Table of Contents

 

 

 

# **UNITEDSTATES**

# **SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

## **FORM 10-Q**

 

**x**        **QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the quarterly period ended March 31, 2008 or**

 

**o****        TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from                    to                    .**

 

**Commission File 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.) |

 

**19500 Jamboree Road, Irvine, California 92612**

**(Address ofprincipal executive offices)**

 

**(949) 475-3600**

**(Registrant’stelephone number, including area code)**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90days.    Yes  o    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 o  Acceleratedfiler x   Non-accelerated filer o Smaller reporting company o

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2)    Yes o No x

 

Therewere 76,096,392 shares of common stock outstanding as of September 12,2008.

 

 

 

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**IMPAC MORTGAGE HOLDINGS, INC.**

 

### **FORM 10-Q QUARTERLY REPORT**

 

**TABLEOF CONTENTS**

 
| ** ** | ** **                                                                                                                        | ** ** | **Page**   |
|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** ** | **PART I.  FINANCIAL INFORMATION**                                                                                           | ** ** | ** ** |
|       |                                                                                                                              |       |       |
| ITEM 1.    | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                            | ** ** | ** ** |
|       | Consolidated  Balance Sheets as of March 31, 2008 and December 31, 2007                                                 |       | 1          |
|       | Consolidated Statements of Operations and  Comprehensive Earnings (Loss) for the Three Months Ended March 31, 2008  and 2007 |       | 2          |
|       | Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2008 and 2007                                    |       | 4          |
|       | Notes to Unaudited Consolidated Financial Statements                                                                              |       | 6          |
|       |                                                                                                                              |       |       |
| ITEM 2.    | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                   |       | 21         |
|       | Forward-Looking  Statements                                                                                                       |       | 21         |
|       | The Mortgage  Banking Industry and Discussion of Relevant Fiscal Periods                                                          |       | 22         |
|       | Status of  Operations, Liquidity and Capital Resources                                                                            |       | 22         |
|       | Market Conditions                                                                                                                 |       | 25         |
|       | Critical Accounting  Policies                                                                                                     |       | 27         |
|       | Fair Value of  Financial Instruments                                                                                              |       | 28         |
|       | Interest Income and  Expense                                                                                                      |       | 30         |
|       | Selected  Financial Results for the Three Months Ended March 31, 2008                                                        |       | 30         |
|       | Estimated Taxable Income                                                                                                          |       | 30         |
|       | Financial  Condition and Results of Operations                                                                                    |       | 31         |
|       |                                                                                                                              |       |       |
| ITEM 3.    | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                   |       | 39         |
|       |                                                                                                                              |       |       |
| ITEM  4.   | **CONTROLS AND  PROCEDURES**                                                                                                      |       | 39         |
|       |                                                                                                                              |       |       |
| ** ** | **PART II.  OTHER INFORMATION**                                                                                              | ** ** | ** ** |
|       |                                                                                                                              |       |       |
| ITEM  1.   | **LEGAL PROCEEDINGS**                                                                                                             |       | 40         |
|       | ** **                                                                                                                        |       |       |
| ITEM 1A.   | **RISK FACTORS**                                                                                                                  |       | 40         |
|       | ** **                                                                                                                        |       |       |
| ITEM 2.    | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                                  |       | 43         |
|       | ** **                                                                                                                        |       |       |
| ITEM 3.    | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                              |       | 43         |
|       | ** **                                                                                                                        |       |       |
| ITEM 4.    | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                          |       | 44         |
|       | ** **                                                                                                                        |       |       |
| ITEM  5.   | **OTHER INFORMATION**                                                                                                             |       | 44         |
|       | ** **                                                                                                                        |       |       |
| ITEM 6.    | **EXHIBITS**                                                                                                                      |       | 45         |
|       | ** **                                                                                                                        |       |       |
|       | **SIGNATURES**                                                                                                                    |       | 45         |
|       | ** **                                                                                                                        |       |       |
|       | **CERTIFICATIONS**                                                                                                                | ** ** | ** ** |

 

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#### **PART I.FINANCIAL INFORMATION**

 

#### **ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS**

 

**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                        | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                        | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                         |       | $                  | 32,901     |                  | $          | 24,387 |   |
| Trust assets                                                                                                                                                                                                                      |       |               |       |                  |       |
| Investment securities available-for-sale                                                                                                                                                                                          |       | 10,621             |       | 15,248                |       |
| Securitized mortgage collateral (at fair  value at March 31, 2008)                                                                                                                                                           |       | 11,634,134         |       | 16,532,633            |       |
| Derivative assets                                                                                                                                                                                                                 |       | 43                 |       | 7,497                 |       |
| Real estate owned (REO)                                                                                                                                                                                                           |       | 502,473            |       | 400,863               |       |
| Total trust assets                                                                                                                                                                                                                |       | 12,147,271         |       | 16,956,241            |       |
|                                                                                                                                                                                                                              |       |               |       |                  |       |
| Assets of discontinued operations                                                                                                                                                                                                 |       | 223,484            |       | 353,250               |       |
| Other assets                                                                                                                                                                                                                      |       | 55,702             |       | 57,194                |       |
| Total assets                                                                                                                                                                                                                      |       | $                  | 12,459,358 |                  | $          | 17,391,072 |   |
|                                                                                                                                                                                                                              |       |               |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                                                   |       |               |       |                  |       |
| Trust liabilities                                                                                                                                                                                                                 |       |               |       |                  |       |
| Securitized mortgage borrowings (at fair  value at March 31, 2008)                                                                                                                                                           |       | $                  | 11,793,783 |                  | $          | 17,780,060 |   |
| Derivative liabilities                                                                                                                                                                                                            |       | 280,618            |       | 127,757               |       |
| Total trust liabilities                                                                                                                                                                                                           |       | 12,074,401         |       | 17,907,817            |       |
|                                                                                                                                                                                                                              |       |               |       |                  |       |
| Trust preferred securities (at fair value  at March 31, 2008)                                                                                                                                                                |       | 45,129             |       | 98,398                |       |
| Liabilities of discontinued operations                                                                                                                                                                                            |       | 279,614            |       | 405,341               |       |
| Other liabilities                                                                                                                                                                                                                 |       | 5,532              |       | 57,244                |       |
| Total liabilities                                                                                                                                                                                                                 |       | 12,404,676         |       | 18,468,800            |       |
|                                                                                                                                                                                                                              |       |               |       |                  |       |
| Commitments and contingencies                                                                                                                                                                                                     |       |               |       |                  |       |
|                                                                                                                                                                                                                              |       |               |       |                  |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                    |       |               |       |                  |       |
| Series-A junior participating preferred  stock, $0.01 par value; 2,500,000 shares authorized;                                                                                                                                     |       | —             |       | —                |       |
| Series-B 9.375% cumulative redeemable  preferred stock, $0.01 par value; liquidation value $50,000; 2,000,000 shares  authorized, issued and outstanding                                                                          |       | 20                 |       | 20                    |       |
| Series-C 9.125% cumulative redeemable  preferred stock, $0.01 par value; liquidation value $111,765; 5,500,000  shares authorized; 4,470,600 shares issued and outstanding as of  March 31, 2008 and December 31, 2007. |       | 45                 |       | 45                    |       |
| Common stock, $0.01 par value; 200,000,000  shares authorized; 76,096,392 shares issued and outstanding as of  March 31, 2008 and December 31, 2007                                                                     |       | 761                |       | 761                   |       |
| Additional paid-in capital                                                                                                                                                                                                        |       | 1,174,091          |       | 1,173,562             |       |
| Accumulated other comprehensive income                                                                                                                                                                                            |       | —             |       | 1,028                 |       |
| Net accumulated deficit:                                                                                                                                                                                                          |       |               |       |                  |       |
| Cumulative dividends declared                                                                                                                                                                                                     |       | (807,634           | )          | (803,912              | )          |
| Retained deficit                                                                                                                                                                                                                  |       | (312,601           | )          | (1,449,232            | )          |
| Net accumulated deficit                                                                                                                                                                                                           |       | (1,120,235         | )          | (2,253,144            | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                         |       | 54,682             |       | (1,077,728            | )          |
| Total liabilities and stockholders’ equity                                                                                                                                                                                   |       | $                  | 12,459,358 |                  | $          | 17,391,072 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**AND COMPREHENSIVE EARNINGS (LOSS)**

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

**(Unaudited)**

 
| ** **                                                     | ** ** | **For the Three Months** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                     | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                     | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| **INTEREST INCOME:**                                           |       |                                    |       |   |   |
| Total interest income                                          |       | $                                       | 271,955    |   | $ | 304,748 |   |
|                                                           |       |                                    |       |   |   |
| **INTEREST EXPENSE:**                                          |       |                                    |       |   |   |
| Total interest expense                                         |       | 264,606                                 |       | 296,805 |   |
|                                                           |       |                                    |       |   |   |
| Net interest income                                            |       | 7,349                                   |       | 7,943 |   |
| Provision for loan losses                                      |       | —                                  |       | 29,132 |   |
| Net interest income (expense) after provision  for loan losses |       | 7,349                                   |       | (21,189 | ) |
|                                                           |       |                                    |       |   |   |
| **NON-INTEREST INCOME:**                                       |       |                                    |       |   |   |
| Change in fair value of derivative  instruments                |       | —                                  |       | (17,998 | ) |
| Change in fair value of net trust assets,  excluding REO       |       | 3,528                                   |       | — |   |
| Change in fair value of trust preferred  securities            |       | (4,023                                  | )          | — |   |
| Losses from real estate owned                                  |       | (4,256                                  | )          | (9,892 | ) |
| Real estate advisory fees                                      |       | 3,845                                   |       | — |   |
| Other                                                          |       | 1,898                                   |       | 5,287 |   |
| Total non-interest income (expense)                            |       | 992                                     |       | (22,603 | ) |
|                                                           |       |                                    |       |   |   |
| **NON-INTEREST EXPENSE:**                                      |       |                                    |       |   |   |
| General and administrative                                     |       | 3,988                                   |       | 5,509 |   |
| Personnel expense                                              |       | 2,330                                   |       | 844 |   |
| Total non-interest expense                                     |       | 6,318                                   |       | 6,353 |   |
| Net earnings (loss) from continuing  operations                |       | 2,023                                   |       | (50,145 | ) |
| Income tax expense from continuing  operations                 |       | 6,526                                   |       | 3,988 |   |
| Net loss from continuing operations                            |       | (4,503                                  | )          | (54,133 | ) |
| Net earnings (loss) from discontinued  operations, net of tax  |       | 688                                     |       | (67,535 | ) |
| Net loss                                                       |       | (3,815                                  | )          | (121,668 | ) |
| Cash dividends on cumulative redeemable  preferred stock       |       | (3,722                                  | )          | (3,722 | ) |
| Net loss available to common stockholders                      |       | $                                       | (7,537     | ) | $ | (125,390 | ) |

 

See accompanying notes to consolidated financial statements.

 

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| ** **                                       | ** ** | **For the Three Months** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **Ended March 31,**           | ** ** |
| ** **                                       | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| Net loss                                         |       | $                                       | (3,815     | ) | $ | (121,668 | ) |
| Net unrealized losses on securities:             |       |                                    |       |   |   |
| Unrealized holding losses arising during  year   |       | —                                  |       | (1,063 | ) |
| Net unrealized losses                            |       | —                                  |       | (1,063 | ) |
| Comprehensive loss                               |       | $                                       | (3,815     | ) | $ | (122,731 | ) |
|                                             |       |                                    |       |   |   |
| Net (loss) earnings per common share -  Basic:   |       |                                    |       |   |   |
| Loss from continuing operations                  |       | $                                       | (0.11      | ) | $ | (0.76 | ) |
| Earnings (loss) from discontinued  operations    |       | 0.01                                    |       | (0.89 | ) |
| Net loss per share                               |       | $                                       | (0.10      | ) | $ | (1.65 | ) |
|                                             |       |                                    |       |   |   |
| Net (loss) earnings per common share -  Diluted: |       |                                    |       |   |   |
| Loss from continuing operations                  |       | $                                       | (0.11      | ) | $ | (0.76 | ) |
| Earnings (loss) from discontinued  operations    |       | 0.01                                    |       | (0.89 | ) |
| Net loss per share                               |       | $                                       | (0.10      | ) | $ | (1.65 | ) |
|                                             |       |                                    |       |   |   |
| Dividends declared per common share              |       | $                                       | —     |   | $ | 0.10 |   |

 

See accompanying notes to consolidated financial statements.

 

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **For the Three Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                                      | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                       | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Net loss from continuing operations                                             |       | $                                       | (4,503     | ) | $ | (54,133 | ) |
|                                                                            |       |                                    |       |   |   |
| Provision for loan losses                                                       |       | —                                  |       | 29,132 |   |
| Provision for REO losses                                                        |       | 7,727                                   |       | 9,890 |   |
| Gain on sale of REO                                                             |       | (3,471                                  | )          | — |   |
| Amortization of deferred charge, net                                            |       | 6,526                                   |       | 4,101 |   |
| Amortization of premiums and securitization  costs                              |       | —                                  |       | 42,209 |   |
| Amortization of debt issuance costs and  mortgage servicing rights              |       | 647                                     |       | 411 |   |
| Change in fair value of derivative  instruments                                 |       | 155,914                                 |       | 54,623 |   |
| Change in fair value of net trust assets,  excluding REO and derivatives        |       | (185,344                                | )          | — |   |
| Change in fair value of trust preferred  securities                             |       | 4,023                                   |       | — |   |
| Accretion of interest income and expense                                        |       | 101,224                                 |       | — |   |
| Stock-based compensation                                                        |       | 197                                     |       | 869 |   |
| Net change in accrued interest receivable                                       |       | —                                  |       | (4,137 | ) |
| Net cash provided by (used in) operating  activities of discontinued operations |       | 88,984                                  |       | (1,797,314 | ) |
| Net change in other assets and liabilities                                      |       | (24,034                                 | )          | 5,596 |   |
| **Net cash provided by (used in) operating  activities**                        | ** ** | **147,890**                             | ** ** | **(1,708,753** | **)** |
| ** **                                                                      | ** ** | ** **                              | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                       | ** ** | ** **                              | ** ** | ** ** | ** ** |
| Securitized mortgage collateral                                                 |       | 612,291                                 |       | 1,831,520 |   |
| Mortgages held-for-investment                                                   |       | 15                                      |       | 346 |   |
| Purchase of premises and equipment                                              |       | —                                  |       | (434 | ) |
| Principal change on investment securities  available-for-sale                   |       | 538                                     |       | 591 |   |
| Proceeds from the sale of real estate owned                                     |       | 74,961                                  |       | 28,392 |   |
| Net cash provided by investing activities  of discontinued operations           |       | 7,040                                   |       | 57,188 |   |
| **Net cash provided by investing activities**                                   | ** ** | **694,845**                             | ** ** | **1,917,603** | ** ** |
|                                                                            |       |                                    |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                       |       |                                    |       |   |   |
| Cash disbursements under reverse repurchase  agreements                         |       | —                                  |       | (42,163 | ) |
| Cash receipts from reverse repurchase  agreements                               |       | —                                  |       | 71,947 |   |
| Proceeds from securitized mortgage  borrowings                                  |       | —                                  |       | 2,384,131 |   |
| Repayment of securitized mortgage  borrowings                                   |       | (739,536                                | )          | (1,918,566 | ) |
| Common stock dividends paid                                                     |       | —                                  |       | (22,714 | ) |
| Preferred stock dividends paid                                                  |       | (3,722                                  | )          | (3,722 | ) |
| Proceeds from sale of cumulative redeemable  preferred stock                    |       | —                                  |       | 608 |   |
| Net cash used in financing activities of  discontinued operations               |       | (92,942                                 | )          | (676,846 | ) |
| **Net cash used in financing activities**                                       | ** ** | **(836,200**                            | **)**      | **(207,325** | **)** |
|                                                                            |       |                                    |       |   |   |
| Net change in cash and cash equivalents                                         |       | 6,535                                   |       | 1,525 |   |
| Cash and cash equivalents at beginning of  period                               |       | 26,462                                  |       | 179,677 |   |
| Cash and cash equivalents at end of period  - Continuing Operations             |       | 32,901                                  |       | 152,148 |   |
| Cash and cash equivalents at end of period  - Discontinued Operations           |       | 96                                      |       | 29,054 |   |
| Cash and cash equivalents at end of period                                      |       | $                                       | 32,997     |   | $ | 181,202 |   |

 

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                    | ** ** | **For the Three Months** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                    | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                                    | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| **SUPPLEMENTARY INFORMATION (Continuing and  Discontinued Operations):**      |       |                                    |       |   |   |
| Interest paid                                                                 |       | $                                       | 189,435    |   | $ | 387,072 |   |
| Taxes paid                                                                    |       | —                                  |       | 81 |   |
|                                                                          |       |                                    |       |   |   |
| **NON-CASH TRANSACTIONS (Continuing and Discontinued  Operations):**          |       |                                    |       |   |   |
| Accumulated other comprehensive loss                                          |       | $                                       | —     |   | $ | (1,063 | ) |
| Dividends declared but unpaid                                                 |       | —                                  |       | 7,608 |   |
| Transfer of loans held-for-sale and  held-for-investment to real estate owned |       | —                                  |       | 11,761 |   |
| Transfer of securitized mortgage collateral  to real estate owned             |       | 209,801                                 |       | 111,316 |   |
| Transfer of loans held-for-sale to  securitized mortgage collateral           |       | —                                  |       | 2,430,042 |   |

 

See accompanying notes to consolidated financial statements.

 

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**IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

(dollars in thousands, except per share data or as otherwise indicated)

 

**NoteA—Summary of Business and Significant Accounting Policies**

 

**1.****            ****Business Summary and FinancialStatement Presentation**

 

***Business Summary***

 

ImpacMortgage Holdings, Inc. (the Company or IMH) is a Maryland corporationincorporated in August 1995 and has the following subsidiaries: IMH AssetsCorp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG), and ImpacFunding Corporation (IFC), together with its wholly-owned subsidiaries ImpacSecured Assets Corp. (ISAC), Impac Commercial Capital Corporation (ICCC).

 

Duringlate 2007, the Company’s board of directors elected to discontinue thenon-conforming mortgage operations conducted by IFC, commercial operationsconducted by ICCC, retail mortgage operations conducted by IHL, and warehouselending operations conducted by IWLG.

 

The Company consists ofthe continuing operations which includes the long-term mortgage portfolio(residual interests in securitizations) conducted by IMH and IMH Assets, masterservicing portfolio conducted by IFC and real estate advisory fees from IMH’sadvisory services agreement with a real estate marketing company.

 

The information contained throughout this document is presented on acontinuing basis, unless otherwise stated.

 

***Financial Statement Presentation***

 

Theaccompanying unaudited consolidated financial statements of IMH and itssubsidiaries (as defined above) have been prepared in accordance withAccounting Principles Generally Accepted in the United States of America (GAAP)for interim financial information and with the instructions to Form 10-Qand Rule 10-01 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by GAAP for complete financialstatements. In the opinion of management, all adjustments, consisting of normalrecurring adjustments considered necessary for a fair presentation, have beenincluded. Operating results for the three-month period ended March 31,2008 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2008.

 

Allsignificant inter-company balances and transactions have been eliminated inconsolidation. In addition, certain amounts in the prior periods’ consolidatedfinancial statements have been reclassified to conform to the current yearpresentation.

 

Management has made a number of estimates and assumptions relating tothe reporting of assets and liabilities, the disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period to prepare theseconsolidated financial statements in conformity with GAAP.  The items affected by management’s estimatesand assumptions include the valuation of trust assets and liabilities(including investment securities available-for-sale), the valuation ofrepurchase liabilities related to sold loans, the valuation of trust preferredsecurities, and the valuation of loans held-for-sale.  Actual results could differ from thoseestimates.

