10-Q 1 d81738e10-q.txt FORM 10-Q FOR QUARTER ENDED SEPTEMBER 30, 2000 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 0-13091 IMPAC COMMERCIAL HOLDINGS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MARYLAND 33-0745075 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1301 AVENUE OF THE AMERICAS, 42ND FLOOR NEW YORK, NEW YORK 10019 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 798-6100 Indicate by check mark whether the Registrant (1) has filed all documents and 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: Common Stock ($0.01 par value) 6,317,177 as of November 10, 2000 ================================================================================ 2 IMPAC COMMERCIAL HOLDINGS, INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2000 INDEX
PART I. FINANCIAL INFORMATION Item 1. CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Consolidated Balance Sheets - September 30, 2000 and December 31, 1999................................. 2 Consolidated Statements of Operations and Comprehensive Earnings (Loss) - Quarter and Nine Months Ended September 30, 2000 and 1999....................................................... 3 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2000 and 1999.................. 4 Notes to Consolidated Financial Statements............................................................. 5 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................................................... 10 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................................. 15 PART II. OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................................... 15 SIGNATURES............................................................................................. 16
3 PART I. -- FINANCIAL INFORMATION ITEM 1: CONSOLIDATED FINANCIAL STATEMENTS IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA)
SEPTEMBER 30, 2000 DECEMBER 31, 1999 ------------------ ----------------- (UNAUDITED) ASSETS Cash and cash equivalents $ 11,013 $ 25,418 Commercial mortgage-backed securities ("CMBS") 132,013 35,589 Loan receivables: Collateralized mortgage obligation ("CMO") collateral 302,718 312,152 Commercial mortgages held for investment 4,333 4,362 Allowance for loan losses (1,933) (1,427) ------------ ------------ Net loan receivables 305,118 315,087 Accrued interest receivable 2,475 2,355 Other assets 728 708 ------------ ------------ $ 451,347 $ 379,157 ============ ============ LIABILITIES CMO borrowings $ 266,738 $ 274,529 Borrowings under repurchase arrangements 95,433 3,936 Other liabilities 1,530 3,898 ------------ ------------ 363,701 282,363 ------------ ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred Stock; $0.01 par value; 5,520 shares authorized; no shares outstanding Class A Convertible Preferred Stock; $0.01 par value; 3,000 shares authorized; no shares outstanding -- -- Series A Junior Participating Preferred Stock; $0.01 par value; 1,000 shares authorized; no shares outstanding -- -- Series B 8.5% Cumulative Convertible Preferred Stock; $0.01 par value; 480 shares authorized, issued and outstanding ($12,000 aggregate liquidation preference) 5 5 Class A Common Stock; $0.01 par value; 4,000 shares authorized; no shares outstanding -- -- Common Stock; $0.01 par value; 46,000 shares authorized; 6,317 and 8,418 shares issued and outstanding at September 30, 2000 and December 31, 1999, respectively 63 84 Additional paid-in-capital 125,330 137,522 Accumulated other comprehensive loss (7,031) (7,497) Accumulated deficit (30,721) (33,320) ------------ ------------ 87,646 96,794 ------------ ------------ $ 451,347 $ 379,157 ============ ============
See accompanying notes to consolidated financial statements. -2- 4 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS (LOSS) (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ---------------------------- ---------------------------- 2000 1999 2000 1999 ------------ ------------ ------------ ------------ INTEREST INCOME: Commercial mortgage assets $ 9,477 $ 6,878 $ 26,422 $ 23,480 Cash equivalents and due from affiliates 136 436 667 844 ------------ ------------ ------------ ------------ Total interest income 9,613 7,314 27,089 24,324 ------------ ------------ ------------ ------------ INTEREST EXPENSE: CMO borrowings 4,909 5,202 15,078 15,742 Repurchase agreements and warehouse line agreements 1,739 102 3,772 1,261 Other borrowings -- 125 -- 410 ------------ ------------ ------------ ------------ Total interest expense 6,648 5,429 18,850 17,413 ------------ ------------ ------------ ------------ Net interest income 2,965 1,885 8,239 6,911 Provision for loan losses (301) -- (638) -- ------------ ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,664 1,885 7,601 6,911 ------------ ------------ ------------ ------------ OTHER REVENUE (EXPENSE): Gain (loss) on sale of loans and real estate -- 432 (70) 679 Writedown of residual interest -- (5,043) -- (5,543) Settlement of litigation -- -- (490) -- Rental and other income -- 447 44 1,163 General and administrative and other operating expense (492) (2,959) (1,645) (7,810) Management advisory fees (234) -- (234) -- ------------ ------------ ------------ ------------ TOTAL OTHER REVENUE (EXPENSE) (726) (7,123) (2,395) (11,511) ------------ ------------ ------------ ------------ NET EARNINGS (LOSS) $ 1,938 $ (5,238) $ 5,206 $ (4,600) ============ ============ ============ ============ NET EARNINGS (LOSS) AVAILABLE TO COMMON STOCKHOLDERS: Net earnings (loss) $ 1,938 $ (5,238) $ 5,206 $ (4,600) Less cash dividends on preferred stock (255) (255) (765) (414) ------------ ------------ ------------ ------------ Net earnings (loss) available to common stockholders $ 1,683 $ (5,493) $ 4,441 $ (5,014) ============ ============ ============ ============ NET EARNINGS (LOSS) PER COMMON SHARE: Basic $ 0.27 $ (0.65) $ 0.60 $ (0.59) Diluted 0.24 (0.65) 0.57 (0.59) OTHER COMPREHENSIVE EARNINGS (LOSS) : Net earnings (loss) $ 1,938 $ (5,238) $ 5,206 $ (4,600) Unrealized gains (losses) (4) (8,918) 466 (8,260) ------------ ------------ ------------ ------------ Comprehensive earnings (loss) $ 1,934 $ (14,156) $ 5,672 $ (12,860) ============ ============ ============ ============
