# Table of Contents

 

 

 

# **UNITEDSTATES**

# **SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

## **FORM 10-Q**

## ** **

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

 

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

 

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

 

**For the transition period from                    to                    .**

 

**Commission File Number: 1-14100**

** **

**IMPACMORTGAGE HOLDINGS, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

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

**(Address ofprincipal executive offices)**

** **

**(949) 475-3600**

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

** **

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes  o    No  o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act.

 

Large accelerated filer o  Accelerated filer x  Non-accelerated filer o  Smaller reporting company o

 

Indicate by check markwhether the registrant is a shell company (as defined in Exchange Act Rule 12b-2)  Yes o  No x

 

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

 

 

 

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Table ofContents

 

**IMPACMORTGAGE HOLDINGS, INC.**

 

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

### ** **

**TABLE OF CONTENTS**

 
| ** ** | ** **                                                                                                                               | **Page**   |
|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | **PART I. FINANCIAL INFORMATION**                                                                                                   | ** ** |
|       |                                                                                                                                     |       |
| ITEM  1.   | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                                   | ** ** |
|       | Consolidated Balance Sheets as of  June 30, 2008 and December 31, 2007                                                         | 1          |
|       | Consolidated Statements of  Operations and Comprehensive Earnings (Loss) for the Three and Six Months  Ended June 30, 2008 and 2007 | 2          |
|       | Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007                                              | 4          |
|       | Notes to  Unaudited Consolidated Financial Statements                                                                                    | 6          |
|       |                                                                                                                                     |       |
| ITEM 2.    | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**                                           | 23         |
|       | Forward-Looking  Statements                                                                                                              | 23         |
|       | The  Mortgage Banking Industry and Discussion of Relevant Fiscal Periods                                                                 | 24         |
|       | Status of  Operations, Liquidity and Capital Resources                                                                                   | 24         |
|       | Market  Conditions                                                                                                                       | 26         |
|       | Critical Accounting  Policies                                                                                                            | 29         |
|       | Fair Value of  Financial Instruments                                                                                                     | 30         |
|       | Interest Income and  Expense                                                                                                             | 31         |
|       | Selected  Financial Results for the Three Months Ended June 30, 2008                                                                | 32         |
|       | Selected  Financial Results for the Six Months Ended June 30, 2008                                                                  | 32         |
|       | Estimated Taxable  Income                                                                                                                | 32         |
|       | Financial  Condition and Results of Operations                                                                                           | 33         |
|       |                                                                                                                                     |       |
| ITEM  3.   | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                          | 44         |
|       |                                                                                                                                     |       |
| ITEM 4.    | **CONTROLS AND  PROCEDURES**                                                                                                             | 44         |
|       |                                                                                                                                     |       |
|       | **PART II. OTHER  INFORMATION**                                                                                                     | ** ** |
|       |                                                                                                                                     |       |
| ITEM 1.    | **LEGAL PROCEEDINGS**                                                                                                                    | 45         |
|       |                                                                                                                                     |       |
| ITEM 1A.   | **RISK FACTORS**                                                                                                                         | 45         |
|       |                                                                                                                                     |       |
| ITEM  2.   | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                                         | 48         |
|       |                                                                                                                                     |       |
| ITEM  3.   | **DEFAULTS  UPON SENIOR SECURITIES**                                                                                                     | 48         |
|       |                                                                                                                                     |       |
| ITEM  4.   | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                                 | 48         |
|       |                                                                                                                                     |       |
| ITEM 5.    | **OTHER INFORMATION**                                                                                                                    | 48         |
|       |                                                                                                                                     |       |
| ITEM 6.    | **EXHIBITS**                                                                                                                             | 50         |
|       |                                                                                                                                     |       |
|       | **SIGNATURES**                                                                                                                           | 50         |
|       |                                                                                                                                     |       |
|       | **CERTIFICATIONS**                                                                                                                       | ** ** |

 

----

#### **Table of Contents**

 

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

#### ** **

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

 

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

** **

**CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share data)**

 
| ** **                                                                                                                                                                                                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                      | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                                                      | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                                                       |       | $                 | 25,971     |                  | $          | 24,387 |   |
| Trust assets                                                                                                                                                                                                                    |       |              |       |                  |       |
| Investment securities available-for-sale                                                                                                                                                                                        |       | 8,644             |       | 15,248                |       |
| Securitized mortgage collateral (at fair value at June 30, 2008)                                                                                                                                                           |       | 11,055,382        |       | 16,532,633            |       |
| Derivative assets                                                                                                                                                                                                               |       | 109               |       | 7,497                 |       |
| Real estate owned (REO) at net realizeable value                                                                                                                                                                                |       | 621,433           |       | 400,863               |       |
| Total trust assets                                                                                                                                                                                                              |       | 11,685,568        |       | 16,956,241            |       |
|                                                                                                                                                                                                                            |       |              |       |                  |       |
| Assets of discontinued operations                                                                                                                                                                                               |       | 203,320           |       | 353,250               |       |
| Other assets                                                                                                                                                                                                                    |       | 48,684            |       | 57,194                |       |
| Total assets                                                                                                                                                                                                                    |       | $                 | 11,963,543 |                  | $          | 17,391,072 |   |
|                                                                                                                                                                                                                            |       |              |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                                                 |       |              |       |                  |       |
| Trust liabilities                                                                                                                                                                                                               |       |              |       |                  |       |
| Securitized mortgage borrowings (at fair value at June 30, 2008)                                                                                                                                                           |       | $                 | 11,497,132 |                  | $          | 17,780,060 |   |
| Derivative liabilities                                                                                                                                                                                                          |       | 136,580           |       | 127,757               |       |
| Total trust liabilities                                                                                                                                                                                                         |       | 11,633,712        |       | 17,907,817            |       |
|                                                                                                                                                                                                                            |       |              |       |                  |       |
| Trust preferred securities (at fair value at June 30, 2008)                                                                                                                                                                |       | 46,266            |       | 98,398                |       |
| Liabilities of discontinued operations                                                                                                                                                                                          |       | 253,334           |       | 405,341               |       |
| Other liabilities                                                                                                                                                                                                               |       | 5,723             |       | 57,244                |       |
| Total liabilities                                                                                                                                                                                                               |       | 11,939,035        |       | 18,468,800            |       |
|                                                                                                                                                                                                                            |       |              |       |                  |       |
| Commitments and contingencies                                                                                                                                                                                                   |       |              |       |                  |       |
|                                                                                                                                                                                                                            |       |              |       |                  |       |
| **STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                   |       |              |       |                  |       |
| Series-A junior participating preferred stock, $0.01 par value;  2,500,000 shares authorized; none issued and outstanding                                                                                                       |       | —            |       | —                |       |
| Series-B 9.375% cumulative redeemable preferred stock, $0.01 par  value; liquidation value $50,000; 2,000,000 shares authorized, issued and  outstanding                                                                        |       | 20                |       | 20                    |       |
| Series-C 9.125% cumulative redeemable preferred stock, $0.01 par  value; liquidation value $111,765; 5,500,000 shares authorized; 4,470,600  shares issued and outstanding as of June 30, 2008 and December 31,  2007 |       | 45                |       | 45                    |       |
| Common stock, $0.01 par value; 200,000,000 shares authorized;  76,096,392 shares issued and outstanding as of June 30, 2008 and  December 31, 2007                                                                    |       | 761               |       | 761                   |       |
| Additional paid-in capital                                                                                                                                                                                                      |       | 1,175,125         |       | 1,173,562             |       |
| Accumulated other comprehensive income                                                                                                                                                                                          |       | —            |       | 1,028                 |       |
| Net accumulated deficit:                                                                                                                                                                                                        |       |              |       |                  |       |
| Cumulative dividends declared                                                                                                                                                                                                   |       | (811,355          | )          | (803,912              | )          |
| Retained deficit                                                                                                                                                                                                                |       | (340,088          | )          | (1,449,232            | )          |
| Net accumulated deficit                                                                                                                                                                                                         |       | (1,151,443        | )          | (2,253,144            | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                       |       | 24,508            |       | (1,077,728            | )          |
| Total liabilities and stockholders’ equity                                                                                                                                                                                 |       | $                 | 11,963,543 |                  | $          | 17,391,072 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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Tableof Contents

 

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**ANDCOMPREHENSIVE EARNINGS (LOSS)**

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

**(Unaudited)**

 
| ** **                                                    | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                    | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                    | ** ** | **2008**                                | ** ** | **2007**                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| **INTEREST INCOME:**                                          | * *   | * *                                | * *   | * *                              | * *   | * * | * * | * * | * * |
| Total interest income                                         |       | $                                       | 407,855    |                                  | $          | 316,443 |   | $ | 679,811 |   | $ | 621,191 |   |
|                                                          |       |                                    |       |                                  |       |   |   |   |   |
| **INTEREST EXPENSE:**                                         |       |                                    |       |                                  |       |   |   |   |   |
| Total interest expense                                        |       | 403,599                                 |       | 308,569                               |       | 668,206 |   | 605,374 |   |
|                                                          |       |                                    |       |                                  |       |   |   |   |   |
| Net interest income                                           |       | 4,256                                   |       | 7,874                                 |       | 11,605 |   | 15,817 |   |
| Provision for loan losses                                     |       | —                                  |       | 161,163                               |       | — |   | 190,295 |   |
| Net interest income (expense) after provision for loan losses |       | 4,256                                   |       | (153,289                              | )          | 11,605 |   | (174,478 | ) |
|                                                          |       |                                    |       |                                  |       |   |   |   |   |
| **NON-INTEREST INCOME:**                                      |       |                                    |       |                                  |       |   |   |   |   |
| Change in fair value of derivative instruments                |       | —                                  |       | 91,670                                |       | — |   | 73,672 |   |
| Change in fair value of net trust assets, excluding REO       |       | (11,161                                 | )          | —                                |       | (7,633 | ) | — |   |
| Change in fair value of trust preferred securities            |       | (997                                    | )          | —                                |       | (5,020 | ) | — |   |
| Losses from real estate owned                                 |       | (4,830                                  | )          | (19,328                               | )          | (9,086 | ) | (29,220 | ) |
| Real estate advisory fees                                     |       | 4,696                                   |       | —                                |       | 8,540 |   | — |   |
| Other                                                         |       | 1,544                                   |       | (1,538                                | )          | 3,442 |   | 3,749 |   |
| Total non-interest (expense) income                           |       | (10,748                                 | )          | 70,804                                |       | (9,757 | ) | 48,201 |   |
|                                                          |       |                                    |       |                                  |       |   |   |   |   |
| **NON-INTEREST EXPENSE:**                                     |       |                                    |       |                                  |       |   |   |   |   |
| General and administrative                                    |       | 4,925                                   |       | 4,451                                 |       | 8,912 |   | 9,960 |   |
| Personnel expense                                             |       | 2,820                                   |       | 1,620                                 |       | 5,150 |   | 2,464 |   |
| Total non-interest expense                                    |       | 7,745                                   |       | 6,071                                 |       | 14,062 |   | 12,424 |   |
| Net loss from continuing operations                           |       | (14,237                                 | )          | (88,556                               | )          | (12,214 | ) | (138,701 | ) |
| Income tax expense from continuing operations                 |       | 2,202                                   |       | 4,969                                 |       | 8,728 |   | 8,956 |   |
| Net loss from continuing operations                           |       | (16,439                                 | )          | (93,525                               | )          | (20,942 | ) | (147,657 | ) |
| Net loss from discontinued operations, net of tax             |       | (11,048                                 | )          | (59,022                               | )          | (10,360 | ) | (126,558 | ) |
| Net loss                                                      |       | (27,487                                 | )          | (152,547                              | )          | (31,302 | ) | (274,215 | ) |
| Cash dividends on cumulative redeemable preferred stock       |       | (3,722                                  | )          | (3,722                                | )          | (7,443 | ) | (7,443 | ) |
| Net loss available to common stockholders                     |       | $                                       | (31,209    | )                                     | $          | (156,269 | ) | $ | (38,745 | ) | $ | (281,658 | ) |

 

See accompanying notes to consolidated financial statements.

 

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| ** **                                          | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                          | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                          | ** ** | **2008**                                | ** ** | **2007**                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss                                            |       | $                                       | (27,487    | )                                     | $          | (152,547 | ) | $ | (31,302 | ) | $ | (274,215 | ) |
| Net unrealized losses on securities:                |       |                                    |       |                                  |       |   |   |   |   |
| Unrealized holding losses arising during year       |       | —                                  |       | (1,656                                | )          | — |   | (2,718 | ) |
| Reclassification of losses included in net earnings |       | —                                  |       | 1,596                                 |       | — |   | 1,596 |   |
| Net unrealized losses                               |       | —                                  |       | (60                                   | )          | — |   | (1,122 | ) |
| Comprehensive loss                                  |       | $                                       | (27,487    | )                                     | $          | (152,607 | ) | $ | (31,302 | ) | $ | (275,337 | ) |
|                                                |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per common share - Basic:                  |       |                                    |       |                                  |       |   |   |   |   |
| Loss from continuing operations                     |       | $                                       | (0.26      | )                                     | $          | (1.28 | ) | $ | (0.37 | ) | $ | (2.04 | ) |
| Loss from discontinued operations                   |       | (0.15                                   | )          | (0.78                                 | )          | (0.14 | ) | (1.66 | ) |
| Net loss per share                                  |       | $                                       | (0.41      | )                                     | $          | (2.05 | ) | $ | (0.51 | ) | $ | (3.70 | ) |
|                                                |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per common share - Diluted:                |       |                                    |       |                                  |       |   |   |   |   |
| Loss from continuing operations                     |       | $                                       | (0.26      | )                                     | $          | (1.28 | ) | $ | (0.37 | ) | $ | (2.04 | ) |
| Loss from discontinued operations                   |       | (0.15                                   | )          | (0.78                                 | )          | (0.14 | ) | (1.66 | ) |
| Net loss per share                                  |       | $                                       | (0.41      | )                                     | $          | (2.05 | ) | $ | (0.51 | ) | $ | (3.70 | ) |
|                                                |       |                                    |       |                                  |       |   |   |   |   |
| Dividends declared per common share                 |       | $                                       | —     |                                  | $          | — |   | $ | — |   | $ | 0.10 |   |

 

See accompanying notes to consolidated financial statements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(Unaudited)**

 
| ** **                                                                      | ** **   | **For the Six Months** | ** **   |
|---------------------------------------------------------------------------------|--------------|---------------------------------------|--------------|
| ** **                                                                      | ** **   | **Ended June 30,**          | ** **   |
| ** **                                                                      | ** **   | **2008**                              | ** **   | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                       | *** *** | *** ***                          | *** *** | *** *** | *** *** |
| Net loss from continuing operations                                             |         | $                                     | (20,942      | ) | $ | (147,657 | ) |
|                                                                            |         |                                  |         |   |   |
| Provision for loan losses                                                       |         | —                                |         | 190,295 |   |
| Provision for REO losses                                                        |         | 14,323                                |         | 28,074 |   |
| Loss (gain) on sale of REO                                                      |         | (5,237                                | )            | 1,145 |   |
| Amortization of deferred charge, net                                            |         | 8,728                                 |         | 9,069 |   |
| Amortization of debt issuance costs and mortgage servicing rights               |         | 948                                   |         | 807 |   |
| Amortization of premiums and securitization costs                               |         | —                                |         | 84,863 |   |
| Change in fair value of derivative instruments                                  |         | 12,144                                |         | 1,354 |   |
| Change in fair value of net trust assets, excluding REO and  derivatives        |         | (75,878                               | )            | — |   |
| Change in fair value of trust preferred securities                              |         | 5,020                                 |         | — |   |
| Accretion of interest income and expense                                        |         | (25,191                               | )            | — |   |
| Stock-based compensation                                                        |         | 653                                   |         | 812 |   |
| Net change in accrued interest receivable                                       |         | —                                |         | (547 | ) |
| Net cash provided by (used in) operating activities of discontinued  operations |         | 91,219                                |         | (3,157,915 | ) |
| Net change in other assets and liabilities                                      |         | (41,444                               | )            | (8,968 | ) |
| **Net cash used in operating activities**                                       | ** **   | **(35,657**                           | **)**        | **(2,998,668** | **)** |
| ** **                                                                      | ** **   | ** **                            | ** **   | ** ** | ** ** |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                       | ** **   | ** **                            | ** **   | ** ** | ** ** |
| Securitized mortgage collateral                                                 |         | 1,342,015                             |         | 3,468,817 |   |
| Mortgages held-for-investment                                                   |         | 22                                    |         | (3,229 | ) |
| Purchase of premises and equipment                                              |         | 386                                   |         | (873 | ) |
| Principal change on investment securities available-for-sale                    |         | 1,196                                 |         | 6,404 |   |
| Proceeds from the sale of real estate owned                                     |         | 197,796                               |         | 76,532 |   |
| Net cash provided by (used in) investing activities of discontinued  operations |         | 11,805                                |         | 191,664 |   |
| **Net cash provided by investing activities**                                   | ** **   | **1,553,220**                         | ** **   | **3,739,315** | ** ** |
|                                                                            |         |                                  |         |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                       |         |                                  |         |   |   |
| Cash disbursements under reverse repurchase agreements                          |         | —                                |         | (90,642 | ) |
| Cash receipts from reverse repurchase agreements                                |         | —                                |         | 92,392 |   |
| Proceeds from securitized mortgage borrowings                                   |         | —                                |         | 3,858,143 |   |
| Repayment of securitized mortgage borrowings                                    |         | (1,393,987                            | )            | (4,323,044 | ) |
| Common stock dividends paid                                                     |         | —                                |         | (30,326 | ) |
| Preferred stock dividends paid                                                  |         | (7,443                                | )            | (7,443 | ) |
| Proceeds from sale of cumulative redeemable preferred stock                     |         | —                                |         | 608 |   |
| Net cash (used in) povided by investing activities of discontinued  operations  |         | (116,465                              | )            | (306,831 | ) |
| **Net cash used in financing activities**                                       | ** **   | **(1,517,895**                        | **)**        | **(807,143** | **)** |
|                                                                            |         |                                  |         |   |   |
| Net change in cash and cash equivalents                                         |         | (332                                  | )            | (66,496 | ) |
| Cash and cash equivalents at beginning of period                                |         | 26,462                                |         | 179,677 |   |
| Cash and cash equivalents at end of period - Continuing Operations              |         | 25,971                                |         | 107,083 |   |
| Cash and cash equivalents at end of period - Discontinued Operations            |         | 159                                   |         | 6,098 |   |
| Cash and cash equivalents at end of period                                      |         | $                                     | 26,130       |   | $ | 113,181 |   |

 

See accompanying notes to consolidated financial statements.

