#  

# **UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

## **FORM 10-Q**

 
| **x**                                                                                                                                                                                                                                                                                       | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                        |
| **For the quarterly period ended September 30, 2007 or**                                                                                                                                                                                                                               |
|                                                                                                                                                                                                                                                                                        |
| **o**                                                                                                                                                                                                                                                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                                                                                                                                                                        |
| **For the transition period from                        to                      .** |
|                                                                                                                                                                                                                                                                                        |
| **Commission File Number: 1-14100**                                                                                                                                                                                                                                                         |

 

**IMPAC MORTGAGE HOLDINGS, INC.**

(Exact name of registrant as specified in itscharter)

** **

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

 

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

**(Address of principal executive offices)**

 

**(949) 475-3600**

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

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90days.    Yes  x    No  o

 

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

 

Large accelerated filer x   Acceleratedfiler o   Non-accelerated filer o

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule

12b-2)    Yes o No x

 

Therewere 76,083,865 shares of common stock outstanding as of December 14,2007.

 

** **

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** **

**IMPAC MORTGAGEHOLDINGS, INC.**

### ** **

### **FORM 10-QQUARTERLY REPORT**

** **

**TABLE OFCONTENTS**

 
|     | **PART I.  FINANCIAL INFORMATION**                                                                                                                                                                                                                                                                                                    |       |
|----------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|     |                                                                                                                                                                                                                                                                                                                                       | Page       |
| ITEM 1.  | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                                                                                                                                                                                                                                     | **2**      |
|     | Consolidated Balance Sheets as of  September 30, 2007 and December 31, 2006                                                                                                                                                                                                                                                      | 2          |
|     | Consolidated  Statements of Operations and Comprehensive Loss for the Three and Nine Months  Ended September 30, 2007 and 2006                                                                                                                                                                                                        | 3          |
|     | Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2007  and 2006                                                                                                                                                                                                                                         | 5          |
|     | Notes  to Unaudited Consolidated Financial Statements                                                                                                                                                                                                                                                                                      | 7          |
|     |                                                                                                                                                                                                                                                                                                                                       |       |
| ITEM 2.  | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION ANDRESULTS  OF OPERATIONS**                                                                                                                                                                                                                                            | 24         |
|     | Forward-Looking  Statements                                                                                                                                                                                                                                                                                                                | 24         |
|     | The Mortgage Banking  Industry and Discussion of Relevant Fiscal Periods                                                                                                                                                                                                                                                                   | 24         |
|     | Review of  Performance                                                                                                                                                                                                                                                                                                                     | 25         |
|     | Critical Accounting Policies                                                                                                                                                                                                                                                                                                               | 29         |
|     | Selected Financial Results  for the Third Quarter of 2007                                                                                                                                                                                                                                                                                  | 31         |
|     | Third Quarter  and Year-to-date 2007 Taxable Income                                                                                                                                                                                                                                                                                        | 32         |
|     | Financial Condition and  Results of Operations                                                                                                                                                                                                                                                                                             | 34         |
|     | Liquidity and Capital Resources                                                                                                                                                                                                                                                                                                            | 55         |
|     |                                                                                                                                                                                                                                                                                                                                       |       |
| ITEM 3.  | **QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK**                                                                                                                                                                                                                                                                            | **57**     |
|     |                                                                                                                                                                                                                                                                                                                                       |       |
| ITEM 4.  | **CONTROLS  AND PROCEDURES**                                                                                                                                                                                                                                                                                                               | **60**     |
|     |                                                                                                                                                                                                                                                                                                                                       |       |
|     | **PART II.  OTHER INFORMATION**                                                                                                                                                                                                                                                                                                       | **61**     |
|     |                                                                                                                                                                                                                                                                                                                                       |       |
| ITEM 1.  | **LEGAL  PROCEEDINGS**                                                                                                                                                                                                                                                                                                                     | **61**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 1A. | **RISK  FACTORS**                                                                                                                                                                                                                                                                                                                          | **61**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 2.  | **UNREGISTERED SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS**                                                                                                                                                                                                                                                                           | **64**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 3.  | **DEFAULTS UPON SENIOR  SECURITIES**                                                                                                                                                                                                                                                                                                       | **64**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 4.  | **SUBMISSION OF MATTERS TO A  VOTE OF SECURITY HOLDERS**                                                                                                                                                                                                                                                                                   | **64**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 5.  | **OTHER  INFORMATION**                                                                                                                                                                                                                                                                                                                     | **65**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
| ITEM 6.  | **EXHIBITS**                                                                                                                                                                                                                                                                                                                               | **65**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
|     | **SIGNATURES**                                                                                                                                                                                                                                                                                                                             | **66**     |
|     | ** **                                                                                                                                                                                                                                                                                                                                 |       |
|     | **CERTIFICATIONS**                                                                                                                                                                                                                                                                                                                         | ** ** |
|     |                                                                                                                                                                                                                                                                                                                                       | ** ** |
|     | **EXPLANATORY NOTE**                                                                                                                                                                                                                                                                                                                       | ** ** |
|     | ** **                                                                                                                                                                                                                                                                                                                                 | ** ** |
|     | During  the third quarter of 2007, the Company’s Board of Directors elected to  discontinue the Alt-A mortgage operations (IFC), commercial operations  (ICCC), and warehouse lending operations (IWLG).  The information contained throughout this document is presented on a  continuing operations basis, unless otherwise stated. | ** ** |

 

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#### **PART I. FINANCIALINFORMATION**

#### ** **

#### **ITEM 1.       CONSOLIDATEDFINANCIAL STATEMENTS**

** **

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

** **

**CONSOLIDATED BALANCE SHEETS**

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

** **
| ** **                                                                                                                                                                                                                                            | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                            | ** ** | **(Unaudited**)              |       |                        |       |
| **ASSETS**                                                                                                                                                                                                                                            | ** ** | ** **                   |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                             |       | $                            | 41,186     |                        | $          | 151,714 |   |
| Securitized mortgage collateral                                                                                                                                                                                                                       |       | 18,741,520                   |       | 20,936,515                  |       |
| Allowance for loan losses                                                                                                                                                                                                                             |       | (911,218                     | )          | (77,684                     | )          |
| Mortgages held-for-sale - retail operations                                                                                                                                                                                                           |       | 133,497                      |       | —                      |       |
| Investment securities available-for-sale                                                                                                                                                                                                              |       | 16,274                       |       | 31,582                      |       |
| Accrued interest receivable                                                                                                                                                                                                                           |       | 103,255                      |       | 107,913                     |       |
| Derivative assets                                                                                                                                                                                                                                     |       | 36,153                       |       | 142,793                     |       |
| Real estate owned (REO), net                                                                                                                                                                                                                          |       | 360,472                      |       | 137,331                     |       |
| Assets of discontinued operations                                                                                                                                                                                                                     |       | 810,574                      |       | 2,086,216                   |       |
| Other assets                                                                                                                                                                                                                                          |       | 78,663                       |       | 82,575                      |       |
| Total assets                                                                                                                                                                                                                                          |       | $                            | 19,410,376 |                        | $          | 23,598,955 |   |
|                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| **LIABILITIES**                                                                                                                                                                                                                                       |       |                         |       |                        |       |
| Securitized mortgage borrowings                                                                                                                                                                                                                       |       | $                            | 18,712,217 |                        | $          | 20,527,001 |   |
| Reverse repurchase agreements                                                                                                                                                                                                                         |       | 148,116                      |       | 163,890                     |       |
| Trust preferred securities                                                                                                                                                                                                                            |       | 98,232                       |       | 97,661                      |       |
| Liabilities of discontinued operations                                                                                                                                                                                                                |       | 832,216                      |       | 1,774,371                   |       |
| Derivative liabilities                                                                                                                                                                                                                                |       | 41,098                       |       | 14,752                      |       |
| Other liabilities                                                                                                                                                                                                                                     |       | 71,813                       |       | 11,750                      |       |
| Total liabilities                                                                                                                                                                                                                                     |       | 19,903,692                   |       | 22,589,425                  |       |
|                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Commitments and contingencies                                                                                                                                                                                                                         |       |                         |       |                        |       |
| ** **                                                                                                                                                                                                                                            |       |                         |       |                        |       |
| **STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                         |       |                         |       |                        |       |
|                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Series-A junior participating preferred stock, $0.01 par value;  2,500,000 shares authorized; none issued and outstanding as of June 30,  2007 and December 31, 2006, respectively                                                          |       | —                       |       | —                      |       |
| Series-B 9.375% cumulative redeemable preferred stock, $0.01 par  value; liquidation value $50,000; 2,000,000 shares authorized, 2,000,000  shares issued and outstanding as of September 30, 2007 and  December 31, 2006, respectively     |       | 20                           |       | 20                          |       |
| Series-C 9.125% cumulative redeemable preferred stock, $0.01 par  value; liquidation value $111,765; 5,500,000 shares authorized; 4,470,600 and  4,444,000 shares outstanding as of September 30, 2007 and  December 31, 2006, respectively |       | 45                           |       | 44                          |       |
|                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Common stock, $0.01 par value; 200,000,000 shares authorized;  76,083,865 shares issued and outstanding as of September 30, 2007 and  December 31, 2006                                                                                     |       | 761                          |       | 761                         |       |
| Additional paid-in capital                                                                                                                                                                                                                            |       | 1,173,350                    |       | 1,170,872                   |       |
| Accumulated other comprehensive income                                                                                                                                                                                                                |       | 291                          |       | 2,357                       |       |
| Net accumulated deficit:                                                                                                                                                                                                                              |       |                         |       |                        |       |
| Cumulative dividends declared                                                                                                                                                                                                                         |       | (800,191                     | )          | (762,382                    | )          |
| Retained earnings (deficit)                                                                                                                                                                                                                           |       | (867,592                     | )          | 597,858                     |       |
| Net accumulated deficit                                                                                                                                                                                                                               |       | (1,667,783                   | )          | (164,524                    | )          |
| Total stockholders’ (deficit) equity                                                                                                                                                                                                             |       | (493,316                     | )          | 1,009,530                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                       |       | $                            | 19,410,376 |                        | $          | 23,598,955 |   |

 

See accompanying notes toconsolidated financial statements.

 

2

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

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**AND COMPREHENSIVE LOSS**

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

**(Unaudited)**

 
| ** **                                              | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                              | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| **INTEREST INCOME:**                                    | * *   | * *                                             | * *   | * *                                            | * *   | * * | * * | * * | * * |
| Mortgage assets                                         |       | $                                                    | 313,307    |                                                | $          | 259,359 |   | $ | 932,580 |   | $ | 843,845 |   |
| Other                                                   |       | 465                                                  |       | 1,695                                               |       | 3,784 |   | 5,438 |   |
| Total interest income                                   |       | 313,772                                              |       | 261,054                                             |       | 936,364 |   | 849,283 |   |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **INTEREST EXPENSE:**                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Securitized mortgage borrowings                         |       | 294,570                                              |       | 289,837                                             |       | 889,851 |   | 888,056 |   |
| Reverse repurchase agreements                           |       | 5,274                                                |       | 344                                                 |       | 12,488 |   | 981 |   |
| Other borrowings                                        |       | 2,230                                                |       | 2,299                                               |       | 6,721 |   | 6,986 |   |
| Total interest expense                                  |       | 302,074                                              |       | 292,480                                             |       | 909,060 |   | 896,023 |   |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Net interest income (expense)                           |       | 11,698                                               |       | (31,426                                             | )          | 27,304 |   | (46,740 | ) |
| Provision for loan losses                               |       | 789,445                                              |       | 3,533                                               |       | 979,740 |   | 3,638 |   |
| Net interest expense after provision for loan losses    |       | (777,747                                             | )          | (34,959                                             | )          | (952,436 | ) | (50,378 | ) |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **NON-INTEREST INCOME:**                                |       |                                                 |       |                                                |       |   |   |   |   |
| Change in fair value of derivative instruments          |       | (137,553                                             | )          | (150,051                                            | )          | (138,334 | ) | (91,155 | ) |
| Realized gain from derivative instruments               |       | 28,815                                               |       | 60,595                                              |       | 103,840 |   | 156,582 |   |
| Provision for repurchases                               |       | (4,553                                               | )          | —                                              |       | (4,553 | ) | — |   |
| (Loss) gain on sale of other real estate owned          |       | (5,571                                               | )          | 485                                                 |       | (6,716 | ) | 1,740 |   |
| Amortization of mortgage servicing rights               |       | (188                                                 | )          | (380                                                | )          | (603 | ) | (1,112 | ) |
| Lower of cost or market writedown                       |       | (6,657                                               | )          | —                                              |       | (7,396 | ) | — |   |
| Loss on sale of loans                                   |       | (27,586                                              | )          | (20                                                 | )          | (26,195 | ) | (1,407 | ) |
| Provision for REO losses                                |       | (40,371                                              | )          | —                                              |       | (68,445 | ) | — |   |
| Other (expense) income                                  |       | (1,056                                               | )          | 8,383                                               |       | 4,367 |   | 26,664 |   |
| Total non-interest income (expense)                     |       | (194,720                                             | )          | (80,988                                             | )          | (144,035 | ) | 91,312 |   |
|                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| **NON-INTEREST EXPENSE:**                               |       |                                                 |       |                                                |       |   |   |   |   |
| General and administrative and other expense            |       | 8,154                                                |       | 1,868                                               |       | 25,293 |   | 5,831 |   |
| Occupancy expense                                       |       | 4,814                                                |       | 413                                                 |       | 6,986 |   | 1,263 |   |
| Personnel expense                                       |       | 6,127                                                |       | 2,234                                               |       | 14,089 |   | 4,151 |   |
| Data processing expense                                 |       | 1,425                                                |       | 1,478                                               |       | 4,181 |   | 3,434 |   |
| Professional services                                   |       | 622                                                  |       | 285                                                 |       | 2,212 |   | 1,464 |   |
| Equipment expense                                       |       | 493                                                  |       | 502                                                 |       | 1,400 |   | 1,565 |   |
| Total non-interest expense                              |       | 21,635                                               |       | 6,780                                               |       | 54,161 |   | 17,708 |   |
| Net (loss) earnings from continuing operations          |       | (994,102                                             | )          | (122,727                                            | )          | (1,150,632 | ) | 23,226 |   |
| Income tax expense from continuing operations           |       | 3,056                                                |       | 1,700                                               |       | 12,012 |   | 8,070 |   |
| Net (loss) earnings from continuing operations          |       | (997,158                                             | )          | (124,427                                            | )          | (1,162,644 | ) | 15,156 |   |
| Loss from discontinued operations, net of tax           |       | (194,077                                             | )          | (3,264                                              | )          | (302,806 | ) | (30,923 | ) |
| Net (loss) earnings                                     |       | (1,191,235                                           | )          | (127,691                                            | )          | (1,465,450 | ) | (15,767 | ) |
| Cash dividends on cumulative redeemable preferred stock |       | (3,722                                               | )          | (3,672                                              | )          | (11,165 | ) | (11,016 | ) |
| Net loss available to common stockholders               |       | $                                                    | (1,194,957 | )                                                   | $          | (131,363 | ) | $ | (1,476,615 | ) | $ | (26,783 | ) |

 

See accompanyingnotes to consolidated financial statements

** **

**3**

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** **
| ** **                                                  | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                  | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net loss                                                    |       | $                                                    | (1,191,235 | )                                                   | $          | (127,691 | ) | $ | (1,465,450 | ) | $ | (15,767 | ) |
| Net unrealized (losses) gains on securities:                |       |                                                 |       |                                                |       |   |   |   |   |
| Unrealized holding losses arising during year               |       | (700                                                 | )          | (237                                                | )          | (673 | ) | (2,015 | ) |
| Reclassification of (losses) gains included in net earnings |       | (243                                                 | )          | —                                              |       | (1,393 | ) | 143 |   |
| Net unrealized losses                                       |       | (943                                                 | )          | (237                                                | )          | (2,066 | ) | (1,872 | ) |
| Comprehensive loss                                          |       | $                                                    | (1,192,178 | )                                                   | $          | (127,928 | ) | $ | (1,467,516 | ) | $ | (17,639 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss per common share - Basic:                          |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from Continuing Operations                             |       | $                                                    | (13.11     | )                                                   | $          | (1.63 | ) | $ | (15.28 | ) | $ | 0.20 |   |
| (Loss) earnings from Discontinuing Operations               |       | (2.55                                                | )          | (0.04                                               | )          | (3.98 | ) | (0.41 | ) |
| Net Loss per share                                          |       | $                                                    | (15.66     | )                                                   | $          | (1.68 | ) | $ | (19.26 | ) | $ | (0.21 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss per common share - Diluted:                        |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from Continuing Operations                             |       | $                                                    | (13.11     | )                                                   | $          | (1.63 | ) | $ | (15.28 | ) | $ | 0.20 |   |
| (Loss) earnings from Discontinuing Operations               |       | (2.55                                                | )          | (0.04                                               | )          | (3.98 | ) | (0.41 | ) |
| Net Loss per share                                          |       | $                                                    | (15.66     | )                                                   | $          | (1.68 | ) | $ | (19.26 | ) | $ | (0.21 | ) |
|                                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net Loss per share available to common shareholders         |       | $                                                    | (15.71     | )                                                   | $          | (1.73 | ) | $ | (19.41 | ) | $ | (0.35 | ) |
| Dividends declared per common share                         |       | $                                                    | —     |                                                | $          | 0.25 |   | $ | 0.10 |   | $ | 0.75 |   |

 

See accompanying notes toconsolidated financial statements

 

4

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(Unaudited)**

 
| ** **                                                                                                 | ** **   | **For the Nine Months** | ** **   |
|------------------------------------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                                                 | ** **   | **Ended September 30,**      | ** **   |
| ** **                                                                                                 | ** **   | **2007**                               | ** **   | **2006** | ** ** |
| ** **                                                                                                 | ** **   | ** **                             | ** **   | **restated** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                                  | *** *** | *** ***                           | *** *** | *** *** | *** *** |
| Net (loss) earnings of continuing operations                                                               |         | $                                      | (1,162,644   | ) | $ | 15,156 |   |
| *Continuing operations adjustments to reconcile  net earnings to net cash used in operating activities:*   |         |                                   |         |   |   |
| Provision for loan losses                                                                                  |         | 979,740                                |         | 3,638 |   |
| Provision for REO losses                                                                                   |         | 68,445                                 |         | — |   |
| Amortization of deferred charge, net                                                                       |         | 12,071                                 |         | 15,872 |   |
| Amortization of premiums, securitization costs and debt issuance  costs                                    |         | 117,180                                |         | 181,769 |   |
| Loss (gain) on sale of other real estate owned                                                             |         | 6,716                                  |         | (1,740 | ) |
| Loss on sale of loans                                                                                      |         | 26,195                                 |         | 1,407 |   |
| Provision for repurchases                                                                                  |         | 4,553                                  |         | — |   |
| Loss on lower of cost or market writedown                                                                  |         | 7,396                                  |         | — |   |
| Change in fair value of derivative instruments                                                             |         | 138,334                                |         | 91,155 |   |
| Purchase of mortgages held-for-sale                                                                        |         | (686,271                               | )            | — |   |
| Sale and principal reductions on mortgages held-for-sale                                                   |         | 546,223                                |         | — |   |
| Stock-based compensation                                                                                   |         | 1,960                                  |         | 1,628 |   |
| Goodwill impairment                                                                                        |         | 12,360                                 |         | — |   |
| Impairment of long lived assets                                                                            |         | 1,200                                  |         | — |   |
| Write-down of securities available-for-sale                                                                |         | 11,304                                 |         |   |   |
| Net change in other assets and liabilities                                                                 |         | (13,994                                | )            | (11,869 | ) |
| *Net cash provided by operating activities of continuing  operations*                                      |         | 70,768                                 |         | 297,016 |   |
|                                                                                                       |         |                                   |         |   |   |
| Net loss in discontinued operations                                                                        |         | (302,806                               | )            | (30,923 | ) |
| *Discontinued operations adjustments to reconcile  net earnings to net cash used in operating activities:* |         |                                   |         |   |   |
| Provision for repurchases                                                                                  |         | 41,883                                 |         | 7,233 |   |
| Loss on lower of cost or market writedown                                                                  |         | 133,203                                |         | 15,284 |   |
| Provision for loan losses                                                                                  |         | 4,867                                  |         | (349 | ) |
| Purchase of mortgages held-for-sale                                                                        |         | (4,162,759                             | )            | (8,301,684 | ) |
| Sale and principal reductions on mortgages held-for-sale                                                   |         | 1,549,318                              |         | 6,397,450 |   |
| Loss (gain) on sale of loans                                                                               |         | 47,401                                 |         | (37,019 | ) |
| Depreciation and amortization                                                                              |         | 3,167                                  |         | 4,392 |   |
| Impairment of long lived assets                                                                            |         | 11,614                                 |         | — |   |
| Net change in other assets and liabilities                                                                 |         | (16,887                                | )            | 935 |   |
| *Net cash used in operating activities of discontinued  operations*                                        |         | (2,690,999                             | )            | (1,944,681 | ) |
| **Net cash used in by operating activities**                                                               | ** **   | **(2,620,231**                         | **)**        | **(1,647,665** | **)** |
|                                                                                                            |              |                                        |              |  |  |  |  |

 

5

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** **
| ** **                                                                        | ** **   | **For the Nine Months** | ** **   |
|-----------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                        | ** **   | **Ended September 30,**      | ** **   |
| ** **                                                                        | ** **   | **2007**                               | ** **   | **2006** | ** ** |
| ** **                                                                        | ** **   | ** **                             | ** **   | **restated** | ** ** |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                         | *** *** | *** ***                           | *** *** | *** *** | *** *** |
| Net change in securitized mortgage collateral                                     |         | 4,749,658                              |         | 6,865,027 |   |
| Net change in mortgages held-for-investment                                       |         | (2,061                                 | )            | 87,560 |   |
| Purchase of investment securities available-for-sale                              |         | —                                 |         | 34,909 |   |
| Purchase of premises and equipment                                                |         | (6,286                                 | )            | — |   |
| Net principal change on investment securities available-for-sale                  |         | 2,816                                  |         | (27,180 | ) |
| Proceeds from the sale of other real estate owned                                 |         | 163,437                                |         | 61,963 |   |
| Other investing cash flows from continuing operations                             |         | —                                 |         | 91 |   |
| *Net cash provided by investing activities of  continuing operations*             |         | 4,907,564                              |         | 7,022,370 |   |
|                                                                              |         |                                   |         |   |   |
| Finance receivable advances to customers                                          |         | (2,077,204                             | )            | (3,527,463 | ) |
| Repayments of finance receivables                                                 |         | 2,348,536                              |         | 3,579,915 |   |
| Net change in securitized mortgage collateral                                     |         | 103,117                                |         | (136,004 | ) |
| Other investing cash flows from discontinued operations                           |         | 23,342                                 |         | 68 |   |
| *Net cash (used in) provided by investing  activities of discontinued operations* |         | 397,791                                |         | (83,484 | ) |
| **Net cash provided by investing activities**                                     | ** **   | **5,305,355**                          | ** **   | **6,938,886** | ** ** |
|                                                                              |         |                                   |         |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                         |         |                                   |         |   |   |
| Proceeds from securitized mortgage borrowings                                     |         | 3,858,143                              |         | 2,863,509 |   |
| Repayment of securitized mortgage borrowings                                      |         | (5,690,970                             | )            | (7,186,872 | ) |
| Common stock dividends paid                                                       |         | (26,644                                | )            | (53,281 | ) |
| Preferred stock dividends paid                                                    |         | (11,165                                | )            | (11,016 | ) |
| Purchases of common stock                                                         |         | —                                 |         | (951 | ) |
| Proceeds from exercise of stock options                                           |         | —                                 |         | 824 |   |
| Proceeds from sale of cumulative redeemable preferred stock                       |         | 608                                    |         | 203 |   |
| Other financing cash flows from continuing operations                             |         | —                                 |         | 69,364 |   |
| *Net cash used in investing activities of  continuing operations*                 |         | (1,870,028                             | )            | (4,318,220 | ) |
|                                                                              |         |                                   |         |   |   |
| Cash disbursements under reverse repurchase agreements                            |         | (7,323,114                             | )            | (15,905,924 | ) |
| Cash receipts from reverse repurchase agreements                                  |         | 6,382,254                              |         | 14,948,926 |   |
| Other financing cash flows from discontinued operations                           |         | —                                 |         | (723 | ) |
| *Net cash used in investing activities of  discontinued operations*               |         | (940,860                               | )            | (957,721 | ) |
| **Net cash used in financing activities**                                         | ** **   | **(2,810,888**                         | **)**        | **(5,275,941** | **)** |
|                                                                              |         |                                   |         |   |   |
| Net change in cash and cash equivalents                                           |         | (125,764                               | )            | 15,280 |   |
| Cash and cash equivalents at beginning of period                                  |         | 179,677                                |         | 146,621 |   |
| Cash and cash equivalents at end of period - Continuing Operations                |         | 41,186                                 |         | 125,659 |   |
| Cash and cash equivalents at end of period - Discontinued Operations              |         | 12,727                                 |         | 36,242 |   |
| Cash and cash equivalents at end of period                                        |         | $                                      | 53,913       |   | $ | 161,901 |   |
|                                                                              |         |                                   |         |   |   |
| **SUPPLEMENTARY INFORMATION:**                                                    | *** *** | *** ***                           | *** *** | *** *** | *** *** |
| Interest paid                                                                     |         | $                                      | 962,336      |   | $ | 862,033 |   |
| Taxes paid                                                                        |         | 116                                    |         | 45 |   |
|                                                                              |         |                                   |         |   |   |
| **NON-CASH TRANSACTIONS:**                                                        |         |                                   |         |   |   |
| Accumulated other comprehensive loss                                              |         | $                                      | (2,066       | ) | $ | (1,872 | ) |
| Dividends declared but unpaid                                                     |         | —                                 |         | 19,021 |   |
| Transfer of mortgages to other real estate owned                                  |         | 3,046                                  |         | 129,785 |   |
| Transfer of securitized mortgage collateral to other real estate  owned           |         | 419,411                                |         | — |   |
| Transfer of loans held-for-sale to securitized mortgage collateral                |         | 3,245,500                              |         | — |   |
| Transfer of securitized mortgage collateral to loans held-for-sale                |         | 27,040                                 |         | — |   |
| Transfer of assets from discontinued operations to continuing  operations         |         | 4,012                                  |         | — |   |

 

See accompanying notes toconsolidated financial statements.

 

6

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**IMPAC MORTGAGEHOLDINGS, INC. AND SUBSIDIARIES**

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

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

 

**Note A—Summary of Business and Significant Accounting Policies**

 

**1.     BusinessSummary and Financial Statement Presentation**

 

***Market Conditions***

 

Conditions in thesecondary markets, which dramatically worsened during the third quarter,continue to be depressed as investor concerns over credit quality and aweakening of the United States housing market remain high. As a result, thecapital markets remain very volatile and illiquid and, have effectively beenunavailable to the Company. The Company believes the existing conditions in thesecondary markets are unprecedented since the Company’s inception and, as such,inherently involve significant risks and uncertainty. These conditions couldcontinue to adversely impact the performance of our long term investmentportfolio. Until bond spreads and credit performance return to more rationallevels, it will be impossible for the Company to execute securitizations andloan sales. As a result, in the third quarter the Company has been forced tofurther alter its business strategies and discontinue the correspondent andwholesale mortgage operations and the warehouse operations in response to themarket conditions.

 

During the second quarter of2007 the Company accumulated mortgages in the normal course of business;however, starting in July 2007, the secondary mortgage market halted theirpurchase of investments backed by mortgage loans. As a result the Company wasunable to securitize the mortgage loans, which led to significant margin callsduring the third quarter of 2007, reducing the Company’s cash position.

 

The Company has taken steps to reduce operating costs,including reducing staff and lease costs, to a level at which the cashflowsfrom the long-term mortgage portfolio and its master servicing portfolio couldsupport the Company’s ongoing operations. The Company continues to re-size theorganization to a level more in line with its ongoing operations. Once theCompany is able to eliminate the remaining reverse repurchase lines indiscontinued operations the Company should be able to meet its liquidity needsfrom cash flows generated from the long-term mortgage portfolio and its masterservicing fees. In an effort to maintain capital, the Company did not declare a cash dividend on ourcommon stock during the third quarterof 2007.

 

As of September 30, 2007,the Company has negative net worth. While the Company continues to pay itsobligations as they become due, the ability of the Company to continue isdependent upon many factors, particularly the Company’s ability to realize thevalue of its investment portfolio. There can be no assurance of the Company’sability to do so.

 

***Discontinued Operations***

 

As a result of theCompany’s inability to sell or securitize non-conforming loans, the Company hasdiscontinued funding loans other than conforming agency loans.

 

As a result of the marketconditions as described above, the Company discontinued the followingbusinesses:

 

•                            the non-conforming Mortgage Operationsconducted by IFC and ISAC;

 

•                            the Commercial Operations conducted by ICCC;and

 

•                            the Warehouse Lending Operations conducted byIWLG.

 

T*heCompany announced plans to exit certain operations in August 2007. Theamounts presented in the notes to the financial statements, include amountssolely from continuing operations, excluding Note 2, Note 4 and Note K, whichinclude amounts related to discontinued operations.*

 

***Asset Purchase and Related Impairment***

 

In May 2007, the Company completed theacquisition of certain production facilities from Pinnacle FinancialCorporation (PFC), which is primarily located in the East Coast of the UnitedStates. In conjunction with the acquisition the Company created the Impac HomeLoans (IHL) a division of IFC. The IHL retail platform originates agency loans.This transaction was recorded as a business combination for accounting purposesresulting in the Company initially recording $12.4 million in goodwill. Becauseof the current market environment, the goodwill was impaired and the Companyhad recorded an impairment charge for the full amount during the second quarterof 2007.

