Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

x                               **QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period ended September 30, 2008 or**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                    to                    .**

 

**Commission File Number: 1-14100**

** **

**IMPAC MORTGAGE HOLDINGS, INC.**

(Exact name ofregistrant as specified in its charter)

 

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

 

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

**(Address of principal executive offices)**

** **

**(949) 475-3600**

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

** **

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90days.    Yes  o    No  x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.

 

Largeaccelerated filer o  Acceleratedfiler x  Non-accelerated filer o  Smaller reporting company o

 

Indicate by check mark whether the registrant is ashell company (as defined in Exchange Act Rule 12b-2)  Yes o  No x

 

There were 76,100,524 shares of common stockoutstanding as of November 12, 2008.

 

 

 

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Table of Contents

 

**IMPAC MORTGAGE HOLDINGS, INC.**

 

**FORM 10-Q QUARTERLY REPORT**

 

**TABLE OFCONTENTS**

 
| ** **                              | ** ** | ** **                                                                                                                          | ** ** | **Page**   |
|-----------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I.  FINANCIAL INFORMATION** |
|                                    |       |                                                                                                                                |       |       |
| ITEM 1.                                 | ** ** | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                              |       | 1          |
|                                    |       | Consolidated  Balance Sheets as of September 30, 2008 and December 31, 2007                                               |       | 1          |
|                                    |       | Consolidated  Statements of Operations and Comprehensive Loss for the Three and Nine Months  Ended September 30, 2008 and 2007 |       | 2          |
|                                    |       | Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2008 and  2007                                  |       | 4          |
|                                    |       | Notes to Unaudited Consolidated Financial Statements                                                                                |       | 6          |
|                                    |       |                                                                                                                                |       |       |
| ITEM 2.                                 | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**                                      |       | 23         |
|                                    |       | Forward-Looking Statements                                                                                                          |       | 23         |
|                                    |       | The Mortgage Banking Industry and Discussion of  Relevant Fiscal Periods                                                            |       | 23         |
|                                    |       | Status of Operations, Liquidity and Capital Resources                                                                               |       | 24         |
|                                    |       | Market  Conditions                                                                                                                  |       | 26         |
|                                    |       | Critical Accounting Policies                                                                                                        |       | 28         |
|                                    |       | Fair Value of  Financial Instruments                                                                                                |       | 29         |
|                                    |       | Interest Income and Interest  Expense                                                                                               |       | 30         |
|                                    |       | Selected  Financial Results for the Three Months Ended September 30, 2008                                                      |       | 31         |
|                                    |       | Selected  Financial Results for the Nine Months Ended September 30, 2008                                                       |       | 31         |
|                                    |       | Estimated Taxable  Income                                                                                                           |       | 31         |
|                                    |       | Financial  Condition and Results of Operations                                                                                      |       | 32         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 3.                                 | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                     |       | 42         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 4.                                 | ** ** | **CONTROLS AND PROCEDURES**                                                                                                         |       | 42         |
|                                    |       |                                                                                                                                |       |       |
| **PART II.  OTHER INFORMATION**    |
| ** **                              |
| ITEM 1.                                 | ** ** | **LEGAL PROCEEDINGS**                                                                                                               |       | 43         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 1A.                                | ** ** | **RISK FACTORS**                                                                                                                    |       | 44         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 2.                                 | ** ** | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                                    |       | 44         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 3.                                 | ** ** | **DEFAULTS  UPON SENIOR SECURITIES**                                                                                                |       | 44         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 4.                                 | ** ** | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                            |       | 44         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 5.                                 | ** ** | **OTHER INFORMATION**                                                                                                               |       | 45         |
|                                    |       |                                                                                                                                |       |       |
| ITEM 6.                                 | ** ** | **EXHIBITS**                                                                                                                        |       | 45         |
|                                    |       |                                                                                                                                |       |       |
| ** **                              | ** ** | **SIGNATURES**                                                                                                                      |       | 46         |
|                                    |       |                                                                                                                                |       |       |
| ** **                              | ** ** | **CERTIFICATIONS**                                                                                                                  | ** ** | ** ** |

 

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Table of Contents

 

**PART I.FINANCIAL INFORMATION**

 

# **ITEM 1.          CONSOLIDATED FINANCIAL STATEMENTS**

 

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share data)**

 
| ** **                                                                                                                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                     | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                     | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                     |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                      |       | $                      | 24,536     |                  | $          | 24,387 |   |
| Trust assets                                                                                                                                                                                   |       |                   |       |                  |       |
| Investment securities available-for-sale                                                                                                                                                       |       | 4,856                  |       | 15,248                |       |
| Securitized mortgage collateral (at fair  value at September 30, 2008)                                                                                                                    |       | 8,264,413              |       | 16,532,633            |       |
| Derivative assets                                                                                                                                                                              |       | 251                    |       | 7,497                 |       |
| Real estate owned (REO) at net realizeable  value                                                                                                                                              |       | 663,320                |       | 400,863               |       |
| Total trust assets                                                                                                                                                                             |       | 8,932,840              |       | 16,956,241            |       |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| Assets of discontinued operations                                                                                                                                                              |       | 158,468                |       | 353,250               |       |
| Other assets                                                                                                                                                                                   |       | 49,617                 |       | 57,194                |       |
| Total assets                                                                                                                                                                                   |       | $                      | 9,165,461  |                  | $          | 17,391,072 |   |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                |       |                   |       |                  |       |
| Trust liabilities                                                                                                                                                                              |       |                   |       |                  |       |
| Securitized mortgage borrowings (at fair  value at September 30, 2008)                                                                                                                    |       | $                      | 8,787,013  |                  | $          | 17,780,060 |   |
| Derivative liabilities                                                                                                                                                                         |       | 103,800                |       | 127,757               |       |
| Total trust liabilities                                                                                                                                                                        |       | 8,890,813              |       | 17,907,817            |       |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| Trust preferred securities (at fair value  at September 30, 2008)                                                                                                                         |       | 35,898                 |       | 98,398                |       |
| Liabilities of discontinued operations                                                                                                                                                         |       | 225,536                |       | 405,341               |       |
| Other liabilities                                                                                                                                                                              |       | 7,704                  |       | 57,244                |       |
| Total liabilities                                                                                                                                                                              |       | 9,159,951              |       | 18,468,800            |       |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                                                  |       |                   |       |                  |       |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                                                 |       |                   |       |                  |       |
| Series-A junior participating preferred  stock, $0.01 par value; 2,500,000 shares authorized; none issued and  outstanding                                                                     |       | —                 |       | —                |       |
| 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                     |       | 45                     |       | 45                    |       |
|                                                                                                                                                                                           |       |                   |       |                  |       |
| Common stock, $0.01 par value; 200,000,000  shares authorized; 76,100,524 and 76,096,392 shares issued and outstanding as  of September 30, 2008 and December 31, 2007, respectively |       | 761                    |       | 761                   |       |
| Additional paid-in capital                                                                                                                                                                     |       | 1,176,068              |       | 1,173,562             |       |
| Accumulated other comprehensive income                                                                                                                                                         |       | —                 |       | 1,028                 |       |
| Net accumulated deficit:                                                                                                                                                                       |       |                   |       |                  |       |
| Cumulative dividends declared                                                                                                                                                                  |       | (815,076               | )          | (803,912              | )          |
| Retained deficit                                                                                                                                                                               |       | (356,308               | )          | (1,449,232            | )          |
| Net accumulated deficit                                                                                                                                                                        |       | (1,171,384             | )          | (2,253,144            | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                      |       | 5,510                  |       | (1,077,728            | )          |
| Total liabilities and stockholders’ equity                                                                                                                                                |       | $                      | 9,165,461  |                  | $          | 17,391,072 |   |

 

See accompanying notes toconsolidated financial statements.

 

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**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**ANDCOMPREHENSIVE LOSS**

**(inthousands, except per share data)**

**(Unaudited)**

 
| ** **                                                     | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                     | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                     | ** ** | **2008**                                | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| **INTEREST INCOME:**                                           | * *   | * *                                | * *   | * *                               | * *   | * * | * * | * * | * * |
| Total interest income                                          |       | $                                       | 397,445    |                                   | $          | 310,006 |   | $ | 1,077,256 |   | $ | 931,196 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **INTEREST EXPENSE:**                                          |       |                                    |       |                                   |       |   |   |   |   |
| Total interest expense                                         |       | 394,431                                 |       | 298,003                                |       | 1,062,637 |   | 903,377 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| Net interest income                                            |       | 3,014                                   |       | 12,003                                 |       | 14,619 |   | 27,819 |   |
| Provision for loan losses                                      |       | —                                  |       | 789,445                                |       | — |   | 979,740 |   |
| Net interest income (expense) after  provision for loan losses |       | 3,014                                   |       | (777,442                               | )          | 14,619 |   | (951,921 | ) |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST INCOME:**                                       |       |                                    |       |                                   |       |   |   |   |   |
| Change in fair value of derivative  instruments                |       | —                                  |       | (106,532                               | )          | — |   | (32,860 | ) |
| Change in fair value of net trust assets,  excluding REO       |       | 7,778                                   |       | —                                 |       | 145 |   | — |   |
| Losses from real estate owned                                  |       | (15,685                                 | )          | (45,941                                | )          | (24,771 | ) | (75,161 | ) |
| Change in fair value of trust preferred  securities            |       | 10,494                                  |       | —                                 |       | 5,473 |   | — |   |
| Real estate advisory fees                                      |       | 7,039                                   |       | —                                 |       | 15,581 |   | — |   |
| Other                                                          |       | 1,847                                   |       | (29,770                                | )          | 5,287 |   | (26,021 | ) |
| Total non-interest income (expense)                            |       | 11,473                                  |       | (182,243                               | )          | 1,715 |   | (134,042 | ) |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST EXPENSE:**                                      |       |                                    |       |                                   |       |   |   |   |   |
| General and administrative                                     |       | 4,951                                   |       | 4,213                                  |       | 13,864 |   | 14,173 |   |
| Personnel expense                                              |       | 2,382                                   |       | 2,488                                  |       | 7,531 |   | 4,952 |   |
| Total non-interest expense                                     |       | 7,333                                   |       | 6,701                                  |       | 21,395 |   | 19,125 |   |
| Net earnings (loss) from continuing  operations                |       | 7,154                                   |       | (966,386                               | )          | (5,061 | ) | (1,105,088 | ) |
| Income tax expense from continuing  operations                 |       | 5,253                                   |       | 3,056                                  |       | 13,980 |   | 12,012 |   |
| Net earnings (loss) from continuing  operations                |       | 1,901                                   |       | (969,442                               | )          | (19,041 | ) | (1,117,100 | ) |
| Net loss from discontinued operations, net  of tax             |       | (18,121                                 | )          | (221,793                               | )          | (28,481 | ) | (348,350 | ) |
| Net loss                                                       |       | (16,220                                 | )          | (1,191,235                             | )          | (47,522 | ) | (1,465,450 | ) |
| Cash dividends on cumulative redeemable  preferred stock       |       | (3,722                                  | )          | (3,722                                 | )          | (11,165 | ) | (11,165 | ) |
| Net loss available to common stockholders                      |       | $                                       | (19,942    | )                                      | $          | (1,194,957 | ) | $ | (58,687 | ) | $ | (1,476,615 | ) |

 

See accompanying notes to consolidated financial statements.

 

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| ** **                                           | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                           | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                           | ** ** | **2008**                                | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss                                             |       | $                                       | (16,220    | )                                      | $          | (1,191,235 | ) | $ | (47,522 | ) | $ | (1,465,450 | ) |
| Net unrealized losses on securities:                 |       |                                    |       |                                   |       |   |   |   |   |
| Unrealized holding losses arising during  year       |       | —                                  |       | (700                                   | )          | — |   | (673 | ) |
| Reclassification of losses included in net  earnings |       | —                                  |       | (243                                   | )          | — |   | (1,393 | ) |
| Net unrealized losses                                |       | —                                  |       | (943                                   | )          | — |   | (2,066 | ) |
| Comprehensive loss                                   |       | $                                       | (16,220    | )                                      | $          | (1,192,178 | ) | $ | (47,522 | ) | $ | (1,467,516 | ) |
|                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Net loss per common share - Basic:                   |       |                                    |       |                                   |       |   |   |   |   |
| Loss from continuing operations                      |       | $                                       | (0.02      | )                                      | $          | (12.79 | ) | $ | (0.40 | ) | $ | (14.83 | ) |
| Loss from discontinued operations                    |       | (0.24                                   | )          | (2.91                                  | )          | (0.37 | ) | (4.58 | ) |
| Net loss per share                                   |       | $                                       | (0.26      | )                                      | $          | (15.70 | ) | $ | (0.77 | ) | $ | (19.41 | ) |
|                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Net loss per common share - Diluted:                 |       |                                    |       |                                   |       |   |   |   |   |
| Loss from continuing operations                      |       | $                                       | (0.02      | )                                      | $          | (12.79 | ) | $ | (0.40 | ) | $ | (14.83 | ) |
| Loss from discontinued operations                    |       | (0.24                                   | )          | (2.91                                  | )          | (0.37 | ) | (4.58 | ) |
| Net loss per share                                   |       | $                                       | (0.26      | )                                      | $          | (15.70 | ) | $ | (0.77 | ) | $ | (19.41 | ) |
|                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Dividends declared per common share                  |       | $                                       | —     |                                   | $          | — |   | $ | — |   | $ | 0.10 |   |

 

See accompanying notes to consolidated financialstatements.

 

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**IMPAC MORTGAGE HOLDINGS, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                      | ** **   | **For the Nine Months** | ** **   |
|---------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                      | ** **   | **Ended September 30,**      | ** **   |
| ** **                                                                      | ** **   | **2008**                               | ** **   | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                       | *** *** | *** ***                           | *** *** | *** *** | *** *** |
| Net loss from continuing operations                                             |         | $                                      | (19,041      | ) | $ | (1,117,100 | ) |
|                                                                            |         |                                   |         |   |   |
| Provision for loan losses                                                       |         | —                                 |         | 979,740 |   |
| Losses from real estate owned                                                   |         | 24,771                                 |         | 75,161 |   |
| Amortization of deferred charge, net                                            |         | 13,980                                 |         | 12,071 |   |
| Amortization of debt issuance costs and  mortgage servicing rights              |         | 1,363                                  |         | 1,174 |   |
| Amortization of premiums and securitization  costs                              |         | —                                 |         | 116,609 |   |
| Change in fair value of derivative  instruments                                 |         | —                                 |         | 136,701 |   |
| Change in fair value of net trust assets,  excluding REO                        |         | (113,000                               | )            | — |   |
| Change in fair value of trust preferred  securities                             |         | (5,473                                 | )            | — |   |
| Accretion of interest income and expense                                        |         | 385,759                                |         | — |   |
| Write-down of investment securities  available-for-sale                         |         | —                                 |         | 11,304 |   |
| Stock-based compensation                                                        |         | 901                                    |         | 961 |   |
| Net change in accrued interest receivable                                       |         | —                                 |         | 4,658 |   |
| Net cash provided by (used in) operating  activities of discontinued operations |         | 89,973                                 |         | (2,869,413 | ) |
| Net change in other assets and liabilities                                      |         | (42,135                                | )            | 46,396 |   |
| **Net cash provided by (used in) operating  activities**                        | ** **   | **337,098**                            | ** **   | **(2,601,738** | **)** |
| ** **                                                                      | ** **   | ** **                             | ** **   | ** ** | ** ** |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                       | ** **   | ** **                             | ** **   | ** ** | ** ** |
| Principal reductions on securitized  mortgage collateral                        |         | 1,409,506                              |         | 4,749,658 |   |
| Principal reductions on mortgages held-for-investment                           |         | 59                                     |         | (2,061 | ) |
| Purchase of premises and equipment                                              |         | 357                                    |         | (1,362 | ) |
| Proceeds from investment securities  available-for-sale                         |         | 2,358                                  |         | 2,816 |   |
| Proceeds from the sale of real estate owned                                     |         | 351,183                                |         | 161,557 |   |
| Net cash provided by investing activities  of discontinued operations           |         | 13,613                                 |         | 395,710 |   |
| **Net cash provided by investing activities**                                   | ** **   | **1,777,076**                          | ** **   | **5,306,318** | ** ** |
|                                                                            |         |                                   |         |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                       |         |                                   |         |   |   |
| Cash disbursements under reverse repurchase  agreements                         |         | —                                 |         | (256,459 | ) |
| Cash receipts from reverse repurchase  agreements                               |         | —                                 |         | 92,455 |   |
| Proceeds from securitized mortgage  borrowings                                  |         | —                                 |         | 3,858,143 |   |
| Repayment of securitized mortgage  borrowings                                   |         | (1,962,577                             | )            | (5,690,970 | ) |
| Common stock dividends paid                                                     |         | —                                 |         | (30,326 | ) |
| Preferred stock dividends paid                                                  |         | (11,165                                | )            | (11,165 | ) |
| Proceeds from sale of cumulative redeemable  preferred stock                    |         | —                                 |         | 608 |   |
| Net cash used in financing activities of  discontinued operations               |         | (142,345                               | )            | (792,630 | ) |
| **Net cash used in financing activities**                                       | ** **   | **(2,116,087**                         | **)**        | **(2,830,344** | **)** |
|                                                                            |         |                                   |         |   |   |
| Net change in cash and cash equivalents                                         |         | (1,913                                 | )            | (125,764 | ) |
| Cash and cash equivalents at beginning of  period                               |         | 26,462                                 |         | 179,677 |   |
| Cash and cash equivalents at end of period  - Continuing Operations             |         | 24,536                                 |         | 36,086 |   |
| Cash and cash equivalents at end of period  - Discontinued Operations           |         | 13                                     |         | 17,827 |   |
| Cash and cash equivalents at end of period                                      |         | $                                      | 24,549       |   | $ | 53,913 |   |

 

See accompanying notes toconsolidated financial statements.