 

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| ** **                                                                    | ** **   | **For the Six Months** | ** **   |
|-------------------------------------------------------------------------------|--------------|---------------------------------------|--------------|
| ** **                                                                    | ** **   | **Ended June 30,**          | ** **   |
| ** **                                                                    | ** **   | **2008**                              | ** **   | **2007** | ** ** |
| **SUPPLEMENTARY INFORMATION (Continuing and  Discontinued Operations):**      | *** *** | *** ***                          | *** *** | *** *** | *** *** |
| Interest paid                                                                 |         | $                                     | 315,545      |   | $ | 651,736 |   |
| Taxes paid                                                                    |         | —                                |         | 116 |   |
|                                                                          |         |                                  |         |   |   |
| **NON-CASH TRANSACTIONS (Continuing and  Discontinued Operations):**          |         |                                  |         |   |   |
| Accumulated other comprehensive loss                                          |         | $                                     | —       |   | $ | (1,122 | ) |
| Transfer of loans held-for-sale and held-for-investment to real  estate owned |         | —                                |         | 20,872 |   |
| Transfer of securitized mortgage collateral to real estate owned              |         | 435,038                               |         | 255,051 |   |
| Transfer of loans held-for-sale to securitized mortgage collateral            |         | —                                |         | 3,245,500 |   |
| Transfer of securitized mortgage collateral to loans held-for-sale            |         | —                                |         | 27,040 |   |

 

See accompanyingnotes to consolidated financial statements.

 

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

**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

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

 

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

 

**1.     Business Summary andFinancial Statement Presentation**

 

***Business Summary***

 

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

 

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

 

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

 

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

 

***Financial Statement Presentation***

 

Theaccompanying unaudited consolidated financial statements of IMH and itssubsidiaries (as defined above) have been prepared in accordance withAccounting Principles Generally Accepted in the United States of America (GAAP)for interim financial information and with the instructions to Form 10-Qand Rule 10-01 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by GAAP for complete financialstatements. In the opinion of management, all adjustments, consisting of normalrecurring adjustments considered necessary for a fair presentation, have beenincluded. Operating results for the three-month and six month periods ended June 30,2008 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2008.

 

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

 

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 consolidated financial statements in conformity withGAAP.  The items affected by management’sestimates and assumptions include the valuation of trust assets and liabilities(including investment securities available-for-sale), the valuation ofrepurchase liabilities related to sold loans, the valuation of trust preferredsecurities, and the valuation of loans held-for-sale.  Actual results could differ from thoseestimates.

 

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

 

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

 

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As describes in Note L, in September 2008,the Company executed definitive agreements, which require scheduled principalpaydowns and remove any and all technical defaults that existed under theprevious reverse repurchase facility.

 

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

 

The Company earns advisory fees from a real estate marketing companyspecializing in the marketing and disposition of foreclosed properties.  During the three and six months ended June 30,2008, the Company earned $4.7 million and $8.5 million, respectively, from thisrelationship.  The amount of real estateadvisory fees the Company receives from this relationship are based on numerousfactors, including real estate market conditions, the level of foreclosureactivity, the ability of the marketing company to attract new business, and theCompany retaining its CEO and avoiding liquidation.  The agreement terminates in 2010 with theCompany having an option to extend the agreement for an additional three years.

 

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

 

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

 

**2.     Adoption of New AccountingStandards**

 

**Adoption of SFAS 157—Fair Value Measurements**

 

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

 

·                  Level 1 — Quoted prices foridentical instruments in active markets.

 

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

 

·                  Level 3 — Valuations derived fromvaluation techniques in which one or more significant inputs or significantvalue drivers are unobservable.

 

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

 

For some products or in certain market conditions,observable inputs may not always be available. Through the second quarter of 2008, certain markets remained illiquid,and some key observable inputs used in valuing certain exposures were unavailable.  When and if these markets are liquid, theCompany will use the related observable inputs available at that time fromthese markets.

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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| (2) |   | Components  of securitized mortgage collateral at December 31, 2007 include the  allowance for loan loss of $1.2 billion, accrued interest of $99.7 million  and premiums of $183.1 million, which were part of its fair value for the  adoption of SFAS 159. At June 30, 2008 and December 31, 2007,  securitized mortgage collateral included $10.1 million and $9.1 million,  respectively in master servicing rights, recorded at the lower of cost or  market, related to consolidated securitizations and recorded at the lower of  cost or market. |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3) |   | Components  of securitized mortgage borrowings at December 31, 2007 include accrued  interest of $17.1 million and securitization costs of $37.5 million, which  were part of its fair value for the adoption of SFAS 159.                                                                                                                                                                                                                                                                                                                                          |
| (4) |   | There  was no tax effect of the adoption of SFAS 159 as the Company qualifies as a  REIT for federal income tax purposes and its tax liabilities are only related  to it deferred charges associated with previous inter-company loan sales.                                                                                                                                                                                                                                                                                                                             |
| (5) |   | The  securitized mortgage collateral and securitized mortgage borrowings include  the mortgage insurance and bond insurance proceeds to be received from third  parties.                                                                                                                                                                                                                                                                                                                                                                                                 |
| (6) |   | As  of January 1, 2008, after adoption of SFAS 159, total stockholder’s  equity was $61.7 million                                                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

**Changes in Significant Accounting Policies**

 

*Investment Securities Available-for-Sale*

 

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

 

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

 

*Securitized Mortgage Collateral and Borrowings*

 

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

 

*Trust Preferred Securities*

 

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

 

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

 

**3.     Recent AccountingPronouncements**

 

In March 2008, the FASB issued Statement No. 161,“Disclosures about DerivativeInstruments and Hedging Activities” (SFAS 161), an amendment of FASB StatementNo. 133, “Accounting forDerivative Instruments and Hedging Activities” (SFAS 133), to expanddisclosure requirements for an entity’s derivative and hedging activities.Under SFAS 161, entities are required to provide enhanced disclosuresabout how and why an entity uses derivative instruments, how derivative 

 

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instruments and relatedhedged items are accounted for under SFAS 133 and its relatedinterpretations, and how derivative instruments and related hedged items affectan entity’s financial position, financial performance, and cash flows. In orderto meet these requirements, entities shall include qualitative disclosuresabout objectives and strategies for using derivatives, quantitative disclosuresabout fair value amounts of and gains and losses on derivative instruments, anddisclosures about credit-risk-related contingent features in derivative agreements.SFAS 161 is effective for fiscal years and interim periods beginning afterNovember 15, 2008 with early adoption encouraged. The Company plans toadopt this Statement on January 1, 2009, and there should be no impact onthe consolidated financial statements as this Statement only addressesdisclosures.

 

In April 2008, the FASB voted to eliminate qualifying specialpurpose entities (QSPEs) from the guidance in FASB Statement No. 140 “Accountingfor Transfers and Servicing of Financial Assets and Extinguishment ofLiabilities” (SFAS 140).   While therevised standard has not been finalized and the FASB’s proposals will besubject to a public comment period, this change may have a significant impacton the Company’s consolidated financial statements as it may lose salestreatment for assets previously sold to a QSPE, as well as for future sales. Aneffective date for any proposed revisions has not been determined by the FASB.As of June 30, 2008, the current principal balance of QSPEs to which theCompany, acting as principal, has transferred assets and received salestreatment were $727.1 million.  TheCompany’s investment in these QSPE’s consists of residual interests accountedfor as investment securities available-for-sale in its consolidated balance sheets.

 

In connection with the proposed changes to SFAS 140, the FASB alsois proposing three key changes to the consolidation model in FASBInterpretation No. 46(R), “Consolidation of Variable Interest Entities(revised December 2003)—an interpretation of ARB No. 51”(FIN 46(R)). First, the FASB will now include former QSPEs in the scope ofFIN 46(R). In addition, the FASB supports amending FIN 46(R) tochange the method of analyzing which party to a variable interest entity (VIE)should consolidate the VIE to a primarily qualitative determination of controlinstead of today’s risks and rewards model. Finally, the proposed amendment isexpected to require all VIEs and their primary beneficiaries to be reevaluatedquarterly. The previous rules required reconsideration only when specifiedreconsideration events occurred. As of June 30, 2008, the currentprincipal balance of significant unconsolidated VIEs with which the Company isinvolved were approximately $727.1 million.

 

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

 

**4.     Legal Proceedings**

 

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

 

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

 

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

 

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

 

Pleaserefer to IMH’s report on Form 10-K for the year ended December 31,2007 for a description of other litigation and claims.

 

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** **

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

 

In accordance with Accounting Research Bulletin No. 51, “ConsolidatedFinancial Statements,” the Company records a deferred charge representing thedeferral of income tax expense on inter-company profits that resulted from thesale of mortgages from taxable subsidiaries to IMH in prior years. The deferredcharge is included in other assets in the accompanying consolidated balancesheets and is amortized as a component of income tax expense in theaccompanying consolidated statements of operations over the estimated life ofthe mortgages retained in the securitized mortgage collateral. The Company recordeda tax provision of $2.2 million and $8.7 million for the three and sixmonths ending June 30, 2008 and $5.0 million and $9.0 million for thethree and six months ending June 30, 2007, respectively.  The net provision is predominately the resultof the amount of the deferred charge amortized and/or impaired resulting fromcredit losses, which does not result in any tax liability required to be paid.

 

**NoteB—Fair Value of Financial Instruments**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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The following table presents for each of these hierarchy levels, theCompany’s assets and liabilities that are measured at fair value on a recurringbasis, including financial instruments for which the Company has elected thefair value option at June 30, 2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **At June 30, 2008**                  | ** ** |
| ** **                               | ** ** | **Level 1**                                     | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| **Assets**                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Investment securities available-for-sale |       | $                                                    | —     |   | $ | — |   | $ | 8,644 |   | $ | 8,644 |   |
| Securitized mortgage collateral (1)      |       | —                                               |       | 10,747,133 |   | 298,189 |   | 11,045,322 |   |
| **Total Assets at Fair Value**           | ** ** | **$**                                                | **—** | ** ** | **$** | **10,747,133** | ** ** | **$** | **306,833** | ** ** | **$** | **11,053,966** | ** ** |
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Liabilities**                          | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings          |       | $                                                    | —     |   | $ | 11,180,164 |   | $ | 316,968 |   | $ | 11,497,132 |   |
| Derivative liabilities, net (2)          |       | —                                               |       | 136,471 |   | — |   | 136,471 |   |
| Trust preferred securities               |       | —                                               |       | — |   | 46,266 |   | 46,266 |   |
| **Total Liabilities at Fair Value**      | ** ** | **$**                                                | **—** | ** ** | **$** | **11,316,635** | ** ** | **$** | **363,234** | ** ** | **$** | **11,679,869** | ** ** |

 

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| (1) |   | Excluded  from securitized mortgage collateral above is $10.1 million in master  servicing rights related to consolidated securitizations and recorded at the  lower of cost or market.    |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Derivative  liabilities, net includes $109 thousand in derivative assets and $136.6  million in derivative liabilities, included within trust assets and trust  liabilities, respectively. |

 

Level3 assets and liabilities were 2.6 percent and 3.0 percent of total assets atfair value and total liabilities at fair value, respectively.

 

Thefollowing tables present a reconciliation for all assets and liabilitiesmeasured at fair value on a recurring basis using significant unobservableinputs (Level 3) for the three and six months ended June 30, 2008:

 
| ** **                               | ** ** | **Level 3 Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Three Months Ended June 30, 2008**          | ** ** |
| ** **                               | ** ** | **Fair Value -March 31, 2008**                     | ** ** | **Total Gains   (Losses)  Included in   Earnings** | ** ** | **Transfers in  and/or out of  Level 3** | ** ** | **Purchases,  issuances and   settlements** | ** ** | **Fair Value -  June 30, 2008** | ** ** | **Unrealized gains  (losses) still held  (1)** | ** ** |
| Investment securities available-for-sale |       | $                                                                      | 10,621     |   | $ | (1,318 | ) | $ | — |   | $ | (659 | ) | $ | 8,644 |   | $ | (1,977 | ) |
| Securitized mortgage collateral          |       | 966,958                                                                |       | 12,581 |   | (645,986 | ) | (35,364 | ) | 298,189 |   | (22,783 | ) |
| Securitized mortgage borrowings          |       | (998,395                                                               | )          | (12,388 | ) | 661,157 |   | 32,658 |   | (316,968 | ) | 20,270 |   |
| Trust preferred securities               |       | (45,129                                                                | )          | (1,137 | ) | — |   | — |   | (46,266 | ) | (1,137 | ) |
|                                     |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
|                                          |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Level 3 Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Six Months Ended June 30, 2008**            | ** ** |
| ** **                               | ** ** | **Fair Value -  January 1, 2008**                  | ** ** | **Total Gains   (Losses)   Included in   Earnings** | ** ** | **Transfers in  and/or out of   Level 3** | ** ** | **Purchases,   issuances and   settlements** | ** ** | **Fair Value -  June 30, 2008** | ** ** | **Unrealized gains   (losses)  still held  (1)** | ** ** |
| Investment securities available-for-sale |       | $                                                                      | 15,248     |   | $ | (5,408 | ) | $ | — |   | $ | (1,196 | ) | $ | 8,644 |   | $ | (5,006 | ) |
| Securitized mortgage collateral          |       | 782,574                                                                |       | (236,490 | ) | (119,516 | ) | (128,379 | ) | 298,189 |   | (189,290 | ) |
| Securitized mortgage borrowings          |       | (767,704                                                               | )          | 265,815 |   | 98,688 |   | 86,233 |   | (316,968 | ) | 183,216 |   |
| Trust preferred securities               |       | (40,952                                                                | )          | (5,314 | ) | — |   | — |   | (46,266 | ) | (5,020 | ) |
|                                          |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

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The tables below summarize gains and losses due to changes in fairvalue, including both realized and unrealized gains and losses, recorded inearnings for Level 3 assets and liabilities for the three and six months ended June 30,2008.

 
| ** **                                               | ** ** | **Recurring Fair Value Measurements**                                                 | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Level 3 - Total Gains (Losses) Included in Net Loss** | ** ** |
| ** **                                               | ** ** | **Three Months Ended June 30, 2008**                                        | ** ** |
| ** **                                               | ** ** | **Investment Securities   Available-for-Sale**                                             | ** ** | **Securitized Mortgage   Collateral** | ** ** | **Securitized Mortgage   Borrowings** | ** ** | **Trust Preferred   Securities** | ** ** |
| Interest income                                          |       | $                                                                                                    | 199        |   | $ | 10,306 |   | $ | — |   | $ | — |   |
| Interest expense                                         |       | —                                                                                               |       | — |   | (6,275 | ) | (140 | ) |
| Change in fair value of net trust assets,  excluding REO |       | (1,517                                                                                               | )          | 2,275 |   | (6,113 | ) | — |   |
| Change in fair value of trust preferred  securities      |       | —                                                                                               |       | — |   | — |   | (997 | ) |
| **Total**                                                | ** ** | **$**                                                                                                | **(1,318** | **)** | **$** | **12,581** | ** ** | **$** | **(12,388** | **)** | **$** | **(1,137** | **)** |

 
| ** **                                               | ** ** | **Recurring Fair Value Measurements**                                                 | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **Level 3 - Total Gains (Losses) Included in Net Loss** | ** ** |
| ** **                                               | ** ** | **Six Months Ended June 30, 2008**                                          | ** ** |
| ** **                                               | ** ** | **Investment Securities   Available-for-Sale**                                             | ** ** | **Securitized Mortgage   Collateral** | ** ** | **Securitized Mortgage   Borrowings** | ** ** | **Trust Preferred   Securities** | ** ** |
| Interest income                                          |       | $                                                                                                    | 399        |   | $ | 10,217 |   | $ | — |   | $ | — |   |
| Interest expense                                         |       | —                                                                                               |       | — |   | (15,176 | ) | (294 | ) |
| Change in fair value of net trust assets,  excluding REO |       | (5,807                                                                                               | )          | (246,707 | ) | 280,991 |   | — |   |
| Change in fair value of trust preferred  securities      |       | —                                                                                               |       | — |   | — |   | (5,020 | ) |
| **Total**                                                | ** ** | **$**                                                                                                | **(5,408** | **)** | **$** | **(236,490** | **)** | **$** | **265,815** | ** ** | **$** | **(5,314** | **)** |

 

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

 

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

 

***Recurring basis***

 

*Investment Securities Available-for-Sale.* Pursuant to the Company’s adoption of SFAS 159, the Company electedto carry all of its investment securities available-for-sale at fairvalue.  These investment securities arerecorded at fair value and consist primarily of non-investment grademortgage-backed securities.  The fairvalue of the investment securities are measured based upon the Company’sexpectation of inputs that other market participants would use.  Such assumptions include judgments about theunderlying collateral, prepayment speeds, credit losses, and certain otherfactors.  Given the market disruption andlack of observable market data as of June 30, 2008, the fair value of theinvestment securities available-for-sale were measured using significantinternal expectations of market participants’ assumptions. At June 30,2008, investment securities available-for-sale were classified as Level 3fair value measurements.

 

*Securitized Mortgage Collateral* – Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgagecollateral at fair value.  These assetsconsist primarily of Alt-A mortgage loans securitized between 2002 and2007.  Fair value measurements are basedon the Company’s estimated cash flow models, which incorporate assumptions,inputs of other market participants and quoted prices for the underlyingbonds.  The Company’s assumptions includeits expectations of inputs that other market participants would use. Theseassumptions include judgments about the underlying collateral, prepaymentspeeds, credit losses, and certain other factors.  At June 30, 2008, securitized mortgagecollateral was classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.  As of June 30, 2008, the unpaidprincipal balance and fair values of loans 90 days or more past due was$2.7 billion and estimated at $1.6 billion, respectively.  The aggregate unpaid principal balancesexceed the fair value by $1.1 billion at June 30, 2008.

 

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*Securitized Mortgage Borrowings* - Pursuant to the Company’s adoption ofSFAS 159, the Company elected to carry all of its securitized mortgageborrowings at fair value.  Theseborrowings consist of individual tranches of bonds issued by securitizationtrusts and are primarily backed by Alt-A mortgage loans.  Fair value measurements include the Company’sjudgments about the underlying collateral assumptions such as prepaymentspeeds, credit losses, and certain other factors and are based upon quotedprices for the individual tranches of bonds, if available.  At June 30, 2008, securitized mortgageborrowings were classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.  As of June 30, 2008, the unpaidprincipal balance and fair value of securitized mortgage borrowings was $16.5billion and estimated at $11.5 billion, respectively.  The aggregate unpaid principal balanceexceeds the fair value by $5 billion at June 30, 2008.

 

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

 
| · |   | Stated  interest rate adjustments to account for the stated yield difference between  the trust preferred securities and the preferred stock issued by the Company, |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |
| · |   | Liquidity  adjustments to reflect the presence of a lack of an actively traded market  for these securities.                                                        |
|   |   |                                                                                                                                                                |
| · |   | Preference  adjustments to reflect the rights of the trust preferred securities as  compared to the preferred securities.                                           |

 

At June 30, 2008 trust preferred securities were classified asLevel 3 measurements. As of June 30, 2008, the unpaid principalbalance and fair value of trust preferred securities was $99.2 million and$46.3 million, respectively.  Theaggregate unpaid principal balance exceeds the fair value by $52.9 million at June 30,2008.