 

***Market Conditions, Status of Operations, Liquidity and CapitalResources***

 

In 2007 and 2008, management has been seriously challenged by theunprecedented turmoil in the mortgage market, including the following:significant increases in delinquencies and foreclosures; significant increasesin credit-related losses; decline in originations; tightening of warehousecredit and the virtual elimination of the market for loan securitizations.  As a result, the Company discontinued certainoperations, resolved and terminated all but one of the Company’s reverserepurchase facilities and settled a portion of its outstanding repurchaseclaims, while also reducing its operating costs and liabilities.  In the first quarter of 2008, the Companyalso entered into an agreement with a real estate marketing company to generateadvisory fees.

 

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As describedin Note L, in September 2008, the Company executed definitive agreements, whichrequire scheduled principal paydowns and remove any and all technical defaultsthat existed under the previous reverse repurchase facility.

 

In order to reduce dividend payments on its preferred stock, theCompany is considering exchanging the preferred stock for common stock.  In July 2008, the Company’s stockholdersapproved the potential issuance of common shares in excess of 20 percent of theexisting common shares.

 

The Company earns advisory fees from a real estate marketing companyspecializing in the marketing and disposition of foreclosed properties.  During the three months ended March 31,2008, the Company earned $3.8 million from this relationship.  The amount of real estate advisory fees theCompany receives from this relationship are based on numerous factors,including real estate market conditions, the level of foreclosure activity, theability of the marketing company to attract new business, and the Companyretaining its CEO and avoiding liquidation. The agreement terminates in 2010 with the Company having an option toextend the agreement for an additional three years.

 

In July 2008, the Company executed a letter of intent, subject toexecution of definitive agreements, to acquire a special servicing platform,whereby the seller will contribute specified balances of loans (mostlydistressed) to the platform in order to provide sufficient cash flows tomaintain the business during its initial operations.

 

There can be no assurance that the Company will be successful inexecuting the agreements outlined above. Also, there can be no assurance that the restructuring of the trustpreferred securities or the preferred stock will occur.  In this event, the Company intends to reduceoperating expenses to a level that is supportable by the revenues from theexisting long-term mortgage portfolio (residual interests in securitizations),master servicing portfolio and real estate advisory fees. Nevertheless, if theCompany is not successful in completing the objectives outlined above, it maynot be able to meet its contractual obligations for the next year, includingrepayment of the reverse repurchase line, interest payments on trust preferredsecurities and preferred stock dividends.

 

**2.****             Adoption of NewAccounting Standards**

** **

**Adoption of SFAS 157—Fair ValueMeasurements**

 

The Company prospectively adopted the provisions ofFinancial Accounting Standards Board (FASB) Statement No. 157 “Fair ValueMeasurements” (SFAS 157), as of January 1, 2008.  SFAS 157 defines fair value, expandsdisclosure requirements around fair value and specifies a hierarchy ofvaluation techniques based on whether the inputs to those valuation techniquesare observable or unobservable. Observable inputs reflect market data obtainedfrom independent sources, while unobservable inputs reflect the Company’smarket assumptions.  These two types ofinputs create the following fair value hierarchy:

 

·                  Level 1 — Quoted prices for identicalinstruments in active markets.

·                  Level 2 — Quoted prices for similarinstruments in active markets; quoted prices for identical or similarinstruments in markets that are not active; and model-derived valuations inwhich all significant inputs and significant value drivers are observable inactive markets.

·                  Level 3 — Valuations derived from valuationtechniques in which one or more significant inputs or significant value driversare unobservable.

 

This hierarchy requires theCompany to use observable market data, when available, and to minimize the useof unobservable inputs when determining fair value.

 

For some products or in certain market conditions,observable inputs may not always be available. Through the first quarter of 2008, certain markets remained illiquid,and some key observable inputs used in valuing certain exposures were

 

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unavailable.  When and if these markets are liquid, theCompany will use the related observable inputs available at that time fromthese markets.

 

Under fair value accounting, the Company is requiredto take into account its own credit risk when measuring the fair value ofassets and liabilities.

 

**Adoption of SFAS 159 - Fair Value Option**

 

The adoption of Statement No. 159 “The FairValue Option for Financial Assets and Financial Liabilities” (SFAS 159)has also resulted in new valuation techniques used by the Company whendetermining fair value, most notably to value its securitized mortgagecollateral and borrowings and trust preferred securities, which had notpreviously been carried at fair value. The Company prospectively adopted SFAS 159 as of January 1,2008. SFAS 159 provides an option on an instrument-by-instrument basis formost financial assets and liabilities to be reported at fair value with changesin fair value reported in earnings. After the initial adoption, the election ismade at the acquisition of a financial asset, financial liability, or a firmcommitment and it may not be revoked. Management believes that the adoption of SFAS 159 provides anopportunity to mitigate volatility in reported earnings and provides a betterrepresentation of the economics of the trust assets and liabilities.

 

Under the SFAS 159 transition provisions, theCompany elected to apply fair value accounting to certain financial instruments(certain trust assets, trust liabilities and trust preferred securities) heldat January 1, 2008.  Differencesbetween the December 31, 2007 carrying values and the January 1, 2008fair values were recognized as an adjustment to retained deficit. The adoptionof SFAS 159 resulted in a $1.1 billion decrease to retained deficit on January 1,2008 from $(1.4) billion at December 31, 2007 to $(308.8) million at January 1,2008.

 

As a result of deterioration in the real estatemarket since the second half of 2007, the Company significantly added to itsallowance for loan losses during the third and fourth quarters of 2007.  Principally, because of the increase in theallowance for loan losses, the Company reported a stockholders’ deficit as of December 31,2007. This stockholders’ deficit was created primarily because the Company wasrequired under GAAP to record an allowance for loan losses that reducedsecuritized mortgage collateral in its consolidated trusts below the balance ofthe related securitized mortgage borrowings, resulting in a negative investmentin certain consolidated trusts, even though the related trust agreements arenonrecourse to the Company.  However,with the adoption of SFAS 159, the Company’s net investment position is unableto go below zero since the related trust liabilities are also recorded at fairvalue.  Therefore the difference betweenthe fair value of the trust assets and trust liabilities represents the netinvestment interests (residual interests in securitizations) in the trust atfair value.

 

The following table summarizes the initial retainedearnings charge related to the prospective adoption SFAS 159 as of January 1,2008 and the related fair value balances as of the periods indicated.

 
| ** **                                               | ** ** | **Ending Balance as of  December 31, 2007** | ** ** | **Adoption Net** | ** **    | **Fair Value Balance  as of January 1, 2008** | ** ** | **Fair Value Balance**             | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------|---------------|-----------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                               | ** ** | **(Prior to Adoption)**                                    | ** ** | **Gain/(Loss)**       | ** **    | **(After Adoption) (5)**                                          | ** ** | **as of March 31, 2008** | ** ** |
| Impact of electing the fair value option under SFAS 159: |       |                                                                 |       |                  |          |                                                                        |       |                                         |       |
| Investment securities available-for-sale                 |       | $                                                                    | 15,248     |                  | $             | 1,028                                                                       | (1)        | $                                            | 15,248     |   | $ | 10,621 |   |
| Securitized mortgage collateral (2)                      |       | 16,532,633                                                           |       | (821,311              | )             | 15,711,322                                                                  |       | 11,634,134                                   |       |
| Securitized mortgage borrowings (3)                      |       | (17,780,060                                                          | )          | 1,903,283             |          | (15,876,777                                                                 | )          | (11,793,783                                  | )          |
| Trust preferred securities                               |       | (98,398                                                              | )          | 57,446                |          | (40,952                                                                     | )          | (45,129                                      | )          |
| Cumulative-effect adjustment (pre-tax)                   |       |                                                                 |       | 1,140,446             |          |                                                                        |       |                                         |       |
| Tax impact (4)                                           |       |                                                                 |       | —                |          |                                                                        |       |                                         |       |
| Cumulative-effect adjustment to reduce retained deficit  | ** ** | ** **                                                           |       | **$**                 | **1,140,446** |                                                                        |       |                                         |       |   |
|                                                     |       |                                                                 |       |                  |          |                                                                        |       |                                         |       |
| Total retained deficit as of December 31, 2007           |       |                                                                 |       | $                     | (1,449,232    | )                                                                           |       |                                         |       |   |
| Cumulative-effect adjustment to reduce retained deficit  |       |                                                                 |       | 1,140,446             |          |                                                                        |       |                                         |       |
| Total retained deficit as of January 1, 2008 (6)         | ** ** | ** **                                                           |       | **$**                 | **(308,786**  | **)**                                                                       |       |                                         |       |   |
|                                                          |            |                                                                      |            |                       |               |                                                                             |            |                                              |            |  |  |  |  |

 

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(1)         Investment securities available-for-sale are recorded at fair value at December 31,2007, with a corresponding $1,028 thousand unrealized gain included inaccumulated other comprehensive income. Included in the cumulative-effect adjustment was $1,028 thousand in unrealizedholding gains that were reclassified from accumulated other comprehensiveincome to retained deficit.  Due to theeffect of reclassifying the $1,028 thousand from accumulated othercomprehensive income to retained deficit, the investment securities available-for-salebalances do not add across.

 

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(2)         Components of securitized mortgage collateral at December 31, 2007include the allowance for loan loss of $1.2 billion, accrued interest of $99.7million and premiums of $183.1 million, which were part of its fair value forthe adoption of SFAS 159. At March 31, 2008 and December 31, 2007,securitized mortgage collateral included $10.6 million and $9.1 million,respectively in master servicing rights, recorded at the lower of cost ormarket, related to consolidated securitizations and recorded at the lower ofcost or market.

(3)        Components of securitized mortgage borrowings at December 31, 2007include accrued interest of $17.1 million and securitization costs of $37.5million, which were part of its fair value for the adoption of SFAS 159.

(4)        There was no tax effect of the adoption of SFAS 159 as the Companyqualifies as a REIT for federal income tax purposes and its tax liabilities areonly related to it deferred charges associated with previous inter-company loansales.

(5)        The securitized mortgage collateral and securitized mortgage borrowingsinclude the mortgage insurance and bond insurance proceeds to be received fromthird parties.

(6)        As of January 1, 2008, after adoption of SFAS 159, totalstockholder’s equity was $61.7 million

 

**Changes in Significant Accounting Policies**

 

*Investment Securities Available-for-Sale*

 

TheCompany elected to continue to account for all of its existing investmentsecurities available-for-sale at fair value. Interest income is recorded based on the effective yield for the periodbased on the valuation of the previous quarter. Net gains and losses resulting from changes in fair value of investmentsecurities available-for-sale are recorded within change in fair value of nettrust assets in the Company’s consolidated statement of operations.

 

TheCompany’s election to account for its investment securities available-for-saleat fair value was based on the Company’s overall objective of moving towardfair value accounting for significant financial assets and liabilities.  The election of SFAS 159 for these investmentsecurities results in increased volatility within net earnings as a result ofthe recognition of fair value changes with no offsetting amounts that wouldresult if these assets were economically hedged.  However, management believes that electingfair value accounting for its investment securities results in a strongerreflection of the value, while furthering its objective of migrating towardfair value accounting.

 

*Securitized Mortgage Collateral and Borrowings*

 

TheCompany elected to account for certain of its securitized assets at fairvalue.  Interest income on securitizedmortgage collateral and interest expense on securitized mortgage borrowings,respectively, is recorded based on the effective yield for the period based onthe previous quarter’s valuation resulting in interest income and expenseaccretion.  Net gains (losses) resultingfrom the changes in fair value of these items, are included in non-interestincome in the Company’s consolidated statement of operations.  Electing the fair value option allows theCompany to avoid the burden of recording losses on collateral for which theCompany will not ultimately bare the loss. In addition, recording thecollateral and borrowings at fair value will help to reflect the true economicsof the transactions within the consolidated statement of operations.  Upon the adoption of SFAS 159, all deferredcosts associated with securitized mortgage collateral and borrowings have beenrecognized as a cumulative effect of a change in accounting principle withinretained deficit as of January 1, 2008.

 

*Trust Preferred Securities*

 

TheCompany elected to account for all of its trust preferred securities at fairvalue.  Interest expense on these itemsis recorded based on the effective yield for the period.  Gains and losses resulting from the changesin fair value of these items are recorded within change in fair value of trustpreferred securities in the Company’s consolidated statement of operations.

 

TheCompany’s election to account for its trust preferred securities at fair valuewas based on the Company’s overall objective of moving toward fair valueaccounting for significant financial assets and liabilities.  The election of SFAS 159 for theseliabilities results in increased volatility within net earnings as a result ofthe recognition of fair value changes with no offsetting amounts that wouldresult if these liabilities were economically hedged.  However, management believes that electingfair value accounting for its trust preferred securities results in a strongerreflection of the value, while furthering its objective to migrate toward fairvalue accounting.

 

**3.****            ****Recent Accounting Pronouncements**

 

In March 2008, the FASB issued Statement No. 161,“Disclosures about DerivativeInstruments and Hedging Activities” (SFAS 161), an amendment of FASBStatement No. 133, “Accountingfor Derivative Instruments and Hedging Activities” (SFAS 133), toexpand disclosure requirements for an entity’s derivative and hedgingactivities. Under SFAS 161, entities are required to provide enhanceddisclosures about how and why an entity uses derivative instruments, howderivative instruments and related hedged items are accounted for underSFAS 133 and its related interpretations, and how derivative instrumentsand related hedged items affect an entity’s financial position, financialperformance, and cash flows. In order to

 

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meetthese requirements, entities shall include qualitative disclosures aboutobjectives and strategies for using derivatives, quantitative disclosures aboutfair value amounts of and gains and losses on derivative instruments, anddisclosures about credit-risk-related contingent features in derivativeagreements. SFAS 161 is effective for fiscal years and interim periodsbeginning after November 15, 2008 with early adoption encouraged. TheCompany plans to adopt this Statement on January 1, 2009, and there shouldbe no impact on the consolidated financial statements as this Statement onlyaddresses disclosures.

 

In April 2008, the FASB voted to eliminate qualifying specialpurpose entities (QSPEs) from the guidance in FASB Statement No. 140 “Accountingfor Transfers and Servicing of Financial Assets and Extinguishment ofLiabilities” (SFAS 140).   While therevised standard has not been finalized and the FASB’s proposals will besubject to a public comment period, this change may have a significant impacton the Company’s consolidated financial statements as it may lose salestreatment for assets previously sold to a QSPE, as well as for future sales. Aneffective date for any proposed revisions has not been determined by the FASB.As of March 31, 2008, the current principal balance of QSPEs to which theCompany, acting as principal, has transferred assets and received salestreatment were $754.9 million.  TheCompany’s investment in these QSPE’s consists of residual interests accountedfor as investment securities available-for-sale in its consolidated balancesheets.

 

In connection with the proposed changes to SFAS 140, the FASB alsois proposing three key changes to the consolidation model in FASBInterpretation No. 46(R), “Consolidation of Variable Interest Entities(revised December 2003)—an interpretation of ARB No. 51”(FIN 46(R)). First, the FASB will now include former QSPEs in the scope ofFIN 46(R). In addition, the FASB supports amending FIN 46(R) tochange the method of analyzing which party to a variable interest entity (VIE)should consolidate the VIE to a primarily qualitative determination of controlinstead of today’s risks and rewards model. Finally, the proposed amendment isexpected to require all VIEs and their primary beneficiaries to be reevaluatedquarterly. The previous rules required reconsideration only when specifiedreconsideration events occurred. As of March 31, 2008, the currentprincipal balance of significant unconsolidated VIEs with which the Company isinvolved were approximately $754.9 million.

 

The Company will be evaluating the impact of these changes on theCompany’s consolidated financial statements once the standard is approved andissued.

 

**4.****            ****Legal Proceedings**

 

TheCompany is party to litigation and claims which are normal in the course of itsoperations.  While the results of suchlitigation and claims cannot be predicted with certainty, the Company believesthe final outcome of such matters will not have a material adverse effect onthe Company’s financial condition or results of operations.

 

OnNovember 9, 2007, and separately on August 25, 2008, two matters werefiled against IFC in Orange County in the Superior Court of California, as casenos. 07CC11612 and 00110553, respectively, by Citimortgage, Inc., allegingclaims for breach of contract and damages based upon representations andwarranties made in conjunction with whole loan sales. These actions seekcombined damages in excess of $4.2 million.

 

OnJune 28, 2008 a matter was filed against IFC in the Circuit Court of theEighteenth Judicial District, Dupage County in Illinois, as case no.2008L000721, by TR Mid America Plaza Corp., seeking damages for breach ofcontract (a lease agreement) in excess of $0.6 million plus such amount asdetermined through the date of judgment and payment of attorneys fees andcosts.

 

TheCompany believes that it has meritorious defenses to the above claims andintends to defend these claims vigorously. Nevertheless, litigation isuncertain and the Company may not prevail in the lawsuits and can express noopinion as to their ultimate resolution. An adverse judgment in any of thesematters could have a material adverse effect on the Company.

 

Please refer to IMH’s report on Form 10-K forthe year ended December 31, 2007 for a description of other litigation andclaims.

 

**5.****            ****Income Taxes and Deferred Charge**

 

In accordance with Accounting Research Bulletin No. 51, “ConsolidatedFinancial Statements,” the Company records a deferred charge representing thedeferral of income tax expense on inter-company profits that resulted from thesale of mortgages from taxable subsidiaries to IMH in prior years. The deferredcharge is included in other assets in the

 

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accompanyingconsolidated balance sheets and is amortized as a component of income taxexpense in the accompanying consolidated statements of operations over theestimated life of the mortgages retained in the securitized mortgagecollateral. The Company recorded a tax provision of $6.5 million and$4.0 million for the three months ending March 31, 2008 and 2007,respectively.  The net provision ispredominately the result of the amount of the deferred charge amortized and/orimpaired resulting from credit losses, which does not result in any taxliability required to be paid.

 

**NoteB—Fair Value of Financial Instruments**

 

The Company’s consolidatedfinancial statements include financial assets and liabilities that are measuredbased on their estimated fair values. The use of fair value to measure the Company’s financial instruments isfundamental to its consolidated financial statements and is a criticalaccounting estimate because a substantial portion of its assets and liabilitiesare recorded at estimated fair value.

 

The application of fairvalue estimates may be on a recurring or nonrecurring basis depending on theaccounting principles applicable to the specific asset or liability or whethermanagement has elected to carry the item at its estimated fair value asdiscussed previously.

 

Effective January 1,2008, the Company adopted two pronouncements affecting its fair valuemeasurements and accounting: SFAS 157 and SFAS 159.

 

SFAS 157 defines fair valueas the price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. SFAS 157 establishes a three-tiered fair value hierarchythat prioritizes the inputs used to estimate fair value into three broadlevels, considering the relative reliability of the inputs:

 

·                  Level 1— Quoted prices in activemarkets for identical assets or liabilities. Level 1 assets and liabilities includedebt and equity securities and derivative contracts that are traded in anactive exchange market, as well as certain U.S. treasury, other U.S. Governmentand agency mortgage-backed debt securities that are highly liquid and areactively traded in over-the-counter markets.

 

·                  Level 2— Observable inputs otherthan Level 1 prices, such as quoted prices for similar assets or liabilities;quoted prices in markets that are not active; or other inputs that areobservable or can be corroborated by observable market data for substantiallythe full term of the assets or liabilities. Level 2 assets and liabilitiesinclude securities with quoted prices that are traded less frequently thanexchange-traded instruments, securities and derivative contracts and financialliabilities whose value is determined using a pricing model with inputs thatare observable in the market or can be derived principally from or corroboratedby observable market data. This category generally includes trust assets orliabilities where more than a significant percentage of the fair values werederived using a pricing process that was based upon observable inputs.

 

·                  Level 3— Unobservable inputs thatare supported by little or no market activity and that are significant to thefair value of the assets or liabilities. Level 3 assets and liabilities includefinancial instruments whose value is determined using pricing models,discounted cash flow methodologies, or similar techniques, as well asinstruments for which the determination of fair value requires significantmanagement judgment or estimation. This category includes those assets andliabilities that were not included in Level 1 or Level 2.