 

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| ** **                                                                    | ** **   | **For the Nine Months** | ** **   |
|-------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                    | ** **   | **Ended September 30,**      | ** **   |
| ** **                                                                    | ** **   | **2008**                               | ** **   | **2007** | ** ** |
| **SUPPLEMENTARY INFORMATION (Continuing and  Discontinued Operations):**      | *** *** | *** ***                           | *** *** | *** *** | *** *** |
| Interest paid                                                                 |         | $                                      | 435,861      |   | $ | 962,116 |   |
| Taxes paid                                                                    |         | —                                 |         | 116 |   |
|                                                                          |         |                                   |         |   |   |
| **NON-CASH TRANSACTIONS (Continuing and  Discontinued Operations):**          |         |                                   |         |   |   |
| Accumulated other comprehensive loss                                          |         | $                                      | —       |   | $ | (2,066 | ) |
| Transfer of mortgages to real estate owned                                    |         | 3,009                                  |         | 28,445 |   |
| Transfer of securitized mortgage collateral  to real estate owned             |         | 628,779                                |         | 419,411 |   |
| Transfer of loans held-for-sale to  securitized mortgage collateral           |         | —                                 |         | 3,245,500 |   |
| Transfer of securitized mortgage collateral  to loans held-for-sale           |         | —                                 |         | 27,040 |   |
| Transfer of net assets from discontinued  operations to continuing operations |         | 25,600                                 |         | 4,012 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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

**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

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

 

**Note A—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 IFC, and warehouselending operations conducted by IWLG (collectively, the discontinuedoperations).

 

The Company consists ofthe continuing operations, which includes the long-term mortgage portfolio (residual interests insecuritizations) conducted by IMH and IMH Assets, the master servicingportfolio, and real estate advisory fees from the Company’s advisory servicesagreement with a real estate marketing company.

 

The information containedthroughout this document is presented on a continuing basis, unless otherwisestated.

 

***Financial Statement Presentation***

 

The accompanying unaudited consolidated financialstatements of IMH and its subsidiaries (as defined above) have been prepared inaccordance with Accounting Principles Generally Accepted in the United Statesof America (GAAP) for interim financial information and with the instructionsto Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they donot include all of the information and footnotes required by GAAP for completefinancial statements. In the opinion of management, all adjustments, consistingof normal recurring adjustments considered necessary for a fair presentation,have been included. Operating results for the three-month and nine-monthperiods ended September 30, 2008 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2008.

 

All significant inter-company balances andtransactions have been eliminated in consolidation. In addition, certainamounts in the prior periods’ consolidated financial statements have beenreclassified to conform to the current year presentation.

 

Management has made a numberof estimates and assumptions relating to the reporting of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period to prepare these consolidated financial statementsin conformity with GAAP.  The itemsaffected by management’s estimates and assumptions include the valuation oftrust assets and liabilities, the valuation of repurchase liabilities relatedto loans sold to investors, the valuation of trust preferred securities, thevaluation of lease restructuring liabilities and the valuation of loansheld-for-sale.  Actual results coulddiffer from those estimates.

 

***Market Conditions, Status of Operations,Liquidity and Capital Resources***

 

Real estate prices havefallen significantly since the peak levels in 2006.  During the third quarter of 2008, the creditand housing markets continued to suffer from significant market disruption dueto continued deterioration of the real estate and credit markets.  The federal government has taken steps toattempt to stabilize the housing and credit markets.  At this time, the government’s actions havenot affected the Company’s financial position or operations.

 

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 the Company’s reverse repurchase facilities and settled a portionof its outstanding repurchase claims, while also reducing its operating costsand liabilities in 2007.

 

During the third quarter of2008, the Company continued to fund its operations with revenues and cash flowsfrom real estate advisory fees and its residual interests in securitizationsand master servicing fees generated from the long-term mortgage portfolio.

 

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In the first quarter of2008, the Company entered into an agreement with a real estate marketingcompany to generate advisory fees.  Thereal estate marketing company specializes in the marketing of foreclosedproperties.  During the three and ninemonths ended September 30, 2008, the Company earned $7.0 million and $15.6million, respectively, from this relationship. On November 12, 2008, the Company and the real estate marketing companyagreed to terminate the advisory services agreement.  See Note L for details of the agreement toterminate.

 

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.

 

In September 2008, theCompany entered into an agreement to restructure its reverse repurchase linewith its remaining lender.  See Note Jfor details of the restructure.

 

The Company paid its October 2008trust preferred interest payment as part of its negotiations to restructure orexchange the current trust preferred securities.  To date, the Company has been unsuccessful incompleting these negotiations.

 

In July 2008, theCompany’s stockholders approved the potential issuance of common shares inexcess of 20 percent of the existing common shares.

 

There can be no assurancethat the Company will be successful in acquiring the special servicer,restructuring the trust preferred securities or exchanging the preferredstock.  In any event, the Company intendsto reduce operating expenses to a level that is supportable by the revenuesfrom the existing long-term mortgage portfolio (residual interests insecuritizations), master servicing portfolio and real estate advisory fees.

 

If the Company is notsuccessful in completing the objectives outlined above, it may not be able tomeet its contractual obligations for the next year, including repayment of therestructured reverse repurchase line, interest payments on trust preferredsecurities and preferred stock dividends.

 

**2.     Adoption of New Accounting Standards**

 

**Adoption of SFAS 157—FairValue Measurements**

 

The Company prospectivelyadopted the provisions of Financial Accounting Standards Board (FASB) StatementNo. 157 “Fair Value Measurements” (SFAS 157), as of January 1,2008.  SFAS 157 defines fair value,expands disclosure 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 foridentical instruments 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 fromvaluation techniques in which one or more significant inputs or significantvalue drivers are unobservable.

 

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

 

For someproducts or in certain market conditions, observable inputs may not always beavailable.  Through the third quarter of2008, certain markets remained inactive, and some key observable inputs used invaluing certain financial assets and liabilities were unavailable.  Under the provisions of FASB Staff Position No. 157-3“Determining the Fair Value of a Financial Asset When the 

 

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Market for That Asset Is NotActive”, in situations in which there is little, if any, market activity for anasset at measurement date, the fair value measurement objective remains tomeasure the financial asset at the price that would be received by the holderof the financial asset in an orderly transaction that is not a forcedliquidation or distressed sale at the measurement date.  In the absence of observable market data at September 30,2008, the Company’s fair value measurements include its own internalassumptions about future cash flows and appropriately risk-adjusted discountrates that it believes market participants would make in orderly markettransactions.  When and if these marketsbecome active, the Company will use the related observable inputs available atthat time.  Therefore, at September 30,2008, all of the items measured at fair value are considered Level 3 fair valuemeasurements.

 

Under fair value accounting,the Company is required to take into account its own credit risk when measuringthe fair value of assets and liabilities.

 

**Adoption of SFAS 159 - FairValue Option**

 

The adoption of Statement No. 159“The Fair Value Option for Financial Assets and Financial Liabilities”(SFAS 159) has also resulted in new valuation techniques used by theCompany when determining fair value, most notably to value its securitizedmortgage collateral and borrowings and trust preferred securities, which hadnot previously 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 159transition provisions, the Company elected to apply fair value accounting tocertain financial instruments (certain trust assets, trust liabilities andtrust preferred securities) held at January 1, 2008.  Differences between the December 31,2007 carrying values and the January 1, 2008 fair values were recognizedas an adjustment to retained deficit. The adoption of SFAS 159 resulted ina $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 deteriorationin the real estate market since the second half of 2007, the Companysignificantly added to its allowance for loan losses during the third andfourth quarters of 2007.  Principally,because of the increase in the allowance for loan losses, the Company reporteda stockholders’ deficit as of December 31, 2007. This stockholders’deficit was created primarily because the Company was required under GAAP torecord an allowance for loan losses that reduced securitized mortgagecollateral in its consolidated trusts below the balance of the relatedsecuritized mortgage borrowings, resulting in a negative investment in certainconsolidated trusts, even though the related trust agreements are nonrecourseto the Company.  However, with theadoption of SFAS 159, the Company’s net investment position is unable to gobelow 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 theconsolidated trusts at fair value.

 

The following tablesummarizes the initial retained earnings charge related to the prospectiveadoption of SFAS 159 as of January 1, 2008 and the related fair valuebalances as of January 1, 2008.

 
| ** **                                                | ** ** | **Ending Balance as of  December 31, 2007** | ** ** | **Adoption Net** | ** **    | **Fair Value Balance  as of January 1, 2008** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------|---------------|-----------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **(Prior to Adoption)**                                    | ** ** | **Gain/(Loss)**       | ** **    | **(After Adoption) (5)**                                          | ** ** |
| Impact of electing the fair value option  under SFAS 159: |       |                                                                 |       |                  |          |                                                                        |       |
| Investment securities available-for-sale                  |       | $                                                                    | 15,248     |                  | $             | 1,028                                                                       | (1)        | $ | 15,248 |   |
| Securitized mortgage collateral (2)                       |       | 16,532,633                                                           |       | (821,311              | )             | 15,711,322                                                                  |       |
| Securitized mortgage borrowings (3)                       |       | (17,780,060                                                          | )          | 1,903,283             |          | (15,876,777                                                                 | )          |
| Trust preferred securities                                |       | (98,398                                                              | )          | 57,446                |          | (40,952                                                                     | )          |
| 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 in accumulated other comprehensive income.  Included in the cumulative-effect adjustment was $1,028 thousand in  unrealized holding gains that were reclassified from accumulated other comprehensive  income to retained deficit. Due to the effect of reclassifying the $1,028  thousand from accumulated other comprehensive income to retained deficit, the  investment securities available-for-sale balances do not add across. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (2)    |   | Components of securitized mortgage collateral at  December 31, 2007 include the allowance for loan loss of $1.2 billion,  accrued interest of $99.7 million and premiums of $183.1 million, which were  part of its fair value for the adoption of SFAS 159. At September 30,  2008 and December 31, 2007, securitized mortgage collateral included  $10.4 million and $9.1 million, respectively in master servicing rights,  recorded at the lower of cost or market, related to consolidated  securitizations and recorded at the lower of cost or market.                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (3)    |   | Components of securitized mortgage borrowings at  December 31, 2007 include accrued interest of $17.1 million and  securitization costs of $37.5 million, 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 Company qualifies as a REIT for federal income tax purposes and its  tax liabilities are only related to it deferred charges associated with  previous inter-company loan sales.                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (5)    |   | The securitized mortgage collateral and securitized  mortgage borrowings include the mortgage insurance and bond insurance  proceeds to be received from third parties.                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (6)    |   | As of January 1, 2008, after adoption of SFAS  159, total stockholders’ equity was $61.7 million                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

 

**Changes in Significant AccountingPolicies**

 

*Investment SecuritiesAvailable-for-Sale*

 

The Company elected to continue to account for allof its existing investment securities available-for-sale at fair value.  Interest income is recorded based on theeffective yield for the period based on the valuation of the previousquarter.  Net gains and losses resultingfrom changes in fair value of investment securities available-for-sale arerecorded within change in fair value of net trust assets in the Company’sconsolidated statement of operations and comprehensive loss.

 

The Company’s election to account for its investmentsecurities available-for-sale at fair value was based on the Company’s overallobjective of moving toward fair value accounting for significant financialassets and liabilities.  The election ofSFAS 159 for these investment securities results in increased volatility withinnet earnings as a result of the recognition of fair value changes with nooffsetting amounts that would result if these assets were economicallyhedged.  However, management believesthat electing fair value accounting for its investment securities results in astronger reflection of the value, while furthering its objective of migratingtoward fair value accounting.

 

*Securitized Mortgage Collateraland Borrowings*

 

The Company elected to account for certain of itssecuritized assets at fair value. Interest income on securitized mortgage collateral and interest expenseon securitized mortgage borrowings, respectively, is recorded based on theeffective yield for the period based on the previous quarter’s valuationresulting in interest income and interest expense accretion included ininterest income and interest expense in the Company’s consolidated statement ofoperations and comprehensive loss.  Netgains (losses) resulting from the changes in fair value of securitized mortgagecollateral and borrowings, are included in change in fair value of net trustassets, excluding REO, within non-interest income in the Company’s consolidatedstatement of operations and comprehensive loss. Electing the fair value option allows the Company to avoid the burden ofrecording losses on collateral for which the Company will not ultimately barethe loss. In addition, recording the collateral and borrowings at fair valuewill help to reflect the true economics of the transactions within theconsolidated statement of operations and comprehensive loss.  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*

 

The Company elected to account for all of its trustpreferred securities at fair value.  Interestexpense on trust preferred securities is recorded based on the effective yieldfor the period and included in interest expense in the consolidated statementof operations and comprehensive loss. Gains and losses resulting from the changes in fair value of trustpreferred securities are recorded within change in fair value of trustpreferred securities in the Company’s consolidated statement of operations andcomprehensive loss.

 

The Company’s election to account for its trustpreferred securities at fair value was based on the Company’s overall objectiveof moving toward fair value accounting for significant financial assets andliabilities.  The election of SFAS 159for these liabilities results in increased volatility within net earnings as aresult of the recognition of fair value changes with no offsetting amounts thatwould result 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.

 

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

 

In October 2008, theFASB issued FASB Staff Position No. 157-3 “Determining the Fair Value of aFinancial Asset When the Market for That Asset Is Not Active” (FSP 157-3).  The staff position clarifies the applicationof SFAS 157 in inactive markets and provides an illustrative example of how thefair value of a financial asset is determined in an inactive market.  FSP 157-3 is effective immediately, includingprior periods for which financial statements have not been issued.  The issuance of this staff position affectsthe Company as a significant portion of the Company’s financial assets andliabilities are measured at fair value using market value approaches based onactive markets.  Availability ofobservable market inputs has diminished considerably as a result of theincreasing inactivity in the secondary market for mortgage loans, mortgage-backedsecurities and other real estate related assets.  The lack of observable market inputs requiresthat the Company rely heavily on its own internal assumptions of the futurecash flows and appropriate risk-adjusted discount rates market participantswould apply in measuring the fair value of financial assets and liabilities inorderly market transactions that are not forced liquidations or distressedsales.  As discussed in Note B, asignificant portion of the Company’s financial assets and liabilities, whichwere previously classified as Level 2 fair value measurements, were classifiedas Level 3 fair value measurements at September 30, 2008, as a result ofmarket inactivity and the lack of availability of observable market inputs.

 

In May 2008, the FASBissued SFAS No. 162, “The Hierarchy of Generally Accepted AccountingPrinciples” (“SFAS 162”).  The newstandard is intended to improve financial reporting by identifying a consistentframework for selecting accounting principles to be used in preparing financialstatements that are presented in conformity with U.S. GAAP for nongovernmentalentities. SFAS 162 will be effective 60 days after the U.S. Securities andExchange Commission approves the Public Company Accounting Oversight Board’samendments to AU Section 411, “The Meaning of Present Fairly in Conformity withGenerally Accepted Accounting Principles.” The Company does not expect theadoption of SFAS 162 to have a significant impact on its consolidated financialstatements.

 

In April 2008, the FASBvoted to eliminate qualifying special purpose entities (QSPEs) from theguidance in FASB Statement No. 140 “Accounting for Transfers and Servicingof Financial Assets and Extinguishment of Liabilities” (SFAS 140).   While the revised standard has not beenfinalized and the FASB’s proposals will be subject to a public comment period,this change may have a significant impact on the Company’s consolidatedfinancial statements as it may lose sales treatment for assets previously soldto a QSPE, as well as for future sales. An effective date for any proposedrevisions has not been determined by the FASB. As of September 30, 2008,the current principal balance of QSPEs to which the Company, acting asprincipal, has transferred assets and received sales treatment were$699.0 million.  The Company’sinvestment in these QSPE’s consists of residual interests accounted for asinvestment securities available-for-sale in its consolidated balance sheets.

 

In connection with theproposed changes to SFAS 140, the FASB also is proposing three key changesto the consolidation model in FASB Interpretation No. 46(R), “Consolidationof Variable Interest Entities (revised December 2003)—an interpretation ofARB No. 51” (FIN 46(R)). First, the FASB has proposed to includeformer QSPEs in the scope of FIN 46(R). In addition, the FASB supportsamending FIN 46(R) to change the method of analyzing which party to avariable interest entity (VIE) should consolidate the VIE to a primarilyqualitative determination of control instead of today’s risks and rewardsmodel. Finally, the proposed amendment is expected to require all VIEs andtheir primary beneficiaries to be reevaluated quarterly. The previous rules requiredreconsideration only when specified reconsideration events occurred. As of September 30,2008, the current principal balance of significant unconsolidated VIEs withwhich the Company is involved were approximately $699.0 million.

 

The Company will beevaluating the impact of these changes on the Company’s consolidated financialstatements once the standard is approved and issued.

 

In March 2008, the FASBissued Statement No. 161, “Disclosuresabout Derivative Instruments and Hedging Activities” (SFAS 161), anamendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”(SFAS 133), to expand disclosure requirements for an entity’s derivative andhedging activities. Under SFAS 161, entities are required to provideenhanced disclosures about how and why an entity uses derivative instruments,how derivative 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 meet these requirements, entitiesshall include qualitative disclosures about objectives and strategies for usingderivatives, quantitative disclosures about fair value amounts of and gains andlosses on derivative instruments, and disclosures about credit-risk-relatedcontingent features in derivative agreements. SFAS 161 is effective forfiscal years and interim periods beginning after November 15, 2008 withearly adoption encouraged. The Company plans to adopt SFAS 161 on January 1,2009, and there should be no impact on the consolidated financial statements asit only addresses disclosures.

 

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

 

The Company is party to litigation and claims whichare normal in the course of its operations. While the results of such litigation and claims cannot be predicted withcertainty, the Company believes the final outcome of such matters will not havea material adverse effect on the Company’s financial condition or results ofoperations.

 

The Company believes that it has meritoriousdefenses to the above claims and intends to defend these claims vigorously.Nevertheless, litigation is uncertain and the Company may not prevail in thelawsuits and can express no opinion as to their ultimate resolution. An adversejudgment in any of these matters could have a material adverse effect on theCompany.

 

Please refer to IMH’s report on Form 10-K forthe year ended December 31, 2007 and reports on Form 10-Q for theperiods ending March 31, 2008 and June 30, 2008 for a description ofother litigation and claims.

