# **UNITED STATES**

# **SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

## **FORM 10-Q**

**x**        **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period ended September 30, 2006 or**

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

**For the transition period from                    to                    .**

**Commission File Number: 1-14100**

**IMPACMORTGAGE HOLDINGS, INC.**

(Exact name of registrant asspecified in its charter)

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

 

**19500 Jamboree Road, Irvine, CA 92612**

**(Address of principal executive offices)**

**(949) 475-3600**

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

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90days.    Yes  x    No  o

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

Large accelerated filer xAccelerated filer o Non-acceleratedfiler o

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

There were76,143,144 shares of common stock outstanding as of November 6, 2006.

 

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**IMPACMORTGAGE HOLDINGS, INC.**

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

**TABLE OF CONTENTS**
|          | **PART I.  FINANCIAL INFORMATION**                                                                                                   |   |
|----------|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
|     |                                                                                                                                      |   |
| ITEM  1. | **CONSOLIDATED FINANCIAL  STATEMENTS**                                                                                                    | 1      |
|     | Consolidated Balance Sheets as of  September 30, 2006 and December 31, 2005                                                               | 1      |
|     | Consolidated Statements of  Operations and Comprehensive Earnings (Loss) for the Three and Nine Months  Ended September 30, 2006 and 2005 | 2      |
|     | Consolidated Statements of  Cash Flows for the Nine Months Ended September 30, 2006 and 2005                                              | 4      |
|     | Notes to Consolidated  Financial Statements                                                                                               | 6      |
|     |                                                                                                                                      |   |
| ITEM  2. | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                           | 19     |
|     | Forward-Looking Statements                                                                                                                | 19     |
|     | General Overview                                                                                                                          | 19     |
|     | Critical  Accounting Policies                                                                                                             | 21     |
|     | Selected Financial  Results for the Third Quarter of 2006                                                                                 | 21     |
|     | Selected Financial  Results for the First Nine Months of 2006                                                                             | 22     |
|     | Third Quarter and  Year to Date 2006 Taxable Income                                                                                       | 22     |
|     | Financial Condition  and Results of Operations                                                                                            | 24     |
|     | Liquidity and Capital  Resources                                                                                                          | 43     |
|     |                                                                                                                                      |   |
| ITEM  3. | **QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK**                                                                           | 47     |
|     |                                                                                                                                      |   |
| ITEM 4.  | **CONTROLS  AND PROCEDURES**                                                                                                              | 50     |
|     |                                                                                                                                      |   |
|     | **PART II. OTHER INFORMATION**                                                                                                            |   |
|     |                                                                                                                                      |   |
| ITEM 1.  | **LEGAL  PROCEEDINGS**                                                                                                                    | 50     |
|     | ** **                                                                                                                                |   |
| ITEM 1A. | **RISK FACTORS**                                                                                                                          | 50     |
|     | ** **                                                                                                                                |   |
| ITEM  2. | **UNREGISTERED SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS**                                                                          | 51     |
|     | ** **                                                                                                                                |   |
| ITEM  3. | **DEFAULTS UPON SENIOR  SECURITIES**                                                                                                      | 52     |
|     | ** **                                                                                                                                |   |
| ITEM  4. | **SUBMISSION OF MATTERS TO A  VOTE OF SECURITY HOLDERS**                                                                                  | 52     |
|     | ** **                                                                                                                                |   |
| ITEM 5.  | **OTHER  INFORMATION**                                                                                                                    | 52     |
|     | ** **                                                                                                                                |   |
| ITEM 6.  | **EXHIBITS**                                                                                                                              | 52     |
|     | ** **                                                                                                                                |   |
|     | **SIGNATURES**                                                                                                                            | 53     |
|     | ** **                                                                                                                                |   |
|     | **CERTIFICATIONS**                                                                                                                        |   |

 

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

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

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                     | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                                                                                     | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                     |       | $                      | 161,901    |                  | $          | 146,621 |   |
| Restricted cash                                                                                                                                                                                                                                                |       | 498                    |       | 698                   |       |
| Securitized mortgage  collateral                                                                                                                                                                                                                               |       | 20,232,463             |       | 24,494,290            |       |
| Finance receivables                                                                                                                                                                                                                                            |       | 297,657                |       | 350,217               |       |
| Mortgages  held-for-investment                                                                                                                                                                                                                                 |       | 3,134                  |       | 160,070               |       |
| Allowance for loan  losses                                                                                                                                                                                                                                     |       | (65,715                | )          | (78,514               | )          |
| Mortgages held-for-sale                                                                                                                                                                                                                                        |       | 1,293,085              |       | 2,052,694             |       |
| Accrued interest  receivable                                                                                                                                                                                                                                   |       | 103,807                |       | 123,565               |       |
| Derivatives                                                                                                                                                                                                                                                    |       | 176,797                |       | 250,368               |       |
| Other assets                                                                                                                                                                                                                                                   |       | 286,757                |       | 220,370               |       |
| Total assets                                                                                                                                                                                                                                                   |       | $                      | 22,490,384 |                  | $          | 27,720,379 |   |
|                                                                                                                                                                                                                                                           |       |                   |       |                  |       |
| **LIABILITIES**                                                                                                                                                                                                                                                | ** ** | ** **             | ** ** | ** **            | ** ** |
| Securitized mortgage  borrowings                                                                                                                                                                                                                               |       | $                      | 19,697,798 |                  | $          | 23,990,430 |   |
| Reverse repurchase  agreements                                                                                                                                                                                                                                 |       | 1,542,441              |       | 2,430,075             |       |
| Trust preferred  securities                                                                                                                                                                                                                                    |       | 97,448                 |       | 96,750                |       |
| Other liabilities                                                                                                                                                                                                                                              |       | 85,036                 |       | 36,177                |       |
| Total  liabilities                                                                                                                                                                                                                                             |       | 21,422,723             |       | 26,553,432            |       |
|                                                                                                                                                                                                                                                           |       |                   |       |                  |       |
| 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 September 30, 2006 and December 31, 2005,  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, 2006 and December 31, 2005, respectively                        |       | 20                     |       | 20                    |       |
| Series-C 9.125%  cumulative redeemable preferred stock, $0.01 par value; liquidation value  $109,280; 5,500,000 shares authorized; 4,383,900 shares and 4,371,200 shares  issued and outstanding as of September 30, 2006 and December 31, 2005,  respectively |       | 44                     |       | 44                    |       |
|                                                                                                                                                                                                                                                           |       |                   |       |                  |       |
| Common stock, $0.01 par  value; 200,000,000 shares authorized; 76,083,865 and 76,112,963 shares issued  and outstanding as of September 30, 2006 and December 31, 2005, respectively                                                                           |       | 761                    |       | 761                   |       |
| Additional paid-in  capital                                                                                                                                                                                                                                    |       | 1,168,729              |       | 1,167,059             |       |
| Accumulated other  comprehensive (loss) income                                                                                                                                                                                                                 |       | (567                   | )          | 1,305                 |       |
| Net accumulated  deficit:                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Cumulative  dividends declared                                                                                                                                                                                                                                 |       | (758,689               | )          | (675,373              | )          |
| Retained  earnings                                                                                                                                                                                                                                             |       | 657,363                |       | 673,131               |       |
| Net accumulated  deficit                                                                                                                                                                                                                                       |       | (101,326               | )          | (2,242                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                               |       | 1,067,661              |       | 1,166,947             |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                                                               |       | $                      | 22,490,384 |                  | $          | 27,720,379 |   |

 

See accompanying notes to consolidated financialstatements.

1

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**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFOPERATIONSAND COMPREHENSIVE EARNINGS (LOSS)**

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

**(unaudited)**

 
| ** **                                                     | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                     | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                     | ** ** | **2006**                                | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| **INTEREST  INCOME:**                                          | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Mortgage assets                                                |       | $                                       | 298,139    |                                   | $          | 322,705 |   | $ | 942,778 |   | $ | 907,065 |   |
| Other                                                          |       | 2,127                                   |       | 1,345                                  |       | 6,451 |   | 4,149 |   |
| Total interest income                                          |       | 300,266                                 |       | 324,050                                |       | 949,229 |   | 911,214 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **INTEREST  EXPENSE:**                                         | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage borrowings                                |       | 289,925                                 |       | 243,945                                |       | 888,144 |   | 639,667 |   |
| Reverse repurchase agreements                                  |       | 32,552                                  |       | 35,448                                 |       | 81,881 |   | 78,192 |   |
| Other borrowings                                               |       | 2,299                                   |       | 1,761                                  |       | 6,986 |   | 3,200 |   |
| Total interest expense                                         |       | 324,776                                 |       | 281,154                                |       | 977,011 |   | 721,059 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| Net interest (expense) income                                  |       | (24,510                                 | )          | 42,896                                 |       | (27,782 | ) | 190,155 |   |
| Provision for loan losses                                      |       | 3,183                                   |       | 13,434                                 |       | 3,288 |   | 25,219 |   |
| Net interest (expense) income after provision for  loan losses |       | (27,693                                 | )          | 29,462                                 |       | (31,070 | ) | 164,936 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST  INCOME:**                                      | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Realized gain (loss) from derivative instruments               |       | 60,630                                  |       | 10,975                                 |       | 156,633 |   | (4,209 | ) |
| Change in fair value of derivative instruments                 |       | (155,534                                | )          | 107,881                                |       | (92,602 | ) | 141,521 |   |
| Gain on sale of loans                                          |       | 4,906                                   |       | 12,118                                 |       | 35,647 |   | 44,063 |   |
| Recovery of (provision for) repurchases                        |       | 15,876                                  |       | (3,242                                 | )          | (7,233 | ) | (8,606 | ) |
| Loss on lower of cost or market writedown                      |       | —                                  |       | —                                 |       | (15,284 | ) | — |   |
| Other income                                                   |       | 8,724                                   |       | 1,280                                  |       | 27,128 |   | 8,664 |   |
| Total non-interest (loss) income                               |       | (65,398                                 | )          | 129,012                                |       | 104,289 |   | 181,433 |   |
|                                                           |       |                                    |       |                                   |       |   |   |   |   |
| **NON-INTEREST  EXPENSE:**                                     | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Personnel expense                                              |       | 16,643                                  |       | 19,592                                 |       | 51,973 |   | 59,282 |   |
| General and administrative and other expense                   |       | 4,591                                   |       | 7,111                                  |       | 14,190 |   | 18,584 |   |
| Amortization of deferred charge                                |       | 4,861                                   |       | 6,908                                  |       | 15,872 |   | 19,503 |   |
| Professional services                                          |       | 1,692                                   |       | 1,730                                  |       | 6,201 |   | 7,170 |   |
| Equipment expense                                              |       | 1,543                                   |       | 1,414                                  |       | 4,862 |   | 3,797 |   |
| Occupancy expense                                              |       | 1,248                                   |       | 1,284                                  |       | 3,860 |   | 3,599 |   |
| Data processing expense                                        |       | 1,709                                   |       | 1,296                                  |       | 3,819 |   | 3,075 |   |
| Amortization and impairment of mortgage servicing  rights      |       | 380                                     |       | 551                                    |       | 1,112 |   | 1,577 |   |
| Gain on sale of other real estate owned                        |       | (302                                    | )          | (432                                   | )          | (1,277 | ) | (1,261 | ) |
| Total non-interest expense                                     |       | 32,365                                  |       | 39,454                                 |       | 100,612 |   | 115,326 |   |
| Net (loss) earnings before income taxes                        |       | (125,456                                | )          | 119,020                                |       | (27,393 | ) | 231,043 |   |
| Income tax expense (benefit)                                   |       | 2,234                                   |       | (7,337                                 | )          | (11,625 | ) | (13,924 | ) |
| Net (loss) earnings                                            |       | (127,690                                | )          | 126,357                                |       | (15,768 | ) | 244,967 |   |
| Cash dividends on cumulative redeemable preferred  stock       |       | (3,672                                  | )          | (3,624                                 | )          | (11,016 | ) | (10,872 | ) |
| Net (loss)  earnings available to common stockholders          |       | $                                       | (131,362   | )                                      | $          | 122,733 |   | $ | (26,784 | ) | $ | 234,095 |   |

 

See accompanying notes toconsolidated financial statements

2

----

 
| ** **                                         | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                         | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                         | ** ** | **2006**                                | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net (loss)  earnings                               |       | $                                       | (127,690   | )                                      | $          | 126,357 |   | $ | (15,768 | ) | $ | 244,967 |   |
| Net unrealized  (losses) gains on securities:      |       |                                    |       |                                   |       |   |   |   |   |
| Unrealized holding losses arising during period    |       | (237                                    | )          | (803                                   | )          | (2,015 | ) | (363 | ) |
| Reclassification of gains included in net earnings |       | —                                  |       | —                                 |       | 143 |   | — |   |
| Net unrealized losses                              |       | (237                                    | )          | (803                                   | )          | (1,872 | ) | (363 | ) |
| Comprehensive  (loss) earnings                     |       | $                                       | (127,927   | )                                      | $          | 125,554 |   | $ | (17,640 | ) | $ | 244,604 |   |
|                                               |       |                                    |       |                                   |       |   |   |   |   |
| Net (loss)  earnings per share:                    |       |                                    |       |                                   |       |   |   |   |   |
| Basic                                              |       | $                                       | (1.73      | )                                      | $          | 1.62 |   | $ | (0.35 | ) | $ | 3.10 |   |
| Diluted                                            |       | $                                       | (1.73      | )                                      | $          | 1.61 |   | $ | (0.35 | ) | $ | 3.07 |   |
| Dividends declared per  common share               |       | $                                       | 0.25       |                                   | $          | 0.45 |   | $ | 0.75 |   | $ | 1.95 |   |

 

Seeaccompanying notes to consolidated financial statements

3

----

 

**IMPACMORTGAGE HOLDINGS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                                                     | ** ** | **For the Nine Months** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                     | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                                     | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                                     | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net (loss) earnings                                                                            |       | $                                      | (15,768    | ) | $ | 244,967 |   |
| Adjustments to reconcile net earnings to net cash  provided by (used in) operating activities: |       |                                   |       |   |   |
| Provision for loan losses                                                                      |       | 3,288                                  |       | 25,219 |   |
| Amortization of deferred charge                                                                |       | 15,872                                 |       | 19,503 |   |
| Amortization of premiums, securitization costs and  debt issuance costs                        |       | 181,769                                |       | 216,284 |   |
| Gain on sale of other real estate owned                                                        |       | (1,277                                 | )          | (1,261 | ) |
| Gain on sale of loans                                                                          |       | (35,647                                | )          | (44,063 | ) |
| Provision for repurchases                                                                      |       | 7,233                                  |       | 8,606 |   |
| Lower of cost or market writedown                                                              |       | 15,284                                 |       | — |   |
| Change in fair value of derivative instruments                                                 |       | 92,602                                 |       | (141,521 | ) |
| Purchase of mortgages held-for-sale                                                            |       | (7,594,574                             | )          | (16,300,056 | ) |
| Sale and principal reductions on mortgages  held-for-sale                                      |       | 8,369,598                              |       | 14,700,238 |   |
| Net change in deferred taxes                                                                   |       | 83                                     |       | (2,077 | ) |
| Share-based compensation                                                                       |       | 1,628                                  |       | — |   |
| Depreciation and amortization                                                                  |       | 4,422                                  |       | 3,427 |   |
| Amortization and impairment of mortgage servicing  rights                                      |       | 1,112                                  |       | 1,577 |   |
| Net change in accrued interest receivable                                                      |       | 19,758                                 |       | (18,712 | ) |
| Net change in restricted cash                                                                  |       | 200                                    |       | 252,964 |   |
| Net change in other assets and liabilities                                                     |       | (16,890                                | )          | (35,365 | ) |
| Net cash provided by (used in) operating activities                                            |       | 1,048,693                              |       | (1,070,270 | ) |
|                                                                                           |       |                                   |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                     | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net change in securitized mortgage collateral                                                  |       | 3,974,163                              |       | (3,467,578 | ) |
| Net change in finance receivables                                                              |       | 52,560                                 |       | 166,677 |   |
| Purchase of premises and equipment                                                             |       | (8,162                                 | )          | (5,880 | ) |
| Net change in mortgages held-for-investment                                                    |       | 154,130                                |       | 388,105 |   |
| Purchase (disposition) of investment securities  available-for-sale                            |       | 36,781                                 |       | (36,413 | ) |
| Net change in mortgage servicing rights                                                        |       | (495                                   | )          | (736 | ) |
| Purchase of investments for deferred compensation  plan                                        |       | —                                 |       | (3,201 | ) |
| Net principal reductions on investment securities  available-for-sale                          |       | (29,035                                | )          | 1,501 |   |
| Proceeds from the sale of other real estate owned                                              |       | 62,588                                 |       | 38,960 |   |
| Net cash provided by (used in) investing activities                                            |       | 4,242,530                              |       | (2,918,565 | ) |
|                                                                                           |       |                                   |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                     | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net change in reverse repurchase agreements                                                    |       | (887,634                               | )          | 1,026,328 |   |
| Proceeds from securitized mortgage borrowings                                                  |       | 2,973,399                              |       | 10,564,127 |   |
| Repayment of securitized mortgage borrowings                                                   |       | (7,297,487                             | )          | (7,754,514 | ) |
| Issuance of trust preferred                                                                    |       | —                                 |       | 76,202 |   |
| Common stock dividends paid                                                                    |       | (53,281                                | )          | (113,194 | ) |
| Preferred stock dividends paid                                                                 |       | (11,016                                | )          | (10,872 | ) |
| Proceeds from sale of cumulative redeemable  preferred stock                                   |       | 203                                    |       | — |   |
| Purchases of common stock                                                                      |       | (951                                   | )          | — |   |
| Proceeds from exercise of stock options                                                        |       | 824                                    |       | 6,311 |   |
| Net cash provided by (used in) financing activities                                            |       | (5,275,943                             | )          | 3,794,388 |   |
|                                                                                           |       |                                   |       |   |   |
| Net change in cash and cash equivalents                                                        |       | 15,280                                 |       | (194,447 | ) |
| Cash and cash equivalents at beginning of period                                               |       | 146,621                                |       | 324,351 |   |
| Cash and cash  equivalents at end of period                                                    |       | $                                      | 161,901    |   | $ | 129,904 |   |

 

4

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| ** **                                       | ** ** | **For the Nine Months** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                       | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| **SUPPLEMENTARY  INFORMATION:**                  | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Interest paid                                    |       | $                                      | 862,033    |   | $ | 656,422 |   |
| Taxes paid                                       |       | 45                                     |       | 17,821 |   |
|                                             |       |                                   |       |   |   |
| **NON-CASH  TRANSACTIONS:**                      | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Accumulated other comprehensive loss             |       | $                                      | (1,872     | ) | $ | (363 | ) |
| Transfer of mortgages to other real estate owned |       | 129,785                                |       | 58,169 |   |
| Dividends  declared and accrued but unpaid       |       | 19,021                                 |       | 34,194 |   |

 

See accompanyingnotes to consolidated financial statements.

5

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**IMPAC MORTGAGE HOLDINGS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(in thousands, except per share data or as otherwise indicated)**(unaudited)

**Note A—Summaryof Business and Significant Accounting Policies**

**1.     BusinessSummary and Financial Statement Presentation**

***BusinessSummary***

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

TheCompany is a mortgage real estate investment trust, or “REIT,” that is anationwide acquirer, originator, seller and investor of non-conforming Alt-Aresidential mortgages or “Alt-A mortgages” and to a lesser extent,small-balance commercial mortgages or “commercial mortgages.”  The Company also provides warehouse financingto originators of mortgages.

TheCompany operates four core businesses:

·      the Long-Term Investment Operations thatis conducted by IMH and IMH Assets;

·      the Mortgage Operations that is conductedby IFC and ISAC;

·      the Warehouse Lending Operations that isconducted by IWLG; and

·      the Commercial Operations that isconducted by ICCC.

The REIT (IMH) iscomprised of the long-term investment operations and the warehouse lendingoperations.  The Taxable REITSubsidiaries (TRS) include the Mortgage Operations and Commercial Operationsand are subsidiaries of the REIT.

The long-term investmentoperations generate earnings primarily from net interest income earned onmortgages held as securitized mortgage collateral and mortgagesheld-for-investment (long-term mortgage portfolio) and associated derivativecash flows.  The long-term mortgageportfolio as reported on our consolidated balance sheets consists of mortgagesheld as securitized mortgage collateral and mortgages held-for-investment.  Investments in Alt-A mortgages and commercialmortgages are initially financed with short-term borrowings under reverserepurchase agreements, which are subsequently converted to long-term financingin the form of securitized mortgage borrowings. Cash flows from the long-term mortgage portfolio and proceeds from thesale of capital stock finance the acquisition of new Alt-A and commercialmortgages.

The mortgage operationsacquire, originate, sell and securitize primarily Alt-A adjustable ratemortgages (ARMs) and fixed rate mortgages (FRMs) from correspondents, mortgagebrokers and retail customers. Correspondents originate and close mortgages under their mortgageprograms and then sell the closed loans to the mortgage operations on a flow(loan-by-loan) basis or through bulk sale commitments. Correspondents include;savings and loan associations, commercial banks and mortgage bankers. Themortgage operations generate income by securitizing and selling mortgages topermanent investors, including the long-term investment operations. Thisbusiness also earns revenue from fees associated with mortgage servicingrights, master servicing agreements and interest income earned on mortgagesheld-for-sale. The mortgage operations use facilities provided by the warehouselending operations to finance the acquisition and origination of mortgages.

6

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The warehouse lendingoperations provide repurchase financing to mortgage loan originators, includingthe mortgage and commercial operations, by funding mortgages from their closingdate until sale to pre-approved investors. This business earns fees from eachtransaction as well as net interest income from the difference between its costof borrowings and the interest earned on repurchase advances.

The commercial operationsoriginate commercial mortgages, that are primarily adjustable rate mortgageswith initial fixed interest rate periods of two-, three-, five-, seven-and ten-years that subsequently convert to adjustable rate mortgages, or “hybridARMs,” with balances that generally range from $500,000 to$5.0 million.  Commercial mortgageshave interest rate floors, which is the initial start rate; in somecircumstances have lock out periods, and prepayment penalty periods of three-,five-, seven- and ten-years.  Thesemortgages provide greater asset diversification on our balance sheet ascommercial mortgage borrowers typically have higher credit scores and typicallyhave lower loan-to-value ratios, or “LTV ratios,” and the mortgages have longeraverage lives than residential mortgages.

The Company securitizesmortgages in the form of collateralized mortgage obligations (CMOs) and realestate mortgage investment conduits (REMICs). The typical CMO securitization isdesigned so that the transferee (securitization trust) is not a qualifyingspecial purpose entity (QSPE) and thus as the sole residual interest holder,the Company consolidates securitization. Amounts consolidated are classified as securitized mortgage collateraland securitized mortgage borrowings in the consolidated balance sheets. In somecases, the REMIC securitization qualifies for sale accounting treatment and thesecuritization trust is a QSPE and thus not consolidated by the Company.Generally, a REMIC securitization trust does not meet sale accounting and QSPEcriteria, and thus the securitization is treated as a secured borrowing andconsolidation is assessed pursuant to FIN 46R, “Consolidation of VariableInterest Entities.”

