Form 10-Q for IMPAC MORTGAGE HOLDINGS INC
13-Nov-2012
Quarterly Report
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollars in thousands, except per share data or as otherwise indicated)
Unless the context otherwise requires, the terms "Company," "we," "us," and "our" refer to Impac Mortgage Holdings, Inc. (the Company or IMH), a Maryland corporation incorporated in August 1995, and its subsidiaries, Integrated Real Estate Service Corporation (IRES), IMH Assets Corp. (IMH Assets), and Impac Funding Corporation (IFC).
Forward-Looking Statements
This report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements, some of which are based on various assumptions and events that are beyond our control, may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "likely," "appears," "should," "could," "seem to," "anticipate," or similar terms or variations on those terms or the negative of those terms. The forward-looking statements are based on current management expectations. Actual results may differ materially as a result of several factors, including, but not limited to the following: the ongoing volatility in the mortgage industry; our ability to manage successfully through the current market environment; our compliance with applicable local, state and federal laws and regulations and other general market and economic conditions; our ability to meet liquidity needs from current cash flows or generate new sources of revenue; management's ability to manage successfully and grow the Company's mortgage and real estate business activities including the mortgage lending operations; the ability to make interest payments; increases in default rates or loss severities and mortgage related losses; our ability to obtain additional financing and the terms of any financing that we do obtain; inability to effectively liquidate properties to mitigate losses; increase in loan repurchase requests and ability to adequately settle repurchase obligations;the competition, structure and court approval of proposed legal settlements; and the outcome, including any settlements, of litigation or regulatory actions pending against us or other legal contingencies.
For a discussion of these and other risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the period ended December 31, 2011, and other reports we file under the Securities and Exchange Act of 1934. This document speaks only as of its date and we do not undertake, and specifically disclaim any obligation, to release publicly the results of any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
The Mortgage Industry and Discussion of Relevant Fiscal Periods
The mortgage industry is subject to current events that occur in the financial services industry including changes to regulations and compliance requirements that result in uncertainty surrounding the actions of new government agencies, including the Consumer Financial Protection Board (CFPB) and Federal Housing Finance Agency (FHFA). These events can also include changes in economic indicators, interest rates, price competition, geographic shifts, disposable income, housing prices, market liquidity, market anticipation, and customer perception, as well as others. The factors that affect the industry change rapidly and can be unforeseeable making it difficult to predict and manage.
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 attempts to present financial information in its Management's Discussion and Analysis of Financial Condition and Results of Operations that is the most relevant to its financial information.
Market Update
The U.S. economy expanded at a 2.0% annual rate during the third quarter of 2012 as compared to 1.3% in the second quarter of 2012 primarily as a result of government and consumer spending. While the economy added jobs in the third quarter of 2012, the pace of new job creation continues to be slower than needed to meaningfully reduce unemployment. U.S. unemployment rates, which have been a major factor in the deterioration of credit quality in the U.S., although improving slightly, continue to remain high at 7.8% in September 2012. Despite the trend toward improving U.S. data, significant downside risk factors remain in place, at least through mid-2013. Downside risk associated with global macroeconomic conditions, particularly in Europe and Asia, remains significant. Also, the combination of federal tax increases and spending cuts known as the "Fiscal Cliff" is scheduled to take effect in early 2013 unless the U.S. Congress acts to change current laws. According to studies done by the Congressional budget office, if nothing is done to address the Fiscal Cliff, the U.S. economy may be pushed back into a recession in 2013. As a result, there continues to be significant uncertainty as to how pronounced the economic recovery will be and whether it can be sustained.
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Real estate activity showed some encouraging signs as the nationwide average of home prices have appeared to hit a bottom and are starting to recover, although home prices continued to decline in many parts of the U.S. during the first nine months of 2012. Some positive news indicates that construction of new homes continued to grow in the third quarter, although at a slow rate. However, foreclosures remain one of the biggest risks to the housing market recovery. As the industry-wide compliance issues associated with foreclosures are resolved, an increase in foreclosures is anticipated which is expected to result in downward pressure and uncertainty in the housing market.