 

7

----

 

***Business Summary***

 

Impac Mortgage Holdings, Inc.(the Company or IMH) is a Maryland corporation incorporated in August 1995and has the following subsidiaries: IMH Assets Corp. (IMH Assets), ImpacWarehouse Lending Group, Inc. (IWLG), and Impac Funding Corporation (IFC),together with its wholly-owned subsidiaries Impac Secured Assets Corp. (ISAC),and Impac Commercial Capital Corporation (ICCC).

 

Duringthe third quarter of 2007, the Company’s board of directors elected todiscontinue the non-conforming mortgage operations (IFC), commercial operations(ICCC), and warehouse lending operations (IWLG).

 

Currently, the Companyconsists of:

 

•                          the Long-Term Investment operations conducted by IMH and IMH Assets;and

 

•                          the Retail Mortgage operations conducted by Impac Home Lending (IHL), adivision of IFC.

 

The long-term investmentoperations generate earnings primarily from net interest income earned onmortgages held as securitized mortgage collateral and mortgagesheld-for-investment collectively (long-term mortgage portfolio) and associatedhedging derivative cash flows. The long-term mortgage portfolio, as reported onthe Company’s consolidated balance sheet, consist of mortgages held assecuritized mortgage collateral and mortgages held-for-investment.

 

The retail mortgageoperations continue to originate and sell agency conforming adjustable ratemortgages (ARMs) and fixed rate mortgages (FRMs). The retail mortgageoperations generate income by selling mortgages to permanent investors. Theseoperations also earn interest income on mortgages held-for-sale. The retailmortgage operations use short term reverse warehouse facilities to finance theorigination of mortgages. The Company has been notified that its lender to theretail operations is considering winding down the available line. The Companywill either dispose of the retail mortgage operations, or discontinue and winddown the operations by March 31, 2008.

 

***Financial StatementPresentation***

 

The accompanyingunaudited consolidated financial statements of IMH and our subsidiaries (asdefined above) have been prepared in accordance with GAAP for interim financialinformation and with the instructions to Form 10-Q and Rule 10-01 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles (GAAP) forcomplete financial statements. In the opinion of management, all adjustments,consisting of normal recurring adjustments considered necessary for a fairpresentation, have been included. Operating results for the nine-month periodended September 30, 2007 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2007.

 

All significantinter-company balances and transactions have been eliminated in consolidation.In addition, certain amounts in the prior periods’ consolidated financialstatements have been reclassified to conform to the current year presentation.

 

Management has made anumber of estimates and assumptions relating to the reporting of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period to prepare these financial statements in conformitywith GAAP. The items affected by management’s estimates and assumptions includeallowance for loan losses, valuation of derivative financial instruments, netrealizable value of real estate owned (REO), lower of cost or market adjustmentto loans held-for-sale, repurchase liabilities related to sold loans, valuationof residual interests, asset impairment charges, restructuring charges, and theamortization of various loan premiums and discounts due to prepaymentestimates. Actual results could differ materially from those estimates.

 

**2.****    Discontinued Operations**

 

During the thirdquarter of 2007, the Company announced plans to exit substantially all of itsmortgage, the commercial, and the warehouse lending operations. Consequently,the amounts related to these operations are presented as discontinuedoperations in our consolidated statements of income and our consolidatedstatements of cash flows, and the asset groups to be exited are reported asassets and liabilities of discontinued operations in our consolidated balancesheets for the periods presented.

 

8

----

 

Thefollowing tables present discontinued operations condensed balance sheets forthe periods ended September 30, 2007 and December 31, 2006;

 
| ** **                                                        | ** ** | **Discontinued Operations**       | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                        | ** ** | **as of September 30,** | ** ** |
| ** **                                                        | ** ** | **2007**                               | ** ** |
| ** **                                                        | ** ** | ** **                             | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                                        | ** ** | **Warehouse**                          | ** ** | **Operations (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Balance Sheet Items:**                                | ** ** | **Lending**                            | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Securitized mortgage collateral and mortgages held-for-investment |       | $                                      | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Mortgages held-for-sale                                           |       | —                                 |       | 592,376 |   | 129,295 |   | — |   | 721,671 |   |
| Finance receivables                                               |       | 994,768                                |       | — |   | — |   | (959,818 | ) | 34,950 |   |
| Allowance for loan losses                                         |       | (7,759                                 | )          | — |   | — |   | — |   | (7,759 | ) |
| Total assets                                                      |       | 1,179,849                              |       | 804,543 |   | 129,680 |   | (1,303,498 | ) | 810,574 |   |
| Reverse repurchase agreements                                     |       | 923,733                                |       | 714,182 |   | 130,581 |   | (992,850 | ) | 775,646 |   |
|                                                                   |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                        | ** ** | **Discontinued Operations**      | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                        | ** ** | **as of December 31,** | ** ** |
| ** **                                                        | ** ** | **2006**                              | ** ** |
| ** **                                                        | ** ** | ** **                            | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                                        | ** ** | **Warehouse**                         | ** ** | **Operations (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Balance Sheet Items:**                                | ** ** | **Lending**                           | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Securitized mortgage collateral and mortgages held-for-investment |       | $                                     | —     |   | $ | 114,315 |   | $ | — |   | $ | — |   | $ | 114,315 |   |
| Mortgages held-for-sale                                           |       | —                                |       | 1,382,626 |   | 179,293 |   | — |   | 1,561,919 |   |
| Finance receivables                                               |       | 1,847,097                             |       | — |   | — |   | (1,540,816 | ) | 306,281 |   |
| Allowance for loan losses                                         |       | (10,598                               | )          | (3,493 | ) | — |   | — |   | (14,091 | ) |
| Total assets                                                      |       | 1,966,317                             |       | 1,629,180 |   | 181,406 |   | (1,690,687 | ) | 2,086,216 |   |
| Reverse repurchase agreements                                     |       | 1,716,512                             |       | 1,356,524 |   | 176,800 |   | (1,533,331 | ) | 1,716,505 |   |
|                                                                   |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing tables present discontinued operations condensed statement ofoperations for the three and nine month periods ended September 30, 2007and 2006.

 
| ** **                                     | ** ** | **Discontinued Operations**                                          | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **for the nine months ended September 30,** | ** ** |
| ** **                                     | ** ** | **2007**                                                                  | ** ** |
| ** **                                     | ** ** | ** **                                                                | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                     | ** ** | **Warehouse**                                                             | ** ** | **Operations (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Income Statement Items:**          | ** ** | **Lending**                                                               | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Net interest income (expense)                  |       | $                                                                         | 18,203     |   | $ | (7,622 | ) | $ | (2,424 | ) | $ | 5,758 |   | $ | 13,915 |   |
| Provision (benefit) for loan losses            |       | 4,979                                                                     |       | (112 | ) | — |   | — |   | 4,867 |   |
| Realized gain from derivative instruments      |       | —                                                                    |       | 910 |   | 270 |   | — |   | 1,180 |   |
| Change in fair value of derivative instruments |       | —                                                                    |       | (3,479 | ) | (1,479 | ) | — |   | (4,958 | ) |
| Other non-interest (expense) income            |       | 1,481                                                                     |       | (194,106 | ) | (6,376 | ) | (24,671 | ) | (223,672 | ) |
| Non-interest expense and income taxes          |       | 8,508                                                                     |       | 67,267 |   | 8,629 |   | — |   | 84,404 |   |
| Net earnings (loss)                            |       | $                                                                         | 6,197      |   | $ | (271,452 | ) | $ | (18,638 | ) | $ | (18,913 | ) | $ | (302,806 | ) |

 

9

----

 
| ** **                                      | ** ** | **Discontinued Operations**                                           | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **for the three months ended September 30,** | ** ** |
| ** **                                      | ** ** | **2007**                                                                   | ** ** |
| ** **                                      | ** ** | ** **                                                                 | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                      | ** ** | **Warehouse**                                                              | ** ** | **Operations (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Income Statement Items:**                     | ** ** | **Lending**                                                                | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Net interest income (expense)                   |       | $                                                                          | 6,025      |   | $ | (1,691 | ) | $ | (2,041 | ) | $ | 789 |   | $ | 3,082 |   |
| Provision for loan losses                       |       | 2,637                                                                      |       | 170 |   | — |   | — |   | 2,807 |   |
| Realized gain from derivative instruments       |       | —                                                                     |       | 54 |   | 52 |   | — |   | 106 |   |
| Change in fair value of derivative  instruments |       | —                                                                     |       | (1,098 | ) | (2,780 | ) | — |   | (3,878 | ) |
| Other non-interest (expense) income             |       | 267                                                                        |       | (146,028 | ) | (6,106 | ) | — |   | (151,867 | ) |
| Non-interest expense and income taxes           |       | 3,966                                                                      |       | 31,768 |   | 2,979 |   | — |   | 38,713 |   |
| Net (loss) earnings                             |       | $                                                                          | (311       | ) | $ | (180,701 | ) | $ | (13,854 | ) | $ | 789 |   | $ | (194,077 | ) |

 
| ** **                                      | ** ** | **Discontinued Operations**                                          | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **for the nine months ended September 30,** | ** ** |
| ** **                                      | ** ** | **2006**                                                                  | ** ** |
| ** **                                      | ** ** | ** **                                                                | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                      | ** ** | **Warehouse**                                                             | ** ** | **Operations (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Income Statement Items:**           | ** ** | **Lending**                                                               | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Net interest income (expense)                   |       | $                                                                         | 24,229     |   | $ | (4,421 | ) | $ | 251 |   | $ | (1,101 | ) | $ | 18,958 |   |
| Provision for loan losses                       |       | (350                                                                      | )          | — |   | — |   | — |   | (350 | ) |
| Realized gain from derivative instruments       |       | —                                                                    |       | 21 |   | 30 |   | — |   | 51 |   |
| Change in fair value of derivative  instruments |       | —                                                                    |       | 4,877 |   | (6,324 | ) | — |   | (1,447 | ) |
| Other non-interest (expense) income             |       | 2,426                                                                     |       | 31,787 |   | 3,387 |   | (23,059 | ) | 14,541 |   |
| Non-interest expense and income taxes           |       | 5,578                                                                     |       | 51,684 |   | 6,114 |   | — |   | 63,376 |   |
| Net earnings (loss)                             |       | $                                                                         | 21,427     |   | $ | (19,420 | ) | $ | (8,770 | ) | $ | (24,160 | ) | $ | (30,923 | ) |

 
| ** **                                     | ** ** | **Discontinued  Operations**                  | ** ** |
|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                     | ** ** | **for the  three months ended September 30,** | ** ** |
| ** **                                     | ** ** | **2006**                                      | ** ** |
| ** **                                     | ** ** | ** **                                    | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                     | ** ** | **Warehouse**                                 | ** ** | **Operations  (2)** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | **Discontinued** | ** ** |
| **Income  Statement Items:**                   | ** ** | **Lending**                                   | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Operations** | ** ** |
| Net interest income (expense)                  |       | $                                             | 9,659      |   | $ | (3,183 | ) | $ | 61 |   | $ | 378 |   | $ | 6,915 |   |
| Provision for loan losses                      |       | (350                                          | )          | — |   | — |   | — |   | (350 | ) |
| Realized gain from derivative instruments      |       | —                                        |       | 18 |   | 17 |   | — |   | 35 |   |
| Change in fair value of derivative instruments |       | —                                        |       | 623 |   | (6,106 | ) | — |   | (5,483 | ) |
| Other non-interest (expense) income            |       | 878                                           |       | 31,861 |   | 286 |   | (12,065 | ) | 20,960 |   |
| Non-interest expense and income taxes          |       | 2,077                                         |       | 22,955 |   | 1,009 |   | — |   | 26,041 |   |
| Net earnings (loss)                            |       | $                                             | 8,810      |   | $ | 6,364 |   | $ | (6,751 | ) | $ | (11,687 | ) | $ | (3,264 | ) |

 

----

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

 

(2)         Alt-A mortgage operations of IFC.

 

10

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Segments Discontinued Summary

 

As aresult of the market conditions as described above, the Company discontinuedthe following businesses:

 

•the Non-ConformingMortgage Operations conducted by IFC and ISAC;

 

•the Commercial Operationsconducted by ICCC; and

 

•the Warehouse LendingOperations conducted by IWLG.

 

The mortgage operations acquired, originated, sold and securitizedprimarily Alt-A adjustable rate mortgages (ARMs) and fixed rate mortgages(FRMs) from correspondents, mortgage brokers and retail customers. Correspondentsoriginated and closed mortgages under our mortgage programs and then sold theclosed mortgages to the mortgage operations on a flow (loan-by-loan basis) orthrough bulk sale commitments. Correspondents include savings and loanassociations, commercial banks and mortgage bankers. The mortgage operationsgenerated income by securitizing and selling mortgages to permanent investors,including the long-term investment operations. The mortgage operations used warehousefacilities provided by the warehouse lending operations to finance theacquisition and origination of mortgages.

 

The commercial operations originated commercial mortgages, that wereprimarily adjustable rate mortgages with initial fixed interest rate periods ofthree-, five-, seven- and ten-years that subsequently convert to adjustablerate mortgages, or “hybrid ARMs,” with balances that generally ranged from$500,000 to $5.0 million or by additional underwriting exceptions up to$10 million. Commercial mortgages have an interest rate floor, which isthe initial start rate; in some circumstances have lock out periods, andprepayment penalty periods of three-, five-, seven- and ten-years.

 

The warehouse lending operations provided short-term financing tomortgage loan originators, including the mortgage and commercial operations, byfunding mortgages from their closing date until sale to pre-approved investors.This business earned fees from warehouse transactions as well as net interestincome from the difference between its cost of borrowings and the interestearned on warehouse advances, both of which were tied to the one-month LondonInter-Bank Offered Rate (LIBOR) rate.

 

***Mortgage Loans Held-for-Sale***

 

Mortgages held-for-salefor the discontinued operations for the periods indicated consisted of thefollowing:

 

| ** **                                                   | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                   | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Mortgages held-for-sale - residential                        |       | $                              | 714,359    |                          | $          | 1,381,264 |   |
| Mortgages held-for-sale - commercial                         |       | 128,869                        |       | 177,619                       |       |
| Net premiums on mortgages held-for-sale -  residential       |       | 2,438                          |       | 18,024                        |       |
| Net premiums on mortgages held-for-sale -  commercial        |       | 79                             |       | 857                           |       |
| Change in fair value of residential  mortgages held-for-sale |       | (126,849                       | )          | (18,717                       | )          |
| Net deferred costs                                           |       | 2,775                          |       | 2,872                         |       |
| Total mortgages held-for-sale                                |       | $                              | 721,671    |                          | $          | 1,561,919 |   |

 

Mortgage loansheld-for-sale are recorded at the lower of cost or market determined on anaggregate basis. The change in fair value of the loans held-for-sale isrecorded as an increase or decrease to non-interest income. During the threeand nine months ended September 30, 2007, the discontinued operations sold$610.9 million and $1.6 billion of loans, respectively. Subsequent to September30, 2007 the Company sold $393.4 million of the loans held-for-sale.

 

11

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***Repurchase Reserve***

 

Repurchase reserve for the discontinued operations forthe periods indicated consisted of the following:

 

| ** **                                     | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                     | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Reserve for early payment defaults (1)         |       | $                              | 20,225     |                          | $          | 12,220 |   |
| Reserve for misrepresentations and  warranties |       | 11,187                         |       | —                        |       |
| Other                                          |       | 791                            |       | 3,126                         |       |
| Total repurchase reserve                       |       | $                              | 32,203     |                          | $          | 15,346 |   |

 

----

(1)         This figure at December 31, 2006 includes boththe reserve for early payment default and the reserve for misrepresentations.

 

Thisrepurchase liability for discontinued operations is included in liabilities ofdiscontinued operations and represents estimated losses for normalrepresentation and warranty terms related to previously sold whole loans. Thereserve totaled approximately $32.2 million at September 30, 2007, compared to$15.3 million at December 31, 2006. In determining the adequacy of the reservefor mortgage repurchases, management considers such factors as specific requestsfor repurchase, known problem loans, underlying collateral values, recent salesactivity of similar loans, historical experience, current market conditions andother appropriate information. For the three and nine months ended September30, 2007, the Company recorded a provision for repurchase losses of $11.2million and $41.9 million as compared to a benefit of $15.9 million and aprovision of $7.2 million for the same periods in 2006, included in loss fromdiscontinued operations.

 

***Income Taxes***

 

**During the three and nine months ended September 30, 2007,income tax expense was a benefit of $0.4 million and an expense of $4.3million, respectively, as compared to an benefit of $5.4 million and an expenseof $3.8 million, respectively, during the same periods in 2006. The amount ofincome tax benefit for the quarter ended September 30, 2007 was the result ofthe loss carrybacks available to the Company for current year tax losses.**

** **

***Fixed Asset and Lease Impairment***

 

Inconjunction with the discontinued operations, the Company has recorded a $11.6million impairment charge on the property plant and equipment that the Companyno longer will be utilizing. Additionally, assets with fair values that weredeemed recoverable were transferred to continuing operations. During thirdquarter the discontinued operations of the Company incurred a lease impairmentcharge in the amount of $4.2 million.

 

**3.****              RestatedConsolidated Cash Flows for 2006 Interim Periods and Reclassifications**

 

Certain interim amountsin the nine months ended September 30, 2006 Consolidated Statement of CashFlows have been restated to reflect properly the specific intercompanyactivities related to cash receipts from loan sales and cash disbursements forloan purchases between consolidated companies. Such intercompany loan sale andpurchase transaction activities had the effect of presenting separate cashinflows and outflows even though there was no cash inflow or outflow on aconsolidated basis. This restatement serves to eliminate this intercompany activityfrom its Consolidated Statements of Cash Flows and present them as non-cashtransactions.

 

The restatement increasescash used in operating activities and increases cash provided by investingactivities. The restatement of these transactions does not change total cashand cash equivalents as previously reported. Furthermore, the restatement hasno effect on the Company’s Consolidated Statements of Operations andComprehensive Earnings, or Consolidated Balance Sheets.

 

The Company hasreclassified the presentation of the Consolidated Statement of Operations andComprehensive Earnings (Loss) to reflect “Amortization of mortgage servicingrights,” “Write-down on investment securities available-for-sale,” and “Loss(gain) on sale of other real estate owned” as other non-interest income ratherthan non-interest expense, for the third quarter of 2006 to conform to thecurrent period presentation. In addition, the “Amortization of deferred charge”for 2006 was reclassified as income tax expense (benefit) rather thannon-interest expense.

 

Please refer to theCompany’s Form 10-K for the year ended December 31, 2006, for more informationregarding these reclassifications.

 

12

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**4.****              Stock Options**

 

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

 

| ** **                             | ** ** | **Nine Months**              | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Ended September 30,** | ** ** |
| ** **                             | ** ** | **2007**                          | ** ** | **2006** | ** ** |
| Risk-free interest rate                |       | 4.28% to 4.60%                    |       | 3.90% to 4.26% |   |
| Expected lives (in years)              |       | 3                                 |       | 3 |   |
| Expected volatility (1)                |       | 75.09%                            |       | 34.75% |   |
| Expected dividend yield (2)            |       | 0.00%                             |       | 11.00% |   |
| Grant date fair value of share options |       | $0.60                             |       | $1.41 |   |

 

----

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

 

(2)Expected dividend yield is zero as a dividend onthe common stock is currently not probable over the expected life of theoptions granted during the nine months ended September 30, 2007.

 

The following table summarizes activity, pricing and other informationfor the Company’s stock options for the nine-month period ended September 30,2007:

 

| ** **                             | ** ** | ** **         | ** ** | **Weighted-**      | ** ** |
|----------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                             | ** ** | ** **         | ** ** | **Average**        | ** ** |
| ** **                             | ** ** | **Number of** | ** ** | **Exercise**       | ** ** |
| ** **                             | ** ** | **Shares**         | ** ** | **Price ($)** | ** ** |
| Options outstanding at January 1, 2007 |       | 7,048,755          |       | $                  | 12.91      |   |
| Options granted                        |       | 2,158,500          |       | 2.56               |       |
| Options exercised                      |       | —             |       | —             |       |
| Options forfeited / cancelled          |       | (1,887,173         | )          | 12.75              |       |
| Options outstanding at end of period   |       | 7,320,082          |       | $                  | 9.90       |   |
| Options exercisable at end of period   |       | 3,468,038          |       | $                  | 13.60      |   |

 

As of September 30, 2007, there was approximately $3.0 million and $300thousand of total unrecognized compensation cost related to nonvestedshare-based, and nonvested stock-based compensation arrangements, respectively,granted under the plan. That cost is expected to be recognized over a weightedaverage period of 1.12 and 1.04 years, respectively.

 

**5.****              RecentAccounting Pronouncements**

 

InJune 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes,*(“FIN 48”) which expands on the accounting guidance of FASB StatementNo. 109, *Accounting for Income Taxes*.This interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. This interpretationalso provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure and transition. FIN 48 iseffective for fiscal years beginning after December 15, 2006. The adoptionof this interpretation by the Company has not had a significant effect on theconsolidated financial statements.

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurement* (“SFAS 157”),which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS 157 is effective for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. TheCompany is currently assessing the effects SFAS 157 will have on theconsolidated financial statements.

 

InFebruary 2007, the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities* (“SFAS159”), which provides reporting entities an option to report selected financialassets, which includes investment securities designated as available for sale,and liabilities, at fair value. SFAS 159 establishes presentation anddisclosure requirements designed to facilitate comparisons between companiesthat choose different measurement attributes for similar types of assets andliabilities. The standard also requires additional information to aid financialstatement users’ understanding of a reporting entity’s choice to use fair valueon its earnings and also requires entities to display on the face of thebalance sheet the fair value of those assets and liabilities which thereporting entity has chosen to measure at fair value. SFAS  159 iseffective as of the beginning of a reporting entity’s first fiscal yearbeginning after November 15, 2007.

 

13

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The Company intends to adopt SFAS157 and SFAS 159 as of January 1, 2008, and the effect of adoption will bereflected in the consolidated financial statements for the quarter ended March31, 2008.

 

**6.****              Net Investment inSecuritized Trusts**

 

Certain of the Company’ssecuritizations are required to be consolidated due to the following factorsrelated to SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities-a replacement of FASB Statement No. 125:* the transfer ofthe Company’s mortgage loans to these trusts were not accounted for as sales;and the trusts did not meet the characteristics of qualifying special purposeentities. These trusts were considered variable interest entities and wereconsolidated because the Company was initially considered the primary beneficiarypursuant to FASB Interpretation No. 46, “*Consolidation of VariableInterest Entities – an interpretation of ARB No. 51.*”

 

The negative net investmentpositions in certain trusts occured because the trusts’ liabilities are greaterthan the trusts’ assets primarily due to large increases in the allowance forloan losses. The trust agreements are non-recourse for which the Company cannotultimately lose more than its original net investment in each trust. Therefore,the Company is not responsible to fund losses in excess of its equityinvestment and subsequently is not required to advance any cash to trusts forcredit or derivative loss.

 

The following table presents thesummation of the consolidated trusts with positive and negative net investmentpositions, as of September 30, 2007 (in thousands):

 

| ** **                                     | ** ** | **Securitized  Mortgage Collateral** | ** ** | **Net Investment** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|-------------------------|------------|
| Trusts with positive net investment  positions |       | $                                         | 5,353,083  |                    | $          | 143,694 |   |
| Trusts with negative net investment  positions |       | 13,388,437                                |       | (561,673                | )          |
|                                           |       | $                                         | 18,741,520 |                    | $          | (417,979 | ) |

 

If the securitizations withnegative equity (liabilities greater than assets) had been accounted for assales, the Company’s estimate of the fair value of the trusts would be minimal.However, some of these positive and negative net investment positions couldcontinue to provide cash flows to the Company until estimated losses ondisposition have been realized.

 

**7.****              LegalProceedings**

 

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

 

On August 17, 2007, a purported class action matter was filed in theUnited States District Court, Central District of California, against IMH andseveral of its senior officers entitled Sheldon Pittleman v. Impac MortgageHoldings, Inc., et al. The action alleges against all defendants violations ofSection 10(b) and 10b-5 of the Securities Exchange Act of 1934 (the “ExchangeAct”) and against the individual defendants violations of Section 20(a) of theExchange Act. Plaintiffs contend that the defendants caused the Company’s stockto trade at artificially inflated prices through false and misleadingstatements 

 

14

----

 

and intentional or reckless disregard of basic accounting principles. Thecomplaint seeks compensatory damages for all damages sustained as a result ofthe defendants’ actions, including reasonable costs and expenses and otherrelief as the court may deem proper. On October 3, 2007, a similar case wasfiled in the same Court entitled Richard Abrams v. Impac Mortgage Holdings, Inc.,et al. This action makes allegations similar to those in the Pittleman actionand also seeks similar recovery.

 

On October 4, 2007, a purported class action matter was filed in theUnited States District Court, Central District of California against ImpacFunding Corporation and Impac Mortgage Holdings, Inc. entitled Vincent Marshellv. Impac Funding Corporation, et al. The action alleges violations of Truth inLending Act, Violation of California Business and Professional Code Section17200, et seq, breach of contract, and an additional claim under Business andProfessional Code Section 17200. The complaint alleges that the defendantsfailed to disclose pertinent information in a clear conspicuous manner ascalled for in the Truth in Lending Act, and that they misled the plaintiff. Theaction seeks to recover actual damages, compensatory damages, consequentialdamages, punitive damages, rescission, reasonable attorneys fees and costs,statutory damages, a disgorgement of all profits obtained as a result of theunfair competition, equitable relief including restitution and such otherrelief as is just and proper.

 

On October 11, 2007, a shareholder derivative action was filed in theSuperior Court of California, Orange County against the Company and certain ofits officers and directors. The complaint alleges claims for a breach offiduciary duty, abuse of control, gross mismanagement, waste of corporateassets, a violation of California Civil Code Sections 1709 and 1710 for deceitand for contribution and indemnification. The action seeks to recover for thecompany the damages suffered by the Company as a result of the individualsbreach of fiduciary duty, abuse of control, gross mismanagement and waste ofcorporate assets. It also seeks to impose a constructive trust on the proceedsof any individuals trading activity, disgorgement of profits benefits of othercompensation of the individual defendants, costs and disbursements in theaction including reasonable attorney’s fees, expert fees, accountant’s fees,expenses and such other relief as the court may deem proper.

 

On December 17, 2007, a purported class action matter wasfiled in the United States District Court, Central District of California,against IMH and several of its senior officers entitled Sharon Page v. ImpacMortgage Holdings, Inc., et al.  Theaction is a complaint for violations of the Employee Retirement Income SecurityAct in relation to the Company’s 401(k) plan. The complaint alleges breach of fiduciary duties, breach of duty toavoid conflicts of interest, allegations of co-fiduciary liability and knowingparticipation in a breach of fiduciary duty by IMH.  Plaintiffs contend that the defendantsbreached their fiduciary duties in violation of ERISA by failing to prudentlyand loyally manage the plan’s investment in IMH stock by continuing to offerIMH stock as an investment option and to make contributions in stock, providecomplete and accurate information to participants, and monitor appointed planfiduciaries and provide them with accurate information. The complaint seeksmonetary payment to the plan for the losses in an amount to be proven,injunctive and other appropriate equitable relief, a constructive trust onamounts by which any defendant was unjustly enriched, an appointment of one ormore independent fiduciaries, actual damages, reasonable attorney fees andexpenses, taxable costs, interests on these amounts and other legal orequitable relief as may be just and proper.

 

Please refer to IMH’s report on Form 10-K for the year ended December31, 2006 and reports on Form 10-Q for the periods ending March 31, 2007 andJune 30, 2007 for a description of other litigation and claims.

 

15

----

 

**NoteB—Reconciliation of Earnings Per Share**

 

The following tablepresents the computation of basic and diluted net earnings per share includingthe dilutive effect of stock options and cumulative redeemable preferred stockoutstanding for the periods indicated:

 
| ** **                                                                      | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                      | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                      | ** ** | **2007**                                | ** ** | **2006**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Numerator for basic earnings per share:**                                     |       |                                    |       |                                   |       |   |   |   |   |
| Net (loss) earnings from continuing  operations                                 |       | $                                       | (997,158   | )                                      | $          | (124,427 | ) | $ | (1,162,644 | ) | $ | 15,156 |   |
| Net (loss) earnings from discontinuing  operations                              |       | (194,077                                | )          | (3,264                                 | )          | (302,806 | ) | (30,923 | ) |
| Less: Cash dividends on cumulative  redeemable preferred stock                  |       | (3,722                                  | )          | (3,672                                 | )          | (11,165 | ) | (11,016 | ) |
| Net loss available to common stockholders                                       |       | $                                       | (1,194,957 | )                                      | $          | (131,363 | ) | $ | (1,476,615 | ) | $ | (26,783 | ) |
| **Denominator for basic earnings per share:**                                   |       |                                    |       |                                   |       |   |   |   |   |
| Basic weighted average number of common  shares outstanding during the period   |       | 76,084                                  |       | 76,132                                 |       | 76,084 |   | 76,119 |   |
| **Denominator for diluted earnings per share:**                                 |       |                                    |       |                                   |       |   |   |   |   |
| Diluted weighted average number of common  shares outstanding during the period |       | 76,084                                  |       | 76,132                                 |       | 76,084 |   | 76,119 |   |
| Net effect of dilutive stock options                                            |       | —                                  |       | —                                 |       | — |   | — |   |
| Diluted weighted average common shares                                          |       | 76,084                                  |       | 76,132                                 |       | 76,084 |   | 76,119 |   |
|                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Net loss per common share - Basic:                                              |       |                                    |       |                                   |       |   |   |   |   |
| (Loss) earnings from Continuing Operations                                      |       | $                                       | (13.11     | )                                      | $          | (1.63 | ) | $ | (15.28 | ) | $ | 0.20 |   |
| Loss from Discontinuing Operations                                              |       | $                                       | (2.55      | )                                      | $          | (0.04 | ) | $ | (3.98 | ) | $ | (0.41 | ) |
| Net loss per share                                                              |       | $                                       | (15.66     | )                                      | $          | (1.68 | ) | $ | (19.26 | ) | $ | (0.21 | ) |
|                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Net loss per common share - Diluted:                                            |       |                                    |       |                                   |       |   |   |   |   |
| (Loss) earnings from Continuing Operations                                      |       | $                                       | (13.11     | )                                      | $          | (1.63 | ) | $ | (15.28 | ) | $ | 0.20 |   |
| Loss from Discontinuing Operations                                              |       | $                                       | (2.55      | )                                      | $          | (0.04 | ) | $ | (3.98 | ) | $ | (0.41 | ) |
| Net loss per share                                                              |       | $                                       | (15.66     | )                                      | $          | (1.68 | ) | $ | (19.26 | ) | $ | (0.21 | ) |
|                                                                            |       |                                    |       |                                   |       |   |   |   |   |
| Net loss per share available to common  shareholders                            |       | $                                       | (15.71     | )                                      | $          | (1.73 | ) | $ | (19.41 | ) | $ | (0.35 | ) |

 

For the three and ninemonth periods ended September 30, 2007, stock options to purchase 7.3 millionshares were outstanding but not included in the above weighted averagecalculations because they were anti-dilutive.

