Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2010**

 

**or**

 

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

 

**For the transition periodfrom           to            .**

 

**CommissionFile Number: 1-14100**

 

**IMPACMORTGAGE HOLDINGS, INC.**

(Exact name of registrant asspecified in its charter)

 

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

 

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

(Address of principalexecutive offices)

 

**(949) 475-3600**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorterperiod that the registrant was required to submit and post suchfiles). Yes o  No o

 

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

 

| Large accelerated filer o      |   | Accelerated filer  ̈         |
|-----------------------------------------------|--------|--------------------------------------------|
|                                          |   |                                       |
| Non-accelerated filer o             |   | Smaller reporting company x |
| (Do not check if a smaller reporting company) |   |                                       |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Exchange Act Rule 12b-2) Yes o  No x

 

There were 7,768,748 shares of common stock outstanding as ofNovember 12, 2010.

 

 

 

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**IMPACMORTGAGE HOLDINGS, INC.**

 

**FORM 10-QQUARTERLY REPORT**

**TABLE OF CONTENTS**

 
| ** ** | ** **                                                                                                              | ** ** | **Page** |
|------------|-------------------------------------------------------------------------------------------------------------------------|------------|----------|
|       | ***PART I.  FINANCIAL INFORMATION***                                                                               |       |     |
|       |                                                                                                                    |       |     |
| ITEM 1.    | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                  |       |     |
|       | Consolidated Balance Sheets as of September 30,  2010 (unaudited) and December 31, 2009                       |       | 1        |
|       | Consolidated Statements of Operations for the Three  and Nine Months Ended September 30, 2010 and 2009 (unaudited) |       | 2        |
|       | Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2010  and 2009 (unaudited)          |       | 3        |
|       | Notes to Unaudited Consolidated Financial Statements                                                                    |       | 4        |
|       |                                                                                                                    |       |     |
| ITEM 2.    | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                         |       |     |
|       |                                                                                                                    |       |     |
|       | Forward-Looking Statements                                                                                              |       | 21       |
|       | The Mortgage Industry and Discussion of Relevant  Fiscal Periods                                                        |       | 21       |
|       | Status of Operations, Liquidity and Capital Resources                                                                   |       | 21       |
|       | Market Conditions                                                                                                       |       | 24       |
|       | Critical Accounting Policies                                                                                            |       | 27       |
|       | Income Taxes                                                                                                            |       | 28       |
|       | Selected Financial Results for the Three Months Ended  September 30, 2010                                          |       | 28       |
|       | Selected Financial Results for the Nine Months Ended  September 30, 2010                                           |       | 28       |
|       | Financial Condition and Results of Operations                                                                           |       | 29       |
|       |                                                                                                                    |       |     |
| ITEM 3.    | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                         |       | 45       |
|       |                                                                                                                    |       |     |
| ITEM 4.    | **CONTROLS AND  PROCEDURES**                                                                                            |       | 45       |
|       |                                                                                                                    |       |     |
|       | ***PART II.  OTHER INFORMATION***                                                                                  |       |     |
|       |                                                                                                                    |       |     |
| ITEM 1.    | **LEGAL  PROCEEDINGS**                                                                                                  |       | 46       |
|       |                                                                                                                    |       |     |
| ITEM 1A.   | **RISK  FACTORS**                                                                                                       |       | 46       |
|       |                                                                                                                    |       |     |
| ITEM 2.    | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                        |       | 47       |
|       |                                                                                                                    |       |     |
| ITEM 3.    | **DEFAULTS  UPON SENIOR SECURITIES**                                                                                    |       | 47       |
|       |                                                                                                                    |       |     |
| ITEM 4.    | **RESERVED**                                                                                                            |       | 47       |
|       |                                                                                                                    |       |     |
| ITEM 5.    | **OTHER  INFORMATION**                                                                                                  |       | 47       |
|       |                                                                                                                    |       |     |
| ITEM 6.    | **EXHIBITS**                                                                                                            |       | 47       |
|       |                                                                                                                    |       |     |
|       | **SIGNATURES**                                                                                                          |       | 48       |
|       |                                                                                                                    |       |     |
|       | **CERTIFICATIONS**                                                                                                      |       |     |

 

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Tableof Contents

 

**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.          CONSOLIDATED FINANCIALSTATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                                                                                | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                | ** ** | ** **             |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                 |       | $                      | 10,601     |                  | $          | 25,678 |   |
| Restricted cash                                                                                                                                                                                                                                           |       | 1,003                  |       | 1,253                 |       |
| Short-term investments                                                                                                                                                                                                                                    |       | —                 |       | 5,002                 |       |
| Trust assets                                                                                                                                                                                                                                              |       |                   |       |                  |       |
| Investment securities available-for-sale                                                                                                                                                                                                                  |       | 1,254                  |       | 813                   |       |
| Securitized mortgage collateral                                                                                                                                                                                                                           |       | 6,070,577              |       | 5,666,122             |       |
| Derivative assets                                                                                                                                                                                                                                         |       | 39                     |       | 146                   |       |
| Real estate owned                                                                                                                                                                                                                                         |       | 106,042                |       | 142,364               |       |
| Total trust assets                                                                                                                                                                                                                                        |       | 6,177,912              |       | 5,809,445             |       |
|                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Assets of discontinued operations                                                                                                                                                                                                                         |       | 672                    |       | 4,480                 |       |
| Other assets                                                                                                                                                                                                                                              |       | 30,429                 |       | 27,054                |       |
| Total assets                                                                                                                                                                                                                                              |       | $                      | 6,220,617  |                  | $          | 5,872,912 |   |
|                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                                                                           |       |                   |       |                  |       |
| Trust liabilities                                                                                                                                                                                                                                         |       |                   |       |                  |       |
| Securitized mortgage borrowings                                                                                                                                                                                                                           |       | $                      | 6,061,000  |                  | $          | 5,659,865 |   |
| Derivative liabilities                                                                                                                                                                                                                                    |       | 89,028                 |       | 126,603               |       |
| Total trust liabilities                                                                                                                                                                                                                                   |       | 6,150,028              |       | 5,786,468             |       |
|                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Long-term debt                                                                                                                                                                                                                                            |       | 10,822                 |       | 9,773                 |       |
| Note payable                                                                                                                                                                                                                                              |       | 8,125                  |       | 31,060                |       |
| Liabilities of discontinued operations                                                                                                                                                                                                                    |       | 14,125                 |       | 19,152                |       |
| Other liabilities                                                                                                                                                                                                                                         |       | 11,284                 |       | 11,026                |       |
| Total liabilities                                                                                                                                                                                                                                         |       | 6,194,384              |       | 5,857,479             |       |
|                                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| 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% redeemable preferred stock,  $0.01 par value; liquidation value $16,639; 2,000,000 shares authorized,  665,592 noncumulative shares issued and outstanding as of September 30,  2010 and December 31, 2009, respectively   |       | 7                      |       | 7                     |       |
| Series C 9.125% redeemable preferred stock,  $0.01 par value; liquidation value $35,127; 5,500,000 shares authorized;  1,405,086 noncumulative shares issued and outstanding as of  September 30, 2010 and December 31, 2009, respectively |       | 14                     |       | 14                    |       |
| Common stock, $0.01 par value; 200,000,000 shares  authorized; 7,768,746 and 7,698,146 shares issued and outstanding as of  September 30, 2010 and December 31, 2009, respectively                                                              |       | 78                     |       | 77                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                |       | 1,076,328              |       | 1,075,707             |       |
| Net accumulated deficit:                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Cumulative dividends declared                                                                                                                                                                                                                             |       | (822,520               | )          | (822,520              | )          |
| Retained deficit                                                                                                                                                                                                                                          |       | (227,674               | )          | (237,852              | )          |
| Net accumulated deficit                                                                                                                                                                                                                                   |       | (1,050,194             | )          | (1,060,372            | )          |
| Total stockholders’ equity                                                                                                                                                                                                                           |       | 26,233                 |       | 15,433                |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                           |       | $                      | 6,220,617  |                  | $          | 5,872,912 |   |

 

See accompanying notes toconsolidated financial statements.

 

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                      | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                      | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                                      | ** ** | **2010**                                | ** ** | **2009**                               | ** ** | **2010** | ** ** | **2009** | ** ** |
| * *                                                                                        | * *   | * *                                | * *   | * *                               | * *   | * * | * * | * * | * * |
| **INTEREST INCOME**                                                                             |       | $                                       | 230,927    |                                   | $          | 341,323 |   | $ | 759,016 |   | $ | 1,508,230 |   |
| **INTEREST EXPENSE**                                                                            |       | 229,256                                 |       | 339,417                                |       | 755,020 |   | 1,499,729 |   |
| Net interest income                                                                             |       | 1,671                                   |       | 1,906                                  |       | 3,996 |   | 8,501 |   |
|                                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST INCOME:**                                                                        |       |                                    |       |                                   |       |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO                                        |       | 9,573                                   |       | 46,325                                 |       | 12,701 |   | 234,167 |   |
| Losses from REO                                                                                 |       | (10,147                                 | )          | (43,160                                | )          | (6,290 | ) | (218,083 | ) |
| Non-interest (loss) income - net trust assets                                                   |       | (574                                    | )          | 3,165                                  |       | 6,411 |   | 16,084 |   |
|                                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Change in fair value of long-term debt                                                          |       | 1,168                                   |       | 341                                    |       | 952 |   | 682 |   |
| Mortgage and real estate services fees                                                          |       | 15,521                                  |       | 13,514                                 |       | 42,523 |   | 32,296 |   |
| Other                                                                                           |       | 39                                      |       | (107                                   | )          | (56 | ) | (333 | ) |
| Total non-interest income                                                                       |       | 16,154                                  |       | 16,913                                 |       | 49,830 |   | 48,729 |   |
|                                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST EXPENSE:**                                                                       |       |                                    |       |                                   |       |   |   |   |   |
| General and administrative                                                                      |       | 4,869                                   |       | 4,603                                  |       | 14,278 |   | 15,053 |   |
| Personnel expense                                                                               |       | 10,683                                  |       | 9,413                                  |       | 31,132 |   | 26,050 |   |
| Total non-interest expense                                                                      |       | 15,552                                  |       | 14,016                                 |       | 45,410 |   | 41,103 |   |
| Earnings from continuing operations before income  taxes                                        |       | 2,273                                   |       | 4,803                                  |       | 8,416 |   | 16,127 |   |
| Income tax expense from continuing operations                                                   |       | 14                                      |       | —                                 |       | 143 |   | 2,018 |   |
| Earnings from continuing operations                                                             |       | 2,259                                   |       | 4,803                                  |       | 8,273 |   | 14,109 |   |
| (Loss) earnings from discontinued operations, net  of tax                                       |       | (1,285                                  | )          | (1,776                                 | )          | 1,905 |   | (8,366 | ) |
| Net earnings                                                                                    |       | 974                                     |       | 3,027                                  |       | 10,178 |   | 5,743 |   |
| Cash dividends on preferred stock                                                               |       | —                                  |       | —                                 |       | — |   | (7,443 | ) |
| Earnings (loss) available to common stockholders  before redemption of preferred stock (Note 4) |       | $                                       | 974        |                                   | $          | 3,027 |   | $ | 10,178 |   | $ | (1,700 | ) |
|                                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Earnings (loss) per common share - basic:                                                       |       |                                    |       |                                   |       |   |   |   |   |
| Earnings from continuing operations                                                             |       | $                                       | 0.29       |                                   | $          | 0.63 |   | $ | 1.07 |   | $ | 0.88 |   |
| (Loss) earnings from discontinued operations                                                    |       | (0.16                                   | )          | (0.23                                  | )          | 0.25 |   | (1.10 | ) |
| Earnings (loss) available to common stockholders  before redemption of preferred stock (Note 4) |       | $                                       | 0.13       |                                   | $          | 0.40 |   | $ | 1.32 |   | $ | (0.22 | ) |
|                                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Earnings (loss) per common share - diluted:                                                     |       |                                    |       |                                   |       |   |   |   |   |
| Earnings from continuing operations                                                             |       | $                                       | 0.27       |                                   | $          | 0.60 |   | $ | 0.99 |   | $ | 0.88 |   |
| (Loss) earnings from discontinued operations                                                    |       | (0.15                                   | )          | (0.22                                  | )          | 0.23 |   | (1.10 | ) |
| Earnings (loss) available to common stockholders  before redemption of preferred stock (Note 4) |       | $                                       | 0.12       |                                   | $          | 0.38 |   | $ | 1.22 |   | $ | (0.22 | ) |

 

See accompanying notes toconsolidated financial statements

 

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
| ** **                                                                                  | ** ** | **For the Nine Months** | ** **   |
|---------------------------------------------------------------------------------------------|------------|----------------------------------------|--------------|
| ** **                                                                                  | ** ** | **Ended September 30,**      | ** **   |
| ** **                                                                                  | ** ** | **2010**                               | ** **   | **2009** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                  |       |                                   | *** *** | *** *** | *** *** |
| Net Earnings                                                                                |       | $                                      | 10,178       |   | $ | 5,743 |   |
|                                                                                        |       |                                   |         |   |   |
| Losses from real estate owned                                                               |       | 6,290                                  |         | 218,083 |   |
| Amortization and impairment of deferred charge,  net                                        |       | —                                 |         | 1,998 |   |
| Change in fair value of net trust assets,  excluding REO                                    |       | (101,706                               | )            | (392,962 | ) |
| Change in fair value of long-term debt                                                      |       | (952                                   | )            | (682 | ) |
| Accretion of interest income and expense                                                    |       | 307,710                                |         | 553,813 |   |
| Stock-based compensation                                                                    |       | 472                                    |         | 3,297 |   |
| Change in REO impairment reserve                                                            |       | (12,462                                | )            | (106,021 | ) |
| Net change in other assets and liabilities                                                  |       | (3,338                                 | )            | 3,051 |   |
| Net cash (used in) provided by operating  activities of discontinued operations             |       | (3,226                                 | )            | 20,956 |   |
| **Net cash provided by operating  activities**                                              | ** ** | **202,966**                            | ** **   | **307,276** | ** ** |
| ** **                                                                                  | ** ** | ** **                             | ** **   | ** ** | ** ** |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                  |       |                                   | ** **   | ** ** | ** ** |
| Net change in securitized mortgage collateral                                               |       | 563,708                                |         | 663,938 |   |
| Net change in mortgages held-for-investment                                                 |       | 148                                    |         | 406 |   |
| Purchase of premises and equipment                                                          |       | (1,274                                 | )            | (378 | ) |
| Maturity (purchase) of short-term investments                                               |       | 5,000                                  |         | (5,041 | ) |
| Net principal change on investment securities  available-for-sale                           |       | 117                                    |         | 3,889 |   |
| Proceeds from the sale of real estate owned                                                 |       | 175,707                                |         | 596,423 |   |
| Net cash provided by investing activities of  discontinued operations                       |       | 1,907                                  |         | 14,148 |   |
| **Net cash provided by investing  activities**                                              | ** ** | **745,313**                            | ** **   | **1,273,385** | ** ** |
|                                                                                        |       |                                   |         |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                  |       |                                   |         |   |   |
| Repayment of warehouse borrowings                                                           |       | (580                                   | )            | — |   |
| Borrowings under warehouse agreement                                                        |       | 2,024                                  |         | — |   |
| Settlement of trust preferred securities                                                    |       | —                                 |         | (4,275 | ) |
| Repurchase of preferred stock                                                               |       | —                                 |         | (1,259 | ) |
| Preferred stock dividends paid                                                              |       | —                                 |         | (7,443 | ) |
| Principal payments on notes payable                                                         |       | (22,935                                | )            | — |   |
| Repayment of securitized mortgage borrowings                                                |       | (941,985                               | )            | (1,537,530 | ) |
| Proceeds from exercise of stock options                                                     |       | 20                                     |         | — |   |
| Net cash used in financing activities of  discontinued operations                           |       | —                                 |         | (37,622 | ) |
| **Net cash used in financing  activities**                                                  | ** ** | **(963,456**                           | **)**        | **(1,588,129** | **)** |
|                                                                                        |       |                                   |         |   |   |
| Net change in cash and cash equivalents                                                     |       | (15,177                                | )            | (7,468 | ) |
| Cash and cash equivalents at beginning of period                                            |       | 25,850                                 |         | 46,228 |   |
| Cash and cash equivalents at end of period -  Continuing Operations                         |       | 10,601                                 |         | 37,893 |   |
| Cash and cash equivalents at end of period -  Discontinued Operations                       |       | 72                                     |         | 867 |   |
| Total cash and cash equivalents at end of period                                            |       | $                                      | 10,673       |   | $ | 38,760 |   |
|                                                                                        |       |                                   |         |   |   |
| **NON-CASH TRANSACTIONS (Continuing  and Discontinued Operations):**                        |       |                                   |         |   |   |
| Common stock issued per marketing service  agreement                                        |       | $                                      | 129          |   | $ | — |   |
| Transfer of loans held-for-sale and  held-for-investment to real estate owned               |       | —                                 |         | 12,540 |   |
| Transfer of securitized mortgage collateral to  real estate owned                           |       | 129,907                                |         | 279,368 |   |
| Net effect of consolidation of net trust assets  from adoption of accounting principle      |       | 119,631                                |         | — |   |
| Net effect of consolidation of net trust  liabilities from adoption of accounting principle |       | (119,631                               | )            | — |   |

 

See accompanying notes toconsolidated financial statements.

 

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

**NOTES TOUNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

**(dollars in thousands, except share and per share dataor as otherwise indicated)**

 

**Note 1.—Summary of Business, Financial StatementPresentation, Market Conditions and Liquidity**

 

***Business Summary***

 

Impac Mortgage Holdings, Inc. (the Company or IMH) is a Marylandcorporation incorporated in August 1995 and has the followingsubsidiaries: Integrated Real Estate Service Corporation (IRES), IMHAssets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG)and Impac Funding Corporation (IFC).

 

The Company’s continuing operations include the long-term mortgageportfolio (residual interests in securitizations determined as total trustassets minus total trust liabilities in the consolidated balance sheets) andthe mortgage and real estate fee-based business activities conducted by IRES.The discontinued operations include the former non-conforming mortgage andretail operations conducted by IFC and subsidiaries, and warehouse lendingoperations conducted by IWLG.

 

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

 

***Financial Statement Presentation***

 

The accompanying unaudited consolidated financial statements of IMH andits subsidiaries (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 8-03 of Regulation S-X. Accordingly, they do not include allof the information and footnotes required by GAAP for complete financial statements.In the opinion of management, all adjustments, consisting of normal recurringadjustments considered necessary for a fair presentation, have been included.Operating results for the three and nine months ended September 30, 2010are not necessarily indicative of the results that may be expected for the yearending December 31, 2010. These interim period condensed consolidatedfinancial statements should be read in conjunction with the Company’s auditedconsolidated financial statements, which are included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2009, filed withthe United States Securities and Exchange Commission (SEC).

 

All significant inter-company balances and transactions have beeneliminated in consolidation. In addition, certain amounts in the prior periods’consolidated financial statements have been reclassified to conform to thecurrent year presentation.

 

Management has made a number of estimates and assumptions relating tothe reporting of assets and liabilities, the disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period to prepare theseconsolidated financial statements in conformity with GAAP. The items affectedby such estimates and assumptions include the valuation of trust assets andtrust liabilities, the estimated obligation of repurchase liabilities relatedto sold loans, the valuation of long-term debt and the carrying amount andevaluation of impairment of loans held-for-sale. Actual results could differfrom those estimates and assumptions.

 

***Recently Adopted AccountingPronouncements***

 

In February 2010, the FASB issued Accounting Standards Update(ASU) No. 2010-9 “Amendments to Certain Recognition and DisclosureRequirements” (ASU 2010-9). The ASU amends FASB Accounting StandardsCodification Topic 855 “Subsequent Events” to address certain implementationissues related to an entity’s requirement to perform and disclose subsequentevents procedures. ASU 2010-9 requires (a) SEC filers and (b) conduitdebt obligors for conduit debt securities that are traded in a public market toevaluate subsequent events through the date the financial statements areissued. All other entities are required to evaluate subsequent events throughthe date the financial statements are available to be issued. ASU 2010-9exempts SEC filers from disclosing the date through which subsequent eventshave been evaluated. For the Company, ASU 2010-9 is effective immediately forfinancial statements that are to be issued or revised. The adoption of ASU2010-9 did not have an impact on the Company’s consolidated financialstatements.

 

In January 2010, the FASB issued Accounting Standards Update (ASU)No. 2010-6 “Improving Disclosures About Fair Value Measurements” (ASU2010-6). The ASU amends Codification Topic 820 “Fair Value Measurements andDisclosures” to add new disclosure requirements for transfers into and out ofLevels 1 and 2 fair value measurements, as well as separate disclosuresabout purchases, sales, issuances, and settlements relating to Level 3fair value measurements. ASU 2010-6 also clarifies existing fair valuedisclosures regarding the level of disaggregation and inputs and valuationtechniques used to measure fair value. ASU 2010-6 is effective for the firstreporting period (including interim periods) beginning after December 15,2009, except for the requirement to provide the Level 3 activity ofpurchases, sales, issuances, and settlements on a gross basis, which will beeffective for fiscal years beginning after December 15, 2010, and forinterim periods within those fiscal years. ASU 2010-6 only adds new disclosuresrequirements and as a result, its adoption did not have an impact on theCompany’s consolidated financial statements.

 

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In June 2009, the FASB issued SFAS No. 166, “Accounting forTransfers of Financial Assets—An Amendment of FASB Statement 140” whicheliminates the concept of qualifying special purpose entity’s (QSPEs) andprovides additional criteria transferors must use to evaluate transfers offinancial assets. This standard modifies certain guidance contained in FASB ASC860 “Transfers and Servicing” and is adopted into the Codification through theissuance of ASU 2009-16 “Transfers and Servicing (Topic 860): Accounting forTransfers of Financial Assets.” In order to determine whether a transfer isaccounted for as a sale, the transferor must assess whether it and all of itsconsolidated entities have surrendered control of the financial assets. Thestandard also requires financial assets and liabilities retained from atransfer accounted for as a sale to be initially recognized at fair value. TheCompany adopted this standard effective January 1, 2010 with no impact onits consolidated financial statements.

 

In June 2009, the FASB issued SFAS No. 167, “Amendments toFASB Interpretation No. 46(R),” which amends several key consolidationprovisions related to variable interest entities (VIEs). This standard amendsguidance contained in FASB ASC 810 “Consolidation” and is adopted into theCodification through the issuance of ASU 2009-17 “Consolidations (Topic 810): Improvementsto Financial Reporting by Enterprises Involved with Variable Interest Entities.”Former QSPEs will be evaluated for consolidation based on the provisions ofFASB ASC 810-10-25, which changes the approach to determining a VIE’s primarybeneficiary and requires companies to more frequently reassess whether theymust consolidate or deconsolidate VIEs. The accounting standard requires aqualitative, rather than quantitative, analysis to determine the primarybeneficiary of a VIE for consolidation purposes. The primary beneficiary of aVIE is the enterprise that has (a) the power to direct the VIE activitiesthat most significantly affect the VIE’s economic performance, and (b) theright to receive benefits of the VIE that could potentially be significant tothe VIE or the obligation to absorb losses of the VIE that could potentially besignificant to the VIE. This standard is effective for fiscal years and interimperiods beginning after November 15, 2009 and applies to all current QSPEsand VIEs, and all VIEs created after the effective date. In accordance withthis standard, the Company may consolidate QSPEs and VIEs at carrying value orelect the fair value option. The Company intends to elect the fair valueoption, in which all of the financial assets and liabilities of certaindesignated QSPEs and VIEs would be recorded at fair value upon the adoption ofthis standard and continue to be recorded at fair value thereafter with changesin fair value reported in earnings.