See accompanying notes to consolidated financial statements. -3- 5 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30 ---------------------------------- 2000 1999 --------------- --------------- OPERATING ACTIVITIES: Net earnings (loss) $ 5,206 $ (4,600) Adjustments to reconcile net earnings to net cash provided by operating activities: Decrease in minority interest in ICCC -- 788 Depreciation and amortization 772 (367) Provision for loan losses 638 -- Writedown in residual interest -- 5,543 Loss on sale of REO 70 -- Net change in accrued interest on receivables 485 562 Net change in other assets and liabilities (3,020) 1,723 Net change in due from affiliates and due to affiliates -- 5,849 Net change in commercial mortgages held-for-sale -- 43,480 --------------- --------------- Net cash provided by operating activities 4,151 52,978 --------------- --------------- INVESTING ACTIVITIES: Net change in commercial mortgages held-for-investment 19 18,188 Net change in CMO collateral 7,471 3,734 Purchases of CMBS (99,916) -- Proceeds from sale of REO 426 -- Principal reductions on CMBS, net of amortization 4,208 2,322 Purchase of premises and equipment -- (1,586) Net cash acquired through the consolidation of ICCC -- 692 --------------- --------------- Net cash provided by (used in) investing activities (87,792) 23,350 --------------- --------------- FINANCING ACTIVITIES: Net change in reverse repurchase agreements and other borrowings 91,497 (50,188) Net change in CMO borrowings (7,441) (9,229) Issuance of preferred shares -- 11,592 Repurchase of common shares (12,213) (1,072) Dividends paid (2,607) (1,211) --------------- --------------- Net cash provided by (used in) financing activities 69,236 (50,108) --------------- --------------- 296,831 Net change in cash and cash equivalents (14,405) 26,220 Cash and cash equivalents at beginning of period 25,418 14,161 --------------- --------------- Cash and cash equivalents at end of period $ 11,013 $ 40,381 =============== =============== SUPPLEMENTARY INFORMATION: Interest paid $ 17,084 $ 17,580 NON-CASH TRANSACTIONS: Transfer of loans to other real estate owned -- 1,325 Dividends declared and unpaid 255 1,307
See accompanying notes to consolidated financial statements. -4- 6 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2000 (UNAUDITED) NOTE 1 - BUSINESS AND PENDING MERGER Impac Commercial Holdings, Inc. and subsidiaries ("Impac" or the "Company"), a specialty commercial property finance company, earns income from investing in commercial mortgage assets on a leveraged basis and other activities in the commercial mortgage market. By mid-April 2000, Impac had substantially completed modifying its business plan to focus primarily on CMBS investments. On October 6, 2000 the Company announced it had signed a definitive merger agreement providing for the acquisition by a wholly-owned subsidiary of Fortress Investment Corp. ("Fortress") of all of the Company's outstanding common shares not already owned by Fortress and its affiliates for $7.55 per share in cash. Fortress is an affiliate of FIC Management Inc., the Company's external manager. Fortress and its affiliates own common and preferred shares representing approximately 31% of the voting power of the Company, on a fully diluted basis. The all-cash transaction, which is structured as a $7.55 per share cash tender offer followed by a second-step merger of the Company with a subsidiary of Fortress, is valued at approximately $41.4 million excluding shares already owned by affiliates of Fortress. The tender offer commenced October 13, 2000 and is expected to conclude on November 17, 2000. The tender offer and merger are subject to certain customary conditions; however, the tender offer is not subject to a financing condition, nor a condition that any minimum number of shares be tendered and the merger is not subject to a "break-up" or "commitment" fee other than an expense reimbursement of up to $400,000 payable in the event that an independent committee of the Board of Directors receives a higher offer from a third party and accepts that offer pursuant to the exercise of its fiduciary duties. NOTE 2 - BASIS OF FINANCIAL STATEMENT PRESENTATION Basis of Presentation. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2000. For further information refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1999. Reclassifications. Certain amounts in the consolidated financial statements as of and for the quarter and nine months ended September 30, 1999 have been reclassified to conform to the 2000 presentation. NOTE 3 - SHARE REPURCHASES On May 24, 2000 the Company repurchased 2,101,023 of its common shares at a price of $5.81 per share (including transaction costs) pursuant to a tender offer that was completed May 19, 2000. -5- 7 NOTE 4 - NET EARNINGS (LOSS) PER COMMON SHARE The following table represents the computation of basic and diluted earnings (loss) per common share for the periods presented (in thousands, except per share data):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ---------------------------- ---------------------------- 2000 1999 2000 1999 ------------ ------------ ------------ ------------ NUMERATOR: Numerator for diluted computation--net earnings (loss) $ 1,938 $ (5,238) $ 5,206 $ (4,600) Less preferred share dividends paid or accrued (255) (255) (765) (414) ------------ ------------ ------------ ------------ Net earnings (loss) available to common stockholders and numerator for basic computation $ 1,683 $ (5,493) $ 4,441 $ (5,014) ============ ============ ============ ============ DENOMINATOR: Denominator for basic computation--weighted average common shares outstanding 6,317 8,418 7,429 8,476 Net effect of dilutive convertible preferred shares 1,684 -- 1,684 -- ------------ ------------ ------------ ------------ Denominator for diluted computation 8,001 8,418 9,113 8,476 ============ ============ ============ ============ NET EARNINGS (LOSS) PER COMMON SHARE: Basic $ 0.27 $ (0.65) $ 0.60 $ (0.59) Diluted 0.24 (0.65) 0.57 (0.59)