In 2005 and 2006, theCompany completed ISAC REMIC 2005-2, ISAC REMIC 2006-1, and ISAC REMIC 2006-3securitizations which were treated as sales for tax purposes but treated assecured borrowings for generally accepted accounting principles (GAAP) andconsolidated in the financial statements. The associated collateral and borrowings are included in securitizedmortgage collateral and borrowings, respectively, for reporting purposes.Hence, reference to “Securitized mortgage collateral” or “Securitized mortgageborrowings” includes the REMIC 2005-2, 2006-1, and 2006-3 securitizedcollateral and borrowings.

In the second quarter of2006, the Company completed ISAC REMIC 2006-2 securitization in the amount of$834.0 million which was treated as a sale for both tax and GAAP purposes.  The residual interest, calculated as the presentvalue of estimated future cash flows, was retained as a result of the ISACREMIC 2006-2 securitization, and is recorded in other assets on the balancesheet as investment securities available-for-sale.  Investments in residual interest andsubordinated securities represent higher risk than investments in seniormortgage-backed securities because these subordinated securities bear allcredit losses prior to the related senior securities.  The risk associated with holding residualinterests and subordinated securities is greater than holding the underlying mortgageloans directly due to the concentration of losses attributed to thesubordinated securities.   The value of residual interests representsthe present value of future cash flows expected to be received by us fromexcess cash flows created in the securitization transaction. In general, futurecash flows are estimated by taking the coupon rate of the loans underlying thetransaction less the interest rate paid to the investors, less contractuallyspecified servicing and trustee fees, and after giving effect to estimatedprepayments and credit losses.  The Company estimates future cash flowsfrom these securities utilizing assumptions based in part on projected discountrates, delinquency rates, mortgage loan prepayment speeds and credit losses.

In January 2006, theCompany combined our Alt-A wholesale and sub-prime residential mortgage productofferings under one platform. Our sub-prime residential mortgage productspreviously marketed under Novelle Financial Services, Inc., are now offeredby our Alt-A wholesale operations, Impac Lending Group (ILG), a division ofIFC.

On January 1,2006, the Company elected to convert Impac Commercial Capital Corporation “ICCC”from a qualified REIT subsidiary to a taxable REIT subsidiary.  On June 30, 2006, the Company approved thetransfer of ICCC to be a wholly-owned subsidiary of IFC effective January 1,2006.

7

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***Financial Statement Presentation***

Theaccompanying unaudited consolidated financial statements of the Company and oursubsidiaries (as defined above) have been prepared in accordance with GAAP forinterim financial information and with the instructions to Form 10-Q and Rule10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnotes required by GAAP foraudited financial statements.  In theopinion of management, all adjustments, consisting of normal recurringadjustments considered necessary for a fair presentation, have beenincluded.  Operating results for thethree-month and nine-month period ended September 30, 2006 are not necessarilyindicative of the results that may be expected for the year ending December 31,2006.

TheCompany’s consolidated financial statements should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and the consolidated financial statements of the Company and thenotes thereto, included in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2005.

Allsignificant inter-company balances and transactions have been eliminated inconsolidation.  In addition, certainamounts in the prior periods’ consolidated financial statements have beenreclassified to conform to the current period presentation.

Management has made a number of estimates andassumptions relating to the reporting of assets and liabilities, including thedisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period to prepare these financial statements in conformity withGAAP.  The items effected by management’sestimates and assumptions include allowance for loan losses, valuation ofderivative financial instruments, repurchase liabilities related to sold loans, the amortization ofvarious loan premiums and discounts due to prepayment estimates, and lower ofcost or market “LOCOM.”  Actual resultscould differ from those estimates.

Premiums, discounts and securitization costsassociated with the securitized mortgage collateral and securitized mortgageborrowing are amortized or accreted into interest income/expense over theprojected lives of the securitized mortgage collateral and securitized mortgageborrowings using the interest method. The Company policy for estimating prepayment speeds for calculating theeffective yield is to evaluate historical performance, market prepaymentspeeds, and current conditions.  If theestimate of prepayments is incorrect, the Company may be required to make anadjustment to the amortization or accretion of premiums and discounts thatwould have an effect on future income.

**2.     StockOptions**

The Company maintains a stock based incentivecompensation plan the terms of which are governed by the Impac MortgageHoldings, Inc. 2001 Stock Option, Deferred Stock and Restricted StockPlan, as amended (the 2001 Stock Plan).  Officers, keyemployees, directors, consultants and advisors are eligible to receive awardspursuant to the 2001 Stock Plan.  The aggregate number of shares reservedunder the 2001 Stock Plan is 10,222,765 shares  (including increasespursuant to the plan’s “evergreen provision”), and as of September30, 2006 there were 2,225,699 shares available for grant as stock options,restricted stock and deferred stock awards.

Effective January 1, 2006, the Company adopted theStatement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-BasedPayment,” using the modified prospective method, which requires recognition ofcompensation expense for all awards granted after the date of adoption, and forthe unvested portion of previously granted awards that remain outstanding atthe date of adoption.  Accordingly, priorperiod amounts presented herein have not been restated to reflect the adoptionof SFAS 123R.  As required, the pro formaeffect from recognition of the estimated fair value of stock options granted toemployees has been disclosed for previous periods.

As a result of adopting SFAS 123R on January 1, 2006,the Company’s net earnings before income taxes and net earnings for the ninemonths ended September 30, 2006 are $1.6 million and $1.3 million lower,respectively, than if it had continued to account for share-based compensationunder Accounting Principles Board Opinion No. 25 “Accounting for Stock Issuedto Employees, “(“APB 25”).  Basic and dilutedearnings per share for the nine months ended September 30, 2006 are $0.02 and$0.02 lower, respectively, than if the Company had continued to account forshare-based compensation under APB 25.

8

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The fair value of each stock option granted under theCompany’s stock based compensation plan is estimated on the date of grant usingthe Black-Scholes option-pricing model and the assumptions noted below. Theexpected volatility is based on both the implied and historical volatility ofthe Company’s stock. The expected option term of options granted represents theperiod of time that the options granted are expected to be outstanding and isbased on historical experience giving consideration for the contractual terms,vesting periods and expectations of future employee behavior. The risk-freeinterest rate is based on the U.S. Treasury rate with a term equal to theexpected term of the option grants on the date of grant.

SFAS 123R requires forfeitures to be estimated at thetime of grant and prospectively revised, if necessary, in subsequent periods ifactual forfeitures differ from initial estimates. Share-based compensationexpense was recorded net of estimated forfeitures for the nine months endedSeptember 30, 2006 such that expense was recorded only for those stock-basedawards that were expected to vest. Previously under APB 25 to the extent awardswere forfeited prior to vesting, the corresponding previously recognizedexpense was reversed in the period of forfeiture.

On August 18, 2006, the Compensation Committee of theBoard of Directors approved performance criteria for the 225,000 performancebased options granted to each of the following, Messrs. Joseph R. Tomkinson,our Chairman and Chief Executive Officer, William S. Ashmore, our President,and Richard J. Johnson our Executive Vice President and Chief OperatingOfficer.  The awards vest in one-third increments if the Company meetsspecified estimated taxable income targets over each of the three 12-monthperiods ending June 30, 2009. The options expire four years from the date ofgrant. If a portion of an award does not vest, the failure of that portionto vest will not affect the vesting of earlier or subsequent portions.  These options were granted in the thirdquarter of 2006, and are included in the option grants below.  The fair value of each performance basedoption was measured on the date of grant using the same assumptions used tovalue the service based options, and assumed that performance goals would beachieved. If such goals are not met, no compensation cost is recognized and anyrecognized compensation cost is reversed.

Thefollowing table illustrates the effect as if the Company had elected to use thefair value approach to account for its employee stock-based compensation planat September 30, 2005:
|                                                                                    | ** ** | **For the Three Months**     | ** ** | **For the Nine Months**      | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                         | ** ** | **Ended September 30, 2005** | ** ** | **Ended September 30, 2005** | ** ** |
| Net earnings  available to common stockholders                                     |       | $                                           | 122,733    |                                        | $          | 234,095 |   |
| Less: Total stock-based employee compensation expense  using the fair value method |       | (686                                        | )          | (1,764                                      | )          |
| Pro forma net  earnings                                                            |       | $                                           | 122,047    |                                        | $          | 232,331 |   |
|                                                                               |       |                                        |       |                                        |       |
| Net earnings per  share as reported:                                               |       |                                        |       |                                        |       |
| Basic                                                                              |       | $                                           | 1.62       |                                        | $          | 3.10 |   |
| Diluted                                                                            |       | $                                           | 1.61       |                                        | $          | 3.07 |   |
|                                                                               |       |                                        |       |                                        |       |
| Pro forma net  earnings per share:                                                 |       |                                        |       |                                        |       |
| Basic                                                                              |       | $                                           | 1.61       |                                        | $          | 3.08 |   |
| Diluted                                                                            |       | $                                           | 1.59       |                                        | $          | 3.01 |   |

 

The fair value of optionsgranted, which is amortized to expense over the option vesting period, isestimated on the date of grant using the Black-Scholes-Merton optionpricing model with the following weighted average assumptions:

9

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|                                        | ** ** | **For the Nine Months** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | **Ended September 30,**      | ** ** |
| ** **                             | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Risk-free interest rate                |       | 3.90%  to 4.26%                        |       | 2.16%  to 4.50% |   |
| Expected lives (in  years)             |       | 3                                      |       | 3 -  4 |   |
| Expected volatility (1)                |       | 34.75%                                 |       | 42.26% |   |
| Expected dividend yield                |       | 11.00%                                 |       | 10.00% |   |
| Grant date fair value of share options |       | $1.41                                  |       | $3.71 |   |

 

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

Thefollowing table summarizes activity, pricing and other information for theCompany’s stock options for the nine-month period ended September 30, 2006:
| ** **                                | ** ** | ** **         | ** ** | **Weighted-**          | ** ** | **Weighted-**           | ** ** | **Aggregate**           | ** ** |
|-------------------------------------------|------------|--------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | ** **         | ** ** | **Average**            | ** ** | **Average**             | ** ** | **Intrinsic**           | ** ** |
| ** **                                | ** ** | **Number of** | ** ** | **Exercise**           | ** ** | **Remaining Life** | ** ** | **Value (1)**      | ** ** |
| ** **                                | ** ** | **Shares**         | ** ** | **Price $ ** | ** ** | **(Years)**             | ** ** | **(in thousands)** | ** ** |
| Options outstanding at  beginning of year |       | 5,266,544          |       | $                      | 14.55      |                    |       |                    |       |   |
| Options granted                           |       | 2,774,000          |       | 9.94                   |       |                    |       |                    |       |
| Options exercised                         |       | (75,202            | )          | 10.95                  |       |                    |       |                    |       |
| Options forfeited /  cancelled            |       | (853,087           | )          | 13.64                  |       |                    |       |                    |       |
| Options outstanding at  end of period     |       | 7,112,255          |       | $                      | 12.90      |                    | 3.00       |                    | $          | 3,753.9 |   |
| Options exercisable at end of period      |       | 3,116,390          |       | $                      | 13.98      |                    | 2.41       |                    | $          | 3,753.9 |   |

 

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(1)                       The intrinsic value of a stock option is theamount by which the fair value of the underlying stock exceeds the exerciseprice of the option.

The aggregate intrinsic value in the preceding tablerepresents the total pretax intrinsic value, based on the Company’s closingstock price of $9.37 per share as of September 30, 2006, which would have beenreceived by the option holders had all option holders exercised their optionsas of that date.  As of September 30,2006, there was approximately $4.9 million of total unrecognized compensationcost related to nonvested share-based compensation arrangements granted underthe plan.  That cost is expected to berecognized over a weighted average period of 1.19 years.

In addition to the options granted, the Company hasgranted nonvested shares, which vest over a three year period.  The fair value of each nonvested share wasmeasured on the date of grant using the grant date price of the Company’sstock.  A summary of the option activityof the Company’s nonvested shares during the nine month period ended September30, 2006, is presented below:
|                                               | ** ** | ** ** | ** ** | **Weighted-Average** | ** ** |
|-----------------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **Grant-Date**       | ** ** |
| ** **                                    | ** ** | **Shares** | ** ** | **Fair Value**  | ** ** |
| Nonvested outstanding  at beginning of period |       | 5,000      |       | $                    | 13.76      |   |
| Shares Granted                                |       | 42,577     |       | 9.94                 |       |
| Shares Vested                                 |       | —     |       | —               |       |
| Shares Forfeited                              |       | —     |       | —               |       |
| Nonvested outstanding at end of period        |       | 47,577     |       | $                    | 10.34      |   |

10

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As of September 30, 2006, there was approximately$450,000 of total unrecognized compensation cost related to nonvested stockcompensation arrangements granted under the plan.  That cost is expected to be recognized over aweighted average period of 1.52 years.

Additional information regarding stock optionsoutstanding as of September 30, 2006, is as follows:
|                    | ** ** | **Stock Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------|------------|-----------------------------------------|------------|------------------------------|------------|
| ** **         | ** ** | ** **                              | ** ** | **Weighted-**                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **         | ** ** | ** **                              | ** ** | **Average**                  | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| **Exercise**       | ** ** | ** **                              | ** ** | **Remaining**                | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Price**          | ** ** | **Number**                              | ** ** | **Contractual**              | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Range ($)** | ** ** | **Outstanding**                         | ** ** | **Life in Years**  | ** ** | **Price ($)** | ** ** | **Exercisable** | ** ** | **Price ($)** | ** ** |
| 3.85 - 9.42        |       | 796,250                                 |       | 4.55                         |       | 4.65 |   | 796,250 |   | 4.66 |   |
| 9.94               |       | 2,708,500                               |       | 3.88                         |       | 9.94 |   | — |   | — |   |
| 13.76 - 14.27      |       | 2,410,505                               |       | 1.98                         |       | 13.98 |   | 1,508,825 |   | 14.12 |   |
| 21.77 - 22.83      |       | 692,000                                 |       | 2.17                         |       | 22.77 |   | 474,654 |   | 22.74 |   |
| 23.10              |       | 505,000                                 |       | 1.84                         |       | 23.10 |   | 336,661 |   | 23.10 |   |
| 3.85 - 23.10       |       | 7,112,255                               |       | 3.00                         |       | 12.90 |   | 3,116,390 |   | 13.98 |   |

 

**3.     RecentAccounting Pronouncements**

In February 2006, the FASB issued SFAS No. 155, *“Accounting for Certain Hybrid Financial Instruments, “an amendment ofFASB Statements No. 133 and SFAS No. 140* (“SFAS 155”).  This statement permits fair valuere-measurement for any hybrid financial instrument that contains an embeddedderivative that otherwise would require bifurcation. It also clarifies whichinterest-only strips and principal-only strips are not subject to FASBStatement No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“SFAS 133”).  The statementalso establishes a requirement to evaluate interests in securitized financialassets to identify interests that are freestanding derivatives or hybridfinancial instruments that contain an embedded derivative requiringbifurcation. The statement also clarifies that concentration of credit risks inthe form of subordination are not embedded derivatives, and it also amends SFAS140 to eliminate the prohibition on a QSPE from holding a derivative financialinstrument that pertains to a beneficial interest other than another derivativefinancial instrument. SFAS 155 is effective for all financial instrumentsacquired or issued after the beginning of an entity’s first fiscal year thatbegins after September 15, 2006. The adoption of this statement by the Companywill not have a significant effect on the consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, *Accounting for Servicing of Financial Assets- an amendment of FASBStatement No. 140* (“SFAS 156”). This statement requires an entity to recognize a servicing asset orservicing liability each time it undertakes an obligation to service afinancial asset by entering into a servicing contract in any of the followingsituations; whenever a transfer of the servicer’s financial assets that meetsthe requirements for sale accounting, a transfer of the servicer’s financialassets to a qualifying special-purpose entity in a guaranteed mortgagesecuritization in which the transferor retains all of the resulting securitiesand classifies them as either available-for-sale securities or tradingsecurities in accordance with FASB Statement No. 115, Accounting for CertainInvestments in Debt and Equity Securities, an acquisition or assumption of anobligation to service a financial asset that does not relate to financialassets of the servicer or its consolidated affiliates. This statement requiresall separately recognized servicing assets and servicing liabilities to beinitially measured at fair value, if practicable. This statement permits anentity to choose either the amortization method or the fair value measurementmethod for each class of separately recognized servicing assets and servicingliabilities. This statement at its initial adoption, permits a one-timereclassification of available-for-sale securities to trading securities byentities with recognized servicing rights, without calling into question thetreatment of other available-for-sale securities under Statement 115, providedthat the available-for-sale securities are identified in some manner asoffsetting the entity’s exposure to changes in fair value of servicing assetsor servicing liabilities that a servicer elects to subsequently measure at fairvalue. This statement also requires separate presentation of servicing assetsand servicing liabilities subsequently measured at fair value in the statementof financial position and additional disclosures for all separately recognizedservicing assets and servicing liabilities. An entity should adopt thisstatement as of the beginning of its first fiscal year that begins afterSeptember 15, 2006. The adoption of this statement by the Company is notexpected to have a significant effect on the consolidated financial statements.

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In June 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes,*(“FIN 48”)which expands on the accounting guidance of FASB Statement No. 109, *Accounting for Income Taxes*.  This interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return.  This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition.  FIN 48 is effective for fiscalyears beginning after December 15, 2006.  The adoption of thisinterpretation by the Company is not expected to have a significant effect onthe consolidated financial statements.

In September 2006, the SEC issued Staff AccountingBulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Qualifying Misstatements in Current YearFinancial Statements*(“SAB 108”), which provides interpretiveguidance on the consideration of the effects of prior year misstatements inquantifying current year misstatements for the purpose of a materialityassessment.  SAB 108 was issued toaddress diversity in practice in quantifying financial statementmisstatements.  SAB 108 requires that wequantify misstatements based on their effect on each of our financialstatements and related disclosures.  SAB108 is effective as of the end of the Company’s 2006 fiscal year.

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurement* (“SFAS 157”), which defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair valuemeasurements.  SFAS 157 is effectivefor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years.  The Companyis currently assessing the effect, if any, from the adoption of SFASNo. 157 on the consolidated financial statements.

**4.     LegalProceedings**

The Company’s Form 10-Kfor the year ended December 31, 2005 and Forms 10-Q for the periods ended March31, 2006 and June 30, 2006, reported shareholder derivative actions filedagainst the Company and its senior officers and directors in the U.S. DistrictCourt, Central District of California and Orange County Superior Court.  On September 14, 2006, the Orange CountySuperior Court stayed the consolidated state shareholder derivative actionpending resolution of the federal securities class actions and federalshareholder derivative actions.

Management believes thatthey have meritorious defenses to the above claims and intend to defend theseclaims vigorously. Nevertheless, litigation is uncertain and the Company maynot prevail in the lawsuits and can express no opinion as to their ultimateresolution. An adverse judgment in any of these matters could have a materialadverse effect on the consolidated financial statements.

**Note B—Reconciliation of EarningsPer Share**

Thefollowing table presents the computation of basic and diluted net earnings percommon share including the dilutive effect of stock options outstanding for theperiods indicated:

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| ** **                                                                    | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                                                                    | ** ** | **2006**                                | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Numerator for basic earnings  per share:**                                  | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss) earnings                                                           |       | $                                       | (127,690   | )                                      | $          | 126,357 |   | $ | (15,768 | ) | $ | 244,967 |   |
| Less: Cash  dividends on cumulative redeemable preferred stock                |       | (3,672                                  | )          | (3,624                                 | )          | (11,016 | ) | (10,872 | ) |
| Net (loss) earnings  available to common stockholders                         |       | $                                       | (131,362   | )                                      | $          | 122,733 |   | $ | (26,784 | ) | $ | 234,095 |   |
| **Denominator for basic earnings  per share:**                                | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic weighted average  number of common shares outstanding during the period |       | 76,132                                  |       | 75,720                                 |       | 76,119 |   | 75,440 |   |
| **Denominator for diluted  earnings per share:**                              | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic weighted average  number of common shares outstanding during the period |       | 76,132                                  |       | 75,720                                 |       | 76,119 |   | 75,440 |   |
| Net effect of  dilutive stock options                                         |       | —                                  |       | 598                                    |       | — |   | 871 |   |
| Diluted weighted  average common shares                                       |       | 76,132                                  |       | 76,318                                 |       | 76,119 |   | 76,311 |   |
|                                                                          |       |                                    |       |                                   |       |   |   |   |   |
| Net (loss) earnings per  share:                                               |       |                                    |       |                                   |       |   |   |   |   |
| Basic                                                                         |       | $                                       | (1.73      | )                                      | $          | 1.62 |   | $ | (0.35 | ) | $ | 3.10 |   |
| Diluted                                                                       |       | $                                       | (1.73      | )                                      | $          | 1.61 |   | $ | (0.35 | ) | $ | 3.07 |   |

 

Forthe three and nine month periods ended September 30, 2006, stock options topurchase 7.1 million shares were outstanding but not included in the aboveweighted average calculations because they were anti-dilutive.  For the three and nine month periods endedSeptember 30, 2005, stock options to purchase 1.4 million shares, wereoutstanding but not included in the above weighted average calculations becausethey were anti-dilutive.