As a result of the current conditions of the U.S. economy, in September 2012, the Federal Reserve announced a new quantitative easing program including agency mortgage-backed securities purchases, known as QE3. In addition to QE3, the Federal Reserve announced its intention to keep the federal funds rate near zero through mid-2015. The combination of these actions may increase equity prices and has decreased mortgage interest rates. Although the benefits of these actions are difficult to assess, the expectation is that they will add to the current moderate pace of consumer spending and to the improving pace of new and existing home purchases for the remainder of 2012 and into 2013.
In late October, hurricane Sandy impacted the Mid-Atlantic and Northeast coasts of the U.S. Given the severe magnitude and recent occurrence of this event, the ongoing dislocation within the affected region and lack of data available, the effect of hurricane Sandy on the economy cannot yet be fully assessed.
Selected Financial Results for the Three Months Ended September 30, 2012
Q3 2012 Q2 2012 Q3 2011 YTD 2012 YTD 2011
Net earnings Net earnings Net earnings Net earnings Net earnings
(loss) (loss) (loss) (loss) (loss)
Long-term Portfolio $ (4,787 ) $ (252 ) $ 163 $ (11,614 ) $ (2,637 )
Mortgage Lending 8,156 3,800 (3,025 ) 12,280 (9,268 )
Real Estate Services 3,585 4,012 7,298 10,562 15,562
Continuing operations $ 6,954 $ 7,560 $ 4,436 $ 11,228 $ 3,657
Discontinued operations (9,021 ) (3,113 ) (1,490 ) (13,402 ) (1,832 )
Noncontrolling interests (212 ) (235 ) 156 (683 ) 651
Net (loss) earnings
attributable to IMH $ (2,279 ) $ 4,212 $ 3,102 $ (2,857 ) $ 2,476
Continuing Operations
? Earnings from continuing operations increased to $7.0 million for the three months ended September 30, 2012, compared to earnings of $4.4 million for the comparable 2011 period primarily due to an increase in earnings from mortgage lending, partially offset by a decline in earnings from real estate services and a decline in earnings from the long-term mortgage portfolio.
? Earnings from the long-term portfolio segment decreased to a loss of $4.8 million for the three months ended September 30, 2012, compared to earnings of $163 thousand for the comparable period in 2011 primarily due to the decrease in change in fair value of net trust assets.
? Earnings from the mortgage lending segment increased to $8.2 million for the three months ended September 30, 2012, compared to a loss of $3.0 million for the comparable period in 2011 primarily due to the increase in origination volumes and increase in service retained sales. The mortgage lending segment originated $709.8 million and sold $661.6 million of loans during the three months ended September 30, 2012 as compared to $256.6 million and $250.3 million of loans originated and sold, respectively, for the comparable 2011 period. The increase in mortgage lending activities produced revenues of $24.3 million for the three months ended September 30, 2012, compared to $4.6 million for the comparable period in 2011.
? Earnings from the real estate services segment decreased to $3.6 million in the third quarter of 2012, compared to earnings of $7.3 million for the comparable period in 2011 due to the sale of the title insurance company in 2011 and a decrease in real estate service fees associated with a decline in the long-term mortgage portfolio.
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Discontinued Operations
? Loss from discontinued operations, net of tax, was $9.0 million for the three months ended September 30, 2012, compared to a loss of $1.5 million for the comparable 2011 period primarily due to the $6.1 million legal settlement charge recorded for the intended settlement of two of the Company's remaining legacy lawsuits and a $1.8 million increase in the repurchase provision related to the discontinued mortgage operations conducted by IFC.
Selected Financial Results for the Nine Months Ended September 30, 2012
Continuing Operations
? Earnings from continuing operations increased to $11.2 million for the nine months ended September 30, 2012, compared to earnings of $3.7 million for the comparable 2011 period primarily due to an increase in earnings from mortgage lending, partially offset by a decline in earnings from real estate services and a decline in earnings from the long-term mortgage portfolio.
? Loss from the long-term portfolio segment increased to $11.6 million for the nine months ended September 30, 2012, compared to a loss of $2.6 million for the comparable period in 2011 primarily due to the decrease in change in fair value of net trust assets.