 

In connection with the adoption of this standard on January 1,2010, the Company consolidated $253.7 million of trust assets and trustliabilities at fair value.  Additionally,the Company deconsolidated $134.1 million of trust assets and liabilities atfair value. The following is a summary of the impact of adopting the newconsolidation provisions of FASB ASC 810.

 
| ** **                               | ** ** | **(prior to adoption)** | ** ** | ** **                               | ** ** | ** **          | ** ** | **(after adoption)** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|---------------------|------------|---------------------------|------------|
| ** **                               | ** ** | **December 31,**             | ** ** | **Variable Interest Entities** | ** ** | **January 1,** | ** ** |
| ** **                               | ** ** | **2009**                          | ** ** | **Consolidated**                         | ** ** | **Deconsolidated**  | ** ** | **2010**                  | ** ** |
| Investment securities available-for-sale |       | $                                 | 813        |                                     | $          | (298                | )          | $                         | —     |   | $ | 515 |   |
| Securitized mortgage collateral          |       | 5,666,122                         |       | 249,523                                  |       | (132,615            | )          | 5,783,030                 |       |
| REO                                      |       | 142,364                           |       | 4,499                                    |       | (1,478              | )          | 145,385                   |       |
| Securitized mortgage borrowings          |       | (5,649,865                        | )          | (244,683                                 | )          | 134,065             |       | (5,760,483                | )          |
| Derivative liabilities, net              |       | (126,457                          | )          | (9,041                                   | )          | 28                  |       | (135,470                  | )          |
| Net trust assets                         |       | $                                 | 32,977     |                                     | —     |                | —     |                      | $          | 32,977 |   |
|                                          |            |                                   |            |                                          |            |                     |            |                           |            |  |  |  |  |

 

There was no overall impact on stockholders’ equity as a result of theconsolidation and deconsolidation of these trust assets and liabilities onJanuary 1, 2010.

 

***Income Taxes and Deferred Charge***

 

Effective January 1, 2009, the Company revoked its election to betaxed as a REIT. As a result of revoking this election, the Company is subjectto income taxes as a regular (Subchapter C) corporation.

 

The Company recorded income tax expense of $14 thousand and $143thousand for the three and nine months ended September 30, 2010,respectively. Income tax expense for the three and nine months ended September 30,2009 was zero and $2.0 million, respectively.  The income tax expense for 2010 is the result of state incometaxes.  The income tax expense for 2009is primarily the result of the amount of the deferred charge amortized and/orimpaired resulting from credit losses, which does not result in any taxliability required to be paid. The deferred charge represents the deferral ofincome tax expense on inter-company profits that resulted from the sale ofmortgages from taxable subsidiaries to IMH in prior years. The deferred chargeis included in other assets in the accompanying consolidated balance sheets andis amortized as a component of income tax expense in the accompanyingconsolidated statement of operations over the estimated life of the mortgagesretained in the securitized mortgage collateral.

 

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As of December 31, 2009, the Company had estimated federal andCalifornia net operating loss carryforwards in the amount of $835.8 millionand $837.3 million, respectively, of which $277.6 million (federal)relate to discontinued operations. Federal and state net operating loss (NOL) carryforwards begin to expirein 2020 and 2013, respectively.  TheCompany recorded a full valuation allowance against the deferred tax assets asit believes that as of September 30, 2010 it is more likely than not thatthe deferred tax assets will not be recoverable.

 

During the fourth quarter of 2009, the Company received a federalincome tax refund in the amount of $8.9 million as a result of an electionto carryback NOLs five years pursuant to 2009 federal legislation, *The Worker, Homeownership, and Business AssistanceAct of 2009*.   The Companyfiles income tax returns in the U.S. federal and various statejurisdictions.  The Company is subject toroutine income tax audits in the various jurisdictions.  A subsidiary of the Company is currentlyunder examination by the Internal Revenue Service for tax year 2008.  Management believes that there are nounresolved issues or claims likely to be material to our financialposition.  As of September 30, 2010,the Company has no material uncertain tax positions.

 

***Repurchase Reserve***

 

When the Company sells loans through whole loan sales it is required tomake normal 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. The repurchase reserve is an estimate of losses from expectedrepurchases, and is based, in part, on the recent settlement of claims.  During the third quarter, consistent withother mortgage lenders, the Company received repurchase requests from FannieMae for loans funded primarily in 2007 resulting in a repurchase reserve of$8.7 million at September 30, 2010 as compared to $11.0 million atDecember 31, 2009.

 

***Legal Proceedings***

 

The Company is party to litigation and claims which arise in theordinary course of business.

 

Pleaserefer to IMH’s reports on Form 10-K for the year ended December 31,2009 and Forms 10-Q for the quarters ended June 30, 2010 and March 31,2010 for a description of litigation and claims.

 

***Market Conditions and Liquidity***

 

The housing market showedsigns of improvement earlier in the year as housing prices were stabilizing inmany markets and began to recover in others due to the low interest rateenvironment and the first-time homebuyer tax credit.  Since the expiration of the homebuyer taxcredit in May 2010, home sales have declined in the third quarter of 2010and inventory levels have increased.  Thehousing market is not expected to improve until job and income growth increase.

 

Mortgage and credit marketconditions remained weak in the third quarter of 2010 due primarily to acontinued weak labor market. Existing uncertainties surrounding the housingmarket, economy and regulatory environment will continue to present challengesfor the Company.  The ongoing economicstress or further deterioration of general economic conditions could prolong orincrease borrower defaults leading to deteriorating performance of the Company’sportfolio.

 

A number of factors make itdifficult to predict when a sustained recovery in the housing and creditmarkets will occur.  Concerns about thefuture of the U.S. economy, including the pace and magnitude of recoveryfrom the recent economic recession, consumer confidence, volatility in energyprices, volatility experienced by the credit markets including the possibilitythat the recent European sovereign debt crisis will spread and trends incorporate earnings will continue to influence the U.S. economic recoveryand the capital markets. In particular, improvement in unemployment rates and asustained recovery of the housing market remain critical components of abroader U.S. economic recovery. Further weakening in these components aswell as in consumer confidence may result in additional deterioration inconsumer payment patterns and credit quality. Although consumer confidence hasimproved from the levels seen early in 2009, it remains low on a historicalbasis. Weak consumer fundamentals, including declines in wage income, reducedconsumer spending, declines in wealth and a difficult job market continue todepress consumer confidence. Additionally, there is uncertainty related to therecently announced monetary policy under the Federal government’s quantitativeeasing program and uncertainty as to the impact on the economy and consumerconfidence whether the remaining actions taken by the government will restorefaith in the capital markets and stimulate consumer spending. These conditionsin combination with general economic weakness and the impact of recent andproposed regulatory changes will continue to affect our results of operations,the degree of which is largely dependent upon the nature and timing of theeconomic recovery.

 

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The ability to meet our long-term liquidity requirements is subject toseveral factors, such as generating fees from our mortgage and real estatefee-based business activities and realizing cash flows from our long-termmortgage portfolio. Our future financial performance and success are dependentin large part upon our ability to grow our mortgage and real estate fee-basedbusiness activities, including providing services to third parties andexpanding our mortgage lending operations.  We believe that current cash balances, cash flows from mortgage and realestate services fees generated from our long-term mortgage portfolio, andresidual interest cash flows from our long-term mortgage portfolio are adequatefor our current operating needs. However, the mortgage and real estate servicesmarket is volatile, highly competitive and subject to increased regulation. TheCompany’s ability to successfully compete in the mortgage and real estateservices industry may be challenging as its business activities are recentlyestablished and many competitors have recently entered or have establishedbusinesses delivering similar services. Additionally, the mortgagelending environment is extremely competitive and highly regulated.  Thefuture success of our mortgage lending operations will depend on a number offactors, including how well we compete, housing market conditions, economicrecovery and financial regulatory reform. If we are unsuccessful, we may be unable to satisfy our futureoperating costs and liabilities, including repayment of the note payable andlong-term debt.

 

**Note 2.—Fair Value of Financial Instruments**

 

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.

 

For securitized mortgage collateral and securitized mortgageborrowings, the underlying Alt-A residential and commercial loans andmortgage-backed securities market have experienced significant declines inmarket activity, along with a lack of orderly transactions. The Company’smethodology to estimate fair value of these assets and liabilities include theuse of internal pricing techniques such as the net present value of future expectedcash flows (with observable market participant assumptions, where available)discounted at a rate of return based on the Company’s estimates of marketparticipant requirements. The significant assumptions utilized in theseinternal pricing techniques, which are based on the characteristics of theunderlying collateral, include estimated credit losses, estimated prepaymentspeeds and appropriate discount rates.The following table presents theestimated fair value of financial instruments included in the consolidatedfinancial statements as of the dates indicated:

 
| ** **                               | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **Carrying  Amount**             | ** ** | **Estimated  Fair Value**  | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
| **Assets**                               |       |                             |       |                            |       |   |   |   |   |
| Cash and cash equivalents                |       | $                                | 10,601     |                            | $          | 10,601 |   | $ | 25,678 |   | $ | 25,678 |   |
| Restricted cash                          |       | 1,003                            |       | 1,003                           |       | 1,253 |   | 1,253 |   |
| Short-term investments                   |       | —                           |       | —                          |       | 5,002 |   | 5,002 |   |
| Investment securities available-for-sale |       | 1,254                            |       | 1,254                           |       | 813 |   | 813 |   |
| Securitized mortgage collateral          |       | 6,070,577                        |       | 6,070,577                       |       | 5,666,122 |   | 5,666,122 |   |
| Derivative assets                        |       | 39                               |       | 39                              |       | 146 |   | 146 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| **Liabilities**                          |       |                             |       |                            |       |   |   |   |   |
| Securitized mortgage borrowings          |       | 6,061,000                        |       | 6,061,000                       |       | 5,659,865 |   | 5,659,865 |   |
| Derivative liabilities                   |       | 89,028                           |       | 89,028                          |       | 126,603 |   | 126,603 |   |
| Long-term debt                           |       | 10,822                           |       | 10,822                          |       | 9,773 |   | 9,773 |   |
| Note payable                             |       | 8,125                            |       | 7,911                           |       | 31,060 |   | 27,789 |   |
|                                          |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

The fair value amounts above have been estimated by management usingavailable market information and appropriate valuation methodologies.Considerable judgment is required to interpret market data to develop the estimatesof fair value in both inactive and orderly markets. Accordingly, the estimatespresented are not necessarily indicative of the amounts that could be realizedin a current market exchange. The use of different market assumptions and/orestimation methodologies may have a material effect on the estimated fair valueamounts.

 

The carrying amount of cash and cash equivalents and restricted cashapproximates fair value. The fair value of short-term investments wasdetermined using quoted prices in active markets.

 

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Refer to *Recurring Fair ValueMeasurements* below for a description of the valuation methods usedto determine the fair value of investment securities available for sale,securitized mortgage collateral and borrowings, derivative assets andliabilities and long-term debt.

 

Note payable is recorded at amortized cost. Fair value of note payableis determined using a discounted cash flow model which factors in expectedchanges in interest rates and the Company’s own credit risk.

 

***Fair Value Hierarchy***

 

The application of fair value measurements may be on a recurring ornonrecurring basis depending on the accounting principles applicable to thespecific asset or liability or whether management has elected to carry the itemat its estimated fair value.

 

FASB ASC 820-10-35 specifies a hierarchy of valuation techniques basedon whether the inputs to those techniques are observable or unobservable.Observable inputs reflect market data obtained from independent sources, whileunobservable inputs reflect the Company’s market assumptions. These two typesof inputs create the following fair value hierarchy:

 

·                  Level 1—Quoted prices(unadjusted) in active markets for identical instruments or liabilities that anentity has the ability to assess at measurement date.

 

·                  Level 2—Quoted pricesfor similar instruments in active markets; quoted prices for identical orsimilar instruments in markets that are not active; inputs other than quotedprices that are observable for an asset or liability, including interest ratesand yield curves observable at commonly quoted intervals, prepayment speeds,loss severities, credit risks and default rates; and market-corroboratedinputs.

 

·                  Level 3—Valuationsderived from valuation techniques in which one or more significant inputs orsignificant value drivers are unobservable.

 

This hierarchy requires the Company to use observable market data, whenavailable, and to minimize the use of unobservable inputs when estimating fairvalue.

 

As a result of the lack of observable market data resulting frominactive markets, the Company has classified its investment securitiesavailable-for-sale, securitized mortgage collateral and borrowings, net derivativeliabilities and long-term debt as Level 3 fair value measurements atSeptember 30, 2010 and December 31, 2009. Level 3 assets andliabilities were 100% of total assets and total liabilities measured atestimated fair value at September 30, 2010 and December 31, 2009.

 

***Recurring Fair Value Measurements***

 

We assess our financial instruments on a quarterly basis to determinethe appropriate classification within the fair value hierarchy, as defined byASC Topic 810. Transfers between fair value classifications occur when thereare changes in pricing observability levels. Transfers of financial instrumentsamong the levels occur at the beginning of the reporting period. There were nomaterial transfers between our Level 1 and Level 2 classified instruments duringthe three and nine months ended September 30, 2010.  The adoption of ASU 2009-17 resulted in theCompany consolidating and deconsolidating certain trust assets and liabilitiesat fair value as of January 1, 2010. The details of the effect of the adoption of this standard areillustrated in Note 1.—Summary ofBusiness, Significant Accounting Policies and Legal Proceedings.

 

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The following tables present the Company’s assets and liabilities thatare measured at estimated fair value on a recurring basis, including financialinstruments for which the Company has elected the fair value option atSeptember 30, 2010 and December 31, 2009, based on the fair valuehierarchy:

 
| ** **                               | ** ** | **Recurring Fair Value Measurements** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **September 30, 2010**                     | ** ** | **December 31, 2009** | ** ** |
| ** **                               | ** ** | **Level 1**                                     | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                               |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Investment securities available-for-sale |       | $                                                    | —     |   | $ | — |   | $ | 1,254 |   | $ | — |   | $ | — |   | $ | 813 |   |
| Securitized mortgage collateral          |       | —                                               |       | — |   | 6,070,577 |   | — |   | — |   | 5,666,122 |   |
| Total assets at fair value               |       | $                                                    | —     |   | $ | — |   | $ | 6,071,831 |   | $ | — |   | $ | — |   | $ | 5,666,935 |   |
| ** **                               | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Liabilities**                          |       |                                                 |       |   |   |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings          |       | $                                                    | —     |   | $ | — |   | $ | 6,061,000 |   | $ | — |   | $ | — |   | $ | 5,659,865 |   |
| Derivative liabilities, net (1)          |       | —                                               |       | — |   | 88,989 |   | — |   | — |   | 126,457 |   |
| Long-term debt                           |       | —                                               |       | — |   | 10,822 |   | — |   | — |   | 9,773 |   |
| Total liabilities at fair value          |       | $                                                    | —     |   | $ | — |   | $ | 6,160,811 |   | $ | — |   | $ | — |   | $ | 5,796,095 |   |

 

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(1)          At September 30, 2010,derivative liabilities, net included $39 thousand in derivative assets and$89.0 million in derivative liabilities, included within trust assets andtrust liabilities, respectively. At December 31, 2009, derivativeliabilities, net included $146 thousand in derivative assets and$126.6 million in derivative liabilities, included within trust assets andtrust liabilities, respectively.

 

The following tables present a reconciliation for all assets andliabilities measured at estimated fair value on a recurring basis usingsignificant unobservable inputs (Level 3) for the three and nine monthsended September 30, 2010 and 2009:

 
| ** **                                 | ** ** | **Level 3 Recurring Fair Value Measurements**               | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **For the three months ended September 30, 2010** | ** ** |
| ** **                                 | ** ** | **Investment  securities available-  for-sale**                                 | ** ** | **Securitized  mortgage  collateral** | ** ** | **Securitized  mortgage  borrowings** | ** ** | **Derivative  liabilities, net** | ** ** | **Long-term  debt** | ** ** |
| Fair value, June 30, 2010             |       | $                                                                                    | 1,269      |   | $ | 6,215,213 |   | $ | (6,200,592 | ) | $ | (100,723 | ) | $ | (11,357 | ) |
| Total gains (losses) included in earnings: |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Interest income (1)                        |       | 90                                                                                   |       | 120,487 |   | — |   | — |   | — |   |
| Interest expense (1)                       |       | —                                                                               |       | — |   | (203,594 | ) | — |   | (633 | ) |
| Change in fair value                       |       | (66                                                                                  | )          | (44,287 | ) | 66,194 |   | (12,268 | ) | 1,168 |   |
| Total gains (losses) included in earnings  |       | 24                                                                                   |       | 76,200 |   | (137,400 | ) | (12,268 | ) | 535 |   |
| Transfers in and/or out of Level 3         |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Purchases, issuances and settlements       |       | (39                                                                                  | )          | (220,836 | ) | 276,992 |   | 24,002 |   | — |   |
| Fair value, September 30, 2010        |       | $                                                                                    | 1,254      |   | $ | 6,070,577 |   | $ | (6,061,000 | ) | $ | (88,989 | ) | $ | (10,822 | ) |
|                                       |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Unrealized gains (losses) still held (2)   |       | $                                                                                    | 971        |   | $ | (4,949,059 | ) | $ | 6,772,511 |   | $ | (89,889 | ) | $ | 59,941 |   |

 

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(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was $1.7million for the three months ended September 30, 2010, as reflected in theaccompanying consolidated statement of operations.

(2)          Represents the amount ofunrealized gains (losses) relating to assets and liabilities classified asLevel 3 that are still held and reflected in the fair values atSeptember 30, 2010.

 

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| ** **                                 | ** ** | **Level 3 Recurring Fair Value Measurements**               | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **For the three months ended September 30, 2009** | ** ** |
| ** **                                 | ** ** | **Investment  securities available-  for-sale**                                 | ** ** | **Securitized  mortgage  collateral** | ** ** | **Securitized  mortgage  borrowings** | ** ** | **Derivative  liabilities, net** | ** ** | **Long-term  debt** | ** ** |
| Fair value, June 30, 2009             |       | $                                                                                    | 1,332      |   | $ | 6,018,391 |   | $ | (6,080,637 | ) | $ | (184,672 | ) | $ | (9,797 | ) |
| Total gains (losses) included in earnings: |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Interest income (1)                        |       | —                                                                               |       | 139,958 |   | — |   | — |   | — |   |
| Interest expense (1)                       |       | —                                                                               |       | — |   | (312,226 | ) | — |   | (318 | ) |
| Change in fair value                       |       | 1,160                                                                                |       | (79,422 | ) | 152,960 |   | (28,373 | ) | 341 |   |
| Total gains (losses) included in earnings  |       | 1,160                                                                                |       | 60,536 |   | (159,266 | ) | (28,373 | ) | 23 |   |
| Transfers in and/or out of Level 3         |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Purchases, issuances and settlements       |       | (1,443                                                                               | )          | (311,548 | ) | 495,178 |   | 48,432 |   | 375 |   |
| Fair value, September 30, 2009        |       | $                                                                                    | 1,049      |   | $ | 5,767,379 |   | $ | (5,744,725 | ) | $ | (164,613 | ) | $ | (9,399 | ) |
|                                       |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Unrealized gains (losses) still held (2)   |       | $                                                                                    | 709        |   | $ | (6,748,258 | ) | $ | 8,144,739 |   | $ | (166,793 | ) | $ | 61,721 |   |

 

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(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$1.9 million for the three months ended September 30, 2009, asreflected in the accompanying consolidated statement of operations.

(2)          Represents the amount of unrealized gains (losses)relating to assets and liabilities classified as Level 3 that are stillheld at September 30, 2009

 
| ** **                                 | ** ** | **Level 3 Recurring Fair Value Measurements**              | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **For the nine months ended September 30, 2010** | ** ** |
| ** **                                 | ** ** | **Investment  securities available-  for-sale**                                | ** ** | **Securitized  mortgage  collateral** | ** ** | **Securitized  mortgage  borrowings** | ** ** | **Derivative  liabilities, net** | ** ** | **Long-term  debt** | ** ** |
| Fair value, December 31, 2009         |       | $                                                                                   | 813        |   | $ | 5,666,122 |   | $ | (5,659,865 | ) | $ | (126,457 | ) | $ | (9,773 | ) |
| Total gains (losses) included in earnings: |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Interest income (1)                        |       | 203                                                                                 |       | 374,686 |   | — |   | — |   | — |   |
| Interest expense (1)                       |       | —                                                                              |       | — |   | (680,598 | ) | — |   | (2,001 | ) |
| Change in fair value                       |       | 653                                                                                 |       | 606,477 |   | (552,853 | ) | (41,576 | ) | 952 |   |
| Total gains (losses) included in earnings  |       | 856                                                                                 |       | 981,163 |   | (1,233,451 | ) | (41,576 | ) | (1,049 | ) |
| Adoption of ASU 2009-17 (2)                |       | (298                                                                                | )          | 116,907 |   | (110,618 | ) | (9,013 | ) | — |   |
| Transfers in and/or out of Level 3         |       | —                                                                              |       | — |   | — |   | — |   | — |   |
| Purchases, issuances and settlements       |       | (117                                                                                | )          | (693,615 | ) | 942,934 |   | 88,057 |   | — |   |
| Fair value, September 30, 2010        |       | $                                                                                   | 1,254      |   | $ | 6,070,577 |   | $ | (6,061,000 | ) | $ | (88,989 | ) | $ | (10,822 | ) |

 

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(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$4.0 million for the nine months ended September 30, 2010, asreflected in the accompanying consolidated statement of operations.

(2)          Amounts represent theconsolidation and deconsolidation of trust assets and liabilities as a resultof the adoption of ASU 2009-17 on January 1, 2010.

 

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| ** **                                 | ** ** | **Level 3 Recurring Fair Value Measurements**              | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **For the nine months ended September 30, 2009** | ** ** |
| ** **                                 | ** ** | **Investment  securities available-  for-sale**                                | ** ** | **Securitized  mortgage  collateral** | ** ** | **Securitized  mortgage  borrowings** | ** ** | **Derivative  liabilities, net** | ** ** | **Long-term  debt** | ** ** |
| Fair value, December 31, 2008         |       | $                                                                                   | 2,068      |   | $ | 5,894,424 |   | $ | (6,193,984 | ) | $ | (273,547 | ) | $ | (15,403 | ) |
| Total gains (losses) included in earnings: |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Interest income (1)                        |       | —                                                                              |       | 850,079 |   | — |   | — |   | — |   |
| Interest expense (1)                       |       | —                                                                              |       | — |   | (1,403,248 | ) | — |   | (644 | ) |
| Change in fair value                       |       | 2,870                                                                               |       | (33,818 | ) | 313,827 |   | (48,712 | ) | 682 |   |
| Total gains (losses) included in earnings  |       | 2,870                                                                               |       | 816,261 |   | (1,089,421 | ) | (48,712 | ) | 38 |   |
| Transfers in and/or out of Level 3         |       | —                                                                              |       | — |   | — |   | — |   | — |   |
| Purchases, issuances and settlements       |       | (3,889                                                                              | )          | (943,306 | ) | 1,538,680 |   | 157,646 |   | 5,966 |   |
| Fair value, September 30, 2009        |       | $                                                                                   | 1,049      |   | $ | 5,767,379 |   | $ | (5,744,725 | ) | $ | (164,613 | ) | $ | (9,399 | ) |

 

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(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$8.5 million for the nine months ended September 30, 2009, asreflected in the accompanying consolidated statement of operations.