 

For the three and ninemonth periods ended September 30, 2006, stock options to purchase 7.1 millionshares were outstanding but not included in the above weighted averagecalculations because they were anti-dilutive.

 

16

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**Note C—SegmentReporting**

 

During the quarter ended September 30, 2007, theCompany segregated the retail mortgage origination entity from the mortgageoperations as that component was deemed to be continuing operations atSeptember 30, 2007. The following tables present reporting segmentsconsolidated balance sheets for the periods ended September 30, 2007 andDecember 31, 2006:

 
| ** **                                                         | ** ** | **Reporting Segments as of the Nine Months** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Ended September 30, 2007**                                | ** ** |
| ** **                                                         | ** ** | **Long-Term**                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Investment**                                                             | ** ** | **Retail** | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Balance Sheet Items:**                                 | ** ** | **Operations**                                                             | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Securitized mortgage collateral and  mortgages held-for-investment |       | $                                                                          | 18,866,749 |   | $ | — |   | $ | — |   | $ | (124,721 | ) | $ | 18,742,029 |   |
| Mortgages held-for-sale                                            |       | 2,201                                                                      |       | 131,296 |   | 721,671 |   | — |   | 855,168 |   |
| Finance receivables                                                |       | —                                                                     |       | 185 |   | 34,950 |   | (6 | ) | 35,129 |   |
| Allowance for loan losses                                          |       | (911,218                                                                   | )          | — |   | (7,759 | ) | — |   | (918,977 | ) |
| Total assets                                                       |       | 18,516,644                                                                 |       | 167,886 |   | 810,574 |   | (84,728 | ) | 19,410,376 |   |
| Total stockholders’ equity                                    |       | (351,016                                                                   | )          | (39,614 | ) | 299,664 |   | (402,350 | ) | (493,316 | ) |
|                                                                    |            |                                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                         | ** ** | **Reporting Segments as of the year** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Ended December 30, 2006**                     | ** ** |
| ** **                                                         | ** ** | **Long-Term**                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Investment**                                                 | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Balance Sheet Items:**                                 | ** ** | **Operations**                                                 | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Securitized mortgage collateral and  mortgages held-for-investment |       | $                                                              | 21,072,413 |   | $ | 114,315 |   | $ | (134,018 | ) | $ | 21,052,710 |   |
| Mortgages held-for-sale                                            |       | —                                                         |       | 1,561,919 |   | — |   | 1,561,919 |   |
| Finance receivables                                                |       | —                                                         |       | 306,281 |   | 13 |   | 306,294 |   |
| Allowance for loan losses                                          |       | (77,684                                                        | )          | (14,091 | ) | — |   | (91,775 | ) |
| Total assets                                                       |       | 21,516,202                                                     |       | 2,086,216 |   | (3,463 | ) | 23,598,955 |   |
| Total stockholders’ equity                                    |       | 829,494                                                        |       | 319,792 |   | (139,756 | ) | 1,009,530 |   |
|                                                                    |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing tables present reporting segments consolidated statements ofoperations for the three and nine month periods ended September 30, 2007 and2006:

 
| ** **                                      | ** ** | **Reporting Segments as of and for the Nine Months** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Ended September 30, 2007**                                                  | ** ** |
| ** **                                      | ** ** | **Long-Term**                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                               | ** ** | **Retail** | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Income Statement Items:**           | ** ** | **Operations**                                                                               | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Net interest income (expense)                   |       | $                                                                                            | 383        |   | $ | (312 | ) | $ | 13,915 |   | $ | 27,233 |   | $ | 41,219 |   |
| Provision for loan losses                       |       | 979,740                                                                                      |       | — |   | 4,867 |   | — |   | 984,607 |   |
| Realized gain from derivative instruments       |       | 103,840                                                                                      |       | — |   | 1,180 |   | — |   | 105,020 |   |
| Change in fair value of derivative  instruments |       | (136,701                                                                                     | )          | (1,633 | ) | (4,958 | ) | — |   | (143,292 | ) |
| Other non-interest (expense) income             |       | (102,767                                                                                     | )          | (8,921 | ) | (223,672 | ) | 2,147 |   | (333,213 | ) |
| Non-interest expense and income taxes           |       | 19,702                                                                                       |       | 34,459 |   | 84,404 |   | 12,012 |   | 150,577 |   |
| Net (loss) earnings                             |       | $                                                                                            | (1,134,687 | ) | $ | (45,325 | ) | $ | (302,806 | ) | $ | 17,368 |   | $ | (1,465,450 | ) |

 

17

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| ** **                                      | ** ** | **Reporting Segments as of and for the Nine Months** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Ended September 30, 2006**                                                  | ** ** |
| ** **                                      | ** ** | **Long-Term**                                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                               | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Income Statement Items:**           | ** ** | **Operations**                                                                               | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Net interest (expense) income                   |       | $                                                                                            | (91,593    | ) | $ | 18,958 |   | $ | 44,853 |   | $ | (27,782 | ) |
| Provision for loan losses                       |       | 3,638                                                                                        |       | (350 | ) | — |   | 3,288 |   |
| Realized gain from derivative instruments       |       | 156,582                                                                                      |       | 51 |   | — |   | 156,633 |   |
| Change in fair value of derivative  instruments |       | (95,185                                                                                      | )          | (1,447 | ) | 4,030 |   | (92,602 | ) |
| Other non-interest income                       |       | 21,332                                                                                       |       | 14,541 |   | 4,553 |   | 40,426 |   |
| Non-interest expense and income taxes           |       | 17,708                                                                                       |       | 63,376 |   | 8,070 |   | 89,154 |   |
| Net (loss) earnings                             |       | $                                                                                            | (30,210    | ) | $ | (30,923 | ) | $ | 45,366 |   | $ | (15,767 | ) |

 
| ** **                                      | ** ** | **Reporting Segments as of and for the Three Months** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Ended September 30, 2007**                                                   | ** ** |
| ** **                                      | ** ** | **Long-Term**                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                                | ** ** | **Retail** | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Income Statement Items:**           | ** ** | **Operations**                                                                                | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Net interest income (expense)                   |       | $                                                                                             | 3,040      |   | $ | (116 | ) | $ | 3,082 |   | $ | 8,774 |   | $ | 14,780 |   |
| Provision for loan losses                       |       | 789,445                                                                                       |       | — |   | 2,807 |   | — |   | 792,252 |   |
| Realized gain from derivative instruments       |       | 28,815                                                                                        |       | — |   | 106 |   | — |   | 28,921 |   |
| Change in fair value of derivative  instruments |       | (135,347                                                                                      | )          | (2,206 | ) | (3,878 | ) | — |   | (141,431 | ) |
| Other non-interest (expense) income             |       | (76,159                                                                                       | )          | (10,832 | ) | (151,867 | ) | 1,009 |   | (237,849 | ) |
| Non-interest expense and income taxes           |       | 7,262                                                                                         |       | 14,373 |   | 38,713 |   | 3,056 |   | 63,404 |   |
| Net (loss) earnings                             |       | $                                                                                             | (976,358   | ) | $ | (27,527 | ) | $ | (194,077 | ) | $ | 6,727 |   | $ | (1,191,235 | ) |

 
| ** **                                      | ** ** | **Reporting Segments as of and for the Three Months** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Ended September 30, 2006**                                                   | ** ** |
| ** **                                      | ** ** | **Long-Term**                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Investment**                                                                                | ** ** | **Discontinued** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| **Income Statement Items:**           | ** ** | **Operations**                                                                                | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| Net interest (expense) income                   |       | $                                                                                             | (44,131    | ) | $ | 6,915 |   | $ | 12,705 |   | $ | (24,511 | ) |
| Provision for loan losses                       |       | 3,533                                                                                         |       | (350 | ) | — |   | 3,183 |   |
| Realized gain from derivative instruments       |       | 60,595                                                                                        |       | 35 |   | — |   | 60,630 |   |
| Change in fair value of derivative  instruments |       | (150,051                                                                                      | )          | (5,483 | ) | — |   | (155,534 | ) |
| Other non-interest income                       |       | 6,803                                                                                         |       | 20,960 |   | 1,665 |   | 29,428 |   |
| Non-interest expense and income taxes           |       | 6,780                                                                                         |       | 26,041 |   | 1,700 |   | 34,521 |   |
| Net (loss) earnings                             |       | $                                                                                             | (137,097   | ) | $ | (3,264 | ) | $ | 12,670 |   | $ | (127,691 | ) |

 

----

(1)          Corporate overhead expenses are allocated to the segments based on thepercentage of time devoted to the segment, headcount, loan production, or otherrelevant measures. Income statement items include inter-company loan saletransactions and the elimination of related gains or losses. Balance sheetitems include inter-company warehouse borrowings and the elimination of relatedinterest income and interest expense.

 

18

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**NoteD—Mortgages Held-for-Sale**

 

Mortgages held-for-sale for the periods indicatedconsisted of the following:

 

| ** **                                                        | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                        | ** ** | **2007**                       | ** ** | **2006 (1)**             | ** ** |
| Mortgages held-for-sale - residential                             |       | $                              | 139,561    |                          | $          | — |   |
| Net (discount) premiums on mortgages  held-for-sale - residential |       | (217                           | )          | —                        |       |
| Change in fair value of residential  mortgages held-for-sale      |       | (6,484                         | )          | —                        |       |
| Net deferred costs                                                |       | 637                            |       | —                        |       |
| Total mortgages held-for-sale                                     |       | $                              | 133,497    |                          | $          | — |   |

 

----

(1)There were no loansincluded in held-for-sale at December 31, 2006, for continuing operations asthe retail operations were acquired during the second quarter of 2007.

 

Mortgage loansheld-for-sale are recorded at the lower of cost or market determined on anaggregate basis. The change in fair value of the loans held-for-sale isrecorded as an increase or decrease to non-interest income.

 

**NoteE—****Securitized Mortgage Collateral**

 

Securitized mortgage collateral for the periodsindicated consisted of the following:

 

| ** **                                                  | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Mortgages secured by single-family  residential real estate |       | $                              | 16,725,348 |                          | $          | 18,978,268 |   |
| Mortgages secured by commercial real estate                 |       | 1,818,439                      |       | 1,728,240                     |       |
| Net unamortized premiums on mortgages -  residential (1)    |       | 173,874                        |       | 212,045                       |       |
| Net unamortized premiums on mortgages -  commercial (1)     |       | 23,859                         |       | 17,962                        |       |
| Total securitized mortgage collateral                       |       | $                              | 18,741,520 |                          | $          | 20,936,515 |   |

 

----

(1)Net unamortized premiumson mortgages include loan discounts from intercompany transfers of $152.5million and $165.1 million at September 30, 2007 and December 31, 2006,respectively.

 

Securitizedmortgage collateral includes our CMOs and REMICs. The Company’s exposure tolosses from consolidated securitizations is limited to the carrying value ofthe collateral in excess of the carrying value of the debt, which isnon-recourse to the Company in each of its securitizations.

 

**NoteF—Allowance for Loan Losses**

 

The allowance for loan losses for the periodsindicated consisted of the following:

 

| ** **                                                             | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                             | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Securitized mortgage collateral and  held-for-investment - Residential |       | $                              | 900,495    |                          | $          | 69,711 |   |
| Securitized mortgage collateral and  held-for-investment - Commercial  |       | 10,723                         |       | 7,973                         |       |
| Allowance for loan losses                                              |       | $                              | 911,218    |                          | $          | 77,684 |   |

 

19

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Activity for allowance for loan losses for the periodsindicated was as follows:

 
| ** **                     | ** ** | **Three Months**             | ** ** | **Nine Months**              | ** ** |
|--------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                     | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                     | ** ** | **2007**                          | ** ** | **2006**                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning balance              |       | $                                 | 214,734    |                              | $          | 57,388 |   | $ | 77,684 |   | $ | 67,831 |   |
| Provision for loan losses      |       | 789,445                           |       | 3,533                             |       | 979,740 |   | 3,638 |   |
| Charge-offs, net of recoveries |       | (92,961                           | )          | (5,540                            | )          | (146,206 | ) | (16,088 | ) |
| Allowance for loan losses      |       | $                                 | 911,218    |                              | $          | 55,381 |   | $ | 911,218 |   | $ | 55,381 |   |

 

**Note G—Other Assets**

 

Other assets for the periods indicated consisted ofthe following:

 

| ** **                         | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Deferred charge                    |       | $                              | 40,260     |                          | $          | 52,272 |   |
| Mortgages held-for-investment      |       | 509                            |       | 1,880                         |       |
| Prepaid and other assets           |       | 27,099                         |       | 6,673                         |       |
| Cash margin balances               |       | 588                            |       | 19,112                        |       |
| Premises and equipment, net        |       | 7,736                          |       | —                        |       |
| Investment in Impac capital trusts |       | 2,471                          |       | 2,638                         |       |
| Total other assets                 |       | $                              | 78,663     |                          | $          | 82,575 |   |

 

**As ofDecember 31,**2006, all premises and equipment werelocated at IFC, which is included in discontinued operations. **The $7.7 million of premises and equipment,net represents the premises and equipment acquired from Pinnacle FinancialCorporation, during the second quarter of 2007, and approximately $4.0 millionin equipment transferred from IFC to the long-term investment operations, inthe third quarter of 2007.**

 

**NoteH—Securities Available-for-Sale**

 

During the third quarterof 2007, approximately $6.4 million of investment securities available-for-salewere considered to be other than temporarily impaired (“OTTI”) and were chargedoff (expensed) primarily due to changes in the expected credit losses.

 

**Note I—RealEstate Owned (“REO”)**

 

The following tablepresents a rollforward of the real estate owned:

 

| ** **                            | ** ** | **Nine months**              | ** ** | **Year ended**   | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **ended September 30,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **2007**                          | ** ** | **2006**              | ** ** |
| Beginning balance                     |       | $                                 | 137,331    |                  | $          | 46,092 |   |
| Additions                             |       | 440,979                           |       | 181,120               |       |
| Sales                                 |       | (170,153                          | )          | (82,553               | )          |
| Net realizable value (NRV) adjustment |       | (47,685                           | )          | (7,328                | )          |
| REO, net                              |       | $                                 | 360,472    |                  | $          | 137,331 |   |

 

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

 

20

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**NoteJ— Securitized Mortgage Borrowings**

 

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

 

 
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **            | ** ** | **Range of Percentages:** | ** ** |
|-------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|-----------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **Original** | ** ** | **Securitized mortgage borrowings** | ** ** | ** **            | ** ** | **Interest Rate**              | ** ** | **Interest Rate** | ** ** |
| ** **                                | ** ** | **Issuance** | ** ** | **outstanding as of**               | ** ** | ** **            | ** ** | **Margins over**               | ** ** | **Margins after** | ** ** |
| ** **                                | ** ** | ** **   | ** ** | **September 30,**                        | ** ** | **December 31,** | ** ** | **Fixed Interest**             | ** ** | **One-Month** | ** ** | **Contractual** | ** ** |
| **Year of Issuance**            | ** ** | **Amount**   | ** ** | **2007**                                      | ** ** | **2006**              | ** ** | **Rates**                           | ** ** | **LIBOR (1)** | ** ** | **Call Date (2)** | ** ** |
| 2002                                      |       | $            | 3,876.1    |                                          | $          | 45.1                  |       | $                                   | 52.0       |   | 5.25 - 12.00 |   | 0.27 - 2.75 |   | 0.54 - 3.68 |   |
| 2003                                      |       | 5,966.1      |       | 428.9                                         |       | 906.7                 |       | 4.34 - 12.75                        |       | 0.27 - 3.00 |   | 0.54 - 4.50 |   |
| 2004                                      |       | 17,710.7     |       | 3,055.7                                       |       | 5,230.8               |       | 3.58 - 5.56                         |       | 0.25 - 2.50 |   | 0.50 - 3.75 |   |
| 2005                                      |       | 13,387.7     |       | 6,361.7                                       |       | 8,578.1               |       | —                              |       | 0.24 - 2.90 |   | 0.48 - 4.35 |   |
| 2006                                      |       | 5,971.4      |       | 5,152.8                                       |       | 5,794.7               |       | 6.25                                |       | 0.10 - 2.75 |   | 0.20 - 4.13 |   |
| 2007                                      |       | 3,860.5      |       | 3,691.1                                       |       | —                |       | —                              |       | 0.06 - 2.00 |   | 0.12 - 3.00 |   |
| Subtotal  securitized mortgage borrowings |       | 18,735.3     |       | 20,562.3                                      |       |                  |       |                                |       |   |   |
| Accrued  interest payable                 |       | 18.8         |       | 22.8                                          |       |                  |       |                                |       |   |   |
| Unamortized  securitization costs         |       | (41.9        | )          | (58.1                                         | )          |                  |       |                                |       |   |   |
| Total securitized mortgage borrowings     |       | $            | 18,712.2   |                                          | $          | 20,527.0              |       |                                |       |   |   |   |   |
|                                           |            |              |            |                                               |            |                       |            |                                     |            |  |  |  |  |  |  |  |

 

----

(1)                                 One-month LIBOR was 5.7200% as of September 30, 2007.

 

(2)                                 Interest rate margins increase  whenthe unpaid principal balance is reduced to less than the contractual callamount (10-20% of the original issuance amount).

 

Securitized mortgageborrowings are issued by bankruptcy-remote trusts. These securitizations issuedare carried at their unpaid principal balances net of any unamortized discountor premium. Securitized mortgage borrowings are payable solely from thecashflows produced by these entities and are non-recourse to the Company.

 

During the third quarter of 2007, the Companyexchanged certain net interest margin (“NIM”) and subordinated bonds,originally retained from six on-balance sheet securitizations the Companycompleted in 2006 and early 2007, to one lender to satisfy certain reverserepurchase borrowings. At the time of each securitization, the Company borrowedagainst these retained securities in a reverse repurchase financing arrangementwith this lender. In order to satisfy the outstanding reverse repurchaseobligation, in the third quarter of 2007, the Company issued securities with acurrent face value of $137.5 million at a discount of $76.3 million for netproceeds of $61.2 million, along with $8.0 million of various other assets tothis lender in full satisfaction of the $69.2 million reverse repurchaseborrowing.

 

The sale of these retained interests for the six affectedsecuritizations qualified these consolidated trusts for reassessment under FIN46 because the $61.2 million issuance to a third party was consideredsignificant and, an updated analysis showed the Company was no longer theprimary beneficiary of these trusts.  However, since the Company did notobtain sale accounting for the transfer of loans to the trusts, the Companycontinues to reflect the trust assets on the Company’s balance sheet.

 

**Note K—ReverseRepurchase Agreements (from Continuing and Discontinuing Operations)**

 

**The tablebelow includes $148.1 million outstanding for the continuing operations, aswell as the $775.6 million outstanding as liabilities of discontinuedoperations at September 30, 2007. As of December 31, 2006 the $1.7 billion inoutstanding reverse repurchase borrowings were owed by the discontinuedoperations. At December 31, 2006 the balance outstanding for repurchaseobligations represents borrowings by the continuing operations secured bycertain retained interests from securitizations.**

 

21

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| ** **                                          | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                          | ** ** | **2007**                       | ** ** | **2006**                      | ** ** |
| Reverse  Repurchase Line (1)                        |       | $                              | 334,848    |                          | $          | 602,303 |   |
| Reverse  Repurchase Line (2)                        |       | —                         |       | 207,225                       |       |
| Reverse  Repurchase Line (3)                        |       | 90,136                         |       | 157,214                       |       |
| Reverse  Repurchase Line (4)                        |       | 112,265                        |       | 87,974                        |       |
| Reverse  Repurchase Line (5)                        |       | 314,182                        |       | —                        |       |
| Reverse  Repurchase Line (6)                        |       | 72,332                         |       | —                        |       |
| Reverse  Repurchase Line (7)                        |       | —                         |       | 298,656                       |       |
| Reverse  Repurchase Line (8)                        |       | —                         |       | 363,133                       |       |
| Reverse  Repurchase Line (9)                        |       | —                         |       | 163,890                       |       |
| Total Reverse Repurchase Lines Outstanding          |       | $                              | 923,762    |                          | $          | 1,880,395 |   |
| Included in liabilities of Discontinued  Operations |       | $                              | 775,646    |                          | $          | 1,716,505 |   |
| Included in liabilities of Continuing  Operations   |       | $                              | 148,116    |                          | $          | 163,890 |   |

 

----

(1)                               Line 1 is no longer funding loans and was intechnical default due to certain income and tangible net worth covenants;however, the Company has not received a letter of default from the lender.

(2)                               Line 2 expired during 2007 according to thenormal provisions of the agreement.

(3)                               Line 3 is no longer funding loans and was intechnical default due to certain income and tangible net worth covenants. Theseloans were sold subsequent to quarter end. The line was satisfied subsequent toquarter end.

(4)                               Line 4 was in default, and the Companyreceived a notice of default which notified the Company that the lender wasseizing the collateral. Under the terms of the agreement, the Company is liablefor any loss incurred by the lender on disposal of this collateral. The linewas satisfied subsequent to quarter end.

(5)                               Line 5 is no longer funding loans, and was intechnical default due to certain income and tangible net worth covenants. Theseloans were sold subsequent to quarter end. The line was satisfied subsequent toquarter end.

(6)                               Line 6 continues to fund conforming loans andhas a maximum borrowing capacity of $98 million. Line 6 was in technicaldefault due to certain income and tangible net worth covenants, however, theCompany has obtained a waiver. As described in Note N, subsequent events, theavailable borrowings on Line 6 were reduced to $35.0 million, with a furtherreduction to $25.0 million by December 31, 2007.

(7)                               Line 7 expired during 2007 according to thenormal provisions of the agreement.

(8)                               Line 8 expired during 2007 according to thenormal provisions of the agreement.

(9)                               Line 9 represented borrowing secured byresidual and subordinated securities. This borrowing was paid off predominantlythrough an exchange of certain residuals to satisfy the borrowing balance. SeeNote J.

 

The reverse repurchase facilities presentedabove represent the facilities for the combined company, including continuingand discontinued operations. The Company will only have the ability to fundloans on Line 6 in subsequent periods. For the quarter ended September 30,2007, the Company obtained required waivers of non-compliance with thefinancial covenants related to earnings (as defined) for the reverse repurchaseagreement Line 6.

 

**Note L—RepurchaseReserve**

 

Repurchase reserve forthe retail operations for the periods indicated consisted of the following:

 

| ** **                                     | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                     | ** ** | **2007**                       | ** ** | **2006 (1)**             | ** ** |
| Reserve for early payment defaults             |       | $                              | 3,373      |                          | $          | — |   |
| Reserve for misrepresentations and  warranties |       | 709                            |       | —                        |       |
| Other                                          |       | 1,370                          |       | —                        |       |
| Total repurchase reserve                       |       | $                              | 5,452      |                          | $          | — |   |

 

----

(1) There was not arepurchase reserve at December 31, 2006 for continuing operations.

 

22

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The repurchase liability is included in otherliabilities and represents estimated losses for normal representation andwarranty terms related to previously sold whole loans. The reserve totaledapproximately $5.5 million at September 30, 2007 compared to none at December 31,2006. In determining the adequacy of the reserve for mortgage repurchases,management considers such factors as specific requests for repurchase, knownproblem loans, underlying collateral values, recent sales activity of similarloans, historical experience, current market conditions and other appropriateinformation. For the three and nine months ended September 30, 2007, theCompany recorded a provision for repurchase losses of $4.6 million as comparedto no provision for the same periods in 2006, included in non-interest income.

 

During the quarter ended September 30, 2007, theCompany sold $379.8 million in whole loans originated from its retailoperations compared to none during the same period in 2006.

 

**Note M—Income Taxes**

 

**During the three and nine monthsended September 30, 2007, income tax expense was $3.1 million and $12.0million, respectively, as compared to an expense of $1.7 million and $8.1million, respectively, during the same periods in 2006. The amount of incometax expense for the quarter ended September 30, 2007 was the result of therecognition of tax expense related to the amortization of the existing deferredcharge balance. The deferred charge represents the deferral of the tax effectof the increase in taxable income at the taxable REIT subsidiaries, due tointercompany loan sales. As the gains on loans sold between subsidiaries iseliminated, the related tax effects are recorded as deferred charge, andsubsequently recognized over the life of the loans, using the effective yield.**

** **

**Note N—Subsequent Events**

 

*Reverse Repurchase and WarehouseFacilities*

 

In November 2007, the Company amended its lending agreement (line6 in Note L) providing for a reduced amount of available borrowings effectiveas of the date of the amendment. The availableborrowings on Line 6 were reduced to $35.0 million with a further reduction to$25.0 million by December 31, 2007. The Company relies on this line to provide theavailable funds necessary to finance the origination of agency loans. TheCompany has been notified that this lender is expecting to recommend to itscredit committee an orderly wind down of this line over the next few months. TheCompany will either dispose of the retail mortgage operations, or discontinueand wind down the operations by March 31, 2008.

 

*LoansHeld-for-Sale*

 

During October 2007, theCompany sold $480.8 million of loans that were included in held-for-sale, ofwhich $393.4 million were from the discontinued operations and $87.4 millionwere from the continuing retail operations.

 

23

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**ITEM 2:**                          MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION ANDRESULTS OF OPERATIONS

** **

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

 

**Forward-LookingStatements**

 

This report on Form 10-Qcontains certain forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. Forward-looking statements, some of which are based on variousassumptions and events that are beyond our control, may be identified byreference to a future period or periods or by the use of forward-lookingterminology, such as “may,” “will,” “believe,” “expect,” “likely,” “should,” “could,”“anticipate,” or similar terms or variations on those terms or the negative ofthose terms. The forward-looking statements are based on current managementexpectations. Actual results may differ materially as a result of severalfactors, including, but not limited to our ability to successfully managethrough the current market environment; ability to meet liquidity needs fromcash flows generated from the long-term mortgage portfolio and master servicingfees; our ability to reduce expenses from our discontinued operations; ourability to sell our remaining mortgages; failure to sell, or achieve expectedreturns on sale of, negotiated loan sales, including non-performing loans, inthe secondary market due to market conditions, lack of interest or ineffectualpricing; inability to effectively liquidate properties through auction processor otherwise; unexpected increases in our loan repurchase obligations;inability to effectively implement strategies to increase cure rates, reducedelinquencies or mitigate losses on mortgage loans; changes in assumptionsregarding estimated loan losses or fair value amounts; increase in defaultrates on our mortgages; inability to continue funding prime loans; inability tocontinue existing reverse repurchase facility or obtain other financing onacceptable terms; ability to continue as a going concern as a result ofdeteriorating market conditions causing further losses on mortgage loans;ability to continue to pay dividend on outstanding preferred stock; the abilityof our common stock and Series B and C preferred stock to continue trading inan active market; the loss of executive officers and other key managementemployees; our ability to maintain effective internal control over financialreporting and disclosure controls and procedures; the adoption of changes ofnew laws that affect our business or the business of people with whom we dobusiness; interest rate fluctuations on our assets that differ from ourliabilities; the outcome of litigation or regulatory actions pending against usor other legal contingencies; our compliance with applicable local, state andfederal laws and regulations and other general market and economic conditions.

 

For a discussion of these and other risks anduncertainties that could cause actual results to differ from those contained inthe forward-looking statements, see “Risk Factors” and “Management’s Discussionand Analysis of Financial Condition and Results of Operations” in the Company’sAnnual Report on Form 10-K for the period ended December 31, 2006,and the other reports we file under the Securities and Exchange Act of 1934,and the additional risk factors set forth below in this quarterly report. Thisdocument speaks only as of its date and we do not undertake, and specificallydisclaim any obligation, to release the results of any revisions publicly thatmay be made to any forward-looking statements to reflect the occurrence ofanticipated or unanticipated events or circumstances after the date of suchstatements.

 

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

 

The mortgage banking industry is continually subjectto current events that occur in the financial services industry. Such eventsinclude changes in economic indicators, government regulation, interest rates,price competition, geographic shifts, disposable income, housing prices, marketanticipation, and customer perception, as well as others. The factors thataffect the industry change rapidly.