 

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The following table presents for each of these hierarchy levels, theCompany’s assets and liabilities that are measured at fair value on a recurringbasis, including financial instruments for which the Company has elected thefair value option at March 31, 2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **At March 31, 2008**                 | ** ** |
| ** **                               | ** ** | **Level 1**                                     | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| **Assets**                               |       |                                                 |       |   |   |   |   |   |   |
| Investment securities available-for-sale |       | $                                                    | —     |   | $ | — |   | $ | 10,621 |   | $ | 10,621 |   |
| Securitized mortgage collateral (1)      |       | —                                               |       | 10,656,584 |   | 966,958 |   | 11,623,542 |   |
| **Total Assets at Fair Value**           | ** ** | **$**                                                | **—** | ** ** | **$** | **10,656,584** | ** ** | **$** | **977,579** | ** ** | **$** | **11,634,163** | ** ** |
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Liabilities**                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings          |       | $                                                    | —     |   | $ | 10,795,388 |   | $ | 998,395 |   | $ | 11,793,783 |   |
| Derivative liabilities, net (2)          |       | —                                               |       | 280,575 |   | — |   | 280,575 |   |
| Trust preferred securities               |       | —                                               |       | — |   | 45,129 |   | 45,129 |   |
| **Total Liabilities at Fair Value**      | ** ** | **$**                                                | **—** | ** ** | **$** | **11,075,963** | ** ** | **$** | **1,043,524** | ** ** | **$** | **12,119,487** | ** ** |

 

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(1)        Excluded from securitized mortgage collateral above is $10.6 million inmaster servicing rights related to consolidated securitizations and recorded atthe lower of cost or market.

(2)        Derivative liabilities, net includes $43 thousand in derivative assetsand $280.6 million in derivative liabilities, included within trust assets andtrust liabilities, respectively.

 

Level3 assets and liabilities were 7.8 percent and 8.4 percent of total assets atfair value and total liabilities at fair value at March 31, 2008,respectively.

 

Thefollowing table presents a reconciliation for all assets and liabilitiesmeasured at fair value on a recurring basis using significant unobservableinputs (Level 3) for the three months ended March 31, 2008:

 
| ** **                                | ** ** | **Level 3 Recurring Fair Value Measurements** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months Ended March 31, 2008**         | ** ** |
| ** **                                | ** ** | **Fair Value -   January 1, 2008**            | ** ** | **Total Gains  (Losses)  Included in** | ** ** | **Transfers in  and/or out of  Level 3** | ** ** | **Purchases,  issuances and  settlements** | ** ** | **Fair Value -  March 31, 2008** | ** ** | **Unrealized gains  (losses) still held (1)** | ** ** |
| Investment securities  available-for-sale |       | $                                                                      | 15,248     |   | $ | (4,090 | ) | $ | — |   | $ | (537 | ) | $ | 10,621 |   | $ | (4,290 | ) |
| Securitized mortgage  collateral          |       | 782,574                                                                |       | (249,070 | ) | 526,469 |   | (93,015 | ) | 966,958 |   | (342,085 | ) |
| Securitized mortgage  borrowings          |       | (767,704                                                               | )          | 278,203 |   | (562,467 | ) | 53,573 |   | (998,395 | ) | 331,777 |   |
| Trust preferred securities                |       | (40,952                                                                | )          | (4,177 | ) | — |   | — |   | (45,129 | ) | (4,023 | ) |
|                                           |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)           Represents the amount of total gains or lossesfor the period, included in earnings, attributable to the change in unrealizedgains (losses) relating to assets and liabilities classified as Level 3 thatare still held at March 31, 2008.

 

The table below summarizes gains and losses due to changes in fairvalue, including both realized and unrealized gains and losses, recorded inearnings for Level 3 assets and liabilities for the three months ended March 31,2008.

 
| ** **                                               | ** ** | **Recurring Fair Value Measurements  Level 3 - Total Gains (Losses) Included in Net Loss  Three Months Ended March 31, 2008** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Investment Securities  Available-for-Sale**                                                                                                                                                                 | ** ** | **Securitized Mortgage  Collateral** | ** ** | **Securitized Mortgage  Borrowings** | ** ** | **Trust Preferred  Securities** | ** ** |
| Interest income                                          |       | $                                                                                                                                                                                                                  | 200        |   | $ | (88 | ) | — |   | — |   |
| Interest expense                                         |       | —                                                                                                                                                                                                             |       | — |   | (8,901 | ) | (154 | ) |
| Change in fair value of net trust assets,  excluding REO |       | (4,290                                                                                                                                                                                                             | )          | (248,982 | ) | 287,104 |   | — |   |
| Change in fair value of trust preferred  securities      |       | —                                                                                                                                                                                                             |       | — |   | — |   | (4,023 | ) |
| **Total**                                                | ** ** | **$**                                                                                                                                                                                                              | **(4,090** | **)** | **$** | **(249,070** | **)** | **$** | **278,203** | ** ** | **$** | **(4,177** | **)** |
|                                                          |            |                                                                                                                                                                                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

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SFAS 159 permits fair value accounting to be elected for certainassets and liabilities on an individual contract basis at the time ofacquisition or under certain other circumstances referred to as “remeasurementevent dates.” For those items for which fair value accounting is elected,changes in fair value will be recognized in earnings, and fees and costsassociated with the origination or acquisition of such items will be recognizedas incurred rather than deferred. In addition, SFAS 159 allows applicationof the Statement’s provisions to eligible items existing at the effective dateand management has elected to apply SFAS 159 to certain of those items asdiscussed below.

 

The following is a description of the measurement techniques for itemsrecorded at fair value on a recurring basis and a non-recurring basis.

 

***Recurring basis***

 

*Investment Securities Available-for-Sale.* Pursuant to the Company’s adoption of SFAS 159, the Company electedto carry all of its investment securities available-for-sale at fairvalue.  These investment securities arerecorded at fair value and consist primarily of non-investment grademortgage-backed securities.  The fairvalue of the investment securities are measured based upon the Company’sexpectation of inputs that other market participants would use.  Such assumptions include judgments about theunderlying collateral, prepayment speeds, credit losses, and certain otherfactors.  Given the market disruption andlack of observable market data as of March 31, 2008, the fair value of theinvestment securities available-for-sale were measured using significantinternal expectations of market participants’ assumptions. At March 31,2008, investment securities available-for-sale were classified as Level 3fair value measurements.

 

*Securitized Mortgage Collateral* – Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgagecollateral at fair value.  These assetsconsist primarily of Alt-A mortgage loans securitized between 2002 and 2007.  Fair value measurements are based on theCompany’s estimated cash flow models, which incorporate assumptions, inputs ofother market participants and quoted prices for the underlying bonds.  The Company’s assumptions include itsexpectations of inputs that other market participants would use. Theseassumptions include judgments about the underlying collateral, prepaymentspeeds, credit losses, and certain other factors.  At March 31, 2008, securitized mortgagecollateral was classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.  As of March 31, 2008, the unpaidprincipal balance and fair values of loans 90 days or more past due was $2.3billion and estimated at $1.4 billion, respectively.  The aggregate unpaid principal balancesexceed the fair value by $883.5 million as of March 31, 2008.

 

*Securitized Mortgage Borrowings* - Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgageborrowings at fair value.  Theseborrowings consist of individual tranches of bonds issued by securitizationtrusts and are primarily backed by Alt-A mortgage loans.  Fair value measurements include the Company’sjudgments about the underlying collateral assumptions such as prepaymentspeeds, credit losses, and certain other factors and are based upon quotedprices for the individual tranches of bonds, if available.  At March 31, 2008, securitized mortgageborrowings were classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.  As of March 31, 2008, the unpaidprincipal balance and fair value of securitized mortgage borrowings was $17.1billion and estimated at $11.8 billion, respectively.  The aggregate unpaid principal balanceexceeds the fair value by $5.3 billion at March 31, 2008.

 

*Trust Preferred Securities* - Pursuant to the Company’s adoption of SFAS 159, the Companyelected to carry all of its trust preferred securities at fair value.  These securities were measured based uponusing other preferred stock issued by the Company adjusted for differencesbetween the securities. The fair value of the trust preferred securitiesresulted in adjustments to reduce the par value for the following factors:

 

·                  Statedinterest rate adjustments to account for the stated yield difference betweenthe trust preferred securities and the preferred stock issued by the Company,

 

·                  Liquidityadjustments to reflect the presence of a lack of an actively traded market forthese securities.

 

·                  Preferenceadjustments to reflect the rights of the trust preferred securities as comparedto the preferred securities.

 

At March 31, 2008 trust preferred securities were classified asLevel 3 measurements.  As of March 31,2008, the unpaid principal balance and fair value of trust preferred securitieswas $99.2 million and $45.1 million, respectively.  The aggregate unpaid principal balanceexceeds the fair value by $54.1 million at March 31, 2008.

 

*Derivative Assets andLiabilities.*****For non-exchange traded contracts, fair valueis based on the amounts that would be required to settle the positions with therelated counterparties as of the valuation date.   Valuations of derivative assets andliabilities reflect the value of the instruments, including the valuesassociated with counterparty risk. With the issuance of SFAS 157, these valuesmust also take into account the Company’s own credit standing, to the extentapplicable, thus

 

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includedin the valuation of the derivative instrument is the value of the net creditdifferential between the counterparties to the derivative contract.  At March 31, 2008, derivative assets andliabilities were classified as Level 2 measurements.

 

***Non-recurring basis***

 

TheCompany is required to measure certain assets at fair value fromtime-to-time.  These fair valuemeasurements typically result from the application of specific accountingpronouncements under GAAP.  The fairvalue measurements are considered non-recurring fair value measurements underSFAS 157.

 

*Loans Held-for-Sale -*Loans held-for-sale for which the fair value option was not elected arecarried at lower of cost or market (LOCOM). When available, such measurements are based upon what secondary marketsoffer for portfolios with similar characteristics, and are consideredLevel 2 measurements. If market pricing is not available, suchmeasurements are significantly impacted by the Company’s expectations of othermarket participants’ assumptions, and are considered Level 3 measurementsat March 31, 2008.  The Companyutilizes internal pricing processes to estimate the fair value of loansheld-for-sale, which is based on recent loan sales and estimates of the fairvalue of the underlying collateral. Loans held-for-sale, which are primarily included in assets ofdiscontinued operations, are considered Level 3 measurements at March 31,2008.

* *

*Mortgage Servicing Rights -*Mortgage servicing rights (MSRs) for which the fair value option wasnot elected are carried at LOCOM.  MSRsare not traded in an active market with observable prices.  The Company utilizes internal pricingprocesses to estimate the fair value of MSRs, which are based on assumptionsthe Company believes would be used by market participants, including marketdiscount rates, float, prepayment speeds and master servicing fees.  MSRs, which are included in other assets, areconsidered Level 3 measurements at March 31, 2008.

 

Thefollowing table presents the fair values of those financial assets measured atfair value on a non-recurring basis at March 31, 2008.

 
| ** **                | ** ** | **Non-recurring Fair Value Measurements  As of March 31, 2008** | ** ** | **Year to date** | ** ** |
|---------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                | ** ** | **Level 1**                                                                                   | ** ** | **Level 2**           | ** ** | **Level 3** | ** ** | **Total** | ** ** | **(losses)** | ** ** |
| Loans held-for-sale (1)   |       | $                                                                                                  | —     |                       | $          | — |   | $ | 191,529 |   | $ | 191,529 |   | $ | (8,364 | ) |
| Mortgage servicing rights |       | $                                                                                                  | —     |                       | $          | — |   | $ | 1,978 |   | $ | 1,978 |   | $ | (647 | ) |

 

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(1)         Includes $1.7 million and $189.8 million of loans held-for-sale withincontinuing and discontinued operations, respectively at March 31, 2008.

 

Thefollowing table represents changes in fair value of recurring fair valuemeasurements for the three months ended March 31, 2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements  Changes in Fair Value Included in Net Loss  Three Months Ended March 31, 2008** | ** **  |
|------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | ** **                                                                                                                                                                                      | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income**                                                                                                                                                                        | ** **  | **Interest  Expense** | ** ** | **Net Trust  Assets** | ** ** | **Trust  Preferred  Securities** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                                                                                                                               | 733         |   | $ | — |   | $ | (4,290 | )(1) | $ | — |   | $ | (3,557 | ) |
| Securitized mortgage collateral          |       | 269,897                                                                                                                                                                                         |        | — |   | (3,229,500 | )(1) | — |   | (2,959,603 | ) |
| Securitized mortgage borrowings          |       | —                                                                                                                                                                                          |        | (261,816 | ) | 3,419,134 | (1) | — |   | 3,157,318 |   |
| Trust preferred securities               |       | —                                                                                                                                                                                          |        | (2,183 | ) | — |   | (4,023 | ) | (6,206 | ) |
| Derivative instruments                   |       | —                                                                                                                                                                                          |        | — |   | (181,816 | )(2) | — |   | (181,816 | ) |
| **Total**                                | ** ** | **$**                                                                                                                                                                                           | **270,630** | **(3)** | **$** | **(263,999** | **)(3)** | **$** | **3,528** | ** ** | **$** | **(4,023** | **)** | **$** | **6,136** | ** ** |

 

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(1)                     The $185.3 million total change in fair valueof these financial instruments is included as change in fair value of trustassets, excluding REO and derivatives, in the accompanying statement of cashflows for the three months ended March 31, 2008.

 

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(2)                     Included in this amount is $(155.9) million innon-cash changes in the fair value of derivative instruments, which areincluded in the accompanying statement of cash flows for the three months endedMarch 31, 2008, and $(25.9) million in cash settlements paid.

 

(3)                     Thetotals include $25.4 million and $75.8 million of accretion of interest incomeand expense, respectively.

 

Thechange in fair value of the asset and liabilities above, excluding derivativeinstruments, are primarily due to the changes in credit risk.  The change in fair value for derivativeinstruments is primarily due to the change in the forward LIBOR curve for thequarter.

 

**Note C— Stock Options**

 

The fair value of options granted, which isamortized to expense over the option vesting period, is estimated on the dateof grant using the Black-Scholes-Merton option pricing model with the followingweighted average assumptions:

 
| ** **                             | ** ** | **Three Months**         | ** ** |
|----------------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Ended March 31,** | ** ** |
| ** **                             | ** ** | **2008**                      | ** ** | **2007** | ** ** |
| Risk-free interest rate                |       | 1.88% to 2.13%                |       | — |   |
| Expected lives (in years)              |       | 3.25                          |       | — |   |
| Expected volatility (1)                |       | 87.3% - 89.9%                 |       | — |   |
| Expected dividend yield (2)            |       | 0.00%                         |       | — |   |
| Grant date fair value of share options |       | $ 0.71 - 0.78            |       | — |   |

 

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

(2)                     Expected dividend yield is zero because adividend on the common stock is currently not probable over the expected life of the options granted during the quarter ended March 31, 2008.

 

There were no stock options granted during the threemonths ended March 31, 2007.

 

The following table summarizes activity, pricing andother information for the Company’s stock options for the three month periodended March 31, 2008:

 
| ** **                             | ** ** | ** **         | ** ** | **Weighted-**      | ** ** |
|----------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                             | ** ** | ** **         | ** ** | **Average**        | ** ** |
| ** **                             | ** ** | **Number of** | ** ** | **Exercise**       | ** ** |
| ** **                             | ** ** | **Shares**         | ** ** | **Price ($)** | ** ** |
| Options outstanding at January 1, 2008 |       | 5,939,914          |       | $                  | 9.75       |   |
| Options granted                        |       | 7,810,000          |       | 1.28               |       |
| Options exercised                      |       | —             |       | —             |       |
| Options forfeited / cancelled          |       | (647,498           | )          | 7.83               |       |
| Options outstanding at March 31, 2008  |       | 13,102,416         |       | $                  | 4.78       |   |
| Options exercisable at March 31, 2008  |       | 2,665,225          |       | $                  | 12.94      |   |

 

As of March 31, 2008, there was approximately$6.6 million of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements granted under the plan. That cost isexpected to be recognized over a weighted average period of 1.3 years.

 

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**NoteD—Reconciliation of Earnings Per Share**

 

Thefollowing table presents the computation of basic and diluted net earnings pershare including the dilutive effect of stock options and cumulative redeemablepreferred stock outstanding for the periods indicated:

 
| ** **                                                                      | ** ** | **For the Three Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended March 31,**           | ** ** |
| ** **                                                                      | ** ** | **2008**                                | ** ** | **2007** | ** ** |
| **Numerator for basic earnings per share:**                                     |       |                                    |       |   |   |
| Net loss from continuing operations                                             |       | $                                       | (4,503     | ) | $ | (54,133 | ) |
| Net earnings (loss) from discontinued  operations                               |       | 688                                     |       | (67,535 | ) |
| Less: Cash dividends on cumulative  redeemable preferred stock                  |       | (3,722                                  | )          | (3,722 | ) |
| Net loss available to common stockholders                                       |       | $                                       | (7,537     | ) | $ | (125,390 | ) |
| **Denominator for basic earnings per share:**                                   |       |                                    |       |   |   |
| Basic weighted average number of common  shares outstanding during the period   |       | 76,096                                  |       | 76,081 |   |
| **Denominator for diluted earnings per share:**                                 |       |                                    |       |   |   |
| Diluted weighted average number of common  shares outstanding during the period |       | 76,096                                  |       | 76,081 |   |
| Net effect of dilutive stock options                                            |       | —                                  |       | — |   |
| Diluted weighted average common shares                                          |       | 76,096                                  |       | 76,081 |   |
|                                                                            |       |                                    |       |   |   |
| Net (loss) earnings per common share -  Basic:                                  |       |                                    |       |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.11      | ) | $ | (0.76 | ) |
| Earnings (loss) from discontinued  operations                                   |       | 0.01                                    |       | (0.89 | ) |
| Net loss per share                                                              |       | $                                       | (0.10      | ) | $ | (1.65 | ) |
|                                                                            |       |                                    |       |   |   |
| Net (loss) earnings per common share -  Diluted:                                |       |                                    |       |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.11      | ) | $ | (0.76 | ) |
| Earnings (loss) from discontinued  operations                                   |       | 0.01                                    |       | (0.89 | ) |
| Net loss per share                                                              |       | $                                       | (0.10      | ) | $ | (1.65 | ) |

 

Forthe three month periods ended March 31, 2008 and 2007, stock options topurchase 13.1 million and 6.9 million shares, respectively, were outstanding butnot included in the above weighted average calculations because they wereanti-dilutive.