 

The following tables present the changes in recurring fair valuemeasurements included in net earnings (loss) for the three and nine monthsended September 30, 2010 and 2009:

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                                  | ** **  |
|------------------------------------------|------------|---------------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Earnings** | ** **  |
| ** **                               | ** ** | **For the three months ended September 30, 2010**  | ** **  |
| ** **                               | ** ** | ** **                                                                            | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income (1)**                                                     | ** **  | **Interest Expense (1)** | ** ** | **Net Trust Assets** | ** ** | **Long-term Debt** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                     | 90          |   | $ | — |   | $ | (66 | ) | $ | — |   | $ | 24 |   |
| Securitized mortgage collateral          |       | 120,487                                                                               |        | — |   | (44,287 | ) | — |   | 76,200 |   |
| Securitized mortgage borrowings          |       | —                                                                                |        | (203,594 | ) | 66,194 |   | — |   | (137,400 | ) |
| Derivative instruments, net              |       | —                                                                                |        | — |   | (12,268 | )(2) | — |   | (12,268 | ) |
| Long-term debt                           |       | —                                                                                |        | (633 | ) | — |   | 1,168 |   | 535 |   |
| **Total**                                | ** ** | **$**                                                                                 | **120,577** | ** ** | **$** | **(204,227** | **)** | **$** | **9,573** | ** ** | **$** | **1,168** | ** ** | **$** | **(72,909** | **)** |

 

----

(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was $1.7million for the three months ended September 30, 2010, as reflected in theaccompanying consolidated statement of operations.

(2)          Included in this amount is$12.0 million in changes in the fair value of derivative instruments,offset by $24.3 million in cash payments from the securitization trustsfor the three months ended September 30, 2010.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                                 | ** **  |
|------------------------------------------|------------|--------------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss**    | ** **  |
| ** **                               | ** ** | **For the three months ended September 30, 2009** | ** **  |
| ** **                               | ** ** | ** **                                                                           | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income (1)**                                                    | ** **  | **Interest Expense (1)** | ** ** | **Net Trust Assets** | ** ** | **Long-term Debt** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                    | —      |   | $ | — |   | $ | 1,160 |   | $ | — |   | $ | 1,160 |   |
| Securitized mortgage collateral          |       | 139,958                                                                              |        | — |   | (79,422 | ) | — |   | 60,536 |   |
| Securitized mortgage borrowings          |       | —                                                                               |        | (312,226 | ) | 152,960 |   | — |   | (159,266 | ) |
| Derivative instruments, net              |       | —                                                                               |        | — |   | (28,373 | )(2) | — |   | (28,373 | ) |
| Long-term debt                           |       | —                                                                               |        | (318 | ) | — |   | 341 |   | 23 |   |
| **Total**                                | ** ** | **$**                                                                                | **139,958** | ** ** | **$** | **(312,544** | **)** | **$** | **46,325** | ** ** | **$** | **341** | ** ** | **$** | **(125,920** | **)** |

 

----

(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$1.9 million for the three months ended September 30, 2009, as reflectedin the accompanying consolidated statement of operations.

(2)          Included in this amount is$20.4 million in changes in the fair value of derivative instruments,offset by $48.8 million in cash payments from the securitization trustsfor the three months ended September 30, 2009.

 

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| ** **                               | ** ** | **Recurring Fair Value Measurements**                                  | ** **  |
|------------------------------------------|------------|---------------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Earnings** | ** **  |
| ** **                               | ** ** | **For the nine months ended September 30, 2010**   | ** **  |
| ** **                               | ** ** | ** **                                                                            | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income (1)**                                                     | ** **  | **Interest Expense (1)** | ** ** | **Net Trust Assets** | ** ** | **Long-term Debt** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                     | 203         |   | $ | — |   | $ | 653 |   | $ | — |   | $ | 856 |   |
| Securitized mortgage collateral          |       | 374,686                                                                               |        | — |   | 606,477 |   | — |   | 981,163 |   |
| Securitized mortgage borrowings          |       | —                                                                                |        | (680,598 | ) | (552,853 | ) | — |   | (1,233,451 | ) |
| Derivative instruments, net              |       | —                                                                                |        | — |   | (41,576 | )(2) | — |   | (41,576 | ) |
| Long-term debt                           |       | —                                                                                |        | (2,001 | ) | — |   | 952 |   | (1,049 | ) |
| **Total**                                | ** ** | **$**                                                                                 | **374,889** | ** ** | **$** | **(682,599** | **)** | **$** | **12,701** | (3) | **$** | **952** | ** ** | **$** | **(294,057** | **)** |

 

----

(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$4.0 million for the nine months ended September 30, 2010, asreflected in the accompanying consolidated statement of operations.

(2)          Included in this amount is$47.4 million in changes in the fair value of derivative instruments,offset by $89.0 million in cash payments from the securitization trustsfor the nine months ended September 30, 2010.

(3)          For the nine months ended September 30, 2010,change in the fair value of trust assets, excluding REO was $12.7 million.  Excluded from the $101.7 million changein fair value of net trust assets, excluding REO, in the accompanyingconsolidated statement of cash flows is $89.0 million in cash payments from thesecuritization trusts related to the Company’s net derivative liabilities.

 
| ** **                               | ** ** | **Recurring Fair Value Measurements**                                | ** **  |
|------------------------------------------|------------|-------------------------------------------------------------------------------------|-------------|
| ** **                               | ** ** | **Changes in Fair Value Included in Net Loss**   | ** **  |
| ** **                               | ** ** | **For the nine months ended September 30, 2009** | ** **  |
| ** **                               | ** ** | ** **                                                                          | ** **  | ** ** | ** ** | **Change in Fair Value of** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Interest Income (1)**                                                   | ** **  | **Interest Expense (1)** | ** ** | **Net Trust Assets** | ** ** | **Long-term Debt** | ** ** | **Total** | ** ** |
| Investment securities available-for-sale |       | $                                                                                   | —      |   | $ | — |   | $ | 2,870 |   | $ | — |   | $ | 2,870 |   |
| Securitized mortgage collateral          |       | 850,079                                                                             |        | — |   | (33,818 | ) | — |   | 816,261 |   |
| Securitized mortgage borrowings          |       | —                                                                              |        | (1,403,248 | ) | 313,827 |   | — |   | (1,089,421 | ) |
| Derivative instruments, net              |       | —                                                                              |        | — |   | (48,712 | )(2) | — |   | (48,712 | ) |
| Long-term debt                           |       | —                                                                              |        | (644 | ) | — |   | 682 |   | 38 |   |
| **Total**                                | ** ** | **$**                                                                               | **850,079** | ** ** | **$** | **(1,403,892** | **)** | **$** | **234,167** | (3) | **$** | **682** | ** ** | **$** | **(318,964** | **)** |

 

----

(1)          Amounts primarily representaccretion to recognize interest income and interest expense using effectiveyields based on estimated fair values for trust assets and trust liabilities.The total net interest income, including cash received and paid, was$8.5 million for the nine months ended September 30, 2009, asreflected in the accompanying consolidated statement of operations.

(2)          Included in this amount is$110.1 million in changes in the fair value of derivative instruments,offset by $158.8 million in cash payments from the securitization trustsfor the nine months ended September 30, 2009.

(3)          For the nine months endedSeptember 30, 2009, change in the fair value of net trust assets,excluding REO was $234.2 million. Excluded from the $393.0 millionchange in fair value of net trust assets, excluding REO, in the accompanyingconsolidated statement of cash flows is $158.8 million in cash paymentsfrom the securitization trusts related to the Company’s net derivativeliabilities.

 

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

 

*Investment securities available-for-sale*—The Companyelected to carry all of its investment securities available-for-sale at fairvalue. The investment securities consist primarily of non-investment grademortgage-backed securities. The fair value of the investment securities ismeasured based upon the Company’s expectation of inputs that other marketparticipants would use. Such assumptions include judgments about the underlyingcollateral, prepayment speeds, future credit losses, forward interest rates andcertain other factors.  Given the marketdisruption and lack of observable market data as of September 30, 2010 andDecember 31, 2009, the estimated fair value of the investment securitiesavailable-for-sale was measured using significant internal expectations ofmarket participants’ assumptions.

 

*Securitized mortgage collateral*—The Companyelected to carry all of its securitized mortgage collateral at fair value.These assets consist primarily of non-conforming mortgage loans securitizedbetween 2002 and 2007.  Fair valuemeasurements are based on the Company’s internal models used to compute the netpresent value of future expected cash flows, with observable market participantassumptions, where available. The Company’s assumptions include itsexpectations of inputs that other market participants would use in pricingthese assets. These assumptions include judgments about the underlyingcollateral, prepayment speeds, estimated future credit losses, forward interestrates, investor yield requirements and certain other factors.  As of September 30, 2010, securitizedmortgage collateral had an unpaid principal balance of $11.0 billion,compared to an estimated fair value of $6.1 billion. The aggregate unpaidprincipal balance exceeds the fair value by $4.9 billion atSeptember 30, 2010.  As ofSeptember 30, 2010, the unpaid principal balance of loans 90 days ormore past due was $2.0 billion compared to an estimated fair value of $0.6 billion.The aggregate unpaid principal balances of loans 90 days or more past dueexceed the fair value by $1.4 billion at September 30, 2010.

 

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*Securitized mortgage borrowings*—The Companyelected to carry all of its securitized mortgage borrowings at fair value.These borrowings consist of individual tranches of bonds issued bysecuritization trusts and are primarily backed by non-conforming mortgageloans. Fair value measurements include the Company’s judgments about theunderlying collateral and assumptions such as prepayment speeds, estimatedfuture credit losses, forward interest rates, investor yield requirements andcertain other factors. As of September 30, 2010, securitized mortgageborrowings had an outstanding principal balance of $12.8 billion compared to anestimated fair value of $6.1 billion. The aggregate outstanding principalbalance exceeds the fair value by $6.7 billion at September 30, 2010.

 

*Long-term debt*—The Company elected tocarry all of its long-term debt (consisting of trust preferred securities andjunior subordinated notes) at fair value. These securities are measured basedupon an analysis prepared by management, which considered the Company’s owncredit risk, including settlements with trust preferred debt holders anddiscounted cash flow analysis. As of September 30, 2010, long-term debthad an unpaid principal balance of $70.5 million compared to an estimatedfair value of $10.8 million. The aggregate unpaid principal balanceexceeds the fair value by $59.7 million at September 30, 2010.

 

*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 ofderivative assets and liabilities are based on observable market inputs, ifavailable. To the extent observable market inputs are not available, fairvalues measurements include the Company’s judgments about future cash flows,forward interest rates and certain other factors, including counterparty risk.Additionally, these values also take into account the Company’s own creditstanding, to the extent applicable; thus, the valuation of the derivativeinstrument includes the estimated value of the net credit differential betweenthe counterparties to the derivative contract.

 

***Nonrecurring Fair Value Measurements***

 

The Company is required to measure certain assets and liabilities atestimated fair value from time to time. These fair value measurements typicallyresult from the application of specific accounting pronouncements under GAAP.The fair value measurements are considered nonrecurring fair value measurementsunder FASB ASC 820-10.

 

The following tables present financial and non-financial assets andliabilities measured using nonrecurring fair value measurements at September 30,2010 and 2009, respectively:

 
| ** **           | ** ** | **Nonrecurring Fair Value Measurements** | ** ** | **Total Gains (Losses)**                 | ** ** |
|----------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **           | ** ** | **September 30, 2010**                        | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
| ** **           | ** ** | **Level 1**                                        | ** ** | **Level 2**                                   | ** ** | **Level 3** | ** ** | **September 30, 2010 (5)** | ** ** | **September 30, 2010 (5)** | ** ** |
| Loans held-for-sale  |       | $                                                       | —     |                                               | $          | — |   | $ | — |   | $ | — |   | $ | (218 | ) |
| REO (1)              |       | —                                                  |       | 69,488                                             |       | — |   | (10,258 | ) | (9,430 | ) |
| Lease liability (2)  |       | —                                                  |       | —                                             |       | (2,353 | ) | (44 | ) | 357 |   |
| Deferred charge (3)  |       | —                                                  |       | —                                             |       | 13,144 |   | — |   | — |   |
| Intangible asset (4) |       | —                                                  |       | —                                             |       | 1,000 |   | — |   |   |   |
|                      |            |                                                         |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)         Amounts are included in continuingoperations.   For the three months ended September 30,2010, the $10.3 million loss related to additional impairment write-downsduring the period is within continuing operations.  For the nine months ended September 30,2010, the $9.4 million loss during the period included $9.8 million ofadditional impairment write-downs and $355 thousand in recoveries withincontinuing and discontinued operations, respectively.

(2)         Amounts are included indiscontinued operations.  For the three and nine months ended September 30,2010, the Company recorded $44 thousand in losses and $357 thousand in recoveriesresulting from changes in lease liabilities as a result of changes in ourexpected minimum future lease payments, respectively.

(3)          Amounts are included incontinuing operations. For the three and nine months ended September 30,2010, the Company recorded zero in income tax expense resulting from impairmentwrite-downs based on changes in estimated cash flows and lives of the relatedmortgages retained in the securitized mortgage collateral.

(4)          Amount is included in otherassets in the accompanying consolidated balance sheets.

(5)          Total gains (losses) reflectgains and losses from all nonrecurring measurements during the period.

 

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| ** **              | ** ** | **Non-recurring Fair Value Measurements** | ** ** | **Total Gains (Losses)**                 | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **September 30, 2009**                         | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
| ** **              | ** ** | **Level 1**                                         | ** ** | **Level 2**                                   | ** ** | **Level 3** | ** ** | **September 30, 2009** | ** ** | **September 30, 2009** | ** ** |
| Loans held-for-sale (1) |       | $                                                        | —     |                                               | $          | — |   | $ | 79,505 |   | $ | — |   | $ | (7,517 | ) |
| REO (2)                 |       | —                                                   |       | 116,694                                            |       | — |   | (25,285 | ) | (120,523 | ) |
| Lease liability (3)     |       | —                                                   |       | —                                             |       | (3,924 | ) | (28 | ) | 2,531 |   |
| Deferred charge (4)     |       | —                                                   |       | —                                             |       | 13,144 |   | — |   | (1,998 | ) |
|                         |            |                                                          |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Includes $332 thousand and$79.2 million of loans held-for-sale within continuing and discontinuedoperations, respectively, at September 30, 2009.

(2)          Includes $112.8 millionand $3.9 million in REO within continuing and discontinued operations,respectively, at September 30, 2009 which had additional impairmentwrite-downs subsequent to the date of foreclosure. For the three months endedSeptember 30, 2009, the $25.3 million loss related to additional impairmentwrite-downs during the period included $24.5 million and $0.8 millionwithin continuing and discontinued operations, respectively. For the ninemonths ended September 30, 2009, the $120.5 million loss related toadditional impairment write-downs during the period included$117.9 million and $2.6 million within continuing and discontinuedoperations, respectively.

(3)          Amounts are included indiscontinued operations. For the three and nine months ended September 30,2009, the Company recorded $28 thousand in losses and $2.5 million ingains resulting from changes in lease liabilities as a result of changes in ourexpected minimum future lease payments, respectively.

(4)          Amounts are included incontinuing operations. For the three and nine months ended September 30,2009, the Company recorded zero and $2.0 million, respectively, in incometax expense resulting from impairment writedowns based on changes in estimatedcash flows and lives of the related mortgages retained in the securitizedmortgage collateral.

 

*Loans held-for-sale*—Loans held-for-sale forwhich the fair value option was not elected are carried at the lower of cost ormarket (LOCOM). When available, such measurements are based upon what secondarymarkets offer for portfolios with similar characteristics, and are consideredLevel 2 measurements. If market pricing is not available, suchmeasurements are significantly impacted by the Company’s expectations of othermarket participants’ assumptions, and are considered Level 3 measurements.The Company utilizes internal pricing processes to estimate the fair value ofloans held-for-sale, which is based on recent loan sales and estimates of thefair value of the underlying collateral. Loans held-for-sale, which areprimarily included in assets of discontinued operations, are consideredLevel 3 fair value measurements at September 30, 2010.

 

*Real estate owned*—REO consists of residentialreal estate acquired in satisfaction of loans. Upon foreclosure, REO isadjusted to the estimated fair value of the residential real estate lessestimated selling and holding costs, offset by expected contractual mortgageinsurance proceeds to be received, if any. Subsequently, REO is recorded at thelower of carrying value or estimated fair value less costs to sell. Fair valuesof REO are generally based on observable market inputs, and consideredLevel 2 measurements at September 30, 2010.

 

*Lease liability*—In connection with thediscontinuation of our non-conforming mortgage, retail mortgage, warehouselending and commercial operations, a significant amount of office space thatwas previously occupied is no longer being used by the Company. The Company hassubleased a significant amount of this office space. The Company has recorded aliability, included within discontinued operations, representing the presentvalue of the minimum lease payments over the remaining life of the lease,offset by the expected proceeds from sublet revenue related to this officespace. This liability is based on present value techniques that incorporate theCompany’s judgments about estimated sublet revenue and discount rates.Therefore, this liability is considered a Level 3 measurement atSeptember 30, 2010.

 

*Deferred charge*—Deferred charge representsthe deferral of income tax expense on inter-company profits that resulted fromthe sale of mortgages from taxable subsidiaries to IMH in prior years. Thedeferred charge is amortized as a component of income tax expense over theestimated life of the mortgages retained in the securitized mortgagecollateral. The Company evaluates the deferred charge for impairment quarterlyusing internal estimates of estimated cash flows and lives of the relatedmortgages retained in the securitized mortgage collateral. If the deferredcharge is determined to be impaired, it is amortized as a component of incometax expense.  Deferred charge isconsidered a Level 3 measurement at September 30, 2010.

 

*Intangible asset*—Intangible assets deemed tohave an indefinite life are tested annually for impairment, or more frequentlyif events or changes in circumstances indicate that the asset might beimpaired. Impairment losses are recognized if carrying amount of an intangibleasset exceeds its estimated fair value. Intangible asset, which is included inother assets of continuing operations, is considered a Level 3 measurementat September 30, 2010.

 

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**Note 3.—Stock Options**

 

The fair value of stock options granted, which is amortized to expenseover the service period, is estimated on the date of grant using theBlack-Scholes-Merton option pricing model with the following weighted averageassumptions:

 
| ** **                             | ** ** | **Nine Months**              | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Ended September 30,** | ** ** |
| ** **                             | ** ** | **2009**                          | ** ** |
| Risk-free interest rate                |       | 2.86                              | %          |
| Expected lives (in years)              |       | 5.50                              |       |
| Expected volatility (1)                |       | 259.16                            | %          |
| Expected dividend yield (2)            |       | 0.00                              | %          |
| Grant date fair value of share options |       | $                                 | 0.53       |   |
|                                        |            |                                   |            |  |

 

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(1)          Expected volatility is basedon the historical volatility of the Company’s stock over the expected life ofthe stock option.

(2)          Expected dividend yield iszero because a dividend on the common stock was not probable over the expectedlife of the options granted during the nine months ended September 30,2009.

 

There were no options granted during the nine months ended September 30,2010.

 

The following table summarizes activity, pricing and other informationfor the Company’s stock options for the nine months ended September 30,2010:

 
| ** **                                     | ** ** | ** **         | ** ** | **Weighted-**      | ** ** |
|------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                     | ** ** | ** **         | ** ** | **Average**        | ** ** |
| ** **                                     | ** ** | **Number of** | ** ** | **Exercise**       | ** ** |
| ** **                                     | ** ** | **Shares**         | ** ** | **Price ($)** | ** ** |
| Options outstanding at January 1, 2010    |       | 1,294,585          |       | $                  | 13.47      |   |
| Options granted                                |       | —             |       | —             |       |
| Options exercised                              |       | 40,600             |       | 0.53               |       |
| Options forfeited / cancelled                  |       | 142,335            |       | 63.81              |       |
| Options outstanding at September 30, 2010 |       | 1,111,650          |       | $                  | 7.50       |   |
| Options exercisable at September 30, 2010 |       | 1,111,650          |       | $                  | 7.50       |   |

 

As of September 30, 2010, there was no unrecognized compensationcost related to nonvested share-based compensation arrangements granted underthe Company’s stock-based incentive compensation plan.

 

In October 2010, the Company issued approximately 196 thousandstock options at a strike price of $2.80, which will vest over threeyears.   The October 2010 optiongrant resulted in approximately $548 thousand of total unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Company’s stock-based incentive compensation plan. This costis expected to be recognized over three years.

 

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**Note 4.—Reconciliation of Earnings Per Share**

 

Thefollowing table presents the computation of basic and diluted earnings (loss)per common share, including the dilutive effect of stock options and cumulativeredeemable preferred stock outstanding for the periods indicated:

 
| ** **                                                                                           | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                           | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                                           | ** ** | **2010**                                | ** ** | **2009**                               | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Numerator for basic earnings  (loss) per share:**                                                  |       |                                    |       |                                   |       |   |   |   |   |
| Earnings from continuing operations                                                                  |       | $                                       | 2,259      |                                   | $          | 4,803 |   | $ | 8,273 |   | $ | 14,109 |   |
| Cash dividends on cumulative redeemable preferred  stock                                             |       | —                                  |       | —                                 |       | — |   | (7,443 | ) |
| (Loss) earnings from discontinued operations                                                         |       | (1,285                                  | )          | (1,776                                 | )          | 1,905 |   | (8,366 | ) |
| Earnings (loss) per share available to common  stockholders before redemption of preferred stock (1) |       | $                                       | 974        |                                   | $          | 3,027 |   | $ | 10,178 |   | $ | (1,700 | ) |
| **Denominator for basic earnings  (loss) per share (2):**                                            |       |                                    |       |                                   |       |   |   |   |   |
| Weighted average number of common shares outstanding  during the period                              |       | 7,760                                   |       | 7,618                                  |       | 7,727 |   | 7,618 |   |
| **Denominator for diluted earnings  per share (2):**                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Weighted average number of common shares outstanding  during the period                              |       | 7,760                                   |       | 7,618                                  |       | 7,727 |   | 7,618 |   |
| Net effect of dilutive stock options                                                                 |       | 584                                     |       | 384                                    |       | 601 |   | — |   |
| Diluted weighted average common shares                                                               |       | 8,344                                   |       | 8,002                                  |       | 8,328 |   | 7,618 |   |
|                                                                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Earnings (loss) per common share - basic:                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Earnings from continuing operations                                                                  |       | $                                       | 0.29       |                                   | $          | 0.63 |   | $ | 1.07 |   | $ | 0.88 |   |
| (Loss) earnings from discontinued operations                                                         |       | (0.16                                   | )          | (0.23                                  | )          | 0.25 |   | (1.10 | ) |
| Earnings (loss) per share available to common  stockholders before redemption of preferred stock (1) |       | $                                       | 0.13       |                                   | $          | 0.40 |   | $ | 1.32 |   | $ | (0.22 | ) |
|                                                                                                 |       |                                    |       |                                   |       |   |   |   |   |
| Earnings (loss) per common share - diluted:                                                          |       |                                    |       |                                   |       |   |   |   |   |
| Earnings from continuing operations                                                                  |       | $                                       | 0.27       |                                   | $          | 0.60 |   | $ | 0.99 |   | $ | 0.88 |   |
| (Loss) earnings from discontinued operations                                                         |       | (0.15                                   | )          | (0.22                                  | )          | 0.23 |   | (1.10 | ) |
| Earnings (loss) per share available to common  stockholders before redemption of preferred stock (1) |       | $                                       | 0.12       |                                   | $          | 0.38 |   | $ | 1.22 |   | $ | (0.22 | ) |

 

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(1)          As discussed below, thedifference between the carrying value of the tendered preferred stock($106.1 million) and the amount paid for the shares ($1.3 million)was recognized as a decrease in retained deficit in 2009. Including the redemption,total basic earnings per share from continuing operations available to commonstockholders for the three and nine month period ended September 30, 2009,were $14.16 and $13.54, respectively. Including the redemption, total dilutedearnings per share from continuing operations available to common stockholdersfor the three and nine month period ended September 30, 2009, were $13.48and $13.54, respectively.

 

(2)          Share amounts presented inthousands.

