IMPAC MORTGAGE HOLDINGS INC - Quarter Report: 2011 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2011

 

or

 

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

 

For the transition period from           to            .

 

Commission File Number: 1-14100

 

IMPAC MORTGAGE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

19500 Jamboree Road, Irvine, California 92612

(Address of principal executive offices)

 

(949) 475-3600

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o

 

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

 

 

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

 

There were 7,789,946 shares of common stock outstanding as of May 13, 2011.

 

 

Table of Contents

 

IMPAC MORTGAGE HOLDINGS, INC.

 

FORM 10-Q QUARTERLY REPORT

TABLE OF CONTENTS

 

		Page
PART I. FINANCIAL INFORMATION
ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS
	Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010	1
	Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010 (unaudited)	2
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010 (unaudited)	3
	Notes to Unaudited Consolidated Financial Statements	4
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Forward-Looking Statements	17
	The Mortgage Industry and Discussion of Relevant Fiscal Periods	17
	Status of Operations, Liquidity and Capital Resources	17
	Market Update	21
	Critical Accounting Policies	23
	Selected Financial Results for the Three Months Ended March 31, 2011	23
	Financial Condition and Results of Operations	24
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	34
ITEM 4.	CONTROLS AND PROCEDURES	34
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	35
ITEM 1A.	RISK FACTORS	35
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	35
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	35
ITEM 4.	RESERVED	35
ITEM 5.	OTHER INFORMATION	35
ITEM 6.	EXHIBITS	36
	SIGNATURES	37
	CERTIFICATIONS

 

Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.          CONSOLIDATED FINANCIAL STATEMENTS

 

IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

		March 31,			December 31,
		2011			2010
		(Unaudited)
ASSETS
Cash and cash equivalents		$	7,750		$	11,507
Restricted cash		2,507			1,495
Trust assets
Investment securities available-for-sale		415			645
Securitized mortgage collateral		6,053,766			6,011,675
Derivative assets		37			40
Real estate owned		74,709			92,708
Total trust assets		6,128,927			6,105,068
Mortgage loans held-for-sale		31,888			4,283
Finance receivables		3,911			—
Assets of discontinued operations		296			373
Other assets		30,515			31,213
Total assets		$	6,205,794		$	6,153,939
LIABILITIES
Trust liabilities
Securitized mortgage borrowings		$	6,056,577		$	6,012,745
Derivative liabilities		46,243			65,916
Total trust liabilities		6,102,820			6,078,661
Warehouse borrowings		34,266			4,057
Long-term debt		12,030			11,728
Notes payable		4,763			6,874
Liabilities of discontinued operations		12,004			13,053
Other liabilities		13,155			11,869
Total liabilities		6,179,038			6,126,242
Commitments and contingencies
STOCKHOLDERS’ EQUITY
Series A junior participating preferred stock, $0.01 par value; 2,500,000 shares authorized; none issued or outstanding		—			—
Series B 9.375% redeemable preferred stock, $0.01 par value; liquidation value $16,904; 2,000,000 shares authorized, 665,592 noncumulative shares issued and outstanding as of March 31, 2011 and December 31, 2010, respectively		7			7
Series C 9.125% redeemable preferred stock, $0.01 par value; liquidation value $35,389; 5,500,000 shares authorized; 1,405,086 noncumulative shares issued and outstanding as of March 31, 2011 and December 31, 2010, respectively		14			14
Common stock, $0.01 par value; 200,000,000 shares authorized; 7,788,546 and 7,787,546 shares issued and outstanding as of March 31, 2011 and December 31, 2010, respectively		78			78
Additional paid-in capital		1,076,451			1,076,375
Net accumulated deficit:
Cumulative dividends declared		(822,520		)	(822,520		)
Retained deficit		(228,545		)	(227,558		)
Net accumulated deficit		(1,051,065		)	(1,050,078		)
Total Impac Mortgage Holdings, Inc. stockholders’ equity		25,485			26,396
Noncontrolling interests		1,271			1,301
Total equity		26,756			27,697
Total liabilities and stockholders’ equity		$	6,205,794		$	6,153,939

 

See accompanying notes to consolidated financial statements.