 

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**Note E—Segment Reporting**

 

The Company has two reporting segments, thecontinuing operations and discontinued operations.  The following tables present the selectedfinancial data and operating results by reporting segments for the periodsindicated:

 
| ** **                                                                              | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                              | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Balance  Sheet Items as of March 31, 2008:**                                          | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Securitized mortgage collateral                                                         |       | $              | 11,634,134 |             | $          | —           |       | $ | 11,634,134 |   |
| Loans held-for-sale                                                                     |       | 1,684          |       | 189,845          |       | 191,529          |       |
| Total assets                                                                            |       | 12,235,874     |       | 223,484          |       | 12,459,358       |       |
| Total liabilities                                                                       |       | 12,125,062     |       | 279,614          |       | 12,404,676       |       |
| Total stockholders’ equity (deficit)                                               |       | 110,812        |       | (56,130          | )          | 54,682           |       |
|                                                                                    |       |           |       |             |       |             |       |
| **Balance  Sheet Items as of December 31, 2007:**                                       | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Securitized mortgage collateral                                                         |       | $              | 16,532,633 |             | $          | —           |       | $ | 16,532,633 |   |
| Loans held-for-sale                                                                     |       | 1,684          |       | 279,659          |       | 281,343          |       |
| Finance receivables                                                                     |       | 336            |       | 12,458           |       | 12,794           |       |
| Total assets                                                                            |       | 17,037,822     |       | 353,250          |       | 17,391,072       |       |
| Total liabilities                                                                       |       | 18,063,459     |       | 405,341          |       | 18,468,800       |       |
| Total stockholders’ deficit                                                        |       | (1,025,637     | )          | (52,091          | )          | (1,077,728       | )          |
|                                                                                    |       |           |       |             |       |             |       |
| ** **                                                                              | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
| ** **                                                                              | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Statement  of Operations Items for the three months ended March 31, 2008:** |       |           |       |             |       |             |       |
| Net interest income                                                                     |       | $              | 7,349      |             | $          | 1,671            |       | $ | 9,020 |   |
| Change in fair value of derivatives, net                                                |       | —         |       | (145             | )          | (145             | )          |
| Change in fair value of net trust assets                                                |       | 3,528          |       | —           |       | 3,528            |       |
| Other non-interest (expense) income                                                     |       | (2,536         | )          | 9,478            |       | 6,942            |       |
| Non-interest expense and income taxes                                                   |       | (12,844        | )          | (10,316          | )          | (23,160          | )          |
| Net (loss) earnings                                                                     |       | $              | (4,503     | )                | $          | 688              |       | $ | (3,815 | ) |
|                                                                                    |       |           |       |             |       |             |       |
| **Statement  of Operations Items for the three months ended March 31, 2007:** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                                     |       | $              | 7,943      |             | $          | 5,513            |       | $ | 13,456 |   |
| Provision for loan losses                                                               |       | (29,132        | )          | (243             | )          | (29,375          | )          |
| Change in fair value of derivatives, net                                                |       | (17,998        | )          | (3,303           | )          | (21,301          | )          |
| Other non-interest income (expense)                                                     |       | (4,605         | )          | (44,655          | )          | (49,260          | )          |
| Non-interest expense and income taxes                                                   |       | (10,341        | )          | (24,847          | )          | (35,188          | )          |
| Net loss                                                                                |       | $              | (54,133    | )                | $          | (67,535          | )          | $ | (121,668 | ) |

 

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**Note G—Other Assets**

 

Other assets for the periods indicated consisted ofthe following:

 
| ** **                      | ** ** | **At March 31,** | ** ** | **At December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2008**                   | ** ** | **2007**                      | ** ** |
| Deferred charge                 |       | $                          | 30,885     |                          | $          | 37,412 |   |
| Premises and equipment          |       | 3,608                      |       | 3,904                         |       |
| Real estate owned outside trust |       | 3,205                      |       | 4,571                         |       |
| Prepaid expenses                |       | 3,109                      |       | 3,505                         |       |
| Other receivables               |       | 2,729                      |       | —                        |       |
| Investment in capital trusts    |       | 2,333                      |       | 2,394                         |       |
| Mortgage sevicing rights        |       | 1,978                      |       | 2,083                         |       |
| Other assets                    |       | 7,855                      |       | 3,325                         |       |
| Total other assets              |       | $                          | 55,702     |                          | $          | 57,194 |   |

 

**Note H—Real Estate Owned (REO)**

 

Real estate owned, whichconsists of residential real estate acquired in satisfaction of loans, iscarried at the net realizeable value less estimated selling and holding costs,offset by expected mortgage insurance proceeds to be received. Historically,adjustments to the loan carrying value required at the time of foreclosure arecharged off against the allowance for loan losses. Historically, the Companywould writedown REO for changes in the value of the real estate due todeclining home prices during the holding period and recognize that amount as aprovision for REO losses.  The gains andlosses related to REO are included in the cash flows of the securitizedmortgage collateral.  Losses or gainsfrom the ultimate disposition of real estate owned are recorded as gain (loss)on sale of other real estate owned in the consolidated statements ofoperations. REO is recorded at its estimated net realizable value at March 31,2008 and December 31, 2007.

 

Activity for the Company’sREO consisted of the following:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Year Ended**             | ** ** |
|-----------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **March 31, 2008**     | ** ** | **December 31, 2007** | ** ** |
| Beginning balance     |       | $                                | 405,434    |                            | $          | 137,331 |   |
| Foreclosures          |       | 154,802                          |       | 487,314                         |       |
| Liquidations          |       | (54,558                          | )          | (219,211                        | )          |
| REO                   |       | $                                | 505,678    |                            | $          | 405,434 |   |
|                  |       |                             |       |                            |       |
| REO inside trusts     |       | $                                | 502,473    |                            | $          | 400,863 |   |
| REO outside trust (1) |       | 3,205                            |       | 4,571                           |       |
| REO                   |       | $                                | 505,678    |                            | $          | 405,434 |   |

 

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(1)         Amount represents REO related to a formeron-balance sheet securitization, which was collapsed as the result of theCompany exercising its clean-up call option. This REO is included in other assets within continuing operations.

 

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**Note I—****Securitized Mortgage****Borrowings**

 

The following is selected information on securitizedmortgage borrowings for the periods indicated (dollars in millions):

 
| ** **                               | ** ** | ** **             | ** ** | ** **                                                                 | ** ** | ** **                      | ** ** | **Range of Percentages:**                  | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **Original  Issuance** | ** ** | **Securitized mortgage borrowings  outstanding as of** | ** ** | **Fixed  Interest**             | ** ** | **Interest Rate  Margins over  One-Month** | ** ** | **Interest Rate  Margins after  Adjustment** | ** ** |
| **Year of Issuance**           | ** ** | **Amount**             | ** ** | **March 31, 2008**                                               | ** ** | **December 31, 2007** | ** ** | **Rates**                                            | ** ** | **LIBOR (1)** | ** ** | **Date (2)** | ** ** |
| 2002                                     |       | $                      | 3,876.1    |                                                                       | $          | 40.4                            |       | $                                                    | 42.1       |   | 5.25 - 12.00 |   | 0.27 - 2.75 |   | 0.54 - 3.68 |   |
| 2003                                     |       | 5,966.1                |       | 386.1                                                                      |       | 409.4                           |       | 4.34 - 12.75                                         |       | 0.27 - 3.00 |   | 0.54 - 4.50 |   |
| 2004                                     |       | 17,710.7               |       | 2,562.3                                                                    |       | 2,751.8                         |       | 3.58 - 5.56                                          |       | 0.25 - 2.50 |   | 0.50 - 3.75 |   |
| 2005                                     |       | 13,387.7               |       | 5,653.9                                                                    |       | 5,961.6                         |       | —                                               |       | 0.24 - 2.90 |   | 0.48 - 4.35 |   |
| 2006                                     |       | 5,971.4                |       | 4,914.1                                                                    |       | 5,015.7                         |       | 6.25                                                 |       | 0.10 - 2.75 |   | 0.20 - 4.125 |   |
| 2007                                     |       | 3,860.5                |       | 3,566.7                                                                    |       | 3,619.9                         |       | —                                               |       | 0.06 - 2.00 |   | 0.12 - 3.00 |   |
| Subtotal securitized mortgage borrowings |       |                   |       | 17,123.5                                                                   |       | 17,800.5                        |       |                                                 |       |   |   |   |   |
| Accrued interest expense                 |       |                   |       | —                                                                     |       | 17.1                            |       |                                                 |       |   |   |   |   |
| Unamortized securitization costs         |       |                   |       | —                                                                     |       | (37.5                           | )          |                                                 |       |   |   |   |   |
| Fair value adjustment                    |       |                   |       | (5,329.7                                                                   | )          | —                          |       |                                                 |       |   |   |   |   |
| Total securitized mortgage borrowings    |       |                   |       | $                                                                          | 11,793.8   |                            | $          | 17,780.1                                             |       |   |   |   |   |   |   |
|                                          |            |                        |            |                                                                            |            |                                 |            |                                                      |            |  |  |  |  |  |  |  |

 

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(1)         One-month London Interbank Offered Rate(LIBOR) was 3.11percent as of March 31, 2008.

(2)         Interest rate margins are generally adjustedwhen the unpaid principal balance of the securitized mortgage borrowings isreduced to less than 10% - 20% of the original issuance amount.

 

**Note J—Repurchase Liabilities (Discontinued Operations)**

* *

*Reverse RepurchaseFacilities*

 

The Company’s reverserepurchase agreements, included in discontinued operations, are secured by theCompany’s loans held-for-sale, restricted cash and certain REOs.  The following table presents the outstandingbalance of the Company’s reverse repurchase facilities as of the datesindicated:

 
| ** **                  | ** ** | **Discontinued Operations**   | ** ** |
|-----------------------------|------------|------------------------------------|------------|
| ** **                  | ** ** | **as of March 31,** | ** ** | **as of December 31,** | ** ** |
| ** **                  | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| ** **                  | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Reverse repurchase line (1) |       | $                                  | 236,294    |   | $ | 318,669 |   |
| Warehouse line (2)          |       | 7,454                              |       | 18,021 |   |
| Total                       |       | $                                  | 243,748    |   | $ | 336,690 |   |

 

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(1)         This line, which is guaranteed by IMH, is nolonger funding loans and was in technical default of several covenants,including warehouse borrowing reduction, delivery of financial statements andfinancial covenants.  As described inNote L, the Company has entered into an agreement to restructure thisline.

(2)         This line was paid off in full in May 2008.

 

*RepurchaseReserve*

 

When the Company sells loansthrough loan sales it is required to make normal and customary representationsand warranties about the loans to the purchaser. The Company’s whole loan saleagreements generally require it to repurchase loans if the Company breaches arepresentation or warranty given to the loan purchaser. In addition, theCompany may be required to repurchase loans as a result of borrower fraud or ifa payment default occurs on a mortgage loan shortly after its sale. During thefirst quarter of 2008, the Company sold $68.1 million of loans as compared to $641.9million in the fourth quarter of 2007. During the first quarter of 2008, we negotiated the settlement of $113million in repurchase claims.  As of March 31,2008 and December 31, 2007, the Company had a liability for losses onloans sold with representations and warranties totaling $12.4 million and$25.7 million, respectively, included in liabilities from discontinuedoperations.

 

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**Note K—DiscontinuedOperations**

 

During 2007, the Companyannounced plans to exit substantially all of its mortgage, commercial, retail,and warehouse lending operations. Consequently, the amounts related to theseoperations are presented as discontinued operations in the Company’sconsolidated statements of operations and its consolidated statements of cashflows, and the asset groups to be exited are reported as assets and liabilitiesof discontinued operations in its consolidated balance sheets for the periodspresented.

 

The following table presentsthe discontinued operations’ condensed balance sheets at March 31, 2008and December 31, 2007:

 
| ** **                         | ** ** | **Discontinued Operations**   | ** ** |
|------------------------------------|------------|------------------------------------|------------|
| ** **                         | ** ** | **as of March 31,** | ** ** | **as of December 31,** | ** ** |
| ** **                         | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| **Balance Sheet Items:** |       |                               |       |   |   |
| Loans held-for-sale                |       | $                                  | 189,845    |   | $ | 279,659 |   |
| Finance receivables                |       | —                             |       | 12,458 |   |
| Total assets                       |       | 223,484                            |       | 353,250 |   |
| Total liabilities                  |       | 279,614                            |       | 405,341 |   |
| Total stockholders’ deficit   |       | (56,130                            | )          | (52,091 | ) |
|                                    |            |                                    |            |  |  |  |  |

 

Included in totalliabilities at March 31, 2008 and December 31, 2007 is a leaseliability of $12 million and $10.9 million respectively, which is guaranteed byIMH, related to office space that was previously occupied by the discontinuedoperations and is no longer being used by the Company. Loans held-for-saleincludes a $106.9 million and $118.4 million fair value adjustment at March 31,2008 and December 31, 2007, respectively.

 

The following tables presentdiscontinued operations condensed statement of operations for the three monthsended March 31, 2008 and 2007;

 
| ** **                                      | ** ** | **Discontinued Operations**                                       | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **For the Three Months Ended March 31,** | ** ** |
| ** **                                      | ** ** | **2008**                                                               | ** ** | **2007** | ** ** |
| **Income Statement Items:**                     |       |                                                                   |       |   |   |
| Net interest income                             |       | $                                                                      | 1,671      |   | $ | 5,513 |   |
| Provision for loan losses                       |       | —                                                                 |       | (243 | ) |
| Change in fair value of derivative  instruments |       | (145                                                                   | )          | (3,303 | ) |
| Other non-interest income (expense)             |       | 9,478                                                                  |       | (44,655 | ) |
| Non-interest expense and income taxes           |       | (10,316                                                                | )          | (24,847 | ) |
| Net earnings (loss)                             |       | $                                                                      | 688        |   | $ | (67,535 | ) |

 

**Note L—Subsequent Events**

** **

In September 2008, the Company entered into anagreement to restructure its reverse repurchase line with its remaining lender.The balance of this line was $236.3 million at March 31, 2008.  The agreement removes all technical defaultsfrom financial covenant noncompliance and any associated margin calls for theterm of the agreement.  The agreementcalls for certain targets including a reduction of the borrowings balance to$100 million in 18 months with an advance rate of no more than 65 percent ofthe unpaid principal balance and $50 million in 24 months with an advance rateof no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the Company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will berequired to be paid as an additional principal paydown and the monthlyprincipal paydown is reduced to $750,000. The interest rate is LIBOR plus 325 basis points, and all cash collectedfrom the securing mortgage loans is required to be paid to the lender.  Accomplishing the restructuring of thisreverse repurchase line allows the Company to manage the remaining loans on theline for the eventual collection, refinance, sale or securitization without therisk of receiving margin calls.

 

In July 2008, theCompany executed a letter of intent, subject to execution of definitiveagreements, to acquire a special servicing platform, whereby the seller willcontribute specified balances of loans (mostly distressed) to the platform inorder to provide sufficient cash flows to maintain the business during itsinitial operations. 

 

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

** **

**(dollars in thousands, except pershare data or as otherwise indicated)**

 

Unless the context otherwise requires, the terms “Company,”“we,” “us,” and “our” refer to Impac Mortgage Holdings, Inc. (the Companyor IMH), a Maryland corporation incorporated in August 1995, and itssubsidiaries, IMH Assets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc.(IWLG), and Impac Funding Corporation (IFC), together with its wholly-ownedsubsidiaries Impac Secured Assets Corp. (ISAC), and Impac Commercial CapitalCorporation (ICCC).

 

**Forward-Looking Statements**

 

This report on Form 10-Q contains certainforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934. 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-lookingterminology, such as “may,” “will,” “believe,” “expect,” “likely,” “should,” “could,”“anticipate,” or similar terms or variations on those terms or the negative ofthose terms. The forward-looking statements are based on current managementexpectations. Actual results may differ materially as a result of severalfactors, including, but not limited to the following: the ongoing volatility inthe mortgage and mortgage-backed securities industry and our ability tosuccessfully manage through the current market environment; management’sability to successfully implement future strategies and initiatives; ability tomeet liquidity needs from cash flows generated from the long-term mortgageportfolio and master servicing fees; our ability to reduce operating expensesand other outstanding liabilities, such as the trust preferred obligations; ourability to reduce dividend payments on preferred stock; ability to continue topay dividends on outstanding preferred stock; failure to sell, or achieveexpected returns upon sale of, mortgage loans, including non-performing loans,in the secondary market due to market conditions, lack of interest orineffectual pricing; risks related to the restructuring of the existing reverserepurchase facility, such as completion of definitive agreements, which may behindered by worsening economic conditions in the mortgage market, and potentialdifficulties in meeting conditions set forth in the definitive agreement; ourability to meet margin calls to the extent the reverse repurchase line is notrestructured; our ability to obtain additional financing and the terms of anyfinancing that we do obtain; our ability to raise additional capital; inabilityto effectively liquidate properties through auction process or otherwisethereby decreasing advisory fees; increase in loan repurchase requests andability to adequately settle repurchase obligations; risks related to theacquisition of a special servicing platform, which will involve or require,among other things, continuing due diligence, which could reveal matters notnow known that affect our decision to seek to complete the acquisition ondifferent terms than those announced or at all, obtaining necessary approvalsand consents, including regulatory approvals related to servicing, whichconsents and approvals may be delayed or unobtainable, difficulties and delaysin obtaining regulatory approvals for the proposed transaction, potentialdifficulties in meeting conditions set forth in the definitive purchaseagreement, and the parties’ timely performance of their respective pre-closingcovenants and the satisfaction of other conditions, some of which may be beyondthe control of the parties or render the acquisition uneconomical; the Company’sability to successfully integrate the new servicing platform with its existingservices;  our ability to identify andestablish or invest in, and successfully manage and grow, businesses that maybe outside of the businesses in which we historically have operated;impairments on our mortgage assets; increases in default rates or losses onmortgage loans underlying our mortgage assets; inability to implementstrategies effectively to increase cure rates, reduce delinquencies or mitigatelosses on mortgage loans; changes in assumptions regarding estimated loanlosses or fair value amounts; increase in default rates on our mortgages;changes in yield curve; the ability of our common stock and Series B and Cpreferred stock to continue trading in an active market; the loss of executiveofficers and other key management employees; our ability to maintain effectiveinternal control over financial reporting and disclosure controls andprocedures; the adoption of changes of new laws that affect our business or thebusiness of people with whom we do business; interest rate fluctuations on ourassets that differ from our liabilities; the outcome of litigation orregulatory actions pending against us or other legal contingencies; and ourcompliance with applicable local, state and federal laws and regulations andother general market and economic conditions.

 

For a discussion of these and other risks anduncertainties that could cause actual results to differ from those contained inthe forward-looking statements, see “Risk Factors” and “Management’s Discussionand Analysis of Financial Condition and Results of Operations” in the Company’sAnnual Report on Form 10-K for the period ended December 31, 2007,the other reports we file under the Securities and Exchange Act of 1934, andthe 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 ofanticipated or unanticipated events or circumstances after the date of suchstatements.

 

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**The Mortgage Banking Industry andDiscussion of Relevant Fiscal Periods**

 

The mortgage banking industry is continuallyvulnerable to current events that occur in the financial services industry.These events include changes in economic indicators, government regulation,interest rates, price competition, geographic shifts, disposable income,housing prices, market liquidity, market anticipation, and customer perception,as well as others. The factors that affect the industry change rapidly and canbe unforeseeable.

 

Current events, including the adoption of SFAS 159,can diminish the relevance of “quarter over quarter” and “year-to-date overyear-to-date” comparisons of financial information. In such instances, theCompany attempts to present financial information in its Management’sDiscussion and Analysis of Financial Condition and Results of Operations thatis the most relevant to its financial information.

 

**Status of Operations, Liquidity andCapital Resources**

 

In 2007 and 2008, managementhas been seriously challenged by the unprecedented turmoil in the mortgagemarket, including the following: significant increases in delinquencies andforeclosures; significant increases in credit-related losses; decline inoriginations; tightening of warehouse credit and the virtual elimination of themarket for loan securitizations.  As aresult, the Company discontinued certain operations, resolved and terminatedall but one of our reverse repurchase facilities and settled a portion of ouroutstanding repurchase claims, while also reducing our operating costs andliabilities.  In the first quarter of2008, the Company also entered into an agreement with a real estate marketingcompany to generate advisory fees.

 

One of our goals has been toalign the costs of our operations to the cash flows from our long-term mortgageportfolio (residual interests in securitizations), master servicing portfolioand real estate advisory fees.  However,we have intentionally maintained certain personnel to allow us to explorefuture business opportunities should we be able to raise capital.  As part of our other goals, we intend to 1)reduce or eliminate dividend payments on the Company’s preferred stock, and 2)modify the Company’s trust preferred securities, which may include reducing theinterest rate.

 

In September 2008, theCompany entered into an agreement to restructure its reverse repurchase linewith its remaining lender. The balance of line was $236.3 million at March 31,2008.  The agreement removes alltechnical defaults from financial covenant noncompliance and any associatedmargin calls for the term of the agreement. The agreement calls for certain targets including a reduction of theborrowings balance to $100 million in 18 months with an advance rate of no morethan 65 percent of the unpaid principal balance and $50 million in 24 months withan advance rate of no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the Company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will berequired to be paid as an additional principal paydown and the monthlyprincipal paydown is reduced to $750,000. The interest rate is LIBOR plus 325 basis points, and all cash collectedfrom the securing mortgage loans is required to be paid to the lender.  Accomplishing the restructuring of thisreverse repurchase line allows the Company to manage the remaining loans on theline for the eventual collection, refinance, sale or securitization without therisk of receiving margin calls.

