IMPAC MORTGAGE HOLDINGS INC - Quarter Report: 2015 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, 2015

 

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 x 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 10,189,293 shares of common stock outstanding as of May 5, 2015.

 

 

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, 2015 (unaudited) and December 31, 2014	2
	Consolidated Statements of Operations for the Three Months Ended March 31, 2015 and 2014 (unaudited)	3
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2015 and 2014 (unaudited)	4
	Notes to Unaudited Consolidated Financial Statements	5
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	26
	Forward-Looking Statements	26
	The Mortgage Industry and Discussion of Relevant Fiscal Periods	26
	Selected Financial Results	27
	Status of Operations	27
	Liquidity and Capital Resources	31
	Critical Accounting Policies	32
	Financial Condition and Results of Operations	34
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	48
ITEM 4.	CONTROLS AND PROCEDURES	48
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	49
ITEM 1A.	RISK FACTORS	50
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	51
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	51
ITEM 4.	MINE SAFETY DISCLOSURES	51
ITEM 5.	OTHER INFORMATION	51
ITEM 6.	EXHIBITS	52
	SIGNATURES	53
	CERTIFICATIONS

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.                                                CONSOLIDATED FINANCIAL STATEMENTS

 

IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		March 31,			December 31,
		2015			2014
		(Unaudited)
ASSETS
Cash and cash equivalents		$	5,635		$	10,073
Restricted cash		4,932			2,420
Mortgage loans held-for-sale		531,586			239,391
Finance receivables		53,340			8,358
Mortgage servicing rights		26,656			24,418
Securitized mortgage trust assets		5,130,193			5,268,531
Goodwill		104,938			352
Intangible assets, net		33,122			—
Deferred tax asset		24,420			—
Other assets		41,846			25,029
Total assets		$	5,956,668		$	5,578,572
LIABILITIES
Warehouse borrowings		$	552,493		$	226,718
Short-term structured debt		4,156			6,000
Convertible notes		20,000			20,000
Contingent consideration		124,592			—
Long-term debt		29,646			22,122
Securitized mortgage trust liabilities		5,113,632			5,251,307
Other liabilities		52,906			27,469
Total liabilities		5,897,425			5,553,616
Commitments and contingencies (See Note 15)
STOCKHOLDERS’ EQUITY
Series A-1 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 $16,640; 2,000,000 shares authorized, 665,592 noncumulative shares issued and outstanding as of March 31, 2015 and December 31, 2014, respectively		7			7
Series C 9.125% redeemable preferred stock, $0.01 par value; liquidation value $35,127; 5,500,000 shares authorized; 1,405,086 noncumulative shares issued and outstanding as of March 31, 2015 and December 31, 2014, respectively		14			14
Common stock, $0.01 par value; 200,000,000 shares authorized; 9,690,415 and 9,588,532 shares issued and outstanding as of March 31, 2015 and December 31, 2014, respectively		97			96
Additional paid-in capital		1,089,888			1,089,574
Net accumulated deficit:		—			—
Cumulative dividends declared		(822,520		)	(822,520		)
Retained deficit		(208,243		)	(242,215		)
Net accumulated deficit		(1,030,763		)	(1,064,735		)
Total stockholders’ equity		59,243			24,956
Total liabilities and stockholders’ equity		$	5,956,668		$	5,578,572

 

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,
		2015			2014
Revenues:
Gain on sale of loans, net		$	37,398		$	4,573
Real estate services fees, net		2,742			3,679
Servicing income, net		635			1,569
Loss on mortgage servicing rights		(6,568		)	(977		)
Other		136			1,385
Total revenues		34,343			10,229
Expenses:
Personnel expense		11,490			9,460
General, administrative and other		5,651			5,468
Total expenses		17,141			14,928
Operating income (loss):		17,202			(4,699		)
Other income (expense):
Interest income		72,608			72,021
Interest expense		(71,550		)	(72,334		)
Change in fair value of long-term debt		(7,116		)	(650		)
Change in fair value of net trust assets, including trust REO (losses) gains		(876		)	3,038
Total other (expense) income		(6,934		)	2,075
Earnings (loss) before income taxes		10,268			(2,624		)
Income tax (benefit) expense		(23,704		)	342
Net earnings (loss)		$	33,972		$	(2,966	)
Earnings (loss) per common share :
Basic		$	3.54		$	(0.33	)
Diluted		$	2.94		$	(0.33	)