 

In June 2009, the Company completed the Offer to Purchase andConsent Solicitation (the “Offer to Purchase”) of all of its 9.375%Series B Cumulative Redeemable Preferred Stock and 9.125% Series CCumulative Redeemable Preferred Stock (which are sometimes collectivelyhereinafter referred to as the Preferred Stock). The aggregate purchase pricefor the Preferred Stock was $1.3 million. In addition, in connection withcompleting the Offer to Purchase the Company paid $7.4 million ofaccumulated but unpaid dividends on its Preferred Stock.  With the total cash payment of$8.7 million, the Company eliminated $109.5 million of liquidationpreference on its Preferred Stock. After the completion of the Offer toPurchase, the Company has outstanding $52.3 million liquidation preferenceof Series B and Series C Preferred Stock. As this transaction isconsidered a redemption for accounting purposes, in accordance with FASB ASC505-10 and 260-10-S99, the difference between the carrying value of thetendered preferred stock ($106.1 million) and the amount paid for theshares ($1.3 million) was recognized as a decrease in retained deficit in2009. Including the redemption, total basic earnings per share from continuingoperations available to common stockholders for the three and nine month periodended September 30, 2009, were $14.16 and $13.54, respectively. Includingthe redemption, total diluted earnings per share from continuing operationsavailable to common stockholders for the three and nine month period ended September 30,2009, were $13.48 and $13.54, respectively.

 

For the three and nine months ended September 30, 2010, stockoptions to purchase 338 thousand shares were outstanding but not included inthe above weighted average share calculations because they were anti-dilutive.

 

For the three and nine months ended September 30, 2009, stockoptions to purchase 504 thousand and 1.3 million shares,respectively, were outstanding but not included in the above weighted averageshare calculations because they were anti-dilutive.

 

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**Note 5.—Segment Reporting**

 

The Company has three reporting segments, consisting of the long-termmortgage portfolio, mortgage and real estate services and discontinuedoperations. The following tables present the selected financial data andoperating results by reporting segment for the periods indicated:

 
| ** **                                              | ** ** | ** **    | ** ** | **Mortgage and** | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|---------------|------------|-----------------------|------------|------------------|------------|--------------------------------|------------|------------------|------------|
| ** **                                              | ** ** | **Long-term** | ** ** | **Real Estate**  | ** ** | **Discontinued** | ** ** | ** **                     | ** ** | ** **       | ** ** |
| ** **                                              | ** ** | **Portfolio** | ** ** | **Services**          | ** ** | **Operations**   | ** ** | **Reclassifications (1)** | ** ** | **Consolidated** | ** ** |
| **Balance sheet items as of  September 30, 2010:** | ** ** | ** **    | ** ** | ** **            | ** ** | ** **       |       |                           | ** ** | ** **       | ** ** |
| Cash and cash equivalents                               |       | $             | 375        |                  | $          | 10,226           |       | $                              | 72         |             | $          | (72 | ) | 10,601 |   |
| Restricted cash                                         |       | —        |       | 1,003                 |       | 391              |       | (391                           | )          | 1,003            |       |
| Securitized mortgage collateral                         |       | 6,070,577     |       | —                |       | —           |       | —                         |       | 6,070,577        |       |
| Other assets                                            |       | 117,847       |       | 19,917                |       | 209              |       | (209                           | )          | 137,764          |       |
| Total assets                                            |       | 6,188,799     |       | 31,146                |       | 672              |       | —                         |       | 6,220,617        |       |
| Total liabilities                                       |       | 6,172,530     |       | 7,729                 |       | 14,125           |       | —                         |       | 6,194,384        |       |
| Total stockholders’ equity (deficit)               |       | 16,269        |       | 23,417                |       | (13,453          | )          | —                         |       | 26,233           |       |
|                                                    |       |          |       |                  |       |             |       |                           |       |             |       |
| **Balance sheet items as of  December 31, 2009:**  | ** ** | ** **    | ** ** | ** **            | ** ** | ** **       |       |                           | ** ** | ** **       | ** ** |
| Cash and cash equivalents                               |       | $             | 7,940      |                  | $          | 17,738           |       | $                              | 172        |             | $          | (172 | ) | 25,678 |   |
| Restricted cash                                         |       | —        |       | 1,253                 |       | 501              |       | (501                           | )          | 1,253            |       |
| Short-term investment                                   |       | 5,002         |       | —                |       | —           |       | —                         |       | 5,002            |       |
| Securitized mortgage collateral                         |       | 5,666,122     |       | —                |       | —           |       | —                         |       | 5,666,122        |       |
| Loans held-for-sale                                     |       | —        |       | —                |       | 2,371            |       | (2,371                         | )          | —           |       |
| Other assets                                            |       | 162,829       |       | 7,548                 |       | 1,436            |       | (1,436                         | )          | 170,377          |       |
| Total assets                                            |       | 5,841,893     |       | 26,539                |       | 4,480            |       | —                         |       | 5,872,912        |       |
| Total liabilities                                       |       | 5,831,936     |       | 6,391                 |       | 19,152           |       | —                         |       | 5,857,479        |       |
| Total stockholders’ equity (deficit)               |       | 9,957         |       | 20,148                |       | (14,672          | )          | —                         |       | 15,433           |       |

 

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| ** **                                               | ** ** | ** **    | ** ** | **Mortgage and** | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|---------------|------------|-----------------------|------------|------------------|------------|--------------------------------|------------|------------------|------------|
| ** **                                               | ** ** | **Long-term** | ** ** | **Real Estate**  | ** ** | **Discontinued** | ** ** | ** **                     | ** ** | ** **       | ** ** |
| ** **                                               | ** ** | **Portfolio** | ** ** | **Services**          | ** ** | **Operations**   | ** ** | **Reclassifications (1)** | ** ** | **Consolidated** | ** ** |
| **Statement of Operations Items**                        | ** ** | ** **    | ** ** | ** **            | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
| **for the three months ended  September 30, 2010:** |       |          |       |                  |       |             |       |                           |       |             |       |
| Net interest income                                      |       | $             | 1,666      |                  | $          | 5                |       | $                              | 4          |             | $          | (4 | ) | $ | 1,671 |   |
| Non-interest income- net trust assets                    |       | (574          | )          | —                |       | —           |       | —                         |       | (574             | )          |
| Mortgage and real estate services fees                   |       | —        |       | 15,521                |       | —           |       | —                         |       | 15,521           |       |
| Other non-interest income (expense)                      |       | 1,189         |       | 18                    |       | (1,673           | )          | 1,673                          |       | 1,207            |       |
| Non-interest expense and income taxes                    |       | (4,364        | )          | (11,202               | )          | 384              |       | (384                           | )          | (15,566          | )          |
| (Loss) earnings from continuing operations               |       | $             | (2,083     | )                     | $          | 4,342            |       |                           |       |             |       | 2,259 |   |
| Loss from discontinued operations, net of tax            |       |          |       |                  |       | $                | (1,285     | )                              |       |             | (1,285     | ) |
| Net earnings                                             |       |          |       |                  |       |             |       |                           |       | $                | 974        |   |
|                                                     |       |          |       |                  |       |             |       |                           |       |             |       |
| **Statement of Operations Items**                        | ** ** | ** **    | ** ** | ** **            | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
| **for the nine months ended  September 30, 2010:**  |       |          |       |                  |       |             |       |                           |       |             |       |
| Net interest income                                      |       | $             | 3,980      |                  | $          | 16               |       | $                              | 48         |             | $          | (48 | ) | $ | 3,996 |   |
| Non-interest income- net trust assets                    |       | 6,411         |       | —                |       | —           |       | —                         |       | 6,411            |       |
| Mortgage and real estate services fees                   |       | —        |       | 42,523                |       | —           |       | —                         |       | 42,523           |       |
| Other non-interest income                                |       | 876           |       | 20                    |       | 460              |       | (460                           | )          | 896              |       |
| Non-interest expense and income taxes                    |       | (13,582       | )          | (31,971               | )          | 1,397            |       | (1,397                         | )          | (45,553          | )          |
| (Loss) earnings from continuing operations               |       | $             | (2,315     | )                     | $          | 10,588           |       |                           |       |             |       | 8,273 |   |
| Earnings from discontinued operations, net of tax        |       |          |       |                  |       | $                | 1,905      |                           |       |             | 1,905      |   |
| Net earnings                                             |       |          |       |                  |       |             |       |                           |       | $                | 10,178     |   |

 
| ** **                                               | ** ** | ** **    | ** ** | **Mortgage and** | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|---------------|------------|-----------------------|------------|------------------|------------|--------------------------------|------------|------------------|------------|
| ** **                                               | ** ** | **Long-term** | ** ** | **Real Estate**  | ** ** | **Discontinued** | ** ** | ** **                     | ** ** | ** **       | ** ** |
| ** **                                               | ** ** | **Portfolio** | ** ** | **Services**          | ** ** | **Operations**   | ** ** | **Reclassifications (1)** | ** ** | **Consolidated** | ** ** |
| **Statement of Operations Items**                        |       |          |       |                  |       |             |       |                           |       |             |       |
| **for the three months ended  September 30, 2009:** |       |          |       |                  |       |             |       |                           |       |             |       |
| Net interest income                                      |       | $             | 1,894      |                  | $          | 12               |       | $                              | 834        |             | $          | (834 | ) | $ | 1,906 |   |
| Non-interest income- net trust assets                    |       | 3,165         |       | —                |       | —           |       | —                         |       | 3,165            |       |
| Mortgage and real estate services fees                   |       | —        |       | 13,514                |       | —           |       | —                         |       | 13,514           |       |
| Other non-interest income (expense)                      |       | 361           |       | (127                  | )          | (2,148           | )          | 2,148                          |       | 234              |       |
| Non-interest expense and income taxes                    |       | (5,422        | )          | (8,594                | )          | (462             | )          | 462                            |       | (14,016          | )          |
| (Loss) earnings from continuing operations               |       | $             | (2         | )                     | $          | 4,805            |       |                           |       |             |       | 4,803 |   |
| Loss from discontinued operations, net of tax            |       |          |       |                  |       | $                | (1,776     | )                              |       |             | (1,776     | ) |
| Net earnings                                             |       |          |       |                  |       |             |       |                           |       | $                | 3,027      |   |
|                                                     |       |          |       |                  |       |             |       |                           |       |             |       |
| **Statement of Operations Items**                        | ** ** | ** **    | ** ** | ** **            | ** ** | ** **       | ** ** | ** **                     | ** ** | ** **       | ** ** |
| **for the nine months ended  September 30, 2009:**  |       |          |       |                  |       |             |       |                           |       |             |       |
| Net interest income (expense)                            |       | $             | 8,496      |                  | $          | 5                |       | $                              | (244       | )                | $          | 244 |   | $ | 8,501 |   |
| Non-interest income- net trust assets                    |       | 16,084        |       | —                |       | —           |       | —                         |       | 16,084           |       |
| Mortgage and real estate services fees                   |       | —        |       | 32,296                |       | —           |       | —                         |       | 32,296           |       |
| Other non-interest income (expense)                      |       | 661           |       | (312                  | )          | (10,928          | )          | 10,928                         |       | 349              |       |
| Non-interest expense and income taxes                    |       | (22,962       | )          | (20,159               | )          | 2,806            |       | (2,806                         | )          | (43,121          | )          |
| Earnings from continuing operations                      |       | $             | 2,279      |                  | $          | 11,830           |       |                           |       |             |       | 14,109 |   |
| Loss from discontinued operations, net of tax            |       |          |       |                  |       | $                | (8,366     | )                              |       |             | (8,366     | ) |
| Net earnings                                             |       |          |       |                  |       |             |       |                           |       | $                | 5,743      |   |

 

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(1)          Amounts representreclassifications of activity in the discontinued operations segment into lossfrom discontinued operations, net of tax as presented in the accompanyingconsolidated statements of operations.

 

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**Note 6.—Real Estate Owned (REO)**

 

The Company’s REO consisted of the following:

 
| ** **         | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| REO                |       | $                            | 137,517    |                        | $          | 176,800 |   |
| Impairment (1)     |       | (31,403                      | )          | (34,080                     | )          |
| Ending balance     |       | $                            | 106,114    |                        | $          | 142,720 |   |
|               |       |                         |       |                        |       |
| REO inside trusts  |       | $                            | 106,042    |                        | $          | 142,364 |   |
| REO outside trusts |       | 72                           |       | 356                         |       |
| Total              |       | $                            | 106,114    |                        | $          | 142,720 |   |

 

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(1)          Impairment represents thecumulative write-downs of REO to estimated net realizable value subsequent toforeclosure.

 

**Note 7.—Long-term Debt**

 

*Trust Preferred Securities*

 

The following table shows the remaining balance of Trust PreferredSecurities issued as of September 30, 2010 and December 31, 2009:

 
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Trust preferred securities (1) |       | $                      | 8,500      |                  | $          | 8,500 |   |
| Common securities              |       | 263                    |       | 263                   |       |
| Fair value adjustment          |       | (6,582                 | )          | (6,501                | )          |
| Total                          |       | $                      | 2,181      |                  | $          | 2,262 |   |

 

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(1)          Stated maturity ofJuly 30, 2035. Redeemable at par at any time after July 30, 2010.Requires quarterly distributions initially at a fixed rate of 8.55% per annumthrough July 30, 2010 and thereafter at a variable rate of three-monthLIBOR plus 3.75% per annum.

 

*Junior Subordinated Notes*

 

The following table shows the remaining balance of junior subordinatednotes issued as of September 30, 2010 and December 31, 2009:

 
| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Junior subordinated notes (1) |       | $                      | 62,000     |                  | $          | 62,000 |   |
| Fair value adjustment         |       | (53,359                | )          | (54,489               | )          |
| Total                         |       | $                      | 8,641      |                  | $          | 7,511 |   |

 

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(1)          Stated maturity ofMarch 2034. Requires quarterly distributions initially at a fixed rate of2.00% through 2013 with increases of 1.00% per annum through 2017. Starting in2018, the interest rates become variable at three-month LIBOR plus 3.75% perannum.

 

**Note 8.—Note Payable**

 

In October 2009, the Company entered into a settlement agreement(the Settlement Agreement) with its remaining reverse repurchase facilitylender to settle the restructured financing. The Settlement Agreement retiredthe facility and removed any further exposure associated with the line or theloans that secured the line. Pursuant to the terms of the Settlement Agreement,the Company settled the $140.0 million balance of the reverse repurchaseline by (i) transferring the loans securing the line to the lender attheir approximate carrying values, (ii) making in a cash payment of$20.0 million and (iii) entering into a credit agreement with thelender (the Credit Agreement) for a $33.9 million note payable. Theborrowing under the Credit Agreement, which is to be paid over 18 months,bears interest at a rate of one-month LIBOR plus 350 basis points and requiresa monthly principal and interest payment of $1.5 million. An additional$10.0 million principal payment was due and paid in April 2010 aspart of the Credit Agreement. At September 30, 2010, the balance of thenote payable was $8.1 million.

 

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The borrowing under the Credit Agreement may be prepaid by the Companyat any time.  Proceeds from any of thefollowing are required to be applied to the balance under the credit agreement:(i) the sale of any assets, excluding mortgage assets, (ii) theissuance of debt, excluding warehouse borrowings and (iii) the issuance ofequity by the Company.

 

In addition to the restrictions above, the Credit Agreement requiresthe Company to maintain certain business and financial covenants until theborrowing is paid in full. These covenants place several restrictions on theCompany and its operations, including limiting its ability to pay dividends,issue equity interests, make investments over certain amounts without priorconsent or enter into any transaction to merge or consolidate. The covenantsalso require the Company to maintain cash and cash equivalents of$10.0 million (based on certain calculations) and stockholders’ equitygreater than zero (based on certain calculations). At September 30, 2010,the Company was in compliance with these covenants.

 

**Note 9.—Warehouse Line**

 

In June 2010, the Company, through IRES and itssubsidiaries, entered into a Master Repurchase Agreement with aregional bank providing a $10 million warehouse facility. The warehousefacility will be used to fund and will be secured by conforming single familyresidential mortgage loans that are held for sale. As of September 30,2010, there was $1.4 million outstanding on this facility. The agreementexpires June 2011. The rate is one month LIBOR plus 4.00% with a floor of5.00%.  Under the terms of the warehouse facility, IRES and itssubsidiaries are required to maintain various financial and othercovenants, including maintaining a minimum tangible net worth of $17.0million and cash or cash equivalents of at least $5.0 million.  At September 30, 2010, the Company wasin compliance with these financial covenants.

 

**Note 10.—Subsequent Events**

 

Subsequent events have been evaluated throughthe date of this filing.

 

InOctober 2010, the Company completed the acquisition of 51% of AmeriHomeMortgage Corporation (AmeriHome) for $1.8 million, whereby the Company made a$950 thousand capital contribution to AmeriHome, paid $150 thousand to thefounder of AmeriHome, and entered into a note payable requiring $20 thousandmonthly payments for three years.  Aspart of the transaction, the Company has an option to purchase an additional39% ownership interest beginning January 1, 2011 for 1.5 times of 39% ofthe book value of AmeriHome plus $550,000 in cash.    In addition, the founder has an option tosell his 49%, ownership beginning January 1, 2014, to the Company for 49%of book value.  The book value ofAmeriHome was approximately $2.8 million at the time of the Company’s purchaseof 51% ownership interest.

 

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**ITEM2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

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

 

Unless the context otherwise requires, the terms “Company,” “we,” “us,”and “our” refer to Impac Mortgage Holdings, Inc. (the Company or IMH), aMaryland corporation incorporated in August 1995, and its subsidiaries, IntegratedReal Estate Service Corporation (IRES), IMH Assets Corp. (IMH Assets), ImpacWarehouse Lending Group, Inc. (IWLG) and Impac Funding Corporation (IFC).

 

**Forward-LookingStatements**

 

This report on Form 10-Q contains certain forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934. Forward-lookingstatements, some of which are based on various assumptions and events that arebeyond our control, may be identified by reference to a future period orperiods or by the use of forward-looking terminology, such as “may,” “will,” “believe,”“expect,” “likely,” “should,” “could,” “seem to,” “anticipate,” or similarterms or variations on those terms or the negative of those terms. Theforward-looking statements are based on current management expectations. Actualresults may differ materially as a result of several factors, including, butnot limited to the following: the ongoing volatility in the mortgage industry;our ability to successfully manage through the current market environment; ourability to meet liquidity needs from current cash flows or generate new sourcesof revenue; management’s ability to successfully manage and grow the Company’smortgage and real estate fee-based business activities; the ability to makeinterest payments; increases in default rates or loss severities and mortgagerelated losses; the ability to satisfy conditions (payment and covenants) inthe note payable with a major creditor; our ability to obtain additionalfinancing and the terms of any financing that we do obtain; inability toeffectively liquidate properties to mitigate losses; increase in loanrepurchase requests and ability to adequately settle repurchase obligations;decreases in value of our residual interests that differ from our assumptions;the ability of our common stock to continue trading in an active market; theoutcome of litigation or regulatory actions pending against us or other legalcontingencies; our compliance with applicable local, state and federal laws andregulations and other general market and economic conditions.

 

For a discussion of these and other risks and uncertainties that couldcause actual results to differ from those contained in the forward-lookingstatements, see “Risk Factors” and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in the Company’s Annual Reporton Form 10-K for the period ended December 31, 2009, the otherreports we file under the Securities and Exchange Act of 1934. This documentspeaks only as of its date and we do not undertake, and specifically disclaimany obligation, to release publicly the results of any revisions that may bemade to any forward-looking statements to reflect the occurrence of anticipatedor unanticipated events or circumstances after the date of such statements.

 

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

 

The mortgage industry is continually vulnerable to current events thatoccur in the financial services industry. These events include changes ineconomic indicators, government regulation, interest rates, price competition,geographic shifts, disposable income, housing prices, market liquidity, marketanticipation, and customer perception, as well as others. The factors thataffect the industry change rapidly and can be unforeseeable.

 

Current events can diminish the relevance of “quarter over quarter” and“year-to-date over year-to-date” comparisons of financial information. In suchinstances, the Company attempts to present financial information in itsManagement’s Discussion and Analysis of Financial Condition and Results ofOperations that is the most relevant to its financial information.

 

**Status ofOperations, Liquidity and Capital Resources**

 

*Mortgage and real estate services*

 

In 2009, the Company sought to create an integrated services platformto provide solutions to the mortgage and real estate markets. Pursuant to that,the Company initiated various mortgage and real estate fee-based businessactivities, including loan modifications, real estate disposition, monitoringand surveillance services, real estate brokerage and lending services and titleand escrow services. The Company has been able to develop and enhance itsservice offerings in providing services to investors, servicers and individualborrowers primarily by focusing on loss mitigation and performance of our ownlong-term mortgage portfolio. These business activities have been developed aspart of a centralized platform to operate synergistically to maximize theirsuccess. The Company has established the following business activities:

 

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·                  *LossMitigation*—The Company has established loss mitigationoperations to provide loss mitigation services including loan modification andshort sale services to its long-term mortgage portfolio, investors andinstitutions with distressed and delinquent residential and multifamilymortgage portfolios. In addition, we provide modification solutions toindividual borrowers by interacting with loan servicers on behalf of theborrowers to assist them in lowering the monthly mortgage payments to anaffordable level allowing them to remain in their homes. The Company receivesfees paid by the borrower for loan modification services performed for theborrower.  During the first quarter of2010, the Company established operations to market debt resolution services toconsumers and assist them in entering a program that helps them repay theirunsecured debt at a discount.  However inOctober 2010, given recent regulation, the Company has decided not topursue further offering debt resolution services.

 

·                  *RealEstate Owned (REO) Services*—The Company has establishedREO services operations to provide REO surveillance services to servicers andportfolio managers to assist them in maximizing loss mitigation performance inmanaging distressed mortgage portfolios and foreclosed real estate assets,along with disposition of such assets. In addition, we perform defaultsurveillance and monitoring services for residential and multifamily mortgageportfolios for investors and servicers to assist them with overall portfolioperformance.

 

·                  *RealEstate Brokerage*—The Company has established real estate brokerageoperations which primarily serves the southern California area. The primarybusiness of the real estate brokerage business is the listing and selling ofREO and pre-foreclosure properties associated with short sales.

 

·                  *MortgageLending Operations*—The Company has established mortgage lendingoperations as it seeks to re-enter mortgage banking. The mortgage lendingactivities include earning fees for brokering loans to third-party lenderssince 2008 and originating loans through our mortgage banking platform underthe “Impac” brand name.  We originatedonly a minimal amount of loans in 2009, and we have increased our loanoriginations, including brokering loans, to $22.1 million for the first ninemonths of 2010.  We expect to increaseloan production further in the future through retail channels, wholesalechannels and captive financing from the Company’s portfolio of transactions,focusing on originating only loans that are eligible for sale to HUD and othergovernment-sponsored enterprises.   In October 2010,the Company completed the acquisitionof 51% of AmeriHome Mortgage Corporation (AmeriHome) which is anapproved seller/servicer for Fannie Mae, Freddie Mac and HUD, in addition tobeing an approved Ginnie Mae issuer.

 

·                  *Title andEscrow*—During the fourth quarter of 2009, the Company received CaliforniaDepartment of Insurance approval for our acquisition of a title insuranceagency and escrow operations. Upon the approval, the Company acquired theoperations effective December 31, 2009. The title insurance companyservices California and selected national markets to provide title insurance,escrow and settlement services to residential mortgage lenders, real estateagents, asset managers and REO companies in the residential market sector ofthe real estate industry. We deliver services through a proprietary integratedtechnology platform.

 

For the three and nine months ended September 30, 2010, mortgageand real estate services fees were $15.5 million and $42.5 million, respectively,as follows:

 
| ** **                                   | ** ** | **For the Three Months**     | ** ** | **For the Nine Months**      | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **Ended September 30, 2010** | ** ** | **Ended September 30, 2010** | ** ** |
| Monitoring, surveillance and recovery fees   |       | 7,342                                       |       | 20,150                                      |       |
| Title and escrow                             |       | 4,502                                       |       | 10,462                                      |       |
| Servicing income                             |       | 1,846                                       |       | 7,669                                       |       |
| Loan modification fees                       |       | 1,831                                       |       | 4,242                                       |       |
| Total mortgage and real estate services fees |       | $                                           | 15,521     |                                        | $          | 42,523 |   |
|                                              |            |                                             |            |                                             |            |  |  |

 

Although the Company intends to generate more fees by providing theseservices to third parties in the marketplace, the revenues from thesebusinesses have primarily been generated from the Company’s long-term mortgageportfolio.  Despite our efforts to expandthese services, we have encountered challenges in selling these servicesto third-parties.  Furthermore, sincethese businesses are recently established there remains uncertainty about theirfuture success.  During the first quarterof 2010, the Company began to expand the portfolio surveillance and recoveryservices operations and entered into an agreement with a third party to assistin credit risk management and portfolio surveillance services.  However, we anticipate third party revenuesmay decline and there is no certainty that they will continue.