NOTE 5 - CMBS Investments in CMBS are secured by commercial real property. The yield to maturity on each security depends on, among other things, the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), the pass-through rate, and interest rate fluctuations. Average effective interest rates (calculated for the quarter ended September 30, 2000 and the year ended December 31, 1999, excluding unrealized gains and losses) along with amortized cost and estimated fair value information for investment securities held available-for-sale is summarized as follows (dollars in thousands):
AVERAGE AMORTIZED UNREALIZED UNREALIZED ESTIMATED EFFECTIVE COST GAIN LOSS FAIR VALUE RATE ------------ ------------ ------------ ------------ ------------ AT SEPTEMBER 30, 2000: Fixed-rate securities $ 6,729 $ -- $ (4,172) $ 2,557 12.01% Adjustable-rate securities 122,719 651 (260) 123,110 9.78 Interest-only securities 5,894 34 (3,294) 2,634 11.65 Residual interest in securitization 3,702 10 -- 3,712 20.05 ------------ ------------ ------------ ------------ ------------ $ 139,044 $ 695 $ (7,726) $ 132,013 10.25 ============ ============ ============ ============ ============ AT DECEMBER 31, 1999: Fixed-rate securities $ 6,635 $ -- $ (3,915) $ 2,720 11.88% Adjustable-rate securities 24,396 22 (4) 24,414 8.24 Interest-only securities 7,955 16 (3,616) 4,355 12.44 Residual interest in securitization 4,100 -- -- 4,100 20.00 ------------ ------------ ------------ ------------ ------------ $ 43,086 $ 38 $ (7,535) $ 35,589 10.70 ============ ============ ============ ============ ============
As of September 30, 2000 and December 31, 1999, the amortized cost of fixed-rate and adjustable-rate securities included unamortized purchase discounts of $3.6 million and $1.7 million, respectively. Interest-only securities are entitled to receive only coupon interest stripped from pools of commercial mortgage loans. Consequently, the amortized cost of these securities represents unamortized purchase premium. The residual interest in Southern Pacific Secured Assets Corp. Mortgage Pass-Through Certificate 1995-2 (the "Residual") was previously classified as held-for-trading and marked to market through earnings each balance sheet date. On January 1, 2000 the Residual was reclassified as available-for-sale. Under the terms of the securitization, the Residual is required to build over-collateralization to specified levels using excess cash flows after payments required to senior securities until set percentages of the securitized portfolio are attained. This over-collateralization is held by the real estate mortgage investment conduit ("REMIC") trust to provide credit enhancement for senior security holders and is recorded as part of the Residual. -6- 8 NOTE 6 - LOAN RECEIVABLES CMO COLLATERAL CMO collateral includes various types of mortgages secured by commercial real property and loans to developers secured by first liens on condominium complexes. All CMO collateral is pledged to secure CMO borrowings. The components of CMO collateral are summarized in the following table (in thousands):
SEPTEMBER 30, 2000 DECEMBER 31, 1999 ------------------ ----------------- Commercial mortgages held as CMO collateral $ 293,727 $ 301,198 Unamortized net premiums 2,581 3,338 Prepaid securitization costs 6,410 7,616 ------------ ------------ $ 302,718 $ 312,152 ============ ============
The weighted average yield on CMO collateral was 7.55% and 7.65% during the quarter and nine months ended September 30, 2000, respectively. ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses was as follows (in thousands):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ---------------------------- ---------------------------- 2000 1999 2000 1999 ------------ ------------ ------------ ------------ Balance, beginning of period $ 1,648 $ 1,427 $ 1,427 $ 2,110 Provision for loan losses 301 -- 638 -- Charge-offs (16) -- (132) (683) ------------ ------------ ------------ ------------ Balance, end of period $ 1,933 $ 1,427 $ 1,933 $ 1,427 ============ ============ ============ ============
NOTE 7 - CMO BORROWINGS CMO borrowings are fully payable from the principal and interest payments on the underlying mortgage loans collateralizing such debt and any investment income earned on such payments held by the bond trustee. The maturity of each class of CMO is directly affected by the rate of principal prepayments on the related CMO collateral and is also subject to redemption according to specific terms of the related indenture. As a result, the actual maturity of CMO borrowings is likely to occur earlier than the stated maturities of the underlying mortgage loans. The components of CMO borrowings, along with related other information, are summarized as follows (dollars in thousands):
SEPTEMBER 30, 2000 DECEMBER 31, 1999 ------------------ ----------------- CMO borrowings: Fixed-rate $ 249,615 $ 253,230 Adjustable-rate 21,073 24,857 Accrued interest payable 1,488 1,530 ------------ ------------ Total obligation 272,176 279,617 Unamortized discount (5,438) (5,088) ------------ ------------ $ 266,738 $ 274,529 ============ ============ Range of fixed interest rates 6.06% to 7.58% 6.06% to 7.58% Adjustable-rate margin over 1-month LIBOR 0.29% 0.28% Number of series 1 2