 

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

 

In accordance withAccounting Research Bulletin No. 51, “Consolidated Financial Statements,”the Company records a deferred charge representing the deferral of income taxexpense on inter-company profits that resulted from the sale of mortgages fromtaxable subsidiaries to IMH in prior years. The deferred charge is included inother assets in the accompanying consolidated balance sheets and is amortizedas a component of income tax expense in the accompanying consolidatedstatements of operations over the estimated life of the mortgages retained inthe securitized mortgage collateral. The Company recorded a tax provision of$5.3 million and $14.0 million for the three and nine months ending September 30,2008 and $3.1 million and $12.0 million for the three and nine months ending September 30,2007, respectively.  The net provision isthe result of the amount of the deferred charge amortized and/or impairedresulting from credit losses, which does not result in any tax liabilityrequired to be paid.

 

**Note B—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 active marketsfor 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 other thanLevel 1 prices, such as quoted prices for similar assets or liabilities; quotedprices in markets that are not active; or other inputs that are observable orcan be corroborated by observable market data for substantially the full termof the assets or liabilities. Level 2 assets and liabilities include securitieswith quoted prices that are traded less frequently than exchange-tradedinstruments, securities and derivative contracts and financial liabilitieswhose value is determined using a pricing model with inputs that are observablein the market or can be derived principally from or corroborated by observablemarket data. This category generally includes trust assets or liabilities wheremore than a significant percentage of the fair values were derived using apricing process that was based upon observable inputs.

 

·                  Level 3— Unobservable inputs that aresupported by little or no market activity and that are significant to the fairvalue 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. 

 

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This category includes thoseassets and liabilities that were not included in Level 1 or Level 2.

 

The following table presentsfor each of these hierarchy levels, the Company’s assets and liabilities thatare measured at fair value on a recurring basis, including financialinstruments for which the Company has elected the fair value option at September 30,2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **At September 30, 2008**             | ** ** |
| ** **                               | ** ** | **Level 1**                                     | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment securities available-for-sale |       | $                                                    | —     |   | $ | — |   | $ | 4,856 |   |
| Securitized mortgage collateral (1)      |       | —                                               |       | — |   | 8,253,995 |   |
| **Total Assets at Fair Value**           |       | $                                                    | —     |   | $ | — | ** ** | **$** | **8,258,851** | ** ** |
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Liabilities**                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings          |       | $                                                    | —     |   | $ | — |   | $ | 8,787,013 |   |
| Derivative liabilities, net (2)          |       | —                                               |       | — |   | 103,549 |   |
| Trust preferred securities               |       | —                                               |       | — |   | 35,898 |   |
| **Total Liabilities at Fair Value**      |       | $                                                    | —     |   | $ | — | ** ** | **$** | **8,926,460** | ** ** |

 

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| (1)    |   | Excluded from securitized mortgage collateral above is $10.4 million  in master servicing rights related to consolidated securitizations and  recorded at the lower of cost or market. Also, securitized mortgage  collateral excludes REO, which is separately presented within trust assets in  the consolidated balance sheet. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                              |
| (2)    |   | Derivative liabilities, net includes $251 thousand in derivative  assets and $103.8 million in derivative liabilities, included within trust  assets and trust liabilities, respectively.                                                                                                                                         |

 

During the third quarter of2008, market inactivity has resulted in a lack of observable market data forpurposes of measuring the fair value of financial assets and liabilities.  As a result of the severe market inactivity,the Office of the Chief Accountant of the Securities and Exchange Commission(SEC) and the FASB jointly issued a press release to assist financial statementusers, preparers, and auditors with application issues surrounding thedetermination of the fair value of financial assets in markets that areinactive.  Subsequent to the issuance ofthe joint press release, the FASB issued FSP 157-3, which formalizes theguidance jointly issued by the SEC and FASB.

 

As a result of the lack ofobservable market data resulting from inactive markets, the Company hasclassified its investment securities available-for-sale, securitized mortgagecollateral and borrowings and net derivative liabilities as Level 3 fair valuemeasurements at September 30, 2008. Level 3 assets and liabilities were 100 percent of total assets andliabilities at fair value.

 

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The following tables presenta reconciliation for all assets and liabilities measured at fair value on arecurring basis using significant unobservable inputs (Level 3) for the threeand nine months ended September 30, 2008:

 
| ** **                               | ** ** | **Level 3 Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended September 30, 2008**     | ** ** |
| ** **                               | ** ** | **Fair Value -  June 30, 2008**                    | ** ** | **Total Gains  (Losses)  Included in  Earnings** | ** ** | **Transfers  to  Level 3** | ** ** | **Purchases,  issuances and  settlements** | ** ** | **Fair Value -  September 30,  2008** | ** ** | **Unrealized gains  (losses) still held   (1)** | ** ** |
| Investment securities available-for-sale |       | $                                                                      | 8,644      |   | $ | (2,626 | ) | $ | — |   | $ | (1,162 | ) | $ | 4,856 |   | $ | (3,788 | ) |
| Securitized mortgage collateral          |       | 298,189                                                                |       | (2,256,972 | ) | 10,747,133 |   | (534,355 | ) | 8,253,995 |   | (2,791,327 | ) |
| Securitized mortgage borrowings          |       | (316,968                                                               | )          | 2,141,292 |   | (11,180,164 | ) | 568,827 |   | (8,787,013 | ) | 2,710,119 |   |
| Derivative liabilities, net              |       | —                                                                 |       | (10,890 | ) | (136,471 | ) | 43,812 |   | (103,549 | ) | 32,922 |   |
| Trust preferred securities               |       | (46,266                                                                | )          | 10,368 |   | — |   | — |   | (35,898 | ) | 10,368 |   |
|                                          |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Level 3 Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Nine Months Ended September 30, 2008**      | ** ** |
| ** **                               | ** ** | **Fair Value -  January 1, 2008**                  | ** ** | **Total Gains  (Losses)  Included in  Earnings** | ** ** | **Transfers  to  Level 3** | ** ** | **Purchases,  issuances and  settlements** | ** ** | **Fair Value -  September 30,  2008** | ** ** | **Unrealized gains  (losses) still held  (1)** | ** ** |
| Investment securities available-for-sale |       | $                                                                      | 15,248     |   | $ | (8,034 | ) | $ | — |   | $ | (2,358 | ) | $ | 4,856 |   | $ | (10,392 | ) |
| Securitized mortgage collateral          |       | 782,574                                                                |       | (5,408,626 | ) | 14,919,649 |   | (2,039,602 | ) | 8,253,995 |   | (7,448,228 | ) |
| Securitized mortgage borrowings          |       | (767,704                                                               | )          | 5,125,864 |   | (15,109,073 | ) | 1,963,900 |   | (8,787,013 | ) | 7,089,764 |   |
| Derivative liabilities, net              |       | —                                                                 |       | (94,399 | ) | (120,260 | ) | 111,110 |   | (103,549 | ) | 16,711 |   |
| Trust preferred securities               |       | (40,952                                                                | )          | 5,054 |   | — |   | — |   | (35,898 | ) | 5,054 |   |
|                                          |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1) |   | Represents the amount of total gains or losses for the period,  included in earnings, attributable to the change in unrealized gains (losses)  relating to assets and liabilities classified as Level 3 that are still held  at September 30, 2008. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

As discussed above, thesignificant market disruption due to continued deterioration of the real estateand credit markets and the resulting lack of observable market data from thesemarkets during the third quarter of 2008 resulted in securitized mortgage collateraland borrowings and net derivative liabilities being classified as Level 3 fairvalue measurements at September 30, 2008. During the quarter, $10.7 billion and $11.2 billion in securitizedmortgage collateral and borrowings, respectively, was transferred from Level 2to Level 3 fair value measurements.  Forthe nine months ended September 30, 2008, $14.9 billion and $15.1 billionin securitized mortgage collateral and borrowings, respectively, wastransferred from Level 2 to Level 3 fair value measurements.  There were no changes, for the three and ninemonths ended September 30, 2008, in the classification of investmentsecurities available-for-sale or trust preferred securities, which remainedLevel 3 fair value measurements.

 

The tables below summarizegains and losses due to changes in fair value, including both realized andunrealized gains and losses, recorded in earnings for Level 3 assets andliabilities for the three and nine months ended September 30, 2008.

 
| ** **                                               | ** ** | **Recurring Fair Value Measurements**                                                 | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Level 3 - Total Gains (Losses) Included in Net Loss** | ** ** |
| ** **                                               | ** ** | **Three Months Ended September 30, 2008**                                   | ** ** |
| ** **                                               | ** ** | **Investment Securities  Available-for-Sale**                                                   | ** ** | **Securitized Mortgage   Collateral** | ** ** | **Securitized Mortgage   Borrowings** | ** ** | **Derivative  Liabilities, Net** | ** ** | **Trust Preferred  Securities** | ** ** |
| Interest income                                          |       | $                                                                                                    | 466        |   | $ | 134,377 |   | $ | — |   | $ | — |   | $ | — |   |
| Interest expense                                         |       | —                                                                                               |       | — |   | (271,817 | ) | — |   | (126 | ) |
| Change in fair value of net trust assets,  excluding REO |       | (3,092                                                                                               | )          | (2,391,349 | ) | 2,413,109 |   | (10,890 | ) | — |   |
| Change in fair value of trust preferred  securities      |       | —                                                                                               |       | — |   | — |   | — |   | 10,494 |   |
| **Total**                                                | ** ** | **$**                                                                                                | **(2,626** | **)** | **$** | **(2,256,972** | **)** | **$** | **2,141,292** | ** ** | **$** | **(10,890** | **)** | **$** | **10,368** | ** ** |

 

13

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| ** **                                               | ** ** | **Recurring Fair Value Measurements**                                                 | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Level 3 - Total Gains (Losses) Included in Net Loss** | ** ** |
| ** **                                               | ** ** | **Nine Months Ended September 30, 2008**                                    | ** ** |
| ** **                                               | ** ** | **Investment Securities  Available-for-Sale**                                                   | ** ** | **Securitized Mortgage  Collateral** | ** ** | **Securitized Mortgage  Borrowings** | ** ** | **Derivative  Liabilities, Net** | ** ** | **Trust Preferred  Securities** | ** ** |
| Interest income                                          | ** ** | $                                                                                                    | 865        |   | $ | 231,288 |   | $ | — |   | $ | — |   | $ | — |   |
| Interest expense                                         | ** ** | —                                                                                               |       | — |   | (617,493 | ) | — |   | (419 | ) |
| Change in fair value of net trust assets,  excluding REO | ** ** | (8,899                                                                                               | )          | (5,639,914 | ) | 5,743,357 |   | (94,399 | ) | — |   |
| Change in fair value of trust preferred  securities      | ** ** | —                                                                                               |       | — |   | — |   | — |   | 5,473 |   |
| **Total**                                                | ** ** | **$**                                                                                                | **(8,034** | **)** | **$** | **(5,408,626** | **)** | **$** | **5,125,864** | ** ** | **$** | **(94,399** | **)** | **$** | **5,054** | ** ** |

 

SFAS 159 permits fairvalue accounting to be elected for certain assets and liabilities on an individualcontract basis at the time of acquisition or under certain other circumstancesreferred to as “remeasurement event dates.” For those items for which fairvalue accounting is elected, changes in fair value will be recognized inearnings, and fees and costs associated with the origination or acquisition ofsuch items will be recognized as incurred rather than deferred. In addition,SFAS 159 allows application of the Statement’s provisions to eligibleitems existing at the effective date and management has elected to applySFAS 159 to certain of those items as discussed below.

 

The following is adescription of the measurement techniques for items recorded at fair value on arecurring basis and a non-recurring basis.

 

***Recurring basis***

 

*Investment SecuritiesAvailable-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 of non-investmentgrade mortgage-backed securities.  Thefair value 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, forward interest ratesand certain other factors.  Given themarket disruption and lack of observable market data as of September 30,2008, the fair value of the investment securities available-for-sale weremeasured using significant internal expectations of market participants’assumptions. At September 30, 2008, investment securitiesavailable-for-sale were 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 assumptions include itsexpectations of inputs that other market participants would use. Theseassumptions include judgments about the underlying collateral, prepaymentspeeds, credit losses, forward interest rates and certain other factors.  At September 30, 2008, securitizedmortgage collateral was classified as Level 3 fair value measurementsbased on the lack of observability of significant inputs to the model.  As of September 30, 2008, the unpaidprincipal balance and estimated fair value of securitized mortgage collateralwas $14.7 billion and $8.3 billion, respectively.  The aggregate unpaid principal balanceexceeds the fair value by $6.4 billion at September 30, 2008.  As of September 30, 2008, the unpaidprincipal balance and estimated fair value of loans 90 days or more pastdue was $2.4 billion and $1.3 billion, respectively.  The aggregate unpaid principal balances ofloans 90 days or more past due exceed the fair value by $1.1 billion at September 30,2008.

 

*Securitized Mortgage Borrowings* - Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgage borrowingsat fair value.  These borrowings consistof individual tranches of bonds issued by securitization trusts and areprimarily backed by Alt-A mortgage loans. Fair value measurements include the Company’s judgments about theunderlying collateral assumptions such as prepayment speeds, credit losses,forward interest rates and certain other factors and are based upon quotedprices for the individual tranches of bonds, if available.  At September 30, 2008, securitizedmortgage borrowings were classified as Level 3 fair value measurementsbased on the lack of observability of significant inputs to the model.  As of September 30, 2008, theoutstanding principal balance and estimated fair value of securitized mortgageborrowings was $15.8 billion and $8.8 billion, respectively.  The aggregate outstanding principal balanceexceeds the fair value by $7.0 billion at September 30, 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 upon ananalysis prepared by the Company, which considered the Company’s own creditrisk, included a comparison to the terms of the Company’s preferred stock andthe expected terms of restructuring negotiations with a majority of the trustpreferred debt holders.

 

14

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At September 30, 2008trust preferred securities were classified as Level 3 measurements basedon the lack of observability of market inputs. As of September 30, 2008,the unpaid principal balance and fair value of trust preferred securities was$99.2 million and $35.9 million, respectively. The aggregate unpaid principal balance exceeds the fair value by $63.3million at September 30, 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 are based on observable market inputs, if available.  To the extent observable market inputs arenot available, fair values measurements include the Company’s judgments aboutthe future cash flows, forward interest rates and certain other factors,including counterparty risk.  With theissuance of SFAS 157, these values must also take into account the Company’sown credit standing, to the extent applicable, thus included in the valuationof the derivative instrument is the value of the net credit differentialbetween the counterparties to the derivative contract.  At September 30, 2008, derivative assetsand liabilities were classified as Level 3 fair value measurements based on thelack of observability of market inputs.

 

On September 15, 2008, Lehman Brothers HoldingsInc. (“LBHI”) filed a petition for protection under Chapter 11 of the U.S.Bankruptcy Code. As of that date, LBHI, through affiliated companies, was aninterest rate swap counterparty to several of the Company’s CMO and REMICsecuritizations.  As the relatedsecuritization trusts are non-recourse to the Company, the Company is notrequired to replace or otherwise settle any derivative positions affected bycounterparty default within the consolidated trusts.  At September 30, 2008, the estimatedvalue of these derivatives is included in derivative liabilities in theconsolidated balance sheet.

 

***Non-recurring basis***

 

The Company is required to measure certain assets atfair value from time-to-time.  These fairvalue measurements 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 valueoption was not elected are carried at lower of cost or market (LOCOM).  When available, such measurements are basedupon what secondary markets offer for portfolios with similar characteristics,and are considered Level 2 measurements. If market pricing is notavailable, such measurements are significantly impacted by the Company’sexpectations of other market participants’ assumptions, and are consideredLevel 3 measurements.  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 fair value measurements at September 30,2008 based on the lack of observability of market inputs.

 

*Mortgage Servicing Rights -*Mortgage servicing rights (MSRs) for whichthe fair value option was not elected are carried at LOCOM.  MSRs are not traded in an active market withobservable prices.  The Company utilizesinternal pricing processes to estimate the fair value of MSRs, which are basedon assumptions the Company believes would be used by market participants,including market discount rates, float, prepayment speeds and master servicingfees.  MSRs, which are included in otherassets, are considered Level 3 fair value measurements at September 30,2008.