 

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In June 2010, the Company signed adefinitive agreement with a regional bank providing the Company with a $10million warehouse facility.  This facilityprovides the company with a funding source to originate residential conformingmortgage loans that are eligible for sale to HUD and other government-sponsoredenterprises.  As of September 30,2010, there was $1.4 million outstanding on this facility.  The interest rate on the facility is onemonth LIBOR plus 4.00%, with a floor of 5.00%. The agreement expiresJune 2011.

 

*Liquidity and capital resources*

 

During the first nine months of 2010, the Company continued to fund itsoperations primarily from income generated from its long-term mortgageportfolio, which included mortgage and real estate services fees and cash flowsfrom our residual interests in securitizations.

 

The ability to meet our long-term liquidity requirements is subject toseveral factors, such as generating fees from our mortgage and real estatefee-based business activities and realizing cash flows from our long-termmortgage portfolio. Our future financial performance and success are dependentin large part upon our ability to grow our mortgage and real estate fee-basedbusiness activities, including providing services to third parties andexpanding our mortgage lending operations.  We believe that current cash balances, cash flows from mortgage and realestate services fees generated from our long-term mortgage portfolio, andresidual interest cash flows from our long-term mortgage portfolio are adequatefor our current operating needs. However, the mortgage and real estate servicesmarket is volatile, highly competitive and subject to increased regulation. TheCompany’s ability to successfully compete in the mortgage and real estateservices industry may be challenging as its business activities are recentlyestablished and many competitors have recently entered or have establishedbusinesses delivering similar services. Additionally, the mortgagelending environment is extremely competitive and highly regulated.  Thefuture success of our mortgage lending operations will depend on a number offactors, including how well we compete, housing market conditions, economicrecovery and financial regulatory reform. If we are unsuccessful, we may be unable to satisfy our futureoperating costs and liabilities, including repayment of the note payable andlong-term debt.

 

To understand the financial position of the Company better, we believeit is important to understand the composition of the Company’s stockholders’equity (deficit) and to which component of the business it relates. AtSeptember 30, 2010, the equity (deficit) within our continuing anddiscontinued operations was comprised of the following significant assets andliabilities:

 
| ** **                              | ** ** | **Condensed Components of Stockholders’ Equity (Deficit)** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **As of September 30, 2010**                                         | ** ** |
| ** **                              | ** ** | **Continuing**                                                                           | ** ** | **Discontinued** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Operations**                                                                           | ** ** | **Operations** | ** ** | **Total** | ** ** |
| Cash                                    |       | $                                                                                        | 10,601     |   | $ | 72 |   | $ | 10,673 |   |
| Residual interests in securitizations   |       | 27,884                                                                                   |       | — |   | 27,884 |   |
| Note payable                            |       | (8,125                                                                                   | )          | — |   | (8,125 | ) |
| Long-term debt ($71,120 par)            |       | (10,822                                                                                  | )          | — |   | (10,822 | ) |
| Repurchase reserve                      |       | (25                                                                                      | )          | (8,707 | ) | (8,732 | ) |
| Lease liability (1)                     |       | —                                                                                   |       | (2,353 | ) | (2,353 | ) |
| Deferred charge                         |       | 13,144                                                                                   |       | — |   | 13,144 |   |
| Net other assets (liabilities)          |       | 7,029                                                                                    |       | (2,465 | ) | 4,564 |   |
| **Stockholders’ equity (deficit)** |       | $                                                                                        | 39,686     |   | $ | (13,453 | ) | $ | 26,233 |   |

 

----

(1)          Guaranteed by IMH.

 

*Continuing operations*

 

At September 30, 2010, cash within our continuing operationsdecreased to $10.6 million from $25.7 million at December 31,2009. The primary sources of cash between periods were $42.5 million in feesgenerated from the mortgage and real estate fee-based businesses and $9.9million from residual interests in securitizations. Offsetting the sources ofcash were operating expenses totaling $45.4 million and $23.5 million inpayments on the note payable.

 

Since our consolidated and unconsolidated securitization trusts arenonrecourse, we have netted trust assets and liabilities to present the Company’sinterest in these trusts more simply, which are considered our residualinterests in securitizations. For unconsolidated securitizations our residualinterests represent the fair value of investment securities available-for-sale.For consolidated securitizations, our residual interests are represented by thefair value of securitized mortgage collateral and real estate owned, offset bythe fair value of securitized mortgage borrowings and net derivativeliabilities. We receive cash flows from our residual interests insecuritizations to the extent they are available after required distributionsto bondholders and maintaining overcollateralization levels within the trusts.The estimated fair value of the residual interests, represented by thedifference in the fair value of trust assets and trust liabilities, was $27.9million at September 30, 2010, compared to $23.0 million atDecember 31, 2009.

 

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At September 30, 2010, our note payable decreased $22.9 millionfrom December 31, 2009, as a result of monthly payments totaling $13.5million comprising of principal and interest. Additionally, during April 2010, the Company made a $10.0 millionprincipal payment that was due per the terms of the note payable.  As of September 30, 2010, the balance ofthe note was $8.1 million and will mature in March of 2011.

 

At September 30, 2010, we had deferred charges of$13.1 million, which is amortized as a component of income tax expense inthe consolidated statements of operations over the estimated life of themortgages retained in the securitized mortgage collateral. The deferred chargesrepresent the deferral of income tax expense on inter-company profits thatresulted from the sale of mortgages from taxable subsidiaries to IMH in prioryears. This balance is recorded as required by GAAP and does not have anyrealizable cash value.

 

Net other assets include $3.5 million in accounts receivable,$3.1 million in premises and equipment, $2.3 million in prepaidexpenses and $1.0 million in restricted cash.

 

*Discontinued operations*

 

The Company’s most significant liabilities in discontinued liabilitiesat September 30, 2010 relate to its repurchase reserve and a leaseliability associated with the former non-conforming mortgage operations.

 

In previous years when our discontinued operations sold loans toinvestors, we were required to make normal and customary representations andwarranties about the loans we had previously sold to investors. Our whole loansale agreements generally required us to repurchase loans if we breached arepresentation or warranty given to the loan purchaser. In addition, we alsocould be required to repurchase loans as a result of borrower fraud or if apayment default occurs on a mortgage loan shortly after its sale. Therepurchase reserve is an estimate of losses from expected repurchases, and isbased, in part, on the recent settlement of claims. During the third quarter,consistent with other mortgage lenders, we received repurchase requests fromFannie Mae for loans funded primarily in 2007 resulting in an increase in ourrepurchase reserve to $8.7 million at September 30, 2010 as compared to$7.6 million at June 30, 2010.

 

In connection with the discontinuation of our non-conforming mortgage,retail mortgage, warehouse lending and commercial operations, a significantamount of office space that was previously occupied is no longer being used bythe Company.  The Company has subleased asignificant amount of this office space. At September 30, 2010, theCompany had a liability of $2.4 million included within discontinuedoperations, representing the present value of the minimum lease payments overthe remaining life of the lease, offset by the expected proceeds from subletrevenue related to this office space.

 

**MarketConditions**

 

The housing market showedsigns of improvement earlier in the year as housing prices were stabilizing inmany markets and began to recover in others due to the low interest rateenvironment and the first-time homebuyer tax credit.  Since the expiration of the homebuyer taxcredit in May 2010, home sales have declined in the third quarter of 2010and inventory levels have increased.  Thehousing market is not expected to improve until job and income growth increase.

 

Mortgage and credit marketconditions remained weak in the third quarter of 2010 due primarily to acontinued weak labor market. Existing uncertainties surrounding the housingmarket, economy and regulatory environment will continue to present challengesfor the Company.  The ongoing economicstress or further deterioration of general economic conditions could prolong orincrease borrower defaults leading to deteriorating performance of the Company’sportfolio.

 

InOctober 2010, certain large mortgage servicers announced investigationsinto their internal servicing operations. As reported, these investigationscentered around foreclosure processing and, shortly thereafter, these servicersalso announced the temporary national suspension of foreclosure activity.  Some state attorney generals and variousstate and federal regulators and policymakers have since initiated inquiriesconcerning foreclosure procedures for single family mortgage loans.  Certain courts have issued new rules relatingto foreclosures and we anticipate that scrutiny of foreclosure documentationwill increase. Also, in some areas, officials are requiring additionalverification of information filed prior to the foreclosure proceeding. If thesetrends continue, there could be an extended delay in the processing offoreclosures, which could have an adverse effect upon the timing of foreclosuresales which may lead to higher loss severities and REO expenses.

 

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Despitepositive job creation in the first half of 2010, the economy began to lose jobsagain in the third quarter as job creation in the private sector, while positive,slowed and was more than offset by reductions in temporary government relatedjobs which has again raised fears as to how pronounced any economic recoverymay be. U.S. unemployment rates, which have been a major factor in thedeterioration of credit quality in the U.S., remained high at 9.6 percentin September 2010, an increase of 10 basis points during the quarterand a decrease of 40 basis points since December 2009.  The increase in unemployment rates havegenerally been most pronounced in the markets which had previously experiencedthe highest appreciation in home values. Unemployment rates in 6 statesare at or above 11%, including California and Florida.   Californiaand Florida represent 52% and 12% of the aggregate unpaid principal of the long-termportfolio, respectively, at September 30, 2010.

 

In addition to the weaklabor market, we continue to be affected by the following trends:

 

·      Overall levels ofdelinquencies remain elevated;

 

·      Loss severity rates remainrelatively high, as market conditions, such as home prices and the rate of homesales remain weak;

 

·      Growth in the number ofloans in the foreclosure process as well as prolonged foreclosure timelinesrelated to deficiencies in foreclosure practices of servicers as discussedabove;

 

·      Mortgage loan originationsfrom 2005 to 2008 continue to perform worse than originations from priorperiods;

 

·      Real estate markets in alarge portion of the United States continue to be affected by stagnation ordeclines in property values experienced over the last three years;

 

·      Home prices remain underpressure due to elevated foreclosure levels even though they have begun tostabilize in most markets, including some parts of California; and

 

·      Tighter lending standards bymortgage lenders which affects the ability of borrowers to refinance existingmortgage loans.

 

A number of factors make itdifficult to predict when a sustained recovery in the housing and creditmarkets will occur.  Concerns about thefuture of the U.S. economy, including the pace and magnitude of recoveryfrom the recent economic recession, consumer confidence, volatility in energyprices, volatility experienced by the credit markets including the possibilitythat the recent European sovereign debt crisis will spread and trends incorporate earnings will continue to influence the U.S. economic recoveryand the capital markets. In particular, improvement in unemployment rates and asustained recovery of the housing market remain critical components of abroader U.S. economic recovery. Further weakening in these components aswell as in consumer confidence may result in additional deterioration inconsumer payment patterns and credit quality. Although consumer confidence hasimproved from the levels seen early in 2009, it remains low on a historicalbasis. Weak consumer fundamentals, including declines in wage income, reducedconsumer spending, declines in wealth and a difficult job market continue todepress consumer confidence. Additionally, there is uncertainty related to therecently announced monetary policy under the Federal government’s quantitativeeasing program and uncertainty as to the impact on the economy and consumerconfidence whether the remaining actions taken by the government will restorefaith in the capital markets and stimulate consumer spending. These conditionsin combination with general economic weakness and the impact of recent andproposed regulatory changes will continue to affect our results of operations,the degree of which is largely dependent upon the nature and timing of theeconomic recovery.

 

AmbacFinancial Group, Inc. (Ambac) provides bond guaranty insurance forthirteen of the Company’s consolidated securitizations.  In November 2010, Ambac filed forbankruptcy protection.  As the relatedsecuritization trusts are nonrecourse to the Company, it is not required toreplace or otherwise settle bond guaranty insurance within the consolidatedtrusts.  Furthermore, in determining thefair value of securitized mortgage borrowings, the Company excludes considerationof bond guaranty insurance payments in accordance with FASB ASC820-10-35-18A.  In addition to Ambac,other insurance companies have issued bond guaranty insurance policies forcertain securities within the Company’s securitized mortgage borrowings.  Other bond insurers are experiencing similarfinancial difficulties.  Bankruptcyfilings by Ambac and other bond insurance companies could materially affectindustry-wide market prices for collateralized mortgage bonds.

 

*FinancialRegulatory Reform* On July 21, 2010, the “Dodd-Frank Wall StreetReform and Consumer Protection Act” was signed into law. This legislation is asweeping overhaul of the financial regulatory system.

 

The legislation provides fornew regulation on financial institutions, creates new supervisory and advisorybodies, including the new Consumer Financial Protection Bureau, and containsmany consumer related provisions including provisions addressing mortgagereform. In the area of mortgage origination, it appears there is an effectiveelimination of stated income loans and a requirement to apply a net tangiblebenefit test for all refinancing transactions. There are also numerous revisedservicing requirements for mortgage loans.

 

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The legislation will have asignificant impact on the operations of many financial institutions in the U.S.As the legislation calls for extensive regulations to be promulgated tointerpret and implement the legislation, it is not possible to preciselydetermine the impact to operations and financial results at this time.  The Company will continue to assess theeffect of the legislation on the Company’s business as the associatedregulations are adopted.

 

*Effects of Recent Market Activity*

 

As a result of the Company’s inability to sell or securitizenon-conforming loans during the second half of 2007, the Company discontinuedfunding loans and discontinued substantially all of its mortgage(non-conforming single-family loans and commercial loans, which consistprimarily of multifamily loans) and warehouse lending operations. Marketconditions deteriorated in 2008 and continued to be depressed for most of 2009before recovering slightly towards the end of 2009 and early 2010. As a result,the Company’s investment in securitized non-conforming loans (residualinterests) has been affected by the increase in estimated defaults andseverities, evidenced by significant home price depreciation. The decline insingle-family home prices can be seen in the chart below.

 

 

As depicted in the chart above, average home prices peaked inJune 2006 at 226.29 and continued their dramatic decline through much ofthe first half of 2009, while increasing slightly over the remaining half ofthe year. The Standard & Poor’s Case-Shiller 10-City Composite HomePrice Index (the Index) for August 2010 was 162.13 (with the base of100.00 for January 2000) and hasn’t been this low since December 2003when the Index was 161.27. Beginning in the third quarter of 2007, the Companybegan to believe that there was a correlation between the borrowers’ perceivedequity in their homes and defaults. The original loan-to-value (defined as loanamount as a percentage of collateral value, “LTV”) and original combinedloan-to-value (defined as first lien plus total subordinate liens to collateralvalue, “CLTV”) ratios of single-family mortgages remaining in the Company’ssecuritized mortgage collateral as of September 30, 2010 was 72% and 80%,respectively. The current LTV and CLTV ratios likely increased from originationdate as a result of the deterioration in the real estate market. We believethat home prices that have declined below the borrower’s original purchaseprice have a higher risk of default within our portfolio. Based on the Index,home prices have declined 28% through August 2010 from the 2006 peak.Further, we believe the home prices in general within California and Florida,the states with the highest concentration of our mortgages, have declined evenfurther than the Index. We have considered the deterioration in home prices andits impact on our loss severities, which are a primary assumption used in thevaluation of securitized mortgage collateral and borrowings.

 

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** **

**CriticalAccounting Policies**

 

We define critical accounting policies as those that are important tothe portrayal of our financial condition and results of operations. Ourcritical accounting policies require management to make difficult and complexjudgments that rely on estimates about the effect of matters that areinherently uncertain due to the effect of changing market conditions and/orconsumer behavior. In determining which accounting policies meet thisdefinition, we considered our policies with respect to the valuation of ourassets and liabilities and estimates and assumptions used in determining thosevaluations. We believe the most critical accounting issues that require themost complex and difficult judgments and that are particularly susceptible tosignificant change to our financial condition and results of operations includethe following:

 

Pleaserefer to IMH’s report on Form 10-K on pages 33 through 39 ofManagement’s Discussion and Analysis of Results of Operations for the yearended December 31, 2009  for adetailed discussion of our significant accounting policies. Such policies havenot changed during 2010 except those outlined below.

 

***Variable Interest Entities andTransfers of Financial Assets and Liabilities***

 

Historically, the Company securitized mortgages in the form ofcollateralized mortgage obligations (CMO), which were consolidated andaccounted for as secured borrowings for financial statement purposes. TheCompany also securitized mortgages in the form of real estate mortgageinvestment conduits (REMICs), which were either consolidated or unconsolidateddepending on the design of the securitization structure. CMO and certain REMICsecuritizations were designed so that the transferee (securitization trust) wasnot a qualifying special purpose entity (QSPE), and therefore the Companyconsolidated the variable interest entity (VIE) as it was the primarybeneficiary of the sole residual interest in each securitization trust.Generally, this was achieved by including terms in the securitizationagreements that gave the Company the ability to unilaterally cause the securitizationtrust to return specific mortgages, other than through a clean-up call. Amountsconsolidated are included in trust assets and liabilities as securitizedmortgage collateral, real estate owned, derivative assets, securitized mortgageborrowings and derivative liabilities in the accompanying consolidated balancesheets.

 

Our estimate of the fair value of our net retained residual interestsin unconsolidated securitizations, which are included in investment securitiesavailable-for-sale in the consolidated balance sheets, requires us to exercisesignificant judgment as to the timing and amount of future cash flows from theresidual interests. We are exposed to credit risk from the underlying mortgageloans in unconsolidated securitizations to the extent we retain subordinatedinterests. Changes in expected cash flows resulting from changes in expectednet credit losses will impact the value of our subordinated retained interestsand those changes are recorded as a component of change in fair value of nettrust assets.

 

In contrast, for securitizations that are structured as securedborrowings, we recognize interest income over the life of the securitizedmortgage collateral and interest expense incurred for the securitized mortgageborrowings. We refer to these transactions as consolidated securitizations. Themortgage loans collateralizing the debt securities for these financings areincluded in securitized mortgage collateral and the debt securities payable toinvestors in these securitizations are included in securitized mortgageborrowings in our consolidated balance sheet.

 

Whether a securitization is consolidated or unconsolidated, investorsin the securities issued by the securitization trust have no recourse to ournon-securitized assets or to us and have no ability to require us to provideadditional assets, but rather have recourse only to the assets transferred tothe trust. Whereas the accounting differences are significant, the underlyingeconomic impact to us, over time, will be the same regardless of whether thesecuritization trust is consolidated or unconsolidated.

 

Effective January 1, 2010, former QSPEs are evaluated forconsolidation based on the provisions of FASB ASC 810-10-25, which eliminatesthe concept of a QSPE and changes the approach to determining a securitizationtrust’s primary beneficiary. Refer to Note 1.—*****Summary of Business,Financial Statement Presentation, Market Conditions and Liquidity* inthe notes to the consolidated financial statements for a discussion of theimpact of this new standard on the Company’s consolidated balance sheet atJanuary 1, 2010.

 

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**IncomeTaxes**

 

While the Company has generated significant net operating losscarryforwards in recent periods, we do not expect to generate sufficienttaxable income in future periods to be able to realize these tax benefits.Therefore, we have recorded a full valuation allowance against the net deferredtax assets as we believe that as of September 30, 2010 it is more likelythan not that the net deferred tax assets will not be recoverable.

 

**SelectedFinancial Results for the Three Months Ended September 30, 2010**

 

*Continuing Operations*

 

·*     *Earnings from continuingoperations of $2.3 million for the third quarter of 2010, compared to $4.8million for the comparable 2009 period.

 

·      Net interest income of$1.7 million for the third quarter of 2010, primarily from our long-termmortgage portfolio, compared to $1.9 million for the comparable 2009period.

 

·      Non-interest (loss) income -net trust assets of $(574) thousand for the third quarter of 2010, compared to$3.2 million for the comparable 2009 period.

 

·      Mortgage and real estate servicesfees of $15.5 million for the third quarter of 2010, compared to$13.5 million for the comparable 2009 period.

 

·      Personnel expense of $10.7million for the third quarter of 2010, compared to $9.4 million for thecomparable 2009 period.

 

*Discontinued Operations*

 

·*     *Loss from discontinuedoperations of $1.3 million for the third quarter of 2010, compared to a loss of$1.8 million for the comparable 2009 period.

 

·      Repurchase reserve was $8.7million at September 30, 2010, compared to $11.0 million at December 31,2009.

 

**SelectedFinancial Results for the Nine Months Ended September 30, 2010**

 

·*     *Earnings from continuingoperations of $8.3 million for the nine months ended September 30,2010, compared to $14.1 million for the comparable 2009 period.

 

·      Net interest income of$4.0 million for the nine months ended September 30, 2010, primarilyfrom our long-term mortgage portfolio, compared to $8.5 million for thecomparable 2009 period.

 

·      Non-interest income—nettrust assets of $6.4 million for the nine months ended September 30, 2010,compared to $16.1 million for the comparable 2009 period.

 

·      Mortgage and real estateservices fees of $42.5 million for the nine months ended September 30,2010, compared to $32.3 million for the comparable 2009 period.

 

·      Personnel expense of $31.1million for the nine months ended September 30, 2010, compared to $26.1million for the comparable 2009 period.

 

*Discontinued Operations*

 

·*     *Earnings from discontinuedoperations of $1.9 million for the nine months ended September 30, 2010,compared to a loss of $8.4 million for the comparable 2009 period.

 

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**FinancialCondition and Results of Operations**

 

*Financial Condition*

 

Condensed Balance Sheet Data

 
| ** **                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                           | ** ** | **2010**               | ** ** | **2009**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Investment securities available-for-sale             |       | $                      | 1,254      |                  | $          | 813            |       | $          | 441        |   | 54 | % |
| Securitized mortgage collateral                      |       | 6,070,577              |       | 5,666,122             |       | 404,455        |       | 7          |       |
| Derivative assets                                    |       | 39                     |       | 146                   |       | (107           | )          | (73        | )          |
| Real estate owned                                    |       | 106,042                |       | 142,364               |       | (36,322        | )          | (26        | )          |
| Total trust assets                                   |       | 6,177,912              |       | 5,809,445             |       | 368,467        |       | 6          |       |
|                                                 |       |                   |       |                  |       |           |       |       |       |
| Assets of discontinued operations                    |       | 672                    |       | 4,480                 |       | (3,808         | )          | (85        | )          |
| Other assets                                         |       | 42,033                 |       | 58,987                |       | (16,954        | )          | (29        | )          |
| **Total assets**                                     |       | $                      | 6,220,617  |                  | $          | 5,872,912      |       | $          | 347,705    |   | 6 | % |
|                                                 |       |                   |       |                  |       |           |       |       |       |
| Securitized mortgage borrowings                      |       | $                      | 6,061,000  |                  | $          | 5,659,865      |       | $          | 401,135    |   | 7 | % |
| Derivative liabilities                               |       | 89,028                 |       | 126,603               |       | (37,575        | )          | (30        | )          |
| Total trust liabilities                              |       | 6,150,028              |       | 5,786,468             |       | 363,560        |       | 6          |       |
|                                                 |       |                   |       |                  |       |           |       |       |       |
| Liabilities of discontinued operations               |       | 14,125                 |       | 19,152                |       | (5,027         | )          | (26        | )          |
| Other liabilities                                    |       | 30,231                 |       | 51,859                |       | (21,628        | )          | (42        | )          |
| Total liabilities                                    |       | 6,194,384              |       | 5,857,479             |       | 336,905        |       | 6          |       |
| Total stockholders’ equity                      |       | 26,233                 |       | 15,433                |       | 10,800         |       | 70         |       |
| **Total liabilities and  stockholders’ equity** |       | $                      | 6,220,617  |                  | $          | 5,872,912      |       | $          | 347,705    |   | 6 | % |

 

Total assets and total liabilities were $6.2 billion atSeptember 30, 2010 as compared to $5.9 billion at December 31,2009. The increase in total assets and liabilities are primarily attributableto increases in the Company’s trust assets and trust liabilities as summarizedbelow.