 

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

		For the Three Months
		Ended March 31,
		2011			2010
INTEREST INCOME		$	218,082		$	279,876
INTEREST EXPENSE		216,547			279,106
Net interest income		1,535			770
NON-INTEREST INCOME:
Change in fair value of net trust assets, excluding REO		4,896			7,372
Losses from REO		(4,249		)	(1,108		)
Non-interest income - net trust assets		647			6,264
Change in fair value of long-term debt		238			(291		)
Mortgage and real estate services fees		11,690			10,950
Other		295			80
Total non-interest income		12,870			17,003
NON-INTEREST EXPENSE:
General and administrative		4,579			4,778
Personnel expense		10,766			9,681
Total non-interest expense		15,345			14,459
(Loss) earnings from continuing operations before income taxes		(940		)	3,314
Income tax expense from continuing operations		12			85
(Loss) earnings from continuing operations		(952		)	3,229
(Loss) earnings from discontinued operations, net of tax		(350		)	2,386
Net (loss) earnings		(1,302		)	5,615
Net loss attributable to noncontrolling interests		315			303
Net (loss) earnings attributable to IMH		$	(987	)	$	5,918
(Loss) earnings per common share - basic:
(Loss) earnings from continuing operations attributable to IMH		$	(0.08	)	$	0.46
(Loss) earnings from discontinued operations		(0.04		)	0.31
Net (loss) earnings per share available to common stockholders		$	(0.12	)	$	0.77
(Loss) earnings per common share - diluted:
(Loss) earnings from continuing operations attributable to IMH		$	(0.08	)	$	0.42
(Loss) earnings from discontinued operations		(0.04		)	0.29
Net (loss) earnings per share available to common stockholders		$	(0.12	)	$	0.71

 

See accompanying notes to consolidated financial statements

 

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

		For the Three Months
		Ended March 31,
		2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) earnings		$	(1,302	)	$	5,615
Losses from real estate owned		4,249			1,108
Change in fair value of mortgage servicing rights		99			—
Gain on sale of loans		(646		)	—
Origination of mortgage loans held-for-sale		(53,444		)	—
Sale and principal reduction on mortgage loans held-for-sale		26,768			—
Change in fair value of net trust assets, excluding REO		(21,950		)	(43,300		)
Change in fair value of long-term debt		(238		)	291
Accretion of interest income and expense		87,158			125,906
Change in REO impairment reserve		(10,305		)	(5,951		)
Stock-based compensation		76			350
Net change in restricted cash		(1,012		)	—
Net cash used in operating activities of discontinued operations		(1,076		)	(1,204		)
Net change in other assets and liabilities		(1,907		)	(5,107		)
Net cash provided by operating activities		26,470			77,708
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in securitized mortgage collateral		178,988			185,917
Net change in mortgages held-for-investment		3			6
Maturity of short-term investments		—			5,000
Purchase of premises and equipment		(351		)	(436		)
Net principal change on investment securities available-for-sale		56			70
Proceeds from the sale of real estate owned		49,736			63,563
Net cash provided by investing activities of discontinued operations		—			864
Net cash provided by investing activities		228,432			254,984
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of warehouse borrowings		(32,169		)	—
Borrowings under warehouse agreement		62,378			—
Repayment of securitized mortgage borrowings		(287,146		)	(329,986		)
Principal payments on notes payable		(1,826		)	(4,224		)
Net cash used in financing activities		(258,763		)	(334,210		)
Net change in cash and cash equivalents		(3,861		)	(1,518		)
Cash and cash equivalents at beginning of period		11,620			25,850
Cash and cash equivalents at end of period - Continuing Operations		7,750			23,023
Cash and cash equivalents at end of period - Discontinued Operations		9			1,309
Total cash and cash equivalents at end of period		$	7,759		$	24,332
NON-CASH TRANSACTIONS (Continuing and Discontinued Operations):
Transfer of securitized mortgage collateral to real estate owned		$	25,735		$	41,894
Net effect of consolidation of net trust assets from adoption of accounting principle		—			119,631
Net effect of consolidation of net trust liabilities from adoption of accounting principle		—			(119,631		)

 

See accompanying notes to consolidated financial statements.

