# **UNITEDSTATES**

# **SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

## **FORM10-Q**

| **x****        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                    | ** ** | ** ** |
| ** **                                                                                                                                    | ** ** | **For the  quarterly period ended June 30, 2007 or** |
| ** **                                                                                                                                    | ** ** | ** ** |
| **o****        TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                    to                    .**

**Commission File Number: 1-14100**

**IMPACMORTGAGE HOLDINGS, INC.**

(Exact name of registrant as specified in its charter)

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

 

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

**(Address of principal executive offices)**

**(949)475-3600**

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

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act.

Large accelerated filer xAccelerated filer o Non-acceleratedfiler o

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

There were 76,083,865shares of common stock outstanding as of August 14, 2007.

 

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**IMPACMORTGAGE HOLDINGS, INC.**

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

**TABLE OF CONTENTS**
|           | ** ** | ** **                                                                                                                          | ** ** | **Page** |
|-----------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
|      | ** ** | **PART  I. FINANCIAL INFORMATION**                                                                                                  |       |     |
|      |       |                                                                                                                                |       |     |
| ITEM 1.   | ** ** | **CONSOLIDATED  FINANCIAL STATEMENTS**                                                                                              |       | 1        |
|      |       | Consolidated  Balance Sheets as of June 30, 2007 and December 31, 2006                                                              |       | 1        |
|      |       | Consolidated Statements of Operations and  Comprehensive Earnings (Loss) for the Three and Six Months Ended June 30,  2007 and 2006 |       | 2        |
|      |       | Consolidated Statements of Cash Flows for the Six  Months Ended June 30, 2007 and 2006                                              |       | 4        |
|      |       | Notes to Consolidated Financial Statements                                                                                          |       | 6        |
|      |       |                                                                                                                                |       |     |
| ITEM 2.   | ** ** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS**                                     |       | 16       |
|      | ** ** |
|      |       | Forward-Looking  Statements                                                                                                         |       | 16       |
|      |       | The Mortgage Banking Industry and Discussion of  Relevant Fiscal Periods                                                            |       | 16       |
|      |       | General  Overview                                                                                                                   |       | 17       |
|      |       | Critical Accounting Policies                                                                                                        |       | 18       |
|      |       | Financial Highlights for the Second Quarter of 2007                                                                                 |       | 19       |
|      |       | Second Quarter and Year-to-date 2007 Taxable Income                                                                                 |       | 20       |
|      |       | Financial Condition and Results of Operations                                                                                       |       | 22       |
|      |       | Liquidity and Capital Resources                                                                                                     |       | 43       |
|      |       |                                                                                                                                |       |     |
| ITEM 3.   | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                     |       | 47       |
|      |       |                                                                                                                                |       |     |
| ITEM 4.   |       | **CONTROLS AND  PROCEDURES**                                                                                                        |       | 50       |
|      |       |                                                                                                                                |       |     |
|      | ** ** | **PART  II. OTHER INFORMATION**                                                                                                     |       | 50       |
|      |       |                                                                                                                                |       |     |
| ITEM  1.  |       | **LEGAL PROCEEDINGS**                                                                                                               |       | 50       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM  1A. |       | **RISK  FACTORS**                                                                                                                   |       | 51       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM 2.   |       | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                                    |       | 51       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM 3.   |       | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                                |       | 51       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM 4.   |       | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                            |       | 51       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM  5.  |       | **OTHER INFORMATION**                                                                                                               |       | 52       |
|      |       | ** **                                                                                                                          |       |     |
| ITEM  6.  |       | **EXHIBITS**                                                                                                                        |       | 52       |
|      |       | ** **                                                                                                                          |       |     |
|      |       | **SIGNATURES**                                                                                                                      |       | 53       |
|      |       | ** **                                                                                                                          |       |     |
|      |       | **CERTIFICATIONS**                                                                                                                  |       |     |

 

----

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

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

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED BALANCE SHEETS**

**(dollaramounts in thousands, except share data)**
| ** **                                                                                                                                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                                             | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                             |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                             |       | $                 | 113,180    |                  | $          | 179,677 |   |
| Restricted cash                                                                                                                                                                                                                        |       | 6,598             |       | 617                   |       |
| Securitized mortgage  collateral                                                                                                                                                                                                       |       | 20,388,616        |       | 21,050,829            |       |
| Finance receivables                                                                                                                                                                                                                    |       | 132,985           |       | 306,294               |       |
| Mortgages  held-for-investment                                                                                                                                                                                                         |       | 4,319             |       | 1,880                 |       |
| Allowance for loan  losses                                                                                                                                                                                                             |       | (220,944          | )          | (91,775               | )          |
| Mortgages held-for-sale                                                                                                                                                                                                                |       | 1,362,204         |       | 1,561,919             |       |
| Accrued interest  receivable                                                                                                                                                                                                           |       | 115,540           |       | 115,054               |       |
| Derivative assets                                                                                                                                                                                                                      |       | 145,505           |       | 147,291               |       |
| Real estate owned, net                                                                                                                                                                                                                 |       | 352,935           |       | 161,538               |       |
| Other assets                                                                                                                                                                                                                           |       | 162,647           |       | 165,631               |       |
| Total assets                                                                                                                                                                                                                           |       | $                 | 22,563,585 |                  | $          | 23,598,955 |   |
|                                                                                                                                                                                                                                   |       |              |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                                                        | ** ** | ** **        | ** ** | ** **            | ** ** |
| Securitized mortgage  borrowings                                                                                                                                                                                                       |       | $                 | 20,075,004 |                  | $          | 20,526,369 |   |
| Reverse repurchase  agreements                                                                                                                                                                                                         |       | 1,575,314         |       | 1,880,395             |       |
| Trust preferred  securities                                                                                                                                                                                                            |       | 98,052            |       | 97,661                |       |
| Other liabilities                                                                                                                                                                                                                      |       | 112,953           |       | 85,000                |       |
| Total  liabilities                                                                                                                                                                                                                     |       | 21,861,323        |       | 22,589,425            |       |
|                                                                                                                                                                                                                                   |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                                                         |       |              |       |                  |       |
|                                                                                                                                                                                                                                   |       |              |       |                  |       |
| **STOCKHOLDERS'  EQUITY**                                                                                                                                                                                                              | ** ** | ** **        | ** ** | ** **            | ** ** |
| Series-A junior  participating preferred stock, $0.01 par value; 2,500,000 shares authorized;  none issued and outstanding as of June 30, 2007 and December 31, 2006,  respectively                                                    |       | —            |       | —                |       |
| Series-B 9.375%  cumulative redeemable preferred stock, $0.01 par value; liquidation value  $50,000; 2,000,000 shares authorized, 2,000,000 shares issued and outstanding  as of June 30, 2007 and December 31, 2006, respectively     |       | 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 and 4,444,000 shares  outstanding as of June 30, 2007 and December 31, 2006, respectively |       | 45                |       | 44                    |       |
| Common stock, $0.01 par  value; 200,000,000 shares authorized; 76,083,865 shares issued and  outstanding as of June 30, 2007 and December 31, 2006                                                                                     |       | 761               |       | 761                   |       |
| Additional paid-in  capital                                                                                                                                                                                                            |       | 1,173,027         |       | 1,170,872             |       |
| Accumulated other  comprehensive income                                                                                                                                                                                                |       | 1,235             |       | 2,357                 |       |
| Net accumulated  deficit:                                                                                                                                                                                                              |       |              |       |                  |       |
| Cumulative  dividends declared                                                                                                                                                                                                         |       | (796,469          | )          | (762,382              | )          |
| Retained  earnings                                                                                                                                                                                                                     |       | 323,643           |       | 597,858               |       |
| Net accumulated  deficit                                                                                                                                                                                                               |       | (472,826          | )          | (164,524              | )          |
| Total  stockholders’ equity                                                                                                                                                                                                       |       | 702,262           |       | 1,009,530             |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                       |       | $                 | 22,563,585 |                  | $          | 23,598,955 |   |

 

See accompanying notes to consolidated financialstatements.

1

----

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**ANDCOMPREHENSIVE EARNINGS (LOSS)**

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

**(unaudited)**

 
| ** **                                               | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                               | ** ** | **2007**                                | ** ** | **2006**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| **INTEREST  INCOME:**                                    | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage assets                                          |       | $                                       | 334,694    |                                  | $          | 311,263 |   | $ | 675,465 |   | $ | 644,639 |   |
| Other                                                    |       | 2,316                                   |       | 2,496                                 |       | 4,366 |   | 4,325 |   |
| Total interest income                                    |       | 337,010                                 |       | 313,759                               |       | 679,831 |   | 648,964 |   |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| **INTEREST  EXPENSE:**                                   | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings                          |       | 304,551                                 |       | 302,744                               |       | 597,928 |   | 598,219 |   |
| Reverse repurchase agreements                            |       | 17,236                                  |       | 23,456                                |       | 50,973 |   | 49,329 |   |
| Other borrowings                                         |       | 2,240                                   |       | 2,306                                 |       | 4,492 |   | 4,688 |   |
| Total interest expense                                   |       | 324,027                                 |       | 328,506                               |       | 653,393 |   | 652,236 |   |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| Net interest income (expense)                            |       | 12,983                                  |       | (14,747                               | )          | 26,438 |   | (3,272 | ) |
| Provision for loan losses                                |       | 162,981                                 |       | (45                                   | )          | 192,355 |   | 105 |   |
| Net interest expense after provision for loan losses     |       | (149,998                                | )          | (14,702                               | )          | (165,917 | ) | (3,377 | ) |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| **NON-INTEREST  INCOME:**                                | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Change in fair value of derivative instruments           |       | 56,900                                  |       | 11,504                                |       | (1,861 | ) | 62,933 |   |
| Realized gain from derivative instruments                |       | 38,640                                  |       | 55,868                                |       | 76,099 |   | 96,004 |   |
| Gain (loss) on sale of loans                             |       | 2,406                                   |       | 16,548                                |       | (6,725 | ) | 30,741 |   |
| Amortization of mortgage servicing rights                |       | (206                                    | )          | (381                                  | )          | (416 | ) | (732 | ) |
| (Loss) gain on sale of other real estate owned           |       | (1,060                                  | )          | 621                                   |       | (215 | ) | 976 |   |
| Loss on lower of cost or market writedown                |       | (10,180                                 | )          | (18,780                               | )          | (34,874 | ) | (15,283 | ) |
| Goodwill impairment                                      |       | (12,360                                 | )          | —                                |       | (12,360 | ) | — |   |
| Provision for REO losses                                 |       | (18,421                                 | )          | —                                |       | (28,311 | ) | — |   |
| Provision for repurchases                                |       | (18,889                                 | )          | (12,773                               | )          | (30,718 | ) | (23,110 | ) |
| Other income (expense)                                   |       | (314                                    | )          | 9,581                                 |       | 5,334 |   | 18,403 |   |
| Total non-interest income (expense)                      |       | 36,516                                  |       | 62,188                                |       | (34,047 | ) | 169,932 |   |
|                                                     |       |                                    |       |                                  |       |   |   |   |   |
| **NON-INTEREST  EXPENSE:**                               | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Personnel expense                                        |       | 23,640                                  |       | 16,710                                |       | 42,028 |   | 35,331 |   |
| General and administrative and other expense             |       | 4,487                                   |       | 4,524                                 |       | 9,609 |   | 9,600 |   |
| Professional services                                    |       | 2,137                                   |       | 2,192                                 |       | 4,831 |   | 4,509 |   |
| Equipment expense                                        |       | 1,550                                   |       | 1,809                                 |       | 3,108 |   | 3,319 |   |
| Occupancy expense                                        |       | 2,846                                   |       | 1,244                                 |       | 6,667 |   | 2,612 |   |
| Data processing expense                                  |       | 1,185                                   |       | 744                                   |       | 2,922 |   | 2,110 |   |
| Total non-interest expense                               |       | 35,845                                  |       | 27,223                                |       | 69,165 |   | 57,481 |   |
| Net (loss) earnings before income taxes                  |       | (149,327                                | )          | 20,263                                |       | (269,129 | ) | 109,074 |   |
| Income tax expense (benefit)                             |       | 3,220                                   |       | (6,093                                | )          | 5,086 |   | (2,848 | ) |
| Net (loss) earnings                                      |       | (152,547                                | )          | 26,356                                |       | (274,215 | ) | 111,922 |   |
| Cash dividends on cumulative redeemable preferred  stock |       | (3,722                                  | )          | (3,672                                | )          | (7,443 | ) | (7,344 | ) |
| Net (loss) earnings available to common stockholders     |       | $                                       | (156,269   | )                                     | $          | 22,684 |   | $ | (281,658 | ) | $ | 104,578 |   |

 

See accompanying notes to consolidated financial statements.

2

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**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS (LOSS) - (continued)**

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

**(unaudited)**

 
| ** **                                          | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                          | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                          | ** ** | **2007**                                | ** ** | **2006**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net (loss) earnings                                 |       | $                                       | (152,547   | )                                     | $          | 26,356 |   | $ | (274,215 | ) | $ | 111,922 |   |
| Net unrealized gains (losses) on securities:        |       |                                    |       |                                  |       |   |   |   |   |
| Unrealized holding losses arising during year       |       | (1,656                                  | )          | (991                                  | )          | (2,718 | ) | (1,778 | ) |
| Reclassification of losses included in net earnings |       | 1,596                                   |       | (55                                   | )          | 1,596 |   | 143 |   |
| Net unrealized losses                               |       | (60                                     | )          | (1,046                                | )          | (1,122 | ) | (1,635 | ) |
| Comprehensive  (loss) earnings                      |       | $                                       | (152,607   | )                                     | $          | 25,310 |   | $ | (275,337 | ) | $ | 110,287 |   |
|                                                |       |                                    |       |                                  |       |   |   |   |   |
| Net (loss)  earnings per share:                     |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                               |       | $                                       | (2.05      | )                                     | $          | 0.30 |   | $ | (3.70 | ) | $ | 1.37 |   |
| Diluted                                             |       | $                                       | (2.05      | )                                     | $          | 0.30 |   | $ | (3.70 | ) | $ | 1.37 |   |
| Dividends  declared per common share                |       | $                                       | —     |                                  | $          | 0.25 |   | $ | 0.10 |   | $ | 0.50 |   |

 

See accompanying notes to consolidated financial statements.

3

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**
| ** **                                                                       | ** **   | **For the Six Months** | ** **   |
|----------------------------------------------------------------------------------|--------------|---------------------------------------|--------------|
| ** **                                                                       | ** **   | **Ended June 30,**          | ** **   |
| ** **                                                                       | ** **   | **2007**                              | ** **   | **2006** | ** ** |
| ** **                                                                       | *** *** | ** **                            | *** *** | **restated** | *** *** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                       |         |                                  |         |   |   |
| Net (loss) earnings                                                              |         | $                                     | (274,215     | ) | $ | 111,922 |   |
| Adjustments to reconcile net earnings to net cash  used in operating activities: |         |                                  |         |   |   |
| Provision for loan losses                                                        |         | 192,355                               |         | 105 |   |
| Provision for REO losses                                                         |         | 28,311                                |         | — |   |
| Amortization of deferred charge, net                                             |         | 9,069                                 |         | 11,011 |   |
| Amortization of premiums, securitization costs and  debt issuance costs          |         | 85,422                                |         | 126,952 |   |
| (Gain) loss on sale of other real estate owned                                   |         | 215                                   |         | (976 | ) |
| (Gain) loss on sale of loans                                                     |         | 6,725                                 |         | (30,741 | ) |
| Provision for repurchases                                                        |         | 30,718                                |         | 23,110 |   |
| Loss on lower of cost or market writedown                                        |         | 34,874                                |         | 15,283 |   |
| Change in fair value of derivative instruments                                   |         | 1,861                                 |         | (62,933 | ) |
| Purchase of mortgages held-for-sale                                              |         | (4,229,695                            | )            | (4,915,058 | ) |
| Sale and principal reductions on mortgages  held-for-sale                        |         | 1,145,966                             |         | 5,084,020 |   |
| Net change in deferred taxes                                                     |         | 20,060                                |         | 84 |   |
| Stock-based compensation                                                         |         | 1,639                                 |         | 1,332 |   |
| Depreciation and amortization                                                    |         | 2,930                                 |         | 2,998 |   |
| Goodwill impairment                                                              |         | 12,360                                |         | — |   |
| Amortization and impairment of mortgage servicing  rights                        |         | 416                                   |         | 732 |   |
| Net change in accrued interest (receivable) payable                              |         | (486                                  | )            | 20,571 |   |
| Net change in restricted cash                                                    |         | (5,981                                | )            | 37 |   |
| Net change in other assets and liabilities                                       |         | (61,338                               | )            | 3,493 |   |
| Net cash (used in) provided by operating activities                              |         | (2,998,794                            | )            | 391,942 |   |
|                                                                             |         |                                  |         |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                       | ** **   | ** **                            | ** **   | ** ** | ** ** |
| Net change in securitized mortgage collateral                                    |         | 3,491,323                             |         | 4,608,289 |   |
| Finance receivable advances to customers                                         |         | (1,954,790                            | )            | (2,180,281 | ) |
| Repayments of finance receivables                                                |         | 2,128,099                             |         | 2,238,212 |   |
| Purchase of premises and equipment                                               |         | (9,202                                | )            | (3,932 | ) |
| Net change in mortgages held-for-investment                                      |         | (3,229                                | )            | 38,230 |   |
| Sale of investment securities available-for-sale                                 |         | —                                |         | 35,146 |   |
| Distribution of deferred compensation plan benefits                              |         | —                                |         | 8,041 |   |
| Net principal reductions on investment securities  available-for-sale            |         | 6,417                                 |         | (28,787 | ) |
| Proceeds from the sale of other real estate owned                                |         | 80,822                                |         | 38,134 |   |
| Net cash provided by investing activities                                        |         | 3,739,440                             |         | 4,753,052 |   |
|                                                                             |         |                                  |         |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                       | ** **   | ** **                            | ** **   | ** ** | ** ** |
| Cash disbursements under reverse repurchase  agreements                          |         | (6,687,335                            | )            | (9,419,575 | ) |
| Cash receipts from reverse repurchase agreements                                 |         | 6,382,254                             |         | 8,267,985 |   |
| Proceeds from securitized mortgage borrowings                                    |         | 3,858,143                             |         | 919,769 |   |
| Repayment of securitized mortgage borrowings                                     |         | (4,323,044                            | )            | (4,837,825 | ) |
| Common stock dividends paid                                                      |         | (30,326                               | )            | (34,253 | ) |
| Preferred stock dividends paid                                                   |         | (7,443                                | )            | (7,344 | ) |
| Proceeds from sale of cumulative redeemable  preferred stock                     |         | 608                                   |         | 272 |   |
| Net cash used in financing activities                                            |         | (807,143                              | )            | (5,110,971 | ) |
|                                                                             |         |                                  |         |   |   |
| Net change in cash and cash equivalents                                          |         | (66,497                               | )            | 34,023 |   |
| Cash and cash equivalents at beginning of period                                 |         | 179,677                               |         | 146,621 |   |
| Cash and cash  equivalents at end of period                                      |         | $                                     | 113,180      |   | $ | 180,644 |   |

 

See accompanyingnotes to consolidated financial statements.

4

----

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**
| ** **                                                                | ** **   | **For the Six Months** | ** **   |
|---------------------------------------------------------------------------|--------------|---------------------------------------|--------------|
| ** **                                                                | ** **   | **Ended June 30,**          | ** **   |
| ** **                                                                | ** **   | **2007**                              | ** **   | **2006** | ** ** |
| ** **                                                                | *** *** | *** ***                          | *** *** | **restated** | *** *** |
| **SUPPLEMENTARY INFORMATION:**                                       |         |                                  |         |   |   |
| Interest paid                                                             |         | $                                     | 651,736      |   | $ | 517,438 |   |
| Taxes paid                                                                |         | 116                                   |         | 45 |   |
|                                                                      |         |                                  |         |   |   |
| **NON-CASH  TRANSACTIONS:**                                               | ** **   | ** **                            | ** **   | ** ** | ** ** |
| Accumulated other comprehensive loss                                      |         | $                                     | (1,122       | ) | $ | (1,635 | ) |
| Dividends declared but unpaid                                             |         | —                                |         | 19,028 |   |
| Transfer of mortgages to other real estate owned                          |         | 20,872                                |         | 2,575 |   |
| Transfer of securitized mortgage collateral to other  real estate owned   |         | 255,051                               |         | 68,300 |   |
| Transfer of loans held-for-sale to securitized  mortgage collateral       |         | 3,245,500                             |         | 694,336 |   |
| Transfer of loans held-for-investment to securitized  mortgage collateral |         | —                                |         | 225,764 |   |
| Transfer of  securitized mortgage collateral to loans held-for-sale       |         | 27,040                                |         | — |   |

 

See accompanyingnotes to consolidated financial statements.

5

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

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(dollars inthousands, except per share data or as otherwise indicated)**

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

**1.     BusinessSummary and Financial Statement Presentation**

*Market Conditions*

 

During the secondquarter, the secondary and securitization mortgage markets have deteriorated,become more unpredictable and volatile, making it more difficult to sell loansand securities to investors.  In addition,because housing prices have declined, default and credit losses have increased;investors are requiring higher returns, reducing the price of mortgageloans.  As a result, the loans have notperformed up to expectations and the fair value of mortgage loans hasdeteriorated.  

 

In light of the continuedand widely publicized volatility in the secondary and securitization markets, theCompany suspended funding on loans previously referred to as Alt-A loans inAugust 2007 and currently do not have any plans to originate these types ofloans in the near future. At this point, the Company is only funding loans thatare eligible to be sold to government sponsored agencies.

** **

***BusinessSummary***

Impac MortgageHoldings, Inc. (the Company or IMH), is a Maryland corporationincorporated in August 1995, and has the following subsidiaries, IMHAssets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG), andImpac Funding Corporation (IFC), together with its wholly-ownedsubsidiaries Impac Secured Assets Corp. (ISAC), and Impac Commercial CapitalCorporation (ICCC).

The Company is a mortgage realestate investment trust, or “REIT,” that is a nationwide acquirer, originator,seller and investor of non-conforming Alt-A residential mortgages, or “Alt-Amortgages,” and to a lesser extent, small-balance, commercial and multi-familymortgages, or “commercial mortgages.” We also provide warehouse financing tooriginators of mortgages.

Duringthe six months ended June 30, 2007, the Company operated four core businesses:

·      the Long-Term Investment operationsconducted by IMH and IMH Assets;

·      the Mortgage Operations conducted by IFCand ISAC;

·      the Commercial Operations conducted byICCC; and

·      the Warehouse Lending Operations conductedby IWLG.

The long-term investmentoperations and the warehouse lending operations are conducted by IMH and IWLGat the REIT. The mortgage operations and commercial operations, which are eacha taxable REIT subsidiary (TRS), are conducted by IFC and ICCC, respectively.

The long-term investmentoperations generate earnings primarily from net interest income earned onmortgages held as securitized mortgage collateral and mortgagesheld-for-investment collectively (long-term mortgage portfolio) and associatedhedging derivative cash flows. The long-term mortgage portfolio as reported onthe Company’s consolidated balance sheet consists of mortgages held assecuritized mortgage collateral and mortgages held-for-investment. Investmentsin Alt-A mortgages and commercial mortgages are initially financed withshort-term borrowings supported by reverse repurchase agreements that aresubsequently converted to long-term financing in the form of collateralized mortgageobligations (CMOs) and real estate mortgage investment conduits (REMICs). Cashflows from the long-term mortgage portfolio, proceeds from the prior sale ofcapital stock and the issuance of trust preferred securities also finance theacquisitions of new residential and commercial mortgages.

The mortgage operationsacquire, originate, sell and securitize primarily Alt-A adjustable ratemortgages (ARMs) and fixed rate mortgages (FRMs) from correspondents, mortgagebrokers and retail customers. The Company also originates prime and agencyloans (Fannie Mae, Freddie Mac, FHA, VA). Correspondents originate and close mortgages under our mortgage programsand then sell the closed mortgages to the mortgage operations on a flow(loan-by-loan basis) or through bulk sale commitments. Correspondents includesavings and loan associations, commercial banks and mortgage bankers. Themortgage operations generate income by securitizing and selling mortgages topermanent investors, including the long-term investment operations. Theseoperations also earn revenue from fees associated with master servicing rightsand interest income earned on mortgages held-for-sale. The mortgage operationsuse warehouse facilities provided by the warehouse lending operations to financethe acquisition and origination of mortgages.

The commercial operationsoriginate commercial mortgages, that are primarily adjustable rate mortgageswith initial fixed interest rate periods of three-, five-, seven-and ten-years that subsequently convert to adjustable rate mortgages, or “hybridARMs,” with balances that generally range from $500,000 to $5.0 million orby additional underwriting exceptions up to $10 million. Commercialmortgages have an interest rate floor, which is the initial start rate; in somecircumstances have lock out periods, and prepayment penalty periods of three-,five-, seven- and ten-years. These mortgages provide greater assetdiversification on our balance sheet as commercial mortgage borrowers typicallyhave higher credit scores, typically have lower loan-to-value ratios, or “LTVratios,” and the mortgages have longer average lives than residentialmortgages.

6

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The warehouse lendingoperations provide short-term financing to mortgage loan originators, includingthe mortgage and commercial operations, by funding mortgages from their closingdate until sale to pre-approved investors. This business earns fees fromwarehouse transactions as well as net interest income from the differencebetween its cost of borrowings and the interest earned on warehouse advances,both of which are tied to the one-month London Inter-Bank Offered Rate (LIBOR)rate.

***Financial Statement Presentation***

Theaccompanying unaudited consolidated financial statements of IMH and oursubsidiaries (as defined above) have been prepared in accordance with GAAP forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X. Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principles(GAAP) for complete financial statements. In the opinion of management, alladjustments, consisting of normal recurring adjustments considered necessaryfor a fair presentation, have been included. Operating results for the six-monthperiod ended June 30, 2007 are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2007.