 

The Company updates its collateral assumptions quarterly based onrecent delinquency, default, prepayment and loss experience.  Additionally, the Company updates the forwardinterest rates and investor yield (discount rate) assumptions based oninformation derived from market participants. At March 31, 2010, the Company decreased the investor yield requirementsfor senior bonds of the securitized mortgage borrowings as yields tightenedsignificantly compared to prior periods. The Company continues to see a corresponding increase in the prices forsenior bonds from our pricing services. The decrease in investor yield assumptions on securitized mortgagecollateral and securitized mortgage borrowings resulted in an increase in thevalue of these trust assets and liabilities. However, this change in assumption did not have any effect on theconsolidated statement of operations or equity of the Company as the increasein the value of collateral directly offset the increase in the value of theborrowings.  The Company did not make anychanges to the discount rate assumptions for residual interests during thefirst nine months of 2010.

 

·      Securitized mortgagecollateral increased $404.5 million during the nine months endedSeptember 30, 2010. The increase in securitized mortgage collateral from$5.7 billion at December 31, 2009 to $6.1 billion atSeptember 30, 2010 was primarily due to decreased loss assumptions forsingle-family collateral, reduction in investor yield requirements as discussedbelow, and the net consolidation of trust assets, partially offset byreductions in principal balances from defaults and principal payments duringthe period. For the nine months ended September 30, 2010, the balanceincreased due to increases in fair value of $981.2 million and netconsolidation of trust assets related to the adoption of ASU 2009-17 of $116.9million, offset by reductions in principal balances (resulting from transfersto REO and principal paydowns) of $693.6 million.

 

·      REO within the Company’ssecuritization trusts decreased $36.3 million to $106.0 million atSeptember 30, 2010.  Decreases inREO were due to liquidations of $159.7 million.  Offsetting the decrease from liquidationswere increases in REO from foreclosures of $129.9 million, $3.0 million inthe net consolidation of trust assets related to the adoption of ASU 2009-17,and $9.8 million in additional impairment write-downs.

 

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·      Securitized mortgageborrowings increased $401.1 million to $6.1 billion atSeptember 30, 2010. The increase in securitized mortgage borrowings wasprimarily due to decreased loss assumptions for single-family collateral,reduction in investor yield requirements as discussed below, and the netconsolidation of trust liabilities, offset by reductions in principal balancesduring the period. For the nine months ended September 30, 2010, thebalance increased due to increases in fair value of $1.2 billion, netconsolidation of trust liabilities related to the adoption of ASU 2009-17 of$110.6 million, offset by reductions in outstanding balances of$942.9 million.

 

·      Derivative liabilities, netdecreased $37.6 million to $89.0 million at September 30, 2010.The decrease is the result of $88.1 million in derivative cash paymentsfrom the securitization trusts, offset by a $41.6 million increase in fairvalue resulting from decreases in the forward LIBOR curve and the netconsolidation of off balance sheet trusts related to the adoption of ASU2009-17 of $9.0 million.

 

Since our consolidated and unconsolidated securitization trusts arenonrecourse to the Company, our economic risk is limited to our residualinterests in these securitization trusts. Therefore, in the following table wehave netted trust assets and trust liabilities to present these residualinterests more simply. Our residual interests in securitizations are segregatedbetween our single-family (SF) residential and multifamily (MF) residentialportfolios and are represented by the difference between trust assets and trustliabilities. The following tables present the estimated fair value of ourresidual interests, including investment securities available for sale, bysecuritization vintage year and other related assumptions used to derive thesevalues at September 30, 2010:

 
| **Origination**                         | ** ** | ** ** | ** ** | **Estimated Fair Value of  Residual Interests by Vintage Year** | ** ** |
|-----------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------|------------|
| **Year**                                | ** ** | ** ** | ** ** | **SF**                                                                                             | ** ** | **MF** | ** ** | **Total** | ** ** |
| 2002-2003                               |       | (1)        |       | $                                                                                                  | 14,185     |   | $ | 3,897 |   | $ | 18,082 |   |
| 2004                                    |       |       |       | 2,245                                                                                              |       | 7,395 |   | 9,640 |   |
| 2005                                    |       | (2)        |       | —                                                                                             |       | 126 |   | 126 |   |
| 2006                                    |       | (2)        |       | —                                                                                             |       | 36 |   | 36 |   |
| 2007                                    |       | (2)        |       | —                                                                                             |       | — |   | — |   |
| **Total**                               | ** ** | ** ** | ** ** | **$**                                                                                              | **16,430** | ** ** | **$** | **11,454** | ** ** | **$** | **27,884** | ** ** |
|                                    |       |       |       |                                                                                               |       |   |   |   |   |
| Weighted  average prepayment rate  |       | 7          | %          | 6                                                                                                  | %          | 7 | % |
| Weighted average discount rate     |       | 30         | %          | 20                                                                                                 | %          | 26 | % |

 

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(1)   2002-2003 vintage yearincludes CMO 2007-A, since the majority of the mortgages collateralized in thissecuritization were originated during this period.

(2)   The estimated fair values ofresidual interests in vintage years 2005 through 2007 is reflective of higherestimated future losses and investor yield requirements compared to earliervintage years.

 

The Company utilizes a number of assumptions to value securitizedmortgage collateral, securitized mortgage borrowings and residualinterests.  These assumptions includeestimated collateral default rates and loss severities (credit losses),collateral prepayment rates, forward interest rates and investor yields(discount rates).  The Company uses thesame collateral assumptions for securitized mortgage collateral and securitizedmortgage borrowings as the collateral assumptions determine collateral cashflows which are used to pay interest and principal for securitized mortgageborrowings and excess spread, if any, to the residual interests. However, theCompany uses different investor yield (discount rate) assumptions forsecuritized mortgage collateral and securitized mortgage borrowings and thediscount rate used for residual interests based on underlying collateralcharacteristics, vintage year, assumed risk and market participantassumptions.  The table below reflectsthe estimated future credit losses and investor yield requirements for trustassets by product (SF and MF) and securitization vintage:

 

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| ** ** | ** ** | **Estimated Future Losses (1)** | ** ** | **Investor Yield Requirement (2)** | ** ** |
|------------|------------|------------------------------------------------|------------|---------------------------------------------------|------------|
| ** ** | ** ** | **SF**                                         | ** ** | **MF**                                            | ** ** | **SF** | ** ** | **MF** | ** ** |
| 2002-2003  |       | 5                                              | %          | 8                                                 | %          | 12 | % | 11 | % |
| 2004       |       | 15                                             | %          | 1                                                 | %          | 11 | % | 9 | % |
| 2005       |       | 30                                             | %          | 13                                                | %          | 13 | % | 11 | % |
| 2006       |       | 39                                             | %          | 8                                                 | %          | 20 | % | 14 | % |
| 2007       |       | 33                                             | %          | 7                                                 | %          | 21 | % | 8 | % |

 

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(1)          Estimated future lossesderived by dividing future projected losses by unpaid principal balances atSeptember 30, 2010.

(2)          Investor yield requirementsrepresent the Company’s estimate of the yield third-party market participantswould require to price our trust assets and liabilities given our prepayment,credit loss and forward interest rate assumptions.

 

As illustrated in S&Ps Case Shiller 10-City Composite Home PriceIndex, from 2002 through 2006, home price appreciation escalated to historiclevels. During 2005 through 2007, the company originated or acquired mortgagessupported by these elevated real estate values. Beginning in 2007,deterioration in the economy resulting in high unemployment and a dramatic dropin home prices resulted in significant negative equity for borrowers. Thesefactors have led to significant increases in loss severities resulting fromdeterioration in the credit quality of borrowers, as well as strategicdefaults, whereby borrowers with the ability to pay are defaulting on theirmortgages based on the belief that home prices will not recover in a reasonableamount of time. Home prices have deteriorated back to December 2003 levelswhich has significantly reduced or eliminated equity for loans originated after2003. Future loss estimates are significantly higher for mortgage loansincluded in securitization vintages after 2004 which reflect severe home pricedeterioration and defaults experienced with mortgages originated during theseperiods.

 

Cash flows from the Company’s long-term mortgage portfolio are affectedby the following market and operational risks:

 

·                  liquidity risk;

 

·                  interest rate risk;

 

·                  credit risk; and

 

·                  prepayment risk.

 

*Liquidity Risk.*Referto “Liquidity and Capital Resources.”

 

*Interest Rate Risk.*  The Company’s earnings from the long-termmortgage portfolio depend largely on our interest rate spread, represented bythe relationship between the yield on our interest- earning assets (primarilyinvestment securities available-for-sale and securitized mortgage collateral)and the cost of our interest-bearing liabilities (primarily securitizedmortgage borrowings, long-term debt and note payable). Our interest rate spreadis impacted by several factors, including general economic factors, forwardinterest rates and the credit quality of mortgage loans in the long-termmortgage portfolio.

 

The residual interests in our long-term mortgage portfolio aresensitive to changes in interest rates on securitized mortgage collateral andthe related securitized mortgage borrowings. Changes in interest rates cansignificantly affect the cash flows and fair values of the Company’s assets andliabilities, as well as our earnings and stockholders’ equity.

 

The Company uses derivative instruments to manage some of its interestrate risk. However, the Company does not attempt to completely hedge interestrate risk. To help mitigate some of the exposure to the effect of changinginterest rates on cash flows on securitized mortgage borrowings, the Companyutilized derivative instruments primarily in the form of interest rate swapagreements (swaps) and, to a lesser extent, interest rate cap agreements (caps)and interest rate floor agreements (floors). These derivative instruments arerecorded at fair value in the consolidated balance sheets. For non-exchangetraded contracts, fair value is based on the amounts that would be required tosettle the positions with the related counterparties as of the valuation date.Valuations of derivative assets and liabilities are based on observable marketinputs, if available. To the extent observable market inputs are not available,fair values measurements include the Company’s judgments about future cashflows, forward interest rates and certain other factors, including counterpartyrisk. Additionally, these values also take into account the Company’s owncredit standing, to the extent applicable; thus, the valuation of thederivative instrument includes the estimated value of the net creditdifferential between the counterparties to the derivative contract.

 

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At September 30, 2010, derivative liabilities, net were $89.0million and reflect the securitization trust’s liability to pay third-partycounterparties based on the estimated value to settle the derivativeinstruments. Cash payments on these derivative instruments are based onnotional amounts that are decreasing over time. Excluding the effects of otherfactors such as portfolio delinquency and loss severities within thesecuritization trusts, as the notional amount of these derivative instrumentsdecrease over time, payments to counterparties in the current interest rateenvironment are reduced, thereby potentially increasing cash flows on ourresidual interests in securitizations. Conversely, increases in interest ratesfrom current levels could potentially reduce overall cash flows on our residualinterests in securitizations. Since our consolidated and unconsolidatedsecuritization trusts are nonrecourse to the Company, our economic risk islimited to our residual interests in these securitization trusts.

 

The Company is also subject to interest rate risk on its long-term debt(consisting of trust preferred securities and junior subordinated notes) andnotes payable. These interest bearing liabilities include adjustable rateperiods based on one-month LIBOR (note payable) and three-month LIBOR (trustpreferred securities and junior subordinated notes). The Company does notcurrently hedge its exposure to the effect of changing interest rates relatedto these interest-bearing liabilities. Significant fluctuations in interestrates could have a material adverse effect on the Company’s business, financialcondition, results of operations or liquidity.

 

*Credit risk.*  We manage credit risk by actively managingdelinquencies and defaults through our servicers. Starting with the second halfof 2007 we have not retained any additional Alt-A mortgages in our long-termmortgage portfolio. Our securitized mortgage collateral primarily consists ofAlt-A mortgages which are generally within typical Fannie Mae and Freddie Macguidelines but have loan characteristics, which may include higher loanbalances, higher loan-to-value ratios or lower documentation requirements(including stated-income loans), that make them non-conforming under thoseguidelines.

 

Using historical losses, current portfolio statistics and marketconditions and available market data, the Company has estimated future loanlosses, which are included in the fair value adjustment to our securitizedmortgage collateral. While the credit performance for the loans has beenclearly far worse than the Company’s initial expectations when the loans wereoriginated, the ultimate level of realized losses will largely be influenced byevents 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 and residual interests.

 

We monitor our servicers to attempt to ensure that they perform lossmitigation, foreclosure and collection functions according to their servicingpractices and each securitization trust’s pooling and servicing agreement. Wehave met with the management of our servicers to assess our borrowers’ currentability to pay their mortgages and to make arrangements with selecteddelinquent borrowers which will result in the best interest of the trust andborrower, in an effort to minimize the number of mortgages which becomeseriously delinquent. When resolving delinquent mortgages, servicers arerequired to take timely action. The servicer is required to determine paymentcollection under various circumstances, which will result in the maximumfinancial benefit. This is accomplished by either working with the borrower tobring the mortgage current by modifying the loan with terms that will maximizethe recovery or by foreclosing and liquidating the property. At a foreclosuresale, the trusts consolidated on our balance sheet generally acquire title tothe property.

 

We use the Mortgage Bankers Association (MBA) method to definedelinquency as a contractually required payment being 30 days or more pastdue. We measure delinquencies from the date of the last payment due date inwhich a payment was received. Delinquencies for loans 60 days late orgreater, foreclosures and delinquent bankruptcies were $2.5 billion or21.7% as of September 30, 2010.

 

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The following table summarizes the unpaid principal balances of loansin our mortgage portfolio, included in securitized mortgage collateral, loansheld-for-investment and loans held-for-sale for continuing and discontinuedoperations combined, that were 60 or more days delinquent (utilizing the MBAmethod) as of the periods indicated:

 
| ** **                                                    | ** ** | ** **             | ** ** | **Total**      | ** ** | ** **            | ** ** | **Total**      | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                    | ** ** | **September 30,** | ** ** | **Collateral** | ** ** | **December 31,** | ** ** | **Collateral** | ** ** |
| ** **                                                    | ** ** | **2010**               | ** ** | **%**          | ** ** | **2009**              | ** ** | **%**          | ** ** |
| Loans held for sale and investment (1)                        |       |                   |       |           |       |                  |       |           |       |
| 60 - 89 days delinquent                                       |       | $                      | —     |           | 0.0        | %                     | $          | 66             |       | 0.0 | % |
| 90 or more days delinquent                                    |       | 1,139                  |       | 0.0            | %          | 6,928                 |       | 0.1            | %          |
| Foreclosures (2)                                              |       | 1,043                  |       | 0.0            | %          | 7,397                 |       | 0.1            | %          |
| Total 60+ days delinquent loans held-for-sale and  investment |       | 2,182                  |       | 0.0            | %          | 14,391                |       | 0.1            | %          |
|                                                          |       |                   |       |           |       |                  |       |           |       |
| Securitized mortgage collateral                               |       |                   |       |           |       |                  |       |           |       |
| 60 - 89 days delinquent                                       |       | $                      | 252,739    |           | 2.2        | %                     | $          | 324,032        |       | 2.6 | % |
| 90 or more days delinquent                                    |       | 865,534                |       | 7.5            | %          | 1,043,718             |       | 8.4            | %          |
| Foreclosures (2)                                              |       | 1,053,384              |       | 9.1            | %          | 1,449,538             |       | 11.6           | %          |
| Delinquent bankruptcies (3)                                   |       | 342,125                |       | 2.9            | %          | 302,314               |       | 2.4            | %          |
| Total 60+ days delinquent long-term mortgage  portfolio       |       | 2,513,782              |       | 21.6           | %          | 3,119,602             |       | 25.0           | %          |
| Total 60 or more days delinquent                              |       | $                      | 2,515,964  |           | 21.7       | %                     | $          | 3,133,993      |       | 25.1 | % |
| Total collateral                                              |       | $                      | 11,616,852 |           |       |                  | $          | 12,492,493     |       |   |   |

 

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(1)          Loans held-for-sale aresubstantially included in discontinued operations in the consolidated balancesheets.

(2)          Represents properties in theprocess of foreclosure.

(3)          Represents bankruptcies thatare 30 days or more delinquent.

 

The following table summarizes securitized mortgage collateral, loansheld-for-investment, loans held-for-sale and real estate owned, that werenon-performing for continuing and discontinued operations combined as of thedates indicated (excludes 60-89 days delinquent):

 
| ** **                                                            | ** ** | ** **             | ** ** | **Total**      | ** ** | ** **            | ** ** | **Total**      | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                            | ** ** | **September 30,** | ** ** | **Collateral** | ** ** | **December 31,** | ** ** | **Collateral** | ** ** |
| ** **                                                            | ** ** | **2010**               | ** ** | **%**          | ** ** | **2009**              | ** ** | **%**          | ** ** |
| 90 or more days delinquent, foreclosures and  delinquent bankruptcies |       | $                      | 2,263,225  |           | 19.5       | %                     | $          | 2,809,895      |       | 22.5 | % |
| Real estate owned                                                     |       | 106,114                |       | 0.9            | %          | 142,676               |       | 1.1            | %          |
| Total non-performing assets                                           |       | $                      | 2,369,339  |           | 20.4       | %                     | $          | 2,952,571      |       | 23.6 | % |

 

Non-performing assets consist of non-performing loans (mortgages thatare 90 days or more delinquent, including loans in foreclosure anddelinquent bankruptcies) plus REO. 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 the servicer.The servicers are required to advance principal and interest on loans withinthe securitization trusts to the extent the advances are consideredrecoverable. As of September 30, 2010, non-performing assets (unpaidprincipal balance of loans 90 or more days delinquent, foreclosures anddelinquent bankruptcies plus REO) as a percentage of the total collateral was20%. At December 31, 2009, non-performing assets to total collateral was24%.  As of September 30, 2010, theestimated fair value of non-performing assets (representing the fair value ofloans 90 or more days delinquent, foreclosures and delinquent bankruptcies plusREO) as a percentage of the total assets was 12%. At December 31, 2009,the estimated fair value of non-performing assets to total assets was 16%.

 

REO, which consists of residential real estate acquired in satisfactionof loans, is carried at the lower of cost or net realizable value lessestimated selling costs. Adjustments to the loan carrying value required at thetime of foreclosure are included in the change in the fair value of net trustassets. Changes in the Company’s estimates of net realizable value subsequentto the time of foreclosure and through the time of ultimate disposition arerecorded as gains or losses from real estate owned in the consolidatedstatements of operations. REO, for continuing and discontinued operations, atSeptember 30, 2010 decreased $36.3 million or 26% from December 31, 2009as a result of liquidations and a decrease in foreclosures.

 

We realized gains on the sale of real estate owned in the amount $111thousand and $3.5 million for the three and nine months ended September 30,2010, respectively,  compared to losses of $18.6 million and $100.2million, respectively for the comparable 2009 periods.  Additionally,during the three and nine month ended September 30, 2010, the Companyrecorded write-downs of the net realizable value of the REO in the amount of$10.3 million and $9.8 million, respectively, compared to write-downs of $24.5million and $117.9 million, respectively for the comparable 2009periods.  These write-downs of the net realizable value reflectdeclines in value of the REO subsequent to foreclosure date.

 

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The following table presents the balances of REO for continuingoperations:

 
| ** **         | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------|------------|------------------------------|------------|-----------------------------|------------|
| REO                |       | $                            | 137,517    |                        | $          | 176,800 |   |
| Impairment (1)     |       | (31,403                      | )          | (34,080                     | )          |
| Ending balance     |       | $                            | 106,114    |                        | $          | 142,720 |   |
|               |       |                         |       |                        |       |
| REO inside trusts  |       | $                            | 106,042    |                        | $          | 142,364 |   |
| REO outside trusts |       | 72                           |       | 356                         |       |
| Total              |       | $                            | 106,114    |                        | $          | 142,720 |   |

 

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(1)                                  Impairmentrepresents the cumulative write-downs of net realizable value subsequent toforeclosure.

 

In calculating the cash flows to assess the fair value of thesecuritized mortgage collateral, the Company estimates the future lossesembedded in our loan portfolio. In evaluating the adequacy of these losses,management takes many factors into consideration. For instance, a detailedanalysis of historical loan performance data is accumulated and reviewed. Thisdata is analyzed for loss performance and prepayment performance by producttype, origination year and securitization issuance. The data is also brokendown by collection status. Our estimate of losses for these loans is developedby estimating both the rate of default of the loans and the amount of lossseverity in the event of default. The rate of default is assigned to the loansbased on their attributes (*e.g.*, originalloan-to-value, borrower credit score, documentation type, geographic location, etc.)and collection status. The rate of default is based on analysis of migration ofloans from each aging category. The loss severity is determined by estimatingthe net proceeds from the ultimate sale of the foreclosed property. The resultsof that analysis are then applied to the current mortgage portfolio and anestimate is created. We believe that pooling of mortgages with similarcharacteristics is an appropriate methodology in which to evaluate the futureloan losses.

 

Management recognizes that there are qualitative factors that must betaken into consideration when evaluating and measuring losses in the loanportfolios. These items include, but are not limited to, economic indicatorsthat may affect the borrower’s ability to pay, changes in value of collateral,political factors, employment and market conditions, competitor’s performance,market perception, historical losses, and industry statistics. The assessmentfor losses, is based on delinquency trends and prior loss experience andmanagement’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.

 

*Prepayment Risk.*  The Company historically used prepaymentpenalties as a method of partially mitigating prepayment risk for thoseborrowers that have the ability to refinance. The recent economic downturn,lack of available credit and declines in property values have limited borrowers’ability to refinance. These factors have significantly reduced prepayment riskwithin our long-term mortgage portfolio. With the seasoning of the long-termmortgage portfolio, a significant portion of prepayment penalties terms haveexpired, thereby further reducing prepayment penalty income.