 

As a result, current events can diminish the relevanceof “quarter over quarter” and “year-to-date over year-to-date” comparisons offinancial information. In such instances, the Company intends to presentfinancial information in its Management’s Discussion and Analysis of FinancialCondition and Results of Operations that is the most relevant to its financialinformation.

 

24

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**Reviewof Performance**

 

*Market Conditions*

 

The mortgage market faced adversity in the third quarter of 2007 as thecontinued broad repricing of mortgage credit risk led to a severe contractionin market liquidity.

 

Conditions in the secondary markets, whichdramatically worsened during the third quarter, continue to be depressed asinvestor concerns over credit quality and a weakening of the United Stateshousing market remain high. As a result, the capital markets remain veryvolatile and illiquid and have effectively been unavailable to the Company. TheCompany believes the existing conditions in the secondary markets areunprecedented since the Company’s inception and, as such, inherently involvesignificant risks and uncertainty. These conditions could continue to adverselyimpact the performance of our long term investment portfolio. Until bondspreads and credit performance return to more recent levels, it will beimpossible for the Company to execute securitizations and loan sales. As aresult, in the third quarter the Company has been forced to further alter itsbusiness strategies and discontinue the correspondent and wholesale mortgageoperations and the warehouse operations in response to the market conditions.The Company does not intend to reenter the discontinued operations until theeconomics become more favorable.

 

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

 

The downward spiraling of negative pricingadjustments on assets had a snowball effect as lower prices led to increasedlender margin calls for some market participants, which in turn, forcedadditional selling, causing yet further declines in prices. These eventscontinued to feed off each other through much of the quarter.

 

Normal market trading activity during the quarterwas unusually light as uncertainty related to future loss estimates made itdifficult for willing buyers and sellers to agree on price. This condition wasparticularly acute with respect to securities backed by 2006 and 2007 Alt-Aloans where market participants are setting price levels based on widely variedopinions about future loan performance and loan loss severity. While the earlycredit performance for these securities has been clearly far worse than initialexpectations, the ultimate level of realized losses will largely be influencedby events that will likely unfold over the next 12 to 36 months, including theseverity of housing price declines and the overall strength of the economy.

 

The graph below reflects the increase in the yieldsover the relevant interest rate index that the market was requiring for BBBrated bonds backed by single-family mortgage collateral . The graph depicts thedramatically worsening secondary market.

 

BBB Spreads

 

 

25

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The actions taken late in the quarter by the FederalReserve to reduce the federal funds and discount rates provided some temporarymarket confidence. We caution that Federal Reserve actions alone are not likelyto result in price stability, as the aforementioned market concerns remainlargely unresolved. The following has contributed to the current marketconditions:

 

•                  mortgage bankers tightened theirunderwriting standards;

 

•                  the reduction in availability ofcredit to borrowers reduced demand for homes, decreasing home prices;

 

•                  the reduction in home prices hascaused increased delinquencies and defaults on mortgage loans, especiallyhigher combined loan-to-value “CLTV” loans, increasing credit loss severities;

 

•                  the lack of liquidity and lower homeprices reduced borrowers’ ability to refinance out of economic hardship,exacerbating home price decline and credit loss severities;

 

•                  adjustable rate mortgage loansresetting higher compounded the depressed market conditions; and

 

•                  the securitization market, which hasserved as the primary source of term financing for the Company, remainsvirtually closed as investors, rating agencies and issuers continue to managethrough this difficult environment.

 

The deteriorating market for residential real estate loans is alsoillustrated in the ABX Indices below in subprime securitization bonds byinitial rating. The ABX index shows market prices for a designated group ofsubprime securities by credit rating. The index does not include any Impacdeals. It is shown here as an illustration of the price volatility in thegeneral mortgage market during the quarter and does not reflect actual pricingon Impac bonds which are backed by Alt-A loans rather than subprime. There iscurrently no comparable index for Alt-A mortgage product, but the generaldirection and magnitude of price movement in the index is reflective of theprice movement experienced by the Company.

 

 

*Impact ofRecent Market Activity*

 

As a result of the Company’s inabilityto sell or securitize non-conforming loans, the Company has discontinuedfunding loans other than conforming loans. Because the Company stopped fundingnon-conforming loans, the Company discontinued its mortgage and warehouselending operations.

 

In addition to the inability of theCompany to sell loans, the Company’s investment in securitized non-conformingloans has deteriorated in value primarily from estimated losses and secondarilyfrom a reduction in the fair value of derivatives. As a result of continueddeterioration in the real estate market during the third quarter, the Companysignificantly added to its loan loss provisions primarily due to increaseddelinquencies in our long term investment portfolio and increased lossseverities related to the sale and liquidation of real estate owned properties.Principally, because of the increase in provision for loan losses the Companyreported a stockholders’ deficit as of September 30, 2007. Thisstockholders deficit is created primarily because the Company is required underGAAP to record an allowance for loan losses resulting in a 

 

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negativeequity investment in certain consolidated trusts. We would like to point outthat the trust agreements are non-recourse for which the Company cannotultimately lose more than its original net investment in each trust. Therefore,the Company is not responsible for the losses in excess of its equityinvestment and subsequently is not required to advance any cash to trusts forcredit or derivative loss. The Company plans to adopt SFAS 159 on January 1,2008. Had the Company adopted SFAS 159 at September 30, 2007, the Companybelieves that stockholders equity would be positive.

 

Certain of the company’ssecuritizations are required to be consolidated due to the following factorsrelated to SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities-a replacement of FASB Statement No. 125:* the transfer ofthe Company’s mortgage loans to these trusts were not accounted for as sales;and the trusts did not meet the characteristics of qualifying special purposeentities. These trusts were considered variable interest entities and wereconsolidated because the Company was initially considered the primarybeneficiary pursuant to FASB Interpretation No. 46, “*Consolidationof Variable Interest Entities – an interpretation of ARB No. 51.*”

 

The following table presents thesummation of the consolidated trusts with positive and negative net investmentpositions, as of September 30, 2007 (in thousands):

 

| ** **                                                             | ** ** | **Securitized  Mortgage Collateral** | ** **      | **Net Investment** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------|-----------------|-------------------------|------------|
| Trusts with positive net investment positions |       | $                                         |  5,353,083 |                    | $          |  143,694 |   |
| Trusts with negative net investment  positions                         |       | 13,388,437                                |            | (561,673                | )          |
|                                                                   |       | $                                         | 18,741,520      |                    | $          | (417,979 | ) |

 

If thesecuritizations with negative equity had been accounted for as sales, theCompany’s estimate of the fair value of the trusts would be minimal. However,some of these positive and negative net investment positions could continue toprovide cash flows to the Company until estimated losses on disposition havebeen realized. While the Company can not adopt SFAS 159 until January 1,2008, had the Company adopted SFAS 159 at September 30, 2007 for thefinancial assets and liabilities of the trusts with negative net investment,the Company believes the effect of adoption could have resulted in a benefit tostockholders’ equity, as presented in the table below (in thousands):

 

| ** **                                                   | ** ** | **Stockholders’  Equity  (Deficit)** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|
| As presented September 30, 2007                         |       | $                                         | (493,316   | ) |
| Estimated benefit of adopting SFAS 159 (as  described above) |       | 561,673                                   |       |
| Had the Company adopted SFAS 159 at  September 30, 2007 |       | $                                         | 68,357     |   |

 

The Company intends to adopt SFAS157 and SFAS 159 as of January 1, 2008, and the effect of adoption will bereflected in the consolidated financial statements for the quarter ended March 31,2008.

 

 

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*Liquidity*

* *

During the second quarter the Company accumulated mortgages in thenormal course of business, however, starting in July 2007, the secondarymortgage market halted their purchase of investments backed by mortgage loans. Asa result the Company was unable to securitize the mortgage loans, which led tosignificant margin calls, reducing the Company’s cash position. The Companycontinues to work toward eliminating its margin call exposure on non-conformingmortgages. As of September 30, 2007 the Company had the following reverserepurchase lines outstanding (in thousands):

 

| ** **                                          | ** ** | **At September 30,** | ** ** | **At October 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **2007**                       | ** ** | **2007**                     | ** ** |
| Reverse  Repurchase Line (1)                        |       | $                              | 334,848    |                         | $          | 327,859 |   |
| Reverse  Repurchase Line (3)                        |       | 90,136                         |       | —                       |       |
| Reverse  Repurchase Line (4)                        |       | 112,265                        |       | 112,494                      |       |
| Reverse  Repurchase Line (5)                        |       | 314,182                        |       | 13,275                       |       |
| Reverse  Repurchase Line (6)                        |       | 72,332                         |       | 34,600                       |       |
| Total Reverse Repurchase Lines Outstanding          |       | $                              | 923,762    |                         | $          | 488,228 |   |
| Included in liabilities of Discontinued  Operations |       | $                              | 775,646    |                         | $          | 340,980 |   |
| Included in liabilities of Continuing  Operations   |       | $                              | 148,116    |                         | $          | 147,248 |   |

 

All of the Company’s reverserepurchase lines outstanding at September 30, 2007 were in technicaldefault of certain debt covenants, except Line 6 lender which provided awaiver. Lines 3, 4, and 5 in the table below were satisfied subsequent to September 30,2007, by either the sale of the loans to third parties or the sale of the loansto the respective lenders. The Company continues to fundconforming loans on Line 6. Also, the available borrowings on Line 6 werereduced to $35.0 million, with a further reduction to $25.0 million byDecember 31, 2007. The Company has been notified that this lender isexpecting to recommend to its credit committee an orderly wind down of thisline over the next few months. The Company will either dispose of the retailmortgage operations or discontinue and wind down of the operations.

 

The Company has taken steps toreduce operating costs, including reducing staff and lease costs, to a level atwhich the cashflows from the long-term mortgage portfolio and its master servicingportfolio could support the Company’s ongoing operations. The Company continuesto re-size the organization to a level more in line with its ongoing operations.Once the Company is able to eliminate the remaining reverse repurchase lines indiscontinued operations the Company should be able to meet its liquidity needsfrom cash flows generated from the long-term mortgage portfolio and its masterservicing fees. In an effort to maintain capital, the Company didnot declare a cash dividend on our common stock during the third quarter of 2007. Currently, wedo not anticipate paying any further dividends on our common stock for theremainder of 2007.

 

In light of the continued andwidely publicized volatility in the secondary markets, we have discontinuedfunding of loans previously referred to as Alt-A loans andcurrently do not have any plans to originate these types of loans in thefuture. At this point, the Company is only funding loans that are eligible tobe sold to government sponsored agencies. In addition to the suspension ofAlt-A originations, the Company has taken steps to reduce operating expensessignificantly which include staff reductions and closure of selected facilities.The Company has discontinued its mortgage origination business, except for itsretail operations which originates conforming loans. The Company has alsodiscontinued its warehouse lending operations.

 

In addition, during thethird quarter of 2007, the Company transferred certain net interest margin (“NIM”)and subordinated bonds, originally retained from six on-balance sheetsecuritizations we completed in 2006 and early 2007, to a lender to satisfycertain reverse repurchase borrowings. At the time of each securitization, weborrowed against these retained securities in a reverse repurchase financingarrangement with the lender. In order to satisfy the outstanding reverserepurchase obligation, in the third quarter of 2007, we issued securities witha current face value of $137.5 million at a discount of $76.3 million for netproceeds of $61.2 million, along with various other assets to the lender infull satisfaction of the $69.2 million borrowing.

 

The sale of these retained interests for thesix affected securitizations qualified these consolidated trusts for reassessmentunder FIN 46 because the $61.2 million sale to a third party was consideredsignificant and, an updated analysis showed the Company was no longer theprimary beneficiary of these trusts.  However, since the Company did notobtain sale accounting under FAS 140 for the transfer of loans to the trusts,the Company continues to reflect the trust assets on the Company’s balancesheet.

 

*Allowance for Loan Loss and REO*

 

The Company’s allowance for loan losses increasedsignificantly in the third quarter to reflect higher estimated loan losses. Thesehigher loss estimates stemmed from higher delinquencies, higher ratios ofdelinquent loans rolling to foreclosure, deterioration in the prevailing realestate market, increasing loss severities, current economic conditions, andthe seasoning of the Long-Term Investment Operations investment portfolio.

 

In an effort to mitigatedelinquencies, the Company is pursuing a strategy to assist qualifieddelinquent borrowers by modifying interest rates or delaying the reset ofinitially adjusting variable interest rate loans. The Company’s recentlyimplemented strategy includes reducing delinquencies by more closely workingwith the sub-servicers and borrowers. This includes working with management ofthe sub-servicers to execute a plan to reduce future delinquency rates. Some ofthe strategies to reduce delinquencies include:

 

•                          increase loss mitigationefforts (forbearance plans, or loan modifications);

 

•                          an aggressive focus onfront end collections;

 

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•                          preemptive contact withborrowers about to have their mortgages reset to a higher interest rate; and

 

•                          closely monitoringperformance against industry metrics.

 

These strategies are intended toimprove delinquent loan cure rates in an effort to reduce the increase offoreclosed loans moving into REO. However, during the quarter the loanportfolio continued to deteriorate from additional delinquencies and REO. Althoughthese strategies have not been as effective as desired, we do believe they willimprove performance as they are further implemented.

 

Additionally, during the third quarter of 2007,the Company continued alternative REO liquidation methods, in an effort to accelerate thedisposition of foreclosed loans, through the use of the auction process whichwas begun in the second quarter. While this liquidation strategy mitigatescertain holding costs and provides potential long term benefits, includingdisposition of properties prior to further home price depreciation, in certaininstances the Company incurred higher severities, through such auction salesthan it expected. The Company intends to adjust its strategy to auction onlythose properties more difficult to sell at retail as a further effort to reduceloss severities. In addition the Company is evaluating a plan to lease suchproperties until market prices recover.

 

**Company Overview**

** **

Impac Mortgage Holdings, Inc. (the Company or IMH), is a Marylandcorporation incorporated in August 1995, and has the following subsidiaries:IMH Assets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG),and Impac Funding Corporation (IFC), together with its wholly-ownedsubsidiaries Impac Secured Assets Corp. (ISAC), and Impac Commercial CapitalCorporation (ICCC).

 

During the third quarter of 2007, the Company’sboard of directors elected to discontinue the mortgage operations (IFC),commercial operations (ICCC), and warehouse lending operations (IWLG).

 

Currently, the Company consists of:

 

•                          the Long-Term Investmentoperations conducted by IMH and IMH Assets; and

 

•                          the Retail Mortgageoperations conducted by Impac Home Lending (IHL), a division of IFC.

 

As a result of the market conditions as described above,the Company discontinued the following businesses:

 

•                          the Mortgage Operationsconducted by IFC and ISAC;

 

•                          the Commercial Operationsconducted by ICCC; and

 

•                          the Warehouse LendingOperations conducted by IWLG.

 

Thefollowing sections of the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations include thecombined results of continuing and discontinuing operations, to improvecomparability:

 

•                          Delinquency Data

 

•                          Yield Discussion

 

•                          Production Volumes

 

**CriticalAccounting Policies**

 

Wedefine critical accounting policies as those that are important to theportrayal of our financial condition and results of operations and requireestimates and assumptions based on our judgment ofchanging market conditions and the performance of our assets and liabilities atany given time. In determining which accounting policies meet this definition,we considered our policies with respect to the valuation of our assets andliabilities and estimates and assumptions used in determining those valuations.We believe the most critical accounting issues that require the most complexand difficult judgments and that are particularly susceptible to significantchange to our financial condition and results of operations include thefollowing:

 

29

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•                          allowance for loan losses;

 

•                          allowance for REO losses;

 

•                          lower of cost or market(LOCOM) – loans held-for-sale; and

 

•                          repurchase reserve.

 

***Allowance forLoan Losses***

 

We provide an allowance for loan losses for mortgagesheld as securitized mortgage collateral, finance receivables and mortgagesheld-for-investment (“loans provided for”). In evaluating the adequacy of theallowance for loan losses, management takes many factors into consideration.For instance, a detailed analysis of historical loan performance data is accumulatedand reviewed. This data is analyzed for loss performance and prepaymentperformance by product type, origination year and securitization issuance. Thedata is also analyzed by collection status. Our estimate of the requiredallowance for these loans is developed by estimating both the rate of defaultof the loans and the amount of loss in the event of default. The rate ofdefault is based on analysis of migration of loans from each aging category. Theloss severity is determined by estimating the net proceeds from the ultimatesale of the foreclosed property. The results of that analysis are then appliedto the current mortgage portfolio and an estimate is created. We believe thatpooling of mortgages with similar characteristics is an appropriate method inwhich to evaluate the allowance for loan losses. Management also recognizesthat there are qualitative factors that must be taken into consideration whenevaluating and measuring inherent loss in our loan portfolios. These itemsinclude, but are not limited to, economic indicators that may affect theborrower’s ability to pay, changes in value of collateral, projected losscurves, political factors, market conditions, competitor’s performance, marketperception and industry statistics. This evaluation is inherently subjective,as it requires estimates that are susceptible to significant revision asfactors change or as more information becomes available.

 

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

 

***Allowance for REO Losses***

 

We provide an allowance for REOlosses for mortgages held as real estate owned. In evaluating the adequacy ofthe allowance for REO losses, management takes many items into consideration. Whenreal estate is acquired in settlement of loans, or other real estate owned, themortgage is written-down to a percentage of the property’s appraised value orbroker’s price opinion or list price less estimated selling costs and includingmortgage insurance expected to be received. Subsequent changes in the netrealizable value of the real estate owned is reflected as an allowance for REOlosses. The allowance for REO losses increased as a result of increasedexpected loss severities from a reduction in estimated sales prices principallyas home prices have deteriorated. In prior periods the Company generallyrealized small gains from the sale of REOs, as the Company realized an amountgreater than the net realizeable value.

 

***Lower of Cost or Market—LOCOM – Loans Held-for-Sale***

 

Mortgageloans held for sale are carried at the lower of amortized cost or fair value.Traditionally, we have estimated fair value by evaluating a variety of marketindicators including recent trades and outstanding commitments. During thethird quarter, due to the lack of activity in the secondary mortgage market, wealso used the reverse repurchase line basis as an estimate of fair value. Toperform the analysis we stratify the mortgage loans in our held-for-saleportfolio into loans with expected trades and those on the reverse repurchaselines. After the valuation method is determined (*e.g.,*trade price or warehouse line basis) we apply fair value estimates to thesestratifications to arrive at a valuation allowance which is applied against ourcarrying amount resulting in a net fair value estimate for mortgage loans heldfor sale. However, during the third quarter of 2007 the market for unsold loanscollapsed resulting in significant write-downs the Company’s remaining unsoldloans.

 

***Calculation of Repurchase Reserve***

 

Whenwe sell loans through whole loan sales we are required to make normal andcustomary representations and warranties about the loans to the purchaser. Ourwhole loan sale agreements generally require us to repurchase loans if webreach a representation or warranty given to the loan purchaser. In addition,we may be required to repurchase loans as a result of borrower fraud or if apayment default occurs on a mortgage loan shortly after its sale.

 

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Investorshave requested the Company to repurchase loans or to indemnify them againstlosses on certain loans which the investors believe either do not comply withapplicable representations or warranties or defaulted shortly after itspurchase. Upon completion of its own investigation regarding the investorclaims, the Company repurchases or provides indemnification on certain loans,as appropriate. The Company maintains a liability for expected losses ondispositions of loans expected to be repurchased or on which indemnification isexpected to be provided and regularly evaluates the adequacy of this repurchaseliability based on trends in repurchase and indemnification requests, actualloss experience, and other relevant factors including economic conditions.

 

TheCompany estimates the repurchase reserve based on the estimated trailing wholeloan sales that still have outstanding early payment warranties andmisrepresentation warranties. The calculation of the trailing whole loan salessubject to request is based upon historical analysis of the timing of requestsin relation to their sale date. The Company also calculates the rate at whichour whole loan sales will develop into early payment default ormisrepresentation claims. Based on historical experience, management willdetermine what percentage of the claims that will incur a loss. The Companyapplies a historical loss rate, adjusted for current market conditions based onthe type of loan (first lien or to a lesser extent second lien) to the loans weexpect to incur loss on in the future to derive the repurchase reserve. Thereserve includes the Company’s estimate of losses in the fair value of loansthe Company expects it will repurchase, plus any premiums that will be refundedto the investor. The loss in fair value is predominately determined based oncurrent market value of non-performing loans.

 

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

 

•                  The net loss for the third quarter of2007 was $1.2 billion or $15.66 per diluted share, compared to $127.7 millionor $1.68 per diluted share for the third quarter of 2006;

 

•                  Estimated taxable loss per dilutedshare was ($0.21) compared to ($0.25) for the second quarter of 2007 and $0.23for the third quarter of 2006;

 

•                  No common stock cash dividend wasdeclared for the third or second quarter of 2007 compared to $0.10 for thefirst quarter of 2007;

 

•                  Total assets were $19.4 billion as ofSeptember 30, 2007 compared to $23.6 billion as of December 31, 2006and $22.5 billion as of September 30, 2006;

 

•                  The retail mortgage operations, whichwas acquired at the end of May 2007, originated $260.9 million ofconforming mortgages compared to $147.4 million for the second quarter of 2007,which only includes the month of June as the retail operations wereacquired at the end of May; and

 

•                  The long-term investment operationsdid not retain any residential or commercial mortgages compared to $795.6million of primarily Alt-A mortgages and no commercial mortgages for the secondquarter of 2007 and $3.1 billion of primarily Alt-A mortgages and $233.9million of commercial mortgages for the third quarter of 2006.

 

**Selected Financial Results for the First Nine Months of 2007**

 

•                  The net loss for the first ninemonths of 2007 was $1.5 billion or $19.26 per diluted share, compared to $15.8million or $0.21 per diluted share for the first nine months of 2006;

 

•                  Estimated taxable income per dilutedshare was a loss of ($0.22) compared to income of $0.86 for the first ninemonths of 2006;

 

•                  Cash dividends declared per sharewere $0.10 compared to $0.75 for the first nine months of 2006; Based oncurrent tax estimates, some portion or all of the 2007 dividends will be areturn of capital.

 

•                  The retail mortgage operations, whichwas acquired at the end of May 2007, originated $408.3 million ofconforming mortgages compared to none for the first nine months of 2006; and

 

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•                  The long-term investment operationsretained for investment $3.0 billion of primarily Alt-A mortgages and $234.9 millionof commercial mortgages compared to $579.7 million of primarily Alt-A mortgagesand $114.7 million of commercial mortgages for the first nine months of 2006.

 

**Third Quarter 2007 vs.Second Quarter 2007 Net Earnings**

** **

| ** **                                            | ** ** | **Three Months Ended ,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                            | ** ** | **September 30,**                  | ** ** | **June 30,** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                            | ** ** | **2007**                                | ** ** | **2007** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Interest income                                       |       | $                                       | 313,772    |   | $ | 316,285 |   | $ | (2,513 | ) | (1 | )% |
| Interest expense                                      |       | 302,074                                 |       | 305,076 |   | (3,002 | ) | (1 | ) |
| Net interest income                                   |       | 11,698                                  |       | 11,209 |   | 489 |   | 4 |   |
| Provision for loan losses                             |       | 789,445                                 |       | 161,163 |   | 628,282 |   | 390 |   |
| Net interest expense after provision for  loan losses |       | (777,747                                | )          | (149,954 | ) | (627,793 | ) | (419 | ) |
| Total non-interest income                             |       | (194,720                                | )          | 59,887 |   | (254,607 | ) | (425 | ) |
| Total non-interest expense                            |       | 21,635                                  |       | 24,569 |   | (2,934 | ) | (12 | ) |
| Income tax expense                                    |       | 3,056                                   |       | 4,969 |   | (1,913 | ) | (38 | ) |
| Loss from discontinued operations, net                |       | (194,077                                | )          | (32,942 | ) | (161,135 | ) | (489 | ) |
| Net loss                                              |       | $                                       | (1,191,235 | ) | $ | (152,547 | ) | $ | (1,038,688 | ) | (681 | )% |
|                                                  |       |                                    |       |   |   |   |   |   |   |
| Net loss per share - diluted                          |       | $                                       | (15.66     | ) | $ | (2.00 | ) | $ | (13.66 | ) | (683 | )% |
| Dividends declared per common share                   |       | $                                       | —     |   | $ | — |   | $ | — |   | — | % |

 

Theresults of operations for the third quarter of 2007 resulted in a net loss of$1.2 billion, or $15.66 per share as compared to a net loss of $152.5 million,or $2.00 per share, for the second quarter of 2007. The increase in the netloss was primarily due to a $628.3 million increase in provision for loanlosses, and a $190.9 million loss on the change in fair value and realizedlosses from derivative instruments. In addition the Company incurred a $27.5million loss on the disposition of the loans, a $22.2 million increase inprovision for REO losses and a $9.6 million decrease in realized gains fromderivative instruments, recorded in non-interest income. The loss fromdiscontinued operations increased by $161.1 million, primarily the result of a$88.9 million increase in the LOCOM losses recorded due to the decline in valueof the mortgage loans held-for-sale, and a $42.7 million unfavorable change inlosses from loan sales which resulted in $48.3 million of losses compared to$3.3 million of gains in the second quarter of 2007.

 

**Estimated Taxable Income**

 

Because dividend payments are based on estimatedtaxable income, dividends may be more or less than net earnings. As such, webelieve that the disclosure of estimated taxable income available to commonstockholders, which is a non-generally accepted accounting principle, or “non-GAAP,”financial measurement, is useful information for our investors. Based oncurrent tax estimates, some portion or all of the 2007 dividends may be areturn of capital. Additionally, losses recorded for GAAP, generally arereflected as losses in taxable income in subsequent periods.

 

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The following table presents a reconciliation of net(loss) earnings (GAAP) to estimated taxable income available to commonstockholders for the periods indicated (in thousands, except per shareamounts):

 
| ** **                                                                   | ** ** | **Three Months Ended (1)** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**                    | ** ** | **June 30,**               | ** ** | **September 30,** | ** ** | **September 30, (1)** | ** ** |
| ** **                                                                   | ** ** | **2007**                                  | ** ** | **2007**                        | ** ** | **2006** | ** ** | **2007** | ** ** |
| Net loss                                                                     |       | $                                         | (1,191,235 | )                               | $          | (152,547 | ) | $ | (127,690 | ) | $ | (1,465,450 | ) |
| Adjustments to net (loss) earnings: (2)                                      |       |                                      |       |                            |       |   |   |   |   |
| Loan loss provisions (3)                                                     |       | 832,453                                   |       | 181,977                         |       | 3,183 |   | 1,053,164 |   |
| Tax deduction for actual loan losses (3)                                     |       | (34,348                                   | )          | (49,460                         | )          | (5,540 | ) | (93,394 | ) |
| GAAP earnings on REMICs (4)                                                  |       | (13,421                                   | )          | (21,070                         | )          | (4,554 | ) | (49,423 | ) |
| Taxable income on REMICs (5)                                                 |       | 21,181                                    |       | 28,224                          |       | 7,392 |   | 60,572 |   |
| Change in fair value of derivatives (6)                                      |       | 135,347                                   |       | (53,269                         | )          | 150,051 |   | 136,701 |   |
| Dividends on preferred stock                                                 |       | (3,722                                    | )          | (3,722                          | )          | (3,672 | ) | (11,165 | ) |
| Net loss (earnings) of taxable REIT  subsidiaries (7)                        |       | 220,071                                   |       | 49,551                          |       | (4,853 | ) | 328,289 |   |
| Dividend from taxable REIT subsidiaries (8)                                  |       | —                                    |       | —                          |       | 3,900 |   | — |   |
| Elimination of inter-company loan sales  transactions (9)                    |       | (9,500                                    | )          | 368                             |       | (983 | ) | (3,661 | ) |
| Non deductible capital loss on security  available-for-sale (10)        |       | 26,709                                    |       | —                          |       | — |   | 26,709 |   |
| Miscellaneous adjustments                                                    |       | 168                                       |       | 1,012                           |       | 96 |   | 1,288 |   |
| Estimated taxable income (loss) available  to common stockholders’ (11) |       | $                                         | (16,297    | )                               | $          | (18,936 | ) | $ | 17,330 |   | $ | (16,370 | ) |
| Estimated taxable income (loss) per diluted  common share (11)          |       | $                                         | (0.21      | )                               | $          | (0.25 | ) | $ | 0.23 |   | $ | (0.22 | ) |
| Diluted weighted average common shares  outstanding                          |       | 76,084                                    |       | 76,084                          |       | 76,132 |   | 76,084 |   |

 

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(1)         Estimated taxable income includes estimates ofbook to tax adjustments and can differ from actual taxable income as calculatedwhen we file our annual corporate tax return. Since estimated taxable income isa non-GAAP financial measurement, the reconciliation of estimated taxableincome available to common stockholders to net earnings is intended to meet therequirements of Regulation G as promulgated by the SEC for the presentation of non-GAAPfinancial measurements. To maintain our REIT status, we are required todistribute a minimum of 90% of our annual taxable income to our stockholders.

(2)         Certain adjustments are made to net earningsin order to calculate estimated taxable income due to differences in the wayrevenues and expenses are recognized under the two methods.

(3)         To calculate estimated taxable income, actualloan losses are deducted. For the calculation of net earnings, GAAP requires adeduction for estimated losses inherent in our mortgage portfolios in the formof a provision for loan losses, which are generally not deductible for taxpurposes. Therefore, as the estimated losses provided for GAAP are realized,the losses will negatively and may materially impact future taxable income. Theloan loss provisions include the allowance for loan loss provision and the REOloan loss provision for the REIT.

(4)         Includes GAAP amounts related to the REMICsecuritizations, which were treated as secured borrowings for GAAP purposes andsales for tax purposes. The REMIC GAAP income excludes the provision for loanlosses recorded that may relate to the REMIC collateral included in securitizedmortgage collateral. The Company does not have any specific valuationallowances recorded as an offset to the REMIC collateral.