**Note C—Segment Reporting**

The followingtables present reporting segments as of and for the nine and three months endedSeptember 30, 2006 and 2005:

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| ** **                                                         | ** ** | **Reporting Segments as of and for the Nine Months** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Ended September 30, 2006**                                                  | ** ** |
| ** **                                                         | ** ** | **Long-Term**                                                                                | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Investment**                                                                               | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Operations**                                                                               | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company (1)** | ** ** | **Consolidated** | ** ** |
| **Balance Sheet Items:**                                           | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage  collateral and Mortgages held-for-investment |       | $                                                                                            | 20,203,367 |   | $ | — |   | $ | 136,004 |   | $ | — |   | $ | (103,774 | ) | $ | 20,235,597 |   |
| Mortgages held-for-sale                                            |       | —                                                                                       |       | — |   | 932,419 |   | 360,666 |   | — |   | 1,293,085 |   |
| Finance receivables                                                |       | —                                                                                       |       | 1,614,544 |   | — |   | — |   | (1,316,887 | ) | 297,657 |   |
| Total assets                                                       |       | 20,638,699                                                                                   |       | 1,683,810 |   | 1,235,179 |   | 355,578 |   | (1,422,882 | ) | 22,490,384 |   |
| Total stockholders’  equity (deficit)                         |       | 873,154                                                                                      |       | 239,887 |   | 91,540 |   | (6,453 | ) | (130,467 | ) | 1,067,661 |   |
|                                                               |       |                                                                                         |       |   |   |   |   |   |   |   |   |   |   |
| **Income Statement Items:**                                        | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest (expense)  income                                     |       | $                                                                                            | (91,393    | ) | $ | 24,229 |   | $ | (4,621 | ) | $ | 251 |   | $ | 43,752 |   | $ | (27,782 | ) |
| Provision for (recovery  of) loan losses                           |       | 3,638                                                                                        |       | (350 | ) | — |   | — |   | — |   | 3,288 |   |
| Realized gain from  derivatives                                    |       | 156,582                                                                                      |       | — |   | 21 |   | 30 |   | — |   | 156,633 |   |
| Change in fair value of  derivatives                               |       | (95,186                                                                                      | )          | — |   | 4,877 |   | (6,324 | ) | 4,031 |   | (92,602 | ) |
| Other non-interest  (loss) income                                  |       | (852                                                                                         | )          | 2,426 |   | 57,971 |   | 3,387 |   | (22,674 | ) | 40,258 |   |
| Non-interest expense  and income taxes                             |       | 12,916                                                                                       |       | 5,578 |   | 60,476 |   | 6,113 |   | 3,904 |   | 88,987 |   |
| Net (loss) earnings                                                |       | $                                                                                            | (47,403    | ) | $ | 21,427 |   | $ | (2,228 | ) | $ | (8,769 | ) | $ | 21,205 |   | $ | (15,768 | ) |

 
| ** **                               | ** ** | **Reporting Segments as of and for the Three Months** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Ended September 30, 2006**                                                   | ** ** |
| ** **                               | ** ** | **Long-Term**                                                                                 | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Investment**                                                                                | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Commercial** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Operations**                                                                                | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Operations** | ** ** | **Company(1)** | ** ** | **Consolidated** | ** ** |
| **Income Statement Items:**              | ** ** | ** **                                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest (expense)  income           |       | $                                                                                             | (44,079    | ) | $ | 9,659 |   | $ | (3,234 | ) | $ | 61 |   | $ | 13,083 |   | $ | (24,510 | ) |
| Provision for (recovery  of) loan losses |       | 3,533                                                                                         |       | (350 | ) | — |   | — |   | — |   | 3,183 |   |
| Realized gain from  derivatives          |       | 60,595                                                                                        |       | — |   | 18 |   | 17 |   | — |   | 60,630 |   |
| Change in fair value of  derivatives     |       | (150,051                                                                                      | )          | — |   | 623 |   | (6,106 | ) | — |   | (155,534 | ) |
| Other non-interest  (loss) income        |       | (70                                                                                           | )          | 878 |   | 40,092 |   | 286 |   | (11,680 | ) | 29,506 |   |
| Non-interest expense  and income taxes   |       | 5,198                                                                                         |       | 2,077 |   | 25,896 |   | 1,008 |   | 420 |   | 34,599 |   |
| Net (loss) earnings                      |       | $                                                                                             | (142,336   | ) | $ | 8,810 |   | $ | 11,603 |   | $ | (6,750 | ) | $ | 983 |   | $ | (127,690 | ) |

 

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(1)                       Income statement items include inter-companyloan sale transactions and the elimination of related gains.  Corporate overhead expenses are generallyallocated to the segments based on percentage of time devoted to the segment.

14

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| ** **                                                         | ** ** | **Reporting Segments as of and for the Nine Months** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **Ended September 30, 2005**                                                  | ** ** |
| ** **                                                         | ** ** | **Long-Term**                                                                                | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Investment**                                                                               | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Operations (1)**                                                                      | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Company (2)** | ** ** | **Consolidated** | ** ** |
| **Balance Sheet Items:**                                           | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Securitized mortgage  collateral and Mortgages held-for-investment |       | $                                                                                            | 24,859,044 |   | $ | — |   | $ | — |   | $ | (129,355 | ) | $ | 24,729,689 |   |
| Mortgages held-for-sale                                            |       | —                                                                                       |       | — |   | 2,214,215 |   | — |   | 2,214,215 |   |
| Finance receivables                                                |       | —                                                                                       |       | 2,619,075 |   | — |   | (2,313,932 | ) | 305,143 |   |
| Total assets                                                       |       | 25,109,976                                                                                   |       | 2,757,884 |   | 2,267,415 |   | (2,246,326 | ) | 27,888,949 |   |
| Total stockholders’  equity                                   |       | 981,721                                                                                      |       | 203,324 |   | 19,469 |   | (67,810 | ) | 1,136,704 |   |
|                                                               |       |                                                                                         |       |   |   |   |   |   |   |   |   |
| **Income Statement Items:**                                        | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest income                                                |       | $                                                                                            | 89,967     |   | $ | 40,455 |   | $ | 6,559 |   | $ | 53,174 |   | $ | 190,155 |   |
| Provision for (recovery  of) loan losses                           |       | 25,484                                                                                       |       | (265 | ) | — |   | — |   | 25,219 |   |
| Realized loss from  derivatives                                    |       | (4,209                                                                                       | )          | — |   | — |   | — |   | (4,209 | ) |
| Change in fair value of  derivatives                               |       | 146,913                                                                                      |       | — |   | (5,392 | ) | — |   | 141,521 |   |
| Other non-interest  income (loss)                                  |       | 451                                                                                          |       | 6,268 |   | 105,959 |   | (68,557 | ) | 44,121 |   |
| Non-interest expense  and income taxes                             |       | 10,256                                                                                       |       | 5,833 |   | 90,872 |   | (5,559 | ) | 101,402 |   |
| Net earnings                                                       |       | $                                                                                            | 197,382    |   | $ | 41,155 |   | $ | 16,254 |   | $ | (9,824 | ) | $ | 244,967 |   |

 
| ** **                               | ** ** | **Reporting Segments as of and for the Three Months** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Ended September 30, 2005**                                                   | ** ** |
| ** **                               | ** ** | **Long-Term**                                                                                 | ** ** | **Warehouse** | ** ** | **Mortgage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Investment**                                                                                | ** ** | **Lending** | ** ** | **Operations** | ** ** | **Inter-** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Operations (1)**                                                                       | ** ** | **Operations** | ** ** | **(IFC)** | ** ** | **Company (2)** | ** ** | **Consolidated** | ** ** |
| **Income  Statement Items:**             | ** ** | ** **                                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net interest  income (expense)           |       | $                                                                                             | 8,941      |   | $ | 15,475 |   | $ | (101 | ) | $ | 18,581 |   | $ | 42,896 |   |
| Provision for  (recovery of) loan losses |       | 13,699                                                                                        |       | (265 | ) | — |   | — |   | 13,434 |   |
| Realized gain  from derivatives          |       | 10,975                                                                                        |       | — |   | — |   | — |   | 10,975 |   |
| Change in fair  value of derivatives     |       | 108,905                                                                                       |       | — |   | (1,024 | ) | — |   | 107,881 |   |
| Other  non-interest (loss) income        |       | (530                                                                                          | )          | 2,011 |   | 31,559 |   | (22,884 | ) | 10,156 |   |
| Non-interest  expense and income taxes   |       | 3,257                                                                                         |       | 1,978 |   | 29,604 |   | (2,722 | ) | 32,117 |   |
| Net earnings                             |       | $                                                                                             | 111,335    |   | $ | 15,773 |   | $ | 830 |   | $ | (1,581 | ) | $ | 126,357 |   |

 

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(1)                       For the three and nine month periods endedSeptember 30, 2005, the commercial operations were included in the Long TermInvestment Operations.  OnJanuary 1, 2006, we elected to convert Impac Commercial CapitalCorporation “ICCC” from a qualified REIT subsidiary to a taxable REITsubsidiary.  Therefore, there is nocorresponding three or nine month comparison.

(2)                       Income statement items include inter-companyloan sale transactions and the elimination of related gains.  Corporate overhead expenses are generallyallocated to the segments based on percentage of time devoted to the segment.

**NoteD—Mortgages Held-for-Sale**

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

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|                                                        | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                             | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| Mortgages  held-for-sale - residential                 |       | $                              | 921,189    |                          | $          | 2,027,194 |   |
| Mortgages held-for-sale  - commercial                  |       | 356,520                        |       | —                        |       |
| Change in fair value of  mortgages held-for-sale       |       | —                         |       | (4,465                        | )          |
| Net premiums on  mortgages held-for-sale - residential |       | 13,241                         |       | 29,965                        |       |
| Net premiums on  mortgages held-for-sale - commercial  |       | 2,135                          |       | —                        |       |
| Total mortgages  held-for-sale                         |       | $                              | 1,293,085  |                          | $          | 2,052,694 |   |

 

Mortgages held-for-saleconsist primarily of Alt-A mortgages, which are secured by residential andcommercial properties, located throughout the United States. Mortgagesheld-for-sale are carried at the lower of cost net of purchase discounts orpremiums and deferred fees, or market value. We determine the fair value ofmortgages held-for-sale using current secondary market prices for loans withsimilar coupons, maturities and credit quality.

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

Securitizedmortgage collateral consisted of the following:
|                                                             | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                  | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| Mortgages  secured by single-family residential real estate |       | $                              | 18,676,687 |                          | $          | 22,986,632 |   |
| Mortgages  secured by commercial real estate                |       | 1,347,646                      |       | 1,195,541                     |       |
| Net unamortized  premiums on mortgages - residential        |       | 195,845                        |       | 301,709                       |       |
| Net unamortized  premiums on mortgages - commercial         |       | 12,285                         |       | 10,408                        |       |
| Total  securitized mortgage collateral                      |       | $                              | 20,232,463 |                          | $          | 24,494,290 |   |

 

**Note F—Allowance for Loan Losses**

The allowance forloan losses is comprised of the following:
|                                                                    | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                         | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| Securitized  mortgage collateral and mortgages held-for-investment |       | $                              | 48,791     |                          | $          | 55,007 |   |
| Specific reserve for finance receivables                           |       | 10,334                         |       | 10,683                        |       |
| Specific reserve  for estimated hurricane losses                   |       | 6,590                          |       | 12,824                        |       |
| Total allowance  for loan losses                                   |       | $                              | 65,715     |                          | $          | 78,514 |   |

 

Activity forallowance for loan losses for the periods indicated was as follows:

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| ** **                       | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|----------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                       | ** ** | **2006**                                | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Beginning balance                |       | $                                       | 68,072     |                                   | $          | 69,826 |   | $ | 78,514 |   | $ | 63,955 |   |
| Provision for loan  losses       |       | 3,183                                   |       | 13,434                                 |       | 3,288 |   | 25,219 |   |
| Charge-offs, net of  recoveries  |       | (5,540                                  | )          | (4,690                                 | )          | (16,087 | ) | (10,604 | ) |
| Total allowance for  loan losses |       | $                                       | 65,715     |                                   | $          | 78,570 |   | $ | 65,715 |   | $ | 78,570 |   |

 

**NoteG—Other Assets**

Other assetsconsisted of the following:
|                                             | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| Real estate  owned                          |       | $                              | 114,825    |                          | $          | 46,351 |   |
| Cash collateral  balances                   |       | 47,828                         |       | 16,567                        |       |
| Deferred charge                             |       | 39,335                         |       | 47,406                        |       |
| Investment  securities available-for-sale   |       | 30,579                         |       | 40,227                        |       |
| Prepaid and  other assets                   |       | 23,315                         |       | 34,422                        |       |
| Premises and  equipment, net                |       | 16,082                         |       | 12,312                        |       |
| Deferred income  taxes                      |       | 12,077                         |       | 12,160                        |       |
| Investment in  Impac Capital Trusts         |       | 2,716                          |       | 2,884                         |       |
| Investments for  deferred compensation plan |       | —                         |       | 8,041                         |       |
| Total other  assets                         |       | $                              | 286,757    |                          | $          | 220,370 |   |

 

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

Investmentsecurities are classified as available-for-sale and are included in otherassets on our consolidated balance sheets. Available-for-sale securities arereported at fair value with unrealized gains and losses as other comprehensiveearnings.  Securities available for saleinclude the residual interest from the ISAC REMIC 2006-2 securitization ofapproximately $27.5 million, calculated as the present value of estimatedfuture cash flows.  Gains and lossesrealized on the sale of available-for-sale investment securities and declinesin value judged to be other-than-temporary are based on the specificidentification method and reported in current earnings.

**Note I— Securitized Mortgage Borrowings**

Selectedinformation on securitized mortgage borrowings for the periods indicatedconsisted of the following (dollars in millions):

17

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| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | **Range of Percentages:** | ** ** |
|-------------------------------------------|------------|--------------|------------|-----------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | ** **   | ** ** | ** **                                    | ** ** | ** **                      | ** ** | ** **                          | ** ** | **Interest Rate** | ** ** | **Interest Rate** | ** ** |
| ** **                                | ** ** | **Original** | ** ** | **Securitized mortgage borrowings** | ** ** | ** **                      | ** ** | **Margins over**               | ** ** | **Margins after** | ** ** |
| ** **                                | ** ** | **Issuance** | ** ** | **outstanding as of**               | ** ** | **Fixed Interest**         | ** ** | **One-Month**                       | ** ** | **Adjustment** | ** ** |
| **Year of Issuance**            | ** ** | **Amount**   | ** ** | **September 30, 2006**              | ** ** | **December 31, 2005** | ** ** | **Rates**                           | ** ** | **LIBOR (1)** | ** ** | **Date (2)** | ** ** |
| 2002                                      |       | $            | 3,876.1    |                                          | $          | 53.8                            |       | $                                   | 219.8      |   | 5.25  - 12.00 |   | 0.27  - 2.75 |   | 0.54  - 3.68 |   |
| 2003                                      |       | 5,966.1      |       | 1,063.9                                       |       | 1,723.0                         |       | 4.34  - 12.75                       |       | 0.27  - 3.00 |   | 0.54  - 4.50 |   |
| 2004                                      |       | 17,710.7     |       | 6,447.4                                       |       | 10,191.9                        |       | 3.58  - 5.56                        |       | 0.25  - 2.50 |   | 0.50  - 3.75 |   |
| 2005                                      |       | 13,387.7     |       | 9,345.5                                       |       | 11,902.9                        |       | —                              |       | 0.24  - 2.90 |   | 0.48  - 4.35 |   |
| 2006                                      |       | 3,004.7      |       | 2,820.6                                       |       | —                          |       | 6.25                                |       | 0.10  - 2.50 |   | 0.20  - 3.75 |   |
| Subtotal securitized  mortgage borrowings |       |         |       | 19,731.2                                      |       | 24,037.6                        |       |                                |       |   |   |   |   |
| Accrued interest  expense                 |       |         |       | 19.5                                          |       | 18.1                            |       |                                |       |   |   |   |   |
| Unamortized  securitization costs         |       |         |       | (52.9                                         | )          | (65.3                           | )          |                                |       |   |   |   |   |
| Total securitized  mortgage borrowings    |       |         |       | $                                             | 19,697.8   |                            | $          | 23,990.4                            |       |   |   |   |   |   |   |
|                                           |            |              |            |                                               |            |                                 |            |                                     |            |  |  |  |  |  |  |  |

 

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(1)           One-month LIBOR was 5.32%as of September 30, 2006.

(2)                                  Interest rate marginsover one-month LIBOR are generally adjusted when the unpaid principal balanceis reduced to less than 10% to 20% of the original issuance amount, or ifcertain other triggers are met.

**NoteJ—Reverse Repurchase Agreements**

Reverserepurchase agreements are entered into to finance our warehouse lendingoperations and to fund the closing and purchase of mortgages by the mortgageand commercial operations.  Thesefacilities consist of committed and uncommitted lines.  At September 30, 2006, the Company was incompliance with all of the financial covenants associated with the reverserepurchase agreements.  During the thirdquarter of 2006, these facilities amounted to $5.5 billion, of which $1.5billion was outstanding at September 30, 2006.

**NoteK—Repurchase Reserve**

The liability formortgage repurchases is maintained for the purpose of purchasing previouslysold mortgages for various reasons, including early payment defaults or breachof representations or warranties, which may be subsequently sold at a loss. Actualgains and losses on repurchases are recorded against the gain on sale of loansin the consolidated financial statements. In determining the adequacy of theliability for mortgage repurchases, management considers such factors asspecific requests for repurchase, known problem loans, underlying collateralvalues, recent sales activity of similar loans and other appropriateinformation. During the third quarter of 2006 a recovery of repurchases of$15.9 million was recorded compared to a provision of $3.2 million for the sameperiod in 2005.  The provision forrepurchases decreased as a result of $114.4 million in outstanding requestswhich were rescinded by investors during the third quarter of 2006.

In the ordinary course of business, the Company sellswhole pools of loans with standard representations and warranties includingborrower defaults. When whole pools are sold, as opposed to securitized, theCompany makes an estimate of the ultimate losses to be realized on therepurchased loans.  Because the loans areno longer on the Company’s balance sheet, the implied warranty component isconsidered a guarantee, under FIN 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers.”  During the nine months endedSeptember 30, 2006, the Company sold $5.3 billion in whole loansales.  The Company maintains a $15.2million reserve related to these guarantees as of September 30, 2006compared to $10.4 million at December 31, 2005, included in other liabilities.

**NoteL—Income Taxes**

Duringthe three and nine months ended September 30, 2006, income tax expense(benefit) was $2.2 million and ($11.6) million, respectively.  During the three and nine months endedSeptember 30, 2005, income tax benefit was $7.3 million and $13.9 million,respectively.  The income tax provisionfor three months ended September 30, 2006 was primarily due to reduced netlosses at the taxable REIT subsidiaries. The Company makes an estimate of theeffective tax rate expected to be applicable for the fiscal year when providingfor income tax expense (benefit).

18

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

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

**Forward-Looking Statements**

Thisreport on Form 10-Q contains certain forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. Forward-looking statements, some ofwhich are based on various assumptions and events that are beyond our controlmay be identified by reference to a future period or periods or by the use offorward-looking terminology, such as “may,” “will,” “believe,” “expect,” “likely,”“should,” “could,” “anticipate,” or similar terms or variations on those termsor the negative of those terms.  Theforward-looking statements are based on management expectations. Actual resultsmay differ materially as a result of several factors, including, but notlimited to, failure to achieve projected earnings levels; unexpected or greaterthan anticipated increases in credit and bond spreads; the ability to generatesufficient liquidity; the ability to access the equity markets; increasedoperating expenses and mortgage origination or purchase expenses that reducecurrent liquidity position more than anticipated; continued increase in pricecompetition; risks of delays in raising, or the inability to raise onacceptable terms, additional capital, either through equity offerings, lines ofcredit or otherwise; the ability to generate taxable income and to paydividends; interest rate fluctuations on our assets that unexpectedly differfrom those on our liabilities; unanticipated interest rate fluctuations;changes in expectations of future interest rates; unexpected increase inprepayment rates on our mortgages; changes in assumptions regarding estimatedloan losses or an increase in loan losses; continued ability to access thesecuritization markets or other funding sources, the availability of financingand, if available, the terms of any financing; changes in markets which theCompany serves, such as mortgage refinancing activity and housing priceappreciation; changes in laws that affect our products and our business; andother general market and economic conditions.

Fora discussion of these and other risks and uncertainties that could cause actualresults to differ from those contained in the forward-looking statements, see “RiskFactors” and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in the Company’s Annual Report on Form 10-K for theperiod ended December 31, 2005, and the other reports we file under theSecurities and Exchange Act of 1934. This document speaks only as of its date and we do not undertake, andspecifically disclaim any obligation, to publicly release the results of anyrevisions that may be made to any forward-looking statements to reflect theoccurrence of anticipated or unanticipated events or circumstances after thedate of such statements.

***The Mortgage Banking Industry and Discussion of Relevant Fiscal Periods***

Themortgage banking industry is continually subject to current events that occurin the financial services industry. Such events include changes in economicindicators, interest rates, price competition, housing prices, geographicshifts, disposable income, market anticipation and customer perception as wellas others. The factors that affect the industry change rapidly.

Inthis environment, mortgage banking companies generally attempt to anticipatethe future marketplace, engage in hedging activities and continuously reassessbusiness plans and strategies to effectively position themselves in themarketplace.

As aresult, current events can diminish the relevance of “quarter over quarter” and“year-to-date over year-to-date” comparisons of financial information.  In such instances, the Company intends topresent financial information in its Management Discussion and Analysis that isthe most relevant to its financial information.

**General Overview**

Weare a mortgage real estate investment trust, or “REIT,” that is a nationwideacquirer, originator, seller and investor of non-conforming Alt-A residentialmortgages, or “Alt-A mortgages,” and to a lesser extent, small-balance,commercial mortgages, or “commercial mortgages.”  We also provide warehouse financing tooriginators of mortgages.

Weoperate four core businesses:

·      the Long-Term Investment Operations thatis conducted by IMH and IMH Assets;

19

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·      the Mortgage Operations that is conductedby IFC and ISAC;

·      the Warehouse Lending Operations that isconducted by IWLG; and

·      the Commercial Operations that isconducted by ICCC.

Thelong-term investment operations primarily invest in adjustable rate and, to alesser extent, fixed rate Alt-A mortgages and commercial mortgages that areacquired and originated by our mortgage and commercial operations. Alt-Amortgages are primarily first lien mortgages made to borrowers whose credit isgenerally within typical Fannie Mae and Freddie Mac guidelines, but have loancharacteristics that make them non-conforming under those guidelines. Some ofthe principal differences between mortgages purchased by Fannie Mae and FreddieMac and Alt-A mortgages are as follows:

·      credit and income histories of themortgagor;

·      underwriting guidelines for debt andincome ratios;

·      documentation required for approval of themortgagor; and

·      loan balances in excess of maximum FannieMae and Freddie Mac lending limits.

Forinstance, Alt-A mortgages may not have certain documentation or verificationsthat are required by Fannie Mae and Freddie Mac and, therefore, in making ourcredit decisions, we are more reliant upon the borrower’s credit score and theadequacy of the underlying collateral. We believe that Alt-A mortgages providean attractive net earnings profile by producing higher yields without commensuratelyhigher credit losses than other types of mortgages.

Thelong-term investment operations also invest in commercial mortgages that areprimarily adjustable rate mortgages with initial fixed interest rate periods oftwo-, three-, five-, seven- and ten-years that subsequently convert toadjustable rate mortgages, or “hybrid ARMs.” Commercial mortgages have interest rate floors, which are the initialstart rate, in some circumstances lock out periods and prepayment penaltyperiods of three-, five-, seven- and ten-years. Commercial mortgages provide greater asset diversification on ourbalance sheet as borrowers of commercial mortgages typically have higher creditscores and commercial mortgages typically have lower loan-to-value ratios, or “LTVratios,” and longer average life to payoff than Alt-A mortgages.

Thelong-term investment operations generate earnings primarily from net interestincome earned on mortgages held for long-term investment, or (long-termmortgage portfolio).  The long-termmortgage portfolio as reported on our consolidated balance sheet consists ofmortgages held as securitized mortgage collateral and mortgagesheld-for-investment. Investments in Alt-A mortgages and commercial mortgagesare initially financed with short-term borrowings under reverse repurchaseagreements that are subsequently converted to long-term financing in the formof securitized mortgage borrowings. Cash flows from the long-term mortgageportfolio, proceeds from the sale of capital stock and issuance of trust preferredsecurities also finance new Alt-A and commercial mortgages.

In 2005 and 2006, theCompany completed ISAC REMIC 2005-2, ISAC REMIC 2006-1, and ISAC REMIC 2006-3securitizations which were treated as sales for tax purposes but treated assecured borrowings for generally accepted accounting principles (GAAP) andconsolidated in the financial statements. The associated collateral and borrowings are included in securitizedmortgage collateral and borrowings, respectively, for reporting purposes.Hence, reference to “Securitized mortgage collateral” or “Securitized mortgageborrowings” includes the REMIC 2005-2, 2006-1, and 2006-3 securitizedcollateral and borrowings.