 

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,
		2015			2014
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss)		$	33,972		$	(2,966	)
Loss on sale of mortgage servicing rights		3,474			16
Change in fair value of mortgage servicing rights		3,094			961
Gain on sale of AmeriHome		—			(1,208		)
Gain on sale of mortgage loans		(19,192		)	(4,433		)
Change in fair value of mortgage loans held-for-sale		(10,911		)	(539		)
Change in fair value of derivatives lending, net		(7,868		)	338
Provision for repurchases		871			259
Origination of mortgage loans held-for-sale		(2,412,206		)	(348,623		)
Sale and principal reduction on mortgage loans held-for-sale		2,127,743			379,189
Losses (gains) from REO		2,670			(6,081		)
Change in fair value of net trust assets, excluding REO		(2,932		)	1,852
Change in fair value of long-term debt		7,116			650
Accretion of interest income and expense		39,051			49,066
Change in REO impairment reserve		565			3,849
Amortization of debt issuance costs and discount on note payable		80			12
Stock-based compensation		244			390
Impairment of deferred charge		309			—
Change in deferred tax assets		(24,420		)	—
Net change in restricted cash		(2,512		)	9
Net change in other assets and liabilities		7,315			(2,774		)
Net cash (used in) provided by operating activities		(253,537		)	69,967
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in securitized mortgage collateral		144,792			144,312
Proceeds from the sale of mortgage servicing rights		13,565			5,783
Finance receivable advances to customers		(124,206		)	(2,148		)
Repayments of finance receivables		79,224			1,300
Net change in mortgages held-for-investment		43			2
Purchase of premises and equipment		—			(22		)
Net principal change on investment securities available-for-sale		41			11
Acquisition of CashCall Mortgage		(5,000		)	—
Proceeds from the sale of REO		6,173			9,011
Proceeds from the sale of AmeriHome		—			10,200
Net cash provided by investing activities		114,632			168,449
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of warehouse borrowings		(2,021,096		)	(358,079		)
Borrowings under warehouse agreement		2,346,871			330,179
Repayment of line of credit		(7,000		)	(6,000		)
Borrowings under line of credit		7,000			7,000
Repayment of short-term borrowing		(5,000		)	—
Short-term borrowing		5,000			—
Repayment of securitized mortgage borrowings		(189,288		)	(202,294		)
Principal payments on short-term debt		(1,844		)	—
Principal payments on capital lease		(197		)	(188		)
Capitalized debt issuance costs		(50		)	—
Proceeds from exercise of stock options		71			18
Net cash provided by (used in) financing activities		134,467			(229,364		)
Net change in cash and cash equivalents		(4,438		)	9,052
Cash and cash equivalents at beginning of period		10,073			9,969
Cash and cash equivalents at end of period		$	5,635		$	19,021
NON-CASH TRANSACTIONS:
Transfer of securitized mortgage collateral to real estate owned		$	9,729		$	9,025
Mortgage servicing rights retained from loan sales and issuance of mortgage backed securities		22,371			3,763
Common stock issued upon legal settlement		—			1,012
Acquisition of equipment purchased through capital leases		413			—

 

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 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 wholly-owned subsidiaries: Integrated Real Estate Service Corporation (IRES), Impac Mortgage Corp. (IMC), IMH Assets Corp. (IMH Assets) and Impac Funding Corporation (IFC).

 

In the first quarter of 2015, the Company settled its repurchase liability with Fannie Mae (FNMA) related to its legacy non-conforming mortgage operations.  As a result of this settlement and previous resolution of other legal matters pertaining to the legacy non-conforming mortgage operations, the Company determined the legacy non-conforming mortgage operations previously reported as discontinued operations is no longer significant for reporting purposes.

 

The Company’s operations include the mortgage lending operations and real estate services conducted by IRES and IMC and the long-term mortgage portfolio (residual interests in securitizations reflected as net trust assets and liabilities in the consolidated balance sheets) conducted by IMH.  Beginning in the first quarter of 2015, the mortgage lending operations include the activities of the CashCall Mortgage operations (CCM).