 

*Derivative Assets andLiabilities.*****For non-exchange traded contracts, fair valueis based on the amounts that would be required to settle the positions with therelated counterparties as of the valuation date.   Valuations of derivative assets andliabilities reflect the value of the instruments, including the valuesassociated with counterparty risk. With the issuance of SFAS 157, these valuesmust also take into account the Company’s own credit standing, to the extentapplicable, thus included in the valuation of the derivative instrument is thevalue of the net credit differential between the counterparties to thederivative contract.  At June 30,2008, derivative assets and liabilities were classified as Level 2measurements.

 

***Non-recurring basis***

 

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

 

*Loans Held-for-Sale -*Loans held-for-sale for which the fair value option was not elected arecarried at lower of cost or market (LOCOM). When available, such measurements are based upon what secondary marketsoffer for portfolios with similar characteristics, and are consideredLevel 2 measurements. If market pricing is not available, suchmeasurements are significantly impacted by the Company’s expectations of othermarket participants’ assumptions, and are considered Level 3measurements.  The Company utilizesinternal pricing processes to estimate the fair value of loans held-for-sale,which is based on recent loan sales and estimates of the fair value of theunderlying collateral.  Loansheld-for-sale, which are primarily included in assets of discontinuedoperations, are considered Level 3 measurements at June 30, 2008.

 

*Mortgage Servicing Rights -*Mortgage servicing rights (MSRs) for which the fair value option wasnot elected are carried at LOCOM.  MSRsare not traded in an active market with observable prices.  The Company utilizes internal pricingprocesses to estimate the fair value of MSRs, which are based on assumptionsthe Company believes would be used by market participants, including marketdiscount rates, float, prepayment speeds and master servicing fees.  MSRs, which are included in other assets, areconsidered Level 3 measurements at June 30, 2008.

 

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Thefollowing table presents the fair values of those financial assets measured atfair value on a non-recurring basis at June 30, 2008.

 
| ** **                | ** ** | ** **                                               | ** ** | ** **                               | ** ** | ** **  | ** ** | ** ** | ** ** | **Total Gains (Losses)** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|------------------------------------------|------------|-------------|------------|------------|------------|------------------------------------|------------|
| ** **                | ** ** | **Non-recurring Fair Value Measurements** | ** ** | **For the Periods Ended** | ** ** |
| ** **                | ** ** | **As of June 30, 2008**              | ** ** | **June 30, 2008**              | ** ** |
| ** **                | ** ** | **Level 1**                                              | ** ** | **Level 2**                              | ** ** | **Level 3** | ** ** | **Total**  | ** ** | **Three   Months**                 | ** ** | **Six   Months** | ** ** |
| Loans held-for-sale (1)   |       | $                                                        | —     |                                     | $          | —      |       | $          | 167,420    |                               | $          | 167,420 |   | $ | (7,885 | ) | $ | (16,249 | ) |
| Mortgage servicing rights |       | $                                                        | —     |                                     | $          | —      |       | $          | 1,677      |                               | $          | 1,677 |   | $ | (301 | ) | $ | (948 | ) |

 

----

(1)           Includes $1.8 million and $165.6 million ofloans held-for-sale within continuing and discontinued operations, respectivelyat June 30, 2008.

 

Thefollowing table represents changes in fair value of recurring fair valuemeasurements for the three and six months ended June 30, 2008.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                              | ** **  |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss** | ** **  |
| ** **                               | ** ** | **Three Months Ended June 30, 2008**                     | ** **  |
| ** **                               | ** ** | ** **                                                                        | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income**                                                          | ** **  | **Interest Expense** | ** ** | **Net Trust Assets** | ** ** | **Trust Preferred  Securities** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                 | 687         |   | $ | — |   | $ | (1,517 | ) | $ | — |   | $ | (830 | ) |
| Securitized mortgage collateral          |       | 406,988                                                                           |        | — |   | (19,062 | ) | — |   | 387,926 |   |
| Securitized mortgage borrowings          |       | —                                                                            |        | (401,431 | ) | (88,886 | ) | — |   | (490,317 | ) |
| Trust preferred securities               |       | —                                                                            |        | (2,168 | ) | — |   | (997 | ) | (3,165 | ) |
| Derivative instruments                   |       | —                                                                            |        | — |   | 98,304 |   | — |   | 98,304 |   |
| **Total**                                | ** ** | **$**                                                                             | **407,675** | ** ** | **$** | **(403,599** | **)** | **$** | **(11,161** | **)** | **$** | **(997** | **)** | **$** | **(8,082** | **)** |

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                              | ** **  |
|------------------------------------------|------------|-----------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss** | ** **  |
| ** **                               | ** ** | **Six Months Ended June 30, 2008**                       | ** **  |
| ** **                               | ** ** | ** **                                                                        | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income**                                                          | ** **  | **Interest Expense** | ** ** | **Net Trust Assets** | ** ** | **Trust Preferred  Securities** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                 | 1,420       |   | $ | — |   | $ | (5,807 | )(1) | $ | — |   | $ | (4,387 | ) |
| Securitized mortgage collateral          |       | 676,886                                                                           |        | — |   | (3,248,563 | )(1) | — |   | (2,571,677 | ) |
| Securitized mortgage borrowings          |       | —                                                                            |        | (663,248 | ) | 3,330,248 | (1) | — |   | 2,667,000 |   |
| Trust preferred securities               |       | —                                                                            |        | (4,350 | ) | — |   | (5,020 | ) | (9,370 | ) |
| Derivative instruments                   |       | —                                                                            |        | — |   | (83,511 | )(2) | — |   | (83,511 | ) |
| **Total**                                | ** ** | **$**                                                                             | **678,306** | **(3)** | **$** | **(667,598** | **)(3)** | **$** | **(7,633** | **)** | **$** | **(5,020** | **)** | **$** | **(1,945** | **)** |
|                                          |            |                                                                                   |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

| (1) |   | The  $75.9 million total change in fair value of these financial instruments is  included as change in fair value of trust assets, excluding REO and  derivatives, in the accompanying statement of cash flows for the six months  ended June 30, 2008.              |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Included  in this amount is $(12.1) million in non-cash changes in the fair value of  derivative instruments, which are included in the accompanying statement of  cash flows for the six months ended June 30, 2008, and $(71.4) million  in cash settlements paid. |
| (3) |   | The  totals include $(370.1) million and $344.9 million of accretion of interest  income and expense, respectively.                                                                                                                                                       |

 

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

 

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**Note C—Stock Options**

 

Thefair value of options granted, which is amortized to expense over the optionvesting period, is estimated on the date of grant using the Black-Scholes-Mertonoption pricing model with the following weighted average assumptions:

 
| ** **                             | ** ** | **Six Months**          | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Ended June 30,** | ** ** |
| ** **                             | ** ** | **2008**                     | ** ** | **2007** | ** ** |
| Risk-free interest rate                |       | 1.88% to 2.13%               |       | — |   |
| Expected lives (in years)              |       | 3.25                         |       | — |   |
| Expected volatility (1)                |       | 87.3% - 89.9%                |       | — |   |
| Expected dividend yield (2)            |       | 0.00%                        |       | — |   |
| Grant date fair value of share options |       | $ 0.71 - 0.78           |       | — |   |

 

----

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

(2)                      Expected dividend yield is zero because adividend on the common stock is currently not probable over the expected lifeof the options granted during the six months ended June 30, 2008.

 

Therewere no stock options granted during the six months ended June 30, 2007.

 

Thefollowing table summarizes activity, pricing and other information for theCompany’s stock options for the six-month period ended June 30, 2008:

 
| ** **                                  | ** ** | ** **         | ** ** | **Weighted-**      | ** ** |
|---------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                  | ** ** | ** **         | ** ** | **Average**        | ** ** |
| ** **                                  | ** ** | **Number of** | ** ** | **Exercise**       | ** ** |
| ** **                                  | ** ** | **Shares**         | ** ** | **Price ($)** | ** ** |
| Options outstanding at January 1, 2008 |       | 5,939,914          |       | $                  | 9.75       |   |
| Options granted                             |       | 7,810,000          |       | 1.28               |       |
| Options exercised                           |       | —             |       | —             |       |
| Options forfeited / cancelled               |       | (1,131,164         | )          | 4.69               |       |
| Options outstanding at June 30, 2008   |       | 12,618,750         |       | $                  | 4.91       |   |
| Options exercisable at June 30, 2008   |       | 2,661,559          |       | $                  | 12.94      |   |

 

Asof June 30, 2008, there was approximately $5.6 million of totalunrecognized compensation cost related to nonvested share-based compensationarrangements granted under the plan. That cost is expected to be recognizedover a weighted average period of 1.2 years.

 

**NoteD—Reconciliation of Earnings Per Share**

 

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

 

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| ** **                                                                      | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                                      | ** ** | **2008**                                | ** ** | **2007**                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Numerator for basic earnings per share:**                                     |       |                                    |       |                                  |       |   |   |   |   |
| Net loss from continuing operations                                             |       | $                                       | (16,439    | )                                     | $          | (93,525 | ) | $ | (20,942 | ) | $ | (147,657 | ) |
| Net (loss) earnings from discontinued  operations                               |       | (11,048                                 | )          | (59,022                               | )          | (10,360 | ) | (126,558 | ) |
| Less: Cash dividends on cumulative  redeemable preferred stock                  |       | (3,722                                  | )          | (3,722                                | )          | (7,443 | ) | (7,443 | ) |
| Net loss available to common stockholders                                       |       | $                                       | (31,209    | )                                     | $          | (156,269 | ) | $ | (38,745 | ) | $ | (281,658 | ) |
| **Denominator for basic earnings per share:**                                   |       |                                    |       |                                  |       |   |   |   |   |
| Basic weighted average number of common  shares outstanding during the period   |       | 76,096                                  |       | 76,081                                |       | 76,096 |   | 76,081 |   |
| **Denominator for diluted earnings per share:**                                 |       |                                    |       |                                  |       |   |   |   |   |
| Diluted weighted average number of common  shares outstanding during the period |       | 76,096                                  |       | 76,081                                |       | 76,096 |   | 76,081 |   |
| Net effect of dilutive stock options                                            |       | —                                  |       | —                                |       | — |   | — |   |
| Diluted weighted average common shares                                          |       | 76,096                                  |       | 76,081                                |       | 76,096 |   | 76,081 |   |
|                                                                            |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per common share - Basic:                                              |       |                                    |       |                                  |       |   |   |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.26      | )                                     | $          | (1.28 | ) | $ | (0.37 | ) | $ | (2.04 | ) |
| Loss from discontinued operations                                               |       | (0.15                                   | )          | (0.78                                 | )          | (0.14 | ) | (1.66 | ) |
| Net loss per share                                                              |       | $                                       | (0.41      | )                                     | $          | (2.05 | ) | $ | (0.51 | ) | $ | (3.70 | ) |
|                                                                            |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per common share - Diluted:                                            |       |                                    |       |                                  |       |   |   |   |   |
| Loss from continuing operations                                                 |       | $                                       | (0.26      | )                                     | $          | (1.28 | ) | $ | (0.37 | ) | $ | (2.04 | ) |
| Loss from discontinued operations                                               |       | (0.15                                   | )          | (0.78                                 | )          | (0.14 | ) | (1.66 | ) |
| Net loss per share                                                              |       | $                                       | (0.41      | )                                     | $          | (2.05 | ) | $ | (0.51 | ) | $ | (3.70 | ) |

 

Forthe three and six month periods ended June 30, 2008, stock options to purchase 12.6million shares were outstanding but not included in the above weighted averagecalculations because they were anti-dilutive.

 

For the three and six month periods ended June 30, 2007, stockoptions to purchase 6.7 million shares were outstanding but not included in theabove weighted average calculations because they were anti-dilutive.

 

**NoteE—Segment Reporting**

 

TheCompany has two reporting segments, the continuing operations and discontinuedoperations.  The following tables presentthe selected financial data and operating results by reporting segments for theperiods indicated:

 
| ** **                                             | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
|--------------------------------------------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                             | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Balance Sheet Items as of June 30,  2008:**     | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Securitized mortgage collateral                        |       | $              | 11,055,382 |             | $          | —           |       | $ | 11,055,382 |   |
| Loans held-for-sale                                    |       | 1,785          |       | 165,635          |       | 167,420          |       |
| Total assets                                           |       | 11,760,223     |       | 203,320          |       | 11,963,543       |       |
| Total liabilities                                      |       | 11,685,701     |       | 253,334          |       | 11,939,035       |       |
| Total stockholders’ equity (deficit)              |       | $              | 74,522     |             | $          | (50,014          | )          | $ | 24,508 |   |
|                                                   |       |           |       |             |       |             |       |
| **Balance Sheet Items as of December 31,  2007:** |       |           |       |             |       |             |       |
| Securitized mortgage collateral                        |       | $              | 16,532,633 |             | $          | —           |       | $ | 16,532,633 |   |
| Loans held-for-sale                                    |       | 1,684          |       | 279,659          |       | 281,343          |       |
| Finance receivables                                    |       | 336            |       | 12,458           |       | 12,794           |       |
| Total assets                                           |       | 17,037,822     |       | 353,250          |       | 17,391,072       |       |
| Total liabilities                                      |       | 18,063,459     |       | 405,341          |       | 18,468,800       |       |
| Total stockholders’ deficit                       |       | $              | (1,025,637 | )                | $          | (52,091          | )          | $ | (1,077,728 | ) |

 

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| ** **                                                                      | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                      | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Statement of Operations Items for the three  months ended June 30, 2008:**    | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                             |       | $              | 4,256      |             | $          | 1,543            |       | $ | 5,799 |   |
| Change in fair value of derivatives, net                                        |       | —         |       | 258              |       | 258              |       |
| Change in fair value of net trust assets                                        |       | (11,161        | )          | —           |       | (11,161          | )          |
| Other non-interest income (expense)                                             |       | 413            |       | (8,612           | )          | (8,199           | )          |
| Non-interest expense and income taxes                                           |       | (9,947         | )          | (4,237           | )          | (14,184          | )          |
| Net loss                                                                        |       | $              | (16,439    | )                | $          | (11,048          | )          | $ | (27,487 | ) |
|                                                                            |       |           |       |             |       |             |       |
| **Statement of Operations Items for the six  months ended June 30, 2008:** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                             |       | $              | 11,605     |             | $          | 3,213            |       | $ | 14,818 |   |
| Change in fair value of derivatives, net                                        |       | —         |       | 112              |       | 112              |       |
| Change in fair value of net trust assets                                        |       | (7,633         | )          | —           |       | (7,633           | )          |
| Other non-interest income (expense)                                             |       | (2,124         | )          | 867              |       | (1,257           | )          |
| Non-interest expense and income taxes                                           |       | (22,790        | )          | (14,552          | )          | (37,342          | )          |
| Net loss                                                                        |       | $              | (20,942    | )                | $          | (10,360          | )          | $ | (31,302 | ) |

 
| ** **                                                                        | ** ** | **Continuing** | ** ** | **Discontinued** | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                                        | ** ** | **Operations** | ** ** | **Operations**   | ** ** | **Consolidated** | ** ** |
| **Statement of Operations Items for the three  months ended June 30, 2007:** |       |           |       |             |       |             |       |
| Net interest income                                                               |       | $              | 7,874      |             | $          | 5,109            |       | $ | 12,983 |   |
| Provision for loan losses                                                         |       | (161,163       | )          | (1,818           | )          | (162,981         | )          |
| Change in fair value of derivatives, net                                          |       | 91,670         |       | 3,870            |       | 95,540           |       |
| Other non-interest income (expense)                                               |       | (20,866        | )          | (38,159          | )          | (59,025          | )          |
| Non-interest expense and income taxes                                             |       | (11,040        | )          | (28,024          | )          | (39,064          | )          |
| Net loss                                                                          |       | $              | (93,525    | )                | $          | (59,022          | )          | $ | (152,547 | ) |
|                                                                              |       |           |       |             |       |             |       |
| **Statement of Operations Items for the six  months ended June 30, 2007:**   | ** ** | ** **     | ** ** | ** **       | ** ** | ** **       | ** ** |
| Net interest income                                                               |       | $              | 15,817     |             | $          | 10,622           |       | $ | 26,439 |   |
| Provision for loan losses                                                         |       | (190,295       | )          | (2,061           | )          | (192,356         | )          |
| Change in fair value of derivatives, net                                          |       | 73,672         |       | 567              |       | 74,239           |       |
| Other non-interest income (expense)                                               |       | (25,471        | )          | (82,814          | )          | (108,285         | )          |
| Non-interest expense and income taxes                                             |       | (21,380        | )          | (52,872          | )          | (74,252          | )          |
| Net loss                                                                          |       | $              | (147,657   | )                | $          | (126,558         | )          | $ | (274,215 | ) |

 

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**Note G—Other Assets**

 

Otherassets for the periods indicated consisted of the following:

 
| ** **                      | ** ** | **At June 30,** | ** ** | **At December 31,** | ** ** |
|---------------------------------|------------|---------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **2008**                  | ** ** | **2007**                      | ** ** |
| Deferred charge                 |       | $                         | 28,684     |                          | $          | 37,412 |   |
| Other receivables               |       | 4,618                     |       | —                        |       |
| Premises and equipment          |       | 2,947                     |       | 3,904                         |       |
| Real estate owned outside trust |       | 2,269                     |       | 4,571                         |       |
| Prepaid expenses                |       | 2,423                     |       | 3,505                         |       |
| Investment in capital trusts    |       | 2,271                     |       | 2,394                         |       |
| Mortgage sevicing rights        |       | 1,677                     |       | 2,083                         |       |
| Other assets                    |       | 3,795                     |       | 3,325                         |       |
|                            |       | $                         | 48,684     |                          | $          | 57,194 |   |
|                                 |            |                           |            |                               |            |  |  |  |  |

 

**Note H—Real Estate Owned (REO)**

 

Real estate owned, which consists of residential real estate acquiredin satisfaction of loans, is carried at the net realizeable value lessestimated selling and holding costs, offset by expected mortgage insuranceproceeds to be received. Historically, adjustments to the loan carrying valuerequired at the time of foreclosure are charged off against the allowance forloan losses. Historically, the Company would writedown REO for changes in thevalue of the real estate due to declining home prices during the holding periodand recognize that amount as a provision for REO losses.  The gains and losses related to REO areincluded in the cash flows of the securitized mortgage collateral.  Losses or gains from the ultimate dispositionof real estate owned are recorded as gain (loss) on sale of other real estateowned in the consolidated statements of operations. REO is recorded at itsestimated net realizable value at June 30, 2008 and December 31,2007.