 

The following table presents the fair values ofthose financial assets measured at fair value on a non-recurring basis at September 30,2008.

 
| ** **                | ** ** | ** **                                               | ** ** | ** **                       | ** ** | ** **       | ** ** | **Total Losses**                    | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------------|------------|------------------------------------------|------------|
| ** **                | ** ** | ** **                                               | ** ** | ** **                       | ** ** | ** **       | ** ** | **For the Periods Ended** | ** ** |
| ** **                | ** ** | **Non-recurring Fair Value Measurements** | ** ** | **September 30, 2008** | ** ** |
| ** **                | ** ** | **As of September 30, 2008**         | ** ** | **Three**                        | ** ** | **Nine**         | ** ** |
| ** **                | ** ** | **Level 1**                                         | ** ** | **Level 2**                 | ** ** | **Level 3** | ** ** | **Months**                               | ** ** | **Months** | ** ** |
| Loans held-for-sale (1)   |       | —                                                   |       | —                           |       | 131,193          |       | $                                        | (13,602    | ) | $ | (29,851 | ) |
| Mortgage servicing rights |       | —                                                   |       | —                           |       | 1,256            |       | $                                        | (415       | ) | $ | (1,363 | ) |

 

----

| (1) |   | Includes $1.0 million and $130.2 million of loans held-for-sale within  continuing and discontinued operations, respectively at September 30,  2008. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|

 

15

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The following tables represent changes in fair valueof recurring fair value measurements for the three and nine months ended September 30,2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                              | ** **  |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss** | ** **  |
| ** **                               | ** ** | **Three Months Ended September 30, 2008**                | ** **  |
| ** **                               | ** ** | ** **                                                                        | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income**                                                          | ** **  | **Interest Expense** | ** ** | **Net Trust Assets** | ** ** | **Trust Preferred  Securities** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                 | 466         |   | $ | — |   | $ | (3,092 | ) | $ | — |   | $ | (2,626 | ) |
| Securitized mortgage collateral          |       | 134,377                                                                           |        | — |   | (2,391,349 | ) | — |   | (2,256,972 | ) |
| Securitized mortgage borrowings          |       | —                                                                            |        | (271,817 | ) | 2,413,109 |   | — |   | 2,141,292 |   |
| Trust preferred securities               |       | —                                                                            |        | (126 | ) | — |   | 10,494 |   | 10,368 |   |
| Derivative instruments                   |       | —                                                                            |        | — |   | (10,890 | ) | — |   | (10,890 | ) |
| **Total**                                | ** ** | **$**                                                                             | **134,843** | ** ** | **$** | **(271,943** | **)** | **$** | **7,778** | ** ** | **$** | **10,494** | ** ** | **$** | **(118,828** | **)** |

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                              | ** **  |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss** | ** **  |
| ** **                               | ** ** | **Nine Months Ended September 30, 2008**                 | ** **  |
| ** **                               | ** ** | ** **                                                                        | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income (1)**                                                 | ** **  | **Interest Expense (1)** | ** ** | **Net Trust Assets** | ** ** | **Trust Preferred  Securities** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                 | 865         |   | $ | — |   | $ | (8,899 | ) | $ | — |   | $ | (8,034 | ) |
| Securitized mortgage collateral          |       | 231,288                                                                           |        | — |   | (5,639,914 | ) | — |   | (5,408,626 | ) |
| Securitized mortgage borrowings          |       | —                                                                            |        | (617,493 | ) | 5,743,357 |   | — |   | 5,125,864 |   |
| Trust preferred securities               |       | —                                                                            |        | (419 | ) | — |   | 5,473 |   | 5,054 |   |
| Derivative instruments                   |       | —                                                                            |        | — |   | (94,399 | )(2) | — |   | (94,399 | ) |
| **Total**                                | ** ** | **$**                                                                             | **232,153** | ** ** | **$** | **(617,912** | **)** | **$** | **145** | (3) | **$** | **5,473** | ** ** | **$** | **(380,141** | **)** |

 

----

| (1)    |   | Amounts represent interest income and interest expense accretion  included in interest income and interest expense, respectively in the  consolidated statement of operations and comprehensive loss.                                                |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                 |
| (2)    |   | Included in this amount is $18.5 million in non-cash changes in the  fair value of derivative instruments, which are included in the accompanying  statement of cash flows for the nine months ended September 30, 2008.                             |
|   |   |                                                                                                                                                                                                                                                 |
| (3)    |   | Excluded from the $113 million change in fair value of net trust  assets, excluding REO in the accompanying consolidated statement of cash  flows is $(112.9) million in cash settlements related to the Company’s net  derivative liabilities. |

 

The change in fair value of the asset andliabilities above, excluding derivative instruments, are primarily due to thechanges in credit risk.  The change infair value for derivative instruments is primarily due to the change in theforward LIBOR curve.

 

**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:

 
| ** **                              | ** ** | **Nine Months**              |
|-----------------------------------------|------------|-----------------------------------|
| ** **                              | ** ** | **Ended September 30,** |
| ** **                              | ** ** | **2008**                          | ** ** | **2007** |
| Risk-free  interest rate                |       | 1.88%to 2.54%                     |   | 4.28% to 4.60% |
| Expected  lives (in years)              |       | 3.25 - 3.50                       |   | 3.00 |
| Expected  volatility (1)                |       | 87.3% - 91.9%                     |   | 75.09% |
| Expected  dividend yield (2)            |       | 0.00%                             |   | 0.00% |
| Grant date  fair value of share options |       | $0.50 - 0.78                      |   | $0.60 |

 

----

| (1)    |   | Expected volatilities are based on the historical volatility of the  Company’s stock over the expected option life.                                                                               |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| (2)    |   | Expected dividend yield is zero because a dividend on the common stock  is currently not probable over the expected life of the options granted  during the nine months ended September 30, 2008. |

 

16

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The following table summarizes activity, pricing andother information for the Company’s stock options for the nine-month periodended September 30, 2008:

 
| ** **                                      | ** ** | ** **         | ** ** | **Weighted-**      | ** ** |
|-------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                      | ** ** | ** **         | ** ** | **Average**        | ** ** |
| ** **                                      | ** ** | **Number of** | ** ** | **Exercise**       | ** ** |
| ** **                                      | ** ** | **Shares**         | ** ** | **Price ($)** | ** ** |
| Options outstanding at January 1, 2008     |       | 5,939,914          |       | $                  | 9.75       |   |
| Options granted                                 |       | 7,970,000          |       | 1.27               |       |
| Options exercised                               |       | —             |       | —             |       |
| Options forfeited / cancelled                   |       | (2,263,331         | )          | 11.25              |       |
| Options outstanding at September 30,  2008 |       | 11,646,583         |       | $                  | 3.71       |   |
| Options exercisable at September 30,  2008 |       | 3,025,057          |       | $                  | 8.66       |   |

 

As of September 30, 2008, there wasapproximately $4.7 million of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the plan. Thatcost is expected to be recognized over a weighted average period of 1.1 years.

 

**Note D—Reconciliation of Earnings Per Share**

 

The following table presents the computation ofbasic and diluted net earnings per share including the dilutive effect of stockoptions and cumulative redeemable preferred stock outstanding for the periodsindicated:

 
| ** **                                                                      | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                      | ** ** | **2008**                                | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Numerator for basic earnings per share:**                                     |       |                                    |       |                                   |       |   |   |   |   |
| Net earnings (loss) from continuing  operations                                 |       | $                                       | 1,901      |                                   | $          | (969,442 | ) | $ | (19,041 | ) | $ | (1,117,100 | ) |
| Net loss from discontinued operations                                           |       | (18,121                                 | )          | (221,793                               | )          | (28,481 | ) | (348,350 | ) |
| Less: Cash dividends on cumulative  redeemable preferred stock                  |       | (3,722                                  | )          | (3,722                                 | )          | (11,165 | ) | (11,165 | ) |
| Net loss available to common stockholders                                       |       | $                                       | (19,942    | )                                      | $          | (1,194,957 | ) | $ | (58,687 | ) | $ | (1,476,615 | ) |
| **Denominator for basic earnings per share:**                                   |       |                                    |       |                                   |       |   |   |   |   |
| Basic weighted average number of common  shares outstanding during the period   |       | 76,098                                  |       | 76,088                                 |       | 76,097 |   | 76,083 |   |
| **Denominator for diluted earnings per share:**                                 |       |                                    |       |                                   |       |   |   |   |   |
| Diluted weighted average number of common  shares outstanding during the period |       | 76,098                                  |       | 76,088                                 |       | 76,097 |   | 76,083 |   |
| Net effect of dilutive stock options                                            |       | —                                  |       | —                                 |       | — |   | — |   |
| Diluted weighted average common shares                                          |       | 76,098                                  |       | 76,088                                 |       | 76,097 |   | 76,083 |   |
|                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Loss per common share - Basic:                                                  |       |                                    |       |                                   |       |   |   |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.02      | )                                      | $          | (12.79 | ) | $ | (0.40 | ) | $ | (14.83 | ) |
| Loss from discontinued operations                                               |       | (0.24                                   | )          | (2.91                                  | )          | (0.37 | ) | (4.58 | ) |
| Net loss per share                                                              |       | $                                       | (0.26      | )                                      | $          | (15.70 | ) | $ | (0.77 | ) | $ | (19.41 | ) |
|                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Loss per common share - Diluted:                                                |       |                                    |       |                                   |       |   |   |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.02      | )                                      | $          | (12.79 | ) | $ | (0.40 | ) | $ | (14.83 | ) |
| Loss from discontinued operations                                               |       | (0.24                                   | )          | (2.91                                  | )          | (0.37 | ) | (4.58 | ) |
| Net loss per share                                                              |       | $                                       | (0.26      | )                                      | $          | (15.70 | ) | $ | (0.77 | ) | $ | (19.41 | ) |

 

For the three and nine month periods ended September 30, 2008, stock options to purchase 11.6million shares were outstanding but not included in the above weighted averagecalculations because they were anti-dilutive.

 

For the three and nine month periods ended September 30,2007, stock options to purchase 7.3 million shares wereoutstanding but not included in the above weighted average calculations becausethey were anti-dilutive.

 

17

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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 September 30, 2008:** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Securitized mortgage collateral                                                      |       | $              | 8,264,413  |             | $          | —           |       | $ | 8,264,413 |   |
| Loans held-for-sale                                                                  |       | 977            |       | 130,217          |       | 131,194          |       |
| Total assets                                                                         |       | 9,006,993      |       | 158,468          |       | 9,165,461        |       |
| Total liabilities                                                                    |       | 8,934,415      |       | 225,536          |       | 9,159,951        |       |
| Total stockholders’ equity (deficit)                                            |       | $              | 72,578     |             | $          | (67,068          | )          | $ | 5,510 |   |
|                                                                                 |       |           |       |             |       |             |       |
| **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 September 30, 2008:** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                                    |       | $              | 3,014      |             | $          | 158              |       | $ | 3,172 |   |
| Change in fair value of derivatives, net                                               |       | —         |       | (92              | )          | (92              | )          |
| Change in fair value of net trust assets                                               |       | 7,778          |       | —           |       | 7,778            |       |
| Other non-interest income (expense)                                                    |       | 3,695          |       | (12,908          | )          | (9,213           | )          |
| Non-interest expense and income taxes                                                  |       | (12,586        | )          | (5,279           | )          | (17,865          | )          |
| Net earnings (loss)                                                                    |       | $              | 1,901      |             | $          | (18,121          | )          | $ | (16,220 | ) |
|                                                                                   |       |           |       |             |       |             |       |
| **Statement of Operations Items for the nine  months ended September 30, 2008:**  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                                    |       | $              | 14,619     |             | $          | 3,372            |       | $ | 17,991 |   |
| Change in fair value of derivatives, net                                               |       | —         |       | 20               |       | 20               |       |
| Change in fair value of net trust assets                                               |       | 145            |       | —           |       | 145              |       |
| Other non-interest income (expense)                                                    |       | 1,570          |       | (12,041          | )          | (10,471          | )          |
| Non-interest expense and income taxes                                                  |       | (35,375        | )          | (19,832          | )          | (55,207          | )          |
| Net loss                                                                               |       | $              | (19,041    | )                | $          | (28,481          | )          | $ | (47,522 | ) |

 

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| ** **                                                                             | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                             | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Statement of Operations Items for the three  months ended September 30, 2007:** |       |           |       |             |       |             |       |
| Net interest income                                                                    |       | $              | 12,003     |             | $          | 2,777            |       | $ | 14,780 |   |
| Provision for loan losses                                                              |       | (789,445       | )          | (2,807           | )          | (792,252         | )          |
| Change in fair value of derivatives, net                                               |       | (106,532       | )          | (5,979           | )          | (112,511         | )          |
| Other non-interest income (expense)                                                    |       | (75,711        | )          | (162,138         | )          | (237,849         | )          |
| Non-interest expense and income taxes                                                  |       | (9,757         | )          | (53,646          | )          | (63,403          | )          |
| Net loss                                                                               |       | $              | (969,442   | )                | $          | (221,793         | )          | $ | (1,191,235 | ) |
|                                                                                   |       |           |       |             |       |             |       |
| **Statement of Operations Items for the nine  months ended September 30, 2007:**  | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                                    |       | $              | 27,819     |             | $          | 13,399           |       | $ | 41,218 |   |
| Provision for loan losses                                                              |       | (979,740       | )          | (4,868           | )          | (984,608         | )          |
| Change in fair value of derivatives, net                                               |       | (32,860        | )          | (5,412           | )          | (38,272          | )          |
| Other non-interest income (expense)                                                    |       | (101,182       | )          | (244,952         | )          | (346,134         | )          |
| Non-interest expense and income taxes                                                  |       | (31,137        | )          | (106,517         | )          | (137,654         | )          |
| Net loss                                                                               |       | $              | (1,117,100 | )                | $          | (348,350         | )          | $ | (1,465,450 | ) |

 

**Note G—Other Assets**

 

Other assets for the periods indicated consisted ofthe following:

 
| ** **                           | ** ** | **As of September 30,** | ** ** | **As of December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **2008**                               | ** ** | **2007**                              | ** ** |
| Deferred charge                      |       | $                                      | 23,432     |                                  | $          | 37,412 |   |
| Real estate advisory fees receivable |       | 7,350                                  |       | —                                |       |
| Premises and equipment               |       | 2,719                                  |       | 3,904                                 |       |
| Real estate owned outside trust      |       | 827                                    |       | 4,571                                 |       |
| Prepaid expenses                     |       | 3,982                                  |       | 3,505                                 |       |
| Investment in capital trusts         |       | 2,210                                  |       | 2,394                                 |       |
| Mortgage sevicing rights             |       | 1,256                                  |       | 2,083                                 |       |
| Other assets                         |       | 7,841                                  |       | 3,325                                 |       |
| Total other assets                   |       | $                                      | 49,617     |                                  | $          | 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 realizable value less estimated selling and holding costs,offset by expected mortgage insurance proceeds to be received. Historically, adjustmentsto the loan carrying value required at the time of foreclosure are charged offagainst the allowance for loan losses. With the adoption of SFAS 159, initialwrite-downs of REO affect the estimated fair value of securitized mortgagecollateral. Subsequent write-downs in the net realizable value of REO areincluded in losses from real estate owned in the consolidated statements ofoperations and comprehensive loss. REO is recorded at its estimated netrealizable value at September 30, 2008 and December 31, 2007.

 

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Activity for the Company’sREO consisted of the following:

 

| ** **             | ** ** | **Nine Months Ended**  | ** ** | **Year Ended**             | ** ** |
|------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
| Beginning balance      |       | $                                | 405,434    |                            | $          | 137,331 |   |
| Foreclosures           |       | 592,771                          |       | 487,314                         |       |
| Liquidations           |       | (334,058                         | )          | (219,211                        | )          |
| REO                    |       | $                                | 664,147    |                            | $          | 405,434 |   |
|                   |       |                             |       |                            |       |
| REO inside trusts      |       | $                                | 663,320    |                            | $          | 400,863 |   |
| REO outside trusts (1) |       | 827                              |       | 4,571                           |       |
| REO                    |       | $                                | 664,147    |                            | $          | 405,434 |   |

 

----

(1)          Amount represents REO related to a former on-balance sheetsecuritization, which was collapsed as the result of the Company exercising itsclean-up call option.  This REO isincluded in other assets within continuing operations.

 

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

 

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

 
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | **Range of Percentages:** | ** ** |
|-------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | ** **                          | ** ** | **Interest Rate** | ** ** | **Interest Rate** | ** ** |
| ** **                                | ** ** | **Original** | ** ** | **Securitized mortgage borrowings** | ** ** | ** **                      | ** ** | **Margins over**               | ** ** | **Margins after** | ** ** |
| ** **                                | ** ** | **Issuance** | ** ** | **outstanding as of**               | ** ** | **Fixed Interest**         | ** ** | **One-Month**                       | ** ** | **Adjustment** | ** ** |
| **Year of Issuance**            | ** ** | **Amount**   | ** ** | **September 30, 2008 (1)**     | ** ** | **December 31, 2007** | ** ** | **Rates**                           | ** ** | **LIBOR (2)** | ** ** | **Date (3)** | ** ** |
| 2002                                      |       | $            | 3,876.1    |                                          | $          | 37.7                            |       | $                                   | 42.1       |   | 5.25 - 12.00 |   | 0.27 - 2.75 |   | 0.54 - 3.68 |   |
| 2003                                      |       | 5,966.1      |       | 335.6                                         |       | 409.4                           |       | 4.34 - 12.75                        |       | 0.27 - 3.00 |   | 0.54 - 4.50 |   |
| 2004                                      |       | 17,710.7     |       | 2,325.8                                       |       | 2,751.8                         |       | 3.58 - 5.56                         |       | 0.25 - 2.50 |   | 0.50 - 3.75 |   |
| 2005                                      |       | 13,387.7     |       | 5,154.9                                       |       | 5,961.6                         |       | —                              |       | 0.24 - 2.90 |   | 0.48 - 4.35 |   |
| 2006                                      |       | 5,971.4      |       | 4,652.3                                       |       | 5,015.7                         |       | 6.25                                |       | 0.10 - 2.75 |   | 0.20 - 4.125 |   |
| 2007                                      |       | 3,860.5      |       | 3,394.2                                       |       | 3,619.9                         |       | —                              |       | 0.06 - 2.00 |   | 0.12 - 3.00 |   |
| Subtotal  securitized mortgage borrowings |       |         |       | 15,900.5                                      |       | 17,800.5                        |       |                                |       |   |   |   |   |
| Accrued interest  expense                 |       |         |       | —                                        |       | 17.1                            |       |                                |       |   |   |   |   |
| Unamortized  securitization costs         |       |         |       | —                                        |       | (37.5                           | )          |                                |       |   |   |   |   |
| Fair value  adjustment                    |       |         |       | (7,113.5                                      | )          | —                          |       |                                |       |   |   |   |   |
| Total securitized  mortgage borrowings    |       |         |       | $                                             | 8,787.0    |                            | $          | 17,780.1                            |       |   |   |   |   |   |   |
|                                           |            |              |            |                                               |            |                                 |            |                                     |            |  |  |  |  |  |  |  |

 

----

| (1) | Outstanding balances include $61.2 million in losses allocated to bond  holders. These bondholder losses will not be realized until the related  trusts terminate.                         |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | One-month London Interbank Offered Rate (LIBOR) was 3.93 percent as of  September 30, 2008.                                                                                           |
| (3) | Interest rate margins are generally adjusted when the unpaid principal  balance of the securitized mortgage borrowings is reduced to less than 10% -  20% of the original issuance amount. |

 

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

 

*Reverse Repurchase Facilities*

 

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 September 30,** | ** ** | **as of December 31,** | ** ** |
| ** **                  | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Reverse repurchase line (1) |       | $                                      | 194,345    |   | $ | 318,669 |   |
| Warehouse line (2)          |       | —                                 |       | 18,021 |   |
| Total                       |       | $                                      | 194,345    |   | $ | 336,690 |   |

 

----

(1)   This line, which is guaranteed by IMH, as of December 31,2007, was in technical default of several covenants, including warehouseborrowing reduction, delivery of financial statements and financial covenants.As described below, the Company has restructured this line.