 

In order to reduce dividendpayments on its preferred stock, the Company is considering exchanging thepreferred stock for common stock.  In July 2008,our stockholders approved the potential issuance of common shares in excess of20 percent of our existing common shares. This exchange could offer the current preferred stockholders greaterliquidity as common stockholders.

 

We are currently exploringopportunities to raise capital so that we may accomplish several strategicinitiatives, which may include strategic acquisitions, acquiring a specialservicing platform and investing in distressed mortgage assets and relatedsecurities.  Raising additional capitalthrough the sale of securities could significantly dilute the current commonstockholders.  There can be no assurancethat we will be successful in accomplishing our goal to raise the capitalneeded to implement our strategic initiatives.

 

We earn advisory fees from areal estate marketing company specializing in the marketing and disposition offoreclosed properties.  During the threemonths ended March 31, 2008, we earned $3.8 million from thisrelationship.  The amount of real estateadvisory fees we receive from this relationship are based on numerous factors,including real estate market conditions, the level of foreclosure activity, theability of the marketing company to attract new business, and the Companyretaining our CEO and avoiding liquidation. The agreement terminates in 2010 with the Company having an option toextend the agreement for an additional three years.

 

In July 2008, theCompany executed a letter of intent, subject to execution of definitiveagreements, to acquire a special servicing platform, whereby the seller willcontribute specified balances of loans (mostly distressed) to the platform inorder to provide sufficient cash flows to maintain the business during itsinitial operations.  We believe this specialservicing platform,

 

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combined with our currentand anticipated businesses, will create a fully integrated platform that wouldbe utilized to take advantage of opportunities within the distressed mortgageinvestment market.

 

There can be no assurancethat we will be successful in accomplishing our objectives outlined above.  In the event that we do not raise capital, wemay not be able to make any of the acquisitions or implement the initiativesdescribed above.  Also, there can be noassurance that the restructuring of the trust preferred securities or thepreferred stock will occur.  In thisevent, we intend to reduce operating expenses to a level that is supportable bythe revenues from the existing long-term mortgage portfolio (residual interestsin securitizations), master servicing portfolio and real estate advisory fees.Nevertheless, if we are not successful in completing the objectives outlinedabove, we may not be able to meet our contractual obligations for the nextyear, including repayment of the reverse repurchase line, interest payments ontrust preferred securities and preferred stock dividends.

 

At March 31, 2008, theCompany had $54.7 million in stockholders’ equity.  After reducing total stockholders’ equity bythe $161.8 million in preferred stock liquidation value, our common equitydeficit was $(107.1) million or $(1.41) per share.

 

To understand the financial position of the Companybetter, we believe it is important to understand the composition of the Company’sstockholders’ equity (deficit) and to which segment of the business itrelates.  At March 31, 2008, theequity (deficit) within our continuing and discontinued operations wascomprised of the following significant assets and liabilities:

 
| ** **                               | ** ** | **Condensed Components of Stockholders' Equity (Deficit) by Segment** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **As of March 31, 2008**                                                             | ** ** |
| ** **                               | ** ** | **Continuing**                                                                                           | ** ** | **Discontinued** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Operations**                                                                                           | ** ** | **Operations** | ** ** | **Total** | ** ** |
| Cash                                     |       | $                                                                                                        | 32,901     |   | $ | 96 |   | $ | 32,997 |   |
| Residual interests in securitizations    |       | 62,278                                                                                                   |       | — |   | 62,278 |   |
| Mortgage servicing rights (1)            |       | 12,570                                                                                                   |       | — |   | 12,570 |   |
| Advisory fees receivable                 |       | 2,729                                                                                                    |       | — |   | 2,729 |   |
| Trust preferred securities ($99,244 par) |       | (45,129                                                                                                  | )          | — |   | (45,129 | ) |
| Repurchase liabilities (2)               |       | —                                                                                                   |       | (52,574 | ) | (52,574 | ) |
| Lease liability (3)                      |       | —                                                                                                   |       | (11,992 | ) | (11,992 | ) |
| Deferred charge                          |       | 30,886                                                                                                   |       | — |   | 30,886 |   |
| Net other assets                         |       | 14,577                                                                                                   |       | 8,340 |   | 22,917 |   |
| **Stockholders' equity (deficit)**       |       | $                                                                                                        | 110,812    |   | $ | (56,130 | ) | $ | 54,682 |   |

 

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(1)         Included in mortgage servicing rights is $10.6million in master servicing rights, included in securitized mortgagecollateral, associated with our consolidated securitizations.

(2)         Balance includes the net amount owed to ourlenders, which are guaranteed by IMH, and the repurchase reserve.

(3)         Guaranteed by IMH.

 

*Continuing operations*

 

We currently have three primary sources of cashearnings:

 

·                  cash flows from the long-term mortgageportfolio;

 

·                  master servicing fees from the long-termmortgage portfolio; and

 

·                  real estate advisory fees

 

Since our consolidated and unconsolidatedsecuritization trusts are non-recourse, we have netted trust assets andliabilities to more simply present the Company’s interest in these trusts,which are considered our residual interests in securitizations.  We receive cash flows from our residualinterests in securitizations to the extent they are available after requireddistributions to bondholders and maintaining overcollateralization levelswithin the trusts.  The estimated fairvalue of the residual interests, represented by the difference in the fairvalue of trust assets (excluding the $10.6 in master servicing rights includedin the basis of securitized mortgage collateral) and trust liabilities, was$62.3 million at March 31, 2008.

 

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The Company acts as the master servicer formortgages included in our CMO and REMIC securitizations.  The master servicing fees we earn aregenerally 0.03 percent per annum on the declining principal balances of thesemortgages plus interest income on cash held until remitted to investors.  Master servicing rights retained inconnection with consolidated securitizations are included in securitizedmortgage collateral in the Company’s consolidated balance sheet.  Master servicing rights retained inconnection with unconsolidated securitizations are included in otherassets.  The carrying amount of masterservicing rights was $12.6 million at March 31, 2008, including $10.6million included in securitized mortgage collateral.

 

We earn advisory fees and expect to receivesignificant cash flows from a real estate marketing company specializing in themarketing and disposition of foreclosed properties.  During the quarter ended March 31, 2008,we earned $3.8 million from this relationship. Real estate advisory fees from this relationship are based on numerousfactors, including real estate market conditions, the level of foreclosureactivity, the ability of this company to attract new business, retention of ourCEO and avoiding liquidation.  Theagreement terminates in 2010 with the Company having an option to extend theagreement for an additional three years.

 

For the three months ended March 31, 2008 and2007, we paid $2.0 million and $3.7 million in interest on trust preferredsecurities and preferred stock dividends, respectively.  As of the filing date of this report, theCompany is current on all dividend payments.

 

At March 31, 2008, we had deferred charges of$30.9 million representing the deferral of income tax expense on inter-companyprofits that resulted from the sale of mortgages from taxable subsidiaries toIMH in prior years.  Net other assetsinclude $3.6 million in premises and equipment, $2.3 million in investment in capitaltrusts and $3.1 million in prepaid expenses.

 

At March 31, 2008, cash within our continuingoperations increased to $32.9 million from $24.4 million at December 31,2007.  The increase during the quarter isprimarily related to excess cash flows received from our residual interests insecuritizations and real estate advisory fees. While our operating expenses had remained consistent during the quarter,cash flows received from our residual interests subsequent to March 31,2008 have started to decline as a result of increased credit losses andincreases in interest rates.  Thisdecline in quarterly cash flows during the second quarter of 2008 is expectedto be approximately $5 million.

 

*Discontinued operations*

 

The Company’s most significant liabilities at March 31,2008 relate to its repurchase liabilities and a lease liability withindiscontinued operations.

 

The repurchase liabilities consist of a repurchasereserve and the net amount owed to our lenders which is collateralized by loansheld for sale, restricted cash balances and certain real estate owned and otherassets.  Subsequent to March 31,2008, our $7.5 million warehouse line was fully paid off.  The balance of our reverse repurchase lineand our warehouse line was approximately $243.7 million at March 31,2008.  We are currently distributing allprincipal and interest received from the collateral securing the reverse repurchaseline to the lender.  As described above,in September 2008, the Company entered into an agreement to restructurethis line.

 

We were required to make normal and customary representationsand warranties about the loans we had previously sold to investors. Our wholeloan sale agreements generally required us to repurchase loans if we breached arepresentation or warranty given to the loan purchaser. In addition, we alsocould be required to repurchase loans as a result of borrower fraud or if apayment default occurs on a mortgage loan shortly after its sale.  During the quarter, the repurchase liabilitydecreased $14 million to $12.4 million. The decrease is primarily related to the settlement of $113 million inrepurchase claims.  Determination of therepurchase liability is an estimate of losses from expected repurchases, and isbased, in part, on the recent settlement of claims.

 

In connection with the discontinuation of our non-conformingmortgage, retail mortgage, warehouse lending and commercial operations, asignificant amount of office space that was previously occupied is no longerbeing used by the Company.  At March 31,2008, the Company had a liability of $12 million, representing the presentvalue of the minimum lease payments over the remaining life of the lease,offset by the expected proceeds from sublet revenue related to this officespace.

 

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**Market Conditions**

 

Themortgage market faced continued adversity through the filing date of thisdocument as the continued broad repricing of mortgage credit risk continued thesevere contraction in market liquidity. Furthermore, the market has continuedto try to quantify the ultimate loss rates that are going to be experienced inthe underlying assets in asset backed securities.

 

Conditionsin the secondary markets (the markets in which we historically sold orsecuritized mortgage loans), which dramatically worsened during the thirdquarter of 2007, continue to be depressed as investor concerns over creditquality and a weakening of the United States housing market have remained high.As a result, the capital markets remain very volatile and illiquid and haveeffectively been unavailable to the Company. The Company believes the existingconditions in the secondary markets are unprecedented and, as such, inherently involvesignificant risks and uncertainty. These conditions could continue to adverselyimpact the performance of our long-term investment portfolio. Until bondspreads and credit performance return to more historical levels, it will beimpossible for the Company to execute securitizations and loan sales. As aresult, in 2007, the Company was forced to discontinue its correspondent,retail, wholesale and commercial mortgage operations as well as the warehouselending operations, in response to the market conditions.

 

Webelieve several converging factors led to the broad repricing, includinggeneral concerns over the decline in home prices, the rapid increase in thenumber of delinquent loans (including Alt-A loans), the reduced willingness ofinvestors to acquire commercial paper backed by mortgage collateral, theresulting contraction in market liquidity and availability of financing lines,the numerous rating agency downgrades of securities, and the increase in supplyof securities potentially available for sale.

 

Thedownward spiral of negative pricing adjustments on assets had a compoundingeffect as lower prices led to increased lender margin calls for some marketparticipants, which in turn, forced additional selling, causing yet furtherdeclines in prices. These events continued to multiply throughout this year.

 

Normalmarket trading activity through the first quarter of 2008 was unusually lightas uncertainty related to future loss estimates and the lack of liquidity madeit difficult for willing buyers and sellers to agree on prices. This conditionwas particularly acute with respect to securities backed by Alt-A loans wheremarket participants were setting price levels based on widely varied opinionsabout future loan performance and loan loss severity. While the early creditperformance for these securities has been clearly far worse than initialexpectations, the ultimate level of realized losses will largely be influencedby events that will likely unfold over the next several years, including the severityof housing price declines and the overall strength of the economy.

 

Thedeteriorating market for residential real estate loans is illustrated in theABX 2006-1 indices shown below in subprime securitization bonds by initialrating. This earliest ABX index shows market prices for a designated group ofsubprime securities by credit rating. The index does not include any IMH bonds.It is shown here as an illustration of the price volatility in the generalmortgage market since the beginning of last year and does not reflect actualpricing on IMH bonds which are backed by Alt-A loans rather than subprime.There is currently no comparable index for Alt-A mortgage product, but thegeneral direction and magnitude of price movement in the index is reflective ofthe price movement experienced by the Company.

 

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*Impactof Recent Market Activity*

 

Asa result of the Company’s inability to sell or securitize non-conforming loans,the Company discontinued funding loans. Because the Company stopped fundingloans, the Company discontinued substantially all of its mortgage (includingcommercial) and warehouse lending operations during the second half of 2007.

 

Inaddition to the inability of the Company to sell loans, the Company’sinvestment in securitized non-conforming loans has deteriorated in valueprimarily from estimated losses. As a result of continued deterioration in thereal estate market through March 31, 2008, the Company increased its loanloss estimates primarily due to increased delinquencies in its long-terminvestment portfolio and increased loss severities related to the sale andliquidation of real estate owned properties. The decline in single-family home prices can be seen in the chart below.

 

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Asdepicted in the chart above, average home prices peaked in 2006 at 226.29 andcontinued their dramatic decline through June 2008.  The Standard & Poor’s/Case-Shiller10-City Composite Home Price Index (the Index) for June 2008 was 180.38(with the base of 100.00 for January 2000) and hasn’t been this low since June 2004when the Index was 179.45.  Beginning inthe third quarter of 2007, the Company believes there is a correlation betweenthe borrowers’ perceived equity in their homes and defaults.  The original loan-to-value (defined as loanamount as a percentage of collateral value, “LTV”) and original combinedloan-to-value (defined as first lien plus total subordinate liens to collateralvalue, “CLTV”) ratios of single-family mortgage remaining in the Company’s securitizedmortgage collateral as of March 31, 2008 was 73 percent and 84 percent,respectively.  The LTV and CLTV ratiosmay have increased from origination date as a result of the deterioration ofthe real estate market.  We believe thathome prices that have declined below the borrower’s original purchase pricehave a higher risk of default within our portfolio. Based on the Index, homeprices have declined 20 percent through June 2008. Further, we believe thehome prices in California and Florida, the states with the highestconcentration of our mortgages, have declined even further than the Index.  As a result, we have dramatically increasedour loan loss estimates, which are a primary assumption used in the valuationof securitized mortgage collateral and borrowings.

 

**Critical Accounting Policies**

 

Several of the critical accounting policiesimportant to the portrayal of our financial condition and results of operationsrequire management to make difficult and complex judgments that rely onestimates about the effect of matters that are inherently uncertain due to theimpact of changing market conditions and/or consumer behavior. We believe ourmost critical accounting policies relate to the valuation of: (1) assetsand liabilities that are highly dependent on internal valuation models andassumptions rather than market quotations (see Fair Value of FinancialInstruments discussion below); (2) derivatives and other hedginginstruments; (3) loans held-for-sale, including estimates of fair value,and related lower of cost or market (LOCOM) valuation reserve; and (4) repurchasereserve (included in liabilities of discontinued operations). Refer to our 2007Form 10-K for further discussion of our critical accounting policies andjudgments.

 

During the first quarter of 2008, we added theexpanded disclosures about fair value measurements under SFAS 157 andmeasurement of financial instruments and certain other items at fair valueunder SFAS 159 to our critical accounting policies. We describe below thebasis for including the application of fair value measurements for certain ofour financial instruments as a critical accounting policy. We also describe anysignificant changes in the judgments and assumptions we made during the firstquarter of 2008 in applying our critical accounting policies. For furtherinformation, refer to “Notes to Consolidated Financial Statements—Note B,Fair Value of Financial Instruments.”

 

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Management discusses its critical accounting policies and relatedestimates with the Company’s Audit Committee on a regular basis. We believe thejudgments, estimates and assumptions used in the preparation of ourconsolidated financial statements are appropriate given the factualcircumstances at the time. However, given the sensitivity of our consolidatedfinancial statements to these critical accounting policies, the use of otherjudgments, estimates and assumptions could result in material differences inour results of operations or financial condition.

 

**Fair Value of Financial Instruments**

 

The Company adopted SFAS 157 on January 1,2008.  SFAS 157 defines fair value,establishes a framework for measuring fair value and outlines a fair valuehierarchy based on the inputs to valuation techniques used to measure fairvalue. SFAS 157 defines fair value as the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date (also referred to as an exitprice). SFAS 157 categorizes fair value measurements into a three-levelhierarchy based on the extent to which the measurement relies on observablemarket inputs in measuring fair value. Level 1, which is the highestpriority in the fair value hierarchy, is based on unadjusted quoted prices inactive markets for identical assets or liabilities. Level 2 is based onobservable market-based inputs, other than quoted prices, in active markets foridentical assets or liabilities. Level 3, which is the lowest priority inthe fair value hierarchy, is based on unobservable inputs. Assets andliabilities are classified within this hierarchy in their entirety based on thelowest level of any input that is significant to the fair value measurement.

 

The use of fair value to measure our financialinstruments is fundamental to our financial statements and is a criticalaccounting estimate because a substantial portion of our assets and liabilitiesare recorded at estimated fair value. Financial instruments classified asLevel 2 in our consolidated financial statements are valued primarilyutilizing inputs and assumptions that are observable in the marketplace, andwhich can be derived from observable market data or corroborated by observablelevels at which transactions are executed in the marketplace. Because financialinstruments classified as Level 3 are generally based on unobservableinputs, the process to determine fair value is generally more subjective andinvolves a high degree of management judgment and assumptions. Theseassumptions may have a significant effect on our estimates of fair value, andthe use of different assumptions, as well as changes in market conditions,could have a material effect on our results of operations or financialcondition.

 

In conjunction with the adoption of SFAS 157,the Company prospectively adopted SFAS 159 as of January 1, 2008.SFAS 159 provides an option on an instrument-by-instrument basis for mostfinancial assets and liabilities to be reported at fair value with changes infair value reported in earnings. After the initial adoption, the election ismade at the acquisition of a financial asset, financial liability, or a firmcommitment and it may not be revoked. Management believes that the adoption of SFAS 159 provides anopportunity to mitigate volatility in reported earnings and provides a betterrepresentation of the economics of the trust assets and liabilities.

 

Under the SFAS 159 transition provisions, theCompany elected to apply fair value accounting to certain financial instruments(certain trust assets, trust liabilities and trust preferred securities) heldat January 1, 2008.  Differencesbetween the December 31, 2007 carrying values and the January 1, 2008fair values were recognized as an adjustment to retained deficit. The adoptionof SFAS 159 resulted in a $1.1 billion decrease to retained deficit on January 1,2008 from $(1.4) billion at December 31, 2007 to $(308.8) million at January 1,2008.

*** ***

***Recurring basis***

 

*Investment Securities Available-for-Sale.* Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its investment securitiesavailable-for-sale at fair value.  Theseinvestment securities are recorded at fair value and consist primarily ofnon-investment grade mortgage-backed securities.  The fair value of the investment securitiesare measured based upon our expectation of inputs that other marketparticipants would use.  Such assumptionsinclude our judgments about the underlying collateral, prepayment speeds,credit losses, and certain other factors. Given the market disruption and lack of observable market data as of March 31,2008, the fair value of the investment securities available-for-sale weremeasured using significant internal expectations of market participants’assumptions. At March 31, 2008, investment securities available-for-salewere classified as Level 3 fair value measurements.

 

*Securitized Mortgage Collateral* – Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgagecollateral at fair value.  These assetsconsist primarily of Alt-A mortgage loans securitized between 2002 and 2007.  Fair value measurements are based on theCompany’s estimated cash flow models, which incorporate assumptions, inputs ofother market participants and quoted prices for the underlying bonds.  The Company’s 

 

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assumptionsinclude our expectations of inputs that other market participants would use.These assumptions include our judgments about the underlying collateral,prepayment speeds, credit losses, and certain other factors.  At March 31, 2008, securitized mortgagecollateral was classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.

 

*Securitized Mortgage Borrowings* - Pursuant to the Company’s adoption of SFAS 159,the Company elected to carry all of its securitized mortgage borrowings at fairvalue.  These borrowings consist ofindividual tranches of bonds issued by securitization trusts and are primarilybacked by Alt-A mortgage loans.  Fairvalue measurements include our judgments about the underlying collateralassumptions such as prepayment speeds, credit losses, and certain other factorsand are based upon quoted prices for the individual tranches of bonds, ifavailable.  At March 31, 2008,securitized mortgage borrowings were classified as Level 2 or Level 3measurements depending on the observability of significant inputs to the model.