 

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

 

Note 1.—Summary of Business, Market Conditions, Status of Operations, Liquidity, and Financial Statement Presentation

 

Business Summary

 

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

 

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

 

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

 

Market Update, Status of Operations and Liquidity

 

Beginning in the third quarter of 2010 and continuing through the first quarter of 2011, we continue to see home price declines in many markets as the homebuyer tax credit expired and housing prices remained under pressure due to elevated foreclosure levels. In addition, foreclosure delays as a result of reviews into foreclosure practices of some prominent loan servicers in the fourth quarter of 2010, among other market conditions may result in continued downward pressure on home prices for the foreseeable future.

 

Mortgage lending and credit market conditions remained soft through the first quarter of 2011 due primarily to an increase in mortgage rates and weak economy. Existing uncertainties surrounding the housing market, economy and regulatory environment will continue to present challenges for the Company. The ongoing economic stress or further deterioration of general economic conditions could prolong or increase borrower defaults leading to deteriorating performance of our long-term mortgage portfolio.

 

In March 2011, the Company expanded its mortgage lending operations by moving into the Pacific Northwest and Gulf Coast Regions, opening regional production offices in Lake Oswego, Oregon, and Baton Rouge, Louisiana.   In addition to the Company’s mortgage lending operations in Irvine, California, this expansion gives the Company origination capabilities throughout the entire West Coast and Gulf Coast regions with additional regional operation centers and retail and wholesale locations.  As part of this expansion, the Company invested approximately $2.0 million in its mortgage lending operations infrastructure, consisting principally of additional personnel and occupancy costs (included in total non-interest expense in the consolidated statement of operations). Also during the quarter ended March 31, 2011, the Company obtained an additional warehouse borrowing facility of $20.0 million bringing total warehouse borrowing capacity to $73.5 million at March 31, 2011.  Through both retail and wholesale channels, the Company funded $53.4 million in mortgage loans during the quarter ended March 31, 2011 of primarily government sponsored and conventional loans eligible for sale to Ginnie Mae, Fannie Mae and Freddie Mac, respectively.

 

The ability to meet the Company’s long-term liquidity requirements is subject to several factors, such as generating fees from the mortgage and real estate business activities and realizing cash flows from the long-term mortgage portfolio. The Company’s future financial performance and success are dependent in large part upon the ability to grow the mortgage and real estate business activities, including providing services to third parties and expanding the mortgage lending operations. The Company believes that current cash balances, cash flows from mortgage and real estate services fees generated from the long-term mortgage portfolio, and residual interest cash flows from the long-term mortgage portfolio are adequate for the current operating needs. However, the mortgage and real estate services market is volatile, highly competitive and subject to increased regulation. The Company’s ability to successfully compete in the mortgage and real estate services industry may be challenging as its business activities have been established in the last few years and many competitors have recently entered or have established businesses delivering similar services. Additionally, the mortgage lending environment is extremely competitive and highly regulated. The future success of the mortgage lending operations will depend on a number of factors, including the ability to procure adequate financing to fund loan production, maintaining associated financial covenants of lenders, how well the Company competes, housing market conditions, economic recovery and financial regulatory reform. If the Company is unsuccessful, the Company may be unable to satisfy the future operating costs and liabilities, including repayment of the note payable and long-term debt. To be successful in expanding the business and providing adequate returns to the shareholders, the Company may seek financing in the form of debt or equity capital.

 

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Financial Statement Presentation

 

The accompanying unaudited consolidated financial statements of IMH and its subsidiaries (as defined above) have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments considered necessary for a fair presentation, have been included. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. These interim period condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, filed with the United States Securities and Exchange Commission (SEC).

 

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

 

Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with GAAP. The items affected by such estimates and assumptions include the valuation of trust assets and trust liabilities, the estimated obligation of repurchase liabilities related to sold loans, the valuation of long-term debt and mortgage loans held-for-sale. Actual results could differ from those estimates and assumptions.

 

Recently Adopted Accounting Pronouncements

 

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

 

Income Taxes and Deferred Charge

 

The Company recorded income tax expense of $12 thousand and $85 thousand for the three months ended March 31, 2011 and 2010, respectively. The income tax expense for 2011 and 2010 is the result of state income taxes primarily from states where the Company does not have net operating loss carryforwards.