The weighted average effective rate on CMO borrowings was 7.31% and 7.46% during the quarter and nine months ended September 30, 2000, respectively. -7- 9 NOTE 8 - REVERSE REPURCHASE AGREEMENTS The Company enters into reverse repurchase agreements whereby specific CMBS are pledged as collateral to secure these loans. The interest rates on the loans are based on 1-month LIBOR plus a margin depending on the type of collateral provided by the Company and generally reset monthly. Interest is generally payable to the lender on the monthly reset date. The following table sets forth information regarding reverse repurchase agreements (dollars in thousands):
AT SEPTEMBER 30, 2000 AT DECEMBER 31, 1999 ------------------------------------ ------------------------------------ AMORTIZED AMORTIZED REVERSE COST OF WEIGHTED REVERSE COST OF WEIGHTED TYPE OF COLLATERAL AND REPURCHASE UNDERLYING AVERAGE REPURCHASE UNDERLYING AVERAGE MATURITY OF RELATED LIABILITY LIABILITY COLLATERAL RATE LIABILITY COLLATERAL RATE ----------------------------------- ---------- ---------- ---------- ---------- ---------- ---------- CMBS (less than 31 days) $ 3,328 $ 10,507 7.60% $ 3,936 $ 5,408 7.28% CMBS (31 to 90 days) 44,002 52,219 7.17 -- -- -- CMBS (91 to 180 days) 23,823 29,801 6.87 -- -- -- CMBS (over 181 days, to 270 days) 13,830 27,775 7.32 -- -- -- CMBS (over 1 year) 10,450 12,924 7.19 -- -- -- ---------- ---------- ---------- ---------- ---------- ---------- $ 95,433 $ 133,226 7.14 $ 3,936 $ 5,408 7.28 ========== ========== ========== ========== ========== ==========
The weighted average effective interest rate on borrowings under reverse repurchase arrangements was 7.14% and 6.98% during the quarter and nine months ended September 30, 2000, respectively. NOTE 9 - ESTIMATED FAIR VALUE INFORMATION The estimated fair values of the Company's assets and liabilities have been determined using available market information and appropriate valuation methodologies; however, considerable judgment is necessarily required to interpret market data to develop these estimates. In addition, fair values fluctuate on a daily basis. Accordingly, the estimates presented herein 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 amounts of cash and cash equivalents, receivables/payables, borrowings under reverse repurchase agreements and nonfinancial instruments approximate fair value. The fair value of mortgage assets were estimated using either (i) quoted market prices when available, including quotes made by lenders in connection with designating collateral for borrowings, or (ii) offer prices for similar assets or market positions. The fair value of fixed-rate CMO borrowings was estimated based on the use of a bond model, which incorporates certain assumptions such as yield, prepayments and losses. The fair value of adjustable-rate CMO borrowings approximate carrying amount because of the variable interest rate nature of these borrowings. The following table summarizes fair value disclosures for financial instruments (in thousands):
AT SEPTEMBER 30, 2000 AT DECEMBER 31, 1999 ----------------------- ----------------------- ESTIMATED ESTIMATED CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- ASSETS Cash and cash equivalents $ 11,013 $ 11,013 $ 25,418 $ 25,418 CMBS 132,013 132,013 35,589 35,589 Loan receivables (principally CMO collateral) 305,118 270,082 315,087 272,646 Accrued interest receivable 2,475 2,475 2,355 2,355 Other assets 728 728 708 708 ---------- ---------- ---------- ---------- $ 451,347 $ 416,311 $ 379,157 $ 336,716 ========== ========== ========== ========== LIABILITIES CMO borrowings $ 266,738 $ 251,427 $ 274,529 $ 251,698 Reverse repurchase agreements 95,433 95,433 3,936 3,936 Other liabilities 1,530 1,530 3,898 3,898 ---------- ---------- ---------- ---------- 363,701 348,390 282,363 259,532 STOCKHOLDERS' EQUITY 87,646 67,921 96,794 77,184 ---------- ---------- ---------- ---------- $ 451,347 $ 416,311 $ 379,157 $ 336,716 ========== ========== ========== ========== BOOK VALUE/NET ASSET VALUE PER DILUTED COMMON SHARE $ 10.95 $ 8.49 $ 9.58 $ 7.64
-8- 10 NOTE 10 - COMMITMENTS AND CONTINGENCIES Commercial Mortgage Loan Sales Commitments. The Company has exposure to liability under representations and warranties made to purchasers and insurers of mortgage loans and the purchasers of servicing rights in the ordinary course of the curtailed mortgage conduit operations. Under certain circumstances, Impac may be required to repurchase mortgage loans if there has been a breach of representations or warranties. Litigation. During the second quarter of 2000, the Company settled a lawsuit characterized as the Bresta Futura Action pertaining to an alleged breach of an office lease agreement. As a result, year-to-date results include a $490,000 charge recorded in the second quarter, which together with previous accruals, represents all costs incurred in connection with this matter. The Company is currently not subject to any other material litigation. -9- 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION OVERVIEW Impac Commercial Holdings, Inc. ("Impac" or the "Company") was incorporated in the Commonwealth of Maryland on February 3, 1997 to seek and capitalize on opportunities in the commercial mortgage market. Impac is a specialty commercial property finance company that elects to be taxed at the corporate level as a real estate investment trust ("REIT") for federal income tax purposes, which generally allows Impac to pass through income to stockholders without payment of federal income tax at the corporate level provided that Impac distributes at least 95% of its taxable income to its stockholders (90% after January 1, 2001). Impac earns income from investing in credit-sensitive commercial mortgage assets on a leveraged basis and other activities in the commercial mortgage market. In May 1999, Fortress Partners, L.P. ("Fortress Partners") made a significant preferred stock investment in Impac and, concurrently with that investment, FIC Management Inc. (the "Manager") an affiliate of Fortress Partners, assumed responsibility for the external management of Impac. Assuming conversion of the preferred shares, and including subsequent open market purchases of 832,400 common shares by an