH’s stockholders can come from dividend distributions from the mortgageoperations and commercial operations, our taxable REIT subsidiaries, to IMH. Duringthe first quarter of 2006, the mortgage and commercial operations provided nodividend distributions to IMH. Because the mortgage and commercial operationsmay seek to retain earnings to fund the acquisition and origination ofmortgages or to expand the mortgage operations, the board of directors of ourtaxable REIT subsidiaries, which is different from the board of directors ofthe registrant, may decide that the mortgage and/or commercial operationsshould cease making dividend distributions in the future. This could reduce theamount of taxable income that would be distributed to IMH stockholders in theform of common stock dividend payment amounts.

 

During the first quarter 2006,our operating businesses were primarily funded as follows:

 

•      reverse repurchaseagreements and securitized mortgage borrowings;

 

•      excess cash flows from ourlong-term mortgage portfolio;

 

•      sale and securitization ofmortgages;

 

and we have the flexibility to fund our business with:

 

•      cash proceeds from theissuance of common and preferred stock; and

 

•      cash proceeds from theissuance of trust preferred securities.

 

*Reverserepurchase agreements and securitized mortgage borrowings.*Weuse reverse repurchase agreements to fund substantially all warehouse financingto affiliates and non-affiliated clients and for the acquisition andorigination of Alt-A and commercial mortgages. As we accumulate mortgages, wefinance the acquisition of mortgages primarily through borrowings on reverserepurchase facilities with third party lenders. We primarily use uncommittedand committed facilities with major investment banks to finance substantiallyall warehouse financing, as needed. During the first quarter of 2006 thewarehouse facilities amounted to $4.4 billion, of which $992.5 billion wasoutstanding at March 31, 2006. The warehouse facilities provide us with ahigher aggregate credit limit to fund the acquisition and origination ofmortgages at terms comparable to those we have received in the past. Thesewarehouse facilities may have certain covenant tests which we continue tosatisfy. From time to time, we may also receive additional uncommitted interimfinancing from our lenders in excess of our permanent borrowing limits tofinance mortgages during the accumulation phase and prior to securitizations orwhole loan sales.

 

From time to time, we may alsoutilize short-term reverse repurchase financing provided to us by underwriterswho underwrite some of our securitizations. The short-term reverse repurchasefinancing funds mortgages that are specifically allocated to securitizationtransactions, which allows us to reduce overall borrowings outstanding onreverse repurchase agreements with other lenders during the period immediatelyprior to the settlement of the securitization. Terms and interest rates on the short-termreverse repurchase facilities are generally lower than on other reverserepurchase agreements. Short-term reverse repurchase financing are generallyrepaid within 30 days from the date funds are advanced.

 

We expect to continue to useshort-term reverse repurchase facilities to fund the acquisition of mortgages.If we cannot renew or replace maturing borrowings, we may have to sell, on awhole loan basis, the mortgages securing these facilities, which, dependingupon market conditions may result in substantial losses. Additionally, if forany reason the market value of our mortgages securing reverse repurchasefacilities decline, our lenders may require us to provide them with additionalequity or collateral to secure our borrowings, which may require us to sellmortgages at substantial losses.

 

In order to mitigate theliquidity risk associated with reverse repurchase agreements, we attempt tosell or securitize our mortgages within 90 days from acquisition ororigination. Although securitizing mortgages more frequently adds operating andsecuritization costs, we believe the added cost is offset as liquidity isprovided more frequently with less interest rate and price volatility, as theaccumulation and holding period of mortgages is shortened. When we haveaccumulated a sufficient amount of mortgages, we seek to issue securitizedmortgage borrowings and convert short-term advances under reverse repurchaseagreements to long-term securitized mortgage borrowings. The use of securitizedmortgage borrowings provides the following benefits:

 

•      allows us to use longterm financing for the duration of the securitized mortgage collateral;and

 

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•      eliminates the potentialfor margin calls on the borrowings that are converted from reverse repurchaseagreements to securitized mortgage borrowings as well as associatedderivatives used to manage interest rate risks on securitized mortgageborrowings.

