-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HC6zPFOlYB2wo+7Uxy5qSQ7P3HQv3/VT/d2riHltTc+zmR6DhSYxrm8Q3Qpu0lOf br3w4+9TDCytk1s84gJ7bw== 0001017062-99-000369.txt : 19990301 0001017062-99-000369.hdr.sgml : 19990301 ACCESSION NUMBER: 0001017062-99-000369 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990226 FILER: COMPANY DATA: COMPANY CONFORMED NAME: IMPAC COMMERCIAL HOLDINGS INC CENTRAL INDEX KEY: 0001036615 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 330745075 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13091 FILM NUMBER: 99552004 BUSINESS ADDRESS: STREET 1: 20371 IRVINE AVE STREET 2: STE 430 CITY: SANTA ANA HEIGHTS STATE: CA ZIP: 92707 BUSINESS PHONE: 7145560122 MAIL ADDRESS: STREET 1: 20371 IRVINE AVE STREET 2: SUITE 430 CITY: SANTA ANA HEIGHTS STATE: CA ZIP: 92707 FORMER COMPANY: FORMER CONFORMED NAME: IMH COMMERCIAL HOLDINGS INC DATE OF NAME CHANGE: 19970728 FORMER COMPANY: FORMER CONFORMED NAME: IMPERIAL CREDIT COMMERCIAL HOLDINGS INC DATE OF NAME CHANGE: 19970728 10-K 1 FORM 10-K - IMPAC COMMERCIAL HOLDINGS, INC. ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _________ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 or [_] 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: 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.) 20371 Irvine Avenue, Santa Ana Heights, California 92614 (Address of principal executive offices) (714) 556-0122 (Registrant's telephone number, including area code) _____________________ Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock $0.01 par value American Stock Exchange _____________________ 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 [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [_] On February 16, 1999, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $48.9 million, based on the closing sales price of the Common Stock on the American Stock Exchange. For purposes of the calculation only, in addition to affiliated companies, all directors and executive officers of the registrant have been deemed affiliates. The number of shares of Common Stock outstanding as of February 16, 1999, was 8,625,000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Definitive Proxy Statement, issued in connection with the 1999 Annual Meeting of Stockholders of the Registrant, are incorporated by reference into Part III. ================================================================================ IMPAC COMMERCIAL HOLDINGS, INC. 1998 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
Page ---- PART I ITEM 1. BUSINESS........................................................................................ 3 ITEM 2. PROPERTIES...................................................................................... 31 ITEM 3. LEGAL PROCEEDINGS............................................................................... 31 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................. 31 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................... 32 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA............................................................ 34 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........... 36 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................... 46 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................................... 50 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............................................................................ 50 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................. 51 ITEM 11. EXECUTIVE COMPENSATION.......................................................................... 51 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................. 51 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................. 51 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K................................ 52 SIGNATURES..................................................................................................... 54
2 PART I Certain information contained in this Report constitutes forward-looking statements under the Securities Act and the Exchange Act. These forward-looking statements can be identified by the use of forward-looking terminology including, but not limited to, "may," "will," "expect," "intend," "should," "anticipate," "estimate," or "believe" or comparable terminology. The Company's actual results may differ materially from those contained in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in "Item 1. Business--Risk Factors" as well as those discussed elsewhere in this Report. ITEM 1. BUSINESS Impac Commercial Holdings, Inc. was incorporated in Maryland in February 1997 under the name Imperial Credit Commercial Holdings, Inc. and changed its name to IMH Commercial Holdings, Inc. in June 1997. Subsequently, by a vote of stockholders on January 28, 1998, IMH Commercial Holdings, Inc. changed its name to Impac Commercial Holdings, Inc. References to the "Company" refer to Impac Commercial Holdings, Inc. ("ICH") and its subsidiaries, Impac Commercial Assets Corporation ("ICH Assets"), IMH/ICH Dove Street, LLC ("Dove") and Impac Commercial Capital Corporation, (together with its wholly-owned subsidiary ICCC Secured Assets Corporation, ("ICCC")). References to ICH refer to Impac Commercial Holdings, Inc. as a separate entity from ICH Assets, Dove or ICCC. General The Company was formed to seek opportunities in the commercial mortgage market, including the origination, purchase, securitization and sale of commercial mortgages and investment in commercial mortgages and commercial mortgage-backed securities. Commercial mortgage assets include mortgage loans on condominium-conversions, commercial properties, such as industrial and warehouse space, office buildings, retail space and shopping malls, hotels and motels, nursing homes, hospitals, multifamily, congregate care facilities and senior living centers (collectively, "Commercial Mortgages"). The Company operates the Long-Term Investment Operations, which, to date, has invested primarily in Commercial Mortgages and mortgage-backed securities on commercial properties ("CMBSs") and, subsequent to ICH's initial public offering ("IPO") in August of 1997, the Conduit Operations, conducted by ICCC, which originates and purchases and securitizes and sells Commercial Mortgages. The Company's Conduit Operations operates three divisions: the CommercialExpress Division, the ConduitExpress Division, and the CondoSelect Division. The Company 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 the Company to pass through income to stockholders without payment of federal income tax at the corporate level. ICH's non-compete agreement with Impac Mortgage Holdings, Inc. ("IMH"), an affiliate of the Company, expired in March 1998 and, as a result, ICH now has the ability to invest in single-family residential mortgages held-for- investment, investment securities available-for-sale, residual interests in securitizations, and finance receivables ("Residential Mortgage Assets"). To date, ICH has not invested in any Residential Mortgage Assets and there can be no assurance that ICH will invest in any such assets in the future. Due to the asset size of ICH, any investments in Residential Mortgage Assets may constitute a substantial percentage of the Company's total investments in mortgage assets. The Manager RAI Advisors, LLC ("RAI" or the "Manager") was formed as a vehicle through which the management team of IMH could effectively manage the operations of the Company, IMH and future real estate investment trusts. This management team oversees the day-to-day operations of the Company pursuant to a management agreement among the Manager, ICH and ICCC. The Manager is responsible for (1) asset-liability management primarily the analysis and oversight of the purchasing, financing and disposition of the Company's assets, (2) capital management primarily the oversight of the Company's capital raising and (3) investor relations activities and operations management primarily the oversight of ICH's operating subsidiaries. The Manager has also entered into a submanagement agreement (the "Submanagement Agreement") with Impac Funding Corporation ("IFC"), IMH's conduit operations, to provide substantially all of the administrative services required by the Company. 