 

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, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. 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, 2014, 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 period presentation.

 

Management has made a number of material 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. Material estimates subject to change include the fair value estimates of assets acquired and liabilities assumed in the acquisition of the residential mortgage operations of CashCall, Inc. (CashCall) as discussed in Note 2. — Acquisition of CashCall Mortgage.  Additionally, other items affected by such estimates and assumptions include the valuation of trust assets and trust liabilities, contingencies, the estimated obligation of repurchase liabilities related to sold loans, the valuation of long-term debt, mortgage servicing rights, mortgage loans held-for-sale and interest rate lock commitments. Actual results could differ from those estimates and assumptions.

 

Recent Accounting Pronouncements

 

In January 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-01, Income Statement-Extraordinary and Unusual Items (Subtopic 225-20). ASU 2015-01 addresses the elimination from U.S. GAAP the concept of extraordinary items. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. This amended guidance will prohibit separate disclosure of extraordinary items in the income statement. This amendment is effective for years, and interim periods within those years, beginning after December 15, 2015. Entities may apply the amendment prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the year of adoption. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.

 

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In April 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. For public business entities, the ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Entities should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, entities are required to comply with the applicable disclosures for a change in an accounting principle. The adoption of this ASU is not expected to have a material impact on the Company’s financial statements.

 

Note 2.—Acquisition of CashCall Mortgage

 

On January 6, 2015, the Company entered into an Asset Purchase Agreement (the Asset Purchase Agreement) with CashCall pursuant to which the Company agreed to purchase certain assets of CashCall’s residential mortgage operations. Upon closing, which occurred on March, 31, 2015, CashCall’s mortgage operations began to operate as a separate division of IMC under the name CashCall Mortgage (CCM).

 

Pursuant to the Asset Purchase Agreement, and subject to the terms and conditions contained therein, the purchase price consists of a fixed component and a contingent component. The fixed component includes (i) the aggregate payment of $10 million in cash, payable in installments through January 2016 and (ii) 494,017 newly issued unregistered shares of the Company. The contingent component consists of a three year earn-out provision beginning on the effective date (January 2, 2015) of 100% of pre-tax net earnings of CCM for January and February of 2015, 65% of the pre-tax net earnings for the next 10 months of 2015, 55% of pre-tax net earnings for the second year and 45% of pre-tax net earnings for the third year.

 

If, during the four years following January 2, 2015, the Company sells all or substantially all of its assets or the assets of CCM, the division of IMC, or a person acquires 50% or more of the securities of the Company or IMC, then the Company will pay, subject to adjustment, CashCall 15% of the enterprise value (as defined in the Asset Purchase Agreement) in excess of $200 million plus an additional 5% of the enterprise value in excess of $500 million (Business Appreciation Rights).

 

During the first quarter of 2015, consideration paid to CashCall, Inc. included $5.0 million cash and 494,017 shares of common stock of the Company valued at $6.2 million, pursuant to the fixed component of the Asset Purchase Agreement.  The transaction closed on March 31, 2015 upon meeting all closing conditions.  The shares were issued April 1, 2015.

 

The table below presents the preliminary purchase price allocation of the estimated acquisition date fair values of assets acquired and the liabilities assumed as of March 31, 2015.

 

Consideration paid:
Cash		$	5,000
IMH common stock		6,150
Deferred payments		5,000
Contingent consideration (1)		124,592
		$	140,742
Assets acquired:
Trademark		$	17,251
Customer list		10,170
Non-compete agreement		5,701
Fixed assets and software		3,034
Total assets acquired		36,156
Liabilities assumed:
Total liabilities assumed		—
Total assets		$	36,156
Goodwill		$	104,586

(1)         Included within the contingent consideration is $1.4 million of Business Appreciation Rights, as defined above.