* *

*Trust Preferred Securities* - Pursuant to the Company’s adoption of SFAS 159, the Companyelected to carry all of its trust preferred securities at fair value.  These securities were measured based uponusing other preferred stock issued by the Company adjusted for differencesbetween the securities. The fair value of the trust preferred securitiesresulted in adjustments to reduce the par value for the following factors:

 

·                  Statedinterest rate adjustments to account for the stated yield difference betweenthe trust preferred securities and the preferred stock issued by the Company,

 

·                  Liquidityadjustments to reflect the presence of a lack of an actively traded market for thesesecurities.

 

·                  Preferenceadjustments to reflect the rights of the trust preferred securities as comparedto the preferred securities.

 

At March 31, 2008 trust preferred securities were classified asLevel 3 measurements.

 

*Derivative Assets and Liabilities.*****For non-exchange traded contracts, fair value is based on the amountsthat would be required to settle the positions with the related counterpartiesas of the valuation date.   Valuations ofderivative assets and liabilities reflect the value of the instrumentsincluding the values associated with counterparty risk. With the issuance ofSFAS 157, these values must also take into account the Company’s own creditstanding, to the extent applicable, thus included in the valuation of thederivative instrument is the value of the net credit differential between thecounterparties to the derivative contract. At March 31, 2008, derivativeassets and liabilities were classified as Level 2 measurements.

 

***Non-recurring basis***

 

TheCompany is required to measure certain assets at fair value fromtime-to-time.  These fair valuemeasurements typically result from the application of specific accountingpronouncements under GAAP.  The fair valuemeasurements are considered non-recurring fair value measurements under SFAS157.

* *

*Loans Held-for-Sale -*Loans held-for-sale for which the fair value option was not elected arecarried at lower of cost or market (LOCOM). When available, such measurements are based upon what secondary marketsoffer for portfolios with similar characteristics, and are consideredLevel 2 measurements. If market pricing is not available, suchmeasurements are significantly impacted by our expectations of other marketparticipants’ assumptions, and are considered Level 3 measurements at March 31,2008.  Loans held-for-sale, which areprimarily included in assets of discontinued operations, are considered Level 3measurements at March 31, 2008.

* *

*Mortgage Servicing Rights -*Mortgage servicing rights (MSR), for which the fair value option wasnot elected are carried at LOCOM.  MSRsare not traded in an active market with observable prices.  The Company utilizes internal pricingprocesses to estimate the fair value of MSRs, which are based on assumptionsthe Company believes would be used by market participants.  MSRs, which are included in other assets, areconsidered Level 3 measurements at March 31, 2008.

* *

We continue to refine our valuation methodologies asmarkets and products develop and the pricing for certain products becomes moreor less transparent. While we believe our valuation methods are appropriate andconsistent with those of other market participants, the use of differentmethodologies or assumptions to determine the fair value of certain financialinstruments could result in a materially different estimate of fair value as ofthe reporting date.

 

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**Interest Income and Expense**

 

Pursuant to the adoption of SFAS 159 on January 1,2008, interest income and expense on the collateral and borrowings inour securitized trusts is based oneffective yields.  The effective yield is the rate usedto derive the fair value of the securitized trusts.  Interestincome and expense is calculated based on the estimated effective yields inthe trusts multiplied by the fair value of the mortgage collateral andborrowings.

 

**SelectedFinancial Results for the Three Months Ended March 31, 2008**

*** ***

***Continuing Operations***

 

·                  Net loss of $4.5 millionfor the first quarter of 2008 compared to a net loss of $54.1 million for thefirst quarter of 2007.

 

·                  Net interest income of$7.3 million for the first quarter of 2008 primarily from our long-termmortgage portfolio as compared to net interest income of $7.9 million for thefirst quarter of 2007.

 

·                  Master servicing fees of$1.5 million for the first quarter of 2008 as compared to $1.5 million for thefirst quarter of 2007.

 

·                  Real estate advisory feesof $3.5 million for the first quarter of 2008 as compared to zero for the firstquarter of 2007.

 

***Discontinued Operations***

 

·                  Net earnings of $688thousand for the first quarter of 2008 compared to a net loss of $67.5 millionfor the first quarter of 2007.

 

·                  Reverse repurchaseagreements were $243.7 million at March 31, 2008 compared to $336.7million at December 31, 2007.

 

·                  Loans held-for-sale were$189.8 million, including a fair value adjustment of $107.8 million at March 31,2008 compared to loans held-for-sale of $279.7 million, including a $118.4million fair value adjustment at December 31, 2007.

 

·                  Decrease in repurchasereserve from $25.7 million at December 31, 2007 to $12.4 million at March 31,2008.

 

**Estimated Taxable Income**

 

Whilethe Company has generated significant net operating loss carryforwards inrecent periods, we do not expect to generate sufficient taxable income infuture periods to be able to realize these tax benefits.  Therefore, we have recognized a fullvaluation allowance against these net operating loss carryforwards in ourconsolidated balance sheets.

 

Tomaintain our REIT status, we are required to distribute a minimum of 90 percentof our annual taxable income to our stockholders, as well as meet certain assetand income tests set forth in the Internal Revenue Code.  If the Company fails to meet theserequirements, or elects to terminate its status as a REIT, we would be subjectto federal income taxes at the regular corporate rates.  While the Company has no current plans toterminate its status as a REIT, there can be no assurance that future events ortransactions would enable the Company to maintain this status.

 

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**Financial Condition and Results of Operations**

 

*Financial Condition*

 

Condensed Balance Sheet Data

 
| ** **                                                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|--------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                                         | ** ** | **2008**           | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Securitized mortgage collateral (at fair  value at March 31, 2008) |       | $                  | 11,634,134 |                  | $          | 16,532,633     |       | $          | (4,898,499 | ) | (30 | )% |
| Assets of discontinued operations                                  |       | 223,484            |       | 353,250               |       | (129,766       | )          | (37        | )          |
| Derivative assets                                                  |       | 43                 |       | 7,497                 |       | (7,454         | )          | (99        | )          |
| Real estate owned (REO)                                            |       | 502,473            |       | 400,863               |       | 101,610        |       | 25         |       |
| Other assets                                                       |       | 99,224             |       | 96,829                |       | 2,395          |       | 2          |       |
| **Total assets**                                                   |       | $                  | 12,459,358 |                  | $          | 17,391,072     |       | $          | (4,931,714 | ) | (28 | )% |
|                                                               |       |               |       |                  |       |           |       |       |       |
| Securitized mortgage borrowings (at fair  value at March 31, 2008) |       | $                  | 11,793,783 |                  | $          | 17,780,060     |       | $          | (5,986,277 | ) | (34 | )% |
| Liabilities of discontinued operations                             |       | 279,614            |       | 405,341               |       | (125,727       | )          | (31        | )          |
| Derivative liabilities                                             |       | 280,618            |       | 127,757               |       | 152,861        |       | 120        |       |
| Other liabilities                                                  |       | 50,661             |       | 155,642               |       | (104,981       | )          | (67        | )          |
| Total liabilities                                                  |       | 12,404,676         |       | 18,468,800            |       | (6,064,124     | )          | (33        | )          |
| Total stockholders' equity (deficit)                               |       | 54,682             |       | (1,077,728            | )          | 1,132,410      |       | 105        |       |
| **Total liabilities and stockholders' equity**                     |       | $                  | 12,459,358 |                  | $          | 17,391,072     |       | $          | (4,931,714 | ) | (28 | )% |

 

Total assets and liabilities were $12.5 billion and $12.4 billionas of March 31, 2008 as compared to $17.4 billion and $18.5 billionas of December 31, 2007, respectively. The decreases in total assets and liabilities were primarily the resultof the Company electing to adopt SFAS 159 for a significant portion of theCompany’s financial instruments.  Theadoption of SFAS 159 resulted in the reduction of the carrying basis of certainfinancial instruments (securitized mortgage collateral and borrowings and trustpreferred securities) to fair value at January 1, 2008.  Future changes in the fair value of these andother financial instruments will be recognized in earnings.  Upon adoption, securitized mortgagecollateral and securitized mortgage borrowings were reduced by $0.8 billion and$1.9 billion, respectively.  During thequarter, the net change in the fair value of securitized mortgage collateraland securitized mortgage borrowings included in earnings was $(3.2) billion and$3.4 billion, respectively.

 

Ourresidual interests in securitizations are segregated between our single-family(SF) residential and multi-family (MF) residential portfolios and arerepresented by the difference between trust assets (including investmentsecurities available-for-sale and excluding the $10.6 million in masterservicing rights included within the basis of securitized mortgage collateral)and trust liabilities.  Future prepaymentestimates for single-family and multi-family loans range from 16 percent and 28percent for the 2002-2003 vintage years, respectively, and 11 percent and 16percent for the 2007 vintage year, respectively.  The following table presents the estimatedfair value of our residual interests and related assumptions used to derivethese values at March 31, 2008:

 
| ** **         | ** ** | ** **                                                 | ** ** | ** **                           | ** ** | ** **           | ** ** | **Fair Value Measurement Assumptions** | ** ** |
|--------------------|------------|------------------------------------------------------------|------------|--------------------------------------|------------|----------------------|------------|-------------------------------------------------------|------------|
| ** **         | ** ** | **Residual Interests by Vintage Year** | ** ** | **Lifetime Loss Estimate** | ** ** | **SF Discount** | ** ** |
| ** **         | ** ** | **SF**                                                     | ** ** | **MF**                               | ** ** | **Total**            | ** ** | **SF**                                                | ** ** | **MF** | ** ** | **Rate (1)** | ** ** |
| **2002-2003  (2)** |       | $                                                          | 18,300     |                                 | $          | 9,749                |       | $                                                     | 28,049     |   | 1 | % | 1 | % | 30 | % |
| **2004**           |       | 7,286                                                      |       | 9,076                                |       | 16,362               |       | 2                                                     | %          | 1 | % | 40 | % |
| **2005**           |       | 3,733                                                      |       | 2,819                                |       | 6,552                |       | 6                                                     | %          | 1 | % | 50 | % |
| **2006 (3)**       |       | 1,353                                                      |       | 9,962                                |       | 11,315               |       | 14                                                    | %          | 5 | % | 50 | % |
| **2007**           |       | —                                                     |       | —                               |       | —               |       | 21                                                    | %          | 7 | % | 50 | % |
| **Total**          | ** ** | **$**                                                      | **30,672** | ** **                           | **$**      | **31,606**           | ** ** | **$**                                                 | **62,278** |   |   |   |   |   |   |   |

 

----

(1)          The discount rate for all multi-familyresidual interests is 20 percent at March 31, 2008.

(2)          2002-2003 vintage year includes CMO 2007-A,due to performance, which uses a 40 percent discount rate and was securitizedin 2007 from collapsed securitizations which were originally securitized in2002, 2003 and 2004.

(3)          2006 vintage year includes ISAC 2005-2, due toperformance, and the fact that it was a REMIC like all other 2006securitizations.

 

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Thefollowing table presents selected financial data as of the dates indicated:

 
| ** **                                  | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                  | ** ** | **March 31,**                                    | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
| ** **                                  | ** ** | **2008**                                              | ** ** | **2007** | ** ** | **2007** | ** ** |
| Prior 12-month (CPR) - Single-family        |       | 20                                                    | %          | 25 | % | 37 | % |
| Prior 12-month (CPR) - Multi-family         |       | 10                                                    | %          | 9 | % | 8 | % |
| Total non-performing loans                  |       | $                                                     | 2,359,590  |   | $ | 2,131,537 |   | $ | 1,416,379 |   |
| Total non-performing loans to total loans   |       | 13.3                                                  | %          | 11.7 | % | 6.5 | % |
| Total non-performing assets                 |       | $                                                     | 2,870,087  |   | $ | 2,543,775 |   | $ | 1,318,591 |   |
| Total non-performing assets to total assets |       | 23.0                                                  | %          | 14.6 | % | 5.7 | % |

 

Webelieve that in order for us to generate positive cash flows and earnings wemust successfully manage the following primary operational and market risks:

 

·      liquidity risk;

 

·      credit risk;

 

·      interest rate risk; and

 

·      prepayment risk.

 

*Liquidity Risk. *Refer to “Status ofOperations, Liquidity and Capital Resources.”

 

*Credit Risk.*Wemanage credit risk by actively managing delinquencies and defaults through theservicers. Starting with the second half of 2007 we have not retained anyadditional Alt-A mortgages in our long-term mortgage portfolio. Our securitizedmortgage collateral primarily consisting of Alt-A mortgages which are generallywithin typical Fannie Mae and Freddie Mac guidelines but that have loancharacteristics, including higher loan balances, higher loan-to-value ratios orlower documentation requirements (including stated-income loans),  that may make them non-conforming under thoseguidelines.

 

As of March 31, 2008, the original weighted average credit scoreof single-family and multi-family securitized mortgage collateral was 700 and 731,an original weighted average LTV ratio of 73 and 66 percent and anoriginal CLTV of 84 percent and 66 percent, respectively.  The LTV and CLTV ratios mayhave increased from origination date as a result of the deterioration of thereal estate market.

 

Usinghistorical losses, current market conditions and available market data, theCompany has estimated future loan losses, which are included in the fair valueadjustment to our securitized mortgage collateral.  While the credit performance for the loanshas been clearly far worse than initial market expectations, the ultimate levelof realized losses will largely be influenced by events that will likely unfoldover the next several years, including the severity of housing price declinesand overall strength of the economy. If market conditions continue todeteriorate in excess of our expectations, the Company may need to recognizeadditional fair value reductions to our securitized mortgage collateral, whichmay also affect the value of the related securitized mortgage borrowings.

 

Wemonitor our servicers to attempt to ensure that they perform loss mitigation,foreclosure and collection functions according to their servicing practices andeach securitization trust’s pooling and servicing agreement. We have met withthe management of our servicers to assess our borrowers’ current ability to paytheir mortgages and to make arrangements with selected delinquent borrowerswhich will result in the best interest of the borrower and the Company, in aneffort to minimize the number of mortgages which become seriously delinquent.When resolving delinquent mortgages, servicers are required to take timelyaction. The servicer is required to determine payment collection under variouscircumstances, which will result in the maximum financial benefit. This isaccomplished by either working with the borrower to bring the mortgage currentor by foreclosing and liquidating the property. When a borrower fails to makerequired payments on a mortgage and does not cure the delinquency within60 days, we generally record a notice of default and commence foreclosureproceedings, or arrange alternative terms of forbearance. If the mortgage isnot reinstated within the time permitted by law for reinstatement, the propertymay then be sold at a foreclosure sale. At foreclosure sales, the trustsconsolidated on our balance sheet generally acquire title to the property.

 

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We usethe Mortgage Bankers Association (MBA) method to define delinquency as acontractually required payment being 30 days or more past due.  We measure delinquencies from the date of thelast payment due date in which a payment was received.  Delinquencies for loans 60 days late orgreater, foreclosures and delinquent bankruptcies were $2,821.9 million or 16.0percent as of March 31, 2008.

 

The followingtable summarizes non-performing loans that we own, including securitized mortgagecollateral, loans held for long-term investment and loans held-for-sale forcontinuing and discontinued operations combined, that were 60 or more daysdelinquent (utilizing the MBA method) for the periods indicated:

 
| ** **                                     | ** ** | **At March 31,** | ** ** | ** ** | ** ** | **At December 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                     | ** ** | **2008**                   | ** ** | **%**      | ** ** | **2007**                      | ** ** | **%**      | ** ** |
| Loans held for sale (1)                        |       |                       |       |       |       |                          |       |       |       |
| 60 - 89 days delinquent                        |       | $                          | 14,141     |       | 1          | %                             | $          | 45,121     |       | 2 | % |
| 90 or more days delinquent                     |       | 35,006                     |       | 1          | %          | 51,294                        |       | 2          | %          |
| Foreclosures (2)                               |       | 9,602                      |       | 0          | %          | 23,936                        |       | 1          | %          |
| Total delinquent loans held-for-sale           |       | 58,749                     |       | 2          | %          | 120,351                       |       | 5          | %          |
|                                           |       |                       |       |       |       |                          |       |       |       |
| Securitized mortgage collateral                |       |                       |       |       |       |                          |       |       |       |
| 60 - 89 days delinquent                        |       | $                          | 448,174    |       | 16         | %                             | $          | 490,946    |       | 18 | % |
| 90 or more days delinquent                     |       | 833,224                    |       | 30         | %          | 773,816                       |       | 29         | %          |
| Foreclosures (2)                               |       | 1,292,705                  |       | 46         | %          | 1,093,385                     |       | 41         | %          |
| Delinquent bankruptcies (3)                    |       | 189,053                    |       | 7          | %          | 189,106                       |       | 7          | %          |
| Total delinquent long-term mortgage  portfolio |       | 2,763,156                  |       | 98         | %          | 2,547,253                     |       | 95         | %          |
|                                           |       |                       |       |       |       |                          |       |       |       |
| Total delinquent loans                         |       | $                          | 2,821,905  |       | 100        | %                             | $          | 2,667,604  |       | 100 | % |
|                                           |       |                       |       |       |       |                          |       |       |       |
| Total loans                                    |       | $                          | 17,685,383 |       |       |                          | $          | 18,252,197 |       |   |   |

 

----

(1)          Loans held-for-sale are substantially included in discontinuedoperations in the consolidated balance sheets.

(2)          Represents properties in the process of foreclosure.

(3)          Represents bankruptcies that are 30 days or more delinquent.

 

The followingtable summarizes securitized mortgage collateral, loans held-for-investment,loans held-for-sale and real estate owned, that were non-performing forcontinuing and discontinued operations combined for the periods indicated:

 
| ** **                                                            | ** ** | **At March 31,** | ** ** | ** ** | ** ** | **At December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                                            | ** ** | **2008**                   | ** ** | **%**      | ** ** | **2007**                      | ** ** | **%**      | ** ** |
| 90 or more days delinquent, foreclosures and  delinquent bankruptcies |       | $                          | 2,359,590  |       | 82         | %                             | $          | 2,131,537  |       | 84 | % |
| Real estate owned                                                     |       | 510,497                    |       | 18         | %          | 412,238                       |       | 16         | %          |
| Total non-performing assets                                           |       | $                          | 2,870,087  |       | 100        | %                             | $          | 2,543,775  |       | 100 | % |

 

Non-performingassets consist of mortgages that are 90 days or more delinquent, includingloans in foreclosure and delinquent bankruptcies. It is our policy to place amortgage on non-accrual status when it becomes 90 days delinquent and toreverse from revenue any accrued interest, except for interest income onsecuritized mortgage collateral when the scheduled payment is received from theservicer.  As of March 31, 2008, non-performingassets as a percentage of the outstanding principal balance of securitizedmortgage assets was 23.0 percent compared to 14.6 percent as of December 31,2007.

 

Real estate owned, which consists of residential real estate acquiredin satisfaction of loans, is carried at the lower of cost or net realizablevalue less estimated selling costs. Historically, adjustments to the loancarrying value required at the time of foreclosure were charged against theallowance for loan losses. With the adoption of FAS 159, the Company no longermaintains an allowance for loan losses and adjustments to the carrying value ofREO at the time of foreclosure are included in the change in the fair value ofnet trust assets.  Changes in the Company’sestimates of net realizable value subsequent to the time of foreclosure andthrough the time of ultimate disposition are recorded as gains or losses fromreal estate owned in the consolidated statement of operations.  Real estate owned at March 31, 2008 was$98.3 million, or 23.8 percent higher than at December 31, 2007 as aresult of an increase in foreclosures from higher delinquencies and deteriorationin the prevailing real estate market and, in part, due to borrowers’ inabilityto obtain replacement financing in conjunction with rising borrowing costs dueto resets, reduced housing demand in the marketplace and lower housing prices.

 

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We realized a gainon sale of real estate owned in the amount $3.5 million for the first quarterof 2008 as compared to a loss of $2 thousand for the first quarter of2007.  Additionally, the Company recordedan unrealized loss on the net realizable value of the REO in the amount of $7.7million, which reflects the decline in value of the REO from the foreclosuredate.