3 Long-Term Investment Operations The Long-Term Investment Operations, conducted by ICH, invests in mortgage loans to be held as long-term investment and mortgage-backed securities ("MBSs"). Income is earned principally from net interest income earned on mortgage loans and MBSs held in the long-term investment portfolio and on short- term warehouse loans or finance receivables. The purchase of mortgage loans and MBSs are financed with capital, long-term financing through Collateralized Mortgage Obligations ("CMOs") and borrowings under warehouse line and reverse repurchase agreements. To date, the Long-Term Investment Operations has invested primarily in Commercial Mortgages and CMBSs. ICCC supports the investment objectives of ICH by selling Commercial Mortgages and CMBSs to ICH at costs that are comparable to those available through investment bankers and other third parties. Commercial Mortgages Held in the Portfolio The Company originates Commercial Mortgages through its Conduit Operations, conducted by ICCC. All Commercial Mortgages originated by ICCC are offered to ICH at costs that are comparable to those available through investment bankers and other third parties. ICH invests a portion of its assets in these Commercial Mortgages, which are held in the long-term investment portfolio. Initially, the Commercial Mortgages are held in the long-term investment portfolio as Commercial Mortgages held-for-investment and are financed by short-term warehouse line agreements and capital. The Commercial Mortgages held-for- investment are used as collateral for the issuance of CMOs which provide the Company with long-term financing to fund its Commercial Mortgages. At the time CMOs are issued, the Commercial Mortgages are reflected on the balance sheet as CMO collateral with a corresponding liability referred to as CMO borrowings. Although the Company has acquired all Commercial Mortgages held in its long-term investment portfolio from ICCC, the Company can, and in the future expects to, purchase mortgage loans from third party investors for long-term investment and for resale. Finance Receivables ICH provides short-term warehouse loans to ICCC to fund the origination and acquisition of Commercial Mortgages during the time between the closing of the Commercial Mortgages to their sale or other settlement with pre-approved investors or ICH. ICCC's outstanding balances on warehouse lines appear on ICH's balance sheet as finance receivables and are structured to qualify under REIT asset tests and to generate income qualifying under the 75% gross income test. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" for a description of these warehouse lines. Investments in Mortgage-Backed Securities The Company may also acquire CMBSs and MBSs generated through its own securitization efforts as well as CMBSs and MBSs generated by third parties. In connection with the issuance of CMBSs by the Company in the form of real estate mortgage investment conduits ("REMICs"), ICH may retain the senior or subordinated securities as regular interests of a REMIC on a short-term or long- term basis. Any such retained CMBSs may include "principal only," "interest only" or residual interest securities or other interest rate or prepayment sensitive securities or investments. Any such retained securities or investments may subject the Company to credit, interest rate and/or prepayment risks. MBSs are securities that represent an interest in, or are secured by, mortgage loans. MBSs may pay fixed or floating rates of interest. MBSs generally have been structured as mortgage pass-through securities, although other structures are possible. With a typical mortgage pass-through security, payment of principal and interest on the underlying mortgages, following deduction of servicing expenses, is passed through directly to the holders of the securities. Mortgage pass-through securities represent an obligation of the issuer, secured by a pool of mortgage loans pledged as collateral for payments of principal and interest on the debt instrument. The issuer's obligation to pay principal and interest under a mortgage pass-through security is limited to the pledged collateral. MBSs generally are structured with some form of credit enhancement to protect against potential losses on the underlying mortgage loans. Credit support increases the likelihood of timely and full payment of principal and interest to the more senior class of MBSs. Because of the particular risks that accompany MBSs, the amount of such credit support may be substantial. Credit supports used in the MBS market has included issuer guarantees, reserve funds, subordinated securities (which bear the risks of default before the more senior classes of securities of the same issuer), cross-collateralization and over- collateralization. In addition to credit support, MBSs may be structured with liquidity 4 protections intended to provide assurance of timely payment of principal and interest. Such protections may include surety bonds, letters of credit and payment advance agreements. The CMBS market is newer than the residential MBS market and in terms of total outstanding principal amount of issues is relatively small compared to the total size of the market for residential MBSs. CMBSs have been issued in public and private transactions by a variety of agency and private-label issuers. CMBSs have been issued using a variety of structures, some of which were developed in the residential mortgage market, including multi-class structures featuring senior and subordinated classes. Because of the great diversity in characteristics of the Commercial Mortgages that secure CMBSs, however, such securities have unique features and characteristics. Financing The Long-Term Investment Operations is principally financed through the issuance of CMOs, short-term borrowings under warehouse line and reverse repurchase agreements, and proceeds from the sale of capital stock. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" for more information regarding the Company's financing arrangements. Collateralized Mortgage Obligations. As the Long-Term Investment Operations accumulates Commercial Mortgages in its long-term investment portfolio, the Company issues CMOs secured by such loans as a method of financing its Long-Term Investment Operations. The decision to issue CMOs will be based on the Company's current and future investment needs, market conditions and other factors. For accounting and tax purposes, the Commercial Mortgages financed through the issuance of CMOs will be treated as assets of the Company and the CMOs will be treated as debt of the Company, in situations when the CMO qualifies as a financing arrangement under Statement of Financial Accounting Standard No. 125 ("SFAS 125"). Each issuance of CMOs is expected to be fully payable from the principal and interest payments on the underlying Commercial Mortgages collateralizing such debt, any cash or other collateral required to be pledged as a condition to receiving the desired rating on the debt, and any investment income on such collateral. The Long-Term Investment Operations earns the net interest spread between the interest income on the Commercial Mortgages and the interest and other expenses associated with the CMO financing. The net interest spread may be directly impacted by the levels of prepayment of the underlying Commercial Mortgages and to the extent CMO classes have variable rates of interest, may be affected by changes in short-term interest rates. The Company believes that under prevailing market conditions an issuance of CMOs receiving other than an investment grade rating would require payment of an excessive yield to attract investors which would reduce net interest spread earned as a result of such CMO issuance. No assurance can be given that the Company will achieve the ratings it plans to seek for the CMOs. The CMOs are guaranteed for the holders by a mortgage loan insurer, giving the CMOs the highest rating established by a nationally recognized rating agency. Warehouse Line Agreements. The Company has warehouse facilities at interest rates that are consistent with the Company's financing objectives. A warehouse line agreement acts as a financing under which the Company pledges certain Commercial Mortgages as collateral to secure a short-term loan. Generally, the lender makes a loan in an amount equal to 75% to 92% of the fair market value of the pledged collateral. The Company's warehouse line agreements require the Company to pledge the collateral to be held by a third-party custodian. The Company's warehouse line agreements call for the Company to pledge cash, additional Commercial Mortgages or additional securities in the event the market value of the existing collateral declines. The terms of the warehouse line agreements stipulate that no Commercial Mortgage may be on the warehouse line agreement for more than 364 days. The interest rate is based upon one-month London interbank offered rate ("LIBOR") or Eurodollar rate plus a certain margin, depending on the type of mortgage collateral provided by the Company, and is repriced daily. In an event of default, the lender may force the liquidation of the pledged collateral subject to any bankruptcy proceeding rights and remedies available to a creditor. Reverse Repurchase Agreements. The Company also obtains reverse repurchase agreements with third-party lenders, at interest rates that are consistent with its financing objectives. Reverse repurchase agreements