 

As of December 31, 2010, the Company had estimated federal and California net operating loss carryforwards of approximately $490.6 million and $492.1 million, respectively, of which $271.7 million (federal) relate to discontinued operations. During the year ended December 31, 2010, estimated net operating loss carryforwards were reduced as a result of the Company generating taxable income from cancellation of debt for approximately $426.2 million of securitized mortgage borrowings. Federal and state net operating loss (NOL) carryforwards begin to expire in 2020 and 2017, respectively. California net operating loss carryforwards have been suspended by the state until 2012, thus the expiration begins in 2017. The Company recorded a full valuation allowance against the deferred tax assets as it believes that as of March 31, 2011 it is more likely than not that the deferred tax assets will not be recoverable.

 

During the fourth quarter of 2009, the Company received a federal income tax refund in the amount of $8.9 million as a result of an election to carryback NOLs five years pursuant to 2009 federal legislation, The Worker, Homeownership, and Business Assistance Act of 2009. The Company files income tax returns in the U.S. federal and various state jurisdictions. The Company is subject to routine income tax audits in the various jurisdictions. A subsidiary of the Company is currently under examination by the Internal Revenue Service for tax year 2008. Management believes that there are no unresolved issues or claims likely to be material to our financial position. As of March 31, 2011, the Company has no material uncertain tax positions.

 

The deferred charge represents the deferral of income tax expense on inter-company profits that resulted from the sale of mortgages from taxable subsidiaries to IMH in prior years. The deferred charge is included in other assets in the accompanying consolidated balance sheets and is amortized as a component of income tax expense in the accompanying consolidated statement of operations over the estimated life of the mortgages retained in the securitized mortgage collateral. There was no amortization of deferred charge during the three months ended March 31, 2011.

 

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Legal Proceedings

 

On May 6, 2011 a case entitled Massachusetts Mutual Life Insurance Company v Impac Funding Corporation, et al was filed in the United States District Court for the District of Massachusetts as Case No. 3:11-cv-30127.   The complaint names Impac Funding Corporation and Impac secured Assets Corporation along with two of their officers as defendants.   The action alleges violations of the Massachusetts Uniform Securities Act and the plaintiff seeks rescission or damages for their purchase of bonds from two securitization trusts issued by the Defendants.   The plaintiff alleges that the loans deposited into the trusts did not meet the representations made in the offering documents when they purchased their bonds.

 

On or about April 20, 2011, an action was filed in the Superior Court of the Commonwealth of Massachusetts as case No. B.L.S. 11-1533 entitled Federal Home Loan bank of Boston v. Ally financial Inc., et al.  Named as defendants in that action are IMH Assets Corp, Impac Funding Corporation, Impac Mortgage Holdings, Inc. and Impac Secured Assets Corp.  The complaint alleges misrepresentations in connection with the materials used to market mortgage backed securities that the plaintiff purchased.  The complaint seeks damages and attorney’s fees in an amount to be established at time of trial.

 

On or about May10, 2011 a purported class action complaint was filed in the United States District court, Central district of California as Case No. SACV11-00717 entitled Norma B. Power Trust, individually and on Behalf of All Others Similarly Situated v Impac Mortgage Holdings, Inc., et al.  The action alleges that the Defendants filed unauthorized false, invalid amendments to the Company’s corporate charter with regards to the holders of series B Preferred Stock and Series C Preferred Stock.  The action seeks recovery under Section 10(b) of the Exchange Act and Rule 10b-5, Section 13(a) of the Exchange Act, Rules 12b-20, 13a-1 and 13a-11.  It also seeks recovery under Rule 14(e) and Section 20(a) of the Exchange Act.  The Plaintiff seeks compensatory damages, costs, expenses, attorney’s fees and rescission.

 

We are party to other litigation and claims which are normal in the course of our operations.  While the results of such other litigation and claims cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on our financial condition or results of operations.

 

The Company believes that it has meritorious defenses to the above claims and intends to defend these claims vigorously and as such the Company believes the final outcome of such matters will not have a material adverse effect on its financial condition or results of operations.  Nevertheless, litigation is uncertain and the Company may not prevail in the lawsuits and can express no opinion as to their ultimate resolution.  An adverse judgment in any of these matters could have a material adverse effect on the Company’s financial position and results of operations.