 

During the first quarter of2006, we completed $923.0 million of securitized mortgage borrowings to providelong-term financing for $920.1 million of primarily Alt-A and commercialmortgages. Because of the credit profile, historical loss performance andprepayment characteristics of our Alt-A and commercial mortgages, we have beenable to borrow a higher percentage against the principal balance of mortgagesheld as securitized mortgage collateral, which means that we have to provideless initial capital upon completion of securitized mortgage borrowings .Capital investment in the securitized mortgage borrowings is established at thetime securitized mortgage borrowings are issued at levels sufficient to achievedesired credit ratings on the securities from credit rating agencies.

 

*Excess cashflows from our long-term mortgage portfolio*. Wereceive excess cash flows on mortgages held as securitized mortgage collateralafter distributions are made to investors on securitized mortgage borrowings tothe extent cash or other collateral required to maintain desired credit ratingson the securitized mortgage borrowings is fulfilled and can be used to providefunding for some of the long-term investment operations’ activities. Excesscash flows represent the difference between principal and interest payments onthe underlying mortgages, adjusted by the following:

 

•      servicing and masterservicing fees paid;

 

•      premiums paid to mortgageinsurers;

 

•      cash payments / receipts onderivatives;

 

•      interest paid on securitizedmortgage borrowings;

 

•      pro-rata early principalprepayments paid on securitized mortgage borrowings;

 

•      OC requirements;

 

•      actual losses, net of anygains incurred upon disposition of other real estate owned or acquired in settlementof defaulted mortgages;

 

•      unpaid interest shortfall;

 

•      basis risk shortfall;

 

•      bond writedowns reinstated;and

 

•      residual cashflow.

 

*Sale and securitization of mortgages.*We sell and securitize loans in thefollowing ways:

 

•      When the mortgage operationsaccumulate a sufficient amount of mortgages that are intended to be depositedinto a securitized mortgage borrowing, it sells the mortgagesto the long-term investment operations,

 

•      When selling mortgages ona whole loan basis, the mortgage operations will accumulate mortgages and enterinto sales transactions with third party investors on a monthly basis; and

 

•      When the mortgageoperations enter into a securitization treated as a sale for GAAP and taxpurposes it accumulates mortgages and sells these loans periodically.

 

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The mortgage operations sold$694.4 million of mortgages to the long-term investment operations duringthe first quarter of 2006 and sold $2.8 billion of mortgages to third partyinvestors through whole loan sales. The mortgage operations sold mortgageservicing rights on all mortgages sold during the first quarter of 2006, butretained all master servicing rights. The sale of mortgage servicing rightsgenerated substantially all cash, which was used to acquire and originateadditional mortgage assets.

 

Since we rely significantlyupon sales and securitizations to generate cash proceeds to repay borrowingsand to create credit availability, any disruption in our ability to completesales and securitizations may require us to utilize other sources of financing,which, if available at all, may be on less favorable terms. In addition, delaysin closing sales and securitizations of our mortgages increase our risk byexposing us to credit and interest rate risk for this extended period of time.

 

*Common andPreferred Stock Sales Agreements.*We filed with theSEC a shelf registration statement that allows us to sell up to $1.0 billion ofsecurities, including common stock, preferred stock, debt securities andwarrants. This registration was declared effective by the SEC on September 6,2005. By issuing new shares periodically throughout 2005 and the first quarterof 2006, we believe that we were able to utilize new capital more efficientlyand profitably.

 

On September 30, 2005, theCompany entered into a common stock sales agreement with Brinson PatrickSecurities Corporation (Brinson Patrick) for the sale of up to 7.5 millionshares of its common stock from time to time through Brinson Patrick as salesagent. No shares of common stock were sold during the first quarter of 2006.

 

On September 30, 2005, theCompany entered into a Preferred Stock sales agreement with Brinson Patrick,for the sale of up to 800,000 shares of its 9.125% Series C CumulativeRedeemable Preferred Stock (Series C Preferred Stock) from time to time throughBrinson Patrick as sales agent. During the three months ended March 31, 2006,we sold 12,700 shares of Series C Preferred Stock and received net proceeds ofapproximately $272,000. Brinson Patrick received a commission of 3% of thegross sales price per share of the shares of preferred stock sold pursuant tothe sales agreement, which amounted to an aggregate commission of $8,400.