take the form of a sale of securities to the lender at a discounted price in return for the lender's agreement to resell the same securities to the borrower at a future date (the maturity of the borrowing) at an agreed price. A reverse repurchase agreement, although structured as a sale and repurchase obligation, acts as a financing vehicle under which the Company pledges certain mortgage loans and/or MBSs as collateral to secure a short-term loan. Generally, the other party to the agreement makes the loan in an amount equal to a percentage of the market value of the pledged collateral. At the maturity of the reverse repurchase agreement, the Company is required to repay the loan in exchange for the return of its 5 collateral. Under a reverse repurchase agreement, the Company retains the instruments of beneficial ownership, including the right to distributions on the collateral and the right to vote on matters as to which certificate holders vote. Upon a payment default under such agreements, the lending party may liquidate the collateral. The borrowing agreements may require the Company to pledge cash, additional mortgage loans or MBSs in the event the market value of the existing collateral declines. The Company may be required to sell assets to reduce its borrowings to the extent that cash reserves are insufficient to cover such deficiencies in collateral. To reduce its exposure to the potential credit risk of reverse repurchase agreement lenders, the Company enters into such agreements with different parties and follows its own credit exposure procedures. The Company monitors the financial condition of its reverse repurchase agreement lenders on a regular basis, including the percentage of mortgage loans that are the subject of reverse repurchase agreements with any single lender. Notwithstanding these measures, no assurance can be given that the Company will be able to avoid such third party risks. Other CMBSs. As an additional alternative for the financing of its Long-Term Investment Operations, the Company may issue other CMBSs, if, in the determination of the Company, the issuance of such other securities is advantageous. In particular, mortgage pass-through certificates representing an undivided interest in pools of Commercial Mortgages formed by the Company may prove to be an attractive vehicle for raising funds. The holders of CMBSs receive their pro rata share of the principal payments made on a pool of Commercial Mortgages and interest at a pass-through interest rate that is fixed at the time of offering. The Company may retain up to a 100% undivided interest in a significant number of the pools of Commercial Mortgages underlying such pass-through certificates. The retained interest, if any, may also be subordinated so that, in the event of a loss, payments to certificate holders will be made before the Company receives its payments. Unlike the issuance of CMOs, the issuance of CMBSs will not create an obligation of the Company to security holders in the event of a borrower default resulting in a short-fall in a principal or interest payment on CMBSs. However, as in the case of CMOs, the Company may be required to obtain various forms of credit enhancements in order to obtain an investment grade rating for issues of mortgage pass-through certificates by a nationally recognized rating agency. Investment Policies The executive officers of the Company are empowered to make day-to-day investment decisions, including the issuance of commitments on behalf of the Company to purchase mortgage loans and MBSs meeting the investment criteria set from time to time by the Company's Board of Directors. Other than statutory limitations imposed in order to have ICH classified as a REIT, there is no current limitation set by the Board of Directors on the percentage of assets which the Company may invest in any one type of investment or the percentage of MBSs of any one issue which the Company may acquire. It is the Company's policy to acquire assets primarily for income and to finance its operations by warehouse line and reverse repurchase agreements, issuance of CMOs and CMBSs, and proceeds from the issuance of capital stock. Conduit Operations ICCC began its mortgage conduit operations in January 1997. The Conduit Operations originates and purchases and subsequently securitizes and sells Commercial Mortgages primarily secured by first liens on commercial properties that are originated or purchased in accordance with ICCC's underwriting guidelines. As the Conduit Operations of the Company, ICCC acts as a flow originator and bulk purchaser of Commercial Mortgages. All Commercial Mortgages originated or purchased by ICCC will be made available for sale to ICH at the same price at which the loans were originated or purchased by ICCC or fair market value at the date of sale and subsequent transfer to ICH. Since ICCC's inception, ICCC has originated all Commercial Mortgages, however, ICCC can, and in the future expects to, purchase Commercial Mortgages from third party investors for long-term investment and for resale. The Company's Conduit Operations operates three divisions: the CommercialExpress Division, the ConduitExpress Division and the CondoSelect Division. CommercialExpress Division The CommercialExpress Division markets Commercial Mortgages directly to property owners who seek Commercial Mortgages to purchase a building or refinance an existing mortgage. The CommercialExpress Division offers smaller balance, primarily fixed rate, Commercial Mortgages to project owners or developers for smaller 6 properties and projects than those offered by the ConduitExpress Division. The CommercialExpress Division's standard program are fixed rate Commercial Mortgages with principal balances ranging from $500,000 to $1.5 million. The amortization schedules range from 15 to 30 years with maturities of 10 or 15 years with a substantial balloon payment due at maturity and with a maximum loan-to-value ("LTV") generally not to exceed 80%. The CommercialExpress Division also offers adjustable rate Commercial Mortgages with a principal amount between $500,000 and $1.5 million. Such adjustable rate Commercial Mortgages bear interest based on LIBOR, 1-Year constant maturity treasury index ("CMT") or prime rate index plus, in each case, a spread, with amortization schedules ranging from 15 to 30 years and maturities of 5 to 15 years with a substantial balloon payment due at maturity and with a maximum LTV generally not to exceed 80%. ICCC utilizes short-term prepayment lock-outs and prepayment penalties in order to reduce its exposure to early mortgage loan payoffs. The Commercial Mortgages offered by the CommercialExpress Division generally utilize non-negotiable loan documents and limited scope third party reports which provide more efficient underwriting and closing. Processing and funding relating to these Commercial Mortgages are performed centrally at ICCC's executive offices. The CommercialExpress Division's marketing strategy is to solicit Commercial Mortgage originations through direct mailings to selected investors in commercial and multi-family real estate, and through advertising in various forms of mass media and trade magazines. The Company believes this centralized approach to processing and closing allows the CommercialExpress Division to originate Commercial Mortgages at a competitive cost. ConduitExpress Division Correspondent Origination. The Company's ConduitExpress Division offers larger principal balance Commercial Mortgages through specified correspondents such as savings and loan associations, banks, mortgage bankers and other mortgage brokers. These Commercial Mortgages are generally for projects of larger size as compared to those funded by the CommercialExpress Division. The ConduitExpress Division's strategic focus is to be a low cost national originator, through a national correspondent network, of Commercial Mortgages to be held for long-term investment or sold in the secondary market as whole loans or securitized as CMBSs. A key feature of this approach is the use of a national network of correspondent originators, which enables the Company to shift the high fixed costs of interfacing with the property owner to such correspondents. The marketing strategy for the ConduitExpress Division is designed to accomplish three objectives: (1) attract a geographically diverse group of correspondent loan originators, (2) establish relationships with such correspondents and facilitate their ability to offer a variety of Commercial Mortgage products designed by the ConduitExpress Division and (3) purchase Commercial Mortgages and securitize and sell them in the secondary market or to ICH. The ConduitExpress Division's standard programs are adjustable and fixed rate Commercial Mortgages with principal balances ranging from $1.5 million to $10.0 million. Adjustable rate Commercial Mortgages bear interest based on LIBOR, 