 

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The CCM acquisition was accounted for under the acquisition method of accounting pursuant to FASB Accounting Standards Codification (ASC) 805, Business Combinations.  The assets and liabilities, both tangible and intangible, were recorded at their fair values as of the acquisition date.  The Company made significant estimates and exercised significant judgment in estimating fair values of the acquired assets and assumed liabilities.  The fair value of all assets acquired and liabilities assumed are preliminary and based on information that was available as of the acquisition date.  The Company is currently completing the final determination of any required purchase price accounting adjustments which will be made upon the completion of all fair value assessments.  Any adjustments to the purchase price allocations are made as soon as practicable but no later than one year from the acquisition date.  The application of the acquisition method of accounting resulted in tax deductible goodwill of $104.6 million.  The acquisition closed on March 31, 2015, however, the effective date of the transaction was January 2, 2015.  From the effective date to the date of the close, IMC was entitled to and recognized the net earnings of the loans originated by CCM.  Acquisition related costs of $0.3 million were expensed as incurred.  The expenses were comprised primarily of legal and professional fees.

 

Unaudited Pro Forma Results of Operations

 

The following table presents unaudited pro forma results of operations for the periods presented as if the CCM acquisition had been completed on January 1, 2014.  The unaudited pro forma results of operations include the historical accounts of the Company and CCM and pro forma adjustments, including the amortization of intangibles with definite lives, depreciation of fixed assets, accretion of discount on contingent consideration and elimination of commissions and loan due diligence costs of IMC.  The unaudited pro forma information is intended for informational purposes only and is not necessarily indicative of the future operating results or operating results that would have occurred had the CCM acquisition been completed at the beginning of 2014.  No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions.

 

		For the Three Months Ended March 31,
		2015			2014
Revenues		$	52,743		$	19,412
Other (expense) income		(6,724		)	2,360
Expenses		(40,831		)	(32,607		)
Pretax net earnings (loss)		$	5,188		$	(10,835	)

 

Revenues of $45.7 million, other income (expense) of $210 thousand and expenses from operations of $18.6 million related to CCM’s acquisition in the first quarter of 2015 were included in gain on sale of loans, net in the consolidated statements of operations.

 

Note 3.—Mortgage Loans Held-for-Sale

 

A summary of the unpaid principal balance (UPB) of mortgage loans held-for-sale by type is presented below:

 

		March 31,			December 31,
		2015			2014
Government (1)		$	179,619		$	156,385
Conventional (2)		320,188			72,553
Other (3)		10,415			—
Fair value adjustment		21,364			10,453
Total mortgage loans held-for-sale		$	531,586		$	239,391

 

(1)         Includes all government-insured loans including Federal Housing Administration (FHA), Veterans Affairs (VA) and United States Department of Agriculture (USDA).

(2)         Includes loans eligible for sale to Fannie Mae and Freddie Mac.

(3)         Includes ALT-QM and Jumbo loans.

 

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Gain on mortgage loans held-for-sale (LHFS) is comprised of the following for the three months ended March 31, 2015 and 2014:

 

		For the Three Months
		Ended March 31,
		2015			2014
Gain on sale of mortgage loans		$	54,992		$	13,798
Premium from servicing retained loan sales		22,371			3,763
Unrealized gains (losses) from derivative financial instruments		7,868			(338		)
Realized losses from derivative financial instruments		(3,162		)	(2,171		)
Mark to market gain on LHFS		10,911			539
Direct origination expenses, net		(54,711		)	(10,759		)
Provision for repurchases		(871		)	(259		)
Total gain on sale of loans, net		$	37,398		$	4,573

 

Note 4.—Mortgage Servicing Rights

 

The Company retains mortgage servicing rights (MSRs) from its sales of certain mortgage loans. MSRs are reported at fair value based on the income derived from the net positive cash flows associated with the servicing contracts. The Company receives servicing fees, less subservicing costs, on the UPB of the loans. The servicing fees are collected from the monthly payments made by the mortgagors or when the underlying real estate is foreclosed upon and liquidated. The Company may receive other remuneration from rights to various mortgagor-contracted fees such as late charges, collateral reconveyance charges, nonsufficient fund fees and the Company is generally entitled to retain the interest earned on funds held pending remittance (or float) related to its collection of mortgagor principal, interest, tax and insurance payments.

 

The following table summarizes the activity of MSRs for the periods presented:

(1)         Changes in fair value are included within loss on mortgage servicing rights in the consolidated statements of operations.