 

For the three months endedMarch 31, 2006, the ratio of earnings to fixed charges and ratio of earnings tocombined fixed charges and preferred stock dividends was 1.26x and 1.24x,respectively. Earnings used in computing the ratio of earnings to fixed chargesconsist of net earnings before income taxes plus fixed charges. Fixed chargesinclude interest expense on debt and the portion of rental expense deemed torepresent the interest factor.

 

*Inflation/Deflation*

 

The consolidated financialstatements and corresponding notes to the consolidated financial statementshave been prepared in accordance with GAAP, which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time dueto inflation. The impact of inflation is reflected in the increased costs ofour operations. Unlike industrial companies, nearly all of our assets andliabilities are monetary in nature. As a result, interest rates have a greaterimpact on our performance than do the effects of general levels of inflation.Inflation affects our operations primarily through its effect on interestrates, since interest rates normally increase during periods of high inflationand decrease during periods of low inflation. During periods of increasinginterest rates, demand for mortgages and a borrower’s ability to qualify formortgage financing in a purchase transaction may be adversely affected. Duringperiods of decreasing interest rates and housing price appreciation, borrowersmay prepay their mortgages, which in turn may adversely affect our yield andsubsequently the value of our portfolio of mortgage assets.

 

**ITEM 3:**     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

**GeneralOverview**

 

Although we manage credit,prepayment and liquidity risk in the normal course of business, we considerinterest rate risk to be a significant market risk, which could potentiallyhave the largest material impact on our financial condition and results ofoperations. Since a significant portion of our revenues and earnings arederived from net interest income, we strive to manage our interest-earningassets and interest-bearing liabilities to generate what we believe to be anappropriate contribution from net interest income. When interest ratesfluctuate, profitability can be adversely affected by changes in the fairmarket value of our assets and liabilities and by the interest spread earned oninterest-earning assets and interest-bearing liabilities. We derive income fromthe differential spread between interest earned on interest-earning assets andinterest paid on interest-bearing liabilities. Any change in interest ratesaffects income received and income paid from assets and liabilities in varyingand typically in unequal amounts. Changing interest rates may compress ourinterest rate margins and adversely affect overall earnings.

 

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Interest rate risk managementis the responsibility of the Asset Liability Committee (“ALCO”), which iscomprised of senior management and reports results of interest rate riskanalysis to the IMH board of directors on at least a quarterly basis. ALCOestablishes policies that monitor and coordinate sources, uses and pricing offunds. ALCO also attempts to reduce the volatility in net interest income bymanaging the relationship of interest rate sensitive assets to interest ratesensitive liabilities. In addition, various modeling techniques are used tovalue interest sensitive mortgage-backed securities, including interest-onlysecurities. The value of investment securities available-for-sale is determinedusing a discounted cash flow model using prepayment rate, discount rate andcredit loss assumptions. Our investment securities portfolio is available-for-sale,which requires us to perform market valuations of the securities in order toproperly record the portfolio. We continually monitor interest rates of ourinvestment securities portfolio as compared to prevalent interest rates in themarket. We do not currently maintain a securities trading portfolio and are notexposed to market risk as it relates to trading activities.

 

**Changesin Interest Rates**

 

Interest rate risk managementpolicies intended to limit our exposure to changes in interest rates primarilyassociated with cash flows on our adjustable rate securitized mortgageborrowings. Our primary objective is to limit our exposure to the variabilityin future cash flows attributable to the variability of one-month LIBOR, whichis the underlying index of our adjustable rate securitized mortgage borrowings.We also monitor on an ongoing basis the prepayment risks that arise influctuating interest rate environments. Our interest rate risk managementpolicies are formulated with the intent to offset potential adverse effects ofchanging interest rates on cash flows on adjustable rate securitized mortgageborrowings.