1-Year CMT or prime rate index plus, in each case, a spread, with amortization schedules ranging from 15 to 30 years and maturities of 5 to 15 years with a substantial balloon payment due at maturity and with a maximum LTV generally not to exceed 75%. The ConduitExpress Division offers fixed rate Commercial Mortgages with amortization schedules range from 15 to 30 years with maturities of 5, 7, 10 or 15 years with a substantial balloon payment due at maturity and with a maximum LTV generally not to exceed 75%. The division utilizes full-term prepayment lockout and prepayment penalties in order to reduce its exposure to early mortgage loan payoffs as well. Correspondents are required to meet certain financial, insurance and performance requirements established by ICCC before they are eligible to participate in its correspondent program, and must submit to periodic reviews by ICCC to ensure continued compliance with these requirements. In addition, correspondents are required to have comprehensive loan origination quality control procedures. In connection with its qualification, each correspondent enters into an agreement that generally provides for recourse by ICCC against the correspondent in the event of certain defects with respect to Commercial Mortgages sold to ICCC. All Commercial Mortgages originated through correspondents are underwritten by ICCC. Bulk Purchases. In addition to originating Commercial Mortgages on a correspondent basis, the division may purchase Commercial Mortgages in bulk packages and on a flow basis. Bulk loan purchases are in the form of complete loan packages that have been originated and underwritten by financial institutions or Commercial Mortgage brokers. All Commercial Mortgages purchased on a bulk basis will be reviewed by ICCC's underwriting staff to determine that the loan packages are complete and materially comply with the Company's underwriting guidelines. Depending on the size of the pool of Commercial Mortgages purchased, the Company may engage a third-party underwriter to underwrite the Commercial Mortgages, determine credit grade, verify the quality of the appraisal, verify the operations of the 7 property, including the Debt Service Coverage Ratios ("DSCR"), and on Commercial Mortgages with smaller balances, verify the borrower's employment status. The Company has established relationships with Commercial Mortgage brokers who are reviewed by the Company to ensure the quality and type of Commercial Mortgages originated. The Company will also analyze the financial conditions of the Commercial Mortgage brokers, including a review of the Commercial Mortgage brokers' licenses and financial statements. Upon approval, the Company expects to require Commercial Mortgage brokers to enter into a broker agreement with customary representations and warranties regarding the loans these Commercial Mortgage brokers will refer and sell to the Company. CondoSelect Division Through its CondoSelect Division, ICCC markets Commercial Mortgages directly to developers and project owners who have completed a condominium complex or the conversion of an apartment complex to a condominium complex, allowing developers and project owners to structure flexible financing on qualified condominium projects. Typical uses of the CondoSelect program are: (1) when existing financing precludes release provisions on individual units, (2) to replace existing matured loans, or (3) for acquisition financing. Commercial Mortgages offered by the CondoSelect Division are typically adjustable rate mortgages with an interest rate equal to a spread over six-month LIBOR, with an initial interest rate for the first 12 to 24 months, and are fully amortizing over a 30-year term. The typical Commercial Mortgage is between $3.0 million and $10.0 million, the current maximum LTV limits for such loans are (i) 65% of the combined retail market value of the sum of individual units and (ii) 80% of the value derived from an income approach as an apartment complex and the DSCR generally exceeds 1.25. The Company believes an opportunity has developed to finance the sale of previously constructed condominium complexes within certain geographic regions. Increases in the prices of single-family detached homes have decreased the ability of many potential first time home buyers to purchase such properties. In addition, the Company believes that rents for high quality apartments have substantially increased and vacancies for such apartments have substantially decreased. The Company believes that previously constructed condominium complexes have become an important alternative for first time buyers in certain geographic regions. In many cases tenants or third party buyers can purchase a condominium unit with a total debt service at or near their existing level of rent. These results combined with tax benefits and potential future appreciation provide a significant incentive for the first-time buyer who may be unable to afford a detached single family residence. The Company believes that these conditions provide a substantial financing opportunity. The Commercial Mortgages offered by the CondoSelect Division are designed for complete or partial condominium complexes that will be marketed to the home buying community in accordance with market demand. The final loan amount is based on both the retail value of the individual condominium unit and the current multi-family value. Each project must have a verified operating history that will provide adequate net income to cover the debt service. The CondoSelect Division offers Commercial Mortgages, which require master loan agreements that include provisions for cross-collateralization and cross-default of units within a complex. In addition, Commercial Mortgages offered by the CondoSelect Division are generally with full recourse to the sponsor/developer. The units may be released at par or on an accelerated basis depending on sales absorption, DSCRs and the integrity of sales values. DSCRs of similar income producing properties will be compared with those of the property to be financed at the time of origination of the Commercial Mortgage. The CondoSelect Division originates, underwrites, processes and funds Commercial Mortgages on a retail basis from ICCC's executive offices. Commercial Mortgage Originations In light of the deterioration of the commercial mortgage-backed securitization market during the third and fourth quarters of 1998, the Company made significant changes in its business strategy and operations. The Company's business strategy was revised to focus on the origination of smaller balance loans that have higher margins, wider spreads and more profitability. Therefore, the Company is concentrating its efforts on the origination of CommercialExpress loans and de-emphasizing the origination of ConduitExpress loans until the commercial mortgage-backed securitization market stabilizes. CommercialExpress loans are Commercial Mortgages with balances generally from $500,000 to $3.0 million while ConduitExpress loans are Commercial Mortgages with balances generally from $3.0 million to $10.0 million. While this decision resulted in lower origination balances in the third and fourth quarters of 1998, the Company anticipates better results on the subsequent sale or securitization of its loans. Historically, the 8 Company's experience has been that CommercialExpress loans have generally had better pricing in the execution of whole loan sales and structured transactions than prices received on ConduitExpress loans. A factor in the higher profitability on CommercialExpress loans is the higher interest rate margins on these loans which generally range from 100 basis points to 150 basis points more than interest rate margins on ConduitExpress loans. The credit quality of the loans originated or purchased by ICCC will vary depending upon the specific program under which such loans are originated or purchased. The following table sets forth ICCC's Commercial Mortgage originations by type and by division for the periods shown:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------ -------------------- (in millions, except for average loan size) Fixed Rate Loans: ConduitExpress Division-- Volume of Loans.......................................................... $ 233.1 $ 142.7 Percent of total volume.................................................. 54.8% 61.1% CommercialExpress Division-- Volume of Loans.......................................................... 166.9 37.6 Percent of total volume.................................................. 39.3% 16.1% CondoSelect Division-- Volume of Loans.......................................................... -- -- Percent of total volume.................................................. --% --% ----------------- ------------------ Total Fixed Rate Loans-- Volume of Loans.......................................................... $ 400.0 $ 180.3 Percent of total volume.................................................. 94.1% 77.2% Variable Rate Loans: ConduitExpress Division-- Volume of Loans.......................................................... $ 6.6 $ 16.5 Percent of total volume.................................................. 1.5% 7.1% CommercialExpress Division-- Volume of Loans.......................................................... 5.8 13.1 Percent of total volume.................................................. 1.4% 5.6% CondoSelect Division-- Volume of Loans.......................................................... 12.7 23.6 Percent of total volume.................................................. 3.0% 10.1% ----------------- ------------------ Total Variable Rate Loans-- Volume of Loans.......................................................... $ 25.1 $ 53.2 Percent of total volume.................................................. 5.9% 22.8% Total Loan Originations...................................................... $ 425.1 $ 233.5 ================= ================== Average Loan Size............................................................ $ 971,000 $ 474,000