 

Please refer to IMH’s report on Form 10-K for the year ended December 31, 2010 for a description of litigation and claims.

 

Note 2.—Fair Value of Financial Instruments

 

The use of fair value to measure the Company’s financial instruments is fundamental to its consolidated financial statements and is a critical accounting estimate because a substantial portion of its assets and liabilities are recorded at estimated fair value.

 

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

 

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		March 31, 2011						December 31, 2010
		Carrying Amount			Estimated Fair Value			Carrying Amount			Estimated Fair Value
Assets
Cash and cash equivalents		$	7,750		$	7,750		$	11,507		$	11,507
Restricted cash		2,507			2,507			1,495			1,495
Investment securities available-for-sale		415			415			645			645
Securitized mortgage collateral		6,053,766			6,053,766			6,011,675			6,011,675
Derivative assets		37			37			40			40
Mortgage servicing rights		1,340			1,340			1,439			1,439
Mortgage loans held-for-sale		31,888			31,888			4,283			4,283
Call option		483			483			706			706
Liabilities
Securitized mortgage borrowings		6,056,577			6,056,577			6,012,745			6,012,745
Derivative liabilities		46,243			46,243			65,916			65,916
Long-term debt		12,030			12,030			11,728			11,728
Warehouse borrowings		34,266			34,266			4,057			4,057
Notes payable		4,763			4,716			6,874			6,818
Put option		61			61			61			61

 

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

 

The carrying amount of cash and cash equivalents and restricted cash approximates fair value.

 

Refer to Recurring Fair Value Measurements below for a description of the valuation methods used to determine the fair value of investment securities available for sale, securitized mortgage collateral and borrowings, derivative assets and liabilities, long-term debt, mortgage servicing rights, loans held-for-sale, and call and put options.

 

Warehouse borrowings fair value approximates carrying amounts due to the short-term nature of the liabilities and do not present unanticipated interest rate or credit concerns.

 

Note payable is recorded at amortized cost. Notes payable includes notes with maturities ranging from less than a year to three years. For notes with maturities of less than a year, the estimated fair value approximates carrying value due to the short-term nature of the liabilities. Notes with maturities greater than a year, the estimated fair value is determined using a discounted cash flow model using market rates. The estimated fair value is less than the carrying value as certain notes are non-interest bearing.

 

Fair Value Hierarchy

 

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

 

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

 

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

 

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

 

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

 

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when estimating fair value.

 

As a result of the lack of observable market data resulting from inactive markets, the Company has classified its investment securities available-for-sale, securitized mortgage collateral and borrowings, net derivative liabilities, long-term debt, mortgage servicing rights, and call and put options as Level 3 fair value measurements. Level 3 assets and liabilities were 99% and 100%, respectively, of total assets and total liabilities measured at estimated fair value at March 31, 2011 and December 31, 2010.

 

Recurring Fair Value Measurements

 

We assess our financial instruments on a quarterly basis to determine the appropriate classification within the fair value hierarchy, as defined by ASC Topic 810. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels occur at the beginning of the reporting period. There were no material transfers between our Level 1 and Level 2 classified instruments during the three months ended March 31, 2011.

 

The following tables present the Company’s assets and liabilities that are measured at estimated fair value on a recurring basis, including financial instruments for which the Company has elected the fair value option at March 31, 2011 and December 31, 2010, based on the fair value hierarchy:

 

		Recurring Fair Value Measurements
		March 31, 2011									December 31, 2010
		Level 1			Level 2			Level 3			Level 1			Level 2			Level 3
Assets
Investment securities available-for-sale		$	—		$	—		$	415		$	—		$	—		$	645
Mortgage loans held-for-sale		—			31,888			—			—			4,283			—
Mortgage servicing rights (1)		—			—			1,340			—			—			1,439
Call option (1)		—			—			483			—			—			706
Securitized mortgage collateral		—			—			6,053,766			—			—			6,011,675
Total assets at fair value		$	—		$	31,888		$	6,056,004		$	—		$	4,283		$	6,014,465
Liabilities
Securitized mortgage borrowings		$	—		$	—		$	6,056,577		$	—		$	—		$	6,012,745
Derivative liabilities, net (2)		—			—			46,205			—			—			65,876
Long-term debt		—			—			12,030			—			—			11,728
Put option (3)		—			—			61			—			—			61
Total liabilities at fair value		$	—		$	—		$	6,114,873		$	—		$	—		$	6,090,410

 

(1)          Included in other assets in the accompanying balance sheets.