In the second quarter of2006, the Company completed ISAC REMIC 2006-2 securitization in the amount of$834.0 million which was treated as a sale for both tax and GAAP purposes.  The residual interest, calculated as presentvalue of estimated future cash flows, was retained as a result of the ISACREMIC 2006-2 securitization, and is recorded in other assets on the balancesheet as investment securities available for sale.  Investments in residual interest andsubordinated securities represent higher risk than investments in seniormortgage-backed securities because these subordinated securities bear allcredit losses prior to the related senior securities.  The risk associated with holding residualinterest and subordinated securities is greater than holding the underlyingmortgage loans directly due to the concentration of losses attributed to thesubordinated securities.   The value of residual interests representsthe present value of future cash flows expected to be received by us fromexcess cash flows created in the securitization transaction. In general, futurecash flows are estimated by taking the coupon rate of the loans underlying thetransaction less the interest rate paid to the investors, less contractuallyspecified servicing and trustee fees, 

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and after giving effect to estimated prepayments andcredit losses.  The Company estimates future cash flows from thesesecurities utilizing assumptions based in part on projected discount rates,delinquency rates, mortgage loan prepayment speeds and credit losses.

Themortgage operations acquire, originate, sell and securitize primarilyadjustable rate and fixed rate Alt-A mortgages and, to a lesser extent,sub-prime residential mortgages.  Themortgage operations generate income by securitizing and selling mortgages topermanent investors, including the long-term investment operations. Thisbusiness also earns revenue from fees associated with mortgage servicingrights, master servicing agreements and interest income earned on mortgagesheld-for-sale. The mortgage operations use warehouse facilitiesprovided by the warehouse lending operations to finance the acquisition andorigination of mortgages.

Thewarehouse lending operations provide short-term financing to mortgage loanoriginators, including our mortgage operations, by funding mortgages from theirclosing date until sale to pre-approved investors. This business earns feesfrom warehouse transactions as well as net interest income from the differencebetween its cost of borrowings and the interest earned on warehouse advances.

The commercial operationsoriginate commercial mortgages that are primarily adjustable rate mortgageswith initial fixed interest rate periods of two-, three-, five-, seven- andten-years that subsequently convert to adjustable rate mortgages, or “hybridARMs,” with balances that generally range from $500,000 to$5.0 million.  Commercial mortgageshave interest rate floors, which is the initial start rate; in somecircumstances have lockouts and prepayment penalty periods of three-, five-,seven- and ten-years.  These mortgagesprovide greater asset diversification on our balance sheet as commercialmortgage borrowers typically have higher credit scores and typically have lowerloan-to-value ratios, or “LTV ratios,” and the mortgages have longer averagelives than residential mortgages.

**Critical Accounting Policies**

Wedefine critical accounting policies as those that are important to theportrayal of our financial condition and results of operations and may requireestimates and assumptions based on our judgment of changing market conditionsand the performance of our assets and liabilities at any given time. Indetermining which accounting policies meet this definition, we considered ourpolicies with respect to the valuation of our assets and liabilities andestimates and assumptions used in determining those valuations. We believe themost critical accounting issues that require the most complex and difficultjudgments and that are particularly susceptible to significant change to ourfinancial condition and results of operations include allowance for loanlosses, derivative financial instruments and securitization of financial assetsas financing versus sale, amortization of loan premium and securitizationcosts, compliance with Regulation AB and taxable income.

**Selected Financial Results for the Third Quarter of 2006**

·                   Estimatedtaxable income per diluted share was $0.23 compared to $0.27 for the secondquarter of 2006 and $0.36 for the first quarter of 2006;

·                   Cashdividends declared per common share was $0.25 compared to $0.25 for the secondquarter of 2006 and $0.25 for the first quarter of 2006;

·                   Bookvalue per common share was $11.94 as of September 30, 2006 compared to $13.24as of December 31, 2005 and $12.93 as of September 30, 2005; the reduction inthe net book value per common share from June 30, 2006 is primarily the resultof a non-cash $155.5 million loss on the change in fair value of derivativeinstruments, as more fully described in the Results of Operations discussion;

·                   Totalassets were $22.5 billion as of September 30, 2006 compared to $27.7 billion asof December 31, 2005 and $27.9 billion as of September 30, 2005;

·                   Themortgage operations acquired and originated $3.1 billion of primarily Alt-Amortgages compared to $2.2 billion for the second quarter of 2006 and $6.2billion for the third quarter of 2005;

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·                   Thecommercial mortgage operations originated $233.9 million of commercialmortgages compared to $277.9 million for the second quarter of 2006 and $211.9million for the third quarter of 2005.

·                  TheCompany completed the $2.0 billion REMIC 2006-3 securitization which wastreated as financing for GAAP purposes and consolidated onto the balance sheetas compared to the $834.0 million REMIC 2006-2 securitization during the secondquarter of 2006 which was treated as a sale for GAAP purposes.  During the third quarter of 2005, the Companydid not complete a REMIC securitization.

**Selected Financial Results for the First Nine Months of 2006**

·                   Estimatedtaxable income per diluted share decreased to $0.86 compared to $1.68 for thefirst nine months of 2005;

·                   Cashdividends declared per share decreased to $0.75 compared to $1.95 for the firstnine months of 2005;

·                   Themortgage operations acquired and originated $7.4 billion of primarily Alt-Amortgages compared to $16.3 billion for the first nine months of 2005;

·                   Thelong-term investment operations, retained for investment $2.8 billion ofprimarily Alt-A mortgages compared to $9.7 billion for the first nine months of2005; and

·                   Thecommercial mortgage operations originated $713.8 million of commercialmortgages compared to $591.8 million for the first nine months of 2005.

**Third Quarter and Year to Date 2006 Taxable Income**

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

Thefollowing table presents a reconciliation of net (loss) earnings (GAAP) toestimated taxable income available to common stockholders for the periodsindicated (in thousands, except per share amounts):
| ** **                                                     | ** ** | **For the Three Months**    | ** ** | **For the Nine Months**     | ** ** |
|----------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                     | ** ** | **Ended September 30, (1)** | ** ** | **Ended September 30, (1)** | ** ** |
| ** **                                                     | ** ** | **2006**                                   | ** ** | **2005**                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net (loss) earnings  GAAP                                      |       | $                                          | (127,690   | )                                          | $          | 126,357 |   | $ | (15,768 | ) | $ | 244,967 |   |
| Adjustments to net  (loss) earnings: (2)                       |       |                                       |       |                                       |       |   |   |   |   |
| Loan loss  provision (3)                                       |       | 3,183                                      |       | 13,434                                     |       | 3,288 |   | 25,219 |   |
| REMIC income (4)                                               |       | 2,838                                      |       | —                                     |       | 11,933 |   | — |   |
| Tax deduction  for actual loan losses (3)                      |       | (5,540                                     | )          | (4,690                                     | )          | (16,087 | ) | (10,604 | ) |
| Change in fair  value of derivatives (5)                       |       | 150,051                                    |       | (108,905                                   | )          | 95,186 |   | (146,913 | ) |
| Dividends on  preferred stock                                  |       | (3,672                                     | )          | (3,624                                     | )          | (11,016 | ) | (10,872 | ) |
| Net (earnings)  loss of taxable REIT subsidiaries (6)          |       | (4,853                                     | )          | (830                                       | )          | 10,997 |   | (16,254 | ) |
| Dividend from  taxable REIT subsidiaries (7)                   |       | 3,900                                      |       | 7,000                                      |       | 7,400 |   | 32,850 |   |
| Elimination of  inter-company loan sales transactions (8)      |       | (983                                       | )          | 1,581                                      |       | (21,205 | ) | 9,824 |   |
| Miscellaneous  adjustments                                     |       | 96                                         |       | —                                     |       | 335 |   | — |   |
| Estimated taxable  income available to common stockholders (9) |       | $                                          | 17,330     |                                       | $          | 30,323 |   | $ | 65,063 |   | $ | 128,217 |   |
| Estimated taxable  income per diluted common share (9)         |       | $                                          | 0.23       |                                       | $          | 0.40 |   | $ | 0.86 |   | $ | 1.68 |   |
| Diluted weighted average common shares outstanding             |       | 76,132                                     |       | 76,318                                     |       | 76,119 |   | 76,311 |   |

 

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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 (loss) earnings is intended tomeet the requirements of Regulation G as promulgated by the SEC for thepresentation of non-GAAP financial measurements. To maintain our REIT status,we are required to distribute a minimum of 90% of our annual taxable income toour stockholders.

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(2)                       Certain adjustments are made to net (loss)earnings in order to calculate 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 not deductible for tax purposes.Therefore, as the estimated losses provided for under GAAP are actuallyrealized, the losses will negatively and may materially effect future taxableincome.

(4)                       Includes GAAP to Tax Differences related tothe ISAC REMIC 2005-2, ISAC REMIC 2006-1, and ISAC REMIC 2006-3securitizations, which were treated as secured borrowings for GAAP purposes andsales for tax purposes.

(5)                       The mark-to-market change for the valuation ofderivatives at IMH is income or expense for GAAP financial reporting purposesbut is not included as an addition or deduction for taxable income calculationsuntil realized.

(6)                       Represents net earnings of IFC and ICCC, ourtaxable REIT subsidiaries (TRSs), which may not necessarily equal taxableincome.  Starting January 1, 2006, theCompany elected to convert ICCC from a qualified REIT subsidiary to a TRS.  Therefore, the three and nine months ended September30, 2005 does not include any net earnings or losses of ICCC.

(7)                       Any dividends paid to IMH by the TRSs inexcess of their cumulative undistributed taxable income would be recognized asreturn of capital by IMH to the extent of IMH’s capital investment in the TRSs.Distributions from the TRSs to IMH may not equal the TRSs’ net earnings,however, IMH can only recognize dividend distributions received from the TRSsas taxable income to the extent that the TRSs’ distributions are from currentor prior period undistributed taxable income. Any distributions by the TRSs inexcess of IMH’s capital investment in the TRSs would be taxed as capital gains.

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

(9)                       Excludes the deduction for common stockdividends paid and the availability of a deduction attributable to net operatingloss carry-forwards. As of December 31, 2005, the Company has estimated federalnet operating loss carry-forwards of $18.1 million that are expected to beutilized prior to their expiration in the year 2020.

***Third Quarter 2006 vs. Second Quarter 2006 Net GAAP Earnings***

The resultsof operations for the third quarter of 2006 resulted in a net loss of $127.7million or $1.73 per share as compared to net earnings $26.4 million or $0.30per share, for the second quarter of 2006. The decrease is primarily due to thedecrease in the fair value of the derivative instruments and a decrease in netinterest income partially offset by an increase in realized gains fromderivative instruments.

Includedin net earnings was a primarily mark-to-market loss in the fair value ofderivative instruments whereby the Company records a change in fair value ofits derivative instruments as a gain or loss in the current period, whichduring the third quarter of 2006 decreased to a loss of $155.5 million ascompared to a gain of $11.5 million during the second quarter 2006.  The change in the fair value of thederivative instruments was the result of a partial inversion in the forward yieldcurve as of September 30, 2006.  Thethird quarter of 2006 resulted in a net interest expense of $24.5 million ascompared to a net interest expense of $14.7 million for the second quarter of2006.  The increase in net interestexpense of $9.8 million was primarily due to a decrease in interest income onmortgage assets of $13.1 million partially offset by a reduction in interestexpense mortgage borrowings of $3.7 million. Realized gains on derivative instruments increased to $60.6 millionduring the third quarter of 2006 as compared to $55.9 million during the secondquarter of 2006.

***Third Quarter2006 vs. Second Quarter 2006 Estimated Taxable Income***

Estimatedtaxable income decreased by $3.3 million to $17.3 million, or $0.23 per dilutedcommon share during the third quarter of 2006, compared to $20.6 million or$0.27 per diluted common share for the second quarter 2006 primarilyattributable to a decrease in adjusted net interest income at the REIT of $3.9million, partially offset by a decrease in actual loan losses of $600,000, anda $400,000 increase in dividend income from the taxable REIT subsidiary, ImpacFunding Corporation.

The decrease in adjustednet interest income at the REIT of $3.9 million was primarily the result of adecrease in interest income of $10.3 million, partially offset by a decrease ininterest expense of $3.7 million and an increase in realized gain fromderivative instruments of $2.7 million. Although interest income and interest expense decreased primarily due toa decline in the average balances of the securitized mortgage collateral andthe related securitized mortgage borrowings, the adjusted net interest marginas a percentage of total average mortgage assets improved to 39 basis points ascompared to 38 basis points during the second quarter 2006.

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**FinancialCondition and Results of Operations**

*Financial Condition*

 

Condensed Balance SheetData

(dollars inthousands)
| ** **                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** | **%**      | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|----------------|------------|------------|------------|
| ** **                                           | ** ** | **2006**               | ** ** | **2005**              | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Cash and cash  equivalents                           |       | $                      | 161,901    |                  | $          | 146,621        |       | $          | 15,280     |   | 10 | % |
| Restricted Cash                                      |       | 498                    |       | 698                   |       | (200           | )          | (29        | )          |
| Securitized mortgage  collateral                     |       | 20,232,463             |       | 24,494,290            |       | (4,261,827     | )          | (17        | )          |
| Finance receivables                                  |       | 297,657                |       | 350,217               |       | (52,560        | )          | (15        | )          |
| Mortgages  held-for-investment                       |       | 3,134                  |       | 160,070               |       | (156,936       | )          | (98        | )          |
| Allowance for loan  losses                           |       | (65,715                | )          | (78,514               | )          | (12,799        | )          | (16        | )          |
| Mortgages held-for-sale                              |       | 1,293,085              |       | 2,052,694             |       | (759,609       | )          | (37        | )          |
| Accrued interest  receivable                         |       | 103,807                |       | 123,565               |       | (19,758        | )          | (16        | )          |
| Derivatives                                          |       | 176,797                |       | 250,368               |       | (73,571        | )          | (29        | )          |
| Other assets                                         |       | 286,757                |       | 220,370               |       | 66,387         |       | 30         |       |
| **Total  assets**                                    |       | $                      | 22,490,384 |                  | $          | 27,720,379     |       | $          | (5,229,995 | ) | (19 | )% |
|                                                 |       |                   |       |                  |       |           |       |       |       |
| Securitized mortgage  borrowings                     |       | $                      | 19,697,798 |                  | $          | 23,990,430     |       | $          | (4,292,632 | ) | (18 | )% |
| Reverse repurchase  agreements                       |       | 1,542,441              |       | 2,430,075             |       | (887,634       | )          | (37        | )          |
| Other liabilities                                    |       | 182,484                |       | 132,927               |       | 49,557         |       | 37         |       |
| Total  liabilities                                   |       | 21,422,723             |       | 26,553,432            |       | (5,130,709     | )          | (19        | )          |
| Total  stockholders’ equity                     |       | 1,067,661              |       | 1,166,947             |       | (99,286        | )          | (9         | )          |
| **Total liabilities and  stockholders’ equity** |       | $                      | 22,490,384 |                  | $          | 27,720,379     |       | $          | (5,229,995 | ) | (19 | )% |

 

Total assets were$22.5 billion as of September 30, 2006 as compared to$27.7 billion as of December 31, 2005. The reduction in total assets of $5.2 billion was mainly attributable to$5.3 billion in whole loan sales, REMIC securitizations for $834.0 million, and$6.7 billion in total principal pay downs, which was partially offset by totalyear-to-date acquisitions and originations of $8.2 billion.

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Thefollowing table presents selected information about mortgages held assecuritized mortgage collateral as of the dates indicated:
| ** **                                    | ** ** | **Residential**        | ** ** | **Commercial**        | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **As of**         | ** ** | **As of**        | ** ** |
| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
| ** **                                    | ** ** | **2006**               | ** ** | **2005**              | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2005** | ** ** |
| Percent of Alt-A  mortgages                   |       | 99                     |       | 99                    |       | 99 |   | N/A |   | N/A |   | N/A |   |
| Percent of  non-hybrid ARMs                   |       | 10                     |       | 14                    |       | 15 |   | 2 |   | 4 |   | 5 |   |
| Percent of  hybrid ARMs                       |       | 75                     |       | 75                    |       | 75 |   | 98 |   | 96 |   | 95 |   |
| Percent of FRMs                               |       | 15                     |       | 11                    |       | 10 |   | 0 |   | 0 |   | 0 |   |
| Percent of  interest-only                     |       | 73                     |       | 71                    |       | 69 |   | 13 |   | 11 |   | 8 |   |
| Weighted average  coupon                      |       | 6.52                   |       | 6.10                  |       | 5.97 |   | 5.84 |   | 5.62 |   | 5.51 |   |
| Weighted average  margin                      |       | 3.73                   |       | 3.79                  |       | 3.77 |   | 2.69 |   | 2.69 |   | 2.71 |   |
| Weighted average  original LTV                |       | 75                     |       | 76                    |       | 76 |   | 67 |   | 67 |   | 67 |   |
| Weighted average  original credit score       |       | 696                    |       | 695                   |       | 695 |   | 730 |   | 728 |   | 728 |   |
| Percent with  active prepayment penalty       |       | 73                     |       | 75                    |       | 76 |   | 100 |   | 100 |   | 100 |   |
| Prior 3-month  constant prepayment rate       |       | 40                     |       | 38                    |       | 40 |   | 8 |   | 9 |   | 11 |   |
| Prior 12-month  prepayment rate               |       | 38                     |       | 37                    |       | 37 |   | 9 |   | 9 |   | 8 |   |
| Lifetime  prepayment rate                     |       | 30                     |       | 25                    |       | 25 |   | 6 |   | 5 |   | 5 |   |
| Weighted average  debt service coverage ratio |       | N/A                    |       | N/A                   |       | N/A |   | 1.29 |   | 1.22 |   | 1.32 |   |
| Percent of  mortgages in California           |       | 53                     |       | 55                    |       | 56 |   | 66 |   | 71 |   | 73 |   |
| Percent of  purchase transactions             |       | 59                     |       | 60                    |       | 59 |   | 51 |   | 52 |   | 52 |   |
| Percent of owner  occupied                    |       | 79                     |       | 81                    |       | 81 |   | N/A |   | N/A |   | N/A |   |
| Percent of first  lien                        |       | 99                     |       | 99                    |       | 99 |   | 100 |   | 100 |   | 100 |   |

 

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* N/A = Not Applicable

 

The following tablepresents selected financial data as of the dates indicated (dollars inthousands, except share data):
|                                         | ** ** | **As of and Year-to-Date Ended,** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                              | ** ** | **September 30,**                                | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
| ** **                              | ** ** | **2006**                                              | ** ** | **2005** | ** ** | **2005** | ** ** |
| Book value per  share                   |       | $                                                     | 11.94      |   | $ | 13.24 |   | $ | 12.93 |   |
| Return on  average assets               |       | (0.09                                                 | )%         | 1.01 | % | 1.25 | % |
| Return on  average equity               |       | (1.73                                                 | )%         | 24.13 | % | 29.74 | % |
| Assets to equity  ratio                 |       | 20.97:1                                               |       | 23.75:1 |   | 24.53:1 |   |
| Debt to equity  ratio                   |       | 19.99:1                                               |       | 22.72:1 |   | 23.46:1 |   |
| Mortgages owned  60+ days delinquent    |       | $                                                     | 1,035,601  |   | $ | 733,348 |   | $ | 512,382 |   |
| 60+ day delinquency of  mortgages owned |       | 5.01                                                  | %          | 3.12 | % | 2.18 | % |

 

Webelieve that in order for us to generate positive cash flows and earnings wemust successfully manage the following primary operational and market risks:

·      creditrisk;

·      prepaymentrisk;

·      liquidityrisk; and

·      interestrate risk.

*Credit Risk.*  We manage credit risk by acquiring forlong-term investment high credit quality Alt-A and commercial mortgages fromour customers, adequately providing for loan losses and actively managingdelinquencies and defaults.  Alt-Amortgages are primarily first lien mortgages made to borrowers whose credit isgenerally within typical Fannie Mae and Freddie Mac guidelines, but that haveloan characteristics that make them non-conforming under those guidelines.

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Asof September 30, 2006, the original weighted average credit score of mortgagesheld as residential and commercial securitized mortgage collateral was 696 and730 respectively, and the original weighted average LTV ratio was 75% and 67%,respectively.  During the third quarterof 2006, the mortgage operations acquired or originated $3.1 billion ofresidential mortgages with an original weighted average credit score of 695 andan original weighted average LTV ratio of 73%. ICCC also originated $233.9 million of commercial mortgages with aweighted average credit score of 724, a weighted average debt service coverratio of 1.22 and an original weighted average LTV ratio of 65%.

Wemonitor our sub-servicers to make sure that they perform loss mitigation,foreclosure and collection functions according to our servicing guide.  This includes an effective and aggressivecollection effort in order to minimize the number of mortgages becoming seriouslydelinquent.  When resolving delinquentmortgages, sub-servicers are required to take timely and aggressiveaction.  The sub-servicer is required todetermine payment collection under various circumstances, which will result inmaximum financial benefit.  We accomplishthis by either working with the borrower to bring the mortgage current or byforeclosing and liquidating the property. We perform ongoing reviews of mortgages that display weaknesses andbelieve that we maintain an adequate loss allowance on the mortgages.  When a borrower fails to make requiredpayments on a mortgage and does not cure the delinquency within 60 days, wegenerally record a notice of default and commence foreclosure proceedings.  If the mortgage is not reinstated within thetime period permitted by law for reinstatement, the property may then be soldat a foreclosure sale.  At foreclosuresales, we generally acquire title to the property.  As of September 30, 2006, our long-termmortgage portfolio included 5.01% of mortgages that were 60 days or moredelinquent compared to 3.12% as of December 31, 2005.

The following table summarizes mortgages that we own,including securitized mortgage collateral, mortgages held for long-terminvestment and mortgages held-for-sale, that were 60 or more days delinquentfor the periods indicated (in thousands):
|                                   | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                        | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| 60 - 89 days  delinquent          |       | $                              | 319,346    |                          | $          | 300,039 |   |
| 90 or more days  delinquent       |       | 322,809                        |       | 221,581                       |       |
| Foreclosures                      |       | 334,415                        |       | 161,414                       |       |
| Delinquent  bankruptcies          |       | 59,031                         |       | 50,314                        |       |
| Total 60 or more  days delinquent |       | $                              | 1,035,601  |                          | $          | 733,348 |   |

 

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. When real estate is acquired in settlement of loans, or other realestate owned, the mortgage is written-down to a percentage of the property’sappraised value or broker’s price opinion less anticipated selling costs. As ofSeptember 30, 2006, non-performing assets as a percentage of total assets was3.70% compared to 1.73% as of December 31, 2005.

The following tablesummarizes mortgages that we own, including securitized mortgage collateral,mortgages held for long-term investment and mortgages held-for-sale, that werenon-performing for the periods indicated (in thousands):
|                                                                       | ** ** | **At September 30,** | ** ** | **At December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                            | ** ** | **2006**                       | ** ** | **2005**                      | ** ** |
| 90 or more days  delinquent, foreclosures and delinquent bankruptcies |       | $                              | 716,255    |                          | $          | 433,309 |   |
| Other real  estate owned                                              |       | 114,825                        |       | 46,351                        |       |
| Total  non-performing assets                                          |       | $                              | 831,080    |                          | $          | 479,660 |   |

 

Real estate owned,which consists of residential real estate acquired in satisfaction of loans, iscarried at the lower of cost or estimated fair 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 gains from the ultimate dispositionof real estate owned are recorded as (gain) loss on sale of other real estateowned in the consolidated statement of operations.  Realestate owned increased from $46.4 million to $114.8 million as a result of anincrease in delinquencies.  We haverealized a gain on

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disposition of real estate owned in the amount of $1.3 million for eachof the nine month periods ended September 30, 2006 and 2005.