? Earnings from the mortgage lending segment increased to $12.3 million for the nine months ended September 30, 2012, compared to a loss of $9.3 million for the comparable period in 2011 primarily due to the increase in origination volumes and increase in service retained sales. The mortgage lending segment originated $1.6 billion and sold $1.5 billion of loans during the nine months ended September 30, 2012 as compared to $538.1 million and $485.5 million of loans originated and sold, respectively, for the comparable 2011 period. The increase in lending activities produced mortgage lending revenues of $48.6 million for the nine months ended September 30, 2012, respectively, compared to $7.7 million for the comparable period in 2011.
? Earnings from the real estate services segment decreased to $10.6 million for the nine months ended September 30, 2012, compared to earnings of $15.6 million for the comparable period in 2011 due to the sale of the title insurance company in 2011 and a decrease in real estate service fees associated with a decline in the long-term mortgage portfolio.
Discontinued Operations
? Loss from discontinued operations, net of tax, was $13.4 million for the nine months ended September 30, 2012, compared to a loss of $1.8 million for the comparable 2011 period due to the $6.1 million legal settlement charge recorded for the intended settlement of two of the Company's remaining legacy lawsuits and a $1.8 million increase in the repurchase provision related to the discontinued mortgage operations conducted by IFC.
Status of Operations, Liquidity and Capital Resources
Mortgage Lending
In the third quarter of 2012, the Company continues to focus on originating Fannie Mae, Freddie Mac, and government loans as it believes that its ability to sell loans direct to Fannie Mae, Freddie Mac, and issue Ginnie Mae securities makes it more competitive in the overall mortgage origination market with regard to products, pricing, operational efficiencies and overall recruitment of higher quality loan originators. The following table depicts the Company's loan sales for the periods indicated:
Q3 2012 YTD 2012
Fannie Mae $ 425,395 $ 976,181
Ginnie Mae 190,530 393,973
Freddie Mac 29,067 61,051
Total servicing retained sales $ 644,992 $ 1,431,205
Other (servicing released) 16,599 60,567
Total loan sales $ 661,591 $ 1,491,772
Key strategies for the Company include having direct access to agencies allowing the Company not only to be more competitive, but also have the ability to build a servicing portfolio of high quality, low interest rate loans. Also, the Company seeks to expand its purchase money channel to serve the real estate community with financing products to help the Company maintain origination volumes should interest rates rise which is expected to result in decreased refinance volumes.
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The Company has increased the mortgage servicing portfolio to $1.7 billion in unpaid principal balance at September 30, 2012 as compared to $1.1 billion at June 30, 2012 and $605.4 million at December 31, 2011. The Company believes having a portfolio of agency loans during this period of low interest rates along with credit quality focus is a good investment for the Company. Management seeks to continue to grow the servicing portfolio but do so in a manner to manage to the amount of needed capital as compared to the amount of available capital. During the nine months ending September 30, 2012, the Company sold $582.5 million in mortgage servicing rights as part of that plan. Building a servicing portfolio will provide an asset that generates net servicing fees which management believes creates a more sustainable mortgage lending operation.
The Company continues to expand its purchase money channel capabilities by leveraging proprietary technology to increase its realtor relationships. As of September 30, 2012, the Company has over 1,000 realtors using our technology. Our goal is to use our technology to facilitate relationships between our retail loan officers and realtors to drive more purchase money lending volume. In the third quarter of 2012, the Company's volume mix was 26% purchase money as compared 74% refinance mortgages. The Company has three main origination channels - retail (consumer direct), wholesale (through approved loan brokers) and correspondent (through approved mortgage bankers). The combination of these channels along with our focus on purchase money transactions is expected to produce what the Company believes is a more stable and diverse origination strategy. Management's plan is to mitigate any drop in refinance volume due to increased interest rates through an expanded purchase money channel in conjunction with an expanded product offering including 203K mortgages, reverse mortgages and jumbo mortgages.