(2)          At March 31, 2011, derivative liabilities, net included $37 thousand in derivative assets and $46.2 million in derivative liabilities, included within trust assets and trust liabilities, respectively. At December 31, 2010, derivative liabilities, net included $40 thousand in derivative assets and $65.9 million in derivative liabilities, included within trust assets and trust liabilities, respectively.

(3)          Included in other liabilities in the accompanying balance sheets.

 

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The following tables present a reconciliation for all assets and liabilities measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2011 and 2010:

 

		Level 3 Recurring Fair Value Measurements
		For the three months ended March 31, 2011
		Investment securities available- for-sale			Securitized mortgage collateral			Securitized mortgage borrowings			Derivative liabilities, net			Mortgage servicing rights			Call option			Put Option			Long-term debt
Fair value, December 31, 2010		$	645		$	6,011,675		$	(6,012,745	)	$	(65,876	)	$	1,439		$	706		$	(61	)	$	(11,728	)
Total gains (losses) included in earnings:
Interest income (1)		28			107,369			—			—			—			—			—			—
Interest expense (1)		—			—			(194,015		)	—			—			—			—			(540		)
Change in fair value		(202		)	139,446			(137,278		)	2,930			(99		)	(223		)	—			238
Total gains (losses) included in earnings		(174		)	246,815			(331,293		)	2,930			(99		)	(223		)	—			(302		)
Transfers in and/or out of Level 3		—			—			—			—			—			—			—			—
Purchases, issuances and settlements
Purchases		—			—			—			—			—			—			—			—
Issuances		—			—			—			—			—			—			—			—
Settlements		(56		)	(204,724		)	287,461			16,741			—			—			—			—
Fair value, March 31, 2011		$	415		$	6,053,766		$	(6,056,577	)	$	(46,205	)	$	1,340		$	483		$	(61	)	$	(12,030	)
Unrealized gains (losses) still held (2)		$	202		$	(4,342,090	)	$	6,222,257		$	(46,475	)	$	—		$	—		$	—		$	58,733

 

(1)          Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. The total net interest income, including cash received and paid, was $1.5 million for the three months ended March 31, 2011, as reflected in the accompanying consolidated statement of operations.

(2)          Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held and reflected in the fair values at March 31, 2011.

 

		Level 3 Recurring Fair Value Measurements
		For the three months ended March 31, 2010
		Investment securities available- for-sale			Securitized mortgage collateral			Securitized mortgage borrowings			Derivative liabilities, net			Long-term debt
Fair value, December 31, 2009		$	813		$	5,666,122		$	(5,659,865	)	$	(126,457	)	$	(9,773	)
Total gains (losses) included in earnings:
Interest income (1)		47			130,229			—			—			—
Interest expense (1)		—			—			(255,513		)	—			(668		)
Change in fair value		178			681,408			(656,199		)	(18,015		)	(291		)
Total gains (losses) included in earnings		225			811,637			(911,712		)	(18,015		)	(959		)
Adoption of ASU 2009-17 (2)		(298		)	116,907			(110,618		)	(9,013		)	—
Transfers in and/or out of Level 3		—			—			—			—			—
Purchases, issuances and settlements
Purchases		—			—			—			—			—
Issuances		—			—			—			—			—
Settlements		(70		)	(227,811		)	330,305			35,609			—
Fair value, March 31, 2010		$	670		$	6,366,855		$	(6,351,890	)	$	(117,876	)	$	(10,732	)
Unrealized (losses) gains still held (3)		$	368		$	(5,491,407	)	$	7,093,620		$	(119,405	)	$	60,031

(1)          Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities. The total net interest income, including cash received and paid, was $770 thousand for the three months ended March 31, 2010, as reflected in the accompanying consolidated statement of operations.