In evaluating the adequacy of the allowance forloan losses, a detailed analysis of historical loan performance data is accumulatedand reviewed, including the delinquency rates. This data is analyzed for lossperformance and prepayment performance by product type, and vintage. Theresults of that analysis are then applied to the current mortgage portfolio andan estimate is calculated. We believe that pooling of mortgages with similarcharacteristics is an appropriate methodology in which to evaluate theallowance for loan losses. Management also recognizes that there arequalitative factors that must be taken into consideration when evaluating andmeasuring inherent loss in our loan portfolios. These items include, but arenot limited to, economic indicators that may affect the borrower’s ability topay, changes in value of collateral, political factors and industry statistics.While our delinquency rates have increased they have not increased at a rate inexcess of our expectations. We believe our total allowance for loan losses isadequate to absorb losses inherent in our mortgage portfolio as of September 30,2006.

*Prepayment Risk. *TheCompany uses prepayment penalties as a method of partially mitigatingprepayment risk.  Mortgage industryevidence suggests that the increase in home appreciation rates and lowerpayment option mortgage products over the last three years was a significantfactor affecting borrowers refinancing decisions through 2005.  The three-month constant prepayment rate(CPR) increased to 40% at September 30, 2006 from 38% as of December 31, 2005,which is related to prepayments on hybrid ARMs at their reset.

During the nine months ended September 30, 2006, 82%of Alt-A mortgages acquired by the long-term investment operations from themortgage operations had prepayment penalty features ranging from six-months tofive years.  As of September 30,2006, 73% and 100% of mortgages held as residential and commercial securitizedmortgage collateral had prepayment penalties, respectively.  As of September 30, 2006, the twelve-monthCPR of mortgages held as securitized mortgage collateral was 38% as compared toa 37% twelve-month CPR as of September 30, 2005.  Prepayment penalties are charged to borrowersfor mortgages that are paid early and recorded as interest income on ourconsolidated financial statements. Interest income from prepayment penaltieshelps offset amortization of loan premiums and securitization costs. During thefirst nine months of 2006, prepayment penalties received from borrowers wererecorded as interest income and increased 7 basis points to 21 basis points ofmortgage assets as compared to 14 basis points of mortgage assets in the firstnine months of 2005.

*Liquidity Risk. *We employ a leveragestrategy to increase assets by financing our long-term mortgage portfolioprimarily with securitized mortgage borrowings, reverse repurchase agreementsand capital, then using cash proceeds to acquire additional mortgage assets. Weretain ARMs and FRMs that are acquired and originated from themortgage and commercial operations and finance the acquisition of thosemortgages, during this accumulation period, with reverse repurchase agreements.After accumulating a pool of mortgages we sell the mortgages in the form ofsecuritized mortgage collateral, whole loan sales or REMICs. Our strategy is tosell or securitize our mortgages within 90 days in order to reduce theaccumulation period that mortgages are outstanding on short-term reverserepurchase facilities, which reduces our exposure to margin calls and reducesspread risk on these facilities. Securitized mortgage borrowings are classes ofbonds that are sold to investors of mortgage-backed securities and assuch are not subject to margin calls. In addition, the securitized mortgageborrowings generally require a smaller initial cash investment as a percentageof mortgages financed than does interim reverse repurchase financing. Wecontinually monitor our leverage ratio and liquidity levels to insure that weare adequately protected against adverse changes in market conditions.Additionally, as interest rates decline our requirement to maintain certaincash collateral balances increases, which reduces our cash and cash equivalentsavailable for use in operations.  As ofSeptember 30, 2006 our cash collateral balance totaled $47.8 million, ascompared to $16.6 million as of December 31, 2005.  For additional information regardingliquidity refer to “Liquidity and Capital Resources.”

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

*Resultsof Operations*

*Forthe Three Months Ended September 30, 2006 compared to the Three Months EndedSeptember 30, 2005*

Condensed Statements ofOperations Data

(dollars inthousands, except share data)
| ** **                                                     | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Total Interest  income                                         |       | $                                                                          | 300,266    |   | $ | 324,050 |   | $ | (23,784 | ) | (7 | )% |
| Total Interest  expense                                        |       | 324,776                                                                    |       | 281,154 |   | 43,622 |   | 16 |   |
| Net interest (expense) income                                  |       | (24,510                                                                    | )          | 42,896 |   | (67,406 | ) | (157 | ) |
| Provision for  loan losses                                     |       | 3,183                                                                      |       | 13,434 |   | (10,251 | ) | (76 | ) |
| Net interest (expense) income after provision for  loan losses |       | (27,693                                                                    | )          | 29,462 |   | (57,155 | ) | (194 | ) |
| Total  non-interest (loss) income                              |       | (65,398                                                                    | )          | 129,012 |   | (194,410 | ) | (151 | ) |
| Total  non-interest expense                                    |       | 32,365                                                                     |       | 39,454 |   | (7,089 | ) | (18 | ) |
| Income tax  expense (benefit)                                  |       | 2,234                                                                      |       | (7,337 | ) | (9,571 | ) | (130 | ) |
| Net (loss) earnings                                            |       | $                                                                          | (127,690   | ) | $ | 126,357 |   | $ | (254,047 | ) | (201 | )% |
|                                                           |       |                                                                       |       |   |   |   |   |   |   |
| Net (loss)  earnings per share - diluted                       |       | $                                                                          | (1.73      | ) | $ | 1.61 |   | $ | (3.34 | ) | (207 | )% |
| Dividends declared per  common share                           |       | $                                                                          | 0.25       |   | $ | 0.45 |   | $ | (0.20 | ) | (44 | )% |

 

*Forthe Nine Months Ended September 30, 2006 compared to the Nine Months EndedSeptember 30, 2005*

Condensed Statements ofOperations Data

(dollars inthousands, except share data)
| ** **                                                     | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Total Interest  income                                         |       | $                                                                         | 949,229    |   | $ | 911,214 |   | $ | 38,015 |   | 4 | % |
| Total Interest  expense                                        |       | 977,011                                                                   |       | 721,059 |   | 255,952 |   | 35 |   |
| Net interest (expense) income                                  |       | (27,782                                                                   | )          | 190,155 |   | (217,937 | ) | (115 | ) |
| Provision for  loan losses                                     |       | 3,288                                                                     |       | 25,219 |   | (21,931 | ) | (87 | ) |
| Net interest (expense) income after provision for  loan losses |       | (31,070                                                                   | )          | 164,936 |   | (196,006 | ) | (119 | ) |
| Total  non-interest income                                     |       | 104,289                                                                   |       | 181,433 |   | (77,144 | ) | (43 | ) |
| Total  non-interest expense                                    |       | 100,612                                                                   |       | 115,326 |   | (14,714 | ) | (13 | ) |
| Income tax  benefit                                            |       | (11,625                                                                   | )          | (13,924 | ) | (2,299 | ) | (17 | ) |
| Net (loss) earnings                                            |       | $                                                                         | (15,768    | ) | $ | 244,967 |   | $ | (260,735 | ) | (106 | )% |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Net (loss)  earnings per share - diluted                       |       | $                                                                         | (0.35      | ) | $ | 3.07 |   | $ | (3.42 | ) | (111 | )% |
| Dividends declared per  common share                           |       | $                                                                         | 0.75       |   | $ | 1.95 |   | $ | (1.20 | ) | (62 | )% |

 

*NetInterest Income*

We earn interestincome primarily on mortgage assets which include securitized mortgagecollateral, mortgages held-for-investment, mortgages held-for-sale, financereceivables and investment securities available-for-sale, or collectively, “mortgageassets,” and, to a lesser extent, interest income earned on cash and cashequivalents.  Interest expense isprimarily interest paid on borrowings on mortgage assets, which includesecuritized mortgage borrowings and reverse repurchase agreements.

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The followingtable summarizes average balance, interest and weighted average yield oninvestments in mortgage assets and borrowings on mortgage assets for theperiods indicated (dollars in thousands):
| ** **                                                             | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** |
| ** **                                                             | ** ** | **Average**                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                             | ** ** | **Balance**                                                                | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE  ASSETS**                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated  securities collateralized by mortgages                   |       | $                                                                          | 31,503     |   | $ | 1,509 |   | 19.16 | % | $ | 58,227 |   | $ | 442 |   | 3.04 | % |
| Securitized  mortgage collateral (1)                                   |       | 19,581,945                                                                 |       | 257,995 |   | 5.27 | % | 23,294,226 |   | 271,661 |   | 4.66 | % |
| Mortgages  held-for-investment and held-for-sale                       |       | 2,073,935                                                                  |       | 33,405 |   | 6.44 | % | 2,956,712 |   | 45,768 |   | 6.19 | % |
| Finance  receivables                                                   |       | 263,106                                                                    |       | 5,230 |   | 7.95 | % | 304,593 |   | 4,834 |   | 6.35 | % |
| Total mortgage  assets\ interest income                                |       | $                                                                          | 21,950,489 |   | $ | 298,139 |   | 5.43 | % | $ | 26,613,758 |   | $ | 322,705 |   | 4.85 | % |
|                                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                         |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Securitized  mortgage borrowings                                       |       | $                                                                          | 19,190,482 |   | $ | 289,925 |   | 6.04 | % | $ | 22,849,177 |   | $ | 243,945 |   | 4.27 | % |
| Reverse  repurchase agreements                                         |       | 2,098,722                                                                  |       | 32,552 |   | 6.20 | % | 3,070,767 |   | 35,448 |   | 4.62 | % |
| Total borrowings  on mortgage assets\ interest expense                 |       | $                                                                          | 21,289,204 |   | $ | 322,477 |   | 6.06 | % | $ | 25,919,944 |   | $ | 279,393 |   | 4.31 | % |
|                                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Net  Interest Spread (2)**                                           |       |                                                                       |       |   |   | (0.63 | ) |   |   |   |   | 0.54 | % |
| **Net  Interest Margin (3)**                                           |       |                                                                       |       |   |   | (0.44 | ) |   |   |   |   | 0.65 | % |
|                                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  (expense) income on mortgage assets                      |       |                                                                       |       | $ | (24,338 | ) | (0.44 | ) |   |   | $ | 43,312 |   | 0.65 | % |
| Less: accretion  of loan discounts (4)                                 |       |                                                                       |       | (14,837 | ) | (0.27 | ) |   |   | (20,355 | ) | (0.31 | ) |
| Adjusted by net  cash receipts on derivatives (5)                      |       |                                                                       |       | 60,630 |   | 1.10 |   |   |   | 10,975 |   | 0.17 |   |
| **Adjusted  Net Interest Margin (6)**                                  |       |                                                                       |       | $ | 21,455 |   | 0.39 | % |   |   | $ | 33,932 |   | 0.51 | % |
|                                                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization  of loan premiums and securitization  costs (7) | ** ** | ** **                                                                 | ** ** | $ | 54,594 | ** ** | (0.99 | ) | ** ** | ** ** | $ | 77,571 | ** ** | (1.17 | ) |

 

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| ** **                                                           | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                                                           | ** ** | **Average**                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                           | ** ** | **Balance**                                                               | ** ** | **Interest** | ** ** | **Yield** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield** | ** ** |
| **MORTGAGE ASSETS**                                                  |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Subordinated securities  collateralized by mortgages                 |       | $                                                                         | 29,722     |   | $ | 2,686 |   | 12.05 | % | $ | 36,343 |   | $ | 1,094 |   | 4.01 | % |
| Securitized mortgage  collateral (1)                                 |       | 21,667,571                                                                |       | 838,452 |   | 5.16 | % | 22,931,073 |   | 780,395 |   | 4.54 | % |
| Mortgages  held-for-investment and held-for-sale                     |       | 1,782,364                                                                 |       | 86,603 |   | 6.48 | % | 2,350,281 |   | 110,902 |   | 6.29 | % |
| Finance receivables                                                  |       | 284,295                                                                   |       | 15,037 |   | 7.05 | % | 342,728 |   | 14,674 |   | 5.71 | % |
| Total mortgage assets\  interest income                              |       | $                                                                         | 23,763,952 |   | $ | 942,778 |   | 5.29 | % | $ | 25,660,425 |   | $ | 907,065 |   | 4.71 | % |
|                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **BORROWINGS**                                                       |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Securitized mortgage  borrowings                                     |       | $                                                                         | 21,233,648 |   | $ | 888,144 |   | 5.58 | % | $ | 22,542,836 |   | $ | 639,667 |   | 3.78 | % |
| Reverse repurchase  agreements                                       |       | 1,870,276                                                                 |       | 81,881 |   | 5.84 | % | 2,499,525 |   | 78,192 |   | 4.17 | % |
| Total borrowings on  mortgage assets\ interest expense               |       | $                                                                         | 23,103,924 |   | $ | 970,025 |   | 5.60 | % | $ | 25,042,361 |   | $ | 717,859 |   | 3.82 | % |
|                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Spread (2)**                                          |       |                                                                      |       |   |   | (0.31 | ) |   |   |   |   | 0.89 | % |
| **Net Interest Margin (3)**                                          |       |                                                                      |       |   |   | (0.15 | ) |   |   |   |   | 0.98 | % |
|                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net interest (expense)  income on mortgage assets                    |       |                                                                      |       | $ | (27,247 | ) | (0.15 | ) |   |   | $ | 189,206 |   | 0.98 | % |
| Less: accretion of loan  discounts (4)                               |       |                                                                      |       | (48,910 | ) | (0.27 | ) |   |   | (57,940 | ) | (0.30 | ) |
| Adjusted by net cash  receipts (payments) on derivatives (5)    |       |                                                                      |       | 156,633 |   | 0.88 |   |   |   | (4,209 | ) | (0.02 | ) |
| **Adjusted Net Interest Margin  (6)**                                |       |                                                                      |       | $ | 80,476 |   | 0.45 | % |   |   | $ | 127,057 |   | 0.66 | % |
|                                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Effect of amortization of loan premiums and securitization costs (7) |       |                                                                      |       | $ | 181,071 |   | (1.02 | ) |   |   | $ | 216,168 |   | (1.12 | ) |

 

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| (1) | Interest on  Securitized mortgage collateral includes amortization of acquisition cost on  mortgages acquired from the mortgage operations and accretion of loan discounts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Net interest  spread on mortgage assets is calculated by subtracting the weighted average  yield on total borrowings on mortgage assets from the weighted average yield  on total mortgage assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (3) | Net interest  margin on mortgage assets is calculated by subtracting interest expense on  total borrowings on mortgage assets from interest income on total mortgage  assets and then dividing by total average mortgage assets and annualized for  the quarter margin.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| (4) | Yield represents  income from the accretion of loan discounts, included in (1) above, divided  by total average mortgage assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (5) | Yield represents  net cash (payments) receipts on derivatives divided by total average mortgage  assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (6) | Adjusted net  interest margin on mortgage assets is calculated by subtracting interest  expense on total borrowings on mortgage assets, accretion of loan discounts  and net cash receipts on derivatives from interest income on total mortgage  assets divided by total average mortgage assets. Net cash receipts on derivatives  are a component of realized gain on derivative instruments on the  consolidated statements of operations. Adjusted net interest margins on  mortgage assets is a non-GAAP financial measurement, however, the  reconciliation provided in this table is intended to meet the requirements of  Regulation G as promulgated by the SEC for the presentation of non-GAAP  financial measurements. We believe that the presentation of adjusted net  interest margin on mortgage assets is useful information for our investors as  it more closely reflects the true economics of net interest margins on  mortgage assets. |
| (7) | The amortization  of loan premiums and securitization costs are components of interest income  and interest expense, respectively. Yield represents the cost of amortization  of net loan premiums and securitization costs divided by total average  mortgage assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

Decreases in net interestincome were primarily due to a decline in net interest margins on mortgageassets primarily caused by the following:

·                  increase in one-month LIBOR rateunderlying borrowings only partially offset by realized gain (loss) fromderivative instruments;

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·                  differences in interest rateadjustment periods;

·                  prepayments ofhigher yielding mortgages;

·                  amore challenging competitive environment; and

·                  partiallyoffset by cash receipts from derivative instruments.

*Third Quarter 2006 vs. Third Quarter 2005*

The operations for the third quarter of 2006 resultedin net interest expense of $24.5 million as compared to net interest income of$42.9 million for 2005. The decrease in net interest income of$67.4 million was primarily due to net interest margins on mortgage assetsdeclining by 109 basis points to (0.44)% for 2006 as compared to 0.65% for2005.  Net interest margin on mortgageassets declined as one-month LIBOR, which is the interest rate index used toprice borrowing costs on securitized mortgage and reverse repurchaseborrowings, rose approximately 146 basis points since the third quarter of 2005while mortgage assets over the same period did not re-price upward as quickly.The increase in borrowings resulted in an increase in interest expense of 16%to $324.8 million during the quarter ended September 30, 2006 as compared to$281.2 million during the quarter ended September 30, 2005.  Adjusted net interest margins on mortgageassets, as defined in the yield table above, declined by 12 basis points to0.39% during the third quarter of 2006 as compared to 0.51% during the thirdquarter of 2005. The decrease in adjusted net interest margins on mortgageassets was primarily due to a negative variance of 175 basis points inborrowing costs partially offset by a favorable variance of 93 basis points onrealized gains from derivative assets and a favorable variance of 58 basispoints on mortgage assets as coupons have adjusted.

Since the third quarterof 2005, the Federal Reserve raised short-term interest rates, which increasedthe one-month LIBOR, approximately 146 basis points.  This caused borrowing costs on adjustablerate securitized mortgage borrowings, which are tied to the one-month LIBOR tore-price monthly without limitation, to rise at a faster pace than coupons onLIBOR ARMs securing securitized mortgage borrowings, which generallyre-price every six months with limitation.  LIBOR ARMs held in our long-term investment portfolio are subjectto the following interest rate risks:

·      interest rate adjustmentlimitations on mortgages held for long-term investment due to periodic andlifetime interest rate cap features as compared to borrowings which are notsubject to adjustment limitations;

·      mismatched interest ratere-pricing periods between mortgages held for long-term investment, whichgenerally re-price every six months, and borrowings, which re-price every monthin regards to securitized mortgage borrowings and daily in regardsto reverse repurchase agreements; and

·      uneven and unequalmovements in the interest rate indices used to re-price mortgages held forlong-term investment, which are generally indexed to one-, three- and six-monthLIBOR and one-year LIBOR, and borrowings, which are generally indexed toone-month LIBOR.

Along with an increase in short-term interest rates,our expectation, based on past experience, was that we would see acorresponding decline in mortgage prepayment speeds. However, mortgageprepayment speeds have continued at heightened levels during 2006.  There is mortgage industry evidence thatdocuments a substantial increase in home appreciation rates over the last threeyears which has been a significant factor affecting prepayment patterns ofresidential borrowers.  The three-monthconstant prepayment rate (CPR) increased to 40% at September 30, 2006 from 38%as of December 31, 2005, which is related to prepayments on hybrid ARMs attheir reset.

Amortization of loanpremiums and securitization expenses decreased by 18 basis points to 0.99% ofaverage mortgage assets during the third quarter of 2006 as compared to 1.17%of average mortgage assets during the same period in 2005.  A substantial portion of our long-termmortgage investment portfolio consists of mortgages with prepayment penaltyfeatures that are primarily designed to help minimize the rate of earlymortgage prepayments.  However, ifborrowers do prepay on mortgages, a prepayment penalty is charged which helpspartially offset additional amortization of loan premiums and securitization costsrelated to the prepaid mortgages. During the third quarter of 2006, prepaymentpenalties received from borrowers was recorded as interest income and remainedflat at 20 basis points of mortgage assets as compared to the third quarter of2005.

Additionally, the netinterest margin continues to be affected by the difficult competitiveenvironment facing mortgage portfolio lenders. As a result, net interest margins continue to tighten on newlyoriginated loans. Furthermore, a 

31

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rise in short-term rates and a decline in long-termrates has resulted in a partial inversion of the yield curve, adding pressureto mortgage lending profitability.

During the third quarterof 2006, adjusted net interest margins on mortgage assets, which is a non-GAAPfinancial measurement as indicated in the yield table above, decreased by 12basis points as compared to a decline of 109 basis points on net interestmargin on mortgage assets.  Adjusted netinterest margin on mortgage assets did not decline as much as net interestmargin on mortgage assets primarily due to a 93 basis point increase inrealized cash receipts from derivative instruments relative to total averagemortgage assets.  Realized cash receiptsfrom derivative instruments partially offset the decline in adjusted netinterest margins on mortgage assets which was caused by the factors describedabove.

Our interest rate riskmanagement 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. However, as a result of thecombination of the factors listed above, the interest rate spread differentialbetween ARMs and adjustable rate securitized mortgage borrowingscompressed, which decreased net interest margins on mortgage assets. By design,our current interest rate risk management program provides 20% to 25% coverageof the outstanding principal balance of our six month LIBOR ARMs and 85%to 98% coverage of the outstanding principal balance of intermediate, orhybrid, ARMs at the point in time that we securitize the mortgages.

*First Nine Months of 2006 vs. First Nine Months of 2005*

The operations for the first nine months of 2006resulted in net interest expense of $27.8 million as compared to net interestincome of $190.2 million for the same period of 2005. The decrease in netinterest income of $217.9 million was primarily due to net interestmargins on mortgage assets declining by 113 basis points to (0.15)% for 2006 ascompared to 0.98% for 2005.  Net interestmargin on mortgage assets declined as the one-month LIBOR, which is theinterest rate index used to price borrowing costs on securitized mortgage andreverse repurchase borrowings, rose approximately 146 basis points since thethird quarter of 2005 while mortgage assets over the same period did notre-price upward as quickly. This resulted in an increase in interest expense of35% to $977.0 million for the nine months ended September 30, 2006 as comparedto $721.1 million for the nine months ended September 30, 2005.  Adjusted net interest margins on mortgageassets, as defined in the yield table above, declined by 21 basis points to0.45% during the first nine months of 2006 as compared to 0.66% during thefirst nine months of 2005. The decrease in adjusted net interest margins onmortgage assets was primarily due to a negative variance of 178 basis points inborrowing costs partially offset by a favorable variance of 90 basis points onrealized gains from derivative assets and a favorable variance of 58 basispoints on mortgage assets as coupons adjust.