As of September 30, 2012, the Company increased its warehouse borrowings capacity to $185.0 million from $87.5 million at December 31, 2011. In September 2012, the Company, through its subsidiaries, entered into a Master Repurchase Agreement with a new lender providing a $40.0 million warehouse facility bringing the total warehouse borrowings facilities to $185.0 million. In addition, in October 2012, the Company amended one of its repurchase agreements which increased its borrowing capacity by $7.5 million bringing the total warehouse borrowings facilities to $192.5 million.
Real Estate Services
The Company provides portfolio loss mitigation and real estate services including REO surveillance and disposition services, default surveillance and loss recovery services, short sale and real estate brokerage services, portfolio monitoring and reporting services.
For the three and nine months ended September 30, 2012 and 2011, mortgage and real estate services fees were as follows:
For the Three Months For the Nine Months Ended September 30, Ended September 30, 2012 2011 2012 2011 Real estate services fees, net (1) $ 5,776 $ 13,272 $ 16,815 $ 36,820
(1) Includes revenues of $4.9 million and $13.9 million for the three and nine months ended September 30, 2011, respectively, from the title insurance company which was sold in 2011.
The decrease in real estate services fees, net is primarily due to a decline in the long-term mortgage portfolio and the associated real estate and recovery activities as well as the sale of the title insurance company in 2011. As expected, the real estate service activities and revenues declined as lending activities and revenues increased from the recent expansion of the mortgage lending business.
Although the Company seeks to expand its portfolio loss mitigation and real estate services to more third parties in the marketplace, the revenues from these business activities have historically been generated from the Company's long-term mortgage portfolio. Furthermore, as the distressed mortgage and real estate markets remain unstable and uncertain due to the number of foreclosure properties that need to be sold, there remains uncertainty about the ongoing need and delivery of these services in the future.
Discontinued Operations
In the third quarter 2012, the Company recorded a legal settlement charge of $6.1 million relating to the estimated losses from two legal matters as described below.
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Citigroup Global Markets, Inc. - In May 2011, Citigroup Global Markets, Inc. (Citigroup) v. Impac Secured Assets Corp., Impac Funding Corporation and Impac Mortgage Holdings, Inc. was filed alleging a violation of Section 18 and
Section 20 of the Securities and Act of 1933 and negligent misrepresentation, all involved in the issuance and sale of bonds from a securitization trust. The plaintiff alleges they relied on certain documents filed with the Securities and Exchange Commission that were subsequently the subject of an amended filing. The matter seeks unspecified damages, interest, legal fees and litigation expenses.
In 2010, the Company became aware of an error in the Pooling and Servicing Agreement (PSA) that was filed with the Securities and Exchange Commission (SEC) as it was not the correct document that was used by the parties in closing the transaction and did not contain same language as in the prospectus supplement. Before the document was correctly amended six weeks later, an investor purchased a bond from this securitization in the market. In January 2012, the Company received a demand to settle this matter but the plaintiff would not identify how the amount of the claim was reached. Although the investor was aware of the discrepancy, in May 2012, the court granted a partial summary judgment indicating, despite the investor's knowledge of the discrepancy, the investor could rely on only the one incorrect document. The Company and counsel believed the decision was incorrect, and thus the Company attempted to appeal the ruling. In addition, throughout the period since the investor filed the complaint against the Company, the plaintiff's damages were still at issue and subject to substantial dispute and the Company believed it would be able to prevail on related complaints.
In June 2012, the Company attempted to resolve the matter through mediation with Citigroup. Mediation was unsuccessful as the plaintiff demanded a higher amount in damages, and the Company did not agree to their disputed demand. In late August 2012, with respect to the pending lawsuit filed by Citigroup, the Company received the plaintiff's motion for summary judgment for damages in an amount of $4.0 million plus interest and legal fees. After reviewing the motion with Company's counsel, in early September 2012, management continued to believe that Citigroup's actual realized damages were incalculable and it was confident that it could prevail on cross complaints with other parties. However, considering the risk of ongoing legal costs to defend this matter, the time and distraction of management and the fact that Citigroup agreed to accept payments over time, management believed a settlement was in the best interest of the Company. In September 2012, the parties tentatively agreed to a settlement with Citigroup for $3.1 million which is currently being documented and is subject to court approval. The Company determined the estimated loss from this matter was probable and reasonably estimated in the third quarter 2012, and thus, the Company recorded a legal settlement charge of $3.1 million for this matter in the third quarter of 2012.