 

The following table presents the balances and related activity of thereal estate owned for continuing operations:

 
| ** **            | ** ** | **Three Months Ended** | ** ** | **Year Ended**             | ** ** |
|-----------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **March 31, 2008**     | ** ** | **December 31, 2007** | ** ** |
| Beginning balance     |       | $                                | 405,434    |                            | $          | 137,331 |   |
| Foreclosures          |       | 154,802                          |       | 487,314                         |       |
| Liquidations          |       | (54,558                          | )          | (219,211                        | )          |
| REO                   |       | $                                | 505,678    |                            | $          | 405,434 |   |
|                  |       |                             |       |                            |       |
| REO inside trusts     |       | $                                | 502,473    |                            | $          | 400,863 |   |
| REO outside trust (1) |       | 3,205                            |       | 4,571                           |       |
| REO                   |       | $                                | 505,678    |                            | $          | 405,434 |   |

 

In calculating the cash flows to assess the fair value of thesecuritized mortgage collateral the Company estimates the lifetime lossesembedded in our loan portfolio. In evaluating the adequacy of the lifetimelosses, management takes many factors into consideration. For instance, adetailed analysis of historical loan performance data is accumulated andreviewed. This data is analyzed for loss performance and prepayment performanceby product type, origination year and securitization issuance. The data is alsobroken down by collection status. Our estimate of the required lifetime lossesfor these loans is developed by estimating both the rate of default of theloans and the amount of loss in the event of default. The rate of default isassigned to the loans based on their attributes (*e.g*., originalloan-to-value, borrower credit score, documentation type, etc.) and collectionstatus. The rate of default is based on analysis of migration of loans fromeach aging category. The loss severity is determined by estimating the netproceeds from the ultimate sale of the foreclosed property. The results of thatanalysis are then applied to the current mortgage portfolio and an estimate iscreated. We believe that pooling of mortgages with similar characteristics isan appropriate methodology in which to evaluate the lifetime loan losses.

 

Management recognizes that there are qualitative factors that must betaken into consideration when evaluating and measuring losses in our loanportfolios. These items include, but are not limited to, economic indicatorsthat may affect the borrower’s ability to pay, changes in value of collateral,projected loss curves, political factors, market conditions, competitor’sperformance, market perception, historical losses, and industry statistics. Theassessment for loan losses, is based on delinquency trends and prior loan lossexperience and management’s judgment and assumptions regarding various matters,including general economic conditions and loan portfolio composition.Management continually evaluates these assumptions and various relevant factorsaffecting credit quality and inherent losses.

* *

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

 

*Prepayment Risk*. The Company uses prepayment penalties as amethod of partially mitigating prepayment risk for those borrowers that havethe ability to refinance.  Mortgageindustry evidence suggests that changes in home appreciation rates and lowerpayment option mortgage products over the last three years had been asignificant factor affecting borrowers refinancing decisions. As mortgage ratesincrease and housing prices decline, borrowers will find it more difficult torefinance to obtain cheaper financing. If borrowers are unable to pay theirmortgage payments at the adjusted rate, delinquencies may increase. Thethree-month average combined constant prepayment rate (CPR) of single-familyand multi-family loans held as securitized mortgage collateral decreased to12 percent at March 31, 2008 from 17 percent as of December 31,2007.

 

As of March 31, 2008, the twelve-month combined CPR ofsingle-family and multi-family loans held as securitized mortgage collateral was19 percent as compared to a 24 percent twelve-month average CPR as ofDecember 31, 2007. Prepayment penalties are charged to borrowers formortgages that are paid early and recorded as interest income.

 

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Results of Operations

 

*For the Three Months Ended March 31, 2008 compared tothe Three Months Ended March 31, 2007*

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                             | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                               | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                                |       | $                                                                      | 271,955    |   | $ | 304,748 |   | $ | (32,793 | ) | (11 | )% |
| Interest expense                                               |       | 264,606                                                                |       | 296,805 |   | (32,199 | ) | (11 | ) |
| Net interest income                                            |       | 7,349                                                                  |       | 7,943 |   | (594 | ) | (7 | ) |
| Provision for loan losses                                      |       | —                                                                 |       | 29,132 |   | (29,132 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 7,349                                                                  |       | (21,189 | ) | 28,538 |   | 135 |   |
| Total non-interest income (expense)                            |       | 992                                                                    |       | (22,603 | ) | 23,595 |   | 104 |   |
| Total non-interest expense                                     |       | 6,318                                                                  |       | 6,353 |   | (35 | ) | (1 | ) |
| Income tax expense                                             |       | 6,526                                                                  |       | 3,988 |   | 2,538 |   | 64 |   |
| Net loss earnings from continuing  operations                  |       | (4,503                                                                 | )          | (54,133 | ) | 49,630 |   | 92 |   |
| Income (loss) from discontinued operations,  net               |       | 688                                                                    |       | (67,535 | ) | 68,223 |   | 101 |   |
| Net loss                                                       |       | $                                                                      | (3,815     | ) | $ | (121,668 | ) | $ | 117,853 |   | 97 | % |
|                                                           |       |                                                                   |       |   |   |   |   |   |   |
| Net loss per share - diluted                                   |       | $                                                                      | (0.10      | ) | $ | (1.65 | ) | $ | 1.55 |   | 94 | % |
| Dividends declared per common share                            |       | $                                                                      | —     |   | $ | 0.10 |   | $ | (0.10 | ) | (100 | )% |

 

*Net Interest Income*

 

Weearn net interest income primarily from mortgage assets which includesecuritized mortgage collateral, loans held-for-sale and investment securitiesavailable-for-sale, or collectively, “mortgage assets,” and, to a lesserextent, interest income earned on cash and cash equivalents. Interest expenseis primarily interest paid on borrowings on mortgage assets, which includesecuritized mortgage borrowings, reverse repurchase agreements and borrowingssecured by investment securities available-for-sale. With the adoption of SFAS159, net interest income during the quarter represents the effective yield ofthe net trust assets.  During 2007, netinterest income included (1) amortization of acquisition costs onmortgages acquired from the mortgage operations, (2) accretion of loandiscounts, which primarily represented the amount allocated to mortgageservicing rights when they are sold to third parties and mortgages aretransferred to the long-term investment operations from the mortgage operationsand retained for long-term investment, (3) amortization of securitizedmortgage securitization expenses and, to a lesser extent, (4) amortizationof securitized mortgage bond discounts.

 

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Thefollowing table summarizes average balance, interest and weighted average yieldon mortgage assets and borrowings on mortgage assets, included withincontinuing and discontinued operations, for the periods indicated:

 
| ** **                                             | ** ** | **For the Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                               | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Average**                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Balance**                                                            | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                    |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by  mortgages   |       | $                                                                      | 15,144     |   | $ | 733 |   | 19.36 | % | $ | 30,813 |   | $ | 1,597 |   | 20.73 | % |
| Securitized mortgage collateral (1)                    |       | 13,672,728                                                             |       | 269,897 |   | 7.90 | % | 20,672,576 |   | 303,602 |   | 5.87 | % |
| Loans held-for-investment and held-for-sale  (2)       |       | 212,811                                                                |       | 4,256 |   | 8.00 | % | 1,963,010 |   | 30,345 |   | 6.18 | % |
| Finance receivables                                    |       | —                                                                 |       | — |   | 0.00 | % | 272,866 |   | 5,227 |   | 7.66 | % |
| Total mortgage assets\ interest income                 |       | $                                                                      | 13,900,683 |   | $ | 274,886 |   | 7.91 | % | $ | 22,939,265 |   | $ | 340,771 |   | 5.94 | % |
|                                                   |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                         |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                        |       | $                                                                      | 13,835,280 |   | $ | 261,816 |   | 7.57 | % | $ | 20,183,144 |   | $ | 293,377 |   | 5.81 | % |
| Reverse repurchase agreements                          |       | 285,808                                                                |       | 3,362 |   | 4.71 | % | 2,241,789 |   | 33,736 |   | 6.02 | % |
| Total borrowings on mortgage assets\  interest expense |       | $                                                                      | 14,121,088 |   | $ | 265,178 |   | 7.51 | % | $ | 22,424,933 |   | $ | 327,113 |   | 5.83 | % |
|                                                   |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (3)**                            |       |                                                                   |       | $ | 9,708 |   | 0.40 | % |   |   | $ | 13,658 |   | 0.11 | % |
| **Net Interest Margin (4)**                            |       |                                                                   |       |   |   | 0.28 | % |   |   |   |   | 0.24 | % |

 

----

| (1) |   | Interest  on securitized mortgage collateral in 2007 includes amortization of  acquisition cost on mortgages acquired from the mortgage operations and  accretion of loan discounts. During 2008, the Company started applying the  effective yield used to derive the fair value of the securitized mortgage  collateral. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | The  held-for-sale balance excludes the lower of cost or market (LOCOM) writedown  on the loans.                                                                                                                                                                                                                           |
| (3) |   | Net  interest spread on mortgage assets is calculated by subtracting the weighted  average yield on total borrowings on mortgage assets from the weighted  average yield on total mortgage assets.                                                                                                                         |
| (4) |   | Net  interest margin on mortgage assets is calculated by subtracting interest  expense on total borrowings on mortgage assets from interest income on total  mortgage assets and then dividing by total average mortgage assets and  annualizing the quarterly margin.                                                     |

 

Net interest income spread for the first quarter of 2008 decreased $4.0million (29 percent) as compared to the first quarter of 2007.  The decrease in net interest income wasprimarily due to declines in outstanding balances offset by an increase in netinterest spread.  During the quarter, theyield on mortgage assets changed by 1.97 percent to 7.91 percent from 5.94percent for the comparable 2007 period. The yield on total borrowings changedby 1.68 percent to 7.51 percent for the quarter from 5.83 percent for thecomparable period.  The increase in thesecuritized mortgage collateral and borrowing yields is primarily a result ofthe adoption of SFAS 159 and the related recognition of interest income andexpense based on effective yields for the three months ended March 31, 2008,based on fair value, as compared to using effective interest rates using thehistorical basis in the loans in the prior period.  As the market’s expectation of future creditlosses has increased, the market has demanded higher yields, as investors requirea higher yield on these financial assets and liabilities.

* *

*Non-Interest Income*

 

Changes in Non-Interest Income

 
| ** **                                               | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                             | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2008**                                                               | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative  instruments          |       | —                                                                 |       | (17,998 | ) | 17,998 |   | n/a |   |
| Change in fair value of net trust assets,  excluding REO |       | 3,528                                                                  |       | — |   | 3,528 |   | n/a |   |
| Change in fair value of trust preferred  securities      |       | (4,023                                                                 | )          | — |   | (4,023 | ) | n/a |   |
| Losses from real estate owned                            |       | (4,256                                                                 | )          | (9,892 | ) | 5,636 |   | 57 | % |
| Real estate advisory fees                                |       | 3,845                                                                  |       | — |   | 3,845 |   | n/a |   |
| Other                                                    |       | 1,898                                                                  |       | 5,287 |   | (3,389 | ) | (64 | ) |
| Total non-interest income                                |       | $                                                                      | 992        |   | $ | (22,603 | ) | $ | 23,595 |   | 104 | % |
|                                                          |            |                                                                        |            |  |  |  |  |  |  |  |  |  |

 

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*Change in Fair Value of Derivative Instruments*. The change in the fair value of derivativeinstruments decreased by $18.0 million during the first quarter of 2008 ascompared to the first quarter of 2007, as the Company no longer recognizes thederivative fair value adjustments as a separate component of non-interestincome.  As a result of the adoption ofSFAS 159 the Company now recognizes changes in the fair value of derivativeinstruments as a component of the change in fair value of net trustassets.  The change in fair value ofderivative instruments was a loss of $181.8 million during the first quarter of2008.

 

*Change in Fair Value of Net Trust Assets.* TheCompany recognized a $3.5 million gain from the change in fair value of nettrust assets, which is comprised of gains on the reduction of fair value ofsecuritized mortgage borrowings of $3.4 billion, loss on the reduction in fairvalue of derivatives instruments of $181.8 million and losses on the reductionin fair value of securitized mortgage collateral and investment securitiesavailable-for-sale of $3.2 billion and $4.3 million, respectively.  The overall reduction in fair value of thesecuritized mortgage collateral and securitized mortgage borrowings is theresult of a decrease in the fair value of derivative instruments, a decrease inLondon Interbank Offered Rate (LIBOR) reflected in the forward yield curve anda decrease in the market prices of our mortgage-backed securities.

 

*Change in the Fair Value of Trust PreferredSecurities. *During the firstquarter of 2008 the Company recognized a loss in the amount of $4.0 million asa result of increase in the fair value of the trust preferred securities.

 

*Non-Interest Expense*

 

Changes in Non-Interest Expense

 
| ** **                 | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                             | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2008**                                                               | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                      | 3,988      |   | $ | 5,509 |   | $ | (1,521 | ) | (28 | )% |
| Personnel expense          |       | 2,330                                                                  |       | 844 |   | 1,486 |   | 176 |   |
| Total operating expense    |       | $                                                                      | 6,318      |   | $ | 6,353 |   | $ | (35 | ) | (1 | )% |

 

Totalnon-interest expenses remained relatively flat on a quarter-over-quarter basisas personnel expense increased $1.5 million (176 percent) during the firstquarter of 2008 as compared to same period in 2007, as a greater amount of theCompany’s personnel costs are being utilized within the continuing operationsversus discontinued operations.  The $1.5million decrease in general and administrative costs is primarily attributableto decrease in data processing and communications costs.

 

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

 

***Continuing Operations***

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                             | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                               | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                            |       | $                                                                      | 7,349      |   | $ | 7,943 |   | $ | (594 | ) | (7 | )% |
| Provision for loan losses                                      |       | —                                                                 |       | 29,132 |   | (29,132 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 7,349                                                                  |       | (21,189 | ) | 28,538 |   | 135 |   |
|                                                           |       |                                                                   |       |   |   |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO       |       | 3,528                                                                  |       | — |   | 3,528 |   | n/a |   |
| Change in fair value of derivative  instruments                |       | —                                                                 |       | (17,998 | ) | 17,998 |   | n/a |   |
| Change in fair value of trust preferred  securities            |       | (4,023                                                                 | )          | — |   |   |   | n/a |   |
| Other non-interest expense                                     |       | (2,536                                                                 | )          | (4,605 | ) | 2,069 |   | 45 |   |
| Total non-interest income (expense)                            |       | 992                                                                    |       | (22,603 | ) | 23,595 |   | 104 |   |
|                                                           |       |                                                                   |       |   |   |   |   |   |   |
| Non-interest expense and income taxes                          |       | 12,844                                                                 |       | 10,341 |   | 2,503 |   | 24 |   |
|  Net loss from continuing operations                      |       | $                                                                      | (4,503     | ) | $ | (54,133 | ) | $ | 49,630 |   | 92 | % |

 

Net loss for the quarter ended March 31, 2008 decreased $49.6million as compared to the first quarter of 2007.  The primary reason for the reduction in netloss is the adoption of SFAS 159 for securitized mortgage collateral,borrowings and trust preferred securities. The Company no longer records a provision for loan losses ($29.1 millionfor the first quarter of 2007) and separately the change in fair value ofderivative instruments ($18.0 million loss for the first quarter of 2007),which is now included in the change in fair value of net trust assets, whichconsisted of a $181.8 million loss on derivatives offset by a $185.3 millionincrease in the fair value of the remaining net trust assets, due to thedecline in forward LIBOR rates.  The fairvalue of trust preferred securities increased $4.0 million during the firstquarter of 2008.

 

***Discontinued Operations***

 

Condensed Statements of Operations Data

 
| ** **                                          | ** ** | **For the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                             | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                          | ** ** | **2008**                                                               | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                 |       | $                                                                      | 1,671      |   | $ | 5,513 |   | $ | (3,842 | ) | (70 | )% |
| Provision for loan losses                           |       | —                                                                 |       | 243 |   | (243 | ) | n/a |   |
| Net interest income after provison for loan  losses |       | $                                                                      | 1,671      |   | $ | 5,270 |   | $ | (3,599 | ) | (68 | ) |
|                                                |       |                                                                   |       |   |   |   |   |   |   |
| Loss on sale of loans                               |       | (465                                                                   | )          | (33,801 | ) | 33,336 |   | 99 |   |
| Provision for repurchases                           |       | 10,258                                                                 |       | (11,828 | ) | 22,086 |   | 187 |   |
| Other loss                                          |       | (460                                                                   | )          | (2,329 | ) | 1,869 |   | 80 |   |
| Personnel expense                                   |       | (5,293                                                                 | )          | (17,543 | ) | 12,250 |   | 70 |   |
| Non-interest expense and income taxes               |       | (5,023                                                                 | )          | (7,304 | ) | 2,281 |   | 31 |   |
| Net loss                                            |       | $                                                                      | 688        |   | $ | (67,535 | ) | $ | 68,223 |   | 101 | % |

 

Netearnings for the discontinued operations increased $68.2 million primarilydue to the following changes:

 

·                  decreaseof $33.3 million in loss on sale of loans.

 

·                  decreaseof $22.1 million in provision for repurchases.

 

·                  decreasein personnel expense of $12.3 million.

 

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Loss on sale of loans decreased $33.3 million to $0.5 millionin the first quarter of 2007.  Thedecrease was due to a significant reduction in the balance of loansheld-for-sale between periods resulting from collections, prepayments, loansales, securitizations and reduced LOCOM adjustments.  For the three months ended March 31,2008, gain on the sale of loans was $7.9 million, compared to a loss of $9.1million in the comparable period of 2007. For the three months ended March 31,3008, we recorded $8.4 million in additional LOCOM adjustments, compared to$24.7 million for the comparable period of 2007.

 

                Provision for repurchasesdecreased $22.1 million during the first quarter of 2008 as compared to2007. The decrease in the provision for repurchases was primarily due to thesettlement of $113 million in repurchase obligations.

 

The decrease in personnel expense during the quarter was a result ofmore costs being allocated to continuing operations due to the discontinuationof the mortgage operations.

 

**ITEM 3:         QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Forquantitative and qualitative disclosures about market risk, see Item 7A, “*Quantitative and Qualitative Disclosures About Market Risk*,”included in our annual report on Form 10-K for the year ended December 31,2007.  Our exposures to market risks havenot changed materially since December 31, 2007.

 

**ITEM 4:         CONTROLSAND PROCEDURES**

 

**Evaluation of DisclosureControls and Procedures**

 

The Company maintains disclosure controls and procedures (as defined inthe Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e))designed to ensure that information required to be disclosed in reports filedor submitted under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by the Company in its reports that it files or submitsunder the Exchange Act is accumulated and communicated to the Company’smanagement, including its principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure.

 

As required by Rules 13a-15 and 15d-15 under the Exchange Act, inconnection with the filing of this Quarterly Report on Form 10-Q, ourmanagement, under the supervision and with the participation of our CEO andCFO, conducted an evaluation of our disclosure controls and procedures, as suchterm is defined under Rule 13a-15(e). Based on that evaluation, theCompany’s chief executive officer and chief financial officer concluded that,as of that date, the Company’s disclosure controls and procedures, were noteffective at a reasonable assurance level, due to the identification of amaterial weakness, as discussed in the 2007 Form 10-K.

 

**Material Weakness**

 

In connection with its assessment of the Company’s internal controlover financial reporting as of December 31, 2007, management identified amaterial weakness related to our effectiveness of internal control overfinancial reporting related to a shortage of resources in the accountingdepartment required to close its books and records effectively at eachreporting date, obtain the necessary information from operational departmentsto complete the work necessary to file its financial reports timely and failureto timely identify and remediate accounting errors.

** **

**Management’s RemediationPlan**

 

The Company’s management has continued to remediate the materialweakness identified in Management’s Report on Internal Control over FinancialReporting as of December 31, 2007 by taking the following actions:

 

·                  effective February 2008, we appointedTodd Taylor as Interim Chief Financial Officer, and

 

·                  we hired additional resources for theaccounting and finance departments on a contract basis to help perform certainaccounting functions, until management can employ a more permanent solution.