 

At March 31, 2015 and December 31, 2014, the outstanding principal balance of the mortgage servicing portfolio was comprised of the following:

 

		March 31,			December 31,
		2015			2014
Government insured		$	276,041		$	926,502
Conventional		2,287,649			1,333,853
Alt-QM		13,425			6,731
Total loans serviced		$	2,577,115		$	2,267,086

 

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The table below illustrates hypothetical changes in fair values of MSRs, caused by assumed immediate changes to key assumptions that are used to determine fair value.  See Note 11.—Fair Value of Financial Instruments, for a description of the key assumptions used to determine the fair value of MSRs.

 

Mortgage Servicing Rights Sensitivity Analysis		March 31,  2015
Fair value of MSRs		$	26,656
Prepayment Speed:
Decrease in fair value from 100 basis point (bp) adverse change		(981		)
Decrease in fair value from 200 bp adverse change		(1,928		)
Discount Rate:
Decrease in fair value from 100 bp adverse change		(992		)
Decrease in fair value from 200 bp adverse change		(1,915		)

 

Sensitivities are hypothetical changes in fair value and cannot be extrapolated because the relationship of changes in assumptions to changes in fair value may not be linear.  Also, the effect of a variation in a particular assumption is calculated without changing any other assumption, whereas a change in one factor may result in changes to another.  Accordingly, no assurance can be given that actual results would be consistent with the results of these estimates.  As a result, actual future changes in MSR values may differ significantly from those displayed above.

 

Loss on mortgage servicing rights is comprised of the following for the three months ended March 31, 2015 and 2014:

 

		For the Three Months
		Ended March 31,
		2015			2014
Loss on sale of mortgage servicing rights		$	(3,474	)	$	(16	)
Change in fair value of mortgage servicing rights		(3,094		)	(961		)
Loss on mortgage servicing rights		$	(6,568	)	$	(977	)

 

During the three months ended March 31, 2015, the Company sold $1.6 billion in UPB of servicing at a loss of $3.5 million.  The Company also recorded a loss of $3.1 million for the change in fair value of mortgage servicing rights retained during the three months ended March 31, 2015.

 

Note 5.—Goodwill and Intangible assets

 

Goodwill arises from the acquisition method of accounting for business combinations and represents the excess of the purchase price over the fair value of the net assets and other identifiable intangible assets acquired.  Other intangible assets with definite lives include trademarks, customer relationships, and non-compete agreements. In the first quarter of 2015, the Company acquired CCM and recorded $104.6 million of goodwill and intangible assets including a $17.3 million trademark, $10.2 million customer relationships and $5.7 million non-compete agreement.

 

Goodwill, trademarks and other intangible assets are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. The carrying value of these intangible assets could be impaired if a significant adverse change in the use, life, or brand strategy of the asset is determined, or if a significant adverse change in the legal and regulatory environment, business or competitive climate occurs that would adversely impact the asset.

 

Goodwill and other intangible assets deemed to have indefinite lives generated from purchase business combinations are not subject to amortization but are instead tested for impairment no less than annually.  Impairment exists when the carrying value of goodwill exceeds its implied fair value.  An impairment loss, if any, is measured as the excess of carrying value of the goodwill over the implied fair value of the goodwill and would be recorded in other expense in the consolidated statements of operations, except if the impairment occurs during the first year after the completion of the acquisition, in which event the impairment of goodwill would be an adjustment to the purchase price.  Intangible assets with definite lives are amortized over their estimated lives using an amortization method that reflects the pattern in which the economic benefits of the asset are consumed.

 

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For goodwill, the determination of fair value of a reporting unit involves, among other things, application of the income approach, which includes developing forecasts of future cash flows and determining an appropriate discount rate. Goodwill is considered a level 3 nonrecurring fair value measurement.

 

The methodology used to determine the fair value of trademarks includes assumptions with inherent uncertainty, including projected sales volumes and related projected revenues, long-term growth rates, royalty rates that a market participant might assume and judgments regarding the factors to develop an applied discount rate. The carrying value of intangible assets is at risk of impairment if future projected revenues or long-term growth rates are lower than those currently projected, or if factors used in the development of a discount rate result in the application of a higher discount rate.  The intangible assets are considered level 3 nonrecurring fair value measurements.