 

Activity for the Company’s REO consisted of the following:

 
| ** **            | ** ** | **Six Months Ended** | ** ** | **Year Ended**             | ** ** |
|-----------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **June 30, 2008**    | ** ** | **December 31, 2007** | ** ** |
| Beginning balance     |       | $                              | 405,434    |                            | $          | 137,331 |   |
| Foreclosures          |       | 388,907                        |       | 487,314                         |       |
| Liquidations          |       | (170,639                       | )          | (219,211                        | )          |
| REO                   |       | $                              | 623,702    |                            | $          | 405,434 |   |
|                  |       |                           |       |                            |       |
| REO inside trusts     |       | $                              | 621,433    |                            | $          | 400,863 |   |
| REO outside trust (1) |       | 2,269                          |       | 4,571                           |       |
| REO                   |       | $                              | 623,702    |                            | $          | 405,434 |   |

 

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

 

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** **

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

 

Thefollowing is selected information on securitized mortgage borrowings for theperiods indicated (dollars in millions):

 
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | **Range of Percentages:** | ** ** |
|-------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | ** **                          | ** ** | **Interest Rate** | ** ** | **Interest Rate** | ** ** |
| ** **                                | ** ** | **Original** | ** ** | **Securitized mortgage borrowings** | ** ** | ** **                      | ** ** | **Margins over**               | ** ** | **Margins after** | ** ** |
| ** **                                | ** ** | **Issuance** | ** ** | **outstanding as of**               | ** ** | **Fixed Interest**         | ** ** | **One-Month**                       | ** ** | **Adjustment** | ** ** |
| **Year of Issuance**            | ** ** | **Amount**   | ** ** | **June 30, 2008**                   | ** ** | **December 31, 2007** | ** ** | **Rates**                           | ** ** | **LIBOR (1)** | ** ** | **Date (2)** | ** ** |
| 2002                                      |       | $            | 3,876.1    |                                          | $          | 38.9                            |       | $                                   | 42.1       |   | 5.25 - 12.00 |   | 0.27 - 2.75 |   | 0.54 - 3.68 |   |
| 2003                                      |       | 5,966.1      |       | 363.5                                         |       | 409.4                           |       | 4.34 - 12.75                        |       | 0.27 - 3.00 |   | 0.54 - 4.50 |   |
| 2004                                      |       | 17,710.7     |       | 2,430.8                                       |       | 2,751.8                         |       | 3.58 - 5.56                         |       | 0.25 - 2.50 |   | 0.50 - 3.75 |   |
| 2005                                      |       | 13,387.7     |       | 5,380.6                                       |       | 5,961.6                         |       | —                              |       | 0.24 - 2.90 |   | 0.48 - 4.35 |   |
| 2006                                      |       | 5,971.4      |       | 4,761.7                                       |       | 5,015.7                         |       | 6.25                                |       | 0.10 - 2.75 |   | 0.20 - 4.125 |   |
| 2007                                      |       | 3,860.5      |       | 3,480.2                                       |       | 3,619.9                         |       | —                              |       | 0.06 - 2.00 |   | 0.12 - 3.00 |   |
| Subtotal  securitized mortgage borrowings |       |         | 16,455.7   |                                          | 17,800.5   |                            |       |                                |       |   |   |   |
| Accrued interest expense                  |       |         |       | —                                        |       | 17.1                            |       |                                |       |   |   |   |   |
| Unamortized securitization costs          |       |         |       | —                                        |       | (37.5                           | )          |                                |       |   |   |   |   |
| Fair value adjustment                     |       |         |       | (4,958.6                                      | )          | —                          |       |                                |       |   |   |   |   |
| Total securitized mortgage borrowings     |       |         | $          | 11,497.1                                      |       | $                               | 17,780.1   |                                |       |   |   |   |   |   |
|                                           |            |              |            |                                               |            |                                 |            |                                     |            |  |  |  |  |  |  |  |

 

----

(1)          One-month London Interbank Offered Rate(LIBOR) was 2.46 percent as of June 30, 2008.

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

 

**Note J— Repurchase Liabilities (DiscontinuedOperations)**

 

*Reverse Repurchase Facilities*

 

The Company’s reverse repurchase agreements, included in discontinuedoperations, are secured by the Company’s loans held-for-sale, restricted cashand certain REOs.  The following tablepresents the outstanding balance of the Company’s reverse repurchase facilitiesas of the dates indicated:

 
| ** **                  | ** ** | **Discontinued Operations**  | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **as of June 30,** | ** ** | **as of December 31,** | ** ** |
| ** **                  | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| Reverse repurchase line (1) |       | $                                 | 220,225    |   | $ | 318,669 |   |
| Warehouse line (2)          |       | —                            |       | 18,021 |   |
| Total                       |       | $                                 | 220,225    |   | $ | 336,690 |   |

 

----

| (1) | This  line, which is guaranteed by IMH, is no longer funding loans and was in  technical default of several covenants, including warehouse borrowing  reduction, delivery of financial statements and financial covenants. As  described in Note L, the Company has entered into an agreement to restructure  this line. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | This  line was paid off in full in May 2008.                                                                                                                                                                                                                                                                        |

 

*Repurchase Reserve*

 

When the Company sells loans through loan sales it is required to makenormal and customary representations and warranties about the loans to thepurchaser. The Company’s whole loan sale agreements generally require it torepurchase loans if the Company breaches a representation or warranty given tothe loan purchaser. In addition, the Company may be required to repurchaseloans as a result of borrower fraud or if a payment default occurs on amortgage loan shortly after its sale. During the second quarter of 2008, the Company sold $7.9 million ofloans as compared to $68.1 million in the first quarter of 2008.  During the second quarter of 2008, wenegotiated the settlement of $4 million in repurchase claims.  As of June 30, 2008 and December 31,2007, the Company had a liability for losses on loans sold with representationsand warranties totaling $12.9 million and $25.7 million,respectively, included in liabilities from discontinued operations.

 

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**Note K—Discontinued Operations**

 

During 2007, the Company announced plans to exit substantially all ofits mortgage, commercial, retail, and warehouse lending operations.Consequently, the amounts related to these operations are presented asdiscontinued operations in the Company’s consolidated statements of operationsand its consolidated statements of cash flows, and the asset groups to beexited are reported as assets and liabilities of discontinued operations in itsconsolidated balance sheets for the periods presented.

 

The following table presents the discontinued operations’ condensedbalance sheets at June 30, 2008 and December 31, 2007:

 
| ** **                         | ** ** | **Discontinued Operations**  | ** ** |
|------------------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **as of June 30,** | ** ** | **as of December 31,** | ** ** |
| ** **                         | ** ** | **2008**                          | ** ** | **2007** | ** ** |
| **Balance Sheet Items:** |       |                              |       |   |   |
| Loans held-for-sale                |       | $                                 | 165,635    |   | $ | 279,659 |   |
| Finance receivables                |       | —                            |       | 12,458 |   |
| Total assets                       |       | 203,320                           |       | 353,250 |   |
| Total liabilities                  |       | 253,334                           |       | 405,341 |   |
| Total stockholders’ deficit   |       | $                                 | (50,014    | ) | $ | (52,091 | ) |

 

Included in total liabilities at June 30, 2008 and December 31,2007 is a lease liability of $9.6 million and $10.9 million, respectively,which is guaranteed by IMH, related to office space that was previouslyoccupied by the discontinued operations and is no longer being used by theCompany. Loans held-for-sale includes a $107.8 million and $118.4 million fairvalue adjustment at June 30, 2008 and December 31, 2008, respectively. 

 

The following tables present discontinued operations condensedstatement of operations for the three and six month periods ended June 30,2008 and 2007;

 
| ** **                                      | ** ** | **Discontinued Operations**                                      | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **For the Three Months Ended June 30,** | ** ** |
| ** **                                      | ** ** | **2008**                                                              | ** ** | **2007** | ** ** |
| **Income Statement Items:**                     |       |                                                                  |       |   |   |
| Net interest income                             |       | $                                                                     | 1,543      |   | $ | 5,109 |   |
| Provision for loan losses                       |       | —                                                                |       | (1,818 | ) |
| Change in fair value of derivative  instruments |       | 258                                                                   |       | 3,870 |   |
| Other non-interest (expense) income             |       | (8,612                                                                | )          | (38,159 | ) |
| Non-interest expense and income taxes           |       | (4,237                                                                | )          | (28,024 | ) |
| Net loss                                        |       | $                                                                     | (11,048    | ) | $ | (59,022 | ) |

 
| ** **                                      | ** ** | **Discontinued Operations**                                    | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **For the Six Months Ended June 30,** | ** ** |
| ** **                                      | ** ** | **2008**                                                            | ** ** | **2007** | ** ** |
| **Income Statement Items:**                     |       |                                                                |       |   |   |
| Net interest income                             |       | $                                                                   | 3,213      |   | $ | 10,622 |   |
| Provision for loan losses                       |       | —                                                              |       | (2,061 | ) |
| Change in fair value of derivative  instruments |       | 112                                                                 |       | 567 |   |
| Other non-interest income (expense)             |       | 867                                                                 |       | (82,814 | ) |
| Non-interest expense and income taxes           |       | (14,552                                                             | )          | (52,872 | ) |
| Net loss                                        |       | $                                                                   | (10,360    | ) | $ | (126,558 | ) |

 

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**Note L—Subsequent Events**

 

InSeptember 2008, the Company entered into an agreement to restructure itsreverse repurchase line with its remaining lender. The balance of this line was$220.2 million at June 30, 2008. The agreement removes all technical defaultsfrom financial covenant noncompliance and any associated margin calls for theterm of the agreement.  The agreementcalls for certain targets including a reduction of the borrowings balance to$100 million in 18 months with an advance rate of no more than 65 percent ofthe unpaid principal balance and $50 million in 24 months with an advance rateof no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the Company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will berequired to be paid as an additional principal paydown and the monthlyprincipal paydown is reduced to $750,000. The interest rate is LIBOR plus 325 basis points, and all cash collectedfrom the securing mortgage loans is required to be paid to the lender.  Accomplishing the restructuring of this reverserepurchase line allows the Company to manage the remaining loans on the linefor the eventual collection, refinance, sale or securitization without the riskof receiving margin calls.

 

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

 

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

** **

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

** **

Unlessthe context otherwise requires, the terms “Company,” “we,” “us,” and “our”refer to Impac Mortgage Holdings, Inc. (the Company or IMH), a Marylandcorporation incorporated in August 1995, and its subsidiaries, IMH AssetsCorp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG), and ImpacFunding Corporation (IFC), together with its wholly-owned subsidiaries ImpacSecured Assets Corp. (ISAC), and Impac Commercial Capital Corporation (ICCC).

 

**Forward-Looking Statements**

 

Thisreport on Form 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, some ofwhich are based on various assumptions and events that are beyond our control,may be identified by reference to a future period or periods or by the use offorward-looking terminology, such as “may,” “will,” “believe,” “expect,” “likely,”“should,” “could,” “anticipate,” or similar terms or variations on those termsor the negative of those terms. The forward-looking statements are based oncurrent management expectations. Actual results may differ materially as aresult of several factors, including, but not limited to the following: theongoing volatility in the mortgage and mortgage-backed securities industry andour ability to successfully manage through the current market environment;management’s ability to successfully implement future strategies andinitiatives; ability to meet liquidity needs from cash flows generated from thelong-term mortgage portfolio and master servicing fees; our ability to reduceoperating expenses and other outstanding liabilities, such as the trust preferredobligations; our ability to reduce dividend payments on preferred stock;ability to continue to pay dividends on outstanding preferred stock; failure tosell, or achieve expected returns upon sale of, mortgage loans, includingnon-performing loans, in the secondary market due to market conditions, lack ofinterest or ineffectual pricing; risks related to the restructuring of theexisting reverse repurchase facility, such as completion of definitiveagreements, which may be hindered by worsening economic conditions in themortgage market, and potential difficulties in meeting conditions set forth inthe definitive agreement; our ability to meet margin calls to the extent thereverse repurchase line is not restructured; our ability to obtain additionalfinancing and the terms of any financing that we do obtain; our ability toraise additional capital; inability to effectively liquidate properties throughauction process or otherwise thereby decreasing advisory fees; increase in loanrepurchase requests and ability to adequately settle repurchase obligations;risks related to the acquisition of a special servicing platform, which willinvolve or require, among other things, continuing due diligence, which couldreveal matters not now known that affect our decision to seek to complete theacquisition on different terms than those announced or at all, obtainingnecessary approvals and consents, including regulatory approvals related toservicing, which consents and approvals may be delayed or unobtainable,difficulties and delays in obtaining regulatory approvals for the proposedtransaction, potential difficulties in meeting conditions set forth in thedefinitive purchase agreement, and the parties’ timely performance of theirrespective pre-closing covenants and the satisfaction of other conditions, someof which may be beyond the control of the parties or render the acquisitionuneconomical; the Company’s ability to successfully integrate the new servicingplatform with its existing services;  ourability to identify and establish or invest in, and successfully manage andgrow, businesses that may be outside of the businesses in which we historicallyhave operated; impairments on our mortgage assets; increases in default ratesor losses on mortgage loans underlying our mortgage assets; inability toimplement strategies effectively to increase cure rates, reduce delinquenciesor mitigate losses on mortgage loans; changes in assumptions regardingestimated loan losses or fair value amounts; increase in default rates on ourmortgages; changes in yield curve; the ability of our common stock and Series Band C preferred stock to continue trading in an active market; the loss ofexecutive officers and other key management employees; our ability to maintaineffective internal control over financial reporting and disclosure controls andprocedures; the adoption of changes of new laws that affect our business or thebusiness of people with whom we do business; interest rate fluctuations on ourassets that differ from our liabilities; the outcome of litigation orregulatory actions pending against us or other legal contingencies; and ourcompliance with applicable local, state and federal laws and regulations andother general market and economic conditions.

 

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, 2007, 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 or circumstancesafter the date of such statements.

 

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** **

**The Mortgage Banking Industry and Discussion ofRelevant Fiscal Periods**

 

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

 

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

 

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

 

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

 

One of our goals has been to align the costs of our operations to thecash flows from our long-term mortgage portfolio (residual interests insecuritizations), master servicing portfolio and real estate advisoryfees.  However, we have intentionallymaintained certain personnel to allow us to explore future businessopportunities should we be able to raise capital.  As part of our other goals, we intend to 1)reduce or eliminate dividend payments on the Company’s preferred stock, and 2)modify the Company’s trust preferred securities, which may include reducing theinterest rate.

 

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

 

In order to reduce dividend payments on its preferred stock, theCompany is considering exchanging the preferred stock for common stock.  In July 2008, our stockholders approvedthe potential issuance of common shares in excess of 20 percent of our existingcommon shares.  This exchange could offerthe current preferred stockholders greater liquidity as common stockholders.

 

We are currently exploring opportunities to raise capital so that wemay accomplish several strategic initiatives, which may include strategicacquisitions, acquiring a special servicing platform and investing in distressedmortgage assets and related securities. Raising additional capital through the sale of securities couldsignificantly dilute the current common stockholders.  There can be no assurance that we will besuccessful in accomplishing our goal to raise the capital needed to implementour strategic initiatives.

 

We earn advisory fees from a real estate marketing company specializingin the marketing and disposition of foreclosed properties.  During the three and six months ended June 30,2008, we earned $4.7 million and $8.5 million, respectively, from thisrelationship.  The amount of real estateadvisory fees we receive from this relationship are based on numerous factors,including real estate market conditions, the level of foreclosure activity, theability of the marketing company to attract new business, and the Companyretaining our CEO and avoiding liquidation. The agreement terminates in 2010 with the Company having an option toextend the agreement for an additional three years.

 

In July 2008, the Company executed a letter of intent, subject toexecution of definitive agreements, to acquire a special servicing platform,whereby the seller will contribute specified balances of loans (mostlydistressed) to the platform in order to provide sufficient cash flows tomaintain the business during its initial operations.  We believe this special servicing platform, combinedwith our current and anticipated businesses, will create a fully integratedplatform that would be utilized to take advantage of opportunities within thedistressed mortgage investment market.

 

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There can be no assurance that we will be successful in accomplishingour objectives outlined above.  In theevent that we do not raise capital, we may not be able to make any of theacquisitions or implement the initiatives described above.  Also, there can be no assurance that therestructuring of the trust preferred securities or the preferred stock willoccur.  In this event, we intend toreduce operating expenses to a level that is supportable by the revenues fromthe existing long-term mortgage portfolio (residual interests insecuritizations), master servicing portfolio and real estate advisory fees.Nevertheless, if we are not successful in completing the objectives outlinedabove, we may not be able to meet our contractual obligations for the nextyear, including repayment of the reverse repurchase line, interest payments ontrust preferred securities and preferred stock dividends.

 

At June 30, 2008, the Company had $24.5 million in stockholders’equity.  After reducing totalstockholders’ equity by the $161.8 million in preferred stock liquidation value,our common equity deficit was $(137.3) million or $(1.80) per share.

 

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

 
| ** **                                | ** ** | **Condensed Components of Stockholders’ Equity (Deficit) by Segment** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **As of June 30, 2008**                                                                   | ** ** |
| ** **                                | ** ** | **Continuing**                                                                                                | ** ** | **Discontinued** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Operations**                                                                                                | ** ** | **Operations** | ** ** | **Total** | ** ** |
| Cash                                      |       | $                                                                                                             | 25,971     |   | $ | 159 |   | $ | 26,130 |   |
| Residual interests in securitizations (1) |       | 41,796                                                                                                        |       | — |   | 41,796 |   |
| Mortgage servicing rights (1)             |       | 11,737                                                                                                        |       | — |   | 11,737 |   |
| Advisory fees receivable                  |       | 4,618                                                                                                         |       | — |   | 4,618 |   |
| Trust preferred securities ($99,244 par)  |       | (46,266                                                                                                       | )          | — |   | (46,266 | ) |
| Repurchase liabilities (2)                |       | —                                                                                                        |       | (55,245 | ) | (55,245 | ) |
| Lease liability (3)                       |       | —                                                                                                        |       | (9,559 | ) | (9,559 | ) |
| Deferred charge                           |       | 28,684                                                                                                        |       | — |   | 28,684 |   |
| Net other assets                          |       | 7,982                                                                                                         |       | 14,631 |   | 22,613 |   |
| **Stockholders’ equity (deficit)**   |       | $                                                                                                             | 74,522     |   | $ | (50,014 | ) | $ | 24,508 |   |

 

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(1)          Included in mortgage servicing rights is $10.1 million in masterservicing rights, included in securitized mortgage collateral, associated withour consolidated securitizations.

(2)          Balance includes the net amount owed to our lender, which is guaranteedby IMH, and the repurchase reserve.

(3)          Guaranteed by IMH.