 

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

 

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In September 2008, the Company entered into anagreement to restructure its reverse repurchase line with its remaining lender.The balance of this line was $194.3 million at September 30, 2008. Theagreement removes all technical defaults from financial covenant noncomplianceand any associated margin calls for the term of the agreement.  The agreement calls for certain targetsincluding a reduction of the borrowings balance to $100 million in 18 monthswith an advance rate of no more than 65 percent of the outstanding principalbalance and $50 million in 24 months with an advance rate of no more than 55percent of the outstanding principal balance. By meeting these targets, the agreement term can extend to 30months.  The agreement also calls formonthly principal paydowns of $750,000 for one month and $1.5 millionthereafter until the earlier of the Company raising capital or the end of theagreement 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 would then be reduced to $750,000.  The interest rate is LIBOR plus 325 basispoints, and all cash collected from the securing mortgage loans is required tobe paid to the lender.  To the extent thecash collected from the collateral is not adequate to pay the interest expensedue on the borrowings, interest expense would be paid to the lender from the margincash account or the Company’s cash balances. Accomplishing the restructuring of this reverse repurchase line allowsthe Company to timely manage the remaining loans on the line for the eventualcollection, refinance, sale or securitization without the risk of receivingmargin calls.

 

*Repurchase Reserve*

 

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 the third quarter of 2008, the Companysold $19.6 million of loans as compared to $7.9 million in the second quarterof 2008.  As of September 30, 2008and December 31, 2007, the Company had a liability for losses on loanssold with representations and warranties totaling $13.5 million and$25.7 million, respectively, included in liabilities from discontinuedoperations.  During the quarter, therepurchase liability increased $0.6 million to $13.5 million.

 

**Note K—Discontinued Operations**

 

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 September 30,2008 and December 31, 2007:

 
| ** **                         | ** ** | **Discontinued Operations**       | ** ** |
|------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **as of September 30,** | ** ** | **as of December 31,** | ** ** |
| ** **                         | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| **Balance Sheet Items:** |       |                                   |       |   |   |
| Loans held-for-sale                |       | $                                      | 130,217    |   | $ | 279,659 |   |
| Finance receivables                |       | —                                 |       | 12,458 |   |
| Total assets                       |       | 158,468                                |       | 353,250 |   |
| Total liabilities                  |       | 225,536                                |       | 405,341 |   |
| Total stockholders’ deficit   |       | (67,068                                | )          | (52,091 | ) |
|                                    |            |                                        |            |  |  |  |  |

 

Included in totalliabilities at September 30, 2008 and December 31, 2007 is a leaseliability of $3.5 million and $10.9 million, respectively, which is guaranteedby IMH, related to office space that was previously occupied by thediscontinued operations and is no longer being used by the Company.  The Company has subleased some of this officespace.  Loans held-for-sale includes a$98.5 million and $118.4 million fair value adjustment at September 30,2008 and December 31, 2007, respectively.

 

As part of the settlement ofintercompany debt, certain net assets, totaling $25.6 million, were transferredfrom discontinued operations to continuing operations.

 

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The following tables presentdiscontinued operations condensed statement of operations for the three andnine month periods ended September 30, 2008 and 2007;

 
| ** **                                      | ** ** | **Discontinued Operations**                                           | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **For the Three Months Ended September 30,** | ** ** |
| ** **                                      | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| **Income Statement Items:**                     |       |                                                                       |       |   |   |
| Net interest income                             |       | $                                                                          | 158        |   | $ | 2,777 |   |
| Provision for loan losses                       |       | —                                                                     |       | (2,807 | ) |
| Change in fair value of derivative  instruments |       | (92                                                                        | )          | (5,979 | ) |
| Other non-interest (expense) income             |       | (12,908                                                                    | )          | (162,138 | ) |
| Non-interest expense and income taxes           |       | (5,279                                                                     | )          | (53,646 | ) |
| Net loss                                        |       | $                                                                          | (18,121    | ) | $ | (221,793 | ) |
| ** **                                      | ** ** | ** **                                                                 | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Discontinued Operations**                                           | ** ** |
| ** **                                      | ** ** | **For the Nine Months Ended September 30,**  | ** ** |
| ** **                                      | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| **Income Statement Items:**                     |       |                                                                       |       |   |   |
| Net interest income                             |       | $                                                                          | 3,372      |   | $ | 13,399 |   |
| Provision for loan losses                       |       | —                                                                     |       | (4,868 | ) |
| Change in fair value of derivative  instruments |       | 20                                                                         |       | (5,412 | ) |
| Other non-interest (expense) income             |       | (12,041                                                                    | )          | (244,952 | ) |
| Non-interest expense and income taxes           |       | (19,832                                                                    | )          | (106,517 | ) |
| Net loss                                        |       | $                                                                          | (28,481    | ) | $ | (348,350 | ) |

 

**Note L—Subsequent Events**

 

On November 12, 2008, the Company and thereal estate marketing company agreed to terminate the advisory servicesagreement.  The Company will receiveapproximately $37 million, inclusive of the $7.4 million receivable included inother assets in the consolidated balance sheet at September 30, 2008.

 

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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),andImpac Funding Corporation (IFC), together with its wholly-owned subsidiariesImpac Secured Assets Corp. (ISAC), and Impac Commercial Capital Corporation(ICCC).

 

### **Forward-LookingStatements**

### ** **

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 current cash flows; our ability to reduce operatingexpenses and other outstanding liabilities, such as the trust preferredobligations; our ability to reduce dividend and interest payments on preferredstock and trust preferred securities; ability to continue to pay dividends onoutstanding preferred stock; failure to sell, or achieve expected returns uponsale of, mortgage loans, including non-performing loans, in the secondarymarket due to market conditions, lack of interest or ineffectual pricing;potential difficulties in satisfying conditions set forth in the restructuredrepurchase facility; our ability to obtain additional financing and the termsof any financing that we do obtain; inability to effectively liquidateproperties; increase in loan repurchase requests and ability to adequatelysettle repurchase obligations; risks related to the acquisition of a specialservicing platform, which will involve or require, among other things,continuing due diligence, which could reveal matters not now known that affectour decision to seek to complete the acquisition on different terms than thoseannounced or at all, obtaining necessary approvals and consents, includingregulatory approvals related to servicing, which consents and approvals may bedelayed or unobtainable, difficulties and delays in obtaining regulatory approvalsfor the proposed transaction, potential difficulties in meeting conditions setforth in the definitive purchase agreement, and the parties’ timely performanceof their respective pre-closing covenants and the satisfaction of otherconditions, some of which may be beyond the control of the parties or renderthe acquisition uneconomical; the Company’s ability to successfully integratethe new servicing platform with its existing services;  impairments on our mortgage assets; increasesin default rates or losses on mortgage loans underlying our mortgage assets;inability to implement strategies effectively to increase cure rates, reducedelinquencies or mitigate losses on mortgage loans; changes in assumptionsregarding estimated loan losses or fair value amounts; the ability of ourcommon stock and Series B and C preferred stock to continue trading in anactive market; the loss of executive officers and other key managementemployees; the outcome of litigation or regulatory actions pending against usor other legal contingencies; and our compliance with applicable local, stateand federal laws and regulations and other general market and economicconditions.

 

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 and thosefiled for the previous 2008 quarterly periods. This document speaks only as ofits date and we do not undertake, and specifically disclaim any obligation, topublicly release the results of any revisions that may be made to anyforward-looking statements to reflect the occurrence of anticipated orunanticipated events or circumstances after the date of such statements.

 

### **The Mortgage BankingIndustry and Discussion 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.

 

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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 and Capital Resources**

### ** **

Real estate prices havefallen significantly since the peak levels in 2006.  During the third quarter of 2008, the creditand housing markets continued to suffer from significant market disruption dueto continued deterioration of the real estate and credit markets.  The federal government has taken steps toattempt to stabilize the housing and credit markets.  At this time, the government’s actions havenot affected the Company’s financial position or operations.

 

In 2007 and 2008, managementhas been seriously challenged by the unprecedented turmoil in the mortgagemarket, including the following: significant increases in delinquencies and foreclosures;significant increases in credit-related losses; decline in originations;tightening of warehouse credit and the virtual elimination of the market forloan securitizations.  As a result, theCompany discontinued certain operations, resolved and terminated all but one ofour reverse repurchase facilities and settled a portion of our outstandingrepurchase claims, while also reducing our operating costs and liabilities in2007.

 

During the third quarter of2008, the Company continued to fund its operations with revenues and cash flowsfrom real estate advisory fees and its residual interests in securitizationsand master servicing fees generated from the long-term mortgage portfolio.  Continued deterioration in the housing andcredit markets may have a significant impact on these revenues and cash flows.

 

In the first quarter of2008, we entered into an agreement with a real estate marketing company togenerate advisory fees.  The real estatemarketing company specializes in the marketing of foreclosed properties.  During the three and nine months ended September 30,2008, we earned $7.0 million and $15.6 million, respectively, from thisrelationship.  On November 12, 2008, the Companyand the real estate marketing company agreed to terminate the advisory servicesagreement.  The Company will receive approximately$37 million, inclusive of the $7.4 million receivable included in other assetsin the consolidated balance sheet at September 30, 2008.

 

The Company’s intent is toalign the costs of its 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.  We areinvestigating opportunities to restructure the trust preferred securitiesand/or reduce or eliminate dividend payments on the Company’s preferred stock.

 

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 thisspecial servicing platform, combined with our current and anticipatedbusinesses, will create a fully integrated platform that would be utilized totake advantage of opportunities within the distressed mortgage investment market.

 

In September 2008, theCompany entered into an agreement to restructure its reverse repurchase linewith its remaining lender.  The balanceof this line was $194.3 million at September 30, 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 outstanding principal balance and $50 million in 24 months with an advancerate of no more than 55 percent of the outstanding principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for October 2008,then $1.5 million thereafter until the earlier of the Company raising capitalor the end of the agreement term.  If theCompany is successful in raising capital, approximately 10% of the grossproceeds will be required to be paid as an additional principal paydown and themonthly principal paydown would then be reduced to $750,000.  The interest rate is LIBOR plus 325 basispoints, and all cash collected from the securing mortgage loans is required tobe paid to the lender.  To the extent thecash collected from the collateral is not adequate to pay the interest expensedue on the borrowings, interest expense would be paid to the lender from themargin cash account or the Company’s cash balances.  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.

 

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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 and could reduce dividend obligations for theCompany.

 

The Company paid its October 2008trust preferred interest payment as part of its negotiations to restructure orexchange the current trust preferred securities for new securities with a lowerinterest rate or reductions in principal. To date, the Company has been unsuccessful in completing thesenegotiations.

 

Although we do not believethat we need additional capital to fund the operations of the special servicer,we are exploring opportunities to raise capital.  There can be no assurance that we will besuccessful in raising additional capital.

 

We can not provide assurancethat we will be successful in accomplishing our objectives outlined above,including a reduction of interest rates for the trust preferred securities orthe exchange of preferred stock for common stock or reducing the dividend.  In the event we are not successful, we intendto reduce operating expenses to a level that is supportable by the revenuesfrom the existing long-term mortgage portfolio (residual interests insecuritizations), master servicing portfolio, real estate advisory fees and anynew businesses.

 

If we are not successful incompleting the objectives outlined above, we may not be able to satisfy ourcontractual obligations for the next year, including repayment of therestructured reverse repurchase line, interest payments on trust preferredsecurities and preferred stock dividends.

 

At September 30, 2008, the Company had $5.5million in stockholders’ equity.  Tounderstand the financial position of the Company better, we believe it isimportant to understand the composition of the Company’s stockholders’ equity(deficit) and to which segment of the business it relates.  At September 30, 2008, the equity(deficit) within our continuing and discontinued operations was comprised ofthe following significant assets and liabilities:

 
| ** **                                | ** ** | **Condensed Components of Stockholders’ Equity (Deficit) by Segment** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **As of September 30, 2008**                                                              | ** ** |
| ** **                                | ** ** | **Continuing**                                                                                                | ** ** | **Discontinued** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Operations**                                                                                                | ** ** | **Operations** | ** ** | **Total** | ** ** |
| Cash                                      |       | $                                                                                                             | 24,536     |   | $ | 13 |   | $ | 24,549 |   |
| Residual interests in securitizations (1) |       | 31,609                                                                                                        |       | — |   | 31,609 |   |
| Mortgage servicing rights (1)             |       | 11,674                                                                                                        |       | — |   | 11,674 |   |
| Advisory fees receivable                  |       | 7,350                                                                                                         |       | — |   | 7,350 |   |
| Trust preferred securities ($99,244 par)  |       | (35,898                                                                                                       | )          | — |   | (35,898 | ) |
| Repurchase liabilities (2)                |       | —                                                                                                        |       | (56,378 | ) | (56,378 | ) |
| Lease liability (3)                       |       | (5,479                                                                                                        | )          | (3,525 | ) | (9,004 | ) |
| Deferred charge                           |       | 23,432                                                                                                        |       | — |   | 23,432 |   |
| Net other assets (liabilities)            |       | 15,354                                                                                                        |       | (7,178 | ) | 8,176 |   |
| **Stockholders’ equity (deficit)**   |       | $                                                                                                             | 72,578     |   | $ | (67,068 | ) | $ | 5,510 |   |

 

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| (1) | Included in mortgage servicing rights is $10.4 million in master  servicing rights associated with our consolidated securitizations, which is  included in securitized mortgage collateral. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Balance includes the net amount owed to our lender, which is  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 (residual interests in securitizations);

 

·                  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 present the Company’s interest in these trusts more simply,which are considered our residual interests in securitizations.  We receive cash flows from our residualinterests in securitizations to the extent they are available after 

 

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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 $10.4 million in master servicing rightswhich are included in the basis of securitized mortgage collateral) and trustliabilities, was $31.6 million at September 30, 2008.

 

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 $11.7 million at September 30, 2008, including $10.4million included in securitized mortgage collateral.

 

For the three months ended September 30, 2008and 2007, we paid $2.0 million and $3.7 million in interest on trust preferredsecurities and preferred stock dividends, respectively.  For the nine months ended September 30,2008 and 2007, we paid $6.0 million and $11.2 million in interest on trustpreferred securities and preferred stock dividends, respectively.  As of the filing date of this report, theCompany is current on all dividend and interest payments.

 

At September 30, 2008, we had deferred chargesof $23.4 million representing the deferral of income tax expense oninter-company profits that resulted from the sale of mortgages from taxablesubsidiaries to IMH in prior years.  Thisbalance is recorded as required by GAAP and does not have any realizable cashvalue.

 

Net other assets include $2.7 million in premisesand equipment, $2.2 million in investment in capital trusts and $4.0 million inprepaid expenses.

 

At September 30, 2008, cash within ourcontinuing operations decreased to $24.5 million from $26.0 million at June 30,2008.

 

*Discontinued operations*

 

The Company’s most significant liabilities at September 30,2008 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.  The balance of our reverserepurchase line was approximately $194.3 million at September 30,2008.  We are currently distributing allprincipal and interest received from the collateral securing the reverserepurchase line to the lender.  Asdescribed above, in September 2008, the Company restructured this line.

 

We were required to make normal and customaryrepresentations and warranties about the loans we had previously sold toinvestors. Our whole loan sale agreements generally required us to repurchaseloans if we breached a representation or warranty given to the loan purchaser.In addition, we also could be required to repurchase loans as a result ofborrower fraud or if a payment default occurs on a mortgage loan shortly afterits sale.  During the quarter, therepurchase liability increased $0.6 million to $13.5 million.  Determination of the repurchase liability isan estimate of losses from expected repurchases, and is based, in part, on therecent settlement of claims.

 

In connection with the discontinuation of ournon-conforming mortgage, retail mortgage, warehouse lending and commercialoperations, a significant amount of office space that was previously occupiedis no longer being used by the Company. The Company has subleased some of this office space.  At September 30, 2008, the Company had aliability of $5.5 million and $3.5 million included within continuingoperations and discontinued operations, respectively, 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.

 

### **Market Conditions**

### ** **

The mortgage market faced continued adversitythrough the filing date of this document as the continued broad repricing ofmortgage credit risk continued the severe contraction in market liquidity.Furthermore, the market has continued to try to quantify the ultimate lossrates that are going to be experienced in the underlying assets in asset backedsecurities.

 

Conditions in the secondary markets (the markets inwhich we historically sold or securitized mortgage loans), which dramaticallyworsened during the third quarter of 2007 and into 2008, continue to bedepressed as investor concerns over credit quality and a weakening of theUnited States housing market have remained high. As a result, the capitalmarkets remain very volatile and illiquid and have effectively been unavailableto the Company. The Company believes the existing conditions in the secondarymarkets are unprecedented and, as such, inherently involve significant risksand uncertainty. These conditions could continue to adversely impact theperformance of our long-term investment portfolio. 

 

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Untilbond spreads and credit performance return to more historical levels, it willbe impossible 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.

 

We believe several converging factors led to thebroad repricing, including general concerns over the decline in home prices,the rapid increase in the number of delinquent loans (including Alt-A loans),the reduced willingness of investors to acquire commercial paper backed bymortgage collateral, the resulting contraction in market liquidity andavailability of financing lines, the numerous rating agency downgrades of securities,and the increase in supply of securities potentially available for sale.

 

The downward spiral of negative pricing adjustmentson assets had a compounding effect as lower prices led to increased lendermargin calls for some market participants, which in turn, forced additionalselling, causing yet further declines in prices. These events continued tomultiply throughout this year.

 

Normal market trading activity through the thirdquarter of 2008 continued to be unusually light as uncertainty related tofuture loss estimates and the lack of liquidity made it difficult for willingbuyers and sellers to agree on prices. This condition was particularly acutewith respect to securities backed by Alt-A loans where market participants weresetting price levels based on widely varied opinions about future loanperformance and loan loss severity. While the early credit performance forthese securities has been clearly far worse than initial expectations, theultimate level of realized losses will largely be influenced by events thatwill likely unfold over the next several years, including the severity ofhousing price declines and the overall strength of the economy.