 

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We believe that our disclosure controls and procedures, including ourcontrol over financial reporting, have improved since year-end due to thescrutiny of such matters by our management and Audit Committee and the changesdescribed above.  However, due in part tocontinued lack of permanent staff in Accounting/Finance and in part to theeffort needed to accurately document the change in accounting for fair valuemeasurements, the Company continued to be late in closing its books and recordseffectively at the required reporting date. Therefore, the Company believes the material weakness related to oureffectiveness of internal control over financial reporting is not fullyremediated as of March 31, 2008.

 

**Changes in Internal Control Over Financial Reporting**

 

There has been no change in the Company’s internal control overfinancial reporting during the Company’s quarter ended March 31, 2008,that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1:          LEGAL PROCEEDINGS**

 

TheCompany is party to litigation and claims which are normal in the course of ouroperations.  While the results of suchlitigation and claims cannot be predicted with certainty, the Company believesthe final outcome of such matters will not have a material adverse effect onour financial condition or results of operations.

 

OnNovember 9, 2007, and separately on August 25, 2008, two matters werefiled against IFC in Orange County in the Superior Court of California, as CaseNo. 07CC11612 and Case No. 00110553, respectively, by Citimortgage, Inc.,alleging claims for breach of contract and damages based upon representationsand warranties made in conjunction with whole loan sales. These actions seekcombined damages in excess of $4.2 million.

 

OnJune 28, 2008, a matter was filed against IFC in the Circuit Court of theEighteenth Judicial District, Dupage County in Illinois, as case no.2008L000721, by TR Mid America Plaza Corp., seeking damages for breach ofcontract (a lease agreement) in excess of $0.6 million plus such amount asdetermined through the date of judgment and payment of attorneys fees andcosts.

 

Webelieve that we have meritorious defenses to the above claims and intend todefend these claims vigorously. Nevertheless, litigation is uncertain and wemay not prevail in the lawsuits and can express no opinion as to their ultimateresolution. An adverse judgment in any of these matters could have a materialadverse effect on us.

 

Please refer to IMH’s report on Form 10-K forthe year ended December 31, 2007 for a description of other litigation andclaims.

 

**ITEM 1A:       RISK FACTORS**

 

Our Annual Report on Form 10-K for the year ended December 31,2007 includes a detailed discussion of our risk factors.  The information presented below updates and shouldbe read in conjunction with the risk factors and information disclosed in that Form 10-K.

** **

**The advisory service fees we earnpursuant to the advisory services agreement may be reduced upon the occurrenceof certain conditions or the agreement may be terminated, which would have amaterial adverse effect on us.**

 

Pursuantto the advisory services agreement with a real estate marketing company we earnadvisory fees.  For the three monthsended March 31, 2008, we earned $3.8 million in advisory fees, which,along with cash flows and master servicing fees from our long-term mortgageportfolio, is one of our primary sources of earnings.  Although the Company is eligible to receive atermination fee in the case of the sale, transfer or merger of the marketingcompany or upon IMH entering into bankruptcy proceedings, IMH’s advisory feesmay be reduced and the agreement subsequently terminated if certain conditionsare not satisfied.  If our CEO is nolonger in a senior management capacity with the Company or any affiliates nor adirector, then the advisory fee percentage is 

 

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substantially reduced andthe marketing company may terminate the agreement.  Furthermore, if the Company fails to providethe agreed upon services, then the agreement may be terminated with no furtherobligations or payments to the Company. The reduction of the advisory fees or termination of the agreement wouldsubstantially decrease our income stream and could have a material adverseeffect on our operations, financial condition and business prospects.

** **

**The occurrence of recent adverse developments in the mortgagefinance and credit markets has affected our business and our stock price.**

 

Beginning in the second quarter of 2007 and continuing through 2008,the mortgage industry and the residential housing market have been adverselyaffected as home prices declined and delinquencies increased. The mortgage marketis currently experiencing unprecedented disruptions, which have had, andcontinue to have, an adverse impact on the Company’s earnings and financialcondition.  These disruptions are furtherevidenced by the recent event surrounding the takeover of Fannie Mae andFreddie Mac by the Federal government. These conditions may not stabilize or they may worsen for theforeseeable future.  Our ability to meetour long-term liquidity requirements is subject to several factors, such asdecreasing our dividend and trust preferred payment obligations and possiblyraising additional capital.  Recentadverse changes in the mortgage finance and credit markets have eliminated orreduced the availability, or increased the cost, of significant sources offunding for us. We may not be able to access sources of funding or, ifavailable to us, we may not be able to negotiate favorable terms. Any decisionby our lenders and/or investors to make additional funds available to us in thefuture will depend upon a number of factors, such as our compliance with theterms of our existing credit arrangements, our financial performance, industryand market trends in our various businesses, the lenders’ and/or investors’ ownresources and policies concerning loans and investments, and the relativeattractiveness of alternative investment or lending opportunities. If we cannotraise cash by selling debt or equity securities, we may be forced to cutadditional resources, sell more of our assets at unfavorable prices ordiscontinue various business activities to preserve cash. Furthermore, theprice of our common stock declined significantly as a result of these eventsand the impact on our results of operations.

** **

**If we fail to successfullyimplement our strategic initiatives, our business, financial condition andresults of operations could be materially and adversely affected.**

 

Inlight of the continuing turmoil in the mortgage market, our ability to continueour operations is dependent upon our ability to successfully implement our strategicinitiatives and acquire new operations that contribute sufficient additionalcash flow to enable us to meet our current and future expenses. Our futurefinancial performance and success are dependent in large part upon our abilityto implement our contemplated strategies successfully.  We have restructured our existing reverserepurchase line and we are exploring to reduce or eliminate the dividendpayments on our outstanding preferred stock and seeking to modify our trustpreferred securities to reduce payment obligations.  Our ability to implement any restructuring isdependent upon agreement of various third parties and security holders. Weexpect that these efforts and negotiations will be complex, and there can be noassurances that any negotiations or other efforts will be successful. To theextent that they are not, we would be unlikely to be able to continue ouroperations as planned thereby requiring us to reduce our operating costs andexpenses so that our income can cover those costs.

 

Weare also considering strategic acquisitions, such as acquiring a real estatemarketing company, a special servicing platform and investing in distressedmortgage assets and related securities. Our ability to acquire new businesses is significantly constrained byour limited liquidity and our likely inability to obtain debt financing or toissue equity securities as a result of our current financial condition, as wellas other uncertainties and risks. There can be no assurances that we will beable to acquire new business operations. We may not be able to implement ourstrategic initiatives successfully or achieve the anticipated benefits of theirimplementation. If we are unable to do so, we may be unable to satisfy ourfuture operating costs and liabilities, including repayment of the restructuredfinance facility, interest payments on the trust preferred securities andpayment of preferred stock dividends. Even if we are able to implement some orall of our strategic initiatives successfully, our operating results may notimprove to the extent we anticipate, or at all.

 

**If we are unable to raise additional capital orgenerate sufficient liquidity we may be unable to implement our strategicinitiatives or conduct our operations.**

 

We are considering raising capital in order to accomplish some of ourstrategic initiatives.  If we are unableto access any capital on reasonable terms, we will not be able to accomplishour goals.  Furthermore, we will then bedependent on our existing revenues from the long-term mortgage and masterservicing portfolios and from real estate advisory fees.  Our ability to conduct our operations willdepend on our ability to effectively reduce operating costs to a level 

 

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thatis supportable by our revenues.  Wecannot assure you that any of these alternatives will be available to us, or ifavailable, that we will be able to negotiate favorable terms.

** **

**Acquisitions of other businesses could result in operatingdifficulties.**

 

Aspart of our strategic initiatives, we may seek to acquire a real estatemarketing company and we may acquire a special servicing platform.  If we continue to pursue these and any otherbusiness opportunities, the process of negotiating the acquisition andintegrating an acquired business may result in operating difficulties andexpenditures and may require significant management attention. Moreover, we maynever realize the anticipated benefits of any new business or acquisition. Wemay not have, and may not be able to acquire or retain, personnel withexperience in any new business we may establish or acquire. In addition, futureacquisitions could result in contingent liabilities and/or amortizationexpenses related to goodwill and other intangible assets, which could harm ourresults of operations, financial condition and business prospects.

 

**We maynot pay dividends to our common or preferred stockholders.**

 

REIT provisions of the Internal Revenue Code generally require that weannually distribute to our stockholders at least 90 percent of all of ourtaxable income, exclusive of the application of any tax loss carry forwardsthat may be used to offset current period taxable income. These provisionsrestrict our ability to retain earnings and thereby generate capital from ouroperating activities. In addition, for any year that we do not generate taxableincome, we are not required to declare and pay dividends to maintain our REITstatus. We have not declared a common stock dividend since March 31, 2007.

 

The Series B PreferredStock and Series C Preferred Stock currently receive quarterly dividendsof $0.58594 and $0.57031 per share, respectively.  Even if we choose not to pay dividends on ourpreferred stock, dividends will accrue whether or not current payment ofdividends is prohibited, whether or not we have earnings, whether or not thereare funds legally available for the payment of such dividends and whether ornot such dividends are declared.  TheCompany may decide not to pay dividends on preferred stock for any quarter orfor a period of time in order to maintain its cash, operate its business orimplement strategic initiatives. Although the Company may choose not to pay dividends, the continuedpayment and accrual of these dividends may prevent the Company fromimplementing new strategies in the current market environment, thereby,hindering our growth prospects. Plus, accumulating dividends with respect toour preferred stock will negatively affect the ability of our commonstockholders to receive any distribution or other value upon liquidation.  The continued accrual and payment of thepreferred stock dividends may have a material adverse effect on our liquidity,financial condition and operations.

** **

**We maynot make payments on our trust preferred debt obligations in the foreseeablefuture**

 

We currently have over $90million in obligations related to junior subordinated debentures related to theoutstanding trust preferred securities. We are required to make quarterly payments on these debtobligations.  In order to preserve cash,the Company may decide not to make payments on these obligations.  If the Company defers quarterly payments, itmay do so for a limited period of time and it may not pay dividends on itscapital stock during such period.  If theCompany continues to fail to pay the trust preferred obligations, then it willbe in default and the entire amount may be immediately due and payable and itcould be in cross-default with other existing finance facilities.  Although the Company is exploring to modifythe trust preferred obligations in order to decrease its payment obligations insome manner, we can not assure you that it will be successful.

 

**The New York Stock Exchange (“NYSE”) has notified usthat we are not in compliance with its continued listing criteria. If we aredelisted by the NYSE, the price and liquidity of our common stock and preferredstock will be negatively affected.**

 

Our common stock and Series B Preferred Stock and Series CPreferred Stock are currently listed on the New York Stock Exchange (the “NYSE”).We must satisfy certain minimum listing maintenance requirements to maintainsuch listing, including maintaining a minimum bid price of $1.00 per share forthe common stock.  On July 8, 2008,we received a second notice from NYSE Regulation Inc. (“NYSE Regulation”) thatthe Company was not in compliance with the NYSE continued listing standardrelated to maintaining a consecutive thirty day average closing stock price ofover $1.00 per common share.  NYSE Regulation noted that effective May 28,2008 the Company had cured its previous non-compliance with the same NYSEcontinued listing standard.  However, NYSE Regulation notified us that theCompany’s common stock again fell below the $1.00 average share pricerequirement.   After reviewingmaterials submitted by the Company specifying details as to its strategic plansto address the current share price deficiency, NYSE Regulation agreed toprovide us an approximately four month cure period. NYSE Regulation willformally reevaluate our continued listing with 

 

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theNYSE’s Listings and Compliance Committee at the end of this approximately fourmonth cure period, and it will also continue to closely monitor the Companyduring this timeframe both with regards to share price levels and progress onits planned initiatives.  Furthermore, onApril 1, 2008 we received notification from the NYSE that the failure totimely file annual and interim reports with the Securities and ExchangeCommission may subject us to suspension and delisting procedures.

 

Wecannot assure you that the NYSE will maintain our listing in the future. In theevent that our common stock and preferred stock is delisted by the NYSE, or ifit becomes apparent to us that we will be unable to meet the NYSE’s continuedlisting criteria in the foreseeable future, we may seek to have our stocklisted or quoted on another national securities exchange or quotation system.If our securities are delisted from the NYSE, then they may trade on theOver-the-Counter-Bulletin Board, which is viewed by most investors as a lessdesirable and less liquid market place. However, we cannot assure you that, if our common stock is listed orquoted on such other exchange or system, the market for our common stock willbe as liquid as it has been on the NYSE. As a result, if we are delisted by theNYSE or transfer our listing to another exchange or quotation system, themarket price for our common stock may become more volatile than it has beenhistorically.  Delisting from the NYSEcould make trading our common stock and preferred stock more difficult for ourinvestors, leading to declines in share price. Delisting of our common stockwould also make it more difficult and expensive for us to raise additionalcapital.

 

**We have restructured our reverse repurchase line whichrequires monthly payments and other payment obligations, will reduce ouroperating income, and contains other provisions that will restrict our businessoperations.**

 

Ourability to finance our operations, grow our business and implement ourstrategic initiatives is dependent upon the availability of credit oncommercially acceptable terms, including the use of warehouse lines of creditand repurchase agreements. On September 11, 2008, we executed a newwarehouse line agreement with UBS Real Estate Securities Inc. (“UBS”).  The agreement removes all technical defaultsfrom financial covenant noncompliance and any associated margin calls for theterm of the agreement.  The agreementcalls for certain targets including a reduction of the borrowings balance to$100 million in 18 months with an advance rate of no more than 65 percent ofthe unpaid principal balance and $50 million in 24 months with an advance rateof no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will berequired to be paid as an additional principal paydown and the monthlyprincipal paydown is reduced to $750,000. The interest rate is LIBOR plus 325 basis points, and all cash collectedfrom the securing mortgage loans is required to be paid to the lender.  We may not have the funds available to makethe required paydowns, which could result in defaults and we may not haveadequate assets to use as collateral.  Inthe event we do not have sufficient liquidity to meet the payment requirements,UBS can accelerate our indebtedness, increase interest rates and terminate ourability to borrow additional funds.  Sucha situation would likely result in a rapid deterioration of our financial condition.

 

**We may not be able to access financing sources onfavorable terms, or at all, which could adversely affect our ability toimplement our strategic initiatives and operate our business as planned.**

 

Wehave historically been dependent on warehouse lines, repurchase agreements,credit facilities, securitizations and other structured financings. Our abilityto use these financing sources depends on various conditions in the markets,which are beyond our control, including lack of liquidity and greater creditspreads. We cannot assure you that these markets will provide an efficientsource of long-term financing. Any new financing could subject us to recourseindebtedness and the risk that debt service on less efficient forms offinancing would require a larger portion of our cash flows, thereby reducingcash available for distribution, funds available for operations as well as forfuture business opportunities.  If we arenot able to borrow additional funds in the future on our new warehouse facilityor arrange for new financing on terms acceptable to us, or if we default on ourcovenants or are otherwise unable to access funds under this facility, we maynot be able to continue to operate our business as planned, which would have amaterial adverse effect on our business, financial condition, liquidity andresults of operations.

 

**ITEM 2:          UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None.

 

**ITEM 3:          DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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**ITEM 4:          SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None

 

**ITEM 5:          OTHER INFORMATION**

 

*Restructure of Reverse Repurchase Line*

 

On September 11, 2008, the Company entered into an agreement with UBS RealEstate Securities Inc. to restructure its reverse repurchase line with itsremaining lender.  The balance of thisline was $220.2 million at June 30, 2008. The agreement removes all technicaldefaults from financial covenant noncompliance and any associated margin callsfor the term of the agreement.  Theagreement calls for certain targets including a reduction of the borrowingsbalance to $100 million in 18 months with an advance rate of no more than 65percent of the unpaid principal balance and $50 million in 24 months with anadvance rate of no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the Company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will berequired to be paid as an additional principal paydown and the monthlyprincipal paydown is reduced to $750,000. The interest rate is LIBOR plus 325 basis points, and all cash collectedfrom the securing mortgage loans is required to be paid to the lender.  Accomplishing the restructuring of thisreverse repurchase line allows the Company to manage the remaining loans on theline for the eventual collection, refinance, sale or securitization without therisk of receiving margin calls.

 

*Annual Meeting of Stockholders*

 

On July 10, 2008, we held our annual meeting of stockholders. Of76,104,656 shares eligible to vote, 69,745,926, or 91.6 percent, votes werereturned, formulating a quorum.  At theannual stockholders meeting, the following matters were submitted to stockholdersfor vote Proposal I - Election of Directors; Proposal II - Ratification of theappointment of Ernst & Young LLP as our independent auditors for theyear ending December 31, 2008; Proposal III – Amendments to the 2001 StockOption, Deferred Stock, and Restricted Stock Plan; and Proposal IV – PotentialIssuance of in excess of 20 percent of our outstanding shares of common stockin connection with a possible exchange of the Company’s Series B PreferredStock and Series C Preferred Stock.

 

**ProposalI—Election of Directors**

 

Theresults of voting on these proposals are as follows:

 
| **Director**         | ** ** | **For**    | ** ** | **Withheld** | ** ** | **Elected** |
|----------------------|------------|------------|------------|--------------|------------|-------------|
| Joseph  R. Tomkinson |       | 66,355,675 |       | 3,390,247    |       | Yes         |
| William  S. Ashmore  |       | 66,436,234 |       | 3,309,688    |       | Yes         |
| James  Walsh         |       | 66,450,743 |       | 3,295,179    |       | Yes         |
| Frank  P. Filipps    |       | 66,212,473 |       | 3,533,449    |       | Yes         |
| Stephan  R. Peers    |       | 66,305,502 |       | 3,440,420    |       | Yes         |
| Leigh  J. Abrams     |       | 66,324,583 |       | 3,421,339    |       | Yes         |

 

All directors are elected at our annual stockholdersmeeting.

 

**Proposal II – Ratification of theappointment of Ernst & Young LLP as our independent auditors for theyear ending December 31, 2008.**

 

Proposal II was approved with 68,372,826 sharesvoted for, 1,039,055 voted against and 334,039 abstained from voting, thereby,ratifying the appointment of Ernst & Young LLP as our independentauditors for the year ending December 31, 2008.

 

**Proposal III – Amendments to the2001 Stock Option, Deferred Stock, and Restricted Stock Plan**

 

Proposal III was approvedwith 30,884,180 shares voted for, 13,826,301 voted against and 738,942abstained from voting, thereby ratifying the amendment to the 2001 Stock Option, Deferred Stock, andRestricted Stock Plan.

 

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**Proposal IV – Potential Issuance of in excess of 20percent of our outstanding shares of common stock in connection with a possibleexchange of the Company’s Series B Preferred Stock and Series CPreferred Stock**

 

Proposal IV was approved with 39,499,182 sharesvoted for, 2,573,181 voted against and 318,320 abstained from voting, therebyapproving the potential issuance of inexcess of 20 percent of our outstanding shares of common stock in connectionwith a possible exchange of the Company’s Series B Preferred Stock and Series CPreferred Stock.

 

**ITEM 6:          EXHIBITS**

 

(a)   Exhibits:

 
| 31.1  |   | Certification  of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                        |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2  |   | Certification  of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                        |
| 32.1* |   | Certifications  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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*         This exhibit shall not be deemed “filed” for purposes of Section 18of the Securities Exchange Act of 1934 or otherwise subject to the liabilitiesof that section, nor shall it be deemed incorporated by reference in any filingunder the Securities Act of 1933 or the Securities Exchange Act of 1934,whether made before or after the date hereof and irrespective of any generalincorporation language in any filings.

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

**IMPACMORTGAGE HOLDINGS, INC.**

 
| /s/  Todd R. Taylor                                                 |   |
|---------------------------------------------------------------------|--------|
| by:  Todd R. Taylor                                                 |
| Interim  Chief Financial Officer                                    |
| (authorized  officer of registrant and principal financial officer) |

 

Date:September 15, 2008

 

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