(5)         Includes amounts that are taxable to theCompany related to its residual interest in the securitizations, as the REMICsare accounted for as sales in its tax filings.

(6)         The mark-to-market change for the valuation ofderivatives at IMH is income or expense for GAAP financial reporting but is notincluded as an addition or deduction for taxable income calculations untilrealized.

(7)         Represents net earnings of IFC and ICCC, ourtaxable REIT subsidiaries (TRS), which may not necessarily equal taxableincome.

(8)         Any dividends paid to IMH by the TRS in excessof their cumulative undistributed taxable income would be recognized as returnof capital by IMH to the extent of IMH’s capital investment in the TRS.Distributions from the TRS to IMH may not equal the TRS net earnings, however,IMH can only recognize dividend distributions received from the TRS as taxableincome to the extent that the TRS distributions are from current or priorperiod undistributed taxable income. Any distributions by the TRS in excess ofIMH’s capital investment in the TRS would be taxed as capital gains.

(9)         Includes the effects to taxable incomeassociated with the elimination of gains from inter-company loan sales andother intercompany transactions between IFC, ICCC, and IMH, net of tax and therelated amortization of the deferred charge.

(10)   This amount includes a non deductible loss foran other than temporary impairment on certain securities classified asavailable-for-sale. It is expected that this loss will be realized in asubsequent period.

(11)   Excludes the deduction for common stockdividends paid and the availability of a deduction attributable to netoperating loss carry-forwards. As of December 31, 2006, the Company hadestimated federal net operating loss carry-forwards of $16.4 million thatexpire in the year 2020.

 

***Third ***Quarter 2007 vs. Second Quarter2007******

 

Estimated taxable loss decreased $2.6 million to aloss of $16.3 million, or ($0.21) per diluted common share, for the third quarter2007, compared to a taxable loss of $18.9 million or ($0.25) per diluted commonshare, for the second quarter 2007. The decrease in estimated taxable loss wasmainly attributable to a decrease in actual loan losses which decreased $15.0million from the second quarter of 2007, as a result of a tax reportingmodification to record losses on loans for certain deals when the losses areincurred by the trusts. Offsetting this increase to taxable income was adecrease in the adjusted net interest margin at IMH which decreased $3.5million from the second quarter of 2007, including the REMIC taxable income. Additionally,losses on the disposition of REO increased by $4.9 million, due to increasedseverities, primarily the result of declining home prices.

 

33

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**Financial Condition and Results of Operations**

* *

*FinancialCondition*

 

Condensed Balance SheetData

(dollars in thousands)

 
| ** **                                          | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|--------------------------|------------|---------------|------------|
| Cash and cash equivalents                           |       | $                            | 41,186     |                        | $          | 151,714                  |       | $             | (110,528   | ) | (73 | )% |
| Securitized mortgage collateral                     |       | 18,741,520                   |       | 20,936,515                  |       | (2,194,995               | )          | (10           | )          |
| Investment securities available-for-sale            |       | 16,274                       |       | 31,582                      |       | (15,308                  | )          | (48           | )          |
| Allowance for loan losses                           |       | (911,218                     | )          | (77,684                     | )          | 833,534                  |       | 1,073         |       |
| Mortgages held-for-sale - retail operations         |       | 133,497                      |       | —                      |       | 133,497                  |       | 100           |       |
| Derivative assets                                   |       | 36,153                       |       | 142,793                     |       | (106,640                 | )          | (75           | )          |
| Real estate owned (REO), net                        |       | 360,472                      |       | 137,331                     |       | 223,141                  |       | 162           |       |
| Assets of discontinued operations                   |       | 810,574                      |       | 2,086,216                   |       | (1,275,642               | )          | (61           | )          |
| Other assets                                        |       | 181,918                      |       | 190,488                     |       | (8,570                   | )          | (4            | )          |
| **Total assets**                                    |       | $                            | 19,410,376 |                        | $          | 23,598,955               |       | $             | (2,912,937 | ) | (12 | )% |
|                                                |       |                         |       |                        |       |                     |       |          |       |
| Securitized mortgage borrowings                     |       | $                            | 18,712,217 |                        | $          | 20,527,001               |       | $             | (1,814,784 | ) | (9 | )% |
| Reverse repurchase agreements                       |       | 148,116                      |       | 163,890                     |       | (15,774                  | )          | (10           | )          |
| Liabilities of discontinued operations              |       | 832,216                      |       | 1,774,371                   |       | (942,155                 | )          | (53           | )          |
| Other liabilities                                   |       | 211,143                      |       | 124,163                     |       | 86,980                   |       | 70            |       |
| Total liabilities                                   |       | 19,903,692                   |       | 22,589,425                  |       | (2,685,733               | )          | (12           | )          |
| Total stockholders’ equity                     |       | (493,316                     | )          | 1,009,530                   |       | (1,502,846               | )          | (149          | )          |
| **Total liabilities and stockholders’ equity** |       | $                            | 19,410,376 |                        | $          | 23,598,955               |       | $             | (4,188,579 | ) | (18 | )% |

 

Totalassets were $19.4 billion as of September 30, 2007 as compared to$23.6 billion as of December 31, 2006, as the long-term investmentoperations retained $3.0 billion of primarily Alt-A mortgages and $0.2 billionof commercial mortgages offset by $2.1 billion in whole loan sales and $4.4billion in total prepayments.

 

The Company’sallowance for loan losses increased to reflect higher estimated losses stemmingfrom higher delinquencies combined with higher estimates of default rates,deterioration in the prevailing real estate market and economic conditionsincreasing loss severities on REO liquidations.

 

Real estate ownedat September 30, 2007 was $360.5 million, or 162 percent, higher thanat December 31, 2006 as a result of an increase in foreclosures in excessof real estate liquidated, which is due to borrowers’ inability to obtainreplacement financing in conjunction with rising borrowing costs due to resets,reduced housing demand in the marketplace and lower housing prices.

 

34

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The following tablepresents selected information about mortgages held as securitized mortgagecollateral as of the dates indicated. Some information is presented as a percentage of the portfolio:

 
| ** **                                   | ** ** | **Residential  As of**  | ** ** | **Commercial  As of**  | ** ** |
|----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** | **September 30,  2006** | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** | **September 30,  2006** | ** ** |
| Alt-A mortgages                              |       | 99%                          |       | 99%                         |       | 99% |   | N/A |   | N/A |   | N/A |   |
| Non-hybrid ARMs                              |       | 5%                           |       | 7%                          |       | 10% |   | 2% |   | 2% |   | 2% |   |
| Hybrid ARMs                                  |       | 71%                          |       | 73%                         |       | 75% |   | 98% |   | 98% |   | 98% |   |
| FRMs                                         |       | 24%                          |       | 20%                         |       | 15% |   | 0% |   | 0% |   | 0% |   |
| Interest-only                                |       | 72%                          |       | 72%                         |       | 73% |   | 15% |   | 14% |   | 13% |   |
| Weighted average coupon                      |       | 7.10%                        |       | 6.75%                       |       | 6.52% |   | 6.26% |   | 6.15% |   | 5.84% |   |
| Weighted average margin                      |       | 3.35%                        |       | 3.60%                       |       | 3.73% |   | 2.67% |   | 2.68% |   | 2.69% |   |
| Weighted average original LTV                |       | 73                           |       | 74                          |       | 75 |   | 66 |   | 66 |   | 67 |   |
| Weighted average original CLTV (1)           |       | 84                           |       | 85                          |       | 85 |   | 66 |   | 66 |   | 67 |   |
| Weighted average original credit score       |       | 699                          |       | 697                         |       | 696 |   | 731 |   | 730 |   | 730 |   |
| Original prepayment penalty                  |       | 66%                          |       | 68%                         |       | 73% |   | 100% |   | 100% |   | 100% |   |
| Prior 3-month constant prepayment rate       |       | 21%                          |       | 39%                         |       | 40% |   | 10% |   | 6% |   | 8% |   |
| Prior 12-month prepayment rate               |       | 30%                          |       | 38%                         |       | 38% |   | 8% |   | 8% |   | 9% |   |
| Lifetime prepayment rate                     |       | 28%                          |       | 29%                         |       | 30% |   | 6% |   | 6% |   | 6% |   |
| Weighted average debt service coverage ratio |       | N/A                          |       | N/A                         |       | N/A |   | 1.30 |   | 1.27 |   | 1.29 |   |
| California                                   |       | 51%                          |       | 51%                         |       | 53% |   | 62% |   | 63% |   | 66% |   |
| Purchase transactions                        |       | 54%                          |       | 58%                         |       | 59% |   | 49% |   | 51% |   | 51% |   |
| Owner occupied                               |       | 78%                          |       | 78%                         |       | 79% |   | N/A |   | N/A |   | N/A |   |
| First lien                                   |       | 98%                          |       | 99%                         |       | 99% |   | 100% |   | 100% |   | 100% |   |

 

----

(1) The CLTV expresses the CLTV of the borrower, and is notindicative of the Company’s exposure, as the Company does not retain asignificant amount of second lien loans. This information is based upon information obtained at the time oforigination.

 

The following table presents selected financial dataas of the dates indicated (dollars in thousands, except per share data):

 
| ** **                             | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                             | ** ** | **September 30,  2007**                          | ** ** | **December 31,  2006** | ** ** | **September 30,  2006** | ** ** |
| Book value per share                   |       | $                                                     | (8.61      | ) | $ | 11.15 |   | $ | 11.94 |   |
| Return on average assets               |       | (8.57                                                 | )%         | (0.31 | )% | (0.09 | )% |
| Mortgages owned 60+ days delinquent    |       | $                                                     | 1,872,283  |   | $ | 1,229,270 |   | $ | 1,035,601 |   |
| 60+ day delinquency of mortgages owned |       | 9.40                                                  | %          | 5.64 | % | 5.01 | % |

 

We believe that in orderfor us to generate net interest spread from the portfolio we must successfullymanage the following primary operational and market risks:

 

·              liquidity risk;

 

·              credit risk;

 

·              interest rate risk; and

 

·              prepayment risk.

 

*LiquidityRisk. *Refer to “Liquidityand Capital Resources.”

 

35

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*CreditRisk.*We manage creditrisk by adequately providing for loan losses and actively managingdelinquencies and defaults through the sub-servicers.  During the third quarter of 2007 we did not retain any Alt-Amortgages.  The loans originated by theretail mortgage operations are generally within typical Fannie Mae and FreddieMac guidelines.  Our securitized mortgageborrowings consist of Alt-A mortgages which are generally within typical FannieMae and Freddie Mac guidelines but that have loan characteristics includinghigher loan balances, higher loan-to-value ratios or lower documentationrequirements that may make them non-conforming under those guidelines.

 

As of September 30, 2007, the original weighted average creditscore of mortgages held as residential and commercial securitized mortgagecollateral was 699 and 731, an original weighted average LTV ratio of 73 and66 percent and an original CLTV of 84 percent and 66 percent,respectively. For additional information regarding the long-term mortgageportfolio refer to “Note E—Securitized Mortgage Collateral” in theaccompanying notes to the consolidated financial statements.

 

Based upon current marketconditions and economic factors, we believe that we have adequately providedfor loan losses, however, if market conditions continue to deteriorate inexcess of our expectations, the Company may need to record an increase to theallowance for loan losses. The allowance for loan losses increased to$911.2 million as of September 30, 2007 as compared to $77.7 million as of December 31,2006. The increase in the provision reflects higher estimated losses stemmingfrom higher delinquencies combined with higher defaults, increased severities,deterioration in the prevailing real estate market and current economicconditions and the seasoning of long term investment operations investment loanportfolio. Actual loan charge-offs net of recoveries on mortgages in themortgage portfolio increased to $93.0 million for third quarter 2007 as compared to $5.5 million forthe third quarter of 2006.

 

We monitor our sub-servicersto attempt to ensure that they perform loss mitigation, foreclosure and collectionfunctions according to their servicing practices and each trust’s pooling andservicing agreement.  We have met withthe management of our sub-servicers to assess our borrowers current ability topay their mortgages and to make arrangements with selected delinquent borrowerswhich will result in the best interest of the borrower and the Company, in aneffort to minimize the number of mortgages which become seriously delinquent.When resolving delinquent mortgages, sub-servicers are required to take timelyand aggressive action. The sub-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 or by foreclosing and liquidating the property. Weperform an ongoing review of mortgages that display weaknesses and believe thatwe maintain an adequate loan loss allowance on our mortgages. When a borrowerfails to make required payments on a mortgage and does not cure the delinquencywithin 60 days, we generally record a notice of default and commenceforeclosure proceedings, or arrange alternative terms of forbearance. If themortgage is not reinstated within the time permitted by law for reinstatement,the property may then be sold at a foreclosure sale. At foreclosure sales, wegenerally acquire title to the property.

 

We believe the MortgageBankers Association (MBA) method is most consistent with the SEC proposal ofdefining delinquency as a contractually required payment being 30 days or morepast due, compared to the Office of Thrift Supervision (OTS) method, which lagsthe MBA method by 30 days. It is our view that the MBA methodology provides amore accurate reading on delinquency. The OTS methodology lags the MBA approachin reporting delinquencies by an additional 30 days. We measure delinquenciesfrom the date of the last payment due date in which a payment was received,compared to the OTS method which starts counting the days on the date the paymentwas not made. Delinquencies under the OTS method including loans 60 days lateor greater, foreclosures and delinquent bankruptcies were $1,466.8 million or7.4 percent, compared to $1,872.3 million or 9.5 percent for the MBA method.

 

36

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The following tablesummarizes non-performing loans that we own, including securitized mortgagecollateral, mortgages held for long-term investment and mortgages held-for-salefor continuing and discontinued operations combined, that were 60 or more daysdelinquent for the periods indicated  (inthousands):

 
| ** **                                             | ** ** | **At September 30,  2007** | ** ** | **%**  | ** ** | **At December 31,  2006** | ** ** | **%**     | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|--------|------------|-------------------------------------|------------|-----------|------------|
|                                                   |       |                                 |       |   |       |                                |       |      |       |
| Loans held-for-sale (1)                                |       |                                 |       |   |       |                                |       |      |       |
| 60 - 89 days delinquent                                |       | $                                    | 33,882     |   | 2%         |                                | $          | 11,107    |       | 1% |   |
| 90 or more days delinquent                             |       | 31,418                               |       | 2%     |       | 34,598                              |       | 3%        |       |
| Foreclosures (2)                                       |       | 10,730                               |       | 1%     |       | 13,267                              |       | 1%        |       |
| Delinquent bankruptcies                                |       | —                               |       | — |       | —                              |       | —    |       |
| Total 60+ days delinquent loans held-for-sale          |       | 76,030                               |       | 4%     |       | 58,972                              |       | 5%        |       |
|                                                   |       |                                 |       |   |       |                                |       |      |       |
| Long-term mortgage portfolio                           |       |                                 |       |   |       |                                |       |      |       |
| 60 - 89 days delinquent                                |       | $                                    | 404,264    |   | 22%        |                                | $          | 373,238   |       | 30% |   |
| 90 or more days delinquent                             |       | 378,915                              |       | 20%    |       | 275,089                             |       | 22%       |       |
| Foreclosures (2)                                       |       | 850,964                              |       | 45%    |       | 403,489                             |       | 33%       |       |
| Delinquent bankruptcies                                |       | 162,110                              |       | 9%     |       | 118,482                             |       | 10%       |       |
| Total 60+ days delinquent long term mortgage portfolio |       | 1,796,253                            |       | 96%    |       | 1,170,298                           |       | 95%       |       |
|                                                   |       |                                 |       |   |       |                                |       |      |       |
| Total 60 or more days delinquent                       |       | $                                    | 1,872,283  |   | 100%       |                                | $          | 1,229,270 |       | 100% |   |

 

----

(1) Delinquenciesincluded in loans held-for-sale are primarily related to loans repurchased frombuyers of whole loans from the Company in accordance with the normalrepresentations and warranties.  Loansheld-for-sale are included as discontinued operations on the consolidatedstatements of operations.

 

(2) Representsproperties in the process of foreclosure.

 

Non-performing assetsconsist of mortgages that are 90 days or more delinquent, including loansin foreclosure and delinquent bankruptcies. It is our policy to place amortgage on non-accrual status when it becomes 90 days delinquent and toreverse from revenue any accrued interest, except for interest income onsecuritized mortgage collateral whereby the scheduled payment is received fromthe servicer whether or not the borrower makes the payment. As of September 30, 2007, non-performing assets as a percentage oftotal assets were 9.27 percent compared to 4.26 percent as ofyear-end 2006.

 

The following tablesummarizes securitized mortgage collateral, mortgages held for long-terminvestment, mortgages held-for-sale and real estate owned, that werenon-performing for continuing and discontinued operations combined for theperiods indicated (in thousands):

 
| ** **                                                           | ** ** | **At September 30,  2007** | ** ** | **%**  | ** ** | **At December 31,  2006** | ** ** | **%**     | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------|------------|--------|------------|-------------------------------------|------------|-----------|------------|
| 90 or more days delinquent, foreclosures and delinquent bankruptcies |       | $                                    | 1,434,137  |   | 80%        |                                | $          | 844,925   |       | 84% |   |
| Other real estate owned                                              |       | 366,061                              |       | 20%    |       | 161,538                             |       | 16%       |       |
| Total non-performing assets                                          |       | $                                    | 1,800,198  |   | 100%       |                                | $          | 1,006,463 |       | 100% |   |

 

Real estate owned,which consists of residential real estate acquired in satisfaction of loans, iscarried at the lower of cost or net realizable value less estimated sellingcosts. Adjustments to the loan carrying value required at the time offoreclosure are charged against the allowance for loan losses. Losses or gainsfrom the ultimate disposition of real estate owned are recorded as (gain) losson sale of other real estate owned in the consolidated statement of operations.Subsequent adjustments to the carrying value after foreclosure are recorded asadjustments to the valuation allowance against the REO balance.  At September 30, 2007, the allowanceagainst REO was $56.3 million, as compared to $8.5 million at December 31,2006.  Real estate owned at September 30,2007 was $366.1 million, or 128 percent, higher than at December 31,2006 as a result of an increase in foreclosures due to higher delinquencies anddeterioration in the prevailing real estate market and due to borrowers’inability to obtain replacement financing in conjunction with rising borrowingcosts due to resets, reduced housing demand in the marketplace and lowerhousing prices.

 

37

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We have realized a losson disposition of real estate owned in the amount of $7.6 million and $7.8million for the three and nine months ended September 30, 2007, respectively,as compared to a gain of $302 thousand and $1.3 million for the three and ninemonths ended September 30, 2006, respectively.  The increase in losses on the disposition ofREO is reflective of the pace at which home prices have deteriorated.

 

The followingtables and discussion present the REO and REO allowance for the continuingoperations.

 

Thefollowing table presents a rollforward of the real estate owned (in thousands):

 
| ** **                            | ** ** | **Nine months  ended September 30,  2007** | ** ** | **Year ended  December 31,  2006** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------|------------|
| Beginning balance                     |       | $                                                         | 137,331    |                                         | $          | 46,092 |   |
| Additions                             |       | 440,979                                                   |       | 181,120                                      |       |
| Sales                                 |       | (170,153                                                  | )          | (82,553                                      | )          |
| Net realizable value (NRV) adjustment |       | (47,685                                                   | )          | (7,328                                       | )          |
| REO, net                              |       | $                                                         | 360,472    |                                         | $          | 137,331 |   |

 

The CLTV of theloans converted to REO was 96 percent as of September 30, 2007, based oninformation we had at the point of origination of the loan.  Predominantlyall of the REO’s held by the securitized trusts.

 

The Company maintains anallowance for loan losses. In evaluating the adequacy of the allowance for loanlosses, management takes many factors into consideration. For instance, adetailed analysis of historical loan performance data is accumulated andreviewed. This data is analyzed for loss performance and prepayment performanceby product type, origination year and securitization issuance. The data is alsobroken down by collection status.  Ourestimate of the required allowance for these loans is developed by estimatingboth the rate of default of the loans and the amount of loss in the event ofdefault. The rate of default is assigned to the loans based on their attributes(*e.g.,* original loan-to-value, borrowercredit score, documentation type, etc.) and collection status. The rate ofdefault is based on analysis of migration of loans from each aging category.The loss severity is determined by estimating the net proceeds from theultimate sale of the foreclosed property. The results of that analysis are thenapplied to the current mortgage portfolio and an estimate is created. We believe that pooling of mortgages withsimilar characteristics is an appropriate methodology in which to evaluate theallowance for loan losses.

 

Activity for allowance for loan losses for the periodsindicated was as follows:

 
| ** **                                                            | ** ** | **At September 30,  2007** | ** ** | **At December 31,  2006** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| Securitized mortgage collateral and held-for-investment - Residential |       | $                                    | 900,495    |                                | $          | 69,711 |   |
| Securitized mortgage collateral and held-for-investment - Commercial  |       | 10,723                               |       | 7,973                               |       |
| Allowance for loan losses                                             |       | $                                    | 911,218    |                                | $          | 77,684 |   |

 

The allowance forloan losses for the periods indicated consisted of the following:

 
| ** **                     | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Beginning balance              |       | $                                                    | 214,734    |                                                | $          | 57,388 |   | $ | 77,684 |   | $ | 67,831 |   |
| Provision for loan losses      |       | 789,445                                              |       | 3,533                                               |       | 979,740 |   | 3,638 |   |
| Charge-offs, net of recoveries |       | (92,961                                              | )          | (5,540                                              | )          | (146,206 | ) | (16,088 | ) |
| Allowance for loan losses      |       | $                                                    | 911,218    |                                                | $          | 55,381 |   | $ | 911,218 |   | $ | 55,381 |   |

 

38

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Management also recognizes that there are qualitativefactors that must be taken into consideration when evaluating and measuringinherent loss in our loan portfolios. These items include, but are not limitedto, economic indicators that may affect the borrower’s ability to pay, changesin value of collateral, projected loss curves, political factors, marketconditions, competitor’s performance, market perception and industrystatistics.  TheCompany provides loan losses in accordance with its policies that include ananalysis of the loan portfolio to determine estimated loan losses in the next12 to 18 months.  The determination ofthe level of the allowance for loan losses and, correspondingly, the provisionfor loan losses, is based on delinquency trends and prior loan loss experienceand management’s judgment and assumptions regarding various matters, includinggeneral economic conditions and loan portfolio composition. Managementcontinually evaluates these assumptions and various relevant factors impactingcredit quality and inherent losses. While our delinquency rates have increased, we believe, based on currentmarket conditions, our total allowance for loan losses is adequate to absorblosses inherent in our mortgage portfolio as of September 30, 2007.

* *

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

* *

*Prepayment Risk.*The Company uses prepayment penalties as a methodof partially mitigating prepayment risk. Mortgage industry evidence suggeststhat the prior years increase in home appreciation rates and lower paymentoption mortgage products over the last three years had been a significantfactor affecting borrowers refinancing decisions. As rates increase and housingprices decline, borrowers will find it more difficult to refinance to obtaincheaper financing. If borrowers are unable to pay their mortgage payments atthe adjusted rate, delinquencies may increase. The three-month averageprepayment rate (“CPR”) decreased to 20 percent at September 30, 2007 from 36 percent as of December 31,2006.  This reduction in prepayment rateshas resulted in an increase in the amortization period for premiums paid toacquire loans, which has increased interest income, as described under “EstimatedTaxable Income.”

 

As of September 30,2007, the twelve-month CPR of mortgages held as securitized mortgage collateralwas 29 percent as compared to a 38 percent twelve-month average CPR as of December 31,2006. Prepayment penalties are charged to borrowers for mortgages that are paidearly and recorded as interest income. Income from prepayment penalties helpsoffset amortization of loan premiums and securitization costs. Due to theprepayment of mortgages during the first nine months of 2007 prepaymentpenalties were received from borrowers and were recorded as interest income andincreased the yield on average mortgage assets by 9 basis points as compared to21 basis points for the same period in 2006.

 

39

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*Results of Operations*

* *

*For the Three Months Ended**September **30, 2007 compared to the Three Months Ended**September **30, 2006*

 

Condensed Statements ofOperations Data

(dollars in thousands, except share data)

 
| ** **                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Interest income                                      |       | $                                                        | 313,772    |   | $ | 261,054 |   | $ | 52,718 |   | 20 | % |
| Interest expense                                     |       | 302,074                                                  |       | 292,480 |   | 9,594 |   | 3 |   |
| Net interest income (expense)                        |       | 11,698                                                   |       | (31,426 | ) | 43,124 |   | 137 |   |
| Provision for loan losses                            |       | 789,445                                                  |       | 3,533 |   | 785,912 |   | 22,245 |   |
| Net interest expense after provision for loan losses |       | (777,747                                                 | )          | (34,959 | ) | 742,788 |   | 2,125 |   |
| Total non-interest income                            |       | (194,720                                                 | )          | (80,988 | ) | 113,732 |   | 140 |   |
| Total non-interest expense                           |       | 21,635                                                   |       | 6,780 |   | 14,855 |   | 219 |   |
| Income tax expense                                   |       | 3,056                                                    |       | 1,700 |   | 1,356 |   | 80 |   |
| Net (loss) earnings from continuing operations       |       | (997,158                                                 | )          | (124,427 | ) | 872,731 |   | 701 |   |
| Loss from discontinued operations, net               |       | (194,077                                                 | )          | (3,264 | ) | (190,813 | ) | (5,846 | ) |
| Net (loss) earnings                                  |       | $                                                        | (1,191,235 | ) | $ | (127,691 | ) | $ | 1,063,544 |   | 833 | % |
|                                                 |       |                                                     |       |   |   |   |   |   |   |
| Net (loss) earnings per share - diluted              |       | $                                                        | (15.66     | ) | $ | (1.68 | ) | $ | (13.98 | ) | (833 | )% |
| Dividends declared per common share                  |       | $                                                        | —     |   | $ | 0.25 |   | $ | (0.25 | ) | (100 | )% |

 

For the Nine Months EndedSeptember 30, 2007 compared to the Nine Months Ended September 30,2006

 
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **Increase  (Decrease)** | ** ** | **%  Change** | ** ** |
| Interest income                                      |       | $                                                       | 936,364    |   | $ | 849,283 |   | $ | 87,081 |   | 10 | % |
| Interest expense                                     |       | 909,060                                                 |       | 896,023 |   | 13,037 |   | 1 |   |
| Net interest income (expense)                        |       | 27,304                                                  |       | (46,740 | ) | 74,044 |   | 158 |   |
| Provision for loan losses                            |       | 979,740                                                 |       | 3,638 |   | 976,102 |   | 26,831 |   |
| Net interest expense after provision for loan losses |       | (952,436                                                | )          | (50,378 | ) | 902,058 |   | 1,791 |   |
| Total non-interest income                            |       | (144,035                                                | )          | 91,312 |   | (235,347 | ) | (258 | ) |
| Total non-interest expense                           |       | 54,161                                                  |       | 17,708 |   | 36,453 |   | 206 |   |
| Income tax expense                                   |       | 12,012                                                  |       | 8,070 |   | 3,942 |   | 49 |   |
| Net (loss) earnings from continuing operations       |       | (1,162,644                                              | )          | 15,156 |   | 1,177,800 |   | 7,771 |   |
| Loss from discontinued operations, net               |       | (302,806                                                | )          | (30,923 | ) | (271,883 | ) | (879 | ) |
| Net (loss) earnings                                  |       | $                                                       | (1,465,450 | ) | $ | (15,767 | ) | $ | 1,449,683 |   | 9,194 | % |
|                                                 |       |                                                    |       |   |   |   |   |   |   |
| Net (loss) earnings per share - diluted              |       | $                                                       | (19.26     | ) | $ | (0.21 | ) | $ | (19.05 | ) | (9,199 | )% |
| Dividends declared per common share                  |       | $                                                       | 0.10       |   | $ | 0.75 |   | $ | (0.65 | ) | (87 | )% |

 

*Net Interest Income (Expense)*

 

We earn net interestincome primarily from mortgage assets which include securitized mortgagecollateral, mortgages held-for-investment, mortgages held-for-sale, andinvestment securities available-for-sale, or collectively, “mortgage assets,”and, to a lesser extent, interest income earned on cash and cash equivalents.Interest expense is primarily interest paid on borrowings on mortgage assets,which include securitized mortgage borrowings, reverse repurchase agreementsand borrowings secured by investment securities available-for-sale. Netinterest income also includes (1) amortization of acquisition costs onmortgages acquired from the mortgage operations, (2) accretion of loandiscounts, which primarily 

 

40

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represents theamount allocated to mortgage servicing rights when they are sold to thirdparties and mortgages are transferred to the long-term investment operationsfrom the mortgage operations and retained for long-term investment, (3) amortizationof securitized mortgage securitization expenses and, to a lesser extent, (4) amortizationof securitized mortgage bond discounts.