 

The following table presents the changes in the carrying amount of goodwill for the period indicated:

 

Balance at December 31, 2014		$	352
Addition from CCM acquisition		104,586
Balance at March 31, 2015		$	104,938

 

As part of the acquisition of CCM, the preliminary purchase price of the intangible assets the Company acquired are listed below:

 

		Net Carrying			Weighted Avg.
		Amount			Remaining Life
Intangible assets:
Trademark		$	17,251		15
Customer relationships		10,170			7
Non-compete agreement		5,701			4
Total intangible assets acquired		$	33,122

 

Note 6.—Warehouse Borrowings

 

The Company, through its subsidiaries, enters into Master Repurchase Agreements with lenders providing warehouse facilities. The warehouse facilities are used to fund, and are secured by, residential mortgage loans that are held for sale. In accordance with the terms of the Master Repurchase Agreements, the Company is required to maintain cash balances with the lender as additional collateral for the borrowings which are included in restricted cash in the accompanying consolidated balance sheets.

 

At March 31, 2015, the Company was not in compliance with certain financial covenants and received waivers.

 

The following table presents certain information on warehouse borrowings and related accrued interest for the periods indicated:

 

		Maximum			Balance Outstanding At
		Borrowing Capacity			March 31, 2015			December 31, 2014
Short-term borrowings:
Repurchase agreement 1		$	125,000		$	98,897		$	64,907
Repurchase agreement 2		50,000			48,566			30,523
Repurchase agreement 3 (1)		75,000			73,515			24,012
Repurchase agreement 4 (2)		225,000			179,925			107,276
Repurchase agreement 5		150,000			78,725			—
Total repurchase agreements		625,000			479,628			226,718
Other warehouse borrowings (3)		—			72,865			—
Total warehouse borrowings		$	625,000		$	552,493		$	226,718

(1)         This line expired in April, 2015 and the Company replaced it with a $100.0 million facility, see Note. 19 - Subsequent Events.

(2)         As of March 31, 2015, $53.3 million is attributable to re-warehousing.

(3)         Other warehouse borrowings are borrowings from CashCall as a result of loans funded on CashCall’s warehouse lines, but not yet transferred to the Company’s lines as of March 31, 2015.

 

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Note 7.—Convertible Notes

 

In April 2013, the Company entered into a Note Purchase Agreement with the purchasers named therein (Noteholders), whereby the Company issued $20.0 million in original aggregate principal amount of Convertible Promissory Notes Due 2018 (Convertible Notes). The Convertible Notes mature on or before April 30, 2018 and accrue interest at a rate of 7.5% per annum, to be paid quarterly.

 

Note 8.—Line of Credit Agreement

 

As of March 31, 2015 and December 31, 2014, the Company had a $4.0 million working capital line of credit agreement with a national bank that bears interest at a variable rate of one-month LIBOR plus 3.50%. The line of credit is unsecured and expires June 2015. Under the terms of the agreement the Company and its subsidiaries are required to maintain various financial and other covenants. The working capital line of credit is included in other liabilities in the accompanying consolidated balance sheets. At March 31, 2015 and December 31, 2014, the outstanding balance under the line of credit was $4.0 million and $4.0 million, respectively, and is included in other liabilities on the consolidated balance sheets. At March 31, 2015, the Company was not in compliance with certain covenants and received a waiver.

 

Note 9.—Short-Term Structured Debt

 

In December 2014, the Company entered into a $6.0 million short-term structured debt agreement using eight of the Company’s residual interests (net trust assets) as collateral. The Company received proceeds of $6.0 million and had transaction costs of approximately $60 thousand. The agreement bears interest at LIBOR + 5.75% per annum, has a final repurchase date of June 29, 2015 and the Company has the right to repurchase the securities without penalty prior to the final repurchase date.  The balance as of March 31, 2015 was $4.2 million.

 

The holder receives monthly principal and interest payments which are equal to the distributions from the residual interest underlying collateral with a minimum payment of $500,000. If the cash flows received from the collateralized residual interests are less than $500,000, the Company would be required to pay the difference to avoid the transfer of the residual interests and the rights to the associated future cash flows to the note holder.