Gilmor - This matter dated back 12 years, and related to purported class action claim in Missouri over origination related fees paid by borrowers on second mortgage loans that were not allowed under Missouri lending laws. The Company did not originate the loans, but purchased the loans from a third party seller. The Company briefly held the loans on its balance sheet prior to selling them through securitization. The Company initially concluded that its exposure was very minimal, if any, (since it did not originate the loans and only held them for a short period). Furthermore, similar cases had been filed against the Company in other states, but the Company prevailed on motions to dismiss in all the other states. Thus, the Company did not consider this contingency to be probable, but disclosed the matter in the notes to its financial statements.
In late 2011, another lender that performed more direct origination services for the borrower than the Company did, received a very unfavorable jury decision resulting in significant damages. Early in the third quarter of 2012, the Company received from the plaintiffs for the first time a demand for $30 million. At this point in time, the Company still could not estimate an amount with any reasonable accuracy that it would consider probable. In connection with handling the lawsuit, the Company had incurred approximately $475,000 in legal costs, which it believes would have continued at that level unless a settlement was achieved. In September 2012, given the risk of ongoing legal costs to defend this matter and the time and distraction of management, the Company agreed to settle the matter for a total of $3.0 million. On October 31, 2012, the Impac corporate defendants entered into a settlement agreement with the plaintiffs on a class-wide basis. The settlement provides total payments to the plaintiffs of $3.0 million over time and is subject to court approval. The Company determined the estimated loss from this matter was probable and reasonably estimated in the third quarter 2012, and thus, the Company recorded a legal settlement charge of $3.0 million in the third quarter of 2012.
Management believes it was and is in the best interest of the shareholders to settle these matters rather than be faced with the uncertainty of any court rulings, the exorbitant cost in terms of legal fees, the time involved and the distractions these matters would create in defending them. Also, the terms of the intended settlements have been structured in a manner to minimize the impact to operational cash flows.
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In addition, the discontinued operation's net loss in the quarter also includes approximately $1.8 million in repurchase provision associated with loans originated and sold to Fannie Mae more than five years ago by the discontinued mortgage operations. Although the number of repurchase requests are decreasing, the Company still continues to receive new repurchase requests while successfully disputing and resolving others. In the third quarter of 2012, an additional $1.8 million provision was recorded both for specific requests that remain outstanding as well as a general reserve for unknown exposure since 2008. The Company has received repurchase requests from other parties which have been resolved. The requests from Fannie Mae remain outstanding, but throughout and since the financial downturn in 2007, the Company has maintained a good relationship with Fannie Mae, and considers them a key partner in expanding the mortgage lending business. The Company's goal is to reach a mutually agreeable resolution on any and all legacy requests with Fannie Mae to minimize any future exposure. At September 30, 2012, the repurchase reserve within discontinued operations was $8.0 million as compared to $5.2 million at December 31, 2011.
Long-Term Mortgage Portfolio
Although there has been some stabilization in the long-term mortgage portfolio, the portfolio continues to suffer losses, which may continue for the foreseeable future until the real estate market becomes more stable, home prices improve across the United States, and there is a significant decline in the number of foreclosure properties in the market.
At September 30, 2012, the Company's residual interest in securitizations (represented by the difference between total trust assets and total trust liabilities) decreased to $20.2 million, compared to $26.5 million at December 31, 2011. The decrease in residual fair value for the nine months ended September 30, 2012 was primarily due to $7.9 million in cash received partially offset by an increase in fair value due to a decrease in expected forward LIBOR interest rates and a reduction in the residual interest discount rate for some of the Company's earlier vintage securitizations.
To estimate fair value of the assets and liabilities within the securitization trusts each reporting period, management uses an industry standard valuation and analytical model that is updated monthly with current collateral, real estate, derivative, bond and cost (servicer, trustee, etc.) information for each . . .
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