 

The following tablesummarizes average balance, interest and weighted average yield on mortgageassets and borrowings on mortgage assets for the periods indicated for combinedcontinued and discontinued operations (dollars in thousands):

 
| ** **                                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                                                           | ** ** | **Average****Balance**                                   | ** ** | **Interest** | ** ** | **(8)****Yield** | ** ** | **Average****Balance** | ** ** | **Interest** | ** ** | **(8)****Yield** | ** ** |
| **MORTGAGE ASSETS**                                                  |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by mortgages                  |       | $                                                        | 14,443     |   | $ | 1,459 |   | 40.41 | % | $ | 31,503 |   | $ | 1,509 |   | 19.16 | % |
| Securitized mortgage collateral (1)                                  |       | 19,662,219                                               |       | 307,433 |   | 6.25 | % | 19,581,945 |   | 257,995 |   | 5.27 | % |
| Mortgages held-for-investment and held-for-sale                      |       | 1,222,466                                                |       | 23,229 |   | 7.60 | % | 2,073,935 |   | 33,405 |   | 6.44 | % |
| Finance receivables                                                  |       | 38,819                                                   |       | 1,584 |   | 16.32 | % | 263,106 |   | 5,230 |   | 7.95 | % |
| Total mortgage assets\ interest income                               |       | $                                                        | 20,937,947 |   | $ | 333,705 |   | 6.38 | % | $ | 21,950,489 |   | $ | 298,139 |   | 5.43 | % |
|                                                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                       |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                                      |       | $                                                        | 19,458,646 |   | $ | 295,325 |   | 6.07 | % | $ | 19,190,482 |   | $ | 289,925 |   | 6.04 | % |
| Reverse repurchase agreements                                        |       | 1,225,321                                                |       | 21,959 |   | 7.17 | % | 2,098,722 |   | 32,552 |   | 6.20 | % |
| Total borrowings on mortgage assets\ interest expense                |       | $                                                        | 20,683,967 |   | $ | 317,284 |   | 6.14 | % | $ | 21,289,204 |   | $ | 322,477 |   | 6.06 | % |
|                                                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (2)**                                          |       |                                                     |       |   |   | 0.24 | % |   |   |   |   | (0.63 | )% |
| **Net Interest Margin (3)**                                          |       |                                                     |       |   |   | 0.31 | % |   |   |   |   | (0.44 | )% |
|                                                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income on mortgage assets                               |       |                                                     |       | $ | 16,421 |   | 0.31 | % |   |   | $ | (24,338 | ) | (0.44 | )% |
| Less: Accretion of loan discounts (4)                                |       |                                                     |       | (12,539 | ) | (0.23 | )% |   |   | (14,837 | ) | (0.27 | )% |
| Adjusted by net cash receipts on derivatives (5)                     |       |                                                     |       | 28,921 |   | 0.55 | % |   |   | 60,630 |   | 1.10 | % |
| **Adjusted Net Interest Margin (6)**                                 |       |                                                     |       | $ | 32,803 |   | 0.63 | % |   |   | $ | 21,455 |   | 0.39 | % |
|                                                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization of loan premiums and securitization costs (7) |       |                                                     |       | $ | 32,212 |   | (0.62 | )% |   |   | $ | 54,594 |   | (0.99 | )% |

 

 

41

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| ** **                                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                                                           | ** ** | **Average  Balance**                                    | ** ** | **Interest** | ** ** | **(8)  Yield** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **(8)  Yield** | ** ** |
| **MORTGAGE ASSETS**                                                  |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities collateralized by mortgages                  |       | $                                                       | 24,723     |   | $ | 4,767 |   | 25.71 | % | $ | 29,722 |   | $ | 2,686 |   | 12.05 | % |
| Securitized mortgage collateral (1)                                  |       | 20,502,803                                              |       | 930,086 |   | 6.05 | % | 21,667,571 |   | 838,452 |   | 5.16 | % |
| Mortgages held-for-investment and held-for-sale                      |       | 1,347,949                                               |       | 64,541 |   | 6.38 | % | 1,782,364 |   | 86,603 |   | 6.48 | % |
| Finance receivables                                                  |       | 277,410                                                 |       | 9,776 |   | 4.70 | % | 284,295 |   | 15,037 |   | 7.05 | % |
| Total mortgage assets\ interest income                               |       | $                                                       | 22,152,885 |   | $ | 1,009,170 |   | 6.07 | % | $ | 23,763,952 |   | $ | 942,778 |   | 5.29 | % |
|                                                                 |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                       |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage borrowings                                      |       | $                                                       | 20,135,424 |   | $ | 893,253 |   | 5.91 | % | $ | 21,233,648 |   | $ | 888,144 |   | 5.58 | % |
| Reverse repurchase agreements                                        |       | 1,654,003                                               |       | 72,932 |   | 5.88 | % | 1,870,276 |   | 81,881 |   | 5.84 | % |
| Total borrowings on mortgage assets\ interest expense                |       | $                                                       | 21,789,427 |   | $ | 966,185 |   | 5.91 | % | $ | 23,103,924 |   | $ | 970,025 |   | 5.60 | % |
|                                                                 |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest Spread (2)                                              |       |                                                    |       |   |   | 0.16 | % |   |   |   |   | (0.31 | )% |
| Net Interest Margin (3)                                              |       |                                                    |       |   |   | 0.26 | % |   |   |   |   | (0.15 | )% |
|                                                                 |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Net Interest (expense) Income on Mortgage Assets                     |       |                                                    |       | $ | 42,985 |   | 0.26 | % |   |   | $ | (27,247 | ) | (0.15 | )% |
| Less: Accretion of loan discounts (4)                                |       |                                                    |       | (41,247 | ) | (0.25 | )% |   |   | (48,910 | ) | (0.27 | )% |
| Adjusted by net cash receipts on derivatives (5)                     |       |                                                    |       | 105,019 |   | 0.63 | % |   |   | 156,633 |   | 0.88 | % |
| Adjusted Net Interest Margin (6)                                     |       |                                                    |       | $ | 106,757 |   | 0.64 | % |   |   | $ | 80,476 |   | 0.45 | % |
|                                                                 |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization of loan premiums and securitization costs (7) | ** ** | ** **                                              |       | $ | 117,242 |   | (0.71 | )% | ** ** |   | $ | 181,071 |   | (1.02 | )% |

 

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(1)                                  Interest on securitized mortgage collateral includesamortization of acquisition cost on mortgages acquired from the mortgageoperations and accretion of loan discounts.

(2)                                  Net interest spread on mortgage assets is calculatedby subtracting the weighted average yield on total borrowings on mortgageassets from the weighted average yield on total mortgage assets.

(3)                                  Net interest margin on mortgage assets is calculatedby subtracting interest expense on total borrowings on mortgage assets frominterest income on total mortgage assets and then dividing by total averagemortgage assets and annualizing the quarterly margin.

(4)                                  Yield represents income from the accretion of loandiscounts, included in (1) above, divided by total average mortgageassets.

(5)                                  Yield represents net cash receipts on derivativesdivided by total average mortgage assets.

(6)                                  Adjusted net interest margin on mortgage assets iscalculated by subtracting interest expense on total borrowings on mortgageassets, accretion of loan discounts and net cash receipts on derivatives frominterest income on total mortgage assets divided by total average mortgageassets. Net cash receipts on derivatives are a component of realized gain onderivative instruments on the consolidated statements of operations. Adjustednet interest margin on mortgage assets is a non-GAAP financial measurement;however, the reconciliation provided in this table is intended to meet therequirements of Regulation G as promulgated by the SEC for thepresentation of non-GAAP financial measurements. We believe that thepresentation of adjusted net interest margin on mortgage assets is a usefuloperating performance measure for our investors as it more closely reflects theeconomics of net interest margins on mortgage assets by providing informationto evaluate net interest income attributable to net investments.

(7)                                  The amortization of loan premiums and securitizationcosts are components of interest income and interest expense, respectively.Yield represents the cost of amortization of net loan premiums andsecuritization costs divided by total average mortgage assets.

(8)                                The yields represent annualized yields based on theresults for the quarter and year-to-date.

(9)                                The yields presented above represents the yields ofcontinuing and discontinued operations.

 

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

* *

Increasesin net interest income were primarily due to an improvement in net interestmargins on mortgage assets as a result of the following:

 

·                          theCompany’s loans have adjusted upward due to resets and the layering ofadditional mortgage loans at higher rates,

 

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

 

·                          theyield on borrowing costs have remained flat from September 2006 through September 2007.

 

Netinterest income for the third quarter of 2007 increased $43.1 million (137percent) as compared to 2006. The increase was primarily due to net interestmargins on mortgage assets increasing by 75 basis points to 0.31 percent forthe third quarter of 2007 as compared to (0.44 percent) for 2006. The increase in adjusted net interest margins onmortgage assets was primarily due to a positive variance of 95 basis points inyield on mortgage assets, as coupons have adjusted, and a decrease of 37 basispoints in amortization of premiums and securitization costs, partially offsetby an unfavorable variance of 8 basis points in borrowing costs and a 55 basispoint decrease from realized gains on derivative assets.

 

As aresult of the illiquidity in the mortgage market and borrowers’ inability toobtain cheaper financing we are seeing a corresponding decline in mortgageprepayment speeds which we started to observe in our portfolio during 2007.Additionally, as home prices have declined in most areas, therefore increasingthe effective loan to value ratios, borrowers’ even those with higher creditscores are facing limited loan refinancing options.  Our securitized mortgage collateral reflectsreduced prepayments with the three-month CPR rate declining to 20 percent as ofSeptember 30, 2007 from 36 percent as of December 31, 2006.

 

Amortizationof loan premiums and securitization expenses decreased by 37 basis points to0.62 percent of average mortgage assets during the third quarter of 2007 ascompared to 0.99 percent of average mortgage assets during the same period in2006. The decrease in amortization of premiums and securitization expenses wasthe result of a decrease in actual prepayments, and a decrease in expectedprepayments, which has increased the number of months in which the Companyamortizes the premiums, therefore increasing interest income.

 

Asubstantial portion of our long-term mortgage investment portfolio consists ofmortgages with prepayment penalty features that are primarily designed to helpminimize the rate of early mortgage prepayments.  However, if borrowers do prepay, a prepaymentpenalty is charged which helps partially offset additional amortization of loanpremiums and securitization costs related to the prepaid mortgages. During thethird quarter of 2007, prepayment penalties received from borrowers wererecorded as interest income and decreased 14 basis points to 6 basis points ofmortgage assets as compared to 20 basis points of mortgage assets in the thirdquarter of 2006.

 

Adjustednet interest margins on mortgage assets, which is a non-GAAP financialmeasurement as indicated in the yield table above, increased by 24 basis pointsas compared to an increase of 75 basis points on net interest margin onmortgage assets in the prior year. Adjusted net interest margin on mortgage assets did not increase as muchas net interest margin on mortgage assets primarily due to a 55 basis pointdecrease in realized gains from derivative instruments.

 

Adjustednet interest margins were also affected during the third quarter of 2007 by ourinterest rate risk management policies which include the employment of balanceguarantees that limit our derivatives to no more than 100%  coverage of the principal amount outstandingon certain securitized mortgage borrowings at any given time. Our interest raterisk management policies are formulated with the intent to offset the potentialadverse effects of changing interest rates primarily associated with cash flowson adjustable rate securitized mortgage borrowings. By design, our currentinterest rate risk management program typically provides 20%  to 25% coverage of the outstanding principalbalance of our six month LIBOR ARMs and 80% to no more than 98% coverage ofthe outstanding principal balance of intermediate, or hybrid, ARMs at thepoint in time that we securitize the mortgages. During the third quarter, as a result of declining interest rates andrising derivative liabilities, the Company closed substantially all open hedgepositions that were not included in the bankruptcy remote securitized mortgagecollateral trusts, which included all hedge positions on its loansheld-for-sale.

 

43

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*For the threemonths ended**September *30, 2007 compared tothe three months ended*September *30, 2006**

 

Increases in netinterest income were primarily due to an improvement in net interest margins onmortgage assets as a result of the following:

 

·                                          theCompany’s loans have adjusted upward due to resets and the layering ofadditional mortgage loans at higher rates,

 

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

 

·                                          theyield on borrowing costs have remained flat from September 2006 through September 2007.

 

Net interest income forthe third quarter of 2007 increased $43.1 million (137 percent) as compared to2006. The increase was primarily due to net interest margins on mortgage assetsincreasing by 75 basis points to 0.31 percent for the third quarter of 2007 ascompared to (0.44 percent) for 2006. Theincrease in adjusted net interest margins on mortgage assets was primarily dueto a positive variance of 95 basis points in yield on mortgage assets, ascoupons have adjusted, and a decrease of 37 basis points in amortization ofpremiums and securitization costs, partially offset by an unfavorable varianceof 8 basis points in borrowing costs and a 55 basis point decrease fromrealized gains on derivative assets.

 

As a result of theilliquidity in the mortgage market and borrowers’ inability to obtain cheaperfinancing we are seeing a corresponding decline in mortgage prepayment speedswhich we started to observe in our portfolio during 2007. Additionally, as homeprices have declined in most areas, therefore increasing the effective loan tovalue ratios, borrowers’ even those with higher credit scores are facinglimited loan refinancing options.  Oursecuritized mortgage collateral reflects reduced prepayments with thethree-month CPR rate declining to 20 percent as of September 30, 2007 from36 percent as of December 31, 2006.

 

Amortization of loanpremiums and securitization expenses decreased by 37 basis points to 0.62percent of average mortgage assets during the third quarter of 2007 as comparedto 0.99 percent of average mortgage assets during the same period in 2006. Thedecrease in amortization of premiums and securitization expenses was the resultof a decrease in actual prepayments, and a decrease in expected prepayments,which has increased the number of months in which the Company amortizes thepremiums, therefore increasing interest income.

 

A substantial portion ofour long-term mortgage investment portfolio consists of mortgages withprepayment penalty features that are primarily designed to help minimize therate of early mortgage prepayments. However, if borrowers do prepay, a prepayment penalty is charged whichhelps partially offset additional amortization of loan premiums andsecuritization costs related to the prepaid mortgages. During the third quarterof 2007, prepayment penalties received from borrowers were recorded as interestincome and decreased 14 basis points to 6 basis points of mortgage assets ascompared to 20 basis points of mortgage assets in the third quarter of 2006.

 

Adjusted net interestmargins on mortgage assets, which is a non-GAAP financial measurement asindicated in the yield table above, increased by 24 basis points as compared toan increase of 75 basis points on net interest margin on mortgage assets in theprior year.  Adjusted net interest marginon mortgage assets did not increase as much as net interest margin on mortgageassets primarily due to a 55 basis point decrease in realized gains fromderivative instruments.

 

Adjusted net interestmargins were also affected during the third quarter of 2007 by our interestrate risk management policies which include the employment of balanceguarantees that limit our derivatives to no more than 100%  coverage of the principal amount outstandingon certain securitized mortgage borrowings at any given time. Our interest raterisk management policies are formulated with the intent to offset the potentialadverse effects of changing interest rates primarily associated with cash flowson adjustable rate securitized mortgage borrowings. By design, our currentinterest rate risk management program typically provides 20%  to 25% coverage of the outstanding principalbalance of our six month LIBOR ARMs and 80% to no more than 98% coverageof the outstanding principal balance of intermediate, or hybrid, ARMs atthe point in time that we securitize the mortgages.  During the third quarter, as a result ofdeclining interest rates and rising derivative liabilities, the Company closedsubstantially all open hedge positions that were not included in the bankruptcyremote securitized borrowings collateral trusts, which included all hedgepositions on its loans held-for-sale.

 

44

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*For the nine months ended**September *30, 2007 compared tothe nine months ended*September *30, 2006**

 

Increases in netinterest income were primarily due to an improvement in net interest margins onmortgage assets as a result of the following:

 

·                                          theCompany’s loans have adjusted upward due to resets and the layering ofadditional mortgage loans at higher rates,

 

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

 

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

 

Net interest income forthe first nine months of 2007 increased $74.0 million (158 percent) as comparedto 2006. The increase was primarily due to net interest margins on mortgageassets increasing by 41 basis points to 0.26 percent for the first nine monthsof 2007 as compared to (0.15 percent) for the same period in 2006.  Theincrease in adjusted net interest margins on mortgage assets was primarily dueto a positive variance of 78 basis points in yield on mortgage assets, ascoupons have adjusted, and a decrease of 31 basis points in amortization ofpremiums and securitization costs, partially offset by an unfavorable varianceof 31 basis points in borrowing costs and an 25 basis point decrease fromrealized gains on derivative assets.

 

As a result of theilliquidity in the mortgage market and borrowers’ inability to obtain cheaperfinancing we are seeing a corresponding decline in mortgage prepayment speedswhich we started to observe in our portfolio during 2007. Additionally, as homeprices have declined in most areas, therefore increasing the effective loan tovalue ratios, borrowers’ with higher credit scores are facing limited loanrefinancing options.  Our securitizedmortgage collateral reflects reduced prepayments with the three-month CPR ratedeclining to 20 percent as of September 30, 2007 from 36 percent as of December 31,2006.

 

Amortization of loanpremiums and securitization expenses decreased by 31 basis points to 0.71percent of average mortgage assets during the first nine months of 2007 ascompared to 1.02 percent of average mortgage assets during the same period in2006. The decrease in amortization of premiums and securitization expenses wasthe result of a decrease in actual prepayments, and a decrease in expectedprepayment speeds, which has increased the number of months in which theCompany amortizes the premiums, therefore increasing interest income.

 

A substantial portion ofour long-term mortgage investment portfolio consists of mortgages withprepayment penalty features that are primarily designed to help minimize therate of early mortgage prepayments. However, if borrowers do prepay, a prepayment penalty is charged whichhelps partially offset additional amortization of loan premiums andsecuritization costs related to the prepaid mortgages. During the first ninemonths of 2007, prepayment penalties received from borrowers were recorded asinterest income and decreased 12 basis points to 9 basis points of mortgageassets as compared to 21 basis points of mortgage assets during the same periodof 2006.

 

Adjusted net interestmargins on mortgage assets, which is a non-GAAP financial measurement asindicated in the yield table above, increased by 19 basis points as compared toan increase of 41 basis points on net interest margin on mortgage assets in theprior year.  Adjusted net interest marginon mortgage assets did not increase as much as net interest margin on mortgageassets primarily due to a 25 basis point decrease in realized gains fromderivative instruments. Realized gains from derivative instruments partiallyoffset the decline in net interest margins on mortgage assets associated withincreases in borrowing costs.

 

Adjusted net interestmargins were also affected during the second half of 2007 by our interest raterisk management policies which include the employment of balance guaranteesthat limit our derivatives to no more than 100% coverage of the principalamount outstanding on certain securitized mortgage borrowings at any giventime. Our interest rate risk management policies are formulated with the intentto offset the potential adverse effects of changing interest rates primarilyassociated with cash flows on adjustable rate securitized mortgage borrowings.By design, our current interest rate risk management program typically provides20% to 25% coverage of the outstanding principal balance of our six month LIBORARMs and 80% to no more than 98% coverage of the outstanding principalbalance of intermediate, or hybrid, ARMs at the point in time that wesecuritize the mortgages.  During thethird quarter, as a result of declining interest rates and rising derivativeliabilities, the Company closed substantially all open hedge positions thatwere not included in the bankruptcy remote securitized borrowings collateraltrusts, which included all hedge positions on its loans held-for-sale.

 

45

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For further informationon our interest rate risk management policies refer to Item 3. “Quantitativeand Qualitative Disclosures About Market Risk.”

 

*Provision for Loan Losses*

 

The Company provides forloan losses in accordance with its policies that include an analysis of theloan portfolio to determine estimated loan losses expected in the next 12 to 18months.  The determination of the levelof the allowance for loan losses and, correspondingly, the provision for loanlosses, is based on delinquency trends and prior loan 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 impactingcredit quality and inherent losses.  Theresults of that analysis are then applied to the current mortgage portfolio andan estimate is created.

 

The allowance for loanlosses was $911.2 million at September 30, 2007, and was comprised ofspecific reserves of $4.0 million and a loan portfolio reserve of $907.2million. Exclusive of specific reserves, the Company maintained an allowancefor securitized mortgage collateral and mortgage loans held-for-investment forloan losses of 485 basis points at September 30, 2007 compared to 34 basispoints at December 31, 2006. The Company believes the total allowance forloan losses is adequate to absorb losses inherent in the loan portfolio at September 30,2007, barring deterioration in future trends in excess of our expectations.

 

For further informationon delinquencies in our long-term investment portfolio and non-performingassets refer to “Financial Condition and Results of Operations—Credit Risk.”

 

*Non-Interest Income*

 

*For the Three Months Ended September 30,2007 compared to the Three Months Ended September 30, 2006:*

 

Changes in Non-InterestIncome

(dollars in thousands)

 
| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative  instruments |       | $                                                        | (137,553   | ) | $ | (150,051 | ) | $ | 12,498 |   | 8 | % |
| Realized gain from derivative instruments       |       | 28,815                                                   |       | 60,595 |   | (31,780 | ) | (52 | ) |
| Provision for repurchases                       |       | (4,553                                                   | )          | — |   | (4,553 | ) | (100 | ) |
| (Loss) gain on sale of other real estate  owned |       | (5,571                                                   | )          | 485 |   | (6,056 | ) | (1249 | ) |
| Amortization of mortgage servicing rights       |       | (188                                                     | )          | (380 | ) | 192 |   | 51 |   |
| Other (expense) income                          |       | (1,056                                                   | )          | 8,383 |   | (9,439 | ) | (113 | ) |
| Lower of cost or market writedown               |       | (6,657                                                   | )          | — |   | (6,657 | ) | (100 | ) |
| Loss on sale of loans                           |       | (27,586                                                  | )          | (20 | ) | (27,566 | ) | (137,830 | )  |
| Provision for REO losses                        |       | (40,371                                                  | )          | — |   | (40,371 | ) | (100 | ) |
| Total non-interest income                       |       | $                                                        | (194,720   | ) | $ | (80,988 | ) | $ | (113,732 | ) | (140 | )% |

 

*Changein Fair Value of Derivative Instruments.* The change in fair value of derivativeinstruments increased income by $12.5 million (8 percent) during the thirdquarter of 2007 as compared to the third quarter of 2006. The amount of marketvaluation adjustment is primarily the result of changes in the expectation offuture interest rates and partially offset by actual cash receipts onderivative instruments. We primarily enter into derivative contracts to offseta portion of the changes in cash flows associated with securitized mortgageborrowings. We record a market valuation adjustment for these derivatives, as acurrent period expense or income.  Changes in fair value of derivatives at IMH areincluded in GAAP net earnings and excluded for purposes of calculatingestimated taxable income.

 

*RealizedGain from Derivative Instruments*.  Realized gains from derivatives decreased by$31.8 million (52 percent) during the third quarter of 2007 as compared to thethird quarter of 2006, or 55 basis points of total average mortgage assetsduring the second quarter of 2007 as compared to 110 basis points of total averagemortgage assets during the second quarter of 2006.  The decrease in realized gains is primarilydue to a decrease in the notional balance of the trusts.  Realized gains

 

46

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from derivativesare recorded as current period expense or revenue on our consolidated financialstatements and are included in the calculation of taxable income. Realized gains exclude the mark to market gains orlosses that are realized for tax purposes at the taxable REIT subsidiaries whenthe loans held-for-sale are deposited into the securitization trust, and therelated derivatives are deposited into a swap trust. These gains are notrealized for GAAP purposes, as the deposit of the derivatives into the swaptrust are considered an inter-company transfer, as the REIT consolidates theswap trust. For GAAP purpose, these gains and losses are included in change infair value of derivative instruments.

 

*Losson Sale of Loans. *TheCompany recorded a loss on the sale of loans of $27.6 million during the thirdquarter of 2007 as a result of a $24.4 million loss on the sale of all theremaining financial interest in one of the Company’s securitizations that theCompany sold to a lender in settlement of all obligations owed on that security.

 

*Provisionfor REO loss. *Duringthe third quarter of 2007, the Company recorded a provision for REO losses inthe amount of $40.4 million as a result of changes in the net realizable valueof the real estate owned subsequent to the foreclosure date, due to increasesin loss severities on recent REO liquidations as a result of an increase inhomes for sale in the marketplace, a reduction in demand due to decliningprices (as home buyers postpone home purchases, thereby exacerbating home pricedeclines), and a reduced ability for borrowers to obtain financing.

 

Changes in Non-InterestIncome

(dollars in thousands)

 
| ** **                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                              | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Change in fair value of derivative  instruments |       | $                                                       | (138,334   | ) | $ | (91,155 | ) | $ | (47,179 | ) | (52 | )% |
| Realized gain from derivative instruments       |       | 103,840                                                 |       | 156,582 |   | (52,742 | ) | (34 | ) |
| Provision for repurchases                       |       | (4,553                                                  | )          | — |   | (4,553 | ) | (100 | ) |
| (Loss) gain on sale of other real estate  owned |       | (6,716                                                  | )          | 1,740 |   | (8,456 | ) | (486 | ) |
| Amortization of mortgage servicing rights       |       | (603                                                    | )          | (1,112 | ) | 509 |   | 46 |   |
| Lower of cost or market writedown               |       | (7,396                                                  | )          | — |   | (7,396 | ) | (100 | ) |
| Other (expense) income                          |       | 4,367                                                   |       | 26,664 |   | (22,297 | ) | (84 | ) |
| Loss on sale of loans                           |       | (26,195                                                 | )          | (1,407 | ) | (24,788 | ) | (1762 | ) |
| Provision for REO losses                        |       | (68,445                                                 | )          | — |   | (68,445 | ) | (100 | ) |
| Total non-interest income                       |       | $                                                       | (144,035   | ) | $ | 91,312 |   | $ | (235,347 | ) | (258 | )% |

 

*RealizedGain from Derivative Instruments*. Realized gains fromderivatives decreased by $52.7 million (34 percent) during the first ninemonths of 2007 as compared to the same period in 2006, or 63 basis points oftotal average mortgage assets during the first nine months of 2007 as comparedto 88 basis points of total average mortgage assets during the same period in2006.  The decrease in realized gains isprimarily due to a decrease in the notional balance of the trusts.  Realized gains from derivatives are recordedas current period expense or revenue on our consolidated financial statementsand are included in the calculation of taxable income.

 

*Changein Fair Value of Derivative Instruments.* The change in fair value of derivativeinstruments decreased by $47.2 million (52 percent) during the third quarter of2007 as compared to the third quarter of 2006. The amount of market valuationadjustment is primarily the result of actual cash receipts on derivativeinstruments, and changes in the expectation of future interest rates. Weprimarily enter into derivative contracts to offset a portion of the changes incash flows associated with securitized mortgage borrowings, as the Federal OpenMarket Committee has reduced the federal funds rate by 50 basis points in September 2007.  We record a market valuation adjustment forthese derivatives as current period expense or income.  Changes infair value of derivatives at IMH are included in GAAP net earnings and excludedfor purposes of calculating estimated taxable income.

 

*Losson Sale of Loans. *TheCompany recorded a loss on the sale of loans of $26.2 million during the ninemonths ended September 30, 2007 as a result of a $24.4 million loss on thesale of all of the remaining financial interest in one of the Company’ssecuritizations that the Company sold to a lender in settlement of allobligations owed on that security.

 

47

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*Provisionfor REO loss. *Duringthe first nine months of 2007, the Company recorded a provision for REO lossesin the amount of $68.4 million as a result of changes in the net realizablevalue of the real estate owned subsequent to the foreclosure date, due toincreases in severities on REO liquidations as a result of an increase in homesfor sale in the marketplace, a reduction in demand due to declining prices (ashome buyers postpone home purchases, thereby exacerbating home price declines),and a reduced ability for borrowers to obtain financing.

 

*Non-Interest Expense*

 

Changes in Non-InterestExpense

(dollars in thousands)

 
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative and other  expense |       | $                                                        | 8,154      |   | $ | 1,868 |   | $ | 6,286 |   | 337 | % |
| Occupancy expense                             |       | 4,814                                                    |       | 413 |   | 4,401 |   | 1,066 |   |
| Personnel expense                             |       | 6,127                                                    |       | 2,234 |   | 3,893 |   | 174 |   |
| Data processing expense                       |       | 1,425                                                    |       | 1,478 |   | (53 | ) | (4 | ) |
| Professional services                         |       | 622                                                      |       | 285 |   | 337 |   | 118 |   |
| Equipment expense                             |       | 493                                                      |       | 502 |   | (9 | ) | (2 | ) |
| Total operating expense                       |       | $                                                        | 21,635     |   | $ | 6,780 |   | $ | 14,855 |   | 219 | % |

 

Total non-interestexpenses increased $14.9 million (219 percent) on a quarter-over-quarter basisas general and administrative expenses have increased $6.3 million (337percent) and occupancy expenses have increased $4.4 million (1,066 percent)during the third quarter of 2007 as compared to same period in 2006.  The increase is primarily the result of thecosts from the Company’s retail mortgage operations that was acquired in thethird quarter of 2007, as a result there are not comparable expense amounts inthe prior year.  Occupancy expenseincreased $4.4 million from the prior year, as the Company recorded a $2.3 millionrestructuring charge for certain leases that were ceased to be used in itsretail operations.  Additionally, theretail mortgage operations included $1.7 million of lease charges with nocomparable costs in the prior year.

 

Changes in Non-InterestExpense

(dollars in thousands)

 
| ** **                                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                    | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| General and administrative and other  expense |       | $                                                       | 25,293     |   | $ | 5,831 |   | $ | 19,462 |   | 334 | % |
| Personnel expense                             |       | 14,089                                                  |       | 4,151 |   | 9,938 |   | 239 |   |
| Occupancy expense                             |       | 6,986                                                   |       | 1,263 |   | 5,723 |   | 453 |   |
| Data processing expense                       |       | 4,181                                                   |       | 3,434 |   | 747 |   | 22 |   |
| Professional services                         |       | 2,212                                                   |       | 1,464 |   | 748 |   | 51 |   |
| Equipment expense                             |       | 1,400                                                   |       | 1,565 |   | (165 | ) | (11 | ) |
| Total operating expense                       |       | $                                                       | 54,161     |   | $ | 17,708 |   | $ | 36,453 |   | 206 | % |

 

Total non-interestexpenses increased $36.5 million (206 percent) during the first nine months of2007 as general and administrative expenses have increased $19.5 million (324percent) and personnel expenses have increased $9.9 million (239 percent)during the third quarter of 2007 as compared to same period in 2006.  The increase is primarily the result of thecosts from the Company’s retail mortgage operations that was acquired in thethird quarter of 2007; as a result there are not comparable expense amounts inthe prior year.  Occupancy expenseincreased $5.7 million from the prior year, as the Company recorded a $2.3million restructuring charge for certain leases that were ceased to be used inits retail operations.  Additionally, theretail mortgage operations included $2.3 million of lease charges with nocomparable costs in the prior year.