 

Note 10.—Securitized Mortgage Trusts

 

Trust Assets

 

Trust assets, which are recorded at fair value, are comprised of the following at March 31, 2015 and December 31, 2014:

 

		March 31,			December 31,
		2015			2014
Securitized mortgage collateral		$	5,110,983		$	5,249,639
Real estate owned		19,122			18,800
Investment securities available-for-sale		88			92
Total securitized mortgage trust assets		$	5,130,193		$	5,268,531

 

Trust Liabilities

 

Trust liabilities, which are recorded at fair value, are comprised of the following at March 31, 2015 and December 31, 2014:

 

		March 31,			December 31,
		2015			2014
Securitized mortgage borrowings		$	5,109,133		$	5,245,860
Derivative liabilities		4,499			5,447
Total securitized mortgage trust liabilities		$	5,113,632		$	5,251,307

 

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Changes in fair value of net trust assets, including trust REO gains (losses) are comprised of the following for the three months ended March 31, 2015 and 2014:

 

		For the Three Months
		Ended March 31,
		2015			2014
Change in fair value of net trust assets, excluding REO		$	1,794		$	(3,043	)
(Losses) gains from REO		(2,670		)	6,081
Change in fair value of net trust assets, including trust REO (losses) gains		$	(876	)	$	3,038

 

Note 11.—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.

 

The following table presents the estimated fair value of financial instruments included in the consolidated financial statements as of the dates indicated:

 

		March 31, 2015												December 31, 2014
		Carrying			Estimated Fair Value									Carrying			Estimated Fair Value
		Amount			Level 1			Level 2			Level 3			Amount			Level 1			Level 2			Level 3
Assets
Cash and cash equivalents		$	5,635		$	5,635		$	—		$	—		$	10,073		$	10,073		$	—		$	—
Restricted cash		4,932			4,932			—			—			2,420			2,420			—			—
Mortgage loans held-for-sale		531,586			—			531,586			—			239,391			—			239,391			—
Finance receivables		53,340			—			53,340			—			8,358			—			8,358			—
Mortgage servicing rights		26,656			—			—			26,656			24,418			—			—			24,418
Derivative assets, lending, net		12,769			—			—			12,769			2,884			—			—			2,884
Investment securities available-for-sale		88			—			—			88			92			—			—			92
Securitized mortgage collateral		5,110,983			—			—			5,110,983			5,249,639			—			—			5,249,639
Warrant		91			—			—			91			84			—			—			84
Liabilities
Warehouse borrowings		$	552,493		$	—		$	552,493		$	—		$	226,718		$	—		$	226,718		$	—
Short-term structured debt		4,156			—			—			4,156			6,000			—			—			6,000
Line of credit		4,000			—			4,000			—			4,000			—			4,000			—
Contingent consideration		124,592			—			—			124,592			—			—			—			—
Convertible notes		20,000			—			—			20,000			20,000			—			—			20,000
Long-term debt		29,646			—			—			29,646			22,122			—			—			22,122
Securitized mortgage borrowings		5,109,133			—			—			5,109,133			5,245,860			—			—			5,245,860
Derivative liabilities, securitized trusts		4,499			—			—			4,499			5,447			—			—			5,447
Derivative liabilities, lending, net		2,948			—			2,948			—			930			—			930			—

 

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.

 

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.

 

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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, warrant, securitized mortgage collateral and borrowings, derivative assets and liabilities, contingent consideration, long-term debt, mortgage servicing rights and mortgage loans held-for-sale.

 

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

 

Finance receivables carrying amounts approximate fair value due to the short-term nature of the assets and do not present unanticipated interest rate or credit concerns.

 

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

 

Convertible notes are recorded at amortized cost. The estimated fair value is determined using a discounted cash flow model using estimated market rates.

 

Line of credit carrying amount approximates fair value due to the short-term nature of the liability and does not present unanticipated interest rate or credit concerns.

 

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.

 

·                  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 is 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, securitized trusts, long-term debt, interest rate lock commitments (IRLCs), mortgage servicing rights, warrant and contingent consideration as Level 3 fair value measurements. Level 3 assets and liabilities were 91% and 99% and 96% and 99%, respectively, of total assets and total liabilities measured at estimated fair value at March 31, 2015 and December 31, 2014.

 

Recurring Fair Value Measurements

 

The Company assesses the 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, 2015.