 

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**Results of Operations**

 

*For the Three and Nine Months EndedSeptember 30, 2010 compared to the Three and Nine Months EndedSeptember 30, 2009*

 

Condensed Statements ofOperations Data

 
| ** **                                                                                                   | ** ** | **For the Three Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                                                                   | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                                                                              |       | $                                                                          | 230,927    |   | $ | 341,323 |   | $ | (110,396 | ) | (32 | )% |
| Interest expense                                                                                             |       | 229,256                                                                    |       | 339,417 |   | (110,161 | ) | (32 | ) |
| Net interest income                                                                                          |       | 1,671                                                                      |       | 1,906 |   | (235 | ) | (12 | ) |
| Total non-interest income                                                                                    |       | 16,154                                                                     |       | 16,913 |   | (759 | ) | (4 | ) |
| Total non-interest expense                                                                                   |       | 15,552                                                                     |       | 14,016 |   | 1,536 |   | 11 |   |
| Income tax expense                                                                                           |       | 14                                                                         |       | — |   | 14 |   | n/a |   |
| Earnings from continuing operations                                                                          |       | 2,259                                                                      |       | 4,803 |   | (2,544 | ) | (53 | ) |
| Loss from discontinued operations, net                                                                       |       | (1,285                                                                     | )          | (1,776 | ) | 491 |   | 28 |   |
| Earnings available to common stockholders before  redemption of preferred stock (1)                          |       | $                                                                          | 974        |   | $ | 3,027 |   | $ | (2,053 | ) | (68 | )% |
|                                                                                                         |       |                                                                       |       |   |   |   |   |   |   |
| Earnings per share available to common  stockholders before redemption of preferred stock (1) - basic   |       | $                                                                          | 0.13       |   | $ | 0.40 |   | $ | (0.27 | ) | (68 | )% |
| Earnings per share available to common  stockholders before redemption of preferred stock (1) - diluted |       | $                                                                          | 0.12       |   | $ | 0.38 |   | $ | (0.26 | ) | (69 | )% |

 
| ** **                                                                                                          | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                                                                          | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                                                                                     |       | $                                                                         | 759,016    |   | $ | 1,508,230 |   | $ | (749,214 | ) | (50 | )% |
| Interest expense                                                                                                    |       | 755,020                                                                   |       | 1,499,729 |   | (744,709 | ) | (50 | ) |
| Net interest income                                                                                                 |       | 3,996                                                                     |       | 8,501 |   | (4,505 | ) | (53 | ) |
| Total non-interest income                                                                                           |       | 49,830                                                                    |       | 48,729 |   | 1,101 |   | 2 |   |
| Total non-interest expense                                                                                          |       | 45,410                                                                    |       | 41,103 |   | 4,307 |   | 10 |   |
| Income tax expense                                                                                                  |       | 143                                                                       |       | 2,018 |   | (1,875 | ) | (93 | ) |
| Earnings from continuing operations                                                                                 |       | 8,273                                                                     |       | 14,109 |   | (5,836 | ) | (41 | ) |
| Earnings (loss) from discontinued operations, net                                                                   |       | 1,905                                                                     |       | (8,366 | ) | 10,271 |   | 123 |   |
| Net Earnings                                                                                                        |       | 10,178                                                                    |       | 5,743 |   | 4,435 |   | 77 |   |
| Cash dividends on preferred stock                                                                                   |       | —                                                                    |       | (7,443 | ) | 7,443 |   | 100 |   |
| Earnings (loss) available to common stockholders  before redemption of preferred stock (1)                          |       | $                                                                         | 10,178     |   | $ | (1,700 | ) | $ | 11,878 |   | 699 | % |
|                                                                                                                |       |                                                                      |       |   |   |   |   |   |   |
| Earnings (loss) per share available to common  stockholders before redemption of preferred stock (1) - basic   |       | $                                                                         | 1.32       |   | $ | (0.22 | ) | $ | 1.54 |   | 690 | % |
| Earnings (loss) per share available to common  stockholders before redemption of preferred stock (1) - diluted |       | $                                                                         | 1.22       |   | $ | (0.22 | ) | $ | 1.45 |   | 648 | % |

 

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(1)          As discussed in Note 4 to the consolidatedfinancial statements, the difference between the carrying value of the tenderedpreferred stock ($106.1 million) and the amount paid for the shares($1.3 million) was recognized as a decrease in retained deficit in 2009Including the redemption, total basic earnings per share from continuingoperations available to common stockholders for the three and nine month periodended September 30, 2009, were $14.16 and $13.54, respectively. Includingthe redemption, total diluted earnings per share from continuing operationsavailable to common stockholders for the three and nine month period ended September 30,2009, were $13.48 and $13.54, respectively. However, because of the special natureof the preferred stock redemption (which the Company considers an infrequentlyoccurring item), management believes that earnings per common share excludingsuch transaction are more meaningful from an operations standpoint.

 

*Net Interest Income*

 

We earn net interest income primarily from mortgage assets whichinclude securitized mortgage collateral, loans held-for-sale and investmentsecurities available-for-sale, or collectively, “mortgage assets,” and, to alesser extent, interest income earned on cash and cash equivalents. Interestexpense is primarily interest paid on borrowings secured by mortgage assets,which include securitized mortgage borrowings and to a lesser extent, interestexpense paid on long-term debt and note payable. Interest income and interestexpense during the period primarily represents the effective yield, based onthe fair value of the trust assets and liabilities.

 

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The following tables summarize average balance, interest and weightedaverage yield on mortgage assets and borrowings, included within continuingoperations, for the periods indicated. Cash receipts and payments on derivativeinstruments hedging interest rate risk related to our securitized mortgageborrowings are not included in the results below. These cash receipts andpayments are included as a component of the change in fair value of net trustassets.

 
| ** **                               | ** ** | **For the three months ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **Average**                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Balance**                                                                | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **ASSETS**                               |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Investment securities available-for-sale |       | $                                                                          | 1,262      |   | $ | 90 |   | 28.53 | % | $ | 1,191 |   | $ | 154 |   | 51.72 | % |
| Securitized mortgage collateral          |       | 6,148,164                                                                  |       | 230,837 |   | 15.02 | % | 5,919,620 |   | 341,169 |   | 23.05 | % |
| Total interest-earning assets            |       | $                                                                          | 6,149,426  |   | $ | 230,927 |   | 15.02 | % | $ | 5,920,811 |   | $ | 341,323 |   | 23.06 | % |
|                                     |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES**                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings          |       | $                                                                          | 6,130,796  |   | $ | 228,077 |   | 14.88 | % | $ | 5,912,681 |   | $ | 338,563 |   | 22.90 | % |
| Long-term debt                           |       | 11,089                                                                     |       | 1,071 |   | 38.63 | % | 9,298 |   | 854 |   | 36.74 | % |
| Note payable                             |       | 10,322                                                                     |       | 108 |   | 4.19 | % | — |   | — |   | — |   |
| Total interest-bearing liabilities       |       | $                                                                          | 6,152,207  |   | $ | 229,256 |   | 14.91 | % | $ | 5,921,979 |   | $ | 339,417 |   | 22.93 | % |
|                                     |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (1)**              |       |                                                                       |       | $ | 1,671 |   | 0.11 | % |   |   | $ | 1,906 |   | 0.13 | % |
| **Net Interest Margin (2)**              |       |                                                                       |       |   |   | 0.11 | % |   |   |   |   | 0.13 | % |

 

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(1)          Net interest spread iscalculated by subtracting the weighted average yield on interest-bearingliabilities from the weighted average yield on interest-earning assets.

(2)          Net interest margin iscalculated by dividing net interest spread by total average interest-earningassets.

 

Net interest income spread decreased $200 thousand for the threemonths ended September 30, 2010 to $1.7 million from $1.9 million forthe comparable 2009 period. The decrease in net interest spread was primarilyattributable to overall declines in yields between periods and the resultingdecrease in net interest income on securitized mortgage collateral andsecuritized mortgage borrowings, as well as an increase in interest expenseincurred on the note payable of $108 thousand for the quarter endedSeptember 30, 2010 as compared to none for the comparable 2009 period.   As a result, net interest margin decreasedfrom 0.13% for the three months ended September 30, 2009 to 0.11% for thethree months ended September 30, 2010.

 

During the three months ended September 30, 2010, the yield oninterest-earning assets decreased to 15.02% from 23.06% in the comparable 2009period. The yield on interest-bearing liabilities decreased to 14.91% for thethree months ended September 30, 2010 from 22.93% for the comparable 2009period.  In connection with the fairvalue accounting for investment securities available-for-sale and securitizedmortgage collateral and borrowings, interest income and interest expense isrecognized using effective yields based on estimated fair values for theseinstruments.  The decrease in yield forsecuritized mortgage collateral and securitized mortgage borrowings isprimarily related to increased prices on mortgage-backed bonds which resultedin a decrease in yield.  Bond pricesreceived from pricing services and other market participants have increasedover the past few quarters as investor’s demand for mortgage-backed securitieshas increased.  This has resulted in anincrease in fair value for both securitized mortgage collateral and securitizedmortgage borrowings.    These increasesin fair value have decreased the effective yields used for purposes ofrecognizing interest income and interest expense on these instruments.

 

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| ** **                               | ** ** | **For the nine months ended September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** |
| ** **                               | ** ** | **Average**                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Balance**                                                               | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **ASSETS**                               |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Investment securities available-for-sale |       | $                                                                         | 927        |   | $ | 203 |   | 29.20 | % | $ | 1,443 |   | $ | 387 |   | 35.76 | % |
| Securitized mortgage collateral          |       | 6,119,520                                                                 |       | 758,813 |   | 16.53 | % | 6,437,085 |   | 1,507,843 |   | 31.23 | % |
| Total interest-earning assets            |       | $                                                                         | 6,120,447  |   | $ | 759,016 |   | 16.54 | % | $ | 6,438,528 |   | $ | 1,508,230 |   | 31.23 | % |
|                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES**                          |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings          |       | $                                                                         | 6,095,991  |   | $ | 751,022 |   | 16.43 | % | $ | 6,499,331 |   | $ | 1,497,476 |   | 30.72 | % |
| Long-term debt                           |       | 10,671                                                                    |       | 3,433 |   | 42.90 | % | 12,401 |   | 2,253 |   | 24.22 | % |
| Note payable                             |       | 17,234                                                                    |       | 565 |   | 4.37 | % | — |   | — |   | — |   |
| Total interest-bearing liabilities       |       | $                                                                         | 6,123,896  |   | $ | 755,020 |   | 16.44 | % | $ | 6,511,732 |   | $ | 1,499,729 |   | 30.71 | % |
|                                     |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (1)**              |       |                                                                      |       | $ | 3,996 |   | 0.10 | % |   |   | $ | 8,501 |   | 0.52 | % |
| **Net Interest Margin (2)**              |       |                                                                      |       |   |   | 0.09 | % |   |   |   |   | 0.18 | % |

 

----

(1)          Net interest spread iscalculated by subtracting the weighted average yield on interest-bearingliabilities from the weighted average yield on interest-earning assets.

(2)          Net interest margin iscalculated by dividing net interest spread by total average interest-earningassets.

 

Net interest income spread decreased $4.5 million for the ninemonths ended September 30, 2010 to $4.0 million from $8.5 million forthe comparable 2009 period. The decrease in net interest spread was primarilyattributable to overall declines in yields and balances between periods and theresulting decrease in net interest income on securitized mortgage collateraland securitized mortgage borrowings, as well as an increase in interest expenseincurred on the note payable of $565 thousand for the nine months endedSeptember 30, 2010 as compared to none for the comparable 2009 period.   As a result, net interest margin decreasedfrom 0.18% for the nine months ended September 30, 2009 to 0.09% for thenine months ended September 30, 2010.

 

During the nine months ended September 30, 2010, the yield oninterest-earning assets decreased to 16.54% from 31.23% in the comparable 2009period. The yield on interest-bearing liabilities decreased to 16.44% for thenine months ended September 30, 2010 from 30.71% for the comparable 2009period.  In connection with the fairvalue accounting for investment securities available-for-sale and securitizedmortgage collateral and borrowings, interest income and interest expense isrecognized using effective yields based on estimated fair values for theseinstruments.  The decrease in yield forsecuritized mortgage collateral and securitized mortgage borrowings isprimarily related to the adoption of FAS ASC 820-10-65-4, “Determining FairValue When the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly,”during the second quarter of 2009.  Thefair value of the securitized mortgage collateral and securitized mortgageborrowings increased and the yields decreased as a result of the adoption whichclarified the use of quoted prices in determining fair value in markets thatare inactive, thus moderating the need to use distressed prices in valuingfinancial assets and liabilities in illiquid markets as the Company had used inprior periods.  Furthermore, bond pricesreceived from pricing services and other market participants have increasedover the past few quarters as investor’s demand for mortgage-backed securitieshas increased.  This has resulted in anincrease in fair value for both securitized mortgage collateral and securitizedmortgage borrowings.  These increases infair value have decreased the effective yields used for purposes of recognizinginterest income and interest expense on these instruments.

 

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*Non-Interest Income*

 

Changes in Non-InterestIncome

 
| ** **                                               | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of net trust assets, excluding  REO |       | $                                                                          | 9,573      |   | $ | 46,325 |   | $ | (36,752 | ) | (79 | )% |
| Losses from REO                                          |       | (10,147                                                                    | )          | (43,160 | ) | 33,013 |   | 76 |   |
| Non-interest income (loss) - net trust assets            |       | (574                                                                       | )          | 3,165 |   | (3,739 | ) | (118 | ) |
| Change in fair value of long-term debt                   |       | 1,168                                                                      |       | 341 |   | 827 |   | 243 |   |
| Mortgage and real estate services fees                   |       | 15,521                                                                     |       | 13,514 |   | 2,007 |   | 15 |   |
| Other                                                    |       | 39                                                                         |       | (107 | ) | 146 |   | 136 |   |
| Total non-interest income                                |       | $                                                                          | 16,154     |   | $ | 16,913 |   | $ | (759 | ) | (4 | )% |

 

*Non-interest income—net trust assets.*  Since our consolidated and unconsolidatedsecuritization trusts are nonrecourse to the Company, our economic risk islimited to our residual interests in these securitization trusts. To betterunderstand the economics on our residual interests in securitizations, it isnecessary to consider the net effect of changes in fair value of net trustassets and losses from real estate owned. All estimated future losses areincluded in the estimate of the fair value of securitized mortgage collateraland REO. Losses on REO are reported separately in the consolidated statement ofoperations as REO is a nonfinancial asset which is the only component of trustassets and liabilities that is not recorded at fair value. Therefore, REO valueat the time of sale or losses from further write-downs are recorded separatelyin the Company’s consolidated statement of operations. The net effect ofchanges in value related to our investment in all trust assets and liabilitiesis shown as non-interest income—net trust assets, which includes losses fromREO.  Non-interest income (loss) relatedto our net trust assets (residual interests in securitizations) was a loss of$574 thousand for the three months ended September 30, 2010, compared to again of $3.2 million in the comparable 2009 period.  The $574 thousand loss on net trust assetswas primarily attributable to losses from REO during the three months endedSeptember 30, 2010. The individual components of the non-interest incomefrom net trust assets are discussed below:

 

*Change in fair value of net trust assets, excludingREO.*  For the quarter endedSeptember 30, 2010, the Company recognized a $9.6 million gain from thechange in fair value of net trust assets, excluding REO.  The net gain recognized during the period wascomprised of gains resulting from the reduction in the fair market value of securitizedmortgage borrowings of $66.2, offset by losses resulting from the decreases inthe fair value of investment securities-for-sale and of securitized mortgagecollateral of $66 thousand and $44.3 million, respectively, as well as anincrease in the fair value of net derivative liabilities of $12.3 million.

 

For the quarter ended September 30, 2009, the Company recognized a$46.3 million gain from the change in fair value of net trust assets,excluding REO. The net gain recognized during the period was comprised of gainsfrom the increase in fair value of investment securities-for-sale and reductionin the fair value of securitized mortgage borrowings of $1.2 million and$153.0 million, respectively. Offsetting these gains were losses resultingfrom decreases in the fair value of securitized mortgage collateral andincreases in the fair value of derivative liabilities, net of$79.4 million and $28.4 million, respectively.

 

*Losses from REO.*  Losses from REO were $10.1 million forthe three months ended September 30, 2010. This loss was comprised of $10.2 million in additional impairmentwrite-downs during the period partially offset by $111 thousand in gain on saleof REO.  During the three months ended September 30,2010, additional impairment write-downs were attributable to higher expectedloss severities on properties held during the period as compared to previouslyreserved.  The gain is attributable tomortgage insurance recovery collected in the period as a result of ourincreased loss mitigation efforts of our portfolio.

 

Losses from real estate owned were $43.2 million for the threemonths ended September 30, 2009. This loss was comprised of an$18.7 million loss on sale of real estate owned, coupled with$24.5 million in additional impairment write-downs during the period.During the quarter, loss severities resulting from liquidations in areas wherewe have high concentration of foreclosed properties (such as California andFlorida) have continued to increase over previous periods as a result ofcontinued deterioration in the U.S. economy and real estate markets. Thesecontinued declines in housing prices have resulted in liquidations offoreclosed assets at prices below expected levels as well as additionalimpairment write-downs of REO since foreclosure.

 

*Change in the fair value of long-term debt.*  Change in the fair value of long-term debtwas a gain of $1.2 million for the three months ended September 30,2010, compared to a gain of $341 thousand for the comparable 2009 period.  Long-term debt (consisting of trust preferredsecurities and junior subordinated notes) is measured based upon an analysisprepared by the Company, which considers the Company’s own credit risk,including consideration of settlements with trust preferred debt holders anddiscounted cash flow analysis.

 

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*Mortgage and real estate services fees.*  Revenues generated from these businesses areprimarily from the Company’s long-term mortgage portfolio. For the three monthsended September 30, 2010, mortgage and real estate services fees, whichprimarily include loan modification fees and monitoring and surveillanceservices fees, were $15.5 million compared to $13.5 million in monitoringfees in the comparable 2009 period.  Themortgage and real estate services fees of $15.5 million for the three monthsended September 30, 2010, was primarily comprised of $7.3 million inmonitoring, surveillance and recovery fees, $4.5 million in title and escrowfees, $1.9 million in servicing income, and $1.8 million in loan modificationfees.  The $2.0 million increase inmortgage and real estate services fees was comprised of increases in title andescrow fees and monitoring, surveillance and recovery fees of $3.6 million and$3.1 million, respectively.  Offsettingthese increases were reductions in loan modification fees and servicing incomeof $4.6 million and $0.1 million, respectively.

 
| ** **                                               | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of net trust assets,  excluding REO |       | $                                                                         | 12,701     |   | $ | 234,167 |   | $ | (221,466 | ) | (95 | )% |
| Losses from REO                                          |       | (6,290                                                                    | )          | (218,083 | ) | 211,793 |   | 97 |   |
| Non-interest income - net trust assets                   |       | 6,411                                                                     |       | 16,084 |   | (9,673 | ) | (60 | ) |
| Change in fair value of long-term debt                   |       | 952                                                                       |       | 682 |   | 270 |   | 40 |   |
| Mortgage and real estate services fees                   |       | 42,523                                                                    |       | 32,296 |   | 10,227 |   | 32 |   |
| Other                                                    |       | (56                                                                       | )          | (333 | ) | 277 |   | 83 |   |
| Total non-interest income                                |       | $                                                                         | 49,830     |   | $ | 48,729 |   | $ | 1,101 |   | 2 | % |

 

*Non-interest income—net trust assets.*  Since our consolidated and unconsolidatedsecuritization trusts are nonrecourse to the Company, our economic risk islimited to our residual interests in these securitization trusts. To betterunderstand the economics on our residual interests in securitizations, it isnecessary to consider the net effect of changes in fair value of net trustassets and losses from real estate owned. All estimated future losses areincluded in the estimate of the fair value of securitized mortgage collateraland REO. Losses on REO are reported separately in the consolidated statement ofoperations as REO is a nonfinancial asset which is the only component of trustassets and liabilities that is not recorded at fair value. Therefore, REO valueat the time of sale or losses from further write-downs are recorded separatelyin the Company’s consolidated statement of operations. The net effect ofchanges in value related to our investment in all trust assets and liabilitiesis shown as non-interest income—net trust assets, which includes losses fromREO.  Non-interest income related to ournet trust assets (residual interests in securitizations) was $6.4 millionfor the nine months ended September 30, 2010, compared to$16.1 million in the comparable 2009 period.  The $6.4 million in non-interest income- net trust assets was primarily attributable to increased expected netinterest spread as a result of a downward shift in the forward LIBOR curveduring the nine months ended September 30, 2010.   The $16.1 million gain on net trustassets was primarily attributable to the adoption of FAS ASC 820-10-65-4, “DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly,”during the second quarter of 2009, which resulted in an increase to the fairvalue of net trust assets before REO losses. The individual components of the non-interest income from net trustassets are discussed below:

 

*Change in fair value of net trust assets, excludingREO.*  For the nine months ended September 30,2010, the Company recognized a $12.7 million gain from the change in fair valueof net trust assets, excluding REO.  Thenet gain recognized during the period was comprised of gains resulting from theincrease in fair value of investment securities-for-sale and securitizedmortgage collateral of $653 thousand and $606.5 million, respectively.Offsetting these gains were losses resulting from increases in the fair valueof securitized mortgage borrowings and net derivative liabilities of $552.9million and $41.6 million, respectively.

 

For the nine months ended September 30, 2009, the Companyrecognized a $234.2 million gain from the change in fair value of nettrust assets, excluding REO. The net gain recognized during the period was comprisedof gains resulting from the increase in fair value of investmentsecurities-for-sale and reduction in the fair value of securitized mortgageborrowings of $2.9 million and $313.8 million, respectively.Offsetting these gains were losses from the reduction in the fair value ofsecuritized mortgage collateral and increase in the fair value of netderivative liabilities of $33.8 million and $48.7 million,respectively.

 

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*Losses from REO.*  Losses from REO were $6.3 million forthe nine months ended September 30, 2010. This loss was comprised of $9.8million in additional impairment write-downs during the period partially offsetby $3.5 million in gain on sale of REO. During the nine months ended September 30, 2010, additionalimpairment write-downs were attributable to higher expected loss severities onproperties held during the period as compared to previously reserved.  The gain is attributable to mortgageinsurance recovery collected in the period as a result of our increased lossmitigation efforts of our portfolio.

 

Losses from real estate owned were $218.1 million for the ninemonths ended September 30, 2009. This loss was comprised of a$100.2 million loss on sale of real estate owned, coupled with$117.9 million in additional impairment write-downs during the period.During the first nine months of 2009, loss severities resulting from liquidationsin areas where we have high concentration of foreclosed properties (such asCalifornia and Florida) have continued to increase significantly over previousperiods as a result of continued deterioration in the U.S. economy and realestate markets. These continued declines in housing prices have resulted inliquidations of foreclosed assets at prices below expected levels as well asadditional impairment write-downs of REO since foreclosure.

 

*Change in the fair value of long-term debt.*  Change in the fair value of long-term debtwas a gain of $952 thousand for the nine months ended September 30,2010, compared to a gain of $682 thousand for the comparable 2009period.  Long-term debt (consisting oftrust preferred securities and junior subordinated notes) is measured basedupon an analysis prepared by the Company, which considers the Company’s owncredit risk, including consideration of settlements with trust preferred debtholders and discounted cash flow analysis.

 

*Mortgage and real estate services fees.*  Revenues generated from these businesses areprimarily from the Company’s long-term mortgage portfolio. For the nine monthsended September 30, 2010, mortgage and real estate services fees, whichprimarily include loan modification fees and monitoring and surveillanceservices fees, were $42.5 million compared to $32.3 million inmonitoring fees in the comparable 2009 period. The mortgage and real estate services fees of $42.5 million for the ninemonths ended September 30, 2010, was primarily comprised of $20.1 millionin monitoring, surveillance and recovery fees, $10.5 million in title andescrow fees, $7.7 million in loan modification fees, and $4.2 million inservicing income.  The $10.2 millionincrease in mortgage and real estate services fees was comprised of increasesin monitoring, surveillance and recovery fees and title and escrow fees of $9.1million and $8.1 million, respectively. Offsetting these increases were reductions in loan modification fees andservicing income of $5.7 million and $1.3 million, respectively.

 

*Non-Interest Expense*

 

Changes in Non-InterestExpense

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                          | 4,869      |   | $ | 4,603 |   | $ | 266 |   | 6 | % |
| Personnel expense          |       | 10,683                                                                     |       | 9,413 |   | 1,270 |   | 13 |   |
| Total operating expense    |       | $                                                                          | 15,552     |   | $ | 14,016 |   | $ | 1,536 |   | 11 | % |

 

Total non-interest expense was $15.6 million for the three monthsended September 30, 2010, compared to $14.0 million for thecomparable period of 2009.  The$1.5 million increase in non-interest expense was primarily attributableto a $1.3 million increase in personnel and related costs associated withthe initiation of the new mortgage and real estate fee-based businessactivities, which was partially offset by a decrease in personnel costsassociated with the long-term mortgage portfolio.

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative |       | $                                                                         | 14,278     |   | $ | 15,053 |   | $ | (775 | ) | (5 | )% |
| Personnel expense          |       | 31,132                                                                    |       | 26,050 |   | 5,082 |   | 20 |   |
| Total operating expense    |       | $                                                                         | 45,410     |   | $ | 41,103 |   | $ | 4,307 |   | 10 | % |

 

Total non-interest expense was $45.4 million for the nine monthsended September 30, 2010, compared to $41.1 million for thecomparable period of 2009.  The$4.3 million increase in non-interest expense was primarily attributableto a $5.1 million increase in personnel expense over the previous periodas a result of increases in personnel and related costs associated with theinitiation of our new mortgage and real estate fee-based business activities,which was partially offset by a decrease in personnel costs associated with thelong-term mortgage portfolio.