(2)          Amounts represent the consolidation and deconsolidation of trust assets and liabilities as a result of the adoption of ASU 2009-17 on January 1, 2010.  See Note 1. — Summary of Market Conditions and Liquidity, Business and Financial Statement Presentation including Significant Accounting Policies in our Annual Report on Form 10K for the year ended December 31, 2010 for the impact of the adoption of ASU 2009-17 on our consolidated financial statements.

(3)          Represents the amount of unrealized gains (losses) relating to assets and liabilities classified as Level 3 that are still held at March 31, 2010.

 

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The following tables present the changes in recurring fair value measurements included in net earnings (loss) for the three months ended March 31, 2011 and 2010:

 

		Recurring Fair Value Measurements
		Changes in Fair Value Included in Net Earnings
		For the three months ended March 31, 2011
								Change in Fair Value of						Other non-interest
		Interest Income (1)			Interest Expense (1)			Net Trust Assets			Long-term Debt			income			Total
Investment securities available-for-sale		$	28		$	—		$	(202	)	$	—		$	—		$	(174	)
Securitized mortgage collateral		107,369			—			139,446			—			—			246,815
Securitized mortgage borrowings		—			(194,015		)	(137,278		)	—			—			(331,293		)
Mortgage servicing rights		—			—			—			—			(99		)	(99		)
Call option		—			—			—			—			(223		)	(223		)
Put option		—			—			—			—			—			—
Derivative instruments, net		—			—			2,930		(2)	—			—			2,930
Long-term debt		—			(540		)	—			238			—			(302		)
Total		$	107,397		$	(194,555	)	$	4,896	(3)	$	238		$	(322	)	$	(82,346	)

(1)          Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)          Included in this amount is $20.0 million in changes in the fair value of derivative instruments, offset by $17.1 million in cash payments from the securitization trusts for the three months ended March 31, 2011.

(3)          For the three months ended March 31, 2011, change in the fair value of trust assets, excluding REO was $4.9 million.  Excluded from the $22.0 million change in fair value of net trust assets, excluding REO, in the accompanying consolidated statement of cash flows is $17.1 million in cash payments from the securitization trusts related to the Company’s net derivative liabilities.

 

		Recurring Fair Value Measurements
		Changes in Fair Value Included in Net Loss
		For the three months ended March 31, 2010
								Change in Fair Value of
		Interest Income (1)			Interest Expense (1)			Net Trust Assets			Long-term Debt			Total
Investment securities available-for-sale		$	47		$	—		$	178		$	—		$	225
Securitized mortgage collateral		130,229			—			681,408			—			811,637
Securitized mortgage borrowings		—			(255,513		)	(656,199		)	—			(911,712		)
Derivative instruments, net		—			—			(18,015		)(2)	—			(18,015		)
Long-term debt		—			(668		)	—			(291		)	(959		)
Total		$	130,276		$	(256,181	)	$	7,372	(3)	$	(291	)	$	(118,824	)

 

(1)          Amounts primarily represent accretion to recognize interest income and interest expense using effective yields based on estimated fair values for trust assets and trust liabilities.

(2)          Included in this amount is $17.9 million in changes in the fair value of derivative instruments, offset by $35.9 million in cash payments from the securitization trusts for the three months ended March 31, 2010.

(3)          For the three months ended March 31, 2010, change in the fair value of net trust assets, excluding REO was $7.4 million. Excluded from the $43.3 million change in fair value of net trust assets, excluding REO, in the accompanying consolidated statement of cash flows is $35.9 million in cash payments from the securitization trusts related to the Company’s net derivative liabilities.

 

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

 

Investment securities available-for-sale—The Company elected to carry all of its investment securities available-for-sale at fair value. The investment securities consist primarily of non-investment grade mortgage-backed securities. The fair value of the investment securities is measured based upon the Company’s expectation of inputs that other market participants would use. Such assumptions include judgments about the underlying collateral, prepayment speeds, future credit losses, forward interest rates and certain other factors. Given the market disruption and lack of observable market data as of March 31, 2011 and December 31, 2010, the estimated fair value of the investment securities available-for-sale was measured using significant internal expectations of market participants’ assumptions.

 

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