9 ICCC's Commercial Mortgage origination and purchase activities typically focus on those regions of the country where higher volumes of Commercial Mortgages are originated. The highest concentration of Commercial Mortgages originated or purchased by ICCC relate to properties located in California because of the generally higher property values and mortgage loan balances prevalent in California. The following table sets forth the geographic distribution of ICCC's Commercial Mortgage originations for the periods shown:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ---------------------------- ------------------------------- Aggregate % of Aggregate Aggregate % of Aggregate Principal Principal Principal Principal Balance Balance Balance Balance --------- -------------- ------------ -------------- (dollars in millions) California................................... $ 183.1 43.1% $ 121.3 52.0% Arizona...................................... 59.6 14.0 13.7 5.9 Texas........................................ 47.0 11.1 16.6 7.1 Washington................................... 33.4 7.9 -- -- Ohio......................................... -- -- 27.9 11.9 Others (1)................................... 102.0 23.9 54.0 23.1 ------- ----- --------- ------- $ 425.1 100.0% $ 233.5 100.0% ======= ===== ========= =======
(1) No other state accounted for more than 5% of mortgage loans originations or acquisitions during the periods shown. Pricing ICCC establishes yield spreads at least once every business day for Commercial Mortgages it originates through its Conduit Operations based on prevailing market conditions. Different prices are established for the various types of Commercial Mortgages and rate-lock periods. ICCC's standard pricing is based on factors such as the anticipated price it would receive upon sale or securitization of such Commercial Mortgages, the anticipated interest spread realized during the accumulation period, the targeted profit margin and the anticipated issuance, credit enhancement and ongoing administrative costs associated with such sale or securitization. The credit enhancement cost component of ICCC's pricing is established for individual Commercial Mortgages or pools of Commercial Mortgages based upon the characteristics of such loans or loan pools. As the characteristics of the Commercial Mortgages or pools of Commercial Mortgages vary, this cost component is correspondingly adjusted upward or downward to reflect such variation. ICCC's adjustments are reviewed periodically by management to reflect changes in the cost of credit enhancements, see "--Securitization and Sale Process." Following the issuance of a rate-lock, ICCC is subject to the risk of interest rate fluctuations and enters into hedging transactions to minimize such risk. Hedging transactions may include, interest rate caps, floors and swaps, mandatory forward sales, mandatory or optional sales of futures and other financial futures transactions including U.S. Treasury obligations. The nature and quantity of hedging transactions are determined by the Company based on various factors, including market conditions, expected duration of the Commercial Mortgages and the expected securitization of Commercial Mortgages. Gains and losses on hedging transactions are deferred until the subsequent sale of the Commercial Mortgages. 10 Underwriting and Quality Control Origination and Purchase Guidelines. ICCC has developed comprehensive guidelines for the origination or purchase of Commercial Mortgages by the Conduit Operations. Subject to certain exceptions, each Commercial Mortgage originated or purchased must conform to program guidelines with respect to, among other things, loan amount, type of property, loan-to-value ratio, type and amount of insurance, credit history of the borrower, DSCRs, sources of funds, appraisals and loan documentation. ICCC also performs a legal documentation review prior to the origination or purchase of any Commercial Mortgage. For Commercial Mortgages that are underwritten by contract underwriters, ICCC performs a full underwriting review prior to origination or purchase. Underwriting Methods. Commercial Mortgages have maximum loan amounts and LTV's and minimum DSCRs which are determined from time-to-time by the Executive Committee of ICCC. The DSCR for any Commercial Mortgage is the ratio of net underwritable cash flows produced by the related mortgaged property compared to the monthly payment due from the borrower on such property, in most cases as underwritten by the related originator and verified by the appraiser, to the amounts of principal and interest due under such Commercial Mortgages. Generally, net underwritable cash flows for a mortgaged property equals the operating revenues for such mortgaged property minus its operating expenses, replacement reserves, tenant improvements and leasing commissions, but without giving effect to debt service, depreciation and non-recurring capital expenditures and similar items. Appraisals and field inspections, performed by outside and certified inspectors, and title insurance are required for each Commercial Mortgage. ICCC's underwriting standards under its Commercial Mortgage lending programs are primarily intended to assess the economic value of the mortgaged property and the financial capabilities, credit standing and managerial ability of the borrower. In determining whether a loan should be made, ICCC will consider, among other things, the borrower's management experience, DSCRs, the borrower's overall financial position and the adequacy of such property as collateral for the Commercial Mortgage, and ICCC will also consider the creditworthiness of the borrower, the borrower's income, liquid assets and liabilities. While the primary consideration in underwriting a Commercial Mortgage is the property securing the Commercial Mortgage and its net underwritable cash flows, sufficient documentation on the borrower is required to establish the financial strength and ability of the borrower to successfully operate the property and meet its obligations under the note and deed of trust. Generally, Commercial Mortgages from the CondoSelect Division require recourse against the related borrower in the form of a guarantee. The Commercial Mortgage lending programs require that the property and records relating to the property are inspected to determine the number of units that can be rebuilt under current zoning requirements, the number of buildings on the property, the type of construction materials used, the proximity of the property to natural hazards, flood zones and fire stations, whether there are any environmental factors and whether a tract map has been recorded. The property must front on publicly dedicated and maintained streets with provisions for an adequate and safe ingress and egress. Properties that share an ingress and egress through an easement or private road must have a recorded non-exclusive easement. Recreational facilities and amenities, if any, must be located on site and be under the exclusive control of the owner of the premises. If available, engineering reports concerning the condition of the major building components of the property are reviewed as is a ground lease analysis if the property is on leased ground. Also, the title is reviewed to determine if there are any covenants, conditions and restrictions, easements or reservations of mineral interests in the property. The properties are appraised by independent appraisers approved by ICCC. In addition to the considerations set forth above, with respect to Commercial Mortgages secured by commercial properties, ICCC's underwriting policies typically require that the usage is permitted under local zoning and use ordinances and the utilization of the commercial space is compatible with