 

48

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*Mortgage Acquisitions andOriginations by Continuing and Discontinuing Operations Channel*

 

The followingtable summarizes the principal balance of mortgage acquisitions andoriginations for the periods indicated (in thousands):

 
| ** **                             | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                                 | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **Principal**                                            | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| **By Production Channel:**   | ** ** | **Balance**                                              | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| Correspondent acquisitions:            | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Flow                                   |       | $                                                        | 24,581     |   | 4 |   | $ | 1,104,017 |   | 33 |   |
| Bulk                                   |       | 69,615                                                   |       | 11 |   | 1,191,686 |   | 35 |   |
| Total correspondent acquisitions       |       | 94,197                                                   |       | 15 |   | 2,295,703 |   | 68 |   |
| Retail originations (1)                |       | 260,917                                                  |       | 42 |   | — |   | — |   |
| Wholesale originations                 |       | 221,602                                                  |       | 36 |   | 846,803 |   | 25 |   |
| Total mortgage operations acquisitions |       | 576,716                                                  |       | 94 |   | 3,142,506 |   | 93 |   |
| Commercial Mortgage Operations         |       | 39,085                                                   |       | 6 |   | 233,894 |   | 7 |   |
| Total acquisitions and originations    |       | $                                                        | 615,801    |   | 100 |   | $ | 3,376,400 |   | 100 |   |

 

----

(1)                                  Originationsare from continuing retail operations conducted by IHL.

 

Acquisitions andoriginations decreased to $615.8 million for the third quarter of 2007 ascompared to $3.4 billion for the same period in 2006. The cessation of theCompany’s ability to sell loans resulted in the discontinuation of the Flow,Bulk, Wholesale and Commercial production channels are the primary reason forthe decline in production.

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **Principal**                                           | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| **By Production Channel:**   | ** ** | **Balance**                                             | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| Correspondent acquisitions:            | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Flow                                   |       | $                                                       | 473,603    |   | 11 |   | $ | 3,766,955 |   | 46 |   |
| Bulk                                   |       | 1,300,690                                               |       | 29 |   | 1,661,781 |   | 20 |   |
| Total correspondent acquisitions       |       | 1,774,293                                               |       | 40 |   | 5,428,736 |   | 66 |   |
| Retail originations (1)                |       | 408,271                                                 |       | 10 |   | — |   | — |   |
| Wholesale originations                 |       | 1,920,900                                               |       | 43 |   | 2,014,900 |   | 25 |   |
| Total mortgage operations acquisitions |       | 4,103,464                                               |       | 92 |   | 7,443,636 |   | 91 |   |
| Commercial Mortgage Operations         |       | 394,962                                                 |       | 8 |   | 713,829 |   | 9 |   |
| Total acquisitions and originations    |       | $                                                       | 4,498,426  |   | 100 |   | $ | 8,157,465 |   | 100 |   |

 

----

(1)                                  Originationsare from continuing retail operations conducted by IHL.

 

Acquisitions andoriginations decreased to $4.5 billion for the first nine months of 2007 ascompared to $8.2 billion for the same period in 2006.  The cessation of the Company’s ability tosell loans resulted in the discontinuation of the Flow, Bulk, Wholesale andCommercial production channels are the primary reason for the decline inproduction.

 

49

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

 

***Long-TermInvestment Operations***

 

Condensed Statements ofOperations Data

(dollars in thousands)

 
| ** **                                            | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                            | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income (expense)                         |       | $                                                        | 3,040      |   | $ | (44,131 | ) | $ | 47,171 |   | 107 | % |
| Provision for loan losses                             |       | 789,445                                                  |       | 3,533 |   | 785,912 |   | 22,245 |   |
| Net interest expense after provision for  loan losses |       | (786,405                                                 | )          | (47,664 | ) | (738,741 | ) | (1550 | ) |
|                                                  |       |                                                     |       |   |   |   |   |   |   |
| Realized gain from derivative instruments             |       | 28,815                                                   |       | 60,595 |   | (31,780 | ) | (52 | ) |
| Change in fair value of derivative  instruments       |       | (135,347                                                 | )          | (150,051 | ) | 14,704 |   | 10 |   |
| Other non-interest income                             |       | (76,159                                                  | )          | 6,803 |   | (82,962 | ) | (1,219 | ) |
| Total non-interest income                             |       | (182,691                                                 | )          | (82,653 | ) | (100,038 | ) | (121 | ) |
|                                                  |       |                                                     |       |   |   |   |   |   |   |
| Non-interest expense                                  |       | 7,262                                                    |       | 6,780 |   | 482 |   | 7 |   |
| Net loss                                              |       | $                                                        | (976,358   | ) | $ | (137,097 | ) | $ | (839,261 | ) | (612 | )% |

 

Net loss for thequarter ended September 30, 2007 increased $839.3 million (612 percent) toa loss of $976.4 million, as compared to the third quarter of 2006. Thequarter-over-quarter decrease in net earnings was primarily due to the increasein the provision for loan losses which increased $785.9 million for the thirdquarter of 2007 as compared to the third quarter of 2006, due to increaseddelinquencies.  In addition, the Companyhas observed an increase in loss severities on its REO liquidations, which isused to estimate the severities on our REO inventory.

 

Net interest incomeincreased $47.2 million (107 percent) quarter over quarter, primarily as aresult of a decrease in projected prepayment speeds which reduced theamortization of loan premiums, which increased interest income.  The decreased amortization was affected by thereduced prepayment rates, which resulted from the sharp decline in availablemortgage products for non-conforming borrowers and declining housing pricesreducing the equity in the borrowers’ properties.  Additionally, the Company’s adjusted couponrates have increased in excess of the increase in borrowing costs, compared tothe prior year.

 

Realized gain (loss) fromderivatives decreased to $28.8 million for the third quarter of 2007 comparedto $60.6 million for the third quarter of 2006, as a result of a decrease inthe size of the mortgage portfolio, and the decrease in the size of theunderlying notional balance of the derivatives.

 

The change in fair valueon derivative instruments decreased $14.7 million for the third quarter of 2007as compared to the third quarter of 2006. The market valuation adjustment isprimarily the result of changes in the expectation of future interest rates.

 

Additionally, othernon-interest income decreased $83.0 million primarily due to the provision forREO losses increasing $40.4 million for the third quarter of 2007, as comparedto no provision for REO losses for the third quarter of 2006, as a result ofthe decline in home prices.  Alsocontributing to the decrease in other non-interest income was a loss of $24.4million on the sale of a financed interest in one of the Company’ssecuritizations that the Company sold to a repo lender in settlement of allobligations owed on that security.

 

50

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Condensed Statements ofOperations Data

(dollars in thousands)

 
| ** **                                            | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | ** **                                              | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                            | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income (expense)                         |       | $                                                       | 383        |   | $ | (91,593 | ) | $ | 91,976 |   | 100 | % |
| Provision for loan losses                             |       | 979,740                                                 |       | 3,638 |   | 976,102 |   | 26,831 |   |
| Net interest expense after provision for  loan losses |       | (979,357                                                | )          | (95,231 | ) | (884,126 | ) | (928 | ) |
|                                                  |       |                                                    |       |   |   |   |   |   |   |
| Realized gain from derivative instruments             |       | 103,840                                                 |       | 156,582 |   | (52,742 | ) | (34 | ) |
| Change in fair value of derivative  instruments       |       | (136,701                                                | )          | (95,185 | ) | (41,516 | ) | (44 | ) |
| Other non-interest income                             |       | (102,767                                                | )          | 21,332 |   | (124,099 | ) | (582 | ) |
| Total non-interest income                             |       | (135,628                                                | )          | 82,729 |   | (218,357 | ) | (264 | ) |
|                                                  |       |                                                    |       |   |   |   |   |   |   |
| Non-interest expense                                  |       | 19,702                                                  |       | 17,708 |   | 1,994 |   | 11 |   |
| Net loss                                              |       | $                                                       | (1,134,687 | ) | $ | (30,210 | ) | $ | (1,104,477 | ) | (3,656 | )% |

 

Net loss for the ninemonths ended September 30, 2007 increased $1.1 billion (3,656 percent) toa loss of $1.1 billion, as compared to the same period in 2006. The decrease innet earnings was primarily due to the increase in the provision for loan losseswhich increased $976.1 million, due to increased severities on REOliquidations, coupled with increased mortgage delinquency dollars.  Net interest income increased $92.0 million(100 percent), primarily as a result of a decrease in projected prepaymentspeeds which reduced the amortization of loan premiums, which increasedinterest income.  Additionally, theCompany’s adjusted coupon rates have increased in excess of the increase inborrowing costs, compared to the prior year.

 

Realized gain (loss) fromderivatives which decreased to $103.8 million compared to $156.6 million forthe first nine months of 2006, as a result of a decrease in the size of themortgage portfolio, and the size of the underlying notional balance of thederivatives.

 

The change in fair valueon derivative instruments decreased $41.5 million due to changes in theexpectation of future interest rates.

 

Additionally, othernon-interest income decreased $124.1 million primarily due to the provision forREO losses increasing to $68.4. million, as compared to no provision for REOlosses for the first nine months of 2006. Also contributing to the decrease in other non-interest income was aloss of $24.4 million on the sale of a financed interest in one of the Company’ssecuritizations that the Company sold to a repo lender in settlement of allobligations owed on that security.

 

51

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***RetailOperations***

 

Condensed Statements ofOperations Data

(dollars in thousands)

 
| ** **                                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                    | ** ** | **2007**                         | ** ** | **2007**                        | ** ** |
| Net interest income (expense)                                 |       | $                                | (116       | )                               | $          | (312 | ) |
| Provision for loan losses                                     |       | —                           |       | —                          |       |
| Net interest income (expense) after  provison for loan losses |       | $                                | (116       | )                               | $          | (312 | ) |
|                                                          |       |                             |       |                            |       |
| Gain on sale of loans                                         |       | 143                              |       | 2,804                           |       |
| Lower of cost or market writedown                             |       | (6,657                           | )          | (4,553                          | )          |
| Provision for repurchases                                     |       | (4,553                           | )          | (7,396                          | )          |
| Other income                                                  |       | (1,971                           | )          | (1,409                          | )          |
| Non-interest expense and income taxes                         |       | 14,373                           |       | 34,459                          |       |
| Net loss                                                      |       | $                                | (27,527    | )                               | $          | (45,325 | ) |

 

On May 31, 2007, the Company acquired productionfacilities from Pinnacle Financial Corporation (PFC), later renamed Impac HomeLoans (IHL) located primarily on the east coast of the United States.  Therefore, there is nocorresponding three or nine month 2006 comparison.

 

The retail operationsgenerates income by selling mortgages to permanent investors, and, to a lesserextent, earns revenue from fees associated with mortgage servicing rights, andinterest income earned on mortgages held-for-sale.

 

Net loss for the retailoperations was a loss of $27.5 million primarily due to the following:

 

·                  $4.6 millionprovision for repurchases;

 

·                  $6.7million loss on lower of cost or market writedown on loans held-for-sale; and

 

·                  non-interestexpense and income taxes of $14.4 million.

 

The Company recordedloans held-for-sale at the lower of cost or market resulting in a$6.7 million write-down of loans held-for-sale as current marketconditions, such as the widening of credit and bond spreads and a lack ofdemand for mortgage product forced the loans to drop in value.  The $6.7 million writedown was primarilydue to a decrease in the fair value in the marketplace for loans, as investorsrequire a higher yield, which reduced the fair value of our loansheld-for-sale.  The retail operations arereflected as a stand-alone entity for segment financial reporting purposes;however, on the consolidated financial statements inter-company loan sales andrelated gains are eliminated.

 

Non-interest expense andincome taxes were $14.4 million which was primarily the result of occupancyexpense of $4.0 million, which includes a $2.3 million lease abandonment chargeand general and administrative expenses of $4.7 million for the third quarterof 2007.  Additionally, the retail operations recorded a $1.2 million impairmenton property plant and equipment in which the book value exceeded the fairvalue.

 

52

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***DiscontinuedOperations***

 

Condensed Statements ofOperations Data

(dollars in thousands)

 
| ** **                                                    | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                               | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income (expense)                                 |       | $                                                        | 3,082      |   | $ | 6,915 |   | $ | (3,833 | ) | (55 | )% |
| Provision for loan losses                                     |       | 2,807                                                    |       | (350 | ) | 3,157 |   | 902 |   |
| Net interest income (expense) after  provison for loan losses |       | $                                                        | 275        |   | $ | 7,265 |   | $ | (6,990 | ) | (96 | ) |
|                                                          |       |                                                     |       |   |   |   |   |   |   |
| Gain on sale of loans                                         |       | (39,287                                                  | )          | 4,926 |   | (44,213 | ) | (898 | ) |
| Lower of cost or market writedown                             |       | (99,067                                                  | )          | — |   | (99,067 | ) | (100 | ) |
| Provision for repurchases                                     |       | (11,165                                                  | )          | 15,876 |   | (27,041 | ) | (170 | ) |
| Other income                                                  |       | (6,120                                                   | )          | (5,290 | ) | (830 | ) | (16 | ) |
| Non-interest expense and income taxes                         |       | 38,713                                                   |       | 26,041 |   | 12,672 |   | 49 |   |
| Net loss                                                      |       | $                                                        | (194,077   | ) | $ | (3,264 | ) | $ | (190,813 | ) | (5,846 | )% |

 

During the thirdquarter of 2007, the Company announced plans to exit its mortgage origination(excluding retail mortgage operations), commercial origination, and warehouselending operations.  These businesses arepresented as discontinued operations in the Company’s consolidated financialstatements.

 

Net earnings for thediscontinued operations decreased $194.1 million (5,846 percent) primarilydue to the following changes:

 

·                  decreaseof $44.2  million in gains from the sale of loans;

 

·                  increaseof $27.0 million in provision for repurchases; and

 

·                  increasein charges to expense of $99.1 million for the change in valuation ofloans held-for-sale (LOCOM).

 

Gains from the sale ofloans decreased $44.2 million primarily as a result of the Company’sexchange of the Company’s ISAC SD 06-1, in settlement of borrowingobligations.  The Company recorded a lossof $24.4 million which represented the difference between the GAAP basis of theloans and the borrowings outstanding on the repo line at the date the interestsin the securitization were exchanged for payoff of the debt. Additionally thepricing obtained on loans sold to third parties was significantly reduced, whencompared to the prior years execution prices, as the market value of performingand non-performing loans decreased due to the saturation of loans for sale inthe market place and the deterioration in theprevailing real estate market and economic conditions.

 

Provision for repurchasesincreased $27.0 million (170 percent) during the third quarter of2007 as compared to the third quarter of 2006. The increase in the provisionfor repurchases was primarily due to an increase in severities of actuallosses, which resulted from a decrease in the perceived credit quality of the loanssubject to repurchase.

 

The Company recordedloans held-for-sale at the lower of cost or market resulting in a$99.1 million increase in the write-down of loans held-for-sale as currentmarket conditions, such as the widening of credit and bond spreads and a lackof demand for mortgage product forced the loans to decline in value. The$99.1 million write-down was primarily attributable to a decrease in theweighted average market price for loans. The Company accumulated $1.6 billion of loans as of June 30, 2007in the normal course of business, however with the deterioration in the creditmarkets the Company was unable to securitize or sell these loans as planned,which resulted in significant margin calls. The mortgage, commercial, and warehouse lending operations are reflectedas discontinued operations for financial reporting purposes; however, on thefinancial statements inter-company loan sales, related gains, financereceivables and borrowings are eliminated.

 

Duringthe three months ended September 30, 2007, the mortgage operationsrecorded a restructuring charge of $4.2 million, for the fair value of leasecosts that were ceased to be utilized at September 30, 2007, included innon-interest expense above. Additionally, the mortgage operations recorded an $11.6 millionimpairment on property plant and equipment in which the book value exceeded thefair value.

 

53

----

 

Condensed Statements ofOperations Data

(dollars in thousands)

 
| ** **                                                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                    | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest income (expense)                                 |       | $                                                       | 13,915     |   | $ | 18,958 |   | $ | (5,043 | ) | (27 | )% |
| Provision for loan losses                                     |       | 4,867                                                   |       | (350 | ) | 5,217 |   | 1,491 |   |
| Net interest income (expense) after  provison for loan losses |       | $                                                       | 9,048      |   | $ | 19,308 |   | $ | (10,260 | ) | (53 | ) |
|                                                          |       |                                                    |       |   |   |   |   |   |   |
| Gain on sale of loans                                         |       | (47,401                                                 | )          | 37,057 |   | (84,458 | ) | (228 | ) |
| Provision for repurchases                                     |       | (41,883                                                 | )          | (7,233 | ) | (34,650 | ) | (479 | ) |
| Lower of cost or market writedown                             |       | (133,203                                                | )          | (15,283 | ) | (117,920 | ) | (772 | ) |
| Other income                                                  |       | (4,963                                                  | )          | (1,396 | ) | (3,567 | ) | (256 | ) |
| Non-interest expense and income taxes                         |       | 84,404                                                  |       | 63,376 |   | 21,028 |   | 33 |   |
| Net loss                                                      |       | $                                                       | (302,806   | ) | $ | (30,923 | ) | $ | (271,883 | ) | (879 | )% |

 

During the thirdquarter of 2007, the Company announced plans to exit its mortgage, commercial,and warehouse lending operations.  Thesebusinesses were presented as discontinued operations in the Company’s financialstatements.

 

Net earnings for thediscontinued operations decreased $271.9 million (879 percent)primarily due to the following changes:

 

·                  decreaseof $84.5  million in gains from the sale of loans;

 

·                  increaseof $34.7 million in provision for repurchases; and

 

·                  increasein charges to expense of $117.9 million for the change in valuation ofloans held-for-sale.

 

Gains from the sale ofloans decreased $84.5 million primarily as a result of the Company’sexchange of the Company’s ISAC SD 06-1, in settlement of borrowingobligations.  The Company recorded a lossof $24.4 million which represented the difference between the GAAP basis of theloans and the borrowings outstanding on the repo line at the date the interestsin the securitization were exchanged for payoff of the debt. Additionally thepricing obtained on loans sold to third parties was significantly reduced, whencompared to the prior years execution prices, as the market value of performingand non-performing loans decreased due to the saturation of loans for sale inthe market place and the deterioration in theprevailing real estate market and economic conditions.

 

Provision for repurchasesincreased $34.7 million (479 percent) during the third quarter of2007 as compared to the third quarter of 2006. The increase in the provisionfor repurchases was primarily due to an increase in severities of actual losses,which resulted from a decrease in the perceived credit quality of the loanssubject to repurchase.

 

The Company recordedloans held-for-sale at the lower of cost or market resulting in a$117.9 million increase in the write-down of loans held-for-sale ascurrent market conditions, such as the widening of credit and bond spreads anda lack of demand for mortgage product forced the loans to decline in value. The$117.9 million write-down was primarily attributable to a decrease in theweighted average market price loans.  TheCompany accumulated $1.6 billion of loans as of June 30, 2007 in thenormal course of business, however with the deterioration in the credit marketsthe Company was unable to securitize or sell these loans as planned, whichresulted in significant margin calls. The mortgage, commercial, and warehouse lending operations are reflectedas discontinued operations for financial reporting purposes; however, on thefinancial statements inter-company loan sales, related gains, finance receivablesand borrowings are eliminated.

 

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**Liquidity andCapital Resources**

 

It has been our policy tohave adequate liquidity to cover normal cyclical swings in funding availabilityand mortgage demand and to allow us to meet abnormal and unexpected fundingrequirements. However, based on the unprecedented volatility in the marketplacesince the beginning of the third quarter it has become difficult to anticipatefuture conditions, and meet these objectives of available liquidity.  The Company accumulated $1.6 billion of loansas of June 30, 2007 in the normal course of business, however with thedeterioration in the credit markets the Company was unable to securitize orsell these loans as planned, which resulted in significant margincalls.  As of September 30, 2007,the Company’s largest liquidity usage was the margin calls required on itsremaining reverse repurchase lines of credit. The Company does not anticipate any further significant margin calls onthe loans held-for-sale.  However, sincewe still have certain facilities outstanding, there can be no assurances the Companymay not receive future margin calls nor can we make any assurances that wewould satisfy these margin calls.  TheCompany’s usage of liquidity in order of significance consisted of thefollowing:

 

·                  meeting margincall requirements on loans held-for-sale,

 

·                  settlingobligations related to the Company’s repurchase obligations, and

 

·                  normal payroll,lease obligations and other operating expenditures.

 

We plan to meet liquidityrequirements through effectively managing our assets and maximizing recovery onour investments with the goal of avoiding unplanned sales of assets oremergency borrowing of funds. Toward this goal, our asset/liability committee,or “ALCO,” is responsible for monitoring our liquidity position and fundingneeds.

 

ALCO participants includesenior executives of the Company. ALCO meets on a weekly basis to reviewcurrent and projected sources and uses of funds. ALCO monitors the compositionof the balance sheet for changes in the liquidity of our assets. Our primaryliquidity consists of cash and cash equivalents; short-term securitiesavailable for sale, and maturing mortgages, or “liquid assets.”

 

We believe that currentcash balances, short-term investments, current financing facilities, excesscash flows generated from our long-term mortgage portfolio, and masterservicing fees will provide for projected funding needs.  However, the secondary market is rapidlyevolving and the performance of the long-term mortgage portfolio is subject tothe deteriorating real estate market and current credit crisis, and thepotential impact on the Company is unknown. Additionally, as the Company liquidates REOs the resulting losses willreduce the cash receipts from the securitized mortgage collateral.  Also the ability of the Company to reduce itslease obligations will effect the future cash flows.

 

Our operating businessesprimarily use available funds as follows:

 

·                 origination ofmortgages by the retail mortgage operations;

 

·                  pay interest onremaining reverse warehouse facilities;

 

·                 distributepreferred stock dividends, and trust preferred interest;

 

·                 pay leaseobligations, payroll obligations, operating expenses and

 

·                 repurchase loans.

 

Our ability to meet liquidity requirements and the financing needs ofour remaining customers is subject to maintaining the remaining reverserepurchase facility. The Company was in technical default of the reverserepurchase lines, however, subsequent to September 30, 2007 the Companysatisfied a large portion of the $923.8 million outstanding at September 30,2007.  The Company continues to use onefacility to fund new retail loan originations, until the retail operations arediscontinued. The retail facility has an outstanding balance of $72.3 millionat September 30, 2007; however the available borrowings on this line werereduced to $35.0 million, with a further reduction to $25.0 million by December 31,2007 and the Company has been notified thatthis lender is expecting to recommend to its credit committee an orderly winddown of this line over the next few months. The Company will either dispose of the retail mortgage operations or discontinue andwind down the operations.

 

55

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Although the Company doesnot anticipate being able to obtain any financing over the next twelve months,any decision to provide available financing to us in the future will dependupon a number of factors, including:

 

·                 our compliancewith the terms of our existing credit arrangements, including any financialcovenants;

 

·                 theability to obtain waivers upon any non compliance;

 

·                 our financialperformance;

 

·                 industry andmarket trends in our various businesses;

 

·                 the generalavailability of, and rates applicable to, financing and investments;

 

·                 our lenders orinvestors resources and policies concerning loans and investments; and

 

·                 the relativeattractiveness of alternative investment or lending opportunities.

* *

*Distributecommon and preferred stock dividends*. We are required todistribute a minimum of 90% of our taxable income to our stockholders in orderto maintain our REIT status, exclusive of the application of any tax loss carryforwards that may be used to offset current period taxable income. Because wepay dividends based on taxable income, dividends may be more or less than netearnings. We did not declare a cash dividend for the second or third quarter of2007 and paid cash dividends of $0.10 per outstanding common share for thefirst quarter of 2007.  Based on currenttax estimates, all of the 2007 dividends will be a return of capital.  In addition, we paid cash dividends of $3.7million on preferred stock during the third quarter of 2007.

 

During the third quarterof 2007, our operating businesses were primarily funded as follows:

 

·          reverserepurchase agreements;

 

·          excesscash flows from our long-term mortgage portfolio master servicing fees; and

 

·          saleof mortgages.

* *

*Reverserepurchase agreements.*Inthe past we used reverse repurchase agreements to fund substantially allfinancing for the origination of mortgages. We currently finance theacquisition of conforming mortgages generated by the retail operations,primarily through borrowings on one remaining reverse repurchase facility whichhad a maximum borrowing capacity of $98.0 million and $72.3 million outstandingat September 30, 2007, which will expire during 2008.

* *

*Excesscash flows from our long-term mortgage portfolio*. We receiveexcess cash flows on mortgages held as securitized mortgage collateral afterdistributions are made to investors on securitized mortgage borrowings to theextent cash or other collateral required to maintain credit ratings on thesecuritized mortgage borrowings is fulfilled and can be used to provide fundingfor some of the long-term investment operations’ activities.  Excess cash flows represent the differencebetween principal and interest payments on the underlying mortgages, adjustedby the following:

 

·                  servicingand master servicing fees paid;

·                  premiumspaid to mortgage insurers;

·                  cashpayments / receipts on derivatives;

·                  interestpaid on securitized mortgage borrowings;

·                  prorata early principal prepayments paid on securitized mortgage borrowings;

·                  OCrequirements;

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

·                  unpaidinterest shortfall;

·                  basisrisk shortfall;

·                  bondwritedowns reinstated; and

·                  residualcashflow.

 

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*Inflation/Deflation*

 

The consolidatedfinancial statements and corresponding notes to the consolidated financialstatements have been prepared in accordance with GAAP, which require themeasurement of financial position and operating results in terms of historicaldollars without considering the changes in the relative purchasing power ofmoney over time due to inflation. The impact of inflation is reflected in theincreased costs of our operations. Unlike industrial companies, nearly all ofour assets and liabilities are monetary in nature. As a result, interest rateshave a greater impact on our performance than do the effects of general levelsof inflation. Inflation affects our operations primarily through its effect oninterest rates, since interest rates normally increase during periods of highinflation and decrease during periods of low inflation. During periods ofincreasing interest rates, demand for mortgages and a borrower’s ability to qualifyfor mortgage financing in a purchase transaction may be adversely affected.During periods of decreasing interest rates and housing price appreciation,borrowers may prepay their mortgages, which in turn may adversely affect ouryield and subsequently the value of our portfolio of mortgage assets.  Additionally, the depreciation in home priceshas increased the loss severities experienced by the Company.

** **

**Off Balance SheetArrangements**

 

When we sell loansthrough whole-loan sales, we are required to make normal and customaryrepresentations and warranties to the loan purchasers, including guaranteesagainst early payment defaults typically 90 days, and fraudulentmisrepresentations by the borrowers. Our whole-loan sale agreements generallyrequire us to repurchase loans if we breach a representation or warranty givento the loan purchaser. In addition, we may be required to repurchase loans as aresult of borrower fraud or if a payment default occurs on a mortgage loanshortly after its sale. Because the loans are no longer on our balance sheet,the recourse component is considered a guarantee. During the third quarter of2007, we sold $920.1 million of loans with recourse compared to $1.2 billion inthe third quarter of 2006. We maintained a $36.9 million reserve relatedto these guarantees as of September 30, 2007 compared with a reserve of$27.8 million as of June 30, 2007. During the third quarter of 2007we paid $2.0 million to repurchase loans previously sold to third partiesas compared to $13.3 million during the second quarter of 2007.

 

**ITEM 3:****    **QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK****

** **

**General Overview**

 

We manage credit, prepayment and liquidity risk in thenormal course of business. Since a significant portion of our revenues andearnings are derived from net interest income, we strive to manage ourinterest-earning assets and interest-bearing liabilities to generate what webelieve to be an appropriate contribution from net interest income. Wheninterest rates fluctuate, profitability can be adversely affected by changes inthe fair market value of our assets and liabilities and by the interest spreadearned on interest-earning assets and interest-bearing liabilities. We deriveincome from the differential spread between interest earned on interest-earningassets and interest paid on interest-bearing liabilities. Any change ininterest rates affects income received and income paid from assets andliabilities in varying and typically in unequal amounts. Changing interestrates may compress or widen our interest rate margins and affect overallearnings.

 

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Interest rate risk management is the responsibility ofthe Asset Liability Committee (ALCO), which is comprised of the senior managementand reports results of interest rate risk analysis to the IMH board ofdirectors on at least a quarterly basis. ALCO establishes policies that monitorand coordinate sources, uses and pricing of funds. ALCO also attempts to reducethe volatility in net interest income by managing the relationship of interestrate sensitive assets to interest rate sensitive liabilities. However, as aresult of the credit crisis, the Company is no longer in a position to activelyhedge its interest rate risk in the future. In addition, various modeling techniques are used to value interestsensitive mortgage-backed securities. The value of investment securitiesavailable-for-sale is determined using a discounted cash flow model usingprepayment rate, discount rate and credit loss assumptions. Our investmentsecurities portfolio is available-for-sale, which requires us to perform marketvaluations of the securities in order to properly record the portfolio. Wecontinually monitor interest rates of our investment securities portfolio ascompared to prevalent interest rates in the market. We do not currentlymaintain a securities trading portfolio and are not exposed to market risk asit relates to speculative trading activities.