Allsignificant inter-company balances and transactions have been eliminated inconsolidation. In addition, certain amounts in the prior periods’ consolidatedfinancial statements have been reclassified to conform to the current yearpresentation.  The ownership interest inconsolidated subsidiaries from non-controlling shareholders is reflected asminority interest.

Management has made a number of estimates andassumptions relating to the reporting of assets and liabilities, the disclosureof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting periodto prepare these financial statements in conformity with GAAP.  The items affected by management’s estimatesand assumptions include allowance for loan losses, valuation of derivativefinancial instruments,  net realizablevalue of real estate owned (REO), repurchase liabilities related to sold loansand the amortization of various loan premiums and discounts due to prepaymentestimates. Actual results could differ from those estimates.

*Asset Purchase and relatedimpairment*

 

In May 2007, the Companycompleted the acquisition of certain production facilities from PinnacleFinancial Corporation (PFC), which is primarily located in the East Coast ofthe United States.  The PFC retailplatform originates prime and agency loans. This transaction was recorded as abusiness combination for accounting purposes resulting in the Company initiallyrecording $12.4 million in goodwill. Because of the current market environment, the goodwill was impaired andthe Company has recorded an impairment charge for the full amount.

**2.    Restated Consolidated Cash Flows for 2006 Interim Periods and Reclassifications**

Certain interim amounts in the 2006 ConsolidatedStatement of Cash Flows have been restated to reflect properly the specificintercompany activities related to cash receipts from loan sales and cashdisbursements for loan purchases between consolidated companies. Suchintercompany loan sale and purchase transaction activities had the effect ofpresenting separate cash inflows and outflows even though there was no cashinflow or outflow on a consolidated basis. This restatement serves to eliminatethis intercompany activity from its Consolidated Statements of Cash Flows andpresent them as non-cash transactions.

The restatement increases cash used in operatingactivities and increases cash provided by investing activities. The restatementof these transactions does not change total cash and cash equivalents aspreviously reported. Furthermore, the restatement has no effect on the Company’sConsolidated Statements of Operations and Comprehensive Earnings, orConsolidated Balance Sheets.

The Company has reclassified the presentation of theConsolidated Statement of Operations and Comprehensive Earnings (Loss) toreflect “Amortization of mortgage servicing rights,” “Write-down on investmentsecurities available-for-sale,” and “Loss (gain) on sale of other real estateowned” as other non-interest income rather than non-interest expense, for thesecond quarter of 2006 to conform to the current period presentation.  In addition, the “Amortization of deferredcharge” for 2006 was reclassified as income tax expense (benefit) rather thannon-interest expense.

Please refer to the Company’s Form 10-K for the yearended December 31, 2006, for more information regarding thesereclassifications.

7

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**3.     StockOptions**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”). ThisStatement requires companies to expense the estimated fair value of stockoptions and similar equity instruments issued to employees over the requisiteservice period. SFAS 123R eliminates the alternative to use the intrinsicmethod of accounting provided for in Accounting Principles Board OpinionNo. 25, Accounting for Stock Issued to Employees (“APB 25”), whichgenerally resulted in no compensation expense recorded in the financialstatements related to the grant of stock options to employees if certainconditions were met.

Effective for the first quarter of fiscal 2006, weadopted SFAS 123R using the modified prospective method, which required us torecord compensation expense for all awards granted after the date of adoption,and for the unvested portion of previously granted awards that remainedoutstanding at the date of adoption.

We continue using both the Black-Scholes-Mertonoption-pricing formula and straight-line amortization of compensation expenseover the requisite service period of the grant. We will reconsider use of theBlack-Scholes-Merton model if additional information becomes available in thefuture that indicates another model would be more appropriate for the Company,or if grants issued in future periods have characteristics that cannot bereasonably estimated using this model.

The following table presents a summary of optionactivity for the six months ended June 30, 2007, under the Company’s stockoption plans:
|                                           | ** ** | **Number of** | ** ** |
|-------------------------------------------|------------|--------------------|------------|
| ** **                                | ** ** | **Shares**         | ** ** |
| Options outstanding  at December 31, 2006 |       | 7,048,755          |       |
| Options granted                           |       | —             |       |
| Options  exercised                        |       | —             |       |
| Options  forfeited / cancelled            |       | (361,168           | )          |
| Options outstanding at  June 30, 2007     |       | 6,687,587          |       |

 

**4.     RecentAccounting Pronouncements**

In February 2007, the FASB issuedSFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities* (“SFAS 159”), whichprovides reporting entities an option to report selected financial assets,including investment securities designated as available for sale, andliabilities, including most insurance contracts, at fair value. SFASNo. 159 establishes presentation and disclosure requirements designed tofacilitate comparisons between companies that choose different measurementattributes for similar types of assets and liabilities. The standard alsorequires additional information to aid financial statement users’ understandingof a reporting entity’s choice to use fair value on its earnings and alsorequires entities to display on the face of the balance sheet the fair value ofthose assets and liabilities which the reporting entity has chosen to measureat fair value. SFAS No. 159 is effective as of the beginning of areporting entity’s first fiscal year beginning after November 15, 2007.The Company is currently assessing the effect that SFAS 159 will have on theconsolidated financial statements.

In September 2006, the FASBissued SFAS No. 157, *Fair ValueMeasurement* (“SFAS 157”), which defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements.SFAS 157 is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. The Company is currentlyassessing the effect that SFAS 157 will have on the consolidated financialstatements.

In June 2006, the FASBissued Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes,* (“FIN 48”) which expands on theaccounting guidance of FASB Statement No. 109, *Accounting for Income Taxes*. This interpretation prescribesa recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. The adoption of this interpretation by the Company hasnot had a significant effect on the consolidated financial statements.

8

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In March 2006, the FASBissued SFAS No. 156, “*Accounting forServicing of Financial Assets - an amendment of FASB Statement No. 140”*(“SFAS 156”). This statement requires an entity to recognize a servicingasset or servicing liability each time it undertakes an obligation to service afinancial asset by entering into a servicing contract. This statement alsorequires separate presentation of servicing assets and servicing liabilitiessubsequently measured at fair value in the statement of financial position andadditional disclosures for all separately recognized servicing assets andservicing liabilities. An entity should adopt this statement as of thebeginning of its first fiscal year that begins after September 15, 2006.The adoption of this statement has not had a material effect on theconsolidated financial statements.

In February 2006, the FASBissued SFAS No. 155, *“Accounting forCertain Hybrid Financial Instruments an amendment of FASB StatementsNo. 133 and SFAS No. 140”* (“SFAS 155”). Thisstatement permits fair value re-measurement for any hybrid financial instrumentthat contains an embedded derivative that otherwise would require bifurcation.It also clarifies which interest-only strips and principal-only strips are notsubject to FASB Statement No. 133, “Accounting for Derivative Instrumentsand Hedging Activities” (“SFAS 133”). SFAS 155 is effective for allfinancial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006.  The adoption of this statement has not had amaterial effect on the consolidated financial statements.

**5.     LegalProceedings**

The Company isparty 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.

The Company's 2006 10-K reported shareholder derivative actions filedagainst the Company and its senior officers and directors in the U.S. DistrictCourt, Central District of California and Orange County Superior Court. In 2007, the Company entered into an agreement to settle the currently pendingfederal and state derivative actions against the Company and its seniorofficers and directors. Under the proposed settlement, all claims assertedagainst the officers and directors named as defendants in those actions will bedismissed with prejudice with no admission of wrongdoing on the part of anydefendant and the Company will agree to certain corporate governance practices.In addition, the proposed settlement will provide for an aggregate cash paymentof up to $300,000 in attorney's fees subject to plaintiff's application to andapproval by the court, which will be paid entirely by the Company's insurancecarriers and will have no effect on the financial position of the Company.  The settlement was executed and approved bythe court on June 19, 2007.  Subsequentto that, an objecting stockholder filed an appeal and, as such, the settlementis not final until the appeal is resolved.

**Note B—Reconciliation of EarningsPer Share**

Thefollowing table presents the computation of basic and diluted net earnings pershare including the dilutive effect of stock options and cumulative redeemablepreferred stock outstanding for the periods indicated:
|                                                                                 | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                                      | ** ** | **2007**                                | ** ** | **2006**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Numerator  for basic earnings per share:**                                    | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss)  earnings                                                            |       | $                                       | (152,547   | )                                     | $          | 26,356 |   | $ | (274,215 | ) | $ | 111,922 |   |
| Less: Cash dividends on cumulative redeemable  preferred stock                  |       | (3,722                                  | )          | (3,672                                | )          | (7,443 | ) | (7,344 | ) |
| Net (loss)  earnings available to common stockholders                           |       | $                                       | (156,269   | )                                     | $          | 22,684 |   | $ | (281,658 | ) | $ | 104,578 |   |
| **Denominator  for basic earnings per share:**                                  | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic weighted  average number of common shares outstanding during the period   |       | 76,084                                  |       | 76,113                                |       | 76,084 |   | 76,113 |   |
| **Denominator  for diluted earnings per share:**                                | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Diluted weighted  average number of common shares outstanding during the period |       | 76,084                                  |       | 76,113                                |       | 76,084 |   | 76,113 |   |
| Net effect of dilutive stock options                                            |       | —                                  |       | 307                                   |       | — |   | 288 |   |
| Diluted weighted  average common shares                                         |       | 76,084                                  |       | 76,420                                |       | 76,084 |   | 76,401 |   |
|                                                                            |       |                                    |       |                                  |       |   |   |   |   |
| Net (loss)  earnings per share:                                                 |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                                           |       | $                                       | (2.05      | )                                     | $          | 0.30 |   | $ | (3.70 | ) | $ | 1.37 |   |
| Diluted                                                                         |       | $                                       | (2.05      | )                                     | $          | 0.30 |   | $ | (3.70 | ) | $ | 1.37 |   |

 

Forthe three and six month periods ended June 30, 2007, stock options to purchase6.7 million shares were outstanding but not included in the above weightedaverage calculations because they were anti-dilutive.

Forthe three and six month periods ended June 30, 2006, stock options to purchase4.1 million and 4.3 million shares, respectively, were outstanding but notincluded in the above weighted average calculations because they wereanti-dilutive.

9

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**Note C—Segment Reporting**

The followingtables present reporting segments for the three and six month periods endedJune 30, 2007 and 2006:
| ** **                                      | ** ** | **Reporting Segments as of and for the Three Months** | ** ** | ** **     | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------|------------|
| ** **                                      | ** ** | **Ended June 30, 2007**                                                        | ** ** | ** **     | ** ** |
| ** **                                      | ** ** | **Long-Term**                                                                                 | ** ** | **Warehouse**  | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                                | ** ** | **Lending**    | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Operations**                                                                                | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| **Income  Statement Items:**                    |       |                                                                                          |       |           |       |   |   |   |   |   |   |   |   |
| Net interest  (expense) income                  |       | $                                                                                             | (975       | )              | $          | 3,727 |   | $ | (1,851 | ) | $ | (68 | ) | $ | 12,150 |   | $ | 12,983 |   |
| Provision  (benefit) for loan losses            |       | 161,594                                                                                       |       | 2,630          |       | (1,243 | ) | — |   | — |   | 162,981 |   |
| Realized gain  from derivative instruments      |       | 38,401                                                                                        |       | —         |       | 115 |   | 124 |   | — |   | 38,640 |   |
| Change in fair  value of derivative instruments |       | 53,269                                                                                        |       | —         |       | 742 |   | 2,889 |   | — |   | 56,900 |   |
| Other  non-interest (expense) income            |       | (24,119                                                                                       | )          | 474            |       | (25,429 | ) | (233 | ) | (9,717 | ) | (59,024 | ) |
| Non-interest  expense and income taxes          |       | 4,765                                                                                         |       | 2,248          |       | 24,108 |   | 2,975 |   | 4,969 |   | 39,065 |   |
| Net (loss)  earnings                            |       | $                                                                                             | (99,783    | )              | $          | (677 | ) | $ | (49,288 | ) | $ | (263 | ) | $ | (2,536 | ) | $ | (152,547 | ) |

 
| ** **                                                         | ** ** | **Reporting Segments as of and for the Six Months** | ** ** | ** **     | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------------|------------|
| ** **                                                         | ** ** | **Ended June 30, 2007**                                                      | ** ** | ** **     | ** ** |
| ** **                                                         | ** ** | **Long-Term**                                                                               | ** ** | **Warehouse**  | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Investment**                                                                              | ** ** | **Lending**    | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Operations**                                                                              | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| **Balance  Sheet Items:**                                          | ** ** | ** **                                                                                  | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized  mortgage collateral and mortgages held-for-investment |       | $                                                                                           | 20,445,335 |           | $          | — |   | $ | 81,866 |   | $ | — |   | $ | (134,266 | ) | $ | 20,392,935 |   |
| Mortgages  held-for-sale                                           |       | 26,380                                                                                      |       | —         |       | 1,038,363 |   | 297,461 |   | — |   | 1,362,204 |   |
| Finance  receivables                                               |       | —                                                                                      |       | 1,402,314      |       | — |   | — |   | (1,269,329 | ) | 132,985 |   |
| Allowance for  loan losses                                         |       | (214,734                                                                                    | )          | (4,989         | )          | (1,221 | ) | — |   | — |   | (220,944 | ) |
| Total assets                                                       |       | 20,905,985                                                                                  |       | 1,613,337      |       | 1,218,994 |   | 307,943 |   | (1,482,674 | ) | 22,563,585 |   |
| Total  stockholders’ equity                                   |       | 631,870                                                                                     |       | 255,681        |       | (6,650 | ) | 10,179 |   | (188,818 | ) | 702,262 |   |
|                                                               |       |                                                                                        |       |           |       |   |   |   |   |   |   |   |   |
| **Income  Statement Items:**                                       | ** ** | ** **                                                                                  | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  (expense) income                                     |       | $                                                                                           | (2,602     | )              | $          | 12,178 |   | $ | (6,183 | ) | $ | (383 | ) | $ | 23,428 |   | $ | 26,438 |   |
| Provision  (benefit) for loan losses                               |       | 190,444                                                                                     |       | 2,343          |       | (432 | ) | — |   | — |   | 192,355 |   |
| Realized gain  from derivative instruments                         |       | 75,026                                                                                      |       | —         |       | 854 |   | 219 |   | — |   | 76,099 |   |
| Change in fair  value of derivative instruments                    |       | (1,354                                                                                      | )          | —         |       | (1,808 | ) | 1,301 |   | — |   | (1,861 | ) |
| Other  non-interest (expense) income                               |       | (34,106                                                                                     | )          | 1,214          |       | (51,590 | ) | (269 | ) | (23,534 | ) | (108,285 | ) |
| Non-interest  expense and income taxes                             |       | 9,963                                                                                       |       | 4,542          |       | 45,139 |   | 5,651 |   | 8,956 |   | 74,251 |   |
| Net (loss) earnings                                                |       | $                                                                                           | (163,443   | )              | $          | 6,507 |   | $ | (103,434 | ) | $ | (4,783 | ) | $ | (9,062 | ) | $ | (274,215 | ) |

 

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(1)                      Corporate overhead expenses are allocated tothe segments based on the percentage of time devoted to the segment, headcount,loan production, or other relevant measures. Income statement items include inter-company loan sale transactions andthe elimination of related gains or losses. Balance sheet items include inter-company warehouse borrowings and theelimination of related interest income and interest expense.

10

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| ** **                                      | ** ** | **Reporting Segments as of and for the Three Months** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Ended June 30, 2006**                                                        | ** ** |
| ** **                                      | ** ** | **Long–Term**                                                                            | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                                | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter–** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Operations**                                                                                | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| **Income Statement Items:**           |       |                                                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  (expense) income                  |       | $                                                                                             | (35,226    | ) | $ | 6,879 |   | $ | (2,664 | ) | $ | 56 |   | $ | 16,208 |   | $ | (14,747 | ) |
| Provision for  loan losses                      |       | (45                                                                                           | )          | — |   | — |   | — |   | — |   | (45 | ) |
| Realized gain  from derivative instruments      |       | 55,851                                                                                        |       | — |   | 4 |   | 13 |   | — |   | 55,868 |   |
| Change in fair  value of derivative instruments |       | 7,903                                                                                         |       | — |   | 629 |   | (1,058 | ) | 4,030 |   | 11,504 |   |
| Other non-nterest  income                       |       | 272                                                                                           |       | 751 |   | (5,265 | ) | 2,064 |   | (3,006 | ) | (5,184 | ) |
| Non-nterest  expense and income taxes           |       | 4,470                                                                                         |       | 1,627 |   | 8,787 |   | 2,696 |   | 3,550 |   | 21,130 |   |
| Net earnings (loss)                             |       | $                                                                                             | 24,375     |   | $ | 6,003 |   | $ | (16,083 | ) | $ | (1,621 | ) | $ | 13,682 |   | $ | 26,356 |   |

 
| ** **                                                       | ** ** | **Reporting Segments as of and for the Six Months** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Ended June 30, 2006**                                                      | ** ** |
| ** **                                                       | ** ** | **Long-Term**                                                                               | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Investment**                                                                              | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter–** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Operations**                                                                              | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| **Balance  Sheet Items:**                                        | ** ** | ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized  mortgage collateral and mortgages held-or-nvestment |       | $                                                                                           | 20,623,573 |   | $ | — |   | $ | — |   | $ | — |   | $ | (106,358 | ) | $ | 20,517,215 |   |
| Mortgages held-or-ale                                            |       | —                                                                                      |       | — |   | 1,076,090 |   | 127,133 |   | — |   | 1,203,223 |   |
| Finance  receivables                                             |       | —                                                                                      |       | 1,388,282 |   | — |   | — |   | (1,095,996 | ) | 292,286 |   |
| Allowance for  loan losses                                       |       | (57,389                                                                                     | )          | (10,683 | ) | — |   | — |   | — |   | (68,072 | ) |
| Total assets                                                     |       | 20,974,306                                                                                  |       | 1,484,173 |   | 1,123,951 |   | 126,699 |   | (961,581 | ) | 22,747,548 |   |
| Total  stockholders’ equity                                 |       | 1,034,678                                                                                   |       | 231,058 |   | 83,658 |   | 240 |   | (131,448 | ) | 1,218,186 |   |
|                                                             |       |                                                                                        |       |   |   |   |   |   |   |   |   |   |   |
| **Income  Statement Items:**                                     | ** ** | ** **                                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  (expense) income                                   |       | $                                                                                           | (47,314    | ) | $ | 14,570 |   | $ | (1,386 | ) | $ | 190 |   | $ | 30,668 |   | $ | (3,272 | ) |
| Provision for  loan losses                                       |       | 105                                                                                         |       | — |   | — |   | — |   | — |   | 105 |   |
| Realized gain  from derivative instruments                       |       | 95,986                                                                                      |       | — |   | 4 |   | 14 |   | — |   | 96,004 |   |
| Change in fair  value of derivative instruments                  |       | 54,866                                                                                      |       | — |   | 4,254 |   | (217 | ) | 4,030 |   | 62,933 |   |
| Other non-nterest  income                                        |       | 362                                                                                         |       | 1,548 |   | 14,089 |   | 3,102 |   | (8,106 | ) | 10,995 |   |
| Non-nterest  expense and income taxes                            |       | 8,862                                                                                       |       | 3,501 |   | 30,792 |   | 5,106 |   | 6,372 |   | 54,633 |   |
| Net earnings (loss)                                              |       | $                                                                                           | 94,933     |   | $ | 12,617 |   | $ | (13,831 | ) | $ | (2,017 | ) | $ | 20,220 |   | $ | 111,922 |   |

 

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(1)                      Corporate overhead expenses are allocated tothe segments based on the percentage of time devoted to the segment, headcount,loan production, or other relevant measures. Income statement items include inter-company loan sale transactions andthe elimination of related gains or losses. Balance sheet items include inter-company warehouse borrowings and theelimination of related interest income and interest expense.

**NoteD—Mortgages Held-for-Sale**

Mortgagesheld-for-sale for the periods indicated consisted of the following:

|                                                                       | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                                                            | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Mortgages  held-for-sale - residential                                |       | $                         | 1,102,773  |                          | $          | 1,381,264 |   |
| Mortgages  held-for-sale - commercial                                 |       | 294,815                   |       | 177,619                       |       |
| Net (discount)  premiums on mortgages held-for-sale - residential (1) |       | (3,526                    | )          | 18,024                        |       |
| Net premiums on  mortgages held-for-sale - commercial                 |       | 1,670                     |       | 857                           |       |
| Change in fair  value of residential mortgages held-for-sale          |       | (38,155                   | )          | (18,717                       | )          |
| Net deferred costs                                                    |       | 4,627                     |       | 2,872                         |       |
| Total mortgages  held-for-sale                                        |       | $                         | 1,362,204  |                          | $          | 1,561,919 |   |

 

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(1)                      Included in the net premiums (discount) for2007 is $4.7 million of discount applied to specific loans that wererepurchased during the second quarter of 2007. Also the Company recorded a $2.8 million discount on loans that weretransferred to loans held-for-sale, from securitized mortgage collateral.

11

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Mortgage loans held-for-sale are recorded at the lowerof cost or market determined on an aggregate basis. The change in fair value ofthe loans held-for-sale is recorded as an increase or decrease to non-interestincome.

During the second quarter of 2007, the Companyrecorded a charge to earnings for the change in fair value of loansheld-for-sale primarily due to loans deemed to be unsaleable at standard salepremiums included in loans held-for-sale of $66.8 million as compared to $66.2million at year end, and the reduction in market prices of performing andnon-performing loans during the second quarter of 2007.

**Note E—****Securitized Mortgage Collateral**

Securitizedmortgage collateral for the periods indicated consisted of the following:
|                                                             | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Mortgages  secured by single-family residential real estate |       | $                         | 18,181,875 |                          | $          | 18,967,431 |   |
| Mortgages  secured by commercial real estate                |       | 1,852,213                 |       | 1,713,737                     |       |
| Net unamortized  premiums on mortgages - residential        |       | 307,065                   |       | 337,196                       |       |
| Net unamortized  premiums on mortgages - commercial         |       | 47,463                    |       | 32,465                        |       |
| Total securitized  mortgage collateral                      |       | $                         | 20,388,616 |                          | $          | 21,050,829 |   |

 

Securitizedmortgage collateral includes our CMOs and REMICs.  The Company’s exposure to losses fromconsolidated securitizations is limited to the carrying value of the collateralin excess of the carrying value of the debt, which is non recourse to theCompany in each of its securitizations.

**Note F—Allowance for Loan Losses**

The allowance forloan losses for the periods indicated consisted of the following:
|                                                                        | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                                                             | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Securitized  mortgage collateral and held-for-investment - Residential |       | $                         | 198,434    |                          | $          | 64,020 |   |
| Specific other  residential reserves                                   |       | 6,799                     |       | 9,184                         |       |
| Securitized  mortgage collateral and held-for-investment - Commercial  |       | 10,722                    |       | 7,973                         |       |
| Specific reserve  for finance receivables                              |       | 4,989                     |       | 10,598                        |       |
| Allowance for loan  losses                                             |       | $                         | 220,944    |                          | $          | 91,775 |   |

 

Activity forallowance for loan losses for the periods indicated was as follows:
| ** **                      | ** ** | **For Three Months** | ** ** | **For Six Months** | ** ** |
|---------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **Ended June 30,**   | ** ** | **Ended June 30,** | ** ** |
| ** **                      | ** ** | **2007**                       | ** ** | **2006**                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning  balance              |       | $                              | 102,838    |                         | $          | 74,258 |   | $ | 91,775 |   | $ | 78,514 |   |
| Provision for  loan losses      |       | 162,981                        |       | (45                          | )          | 192,355 |   | 105 |   |
| Charge-offs, net  of recoveries |       | (44,875                        | )          | (6,141                       | )          | (63,186 | ) | (10,547 | ) |
| Allowance for  loan losses      |       | $                              | 220,944    |                         | $          | 68,072 |   | $ | 220,944 |   | $ | 68,072 |   |

 

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**NoteG—Other Assets**

Other assets forthe periods indicated consisted of the following:
|                                           | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Deferred charge                           |       | $                         | 43,316     |                          | $          | 52,272 |   |
| Investment  securities available-for-sale |       | 24,098                    |       | 31,628                        |       |
| Prepaid and  other assets                 |       | 57,318                    |       | 24,395                        |       |
| Cash margin  balances                     |       | 13,593                    |       | 19,112                        |       |
| Premises and  equipment, net              |       | 21,789                    |       | 15,526                        |       |
| Deferred income  taxes                    |       | —                    |       | 20,060                        |       |
| Investment in  Impac Capital Trusts       |       | 2,533                     |       | 2,638                         |       |
| Total other  assets                       |       | $                         | 162,647    |                          | $          | 165,631 |   |

 

AtJune, 30, 2007, $4.9 million of investment securities available-for-sale wereconsidered to be other than temporarily impaired (“OTTI”) and was charged offprimarily due to expected credit losses.

In May 2007, the Company completed the acquisition ofcertain production facilities from Pinnacle Financial Corporation (PFC).  This transaction was recorded as a businesscombination for accounting purposes resulting in the Company initiallyrecording $12.4 million in goodwill. Because of the current market environment and the lack of projected futureearnings as of June 30, 2007, the goodwill was considered fully impaired.