the property and neighborhood. If the property is an office building, the office building must have a stable occupancy history, must be located in a good office market area and in a conforming neighborhood and must have adequate parking. Industrial properties must be located in a conforming industrial marketplace and may not be used for the production, storage or treatment of toxic waste. Retail properties must be highly visible and located on a heavily traveled thoroughfare and typically have tenants on term leases. ICCC does not generally make loans secured by a property that has any of the following characteristics; inadequate maintenance or repairs as determined by ICCC, the property is subject to unacceptable covenants, the property is not to code or the cost of restoring the property to code is prohibitive or there is the existence of or potential for contamination by hazardous toxic materials as evidenced in environmental reports obtained by ICCC. ICCC analyzes the financial statements of the borrower to determine the borrower's equity in the mortgaged property and overall capitalization, particularly as it relates to real estate mortgage demands on equity. If the borrower's 11 other real estate holdings are heavily encumbered or consist substantially of unimproved or underimproved properties having little or no gross income so that their debt service requirements may consume a high percentage of the rental income from the mortgaged property, ICCC analyzes whether the borrower will be able to meet all of the mortgaged property's loan obligations (expenses, debt service and equity return). In addition to DSCRs, the borrower's income and expense ratios may be calculated. In addition to the income from the mortgaged property, ICCC also evaluates the borrower's income as a possible secondary source of repayment for the Commercial Mortgage. In analyzing such income, ICCC considers, among other factors, employment or business history of the borrower and the stability and seasonality of the borrower's current employment or business. If the borrower derives income from rental property, ICCC evaluates the type of tenancy and the cash flow generated by the borrower's real estate portfolio. ICCC also reviews the borrower's credit history to determine the borrower's ability and willingness to repay debts. In general, ICCC will not grant a Commercial Mortgage to a borrower who has a history of slow payments or delinquencies, bankruptcies, collection actions, foreclosures or judgments against the borrower without adequate explanations for each exception. Securitization and Sale Process General. The Conduit Operations utilizes warehouse line agreements with ICH to finance the origination and purchase of Commercial Mortgages. For a description of the terms of the Company's existing warehouse line agreements, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." When a sufficient volume of Commercial Mortgages with similar characteristics has been accumulated, generally $200 million to $300 million or more than 100 Commercial Mortgages, ICCC will securitize them through the issuance of CMBSs in the form of REMICs, sell them to ICH for the issuance of CMOs or resell them in bulk whole loan sales. The period between the time ICCC commits to purchase or originate a Commercial Mortgage and the time it sells or securitizes Commercial Mortgages generally ranges from 90 to 180 days, depending on certain factors, including the length of the purchase commitment period, the loan volume by product type and the securitization process. Any decision to form a REMIC or to sell Commercial Mortgages in bulk by ICCC is influenced by a variety of factors. REMIC transactions are generally accounted for as sales of the Commercial Mortgages and can eliminate or minimize any long-term residual investment in such loans. REMIC securities consist of one or more classes of "regular interests" and a single class of "residual interest." The regular interests are tailored to the needs of investors and may be issued in multiple classes with varying maturities, average lives and interest rates. These regular interests are predominantly senior securities but, in conjunction with providing credit enhancement, may be subordinated to the rights of other regular interests. The residual interest represents the remainder of the cash flows from the Commercial Mortgages (including, in some instances, reinvestment income) over the amounts required to be distributed to the regular interests. In some cases, the regular interests may be structured so that there is no significant residual cash flow, thereby allowing ICCC to sell its entire interest in the Commercial Mortgages. As a result, in some cases, all of the capital originally invested in the Commercial Mortgages by the Company is redeployed in the Conduit Operations. As part of its operations, the Company may retain regular and residual interests on a short-term or long-term basis. Credit Enhancement. Any REMICs or CMOs created by the Conduit Operations or the Long-Term Investment Operations are typically structured so that one or more of the classes of such securities are rated investment grade by at least one nationally recognized rating agency. In contrast to agency certificates (pass- through certificates guaranteed by the Federal National Mortgage Association ("FNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC") or the Governmental National Mortgage Association ("GNMA")) in which the principal and interest payments are guaranteed by the U.S. government or an agency thereof, securities created by the Conduit Operations or the Long-Term Investment Operations do not benefit from any such guarantee. The ratings for the Conduit Operations' REMICs or the Long-Term Investment Operations' CMOs are based upon the perceived credit risk by the applicable rating agency of the underlying Commercial Mortgages, the structure of the securities, and the associated level of credit enhancement. Credit enhancement is designed to provide protection to the security holders in the event of borrower defaults and other losses including those associated with fraud or reductions in the principal balances or interest rates on Commercial Mortgages as required by law or a bankruptcy court. The Conduit Operations or the Long-Term Investment Operations typically utilizes multiple forms of credit enhancement, including special hazard insurance, letters of credit, over-collateralization and subordination or any combination thereof. In determining whether to provide credit enhancement through subordination or other credit 12 enhancement methods, the Conduit Operations and the Long-Term Investment Operations take into consideration the costs associated with each method. Each series of CMBSs is typically fully payable from the mortgage assets underlying such series, and the recourse of investors is limited to such assets and any associated credit enhancement features, such as senior/subordinated structures. To the extent the Company holds subordinated securities, a form of credit enhancement, the Company generally bears all losses prior to the related senior security holders. Generally, any losses in excess of the credit enhancement obtained are borne by the security holders. Except in the case of a breach of the standard representations and warranties made by the Company when Commercial Mortgages are securitized, such securities are non-recourse to the Company. Typically, the Company has recourse to the correspondents of Commercial Mortgages for any such breaches, but there are no assurances of the correspondent's abilities to honor their respective obligations. Ratings of CMBSs are based primarily upon the characteristics of the pool of underlying Commercial Mortgages and associated credit enhancements. A decline in the credit quality of such pools (including delinquencies and/or credit losses above initial expectations), or adverse developments in general economic trends affecting real estate values or the mortgage industry, could result in downgrades of such ratings. Servicing ICCC generally originates Commercial Mortgages and retains servicing rights due to its belief that control over the servicing and collection functions with respect to such Commercial Mortgages is important to the realization of a satisfactory return. ICCC also acts as the servicer for all loans purchased by the Long-Term Investment Operations. ICCC has contracted with independent third parties, pursuant to sub-servicing agreements, (the "Sub-Servicing Agreements"), for the performance of its servicing functions. While ICCC expects to have its loans sub-serviced by others, ICCC may be retained for special servicing on the securities it issues. As part of this process, ICCC may in the future form a separate collection group to assist sub-servicers in the servicing of these Commercial Mortgages. ICCC has established guidelines for the servicing of mortgage loans and for monitoring the performance of other loan servicers which service mortgage loans for the Company. Servicing includes collecting and remitting loan payments, making required advances, accounting for principal and interest, holding escrow or impound funds for payment of taxes and insurance, making required inspections of the mortgaged property, contacting delinquent borrowers and supervising foreclosures and property dispositions in the event of unremedied defaults in accordance with the Company's guidelines. The following table sets forth certain information regarding ICCC's servicing portfolio of loans for the periods shown:
Period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------ ------------------ (dollars in millions, except for average loan size) Beginning servicing portfolio.............................................. $ 169.2 $ -- Loans added to the servicing portfolio..................................... 425.1 251.1 Loans sold servicing released and principal paydowns (1)................... (215.3) (81.9) ---------- --------- Ending servicing portfolio................................................. $ 379.0 $ 169.2 ========== ========= Number of loans serviced................................................... 443 559 Average loan size.......................................................... $ 856,000 $ 303,000 Weighted average interest rate............................................. 8.09% 8.45%
_______________ (1) Includes normal principal amortization and prepayments. ICCC currently originates or purchases all of its mortgage loans on a "servicing released" basis and thereby acquires the servicing rights. Mortgage loans purchased on a servicing released basis are unencumbered by any obligation on the part of the party purchasing the mortgages to pay a fee to a third party to service the mortgage loans. The rights of any party to service mortgage loans for a fee are commonly referred to as "mortgage servicing rights" or "MSRs." ICCC subcontracts all of its servicing obligations under Commercial Mortgages originated or purchased on a "servicing released basis" pursuant to the Sub- Servicing Agreements with terms that are in accordance with ICCC's 13 guidelines, the Commercial Mortgage documents, customary and usual standards for servicers of Commercial Mortgages and applicable laws. Commercial Mortgage servicing fees paid to these sub-servicers generally range from 0.03% to 0.25% per annum on the declining principal balances of the loans sub-serviced or an amount based on the type and number of loans serviced. Each sub-servicer is required to pay all expenses related to the performance of its duties under the Sub-Servicing Agreements. Each Sub-Servicing Agreement is cancelable by either party upon giving notice. The Company believes that the terms of the Sub- Servicing Agreements are comparable to industry standards. ICCC may terminate a Sub-Servicing Agreement with any subservicer upon the occurrence of one or more of the events specified in the Sub-Servicing Agreements. Such events generally relate to the sub-servicer's proper and timely performance of its duties and obligations under the Sub-Servicing Agreement and the sub-servicer's financial stability. In addition, ICCC has the right to terminate any Sub-Servicing Agreement with respect to any or all of the Commercial Mortgages sub-serviced thereunder, without cause upon 30 to 90 days' notice and may require a termination fee that is comparable to termination fees generally found in the industry. If required, the termination fee will be based on the aggregate outstanding principal amount of the Commercial Mortgages serviced under the Sub-Servicing Agreement. Each Sub-Servicing Agreement provides that the sub-servicer may not assign any of its rights or obligations with respect to the Commercial Mortgages serviced for ICCC without ICCC's consent. With respect to Commercial Mortgages that support CMOs or CMBSs, ICCC may not be able to terminate a sub-servicer without the approval of the trustee or bond insurer for such securities. In the future, ICCC may offer its correspondents of Commercial Mortgages the opportunity to retain commercial mortgage servicing rights to the Commercial Mortgages sold by them to the Company, but only to the extent that it is consistent with ICH's classification as a REIT. Each servicer will enter into an agreement with the Company to service the Commercial Mortgages for ICCC in accordance with ICCC's guidelines, the Commercial Mortgage documents, customary and usual standards for servicers of Commercial Mortgages and applicable laws (the "Servicing Agreements"). The Company believes that the terms of these Servicing Agreements will be comparable to industry standards. The Company issues CMBSs or CMOs backed by the Commercial Mortgages it originates or purchases through its Conduit Operations or Long-Term Investment Operations. When CMBSs or CMOs are issued, a trust is created, and Commercial Mortgages are deposited into the trust for the benefit of the holders of the securities. When the trust is created, the loan servicing function for the Commercial Mortgages deposited into the trust are commonly divided into two areas of responsibility: master servicing and special servicing. The trustee and the depositor of the Commercial Mortgages enter into an agreement, typically called a pooling and servicing agreement, with one or more parties who will assume the responsibilities for master servicing and special servicing. Master servicing generally includes all of the servicing activities associated with non-defaulted Commercial Mortgages which typically includes collecting and remitting loan payments, making required advances, accounting for principal and interest, holding escrow impound or reserve funds for payment of taxes and insurance, making inspections or improvements of the mortgaged property, and remitting funds and reporting to the trustee. Special servicing generally includes managing all loan default matters and other more complicated issues associated with the servicing of the loans. Special servicing generally includes contacting delinquent borrowers and supervising foreclosures and property dispositions in the event of borrower defaults which are not remedied. Special servicing also includes overseeing condemnation issues, insurance claims for casualty losses on collateral property and other matters of this nature. ICCC contracts with qualified Commercial Mortgage master servicers to assume the master servicing and special servicing roles. In the future, the Company may act as special servicer. The Company believes that acting as special servicer will allow it to monitor and manage those matters of significant risk associated with the Commercial Mortgages. In this manner, the Company believes it will be best positioned to protect any beneficial interest it may retain in the trusts it creates. However, the Company reserves the right to act as either the master servicer, the special servicer, both or neither in the future. When ICCC purchases Commercial Mortgages that include the associated Commercial Mortgage servicing rights ("CMSRs") or originates Commercial Mortgages, the allocated cost of the servicing rights will be reflected on its financial statements as CMSRs. CMSRs will be amortized in proportion to, and over the period of, expected future net servicing income. SFAS No. 125 requires that a portion of the cost of originating or purchasing a mortgage loan be allocated to the mortgage loan servicing rights based on its fair value relative to the fair value of the components of the loan. To determine the fair value of the servicing rights created, ICCC uses a valuation model that calculates the present value of future net servicing revenues to determine the fair value of the servicing rights. In using this valuation method, ICCC incorporates assumptions that it believes market participants would use in estimating future net servicing income which include estimates of the cost of servicing or sub- servicing, an inflation rate, ancillary income per Commercial 14 Mortgage, a prepayment rate, loss severity, a default rate and a discount rate commensurate with the risks involved. During periods of declining interest rates, prepayments on mortgage loans increase as borrowers look to refinance at lower rates, resulting in a decrease in the value of the mortgage loan servicing portfolio. Mortgage loans with higher interest rates are more likely to result in prepayments. Regulation The rules and regulations applicable to the Conduit Operations, among other things, prohibit discrimination and establish underwriting guidelines that include provisions for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. Additionally, there are various state and local laws and regulations affecting the Conduit Operations. ICCC is licensed in those states requiring such a license. Mortgage operations also may be subject