 

We primarily acquire forlong-term investment ARMs and hybrid ARMs and, to a lesser extent, FRMs. ARMsare generally subject to periodic and lifetime interest rate caps. This meansthat the interest rate of each ARM is limited to upwards or downwards movementson its periodic interest rate adjustment date, generally six months, or overthe life of the mortgage. Periodic caps limit the maximum interest rate change,which can occur on any interest rate change date to generally a maximum of 1%per semiannual adjustment. Also, each ARM has a maximum lifetime interest ratecap. Generally, borrowings are not subject to the same periodic or lifetimeinterest rate limitations. During a period of rapidly increasing or decreasinginterest rates, financing costs could increase or decrease at a faster ratethan the periodic interest rate adjustments on mortgages would allow, whichcould affect net interest income. In addition, if market rates were to exceedthe maximum interest rate limits of our ARMs, borrowing costs could increasewhile interest rates on ARMs would remain constant. We also acquire hybrid ARMsthat have initial fixed interest rate periods generally ranging from two toseven years which subsequently convert to ARMs. During a rapidly increasing ordecreasing interest rate environment financing costs would increase or decreasemore rapidly than would interest rates on mortgages, which would remain fixeduntil their next interest rate adjustment date. In order to provide protectionagainst potential resulting basis risk shortfall on the related liabilities, wepurchase derivatives.

 

We measure the sensitivity ofour net interest income to changes in interest rates affecting interestsensitive assets and liabilities using various simulations. These simulationstake into consideration changes that may occur in investment and financingstrategies, the forward yield curve, interest rate risk management strategies,mortgage prepayment speeds and the volume of mortgage acquisitions andoriginations. As part of various interest rate simulations, we calculate theeffect of potential changes in interest rates on our interest-earning assetsand interest-bearing liabilities and their affect on overall earnings. Thesimulations assume instantaneous and parallel shifts in interest rates and towhat degree those shifts affect net interest income.

 

We estimate net interest incomealong with net cash flows from derivatives for the next twelve months usingbalance sheet data and the notional amount of derivatives as of January 31,2006 and 12-month projections of the following primary drivers affecting netinterest income:

 

•      future interest rates usingforward yield curves, which are considered market consensus estimates of futureinterest rates;

 

•      mortgage acquisitions andoriginations;

 

•      mortgage prepayment rateassumptions; and

 

•      forward swap rates.

 

We refer to the 12-monthprojection of net interest income along with the 12-month projection of netcash flows from derivatives as the “base case.” For financial reportingpurposes, net cash flows from derivatives are included in realized gain

 

33

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(loss) from derivativeinstruments on the consolidated financial statements. However, for purposes ofinterest rate risk analysis we include net cash flows from derivatives in ourbase case simulations as we acquire derivatives to offset the effect thatchanges in interest rates have on variable borrowing costs, such as securitizedmortgage and warehouse borrowings. We believe that including net cash flowsfrom derivatives in our interest rate risk analysis presents a more usefulsimulation of the effect of changing interest rates on net cash flows generatedby our long-term mortgage portfolio.

 

Once the base case has beenestablished, we “shock” the base case with instantaneous and parallel shifts ininterest rates in 100 basis point increments upward and downward. Calculationsare made for each of the defined instantaneous and parallel shifts in interestrates over or under the forward yield curve used to determine the base case andinclude any associated changes in projected mortgage prepayment rates caused bychanges in interest rates. The results of each 100 basis point change ininterest rates are then compared against the base case to determine theestimated dollar and percentage change to base case. The simulations considerthe affect of interest rate changes on interest sensitive assets andliabilities as well as derivatives. The simulations also consider the impactthat instantaneous and parallel shift in interest rates have on prepaymentrates and the resulting affect of accelerating or decelerating amortization ofpremium and securitization costs.

 

In the following table, the up100 basis point scenario as of January 31, 2006 represents our projection ofthe net change from base case net interest income, which is derived fromassumptions as previously discussed, if market interest rates were toimmediately rise by 100 basis points. This means that we increase interestrates at all data points along our projected forward yield curve by 100 basispoints and recalculate our projection of net interest income over the next 12months. In addition, based on changes in interest rates, or changes in ourforward yield curve, our model adjusts mortgage prepayment rates andrecalculates amortization of acquisition and securitization costs and net cashreceipts or payments on derivatives as part of the calculation of net interestincome. Thus, if a 100 basis point interest rate increase occurred, theprojected volatility to net interest income is negatively impacted by $3.8million, or a decrease of 2% relative to projected base case net interestincome.