 

*Continuingoperations*

 

Wecurrently have three primary sources of cash earnings:

 

·                  cash flows from the long-term mortgageportfolio;

 

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

 

·                  real estate advisory fees

 

Sinceour consolidated and unconsolidated securitization trusts are non-recourse, wehave netted trust assets and liabilities to more simply present the Company’sinterest in these trusts, which are considered our residual interests insecuritizations.  We receive cash flowsfrom our residual interests in securitizations to the extent they are availableafter required distributions to bondholders and maintainingovercollateralization levels within the trusts. The estimated fair value of the residual interests, represented by thedifference in the fair value of trust assets (excluding the $10.1 in masterservicing rights included in the basis of securitized mortgage collateral) andtrust liabilities, was $41.8 million at June 30, 2008.

 

TheCompany acts as the master servicer for mortgages included in our CMO and REMICsecuritizations.  The master servicingfees we earn are generally 0.03 percent per annum on the declining principalbalances of these mortgages plus 

 

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interestincome on cash held until remitted to investors.  Master servicing rights retained inconnection with consolidated securitizations are included in securitizedmortgage collateral in the Company’s consolidated balance sheet.  Master servicing rights retained inconnection with unconsolidated securitizations are included in otherassets.  The carrying amount of masterservicing rights was $11.7 million at June 30, 2008, including $10.1million included in securitized mortgage collateral.

 

Weearn advisory fees and expect to receive significant cash flows from a realestate marketing company specializing in the marketing and disposition offoreclosed properties.  During the threeand six months ended June 30, 2008, we earned $4.7 million and $8.5million, respectively, from this relationship. Real estate advisory fees from this relationship are based on numerousfactors, including real estate market conditions, the level of foreclosureactivity, the ability of this company to attract new business, retention of ourCEO and avoiding liquidation.  Theagreement terminates in 2010 with the Company having an option to extend theagreement for an additional three years.

 

Forthe three months ended June 30, 2008 and 2007, we paid $2.0 million and$3.7 million in interest on trust preferred securities and preferred stockdividends, respectively.  For the sixmonths ended June 30, 2008 and 2007, we paid $4.0 million and $7.4 millionin interest on trust preferred securities and preferred stock dividends,respectively.  As of the filing date ofthis report, the Company is current on all dividend payments.

 

AtJune 30, 2008, we had deferred charges of $28.7 million representing thedeferral of income tax expense on inter-company profits that resulted from thesale of mortgages from taxable subsidiaries to IMH in prior years.  Net other assets include $2.9 million inpremises and equipment, $2.3 million in investment in capital trusts and $2.4million in prepaid expenses.

 

AtJune 30, 2008, cash within our continuing operations decreased to $26.0million from $32.9 million at March 31, 2008.  The decrease during the quarter is primarilyrelated to cash flows from our residual interests in securitizations havestarted to decline as a result of increased credit losses and increases ininterest rates.

 

*Discontinuedoperations*

 

TheCompany’s most significant liabilities at June 30, 2008 relate to itsrepurchase liabilities and a lease liability within discontinued operations.

 

Therepurchase liabilities consist of a repurchase reserve and the net amount owedto our lenders which is collateralized by loans held-for-sale, restricted cashbalances and certain real estate owned and other assets.  During the quarter ended June 30, 2008,our $7.5 million warehouse line was fully paid off.  The balance of our reverse repurchase linewas approximately $220.2 million at June 30, 2008.  We are currently distributing all principaland interest received from the collateral securing the reverse repurchase lineto the lender.  As described above, in September 2008,the Company entered into an agreement to restructure this line.

 

Wewere required to make normal and customary representations and warranties aboutthe loans we had previously sold to investors. Our whole loan sale agreementsgenerally required us to repurchase loans if we breached a representation orwarranty given to the loan purchaser. In addition, we also could be required torepurchase loans as a result of borrower fraud or if a payment default occurson a mortgage loan shortly after its sale. During the quarter, the repurchase liability increased $0.5 million to$12.9 million.  Determination of therepurchase liability is an estimate of losses from expected repurchases, and isbased, in part, on the recent settlement of claims.

 

Inconnection with the discontinuation of our non-conforming mortgage, retailmortgage, warehouse lending and commercial operations, a significant amount ofoffice space that was previously occupied is no longer being used by theCompany.  At June 30, 2008, theCompany had a liability of $9.6 million, representing the present value of theminimum lease payments over the remaining life of the lease, offset by theexpected proceeds from sublet revenue related to this office space.

 

**Market Conditions**

 

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

 

Conditionsin the secondary markets (the markets in which we historically sold orsecuritized mortgage loans), which dramatically worsened during the thirdquarter of 2007, continue to be depressed as investor concerns over creditquality and 

 

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aweakening of the United States housing market have remained high. As a result,the capital markets remain very volatile and illiquid and have effectively beenunavailable to the Company. The Company believes the existing conditions in thesecondary markets are unprecedented and, as such, inherently involvesignificant risks and uncertainty. These conditions could continue to adverselyimpact the performance of our long-term investment portfolio. Until bondspreads and credit performance return to more historical levels, it will beimpossible for the Company to execute securitizations and loan sales. As aresult, in 2007, the Company was forced to discontinue its correspondent,retail, wholesale and commercial mortgage operations as well as the warehouselending operations, in response to the market conditions.

 

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

 

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

 

 Normal market trading activity through thesecond quarter of 2008 was unusually light as uncertainty related to futureloss estimates and the lack of liquidity made it difficult for willing buyersand sellers to agree on prices. This condition was particularly acute withrespect to securities backed by Alt-A loans where market participants weresetting price levels based on widely varied opinions about future loan performanceand loan loss severity. While the early credit performance for these securitieshas been clearly far worse than initial expectations, the ultimate level ofrealized losses will largely be influenced by events that will likely unfoldover the next several years, including the severity of housing price declinesand the overall strength of the economy.

 

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

 

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*Impact of Recent Market Activity*

 

As a result of theCompany’s inability to sell or securitize non-conforming loans, the Companydiscontinued funding loans. Because the Company stopped funding loans, theCompany discontinued substantially all of its mortgage (including commercial)and warehouse lending operations during the second half of 2007.

 

In addition to theinability of the Company to sell loans, the Company’s investment in securitizednon-conforming loans has deteriorated in value primarily from estimated losses.As a result of continued deterioration in the real estate market through June 30,2008, the Company increased its loan loss estimates primarily due to increaseddelinquencies in its long-term investment portfolio and increased lossseverities related to the sale and liquidation of real estate ownedproperties.  The decline in single-familyhome prices can be seen in the chart below.

 

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As depicted in the chartabove, average home prices peaked in 2006 at 226.29 and continued theirdramatic decline through June 2008. The Standard & Poor’s/Case-Shiller 10-City Composite Home PriceIndex (the Index) for June 2008 was 180.38 (with the base of 100.00 for January 2000)and hasn’t been this low since June 2004 when the Index was 179.45.  Beginning in the third quarter of 2007, theCompany believes there is a correlation between the borrowers’ perceived equityin their homes and defaults.  Theoriginal loan-to-value (defined as loan amount as a percentage of collateralvalue, “LTV”) and original combined loan-to-value (defined as first lien plustotal subordinate liens to collateral value, “CLTV”) ratios of single-familymortgage remaining in the Company’s securitized mortgage collateral as of June 30,2008 was 73 percent and 84 percent, respectively.  The LTV and CLTV ratios may have increasedfrom origination date as a result of the deterioration of the real estatemarket.  We believe that home prices thathave declined below the borrower’s original purchase price have a higher riskof default within our portfolio. Based on the Index, home prices have declined20 percent through June 2008. Further, we believe the home prices inCalifornia and Florida, the states with the highest concentration of ourmortgages, have declined even further than the Index.  As a result, we have dramatically increasedour loan loss estimates, which are a primary assumption used in the valuationof securitized mortgage collateral and borrowings.

 

**CriticalAccounting Policies**

 

Severalof the critical accounting policies important to the portrayal of our financialcondition and results of operations require management to make difficult andcomplex judgments that rely on estimates about the effect of matters that areinherently uncertain due to the impact of changing market conditions and/orconsumer behavior. We believe our most critical accounting policies relate tothe valuation of: (1) assets and liabilities that are highly dependent oninternal valuation models and assumptions rather than market quotations (seeFair Value of Financial Instruments discussion below); (2) derivatives andother hedging instruments; (3) loans held-for-sale, including estimates offair value, and related lower of cost or market (LOCOM) valuation reserve; and (4) repurchasereserve (included in liabilities of discontinued operations). Refer to our 2007Form 10-K for further discussion of our critical accounting policies andjudgments.

 

Managementdiscusses its critical accounting policies and related estimates with theCompany’s Audit Committee on a regular basis. We believe the judgments,estimates and assumptions used in the preparation of our consolidated financialstatements are appropriate given the factual circumstances at the time.However, given the sensitivity of our consolidated financial statements tothese critical accounting policies, the use of other judgments, estimates andassumptions could result in material differences in our results of operationsor financial condition.

 

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**Fair Value of Financial Instruments**

 

        TheCompany adopted SFAS 157 on January 1, 2008.  SFAS 157 defines fair value, establishesa framework for measuring fair value and outlines a fair value hierarchy basedon the inputs to valuation techniques used to measure fair value. SFAS 157defines fair value as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date (also referred to as an exit price). SFAS 157categorizes fair value measurements into a three-level hierarchy based on theextent to which the measurement relies on observable market inputs in measuringfair value. Level 1, which is the highest priority in the fair valuehierarchy, is based on unadjusted quoted prices in active markets for identicalassets or liabilities. Level 2 is based on observable market-based inputs,other than quoted prices, in active markets for identical assets orliabilities. Level 3, which is the lowest priority in the fair valuehierarchy, is based on unobservable inputs. Assets and liabilities areclassified within this hierarchy in their entirety based on the lowest level ofany input that is significant to the fair value measurement.

 

        Theuse of fair value to measure our financial instruments is fundamental to ourfinancial statements and is a critical accounting estimate because asubstantial portion of our assets and liabilities are recorded at estimatedfair value. Financial instruments classified as Level 2 in ourconsolidated financial statements are valued primarily utilizing inputs andassumptions that are observable in the marketplace, and which can be derivedfrom observable market data or corroborated by observable levels at whichtransactions are executed in the marketplace. Because financial instrumentsclassified as Level 3 are generally based on unobservable inputs, theprocess to determine fair value is generally more subjective and involves ahigh degree of management judgment and assumptions. These assumptions may havea significant effect on our estimates of fair value, and the use of differentassumptions, as well as changes in market conditions, could have a material effecton our results of operations or financial condition.

 

Inconjunction with the adoption of SFAS 157, the Company prospectivelyadopted SFAS 159 as of January 1, 2008. SFAS 159 provides anoption on an instrument-by-instrument basis for most financial assets andliabilities to be reported at fair value with changes in fair value reported inearnings. After the initial adoption, the election is made at the acquisitionof a financial asset, financial liability, or a firm commitment and it may notbe revoked.  Management believes that theadoption of SFAS 159 provides an opportunity to mitigate volatility inreported earnings and provides a better representation of the economics of thetrust assets and liabilities.

 

Underthe SFAS 159 transition provisions, the Company elected to apply fairvalue accounting to certain financial instruments (certain trust assets, trustliabilities and trust preferred securities) held at January 1, 2008.  Differences between the December 31,2007 carrying values and the January 1, 2008 fair values were recognizedas an adjustment to retained deficit. The adoption of SFAS 159 resulted ina $1.1 billion decrease to retained deficit on January 1, 2008 from $(1.4)billion at December 31, 2007 to $(308.8) million at January 1, 2008.

 

***Recurringbasis***

 

*InvestmentSecurities Available-for-Sale.* Pursuant to the Company’s adoption of SFAS 159,the Company elected to carry all of its investment securitiesavailable-for-sale at fair value.  Theseinvestment securities are recorded at fair value and consist primarily ofnon-investment grade mortgage-backed securities.  The fair value of the investment securitiesare measured based upon our expectation of inputs that other marketparticipants would use.  Such assumptionsinclude our judgments about the underlying collateral, prepayment speeds,credit losses, and certain other factors. Given the market disruption and lack of observable market data as of June 30,2008, the fair value of the investment securities available-for-sale weremeasured using significant internal expectations of market participants’assumptions. At June 30, 2008, investment securities available-for-salewere classified as Level 3 fair value measurements.

 

*SecuritizedMortgage Collateral*– Pursuant to the Company’s adoption of SFAS 159, the Company elected tocarry all of its securitized mortgage collateral at fair value.  These assets consist primarily of Alt-Amortgage loans securitized between 2002 and 2007.  Fair value measurements are based on theCompany’s estimated cash flow models, which incorporate assumptions, inputs ofother market participants and quoted prices for the underlying bonds.  The Company’s assumptions include ourexpectations of inputs that other market participants would use. Theseassumptions include our judgments about the underlying collateral, prepaymentspeeds, credit losses, and certain other factors.  At June 30, 2008, securitized mortgagecollateral was classified as Level 2 or Level 3 measurementsdepending on the observability of significant inputs to the model.

 

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*SecuritizedMortgage Borrowings*- Pursuant to the Company’s adoption of SFAS 159, the Company elected tocarry all of its securitized mortgage borrowings at fair value.  These borrowings consist of individualtranches of bonds issued by securitization trusts and are primarily backed byAlt-A mortgage loans.  Fair valuemeasurements include our judgments about the underlying collateral assumptionssuch as prepayment speeds, credit losses, and certain other factors and arebased upon quoted prices for the individual tranches of bonds, ifavailable.  At June 30, 2008,securitized mortgage borrowings were classified as Level 2 or Level 3measurements depending on the observability of significant inputs to the model.

 

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

 

·      Stated interest rate adjustments toaccount for the stated yield difference between the trust preferred securitiesand the preferred stock issued by the Company,

 

·      Liquidity adjustments to reflect thepresence of a lack of an actively traded market for these securities.

 

·      Preference adjustments to reflect therights of the trust preferred securities as compared to the preferredsecurities.

 

At June 30,2008 trust preferred securities were classified as Level 3 measurements.

 

*Derivative Assets and Liabilities.*****For non-exchange traded contracts, fairvalue is based on the amounts that would be required to settle the positionswith the related counterparties as of the valuation date.   Valuations of derivative assets and liabilitiesreflect the value of the instruments including the values associated withcounterparty risk. With the issuance of SFAS 157, these values must also takeinto account the Company’s own credit standing, to the extent applicable, thusincluded in the valuation of the derivative instrument is the value of the netcredit differential between the counterparties to the derivative contract.  At June 30, 2008, derivative assets andliabilities were classified as Level 2 measurements.

 

***Non-recurringbasis***

 

The Company is requiredto measure certain assets at fair value from time-to-time.  These fair value measurements typicallyresult from the application of specific accounting pronouncements underGAAP.  The fair value measurements areconsidered non-recurring fair value measurements under SFAS 157.

 

*LoansHeld-for-Sale -*Loansheld-for-sale for which the fair value option was not elected are carried atlower of cost or market (LOCOM).  Whenavailable, such measurements are based upon what secondary markets offer forportfolios with similar characteristics, and are considered Level 2measurements. If market pricing is not available, such measurements aresignificantly impacted by our expectations of other market participants’assumptions, and are considered Level 3 measurements.  Loans held-for-sale, which are primarilyincluded in assets of discontinued operations, are considered Level 3measurements at June 30, 2008.

 

*Mortgage ServicingRights -*Mortgageservicing rights (MSR), for which the fair value option was not elected arecarried at LOCOM.  MSRs are not traded inan active market with observable prices. The Company utilizes internal pricing processes to estimate the fairvalue of MSRs, which are based on assumptions the Company believes would beused by market participants.  MSRs, whichare included in other assets, are considered Level 3 measurements at June 30,2008.

 

*       * We continue to refine our valuationmethodologies as markets and products develop and the pricing for certainproducts becomes more or less transparent. While we believe our valuationmethods are appropriate and consistent with those of other market participants,the use of different methodologies or assumptions to determine the fair valueof certain financial instruments could result in a materially different estimateof fair value as of the reporting date.

 

**Interest Income and Expense**

 

Pursuantto the adoption of SFAS 159 on January 1, 2008, interest income andexpense on the collateral and borrowings in our securitized trusts isbased on effective yields.  The effective yield is the rateused to derive the fair value of the securitizedtrusts.  Interest income and expense is calculated based on theestimated effective yields in the trusts multiplied by the fair value ofthe mortgage collateral and borrowings.

 

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**Selected Financial Results****for the Three Months Ended June 30,2008**

 

***Continuing Operations***

 

·      Net loss of $16.4 millioncompared to a net loss of $93.5 million for the second quarter of 2007.

 

·      Net interest income of$4.3 million for the second quarter of 2008 primarily from our long-termmortgage portfolio as compared to net interest income of $7.9 million for the secondquarter of 2007.

 

·      Master servicing fees of$1.5 million for the second quarter of 2008 as compared to $1.7 million for thesecond quarter of 2007.

 

·      Real estate advisory feesof $4.7 million for the second quarter of 2008 as compared to zero for thesecond quarter of 2007.

 

***Discontinued Operations***

 

·      Net loss of $11.0 millioncompared to a net loss of $59.0 million for the second quarter of 2007.

 

·      Reverse repurchaseagreements were $220.2 million compared to $336.7 million at December 31,2007.

 

·      Loans held-for-sale were$165.6 million, including a fair value adjustment of $106.9 million at June 30,2008 compared to loans held-for-sale of $189.8 million, including a $107.8million fair value adjustment at March 31, 2008.  The decline in loans held-for-sale isprimarily due to prepayments and loan sales.

 

**Selected Financial Results****for the Six Months Ended June 30,2008**

 

***Continuing Operations***

 

·      Net loss of $20.9 millioncompared to a net loss of $147.7 million for the first six months of 2007.

 

·      Net interest income of$11.6 million for the first six months of 2008 primarily from our long-termmortgage investment portfolio as compared to net interest income of $15.8million for the first six months of 2007.

 

·      Master servicing fees of$2.9 million for the first six months of 2008 as compared to $3.2 million forthe first six months of 2007.

 

·      Real estate advisory feesof $8.5 million for the first six months of 2008 as compared to zero for thefirst six months of 2007.

 

***Discontinued Operations***

 

·      Net loss of $10.4 millioncompared to a net loss of $126.6 million for the first six months of 2007.

 

**EstimatedTaxable Income**

 

While the Company hasgenerated significant net operating loss carryforwards in recent periods, we donot expect to generate sufficient taxable income in future periods to be ableto realize these tax benefits. Therefore, we have recognized a full valuation allowance against thesenet operating loss carryforwards in our consolidated balance sheets.