 

The deteriorating market for subprime residentialreal estate loans is illustrated in the ABX 2007-1 Index shown below by initialrating. This index shows market prices for designated groups of subprimesecurities by credit rating.  The chartis 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 subprimeloans.  This index, which does notinclude any IMH bonds, is being used for illustrative purposes only because itis a single-family mortgage index that has traded consistently in recentyears.  There is currently no comparableindex for Alt-A mortgage product, but the general direction and magnitude ofprice movement in the index is reflective of the general price movementexperienced by the Company.  As shownbelow, the ABX 2007-1 Index displays dramatic declines in the value of suchsecurities.

 

 

*Impact of Recent Market Activity*

 

As a result of the Company’s inability to sell orsecuritize non-conforming loans, the Company discontinued funding loans.Because the Company stopped funding loans, the Company discontinuedsubstantially all of its mortgage (including commercial) and warehouse lendingoperations during the second half of 2007.

 

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In addition to the inability of the Company to sellloans, the Company’s investment in securitized non-conforming loans hasdeteriorated in value primarily from estimated losses. As a result of continueddeterioration in the real estate market through September 30, 2008, theCompany increased its loan loss estimates primarily due to increased delinquenciesin its long-term investment portfolio and increased loss severities related tothe sale and liquidation of real estate owned properties.  The decline in single-family home prices canbe seen in the chart below.

 

 

As depicted in the chart above, average home pricespeaked in 2006 at 226.29 and continued their dramatic decline through August 2008.  The Standard & Poor’s/Case-Shiller10-City Composite Home Price Index (the Index) for August 2008 was 176.60(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’ssecuritized mortgage collateral as of September 30, 2008 was 73 percentand 84 percent, respectively.  The LTVand CLTV ratios may have increased from origination date as a result of thedeterioration of the real estate market. We believe that home prices that have declined below the borrower’soriginal purchase price have a higher risk of default within our portfolio.Based on the Index, home prices have declined 22 percent through August 2008.Further, we believe the home prices in California and Florida, the states withthe highest concentration of our mortgages, have declined even further than theIndex.  As a result, we have dramaticallyincreased our loan loss estimates, which are a primary assumption used in thevaluation of securitized mortgage collateral and borrowings.

 

### **Critical AccountingPolicies**

### ** **

Several of the criticalaccounting policies important to the portrayal of our financial condition andresults of operations require management to make difficult and complexjudgments that rely on estimates about the effect of matters that areinherently uncertain due to the impact of changing market conditions and/orconsumer behavior. We believe our most critical accounting policies relate tothe valuation of: (1) assets and liabilities that are highly dependent oninternal valuation models and assumptions rather than market quotations (seeFair Value of Financial Instruments discussion below); (2) derivatives andother hedging instruments; (3) loans held-for-sale, including estimates offair 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.

 

Management discusses itscritical accounting policies and related estimates with the Company’s AuditCommittee on a regular basis. We believe the judgments, estimates andassumptions used in the preparation of our consolidated financial statementsare appropriate given the factual circumstances at the time. However, given thesensitivity of our consolidated financial statements to these critical accountingpolicies, the use of other judgments, estimates and assumptions could result inmaterial differences in our results of operations or financial condition.

 

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### **FairValue 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 September 30,2008, the fair value of the investment securities available-for-sale were measuredusing significant internal expectations of market participants’ assumptions. AtSeptember 30, 2008, investment securities available-for-sale wereclassified 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 assumptions include ourexpectations of inputs that other market participants would use. These assumptionsinclude our judgments about the underlying collateral, prepayment speeds,credit losses, and certain other factors. At September 30, 2008, securitized mortgage collateral wasclassified as Level 3 fair value measurements based on the lack of observabilityof significant inputs to the model.

 

*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 our judgments

 

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about the underlyingcollateral assumptions such as prepayment speeds, credit losses, and certainother factors and are based upon quoted prices for the individual tranches ofbonds, if available.  At September 30,2008, securitized mortgage borrowings were classified as Level 3 fairvalue measurements based on the lack of observability of significant inputs tothe 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 upon ananalysis prepared by the Company, which included a comparison to the terms ofthe Company’s preferred stock and the expected terms of restructuringnegotiations with a majority of the trust preferred debt holders.  At September 30, 2008 trust preferredsecurities were classified as Level 3 fair value measurements based on thelack of observability of market inputs.

 

*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 are based on observable market inputs, ifavailable.  To the extent observablemarket inputs are not available, fair values measurements include the Company’sjudgments about the future cash flows, forward interest rates and certain otherfactors, including counterparty risk. With the issuance of SFAS 157, these values must also take into accountthe Company’s own credit standing, to the extent applicable, thus included inthe valuation of the derivative instrument is the value of the net creditdifferential between the counterparties to the derivative contract.  At September 30, 2008, derivative assetsand liabilities were classified as Level 3 fair value measurements based on thelack of observability of market inputs.

 

OnSeptember 15, 2008, Lehman Brothers Holdings Inc. (“LBHI”) filed apetition for protection under Chapter 11 of the U.S. Bankruptcy Code. As ofthat date, LBHI, through affiliated companies, was an interest rate swapcounterparty to several of the Company’s CMO and REMIC securitizations.  As the related securitization trusts arenon-recourse to the Company, the Company is not required to replace orotherwise settle any derivative positions affected by counterparty defaultwithin the consolidated trusts.  At September 30,2008, the estimated value of these derivatives is included in derivativeliabilities in the consolidated balance sheet.

 

***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 our expectations of other marketparticipants’ assumptions, and are considered Level 3 measurements.  Loans held-for-sale, which are primarilyincluded in assets of discontinued operations, are considered Level 3measurements at September 30, 2008 based on the lack of observability ofmarket inputs.

 

*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 September 30, 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.

 

### **InterestIncome and Interest Expense**

### ** **

Pursuant to the adoption of SFAS 159 on January 1,2008, interest income and expense on the collateral and borrowings in oursecuritized trusts is based on effective yields.  Theeffective yield is the rate used to derive the fair value of theassets and liabilities in the securitized trusts.  Interest incomeand interest expense is calculated based on the estimated effective yields inthe trusts multiplied by the fair value of the mortgage collateral andborrowings.

 

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### **SelectedFinancial Results for the Three Months Ended September 30, 2008**

 

***Continuing Operations***

 

·                  Net earnings of $1.9million for the third quarter of 2008 compared to a net loss of $969.4 millionfor the third quarter of 2007.

 

·                  Net interest income of$3.0 million for the third quarter of 2008 primarily from our long-termmortgage portfolio as compared to net interest income of $12.0 million for thethird quarter of 2007.

 

·                  Master servicing fees of$1.4 million for the third quarter of 2008 as compared to $1.7 million for thethird quarter of 2007.

 

·                  Real estate advisory feesof $7.0 million for the third quarter of 2008 as compared to zero for the thirdquarter of 2007.

 

***Discontinued Operations***

 

·                  Net loss of $18.1 millionfor the third quarter of 2008 compared to a net loss of $221.8 million for thethird quarter of 2007.

 

·                  Reverse repurchase agreementswere $194.3 million at September 30, 2008 compared to $336.7 million at December 31,2007.

 

·                  Loans held-for-sale were$130.2 million, including a fair value adjustment of $98.5 million at September 30,2008 compared to loans held-for-sale of $165.6 million, including a $106.9million fair value adjustment at June 30, 2008.  The decline in loans held-for-sale isprimarily related to increased foreclosures, loan sales and additional fairvalue adjustments.

 

### **SelectedFinancial Results for the Nine Months Ended September 30, 2008**

### ** **

***Continuing Operations***

 

·                  Net loss of $19.0 millionfor the first nine months of 2008 compared to a net loss of $1.1 billion forthe first nine months of 2007.

 

·                  Net interest income of$14.6 million for the first nine months of 2008 primarily from our long-termmortgage investment portfolio as compared to net interest income of $27.8million for the first nine months of 2007.

 

·                  Master servicing fees of$4.4 million for the first nine months of 2008 as compared to $4.9 million forthe first nine months of 2007.

 

·                  Real estate advisory feesof $15.6 million for the first nine months of 2008 as compared to zero for thefirst nine months of 2007.

 

***Discontinued Operations***

 

·                  Net loss of $28.5 millionfor the first nine months of 2008 compared to a net loss of $348.4 million forthe first nine months of 2007.

 

### **EstimatedTaxable 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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### **FinancialCondition and Results of Operations**

 

*Financial Condition*

 

Condensed Balance Sheet Data

 
| ** **                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                          | ** ** | **2008**               | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Securitized mortgage collateral                     |       | $                      | 8,264,413  |                  | $          | 16,532,633     |       | $          | (8,268,220 | ) | (50 | )% |
| Assets of discontinued operations                   |       | 158,468                |       | 353,250               |       | (194,782       | )          | (55        | )          |
| Derivative assets                                   |       | 251                    |       | 7,497                 |       | (7,246         | )          | (97        | )          |
| Real estate owned (REO)                             |       | 663,320                |       | 400,863               |       | 262,457        |       | 65         |       |
| Other assets                                        |       | 79,009                 |       | 96,829                |       | (17,820        | )          | (18        | )          |
| **Total assets**                                    |       | $                      | 9,165,461  |                  | $          | 17,391,072     |       | $          | (8,225,611 | ) | (47 | )% |
|                                                |       |                   |       |                  |       |           |       |       |       |
| Securitized mortgage borrowings                     |       | $                      | 8,787,013  |                  | $          | 17,780,060     |       | $          | (8,993,047 | ) | (51 | )% |
| Liabilities of discontinued operations              |       | 225,536                |       | 405,341               |       | (179,805       | )          | (44        | )          |
| Other liabilities                                   |       | 147,402                |       | 283,399               |       | (135,997       | )          | (48        | )          |
| Total liabilities                                   |       | 9,159,951              |       | 18,468,800            |       | (9,308,849     | )          | (50        | )          |
| Total stockholders’ equity (deficit)           |       | 5,510                  |       | (1,077,728            | )          | 1,083,238      |       | 101        |       |
| **Total liabilities and stockholders’ equity** |       | $                      | 9,165,461  |                  | $          | 17,391,072     |       | $          | (8,225,611 | ) | (47 | )% |

 

Total assets and liabilities were $9.2 billion and $9.2 billion asof September 30, 2008, respectively, as compared to $17.4 billion and$18.5 billion as of December 31, 2007, respectively.  The decreases in total assets and liabilitieswere primarily the result of the Company electing to adopt SFAS 159 for asignificant portion of the Company’s financial instruments.  The adoption of SFAS 159 resulted in thereduction of the carrying basis of certain financial instruments (securitizedmortgage collateral and borrowings and trust preferred securities) to fairvalue at January 1, 2008.  Futurechanges in the fair value of these and other financial instruments arerecognized in earnings.  Upon adoption,securitized mortgage collateral and securitized mortgage borrowings werereduced by $0.8 billion and $1.9 billion, respectively.  During the first nine months, the net changein the fair value of securitized mortgage collateral and securitized mortgageborrowings included in earnings was $(5.6) billion and $5.7 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 $10.4 million in masterservicing rights included within the basis of securitized mortgage collateral)and trust liabilities.  Forecastedvoluntary and involuntary prepayment estimates for single-family andmulti-family loans for the next 12 months range from 12 percent and 28 percentfor the 2002-2003 vintage years, respectively, and 7 percent and 15 percent forthe 2007 vintage year, respectively.  Thedecline in the fair value of residual interests in securitizations is primarilydue to increases in credit losses, delinquencies and overall reductions in realestate prices.  The following tablepresents the estimated fair value of our residual interests and relatedassumptions used to derive these values at September 30, 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)** |       | $                                                          | 11,288     |                                 | $          | 6,441                |       | $                                                     | 17,729     |   | 2 | % | 1 | % | 30 | % |
| **2004**           |       | 2,240                                                      |       | 4,652                                |       | 6,892                |       | 3                                                     | %          | 1 | % | 40 | % |
| **2005**           |       | 106                                                        |       | 457                                  |       | 563                  |       | 8                                                     | %          | 1 | % | 50 | % |
| **2006 (3)**       |       | 398                                                        |       | 5,572                                |       | 5,970                |       | 21                                                    | %          | 6 | % | 50 | % |
| **2007**           |       | —                                                     |       | 455                                  |       | 455                  |       | 27                                                    | %          | 7 | % | 50 | % |
| **Total**          | ** ** | **$**                                                      | **14,032** | ** **                           | **$**      | **17,577**           | ** ** | **$**                                                 | **31,609** |   |   |   |   |   |   |   |

 

----

| (1) |   | The discount rate for all  multi-family residual interests is 30 percent at September 30, 2008.                                                                                                                          |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | 2002-2003 vintage year  includes CMO 2007-A, due to performance, which uses a 40 percent discount  rate and was securitized in 2007 from collapsed securitizations which were  originally securitized in 2002, 2003 and 2004. |
| (3) |   | 2006 vintage year includes  ISAC 2005-2, due to performance, and the fact that it was a REMIC like all  other 2006 securitizations.                                                                                           |

 

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

 
| ** **                                       | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                       | ** ** | **September 30,**                                | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
| ** **                                       | ** ** | **2008**                                              | ** ** | **2007** | ** ** | **2007** | ** ** |
| Prior 12-month (CPR) - Single-family             |       | 14                                                    | %          | 25 | % | 30 | % |
| Prior 12-month (CPR) - Multi-family              |       | 11                                                    | %          | 9 | % | 8 | % |
| Total non-performing loans                       |       | $                                                     | 2,687,680  |   | $ | 2,131,537 |   | $ | 1,434,137 |   |
| Total non-performing loans to total loans        |       | 16.5                                                  | %          | 11.7 | % | 7.2 | % |
| Total non-performing assets (1)                  |       | $                                                     | 3,355,838  |   | $ | 2,543,775 |   | $ | 1,800,198 |   |
| Total non-performing assets to total assets  (2) |       | 36.6                                                  | %          | 14.6 | % | 9.3 | % |

 

----

| (1) |   | Non-performing  assets include non-performing loans and REO                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | For  2008, with the adoption of SFAS 159, securitized mortgage collateral is  recorded at fair value and as a result of current market conditions has  significantly decreased. The decrease in the fair value of securitized  mortgage collateral resulted in significant decreases in total assets at  September 30, 2008 compared to prior periods. This decrease in total  assets, along with the increases in non-performing assets has resulted in  higher total non-performing assets to total assets. |

 

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 ourservicers. 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 makethem non-conforming under those guidelines.

 

As of September 30, 2008, theoriginal weighted average credit score of single-family and multi-familysecuritized mortgage collateral was 701 and 732, an original weighted averageLTV ratio of 73 and 66 percent and an original CLTV of 84 percent and 66percent, respectively.  TheLTV and CLTV ratios may have increased from origination date as a result of thedeterioration of the real 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 

 

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alternative terms of forbearance. If the mortgage is notreinstated within the time permitted by law for reinstatement, the property maythen be sold at a foreclosure sale. At foreclosure sale, the trustsconsolidated on our balance sheet generally acquire title to the property.

 

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 $3,140.7 million or 19.3percent as of September 30, 2008.

 

The following tablesummarizes 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:

 
| ** **                                     | ** ** | **As of September 30,** | ** ** | ** ** | ** ** | **As of December 31,** | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|------------|------------|---------------------------------------|------------|------------|------------|
| ** **                                     | ** ** | **2008**                               | ** ** | **%**      | ** ** | **2007**                              | ** ** | **%**      | ** ** |
| Loans held-for-sale (1)                        |       |                                   |       |       |       |                                  |       |       |       |
| 60 - 89 days delinquent                        |       | $                                      | 13,117     |       | 0          | %                                     | $          | 45,121     |       | 2 | % |
| 90 or more days delinquent                     |       | 46,467                                 |       | 1          | %          | 51,294                                |       | 2          | %          |
| Foreclosures (2)                               |       | 62,581                                 |       | 2          | %          | 23,936                                |       | 1          | %          |
| Total delinquent loans held-for-sale           |       | 122,165                                |       | 4          | %          | 120,351                               |       | 5          | %          |
|                                           |       |                                   |       |       |       |                                  |       |       |       |
| Securitized mortgage collateral                |       |                                   |       |       |       |                                  |       |       |       |
| 60 - 89 days delinquent                        |       | $                                      | 439,909    |       | 14         | %                                     | $          | 490,946    |       | 18 | % |
| 90 or more days delinquent                     |       | 833,472                                |       | 27         | %          | 773,816                               |       | 29         | %          |
| Foreclosures (2)                               |       | 1,527,771                              |       | 49         | %          | 1,093,385                             |       | 41         | %          |
| Delinquent bankruptcies (3)                    |       | 217,389                                |       | 7          | %          | 189,106                               |       | 7          | %          |
| Total delinquent long-term mortgage  portfolio |       | 3,018,541                              |       | 96         | %          | 2,547,253                             |       | 95         | %          |
| Total delinquent loans                         |       | $                                      | 3,140,706  |       | 100        | %                                     | $          | 2,667,604  |       | 100 | % |
| Total loans                                    |       | $                                      | 16,270,192 |       |       |                                  | $          | 18,252,197 |       |   |   |

 

----

| (1) |   | Loans held-for-sale are substantially included in  discontinued operations in the consolidated balance sheets. |
|-----|--------|----------------------------------------------------------------------------------------------------------------|
| (2) |   | Represents properties in the process of  foreclosure.                                                          |
| (3) |   | Represents bankruptcies that are 30 days or more  delinquent.                                                  |

 

The following tablesummarizes securitized mortgage collateral, loans held-for-investment, loansheld-for-sale and real estate owned, that were non-performing for continuingand discontinued operations combined for the periods indicated:

 
| ** **                                                           | ** ** | **As of September 30,** | ** ** | ** ** | ** ** | **As of December 31,** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------|------------|------------|------------|---------------------------------------|------------|------------|------------|
| ** **                                                           | ** ** | **2008**                               | ** ** | **%**      | ** ** | **2007**                              | ** ** | **%**      | ** ** |
| 90 or more days delinquent, foreclosures and delinquent bankruptcies | ** ** | $                                      | 2,687,680  | ** ** | 80         | %                                     | $          | 2,131,537  | ** ** | 84 | % |
| Real estate owned                                                    |       | 668,158                                |       | 20         | %          | 412,238                               |       | 16         | %          |
| Total non-performing assets                                          |       | $                                      | 3,355,838  |       | 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 on securitizedmortgage collateral when the scheduled payment is received from theservicer.  The servicers are required toadvance principal and interest on loans within the trusts to the extent theadvances are considered recoverable.  Asof September 30,2008, non-performingassets as a percentage of the total assets was 36.6 percent compared to14.6 percent as of December 31, 2007. At September 30, 2008, with the adoption of SFAS 159, securitizedmortgage collateral is recorded at fair value and as a result of current marketconditions has significantly decreased. The decrease in the fair value of securitized mortgage collateralresulted in significant decreases in total assets at September 30, 2008compared to prior periods.  This decreasein total assets, along with the increases in non-performing assets has resultedin higher total non-performing assets to total assets.