 

The interest rate risk profileof our balance sheet is more sensitive to changes in interest rates related toour liabilities. We use derivatives extensively in order to manage the interestrate, or price risk, inherent in our assets, liabilities and loan commitments.Our main objective in managing interest rate risk is to moderate the impact ofchanges in interest rates on our earnings over time. Our interest rate riskmanagement strategies may result in significant earnings volatility in theshort term. The success of our interest rate risk management strategy islargely dependent on our ability to predict the earnings sensitivity of ourloan production operations and long term investment operations in variousinterest rate environments. There are many market factors that impact theperformance of our interest rate risk management activities including interestrate volatility, prepayment behavior, the shape of the yield curve and thespread between mortgage interest rates and Treasury or Swap rates. The successof this strategy impacts our net income. This impact, which can be eitherpositive or negative, can be material.

 

The following table estimatesthe financial impact to base case, including net cash flow from derivatives, fromvarious instantaneous and parallel shifts in interest rates based on both ouron-balance sheet structure and off-balance sheet structure, which refers to thenotional amount of derivatives that are not recorded on our balance sheet as ofJanuary 31, 2006 (dollar amounts in thousands):

 
| ** **                                                   | ** ** | **Changes in base case as of January 31, 2006 (1)** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                   | ** ** | **Excluding net cash  flow on derivatives**         | ** ** | **Net cash flow  on derivatives** | ** ** | **Including net cash  flow on derivatives** | ** ** |
| **Instantaneous and Parallel  Change in Interest Rates (2)** | ** ** | **$**                                               | ** ** | **(%)** | ** ** | **$** | ** ** | **$** | ** ** | **(%)** | ** ** |
| Up 300 basis points, or 3% (3)                               |       | (443,925                                            | )          | (6,317 | ) | 395,407 |   | (48,518 | ) | (29 | ) |
| Up 200 basis points, or 2%                                   |       | (284,735                                            | )          | (4,052 | ) | 263,658 |   | (21,077 | ) | (13 | ) |
| Up 100 basis points, or 1%                                   |       | (135,616                                            | )          | (1,930 | ) | 131,802 |   | (3,814 | ) | (2 | ) |
| Down 100 basis points or 1%                                  |       | 139,811                                             |       | 1,990 |   | (131,761 | ) | 8,050 |   | 5 |   |
| Down 200 basis points or 2%                                  |       | 275,588                                             |       | 3,922 |   | (263,553 | ) | 12,035 |   | 7 |   |
| Down 300 basis points or 3%                                  |       | 413,206                                             |       | 5,880 |   | (395,408 | ) | 17,798 |   | 11 |   |

 

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(1)        Thedollar and percentage changes represent base case for the next twelve monthsversus the change in base case using various instantaneous and parallelinterest rate change simulations, excluding the effect of amortization of loandiscounts to base case.

(2)        Instantaneousand parallel interest rate changes over and under the projected forward yieldcurve.

 

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(3)        Thissimulation was added to our analysis as it is relevant in light of the interestrate environment as of January 31, 2006 and the projected forward yield curvefor 2006 and 2007.

 

Using information as presentedabove, and other analysis, the Company reviews its interest rate risk profile. Basedon this review, the Company makes certain decisions on how to mitigate itsinterest rate risk.

 

The use of derivatives tomanage risk associated with changes in interest rates is an integral part ofour strategy. The amount of cash payments or cash receipts on derivatives isdetermined by (1) the notional amount of the derivative and (2) current interestrate levels in relation to the various strikes or coupons of derivatives duringa particular time period. As of March 31, 2006 and December 31, 2005, we hadnotional balances of interest rate swaps, caps, and floors of $23.0 billion and$20.2 billion, respectively, with fair values of $297.1 million and $248.2million, respectively. By using derivatives, we attempt to minimize the effectof both upward and downward interest rate changes on our long-term mortgageportfolio. Our goal is to moderate significant changes to base case netinterest income, including net cash flows from derivatives, as interest rateschange. We primarily acquire swaps to essentially convert our adjustable ratesecuritized mortgage borrowings into fixed rate borrowings. For instance, wereceive one-month LIBOR on swaps, which offsets interest expense on adjustablerate securitized mortgage borrowings, and we pay a fixed interest rate.