 

To maintain our REITstatus, we are required to distribute a minimum of 90 percent of our annualtaxable income to our stockholders, as well as meet certain asset and incometests set forth in the Internal Revenue Code. If the Company fails to meet these requirements, or elects to terminateits status as a REIT, we would be subject to federal income taxes at theregular corporate rates.  While theCompany has no current plans to terminate its status as a REIT, there can be noassurance that future events or transactions would enable the Company tomaintain this status.

 

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**FinancialCondition and Results of Operations**

 

*FinancialCondition*

 

Condensed BalanceSheet Data

 

| ** **                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                          | ** ** | **2008**          | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Securitized mortgage collateral                     |       | $                 | 11,055,382 |                  | $          | 16,532,633     |       | $          | (5,477,251 | ) | (33 | )% |
| Assets of discontinued operations                   |       | 203,320           |       | 353,250               |       | (149,930       | )          | (42        | )          |
| Derivative assets                                   |       | 109               |       | 7,497                 |       | (7,388         | )          | (99        | )          |
| Real estate owned (REO)                             |       | 621,433           |       | 400,863               |       | 220,570        |       | 55         |       |
| Other assets                                        |       | 83,299            |       | 96,829                |       | (13,530        | )          | (14        | )          |
| **Total assets**                                    |       | $                 | 11,963,543 |                  | $          | 17,391,072     |       | $          | (5,427,529 | ) | (31 | )% |
|                                                |       |              |       |                  |       |           |       |       |       |
| Securitized mortgage borrowings                     |       | $                 | 11,497,132 |                  | $          | 17,780,060     |       | $          | (6,282,928 | ) | (35 | )% |
| Liabilities of discontinued operations              |       | 253,334           |       | 405,341               |       | (152,007       | )          | (38        | )          |
| Other liabilities                                   |       | 188,569           |       | 283,399               |       | (94,830        | )          | (33        | )          |
| Total liabilities                                   |       | 11,939,035        |       | 18,468,800            |       | (6,529,765     | )          | (35        | )          |
| Total stockholders’ equity (deficit)           |       | 24,508            |       | (1,077,728            | )          | 1,102,236      |       | 102        |       |
| **Total liabilities and stockholders’ equity** |       | $                 | 11,963,543 |                  | $          | 17,391,072     |       | $          | (5,427,529 | ) | (31 | )% |

 

Total assets andliabilities were $12.0 billion and $11.9 billion as of June 30, 2008as compared to $17.4 billion and $18.5 billion as of December 31,2007, respectively.  The decreases intotal assets and liabilities were primarily the result of the Company electingto adopt SFAS 159 for a significant portion of the Company’s financialinstruments.  The adoption of SFAS 159resulted in the reduction of the carrying basis of certain financialinstruments (securitized mortgage collateral and borrowings and trust preferredsecurities) to fair value at January 1, 2008.  Future changes in the fair value of these andother financial instruments will be recognized in earnings.  Upon adoption, securitized mortgagecollateral and securitized mortgage borrowings were reduced by $0.8 billion and$1.9 billion, respectively.  During thefirst six months, the net change in the fair value of securitized mortgagecollateral and securitized mortgage borrowings included in earnings was $(3.2)billion and $3.3 billion, respectively.

 

Our residual interests insecuritizations are segregated between our single-family (SF) residential andmulti-family (MF) residential portfolios and are represented by the differencebetween trust assets (including investment securities available-for-sale andexcluding the $10.1 million in master servicing rights included within thebasis of securitized mortgage collateral) and trust liabilities.  Future prepayment estimates for single-familyand multi-family loans range from 16 percent and 28 percent for the 2002-2003vintage years, respectively, and 11 percent and 14 percent for the 2007 vintageyear, respectively.  The decline in thefair value of residual interest in securitizations is primarily due to anincrease in interest rates.  Thefollowing table presents the estimated fair value of our residual interests andrelated assumptions used to derive these values at June 30, 2008:

 
| ** **        | ** ** | ** **                                                 | ** ** | ** **                           | ** ** | ** **           | ** ** | **Fair Value Measurement Assumptions** | ** ** |
|-------------------|------------|------------------------------------------------------------|------------|--------------------------------------|------------|----------------------|------------|-------------------------------------------------------|------------|
| ** **        | ** ** | **Residual Interests by Vintage Year** | ** ** | **Lifetime Loss Estimate** | ** ** | **SF Discount** | ** ** |
| ** **        | ** ** | **SF**                                                     | ** ** | **MF**                               | ** ** | **Total**            | ** ** | **SF**                                                | ** ** | **MF** | ** ** | **Rate (1)** | ** ** |
| **2002-2003 (2)** |       | $                                                          | 12,743     |                                 | $          | 9,056                |       | $                                                     | 21,799     |   | 1 | % | 1 | % | 30 | % |
| **2004**          |       | 2,787                                                      |       | 6,556                                |       | 9,343                |       | 2                                                     | %          | 1 | % | 40 | % |
| **2005**          |       | 508                                                        |       | 650                                  |       | 1,158                |       | 6                                                     | %          | 1 | % | 50 | % |
| **2006 (3)**      |       | 1,112                                                      |       | 8,384                                |       | 9,496                |       | 16                                                    | %          | 5 | % | 50 | % |
| **2007**          |       | —                                                     |       | —                               |       | —               |       | 22                                                    | %          | 7 | % | 50 | % |
| **Total**         | ** ** | **$**                                                      | **17,150** | ** **                           | **$**      | **24,646**           | ** ** | **$**                                                 | **41,796** |   |   |   |   |   |   |   |

 

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(1)   The discountrate for all multi-family residual interests is 20 percent at June 30,2008.

(2)   2002-2003vintage year includes CMO 2007-A, due to performance, which uses a 40 percentdiscount rate and was securitized in 2007 from collapsed securitizations whichwere originally securitized in 2002, 2003 and 2004.

(3)   2006 vintageyear includes ISAC 2005-2, due to performance, and the fact that it was a REMIClike all other 2006 securitizations.

 

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The following tablepresents selected financial data as of the dates indicated:

 
| ** **                                  | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                  | ** ** | **June 30,**                                     | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
| ** **                                  | ** ** | **2008**                                              | ** ** | **2007** | ** ** | **2007** | ** ** |
| Prior 12-month (CPR) - Single-family        |       | 16                                                    | %          | 25 | % | 35 | % |
| Prior 12-month (CPR) - Multi-family         |       | 10                                                    | %          | 9 | % | 7 | % |
| Total non-performing loans                  |       | $                                                     | 2,542,034  |   | $ | 2,131,537 |   | $ | 1,261,818 |   |
| Total non-performing loans to total loans   |       | 15.0                                                  | %          | 11.7 | % | 6.5 | % |
| Total non-performing assets                 |       | $                                                     | 3,167,904  |   | $ | 2,543,775 |   | $ | 1,614,753 |   |
| Total non-performing assets to total assets |       | 26.5                                                  | %          | 14.6 | % | 7.2 | % |

 

We believe that in orderfor us to generate positive cash flows and earnings we must successfully managethe following primary operational and market risks:

 

·      liquidity risk;

 

·      credit risk;

 

·      interest rate risk; and

 

·      prepayment risk.

 

*LiquidityRisk. *Refer to “Status of Operations, Liquidity and CapitalResources.”

 

*CreditRisk.*We manage creditrisk by actively managing delinquencies and defaults through the servicers.Starting with the second half of 2007 we have not retained any additional Alt-Amortgages in our long-term mortgage portfolio. Our securitized mortgagecollateral primarily consisting of Alt-A mortgages which are generally withintypical Fannie Mae and Freddie Mac guidelines but that have loancharacteristics, including higher loan balances, higher loan-to-value ratios orlower documentation requirements (including stated-income loans),  that may make them non-conforming under thoseguidelines.

 

As of June 30, 2008, theoriginal weighted average credit score of single-family and multi-familysecuritized mortgage collateral was 700 and 732, an original weighted averageLTV ratio of 73 and 66 percent and an original CLTV of 84 percent and 66percent, respectively.  TheLTV and CLTV ratios may have increased from origination date as a result of thedeterioration of the real estate market.

 

Using historical losses, currentmarket conditions and available market data, the Company has estimated futureloan losses, which are included in the fair value adjustment to our securitizedmortgage collateral.  While the creditperformance for the loans has been clearly far worse than initial marketexpectations, the ultimate level of realized losses will largely be influencedby events that will likely unfold over the next several years, including theseverity of housing price declines and overall strength of the economy. Ifmarket conditions continue to deteriorate in excess of our expectations, theCompany may need to recognize additional fair value reductions to oursecuritized mortgage collateral, which may also affect the value of the relatedsecuritized mortgage borrowings.

 

We monitor our servicers to attemptto ensure that they perform loss mitigation, foreclosure and collectionfunctions according to their servicing practices and each securitization trust’spooling and servicing agreement. We have met with the management of ourservicers to assess our borrowers’ current ability to pay their mortgages andto make arrangements with selected delinquent borrowers which will result inthe best interest of the borrower and the Company, in an effort to minimize thenumber of mortgages which become seriously delinquent. When resolvingdelinquent mortgages, servicers are required to take timely action. Theservicer is required to determine payment collection under variouscircumstances, which will result in the maximum financial benefit. This isaccomplished by either working with the borrower to bring the mortgage currentor by foreclosing and liquidating the property. When a borrower fails to makerequired payments on a mortgage and does not cure the delinquency within60 days, we generally record a notice of default and commence foreclosureproceedings, or arrange alternative terms of forbearance. If the mortgage isnot reinstated within the time permitted by law for reinstatement, the propertymay then be sold at a foreclosure sale. At foreclosure sale, the trustsconsolidated on our balance sheet generally acquire title to the property.

 

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We use the Mortgage BankersAssociation (MBA) method to define delinquency as a contractually requiredpayment being 30 days or more past due. We measure delinquencies from the date of the last payment due date inwhich a payment was received. Delinquencies for loans 60 days late or greater, foreclosures anddelinquent bankruptcies were $2,969.1 million or 17.5 percent as of June 30,2008.

 

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

 
| ** **                                    | ** ** | **At June 30,** | ** ** | ** ** | ** ** | **At December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|---------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                    | ** ** | **2008**                  | ** ** | **%**      | ** ** | **2007**                      | ** ** | **%**      | ** ** |
| Loans held-for-sale (1)                       |       |                      |       |       |       |                          |       |       |       |
| 60 - 89 days delinquent                       |       | $                         | 11,483     |       | 0.5        | %                             | $          | 45,121     |       | 2 | % |
| 90 or more days delinquent                    |       | 59,038                    |       | 2          | %          | 51,294                        |       | 2          | %          |
| Foreclosures                                  |       | 10,195                    |       | 0.5        | %          | 23,936                        |       | 1          | %          |
| Total delinquent loans held-for-sale          |       | 80,716                    |       | 3          | %          | 120,351                       |       | 5          | %          |
|                                          |       |                      |       |       |       |                          |       |       |       |
| Securitized mortgage collateral               |       |                      |       |       |       |                          |       |       |       |
| 60 - 89 days delinquent                       |       | $                         | 415,549    |       | 14         | %                             | $          | 490,946    |       | 18 | % |
| 90 or more days delinquent                    |       | 706,692                   |       | 24         | %          | 773,816                       |       | 29         | %          |
| Foreclosures (2)                              |       | 1,555,217                 |       | 52         | %          | 1,093,385                     |       | 41         | %          |
| Delinquent bankruptcies (3)                   |       | 210,892                   |       | 7          | %          | 189,106                       |       | 7          | %          |
| Total delinquent long-term mortgage portfolio |       | 2,888,350                 |       | 97         | %          | 2,547,253                     |       | 95         | %          |
| Total delinquent loans                        |       | $                         | 2,969,066  |       | 100        | %                             | $          | 2,667,604  |       | 100 | % |
| Total loans                                   |       | $                         | 16,926,026 |       |       |                          | $          | 18,252,197 |       |   |   |

 

----

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

(2)   Represents properties in the process of foreclosure.

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

 

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

 
| ** **                                                           | ** ** | **At June 30,** | ** ** | ** ** | ** ** | **At December 31,** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                                           | ** ** | **2008**                  | ** ** | **%**      | ** ** | **2007**                      | ** ** | **%**      | ** ** |
| 90 or more days delinquent, foreclosures and delinquent bankruptcies | ** ** | $                         | 2,542,034  |       | 80         | %                             | $          | 2,131,537  |       | 84 | % |
| Real estate owned                                                    |       | 625,870                   |       | 20         | %          | 412,238                       |       | 16         | %          |
| Total non-performing assets                                          |       | $                         | 3,167,904  |       | 100        | %                             | $          | 2,543,775  |       | 100 | % |

 

Non-performing assets consist ofmortgages that are 90 days or more delinquent, including loans in foreclosureand delinquent bankruptcies. It is our policy to place a mortgage onnon-accrual status when it becomes 90 days delinquent and to reverse fromrevenue any accrued interest, except for interest income on securitizedmortgage collateral when the scheduled payment is received from theservicer.  As of June 30, 2008, non-performingassets as a percentage of the outstanding principal balance of securitizedmortgage assets was 26.5 percent compared to 14.6 percent as of December 31,2007.

 

Real estate owned,which consists of residential real estate acquired in satisfaction of loans, iscarried at the lower of cost or net realizable value less estimated sellingcosts. Historically, adjustments to the loan carrying value required at thetime of foreclosure were charged against the allowance for loan losses. Withthe adoption of FAS 159, the Company no

 

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longer maintainsan allowance for loan losses and adjustments to the carrying value of REO atthe time of foreclosure are included in the change in the fair value of nettrust assets.  Changes in the Company’sestimates of net realizable value subsequent to the time of foreclosure andthrough the time of ultimate disposition are recorded as gains or losses fromreal estate owned in the consolidated statement of operations.  Real estate owned at June 30, 2008 was$213.6 million, or 51.8 percent higher than at December 31, 2007 as aresult of an increase in foreclosures from higher delinquencies anddeterioration in the prevailing real estate market and, in part, due toborrowers’ inability to obtain replacement financing in conjunction with risingborrowing costs due to resets, reduced housing demand in the marketplace andlower housing prices.

 

We realized a gain onsale of real estate owned in the amount $1.8 million and $5.2 million for thethree and six months ended June 30, 2008, respectively, as compared to aloss of $1.1 million for the three and six months ended June 30,2007.  Additionally, for the three andsix months ended June 30, 2008, the Company recorded an unrealized loss onthe net realizable value of the REO in the amount of $6.6 million and $14.3million, respectively, which reflects the decline in value of the REO from theforeclosure date.

 

The followingtable presents the balances and related activity of the real estate owned forcontinuing operations:

 
| ** **            | ** ** | **Six Months Ended** | ** ** | **Year Ended**             | ** ** |
|-----------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **            | ** ** | **June 30, 2008**    | ** ** | **December 31, 2007** | ** ** |
| Beginning balance     |       | $                              | 405,434    |                            | $          | 137,331 |   |
| Foreclosures          |       | 388,907                        |       | 487,314                         |       |
| Liquidations          |       | (170,639                       | )          | (219,211                        | )          |
| REO                   |       | $                              | 623,702    |                            | $          | 405,434 |   |
|                  |       |                           |       |                            |       |
| REO inside trusts     |       | $                              | 621,433    |                            | $          | 400,863 |   |
| REO outside trust (1) |       | 2,269                          |       | 4,571                           |       |
| REO                   |       | $                              | 623,702    |                            | $          | 405,434 |   |

 

In calculating thecash flows to assess the fair value of the securitized mortgage collateral theCompany estimates the lifetime losses embedded in our loan portfolio. Inevaluating the adequacy of the lifetime losses, management takes many factorsinto consideration. For instance, a detailed analysis of historical loanperformance data is accumulated and reviewed. This data is analyzed for lossperformance and prepayment performance by product type, origination year and securitizationissuance. The data is also broken down by collection status. Our estimate ofthe required lifetime losses for these loans is developed by estimating boththe 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. Therate of default is based on analysis of migration of loans from each agingcategory. The loss severity is determined by estimating the net proceeds fromthe ultimate sale of the foreclosed property. The results of that analysis arethen applied to the current mortgage portfolio and an estimate is created. Webelieve that pooling of mortgages with similar characteristics is anappropriate methodology in which to evaluate the lifetime loan losses.

 

Managementrecognizes that there are qualitative factors that must be taken intoconsideration when evaluating and measuring losses in our loan portfolios.These items include, but are not limited to, economic indicators that mayaffect the borrower’s ability to pay, changes in value of collateral, projectedloss curves, political factors, market conditions, competitor’s performance,market perception, historical losses, and industry statistics. The assessmentfor loan losses, is based on delinquency trends and prior loan loss experienceand management’s judgment and assumptions regarding various matters, includinggeneral economic conditions and loan portfolio composition. Managementcontinually evaluates these assumptions and various relevant factors affectingcredit quality and inherent losses.

 

*InterestRate Risk.*Referto Item 3. “Quantitative and Qualitative Disclosures About Market Risk.”

 

*PrepaymentRisk*. The Companyuses prepayment penalties as a method of partially mitigating prepayment riskfor those borrowers that have the ability to refinance.  Mortgage industry evidence suggests thatchanges in home appreciation rates and lower payment option mortgage productsover the last three years had been a significant factor affecting borrowersrefinancing decisions. As mortgage rates increase and housing prices decline,borrowers will find it more difficult to refinance to obtain cheaper financing.If borrowers are unable to pay their mortgage payments at the adjusted rate,delinquencies may increase. The three-month average combined constantprepayment rate (CPR) of single-family and multi-family loans held assecuritized mortgage collateral decreased to 11 percent at June 30, 2008from 17 percent as of December 31, 2007.

 

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As of June 30, 2008,the twelve-month combined CPR of single-family and multi-family loans held assecuritized mortgage collateral was 15 percent as compared to a24 percent twelve-month average CPR as of December 31, 2007.Prepayment penalties are charged to borrowers for mortgages that are paid earlyand recorded as interest income.