 

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*** ***

***Results of Operations by BusinessSegment***

 

***Mortgage and Real Estate Services***

 

During 2009, the Company initiated various mortgage and real estatefee-based business activities, including loan modifications, real estatedisposition, monitoring and surveillance services, real estate brokerage,mortgage lending and title and escrow services. Although the Company intends togenerate more fees by providing these services to third parties in themarketplace, the revenues from these businesses have primarily been generatedfrom the Company’s long-term mortgage portfolio.  Despite our efforts to expand these services,we have encountered challenges in selling these services to third-parties.

 

Condensed Statements ofOperations Data

 
| ** **                             | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                    |       | $                                                                          | 5          |   | $ | 12 |   | $ | (7 | ) | (58 | )% |
|                                   |       |                                                                       |       |   |   |   |   |   |   |
| Mortgage and real estate services fees |       | 15,521                                                                     |       | 13,514 |   | 2,007 |   | 15 |   |
| Other non-interest income              |       | 18                                                                         |       | (127 | ) | 145 |   | 114 |   |
| Total non-interest income              |       | 15,539                                                                     |       | 13,387 |   | 2,152 |   | 16 |   |
|                                   |       |                                                                       |       |   |   |   |   |   |   |
| Personnel expense                      |       | 9,072                                                                      |       | 6,996 |   | 2,076 |   | 30 |   |
| Non-interest expense and income taxes  |       | 2,130                                                                      |       | 1,598 |   | 532 |   | 33 |   |
| Net earnings                           |       | $                                                                          | 4,342      |   | $ | 4,805 |   | $ | (463 | ) | (10 | )% |

 

For the three months ended September 30, 2010, mortgage and realestate services fees, which primarily include loan modification fees andmonitoring and surveillance services fees, were $15.5 million compared to$13.5 million in monitoring fees in the comparable 2009 period.  The $2.0 million increase in mortgage andreal estate services fees was comprised of increases in title and escrow feesand monitoring, surveillance and recovery fees of $3.6 million and $3.1million, respectively.  Offsetting theseincreases were reduction in loan modification fees and servicing income of $4.6million and $0.1 million, respectively.

 

For the three months ended September 30, 2010, personnel expenseincreased $2.1 million to $9.1 million as a result of increases inpersonnel and related costs associated with the growth of our mortgage and realestate fee-based business activities.

 
| ** **                             | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                    |       | $                                                                         | 16         |   | $ | 5 |   | $ | 11 |   | 220 | % |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
| Mortgage and real estate services fees |       | 42,523                                                                    |       | 32,296 |   | 10,227 |   | 32 |   |
| Other non-interest income              |       | 20                                                                        |       | (312 | ) | 332 |   | 106 |   |
| Total non-interest income              |       | 42,543                                                                    |       | 31,984 |   | 10,559 |   | 33 |   |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
| Personnel expense                      |       | 25,512                                                                    |       | 15,598 |   | 9,914 |   | 64 |   |
| Non-interest expense and income taxes  |       | 6,459                                                                     |       | 4,561 |   | 1,898 |   | 42 |   |
| Net earnings                           |       | $                                                                         | 10,588     |   | $ | 11,830 |   | $ | (1,242 | ) | (10 | )% |

 

For the nine months ended September 30, 2010, mortgage and realestate services fees, which primarily include loan modification fees andmonitoring and surveillance services fees, were $42.5 million compared to$32.3 million in monitoring fees in the comparable 2009 period.   The $10.2 million increase in mortgage andreal estate services fees was comprised of increases in monitoring,surveillance and recovery fees and title and escrow fees of $9.1 million and$8.1 million, respectively.  Offsettingthese increases were reduction in loan modification fees and servicing incomeof $5.7 million and $1.3 million, respectively.

 

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For the nine months ended September 30, 2010, personnel expenseincreased $9.9 million to $25.5 million as a result of increases inpersonnel and related costs associated with the growth of our mortgage and realestate fee-based business activities.

 

For the nine months ended September 30, 2010, non-interest expenseand income taxes increased $1.9 million to $6.5 million. The increaseis related to higher business promotion and occupancy expenses associated withthe mortgage and real estate fee-based business activities.

 

***Long-term Portfolio***

 

Condensed Statements ofOperations Data

 
| ** **                                               | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                      |       | $                                                                          | 1,666      |   | $ | 1,894 |   | $ | (228 | ) | (12 | )% |
|                                                     |       |                                                                       |       |   |   |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO |       | 9,573                                                                      |       | 46,325 |   | (36,752 | ) | (79 | ) |
| Losses from REO                                          |       | (10,147                                                                    | )          | (43,160 | ) | 33,013 |   | 76 |   |
| Non-interest (loss) income- net trust assets             |       | (574                                                                       | )          | 3,165 |   | (3,739 | ) | (118 | ) |
| Change in fair value of long-term debt                   |       | 1,168                                                                      |       | 341 |   | 827 |   | 243 |   |
| Other non-interest income                                |       | 21                                                                         |       | 20 |   | 1 |   | 5 |   |
| Total non-interest income                                |       | 615                                                                        |       | 3,526 |   | (2,911 | ) | (83 | ) |
|                                                     |       |                                                                       |       |   |   |   |   |   |   |
| Personnel expense                                        |       | 1,611                                                                      |       | 2,417 |   | (806 | ) | (33 | ) |
| Non-interest expense and income taxes                    |       | 2,753                                                                      |       | 3,005 |   | (252 | ) | (8 | ) |
| Net loss                                                 |       | $                                                                          | (2,083     | ) | $ | (2 | ) | $ | (2,081 | ) | (104,050 | )% |

 

Net loss for the long-term portfolio was $2.1 million for the threemonths ended September 30, 2010, compared to $2 thousand for thecomparable period of 2009.  The increasein net loss is primarily attributable to a $3.7 million decrease innon-interest income-net trust assets, partially offset by an $827 thousandincrease in the change in fair value of long-term debt and $806 thousandreduction in personnel expense.

 

For the quarter ended September 30, 2010, the Company recognized a$9.6 million gain from the change in fair value of net trust assets, excludingREO.  The net gain recognized during theperiod was comprised of gains resulting from the reduction in the fair marketvalue of securitized mortgage borrowings of $66.2, offset by losses resultingfrom the decreases in the fair value of investment securities-for-sale and ofsecuritized mortgage collateral of $66 thousand and $44.3 million,respectively, as well as an increase in the fair value of net derivativeliabilities of $12.3 million.   Lossesfrom REO were $10.1 million for the three months ended September 30,2010.  This loss was comprised of $10.2million in additional impairment write-downs during the period partially offsetby $111 thousand in gain on sale of REO. During the three months ended September 30, 2010, additionalimpairment write-downs were attributable to higher expected loss severities onproperties held during the period as compared to previously reserved.  The gain is attributable to mortgageinsurance recovery collected in the period as a result of our increased lossmitigation efforts of our portfolio.

 

Personnel expense decreased $806 thousand during the three months endedSeptember 30, 2010 as a result of reduced personnel associated with thelong-term portfolio segment of the Company.

 

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| ** **                                               | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                               | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                                      |       | $                                                                         | 3,980      |   | $ | 8,496 |   | $ | (4,516 | ) | (53 | )% |
|                                                     |       |                                                                      |       |   |   |   |   |   |   |
| Change in fair value of net trust assets,  excluding REO |       | 12,701                                                                    |       | 234,167 |   | (221,466 | ) | (95 | ) |
| Losses from REO                                          |       | (6,290                                                                    | )          | (218,083 | ) | 211,793 |   | 97 |   |
| Non-interest income- net trust assets                    |       | 6,411                                                                     |       | 16,084 |   | (9,673 | ) | (60 | ) |
| Change in fair value of long-term debt                   |       | 952                                                                       |       | 682 |   | 270 |   | 40 |   |
| Other non-interest income                                |       | (76                                                                       | )          | (21 | ) | (55 | ) | (262 | ) |
| Total non-interest income                                |       | 7,287                                                                     |       | 16,745 |   | (9,458 | ) | (56 | ) |
|                                                     |       |                                                                      |       |   |   |   |   |   |   |
| Personnel expense                                        |       | 5,620                                                                     |       | 10,452 |   | (4,832 | ) | (46 | ) |
| Non-interest expense and income taxes                    |       | 7,962                                                                     |       | 12,510 |   | (4,548 | ) | (36 | ) |
| Net (loss) earnings                                      |       | $                                                                         | (2,315     | ) | $ | 2,279 |   | $ | (4,594 | ) | (202 | )% |

 

Net (loss) earnings for the long-term portfolio was a loss of $2.3million for the nine months ended September 30, 2010, compared to earningsof $2.3 million for the comparable period of 2009.  This decrease in net earnings is primarilyattributable to a $9.7 million decrease in non-interest income-net trust assetsand a $4.5 million decrease in net interest income, offset by a $4.8million reduction in personnel expense and a $4.5 million reduction innon-interest expense and income taxes.

 

Thedecrease in the fair value of net trust assets was primarily the result of theadoption of FASB ASC 820-10-65-4 during the second quarter of 2009.  This clarified the use of quoted prices indetermining fair values in markets that are inactive, thus moderating the needto use distressed prices in valuing financial assets and liabilities inilliquid markets as the Company used in prior periods.  The Company recorded a significant increasein the fair value of net trust assets as a result of the adoption of ASC820-10-65-4 during June of 2009. For the nine months ended September 30, 2010, the Companyrecognized a $12.7 million gain from the change in fair value of net trustassets, excluding REO.  The net gainrecognized during the period was comprised of gains resulting from the increasein fair value of investment securities-for-sale and securitized mortgagecollateral of $653 thousand and $606.5 million, respectively. Offsetting thesegains were losses resulting from increases in the fair value of securitizedmortgage borrowings and net derivative liabilities of $552.9 million and$41.6 million, respectively.  Lossesfrom REO were $6.3 million for the nine months ended September 30,2010. This loss was comprised of $9.8 million in additional impairment write-downsduring the period partially offset by $3.5 million in gain on sale of REO.  During the nine months ended September 30,2010, additional impairment write-downs were attributable to higher expectedloss severities on properties held during the period as compared to previouslyreserved.  The gain is attributable tomortgage insurance recovery collected in the period as a result of ourincreased loss mitigation efforts of our portfolio.

 

Personnel expense decreased $4.8 million during the nine monthsended September 30, 2010 as a result of reduced personnel associated withthe long-term portfolio segment of the Company.

 

Non-interest expense and income taxes decreased $4.5 million.  The decrease is attributable to a $2.0million reduction in income tax expense, $1.2 million reduction in legal andprofessional fees as well as a $1.3 million decrease in general andadministrative expenses.   The reductionin income tax expense is the result of the amount of the deferred chargeamortized and/or impaired in 2009 resulting from credit losses.

 

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***Discontinued Operations***

 

Condensed Statements ofOperations Data

 
| ** **                            | ** ** | **For the Three Months Ended September 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                            | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income                   |       | $                                                                          | 4          |   | $ | 834 |   | $ | (830 | ) | (100 | )% |
|                                  |       |                                                                       |       |   |   |   |   |   |   |
| Loss on sale of loans                 |       | (66                                                                        | )          | (756 | ) | 690 |   | 91 |   |
| Provision for repurchases             |       | (1,787                                                                     | )          | (1,107 | ) | (680 | ) | (61 | ) |
| Other non-interest income             |       | 180                                                                        |       | (285 | ) | 465 |   | 163 |   |
| Total non-interest income             |       | (1,673                                                                     | )          | (2,148 | ) | 475 |   | 22 |   |
|                                  |       |                                                                       |       |   |   |   |   |   |   |
| Non-interest expense and income taxes |       | (384                                                                       | )          | 462 |   | (846 | ) | (183 | ) |
| Net loss                              |       | $                                                                          | (1,285     | ) | $ | (1,776 | ) | $ | 491 |   | 28 | % |

 

Net loss from discontinued operations was $1.3 million for the threemonths ended September 30, 2010, compared to a loss of $1.8 millionfor the comparable period in 2009.  Netinterest income decreased $830 thousand to $4 thousand due to thereduction in loans held-for-sale as a result of the Settlement Agreement reachedin October 2009.

 

Loss on sale of loans decreased $690 thousand during the quarter to aloss of $66 thousand as compared to a loss of $756 thousand in thecomparable period in 2009.   The decreasein loss on sale of loans was the result of reduced sale activity betweenperiods.

 

Provision for repurchases increased $680 thousand to a provision of$1.8 million for the three months ended September 30, 2010, compared to aprovision of $1.1 million for the same period in 2009. The $680 thousandincrease is the result of increases in estimated repurchase obligations during2010.  During the third quarter,consistent with other mortgage lenders, we received repurchase requests fromFannie Mae for loans funded primarily in 2007 resulting in an increase in ourrepurchase reserve to $8.7 million at September 30, 2010.

 

The $465 thousand increase in other non-interest income is primarilythe result of gains of $215 thousand on sales of REO properties not in trustsduring the three months ended September 30, 2010 as compared to loss onsale of REO properties and write-downs of REO totaling $285 thousand for thecomparable period in 2009.

 

Non-interest expense and income taxes decreased $846 thousand.  The decrease is primarily attributable to a$665 thousand recovery in legal and professional expenses.

 

Condensed Statements ofOperations Data

 
| ** **                             | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income (expense)          |       | $                                                                         | 48         |   | $ | (244 | ) | $ | 292 |   | 120 | % |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
| Gain (loss) on sale of loans           |       | 18                                                                        |       | (8,767 | ) | 8,785 |   | 100 |   |
| (Provision) recoveries for repurchases |       | (2,151                                                                    | )          | 68 |   | (2,219 | ) | (3263 | ) |
| Other non-interest income              |       | 2,593                                                                     |       | (2,229 | ) | 4,822 |   | 216 |   |
| Total non-interest income              |       | 460                                                                       |       | (10,928 | ) | 11,388 |   | 104 |   |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
| Lease impairment adjustment            |       | (357                                                                      | )          | (2,418 | ) | 2,061 |   | 85 |   |
| Non-interest expense and income taxes  |       | (1,040                                                                    | )          | (388 | ) | (652 | ) | (168 | ) |
| Net earnings (loss)                    |       | $                                                                         | 1,905      |   | $ | (8,366 | ) | $ | 10,271 |   | 123 | % |

 

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Net earnings from discontinued operations was $1.9 million for thenine months ended September 30, 2010, compared to a loss of$8.4 million for the comparable period in 2009.  Net interest income increased $292 thousandto $48 thousand as a result of reductions in overall interest expense fromthe previous reverse repurchase facility that was settled as a result of  the Settlement Agreement reached inOctober 2009.

 

Gain (loss) on sale of loans increased $8.8 million to a gain of$18 thousand for the nine months ended September 30, 2010 as comparedto a loss of $8.8 million in the comparable period in 2009.   The decrease in loss on sale of loans wasthe result of reductions in LOCOM adjustments against loans held-for-salebetween periods resulting from the Settlement Agreement in October 2009with its reverse repurchase facility lender which removed the exposureassociated with the loans held for sale that secured the line.

 

(Provision) recoveries for repurchases decreased $2.2 million to aprovision of $2.2 million for the nine months ended September 30,2010, compared to a recovery of $68 thousand for the same period in 2009. The$2.2 million decrease is the result of settlements reached with whole-loaninvestors during 2009, coupled with increases in estimated repurchaseobligations during 2010.   During thethird quarter, consistent with other mortgage lenders, we received repurchaserequests from Fannie Mae for loans funded primarily in 2007 resulting in anincrease in our repurchase reserve to $8.7 million at September 30, 2010.

 

The $4.8 million increase in other non-interest income is primarily theresult of gains of $1.9 million on sales of REO properties not in trusts andrecovery of REO write-downs during the nine months ended September 30,2010 as compared to loss on sale of REO and write-downs of REO totaling $2.2million for the comparable period in 2009.

 

The $2.1 million increase inlease impairment adjustment during the nine months ended September 30,2010 over the comparable period was primarily attributable to a $2.4 milliongain in the second quarter of 2009 resulting from reduction in the leaseliabilities as a result of changes in our expected minimum future leasepayments.

 

**ITEM3:  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

As a smaller reporting company, we are not required to provide theinformation required by this Item.

 

**ITEM4:  CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

The Company maintains disclosure controls and procedures (as defined inthe Securities Exchange Act of 1934 Rules 13a-15(e) or 15d-15(e))designed to ensure that information required to be disclosed in reports filedor submitted under the Securities Exchange Act of 1934, as amended, 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 wereeffective at a reasonable assurance level.

 

***Changes in Internal Control Over Financial Reporting***

 

There has been no change in the Company’s internal control overfinancial reporting during the Company’s quarter ended September 30, 2010,that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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***PART II. OTHER INFORMATION***

 

**ITEM1:  LEGAL PROCEEDINGS**

 

The Company is party to litigation and claims which arise in theordinary course of business.

 

Please refer to IMH’s reports on Form 10-K for the year endedDecember 31, 2009 and Forms 10-Q for the quarters ended June 30,2010 and March 31, 2010 for a description of litigation and claims.

 

**ITEM1A:  RISK FACTORS**

 

Our Annual Report on Form 10-K for the year endedDecember 31, 2009 and our quarterly reports on Form 10-Q for theperiod ended March 31, 2010, include a detailed discussion of our riskfactors.  The information presented below updates andshould be read in conjunction with the risk factors and information disclosedin that Form 10-K.

 

**Representations and warranties made by us in our loansales and securitizations may subject us to liability.**

 

In connection with our loan sales to third parties and our priorsecuritizations, we transferred mortgages acquired and originated by us to thethird parties or into a trust in exchange for cash and, in the case of asecuritized mortgage, residual certificates issued by the trust. The trustee,purchaser, bondholder, or other entities involved in the issuance of thesecurities (which may include bond insurers) may have recourse to us withrespect to the breach of the representations, and warranties made by us at thetime such mortgages are transferred or when the securities are sold. Thoserepresentations and warranties may include, but are not limited to, issues suchas the validity of the lien, the absence of liens or delinquent taxes,  the validity of the appraisal obtained inconjunction with the loan,  thetruthfulness of information used in the loan approval process, the loanscompliance with all local, state and federal laws, the delivery of alldocuments required to perfect title to the lien, the loan meeting allunderwriting criteria and the selection process used to include the loans inany particular transaction.  Also, wepreviously engaged in bulk whole loan sales pursuant to agreements thatgenerally provide for recourse by the purchaser against us in the event of abreach of one of our representations or warranties, any fraud ormisrepresentation during the mortgage origination process, or upon earlydefault on such mortgage. We attempted to limit the potential remedies of suchpurchasers to the potential remedies we received from those from whom weacquired or originated the mortgages. However, in some cases, the remediesavailable to a purchaser of mortgages from us may be broader or extend longerthan those available to us against others whom have sold mortgage loans to usand should a purchaser enforce its remedies against us, we are not always ableto enforce whatever remedies we have against others. Furthermore, if wediscover, prior to the sale or transfer of a loan, that there is any fraud ormisrepresentation with respect to the mortgage and the originator fails torepurchase the mortgage, then we may not be able to sell the mortgage or we mayhave to sell the mortgage at a discount.

 

**There has been recent litigation in the mortgageindustry related to securitizations.**

 

As defaults, delinquencies, foreclosures, and losses in the real estatemarket continue, there have been recent lawsuits by various investors,insurers, underwriters and others against various participants insecuritizations, such as sponsors, depositors, underwriters, and loan sellers.Some lawsuits have alleged that the mortgage loans had origination defects,that there were misrepresentations made about the mortgage loans and theparties failed to properly disclose the quality of the mortgage loans orrepurchase defective loans or that there were other misrepresentations,  lack of representations, or errors insecuritization documents. There have been other claims contending errors ormisrepresentations in the securitization documents or process itself.  Historically, we both securitized and soldmortgage loans to third parties that may have been deposited or included inpools for securitizations.  We haverecently discovered discrepancies in our securitization documents and areworking with the parties involved, including holders of the securities, on theissue.  To the extent that we are notsuccessful in correcting the discrepancies or even if we are successful andmake revisions to correct the discrepancies, we may be subject toliability.   Recently the trustee ofthree of our securitizations has filed actions in the Superior Court of theState of California, County of Orange, seeking instructions on how to resolvethe ambiguities, inconsistencies in and/or omissions by modifying or reformingthe securitizations documents to be consistent. Although the petitions do not seek any affirmative recovery from us, theoutcome of that litigation may have an effect on us.  In connection with these potential claims, wemay be asked to repurchase these mortgage loans, provide indemnificationagainst such claims or we may become subject to litigation related to thesecuritizations. As a result, we may incur significant legal and other expensesin defending against claims and litigation and we may be required to paysettlement costs, damages, penalties or other charges which could adverselyaffect our financial results.

 

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**Our performance may be adversely affected by theperformance of parties who service or sub-service our mortgage loans.**

 

We sell or contract with third-parties for the servicing of all ourmortgage loans. Our operations, performance and liabilities are subject to risks associated with inadequate or untimelyservicing. Poor performance by a servicer may result in greater than expected delinquenciesand losses on our mortgage loans or in our resulting exposure to investors,bond holders, bond insurers or others as we are responsible for the performanceof our loan servicers .  If we, or ourservicers, commit a material breach of our obligations as a servicer or masterservicer, we may be subject to termination if the breach is not cured within aspecified period of time following notice, causing us to lose master servicingincome.  In addition, we may be requiredto indemnify the securitization trustee against losses from any failure by us,as master servicer or on behalf of the servicer, to perform the servicingobligations properly.    Recentannouncements of deficiencies in foreclosure documentation by several largeservicers have raised various concerns relating to foreclosure practices.  We are working with all of our servicers toidentify deficient foreclosure practices. A number of our servicers, including several of our largest ones, havetemporarily suspended foreclosure proceedings in some or all states in whichthey do business while they conduct their evaluations.  We are also evaluating the impact of theseforeclosure practices on our REO properties and the servicers have suspendedcertain REO sales and eviction proceedings for REO properties pending thecompletion of the evaluation.  Issueshave also been identified with respect to practices of certain legal counselinvolved in the foreclosure process and in the use of the mortgage electronicregistration system as a foreclosing party or as a listed beneficiary of amortgage.  We expect that these issuesand the related foreclosure suspensions could prolong the foreclosure processnationwide and may delay sales of our REO properties and hence affect theperformance of our securities.  Continued foreclosure delays and other disruptions in the real estatemarket may result in a material adverse impact to our financial results.

 

Also, a substantial increase in our delinquency or foreclosure ratecould adversely affect our ability to access the capital and secondary marketsfor our financing needs. Also, with respect to mortgage loans subject to asecuritization, greater delinquencies would adversely affect the value of ourresidual interest, if any, we hold in connection with that securitization.

 

In a securitization, relevant agreements permit us to be terminated asservicer or master servicer under specific conditions described in theseagreements. If, as a result of a servicer or sub-servicer’s failure to performadequately, we were terminated as master servicer of a securitization, thevalue of any master servicing rights held by us could be adversely affected.

 

**ITEM2:  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM3:  DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM4:  RESERVED**

 

None.

 

**ITEM5:  OTHER INFORMATION**

 

None

 

**ITEM6:  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 bedeemed “filed” for purposes of Section 18 of the Securities Exchange Actof 1934 or otherwise subject to the liabilities of that section, nor shall itbe deemed incorporated by reference in any filing under the Securities Act of1933 or the Securities Exchange Act of 1934, whether made before or after thedate hereof and irrespective of any general incorporation language in anyfilings.

 

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** **

**SIGNATURES**

 

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

 
| **IMPAC  MORTGAGE HOLDINGS, INC.**                               |     |
|-----------------------------------------------------------------------|----------|
| /s/  TODD R. TAYLOR                                                   |     |
| Todd  R. Taylor                                                       |     |
| *Chief  Financial Officer*                                            | * * |
| *(authorized  officer of registrant and principal financial officer)* | * * |

 

November 15, 2010

 

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