** **

**Changes in Interest Rates**

 

Interest rate riskmanagement policies intended to limit our exposure to changes in interest ratesprimarily associated with cash flows on our adjustable rate securitizedmortgage borrowings. Our primary objective is to limit our exposure to thevariability in future cash flows attributable to the variability of one-monthLIBOR, which is the underlying index of our adjustable rate securitizedmortgage borrowings. We also monitor on an ongoing basis the prepayment risksthat arise in fluctuating interest rate environments. Our interest rate riskmanagement policies are formulated with the intent to offset potential adverseeffects of changing interest rates on cash flows on adjustable rate securitizedmortgage borrowings.  However, we arecurrently limited on what we can do to offset future changes in interest rates.  The Companymaintains derivatives on the securitized mortgage borrowings to offsetapproximately 80-90% of the potentially adverse risk.

 

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

 

The use of derivatives tomanage risk associated with changes in interest rates was an integral part ofour strategy. The amount of cash payments or cash receipts on derivatives isdetermined by (1) the notional amount of the derivative and (2) currentinterest rate levels in relation to the various strikes or coupons ofderivatives during a particular time period. As of September 30, 2007 and December 31,2006, we had notional balances of interest rate swaps, caps, and floors of$15.4 billion and $19.5 billion, respectively, with net fair values of$(4.3) million and $132.5 million, respectively, pertaining to ourcurrent and pending securitizations. By using derivatives, we attempted tominimize the effect of both upward and downward interest rate changes on ourlong-term mortgage portfolio. Our goal was to moderate significant changes tobase case net interest income, including net cash flows from derivatives, asinterest rates change. We primarily acquired swaps, and to a lesser extentcaps, to essentially convert our adjustable rate securitized mortgageborrowings into fixed rate borrowings. For instance, we receive one-month LIBORon swaps, which offsets interest expense on adjustable rate securitized mortgageborrowings, and we pay a fixed interest rate.

 

The interest rate riskprofile of our balance sheet is more sensitive to changes in interest ratesrelated to our liabilities. We used derivatives extensively in order to managethe interest rate, or price risk, inherent in our assets, liabilities and loancommitments. Our main objective in managing interest rate risk was to moderatethe effect of changes in interest rates on our earnings over time. Our interestrate risk management strategies may result in significant earnings volatilityin the short term. The success of our interest rate risk management strategy islargely dependent on our ability to predict the earnings sensitivity of ourlong-term investment operations in various interest rate environments. Thereare many market factors that affect the performance of our interest rate riskmanagement activities including interest rate volatility, prepayment behavior,the shape of the yield curve and the spread between mortgage interest rates andtreasury or swap rates. The success of this strategy affects our net earnings.This effect, which can be either positive or negative, can be material.

 

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We measure thesensitivity of our net interest income to changes in interest rates affectinginterest sensitive assets and liabilities using various simulations. Thesesimulations take into consideration changes that may occur in investment andfinancing strategies, the forward yield curve, interest rate risk managementstrategies, mortgage prepayment speeds. As part of various interest ratesimulations, we calculate the effect of potential changes in interest rates onour interest-earning assets and interest-bearing liabilities and their affecton overall earnings. The simulations assume instantaneous and parallel shiftsin interest rates and to what degree those shifts affect net interest income.

 

The following tableestimates the financial effect to base case, including net cash flow fromderivatives, from various instantaneous and parallel shifts in interest ratesbased on both our consolidated structure and un-consolidated structure, whichrefers to the notional amount of derivatives that are not recorded on ourbalance sheet as of August 31, 2007 (dollar amounts in millions):

 
| ** **                                                                                     | ** ** | **Changes in base case as of August 31, 2007 (1)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| **Instantaneous and Parallel Change in Interest Rates (2)** | ** ** | **Excluding net cash  flow on derivatives**                                 | ** ** | **Net cash flow  on derivatives** | ** ** | **Including net cash  flow on derivatives** | ** ** |
| ** **                                                                                     | ** ** | **$**                                                                                           | ** ** | **(%)** | ** ** | **$** | ** ** | **$** | ** ** | **(%)** | ** ** |
| Up 300 basis points, or 3% (3)                                                                 |       | (177                                                                                            | )          | (1,389 | ) | 139 |   | (38 | ) | (70 | ) |
| Up 200 basis points, or 2%                                                                     |       | (100                                                                                            | )          | (783 | ) | 92 |   | (8 | ) | (14 | ) |
| Up 100 basis points, or 1%                                                                     |       | (46                                                                                             | )          | (362 | ) | 46 |   | — |   | — |   |
| Down 100 basis points or 1%                                                                    |       | 40                                                                                              |       | 313 |   | (47 | ) | (7 | ) | (13 | ) |
| Down 200 basis points or 2%                                                                    |       | 78                                                                                              |       | 613 |   | (94 | ) | (16 | ) | (29 | ) |
| Down 300 basis points or 3%                                                                    |       | 118                                                                                             |       | 923 |   | (141 | ) | (23 | ) | (43 | ) |

 

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

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

(3)                         Thissimulation was added to our analysis as it is relevant in light of the interestrate environment as of August 31, 2007 and the projected forward yieldcurve for 2007 and 2008.

 

In the previous table,the up 100 basis point scenario as of August 31, 2007 represents ourprojection of the net change from base case net interest income, which isderived from assumptions as previously discussed, if market interest rates wereto immediately rise by 100 basis points. This means that we increase interestrates at all data points along our projected forward yield curve by 100 basispoints and recalculate our projection of net interest income over the next 12months. In addition, based on changes in interest rates, or changes in ourforward yield curve, our model adjusts mortgage prepayment rates and recalculatesamortization of acquisition and securitization costs and net cash receipts orpayments on derivatives as part of the calculation of net interest income.Thus, if a 100 basis point interest rate increase occurred, the projectedvolatility to net interest income is positively impacted through our use ofderivatives.

 

We estimate net interestincome along with net cash flows from derivatives for the next twelve monthsusing balance sheet data and the notional amount of derivatives as of August 31,2007 and 12-month projections of the following primary drivers affecting netinterest income:

 

·                   future interest rates using forwardyield curves, which are considered market consensus estimates of futureinterest rates;

 

·                   mortgageprepayment rate assumptions; and

 

·                   forward swaprates.

 

We refer to the12-month projection of net interest income along with the 12-month projectionof net cash flows from derivatives as the “base case.” For financial reportingpurposes, net cash flows from derivatives are included in realized gain (loss)from derivative instruments on the consolidated financial statements. However,for purposes of interest rate risk analysis we include net cash flows fromderivatives in our base case simulations as we acquire derivatives to offsetthe effect that changes in interest rates have on variable borrowing costs,such as securitized mortgage and warehouse borrowings. We believe thatincluding net cash flows from derivatives in our interest rate risk analysispresents a more useful simulation of the effect of changing interest rates onnet cash flows generated by our long-term mortgage portfolio.

 

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Once the base case hasbeen established, we “shock” the base case with instantaneous and parallelshifts in interest rates in 100 basis point increments upward and downward.Calculations are made for each of the defined instantaneous and parallel shiftsin interest rates over or under the forward yield curve used to determine thebase case and include any associated changes in projected mortgage prepaymentrates caused by changes in interest rates. The results of each 100 basis pointchange in interest rates are then compared against the base case to determinethe estimated dollar and percentage change to base case. The simulationsconsider the affect of interest rate changes on interest sensitive assets andliabilities as well as derivatives. The simulations also consider the impactthat instantaneous and parallel shift in interest rates have on prepaymentrates and the resulting affect of accelerating or decelerating amortization ofpremium and securitization costs.

 

Using information aspresented above, and other analysis, the Company reviews its interest rate riskprofile.  Based on this review, in thepast the Company made certain decisions on how to mitigate its interest raterisk.

** **

**ITEM 4:  CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

We are committed tomaintaining disclosure controls and procedures (as defined in the SecuritiesExchange Act of 1934 Rules 13-a-15(e) or 15d – 15 (e)) designed toensure that information required to be disclosed in our periodic reports filedunder the Securities Exchange Act of 1934, as amended, or the Exchange Act, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer (CEO)(who is currently performing the functions of both the principal executive andfinancial officer), to allow for timely decisions regarding requireddisclosure. In designing and evaluating our disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures and implementing controls and procedures based on the application ofmanagement’s judgment.

 

As required by Rules 13a-15and 15d-15 under the Exchange Act, in connection with the filing of thisQuarterly Report on Form 10-Q, our management, under the supervision andwith the participation of our CEO (who is currently performing the functions ofboth the principal executive and financial officer), conducted an evaluation ofour disclosure controls and procedures, as such term is defined under Rule 13a-15(e).Based on this evaluation, our principal executive and financial officerconcluded that our disclosure controls and procedures were effective at areasonable assurance level at September 30, 2007.

 

**Changes in Internal Control Over FinancialReporting**

 

During the quarter ended September 30,2007, the changes to internal control over financial reporting have beensignificant as we have been downsizing and restructuring the Company over thelast few months, to reflect the deterioration in market conditions.  Given the current market environment, we havemade significant changes to the staff levels, our business model, as well ascertain controls that are no longer considered applicable.  The changes that materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting, are as follows:

 

·                  We continue toreduce our workforce, consolidate and eliminate operations and outsourcecertain functions. Accordingly, responsibility for administration, managementand review of many of our assets has transitioned among our remainingpersonnel.

 

·                  In conjunctionwith further reductions in personnel, we have transitioned some of ouraccounting and business support applications to manual processes supported by asystem of manual internal controls and spreadsheets. Management has supervisedthese transitions and has implemented procedures we believe provide effectivedisclosure and internal controls over financial reporting. We are assessing theefficacy of these procedures and will continue to do so in subsequent periods.

 

As themarket for our industry has continued to deteriorate over the last few months,we have been reducing staff levels.  Inaddition, with the discontinuance of certain operations, we have beenevaluating the need to maintain an internal control environment consistent withprevious periods.  This evaluation hasled to the reduction and / or change in certain controls that are not deemed tobe applicable to the current business process and reporting.  We are also in the process of evaluating theneed for information technology systems that we have used in the past toconduct business and report results. With the reduced number of the internal controls, with less staff toperform the steps to maintain the controls, we have identified deficiencies in ourinternal control environment.  In addition,with less staff to maintain the information technology systems,

 

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our risks associated with maintaining an adequatecontrol information technology environment has increased. As a result, it isvery likely that in connection with the annual assessment of our internalcontrol over financial reporting we will identify significantdeficiencies.  Although we are uncertain at this time as we have notcompleted our assessment, any significant deficiencies may, in the aggregate orindividually, rise to the level to be deemed material weaknesses, which wouldresult in a determination of ineffective internal control over financialreporting and disclosure controls.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1:****                               **LEGAL PROCEEDINGS****

 

On August 17, 2007, a purported classaction matter was filed in the United States District Court, Central Districtof California, against IMH and several of its senior officers entitled SheldonPittleman v. Impac Mortgage Holdings, Inc., et al.  The action alleges against all defendantsviolations of Section 10(b) and 10b-5 of the Securities exchange Actof 1934 (the “Exchange Act”) and against the individual defendants violationsof Section 20(a) of the Exchange Act. Plaintiffs contend that the defendants caused the Company’s stock totrade at artificially inflated prices through false and misleading statementsand intentional or reckless disregard of basic accounting principles.  The complaint seeks compensatory damages forall damages sustained as a result of the defendants’ actions, includingreasonable costs and expenses and other relief as the court may deemproper.  On October 3, 2007, asimilar case was filed in the same Court entitled Richard Abrams v. ImpacMortgage Holdings, Inc., et al. This action makes allegations similar to those in the Pittleman actionand also seeks similar recovery.

 

On October 11, 2007, a shareholder derivative action was filed inthe Superior Court of California, Orange County against the Company and certainof its officers and directors.  Thecomplaint alleges claims for a breach of fiduciary duty, abuse of control,gross mismanagement, waste of corporate assets, a violation of California CivilCode Sections 1709 and 1710 for deceit and for contribution and indemnification.  The action seeks to recover for the companythe damages suffered by the Company as a result of the individuals breach offiduciary duty, abuse of control, gross mismanagement and waste of corporate assets.  It also seeks to impose a constructive truston the proceeds of any individuals trading activity, disgorgement of profitsbenefits of other compensation of the individual defendants, costs anddisbursements in the action including reasonable attorney’s fees, expert fees,accountant’s fees, expenses and such other relief as the court may deem proper.

 

On October 4, 2007, a purported class action matter was filed inthe United States District Court, Central District of California against ImpacFunding Corporation and Impac Mortgage Holdings, Inc. entitled VincentMarshell v. Impac Funding Corporation, et al. The action alleges violations of Truth in Lending Act, Violation ofCalifornia Business and Professional Code Section 17200, et seq, breach ofcontract, and an additional claim under Business and Professional Code Section 17200.  The complaint alleges that the defendantsfailed to disclose pertinent information in a clear conspicuous manner ascalled for in the Truth in Lending Act, and that they misled the plaintiff.  The action seeks to recover actual damages,compensatory damages, consequential damages, punitive damages, rescission,reasonable attorneys fees and costs, statutory damages, a disgorgement of allprofits obtained as a result of the unfair competition, equitable relief includingrestitution and such other relief as is just and proper.

 

On December 17, 2007, a purported class action matter wasfiled in the United States District Court, Central District of California,against IMH and several of its senior officers entitled Sharon Page v. ImpacMortgage Holdings, Inc., et al.  Theaction is a complaint for violations of the Employee Retirement Income SecurityAct in relation to the Company’s 401(k) plan. The complaint alleges breach of fiduciary duties, breach of duty toavoid conflicts of interest, allegations of co-fiduciary liability and knowingparticipation in a breach of fiduciary duty by IMH.  Plaintiffs contend that the defendantsbreached their fiduciary duties in violation of ERISA by failing to prudentlyand loyally manage the plan’s investment in IMH stock by continuing to offerIMH stock as an investment option and to make contributions in stock, providecomplete and accurate information to participants, and monitor appointed planfiduciaries and provide them with accurate information. The complaint seeksmonetary payment to the plan for the losses in an amount to be proven,injunctive and other appropriate equitable relief, a constructive trust onamounts by which any defendant was unjustly enriched, an appointment of one ormore independent fiduciaries, actual damages, reasonable attorney fees andexpenses, taxable costs, interests on these amounts and other legal orequitable relief as may be just and proper.

 

Please refer to IMH’s report on Form 10-K for the year ended December 31,2006 and reports on Form 10-Q for the periods ending March 31, 2007and June 30, 2007 for a description of other litigation and claims.

 

We believe that we have meritorious defenses to the above claims andintend to defend these claims vigorously. Nevertheless, litigation is uncertain and we may not prevail in thelawsuits and can express no opinion as to their ultimate resolution.  An adverse judgment in any of these matterscould have a material adverse effect on us.

 

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

 

Our Annual Report on Form 10-Kfor the year ended December 31, 2006 and our quarterly reports on Form 10-Qfor the period ended March 31, 2007 and June 30, 2007, include adetailed discussion of additional risk factors. The information presented belowupdates and should be read in conjunction with the risk factors and informationdisclosed in that Form 10-K, in addition to the March 31, 2007 and June 30,2007 Form 10-Qs.

 

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**We havenegative shareholders’ equity, which could adversely affect our financialcondition and otherwise adversely impact our business and growth prospects.**

 

As of September 30, 2007, we had a shareholders’deficit of $(493.3) million, which means our total liabilities exceed our totalassets.  The existence of a shareholders’deficit may effect our ability to continue to pay scheduled distributions onour preferred stock, limit our ability to obtain future debt or equityfinancing, and cause regulatory issues as it could effect our state mortgagelicenses. If we are unable to obtain financing in the future, it could have anegative effect on our operations and our liquidity.

 

Our ability to generate cash flows from operationsand to make scheduled distributions on our outstanding preferred stock willdepend on our future financial performance and particularly our ability torealize the value of our investment portfolio. Our future performance will beaffected by a range of economic, competitive, legislative, operating and otherbusiness factors, many of which we cannot control, such as general economic andfinancial conditions in our industry or the economy at large. A significantreduction in operating cash flows resulting from further deterioration in themortgage industry, changes in economic conditions, or other events couldincrease the need for additional or alternative sources of liquidity and couldhave a material adverse effect on our business, financial condition, results ofoperations and prospects and our ability to satisfy our obligations. If we areunable to satisfy our obligations, we will be forced to adopt an alternativestrategy that may include actions such as, selling assets, restructuring orrefinancing indebtedness or seeking equity capital. We cannot assure you that anyof these alternative strategies could be effected on satisfactory terms, if atall, or that they would yield sufficient funds for continuing operations.

 

**The New York Stock Exchange (“NYSE”) has notified us that weare not in compliance with its continued listing criteria. If we are delistedby The NYSE, the price and liquidity of our common stock will be negativelyaffected.**

 

On November 28 2007, we receivednotice from NYSE Regulation, Inc. stating that we are not in compliance withthe NYSE’s continued listing standard related to maintaining a consecutivethirty day average closing stock price of over $1.00 per common share. UnderNYSE rules, we have six months to bring our share price and average price backabove $1.00, during which time our common stock and preferred stock willcontinue to be listed and traded on the NYSE, subject to ongoing reassessmentby NYSE Regulation.  If the share priceand average price are not above $1.00 at the expiration of the six-monthperiod, then the NYSE will commence suspension and delisting procedures.  In addition, even if such minimum price isachieved and maintained, there can be no assurance that we will be able tocontinue to meet the NYSE’s other qualitative or quantitative listing standardsfor continued listing. The NYSE has informed us that it will continue tomonitor share price levels and that it reserves the right to take moreimmediate listing action in the event that the stock trades at levels that areviewed as “abnormally low” on a sustained basis or based on other qualitativefactors.

 

We cannot assure you that the NYSE willmaintain our listing in the future. In the event that our common stock isdelisted by the NYSE, or if it becomes apparent to us that we will be unable tomeet the NYSE’s continued listing criteria in the foreseeable future, we mayseek to have our stock listed or quoted on another national securities exchangeor quotation system. However, we cannot assure you that, if our common stock islisted or quoted on such other exchange or system, the market for our commonstock will be as liquid as it has been on the NYSE. As a result, if we aredelisted by the NYSE or transfer our listing to another exchange or quotationsystem, the market price for our common stock may become more volatile than ithas been historically.

 

**If we failto maintain effective systems of internal control over financial reporting anddisclosure controls and procedures, we may not be able to accurately report ourfinancial results or prevent fraud, which could cause current and potentialshareholders to lose confidence in our financial reporting, adversely affectthe trading price of our securities or harm our operating results.**

 

Effectiveinternal control over financial reporting and disclosure controls and proceduresare necessary for us to provide reliable financial reports and effectivelyprevent fraud and operate successfully as a public company. Any failure todevelop or maintain effective internal control over financial reporting anddisclosure controls and procedures could harm our reputation or operatingresults, or cause us to fail to meet our reporting obligations. In the past, wehave reported, and may discover in the future, material weaknesses in ourinternal control over financial reporting.

 

During 2007,as the market for our industry has continued to deteriorate over the last fewmonths, we have been reducing staff levels. In addition, with the discontinuance of certain operations, we have beenevaluating the need to maintain an internal control environment consistent withprevious periods.  This evaluation hasled to the reduction and / or change in certain controls that are not deemed tobe applicable to the current business process and reporting.  We are also in the process of evaluating theneed for information technology systems that we have used in the past toconduct business and

 

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report results.  Even with the reduced number of internalcontrols, we have experienced some deficiencies in our internal controlenvironment.  In addition, with lessstaff to maintain the information technology systems, our risks associated withmaintaining an adequate control information technology environment hasincreased. As a result, it is very likely that in connection with the annualassessment of our internal control over financial reporting, we will identifysignificant deficiencies. Although we are uncertain at this time as we have notcompleted our assessment, any significant deficiencies may, in the aggregate orindividually, rise to the level to be deemed material weaknesses, which wouldresult in a determination of ineffective internal control over financialreporting and disclosure controls.

 

We cannot becertain that our efforts to improve or change our internal control overfinancial reporting and disclosure controls and procedures will be successfulor that we will be able to maintain adequate controls over our financialprocesses and reporting in the future. Any failure to develop or maintaineffective controls or difficulties encountered in their implementation or othereffective improvement of our internal control over financial reporting anddisclosure controls and procedures could harm our operating results or cause usto fail to meet our reporting obligations. If we are unable to adequately maintain our internal control overfinancial reporting, our external auditors will not be able to issue anunqualified opinion and will issue an adverse opinion on the effectiveness ofour internal control over financial reporting~~.~~

 

Ineffectiveinternal control over financial reporting and disclosure controls andprocedures could cause investors to lose confidence in our reported financialinformation, which could have a negative effect on the trading price of our securitiesor affect our ability to access the capital markets and could result inregulatory proceedings against us by, among others, the SEC. In addition, amaterial weakness in internal control over financial reporting, which may leadto deficiencies in the preparation of financial statements, could lead tolitigation claims against us. The defense of any such claims may cause thediversion of management’s attention and resources, and we may be required topay damages if any such claims or proceedings are not resolved in our favor.Any litigation, even if resolved in our favor, could cause us to incursignificant legal and other expenses. Such events could harm our business,affect our ability to raise capital and adversely affect the trading price ofour securities.

 

**Deteriorating mortgage market conditions have had and maycontinue to have a material adverse impact on our earnings and financialcondition.**

 

Beginning in the second quarter of 2007, the mortgage industry and theresidential housing market were adversely affected as home prices declined anddelinquencies increased, particularly in the sub-prime mortgage industry. Thedifficulty that arose as a result of this has spread across various mortgagesectors, including the market in which we operate. These markets are currentlyexperiencing unprecedented disruptions, which have had and continue to have anadverse impact on the Company’s earnings and financial condition.  For the three months ended September 30,2007, the Company had a net loss of $1.2 billion and estimated taxable loss of$16.3 million.

 

During the third quarter, the secondary and securitization mortgagemarkets significantly reduced its purchasing of loans, to almost none, makingit extremely difficult to sell non-conforming mortgage loans and securities toinvestors, which led to significant margin calls, reducing the Company’s cashposition.  In addition, because housingprices have declined and lenders tightened underwriting guidelines, making itmore difficult to refinance, defaults and credit losses increased; whichfurther exacerbated home price depreciation and credit losses. As a result,nonconforming mortgage loans have not performed up to historical expectationsand the fair value of non-conforming mortgage loans has deteriorated.  For the three months ended September 30,2007, the Company’s REO’s was $369.5 million and the long-term mortgageportfolio included 8.97% of mortgages that were 60 days or moredelinquent.  These conditions, whichincrease the cost and reduce the availability of debt, may continue or worsenin the future.

 

As a result of the Company’s inability to sell or securitizenon-conforming loans, the Company has discontinued funding loans other thanconforming agency loans.   TheCompany has discontinued substantially all of its mortgage operations,commercial operations and warehouse lending operations and will either disposeof the remaining retail mortgage operations or discontinue and wind down theoperations.   As a further result of thedeteriorating market conditions, the Company experienced frequent margin calls,was in default on several repurchase facilities, and either terminated orallowed facilities to lapse leaving the Company with one available reverserepurchase facility.  The Company can notmake any assurances that it will not receive future margin calls, that it willbe able to satisfy those margin calls, or that it will be able to obtain anyfuture waivers of non-compliance on those facilities.  If overall market conditions continue todeteriorate and result in additional substantial declines in the value of theassets which we use to collateralize our secured borrowing arrangements,sufficient capital may not be available to support the continued ownership ofour investments, requiring certain assets to be sold at a loss.  The further deterioration of the mortgagemarket have had and may continue to have a material adverse impact on ourearnings and financial condition.

 

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**Recent increased delinquencies and losses with respect toresidential mortgage loans, particularly in the sub-prime sector, may cause usto recognize additional losses, which would further adversely affect ouroperating results, liquidity, financial condition, business prospects andability to continue as a going concern.**

 

The residential mortgage market has continued to encounter difficultieswhich have adversely affected our performance. In recent months, delinquenciesand losses with respect to residential mortgage loans generally have increasedand may continue to increase, particularly in the sub-prime sector. Inaddition, in recent months residential property values in many states havedeclined or remained stable, after extended periods during which those valuesappreciated. A sustained decline or a lack of increase in those values mayresult in additional increases in delinquencies and losses on residentialmortgage loans generally, especially with respect to any residential mortgageloans where the aggregate loan amounts (including any subordinate loans) areclose to or greater than the related property values. Another factor that mayhave contributed to, and may in the future result in, higher delinquency ratesis the increase in monthly payments on adjustable rate mortgage loans. Anyincrease in prevailing market interest rates may result in increased paymentsfor borrowers who have adjustable rate mortgage loans. Moreover, with respectto option ARM mortgage loans with a negative amortization feature which reachtheir negative amortization cap, borrowers may experience a substantialincrease in their monthly payment even without an increase in prevailing marketinterest rates. Compounding this issue, the current lack of appreciation inresidential property values, increased interest rates, and the adoption oftighter underwriting standards throughout the sub-prime mortgage loan industrymay adversely affect the ability of borrowers to refinance these loans andavoid default, particularly borrowers facing a reset of the monthly payment toa higher amount. To the extent that delinquencies or losses continue toincrease for these or other reasons, the value of our mortgage securities andthe remaining mortgage loans held in our portfolio will be further reduced,which will adversely affect our operating results, liquidity, cash flow,financial condition, business prospects and ability to continue as a goingconcern.

 

**Failure to enter into newemployment agreements and retain our current executive officers or otherkey management could significantly harm our business.**

 

We depend on the diligence, skill and experience of our seniorexecutives, including our chief executive officer, president and chiefoperating officer.  We believe that our future results will also depend inpart upon our attracting and retaining highly skilled and qualifiedmanagement.  We seek to compensate our executive officers, as well asother employees, through competitive salaries, bonuses and other incentiveplans, but there can be no assurance that these programs will allow us toretain key management executives or hire new key employees.  Each of ourchief executive officer, our president and chief operating officer have anemployment agreement that expires on December 31, 2007.  We cannot make any assurances that we will successfully negotiate new employmentagreements with these executive officers or that any of them will remain withthe Company.  The loss of our chief executive officer, president, chiefoperating officer or other senior executive officers and key managementcould have a material adverse impact on our operations because other officersmay not have the experience and expertise to readily replace these individuals.Our chief financial officer recently resigned from the Company effective November30, 2007.  Competition for such personnelis intense, and we cannot assure you that we will be successful in attractingor retaining such personnel.  Furthermore, in light of our presentfinancial condition, no assurance can be given that we will retain theseand other executive officers and key management personnel. To the extent thatone or more of our top executives or other key management personnel are nolonger employed by us, our operations and business prospects may be adverselyaffected.    The loss of, and changes in, key personnel andtheir responsibilities may be disruptive to our business and could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

**ITEM 2:****                               **UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS****

 

None.

** **

**ITEM 3:****                               **DEFAULTS UPON SENIORSECURITIES****

 

None.

 

**ITEM 4:****                               **SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS****

 

None.

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**ITEM 5:****                               **OTHER INFORMATION****

 

Resignation of Chief Financial Officer

 

OnDecember 18, 2007, Impac Mortgage Holdings, Inc. and Gretchen D. Verdugo agreedto terminate Ms. Verdugo’s Employment Agreement, originally entered into on May1, 2006, and Ms. Verdugo resigned as the Company’s Executive Vice President andChief Financial Officer effective November 30, 2007.  The Company and Ms. Verdugo also entered intoa Consulting Agreement, effective December 3, 2007.  Pursuant to the Consulting Agreement, theCompany will pay Ms. Verdugo an aggregate of $200,000 for the initial sixmonths, provide reimbursement for business expenses and provide health carebenefits, life insurance and short and long term disability until May 31, 2008.

** **

** **

Amendment to Bylaws

 

Pursuant to American Stock ExchangeRule 778 and Section 135 of the Amex Company Guide, all securities listed onthe Amex on and after January 1, 2008 must be eligible for Direct RegistrationSystem, or DRS.   A DRS permits aninvestor’s ownership of listed companies’ equity securities to be recorded andmaintained on the books of the issuers or their transfer agents without thephysical issuance of a stock certificate. The new rule does not requirecompanies to participate in the DRS; however, all AMEX listed equity securitiesmust be eligible to participate in the DRS by January 1, 2008. To beeligible to participate in the DRS, companies must, among other things, makesure that their governing documents allow their equity securities to be held inbook-entry form. As was the case with many companies, the Bylaws for ImpacMortgage Holdings, Inc. (specifically, Article VII) did not allowregistrant’s stock to be held in book-entry form. Article VII of IMH’sBylaws required the physical issuance of stock certificates to its shareholders.

 

Accordingly, onDecember 14,  2007, IMH’s Board ofDirectors approved amendments to IMH’s Bylaws to allow for either physicalissuance of registrant’s shares in certificated form or their issuance in bookentry form (uncertificated), depending on the individual decision of eachshareholder. The Bylaw amendments render the Common Stock DRS eligible andthereby in compliance with the AMEX Company Guide.

** **

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

 

(a)         Exhibits:

 
|   |   | 3.2    |   | Amendment No. 4 to Bylaws of Impac Mortgage Holdings, Inc.                                                                                                           |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | 10.1   |   | Consulting Agreement between Impac Mortgage Holdings, Inc. and  Gretchen Verdugo dated December 18, 2007                                                             |
|   |   | 31.1   |   | Certification  of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|   |   | 32.1*  |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.        |
|   |   |   |   |                                                                                                                                                                 |

 

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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 SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
| **IMPAC MORTGAGE HOLDINGS, INC.**                                                       | ** ** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                              | ** ** | ** ** |
| /s/ Joseph R. Tomkinson                                                                 |       |       |
| by: Joseph R. Tomkinson                                                                 |       |       |
| Chief Executive Officer                                                                 |       |       |
|  (authorized  officer of registrant and principal executive and financial officer) |       |       |
|                                                                                    |       |       |
| Date: December 20, 2007                                                            |       |       |
|                                                                                         |            |            |  |

 

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