 

*Resultsof Operations*

 

*For theThree and Six Months Ended June 30, 2008 compared to the Three and SixMonths Ended June 30, 2007*

 

CondensedStatements of Operations Data

 
| ** **                                                    | ** ** | **For the Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                               |       | $                                                                     | 407,855    |   | $ | 316,443 |   | $ | 91,412 |   | 29 | % |
| Interest expense                                              |       | 403,599                                                               |       | 308,569 |   | 95,030 |   | 31 |   |
| Net interest income (expense)                                 |       | 4,256                                                                 |       | 7,874 |   | (3,618 | ) | (46 | ) |
| Provision for loan losses                                     |       | —                                                                |       | 161,163 |   | (161,163 | ) | n/a |   |
| Net interest income (expense) after provision for loan losses |       | 4,256                                                                 |       | (153,289 | ) | 157,545 |   | 103 |   |
| Total non-interest income                                     |       | (10,748                                                               | )          | 70,804 |   | (81,552 | ) | (115 | ) |
| Total non-interest expense                                    |       | 7,745                                                                 |       | 6,071 |   | 1,674 |   | 28 |   |
| Income tax expense (benefit)                                  |       | 2,202                                                                 |       | 4,969 |   | (2,767 | ) | (56 | ) |
| Net (loss) earnings from continuing operations                |       | (16,439                                                               | )          | (93,525 | ) | 77,086 |   | 82 |   |
| Loss from discontinued operations, net                        |       | (11,048                                                               | )          | (59,022 | ) | 47,974 |   | 81 |   |
| Net loss                                                      |       | $                                                                     | (27,487    | ) | $ | (152,547 | ) | $ | 125,060 |   | 82 | % |
|                                                          |       |                                                                  |       |   |   |   |   |   |   |
| Net loss per share - diluted                                  |       | $                                                                     | (0.41      | ) | $ | (2.05 | ) | $ | 1.64 |   | 80 | % |
| Dividends declared per common share                           |       | $                                                                     | —     |   | $ | — |   | $ | — |   | n/a | % |

 
| ** **                                                    | ** ** | **For the Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                               |       | $                                                                   | 679,811    |   | $ | 621,191 |   | $ | 58,620 |   | 9 | % |
| Interest expense                                              |       | 668,206                                                             |       | 605,374 |   | 62,832 |   | 10 |   |
| Net interest income (expense)                                 |       | 11,605                                                              |       | 15,817 |   | (4,212 | ) | (27 | ) |
| Provision for loan losses                                     |       | —                                                              |       | 190,295 |   | (190,295 | ) | n/a |   |
| Net interest income (expense) after provision for loan losses |       | 11,605                                                              |       | (174,478 | ) | 186,083 |   | 107 |   |
| Total non-interest income                                     |       | (9,757                                                              | )          | 48,201 |   | (57,958 | ) | (120 | ) |
| Total non-interest expense                                    |       | 14,062                                                              |       | 12,424 |   | 1,638 |   | 13 |   |
| Income tax expense (benefit)                                  |       | 8,728                                                               |       | 8,956 |   | (228 | ) | (3 | ) |
| Net (loss) earnings from continuing operations                |       | (20,942                                                             | )          | (147,657 | ) | 126,715 |   | 86 |   |
| Loss from discontinued operations, net                        |       | (10,360                                                             | )          | (126,558 | ) | 116,198 |   | 92 |   |
| Net loss                                                      |       | $                                                                   | (31,302    | ) | $ | (274,215 | ) | $ | 242,913 |   | 89 | % |
|                                                          |       |                                                                |       |   |   |   |   |   |   |
| Net loss per share - diluted                                  |       | $                                                                   | (0.51      | ) | $ | (3.70 | ) | $ | 3.19 |   | 86 | % |
| Dividends declared per common share                           |       | $                                                                   | —     |   | $ | 0.10 |   | $ | (0.10 | ) | n/a | % |

 

*NetInterest Income*

 

We earn net interestincome primarily from mortgage assets which include securitized mortgagecollateral, loans held-for-sale and investment securities available-for-sale,or collectively, “mortgage assets,” and, to a lesser extent, interest incomeearned on cash and cash equivalents. Interest expense is primarily interestpaid on borrowings on mortgage assets, which include securitized mortgageborrowings, reverse repurchase agreements and borrowings secured by investmentsecurities available-for-sale. With the adoption of SFAS 159, net interestincome during the quarter represents the effective yield of the net trustassets.  During 2007, net interest incomeincluded (1) amortization of acquisition costs on mortgages

 

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acquired from the mortgageoperations, (2) accretion of loan discounts, which primarily representedthe amount allocated to mortgage servicing rights when they are sold to thirdparties and mortgages are transferred to the long-term investment operationsfrom the mortgage operations and retained for long-term investment, (3) amortizationof securitized mortgage securitization expenses and, to a lesser extent, (4) amortizationof securitized mortgage bond discounts.

 

The following tablesummarizes average balance, interest and weighted average yield on mortgageassets and borrowings on mortgage assets, included within continuing anddiscontinued operations, for the periods indicated:

 
| ** **                                            | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                                              | ** ** | **2007** | ** ** |
| ** **                                            | ** ** | **Average**                                                           | ** ** | ** ** | ** ** | **(8)** | ** ** | **Average** | ** ** | ** ** | ** ** | **(8)** | ** ** |
| ** **                                            | ** ** | **Balance**                                                           | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by mortgages   |       | $                                                                     | 10,333     |   | $ | 687 |   | 26.59 | % | $ | 29,094 |   | $ | 1,711 |   | 23.52 | % |
| Securitized mortgage collateral (1)                   |       | 11,344,758                                                            |       | 406,988 |   | 14.35 | % | 21,184,780 |   | 319,051 |   | 6.02 | % |
| Loans held-for-investment and held-for-sale (2)       |       | 183,459                                                               |       | 3,193 |   | 6.96 | % | 866,517 |   | 10,967 |   | 5.06 | % |
| Finance receivables                                   |       | —                                                                |       | — |   | 0.00 | % | 163,456 |   | 2,965 |   | 7.26 | % |
| Total mortgage assets\ interest income                |       | $                                                                     | 11,538,550 |   | $ | 410,868 |   | 14.24 | % | $ | 22,243,847 |   | $ | 334,694 |   | 6.02 | % |
|                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                        |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                       |       | $                                                                     | 11,645,457 |   | $ | 401,432 |   | 13.79 | % | $ | 20,772,443 |   | $ | 304,551 |   | 5.86 | % |
| Reverse repurchase agreements                         |       | 231,489                                                               |       | 1,797 |   | 3.11 | % | 1,134,264 |   | 17,236 |   | 6.08 | % |
| Total borrowings on mortgage assets\ interest expense |       | $                                                                     | 11,876,946 |   | $ | 403,229 |   | 13.58 | % | $ | 21,906,707 |   | $ | 321,787 |   | 5.88 | % |
|                                                  |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (3)**                           |       |                                                                  |       | $ | 7,639 |   | 0.66 | % |   |   | $ | 12,907 |   | 0.14 | % |
| **Net Interest Margin (4)**                           |       |                                                                  |       |   |   | 0.26 | % |   |   |   |   | 0.23 | % |

 
| ** **                                            | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                                            | ** ** | **2007** | ** ** |
| ** **                                            | ** ** | **Average**                                                         | ** ** | ** ** | ** ** | **(8)** | ** ** | **Average** | ** ** | ** ** | ** ** | **(8)** | ** ** |
| ** **                                            | ** ** | **Balance**                                                         | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                   |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by mortgages   |       | $                                                                   | 12,738     |   | $ | 1,420 |   | 22.30 | % | $ | 29,949 |   | $ | 3,308 |   | 22.09 | % |
| Securitized mortgage collateral (1)                   |       | 13,383,352                                                          |       | 676,886 |   | 10.12 | % | 20,930,093 |   | 622,653 |   | 5.95 | % |
| Loans held-for-investment and held-for-sale (2)       |       | 198,135                                                             |       | 7,448 |   | 7.52 | % | 1,411,734 |   | 41,312 |   | 5.85 | % |
| Finance receivables                                   |       | —                                                              |       | — |   | 0.00 | % | 217,859 |   | 8,192 |   | 7.52 | % |
| Total mortgage assets\ interest income                |       | $                                                                   | 13,594,225 |   | $ | 685,754 |   | 10.09 | % | $ | 22,589,635 |   | $ | 675,465 |   | 5.98 | % |
|                                                  |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                        |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                       |       | $                                                                   | 13,686,955 |   | $ | 663,248 |   | 9.69 | % | $ | 20,479,422 |   | $ | 597,928 |   | 5.84 | % |
| Reverse repurchase agreements                         |       | 258,649                                                             |       | 5,159 |   | 3.99 | % | 1,684,967 |   | 50,973 |   | 6.05 | % |
| Total borrowings on mortgage assets\ interest expense |       | $                                                                   | 13,945,604 |   | $ | 668,407 |   | 9.59 | % | $ | 22,164,389 |   | $ | 648,901 |   | 5.86 | % |
|                                                  |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (3)**                           |       |                                                                |       | $ | 17,347 |   | 0.50 | % |   |   | $ | 26,564 |   | 0.12 | % |
| **Net Interest Margin (4)**                           |       |                                                                |       |   |   | 0.39 | % |   |   |   |   | 0.24 | % |

 

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----

(1)   Interest on securitizedmortgage collateral in 2007 includes amortization of acquisition cost onmortgages acquired from the mortgage operations and accretion of loandiscounts. During 2008, the Company started applying the effective yield usedto derive the fair value of the securitized mortgage collateral.

(2)   The held-for-sale balanceexcludes the lower of cost or market (LOCOM) writedown on the loans.

(3)   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.

(4)   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.

 

Net interestincome spread for the second quarter of 2008 decreased $5.3 million (41percent) as compared to the second quarter of 2007.  The decrease in net interest income wasprimarily due to declines in outstanding balances offset by an increase in netinterest spread.  During the quarter, theyield on mortgage assets changed by 8.22 percent to 14.24 percent from6.02 percent for the comparable 2007 period. The yield on total borrowings changedby 7.70 percent to 13.58 percent for the quarter from 5.88 percent for thecomparable period.  The increase in thesecuritized mortgage collateral and borrowing yields is primarily a result ofthe adoption of SFAS 159 and the related recognition of interest income andexpense based on effective yields for the three months ended June 30,2008, based on fair value, as compared to using effective interest rates usingthe historical basis in the loans in the prior period.  As the market’s expectation of future creditlosses has increased, the market has demanded higher yields, as investorsrequire a higher yield on these financial assets and liabilities.

 

Net interestincome spread for the first six months of 2008 decreased $9.2 million (35percent) as compared to the first six months of 2007.  The decrease in net interest income wasprimarily due to declines in outstanding balances offset by an increase in netinterest spread.  During the first sixmonths, the yield on mortgage assets changed by 4.11 percent to10.09 percent from 5.98 percent for the comparable 2007 period. The yieldon total borrowings changed by 3.73 percent to 9.59 percent for the first sixmonths from 5.86 percent for the comparable period.  The increase in the securitized mortgagecollateral and borrowing yields is primarily a result of the adoption of SFAS159 and the related recognition of interest income and expense based oneffective yields for the six months ended June 30, 2008, based on fairvalue, as compared to using effective interest rates using the historical basisin the loans in the prior period.  As themarket’s expectation of future credit losses has increased, the market hasdemanded higher yields, as investors require a higher yield on these financialassets and liabilities.

 

*Non-InterestIncome*

 

Changes inNon-Interest Income

 

| ** **                                              | ** ** | **For the Three Months Ended June 30,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative instruments          |       | —                                                                |       | 91,670 |   | (91,670 | ) | n/a | % |
| Change in fair value of net trust assets, excluding REO |       | (11,161                                                               | )          | — |   | (11,161 | ) | n/a |   |
| Change in fair value of trust preferred securities      |       | (997                                                                  | )          | — |   | (997 | ) | n/a |   |
| Losses from real estate owned                           |       | (4,830                                                                | )          | (19,328 | ) | 14,498 |   | 75 |   |
| Real estate advisory fees                               |       | 4,696                                                                 |       | — |   | 4,696 |   | n/a |   |
| Other                                                   |       | 1,544                                                                 |       | (1,538 | ) | 3,082 |   | 200 |   |
| Total non-interest income                               |       | $                                                                     | (10,748    | ) | $ | 70,804 |   | $ | (81,552 | ) | (115 | )% |
|                                                         |            |                                                                       |            |  |  |  |  |  |  |  |  |  |

 

*Changein Fair Value of Derivative Instruments*. The change in the fair value of derivativeinstruments decreased by $91.7 million during the second quarter of 2008 ascompared to the second quarter of 2007, as the Company no longer recognizes thederivative fair value adjustments as a separate component of non-interestincome.  As a result of the adoption ofSFAS 159 the Company now recognizes changes in the fair value of derivativeinstruments as a component of the change in fair value of net trustassets.  The change in fair value ofderivative instruments was a gain of $98.3 million during the second quarter of2008.

 

*Changein Fair Value of Net Trust Assets.* The Companyrecognized a $11.2 million loss from the change in fair value of net trustassets, which is comprised of a loss in the increase of fair value ofsecuritized mortgage borrowings of $88.9 million, gain in the fair value ofderivatives instruments of $98.3 million and losses on the reduction in fairvalue of securitized mortgage collateral and investment securitiesavailable-for-sale of $19.0 million, and $1.5 million, respectively.  The overall reduction in fair value of thesecuritized mortgage collateral and securitized mortgage borrowings is theresult of a decrease in the fair value of derivative instruments, a decrease inLondon Interbank Offered Rate (LIBOR) reflected in the forward yield curve anda decrease in the market prices of our mortgage-backed securities.

 

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*Changein the Fair Value of Trust Preferred Securities. *During the second quarterof 2008 the Company recognized a loss in the amount of $1.0 million as a resultof increase in the fair value of the trust preferred securities.

* *
| ** **                                              | ** ** | **For the Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                              | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative instruments          |       | —                                                              |       | 73,672 |   | (73,672 | ) | n/a | % |
| Change in fair value of net trust assets, excluding REO |       | (7,633                                                              | )          | — |   | (7,633 | ) | n/a |   |
| Change in fair value of trust preferred securities      |       | (5,020                                                              | )          | — |   | (5,020 | ) | n/a |   |
| Losses from real estate owned                           |       | (9,086                                                              | )          | (29,220 | ) | 20,134 |   | 69 |   |
| Real estate advisory fees                               |       | 8,540                                                               |       | — |   | 8,540 |   | n/a |   |
| Other                                                   |       | 3,442                                                               |       | 3,749 |   | (307 | ) | (8 | ) |
| Total non-interest income                               |       | $                                                                   | (9,757     | ) | $ | 48,201 |   | $ | (57,958 | ) | (120 | )% |
|                                                         |            |                                                                     |            |  |  |  |  |  |  |  |  |  |

 

*Changein Fair Value of Derivative Instruments*. The change in the fair value of derivativeinstruments decreased by $73.7 million during the first six months of 2008 ascompared to the first six months of 2007, as the Company no longer recognizesthe derivative fair value adjustments as a separate component of non-interestincome.  As a result of the adoption ofSFAS 159 the Company now recognizes changes in the fair value of derivativeinstruments as a component of the change in fair value of net trustassets.  The change in fair value ofderivative instruments was a loss of $83.5 million during the first six monthsof 2008.

 

*Changein Fair Value of Net Trust Assets.* The Companyrecognized a $7.6 million loss from the change in fair value of net trustassets, which is comprised of gains on the reduction of fair value ofsecuritized mortgage borrowings of $3.3 billion, loss on the reduction in fairvalue of derivatives instruments of $83.5 million and losses on the reductionin fair value of securitized mortgage collateral and investment securitiesavailable-for-sale of $3.2 billion and $5.8 million, respectively.  The overall reduction in fair value of thesecuritized mortgage collateral and securitized mortgage borrowings is theresult of a decrease in the fair value of derivative instruments, a decrease inLondon Interbank Offered Rate (LIBOR) reflected in the forward yield curve anda decrease in the market prices of our mortgage-backed securities.

 

*Changein the Fair Value of Trust Preferred Securities. *During the first six monthsof 2008 the Company recognized a loss in the amount of $5.0 million as a resultof increase in the fair value of the trust preferred securities.

 

*Non-InterestExpense*

 

Changes inNon-Interest Expense

 
| ** **                 | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                     | 4,925      |   | $ | 4,451 |   | $ | 474 |   | 11 | % |
| Personnel expense          |       | 2,820                                                                 |       | 1,620 |   | 1,200 |   | 74 |   |
| Total operating expense    |       | $                                                                     | 7,745      |   | $ | 6,071 |   | $ | 1,674 |   | 28 | % |

 

Total non-interestexpenses remained increased on a quarter-over-quarter basis as personnelexpense increased $1.2 million (74 percent) during the second quarter of 2008as compared to same period in 2007, as a greater amount of the Company’spersonnel costs are being utilized within the continuing operations versusdiscontinued operations.  The $474thousand increase in general and administrative costs is primarily attributableto an increase in professional expenses.

 

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Changes in Non-Interest Expense

 
| ** **                 | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                   | 8,912      |   | $ | 9,960 |   | $ | (1,048 | ) | (11 | )% |
| Personnel expense          |       | 5,150                                                               |       | 2,464 |   | 2,686 |   | 109 |   |
| Total operating expense    |       | $                                                                   | 14,062     |   | $ | 12,424 |   | $ | 1,638 |   | 13 | % |

 

Totalnon-interest expenses increased as personnel expense increased $2.7 million(109 percent) during the first six months of 2008 as compared to same period in2007, as a greater amount of the Company’s personnel costs are being utilizedwithin the continuing operations versus discontinued operations.  The $1.0 million decrease in general andadministrative costs is primarily attributable to a decrease in dataprocessing, communications costs, and occupancy expense offset by an increasein professional expenses.

 

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

 

***Continuing Operations***

 

Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Three Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                            |       | $                                                                     | 4,256      |   | $ | 7,874 |   | $ | (3,618 | ) | (46 | )% |
| Provision for loan losses                                      |       | —                                                                |       | 161,163 |   | (161,163 | ) | n/a |   |
| Net interest income (expense) after provision  for loan losses |       | 4,256                                                                 |       | (153,289 | ) | 157,545 |   | 103 |   |
|                                                           |       |                                                                  |       |   |   |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO       |       | (11,161                                                               | )          | — |   | (11,161 | ) | n/a |   |
| Change in fair value of derivative  instruments                |       | —                                                                |       | 91,670 |   | (91,670 | ) | n/a |   |
| Real estate advisory fees                                      |       | 4,696                                                                 |       | — |   | 4,696 |   | n/a |   |
| Other non-interest income (expense)                            |       | (4,283                                                                | )          | (20,866 | ) | 16,583 |   | 79 |   |
| Total non-interest (expense) income                            |       | (10,748                                                               | )          | 70,804 |   | (81,552 | ) | (115 | ) |
|                                                           |       |                                                                  |       |   |   |   |   |   |   |
| Non-interest expense and income taxes                          |       | 9,947                                                                 |       | 11,040 |   | (1,093 | ) | (10 | ) |
| Net (loss) earnings from continuing  operations                |       | $                                                                     | (16,439    | ) | $ | (93,525 | ) | $ | 77,086 |   | 82 | % |

 

Net loss for the quarter ended June 30, 2008 decreased $77.1million as compared to the second quarter of 2007.  The primary reason for the reduction in netloss is the adoption of SFAS 159 for securitized mortgage collateral,borrowings and trust preferred securities. The Company no longer records a provision for loan losses ($161.2million for the second quarter of 2007) and separately the change in fair valueof derivative instruments ($91.7 million gain for the second quarter of 2007),which is now included in the change in fair value of net trust assets, whichconsisted of a $98.3 million gain on derivatives offset by a $109.5 milliondecrease in the fair value of the remaining net trust assets, due to thedecline in forward LIBOR rates.  The fairvalue of trust preferred securities increased $1.0 million during the secondquarter of 2008.