**Note H—RealEstate Owned (REO)**

The following table presents a rollforward of the realestate owned:
| ** **         | ** ** | **For the six months  ended June 30,  2007** | ** ** | **For the year  ended December 31,  2006** | ** ** |
|--------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Beginning  balance |       | $                                                                     | 170,077    |                                                           | $          | 46,351 |   |
| Additions          |       | 283,722                                                               |       | 199,583                                                        |       |
| Sales              |       | (81,037                                                               | )          | (84,410                                                        | )          |
| Other              |       | 6,179                                                                 |       | 8,553                                                          |       |
| REO                |       | 378,941                                                               |       | 170,077                                                        |       |
| REO reserve        |       | (26,006                                                               | )          | (8,539                                                         | )          |
| REO, net           |       | $                                                                     | 352,935    |                                                           | $          | 161,538 |   |

 

Activity for theallowance for REO losses for the periods indicated was as follows:
| ** **         | ** ** | **For the quarter  ended June 30,  2007 (1)** | ** ** | **For the six months  ended June 30,  2007 (1)** | ** ** |
|--------------------|------------|------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| Beginning  balance |       | $                                                                      | 15,672     |                                                                           | $          | 8,539 |   |
| Provision          |       | 18,421                                                                 |       | 28,311                                                                         |       |
| Charge-offs        |       | (8,087                                                                 | )          | (10,844                                                                        | )          |
| Ending balance     |       | $                                                                      | 26,006     |                                                                           | $          | 26,006 |   |

 

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(1)           There was not an REO reserve established for the three andsix month periods ended June 30, 2006.

Real estate owned, which consists of residential realestate acquired in satisfaction of loans, is carried at the lower of cost ornet realizable value which has been reduced for estimated selling and holdingcosts, offset by expected mortgage insurance proceeds to be received.Adjustments to the loan carrying value required at the time of foreclosure arecharged to the allowance for loan losses. Gains or losses from the ultimatedisposition of real estate owned are recorded as (gain) loss on sale of otherreal estate owned.

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**Note I— Securitized Mortgage Borrowings**

The following isselected information on securitized mortgage borrowings for the periodsindicated: (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**   | ** ** | **June 30, 2007**                   | ** ** | **December 31, 2006** | ** ** | **Rates**                           | ** ** | **LIBOR (1)** | ** ** | **Date (2)** | ** ** |
| 2002                                      |       | $            | 3,876.1    |                                          | $          | 46.8                            |       | $                                   | 52.0       |   | 5.25  - 12.00 |   | 0.27  - 2.75 |   | 0.54  - 3.68 |   |
| 2003                                      |       | 5,966.1      |       | 455.9                                         |       | 906.7                           |       | 4.34  - 12.75                       |       | 0.27  - 3.00 |   | 0.54  - 4.50 |   |
| 2004                                      |       | 17,710.7     |       | 3,507.2                                       |       | 5,230.8                         |       | 3.58  - 5.56                        |       | 0.25  - 2.50 |   | 0.50  - 3.75 |   |
| 2005                                      |       | 13,387.7     |       | 6,996.9                                       |       | 8,578.1                         |       | —                              |       | 0.24  - 2.90 |   | 0.48  - 4.35 |   |
| 2006                                      |       | 6,079.1      |       | 5,306.6                                       |       | 5,794.7                         |       | 6.25                                |       | 0.10  - 2.75 |   | 0.20  - 4.13 |   |
| 2007                                      |       | 3,860.5      |       | 3,788.1                                       |       | —                          |       | —                              |       | 0.06  - 2.00 |   | 0.12  - 3.00 |   |
| Subtotal  securitized mortgage borrowings |       |         |       | 20,101.5                                      |       | 20,562.3                        |       |                                |       |   |   |   |   |
| Accrued interest  payable                 |       |         |       | 20.0                                          |       | 22.8                            |       |                                |       |   |   |   |   |
| Unamortized  securitization costs         |       |         |       | (46.5                                         | )          | (58.7                           | )          |                                |       |   |   |   |   |
| Total  securitized mortgage borrowings    |       |         |       | $                                             | 20,075.0   |                            | $          | 20,526.4                            |       |   |   |   |   |   |   |
|                                           |            |              |            |                                               |            |                                 |            |                                     |            |  |  |  |  |  |  |  |

 

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(1)           One-month LIBOR was 5.3195% as ofJune 30, 2007.

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

Securitizedmortgage borrowings are issued by bankruptcy-remote trusts. Thesesecuritizations issued are carried at their unpaid principal balances net ofany unamortized discount or premium. Securitized mortgage borrowings arepayable solely from the cashflows produced by these entities and are non recourseto the Company.

**NoteJ—Reverse Repurchase Agreements**

Reverse repurchaseagreements for the periods indicated consisted of the following:
|                                      | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|--------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                           | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Reverse repurchase  facilities       |       | $                         | 1,409,665  |                          | $          | 1,716,512 |   |
| Repo facilities  (1)                 |       | 165,649                   |       | 163,883                       |       |
| Total reverse  repurchase agreements |       | $                         | 1,575,314  |                          | $          | 1,880,395 |   |

 

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(1)          The Repo facilities represent borrowings on residual interests owned bythe Company that are included in securitized mortgage collateral.  The repo facilities represent primarily committedfacilities.

Reverse repurchase facilities finance our warehouselending operations and fund the purchase of mortgages by the mortgageoperations.  During the second quarter of2007, these facilities amounted to $5.2 billion, as compared to a capacity of $5.7 billion at December 31, 2006.  These facilities consist of uncommittedlines, which may be withdrawn at any time by the lender, and committed lines.For the quarter ended June 30, 2007, the Company obtained required waivers ofnon-compliance with the financial covenants related to earnings (as defined)for the reverse repurchase agreements in which a default of the covenantsoccurred.  Additionally, one of the Company’s reverse repurchase agreements withtotal capacity of $750 million expired in June of 2007, per the terms of thearrangement and was not renewed.

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**Note K—RepurchaseReserve**

Repurchase reservefor the periods indicated consisted of the following:
|                                         | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **2007**                  | ** ** | **2006**                      | ** ** |
| Reserve for early  payment defaults (1) |       | $                         | 16,523     |                          | $          | 12,220 |   |
| Reserve for misrepresentations          |       | 9,381                     |       | —                        |       |
| Other                                   |       | 1,908                     |       | 3,126                         |       |
| Total repurchase  reserve               |       | $                         | 27,812     |                          | $          | 15,346 |   |

 

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(1)          This figure at December 31, 2006 includes both the reserve for earlypayment default and the reserve for misrepresentations.

This repurchase liability is included in otherliabilities and represents estimated losses for normal representation andwarranty terms related to previously sold whole loans.  The reserve totaled approximately $27.8 millionat June 30, 2007, compared to $15.3 million at December 31, 2006. Indetermining the adequacy of the reserve for mortgage repurchases, managementconsiders such factors as specific requests for repurchase, known problemloans, underlying collateral values, recent sales activity of similar loans,historical experience, current market conditions and other appropriateinformation.  For the three and sixmonths ended June 30, 2007, the Company recorded a provision for repurchaselosses of $18.9 million and $30.7 million as compared to a provision of$12.8 million and $23.1 million for the same periods in 2006, included innon-interest income.

During the quarter ended June 30, 2007, the Companysold $417.7 million in whole loans compared to $2.1 billion duringthe same period in 2006.

**NoteL—Income Taxes**

**Duringthe three and six months ended June 30, 2007, income tax expense was $3.2million and $5.1 million, respectively, as compared to a benefit of $6.1million and $2.7 million, respectively, during the same periods in 2006. Theamount of income tax expense for the quarter ended June 30, 2007 was primarilya result of the recognition of $5.0 million of tax expense related to theamortization of the existing deferred charge balance, partially offset by a $1.7million tax benefit arising from the refund of taxes paid attributable to thecarryback of the 2007 net operating losses. The Company makes an estimate ofthe effective tax rate expected to be applicable for the fiscal year whenproviding for income tax expense. The Company has reserved all tax benefitsthat cannot be utilized by carrying losses back to years in which tax paymentswere made. During the quarter ended June 30, 2007 there was approximately $12.1million in current quarter tax benefits that were fully reserved as a result ofthe Company’s net losses. Additionally, the Company paid approximately $1,000 and$4,000 of interest and penalties, charged to general and administrativeexpense, related to taxes during the second quarter of fiscal 2007 and 2006,respectively.**

**NoteM—Subsequent Events**

*Reverse Repurchase and Warehouse Facilities*

In August 2007, the Company amended its agreement withone of its lenders primarily increasing the pricing structure should theCompany exceed a specified level of borrowing, which is above the current borrowinglevel.

In August 2007, the Company entered into a new reverserepurchase agreement with a current lender with all the same terms except to conformcovenants to be primarily the same as other lenders including a profitability covenant which is not effective until June 2008.

Associated with the acquisition of certain assets fromPFC, in August 2007, the Company entered into a new warehouse agreement with anew lender with a borrowing capacity of $98.0 million and covenants similar to the Company’s other borrowingfacilities.

*Liquidity*

TheCompany has received a significant amount of margin calls from its lenders andcontinues to receive additional margin calls from its lenders dueto the current market environment. The Company has the ability to satisfy the margin calls received. In light of the continued and widely publicizedvolatility in the secondary and securitization markets, the Company hassuspended funding of loans previously referred to as Alt-A loans. At thispoint, the Company is only funding loans that are eligible to be sold togovernment sponsored agencies. In addition to the suspension of Alt-A loans,the Company has taken steps to reduce operating expenses significantly, whichinclude staff reductions and closure of selected facilities.

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

 

Unless the context otherwise requires, the terms “Company,”“we,” “us,” and “our” refer to Impac Mortgage Holdings, Inc. (the Company orIMH), a Maryland corporation incorporated in August 1995, and itssubsidiaries, IMH Assets Corp. (IMH Assets), Impac Warehouse LendingGroup, Inc. (IWLG), and Impac Funding Corporation (IFC), together with itswholly-owned subsidiaries Impac Secured Assets Corp. (ISAC), and ImpacCommercial Capital Corporation (ICCC).

**Forward-Looking Statements**

This report onForm 10-Q contains certain forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. Forward-looking statements, someof which are based on various assumptions and events that are beyond ourcontrol, may be identified by reference to a future period or periods or by theuse of forward-looking terminology, such as “may,” “will,” “believe,” “expect,”“likely,” “should,” “could,” “anticipate,” or similar terms or variations onthose terms or the negative of those terms. The forward-lookingstatements are based on current management expectations. Actual results may differmaterially as a result of several factors, including, but not limited to theability to generate sufficient liquidity; failure of current strategicinitiatives to achieve their goals and inability to successfully manage throughthe current market environment based on a rapidly changing mortgage market withunexpected events or downturns; inability to renew, or termination of, currentfinance facilities based on the Company’s financial performance or inability tosatisfy financing covenants; inability to obtain financing on acceptable terms;deterioration in the secondary market causing delays or inability to completesecuritizations or mortgage sales; the inability to sell or securitizemortgages for a profit; unexpected deterioration in the housing market changingpreviously appraised home values; significant margin calls; failure to sell, orachieve expected returns on sale of, negotiated loan sales, includingnon-performing loans, in the secondary market due to market conditions, lack ofinterest or ineffectual pricing; inability to effectively liquidate propertiesthrough auction process or otherwise; failure to reduce costs associated withREO portfolio; unexpected increases in our loan repurchase obligations;inability to effectively implement strategies to increase cure rates, reducedelinquencies or mitigate losses on mortgage loans; continued increase in pricecompetition; changes in assumptions regarding estimated loan losses or anincrease in loan losses; risks of delays in raising, or the inability to raiseon acceptable terms, additional capital, either through equity offerings, linesof credit or otherwise; the ability to generate taxable income and to paydividends; interest rate fluctuations on our assets that unexpectedly differfrom those on our liabilities; unanticipated interest rate fluctuations;changes in expectations of future interest rates; the adoption of new laws thataffect our business or the business of people with whom we do business; changesin laws that affect our products and our business; and other general market andeconomic conditions.

Fora discussion of these and other risks and uncertainties that could cause actualresults to differ from those contained in the forward-looking statements, see “RiskFactors” and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in the Company’s Annual Report on Form 10-K for theperiod ended December 31, 2006, and the other reports we file under theSecurities and Exchange Act of 1934, and the additional risk factors set forthbelow in this quarterly report. This document speaks only as of its date and wedo not undertake, and specifically disclaim any obligation, to publicly releasethe results of any revisions that may be made to any forward-looking statementsto reflect the occurrence of anticipated or unanticipated events orcircumstances after the date of such statements.

**The Mortgage Banking Industry and Discussion of RelevantFiscal Periods**

Themortgage banking industry is continually subject to current events that occurin the financial services industry. Such events include changes in economicindicators, government regulation, interest rates, price competition, geographicshifts, disposable income, housing prices, market anticipation, and customerperception, as well as others. The factors that affect the industry changerapidly.

Inthis environment, mortgage banking companies generally anticipate the futuremarketplace, engage in hedging activities and continuously reassess businessplans and strategies to effectively position themselves in the marketplace.

16

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As a result, current events can diminish the relevanceof “quarter over quarter” and “year-to-date over year-to-date” comparisons offinancial information. In such instances, the Company intends to presentfinancial information in its Management Discussion and Analysis that is themost relevant to its financial information.

**Executive Review of Performance**

*Market Conditions*

During the second quarter, thesecondary and securitization mortgage markets have deteriorated, become moreunpredictable and volatile, making it more difficult to sell loans andsecurities to investors.  In addition, becausehousing prices have declined, default and credit losses have increased;investors are requiring higher returns, reducing the price of mortgage loans.  As a result, the loans have not performed upto expectations and the fair value of mortgage loans has deteriorated.  The underlying reason for the deteriorationof industry conditions appears to be initially based on the relatively poorperformance of loans originated in 2006. This decline in performance has led to a lack of confidence by bondinvestors and lenders and their reluctance to invest/lend as aggressively.  These market conditions have also increasedthe Company’s loss severities during the second quarter.

Recently these market conditions required us to focus onpreserving liquidity.  We havereceived a significant amount of margin calls from our lenders and continue toreceive margin calls due to the current market environment, we intend tosatisfy these margin calls; however, we cannot make any assurances wewill satisfy margin calls received in the future.  Inaddition, we are operating under waivers provided by certain lenders, ascertain lenders have waived certain covenants that require us to maintainpositive net income and certain leverage ratios. There can be no assurance thatwe will be able to obtain future waivers or new waivers if covenants are notmet, or that we will be able to obtain waivers on favorable terms. Further, wehave negotiated sales of approximately $1.0 billion of our $1.6 billion ofloans held on financed facilities.

In light of the continued andwidely publicized volatility in the secondary and securitization markets, wehave suspended funding of loans previously referred to as Alt-A loans andcurrently do not have any plans to originate these types of loans in the nearfuture. At this point, the Company is only funding loans that are eligible tobe sold to government sponsored agencies. In addition to the suspension ofAlt-A loans, the Company has taken steps to significantly reduce operatingexpenses which include staff reductions and closure of selected facilities.Should the market conditions continue to deteriorate, we may take further stepsincluding limiting our operations to the Long Term Investment Operations.

During the quarter ended June 30, 2007, the residentialmortgage market continued to be affected by increasing interest rates, aweakening housing market and increasing delinquencies and defaults, regulatorsand legislators increased their focus on tightening underwriting standards fornew mortgage loans.  Many nonprimemortgage lenders were impacted by reduced liquidity and as a result, wererequired to scale back or cease operations.  Most market participants responded to changesin the marketplace with changes in product offering and tightening ofunderwriting guidelines.

Additionally, the Company did not declare a cash dividendon our common stock during the second quarter of 2007, as the dividend may be considereda return of capital.  Currently, we donot anticipate paying any further dividends on our common stock for theremainder of 2007.

*Delinquencies and REO*

Although, we have seen improvements in our adjusted netinterest margin as a result of decreased amortization due to lower actual andexpected prepayments and longer duration loans in the portfolio offset byincreased credit losses, the Company has experienced an increase indelinquencies and loan defaults and an increase in loss severities during thesecond quarter.  The 

17

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Company’s allowance for loan losses increased to reflect higherestimated losses stemming from higher delinquencies and default rates,deterioration in the prevailing real estate market, current economicconditions, and the seasoning of the Long-Term Investment Operations investmentloan portfolio.  In an effort to mitigatethe increase in severities, the Company has pursued a strategy to reduce theloans that ultimately become foreclosures and result in losses.  The Company’s recently implemented strategyincludes reducing delinquencies by more closely managing thesub-servicers.  This includes workingwith management of the sub-servicers to develop a plan to reduce futuredelinquency rates.  Some of the strategiesto reduce delinquencies include:

·                  Increased and new loss mitigation efforts(forbearance plans, or loan modifications),

·                  An aggressive focus on front end collections,

·                  Daily collections goals, and,

·                  Closely monitoring sub-servicers performance againstperformance metrics.

These objectives are expected to improve delinquent loancure rates in an effort to dissipate the increase of foreclosed loans intoREO.   While the loan portfolio continuedto deteriorate in the form of additional delinquencies and REO during July,these recently initiated strategies that are expected to have a fuller impactin the fourth quarter of 2007.

Additionally, during the second quarter of 2007, theCompany explored alternative REO liquidation methods, in an effort toaccelerate the disposition of foreclosed loans, through the use of the auctionprocess.  Two auctions were conductedrecently and the Company accepted bids on approximately 90 percent of theproperties included in the auction which are expected to close in the thirdquarter. As such, the effects of these auctions will be more prominent in thethird quarter of 2007. This acceleration of liquidating the REO properties weanticipate will mitigate increased holding costs and reduce losses if the realestate market deteriorates further.

*Other Events*

On May 31, 2007, the Companyacquired production facilities from Pinnacle Financial Corporation (PFC)located primarily in the East Coast of the United States.  The PFC retail platform originates prime andagency loans.

This transaction was recorded as a business combinationfor accounting purposes resulting in the Company initially recording $12.4million in goodwill.  Because of thecurrent market environment, the goodwill was impaired and the Company has recordedan impairment charge for the full amount.

**General Overview**

We are a mortgage real estateinvestment trust, or “REIT,” that is a nationwide acquirer, originator, sellerand investor of non-conforming Alt-A residential mortgages, or “Alt-Amortgages,” and to a lesser extent, small-balance, commercial mortgagesand multi-family, or “commercial mortgages.” As a result of the recentmarket deterioration, we have suspended the funding of Alt-A mortgages to focuson prime and agency (conforming) loans. We also provide warehouse financing to originators of mortgages.

We operate four core businesses:

·                  theLong-Term Investment Operations conducted by IMH and IMH Assets;

·                  theMortgage Operations conducted by IFC and ISAC;

·                  theCommercial Operations conducted by ICCC; and

·                  theWarehouse Lending Operations conducted by IWLG.

The REIT (IMH) is comprised of the long-term investmentoperations and the warehouse lending operations. The Taxable REIT Subsidiaries(TRS) include the Mortgage Operations and Commercial Operations which aresubsidiaries of the REIT.

**Critical Accounting Policies**

We define critical accountingpolicies as those that are important to the portrayal of our financialcondition and results of operations and require estimates and assumptions basedon our judgment of changing market conditions and the performance of our assetsand liabilities at any given time. In determining which accounting policiesmeet this definition, we considered our policies with respect to the valuationof our assets and liabilities and estimates and assumptions used in determiningthose valuations. We believe the most critical accounting issues that requirethe most complex and difficult judgments and that are particularly susceptibleto significant change to our financial condition and results of operationsinclude the following:

·                  allowancefor loan losses;

·                  calculationof repurchase reserve; and

·                  allowancefor REO Losses.

18

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***Allowance for Loan Losses***

We provide an allowance for loanlosses for mortgages held as securitized mortgage collateral, financereceivables and mortgages held-for-investment (“loans provided for”). Inevaluating the adequacy of the allowance for loan losses, management takes manyfactors into consideration. For instance, a detailed analysis of historicalloan performance data is accumulated and reviewed. This data is analyzed forloss performance and prepayment performance by product type, origination yearand securitization issuance. The data is also broken down by collection status.  Our estimate of the required allowance forthese loans is developed by estimating both the rate of default of the loansand the amount of loss in the event of default. The rate of default is assignedto the loans based on their attributes (*e.g.,* originalloan-to-value, borrower credit score, documentation type, etc.) and collectionstatus. The rate of default is based on analysis of migration of loans fromeach aging category.  The lossseverity is determined by estimating the net proceeds from the ultimate sale ofthe foreclosed property.   The results of that analysis are then applied tothe current mortgage portfolio and an estimate is created. We believe thatpooling of mortgages with similar characteristics is an appropriate methodologyin which to evaluate the allowance for loan losses. Management also recognizesthat there are qualitative factors that must be taken into consideration whenevaluating and measuring inherent loss in our loan portfolios. These itemsinclude, but are not limited to, economic indicators that may affect theborrower’s ability to pay, changes in value of collateral, projected losscurves, political factors, market conditions, competitor’s performance, marketperception and industry statistics. This evaluation is inherentlysubjective, as it requires estimates that are susceptible to significantrevision as factors change or as more information becomes available.

Specific valuation allowances maybe established for loans that are deemed impaired, if default by the borroweris deemed probable, and if the fair value of the loan or the collateral isestimated to be less than the gross carrying value of the loan. Actual losseson loans are recorded as a reduction to the allowance through charge-offs.

***Calculation of Repurchase Reserve***

When we sell loans throughwhole-loan sales we are required to make normal and customary representationsand warranties about the loans to the purchaser. Our whole-loan sale agreementsgenerally require us to repurchase loans if we breach a representation orwarranty given to the loan purchaser. In addition, we may be required torepurchase loans as a result of borrower fraud or if a payment default occurson a mortgage loan shortly after its sale.

Investors have requested theCompany to repurchase loans or to indemnify them against losses on certainloans which the investors believe either do not comply with applicablerepresentations or warranties or defaulted shortly after its purchase. Uponcompletion of its own investigation regarding the investor claims, the Companyrepurchases or provides indemnification on certain loans, as appropriate. TheCompany maintains a liability for expected losses on dispositions of loansexpected to be repurchased or on which indemnification is expected to beprovided and regularly evaluates the adequacy of this repurchase liabilitybased on trends in repurchase and indemnification requests, actual lossexperience, and other relevant factors including economic conditions.

The Company estimates therepurchase reserve based on the estimated trailing whole loan sales that stillhave outstanding early payment warranties and misrepresentation warranties. Thecalculation of the trailing whole loan sales subject to request is based uponhistorical analysis of the timing of requests in relation to their saledate.  The Company also calculates therate at which our whole loan sales will develop into early payment default ormisrepresentation claims.  Then based onhistorical experience management will determine what percentage of the claimsthat will incur a loss.  The Companyapplies a historical loss rate, adjusted for current market conditions based onthe type of loan (first lien or to a lesser extent second lien) to the loans weexpect to incur loss on in the future to derive the repurchase reserve. Thereserve includes the Company’s estimate of losses in the fair value of loansthe Company expects it will repurchase, plus any premiums that will be refundedto the investor.  The loss in fair valueis predominately determined based on historical market losses on repurchased loans.

***Allowance for REO Losses***

We provide an allowance for REOlosses for mortgages held as real estate owned. In evaluating the adequacy of the allowance for REO losses, managementtakes many items into consideration. When real estate is acquired in settlement of loans, or other realestate owned, the mortgage is written-down to a percentage of the property’sappraised value or broker’s price opinion or list price less estimated sellingcosts and including mortgage insurance expected to be received.  Subsequent changes in the net realizablevalue of the real estate owned is reflected as an allowance for REOlosses.  The allowance for REO lossesincreased as a result of increased expected loss severities from a reduction inestimated sales prices principally as home prices have deteriorated.

**Selected Financial Results for the Second quarter of 2007**

·                   Estimatedtaxable loss per diluted share was ($0.25) compared to income of $0.25 for thefirst quarter of 2007 and $0.27 for the second quarter of 2006;

·                   NoCash dividend was declared for the second quarter of 2007 compared to $0.10 forthe first quarter of 2007 and $0.25 for the second quarter of 2006;

19

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·                   Totalassets were $22.6 billion as of June 30, 2007 compared to $23.6 billion as ofDecember 31, 2006 and $22.7 billion as of June 30, 2006;

·                   Bookvalue per common share was $7.10 as of June 30, 2007 compared to $11.15 as ofDecember 31, 2006 and $13.91 as of June 30, 2006;

·                   Themortgage operations acquired and originated $1.3 billion of primarily Alt-Amortgages compared to $2.2 billion for the first quarter of 2007 and $2.2billion for the second quarter of 2006;

·                   Thecommercial mortgage operations originated $159.0 million of commercialmortgages compared to $196.9 million for the first quarter of 2007 and $277.9million for the second quarter of 2006; and

·                   Thelong-term investment operations retained for investment $795.6 million ofprimarily Alt-A mortgages and no commercial mortgages compared to $2.2 billionof primarily Alt-A mortgages and $234.9 million of commercial mortgages for thefirst quarter of 2007 and $579.7 million of primarily Alt-A mortgages and$114.7 million of commercial mortgages for the second quarter of 2006.

**SelectedFinancial Results for the First Six Months of 2007**

·                   Estimatedtaxable income per diluted share was $0.00 compared to $0.63 for the first sixmonths of 2006;

·                   Cashdividends declared per share were $0.10 compared to $0.50 for the first sixmonths of 2006; Based on current tax estimates, some portion or all of the2007 dividends may be a return of capital.

·                   Themortgage operations acquired and originated $3.5 billion of primarily Alt-Amortgages compared to $4.3 billion for the first six months of 2006;

·                   Thecommercial mortgage operations originated $355.9 million of commercialmortgages compared to $480.7 million for the first six months of 2006; and

·                   Thelong-term investment operations retained for investment $3.0 billion ofprimarily Alt-A mortgages and $234.9 million of commercial mortgages comparedto $579.7 million of primarily Alt-A mortgages and $114.7 million of commercialmortgages for the first six months of 2006.