affiliate, Fortress Partners' equity interest represents approximately 31% of the voting power of the Company, on a fully diluted basis. During 1999 Impac's current management formulated a new business plan for Impac designed to produce high current returns, enhance liquidity and reduce reliance on short-term financing. Under the new business plan, the Company is focusing its investments in credit-sensitive commercial mortgage-backed securities ("CMBS"). To this end, since year-end the Company has acquired additional adjustable-rate CMBS to increase mortgage investments by over $86 million to approximately $437 million at September 30, 2000. By mid-April 2000, the Company had substantially completed repositioning its investment portfolio. PENDING MERGER On October 6, 2000 the Company announced it had signed a definitive merger agreement providing for the acquisition by a wholly-owned subsidiary of Fortress Investment Corp., an affiliate of Fortress Partners and the Manager, of all of the Company's outstanding common shares not already owned by Fortress Partners and its affiliates for $7.55 per share in cash. The all-cash transaction, which is structured as a $7.55 per share cash tender offer followed by a second-step merger of the Company with a subsidiary of Fortress Investment Corp., is valued at approximately $41.4 million excluding shares already owned by Fortress Partners and its affiliates. The tender offer commenced October 13, 2000 and is expected to conclude on November 17, 2000. The tender offer and merger are subject to certain customary conditions; however, the tender offer is not subject to a financing condition, nor a condition that any minimum number of shares be tendered and the merger is not subject to a "break-up" or "commitment" fee other than an expense reimbursement of up to $400,000 payable in the event that an independent committee of the Board of Directors receives a higher offer from a third party and accepts that offer pursuant to the exercise of its fiduciary duties. SHARE REPURCHASES On May 24, 2000 the Company repurchased 2,101,023 of its common shares at a price of $5.81 per share (including transaction costs) pursuant to a tender offer that was completed May 19, 2000. COMMERCIAL MORTGAGE INVESTMENTS Impac invests primarily in credit-sensitive CMBS and commercial mortgage loans. Acquisitions of mortgage assets are financed with capital, borrowings under reverse repurchase agreements and long-term financing through collateralized mortgage obligations ("CMOs"). Under its modified business plan the Company anticipates future investments will be made primarily in CMBS. To this end, by mid-April 2000 the Company acquired $99.9 million of adjustable-rate CMBS, bringing the CMBS portfolio to $132 million as of September 30, 2000. -10- 12 Until August 1999, Impac originated commercial mortgage loans through its conduit operations. Initially, these commercial mortgage loans were held as long-term investments and were financed through short-term warehouse line agreements and capital or used as collateral for the issuance of CMOs. From the time CMOs were issued, the commercial mortgage loans pledged as collateral have been reflected on Impac's balance sheet as CMO collateral with a corresponding liability referred to as CMO borrowings. As of September 30, 2000, the Company's CMO residual (defined as CMO collateral, net of CMO borrowings) totaled $36.0 million, compared to $37.6 million at December 31, 1999. Although through August 1999 Impac originated commercial mortgage loans, future loans may be purchased from third parties for long-term investment or for resale. Impac also may acquire CMBS created through its own securitization efforts in addition to the CMBS created by third parties. In connection with the issuance of CMBS by Impac, Impac may retain the senior or subordinated securities as regular interests in these securitizations on a short-term or long-term basis. CMBS investments including any retained CMBS may include "principal-only," "interest-only" or residual interest securities or other credit, interest rate or prepayment sensitive securities. No such securitizations were issued by the Company during 2000. Investments in CMBS, commercial mortgage loans or any retained securities from Impac-issued securitizations may subject Impac to credit, interest rate and/or prepayment risks (see "Effects of Interest Rate Changes" and "Risks Associated with Credit Sensitive Investments"). The executive officers of the Manager are empowered to make day-to-day investment decisions, including the issuance of commitments on behalf of Impac to purchase commercial mortgage loans and CMBS meeting the investment criteria set from time to time by Impac's Board of Directors. Other than the observance of statutory limitations which allow Impac to retain its classification as a REIT, there are no current limitations set by the Board of Directors on the percentage of assets which Impac may invest in any one type of investment or the percentage of CMBS of any one issue which Impac may acquire. It is Impac's policy to acquire assets primarily for income financed by reverse repurchase agreements, the issuance of CMOs and CMBS, and proceeds from the issuance of capital stock. BOOK VALUE AND NET ASSET VALUE At December 31, 1999 the Company's book value was $9.58 per diluted common share while management estimated net asset value at $7.64, the difference primarily related to reflecting at fair value the Company's CMO residual. For financial reporting purposes, CMO collateral and borrowings are reflected in the Company's balance sheet at amortized cost. At September 30, 2000 book value increased to $10.95 per diluted common share and net asset value increased to $8.49, primarily as a result of the share repurchases mentioned above. See NOTE 9 to the consolidated financial statements for more detailed fair value information and a discussion regarding the difficulties of estimating fair values. RESULTS OF OPERATIONS Comparative net operating results by source (interest income, net of related interest expense) were as follows (in thousands, except per share amounts):