 

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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 SFAS 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 and comprehensiveloss.  Real estate owned at September 30,2008 increased $255.9 million or 62.1 percent from December 31, 2007 as aresult of an increase in foreclosures from higher delinquencies anddeterioration in the prevailing real estate market and, in part, due toborrowers’ inability to obtain replacement financing in conjunction with risingborrowing costs due to resets, reduced housing demand in the marketplace andlower housing prices.

 

We realized a loss onsale of real estate owned in the amount $10.1 million and $4.8 million for thethree and nine months ended September 30, 2008, respectively, as comparedto a loss of $5.6 million and $6.7 million for the three and nine months ended September 30,2007, respectively.  Additionally, forthe three and nine months ended September 30, 2008, the Company recordedan unrealized loss on the net realizable value of the REO in the amount of $5.6million and $19.9 million, respectively, which reflects the decline in value ofthe REO from the foreclosure date.

 

The following tablepresents the balances and related activity of the real estate owned forcontinuing operations:

 
| ** **             | ** ** | **Nine Months Ended**  | ** ** | **Year Ended**             | ** ** |
|------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
| Beginning balance      |       | $                                | 405,434    |                            | $          | 137,331 |   |
| Foreclosures           |       | 592,771                          |       | 487,314                         |       |
| Liquidations           |       | (334,058                         | )          | (219,211                        | )          |
| REO                    |       | $                                | 664,147    |                            | $          | 405,434 |   |
|                   |       |                             |       |                            |       |
| REO inside trusts      |       | $                                | 663,320    |                            | $          | 400,863 |   |
| REO outside trusts (1) |       | 827                              |       | 4,571                           |       |
| REO                    |       | $                                | 664,147    |                            | $          | 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, geographic location,etc.) and collection status. The rate of default is based on analysis ofmigration of loans from each aging category. The loss severity is determined byestimating the net proceeds from the ultimate sale of the foreclosed property.The results of that analysis are then applied to the current mortgage portfolioand an estimate is created. We believe that pooling of mortgages with similarcharacteristics is an appropriate methodology in which to evaluate the lifetimeloan 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. Managementcontinually evaluates these assumptions and various relevant factors affectingcredit quality and inherent losses.

 

*Interest Rate Risk.*Refer to Item 3. “Quantitative andQualitative Disclosures 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 lower paymentoption mortgage products over the last three years had been a significantfactor affecting borrowers refinancing decisions. As mortgage rates increaseand housing prices decline, borrowers will find it more difficult to 

 

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refinance to obtain cheaperfinancing. If borrowers are unable to pay their mortgage payments at theadjusted rate, delinquencies may increase. The three-month average combined voluntaryprepayment rate of single-family and multi-family loans held as securitizedmortgage collateral decreased to 10 percent at September 30, 2008 from17 percent as of December 31, 2007.

 

Asof September 30, 2008, the twelve-month combined CPR of single-family andmulti-family loans held as securitized mortgage collateral was 13 percentas compared to a 24 percent twelve-month average CPR as of December 31,2007. Prepayment penalties are charged to borrowers for mortgages that are paidearly and recorded as interest income.

 

*Results of Operations*

 

*For the Three and Nine Months Ended September 30, 2008compared to the Three and Nine Months Ended September 30, 2007*

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                                |       | $                                                                          | 397,445    |   | $ | 310,006 |   | $ | 87,439 |   | 28 | % |
| Interest expense                                               |       | 394,431                                                                    |       | 298,003 |   | 96,428 |   | 32 |   |
| Net interest income                                            |       | 3,014                                                                      |       | 12,003 |   | (8,989 | ) | (75 | ) |
| Provision for loan losses                                      |       | —                                                                     |       | 789,445 |   | (789,445 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 3,014                                                                      |       | (777,442 | ) | 780,456 |   | 100 |   |
| Total non-interest income (expense)                            |       | 11,473                                                                     |       | (182,243 | ) | 193,716 |   | 106 |   |
| Total non-interest expense                                     |       | 7,333                                                                      |       | 6,701 |   | 632 |   | 9 |   |
| Income tax expense                                             |       | 5,253                                                                      |       | 3,056 |   | 2,197 |   | 72 |   |
| Net earnings (loss) from continuing  operations                |       | 1,901                                                                      |       | (969,442 | ) | 971,343 |   | 100 |   |
| Loss from discontinued operations, net                         |       | (18,121                                                                    | )          | (221,793 | ) | 203,672 |   | 92 |   |
| Net loss                                                       |       | $                                                                          | (16,220    | ) | $ | (1,191,235 | ) | $ | 1,175,015 |   | 99 | % |
|                                                           |       |                                                                       |       |   |   |   |   |   |   |
| Net loss per share - diluted                                   |       | $                                                                          | (0.26      | ) | $ | (15.70 | ) | $ | 15.44 |   | 98 | % |
| Dividends declared per common share                            |       | $                                                                          | —     |   | $ | — |   | $ | — |   | n/a | % |

 
| ** **                                                     | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                                |       | $                                                                         | 1,077,256  |   | $ | 931,196 |   | $ | 146,060 |   | 16 | % |
| Interest expense                                               |       | 1,062,637                                                                 |       | 903,377 |   | 159,260 |   | 18 |   |
| Net interest income                                            |       | 14,619                                                                    |       | 27,819 |   | (13,200 | ) | (47 | ) |
| Provision for loan losses                                      |       | —                                                                    |       | 979,740 |   | (979,740 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 14,619                                                                    |       | (951,921 | ) | 966,540 |   | 102 |   |
| Total non-interest income (expense)                            |       | 1,715                                                                     |       | (134,042 | ) | 135,757 |   | 101 |   |
| Total non-interest expense                                     |       | 21,395                                                                    |       | 19,125 |   | 2,270 |   | 12 |   |
| Income tax expense                                             |       | 13,980                                                                    |       | 12,012 |   | 1,968 |   | 16 |   |
| Net loss from continuing operations                            |       | (19,041                                                                   | )          | (1,117,100 | ) | 1,098,059 |   | 98 |   |
| Loss from discontinued operations, net                         |       | (28,481                                                                   | )          | (348,350 | ) | 319,869 |   | 92 |   |
| Net loss                                                       |       | $                                                                         | (47,522    | ) | $ | (1,465,450 | ) | $ | 1,417,928 |   | 97 | % |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Net loss per share - diluted                                   |       | $                                                                         | (0.77      | ) | $ | (19.41 | ) | $ | 18.64 |   | 96 | % |
| Dividends declared per common share                            |       | $                                                                         | —     |   | $ | 0.10 |   | $ | (0.10 | ) | n/a | % |

 

*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 

 

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securities available-for-sale. With theadoption of SFAS 159, net interest income during the quarter represents theeffective yield, based on the fair value of the trust assets andliabilities.  During 2007, net interestincome included (1) amortization of acquisition costs on mortgagesacquired from the mortgage operations, (2) accretion of loan discounts,which primarily represented the amount allocated to mortgage servicing rightswhen they are sold to third parties and mortgages are transferred to thelong-term investment operations from the mortgage operations and retained forlong-term investment, (3) amortization of securitization costs and, to alesser extent, (4) amortization of bond discounts.

 

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 September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Average**                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Balance**                                                                | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                    |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by  mortgages   |       | $                                                                          | 8,322      |   | $ | 560 |   | 26.92 | % | $ | 14,443 |   | $ | 1,459 |   | 40.41 | % |
| Securitized mortgage collateral (1)                    |       | 9,659,897                                                                  |       | 396,695 |   | 16.43 | % | 19,662,219 |   | 307,433 |   | 6.25 | % |
| Loans held-for-investment and held-for-sale (2)   |       | 152,115                                                                    |       | 2,043 |   | 5.37 | % | 1,222,466 |   | 23,229 |   | 7.60 | % |
| Finance receivables                                    |       | —                                                                     |       | — |   | 0.00 | % | 38,819 |   | 1,584 |   | 16.32 | % |
| Total mortgage assets\ interest income                 |       | $                                                                          | 9,820,334  |   | $ | 399,298 |   | 16.26 | % | $ | 20,937,947 |   | $ | 333,705 |   | 6.38 | % |
|                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                         |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                        |       | $                                                                          | 10,142,072 |   | $ | 392,271 |   | 15.47 | % | $ | 19,458,646 |   | $ | 295,325 |   | 6.07 | % |
| Reverse repurchase agreements                          |       | 208,949                                                                    |       | 2,039 |   | 3.90 | % | 1,225,321 |   | 21,959 |   | 7.17 | % |
| Total borrowings on mortgage assets\  interest expense |       | $                                                                          | 10,351,021 |   | $ | 394,310 |   | 15.24 | % | $ | 20,683,967 |   | $ | 317,284 |   | 6.14 | % |
|                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (3)**                            |       |                                                                       |       | $ | 4,988 |   | 1.03 | % |   |   | $ | 16,421 |   | 0.24 | % |
| **Net Interest Margin (4)**                            |       |                                                                       |       |   |   | 0.20 | % |   |   |   |   | 0.31 | % |

 
| ** **                                             | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **Average**                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Balance**                                                               | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                    |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by  mortgages   |       | $                                                                         | 11,250     |   | $ | 1,980 |   | 23.47 | % | $ | 24,723 |   | $ | 4,767 |   | 25.71 | % |
| Securitized mortgage collateral (1)                    |       | 11,666,313                                                                |       | 1,073,580 |   | 12.27 | % | 20,502,803 |   | 930,086 |   | 6.05 | % |
| Loans held-for-investment and held-for-sale  (2)       |       | 182,683                                                                   |       | 9,492 |   | 6.93 | % | 1,347,949 |   | 64,541 |   | 6.38 | % |
| Finance receivables                                    |       | —                                                                    |       | — |   | 0.00 | % | 277,410 |   | 9,776 |   | 4.70 | % |
| Total mortgage assets\ interest income                 |       | $                                                                         | 11,860,246 |   | $ | 1,085,052 |   | 12.20 | % | $ | 22,152,885 |   | $ | 1,009,170 |   | 6.07 | % |
|                                                   |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                         |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                        |       | $                                                                         | 11,988,676 |   | $ | 1,055,519 |   | 11.74 | % | $ | 20,135,424 |   | $ | 893,253 |   | 5.91 | % |
| Reverse repurchase agreements                          |       | 241,961                                                                   |       | 7,197 |   | 3.97 | % | 1,654,003 |   | 72,932 |   | 5.88 | % |
| Total borrowings on mortgage assets\  interest expense |       | $                                                                         | 12,230,637 |   | $ | 1,062,716 |   | 11.59 | % | $ | 21,789,427 |   | $ | 966,185 |   | 5.91 | % |
|                                                   |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (3)**                            |       |                                                                      |       | $ | 22,336 |   | 0.61 | % |   |   | $ | 42,985 |   | 0.16 | % |
| **Net Interest Margin (4)**                            |       |                                                                      |       |   |   | 0.25 | % |   |   |   |   | 0.26 | % |

 

----

| (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. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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| (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 third quarter of 2008 decreased $11.4million to $5.0 million as compared to the third quarter of 2007.  The decrease in net interest income wasprimarily due to declines in outstanding balances and the effective yieldrecognized based on the fair values of the related securitized collateral andborrowings.  During the quarter, theyield on mortgage assets increased to 16.26 percent from 6.38 percent forthe comparable 2007 period. The yield on total borrowings increased to 15.24percent for the quarter from 6.14 percent for the comparable period.  The increase in the securitized mortgagecollateral and borrowings yields is primarily a result of the adoption of SFAS159 and the related recognition of interest income and interest expense usingeffective yields for the three months ended September 30, 2008, based onfair value, as compared to using effective interest rates using the historicalbasis in the loans in the prior period. As the market’s expectation of future credit losses has increased, themarket has demanded higher yields, as investors require a higher yield on thesefinancial assets and liabilities.

 

Net interest income spread for the first nine months of 2008 decreased$20.6 million to $22.3 million as compared to the first nine months of2007.  The decrease in net interest incomewas primarily due to declines in outstanding balances and the effective yieldrecognized based on the fair values of the related securitized collateral andborrowings.  During the first ninemonths, the yield on mortgage assets increased to 12.20 percent from 6.07percent for the comparable 2007 period. The yield on total borrowings increasedto 11.59 percent for the first nine months from 5.91 percent for the comparableperiod.  The increase in the securitizedmortgage collateral and borrowing yields is primarily a result of the adoptionof SFAS 159 and the related recognition of interest income and interest expenseusing effective yields for the nine months ended September 30, 2008, basedon 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 investorsrequire a higher yield on these financial assets and liabilities.

 

*Non-Interest Income*

 
| ** **                                                                   | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                                   | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative instruments |       | —                                                                     |       | (106,532 | ) | 106,532 |   | n/a | % |
| Change in fair value of net trust assets,  excluding REO                     |       | 7,778                                                                      |       | — |   | 7,778 |   | n/a |   |
| Change in fair value of trust preferred  securities                          |       | 10,494                                                                     |       | — |   | 10,494 |   | n/a |   |
| Losses from real estate owned                                                |       | (15,685                                                                    | )          | (45,941 | ) | 30,256 |   | 66 |   |
| Real estate advisory fees                                                    |       | 7,039                                                                      |       | — |   | 7,039 |   | n/a |   |
| Other                                                                        |       | 1,847                                                                      |       | (29,770 | ) | 31,617 |   | 106 |   |
| Total non-interest income                                                    |       | $                                                                          | 11,473     |   | $ | (182,243 | ) | $ | 193,716 |   | 106 | % |
|                                                                              |            |                                                                            |            |  |  |  |  |  |  |  |  |  |

 

*Change in Fair Value of Derivative Instruments*. The change in the fair value of derivativeinstruments increased by $106.5 million during the third quarter of 2008 ascompared to the third 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 derivative instrumentsas a component of the change in fair value of net trust assets.  The change in fair value of derivativeinstruments was a loss of $10.9 million during the third quarter of 2008.

 

*Change in Fair Value of Net Trust Assets.* TheCompany recognized a $7.8 million gain from the change in fair value of nettrust assets, which is comprised of a gain from the decrease of fair value ofsecuritized mortgage borrowings of $2.4 billion, loss in the fair value ofderivatives instruments of $10.9 million and losses on the reduction in fairvalue of securitized mortgage collateral and investment securitiesavailable-for-sale of $2.4 billion, and $3.1 million, respectively.  The overall reduction in fair value of theinvestment securities available-for-sale, securitized mortgage collateral andsecuritized mortgage borrowings is the result of increased credit lossesrelated to increasing delinquencies, foreclosures and higher loss severitiesresulting from home price declines.  Thedecline in net derivative liabilities is the result of decreases in LondonInterbank Offered Rate (LIBOR) reflected in the forward yield curve.

 

*Change in the Fair Value of Trust PreferredSecurities. *During the thirdquarter of 2008, the Company recognized a gain in the amount of $10.5 millionas a result of a decrease in the fair value of the trust preferred securities.

 

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| ** **                                               | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative  instruments          |       | —                                                                    |       | (32,860 | ) | 32,860 |   | n/a | % |
| Change in fair value of net trust assets,  excluding REO |       | 145                                                                       |       | — |   | 145 |   | n/a |   |
| Change in fair value of trust preferred  securities      |       | 5,473                                                                     |       | — |   | 5,473 |   | n/a |   |
| Losses from real estate owned                            |       | (24,771                                                                   | )          | (75,161 | ) | 50,390 |   | 67 |   |
| Real estate advisory fees                                |       | 15,581                                                                    |       | — |   | 15,581 |   | n/a |   |
| Other                                                    |       | 5,287                                                                     |       | (26,021 | ) | 31,308 |   | 120 |   |
| Total non-interest income                                |       | $                                                                         | 1,715      |   | $ | (134,042 | ) | $ | 135,757 |   | 101 | % |
|                                                          |            |                                                                           |            |  |  |  |  |  |  |  |  |  |

 

*Change in Fair Value of Derivative Instruments*. The change in the fair value of derivativeinstruments increased by $32.9 million during the first nine months of 2008 ascompared to the first nine months of 2007, as the Company no longer recognizesthe derivative 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 $94.4 million during the first nine monthsof 2008.

 

*Change in Fair Value of Net Trust Assets.* TheCompany recognized a $145 thousand gain from the change in fair value of nettrust assets, which is comprised of a gain on the reduction of the fair valueof securitized mortgage borrowings of $5.7 billion, loss on the reduction infair value of derivatives instruments of $94.4 million and losses on thereduction in fair value of securitized mortgage collateral and investmentsecurities available-for-sale of $5.6 billion and $8.9 million, respectively.  The overall reduction in fair value of theinvestment securities available-for-sale, securitized mortgage collateral andsecuritized mortgage borrowings is the result of increased credit lossesrelated to increasing delinquencies, foreclosures and higher loss severitiesresulting from home price declines.  Thedecline in net derivative liabilities is the result of decreases in LondonInterbank Offered Rate (LIBOR) reflected in the forward yield curve.

 

*Change in the Fair Value of Trust PreferredSecurities. *During the firstnine months of 2008 the Company recognized a gain in the amount of $5.5 millionas a result of a decrease in the fair value of the trust preferred securities.

 

*Non-Interest Expense*

 

Changes in Non-Interest Expense

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                          | 4,951      |   | $ | 4,213 |   | $ | 738 |   | 18 | % |
| Personnel expense          |       | 2,382                                                                      |       | 2,488 |   | (106 | ) | (4 | ) |
| Total operating expense    |       | $                                                                          | 7,333      |   | $ | 6,701 |   | $ | 632 |   | 9 | % |

 

Totalnon-interest expenses increased on a quarter-over-quarter basis as general andadministrative costs increased $738 thousand (18 percent) during the thirdquarter of 2008 as compared to same period in 2007, which was primarilyattributable to an increase in professional expenses.  Personnel expense decreased $106 thousand ona quarter-over-quarter basis.