Since the third quarterof 2005, the Federal Reserve raised short-term interest rates, which increasedthe one-month LIBOR, approximately 146 basis points.  This caused borrowing costs on adjustablerate securitized mortgage borrowings, which are tied to the one-month LIBOR andre-price monthly without limitation, to rise at a faster pace than coupons onLIBOR ARMs securing securitized mortgage borrowings, which generallyre-price every six months with limitation. LIBOR ARMs held in ourlong-term investment portfolio are subject to the following interest raterisks:

·      interest rate adjustmentlimitations on mortgages held for long-term investment due to periodic andlifetime interest rate cap features as compared to borrowings which are notsubject to adjustment limitations;

·      mismatched interest ratere-pricing periods between mortgages held for long-term investment, whichgenerally re-price every six months, and borrowings, which re-price every monthin regards to securitized mortgage borrowings and daily in regardsto reverse repurchase agreements; and

·      uneven and unequalmovements in the interest rate indices used to re-price mortgages held for long-terminvestment, which are generally indexed to one-, three- and six-month LIBOR andone-year LIBOR, and borrowings, which are generally indexed to one-month LIBOR.

Along with an increase in short-term interest rates,our expectation, based on past experience, was that we would see acorresponding decline in mortgage prepayment speeds. However, mortgageprepayment speeds have continued at heightened levels during 2006.  There is mortgage industry evidence that documentsa substantial increase in home appreciation rates over the last three yearswhich has been a significant factor affecting prepayment patterns ofresidential borrowers.  The three-monthconstant prepayment rate (CPR) increased to 40% at September 30, 2006 from 38%as of December 31, 2005 which is related to prepayments on hybrid ARMs at theirreset.

Amortization of loanpremiums and securitization expenses decreased by 10 basis points to 1.02% ofaverage mortgage assets during the first nine months of 2006 as compared to1.12% of average mortgage assets during the same period in 2005.  

32

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A substantial portion of our long-term mortgageinvestment portfolio consists of mortgages with prepayment penalty featuresthat are primarily designed to help minimize the rate of early mortgage prepayments.  However, if borrowers do prepay on mortgages,a prepayment penalty is charged which helps partially offset additionalamortization of loan premiums and securitization costs related to the prepaidmortgages.  During the first nine monthsof 2006, prepayment penalties received from borrowers was recorded as interestincome and increased 7 basis points to 21 basis points of mortgage assets ascompared to 14 basis points of mortgage assets in the first nine months of2005.

Additionally, the netinterest margin continues to be affected by the difficult competitiveenvironment facing mortgage portfolio lenders. As a result, net interest margins continue to tighten on newlyoriginated loans. Furthermore, a rise in short-term rates and a decline in long-termrates has resulted in a partial inversion of the yield curve, adding pressureto mortgage lending profitability.

During the first ninemonths of 2006, adjusted net interest margins on mortgage assets, which is anon-GAAP financial measurement as indicated in the yield table above, decreasedby 21 basis points as compared to a decline of 113 basis points on net interestmargin on mortgage assets.  Adjusted netinterest margin on mortgage assets did not decline as much as net interestmargin on mortgage assets primarily due to a 90 basis point increase inrealized cash receipts from derivative instruments relative to total averagemortgage assets. Realized cash receipts from derivative instruments partiallyoffset the decline in adjusted net interest margins on mortgage assets whichwas caused by the factors described above.

Our interest rate riskmanagement 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. However, as a result of thecombination of the factors listed above, the interest rate spread differentialbetween ARMs and adjustable rate securitized mortgage borrowingscompressed, which compressed net interest margins on mortgage assets. Bydesign, our current interest rate risk management program provides 20% to 25%coverage of the outstanding principal balance of our six month LIBORARMs and 85% to 98% coverage of the outstanding principal balance ofintermediate, or hybrid, ARMs at the point in time that we securitize themortgages.

For further information on our interest rate riskmanagement policies refer to Item 3. “Quantitative and Qualitative DisclosuresAbout Market Risk.”

*Provision for Loan Losses*

The Company provides for loan losses in accordancewith its policies that include a detailed analysis of historical loanperformance data which is analyzed for loss performance and prepaymentperformance by product type, origination year and securitization issuance. Theresults of that analysis are then applied to the current mortgage portfolio andan estimate is derived. The Company’s general allowance for loan lossesreflects the expectation that losses inherent in the portfolio will exceed thelevel of annualized losses we are currently experiencing.

The allowance for loan losses of $65.7 million atSeptember 30, 2006 was comprised of specific reserves for estimated hurricanelosses of $6.6 million, for finance receivables of $10.3 million and a loanportfolio reserve of $48.8 million. During the nine months ended September 30, 2006, specific reserves onhurricane losses and the loan portfolio reserve both decreased by $6.2 million.The decrease in the specific reserve for estimated hurricane losses was due toupdated property inspection information and principal reductions of loans. Thedecrease in the loan portfolio reserve was due to a decrease in the portfolioof securitized mortgage collateral and mortgages held for investment. However,exclusive of specific reserves, the Company maintained an allowance forsecuritized mortgage collateral and mortgage loan held-for-sale for loan lossesof 24 basis points at September 30, 2006 compared to 22 basis points atDecember 31, 2005. The ratio of loan portfolio reserve to annualized loanlosses was 2.27 at September 30, 2006. The Company believes the total allowancefor loan losses is adequate to absorb losses inherent in the loan portfolio atSeptember 30, 2006.

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

33

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*Non-Interest Income*

Changes inNon-Interest Income

(dollars in thousands)
| ** **                                      | ** ** | **For the Three Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Realized gain  from derivative instruments      |       | $                                                                          | 60,630     |   | $ | 10,975 |   | $ | 49,655 |   | 452 | % |
| Change in fair  value of derivative instruments |       | (155,534                                                                   | )          | 107,881 |   | (263,415 | ) | (244 | ) |
| Gain on sale of  loans                          |       | 4,906                                                                      |       | 12,118 |   | (7,212 | ) | (60 | ) |
| Recovery of  (provision for) repurchases        |       | 15,876                                                                     |       | (3,242 | ) | 19,118 |   | 590 |   |
| Other income                                    |       | 8,724                                                                      |       | 1,280 |   | 7,444 |   | 582 |   |
| Total  non-interest (expense) income            |       | $                                                                          | (65,398    | ) | $ | 129,012 |   | $ | (194,410 | ) | (151 | )% |

 

*Realized Gain from Derivative Instruments*.Realized gain from derivative instruments increased to $60.6 million during thethird quarter of 2006 as compared to $11.0 million during the third quarter of2005, or 110 basis points of total average mortgage assets during the thirdquarter of 2006 as compared to 17 basis points of total average mortgage assetsduring the third quarter of 2005.  Theincrease in realized gain from derivative instruments is due to theapproximately 146 basis point increase in the one-month LIBOR from the end ofthe third quarter 2005, which has caused the floating rate payments received onswaps to increase above the fixed payments made.  Realized gains from derivative instrumentsare recorded as current period expense or income in our consolidated financialstatements and are included in the calculation of taxable income in the “TaxableIncome” table.

*Change in Fair Value of DerivativeInstruments.* Thechange in fair value of derivative instruments decreased to a loss of $155.5million during the third quarter of 2006 as compared to a gain of $107.9million during the third quarter of 2005. The amount of market valuation adjustment is the result of changes inthe market’s expectation of future interest rates, and resulted in a partialinversion in the forward yield curve as of September 30, 2006.  The fair value of the derivative instruments representedthe present value of estimated future net cash flows.  As the forward yield curve inverted thefloating rate cash receipts declined resulting in a reduced fair value of thederivative instruments.  We primarilyenter into derivative contracts to offset changes in cash flows associated withsecuritized mortgage borrowings.  In ourconsolidated financial statements, we record a market valuation adjustment forthese derivatives, as well as other derivatives used by the mortgage operationsto hedge our loan pipeline and mortgage loans held-for-sale, as current periodexpense or income.  The change in fairvalue of derivatives at the qualified REIT entities is excluded for purposes ofcalculating taxable income as shown in the reconciliation table of net earningsto estimated taxable income in the “Taxable Income” table.

*Gain on Sale of Loans.*The quarter-over-quarter decrease ingain on sale of loans was primarily due to a decrease in the associated netgains related to the subsequent sale of whole loans to 43 basis points per loanduring the third quarter of 2006 as compared to 63 basis points per loan forthe same period in 2005.  Additionally,we use derivatives to protect the market value of mortgages when we haveestablished a rate-lock commitment on a particular mortgage prior to its closeand eventual sale or securitization. Any changes in interest rates on mortgagesthat we have committed to acquire at a particular rate until we sell orsecuritize the mortgage generally results in an increase or decrease in themarket value of that mortgage.   Duringthe third quarter of 2006, the value of these derivatives resulted in a loss of$3.8 million as compared to a gain of $6.8 million during the third quarter of2005.

*Recovery of (Provision for)Repurchases. *A recovery of $15.9 million during the thirdquarter of 2006 was recorded compared to a provision of $3.2 million for thesame period in 2005. The change was primarily due to a decrease in theoutstanding repurchase requests at the end of the third quarter of 2006 andexpected future repurchases. Additionally, there was $114.4 million in outstanding repurchaserequests from the second quarter that were rescinded by investors during thethird quarter of 2006.   Repurchases were$16.0 million for the third quarter of 2006 compared to $100.0 million for thesecond quarter of 2006.  Additionally,whole loan sales volume decreased to $1.1 billion during the third quarter of2006 as compared to $1.9 billion for the same period last year.

34

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Changes inNon-Interest Income

(dollars in thousands)
| ** **                                        | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                        | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Realized gain  (loss) from derivative instruments |       | $                                                                         | 156,633    |   | $ | (4,209 | ) | $ | 160,842 |   | 3,821 | % |
| Change in fair  value of derivative instruments   |       | (92,602                                                                   | )          | 141,521 |   | (234,123 | ) | (165 | ) |
| Gain on sale of  loans                            |       | 35,647                                                                    |       | 44,063 |   | (8,416 | ) | (19 | ) |
| Provision for  repurchases                        |       | (7,233                                                                    | )          | (8,606 | ) | (1,373 | ) | (16 | ) |
| Loss on lower of  cost or market writedown        |       | (15,284                                                                   | )          | — |   | 15,284 |   | 100 |   |
| Other income                                      |       | 27,128                                                                    |       | 8,664 |   | 18,464 |   | 213 |   |
| Total  non-interest income                        |       | $                                                                         | 104,289    |   | $ | 181,433 |   | $ | (77,144 | ) | (43 | )% |

 

*Realized Gain (Loss) from DerivativeInstruments*. Realized gain (loss) from derivative instrumentsincreased to $156.6 million gain during the first nine months of 2006 ascompared to a $4.2 million loss during the first nine months of 2005, or 88basis points of total average mortgage assets during the first nine months of2006 as compared to (2) basis points of total average mortgage assets duringthe first nine months of 2005.  Theincrease in realized gain (loss) from derivative instruments is due to the approximately146 basis point increase in the one-month LIBOR from the end of the thirdquarter of 2005, which has caused the floating rate payments received on swapsto increase above the fixed payments made. Realized gain (loss) from derivative instruments is recorded as currentperiod expense or income on our consolidated financial statements and isincluded in the calculation of taxable income in the “Taxable Income” table.

*Change in Fair Value of DerivativeInstruments.* Thechange in fair value of derivative instruments decreased to a loss of $92.6million during the first nine months of 2006 as compared to income of $141.5million during the first nine months of 2005. The amount of market valuation adjustment is the result of changes inthe market’s expectation of future interest rates and resulted in a partialinversion in the forward yield curve as of September 30, 2006.  The fair value of the derivative instruments representedthe present value of estimated future net cash flows.  As the forward yield curve inverted thefloating rate cash receipts declined resulting in a reduced fair value of thederivative instruments.  We primarilyenter into derivative contracts to offset changes in cash flows associated withsecuritized mortgage borrowings.  In ourconsolidated financial statements, we record a market valuation adjustment forthese derivatives, as well as other derivatives used by the mortgage operationsto hedge our loan pipeline and mortgage loans held-for-sale, as current periodexpense or income.  The change in fairvalue of derivatives at IMH is excluded for purposes of calculating taxableincome as shown in the reconciliation table of net earnings to estimatedtaxable income in the “Taxable Income” table.

*Gain on Sale of Loans.  *The decrease in gain on sale of loans for the nine months endedSeptember 30, 2006 was primarily due to a decrease in the associated net gainsrelated to the subsequent sale of whole loans. During the first nine months of 2006, net gains on whole loans decreasedto 67 basis points per loan as compared to 99 basis points for the same periodin 2005.  Additionally, we usederivatives to protect the market value of mortgages when we have establishedan interest rate-lock commitment on a particular mortgage prior to its closeand eventual sale or securitization. Any changes in interest rates on mortgagesthat we have committed to acquire at a particular rate until we sell orsecuritize the mortgage generally results in an increase or decrease in themarket value of that mortgage.  Duringthe nine months ended September 30, 2006, the value of these derivativesresulted in a loss of $3.9 million as compared to a gain of $3.9 million duringthe same period in 2005.

*Provision for Repurchases.* Provision for repurchases decreased to $7.2million during the nine months ended September 30, 2006 as compared to $8.6million for the same period in 2005. The decrease in provision for repurchases was primarily due to adecrease in outstanding repurchase requests at the end of the third quarter of2006 and $114.4 million of outstanding repurchase requests that were rescindedby investors.

*Loss on Lower of Cost or MarketWritedown.*  The loss on lower of cost or market (“LOCOM”)writedown, for the nine months endedSeptember 30, 2006, was primarily due to the writedown on loansrepurchased in the second quarter related to loans sold on a whole loan basisrather than securitized.  The Companyrepurchased approximately $100.0 million in loans in the second quarter of 2006for reasons that primarily included early payment default compared to$16.0 million for the third quarter of 2006.

35

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During September 2006 the Company transferredcollateral with a net book value of $135.7 million, after including theassociated lower of cost or market valuation allowance of $28.6 million, whichconsisted of primarily non-performing collateral from mortgages held-for-saleto securitized mortgage collateral at the lower of aggregate cost ormarket.  Subsequent to the transfer theCompany obtained financing in the amount of $80.5 million.

*Non-Interest Expense*

Changes inNon-Interest Expense

(dollars in thousands)
| ** **                                                | ** ** | **For the Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Personnel  expense                                        |       | $                                                                          | 16,643     |   | $ | 19,592 |   | $ | (2,949 | ) | (15 | )% |
| General and  administrative and other expense             |       | 4,591                                                                      |       | 7,111 |   | (2,520 | ) | (35 | ) |
| Professional  services                                    |       | 1,692                                                                      |       | 1,730 |   | (38 | ) | (2 | ) |
| Equipment  expense                                        |       | 1,543                                                                      |       | 1,414 |   | 129 |   | 9 |   |
| Occupancy  expense                                        |       | 1,248                                                                      |       | 1,284 |   | (36 | ) | (3 | ) |
| Data processing  expense                                  |       | 1,709                                                                      |       | 1,296 |   | 413 |   | 32 |   |
| Total operating expense (1)                               |       | 27,426                                                                     |       | 32,427 |   | (5,001 | ) | (15 | ) |
| Amortization of  deferred charge                          |       | 4,861                                                                      |       | 6,908 |   | (2,047 | ) | (30 | ) |
| Amortization and  impairment of mortgage servicing rights |       | 380                                                                        |       | 551 |   | (171 | ) | (31 | ) |
| Gain on sale of  other real estate owned                  |       | (302                                                                       | )          | (432 | ) | (130 | ) | (30 | ) |
| Total non-operating expense (2)                           |       | 4,939                                                                      |       | 7,027 |   | (2,088 | ) | (30 | ) |
| Total  non-interest expense                               |       | $                                                                          | 32,365     |   | $ | 39,454 |   | $ | (7,089 | ) | (18 | )% |

 

Changes inNon-Interest Expense

(dollars in thousands)
| ** **                                                | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Personnel  expense                                        |       | $                                                                         | 51,973     |   | $ | 59,282 |   | $ | (7,309 | ) | (12 | )% |
| General and  administrative and other expense             |       | 14,190                                                                    |       | 18,584 |   | (4,394 | ) | (24 | ) |
| Professional  services                                    |       | 6,201                                                                     |       | 7,170 |   | (969 | ) | (14 | ) |
| Equipment  expense                                        |       | 4,862                                                                     |       | 3,797 |   | 1,065 |   | 28 |   |
| Occupancy  expense                                        |       | 3,860                                                                     |       | 3,599 |   | 261 |   | 7 |   |
| Data processing  expense                                  |       | 3,819                                                                     |       | 3,075 |   | 744 |   | 24 |   |
| Total operating expense (1)                               |       | 84,905                                                                    |       | 95,507 |   | (10,602 | ) | (11 | ) |
| Amortization of  deferred charge                          |       | 15,872                                                                    |       | 19,503 |   | (3,631 | ) | (19 | ) |
| Amortization and  impairment of mortgage servicing rights |       | 1,112                                                                     |       | 1,577 |   | (465 | ) | (29 | ) |
| Gain on sale of  other real estate owned                  |       | (1,277                                                                    | )          | (1,261 | ) | 16 |   | 1 |   |
| Total non-operating expense (2)                           |       | 15,707                                                                    |       | 19,819 |   | (4,112 | ) | (21 | ) |
| Total  non-interest expense                               |       | $                                                                         | 100,612    |   | $ | 115,326 |   | $ | (14,714 | ) | (13 | )% |

36

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----

| (1) | Operating expenses are primarily related to the  mortgage operations personnel, which generally fluctuate in conjunction with  increases or decreases in mortgage acquisition and origination volumes. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Non-operating expenses generally relate to existing  assets and liabilities and are generally not a function of increases or  decreases in mortgage acquisition or origination volumes.                |

 

*Operating Expense.*  The decrease in operating expense wasprimarily due to the following:

·      decrease in personnel expenses; and

·      decrease in general and administrativeexpenses.

*2006 to 2005 Quarterly Comparative*

Total operating expenses decreased 15% on aquarter-over-quarter basis as personnel expense decreased 15% to $16.6 millionduring the third quarter of 2006 as compared to $19.6 million for the sameperiod in 2005. The quarter over quarter decrease is mainly attributable to a58% decrease in bonus and incentives to $1.6 million for the third quarter of2006 as compared to $3.8 million for the third quarter of 2005. General andadministrative and other expense decreased 35% on a quarter-over-quarter basisas business promotion decreased 53% to approximately $950,000 as compared to $2.0million for the third quarter of 2005.

*2006 to 2005 Nine Month Comparative*

Total operating expenses decreased 11% for the ninemonths ended September 30, 2006 as personnel expense decreased 12% to $52.0million during the first nine months of 2006 as compared to $59.3 million forthe same period in 2005. The decrease is mainly attributable to a 57% decreasein bonus and incentives to $6.6 million for the nine months ended September 30,2006 as compared to $15.5 million for the same period in 2005. General andadministrative and other expense decreased 24% for the nine months endedSeptember 30, 2006 as business promotion expense decreased 48% to $3.2 millionas compared to $6.2 million for the same period in 2005.

*Mortgage Acquisitions and Originations by Channel*

The following table summarizes the principal balanceof mortgage acquisitions and originations for the periods indicated (inthousands):
|                                        | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **Principal**                                                              | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Balance**                                                                | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| By Production  Channel:                | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Correspondent acquisitions:            | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Flow                                   |       | $                                                                          | 1,104,017  |   | 33 |   | $ | 1,692,926 |   | 27 |   |
| Bulk                                   |       | 1,191,686                                                                  |       | 35 |   | 3,523,484 |   | 55 |   |
| Total correspondent acquisitions       |       | 2,295,703                                                                  |       | 68 |   | 5,216,410 |   | 82 |   |
| Wholesale and retail originations      |       | 846,803                                                                    |       | 25 |   | 940,202 |   | 15 |   |
| Total mortgage operations acquisitions |       | 3,142,506                                                                  |       | 93 |   | 6,156,612 |   | 97 |   |
| Commercial Mortgage Operations         |       | 233,894                                                                    |       | 7 |   | 211,891 |   | 3 |   |
| Total  acquisitions and originations   |       | $                                                                          | 3,376,400  |   | 100 |   | $ | 6,368,503 |   | 100 |   |

 

*2006 to 2005 Quarterly Comparative*

As a result of the Company’spricing strategies and a more competitive market, total residentialacquisitions and originations for the third quarter of 2006 decreased to $3.1billion as compared to $6.2 billion for the same period in 2005.  Pricing strategies and an increasinglycompetitive market are the primary drivers behind the reduction in bulkacquisitions, which decreased to 35% of our total acquisitions and originationsduring the third quarter of 2006 as compared to 55% for the same period in2005.  Commercial originations haveincreased to $233.9 million for the third quarter of 2006 as compared to 

37

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$211.9 million for the same period in 2005.  The increase is primarily due to theexpansion of our commercial operations in the west coast and mid-west regions.
|                                        | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **Principal**                                                             | ** ** | ** ** | ** ** | **Principal** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Balance**                                                               | ** ** | **%** | ** ** | **Balance** | ** ** | **%** | ** ** |
| By Production  Channel:                | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Correspondent acquisitions:            | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Flow                                   |       | $                                                                         | 3,766,955  |   | 46 |   | $ | 5,370,751 |   | 32 |   |
| Bulk                                   |       | 1,661,781                                                                 |       | 20 |   | 8,724,538 |   | 52 |   |
| Total correspondent acquisitions       |       | 5,428,736                                                                 |       | 66 |   | 14,095,289 |   | 84 |   |
| Wholesale and retail originations      |       | 2,014,900                                                                 |       | 25 |   | 2,188,945 |   | 13 |   |
| Total mortgage operations acquisitions |       | 7,443,636                                                                 |       | 91 |   | 16,284,234 |   | 97 |   |
| Commercial Mortgage Operations         |       | 713,829                                                                   |       | 9 |   | 591,792 |   | 3 |   |
| Total  acquisitions and originations   |       | $                                                                         | 8,157,465  |   | 100 |   | $ | 16,876,026 |   | 100 |   |

 

*2006 to 2005 Nine Month Comparative*

Acquisitions andoriginations decreased to $8.2 billion for the first nine months of 2006 ascompared to $16.9 billion for the same period in 2005.  The reduction in acquisitions andoriginations at the mortgage operations is primarily due to an 81% decrease inbulk acquisitions to $1.7 billion for the first nine months of 2006 as comparedto $8.7 billion for the same period in 2005. Pricing strategies and an increasingly competitive market are theprimary drivers behind the reduction in bulk acquisitions.  Commercial originations increased 21% to$713.8 million for the first nine months of 2006 as compared to $591.8 millionfor the same period in 2005 as the Company has hired additional sales personnelto manage and support the growth of the commercial operations into otherregions of the United States.