QUARTER ENDED NINE MONTHS ENDED SEPTEMBER 30 SEPTEMBER 30 ---------------------------- ---------------------------- 2000 1999 2000 1999 ------------ ------------ ------------ ------------ CMBS $ 1,830 $ 401 $ 4,686 $ 2,149 Loan receivables (principally CMO collateral) 999 1,173 2,886 4,328 Other (principally short-term investments) 136 311 667 434 Provision for loan losses (301) -- (638) -- ------------ ------------ ------------ ------------ Net interest income after provision for loan losses 2,664 1,885 7,601 6,911 Other revenue (expense): Gain (loss) on asset sales or write downs -- (4,611) (70) (4,864) Settlement of litigation -- -- (490) -- Rental and other income -- 447 44 1,163 General and administrative and other (726) (2,959) (1,879) (7,810) ------------ ------------ ------------ ------------ Net earnings (loss) $ 1,938 $ (5,238) $ 5,206 $ (4,600) ============ ============ ============ ============ Net earnings (loss) per share: Basic $ 0.27 $ (0.65) $ 0.60 $ (0.59) Diluted 0.24 (0.65) 0.57 (0.59)
-11- 13 Overview. Operating results for the quarter and nine months ended September 30, 2000 were substantially improved over the corresponding periods of the previous year. Earnings were higher as a result of decisions made in 1999 to modify the Company's business plan to focus primarily on investments in CMBS, to curtail the mortgage conduit operations and to sell non-strategic assets. Earnings per share also benefited from the repurchase of approximately 25% of the Company's common shares pursuant to a tender offer that closed May 19, 2000. Net Interest Income After Provision for Loan Losses. The CMBS portfolio contributed more to net interest income for the quarter and nine months ended September 30, 2000 than in the same periods in 1999 primarily because of the growth of this portfolio in keeping with the Company's new business plan. Average holdings, before fair value adjustments, of CMBS totaled $139.2 million and $111.6 million during the quarter and nine months ended September 30, 2000 compared $24.6 million and $25.2 million during the same periods in 1999. The CMBS portfolio yielded 10.25% and 10.05% during the quarter and nine months ended September 30, 2000 compared to 7.67% and 12.52% during the same periods in 1999. CMBS portfolio yields for 1999 were negatively impacted by a reduction in cash flow remittances on a residual interest in securitization that also was written down by $5.0 million in the third quarter of 1999. In addition, yields in 2000 reflect changes in portfolio mix with a greater emphasis on lower-yielding adjustable-rate CMBS (adjustable-rate securities represented $122.7 million or 88% of the CMBS portfolio at September 30, 2000 compared to none at September 30, 1999). Borrowing costs were higher in 2000 due to greater use of borrowings to support the larger portfolio and higher prevailing short-term interest rates. The Company's borrowing rates on reverse repurchase agreements were 7.14% and 6.98% during the quarter and nine months ended September 30, 2000 compared to 6.44% and 6.28% during the same periods in 1999. Loan receivables contributed less to net interest income for the quarter and nine months ended September 30, 2000 than in the same periods in 1999 primarily because of lower holdings of these assets with efforts made in 1999 to sell unsecuritized loans and to completely curtail the mortgage conduit operations by August of 1999. During 2000 loan receivables consisted primarily of CMO collateral, secured by CMO borrowings. Average holdings of CMO collateral totaled $306.6 million and $308.8 million during the quarter and nine months ended September 30, 2000 compared $316.3 million and $320.8 million during same periods in 1999. Yields on CMO collateral were 7.55% and 7.65% during the quarter and nine months ended September 30, 2000 compared to 7.81% and 7.77% during the same periods in 1999. The Company's CMO borrowing rates were 7.31% and 7.46% during the quarter and nine months ended September 30, 2000 compared to 7.55% and 7.10% during the same periods in 1999. Average holdings of unsecuritized mortgage loans were less than $5 million in 2000 compared to $12.1 million and $39.6 million during the quarter and nine months ended September 30, 1999. During the quarter and the nine months ended September 30, 2000 the Company recorded $301,000 and $638,000, respectively, in provisions for loan losses bringing the allowance for loan losses to $1.9 million at September 30, 2000. Other Operating Revenue (Expense). Rental and other income and general and administrative expenses have been significantly reduced by decisions made in 1999 to curtail the conduit operation, sell non-strategic assets including the Company's office building and to eliminate certain office lease obligations. During the second quarter of 2000, the Company settled a lawsuit pertaining to an alleged breach of an office lease agreement. As a result, year-to-date results include a $490,000 charge, which together with previous accruals, represents all costs incurred in connection with this matter. LIQUIDITY AND CAPITAL RESOURCES Impac's business operations, including the acquisition of mortgage assets, are primarily funded with monthly interest and principal payments from its CMBS and loan receivable portfolios, borrowings under reverse repurchase agreements secured by CMBS and CMO borrowings, proceeds from the sale of commercial mortgages and other investments, and proceeds from stock issuances. Impac's ability to meet its long-term liquidity requirements is subject to the renewal of its credit and repurchase facilities and/or obtaining other sources of financing, including additional debt or equity from time to time. Any decision by Impac's lenders