**Second Quarter 2007 vs. First Quarter 2007 Net Earnings**
| ** **                                           | ** ** | **For the Three Months Ended ,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **June 30,**                                         | ** ** | **March 31,** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **2007**                                                  | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                      |       | $                                                         | 337,010    |   | $ | 342,821 |   | $ | (5,811 | ) | (2 | )% |
| Interest expense                                     |       | 324,027                                                   |       | 329,366 |   | (5,339 | ) | (2 | ) |
| Net interest income                                  |       | 12,983                                                    |       | 13,455 |   | (472 | ) | (4 | ) |
| Provision for  loan losses                           |       | 162,981                                                   |       | 29,374 |   | 133,607 |   | 455 |   |
| Net interest expense after provision for loan losses |       | (149,998                                                  | )          | (15,919 | ) | (134,079 | ) | (842 | ) |
| Total  non-interest income                           |       | 36,516                                                    |       | (70,562 | ) | 107,078 |   | 152 |   |
| Total  non-interest expense                          |       | 35,845                                                    |       | 33,321 |   | 2,524 |   | 8 |   |
| Income tax  expense                                  |       | 3,220                                                     |       | 1,866 |   | 1,354 |   | 73 |   |
| Net loss                                             |       | $                                                         | (152,547   | ) | $ | (121,668 | ) | $ | (30,879 | ) | (25 | )% |
|                                                 |       |                                                      |       |   |   |   |   |   |   |
| Net loss per  share - diluted                        |       | $                                                         | (2.05      | ) | $ | (1.65 | ) | $ | (0.40 | ) | (24 | )% |
| Dividends  declared per common share                 |       | $                                                         | —     |   | $ | 0.10 |   | $ | (0.10 | ) | (100 | )% |
|                                                 |       |                                                      |       |   |   |   |   |   |   |

 

20

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Theresults of operations for the second quarter of 2007 resulted in a net loss of$152.5 million or $2.05 per share as compared to a net loss of $121.7 millionor $1.65 per share, for the first quarter of 2007. The increase in the net losswas primarily due to a $133.6 million increase in provision for loan losses, a$12.4 million charge off for the impairment of goodwill, and an $8.5 millionincrease in provision for REO losses, offset by a $115.7 million increase inearnings due to the increase in fair value of derivative instruments, and a$14.5 million reduction in losses from the a reduced lower of cost or marketwritedown.

Duringthe second quarter of 2007, the change in fair value of derivative instrumentsincreased to a gain of $56.9 million as compared to a loss of $58.8 millionduring the first quarter of 2007.  Thechange in the fair value of the derivative instruments was primarily the resultof cash receipts received and changes in the expectation of future interestrates.

**EstimatedTaxable Income**

Becausedividend payments are based on estimated taxable income, dividends may be moreor less than net earnings. As such, we believe that the disclosure of estimatedtaxable income available to common stockholders, which is a non-generallyaccepted accounting principle, or “non-GAAP,” financial measurement, is usefulinformation for our investors.   Based oncurrent tax estimates, some portion or all of the 2007 dividends may be areturn of capital.

Thefollowing table presents a reconciliation of net (loss) earnings (GAAP) toestimated taxable income available to common stockholders for the periodsindicated (in thousands, except per share amounts):
| ** **                                                                   | ** ** | **For the Three Months Ended (1)** | ** ** | **For the Six Months** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **June 30,**                                           | ** ** | **March 31,**                    | ** ** | **June 30,** | ** ** | **Ended June 30, (1)** | ** ** |
| ** **                                                                   | ** ** | **2007**                                                    | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2007** | ** ** |
| Net (loss)  earnings                                                         |       | $                                                           | (152,547   | )                                     | $          | (121,668 | ) | $ | 26,356 |   | $ | (274,215 | ) |
| Adjustments to  net (loss) earnings: (2)                                     |       |                                                        |       |                                  |       |   |   |   |   |
| Loan loss provisions (3)                                                     |       | 181,977                                                     |       | 38,734                                |       | (45 | ) | 220,711 |   |
| Tax deduction for actual loan losses (3)                                     |       | (49,460                                                     | )          | (11,262                               | )          | (6,141 | ) | (60,722 | ) |
| GAAP earnings on REMICs (4)                                                  |       | (21,070                                                     | )          | (14,932                               | )          | (1,237 | ) | (36,002 | ) |
| Taxable income on REMICs (5)                                                 |       | 28,224                                                      |       | 12,843                                |       | 5,611 |   | 41,067 |   |
| Change in fair value of derivatives (6)                                      |       | (53,269                                                     | )          | 54,623                                |       | (7,903 | ) | 1,354 |   |
| Dividends on preferred stock                                                 |       | (3,722                                                      | )          | (3,722                                | )          | (3,672 | ) | (7,444 | ) |
| Net loss (earnings) of taxable REIT subsidiaries (7)                         |       | 49,551                                                      |       | 58,667                                |       | 17,704 |   | 108,218 |   |
| Dividend from taxable REIT subsidiaries (8)                                  |       | —                                                      |       | —                                |       | 3,500 |   | — |   |
| Elimination of inter-company loan sales transactions  (9)                    |       | 368                                                         |       | 5,471                                 |       | (13,682 | ) | 5,839 |   |
| Miscellaneous adjustments                                                    |       | 1,012                                                       |       | 108                                   |       | 119 |   | 1,120 |   |
| Estimated  taxable income (loss) available to common stockholders’ (10) |       | $                                                           | (18,936    | )                                     | $          | 18,862 |   | $ | 20,610 |   | $ | (74 | ) |
| Estimated  taxable income (loss) per diluted common share (10)               |       | $                                                           | (0.25      | )                                     | $          | 0.25 |   | $ | 0.27 |   | $ | (0.00 | ) |
| Diluted weighted  average common shares outstanding                          |       | 76,084                                                      |       | 76,084                                |       | 76,420 |   | 76,084 |   |

 

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| (1)    |   | Estimated taxable income includes estimates of book  to tax adjustments and can differ from actual taxable income as calculated  when we file our annual corporate tax return. Since estimated taxable income  is a non-GAAP financial measurement, the reconciliation of estimated taxable  income available to common stockholders to net earnings is intended to meet  the requirements of Regulation G as promulgated by the SEC for the  presentation of non-GAAP financial measurements. To maintain our REIT status,  we are required to distribute a minimum of 90% of our annual taxable income  to our stockholders. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (2)    |   | Certain adjustments are made to net earnings in  order to calculate estimated taxable income due to differences in the way  revenues and expenses are recognized under the two methods.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (3)    |   | To calculate estimated taxable income, actual loan  losses are deducted. For the calculation of net earnings, GAAP requires a  deduction for estimated losses inherent in our mortgage portfolios in the  form of a provision for loan losses, which are generally not deductible for  tax purposes. Therefore, as the estimated losses provided for GAAP are  realized, the losses will negatively and may materially impact future taxable  income. The loan loss provisions include the allowance for loan loss  provision and the REO loan loss provision for the REIT.                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (4)    |   | Includes GAAP amounts related to the REMIC  securitizations, which were treated as secured borrowings for GAAP purposes  and sales for tax purposes. The REMIC GAAP income excludes the provision for  loan losses recorded that may relate to the REMIC collateral included in  securitized mortgage collateral. The Company does not have any specific  valuation allowances recorded as an offset to the REMIC collateral.                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (5)    |   | Includes amounts that are taxable to the Company  related to its residual interest in the securitizations, as the REMICs are  accounted for as sales in its tax filings.                                                                                                                                                                                                                                                                                                                                                                                                                                                       |

21

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| (6)    |   | The mark-to-market change for the valuation of  derivatives at IMH is income or expense for GAAP financial reporting but is  not included as an addition or deduction for taxable income calculations  until realized.                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (7)    |   | Represents net earnings of IFC and ICCC, our taxable  REIT subsidiaries (TRS), which may not necessarily equal taxable income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (8)    |   | Any dividends paid to IMH by the TRS in excess of  their cumulative undistributed taxable income would be recognized as return  of capital by IMH to the extent of IMH’s capital investment in the TRS.  Distributions from the TRS to IMH may not equal the TRS net earnings,  however, IMH can only recognize dividend distributions received from the TRS  as taxable income to the extent that the TRS distributions are from current  or prior period undistributed taxable income. Any distributions by the TRS in  excess of IMH’s capital investment in the TRS would be taxed as capital gains. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (9)    |   | Includes the effects to taxable income associated  with the elimination of gains from inter-company loan sales and other  intercompany transactions between IFC, ICCC, and IMH, net of tax and the  related amortization of the deferred charge.                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (10)   |   | Excludes the deduction for common stock dividends  paid and the availability of a deduction attributable to net operating loss  carry-forwards. As of December 31, 2006, the Company had estimated Federal  net operating loss carry-forwards of $8.2 million that expire in the year  2020.                                                                                                                                                                                                                                                                                                                       |

 

***Second Quarter 2007 vs. First Quarter 2007***

Estimatedtaxable income decreased $37.8 million to a loss of $18.9 million, or ($0.25)per diluted common share, for the second quarter 2007, compared to $18.9million or $0.25 per diluted common share, for the first quarter 2007.  The decrease in estimated taxable income wasmainly attributable to an increase in actual loan losses which increased $38.2million from the first quarter of 2007. Offsetting the increase in chargeoffs was an increase in the adjustednet interest margin at IMH which increased $6.4 million from the first quarterof 2007, including the REMIC taxable income.

**FinancialCondition and Results of Operations**

*FinancialCondition*

Condensed Balance SheetData

(dollars inthousands)
|                                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                           | ** ** | **2007**          | ** ** | **2006**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Cash and cash  equivalents                           |       | $                 | 113,180    |                  | $          | 179,677        |       | $          | (66,497    | ) | (37 | )% |
| Securitized mortgage  collateral                     |       | 20,388,616        |       | 21,050,829            |       | (662,213       | )          | (3         | )          |
| Mortgages  held-for-investment                       |       | 4,319             |       | 1,880                 |       | 2,439          |       | 130        |       |
| Finance  receivables                                 |       | 132,985           |       | 306,294               |       | (173,309       | )          | (57        | )          |
| Allowance for  loan losses                           |       | (220,944          | )          | (91,775               | )          | 129,169        |       | 141        |       |
| Mortgages  held-for-sale                             |       | 1,362,204         |       | 1,561,919             |       | (199,715       | )          | (13        | )          |
| Derivatives                                          |       | 145,505           |       | 147,291               |       | (1,786         | )          | (1         | )          |
| Real Estate  Owned                                   |       | 352,935           |       | 161,538               |       | 191,397        |       | 118        |       |
| Other assets                                         |       | 284,785           |       | 281,302               |       | 3,483          |       | 1          |       |
| **Total assets**                                     |       | $                 | 22,563,585 |                  | $          | 23,598,955     |       | $          | (1,035,370 | ) | (4 | )% |
|                                                 |       |              |       |                  |       |           |       |       |       |
| Securitized  mortgage borrowings                     |       | $                 | 20,075,004 |                  | $          | 20,526,369     |       | $          | (451,365   | ) | (2 | )% |
| Reverse  repurchase agreements                       |       | 1,575,314         |       | 1,880,395             |       | (305,081       | )          | (16        | )          |
| Other  liabilities                                   |       | 211,005           |       | 182,661               |       | 28,344         |       | 16         |       |
| Total liabilities                                    |       | 21,861,323        |       | 22,589,425            |       | (728,102       | )          | (3         | )          |
| Total stockholders’ equity                      |       | 702,262           |       | 1,009,530             |       | (307,268       | )          | (30        | )          |
| **Total liabilities and  stockholders’ equity** |       | $                 | 22,563,585 |                  | $          | 23,598,955     |       | $          | (1,035,370 | ) | (4 | )% |

 

Total assets were$22.6 billion as of June 30, 2007 as compared to $23.6 billion as ofDecember 31, 2006, as the long-term investment operations retained $3.0 billionof primarily Alt-A mortgages and $234.9 million of commercial mortgages offsetby $1.1 billion in whole loan sales and $3.3 billion in total prepayments.

22

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The Company’s allowancefor loan losses increased to reflect higher estimated losses stemming fromhigher delinquencies combined with higher estimates of default rates,deterioration in the prevailing real estate market and economic conditions andthe seasoning of the long term investment operations investment loan portfolio.

Real estate ownedat June 30, 2007 was $352.9 million, or 118 percent, higher than atDecember 31, 2006 as a result of an increase in foreclosures, in excess of realestate liquidated, which is due to a seasoning of the loan portfolio, longerholding periods, reduced housing demand in the marketplace and lower housingprices.

Thefollowing table presents selected information about mortgages held assecuritized mortgage collateral as of the dates indicated.  Some information is presented as a percentageof the portfolio:
| ** **                                    | ** ** | **Residential**   | ** ** | **Commercial**        | ** ** |
|-----------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **As of**    | ** ** | **As of**        | ** ** |
| ** **                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                                    | ** ** | **2007**          | ** ** | **2006**              | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **2006** | ** ** |
| Alt-A mortgages                               |       | 99                | %          | 99                    | %          | 99 | % | N/A |   | N/A |   | N/A |   |
| Non-hybrid ARMs                               |       | 5                 | %          | 7                     | %          | 12 | % | 2 | % | 2 | % | 2 | % |
| Hybrid ARMs                                   |       | 72                | %          | 73                    | %          | 75 | % | 98 | % | 98 | % | 98 | % |
| FRMs                                          |       | 23                | %          | 20                    | %          | 13 | % | 0 | % | 0 | % | 0 | % |
| Interest-only                                 |       | 73                | %          | 72                    | %          | 72 | % | 15 | % | 14 | % | 12 | % |
| Weighted average  coupon                      |       | 6.87              | %          | 6.75                  | %          | 6.28 | % | 6.25 | % | 6.15 | % | 5.82 | % |
| Weighted average  margin                      |       | 3.40              | %          | 3.60                  | %          | 3.80 | % | 2.67 | % | 2.68 | % | 2.69 | % |
| Weighted average  original LTV                |       | 74                |       | 74                    |       | 75 |   | 66 |   | 66 |   | 67 |   |
| Weighted average  original credit score       |       | 699               |       | 697                   |       | 696 |   | 731 |   | 730 |   | 730 |   |
| Original  prepayment penalty                  |       | 66                | %          | 68                    | %          | 75 | % | 100 | % | 100 | % | 100 | % |
| Prior 3-month  constant prepayment rate       |       | 28                | %          | 39                    | %          | 37 | % | 7 | % | 6 | % | 10 | % |
| Prior 12-month  prepayment rate               |       | 35                | %          | 38                    | %          | 38 | % | 7 | % | 8 | % | 9 | % |
| Lifetime  prepayment rate                     |       | 29                | %          | 29                    | %          | 27 | % | 6 | % | 6 | % | 6 | % |
| Weighted average  debt service coverage ratio |       | N/A               |       | N/A                   |       | N/A |   | 1.27 |   | 1.27 |   | 1.29 |   |
| California                                    |       | 51                | %          | 51                    | %          | 54 | % | 62 | % | 63 | % | 66 | % |
| Purchase  transactions                        |       | 54                | %          | 58                    | %          | 59 | % | 49 | % | 51 | % | 52 | % |
| Owner occupied                                |       | 78                | %          | 78                    | %          | 79 | % | N/A |   | N/A |   | N/A |   |
| First lien                                    |       | 98                | %          | 99                    | %          | 99 | % | 100 | % | 100 | % | 100 | % |

 

The following tablepresents selected financial data as of the dates indicated (dollars inthousands, except per share data):
|                                         | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                              | ** ** | **June 30,**                                     | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                              | ** ** | **2007**                                              | ** ** | **2006** | ** ** | **2006** | ** ** |
| Book value per  share                   |       | $                                                     | 7.10       |   | $ | 11.15 |   | $ | 13.91 |   |
| Return on  average assets               |       | (2.33                                                 | %)         | (0.31 | %) | 0.88 | % |
| Return on  average equity               |       | (59.06                                                | %)         | (6.38 | %) | 18.63 | % |
| Assets to equity  ratio                 |       | 32.13:1                                               |       | 23.38:1 |   | 18.67:1 |   |
| Debt to equity  ratio                   |       | 30.97:1                                               |       | 22.29:1 |   | 17.62:1 |   |
| Mortgages owned  60+ days delinquent    |       | $                                                     | 1,685,669  |   | $ | 1,229,270 |   | $ | 841,316 |   |
| 60+ day delinquency of  mortgages owned |       | 7.87                                                  | %          | 5.64 | % | 4.06 | % |

 

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.

23

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*Liquidity Risk. *We employ a leveragestrategy to increase assets by financing our long-term mortgage portfolioprimarily with securitized mortgage borrowings, reverse repurchase agreementsand capital, then using cash proceeds from these borrowings to acquireadditional mortgage assets. We retain ARMs and FRMs that are acquiredfrom and originated by the mortgage and commercial operations and finance theacquisition of those mortgages, during this accumulation period, with reverserepurchase agreements and capital. After accumulating a pool of mortgages,generally between $200 million and $2.5 billion, we sell themortgages in the form of collateralized mortgage obligations, whole loan salesor REMICs. REMICs may be on balance sheet or off balance sheet. Under eitheraccounting method our cash invested on the date of securitization is generallybetween 3 percent and 5 percent of the collateral. Our strategy is tosell or securitize our mortgages within 90 days of origination or purchasein order to reduce the accumulation period that mortgages are outstanding onshort-term reverse repurchase facilities, which reduces our exposure to margincalls and reduces spread risk on these facilities. Securitized mortgageborrowings are classes of bonds that are sold to investors of mortgage-backedsecurities and as such are not subject to margin calls. In addition, thesecuritized mortgage borrowings generally require a smaller initial cashinvestment as a percentage of mortgages financed than does interim reverserepurchase financing. Additionally, as interest rates decline our requirementto maintain certain cash margin balances related to our derivatives increases,which reduces our cash and cash equivalents available for use in operations. Asof June 30, 2007 our cash collateral balance totaled $13.6 million, ascompared to $19.1 million as of December 31, 2006.

Theratio of total assets to total equity, or “leverage ratio,” was 32.13 to 1 asof June 30, 2007 as compared to 23.38 to 1 as of December 31. 2006. Theuse of leverage at these levels allows us to grow our balance sheet byefficiently employing available capital. We continually monitor our leverageratio and liquidity levels to attempt to insure that we are adequatelyprotected against adverse changes in market conditions. For additionalinformation regarding liquidity refer to “Liquidity and Capital Resources.”

*Credit Risk.*We manage credit risk by retaining high creditquality Alt-A mortgages and commercial mortgages from our customers, adequatelyproviding for loan losses and actively managing delinquencies anddefaults.  During the second quarter  of 2007 we retained primarily Alt-A mortgageswith an original weighted average credit score of 705 and an original weightedaverage LTV ratio of 72 percent. Alt-A mortgages are primarily first lienmortgages made to borrowers whose credit is generally within typical Fannie Maeand Freddie Mac guidelines, but that have loan characteristics including higherloan balances, higher loan-to-value ratios or lower documentation requirements,that may make them non-conforming under those guidelines. We primarily acquirenon-conforming “A” or “A-” credit quality mortgages, collectively, Alt-Amortgages. In light of the continued and widely publicized volatility in thesecondary and securitization markets, we have suspended funding of loanspreviously referred to as Alt-A loans and currently do not have any plans tooriginate these types of loans in the near future.

As of June 30, 2007, the original weighted average creditscore of mortgages held as residential and commercial securitized mortgagecollateral was 699 and 731 and original weighted average LTV ratio of 74 and66 percent, respectively. For additional information regarding thelong-term mortgage portfolio refer to “Note E—Securitized MortgageCollateral” in the accompanying notes to the consolidated financial statements.

We believe that we have adequately provided for loanlosses. The allowance for loan losses increased to $220.9 million as ofJune 30, 2007 as compared to $91.8 million as of December 31, 2006. Theincrease in the provision reflects higher estimated losses stemming from higherdelinquencies combined with higher defaults, deterioration in the prevailingreal estate market and current economic conditions and the seasoning of longterm investment operations investment loan portfolio. Actual loan charge-offsnet of recoveries on mortgages in the mortgage portfolio and financereceivables increased to $44.9 million for second quarter 2007 as comparedto $6.1 million for the second quarter of 2006.  

We monitor our sub-servicers to attempt to ensure thatthey perform loss mitigation, foreclosure and collection functions according toour servicing guide.  We have met withthe management of our sub-servicers to commence an effective and aggressivecollection effort in order to minimize the number of mortgages which becomeseriously delinquent. When resolving delinquent mortgages, sub-servicers arerequired to take timely and aggressive action. The sub-servicer is required todetermine payment collection under various circumstances, which will result inthe maximum financial benefit. This is accomplished by either working with theborrower to bring the mortgage current or by foreclosing and liquidating theproperty. We perform an ongoing review of mortgages that display weaknesses andbelieve that we maintain an adequate loan loss allowance on our mortgages. Whena borrower fails to make required payments on a mortgage and does not cure thedelinquency within 60 days, we generally record a notice of default andcommence foreclosure proceedings, or arrange alternative terms of forbearance.If the mortgage is not reinstated within the time permitted by law forreinstatement, the property may then be sold at a foreclosure sale. Atforeclosure sales, we generally acquire title to the property. As of June 30,2007, our long-term mortgage portfolio included 7.87 percent of mortgagesthat were 60 days or more delinquent as compared to 5.64 percent asof December 31, 2006.

24

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We believe the Mortgage BankersAssociation (MBA) method is most consistent with the SEC proposal of definingdelinquency as a contractually required payment being 30 days or more past due,compared to the Office of Thrift Supervision (OTS) method. It is our view thatthe MBA methodology provides a more accurate reading on delinquency. The OTSmethodology lags the MBA approach in reporting delinquencies by an additional30 days. We measure delinquencies from the date of the last payment due date inwhich a payment was received, compared to the OTS method which starts countingthe days on the date the payment was not made.

Thefollowing table summarizes non-performing loans that we own, includingsecuritized mortgage collateral, mortgages held for long-term investment andmortgages held-for-sale, that were 60 or more days delinquent for the periodsindicated (in thousands):
| ** **                                              | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                                              | ** ** | **2007**                  | ** ** | **%**                         | ** ** | **2006 ** | ** ** | **%** | ** ** |
|                                                    |       |                      |       |                          |       |   |   |   |   |
| Loans  held-for-sale (1)                                |       |                      |       |                          |       |   |   |   |   |
| 60 - 89 days delinquent                                 |       | $                         | 18,167     |                          | 1          | % | $ | 11,107 |   | 1 | % |
| 90 or more days delinquent                              |       | 32,590                    |       | 2                             | %          | 34,598 |   | 3 | % |
| Foreclosures (2)                                        |       | 13,317                    |       | 1                             | %          | 13,267 |   | 1 | % |
| Delinquent bankruptcies                                 |       | 491                       |       | 0                             | %          | — |   | 0 | % |
| Total 60+ days delinquent loans held-for-sale           |       | 64,565                    |       | 4                             | %          | 58,972 |   | 5 | % |
|                                                    |       |                      |       |                          |       |   |   |   |   |
| Long term  mortgage portfolio                           |       |                      |       |                          |       |   |   |   |   |
| 60 - 89 days delinquent                                 |       | $                         | 405,684    |                          | 24         | % | $ | 373,238 |   | 30 | % |
| 90 or more days delinquent                              |       | 463,808                   |       | 27                            | %          | 275,089 |   | 22 | % |
| Foreclosures (2)                                        |       | 601,783                   |       | 36                            | %          | 403,489 |   | 33 | % |
| Delinquent bankruptcies                                 |       | 149,829                   |       | 9                             | %          | 118,482 |   | 10 | % |
| Total 60+ days delinquent long term mortgage  portfolio |       | 1,621,104                 |       | 96                            | %          | 1,170,298 |   | 95 | % |
|                                                    |       |                      |       |                          |       |   |   |   |   |
| Total 60 or more days delinquent                        |       | $                         | 1,685,669  |                          | 100        | % | $ | 1,229,270 |   | 100 | % |

 

----

(1) Delinquenciesincluded in loans held-for-sale are primarily related loans repurchased inaccordance with the normal representations and warranties.

(2) Representsproperties in the process of foreclosure.

Non-performing assets consist ofmortgages that are 90 days or more delinquent, including loans inforeclosure and delinquent bankruptcies. It is our policy to place a mortgageon non-accrual status when it becomes 90 days delinquent and to reversefrom revenue any accrued interest, except for interest income on securitizedmortgage collateral whereby the scheduled payment is received from the servicerwhether or not the borrower makes the payment. As of June 30, 2007,non-performing assets as a percentage of total assets were 7.16 percentcompared to 4.26 percent as of year-end 2006.

25

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Thefollowing table summarizes mortgages that we own, including securitizedmortgage collateral, mortgages held for long-term investment, mortgagesheld-for-sale and real estate owned, that were non-performing for the periodsindicated (in thousands):
| ** **                                                            | ** ** | **At June 30,** | ** ** | ** ** | ** ** | **At December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                                            | ** ** | **2007**                  | ** ** | **%**      | ** ** | **2006**                      | ** ** | **%**      | ** ** |
| 90 or more days  delinquent, foreclosures and delinquent bankruptcies |       | $                         | 1,261,818  |       | 78         | %                             | $          | 844,925    |       | 84 | % |
| Other real  estate owned                                              |       | 352,935                   |       | 22         | %          | 161,538                       |       | 16         | %          |
| Total non-performing assets                                           |       | $                         | 1,614,753  |       | 100        | %                             | $          | 1,006,463  |       | 100 | % |

 

Realestate owned, which consists of residential real estate acquired insatisfaction of loans, is carried at the lower of cost or net realizable valueless estimated selling costs. Adjustments to the loan carrying value requiredat the time of foreclosure are charged against the allowance for loan losses.Losses or gains from the ultimate disposition of real estate owned are recordedas (gain) loss on sale of other real estate owned in the consolidated statementof operations. Subsequent adjustments to the carrying value after foreclosureare recorded as adjustments to the valuation allowance against the REO balance.  At June 30, 2007, the allowance against REOwas $26.0 million, as compared to $8.5 million at December 31, 2006.  Real estate owned at June 30, 2007 was$352.9 million, or 118 percent, higher than at December 31, 2006 as aresult of an increase in foreclosures due to higher delinquencies and a deteriorationin the prevailing real estate market and economic conditions.  