***Results of Operations byBusiness Segment***

*Long-Term Investment Operations*

CondensedStatements of Operations Data

(dollars in thousands)
| ** **                                      | ** ** | **For the Three Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (expense) income                  |       | $                                                                          | (44,079    | ) | $ | 8,941 |   | $ | (53,020 | ) | (593 | )% |
| Provision for  loan losses                      |       | 3,533                                                                      |       | 13,699 |   | (10,166 | ) | (74 | ) |
| Net expense after provision for loan losses     |       | (47,612                                                                    | )          | (4,758 | ) | (42,854 | ) | 901 |   |
|                                            |       |                                                                       |       |   |   |   |   |   |   |
| Realized gain  from derivative instruments      |       | 60,595                                                                     |       | 10,975 |   | 49,620 |   | 452 |   |
| Change in fair  value of derivative instruments |       | (150,051                                                                   | )          | 108,905 |   | (258,956 | ) | (238 | ) |
| Other  non-interest expense income              |       | (70                                                                        | )          | (530 | ) | 460 |   | (87 | ) |
| Total non-interest (loss) income                |       | (89,526                                                                    | )          | 119,350 |   | (208,876 | ) | (175 | ) |
|                                            |       |                                                                       |       |   |   |   |   |   |   |
| Non-interest  expense                           |       | 5,198                                                                      |       | 3,257 |   | 1,941 |   | 60 |   |
| Net (loss)  earnings                            |       | $                                                                          | (142,336   | ) | $ | 111,335 |   | $ | (253,671 | ) | (228 | )% |

 

The quarter-over-quarter decrease in net earnings wasprimarily due to the change in fair value on derivative instruments, whichdecreased to a loss of $150.1 million for the third quarter of 2006 as comparedto income of $108.9 million for the third quarter of 2005. The market valuationadjustment is the result of changes in the expectation of 

38

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futureinterest rates.  Additionally, netinterest income declined to a net expense of $44.1 million compared to netinterest income of $8.9 million, for the three months ended September 30, 2006and 2005, respectively, primarily due to an increase in borrowing costs, whichwere substantially offset by realized gains from derivative instruments, whichincreased to $60.6 million for the third quarter of 2006 compared to $11.0million for the third quarter of 2005. Together, net interest income andrealized gains from derivative instruments declined 17% to $16.5 million forthe three months ended September 30, 2006 compared to $19.9 million for thethree months ended September 30, 2005.

CondensedStatements of Operations Data

(dollars in thousands)
| ** **                                                     | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                                     | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (expense) income                                 |       | $                                                                         | (91,393    | ) | $ | 89,967 |   | $ | (181,360 | ) | (202 | )% |
| Provision for  loan losses                                     |       | 3,638                                                                     |       | 25,484 |   | 21,846 |   | 86 |   |
| Net interest (expense) income after provision for  loan losses |       | (95,031                                                                   | )          | 64,483 |   | (159,514 | ) | (247 | ) |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Realized gain  (loss) from derivative instruments              |       | 156,582                                                                   |       | (4,209 | ) | 160,791 |   | 3,820 |   |
| Change in fair  value of derivative instruments                |       | (95,186                                                                   | )          | 146,913 |   | (242,099 | ) | (165 | ) |
| Other  non-interest (expense) income                           |       | (852                                                                      | )          | 451 |   | (1,303 | ) | (289 | ) |
| Total non-interest income                                      |       | 60,544                                                                    |       | 143,155 |   | (82,611 | ) | (58 | ) |
|                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Non-interest  expense                                          |       | 12,916                                                                    |       | 10,256 |   | 2,660 |   | 26 |   |
| Net (loss)  earnings                                           |       | $                                                                         | (47,403    | ) | $ | 197,382 |   | $ | (244,785 | ) | (124 | )% |

 

Operations for the first nine months ended September30, 2006 resulted in net interest expense of $91.4 million compared to netinterest income of $90.0 million for the same period in 2005.  The decrease in net interest income wasprimarily due to an increase in borrowing costs, which were substantiallyoffset by realized gain (loss) from derivative instruments which increased to$156.6 million for the first nine months of 2006 compared to a loss of $4.2million for the same period in 2005. Together, net interest income and realizedgain (loss) from derivative instruments declined 24% to $65.2 million for thenine months ended September 30, 2006 compared to $85.8 million for the ninemonths ended September 30, 2005. This decline is primarily attributable to theaforementioned net interest margin compression. Additionally, the change in fair value on derivative instrumentsdecreased to a net expense of $95.2 million for the first nine months of 2006as compared to net income $146.9 million for the same period in 2005. Themarket valuation adjustment is the result of changes in the expectation offuture interest rates.

*MortgageOperations*

CondensedStatements of Operations Data

(dollars in thousands)
|                                          | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                               | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                               | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (loss)                     |       | $                                                                          | (3,234     | ) | $ | (101 | ) | $ | (3,133 | ) | (3,102 | )% |
| Gain on sale of  loans                   |       | 16,118                                                                     |       | 34,888 |   | (18,770 | ) | (54 | ) |
| Recovery of (provision  for) repurchases |       | 15,876                                                                     |       | (3,242 | ) | 19,118 |   | (590 | ) |
| Other income  (loss)                     |       | 8,739                                                                      |       | (1,111 | ) | 9,850 |   | 887 |   |
| Non-interest  expense and income taxes   |       | 25,896                                                                     |       | 29,604 |   | (3,708 | ) | (13 | ) |
| Net earnings                             |       | $                                                                          | 11,603     |   | $ | 830 |   | $ | 10,773 |   | 1,298 | % |

 

*Gain on Sale of Loans.*Gainon sales to the long-term operations, third party investors and REMICsdecreased to 49 basis points per loan from 67 basis points or $16.4 million forthe third quarter of 2006 as compared to $34.9 million for the 

39

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sameperiod in 2005.  The decrease in gain onsale of loans is primarily attributable to a 37% decrease in mortgageoperations loan sales volume to $3.3 billion for the third quarter of 2006 ascompared to $5.2 billion for the same period in 2005.  Additionally, the long-term investmentoperations did not retain any loans for investment purposes during the thirdquarter of 2006 as compared to $3.3 billion for the same period in 2005.  The mortgage operations utilize derivativesto protect the market value of mortgages when it establishes a rate-lockcommitment on a particular mortgage prior to its close and sale orsecuritization. During the third quarter of 2006, the value of thesederivatives were $(3.8) million as compared to $6.8 million for the thirdquarter of 2005. Any changes in interest rates on mortgages that the mortgageoperations has committed to acquire at a particular rate to the time it sellsor securitizes the mortgage generally results in an increase or decrease in themarket value of that mortgage.  Themortgage operations are reflected as a stand-alone entity for segment financialreporting purposes; however, on the consolidated financial statementsinter-company loan sales and related gains are eliminated.

*Provision for Repurchases.*  Provision for repurchases decreased to arecovery of $15.9 million during the third quarter of 2006 as compared to anexpense of $3.2 million for the same period in 2005.  The provision for repurchases decreased as aresult of, $114.4 million in outstanding requests which were rescinded byinvestors.

*Non-Interest Expense and Income Taxes. *Non-interest expense andincome taxes decreased 13% to $25.9 million for the third quarter of 2006compared to $29.6 million for third quarter of 2005 primarily due to a decreasein operating expenses to $16.7 million for the third quarter of 2006 ascompared to $26.8 million for the same period in 2005.  Operating expenses decreased 38% primarilydue to a decline in personnel expenses to $5.7 million for the third quarter of2006 as compared to $14.1 million for the same period in 2005.

CondensedStatements of Operations Data

(dollars in thousands)
|                                            | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                                 | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  (expense) income             |       | $                                                                         | (4,621     | ) | $ | 6,559 |   | $ | (11,180 | ) | (170 | )% |
| Gain on sale of  loans                     |       | 55,174                                                                    |       | 109,633 |   | (54,459 | ) | (50 | ) |
| Provision for repurchases                  |       | 7,233                                                                     |       | 8,606 |   | 1,373 |   | 16 |   |
| Loss on lower of  cost or market writedown |       | (15,283                                                                   | )          | — |   | (15,283 | ) | (100 | ) |
| Other income  (loss)                       |       | 30,211                                                                    |       | (460 | ) | 30,671 |   | 6,668 |   |
| Non-interest  expense and income taxes     |       | 60,476                                                                    |       | 90,872 |   | (30,396 | ) | (33 | ) |
| Net (loss)  earnings                       |       | $                                                                         | (2,228     | ) | $ | 16,254 |   | $ | (18,482 | ) | (114 | )% |

 

*Gain on Sale of Loans*.Gain on sales to the long-term operations, third party investors and REMICsdecreased to 61 basis points per loan from 74 basis points or $55.2 million forthe first nine months of 2006 as compared to $109.6 million for the same periodin 2005.  The decrease in gain on sale ofloans is primarily attributable to a 39% decrease in mortgage operations loansales volume to $9.0 billion for the first nine months of 2006 as compared to $14.7billion for the same period in 2005. Additionally, the long-term investment operations retained forinvestment purposes $2.8 billion during the first nine months of 2006 ascompared to $9.7 billion for the same period in 2005.  The mortgage operations are reflected as astand-alone entity for segment financial reporting purposes; however, on theconsolidated financial statements inter-company loan sales and related gainsare eliminated.

*Provision for Repurchases. *Provision for repurchasesdecreased to $7.2 million for the first nine months of 2006 as compared to $8.6million for the same period in 2005.  Theprovision for repurchases decreased as a result of a decrease in outstandingrepurchase requests at the end of the third quarter of 2006, as $114.4 millionin outstanding requests were rescinded by investors.

*Loss on Lower of Cost or MarketWritedown. *Net earnings for the nine monthsended September 30, 2006 decreased as the Company recorded a LOCOM writedown inthe second quarter of 2006 in the amount of $15.3 million associated withrepurchased loans at the mortgage operations.

During September 2006 the Company transferredcollateral with a net book value of $135.7 million, after including theassociated lower of cost or market valuation allowance of $28.6 million, whichconsisted of primarily non-performing 

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collateralfrom mortgages held-for-sale to securitized mortgage collateral at the lower ofaggregate cost or market.  Subsequent tothe transfer the Company obtained financing in the amount of $80.5 million.

*Non-Interest Expense and Income Taxes. *Non-interest expense andincome taxes decreased to $60.4 million for the first nine months of 2006compared to $90.9 million for the same period in 2005.  The decrease in non-interest expense isprimarily due to a 29% decrease in personnel related expenses to $55.5 millionfor the first nine months of 2006 as compared to $78.1 million for the sameperiod in 2005.  Additionally, an incometax benefit of approximately $775,000 was recorded during the first nine monthsof 2006 as compared to income taxes expense of $6.4 million for the same periodin 2005 as a result of net losses at the taxable REIT subsidiary during 2006compared to nets gains during the same period in 2005. The Company expects tofully utilize the recorded income tax benefit. The Company makes an estimate ofthe effective tax rate expected to be applicable for the fiscal year whenproviding for tax expense (benefit).

*WarehouseLending Operations*

CondensedStatements of Operations Data

(dollars in thousands)
|                                        | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  income                   |       | $                                                                          | 9,659      |   | $ | 15,475 |   | $ | (5,816 | ) | (38 | )% |
| Recovery of loan  losses               |       | (350                                                                       | )          | (265 | ) | 85 |   | 32 |   |
| Non-interest  income                   |       | 878                                                                        |       | 2,011 |   | (1,133 | ) | (56 | ) |
| Non-interest  expense and income taxes |       | 2,077                                                                      |       | 1,978 |   | 99 |   | 5 |   |
| Net earnings                           |       | $                                                                          | 8,810      |   | $ | 15,773 |   | $ | (6,963 | ) | (44 | )% |

 

The quarter-over-quarter decrease in net earnings wasprimarily due to a decrease in net interest income as interest income onmortgage assets decreased to $41.8 million in the third quarter of 2006 ascompared to $51.4 million for the same period in 2005 due to the decline in theaverage balance of outstanding finance receivables.  The decrease in interest income was partiallyoffset by a decrease in interest expense on mortgage borrowings of $3.2 million.  Additionally, loan fees decreased $1.1million decreasing non-interest income. For the three months ended September30, 2006 and September 30, 2005, no provision for loan loss was recorded. Thewarehouse lending operations is reflected as a stand-alone entity for segmentfinancial reporting purposes. However, on the consolidated financial statementsinter-company finance receivables and borrowings are eliminated.

CondensedStatements of Operations Data

(dollars in thousands)
|                                        | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Increase** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** | **(Decrease)** | ** ** | **Change** | ** ** |
| Net interest  income                   |       | $                                                                         | 24,229     |   | $ | 40,455 |   | $ | (16,226 | ) | (40 | )% |
| Recovery of loan  losses               |       | (350                                                                      | )          | (265 | ) | 85 |   | 32 |   |
| Non-interest  income                   |       | 2,426                                                                     |       | 6,268 |   | (3,842 | ) | (61 | ) |
| Non-interest  expense and income taxes |       | 5,578                                                                     |       | 5,833 |   | (255 | ) | (4 | ) |
| Net earnings                           |       | $                                                                         | 21,427     |   | $ | 41,155 |   | $ | (19,728 | ) | (48 | )% |

 

The decrease in net earnings for the nine months endedSeptember 30, 2006, was primarily due to a decrease in net interest income asborrowing costs on mortgage assets increased to $80.9 million for the firstnine months of 2006 as compared to $78.0 million for the same period in 2005 asone-month LIBOR, which is tied to our borrowing costs, increased approximately146 basis points since the end of the third quarter of 2005.  Additionally, interest income on mortgageassets decreased to $105.6 million for the nine months ended September 30,2006, as compared to $119.5 million during the same 

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periodin 2005 due to the decline in the average balance of outstanding financereceivables.  Net earnings were alsoeffected by the decrease in loan fees of $3.8 million.  For the nine months ended September 30, 2006and September 30, 2005, a recovery from loan losses was recorded whichincreased net earnings by $350,000 and $265,000, respectively.  The warehouse lending operations is reflectedas a stand-alone entity for segment financial reporting purposes. However, onthe consolidated financial statements inter-company finance receivables andborrowings are eliminated.

*CommercialOperations*

CondensedStatements of Operations Data

(dollars in thousands)
|                                        | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **September 30, 2006**                   | ** ** |
| Net interest  income                   |       | $                                                  | 61         |   |
| Non-interest  income                   |       | (5,803                                             | )          |
| Non-interest  expense and income taxes |       | 1,008                                              |       |
| Net loss                               |       | $                                                  | (6,750     | ) |

 

On January 1, 2006, we elected to convert ImpacCommercial Capital Corporation “ICCC” from a qualified REIT subsidiary to ataxable REIT subsidiary.  Therefore,there is no corresponding quarter over quarter comparison.

Net loss for the commercial operations was $6.8million for the third quarter of 2006. Non-interest income was a net expense of $5.8 million in the thirdquarter of 2006 due to the change in fair value of derivative instruments whichdecreased to a loss of $6.1 million during the quarter ended September 30,2006.  The amount of market valuationadjustment on derivative instruments is the result of changes in the market’s expectationof future interest rates.  Additionally,non-interest expense was $2.9 million which was partially offset by an incometax benefit of $1.9 million.  Thecommercial operations are reflected as a stand-alone entity for segmentfinancial reporting purposes; however, on the consolidated financial statementsinter-company loan sales and related gains are eliminated.

CondensedStatements of Operations Data

(dollars in thousands)
|                                        | ** ** | **For the Nine Months Ended** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **September 30, 2006**                  | ** ** |
| Net interest  income                   |       | $                                                 | 251        |   |
| Non-interest  income                   |       | (2,907                                            | )          |
| Non-interest  expense and income taxes |       | 6,113                                             |       |
| Net loss                               |       | $                                                 | (8,769     | ) |

 

On January 1, 2006, we elected to convert ImpacCommercial Capital Corporation “ICCC” from a qualified REIT subsidiary to ataxable REIT subsidiary.  Therefore,there is no corresponding nine month 2005 comparison.

Net loss for the commercial operations was $8.8million for the first nine months of 2006. Non-interest income was a net expense of $2.9 million in the first ninemonths of 2006 due to the change in fair value of derivative instruments whichwas $6.3 million during the first nine months of 2006.  The amount of market valuation adjustment onderivative instruments is the result of changes in the expectation of futureinterest rates.  Partially offsetting thefair value of derivative instruments was a gain on the sale of loans which was$3.4 million for the nine months ended September 30, 2006.  Additionally, non-interest expense was $9.1million which was partially offset by an income tax benefit of $3.0million.  The commercial 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.

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**Liquidity and Capital Resources**

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

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

Webelieve that current cash balances, short-term investments, currently availablefinancing facilities, capital raising capabilities and excess cash flowsgenerated from our long-term mortgage portfolio will adequately provide forprojected funding needs and limited asset growth.

Ouroperating businesses primarily use available funds as follows:

·      acquisition and origination of mortgagesby the mortgage, commercial, and long-term investment operations;

·      long-term investment in mortgages by thelong-term investment operations;

·      provide short-term warehouse advances bythe warehouse lending operations;

·      pay interest on debt;

·      distribute common and preferred stockdividends;

·      pay operating and non-operating expenses;

·      potential repurchase of the Company’scommon stock.

*Acquisition and origination of mortgages by the mortgage,commercial, and long-term investment operations*.  During the third quarter of 2006, themortgage operations acquired and originated $3.1 billion of primarily Alt-Amortgages, of which $2.0 billion was retained by the long-term investmentoperations for long-term investment. Capital invested in mortgages isoutstanding until we sell or securitize mortgages, which is one of the reasonswe attempt to sell or securitize mortgages within 90 days of acquisition ororigination. Initial capital invested in mortgages includes premiums paid whenmortgages are acquired and originated and our capital investment, or “haircut,”required upon financing, which is generally determined by the type ofcollateral provided.  The mortgageoperations acquired and originated mortgages at a weighted average price of101.68 during the third quarter of 2006, which were financed with warehouseborrowings from the warehouse lending operations at a haircut generally between2% to 10% of the outstanding principal balance of the mortgages. In addition,ICCC originated $233.9 million of commercial mortgages at a weighted averageprice of 100.00 which were initially financed with short-term warehousefinancing from the warehouse lending operations at a haircut of generally 3% ofthe outstanding principal balance of the mortgages.

*Long-term investment in mortgages by the long-terminvestment operations*. The long-term investment operations acquires primarily Alt-A mortgagesfrom the mortgage operations and finances them with warehouse borrowings fromthe warehouse lending operations at substantially the same terms as themortgage operations. When the long-term investment operations financesmortgages with long-term securitized mortgage borrowings, short-term warehousefinancing is repaid. Then, depending on credit ratings from national creditrating agencies on our securitized mortgage borrowings, we are generallyrequired to provide an over-collateralization, or “OC,” of 0.35% to 1% of theprincipal balance of mortgages securing securitized mortgage borrowings ascompared to a haircut of 2% to 10% of the principal balance of mortgagessecuring short-term warehouse financing. Our total capital investment in securitized mortgage collateral generallyranges from approximately 2% to 5% of the principal balance of mortgagessecuring securitized mortgage borrowings which includes premiums paid uponacquisition of mortgages from the mortgage operations, costs paid forcompletion of securitized mortgage borrowings, costs to acquire derivatives andOC required to achieve desired credit ratings. Commercial mortgages 

43

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are financed on along-term basis with securitized mortgage borrowings at substantially the samerates and terms as Alt-A mortgages.

*Provide short-term warehouse advances by the warehouselending operations.*We utilize committed and uncommittedreverse repurchase facilities with various lenders to provide short-termwarehouse financing to affiliates and non-affiliated clients of the warehouselending operations. The warehouse lending operations provides short-termfinancing to the mortgage operations and non-affiliated clients from theclosing of mortgages to their sale or other settlement with investors. Thewarehouse lending operations generally finances between 90% and 98% of the fairmarket value of the principal balance of mortgages, which equates to a haircutrequirement of between 10% and 2%, respectively, at the one-month LIBOR, plus aspread. The mortgage and commercial operations have uncommitted warehouse lineagreements to obtain financing from the warehouse lending operations at the one-monthLIBOR plus a spread during the period that the mortgage or commercial operationaccumulates mortgages until the mortgages are securitized or sold.  As of September 30, 2006, the mortgage andcommercial operations had $965.4 million and $351.4 million, respectively, ofwarehouse advances outstanding with the warehouse lending operations. Inaddition, as of September 30, 2006, the warehouse lending operations had $720.5million of approved warehouse lines available to non-affiliated clients, ofwhich $297.7 million was outstanding.

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

·      our compliance with the terms of ourexisting credit arrangements;

·      our financial performance;

·      industry and market trends in our variousbusinesses;

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

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

·      the relative attractiveness of alternativeinvestment or lending opportunities.

*Distribute common and preferred stock dividends*.We are required to distribute a minimum of 90% of our taxable income to ourstockholders in order to maintain our REIT status, exclusive of the applicationof any tax loss carry forwards that may be used to offset current periodtaxable income. Because we pay dividends based on taxable income, dividends maybe more or less than net earnings. We declared cash dividends of $0.25 peroutstanding common share for the third quarter of 2006 on estimated taxableincome of $0.23 per diluted common share and paid cash dividends of $0.25 peroutstanding common share for the second quarter of 2006.  In addition, we paid cash dividends of $3.7million on preferred stock during the third quarter of 2006.  We declared cash dividends of $0.95 peroutstanding common share for the nine months ended September 30, 2006 on estimatedtaxable income of $0.86 per diluted common share.  In addition, we paid cash dividends of $11.0million on preferred stock during the nine months ended September 30, 2006.

Aportion of dividends paid to IMH’s stockholders can come from dividend distributionsfrom the mortgage operations and commercial operations, our taxable REITsubsidiaries, to IMH.  During the thirdquarter of 2006, the mortgage operations provided a $3.9 million dividenddistribution to IMH. Because the mortgage and commercial operations may seek toretain earnings to fund the acquisition and origination of mortgages or toexpand the mortgage operations, the board of directors of our taxable REITsubsidiaries, which is different from the board of directors of IMH, may decidethat the mortgage and/or commercial operations should cease making dividenddistributions in the future. This could reduce the amount of taxable incomethat would be distributed to IMH stockholders in the form of common stockdividend payment amounts.

Duringthe third quarter of 2006, our operating businesses were primarily funded asfollows:

·      reverse repurchase agreements andsecuritized mortgage borrowings;

·      excess cash flows from our long-termmortgage portfolio; and

44

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·      sale and securitization of mortgages;

Wemay also fund our business with:

·      cash proceeds from the issuance of commonand preferred stock; and

·      cash proceeds from the issuance of trustpreferred securities.

*Reverse repurchase agreements and securitized mortgageborrowings.*We use reverse repurchase agreements to fundsubstantially all warehouse financing to affiliates and non-affiliated clientsand for the acquisition and origination of Alt-A and commercial mortgages. Aswe accumulate mortgages, we finance the acquisition of mortgages primarilythrough borrowings on reverse repurchase facilities with third party lenders.We primarily use uncommitted and committed facilities with major investmentbanks to finance substantially all warehouse financing, as needed.  During the third quarter of 2006 thewarehouse facilities amounted to $5.5 billion, of which $1.5 billion wasoutstanding at September 30, 2006. The warehouse facilities provide us with ahigher aggregate credit limit to fund the acquisition and origination ofmortgages at terms comparable to those we have received in the past. Thesewarehouse facilities may have certain covenant tests which we continue tosatisfy.  From time to time, we may alsoreceive additional uncommitted interim financing from our lenders in excess ofour permanent borrowing limits to finance mortgages during the accumulationphase and prior to securitizations or whole loan sales.

Fromtime to time, we may also utilize short-term reverse repurchase financingprovided to us by underwriters who underwrite some of our securitizations. Theshort-term reverse repurchase financing funds mortgages that are specificallyallocated to securitization transactions, which allows us to reduce overallborrowings outstanding on reverse repurchase agreements with other lenders duringthe period immediately prior to the settlement of the securitization. Terms andinterest rates on the short-term reverse repurchase facilities are generallylower than on other reverse repurchase agreements. Short-term reverserepurchase financings are generally repaid within 30 days from the date fundsare advanced.