and/or investors to make additional funds available to Impac in the future will depend upon a number of factors, such as Impac's compliance with the terms of its existing credit arrangements, Impac's financial performance, industry and market trends, the general availability of and rates applicable to financing and investments, such lenders' and/or investors' own resources and policies concerning loans and investments, and the relative attractiveness of alternative investment or lending opportunities (see "Effects of Interest Rate Changes" and "Risks Associated with Credit-sensitive Investments"). -12- 14 The Company has uncommitted repurchase facilities with investment banking firms to finance CMBS, subject to certain conditions. Interest rates on borrowings under these facilities are generally based on overnight to 30-day London Interbank Offered Rate ("LIBOR") rates. The terms and conditions of these agreements, including interest rates, are negotiated on a transaction-by-transaction basis. Amounts available for borrowing under these agreements are dependent upon the fair value of the securities pledged as collateral, which may fluctuate with changes in interest rates and the credit quality of these securities (see "Effects of Interest Rate Changes" and "Risks Associated with Credit-Sensitive Investments"). As of September 30, 2000, $48.1 million of the Company's $95.4 million of borrowings under repurchase agreements had maturities of greater than 90 days. Borrowings under reverse repurchase agreements secured by more recent purchases of adjustable-rate CMBS more closely match the interest rate adjustment features of these investments such that the Company anticipates it can earn more consistent net interest spreads on these investments (see "NOTE 8" to the accompanying consolidated financial statements). EFFECTS OF INTEREST RATE CHANGES INTEREST RATE SENSITIVITY ON OPERATING RESULTS The Company performs earnings sensitivity analysis using an income simulation model to estimate the effects that specific interest rate changes will have on future earnings. All mortgage assets and derivative financial instruments ("derivatives") held, if any, are included in this analysis. The model incorporates management assumptions regarding the level of prepayments on mortgage assets for a given level of market rate changes using industry estimates of prepayment speeds for various coupon segments. These assumptions are developed through a combination of historical analysis and future expected pricing behavior. As of September 30, 2000 and December 31, 1999, the Company had the following interest sensitivity profiles:
IMMEDIATE CHANGE IN: (RATES IN BASIS POINTS, DOLLARS IN THOUSANDS) --------------------------------------------- 30-day LIBOR rate Down 100 Up 100 10-year U.S. Treasury rate Down 100 Up 100 Projected 12-month earnings change:* September 30, 2000 $(415) $415 December 31, 1999 (403) 404
* Note that the impact of actual or planned acquisitions of mortgage assets subsequent to quarter-end (beyond acquisitions necessary to replace runoff) and any new business activities were not factored into the simulation model for purposes of this disclosure. Income simulation modeling is a primary tool used to assess the direction and magnitude of changes in net margins on mortgage assets resulting from changes in interest rates. Key assumptions in the model include prepayment rates on mortgage assets, changes in market conditions, and management's capital plans. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net margins or precisely predict the impact of higher or lower interest rates on net margins. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and other changes in market conditions, management strategies and other factors. GENERAL DISCUSSION OF EFFECTS OF INTEREST RATE CHANGES Changes in interest rates may impact the Company's earnings in various ways. The Company's earnings currently depend, in part, on the difference between the interest received on CMBS investments, and the interest paid on related short-term borrowings. The resulting spread may be reduced or even turn negative in a rising short-term interest rate environment. For investments in adjustable-rate CMBS, the risk of rising short-term interest rates is generally offset to some extent by increases in the rates of interest earned on the underlying adjustable-rate CMBS. The Company may invest in derivatives from time to time as a hedge against rising interest rates on a portion of its short-term borrowings. At September 30, 2000 the Company did not own any derivatives as a hedge against rising interest rates. -13- 15 Another effect of changes in interest rates is that as long-term interest rates decrease the rate of principal prepayments on loans underlying CMBS may increase. To the extent the proceeds of prepayments on mortgage assets cannot be reinvested at a rate of interest at least equal to the rate previously earned on such investments, earnings may be adversely affected. In addition, the rates of interest earned on adjustable-rate CMBS generally will decline during periods of falling short-term interest rates. Changes in interest rates also affect earnings recognized from interest-only CMBS. The amount of income that may be generated from interest-only CMBS is dependent upon the rate of principal prepayments on the underlying mortgage collateral. If mortgage interest rates fall significantly below interest rates on the collateral, principal prepayments may increase, reducing or even turning negative the overall return on these investments. Conversely, if mortgage interest rates rise, interest-only CMBS tend to perform favorably because underlying mortgage loans will generally prepay at slower rates, thereby increasing overall returns. Changes in interest rates affect CMO residuals in a similar fashion. If mortgage interest rates fall, prepayments on the underlying mortgage loans generally will be