Wehave realized a loss on disposition of real estate owned in the amount of$1.1 million and $215 thousand for the three and six months ended June 30,2007, respectively, as compared to a gain of $621 thousand and $976 thousandfor the three and six months ended June 30, 2006, respectively.

The following tablepresents a rollforward of the real estate owned (in thousands):
|                    | ** ** | **For the six months** | ** ** | **For the year**       | ** ** |
|--------------------|------------|---------------------------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **ended June 30,**          | ** ** | **ended December 31,** | ** ** |
| ** **         | ** ** | **2007**                              | ** ** | **2006**                         | ** ** |
| Beginning  balance |       | $                                     | 170,077    |                             | $          | 46,351 |   |
| Additions          |       | 283,722                               |       | 199,583                          |       |
| Sales              |       | (81,037                               | )          | (84,410                          | )          |
| Other              |       | 6,179                                 |       | 8,553                            |       |
| REO                |       | 378,941                               |       | 170,077                          |       |
| REO reserve        |       | (26,006                               | )          | (8,539                           | )          |
| REO, net           |       | 352,935                               |       | 161,538                          |       |
|                    |            |                                       |            |                                  |            |  |  |

 

The following tablepresents a rollforward of the allowance on the real estate owned (inthousands):
|                    | ** ** | **For the quarter** | ** ** | **For the six months** | ** ** |
|--------------------|------------|-------------------------------|------------|---------------------------------------|------------|
| ** **         | ** ** | **ended June 30,**  | ** ** | **ended June 30,**          | ** ** |
| ** **         | ** ** | **2007 (1)**             | ** ** | **2007 (1)**                     | ** ** |
| Beginning  balance |       | $                             | 15,672     |                                  | $          | 8,539 |   |
| Provision          |       | 18,421                        |       | 28,311                                |       |
| Charge-offs        |       | (8,087                        | )          | (10,844                               | )          |
| Ending balance     |       | $                             | 26,006     |                                  | $          | 26,006 |   |

 

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(1)          There is no REO reserve for the three and six month periods ended June30, 2006.

In addition to theallowance for REO losses the Company maintains an allowance for loan losses. In evaluating the adequacy of the allowance forloan losses, 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.  Ourestimate of the required allowance for these loans is developed by estimatingboth the rate of default of the loans and the amount of loss in the event ofdefault. The rate of default is assigned to the loans based on their attributes(e.g., original loan-to-value, borrower credit score, documentation type, etc.)and collection status. The rate of default is based on analysis of migration ofloans from each aging category. The loss severity is determined by estimating the net proceeds from theultimate sale of the foreclosed property. The results of that analysis are thenapplied to the current mortgage portfolio and an estimate is 

26

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created. We believe that poolingof mortgages with similar characteristics is an appropriate methodology inwhich to evaluate the allowance for loan losses. Management also recognizesthat there are qualitative factors that must be taken into consideration whenevaluating and measuring inherent loss in our loan portfolios. These itemsinclude, but are not limited to, economic indicators that may affect theborrower’s ability to pay, changes in value of collateral, projected losscurves, political factors, market conditions, competitor’s performance, marketperception and industry statistics.  The Company provides loan losses in accordancewith its policies that include an analysis of the loan portfolio to determineestimated loan losses in the next 12 to 18 months.  The determination of the level of theallowance for loan losses and, correspondingly, the provision for loan losses,is based on delinquency trends and prior loan loss experience and management’sjudgment and assumptions regarding various matters, including general economicconditions and loan portfolio composition. Management continually evaluatesthese assumptions and various relevant factors impacting credit quality andinherent losses.  While our delinquencyrates have increased, we believe our total allowance for loan losses isadequate to absorb losses inherent in our mortgage portfolio as of June 30,2007.

*Interest Rate Risk.*Refer to Item 3. “Quantitativeand Qualitative Disclosures About Market Risk.”

*Prepayment Risk.*The Company uses prepayment penalties as a method of partiallymitigating prepayment risk. Mortgage industry evidence suggests that theincrease in home appreciation rates and lower payment option mortgage productsover the last three years has been a significant factor affecting borrowersrefinancing decisions. As rates increase and housing prices decline, borrowerswill find it more difficult to refinance to obtain cheaper financing. Ifborrowers are unable to pay their mortgage payments at the adjusted rate,delinquencies may increase. The three-month average prepayment rate (CPR)decreased to 26 percent at June 30, 2007 from 36 percent as ofDecember 31, 2006.  This reductionin prepayment rates has resulted in an increase in the amortization period forpremiums paid to acquire loans, which has increased interest income, asdescribed under “Estimated Taxable Income.”

Duringthe quarter ended June 30, 2007, 72% of Alt-A mortgages acquired or originatedby the long-term investment operations from the mortgage operations hadprepayment penalty features ranging from six-months to five years.  As of June 30, 2007, the twelve-monthCPR of mortgages held as securitized mortgage collateral was 33 percent ascompared to a 38 percent twelve-month average CPR as of December 31,2006. Prepayment penalties are charged to borrowers for mortgages that are paidearly and recorded as interest income. Income from prepayment penalties helpsoffset amortization of loan premiums and securitization costs. During the firstsix months of 2007 prepayment penalties received from borrowers were recordedas interest income and increased the yield on average mortgage assets by 10basis points as compared to 21 basis points for the same period in 2006.

*Resultsof Operations*

*Forthe Three Months Ended June 30, 2007 compared to the Three Months Ended June30, 2006*

Condensed Statements ofOperations Data

(dollars inthousands, except share data)
| ** **                                           | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                      |       | $                                                                     | 337,010    |   | $ | 313,759 |   | $ | 23,251 |   | 7 | % |
| Interest expense                                     |       | 324,027                                                               |       | 328,506 |   | (4,479 | ) | (1 | ) |
| Net interest income (expense)                        |       | 12,983                                                                |       | (14,747 | ) | 27,730 |   | 188 |   |
| Provision for  loan losses                           |       | 162,981                                                               |       | (45 | ) | 163,026 |   | 362,280 |   |
| Net interest expense after provision for loan losses |       | (149,998                                                              | )          | (14,702 | ) | (135,296 | ) | (920 | ) |
| Total  non-interest income                           |       | 36,516                                                                |       | 62,188 |   | (25,672 | ) | (41 | ) |
| Total  non-interest expense                          |       | 35,845                                                                |       | 27,223 |   | 8,622 |   | 32 |   |
| Income tax  (benefit) expense                        |       | 3,220                                                                 |       | (6,093 | ) | 9,313 |   | 153 |   |
|                                                 |       | $                                                                     | (152,547   | ) | $ | 26,356 |   | $ | (178,903 | ) | (679 | )% |
| Net (loss) earnings                                  |       |                                                                  |       |   |   |   |   |   |   |
|                                                 |       |                                                                  |       |   |   |   |   |   |   |
| Net (loss)  earnings per share - diluted             |       | $                                                                     | (2.05      | ) | $ | 0.30 |   | $ | (2.35 | ) | (792 | )% |
| Dividends declared per  common share                 |       | $                                                                     | —     |   | $ | 0.25 |   | $ | (0.25 | ) | (100 | )% |

 

27

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*Forthe Six Months Ended June 30, 2007 compared to the Six Months Ended June 30,2006*
| ** **                                           | ** ** | **For the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                      |       | $                                                                   | 679,831    |   | $ | 648,964 |   | $ | 30,867 |   | 5 | % |
| Interest expense                                     |       | 653,393                                                             |       | 652,236 |   | 1,157 |   | — |   |
| Net interest income (expense)                        |       | 26,438                                                              |       | (3,272 | ) | 29,710 |   | 908 |   |
| Provision for  loan losses                           |       | 192,355                                                             |       | 105 |   | 192,250 |   | 183,095 |   |
| Net interest expense after provision for loan losses |       | (165,917                                                            | )          | (3,377 | ) | (162,540 | ) | (4,813 | ) |
| Total  non-interest income                           |       | (34,047                                                             | )          | 169,932 |   | (203,979 | ) | (120 | ) |
| Total  non-interest expense                          |       | 69,165                                                              |       | 57,481 |   | 11,684 |   | 20 |   |
| Income tax  (benefit) expense                        |       | 5,086                                                               |       | (2,848 | ) | 7,934 |   | 279 |   |
| Net (loss) earnings                                  |       | $                                                                   | (274,215   | ) | $ | 111,922 |   | $ | (386,137 | ) | (345 | )% |
|                                                 |       |                                                                |       |   |   |   |   |   |   |
| Net (loss)  earnings per share - diluted             |       | $                                                                   | (3.70      | ) | $ | 1.37 |   | $ | (5.07 | ) | (370 | )% |
| Dividends declared per  common share                 |       | $                                                                   | 0.10       |   | $ | 0.50 |   | $ | (0.40 | ) | (80 | )% |

 

*NetInterest Income (Expense)*

We earn net interest incomeprimarily from mortgage assets which include securitized mortgage collateral,mortgages held-for-investment, mortgages held-for-sale, finance receivables andinvestment securities available-for-sale, or collectively, “mortgage assets,”and, to a lesser extent, interest income earned on cash and cash equivalents.Interest expense is primarily interest paid on borrowings on mortgage assets,which include securitized mortgage borrowings, reverse repurchase agreementsand borrowings secured by investment securities available-for-sale. Netinterest income also includes (1) amortization of acquisition costs onmortgages acquired from the mortgage operations, (2) accretion of loandiscounts, which primarily represents the amount allocated to mortgageservicing rights when they are sold to third parties and mortgages aretransferred to the long-term investment operations from the mortgage operationsand retained for long-term investment, (3) amortization of securitizedmortgage securitization expenses and, to a lesser extent, (4) amortizationof securitized mortgage bond discounts.

28

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Thefollowing table summarizes average balance, interest and weighted average yieldon mortgage assets and borrowings on mortgage assets for the periods indicated(dollars in thousands):
| ** **                                                                                   | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **Average**                                                           | ** ** | **2007** | ** ** | **(8)** | ** ** | **Average** | ** ** | **2006** | ** ** | **(8)** | ** ** |
| ** **                                                                                   | ** ** | **Balance**                                                           | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
|                                                                                         | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **MORTGAGE  ASSETS**                                                                         | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Subordinated  securities collateralized by mortgages                                         |       | $                                                                     | 29,094     |   | $ | 1,711 |   | 23.52 | % | $ | 17,597 |   | $ | 457 |   | 10.39 | % |
| Securitized  mortgage collateral (1)                                                         |       | 21,184,780                                                            |       | 319,051 |   | 6.02 | % | 21,956,653 |   | 282,948 |   | 5.15 | % |
| Mortgages  held-for-investment and held-for-sale                                             |       | 866,517                                                               |       | 10,967 |   | 5.06 | % | 1,493,017 |   | 22,826 |   | 6.12 | % |
| Finance  receivables                                                                         |       | 163,456                                                               |       | 2,965 |   | 7.26 | % | 270,151 |   | 5,032 |   | 7.45 | % |
| Total mortgage  assets\ interest income                                                      |       | $                                                                     | 22,243,847 |   | $ | 334,694 |   | 6.02 | % | $ | 23,737,418 |   | $ | 311,263 |   | 5.25 | % |
|                                                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                                               | ** ** | ** **                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized  mortgage borrowings                                                             |       | $                                                                     | 20,772,443 |   | $ | 304,551 |   | 5.86 | % | $ | 21,506,608 |   | $ | 302,744 |   | 5.63 | % |
| Reverse  repurchase agreements                                                               |       | 1,134,264                                                             |       | 17,236 |   | 6.08 | % | 1,590,151 |   | 23,456 |   | 5.90 | % |
| Total borrowings  on mortgage assets\ interest expense                                       |       | $                                                                     | 21,906,707 |   | $ | 321,787 |   | 5.88 | % | $ | 23,096,759 |   | $ | 326,200 |   | 5.65 | % |
|                                                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Net  Interest Spread (2)**                                                                 |       |                                                                  |       |   |   | 0.14 | % |   |   |   |   | (0.40 | )% |
| **Net  Interest Margin (3)**                                                                 |       |                                                                  |       |   |   | 0.23 | % |   |   |   |   | (0.25 | )% |
|                                                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income on mortgage assets                                                      |       |                                                                  |       | $ | 12,907 |   | 0.23 | % |   |   | $ | (14,937 | ) | (0.25 | )% |
| Less: Accretion  of loan discounts (4)                                                       |       |                                                                  |       | (15,373 | ) | (0.28 | )% |   |   | (18,153 | ) | (0.31 | )% |
| Adjusted by net  cash receipts on derivatives (5)                                            |       |                                                                  |       | 38,640 |   | 0.69 | % |   |   | 55,868 |   | 0.94 | % |
| **Adjusted  Net Interest Margin (6)**                                                        |       |                                                                  |       | $ | 36,174 |   | 0.65 | % |   |   | $ | 22,778 |   | 0.38 | % |
|                                                                                         |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization  of loan premiums and securitization costs on net interest spread (7) |       |                                                                  |       | $ | 42,734 |   | (0.77 | )% |   |   | $ | 63,978 |   | (1.08 | )% |

 

29

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| ** **                                                                                   | ** ** | **For the  Six Months Ended June 30,** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------|
| ** **                                                                                   | ** ** | **2007**                               | ** ** | **2006** |
| ** **                                                                                   | ** ** | **Average  Balance**                   | ** ** | **Interest** | ** ** | **(8)  Yield** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **(8)  Yield** | ** ** |
| **MORTGAGE  ASSETS**                                                                         |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| Subordinated  securities collateralized by mortgages                                         |       | $                                      | 29,949 |   | $ | 3,308 |   | 22.09 | % | $ | 28,816 |   | $ | 1,177 |   | 8.17 | % |
| Securitized  mortgage collateral (1)                                                         |       | 20,930,093                             |   | 622,653 |   | 5.95 | % | 22,727,668 |   | 580,457 |   | 5.11 | % |
| Mortgages held-for-investment  and held-for-sale                                             |       | 1,411,734                              |   | 41,312 |   | 5.85 | % | 1,634,161 |   | 53,198 |   | 6.51 | % |
| Finance  receivables                                                                         |       | 217,859                                |   | 8,192 |   | 7.52 | % | 290,315 |   | 9,807 |   | 6.76 | % |
| Total mortgage  assets\ interest income                                                      |       | $                                      | 22,589,635 |   | $ | 675,465 |   | 5.98 | % | $ | 24,680,960 |   | $ | 644,639 |   | 5.22 | % |
|                                                                                         |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                                               |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| Securitized  mortgage borrowings                                                             |       | $                                      | 20,479,422 |   | $ | 597,928 |   | 5.84 | % | $ | 22,257,080 |   | $ | 598,219 |   | 5.38 | % |
| Reverse  repurchase agreements                                                               |       | 1,684,967                              |   | 50,973 |   | 6.05 | % | 1,754,160 |   | 49,329 |   | 5.62 | % |
| Total borrowings  on mortgage assets\ interest expense                                       |       | $                                      | 22,164,389 |   | $ | 648,901 |   | 5.86 | % | $ | 24,011,240 |   | $ | 647,548 |   | 5.39 | % |
|                                                                                         |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| Net Interest  Spread (2)                                                                     |       |                                   |   |   |   | 0.12 | % |   |   |   |   | (0.17 | )% |
| Net Interest  Margin (3)                                                                     |       |                                   |   |   |   | 0.24 | % |   |   |   |   | (0.02 | )% |
|                                                                                         |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| Net Interest  (expense) Income on Mortgage Assets                                            |       |                                   |   | $ | 26,564 |   | 0.24 | % |   |   | $ | (2,909 | ) | (0.02 | )% |
| Less: Accretion  of loan discounts (4)                                                       |       |                                   |   | (28,708 | ) | (0.25 | )% |   |   | (34,073 | ) | (0.28 | )% |
| Adjusted by net  cash receipts on derivatives (5)                                            |       |                                   |   | 76,099 |   | 0.67 | % |   |   | 96,004 |   | 0.78 | % |
| Adjusted Net  Interest Margin (6)                                                            |       |                                   |   | $ | 73,955 |   | 0.65 | % |   |   | $ | 59,022 |   | 0.48 | % |
|                                                                                         |       |                                   |   |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization  of loan premiums and securitization costs on net interest spread (7) |       |                                   |   | $ | 85,032 |   | (0.75 | )% |   |   | $ | 126,477 |   | (1.02 | )% |

 

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(1)                                  Interest on securitizedmortgage collateral includes amortization of acquisition cost on mortgagesacquired from the mortgage operations and accretion of loan discounts.

(2)                                  Net interest spread onmortgage assets is calculated by subtracting the weighted average yield ontotal borrowings on mortgage assets from the weighted average yield on totalmortgage assets.

(3)                                  Net interest margin onmortgage assets is calculated by subtracting interest expense on totalborrowings on mortgage assets from interest income on total mortgage assets andthen dividing by total average mortgage assets and annualizing the quarterlymargin.

(4)                                  Yield represents incomefrom the accretion of loan discounts, included in (1) above, divided bytotal average mortgage assets.

(5)                                  Yield represents net cashreceipts on derivatives divided by total average mortgage assets.

(6)                                  Adjusted net interestmargin on mortgage assets is calculated by subtracting interest expense ontotal borrowings on mortgage assets, accretion of loan discounts and net cashreceipts on derivatives from interest income on total mortgage assets dividedby total average mortgage assets. Net cash receipts on derivatives are acomponent of realized gain on derivative instruments on the consolidatedstatements of operations. Adjusted net interest margin on mortgage assets is a non-GAAPfinancial measurement; however, the reconciliation provided in this table isintended to meet the requirements of Regulation G as promulgated by theSEC for the presentation of non-GAAP financial measurements. We believe thatthe presentation of adjusted net interest margin on mortgage assets is a usefuloperating performance measure for our investors as it more closely reflects theeconomics of net interest margins on mortgage assets by providing informationto evaluate net interest income attributable to net investments.

(7)                                  The amortization of loanpremiums and securitization costs are components of interest income andinterest expense, respectively. Yield represents the cost of amortization ofnet loan premiums and securitization costs divided by total average mortgageassets.  

(8)                                The yields representannualized yields based on the results for the quarter and year-to-date.

30

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*For the three months ended June 30,2007 compared to the three months ended June 30, 2006*

Increases in net interest income were primarily due toan improvement in net interest margins on mortgage assets as a result of thefollowing:

·                  theCompany increased the amortization period in which loan premiums paid for loansthat are retained are amortized to interest income, and the periodsecuritization costs are amortized to interest expense, due to lower prepaymentrates; and

·                  theyield on borrowing costs have increased less during the second quarter 2007 ascompared to the second quarter 2006, as our mortgages have re-priced upwardfaster than the increase in borrowing costs on the underlying borrowings aswell as the addition of new collateral with higher coupons.

Net interest income for the second quarter of 2007increased $27.7 million (188 percent) as compared to 2006. The increase wasprimarily due to net interest margins on mortgage assets increasing by 48 basispoints to 0.23% for the second quarter of 2007 as compared to (0.25%) for 2006.  Theincrease in adjusted net interest margins on mortgage assets was primarily dueto a positive variance of 77 basis points in yield on mortgage assets, ascoupons have adjusted, and a decrease of 31 basis points in amortization ofpremiums and securitization costs, partially offset by an unfavorable varianceof 23 basis points in borrowing costs and a 25 basis point decrease fromrealized gains on derivative assets.

Along with an increase inshort-term interest rates, our expectation, based on past experience, was thatwe would see a corresponding decline in mortgage prepayment speeds which wehave started to observe in our portfolio during 2007. Additionally, based uponcurrent market conditions, we would expect prepayments to decrease due toborrowers’ inability to obtain cheaper financing. As home prices have declinedin most areas and interest rates have remained flat, our securitized mortgagecollateral reflects reduced prepayments with the three-month CPR rate decliningto 26 percent as of June 30, 2007 from 36 percent as of December 31, 2006.

Amortization of loanpremiums and securitization expenses decreased by 31 basis points to 0.77% ofaverage mortgage assets during the second quarter of 2007 as compared to 1.08%of average mortgage assets during the same period in 2006.   The decrease in amortization of premiums andsecuritization expenses was the result of a decrease in actual prepayments,which has increased the number of months in which the Company amortizes thepremiums, therefore increasing interest income.

A substantial portion ofour long-term mortgage investment portfolio consists of mortgages withprepayment penalty features that are primarily designed to help minimize therate of early mortgage prepayments. However, if borrowers do prepay on mortgages, a prepayment penalty ischarged which helps partially offset additional amortization of loan premiumsand securitization costs related to the prepaid mortgages. During the secondquarter of 2007, prepayment penalties received from borrowers were recorded asinterest income and decreased 14 basis points to 9 basis points of mortgageassets as compared to 23 basis points of mortgage assets in the second quarterof 2006.

Adjusted net interestmargins on mortgage assets, which is a non-GAAP financial measurement asindicated in the yield table above, increased by 27 basis points as compared toan increase of 48 basis points on net interest margin on mortgage assets in theprior year.  Adjusted net interest marginon mortgage assets did not increase as much as net interest margin on mortgageassets primarily due to a 25 basis point decrease in realized gains fromderivative instruments. Realized gains from derivative instruments partiallyoffset the decline in net interest margins on mortgage assets associated withincreases in borrowing costs.

Adjusted net interestmargins were also affected during the second quarter of 2007 by our interestrate risk management policies which include the employment of balanceguarantees that limit our derivatives to no more than 100% coverage of theprincipal amount outstanding on certain securitized mortgage borrowings at anygiven time. Our interest rate risk management policies are formulated with theintent to offset the potential adverse effects of changing interest ratesprimarily associated with cash flows on adjustable rate securitized mortgageborrowings. By design, our current interest rate risk management programtypically provides 20% to 25% coverage of the outstanding principal balance ofour six month LIBOR ARMs and 80% to no more than 98% coverage of theoutstanding principal balance of intermediate, or hybrid, ARMs at thepoint in time that we securitize the mortgages.

31

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*For the six months ended June 30, 2007compared to the six months ended June 30, 2006*

Increases in net interest income were primarily due toan improvement in net interest margins on mortgage assets as a result of thefollowing:

·                  theCompany increased the amortization period in which loan premiums paid for loansthat are retained are amortized to interest income, and the periodsecuritization costs are amortized to interest expense, due to lower prepaymentrates; and

·                  theyield on borrowing costs have increased less during the second quarter 2007 ascompared to the second quarter 2006, as our mortgages have re-priced upwardfaster than the increase in borrowing costs on the underlying borrowings aswell as the addition of new collateral with higher coupons.

Net interest income for the first six months of 2007increased $29.7 million (908 percent) as compared to 2006. The increase wasprimarily due to net interest margins on mortgage assets increasing by 26 basispoints to 0.24% for the first six months of 2007 as compared to (0.02%) for thesame period in 2006.  The increase in adjusted net interest margins onmortgage assets was primarily due to a positive variance of 76 basis points inyield on mortgage assets, as coupons have adjusted, and a decrease of 27 basispoints in amortization of premiums and securitization costs, partially offsetby an unfavorable variance of 47 basis points in borrowing costs and an 11basis point decrease from realized gains on derivative assets.

Along with an increase inshort-term interest rates, our expectation, based on past experience, was thatwe would see a corresponding decline in mortgage prepayment speeds which wehave started to observe in our portfolio during 2007. Additionally, based uponcurrent market conditions, we would expect prepayments to decrease due toborrowers inability to obtain cheaper financing. As home prices have declinedin some areas and interest rates have remained flat, our securitized mortgagecollateral reflects reduced prepayments with the three-month CPR rate decliningto 26% as of June 30, 2007 from 36% as of December 31, 2006.

Amortization of loanpremiums and securitization expenses decreased by 27 basis points to 0.75% ofaverage mortgage assets during the first six months of 2007 as compared to1.02% of average mortgage assets during the same period in 2006.   The decrease in amortization of premiums andsecuritization expenses was the result of a decrease in actual prepayments,which has increased the number of months in which the Company amortizes thepremiums, therefore increasing interest income.

A substantial portion ofour long-term mortgage investment portfolio consists of mortgages withprepayment penalty features that are primarily designed to help minimize therate of early mortgage prepayments. However, if borrowers do prepay on mortgages, a prepayment penalty ischarged which helps partially offset additional amortization of loan premiumsand securitization costs related to the prepaid mortgages. During the first sixmonths of 2007, prepayment penalties received from borrowers were recorded asinterest income and decreased 11 basis points to 10 basis points of mortgageassets as compared to 21 basis points of mortgage assets during the same periodof 2006.

Adjusted net interestmargins on mortgage assets, which is a non-GAAP financial measurement asindicated in the yield table above, increased by 17 basis points as compared toan increase of 26 basis points on net interest margin on mortgage assets in theprior year.  Adjusted net interest marginon mortgage assets did not increase as much as net interest margin on mortgageassets primarily due to a 11 basis point decrease in realized gains fromderivative instruments. Realized gains from derivative instruments partiallyoffset the decline in net interest margins on mortgage assets associated withincreases in borrowing costs.

Adjusted net interestmargins were also affected during the second half of 2007 by our interest raterisk management policies which include the employment of balance guaranteesthat limit our derivatives to no more than 100% coverage of the principalamount outstanding on certain securitized mortgage borrowings at any giventime. Our interest rate risk management policies are formulated with the intentto offset the potential adverse effects of changing interest rates primarilyassociated with cash flows on adjustable rate securitized mortgage borrowings.By design, our current interest rate risk management program typically provides20% to 25% coverage of the outstanding principal balance of our six month LIBORARMs and 80% to no more than 98% coverage of the outstanding principalbalance of intermediate, or hybrid, ARMs at the point in time that wesecuritize the mortgages.

Forfurther information on our interest rate risk management policies refer to Item3. “Quantitative and Qualitative Disclosures About Market Risk.”