 

Changes in Non-Interest Expense

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                         | 13,864     |   | $ | 14,173 |   | $ | (309 | ) | (2 | )% |
| Personnel expense          |       | 7,531                                                                     |       | 4,952 |   | 2,579 |   | 52 |   |
| Total operating expense    |       | $                                                                         | 21,395     |   | $ | 19,125 |   | $ | 2,270 |   | 12 | % |

 

39

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Totalnon-interest expenses increased as personnel expense increased $2.6 million (52percent) during the first nine months of 2008 as compared to same period in2007, as a greater amount of the Company’s personnel costs are being utilizedwithin the continuing operations versus discontinued operations.  The $309 thousand decrease in general andadministrative costs is primarily attributable to a decrease in data processing,communications costs, and occupancy expense offset by an increase inprofessional expenses.

 

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

 

***Continuing Operations***

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                            |       | $                                                                          | 3,014      |   | $ | 12,003 |   | $ | (8,989 | ) | (75 | )% |
| Provision for loan losses                                      |       | —                                                                     |       | 789,445 |   | (789,445 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 3,014                                                                      |       | (777,442 | ) | 780,456 |   | 100 |   |
|                                                           |       |                                                                       |       |   |   |   |   |   |   |
| Change in fair value of derivative  instruments                |       | —                                                                     |       | (106,532 | ) | 106,532 |   | n/a |   |
| Change in fair value of net trust assets,  excluding REO       |       | 7,778                                                                      |       | — |   | 7,778 |   | n/a |   |
| Losses from real estate owned                                  |       | (15,685                                                                    | )          | (45,941 | ) | 30,256 |   | 66 |   |
| Real estate advisory fees                                      |       | 7,039                                                                      |       | — |   | 7,039 |   | n/a |   |
| Other non-interest income (expense)                            |       | 12,341                                                                     |       | (29,770 | ) | 42,111 |   | 141 |   |
| Total non-interest income (expense)                            |       | 11,473                                                                     |       | (182,243 | ) | 193,716 |   | 106 |   |
|                                                           |       |                                                                       |       |   |   |   |   |   |   |
| Non-interest expense and income taxes                          |       | 12,586                                                                     |       | 9,757 |   | 2,829 |   | 29 |   |
| Net earnings (loss) from continuing  operations                |       | $                                                                          | 1,901      |   | $ | (969,442 | ) | $ | 971,343 |   | 100 | % |

 

Net earnings for the quarter ended September 30, 2008 increased$971.3 million as compared to the third 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 ($789.4million for the third quarter of 2007) under SFAS 159 as the losses are includedin the estimate of fair value for the securitized mortgage collateral.  The change in fair value of derivativeinstruments ($106.5 million loss for the third quarter of 2007), is nowincluded in the change in fair value of net trust assets, which consisted of a$10.9 million loss on derivatives for the third quarter of 2008.  The fair value of trust preferred securitiesdecreased $10.5 million during the third quarter of 2008 and is included inother non-interest income.

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                            |       | $                                                                         | 14,619     |   | $ | 27,819 |   | $ | (13,200 | ) | (47 | )% |
| Provision for loan losses                                      |       | —                                                                    |       | 979,740 |   | (979,740 | ) | n/a |   |
| Net interest income (expense) after  provision for loan losses |       | 14,619                                                                    |       | (951,921 | ) | 966,540 |   | 102 |   |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Change in fair value of derivative  instruments                |       | —                                                                    |       | (32,860 | ) | 32,860 |   | n/a |   |
| Change in fair value of net trust assets,  excluding REO       |       | 145                                                                       |       | — |   | 145 |   | n/a |   |
| Losses from real estate owned                                  |       | (24,771                                                                   | )          | (75,161 | ) | 50,390 |   | 67 |   |
| Real estate advisory fees                                      |       | 15,581                                                                    |       | — |   | 15,581 |   | n/a |   |
| Other non-interest income (expense)                            |       | 10,760                                                                    |       | (26,021 | ) | 36,781 |   | 141 |   |
| Total non-interest income (expense)                            |       | 1,715                                                                     |       | (134,042 | ) | 135,757 |   | 101 |   |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Non-interest expense and income taxes                          |       | 35,375                                                                    |       | 31,137 |   | 4,238 |   | 14 |   |
|   Net loss from continuing  operations               |       | $                                                                         | (19,041    | ) | $ | (1,117,100 | ) | $ | 1,098,059 |   | 98 | % |

 

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Net loss for the nine months ended September 30, 2008 decreased$1.1 billion as compared to the nine months ended September 30, 2007.  The primary reason for the reduction in netloss is the result of the adoption of SFAS 159 for securitized mortgagecollateral, borrowings and trust preferred securities.  The Company no longer records a provision forloan losses ($979.7 million for the first nine months of 2007) under SFAS 159as the losses are included in the estimate of fair value for the securitizedmortgage collateral.  The change in fairvalue of derivative instruments ($32.9 million loss for the first nine monthsof 2007), is now included in the change in fair value of net trust assets,which consisted of a $94.4 million loss on derivatives for the first ninemonths of 2008 The fair value of trust preferred securities decreased $5.5million during the first nine months of 2008 and is included in othernon-interest income.

 

***Discontinued Operations***

 

Condensed Statements of Operations Data

 
| ** **                                                    | ** ** | **For the Three Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                           |       | $                                                                          | 158        |   | $ | 2,777 |   | $ | (2,619 | ) | (94 | )% |
| Provision for loan losses                                     |       | —                                                                     |       | (2,807 | ) | 2,807 |   | n/a |   |
| Net interest income (expense) after  provison for loan losses |       | $                                                                          | 158        |   | $ | (30 | ) | $ | 188 |   | (627 | ) |
|                                                          |       |                                                                       |       |   |   |   |   |   |   |
| Loss on sale of loans                                         |       | (12,279                                                                    | )          | (144,868 | ) | 132,589 |   | 92 |   |
| Provision for repurchases                                     |       | (1,060                                                                     | )          | (15,718 | ) | 14,658 |   | 93 |   |
| Other income (loss)                                           |       | 339                                                                        |       | (7,530 | ) | 7,869 |   | 105 |   |
| Personnel expense                                             |       | (3,979                                                                     | )          | (17,072 | ) | 13,093 |   | 77 |   |
| Non-interest expense and income taxes                         |       | (1,300                                                                     | )          | (36,575 | ) | 35,275 |   | 96 |   |
| Net loss                                                      |       | $                                                                          | (18,121    | ) | $ | (221,793 | ) | $ | 203,672 |   | 92 | % |

 

Net loss for the discontinued operations decreased $203.7 millionprimarily due to the following changes:

 

·                  decreaseof $132.6 million in loss on sale of loans.

 

·                  decreaseof $14.7 million in provision for repurchases

 

·                  decreaseof $35.3 million in non-interest expense and income taxes.

 

·                  decreasein personnel expense of $13.1 million.

 

Loss on sale of loans decreased $132.6 million to a$12.3 million loss in the third quarter of 2008.  For the three months ended September 30,2008, gain on sale of loans was $1.3 million, offset by a $13.6 million chargein additional LOCOM adjustments as a result of continued deterioration of loansheld-for-sale.  This is compared to aloss on whole loan sales of $39.1 million and additional LOCOM adjustments of$105.7 million for the comparable period of 2007.

 

Provision for repurchases decreased to $1.1 million for the thirdquarter of 2008 as compared to $15.7 million in 2007.  The reduction is the result of fewer wholeloan sales and a reduction in the amount of repurchase requests.

 

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.

 

Non-interest expense decreased $35.3 million during the third quarterof 2008 due to certain non-recurring charges in the prior year.  In the third quarter 2007, the Companyrecorded a restructuring charge of $6.5 million related to lease costsassociated with facilities that were no longer used and a $12.8 millionimpairment on property plant and equipment in which the book value exceededfair value at September 30, 2007.

 

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| ** **                                          | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                          | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                 |       | $                                                                         | 3,372      |   | $ | 13,399 |   | $ | (10,027 | ) | (75 | )% |
| Provision for loan losses                           |       | —                                                                    |       | (4,868 | ) | 4,868 |   | n/a |   |
| Net interest income after provison for loan  losses |       | $                                                                         | 3,372      |   | $ | 8,531 |   | $ | (5,159 | ) | (60 | ) |
|                                                |       |                                                                      |       |   |   |   |   |   |   |
| Loss on sale of loans                               |       | (20,990                                                                   | )          | (185,196 | ) | 164,206 |   | 89 |   |
| Provision for repurchases                           |       | 7,375                                                                     |       | (46,436 | ) | 53,811 |   | 116 |   |
| Other income (loss)                                 |       | 1,594                                                                     |       | (18,733 | ) | 20,327 |   | 109 |   |
| Personnel expense                                   |       | (12,953                                                                   | )          | (56,635 | ) | 43,682 |   | 77 |   |
| Non-interest expense and income taxes               |       | (6,879                                                                    | )          | (49,881 | ) | 43,002 |   | 86 |   |
| Net loss                                            |       | $                                                                         | (28,481    | ) | $ | (348,350 | ) | $ | 319,869 |   | 92 | % |

 

Net loss for the discontinued operations decreased $319.9 millionprimarily due to the following changes:

 

·                  decreaseof $164.2 million in loss on sale of loans.

 

·                  decreaseof $53.8 million in provision for repurchases.

 

·                  decreasein personnel expense of $43.7 million.

 

·                  decreaseof $43.0 million in non-interest expense and income taxes.

 

Loss on sale of loans decreased $164.2 million to a$21.0 million loss in the first nine months of 2008.  For the nine months ended September 30,2008, gain on sale of loans was $8.9 million, offset by a $29.9 million chargein additional LOCOM adjustments as a result of continued deterioration of loansheld-for-sale.  This is compared to aloss on whole loan sales of $44.6 million and additional LOCOM adjustments of$140.6 million for the comparable period of 2007.

 

Provision for repurchases decreased to $7.4 million for the first ninemonths of 2008 as compared to a loss of $46.4 million in 2007.  The reduction is the result of settlements of$122.3 million in repurchase obligations during the first half of 2008,combined with fewer whole loan sales and a reduction in the amount ofrepurchase requests during the nine months ended September 30, 2008.

 

Non-interest expense decreased $43.0 million during the first ninemonths of 2008 due to certain non-recurring charges in the prior year.  In the third quarter 2007, the Companyrecorded a restructuring charge of $6.5 million related to lease costsassociated with facilities that were no longer used and a $12.8 millionimpairment on property plant and equipment in which the book value exceededfair value at September 30, 2007.

 

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 andprocedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) or15d-15(e)) designed to ensure that information required to be disclosed inreports filed or submitted under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms. Disclosure controls andprocedures include, without limitation, controls and 

 

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procedures designed toensure that information required to be disclosed by the Company in its reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the Company’s management, including its principal executive and principalfinancial officers, or persons performing similar functions, as appropriate toallow timely decisions regarding required disclosure.

 

As required by Rules 13a-15 and 15d-15 underthe Exchange Act, in connection with the filing of this Quarterly Report on Form 10-Q,our management, 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 remediatethe material weakness identified in Management’s Report on Internal Controlover Financial Reporting as of December 31, 2007 by taking the followingactions:

 
| · |   | effective  February 2008, we appointed Todd Taylor as Interim Chief Financial  Officer and as Chief Financial Officer in November 2008, and                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                 |
| · |   | we  hired additional resources for the accounting and finance departments on a  contract basis to help perform certain accounting functions, until management  can employ a more permanent solution. |

 

We believe that our disclosure controls andprocedures, including our control over financial reporting, have improved sinceyear-end due to the scrutiny of such matters by our management and AuditCommittee and the changes described above. However, the Company believes the material weakness related to oureffectiveness of internal control over financial reporting is not fullyremediated as of September 30, 2008.

 

**Changes in Internal Control Over Financial Reporting**

 

There has been no change in the Company’s internalcontrol over financial reporting during the Company’s quarter ended September 30,2008, that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**PART II. OTHER INFORMATION**

 

# **ITEM 1:         LEGALPROCEEDINGS**

#  

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.

 

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.

 

Pleaserefer to IMH’s report on Form 10-K for the year ended December 31,2007 and reports on Form 10-Q for the periods ending March 31, 2008and June 30, 2008 for a description of other litigation and claims.

 

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# **ITEM 1A:      RISKFACTORS**

#  

Our Annual Report on Form 10-Kfor the year ended December 31, 2007 and our quarterly reports on Form 10-Qfor the period ended March 31, 2008 and June 30, 2008, include adetailed discussion of additional risk factors. The information presented belowupdates and should be read in conjunction with the risk factors and informationdisclosed in that Form 10-K, in addition to the March 31, 2008 and June 30,2008 Form 10-Qs.

 

**Our ability to utilize our net operating losses andcertain other tax attributes may be limited.**

 

Asof December 31, 2007, we had net operating losses (NOLs) of approximately$159.7 million for federal income tax purposes and approximately $463.9 millionfor state income tax purposes.  Utilization of the NOLs and tax creditcarryforwards may be subject to a substantial annual limitation under Section 382of the Internal Revenue Code, and similar state provisions due to ownershipchange limitations that have occurred previously or that could occur in thefuture.  These ownership changes may limit the amount of NOL and taxcredit carryforwards and other deferred tax assets that can be utilized tooffset future taxable income and income tax, respectively. In general, anownership change, as defined by Section 382, results from transactionsincreasing ownership of certain stockholders or public groups in the stock ofthe corporation by more than 50 percentage points over a three-yearperiod.  To the extent that we consummate an exchange offer of ourpreferred stock, we believe that the exchange of the preferred stock for commonstock may result in an ownership change as defined under Section 382 ofthe Internal Revenue Code, which would be expected to create annual limitationson the Company’s ability to utilize NOL and tax credit carryovers.  Suchlimitations would result in approximately $223.1 million of tax benefitsrelated to NOL and tax credit carryforwards that will expire unused.  Anylimitation on our NOL carryforwards that could be used to offset post-ownershipchange taxable income would adversely affect our liquidity and cash flow in theevent we become profitable.  However, even if no ownership change occurs,we may not generate sufficient taxable income in future periods to be able torealize the tax benefits of our NOL carryforwards.

 

**Issuances of additional share of Common Stock mayadversely affect its market price and significantly dilute stockholders.**

 

Inorder to support our business objectives, we may raise capital through the saleof equity.  We may also issue additional shares of common stock if weconsummate an exchange offer of our Series B Preferred Stock and Series CPreferred Stock.  The issuance or sale, or the proposed sale, ofsubstantial amounts of our common stock in the public market could materiallyadversely effect the market price of our common stock or other outstandingsecurities.  We do not know the actual or perceived effect of theseissuances, the timing of any offerings or issuances of securities, thepotential dilution of the book value or earnings per share of our securitiesthen outstanding and the effect on the market price of our securities thenoutstanding.

 

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

#  

None.

 

# **ITEM 3:         DEFAULTSUPON SENIOR SECURITIES**

#  

None.

 

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

#  

*Annual Meeting of Stockholders*

 

On July 10, 2008, we held our annual meeting ofstockholders. Of 76,104,656 shares eligible to vote, 69,745,926, or 91.6percent, votes were returned, formulating a quorum.  At the annual stockholders meeting, thefollowing matters were submitted to stockholders for vote Proposal I - Electionof Directors; Proposal II - Ratification of the appointment of Ernst &Young LLP as our independent auditors for the year ending December 31,2008; Proposal III – Amendments to the 2001 Stock Option, Deferred Stock, andRestricted Stock Plan; and 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.

 

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**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 approved with 30,884,180shares voted for, 13,826,301 voted against and 738,942 abstained from voting,thereby ratifying the amendment to the 2001Stock Option, Deferred Stock, and Restricted Stock Plan.

 

**Proposal IV – Potential Issuance of in excess of 20 percentof 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 shares voted for, 2,573,181voted against and 318,320 abstained from voting, thereby approving the potential issuance of in excess of 20 percentof our outstanding shares of common stock in connection with a possibleexchange of the Company’s Series B Preferred Stock and Series CPreferred Stock.

 

# **ITEM 5:         OTHERINFORMATION**

#  

*Termination of Advisory ServicesAgreement*

 

Inthe first quarter of 2008, we entered into an agreement with a real estatemarketing company to generate advisory fees. The real estate marketing companyspecializes in the marketing of foreclosed properties. On November 12, 2008,the Company and the real estate marketing company agreed to terminate theadvisory services agreement. The Company will receive approximately $37million, inclusive of the $7.4 million receivable included in other assets inthe consolidated balance sheet at September 30, 2008.

 

# **ITEM 6:         EXHIBITS**

#  

(a)   Exhibits:

 
| 10.1    |   | Amended  and Restated Master Purchase Agreement between UBS Real Estate  Securities, Inc., Impac Funding Corporation, Impac Mortgage  Holdings, Inc. and Impac Warehouse Lending Group, Inc. dated as of  September 11, 2008. |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1(a) |   | Waiver  Agreement with UBS Real Estate Securities, Inc., dated  September 11, 2008.                                                                                                                                                     |
| 10.1(b) |   | Fee  Letter with UBS Real Estate Securities, Inc., dated September 11, 2008.                                                                                                                                                                 |
| 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 18 of the  Securities Exchange Act of 1934 or otherwise subject to the liabilities of  that section, nor shall it be deemed incorporated by reference in any filing  under the Securities Act of 1933 or the Securities Exchange Act of 1934,  whether made before or after the date hereof and irrespective of any general  incorporation language in any filings. |
|---|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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# **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,thereunto duly authorized.

 

IMPACMORTGAGE HOLDINGS, INC.

 
| /s/  Todd R. Taylor                                                 |   |
|---------------------------------------------------------------------|--------|
| by:  Todd R. Taylor                                                 |   |
| Chief  Financial Officer                                            |   |
| (authorized  officer of registrant and principal financial officer) |   |
|                                                                |   |
| Date:  November 12, 2008                                       |   |

 

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