higher, thereby reducing or even turning negative the overall returns on these investments. This is due primarily to the acceleration of the amortization of bond discounts and prepaid securitization costs as bond classes are repaid more rapidly than originally anticipated. Conversely, if mortgage interest rates rise significantly above interest rates on the collateral, principal prepayments will typically diminish, improving the overall return on an investment in a CMO residual because of an increase in time over which the Company receives the larger positive interest spread. The Company may periodically sell mortgage assets, which may increase income volatility because of the recognition of transactional gains or losses. Such sales may become attractive as values of mortgage assets fluctuate with changes in interest rates. At other times, it may become prudent to reposition the mortgage asset portfolios to mitigate exposure to potential changes in interest rates. RISKS ASSOCIATED WITH CREDIT-SENSITIVE INVESTMENTS CMBS are generally viewed as exposing an investor to greater risk of loss than residential mortgage-backed securities since such securities are typically secured by larger loans to fewer obligors than residential mortgage-backed securities. Commercial property values and net operating income are subject to volatility, and net operating income may be sufficient or insufficient to cover debt service on the related mortgage loan at any given time. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project and the ability of the applicable property to produce net operating income rather than upon the liquidation value of the underlying real estate. Even when the current net operating income is sufficient to cover debt service, there can be no assurance that this will continue to be the case in the future. Additionally, commercial properties may not readily be convertible to alternative uses if such properties were to become unprofitable due to competition, age of improvements, decreased demand, regulatory changes or other factors. The conversion of commercial properties to alternate uses generally requires substantial capital expenditures, which may or may not be available. The availability of credit for commercial mortgage loans will be significantly dependent upon economic conditions in the markets where such properties are located, as well as the willingness and ability of lenders to make such loans. The availability of funds in the credit markets fluctuates and there can be no assurance that the availability of such funds will increase above, or will not contract below current levels. In addition, the availability of similar commercial properties, and the competition for available credit, may affect the ability of potential purchasers to obtain financing for the acquisition of properties. This could effect the repayment of commercial mortgages pledged to secure CMBS. Through the process of securitizing commercial mortgages, credit risk can be heightened or minimized. Senior classes in multi-class securitizations generally have first priority over cash flows from a pool of mortgages and, as a result, carry the least risk, highest investment ratings and the lowest yields. Typically a securitization will also have mezzanine classes and subordinated classes. Mezzanine classes will generally have somewhat lower credit ratings and may have average lives that are longer than the senior classes. Subordinate classes are junior in the right to receive cash flow from the underlying mortgages, thus providing credit enhancement to the senior and mezzanine classes. As a result, subordinated securities will have lower credit ratings because of the elevated risk of credit loss inherent in these securities. -14- 16 The availability of capital from external sources to finance investments in credit-sensitive CMBS that are not financed to maturity at acquisition may be diminished during periods of mortgage finance market illiquidity, such as was experienced in 1998. Additionally, if market conditions deteriorate resulting in substantial declines in value of these securities, sufficient capital may not be available to support the continued ownership of such investments, requiring these securities to be sold at a loss. OTHER FORWARD LOOKING STATEMENTS This document contains "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) that inherently involve risks and uncertainties. The Company's actual results and liquidity can differ materially from those anticipated in these forward-looking statements because of changes in the level and composition of the Company's investments and unforeseen factors. These factors may include, but are not limited to, changes in general economic conditions, the availability of suitable investments, fluctuations in and market expectations for fluctuations in interest rates and levels of mortgage prepayments, deterioration in credit quality and ratings, the effectiveness of risk management strategies, the impact of leverage, liquidity of secondary markets and credit markets, increases in costs and other general competitive factors. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is included above in "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations." PART II. -- OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: Exhibit 27 - Financial Data Schedule (electronic filing only). (b) Reports on Form 8-K: None. -15- 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: November 10, 2000 IMPAC COMMERCIAL HOLDINGS, INC. By: /s/ Randal A. Nardone --------------------------------------- Randal A. Nardone Chief Operating Officer and Secretary Date: November 10, 2000 IMPAC COMMERCIAL HOLDINGS, INC. By: /s/ Gregory F. Hughes --------------------------------------- Gregory F. Hughes Chief Financial Officer (Principal Financial and Accounting Officer) -16- 18 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 27 Financial Data Schedule