32

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*Provisionfor Loan Losses*

TheCompany provides loan losses in accordance with its policies that include ananalysis of the loan portfolio to determine estimated loan losses expected inthe next 12 to 18 months.  Thedetermination of the level of the allowance for loan losses and,correspondingly, the provision for loan losses, is based on delinquency trendsand prior loan loss experience and management’s judgment and assumptionsregarding various matters, including general economic conditions and loan portfoliocomposition. Management continually evaluates these assumptions and variousrelevant factors impacting credit quality and inherent losses.  The results of that analysis are then appliedto the current mortgage portfolio and an estimate is created.

The allowance for loan losses was $220.9 million atJune 30, 2007, and was comprised of specific reserves of $6.8 million, financereceivables of $5.0 million, and a loan portfolio reserve of $209.1 million.During the six months ended June 30, 2007, specific reserves on financereceivables decreased by $5.6 million. The decrease in the specific reserve forfinance receivables was due to a settlement during the first quarter of areceivable that had a $7.7 million specific reserve, offset by additionalspecific reserves. Exclusive of specific reserves, the Company maintained anallowance for securitized mortgage collateral and mortgage loanheld-for-investment for loan losses of 97 basis points at June 30, 2007compared to 34 basis points at December 31, 2006. The Company believes thetotal allowance for loan losses is adequate to absorb losses inherent in theloan portfolio at June 30, 2007.

For further information on delinquencies in ourlong-term investment portfolio and non-performing assets refer to “FinancialCondition and Results of Operations—Credit Risk.”

*Non-InterestIncome*

*Forthe Three Months Ended June 30, 2007 compared to the Three Months Ended June30, 2006:*

Changes in Non-InterestIncome

(dollars inthousands)
|                                                           | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair  value of derivative instruments           |       | $                                                                     | 56,900     |   | $ | 11,504 |   | $ | 45,396 |   | 395 | % |
| Realized gain  from derivative instruments                |       | 38,640                                                                |       | 55,868 |   | (17,228 | ) | (31 | ) |
| Gain(loss) on  sale of loans                              |       | 2,406                                                                 |       | 16,548 |   | (14,142 | ) | (85 | ) |
| Amortization and  impairment of mortgage servicing rights |       | (206                                                                  | )          | (381 | ) | 175 |   | 46 |   |
| Gain (loss) on  sale of real estate owned                 |       | (1,060                                                                | )          | 621 |   | (1,681 | ) | (271 | ) |
| Goodwill  impairment                                      |       | (12,360                                                               | )          | — |   | (12,360 | ) | (100 | ) |
| Loss on lower of  cost or market writedown                |       | (10,180                                                               | )          | (18,780 | ) | 8,600 |   | 46 |   |
| Provision for  REO losses                                 |       | (18,421                                                               | )          | — |   | (18,421 | ) | (100 | ) |
| Provision for  repurchases                                |       | (18,889                                                               | )          | (12,773 | ) | (6,116 | ) | (48 | ) |
| Other income                                              |       | 314                                                                   |       | 9,581 |   | (9,895 | ) | (103 | ) |
| Total  non-interest income                                |       | $                                                                     | 36,516     |   | $ | 62,188 |   | $ | (25,672 | ) | (41 | )% |

 

*Change in Fair Value of Derivative Instruments.* The change in fair value of derivativeinstruments increased by $45.4 million (395 percent) during the second quarterof 2007 as compared to the second quarter of 2006. The amount of marketvaluation adjustment is primarily the result of changes in the expectation offuture interest rates and partially offset by actual cash receipts onderivative instruments. We primarily enter into derivative contracts to offseta portion of the changes in cash flows associated with securitized mortgageborrowings. We record a market valuation adjustment for these derivatives, aswell as other derivatives used by the mortgage operations to hedge our loanpipeline and mortgage loans held for sale, as current period expense orrevenue.  Changes in fair value of derivatives at IMH are included in GAAP netearnings and backed out for purposes of calculating estimated taxable income.

*Realized Gain from DerivativeInstruments*.  Realizedgains from derivatives decreased by $17.2 million (31 percent) during thesecond quarter of 2007 as compared to the second quarter of 2006, or 69 basispoints of total average mortgage assets during the second quarter of 2007 ascompared to 94 basis points of total average mortgage assets during the secondquarter of 2006.  Realized gains fromderivatives are recorded as current period expense or revenue on ourconsolidated financial statements and are included in the calculation oftaxable income. Realized gains exclude themark to market gains or losses that are realized for tax purposes at thetaxable REIT subsidiaries when the loans held-for-sale are deposited into thesecuritization trust, and the related derivatives are deposited into a swaptrust. These gains are not realized for GAAP purposes, as the deposit of thederivatives into the swap trust are considered an inter-company transfer,as the REIT consolidates the swap trust. For GAAP purpose, these gains andlosses are included in change in fair value of derivative instruments.

33

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*Gainon Sale of Loans. *Gainon sale of loans decreased $14.1 million (85 percent) during the secondquarter of 2007 as compared to the second quarter of 2006. The decrease wasprimarily due to a $1.7 billion (80 percent) decrease in whole loan sales aswell as a reduction in execution prices mainly due to the proportion ofdispositions that were non-performing loans and the reduction in market pricesof performing and non-performing loans during the second quarter of 2007. Themarket value of performing and non-performing loans decreased due to thesaturation of loans for sale in the marketplace, compounded by decreased homeprices, which decreases the effective loan-to-value ratio.* *Weuse derivatives to protect the market value of mortgages from the point in timewhen we establish an interest rate lock commitment on a particular mortgageprior to its close until the eventual sale or securitization. Any changes ininterest rates on mortgages that we have committed to acquire at a particularrate until we sell or securitize the mortgage generally results in an increaseor decrease in the market value of the related derivative.  For the quarter-ended June 30, 2007, werecorded a $183 thousand gain from the settlement of these derivatives ascompared to a gain of $3.0 million for the quarter-ended June 30, 2006.

*Goodwill Impairment.*  In May 2007, the Company completed theacquisition of certain production facilities from Pinnacle FinancialCorporation (PFC). This transaction was recorded as a business combination foraccounting purposes resulting in the Company initially recording $12.4 millionin goodwill. Because of the current market environment as of June 30, 2007, thegoodwill was considered fully impaired.

*Provision for Repurchases.*  Provisionfor repurchases increased $6.1 million (48 percent) to $18.9 millionduring the second quarter of 2007 as compared to the second quarter of 2006.The increase in the provision for repurchases was primarily due to an increasein severities of actual losses, which resulted from a decrease in the marketconditions of the loans subject to repurchase and an increase in the age of theloans subject to repurchase requests.  

*Loss on Lower of Cost or MarketWritedown.*  The loss on lower of cost or market (“LOCOM”)writedown decreased $8.6 million (46 percent), primarily due to adecrease in the amount of loans deemed to be unsaleable at standard salepremiums included in held-for-sale, which decreased to $66.8 million from$144.6 million at June 30, 2006.  Also,the fair value in the marketplace of non-performing loans decreased, asinvestors require a higher yield, which reduced the fair value of loansheld-for-sale.

*Provision for REO loss. *During thesecond quarter of 2007, the Company recorded a provision for REO losses in theamount of $18.4 million as a result of changes in the net realizable value ofthe real estate owned subsequent to the foreclosure date.

Changes in Non-InterestIncome

(dollars inthousands)
|                                                           | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Realized gain  from derivative instruments                |       | $                                                                   | 76,099     |   | $ | 96,004 |   | $ | (19,905 | ) | (21 | )% |
| Gain on sale of  real estate owned                        |       | (215                                                                | )          | 976 |   | (1,191 | ) | (122 | ) |
| Amortization and  impairment of mortgage servicing rights |       | (416                                                                | )          | (732 | ) | 316 |   | 43 |   |
| Change in fair  value of derivative instruments           |       | (1,861                                                              | )          | 62,933 |   | (64,794 | ) | (103 | ) |
| Gain(loss) on  sale of loans                              |       | (6,725                                                              | )          | 30,741 |   | (37,466 | ) | (122 | ) |
| Goodwill  impairment                                      |       | (12,360                                                             | )          | — |   | (12,360 | ) | (100 | ) |
| Provision for  REO losses                                 |       | (28,311                                                             | )          | — |   | (28,311 | ) | (100 | ) |
| Provision for  repurchases                                |       | (30,718                                                             | )          | (23,110 | ) | (7,608 | ) | (33 | ) |
| Loss on lower of  cost or market writedown                |       | (34,874                                                             | )          | (15,283 | ) | (19,591 | ) | (128 | ) |
| Other income                                              |       | 5,334                                                               |       | 18,403 |   | (13,069 | ) | (71 | ) |
| Total  non-interest income                                |       | $                                                                   | (34,047    | ) | $ | 169,932 |   | $ | (203,979 | ) | (120 | )% |

 

34

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*Realized Gain from DerivativeInstruments*. Realized gains from derivatives decreased by$19.9 million (21 percent) during the first six months of 2007 as compared tothe same period in 2006, or 67 basis points of total average mortgage assetsduring the second quarter of 2007 as compared to 78 basis points of totalaverage mortgage assets during the second quarter of 2006.  Realized gains from derivatives are recordedas current period expense or revenue on our consolidated financial statementsand are included in the calculation of taxable income. Realized gains exclude the mark to market gains or losses that arerealized for tax purposes at the taxable REIT subsidiaries when the loansheld-for-sale are deposited into the securitization trust, and the relatedderivatives are deposited into a swap trust. These gains are not realized forGAAP purposes, as the deposit of the derivatives into the swap trust areconsidered an inter-company transfer, as the REIT consolidates the swaptrust. For GAAP purpose, these gains and losses are included in change in fairvalue of derivative instruments.

*Change in Fair Value of Derivative Instruments.* The change in fair value of derivativeinstruments decreased by $64.8 million (103 percent) during the second quarterof 2007 as compared to the second quarter of 2006. The amount of marketvaluation adjustment is primarily the result of actual cash receipts onderivative instruments, and changes in the expectation of future interestrates. We primarily enter into derivative contracts to offset a portion of thechanges in cash flows associated with securitized mortgage borrowings. Werecord a market valuation adjustment for these derivatives, as well as otherderivatives used by the mortgage operations to hedge our loan pipeline andmortgage loans held for sale, as current period expense or revenue.  Changes infair value of derivatives at IMH are included in GAAP net earnings and backedout for purposes of calculating estimated taxable income.

*Gain on Sale of Loans. *Gain on sale of loansdecreased $37.5 million (122 percent) during the first six months of 2007as compared to the same period in 2006. The decrease was primarily due to a$3.9 billion (77 percent) decrease in whole loan sales as well as a reductionin execution prices mainly due to the disposition of non-performing loans andthe reduction in market prices of performing and non-performing loans duringthe first six months of 2007. Also, the market value of performing andnon-performing loans decreased, due to the saturation of loans for sale in themarketplace, compounded by decreased home prices, which decreases the effectiveloan-to-value ratio.* *We use derivatives to protect themarket value of mortgages from the point in time when we establish an interestrate lock commitment on a particular mortgage prior to its close until theeventual sale or securitization. Any changes in interest rates on mortgagesthat we have committed to acquire at a particular rate until we sell orsecuritize the mortgage generally results in an increase or decrease in themarket value of the related derivative. For the six months ended June 30, 2007, we recorded a $478 thousandloss from the settlement of these derivatives as compared to a loss of$83 thousand for the six months ended June 30, 2006.

*Goodwill Impairment.*  In May 2007, the Company completed theacquisition of certain production facilities from Pinnacle FinancialCorporation (PFC). This transaction was recorded as a business combination foraccounting purposes resulting in the Company initially recording $12.4 millionin goodwill. Because of the current market environment as of June 30, 2007, thegoodwill was considered fully impaired.

*Provision for Repurchases.*  Provisionfor repurchases increased $7.6 million (33 percent) to $30.7 millionduring the first six months of 2007 as compared to the same period in 2006. Theincrease in the provision for repurchases was primarily due to an increase inseverities of actual losses, which resulted from a decrease in the marketconditions of the loans subject to repurchase and an increase in the age of theloans subject to repurchase requests.

*Loss on Lower of Cost or MarketWritedown.*  The loss on lower of cost or market (“LOCOM”)writedown increased $19.6 million (128 percent), primarily due to adecrease in the weighted average market price of non-performing loans.  The increase was primarily due to a $24.7million LOCOM writedown in the first quarter of 2007, as $92.7 million ofnon-performing loans remained in loans held-for-sale.   The fair value in the marketplace fornon-performing loans decreased, as investors required a higher yield to offsetincreased expectations of credit losses, which reduced the fair value of loansheld-for-sale.  Non-performing loans inthe Company’s held-for-sale portfolio decreased to $66.8 million as of June 30,2007, as compared to $144.6  million asof June 30, 2006.

*Provision for REO loss. *During thefirst six months of 2007 the Company recorded a provision for REO losses in theamount of $28.3 million as a result of changes in the net realizable value ofthe real estate owned subsequent to the foreclosure date.

35

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*Non-InterestExpense*

Changes in Non-InterestExpense

(dollars inthousands)
| ** **                                    | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Personnel  expense                            |       | $                                                                     | 23,640     |   | $ | 16,710 |   | $ | 6,930 |   | 41 | % |
| General and  administrative and other expense |       | 4,487                                                                 |       | 4,524 |   | (37 | ) | (1 | ) |
| Professional  services                        |       | 2,137                                                                 |       | 2,192 |   | (55 | ) | (3 | ) |
| Equipment  expense                            |       | 1,550                                                                 |       | 1,809 |   | (259 | ) | (14 | ) |
| Occupancy  expense                            |       | 2,846                                                                 |       | 1,244 |   | 1,602 |   | 129 |   |
| Data processing  expense                      |       | 1,185                                                                 |       | 744 |   | 441 |   | 59 |   |
| Total operating  expense                      |       | $                                                                     | 35,845     |   | $ | 27,223 |   | $ | 8,622 |   | 32 | % |

 

Totalnon-interest expenses increased $8.6 million (32 percent) on aquarter-over-quarter basis as personnel expense increased $6.9 million (41percent) during the second quarter of 2007 as compared to same period in2006.  Personnel expenses increased as aresult of severance recorded during the second quarter related to the Company’sstaff reductions, as well as the additional resources utilized to incorporatethe retail operations acquired during the quarter. Occupancy expense increased$1.6 million quarter over quarter due to higher lease rates at the Company’snew headquarters in Irvine, California.  In addition, the Company acquired certain leases during the quarter onthe East Coast, which resulted in additional occupancy expense for the newretail branch operations.

Changes in Non-InterestExpense

(dollars inthousands)
|                                               | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Personnel  expense                            |       | $                                                                   | 42,028     |   | $ | 35,331 |   | $ | 6,697 |   | 19 | % |
| General and  administrative and other expense |       | 9,609                                                               |       | 9,600 |   | 9 |   | 0 |   |
| Professional  services                        |       | 4,831                                                               |       | 4,509 |   | 322 |   | 7 |   |
| Equipment  expense                            |       | 3,108                                                               |       | 3,319 |   | (211 | ) | (6 | ) |
| Occupancy  expense                            |       | 6,667                                                               |       | 2,612 |   | 4,055 |   | 155 |   |
| Data processing  expense                      |       | 2,922                                                               |       | 2,110 |   | 812 |   | 38 |   |
| Total operating  expense                      |       | $                                                                   | 69,165     |   | $ | 57,481 |   | $ | 11,684 |   | 20 | % |

 

Totalnon-interest expenses increased $11.7 million (20 percent) during the first sixmonths of 2007 as occupancy expense increased $4.1 million (155 percent) ascompared to same period in 2006.  Duringthe first quarter of 2007, in compliance with Financial Accounting StandardNo. 146 “Accounting for Costs Associated with Exit or Disposal Activities,”an additional $1.0 million of costs relating to the Company’s ceased use of thebuildings leased in Newport Beach, California, due to a decrease in theestimate of future sublet income. In addition, the Company acquired certainleases during the quarter on the East Coast, which resulted in additionaloccupancy expense. Additionally, personnel expense increased $6.7 million forthe six months ended June 30, 2007, as compared to June 30, 2006, as a resultof severance recorded during the second quarter related to the Company’s staffreductions, as well as the additional resources utilized to incorporate theretail operations acquired during the quarter.

36

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*MortgageAcquisitions and Originations by Channel*

Thefollowing table summarizes the principal balance of mortgage acquisitions andoriginations for the periods indicated (in thousands):
|                                         | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                              | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **Principal**                                                         | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Balance**                                                           | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| By Production Channel:                  |       |                                                                  |       |   |   |   |   |   |   |
| Correspondent  acquisitions:            |       |                                                                  |       |   |   |   |   |   |   |
| Flow                                    |       | $                                                                     | 242,419    |   | 17 |   | $ | 1,519,107 |   | 61 |   |
| Bulk                                    |       | 286,146                                                               |       | 20 |   | 60,079 |   | 3 |   |
| Total  correspondent acquisitions       |       | 528,565                                                               |       | 37 |   | 1,579,186 |   | 64 |   |
| Wholesale and  retail originations      |       | 748,989                                                               |       | 52 |   | 622,815 |   | 25 |   |
| Total mortgage  operations acquisitions |       | 1,277,554                                                             |       | 89 |   | 2,202,001 |   | 89 |   |
| Commercial  Mortgage Operations         |       | 158,982                                                               |       | 11 |   | 277,905 |   | 11 |   |
| Total acquisitions and  originations    |       | $                                                                     | 1,436,536  |   | 100 |   | $ | 2,479,906 |   | 100 |   |

 

Acquisitionsand originations decreased to $1.4 billion for the second quarter of 2007 ascompared to $2.5 billion for the same period in 2006.  Commercial originations decreased 43% to$159.0 million for the second quarter of 2007 as compared to $277.9 million forthe same period in 2006. Pricing and underwriting guideline strategy revisions,including tightening credit guidelines, an effort to maintain liquidity andprofitability, and an increasingly competitive market are the primary reasonsacquisitions and originations have decreased.
|                                         | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                            | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **Principal**                                                       | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Balance**                                                         | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| By Production Channel:                  |       |                                                                |       |   |   |   |   |   |   |
| Correspondent  acquisitions:            |       |                                                                |       |   |   |   |   |   |   |
| Flow                                    |       | $                                                                   | 449,021    |   | 12 |   | $ | 2,942,015 |   | 61 |   |
| Bulk                                    |       | 1,231,075                                                           |       | 32 |   | 191,757 |   | 4 |   |
| Total  correspondent acquisitions       |       | 1,680,096                                                           |       | 44 |   | 3,133,772 |   | 65 |   |
| Wholesale and  retail originations      |       | 1,846,652                                                           |       | 48 |   | 1,172,364 |   | 25 |   |
| Total mortgage  operations acquisitions |       | 3,526,748                                                           |       | 92 |   | 4,306,136 |   | 90 |   |
| Commercial  Mortgage Operations         |       | 355,877                                                             |       | 8 |   | 480,685 |   | 10 |   |
| Total acquisitions and  originations    |       | $                                                                   | 3,882,625  |   | 100 |   | $ | 4,786,821 |   | 100 |   |

 

Acquisitionsand originations decreased to $3.9 billion for the first six months of 2007 ascompared to $4.8 billion for the same period in 2006.  Commercial originations decreased 26% to$355.9 million for the first six months of 2007 as compared to $480.7 millionfor the same period in 2006. Pricing and underwriting guideline strategyrevisions, including tightening credit guidelines, an effort to maintainliquidity and profitability, and an increasingly competitive market are theprimary reasons acquisitions and originations have decreased.

37

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

***Long-Term Investment Operations***

Condensed Statements ofOperations Data

(dollars inthousands)
|                                                      | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest expense                                 |       | $                                                                     | (975       | ) | $ | (35,226 | ) | $ | 34,251 |   | 97 | % |
| Provision for loan  losses                           |       | 161,594                                                               |       | (45 | ) | 161,639 |   | 359,198 |   |
| Net interest  income after provision for loan losses |       | (162,569                                                              | )          | (35,181 | ) | (127,388 | ) | (362 | ) |
|                                                 |       |                                                                  |       |   |   |   |   |   |   |
| Realized gain from  derivative instruments           |       | 38,401                                                                |       | 55,851 |   | (17,450 | ) | (31 | ) |
| Change in fair value of  derivative instruments      |       | 53,269                                                                |       | 7,903 |   | 45,366 |   | 574 |   |
| Other non-interest  income                           |       | (24,119                                                               | )          | 272 |   | (24,391 | ) | (8,967 | ) |
| Total  non-interest income                           |       | 67,551                                                                |       | 64,026 |   | 3,525 |   | 6 |   |
|                                                 |       |                                                                  |       |   |   |   |   |   |   |
| Non-interest expense                                 |       | 4,765                                                                 |       | 4,470 |   | 295 |   | 7 |   |
| Net (loss) earnings                                  |       | $                                                                     | (99,783    | ) | $ | 24,375 |   | $ | (124,158 | ) | (509 | )% |

 

Net loss for the quarter ended June 30, 2007 increased$124.2 million (509 percent) to a loss of $99.8 million, as compared to thesecond quarter of 2006.  Thequarter-over-quarter decrease in net earnings was primarily due to the increasein the provision for loan losses which increased $161.6 million for the secondquarter of 2007 as compared to the second quarter of 2006.  The change in fair value on derivativeinstruments increased $45.4 million for the second quarter of 2007 as comparedto the second quarter of 2006.  Themarket valuation adjustment is primarily the result of changes in theexpectation of future interest rates. Net interest income increased $34.3million (97 percent) quarter over quarter, primarily as a result of a decreasein projected prepayment speeds which reduced the amortization of loan premiums,which increased interest income. Additionally, the Company’s adjusted couponrates have increased in excess of the increase in borrowing costs, compared tothe prior year second quarter, partially offset by realized gain (loss) fromderivatives which decreased to $38.4 million for the second quarter of 2007compared to $55.9 million for the second quarter of 2006. Additionally, othernon-interest income decreased $24.4 million primarily due to the provision forREO losses increasing to $18.4 million for the second quarter of 2007, ascompared to no provision for REO losses for the second quarter of 2006.

Condensed Statements ofOperations Data

(dollars inthousands)
|                                                     | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                          | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  expense                               |       | $                                                                   | (2,602     | ) | $ | (47,314 | ) | $ | 44,712 |   | 95 | % |
| Provision for  loan losses                          |       | 190,444                                                             |       | 105 |   | 190,339 |   | 181,275 |   |
| Net interest income after provision for loan losses |       | (193,046                                                            | )          | (47,419 | ) | (145,627 | ) | (307 | ) |
|                                                |       |                                                                |       |   |   |   |   |   |   |
| Realized gain  from derivative instruments          |       | 75,026                                                              |       | 95,986 |   | (20,960 | ) | (22 | ) |
| Change in fair  value of derivative instruments     |       | (1,354                                                              | )          | 54,866 |   | (56,220 | ) | (102 | ) |
| Other  non-interest income                          |       | (34,106                                                             | )          | 362 |   | (34,468 | ) | (9,522 | ) |
| Total non-interest income                           |       | 39,566                                                              |       | 151,214 |   | (111,648 | ) | (74 | ) |
|                                                |       |                                                                |       |   |   |   |   |   |   |
| Non-interest  expense                               |       | 9,963                                                               |       | 8,862 |   | 1,101 |   | 12 |   |
| Net (loss)  earnings                                |       | $                                                                   | (163,443   | ) | $ | 94,933 |   | $ | (258,376 | ) | (272 | )% |

 

Net loss for the six months ended June 30, 2007 increased$258.4 million (272 percent) as compared to the six months ended June 30,2006.  The decrease in net earnings wasprimarily due to the increase in the provision for loan losses which increased$190.3 million for the first six months of 2007 as compared to the same periodin 2006.  The change in fair value onderivative instruments decreased $56.2 million (102 percent) for the first sixmonths of 2007 as compared to the same period in 2006.  The fair value adjustment to the derivativesis primarily the result of cash receipts on the derivative asset, as well aschanges in the expectation of future interest rates. Net interest incomeincreased $44.7 million (95 percent), primarily as a result of a decrease inthe Company’s projected prepayment speeds. Additionally, adjusted coupon rates have

38

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increasedin excess of the increase in borrowing costs. The increase in net interest income was partially offset by realizedgain (loss) from derivatives which decreased to $75.0 million for the first sixmonths of 2007 compared to $96.0 million for the same period in 2006.Additionally, other non-interest income increased the loss by $34.6 millionprimarily due to the provision for REO losses increasing to $28.3 million forthe first six months of 2007, as compared to no provision for REO losses forthe first six months of 2006.

***Mortgage Operations***

Condensed Statements ofOperations Data

(dollars inthousands)
|                                                               | ** ** | **For the Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income  (expense)                                |       | $                                                                     | (1,851     | ) | $ | (2,664 | ) | $ | 813 |   | 31 | % |
| Provision for loan  losses                                    |       | (1,243                                                                | )          | — |   | (1,243 | ) | (100 | ) |
| Net interest  income (expense) after provison for loan losses |       | $                                                                     | (608       | ) | $ | (2,664 | ) | $ | 2,056 |   | 77 |   |
|                                                          |       |                                                                  |       |   |   |   |   |   |   |
| Gain on sale of loans                                         |       | 13,477                                                                |       | 19,109 |   | (5,632 | ) | (29 | ) |
| Lower of cost or market  writedown                            |       | (10,180                                                               | )          | (18,780 | ) | 8,600 |   | 46 |   |
| Goodwill impairment                                           |       | (12,920                                                               | )          | — |   | (12,920 | ) | (100 | ) |
| Provision for  repurchases                                    |       | (18,889                                                               | )          | (12,773 | ) | (6,116 | ) | (48 | ) |
| Other income                                                  |       | 3,940                                                                 |       | 9,791 |   | (5,851 | ) | (60 | ) |
| Non-interest expense and  income taxes                        |       | 24,108                                                                |       | 10,766 |   | 13,342 |   | 124 |   |
| Net (loss) earnings                                           |       | $                                                                     | (49,288    | ) | $ | (16,083 | ) | $ | (33,205 | ) | (206 | )% |

 

The mortgage operations generates income bysecuritizing or selling mortgages to permanent investors, including thelong-term investment operations and, to a lesser extent, earns revenue fromfees associated with mortgage servicing rights, master servicing agreements andinterest income earned on mortgages held-for-sale.