 

**ITEM 4:**     CONTROLS AND PROCEDURES

 

**Evaluation of Disclosure Controlsand Procedures**

 

Disclosure controls andprocedures are controls and other procedures of the Company that are designedto ensure that information required to be disclosed by the Company in thereports that it files or submits under the Securities Exchange Act of 1934 (the“Exchange Act”) is recorded, processed, summarized and reported, within thetime periods specified in the SEC’s rules and forms. Disclosure controls andprocedures include without limitation, controls and procedures designed toensure that information required to be disclosed by the Company in its reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the Company’s management, including its principal executive and principalfinancial officers, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

 

As of March 31, 2006, ourCEO and CFO, with the participation of other management of the Company,evaluated the effectiveness of our disclosure controls and procedures, as suchterm is defined under Rule 13a-15(e) or 15(d)-15(e) promulgated under theExchange Act, and based upon that evaluation, our CEO and CFO concluded thatthese disclosure controls and procedures were effective to ensure thatinformation required to be disclosed by us in reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms.

 

**Internal Control Over Financial Reporting**

 

During the first quarter of2006, there have been no changes to our internal control over financialreporting that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting, other than the hiring ofa Vice President of Financial Reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1:****         LEGALPROCEEDINGS**

 

The Company’s 2005 10-Kreported shareholder derivative actions filed against the Company and itssenior officers and directors in the U.S. District Court, Central District ofCalifornia and Orange County Superior Court. On April 20, 2006, the OrangeCounty Superior Court approved the consolidation of the state shareholderderivative actions. On March 13, 2006, an additional shareholder derivativeaction was filed in the U.S. District Court, Central District of California byDawn Forsberg, derivatively on behalf of nominal defendant IMH, against theCompany and its senior officers and directors. The complaint alleges claims andseeks damages similar to those in the previously filed derivative actions.

 

We believe that we havemeritorious defenses to the above claims and intend to defend these claimsvigorously. Nevertheless, litigation is uncertain and we may not prevail in thelawsuits and can express no opinion as to their ultimate resolution. An adversejudgment in any of these matters could have a material adverse effect on us.

 

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Please refer to IMH’s report onForm 10-K for the year ended December 31, 2005 regarding litigation and claims.

 

**ITEM 1A:****      RISKFACTORS**

 

Our Annual Report on Form 10-Kfor the year ended December 31, 2005 includes a detailed discussion of our riskfactors. The information presented below updates and should be read inconjunction with the risk factors and information disclosed in that Form 10-K.

 

***A material difference between the assumptionsused in the determination of the value of our residual interests and our actualexperience would cause us to write down the value of these securities and couldharm our financial position.***

 

Our REMIC securitizations, suchas ISAC REMIC 2005-2 and ISAC REMIC 2006-1, in some instances may be treated asa sale for tax purposes but treated as a secured borrowing for GAAP purposesand consolidated in the financial statements due to the retention of residualinterests in the REMICs. The residual interest represents the remainder of thecash flows from the mortgage loans, including, in some instances, reinvestmentincome, over the amounts required to be distributed to regular interests. As ofMarch 31, 2006, the tax basis value of our residual interests fromsecuritization transactions was $90.6 million. Investments in residualinterest and subordinated securities are much riskier than investments insenior mortgage-backed securities because these subordinated securities bearall credit losses prior to the related senior securities. The risk associatedwith holding residual interest and subordinated securities is greater thanholding the underlying mortgage loans directly due to the concentration oflosses attributed to the subordinated securities. The value of residualinterests represents the present value of future cash flows expected to bereceived by us from the excess cash flows created in the securitizationtransaction. In general, future cash flows are estimated by taking the couponrate of the loans underlying the transaction less the interest rate paid to theinvestors, less contractually specified servicing and trustee fees, and aftergiving effect to estimated prepayments and credit losses. We estimate futurecash flows from these securities and value them utilizing assumptions based inpart on projected discount rates, delinquency, mortgage loan prepayment speedsand credit losses. It is extremely difficult to validate the assumptions we usein valuing our residual interests. Even if the general accuracy of thevaluation model is validated, valuations are highly dependent upon thereasonableness of our assumptions and the predictability of the relationshipswhich drive the results of the model. Such assumptions are complex as we mustmake judgments about the effect of matters that are inherently uncertain. Ifour actual experience differs from our assumptions, we would be required toreduce the value of these securities. Furthermore, if our actual experiencediffers materially from these assumptions, our cash flow, financial condition,results of operations and business prospects may be harmed, including anadverse affect on the amount of dividend payments that are made on our commonstock.