 

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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, 2015 and December 31, 2014, based on the fair value hierarchy:

 

		Recurring Fair Value Measurements
		March 31, 2015									December 31, 2014
		Level 1			Level 2			Level 3			Level 1			Level 2			Level 3
Assets
Investment securities available-for-sale		$	—		$	—		$	88		$	—		$	—		$	92
Mortgage loans held-for-sale		—			531,586			—			—			239,391			—
Derivative assets, lending, net (1)		—			—			12,769			—			—			2,884
Mortgage servicing rights		—			—			26,656			—			—			24,418
Warrant (2)		—			—			91			—			—			84
Securitized mortgage collateral		—			—			5,110,983			—			—			5,249,639
Total assets at fair value		$	—		$	531,586		$	5,150,587		$	—		$	239,391		$	5,277,117
Liabilities
Securitized mortgage borrowings		$	—		$	—		$	5,109,133		$	—		$	—		$	5,245,860
Derivative liabilities, securitized trusts (3)		—			—			4,499			—			—			5,447
Long-term debt		—			—			29,646			—			—			22,122
Contingent consideration		—			—			124,592			—			—			—
Derivative liabilities, lending, net (4)		—			2,948			—			—			930			—
Total liabilities at fair value		$	—		$	2,948		$	5,267,870		$	—		$	930		$	5,273,429

 

(1)         At March 31, 2015, derivative assets, lending, net included $12.8 million in IRLCs associated with the Company’s mortgage lending operations, and is included in other assets in the accompanying consolidated balance sheets. At December 31, 2014, derivative assets, lending, net included $3.0 million in IRLCs associated with the Company’s mortgage lending operations, and is included in other assets in the accompanying consolidated balance sheets.

(2)         Included in other assets in the accompanying consolidated balance sheets.

(3)         At March 31, 2015 and December 31, 2014, derivative liabilities, securitized trusts, are included within trust liabilities in the accompanying consolidated balance sheets.

(4)         At March 31, 2015 and December 31, 2014, derivative liabilities, lending, net are included in other liabilities in the accompanying consolidated balance sheets.

 

The following tables present reconciliations 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, 2015 and 2014:

 

		Level 3 Recurring Fair Value Measurements
		For the three months ended March 31, 2015
		Investment securities available-for-sale			Securitized mortgage collateral			Securitized mortgage borrowings			Derivative liabilities, net, securitized trusts			Mortgage servicing rights			Interest rate lock commitments, net			Long-term debt			Contingent consideration			Warrant
Fair value, December 31, 2014		$	92		$	5,249,639		$	(5,245,860	)	$	(5,447	)	$	24,418		$	2,884		$	(22,122	)	$	—		$	84
Total gains (losses) included in earnings:
Interest income (1)		4			17,718			—			—			—			—			—			—			—
Interest expense (1)		—			—			(56,366		)	—			—			—			(408		)	—			—
Change in fair value		34			(1,854		)	3,855			(241		)	(3,094		)	9,885			(7,116		)	—			7
Total gains (losses) included in earnings		38			15,864			(52,511		)	(241		)	(3,094		)	9,885			(7,524		)	—			7
Transfers in and/or out of Level 3		—			—			—			—			—			—			—			—			—
Purchases, issuances and settlements
Purchases		—			—			—			—			—			—			—			—			—
Issuances		—			—			—			—			22,371			—			—			(124,592		)	—
Settlements		(42		)	(154,520		)	189,238			1,189			(17,039		)	—			—			—			—
Fair value, March 31, 2015		$	88		$	5,110,983		$	(5,109,133	)	$	(4,499	)	$	26,656		$	12,769		$	(29,646	)	$	(124,592	)	$	91
Unrealized gains (losses) still held (2)		$	88		$	(1,261,569	)	$	3,399,502		$	(4,164	)	$	26,656		$	12,769		$	41,117		$	(124,592	)	$	91

(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 net interest income, including cash received and paid, was $2.2 million for the three months ended March 31, 2015.  The difference between accretion of interest income and expense and the amounts of interest income and expense recognized in the consolidated statements of operations is primarily from contractual interest on the securitized mortgage collateral and borrowings.

(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, 2015.

 

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