Net earnings for the mortgage operations decreased$33.2 million (206 percent) primarily due to the following changes:

·                  decreaseof $5.6 million in gains from the sale of loans;

·                  increaseof $6.1 million in provision for repurchases;

·                  a$12.9 million impairment of goodwill;

·                  anincrease in non-interest expense and income taxes of $13.3 million;partially offset by

·                  a decrease of$8.6 million in the loss on lower of cost or market writedown.

Gains from the sale of loans decreased$5.6 million as a result of lower volumes of mortgages sold to third partyinvestors which resulted in a decrease in gain (loss) on sale of loans. Thedecrease was primarily due to a $1.5 billion (78 percent) decrease in wholeloan sales as well as a reduction in execution price mainly due to thedisposition of non-performing loans and the reduction in market prices ofnon-performing loans.  Also of the marketvalue of performing and non-performing loans decreased due to the saturation ofloans for sale in the market place and deteriorationin the prevailing real estate market and economic conditions

Provision for repurchases increased $6.1 million(48 percent) during the second quarter of 2007 as compared to the secondquarter of 2006. The increase in the provision for repurchases was primarilydue to an increase in severities of actual losses, which resulted from adecrease in the credit quality of the loans subject to repurchase.

39

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InMay 2007, the Company completed the acquisition of certain productionfacilities from Pinnacle Financial Corporation (PFC). This transaction wasrecorded as a business combination for accounting purposes resulting in theCompany initially recording $12.4 million in goodwill. Because of the currentmarket environment, as of June 30, 2007, the goodwill was considered fullyimpaired.

Non-interest expense and income taxes increased $13.3million which was primarily the result of income taxes decreasing by $8.0million to a benefit of $1.5 million for the second quarter of 2007 as comparedto a benefit of $9.5 million for the same period in 2006.

The Company recorded loans held-for-sale at the lowerof cost or market resulting in a $8.6 million decrease in the write-downof loans held-for-sale as current market conditions, such as the widening ofcredit and bond spreads and a lack of demand for mortgage product forced the loansto drop in value prior to securitization, sale or transfer. The$8.6 million writedown was primarily due to a decrease in non-performingloans held-for-sale to $66.8 million from $144.6 million at June 30, 2006.  Additionally, the fair value in the marketplaceof non-performing loans decreased, as investors require a higher yield, whichreduced the fair value of our loans held-for-sale.  The mortgage operations are reflected as astand-alone entity for segment financial reporting purposes; however, onthe consolidated financial statements inter-company loan sales andrelated gains are eliminated.

Condensed Statements ofOperations Data

(dollars inthousands)
| ** **                                                    | ** ** | **For the Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income  (expense)                                |       | $                                                                   | (6,183     | ) | $ | (1,386 | ) | $ | (4,797 | ) | (346 | )% |
| Provision for loan  losses                                    |       | (432                                                                | )          | — |   | (432 | ) | (100 | ) |
| Net interest  income (expense) after provison for loan losses |       | $                                                                   | (5,751     | ) | $ | (1,386 | ) | $ | (4,365 | ) | (315 | ) |
|                                                          |       |                                                                |       |   |   |   |   |   |   |
| Gain on sale of loans                                         |       | 18,726                                                              |       | 39,056 |   | (20,330 | ) | (52 | ) |
| Goodwill impairment                                           |       | (12,920                                                             | )          | — |   | (12,920 | ) | (100 | ) |
| Provision for  repurchases                                    |       | (30,867                                                             | )          | (23,110 | ) | (7,757 | ) | (34 | ) |
| Lower of cost or market  writedown                            |       | (34,874                                                             | )          | (15,283 | ) | (19,591 | ) | (128 | ) |
| Other income                                                  |       | 7,391                                                               |       | 21,473 |   | (14,082 | ) | (66 | ) |
| Non-interest expense  and income taxes                        |       | 45,139                                                              |       | 34,581 |   | 10,558 |   | 31 |   |
| Net (loss) earnings                                           |       | $                                                                   | (103,434   | ) | $ | (13,831 | ) | $ | (89,603 | ) | (648 | )% |

 

The mortgage operations generates income bysecuritizing or selling mortgages to permanent investors, including thelong-term investment operations and, to a lesser extent, earns revenue fromfees associated with mortgage servicing rights, master servicing agreements andinterest income earned on mortgages held-for-sale.

Net earnings for the mortgage operations decreased$89.6 million (648 percent) primarily due to the following changes:

·                  a$12.9 million impairment of goodwill;

·                  decreaseof $20.3  million in gains from the sale of loans;

·                  increaseof $7.6 million in provision for repurchases; and

·                  increasein charges to expense of $19.6 million for the change in valuation ofloans held-for-sale.

Gains from the sale of loans decreased$20.3 million as a result of lower volumes of mortgages sold to thirdparty investors which resulted in a decrease in gain (loss) on sale of loans.The decrease was primarily due to a $3.8 billion (81 percent) decrease in wholeloan sales as well as a reduction in execution price mainly due to thedisposition of non-performing loans and the reduction in market price ofnon-performing loans.  Also the marketvalue of performing and non-performing loans decreased due to the saturation ofloans for sale in the market place and the deteriorationin the prevailing real estate market and economic conditions.

40

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InMay 2007, the Company completed the acquisition of certain productionfacilities from Pinnacle Financial Corporation (PFC). This transaction wasrecorded as a business combination for accounting purposes resulting in theCompany initially recording $12.4 million in goodwill. Because of the currentmarket environment, as of June 30, 2007, the goodwill was considered fullyimpaired.

Provision for repurchases increased $7.6 million(33 percent) during the second quarter of 2007 as compared to the second quarterof 2006. The increase in the provision for repurchases was primarily due to anincrease in severities of actual losses, which resulted from a decrease in thecredit quality of the loans subject to repurchase.

The Company recorded loans held-for-sale at the lowerof cost or market resulting in a $19.6 million increase in the write-downof loans held-for-sale as current market conditions, such as the widening ofcredit and bond spreads and a lack of demand for mortgage product forced theloans to decline in value. The $19.6 million write-down was primarilyattributable to a decrease in the weighted average market price ofnon-performing loans.  Non-performingloans in the Company’s held-for-sale portfolio decreased to $66.8 million as ofJune 30, 2007, as compared to $144.6 million as of June 30, 2006.  The mortgage operations are reflected as astand-alone entity for segment financial reporting purposes; however, onthe consolidated financial statements inter-company loan sales andrelated gains are eliminated.

***Commercial Operations***

Condensed Statements ofOperations Data

(dollars inthousands)
|                                        | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (loss) income            |       | $                                                                     | (68        | ) | $ | 56 |   | $ | (124 | ) | (221 | )% |
| Non-interest  income                   |       | 2,780                                                                 |       | 1,019 |   | 1,761 |   | 173 |   |
| Non-interest  expense and income taxes |       | 2,975                                                                 |       | 2,696 |   | 279 |   | 10 |   |
| Net loss                               |       | $                                                                     | (263       | ) | $ | (1,621 | ) | $ | 1,358 |   | 84 | % |

 

Net loss for the commercial operations was $1.4million (84 percent) lower for the second quarter of 2007.  Non-interest income was $1.8 million (173percent) higher in the second quarter of 2007 primarily due to the increase inchange in fair value of derivative instruments of $3.9 million partially offsetby a decrease in gain on sale of loans of $2.3 million.    The commercial operations are reflected asa stand-alone entity for segment financial reporting purposes. However, on theconsolidated financial statements inter-company loan sales and related gainsare eliminated.

Condensed Statements ofOperations Data

(dollars in thousands)
|                                        | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (expense) income         |       | $                                                                   | (383       | ) | $ | 190 |   | $ | (573 | ) | (302 | )% |
| Non-interest  income                   |       | 1,251                                                               |       | 2,899 |   | (1,648 | ) | (57 | ) |
| Non-interest expense  and income taxes |       | 5,651                                                               |       | 5,106 |   | 545 |   | 11 |   |
| Net loss                               |       | $                                                                   | (4,783     | ) | $ | (2,017 | ) | $ | (2,766 | ) | (137 | )% |

 

41

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Net loss for the commercial operations was $2.8million (137 percent) higher for the first six months of 2007.  Non-interest income was $1.6 million (57 percent)lower during the first six months of 2007 primarily due to the decrease in gainon sale of loans of $3.4 million only partially offset by the increase inchange in fair value of derivative instruments of $1.5 million.  The commercial operations are reflected as astand-alone entity for segment financial reporting purposes. However, on theconsolidated financial statements inter-company loan sales and related gainsare eliminated.

***Warehouse Lending Operations***

Condensed Statements ofOperations Data

(dollars inthousands)
|                                        | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  income                   |       | $                                                                     | 3,727      |   | $ | 6,879 |   | $ | (3,152 | ) | (46 | )% |
| Provision for  loan losses             |       | 2,630                                                                 |       | — |   | 2,630 |   | 100 |   |
| Non-interest  income                   |       | 474                                                                   |       | 751 |   | (277 | ) | (37 | ) |
| Non-interest  expense and income taxes |       | 2,248                                                                 |       | 1,627 |   | 621 |   | 38 |   |
| Net (loss)  earnings                   |       | $                                                                     | (677       | ) | $ | 6,003 |   | $ | (6,680 | ) | (111 | )% |

 

Netearnings for the quarter ended June 30, 2007 decreased $6.7 million (111percent) as compared to the second quarter of 2006.  The decrease in net earnings was primarilydue to a decrease of $3.2 million (46 percent) in net interest income, as aresult of the average balance on finance receivables declining by 39 percentquarter-over-quarter.   Additionally, aprovision for loan losses was recorded for the second quarter of 2007 whichdecreased net earnings by $2.6 million, as compared to no provision beingbooked for the second quarter of 2006. Non-interest expense and income taxes increased $621 thousand quarterover quarter due to an increase in data processing expense. The warehouselending operations is reflected as a stand-alone entity for segment financialreporting purposes. However, on the consolidated financial statementsinter-company finance receivables and borrowings are eliminated.

Condensed Statements ofOperations Data

(dollars inthousands)
|                                        | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2007**                                                            | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  income                   |       | $                                                                   | 12,178     |   | $ | 14,570 |   | $ | (2,392 | ) | (16 | )% |
| Provision for  loan losses             |       | 2,343                                                               |       | — |   | 2,343 |   | 100 |   |
| Non-interest  income                   |       | 1,214                                                               |       | 1,548 |   | (334 | ) | (22 | ) |
| Non-interest  expense and income taxes |       | 4,542                                                               |       | 3,501 |   | 1,041 |   | 30 |   |
| Net earnings                           |       | $                                                                   | 6,507      |   | $ | 12,617 |   | $ | (6,110 | ) | (48 | )% |

 

Netearnings for the six months ended June 30, 2007 decreased $6.1 million (48percent) as compared to the first six months of 2006.  The decrease in net earnings was primarilydue to a decrease of $2.4 million (16 percent) in net interest income, as aresult of the average balance on finance receivables declining by 25 percentonly slightly offset by a 76 basis point increase in the yield from financereceivables. For the six months ended June 30, 2007 a $2.3 million provisionfor loan losses was recorded as compared to no provision for the six monthsended June 30, 2006.  Non-interestexpense and income taxes increased $1.0 million for the first six months of2007 primarily due to an increase in data processing expense. The warehouselending operations is reflected as a stand-alone entity for segment financialreporting purposes. However, on the consolidated financial statementsinter-company finance receivables and borrowings are eliminated.

42

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**Liquidity and Capital Resources**

Werecognize the need to have funds available for our operating businesses and ourcustomers’ demands for obtaining short-term warehouse financing until thesettlement or sale of mortgages with us or with other investors. It is ourpolicy to have adequate liquidity at all times to cover normal cyclical swingsin funding availability and mortgage demand and to allow us to meet abnormaland unexpected funding requirements. We plan to meet liquidity through normaloperations with the goal of avoiding unplanned sales of assets or emergencyborrowing of funds. Toward this goal, our asset/liability committee, or “ALCO,”is responsible for monitoring our liquidity position and funding needs.

ALCOparticipants include senior executives of the long-term investment operations,the mortgage operations, the commercial operations, and warehouse lendingoperations. ALCO meets on a weekly basis to review current and projectedsources and uses of funds. ALCO monitors the composition of the balance sheetfor changes in the liquidity of our assets. Our primary liquidity consists ofcash and cash equivalents; short-term securities available for sale, andmaturing mortgages, or “liquid assets.”

Webelieve that current cash balances, short-term investments, currently availablefinancing facilities, excess cash flows generated from our long-term mortgageportfolio will adequately provide for projected funding needs and limited assetgrowth. We believe we have adequate funding liquidity to accommodate the recentchanges in the marketplace in the near term; however, the secondary market andfunding liquidity situation is rapidly evolving and the potential impact on theCompany is unknown.

Ouroperating businesses primarily use available funds as follows:

·                 acquisition and origination ofmortgages by the mortgage, commercial, and long-term investment operations;

·                 long-term investment in mortgages andmortgage backed securities by the long-term investment operations;

·                 provide short-term warehouse advancesby the warehouse lending operations;

·                 pay interest on debt;

·                 distribute common and preferred stockdividends;

·                 pay operating and non-operatingexpenses;

·                 repurchase loans, and

·                 payment of.margin calls on credit facilities.

*Acquisition and origination of mortgages by the mortgage,commercial, and long-term investment operations*. During thesecond quarter of 2007, $795.6 million of mortgages were acquired by thelong-term investment operations for long-term investment of primarily Alt-Amortgages originated by the mortgage operations.  Capital invested in mortgages is outstandinguntil we sell or securitize mortgages, which is one of the reasons we attemptto sell or securitize mortgages within 90 days of acquisition or origination.Initial capital invested in mortgages includes premiums paid when mortgages areacquired and originated and our capital investment, or “haircut,” required uponfinancing, which is generally determined by the type of collateral provided. Themortgage operations acquired and originated mortgages which were financed withwarehouse borrowings from the warehouse lending operations at a haircutgenerally between 2 percent to 10 percent of the outstanding principal balanceof the mortgages. In addition, the commercial operations originated $159.0million of commercial mortgages which were initially financed with short-termwarehouse financing from the warehouse lending operations at a haircut ofgenerally 3 percent of the outstanding principal balance of the mortgages.

*Long-term investment in mortgages bythe long-term investment operations.*The long-term investment operations acquire primarily Alt-Amortgages from the mortgage and commercial operations and finance them withreverse repurchase borrowings from the warehouse lending operations atsubstantially the same terms as the mortgage and commercial operations. Whenthe long-term investment operations finance mortgages with long-termsecuritized mortgage borrowings, short-term reverse repurchase financing isrepaid. Then, depending on credit ratings from national credit rating agencieson our securitized mortgages, we are generally required to provide anover-collateralization, or “OC”, of 0.35 percent to 1 percent of theprincipal balance of mortgages securing securitized mortgage financing ascompared to a haircut of 2 percent to 10 percent of the principalbalance of mortgages securing short-term reverse repurchase financing. Ourtotal capital investment in securitized mortgages generally ranges fromapproximately 2 percent to 5 percent of the principal balance ofmortgages securing securitized mortgage borrowings which includes premiums paidupon acquisition of mortgages from the 

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mortgageoperations, costs paid for completion of securitized mortgages, costs toacquire derivatives and OC required to achieve desired credit ratings.Commercial mortgages are financed on a long-term basis with securitizedmortgage borrowings at substantially the same rates and terms as Alt-Amortgages. Commercial loans generally have a 3 percent haircut on reverserepurchase lines and initial over collateralization target of 2.75 percentto 3.37 percent.

*Provide short-term warehouse advances by the warehouselending operations.*We utilize committed and uncommittedreverse repurchase facilities with various lenders to provide short-termwarehouse financing to affiliates and non-affiliated clients of the warehouselending operations. The warehouse lending operations provides short-termfinancing to the mortgage operations and non-affiliated clients from theclosing of mortgages to their sale or other settlement with investors. Thewarehouse lending operations generally finances between 90% and 98% of the fairmarket value of the principal balance of mortgages, which equates to a haircutrequirement of between 10% and 2%, respectively, at one-month LIBOR, plus aspread. The mortgage operations have uncommitted warehouse line agreements toobtain financing from the warehouse lending operations at one-month LIBOR plus aspread during the period that the mortgage operation accumulates mortgagesuntil the mortgages are securitized or sold. As of June 30, 2007, the mortgageand commercial operations had $747.4 million and $292.8 million,respectively, of warehouse advances outstanding with the warehouse lendingoperations.  In addition, as of June 30,2007, the warehouse lending operations had $580.8 million of approved warehouselines available to non-affiliated clients, of which $133.6 million wasoutstanding.

Ourability to meet liquidity requirements and the financing needs of our customersis subject to the renewal of our credit and repurchase facilities or obtainingother sources of financing, if required, including additional debt or equityfrom time to time. Any decision our lenders or investors make to provideavailable financing to us in the future will depend upon a number of factors,including:

·                 our compliance with the terms of ourexisting credit arrangements, including any financial covenants;

·                 theability to obtain waivers upon any non compliance;

·                 our financial performance;

·                 the financial performance of ourcompetitors;

·                 industry and market trends in ourvarious businesses;

·                 the general availability of, and ratesapplicable to, financing and investments;

·                 our lenders or investors resources andpolicies concerning loans and investments; and

·                 the relative attractiveness ofalternative investment or lending opportunities.

*Distribute common and preferred stock dividends*.We are required to distribute a minimum of 90% of our taxable income to ourstockholders in order to maintain our REIT status, exclusive of the applicationof any tax loss carry forwards that may be used to offset current periodtaxable income. Because we pay dividends based on taxable income, dividends maybe more or less than net earnings. We did not declare a cash dividend for thesecond quarter of 2007 and paid cash dividends of $0.10 per outstanding commonshare for the first quarter of 2007. Based on current tax estimates, some portion or all of the 2007dividends may be a return of capital.  Inaddition, we paid cash dividends of $3.7 million on preferred stock during thesecond quarter of 2007.

Aportion of dividends paid to IMH’s stockholders can come from dividenddistributions from the mortgage operations and commercial operations, ourtaxable REIT subsidiaries, to IMH. During the second quarter of 2007, themortgage and commercial operations provided no dividend distributions to IMH.The mortgage and commercial operations may seek to retain earnings to fund theacquisition and origination of mortgages, to expand the mortgage operations, orto fund operating losses. The board of directors of our taxable REITsubsidiaries, which is different from the board of directors of the registrant,may decide that the mortgage and/or commercial operations should cease makingdividend distributions in the future. This could reduce the amount of taxableincome that would be distributed to IMH stockholders in the form of commonstock dividend payment amounts.

Duringthe second quarter of 2007, our operating businesses were primarily funded asfollows:

·          securitized mortgageborrowings and reverse repurchase agreements;

·          excess cash flows fromour long-term mortgage portfolio; and

·          sale and securitizationof mortgages.

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*Reverse repurchase agreements and securitized mortgageborrowings.*We use reverse repurchase agreements to fundsubstantially all financing to affiliates and non-affiliated clients and forthe acquisition and origination of Alt-A and commercial mortgages. As weaccumulate mortgages, we finance the acquisition of mortgages primarily throughborrowings on reverse repurchase facilities with third party lenders. Weprimarily use uncommitted and committed facilities with major investment banksto finance substantially all warehouse financing, as needed. During the secondquarter of 2007 the warehouse facilities amounted to $5.2 billion, of which$1.6 billion was outstanding at June 30, 2007. The warehouse facilities provideus with a higher aggregate credit limit to fund the acquisition and originationof mortgages at terms comparable to those we have received in the past. Thesewarehouse facilities may have certain covenant tests which we are required tosatisfy. For a discussion of the Company’s compliance with its financialcovenants see “Note J—Reverse Repurchase Agreements” in the accompanyingnotes to the consolidated financial statements. From time to time, we may alsoreceive additional uncommitted interim financing from our lenders in excess ofour permanent borrowing limits to finance mortgages during the accumulationphase and prior to securitizations or dispositions in the form of whole loansales.

From time to time, we may also utilize term reverserepurchase financing provided to us by underwriters who underwrite some of oursecuritizations. The term reverse repurchase financing funds mortgages that arespecifically allocated to securitization transactions, which allows us toreduce overall borrowings outstanding on reverse repurchase agreements withother lenders during the period immediately prior to the settlement of thesecuritization. Terms and interest rates on the term reverse repurchasefacilities are generally lower than on other reverse repurchase agreements. Termreverse repurchase financing is generally repaid within 30 days from thedate funds are advanced.

We expect to continue to use short-term reverserepurchase facilities to fund the acquisition of mortgages. If we cannot renewor replace maturing borrowings, we may have to sell, on a whole loan basis, themortgages securing these facilities, which, depending upon market conditionsmay result in substantial losses. Additionally, if for any reason the marketvalue of our mortgages securing reverse repurchase facilities decline, ourlenders may require us to provide them with additional equity or collateral tosecure our borrowings, referred to as a margin call, which may require us tosell mortgages at substantial losses.

In order to mitigate the liquidity risk associated withreverse repurchase agreements, we attempt to sell or securitize our mortgageswithin 90 days from acquisition or origination. Although securitizingmortgages more frequently adds operating and securitization costs, we believethe added cost is offset as liquidity is provided more frequently with lessinterest rate and price volatility, as the accumulation and holding period ofmortgages is shortened. When we have accumulated a sufficient amount ofmortgages, we seek to issue securitized mortgages and convert short-termadvances under reverse repurchase agreements to long-term securitized mortgageborrowings. The use of securitized mortgage borrowings provides the followingbenefits:

·                  allows us to uselong-term financing for the duration of the securitized mortgage asset securedby the underlying mortgages; and

·                  eliminatesmargin calls on the borrowings that are converted from reverse repurchaseagreements to securitized mortgage borrowings.

Duringthe first six months of 2007, we issued $3.9 billion of securitized mortgageborrowings to provide long-term financing for $3.9 billion of primarilyAlt-A and commercial mortgages. Historically, because of the credit profile,historical loss performance and prepayment characteristics of our Alt-A andcommercial mortgages, we have been able to borrow a higher percentage againstthe principal balance of mortgages held as securitized mortgage collateral,which means that we have to provide less initial capital upon completion ofsecuritized mortgage borrowings. Capital investment in the securitized mortgageborrowings is established at the time securitized mortgage borrowings areissued at levels sufficient to achieve desired credit ratings on the securitiesfrom credit rating agencies.

Inconjunction with certain reverse repurchase facilities, the Company hasdeposited restricted cash collateral to satisfy margin calls placed by theCompany’s lenders.

Additionally, one of the Company’s reverse repurchaseagreements with total capacity of $750 million expired in June of 2007, per theterms of the arrangement and was not renewed. In August 2007, the Company amended its agreement with one of itslenders primarily increasing the pricing structure should the Company exceed aspecified level of borrowing, which is above the current borrowing level.

In August 2007, the Company entered into a new reverserepurchase agreement with a current lender with all the same terms aspreviously except conforming covenants to be primarily the same as otherlenders, the profitability covenant is not effective until June 2008.

Associatedwith the acquisition of certain assets from PFC, in August 2007, the Companyentered into a new warehouse agreement with a new lender with a borrowingcapacity of $98.0 million and covenants similar to the Company’s otherborrowing facilities.

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*Repo obligations.*At the Completion of a loan securitization the Company will occasionally borrowmoney using the future cash flows from the spread (NIM) between the mortgage loansand securitized mortgage borrowings; in addition the Company has collateralizedsome repo loans using the future cash flows of the residual interest ascollateral.

Loans financed with repocredit facilities and securities are subject to changing market valuation andmargin calls. The market value is dependent on a variety of economicconditions, including interest rates, borrower demand, borrowercreditworthiness, and end investor desire and capacity. The market value of oursecurities is also dependent on a variety of economic conditions, including defaultrates on the underlying loans and market demand for the types of securities weretain from our securitizations and purchase from other issuers. To the extentthe value of the loans or securities declines below an acceptable level, we maybe required to repay portions of the amounts we have borrowed.

*Excess cash flows from ourlong-term mortgage portfolio*. We receive excess cash flows onmortgages held as securitized mortgage collateral after distributions are madeto investors on securitized mortgage borrowings to the extent cash or othercollateral required to maintain desired credit ratings on the securitizedmortgage borrowings is fulfilled and can be used to provide funding for some ofthe long-term investment operations’ activities. Excess cash flows representthe difference between principal and interest payments on the underlyingmortgages, adjusted by the following:

·                  servicing andmaster servicing fees paid;

·                  premiums paid tomortgage insurers;

·                  cash payments /receipts on derivatives;

·                  interest paid onsecuritized mortgage borrowings;

·                  pro-rata earlyprincipal prepayments paid on securitized mortgage borrowings;

·                  OC requirements;

·                  actual losses,net of any gains incurred upon disposition of other real estate owned oracquired in settlement of defaulted mortgages;

·                  unpaid interestshortfall;

·                  basis riskshortfall;

·                  bond writedownsreinstated; and

·                  residualcashflow.

                        *Sale and securitization of mortgages.*  We sell and securitizeloans in the following ways:

·                  When the mortgage and commercial operationsaccumulate a sufficient amount of mortgages that are intended to be depositedinto a securitized mortgage trust, it sells the mortgages to the long-terminvestment operations; and

·                  When selling mortgages on a whole loan basis,the mortgage operations will accumulate mortgages and enter into salestransactions with third party investors on a monthly basis.