 

***New regulatory actions affecting the mortgageindustry may increase our costs and decrease our mortgage acquisition.***

 

In addition to changes to legalrequirements contained in statutes, regulations, case law, and other sources oflaw, changes in the investigation or enforcement policies of federal and stateregulatory agencies could impact the activities in which we may engage, how theactivities may be carried out, and the profitability of those activities. Forexample, state and federal agencies have initiated regulatory enforcementproceedings against mortgage companies for engaging in business practices thatwere not specifically or clearly proscribed by law, but which in the judgmentof the regulatory agencies were unfair or deceptive to consumers. For example,state attorneys general and other state officials representing various statesentered into a Settlement Agreement with a large subprime mortgage company. Thesubject company agreed to pay a substantial amount in restitution to consumersand reimbursement to the states. The subject company also agreed to makechanges to certain business practices, including the company’s underwritingcriteria and pricing policies. Many of the practices and policies are notspecifically prohibited by any federal or state laws but were alleged to bedeceptive or unfair to consumers. The terms of this Settlement Agreement do notapply directly to us; however, federal and state regulatory agencies andprivate parties might nevertheless expect mortgage companies including us, tomake our business practices consistent with the provisions of the Agreement. Ifthis happens, it could impact the activities in which we may engage, how wecarry out those activities, our acquisition practices and our profitability. Wemight also be required to pay fines, make reimbursements, and make otherpayments to third parties for our business practices. Additionally, if anadministrative enforcement proceeding were to result in us having todiscontinue or alter certain business practices, then we might be placed at acompetitive disadvantage vis-à-vis competitors who are not required to makecomparable changes to their business practices.

 

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**ITEM 2:****         UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3:****         DEFAULTSUPON SENIOR SECURITIES**

 

None.

 

**ITEM 4:****         SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

**ITEM 5:****         OTHERINFORMATION**

 

None

 

**ITEM 6:****         EXHIBITS**

 

(a)   Exhibits:

 
| 10.1  |   | Employment  Agreement dated as of May 1, 2006 between Impac Funding Corporation and  Gretchen D. Verdugo.                                                                         |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2  |   | Guaranty,  dated May 1, 2006, granted by Impac Mortgage Holdings, Inc. in favor of  Gretchen D. Verdugo.                                                                          |
| 10.3  |   | Schedule of  each officer and director that is a party to an Indemnification Agreement  with Impac Mortgage Holdings, Inc.                                                        |
| 12.1  |   | Statements  re: computation of ratios                                                                                                                                             |
| 21.1  |   | Subsidiaries  of the Registrant                                                                                                                                                   |
| 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. |

 

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*      Thisexhibit shall not be deemed “filed” for purposes of Section 18 of theSecurities Exchange Act of 1934 or otherwise subject to the liabilities of thatsection, nor shall it be deemed incorporated by reference in any filing underthe Securities Act of 1933 or the Securities Exchange Act of 1934, whether madebefore or after the date hereof and irrespective of any general incorporationlanguage in any filings.

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

**IMPACMORTGAGE HOLDINGS, INC.**

 
| /s/ Gretchen  D. Verdugo                                            |   |
|---------------------------------------------------------------------|--------|
| by: Gretchen  D. Verdugo                                            |
| Executive  Vice President                                           |
| and Chief  Financial Officer                                        |
| (authorized  officer of registrant and principal financial officer) |
|                                                                |
| Date: May 10,  2006                                                 |

 

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