 

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Condensed Statements of Operations Data

 
| ** **                                                     | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                            |       | $                                                                   | 11,605     |   | $ | 15,817 |   | $ | (4,212 | ) | (27 | )% |
| Provision for loan losses                                      |       | —                                                              |       | 190,295 |   | (190,295 | ) | n/a |   |
|                                                           |       |                                                                |       |   |   |   |   |   |   |
| Net interest income (expense) after  provision for loan losses |       | 11,605                                                              |       | (174,478 | ) | 186,083 |   | 107 |   |
|                                                           |       |                                                                |       |   |   |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO       |       | (7,633                                                              | )          | — |   | (7,633 | ) | n/a |   |
| Change in fair value of derivative  instruments                |       | —                                                              |       | 73,672 |   | (73,672 | ) | n/a |   |
| Real estate advisory fees                                      |       | 8,540                                                               |       | — |   | 8,540 |   | n/a |   |
| Other non-interest income (expense)                            |       | (10,664                                                             | )          | (25,471 | ) | 14,807 |   | 58 |   |
| Total non-interest (expense) income                            |       | (9,757                                                              | )          | 48,201 |   | (57,958 | ) | (120 | ) |
|                                                           |       |                                                                |       |   |   |   |   |   |   |
| Non-interest expense and income taxes                          |       | 22,790                                                              |       | 21,380 |   | 1,410 |   | 7 |   |
| Net (loss) earnings from continuing  operations                |       | $                                                                   | (20,942    | ) | $ | (147,657 | ) | $ | 126,715 |   | 86 | % |

 

Net loss for the six months ended June 30, 2008 decreased $126.7million as compared to the first six months of 2007.  The primary reason for the reduction in netloss is the result of the adoption of SFAS 159 for securitized mortgagecollateral, borrowings and trust preferred securities.  The Company no longer records a provision forloan losses ($190.3 million for the first six months of 2007) and separatelythe change in fair value of derivative instruments ($73.7 million gain for thefirst six months of 2007), which is now included in the change in fair value ofnet trust assets, which consisted of a $83.5 million loss on derivatives offsetby a $75.9 million increase in the fair value of the remaining net trustassets, due to the decline in forward LIBOR rates.  The fair value of trust preferred securitiesincreased $5.0 million during the first six months of 2008.

 

***Discontinued Operations***

*** ***

Condensed Statements of Operations Data

 
| ** **                                          | ** ** | **For the Three Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                            | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                          | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                 |       | $                                                                     | 1,543      |   | $ | 5,109 |   | $ | (3,566 | ) | (70 | )% |
| Provision for loan losses                           |       | —                                                                |       | (1,818 | ) | 1,818 |   | n/a |   |
| Net interest income after provison for loan  losses |       | $                                                                     | 1,543      |   | $ | 3,291 |   | $ | (5,384 | ) | (164 | ) |
|                                                |       |                                                                  |       |   |   |   |   |   |   |
| Loss on sale of loans                               |       | (8,246                                                                | )          | (6,525 | ) | (1,721 | ) | (26 | ) |
| Provision for repurchases                           |       | (1,823                                                                | )          | (18,889 | ) | 17,066 |   | 90 |   |
| Other income (loss)                                 |       | 1,715                                                                 |       | (8,875 | ) | 10,590 |   | 119 |   |
| Personnel expense                                   |       | (3,680                                                                | )          | (22,021 | ) | 18,341 |   | 83 |   |
|                                                |       |                                                                  |       |   |   |   |   |   |   |
| Non-interest expense and income taxes               |       | (557                                                                  | )          | (6,003 | ) | 5,446 |   | 91 |   |
| Net loss                                            |       | $                                                                     | (11,048    | ) | $ | (59,022 | ) | $ | 47,974 |   | 81 | % |

 

Net loss for the discontinued operations decreased $48.0 millionprimarily due to the following changes:

 

·                  decreaseof $17.1 million in provision for repurchases.

 

·                  decreasein other income (loss) of $10.6 million.

 

·                  decreasein personnel expense of $18.3 million.

 

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Provision for repurchases decreased $17.1 million during thesecond quarter of 2008 as compared to 2007. The decrease in the provision forrepurchases was primarily due to the settlement of $117 repurchase obligations.

 

Other income (loss) increased $10.6 million during the second quarterof 2008 as compared to 2007.  Theincrease was mainly attributable to the Company recording a goodwill impairmentcharge of $12.4 million during the second quarter of 2007 related to theacquisition of certain production facilities.

 

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

 
| ** **                                          | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                          | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                 |       | $                                                                   | 3,213      |   | $ | 10,622 |   | $ | (7,409 | ) | (70 | )% |
| Provision for loan losses                           |       | —                                                              |       | (2,061 | ) | 2,061 |   | n/a |   |
| Net interest income after provison for loan  losses |       | $                                                                   | 3,213      |   | $ | 8,561 |   | $ | (9,470 | ) | (111 | ) |
|                                                |       |                                                                |       |   |   |   |   |   |   |
| Loss on sale of loans                               |       | (8,711                                                              | )          | (40,327 | ) | 31,616 |   | 78 |   |
| Provision for repurchases                           |       | 8,435                                                               |       | (30,718 | ) | 39,153 |   | 127 |   |
| Other income (loss)                                 |       | 1,255                                                               |       | (11,202 | ) | 12,457 |   | 111 |   |
| Personnel expense                                   |       | (8,973                                                              | )          | (39,563 | ) | 30,590 |   | 77 |   |
|                                                |       |                                                                |       |   |   |   |   |   |   |
| Non-interest expense and income taxes               |       | (5,579                                                              | )          | (13,309 | ) | 7,730 |   | 58 |   |
| Net loss                                            |       | $                                                                   | (10,360    | ) | $ | (126,558 | ) | $ | 116,198 |   | 92 | % |

 

Net loss for the discontinued operations decreased $116.2 millionprimarily due to the following changes:

 

·                  decreaseof $31.6 million in loss on sale of loans.

 

·                  decreaseof $39.2 million in provision for repurchases.

 

·                  decreasein other income (loss) of $12.5 million.

 

·                  decreasein personnel expense of $30.6 million.

 

Loss on sale of loans decreased $31.6 million to an$8.7 million loss in the first six months of 2008.  The decrease was due to a significantreduction in the balance of loans held-for-sale between periods resulting fromcollections, prepayments, loan sales, securitizations and reduced LOCOM adjustments.  For the six months ended June 30,2008,  gain on sale of loans $7.5million, compared to a loss of $5.5 million in the comparable period of 2007.For the six months ended June 30, 2008, we recorded $16.2 million inadditional LOCOM adjustments, compared to $34.9 million for the comparableperiod of 2007.

 

Provision for repurchases decreased $39.2 million during the firstsix months of 2008 as compared to 2007. The decrease in the provision forrepurchases was primarily due to the settlement of $117 million in repurchaseobligations.

 

Other income (loss) increased $12.5 million during the first six monthsof 2008 as compared to 2007.  Theincrease was mainly attributable to the Company recording a goodwill impairmentcharge of $12.4 million during the second quarter of 2007 related to theacquisition of certain production facilities.

 

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

 

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

 

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

 

**ITEM 4:          CONTROLSAND PROCEDURES**

 

**Evaluation of DisclosureControls and Procedures**

 

The Company maintains disclosure controls and procedures (as defined inthe Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e)) designedto ensure that information required to be disclosed in reports filed orsubmitted under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms. Disclosure controls and procedures include, withoutlimitation, controls and procedures designed to ensure that informationrequired to be disclosed by the Company in its reports that it files or submitsunder the Exchange Act is accumulated and communicated to the Company’smanagement, including its principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure.

 

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

 

**Material Weakness**

 

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

 

**Management’s RemediationPlan**

 

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

 

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

 

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

 

We believe that our disclosure controls and procedures, including ourcontrol over financial reporting, have improved since year-end due to thescrutiny of such matters by our management and Audit Committee and the changesdescribed above.  However, due in part tocontinued lack of permanent staff in Accounting/Finance and in part to theeffort needed to accurately document the change in accounting for fair valuemeasurements, the Company continued to be late in closing its books and recordseffectively at the required reporting date. Therefore, the Company believes the material weakness related to oureffectiveness of internal control over financial reporting is not fullyremediated as of June 30, 2008.

 

**Changes in Internal Control Over Financial Reporting**

 

There has been no change in the Company’s internal control over financialreporting during the Company’s quarter ended June 30, 2008, that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting, except the following:

 

·                                          We have implemented controls associated withthe adoption of SFAS 157 and SFAS 159 and fair value accounting.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1:          LEGAL PROCEEDINGS**

 

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

 

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

 

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

 

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

 

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

 

**ITEM 1A:       RISK FACTORS**

 

Our Annual Report on Form 10-Kfor the year ended December 31, 2007 includes a detailed discussion of ourrisk factors. The information presented below updates and should be read inconjunction with the risk factors and information disclosed in that Form 10-K.

 

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

 

Pursuantto the advisory services agreement with a real estate marketing company we earnadvisory fees.  For the three and sixmonths ended June 30, 2008, we earned $4.7 million and $8.5 million,respectively in advisory fees, which, along with cash flows and masterservicing fees from our long-term mortgage portfolio, is one of our primarysources of earnings.  Although theCompany is eligible to receive a termination fee in the case of the sale,transfer or merger of the marketing company or upon IMH entering intobankruptcy proceedings, IMH’s advisory fees may be reduced and the agreementsubsequently terminated if certain conditions are not satisfied.  If our CEO is no longer in a seniormanagement capacity with the Company or any affiliates nor a director, then theadvisory fee percentage is substantially reduced and the marketing company mayterminate the agreement.  Furthermore, ifthe Company fails to provide the agreed upon services, then the agreement maybe terminated with no further obligations or payments to the Company.  The reduction of the advisory fees ortermination of the agreement would substantially decrease our income stream andcould have a material adverse effect on our operations, financial condition andbusiness prospects.

 

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

 

Beginning in the second quarter of 2007 and continuing through 2008,the mortgage industry and the residential housing market have been adverselyaffected as home prices declined and delinquencies increased. The mortgagemarket is currently

 

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experiencingunprecedented disruptions, which have had, and continue to have, an adverseimpact on the Company’s earnings and financial condition.  These disruptions are further evidenced bythe recent event surrounding the takeover of Fannie Mae and Freddie Mac by theFederal government.  These conditions maynot stabilize or they may worsen for the foreseeable future.  Our ability to meet our long-term liquidityrequirements is subject to several factors, such as decreasing our dividend andtrust preferred payment obligations and possibly raising additionalcapital.  Recent adverse changes in themortgage finance and credit markets have eliminated or reduced the availability,or increased the cost, of significant sources of funding for us. We may not beable to access sources of funding or, if available to us, we may not be able tonegotiate favorable terms. Any decision by our lenders and/or investors to makeadditional funds available to us in the future will depend upon a number offactors, such as our compliance with the terms of our existing creditarrangements, our financial performance, industry and market trends in ourvarious businesses, the lenders’ and/or investors’ own resources and policiesconcerning loans and investments, and the relative attractiveness ofalternative investment or lending opportunities. If we cannot raise cash byselling debt or equity securities, we may be forced to cut additional resources,sell more of our assets at unfavorable prices or discontinue various businessactivities to preserve cash. Furthermore, the price of our common stockdeclined significantly as a result of these events and the impact on ourresults of operations.

 

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

 

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

 

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

 

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

 

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

 

**Acquisitions of other businesses could result in operating difficulties.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our common stock and Series B Preferred Stock and Series CPreferred Stock are currently listed on the New York Stock Exchange (the “NYSE”).We must satisfy certain minimum listing maintenance requirements to maintainsuch listing, including maintaining a minimum bid price of $1.00 per share forthe common stock.  On July 8, 2008,we received a second notice from NYSE Regulation Inc. (“NYSE Regulation”) thatthe Company was not in compliance with the NYSE continued listing standardrelated to maintaining a consecutive thirty day average closing stock price ofover $1.00 per common share.  NYSE Regulation noted that effective May 28,2008 the Company had cured its previous non-compliance with the same NYSE continuedlisting standard.  However, NYSE Regulation notified us that the Company’scommon stock again fell below the $1.00 average share pricerequirement.   After reviewingmaterials submitted by the Company specifying details as to its strategic plansto address the current share price deficiency, NYSE Regulation agreed toprovide us an approximately four month cure period. NYSE Regulation willformally reevaluate our continued listing with the NYSE’s Listings andCompliance Committee at the end of this approximately four month cure period,and it will also continue to closely monitor the Company during this timeframeboth with regards to share price levels and progress on its plannedinitiatives.  Furthermore, on April 1,2008 we received notification from the NYSE that the failure to timely fileannual and interim reports with the Securities and Exchange Commission maysubject us to suspension and delisting procedures.

 

Wecannot assure you that the NYSE will maintain our listing in the future. In theevent that our common stock and preferred stock is delisted by the NYSE, or ifit becomes apparent to us that we will be unable to meet the NYSE’s continuedlisting criteria in the foreseeable future, we may seek to have our stocklisted or quoted on another national securities exchange or quotation system.If our securities are delisted from the NYSE, then they may trade on theOver-the-Counter-Bulletin Board, which is viewed by most investors as a lessdesirable and less liquid market place. However, we cannot assure you that, if our common stock is listed orquoted on such other exchange or system, the market for our common stock

 

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willbe as liquid as it has been on the NYSE. As a result, if we are delisted by theNYSE or transfer our listing to another exchange or quotation system, themarket price for our common stock may become more volatile than it has beenhistorically.  Delisting from the NYSEcould make trading our common stock and preferred stock more difficult for ourinvestors, leading to declines in share price. Delisting of our common stockwould also make it more difficult and expensive for us to raise additionalcapital.

 

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

 

Ourability to finance our operations, grow our business and implement ourstrategic initiatives is dependent upon the availability of credit oncommercially acceptable terms, including the use of warehouse lines of creditand repurchase agreements. On September 11, 2008, we executed a newwarehouse line agreement with UBS Real Estate Securities Inc. (“UBS”). Theagreement removes all technical defaults from financial covenant noncomplianceand any associated margin calls for the term of the agreement.  The agreement calls for certain targetsincluding a reduction of the borrowings balance to $100 million in 18 monthswith an advance rate of no more than 65 percent of the unpaid principal balanceand $50 million in 24 months with an advance rate of no more than 55 percent ofthe unpaid principal balance.  By meetingthese targets, the agreement term can extend to 30 months.  The agreement also calls for monthly principalpaydowns of $750,000 for one month and $1.5 million thereafter until theearlier of the Company raising capital or the end of the agreement term.  If the Company is successful in raisingcapital, approximately 10% of the gross proceeds will be required to be paid asan additional principal paydown and the monthly principal paydown is reduced to$750,000.  The interest rate is LIBORplus 325 basis points, and all cash collected from the securing mortgage loansis required to be paid to the lender.  Wemay not have the funds available to make the required paydowns, which couldresult in defaults and we may not have adequate assets to use as collateral.  In the event we do not have sufficientliquidity to meet the payment requirements, UBS can accelerate ourindebtedness, increase interest rates and terminate our ability to borrowadditional funds.  Such a situation wouldlikely result in a rapid deterioration of our financial condition.

 

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

 

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

 

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

 

None.

 

**ITEM 3:          DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

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

 

None

 

**ITEM 5:          OTHER INFORMATION**

 

*Restructuredof Reverse Repurchase Line*

 

On September 11, 2008, the Company entered into an agreementwith UBS Real Estate Securities Inc. to restructure its reverse repurchase linewith its remaining lender.  The balanceof this line was $220.2 million at June 30, 2008.  The agreement removes all technical defaultsfrom financial covenant noncompliance and any associated margin calls for theterm of the agreement.  The agreementcalls for certain targets including a reduction of the borrowings balance to$100 million in 18 months with an advance rate of no more than 65 percent ofthe unpaid principal balance and $50 million in 24 months with an advance rateof no more than 55 percent of the unpaid principal balance.  By meeting these targets, the agreement termcan extend to 30 months.  The agreementalso calls for monthly principal paydowns of $750,000 for one month and $1.5million thereafter until the earlier of the Company raising capital or the endof the agreement term.  If the Company issuccessful in raising capital, approximately 10% of the gross proceeds will be requiredto be paid as an additional principal paydown and the monthly principal paydownis reduced to $750,000.  The interestrate is LIBOR plus 325 basis points, and all cash collected from the securingmortgage loans is required to be paid to the lender.

 

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Accomplishingthe restructuring of this reverse repurchase line allows the Company to managethe remaining loans on the line for the eventual collection, refinance, sale orsecuritization without the risk of receiving margin calls.

 

*AnnualMeeting of Stockholders*

 

On July 10, 2008, we held our annual meeting ofstockholders. Of 76,104,656 shares eligible to vote, 69,745,926, or 91.6percent, votes were returned, formulating a quorum.  At the annual stockholders meeting, thefollowing matters were submitted to stockholders for vote Proposal I - Electionof Directors; Proposal II - Ratification of the appointment of Ernst &Young LLP as our independent auditors for the year ending December 31,2008; Proposal III – Amendments to the 2001 Stock Option, Deferred Stock, andRestricted Stock Plan; and Proposal IV – Potential Issuance of in excess of 20percent of our outstanding shares of common stock in connection with a possibleexchange of the Company’s Series B Preferred Stock and Series CPreferred Stock.

 

**ProposalI—Election of Directors**

 

Theresults of voting on these proposals are as follows:

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

 

All directors are elected at our annual stockholdersmeeting.

 

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

 

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

 

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

 

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

 

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

 

 Proposal IV was approved with 39,499,182 shares voted for, 2,573,181voted against and 318,320 abstained from voting, thereby approving the potential issuance of in excess of 20 percentof our outstanding shares of common stock in connection with a possibleexchange of the Company’s Series B Preferred Stock and Series CPreferred Stock.

 

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**ITEM 6:          EXHIBITS**

 

(a)   Exhibits:

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

 

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*         This exhibit shall not be deemed “filed” forpurposes of Section 18 of the Securities Exchange Act of 1934 or otherwisesubject to the liabilities of that section, nor shall it be deemed incorporatedby reference in any filing under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, whether made before or after the date hereof andirrespective of any general incorporation language in any filings.

 

**SIGNATURES**

 

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

 

**IMPAC MORTGAGE HOLDINGS, INC.**

 
| /s/  Todd R. Taylor                                                 |   |
|---------------------------------------------------------------------|--------|
| by:  Todd R. Taylor                                                 |
| Interim  Chief Financial Officer                                    |
| (authorized  officer of registrant and principal financial officer) |
|                                                                |
| Date:  September 15, 2008                                      |

 

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