The mortgage andcommercial operations sold $3.2 billion of mortgages to the long-terminvestment operations during the first six months of 2007 and sold $1.1 billionof mortgages to third party investors through whole loan sales. Generally, themortgage operations sold mortgage servicing rights on all mortgages sold duringthe first six months of 2007, but retained all master servicing rights. Thesale of mortgage servicing rights generated substantially all cash, which wasused to acquire and originate additional mortgage assets.

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Sincewe rely significantly upon sales and securitizations to generate cash proceedsto repay borrowings and to create credit availability, any disruption in ourability to complete sales and securitizations may require us to utilize othersources of financing, which, if available at all, may be on less favorableterms. In addition, delays in closing sales and securitizations of ourmortgages increase our risk by exposing us to credit, interest rate, andliquidity risk for this extended period of time.

*Issuance ofCommon and Preferred Stock. *We have a shelf registration statement that allowsus to sell up to $1.0 billion of securities, including common stock,preferred stock, debt securities and warrants.

OnSeptember 30, 2005, the Company entered into a common stock sales agreementwith Brinson Patrick Securities Corporation (Brinson Patrick) for the sale ofup to 7.5 million shares of its common stock from time to time through BrinsonPatrick as sales agent.  No shares ofcommon stock were sold during the second quarter of 2007.

OnSeptember 30, 2005, the Company entered into a Preferred Stock sales agreementwith Brinson Patrick, for the sale of up to 800,000 shares of its 9.125% SeriesC Cumulative Redeemable Preferred Stock (Series C Preferred Stock) from time totime through Brinson Patrick as sales agent. No shares of preferred stock weresold during the second quarter of 2007.

Forthe six months ended June 30, 2007, the ratio of earnings to fixed charges andratio of earnings to combined fixed charges and preferred stock dividends was0.59x and 0.58x, respectively.  Earningsused in computing the ratio of earnings to fixed charges consist of netearnings before income taxes plus fixed charges. Fixed charges include interestexpense on debt and the portion of rental expense deemed to represent theinterest factor. The amount of the shortfall of earnings to fixed charges forthe six months ended June 30, 2007, was $269.1 million, which represents lossesbefore taxes.

*Inflation/Deflation*

Theconsolidated financial statements and corresponding notes to the consolidatedfinancial statements have been prepared in accordance with GAAP, which requirethe measurement of financial position and operating results in terms ofhistorical dollars without considering the changes in the relative purchasingpower of money over time due to inflation. The impact of inflation is reflectedin the increased costs of our operations. Unlike industrial companies, nearlyall of our assets and liabilities are monetary in nature. As a result, interestrates have a greater impact on our performance than do the effects of generallevels of inflation. Inflation affects our operations primarily through itseffect on interest rates, since interest rates normally increase during periodsof high inflation and decrease during periods of low inflation. During periodsof increasing interest rates, demand for mortgages and a borrower’s ability toqualify for mortgage financing in a purchase transaction may be adverselyaffected. During periods of decreasing interest rates and housing priceappreciation, borrowers may prepay their mortgages, which in turn may adverselyaffect our yield and subsequently the value of our portfolio of mortgageassets.

**OffBalance Sheet Arrangements**

When we sell loans through whole-loan sales, we arerequired to make normal and customary representations and warranties about theloans to the purchaser. Our whole-loan sale agreements generally require us torepurchase loans if we breach a representation or warranty given to the loanpurchaser. In addition, we may be required to repurchase loans as a result ofborrower fraud or if a payment default occurs on a mortgage loan shortly afterits sale. Because the loans are no longer on our balance sheet, therecourse component is considered a guarantee. During the second quarter of2007, we sold $417.8 million of loans with recourse compared to $657.7 millionin the first quarter of 2007. We maintained a $27.8 million reserverelated to these guarantees as of June 30, 2007 compared with a reserve of $17.1 millionas of March 31, 2007. During the second quarter of 2007 we paid$13.3 million in cash to repurchase loans previously sold to third partiesas compared to $57.2 million during the first quarter of 2007.

**ITEM 3:****    QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

**GeneralOverview**

We manage credit, prepayment andliquidity risk in the normal course of business. Since a significant portion ofour revenues and earnings are derived from net interest income, we strive tomanage our interest-earning assets and interest-bearing liabilitiesto generate what we believe to be an appropriate contribution from net interestincome. When interest rates fluctuate, profitability can be adversely affectedby changes in the fair market value of our assets and liabilities and by theinterest spread earned on interest-earning assets and interest-bearingliabilities. We derive income from the differential spread between interestearned on interest-earning assets and interest paid on interest-bearingliabilities. Any change in interest rates affects income received and incomepaid from assets and liabilities in varying and typically in unequal amounts.Changing interest rates may compress or widen our interest rate margins andaffect overall earnings.

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Interest rate risk management isthe responsibility of the Asset Liability Committee (ALCO), which is comprisedof senior management and reports results of interest rate risk analysis to theIMH board of directors on at least a quarterly basis. ALCO establishes policiesthat monitor and coordinate sources, uses and pricing of funds. ALCO alsoattempts to reduce the volatility in net interest income by managing therelationship of interest rate sensitive assets to interest rate sensitiveliabilities. In addition, various modeling techniques are used to valueinterest sensitive mortgage-backed securities. The value of investmentsecurities available-for-sale is determined using a discounted cash flow modelusing prepayment rate, discount rate and credit loss assumptions. Ourinvestment securities portfolio is available-for-sale, which requires us toperform market valuations of the securities in order to properly record theportfolio. We continually monitor interest rates of our investment securitiesportfolio as compared to prevalent interest rates in the market. We do notcurrently maintain a securities trading portfolio and are not exposed to marketrisk as it relates to speculative trading activities.

**Changesin Interest Rates**

Interestrate risk management policies intended to limit our exposure to changes ininterest rates primarily associated with cash flows on our adjustable ratesecuritized mortgage borrowings. Our primary objective is to limit our exposureto the variability in future cash flows attributable to the variability ofone-month LIBOR, which is the underlying index of our adjustable ratesecuritized mortgage borrowings. We also monitor on an ongoing basis theprepayment risks that arise in fluctuating interest rate environments. Ourinterest rate risk management policies are formulated with the intent to offsetpotential adverse effects of changing interest rates on cash flows onadjustable rate securitized mortgage borrowings.

Weprimarily acquire for long-term investment ARMs and hybrid ARMs and, to a lesserextent, FRMs. ARMs are generally subject to periodic and lifetime interest ratecaps. This means that the interest rate of each ARM is limited to upwards ordownwards movements on its periodic interest rate adjustment date, generallysix months, or over the life of the mortgage. Periodic caps limit the maximuminterest rate change, which can occur on any interest rate change date togenerally a maximum of 1% per semiannual adjustment. Also, each ARM has amaximum lifetime interest rate cap. Generally, borrowings are not subject tothe same periodic or lifetime interest rate limitations. During a period ofrapidly increasing or decreasing interest rates, financing costs could increaseor decrease at a faster rate than the periodic interest rate adjustments onmortgages would allow, which could affect net interest income. In addition, ifmarket rates were to exceed the maximum interest rate limits of our ARMs,borrowing costs could increase while interest rates on ARMs would remainconstant. We also acquire hybrid ARMs that have initial fixed interest rateperiods generally ranging from two to seven years which subsequently convert toARMs. During a rapidly increasing or decreasing interest rate environmentfinancing costs would increase or decrease more rapidly than would interestrates on mortgages, which would remain fixed until their next interest rateadjustment date. In order to provide protection against potential resultingbasis risk shortfall on the related liabilities, we purchase derivatives.

The use of derivatives to managerisk associated with changes in interest rates is an integral part of ourstrategy. The amount of cash payments or cash receipts on derivatives isdetermined by (1) the notional amount of the derivative and (2) currentinterest rate levels in relation to the various strikes or coupons ofderivatives during a particular time period. As of June 30, 2007 andDecember 31, 2006, we had notional balances of interest rate swaps, caps,and floors of $19.6 billion and $19.5 billion, respectively, with net fairvalues of $139.6 million and $132.5 million, respectively, pertainingto our current and pending securitizations. By using derivatives, we attempt tominimize the effect of both upward and downward interest rate changes on ourlong-term mortgage portfolio. Our goal is to moderate significant changes tobase case net interest income, including net cash flows from derivatives, asinterest rates change. We primarily acquire swaps, and to a lesser extent caps,to essentially convert our adjustable rate securitized mortgage borrowings intofixed rate borrowings. For instance, we receive one-month LIBOR on swaps, whichoffsets interest expense on adjustable rate securitized mortgage borrowings,and we pay a fixed interest rate.

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

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Wemeasure the sensitivity of our net interest income to changes in interest ratesaffecting interest sensitive assets and liabilities using various simulations.These simulations take into consideration changes that may occur in investmentand financing strategies, the forward yield curve, interest rate riskmanagement strategies, mortgage prepayment speeds and the volume of mortgageacquisitions and originations. As part of various interest rate simulations, wecalculate the effect of potential changes in interest rates on ourinterest-earning assets and interest-bearing liabilities and their affect onoverall earnings. The simulations assume instantaneous and parallel shifts ininterest rates and to what degree those shifts affect net interest income.

The following table estimates thefinancial effect to base case, including net cash flow from derivatives, fromvarious instantaneous and parallel shifts in interest rates based on both ourconsolidated structure and un-consolidated structure, which refers to thenotional amount of derivatives that are not recorded on our balance sheet as ofMay 31, 2007 (dollar amounts in millions):
| ** **                                                                                     | ** ** | **Changes in base case as of May 31, 2007 (1)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Excluding net cash  flow on derivatives**                              | ** ** | **Net cash flow  on derivatives** | ** ** | **Including net cash  low on derivatives** | ** ** |
| **Instantaneous and Parallel Change in Interest Rates (2)** | ** ** | **$**                                                                                        | ** ** | **(%)** | ** ** | **$** | ** ** | **$** | ** ** | **(%)** | ** ** |
| Up 300 basis  points, or 3% (3)                                                                |       | (372                                                                                         | )          | (412 | ) | 345 |   | (27 | ) | (16 | ) |
| Up 200 basis  points, or 2%                                                                    |       | (231                                                                                         | )          | (256 | ) | 230 |   | (1 | ) | (1 | ) |
| Up 100 basis  points, or 1%                                                                    |       | (107                                                                                         | )          | (118 | ) | 115 |   | 8 |   | 5 |   |
| Down 100 basis  points or 1%                                                                   |       | 92                                                                                           |       | 102 |   | (104 | ) | (12 | ) | (7 | ) |
| Down 200 basis  points or 2%                                                                   |       | 179                                                                                          |       | 199 |   | (205 | ) | (26 | ) | (16 | ) |
| Down 300 basis points  or 3%                                                                   |       | 264                                                                                          |       | 292 |   | (304 | ) | (40 | ) | (24 | ) |

 

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

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

(3)                       Thissimulation was added to our analysis as it is relevant in light of the interestrate environment as of May 31, 2007 and the projected forward yield curve for2007 and 2008.

In the previous table, the up 100 basis point scenarioas of May 31, 2007 represents our projection of the net change from base casenet interest income, which is derived from assumptions as previously discussed,if market interest rates were to immediately rise by 100 basis points. Thismeans that we increase interest rates at all data points along our projectedforward yield curve by 100 basis points and recalculate our projection of netinterest income over the next 12 months. In addition, based on changes ininterest rates, or changes in our forward yield curve, our model adjustsmortgage prepayment rates and recalculates amortization of acquisition andsecuritization costs and net cash receipts or payments on derivatives as partof the calculation of net interest income. Thus, if a 100 basis point interestrate increase occurred, the projected volatility to net interest income ispositively impacted through our use of derivatives.

Weestimate net interest income along with net cash flows from derivatives for thenext twelve months using balance sheet data and the notional amount ofderivatives as of May 31, 2007 and 12-month projections of the followingprimary drivers affecting net interest income:

·                   futureinterest rates using forward yield curves, which are considered marketconsensus estimates of future interest rates;

·                 mortgage acquisitions andoriginations;

·                 mortgage prepayment rate assumptions;and

·                 forward swap rates.

Werefer to the 12-month projection of net interest income along with the 12-monthprojection of net cash flows from derivatives as the “base case.” For financialreporting purposes, net cash flows from derivatives are included in realizedgain (loss) from derivative instruments on the consolidated financialstatements. However, for purposes of interest rate risk analysis we include netcash flows from derivatives in our base case simulations as we acquirederivatives to offset the effect that changes in interest rates have onvariable borrowing costs, such as securitized mortgage and warehouseborrowings. We believe that including net cash flows from derivatives in ourinterest rate risk analysis presents a more useful simulation of the effect ofchanging interest rates on net cash flows generated by our long-term mortgageportfolio.

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Oncethe base case has been established, we “shock” the base case with instantaneousand parallel shifts in interest rates in 100 basis point increments upward anddownward. Calculations are made for each of the defined instantaneous andparallel shifts in interest rates over or under the forward yield curve used todetermine the base case and include any associated changes in projectedmortgage prepayment rates caused by changes in interest rates. The results ofeach 100 basis point change in interest rates are then compared against thebase case to determine the estimated dollar and percentage change to base case.The simulations consider the affect of interest rate changes on interestsensitive assets and liabilities as well as derivatives. The simulations alsoconsider the impact that instantaneous and parallel shift in interest rateshave on prepayment rates and the resulting affect of accelerating or deceleratingamortization of premium and securitization costs.

Usinginformation as presented above, and other analysis, the Company reviews itsinterest rate risk profile.  Based onthis review, the Company makes certain decisions on how to mitigate itsinterest rate risk.

**ITEM 4:  CONTROLSAND PROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

We are committed to maintaining disclosure controlsand procedures (as defined in the Securities Exchange Act of 1934 Rules13-a-15(e) or 15d – 15 (e)) designed to ensure that information required to bedisclosed in our periodic reports filed under the Securities Exchange Act of1934, as amended, or the Exchange Act, is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms, andthat such information is accumulated and communicated to our management,including our Chief Executive Officer (CEO) (who is currently performing thefunctions of both the principal executive and financial officer), to allow for timelydecisions regarding required disclosure. In designing and evaluating ourdisclosure controls and procedures, management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures and implementingcontrols and procedures based on the application of management’s judgment.

As required by Rules 13a-15 and 15d-15 under theExchange Act, in connection with the filing of this Quarterly Report onForm 10-Q, our management, under the supervision and with theparticipation of our CEO (who is currently performing the functions of both theprincipal executive and financial officer), conducted an evaluation of ourdisclosure controls and procedures, as such term is defined underRule 13a-15(e). Based on this evaluation, our principal executive and financialofficer concluded that our disclosure controls and procedures were effective ata reasonable assurance level at June 30, 2007.

**Changes in Internal Control Over FinancialReporting**

During the quarter ended June 30, 2007, there were nochanges to internal control over financial reporting that materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.  During the second quarter, the Company acquiredproduction facilities from a privately held company (PFC) resulting in theaddition of certain systems and processes.    The Company is in the process of evaluatingassociated risks due to this acquisition in addition to any changes to internalcontrol over financial reporting as a result of the acquisition.

**PART II. OTHER INFORMATION**

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

TheCompany’s 2006 10-K reported shareholder derivative actions filed against theCompany and its senior officers and directors in the U.S. District Court,Central District of California and Orange County Superior Court.  In 2007,the Company entered into an agreement to settle the currently pending federaland state derivative actions against the Company and its senior officers anddirectors. Under the proposed settlement, all claims asserted against theofficers and directors named as defendants in those actions will be dismissedwith prejudice with no admission of wrongdoing on the part of any defendant andthe Company will agree to certain corporate governance practices. In addition,the proposed settlement will provide for an aggregate cash payment of up to$300,000 in attorney’s fees subject to plaintiff’s application to and approvalby the court, which will be paid entirely by the Company’s insurance carriersand will have no effect on the financial position of the Company.  The settlement was executed and approved bythe court on June 19, 2007.  Subsequentto that, an objecting stockholder filed an appeal and, as such, the settlementis not final until the appeal is resolved.

Pleaserefer to IMH’s report on Form 10-K for the year ended December 31, 2006 andreport on Form 10-Q for the period ended March 31, 2007 for a furtherdescription of litigation and claims.

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We believe that we have meritorious defenses to theabove claims and intend to defend these claims vigorously. Nevertheless,litigation is uncertain and we may not prevail in the lawsuits and can expressno opinion as to their ultimate resolution. An adverse judgment in any of thesematters could have a material adverse effect on us.

**ITEM 1A:****                      RISK FACTORS**

Our Annual Report on Form10-K for the year ended December 31, 2006 and our quarterly report on Form 10-Qfor the period ended Match 31, 2007 include a detailed discussion of our riskfactors. The information presented below updates and should be read inconjunction with the risk factors and information disclosed in that Form 10-Kand Form 10-Q.

***Risks related tocurrent market conditions***

**Currentand anticipated deterioration in the housing market may adversely effect ourresults of operations by resulting in lower loan volumes, lower loan prices andincreased loss severities**

During the secondquarter of 2007 the mortgage industry and the residential housing marketcontinued to deteriorate as home prices declined.   The difficulty that arose as a result ofthis has spread across various mortgage sectors, including the market in whichwe operate.  A continued decline, or alack of increase in real estate values, may result in additional increases indelinquencies and losses on our mortgage inventory both held for sale and heldfor investment.   Deterioration anddecline in the housing industry can also adversely affect sales in thesecondary mortgage market as investors may have concerns about mortgage paymentdefaults thereby adversely decreasing the price in the secondary market ofloans that we own, originate and acquire.  Furthermore, changes in market conditions may cause us to re-evaluateour strategy regarding certain assets that could result in additional valuationadjustments relating to our loan portfolio and real estate owned.  If market conditions continue to deteriorate,we may need to continue to reassess the market value of loans held for sale,the loss severities of loans in default and the net realizable value of ourreal estate owned, which may result in additional write-offs in the future, andfuture margin calls. We have received a significant amount of margin calls fromour lenders and continue to receive margin calls due to the current marketenvironment, we intend to satisfy these margin calls; however, we cannot makeany assurances we will satisfy margin calls received in thefuture.

**Currentconditions in the secondary market could materially impact our finances,earnings and our business operations**

As a result of theunprecedented uncertainty and disruption in the capital markets and secondarymortgage markets we are making changes in our business strategies andoperations.  The reduced liquidity andinvestor demand for mortgage loans and mortgage backed securities, and theincreased yield requirements for such instruments, may continue or get worse inthe future.  We have tightened ourunderwriting guidelines and suspended the origination and purchase of what istypically identified as Alt-A loans which will decrease our loan volumes.  Through our acquisition of certain assets wehave entered in to retail lending business with expertise in conformingmortgage markets however these markets may prove to be less profitable andhaving lower volumes than our previous operations which may have an adverseeffect on our earnings.

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Traditionally wehave relied upon the securitization market to create a secondary market for ourloans.  The current disruption in thatmarket caused by, among other things, an increased default rate on residentialmortgage loans, an increase in the number of ratings downgrades with respect tobonds issued in connection with securitization of loans, the lack of liquidityin the bond market and the financial condition of many companies that typicallyparticipate in this market have negatively affected our ability to access thesecuritization market for our mortgage loans and mortgage securities.  This, coupled with the lack of a market forthe sale of whole loans, and the fact that if such sales are negotiated theymay be on terms and conditions less favorable or profitable than they havehistorically been, has also adversely affected the securization market.  As a result we cannot assure you that we willhave purchasers for our loans on terms and conditions that will be profitableto us at all.  An inability to obtainlong term funding for our mortgage loans or mortgage securities on attractiveterms or a continued weakness in the markets demand for our mortgage loans orsecurities would harm our results of operations, financial condition, liquidityand business prospects and could result in defaults under our short termfinancing arrangements for such assets. Realigning our operations with these changes in the market couldsubstantially decrease our loan originations. Furthermore, we could be forced to sell assets on unfavorable terms orto seek additional means to reduce losses or raise funds, including withoutlimitation reducing, eliminating or disposing of our mortgage origination,mortgage purchasing, warehouse lending, loan servicing or other operations.

**We haveoperated under waivers provided by lenders with respect to certain covenants onour credit facilities.  A failure toobtain such waivers can result in the lender’s ability to accelerate repayment**

Certain of ourreverse repurchase agreements contain numerous representations, warranties andcovenants, including requirements to maintain a certain minimum net worth, tomaintain minimum equity ratios, to maintain our REIT status, to maintaincertain profitability levels and other customary debt covenants.  Events of default under these facilities canconstitute a material breach of representations and warranties and as suchallows the lenders to pursue certain remedies which may constitute a crossdefault under other agreements.  Suchacts may cause us to lose the ability to access these financing facilities orto lose the right to a timely liquidation of any assets on suchfacilities.  There can be no assurancethat we can continue to obtain such waivers and as such the lenders will havethe right to accelerate our repayment obligations which may have an adverseimpact on our ability to fund mortgage loans and to be profitable.

**Changesin lending requirements and programs may negatively effect our operations**

As a result of thesuspension of our Alt-A loan originations and purchases our business is moredependent on the origination of commercial loans and conforming loans that areeligible to be sold to government agencies which may negatively affect our loanvolumes and profitability.  Further, anyincrease in prevailing market interest rates may result in increased paymentsfor borrowers who have adjustable rate mortgage loans and for newborrowers.  Moreover, with respect tohybrid mortgage loans after their initial fixed rate period and with respect tomortgage loans with a negative amortization feature or an interest only featureborrowers may experience a substantial increase in their monthly payments even,in some cases, without an increase in prevailing market interest rates.  This may affect the performance of ourmortgage loans or mortgage operations.

The federalbanking agencies also published a final Statement on Subprime Mortgage Lending(“Statement”) on June 29, 2007 to address certain risks and emerging issuesrelating to subprime mortgage lending practices.  On July 17, 2007 the CSBS, the AARMR and theNational Association of Consumer Credit Administrators issued a statementsubstantially similar.  These statementsspecify that an institution’s analysis of a borrower’s repayment capacityshould include an evaluation of the borrower’s ability to repay the debt by itsfinal maturity at the fully indexed rate, assuming a fully amortizing repaymentschedule.  In addition, stated income andreduced documentation should be accepted only if there are documentedmitigating factors that clearly minimize the need for verification of aborrower’s repayment capacity.  Theeffect of this is unclear.  However, itis likely to result in further changes in our origination guidelines therebyaffecting our volumes and quality of loans. This may have a negative effect on our ability to sell loans on aprofitable basis in the future.

**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**

On June 1, 2006,we held our annual meeting of stockholders. Of 76,126,442 shares eligible tovote, 69,476,151, or 91.3%, votes were returned, formulating a quorum.  At the annual stockholders meeting, thefollowing matters were submitted to stockholders for vote Proposal I - Electionof Directors and Proposal II - Ratification of the appointment of Ernst &Young LLP as our independent auditors for the year ending December 31, 2007.

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**Proposal I—Election of Directors**

The results ofvoting on these proposals are as follows:
| Director             | ** ** | **For**    | ** ** | **Against** | ** ** | **Elected** | ** ** |
|----------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Joseph R.  Tomkinson |       | 67,007,657 |       | 2,468,493   |       | Yes         |       |
| William S.  Ashmore  |       | 67,005,688 |       | 2,470,462   |       | Yes         |       |
| James Walsh          |       | 66,766,365 |       | 2,709,785   |       | Yes         |       |
| Frank P. Filipps     |       | 66,794,583 |       | 2,681,567   |       | Yes         |       |
| Stephan R. Peers     |       | 66,779,725 |       | 2,696,425   |       | Yes         |       |
| William E. Rose      |       | 67,226,504 |       | 2,249,646   |       | Yes         |       |
| Leigh J. Abrams      |       | 66,903,645 |       | 2,572,505   |       | Yes         |       |

 

All directors areelected at our annual stockholders meeting.

**Proposal II**–**Ratification of the appointment of Ernst & Young LLP as ourindependent auditors for the year ending December 31, 2007.**

Proposal II was approved with 67,850,912 shares votedfor, 892,206 voted against and 733,029 abstained from voting, thereby,ratifying the appointment of Ernst & Young LLP as our independent auditorsfor the year ending December 31, 2007.

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

Asof the filing date of this report Joseph R. Tomkinson, the Company’s Chairmanand Chief Executive Officer, is also performing the functions of the principalfinancial officer while Gretchen Verdugo, the Company’s Executive VicePresident and Chief Financial Officer, has been out due to an illness from May22, 2007 through June 20, 2007 and June 27, 2007 through July 31, 2007.  Ms. Verdugo’s leave has recently beenextended to a medical leave of absence with an estimated duration untilSeptember 15, 2007 during which time Mr. Tomkinson will continue to perform thefunctions as principal financial officer. Further information regarding Mr. Tomkinson, his business experience andarrangements with the Company are hereby incorporated by reference from thesections entitled “Information Concerning Director Nominees” and “EmploymentAgreements” of the Company’s proxy statement filed with the Securities and ExchangeCommission on April 27, 2007.

 

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

(a)         Exhibits:
| 12.1  |   | Statements re: computation of ratios                                                                                                                            |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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. |
| 32.1* |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.             |
| 99.1  |   | Information from Proxy Statement   re: Joseph R. Tomkinson                                                                                                      |

 

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

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
| **IMPAC MORTGAGE HOLDINGS, INC.**                                                       | ** ** |
|-----------------------------------------------------------------------------------------|------------|
| ** **                                                                              | ** ** | ** ** |
| /s/ Joseph R.  Tomkinson                                                                |       |   |
| by: Joseph R.  Tomkinson                                                                |       |   |
| Chief Executive  Officer                                                                |       |   |
|  (authorized officer of registrant and  principal executive and financial officer) |
|                                                                                    |       |   |
| Date: August 14,  2007                                                                  |       |   |

 

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