Weexpect to continue to use short-term reverse repurchase facilities to fund theacquisition of mortgages. If we cannot renew or replace maturing borrowings, wemay have to sell, on a whole loan basis, the mortgages securing thesefacilities, which, depending upon market conditions may result in substantiallosses. Additionally, if for any reason the market value of our mortgagessecuring reverse repurchase facilities decline, our lenders may require us toprovide them with additional equity or collateral to secure our borrowings,which may require us to sell mortgages at substantial losses.

Inorder to mitigate the liquidity risk associated with reverse repurchaseagreements, we attempt to sell or securitize our mortgages within 90 daysfrom acquisition or origination. Although securitizing mortgages morefrequently adds operating and securitization costs, we believe the added costis offset as liquidity is provided more frequently with less interest rate andprice volatility, as the accumulation and holding period of mortgages isshortened. When we have accumulated a sufficient amount of mortgages, we seekto issue securitized mortgage borrowings and convert short-term advances underreverse repurchase agreements to long-term securitized mortgage borrowings. Theuse of securitized mortgage borrowings provides the following benefits:

·      allows us to use long termfinancing for the duration of the securitized mortgage collateral;and

·      eliminates the potential formargin calls on the borrowings that are converted from reverse repurchaseagreements to securitized mortgage borrowings as well as associatedderivatives used to manage interest rate risks on securitized mortgageborrowings.

Duringthe first nine months of 2006, we completed $3.0 billion of securitizedmortgage borrowings to provide long-term financing for $3.1 billion ofprimarily Alt-A and commercial mortgages. Because of the credit profile,historical loss performance and prepayment characteristics of our Alt-A andcommercial mortgages, we have been able to borrow a higher percentage againstthe principal balance of mortgages held as securitized mortgage collateral,which means that we have to provide less initial capital upon completion ofsecuritized mortgage borrowings. Capital investment in the securitized mortgageborrowings is established at the time securitized mortgage borrowings areissued at levels sufficient to achieve desired credit ratings on the securitiesfrom credit rating agencies.

*Excess cash flows from our long-term mortgageportfolio*.  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 desired credit ratings onthe securitized mortgage borrowings is fulfilled and can be 

45

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used to provide funding for some of the long-terminvestment operations’ activities. Excess cash flows represent the differencebetween principal and interest payments on the underlying mortgages, adjustedby the following:

·  servicing and master servicing fees paid;

·  premiums paid to mortgage insurers;

·  cash payments / receipts on derivatives;

·  interest paid on securitized mortgageborrowings;

·  pro rata early principal prepayments paid onsecuritized mortgage borrowings;

·  OC requirements;

·      actual losses, net of anygains incurred upon disposition of other real estate owned or acquired insettlement of defaulted mortgages;

·  unpaid interest shortfall;

·  basis risk shortfall;

·  bond write downs reinstated; and

·  residual cash flow.

*Sale and securitization ofmortgages.*  We sell and securitize loans in thefollowing ways:

·      Whenthe mortgage operations accumulate a sufficient amount of mortgages that areintended to be deposited into a securitized mortgage borrowing,it sells the mortgages to the long-term investment operations;

·      Whenselling mortgages on a whole loan basis, the mortgage operations willaccumulate mortgages and enter into sales transactions with third partyinvestors on a monthly basis; and

·      Whenthe mortgage operations enter into a securitization treated as a sale for GAAPand tax purposes it accumulates mortgages and sells these loans periodically.

Themortgage operations sold $2.8 billion of mortgages to the long-term investmentoperations during the nine months of 2006 and sold $5.3 billion ofmortgages to third party investors through whole loan sales and REMICs.  The mortgage operations sold mortgageservicing rights on all mortgages sold during the first nine months of 2006.The sale of mortgage servicing rights generated substantially all cash, which wasused to acquire and originate additional mortgage assets.

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

*Common and Preferred Stock Sales Agreements. *We filed with the SEC ashelf registration statement that allows us to sell up to $1.0 billion ofsecurities, including common stock, preferred stock, debt securities andwarrants. This registration was declared effective by the SEC on September 6,2005.  By issuing new shares periodicallythroughout 2005 and the nine months of 2006, we believe that we were able toutilize new capital more efficiently and profitably.

OnSeptember 30, 2005, the Company entered into a common stock sales agreementwith Brinson Patrick Securities Corporation (Brinson Patrick) for the sale ofup to 7.5 million shares of its common stock from time to time through BrinsonPatrick as sales agent.  No shares ofcommon stock were sold during the three months ended September 30, 2006.

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OnSeptember 30, 2005, the Company entered into a Preferred Stock sales agreementwith Brinson Patrick, for the sale of up to 800,000 shares of its 9.125% SeriesC Cumulative Redeemable Preferred Stock (Series C Preferred Stock) from time totime through Brinson Patrick as sales agent. During the three months ended September 30, 2006, no shares of Series CPreferred Stock were sold.

Forthe nine months ended September 30, 2006, the ratio of earnings to fixedcharges and ratio of earnings to combined fixed charges and preferred stockdividends was 0.97x and 0.96x, respectively. Earnings used in computing the ratio of earnings to fixed chargesconsist of net earnings before income taxes plus fixed charges.  Fixed charges include interest expense ondebt and the portion of rental expense deemed to represent the interest factor.

*Share Repurchase Activity*

During the three months ended September 30, 2006the Company repurchased 104,300 shares on the open market at a weighted averageprice of $9.09.  During October 2005 theboard of directors authorized the repurchase of 5 million shares in stockredemptions.  In accordance with the lawsof Maryland these shares were cancelled at acquisition.

*Inflation/Deflation*

Theconsolidated financial statements and corresponding notes to the consolidatedfinancial statements have been prepared in accordance with GAAP, which requirethe measurement of financial position and operating results in terms ofhistorical dollars without considering the changes in the relative purchasingpower of money over time due to inflation. The impact of inflation is reflectedin the increased costs of our operations. Unlike industrial companies, nearly all of our assets and liabilitiesare monetary in nature. As a result, interest rates have a greater impact onour performance than do the effects of general levels of inflation. Inflationaffects our operations primarily through its effect on interest rates, sinceinterest rates normally increase during periods of high inflation and decreaseduring periods of low inflation. During periods of increasing interest rates,demand for mortgages and a borrower’s ability to qualify for mortgage financingin a purchase transaction may be adversely affected. During periods ofdecreasing interest rates and housing price appreciation, borrowers may prepaytheir mortgages, which in turn may adversely affect our yield and subsequentlythe value of our portfolio of mortgage assets.

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

**GeneralOverview**

Althoughwe manage credit, prepayment and liquidity risk in the normal course ofbusiness, we consider interest rate risk to be a significant market risk, whichcould potentially have the largest material impact on our financial conditionand results of operations. 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 in interestrates affects income received and income paid from assets and liabilities invarying and typically in unequal amounts. Changing interest rates may compressour interest rate margins and adversely affect overall earnings.

Interestrate risk management is the responsibility of the Asset Liability Committee (“ALCO”),which is comprised of senior management and reports results of interest raterisk analysis to the IMH board of directors on at least a quarterly basis.  ALCO establishes policies that monitor andcoordinate sources, uses and pricing of funds. ALCO also attempts to reduce thevolatility in net interest income by managing the relationship of interest ratesensitive assets to interest rate sensitive liabilities. In addition, variousmodeling techniques are used to value interest sensitive mortgage-backedsecurities, including interest-only securities. The value of investmentsecurities available-for-sale is determined using a discounted cash flow modelusing prepayment rate, discount rate and credit loss assumptions. Ourinvestment securities portfolio is available-for-sale, which requires us toperform market valuations of the securities in order to properly record theportfolio. We continually monitor interest rates of our investment securities portfolioas compared 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 trading activities.

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**Changesin Interest Rates**

Interestrate risk management policies are intended to limit our exposure to changes ininterest rates primarily associated with cash flows on our adjustable ratesecuritized mortgage borrowings.  Ourprimary objective is to limit our exposure to the variability in future cashflows attributable to the variability of one-month LIBOR, which is theunderlying index of our adjustable rate securitized mortgage borrowings. Wealso monitor on an ongoing basis the prepayment risks that arise in fluctuatinginterest rate environments. Our interest rate risk management policies areformulated with the intent to offset potential adverse effects of changinginterest rates on cash flows on adjustable rate securitized mortgageborrowings.

Weprimarily acquire for long-term investment ARMs and hybrid ARMs and, to alesser extent, FRMs. ARMs are generally subject to periodic and lifetimeinterest rate caps. This means that the interest rate of each ARM is limited toupwards or downwards movements on its periodic interest rate adjustment date,generally six months, or over the life of the mortgage. Periodic caps limit themaximum interest rate change, which can occur on any interest rate change dateto generally 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.We also acquire hybrid ARMs that have initial fixed interest rate periodsgenerally ranging from two to seven years which subsequently convert to ARMs.During a rapidly increasing or decreasing interest rate environment, financingcosts would increase or decrease more rapidly than would interest rates onmortgages, which would remain fixed until their next interest rate adjustmentdate. In order to provide protection against potential resulting basis riskshortfall on the related liabilities, we purchase derivatives.

Theuse of derivatives to manage risk associated with changes in interest rates isan integral part of our strategy. The amount of cash payments or cash receiptson derivatives is determined by (1) the notional amount of the derivative and (2)current interest rate levels in relation to the various strikes or coupons ofderivatives during a particular time period. As of September 30, 2006 andDecember 31, 2005, we had notional balances of interest rate swaps, caps, andfloors of $18.6 billion and $20.2 billion, respectively, with net fair valuesof $150.9 million and $248.2 million, respectively, pertaining to our currentand pending securitizations. By using derivatives, we attempt to minimize theeffect of both upward and downward interest rate changes on our long-termmortgage portfolio. Our goal is to moderate significant changes to base casenet interest income, including net cash flows from derivatives, as interestrates change. We primarily acquire swaps to essentially convert our adjustablerate securitized mortgage borrowings into fixed rate borrowings. For instance,we receive one-month LIBOR on swaps, which offsets interest expense onadjustable rate securitized mortgage borrowings, and we pay a fixed interestrate.

The interest rate riskprofile of our balance sheet is more sensitive to changes in interest ratesrelated to our liabilities.  We usederivatives extensively in order to manage the interest rate, or price risk,inherent in our assets, liabilities and loan commitments. Our main objective inmanaging interest rate risk is to moderate the effect of changes in interestrates on our earnings over time.  Ourinterest rate risk management strategies may result in significant earningsvolatility in the short term. The success of our interest rate risk managementstrategy is largely dependent on our ability to predict the earningssensitivity of our loan production operations and long term investmentoperations in various interest rate environments. There are many market factorsthat effect the performance of our interest rate risk management activitiesincluding interest rate volatility, prepayment behavior, the shape of the yieldcurve and the spread between mortgage interest rates and treasury or swaprates.  The success of this strategyeffects our net earnings.  This effect,which can be either positive or negative, can be material.

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

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Thefollowing table estimates the financial effect to base case, including net cashflow from derivatives, from various instantaneous and parallel shifts ininterest rates based on both our on-balance sheet structure and off-balancesheet structure, which refers to the notional amount of derivatives that arenot recorded on our balance sheet as of July 31, 2006 (dollar amounts inthousands):
| ** **                                                                                     | ** ** | **Changes in base case as of July 31, 2006 (1)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Excluding net cash  flow on derivatives**                               | ** ** | **Net cash flow  on derivatives** | ** ** | **Including net cash  flow on derivatives** | ** ** |
| **Instantaneous and Parallel Change in Interest Rates (2)** | ** ** | **$ **                                                                                   | ** ** | **(%)** | ** ** | **$ ** | ** ** | **$ ** | ** ** | **(%)** | ** ** |
| Up 300 basis  points, or 3% (3)                                                                |       | (366,450                                                                                      | )          | (1,169 | ) | 318,302 |   | (48,148 | ) | (33 | ) |
| Up 200 basis  points, or 2%                                                                    |       | (233,754                                                                                      | )          | (745 | ) | 212,202 |   | (21,552 | ) | (15 | ) |
| Up 100 basis  points, or 1%                                                                    |       | (105,475                                                                                      | )          | (336 | ) | 106,101 |   | 626 |   | — |   |
| Down 100 basis  points or 1%                                                                   |       | 120,015                                                                                       |       | 383 |   | (106,100 | ) | 13,915 |   | 10 |   |
| Down 200 basis  points or 2%                                                                   |       | 214,426                                                                                       |       | 684 |   | (212,201 | ) | 2,225 |   | 2 |   |
| Down 300 basis points  or 3%                                                                   |       | 295,628                                                                                       |       | 943 |   | (318,301 | ) | (22,673 | ) | (16 | ) |

 

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| (1) | The dollar and percentage changes represent base  case for the next twelve months versus the change in base case using various  instantaneous and parallel interest rate change simulations, excluding the  effect of amortization of loan discounts to base case. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Instantaneous and parallel interest rate changes  over and under the projected forward yield curve.                                                                                                                                                                |
| (3) | This simulation was added to our analysis as it is  relevant in light of the interest rate environment as of July 31, 2006 and  the projected forward yield curve for 2006 and 2007.                                                                               |

 

Inthe previous table, the up 100 basis point scenario as of July 31, 2006represents our projection of the net change from base case net interest income,which is derived from assumptions as previously discussed, if market interestrates were to immediately rise by 100 basis points. This means that we increaseinterest rates at all data points along our projected forward yield curve by100 basis points and recalculate our projection of net interest income over thenext 12 months. In addition, based on changes in interest rates, or changes inour forward yield curve, our model adjusts mortgage prepayment rates andrecalculates amortization of acquisition and securitization costs and net cashreceipts or payments on derivatives as part of the calculation of net interestincome. Thus, if a 100 basis point interest rate increase occurred, theprojected volatility to net interest income is approximately $626,000, or anincrease of less than 1% relative to projected base case net interest income.

Weestimated net interest income along with net cash flows from derivatives forthe next twelve months using balance sheet data, the notional amount ofderivatives as of July 31, 2006 and 12-month projections of the followingprimary drivers affecting net interest income:

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

·      mortgage acquisitions and originations;

·      mortgage prepayment rate assumptions; and

·      forward swap rates.

Werefer to the 12-month projection of net interest income along with the 12-monthprojection of net cash flows from derivatives as the “base case.”  For financial reporting purposes, net cashflows from derivatives are included in realized gain (loss) from derivativeinstruments on the consolidated financial statements.  However, for purposes of interest rate riskanalysis we include net cash flows from derivatives in our base casesimulations as we acquire derivatives to offset the effect that changes ininterest rates have on variable borrowing costs, such as securitized mortgageand warehouse borrowings. We believe that including net cash flows fromderivatives in our interest rate risk analysis presents a more usefulsimulation of the effect of changing interest rates on net cash flows generatedby our long-term mortgage portfolio.

Oncethe base case has been established, we “shock” the base case with instantaneousand parallel shifts in interest rates in 100 basis point increments upward anddownward.  Calculations are made for eachof the defined instantaneous and parallel shifts in interest rates over orunder the forward yield curve used to determine the base case and include anyassociated changes in projected mortgage prepayment rates caused by changes ininterest rates. The results of each 100 basis point change in interest ratesare then compared against the base case to determine the estimated dollar andpercentage change to base case. The simulations consider the affect of interestrate changes on interest sensitive assets and liabilities as well asderivatives. The simulations also consider the effect that instantaneous andparallel shift in interest rates have on prepayment rates and the resultingaffect of accelerating or decelerating amortization of premium andsecuritization costs.

 

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

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**ITEM 4:****    CONTROLS AND PROCEDURES**

**Evaluation of Disclosure Controlsand Procedures**

Disclosure controls and procedures are controls andother procedures of the Company that are designed to ensure that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded,processed, summarized and reported, within the time periods specified in theSEC’s rules and forms.  Disclosurecontrols and procedures include without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by the Company inits reports that it files or submits under the Exchange Act is accumulated andcommunicated to the Company’s management, including its principal executive andprincipal financial officers, or persons performing similar functions, asappropriate to allow timely decisions regarding required disclosure.

As of September 30, 2006, our CEO and CFO, withthe participation of other management of the Company, evaluated theeffectiveness of our disclosure controls and procedures, as such term isdefined under Rule 13a-15(e) or 15(d)-15(e) promulgated under the ExchangeAct, and based upon that evaluation, our CEO and CFO concluded that thesedisclosure controls and procedures were effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms.

**InternalControl Over Financial Reporting**

During the quarter endedSeptember 30, 2006, there have been no changes to our internal controlover financial reporting that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

**PART II. OTHER INFORMATION**

**ITEM 1:          LEGALPROCEEDINGS**

The Company’s Form 10-K for the year ended December 31,2005 and Forms 10-Q for the periods ended March 31, 2006 and June 30, 2006,reported shareholder derivative actions filed against the Company and itssenior officers and directors in the U.S. District Court, Central District ofCalifornia and Orange County Superior Court. On September 14, 2006, the Orange County Superior Court stayed theconsolidated state shareholder derivative action pending resolution of thefederal securities class actions and federal shareholder derivative actions.

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

Please refer to the Company’s report on Form 10-K forthe year ended December 31, 2005 and reports on Form 10-Q for the periods endedMarch 31, 2006 and June 30, 2006, for a further description of litigation andclaims.

**ITEM 1A:       RISKFACTORS**

In addition to otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, “Item IA Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2005 and Part II, “Item IA Risk Factors” in ourQuarterly Reports on Form 10-Q for the periods ended March 31, 2006 and June30, 2006, which could materially affect our business, financial condition, orfuture results.

***Thefederal banking agencies’ final guidance on nontraditional mortgage productsmay impact our ability to originate, buy, or sell certain nontraditionalmortgage loans***

***On October 4, 2006, the Office ofthe Comptroller of the Currency, the Board of Governors of the Federal ReserveSystem, the Federal Deposit Insurance Corporation, the Office of ThriftSupervision, and the National Credit Union***

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***Administration issued their final“Interagency Guidance on Nontraditional Mortgage Product Risks” (the “Guidance”).  Nontraditional mortgage products are thosewhich allow borrowers to defer payment of principal and sometimesinterest.  They include what are commonlyreferred to as “option ARM” loans and interest-only loans.  While we are not subject to regulation bythese agencies or to the Guidance, it is possible the Guidance may have anadverse effect on our ability to buy, sell or securitize certain loans coveredby the Guidance.  As a result, theGuidance may also negatively affect our loan origination volume and loansales.  It is also possible that theGuidance, or certain provisions within it, may be adopted as laws or used asguidance by federal, state or local agencies and that those laws or guidancemay be applied to us.***

***The Guidance addresses theportfolio risks and consumer protection issues that the federal agenciesbelieve investors and lenders face when making or investing in nontraditionalmortgage loans.  As a matter of portfoliorisk management, the Guidance warns applicable financial institutions that loanterms should be analyzed to ensure a manageable risk level, utilizing soundunderwriting standards including an evaluation of factors that may compound therisk, such as reduced documentation programs and the use of second lienmortgages.  The analysis of repaymentability “should avoid over-reliance on credit scores as a substitute for incomeverification in the underwriting process” and should include an analysis of theborrower’s ability to make the payment when it increases to includeamortization of the loan.***

***As a matter of consumerprotection, financial institutions subject to the Guidance, when promoting ordescribing nontraditional mortgage products, are directed to ensure that theyprovide consumers with marketing materials and at application with informationthat is designed to help them make informed decisions when selecting and usingthese products.  Lenders subject to theGuidance are instructed that the information they are to provide should appriseconsumers of the risk that the monthly payment amounts could increase in thefuture, and explain the possibility of negative amortization.***

***While not directly applicable tous, the Guidance may affect our ability to make, buy or sell the nontraditionalloans covered by the Guidance.  Further,the Guidance is instructive of the regulatory climate concerning those loansand may be adopted in whole or part by other agencies that regulate us.  The Guidance reports that the Conference ofState Bank Supervisors (“CSBS”) and the State Financial Regulators Roundtable (“SFRR”)are committed to preparing a model guidance document for state regulators ofnon-depository institutions such as us, which would be “similar in nature andscope” to the Guidance***

***If we are required (either by aregulatory agency or by third-party originators or investors) to make changesto our business practices to comply with the Guidance, it might affect thebusiness activities in which we may engage and the profitability of thoseactivities.  Our business could beadversely affected if, as a result of the Guidance, investors from which wepurchase loans, or to whom we sell loans, change their business practices andpolicies relative to nontraditional mortgage products.  For example, if entities from which wepurchase loans are required to change their origination guidelines therebyaffecting the volume, diversity, and quality of loans available for purchase byus, or if purchasers of mortgage loans are required to make changes to thepurchasing policies, then our loan volume, ability to sell mortgage loans and profitability,could be adversely affected.***

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

Thetable below sets forth information regarding the Company’s purchases of itscommon stock during the three months ended September 30, 2006:

|                          | ** ** | **Total**          | ** ** | ** **                   | ** ** | **Authorized Shares**         | ** ** |
|--------------------------|------------|--------------------|------------|------------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **Number of** | ** ** | **Weighted**                 | ** ** | **that May Yet Be** | ** ** |
| ** **               | ** ** | **Shares**         | ** ** | **Average Price**       | ** ** | **Purchased Under the**  | ** ** |
| **Calendar Month:** | ** ** | **Purchased**      | ** ** | **Paid Per Share** | ** ** | **Plans or Programs**    | ** ** |
| August-06                |       | 70,000             |       | 9.0430                       |       |                               |       |
| August-06                |       | 34,300             |       | 9.1994                       |       |                               |       |
| Total                    |       | 104,300            |       | $                            | 9.0944     |                               | 4,895,700  |   |
|                          |            |                    |            |                              |            |                                    |            |  |

 

OnOctober 13, 2005 and September 15, 2006, we announced that our Board ofDirectors had authorized the Company to repurchase up to 5 million shares ofthe Company’s outstanding common stock. All shares were purchased through the Company’s publicly announced sharerepurchase program.  No shares werepurchased during September 2006.  Thereis no expiration date specified for the program.  The Company intends to repurchase stock underthe program in the future.

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**ITEM 3:          DEFAULTSUPON SENIOR SECURITIES**

None.

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

None.

**ITEM 5:          OTHERINFORMATION**

None

**ITEM 6:          EXHIBITS**

(a)   Exhibits:

| 12.1  | Statements re: computation of ratios                                                                                                                                             |
|-------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1  | Certification of Chief Executive Officer pursuant to  Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                  |
| 31.2  | Certification of Chief Financial Officer pursuant to  Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                  |
| 32.1* | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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| * | This exhibit shall not be deemed “filed” for  purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise  subject to the liabilities of that section, nor shall it be deemed  incorporated by reference in any filing under the Securities Act of 1933 or  the Securities Exchange Act of 1934, whether made before or after the date  hereof and irrespective of any general incorporation language in any filings. |
|---|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

**IMPACMORTGAGE HOLDINGS, INC.**
| /s/ Gretchen D. Verdugo |   |
|-------------------------|--------|

by: Gretchen D.Verdugo

Executive Vice President

and Chief FinancialOfficer

(authorized officer ofregistrant and principal financial officer)

 

Date: November 9, 2006

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