to applicable state usury statutes. The Company believes it is presently in material compliance with all material rules and regulations to which it is subject. Competition In originating Commercial Mortgages and issuing CMBSs, the Company competes with established mortgage conduit programs, investment banking firms, savings and loan associations, banks, thrift and loan associations, finance companies, mortgage bankers, insurance companies, other lenders and other entities purchasing mortgage assets. CMBSs issued by the Conduit Operations and CMOs issued by the Long-Term Investment Operations face competition from other investment opportunities available to prospective investors. The Company faces competition in its Conduit Operations from other financial institutions, including but not limited to banks and investment banks. Many of the institutions with which the Company competes in its Conduit Operations have significantly greater financial resources than the Company. Other multifamily residences, self-storage facilities, retail shopping facilities, office buildings and combination warehouse/industrial facilities located in the areas of the mortgaged properties securing the Company's Commercial Mortgages compete with the mortgaged properties of such types to attract residents, retail correspondents, tenants and customers. The leasing of real estate is highly competitive. The principal means of competition are price, location and the nature and condition of the facility to be leased. A borrower under a Commercial Mortgage competes with all lessors and developers of comparable types of real estate in the area in which the mortgaged property is located. Such lessors or developers could have lower rentals, lower operating costs, more favorable locations or better facilities. While a borrower under a Commercial Mortgage may renovate, refurbish or expand the mortgaged property to maintain it and remain competitive, such renovation, refurbishment or expansion may itself entail significant risk. Increased competition could adversely affect income from the market value of the mortgaged properties. In addition, the business conducted at each mortgaged property may face competition from other industries and industry segments. In acquiring residential loans and residential mortgage-backed securities, the Company will compete with other REITs, investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, and other entities purchasing mortgage assets, most of which have greater financial resources than the Company. The existence of these competitors may increase competition for the available supply of residential mortgage assets suitable for purchase by the Company. Increased competition for the acquisition of eligible residential mortgage assets or a diminution in the supply could result in higher prices and, thus, lower yields on such residential mortgage assets. Employees All employees and operating management of the Company are employees of ICCC. As of December 31, 1998, ICCC had approximately 48 employees, as compared to approximately 50 employees at December 31, 1997. The Company believes that relations with its employees are good. The Company is not a party to any collective bargaining agreement. Risk Factors In addition to the other information in the Form 10-K, the following factors should be considered in evaluating the Company and its business. 15 Current Conditions of Mortgage Industry Adversely Affect Our Liquidity and Our Ability to Pay Dividends We must access liquidity to continue our operations, grow our asset base and pay dividends. We have traditionally derived our liquidity from three sources: . financing facilities provided to us by others to acquire mortgage assets; . whole loan sales and securitizations of acquired mortgage loans, and . sales of equity securities. Margin Calls on Financing Facilities Have Adversely Affected Our Operations and Resulted in Losses Until recently, we have not had difficulty in obtaining favorable financing facilities or in selling acquired mortgage loans. However, recently the mortgage industry has experienced substantial turmoil as a result of a lack of liquidity in the secondary markets. Investors have expressed unwillingness to purchase interests in securitizations due in part to: . higher than expected credit losses on many companies' securitization interests, and . the widening of returns expected by institutional investors on securitization interests over the prevailing Treasury rate. As a result, many mortgage loan originators, including our company, have been unable to access the securitization market on favorable terms and some other companies have declared bankruptcy. Originators have been required to sell loans on a whole loan basis and liquidate holdings of mortgage-backed securities to repay financing facilities. However, the large influx of loans available for sale on a whole loan basis has affected the pricing offered for these loans which in turn has reduced the value of the collateral underlying the financing facilities. Therefore, many providers of financing facilities have initiated margin calls. Margin calls result when our lenders evaluate the market value of the collateral securing our financing facilities and require us to provide them with additional equity or collateral to secure our borrowings. Late in the third quarter and in the fourth quarter of 1998, we experienced substantial margin calls on borrowings secured by mortgage loans and mortgage backed securities which we were unable to sell through securitizations. We delayed the payment of our third quarter dividend and sold mortgage-backed securities and mortgage loans on a whole loan basis as a result of these margin calls. We did not declare a dividend for the fourth quarter of 1998. Future margin calls will adversely affect our ability to pay dividends in future periods. Our financing facilities are short-term borrowings. Due to the turmoil in the mortgage industry, many traditional providers of financing facilities have been unwilling to provide facilities on favorable terms or at all. If we cannot renew or replace maturing borrowings, we will have to sell on a whole loan basis the loans securing these facilities and, depending upon market conditions, these sales may result in substantial losses. Deterioration of Secondary Market Has Adversely Affected Our Operations If we cannot profitably securitize or sell on a whole loan basis a sufficient number of our mortgage loans in a particular financial reporting period, then our revenues for such period will decline. As a result of turmoil in the securitization market, many mortgage lenders, including our company, have been required to sell mortgage loans on a whole loan basis under adverse market conditions in order to generate liquidity. Many of these sales were made at prices lower than our carrying value of the mortgage loans and we experienced losses. We cannot assure you that we will be able to continue to sell our loans on a whole loan basis profitably or at all. Gains on sales from our securitizations have historically represented most of our earnings. Our ability to complete securitizations is dependent upon general conditions in the securities and secondary markets and the credit quality of the mortgage loans. We are currently unable to profitably access the securitization market to sell our loans. To improve liquidity and to meet our obligations to our financing sources, we were required to sell our mortgage assets. Our future cash flows will be negatively impacted if the turmoil in the mortgage-backed securities market continues and by the elimination of the cash flows that would have been realized from the securities that are sold. In addition, delays in closing sales of our loans increase our risk by increasing the warehousing period for the loans, further exposing our company to credit risk. If we continue to be unable to profitably complete securitizations or whole loan sales, we will be required to utilize other sources of financing which may be on less favorable terms or not 16 available to all. These trends may continue to adversely affect our operations and our ability to pay dividends in the future. Inability to Access Capital Markets and Generate Liquidity will Continue to Adversely Affect Our Operations and May Result in Losses We do not believe our current operating cash flows are sufficient to fund our lending activities and the growth of our mortgage assets, to pay cash dividends at historical levels. We continue to explore alternatives for increasing our liquidity through additional asset sales and capital raising efforts. However, we cannot assure you that any of these alternatives will be available to us, or if available, that we will be able to negotiate favorable terms. If we cannot raise cash by selling debt and equity, we may be forced to sell our assets at unfavorable prices or discontinue various business activities. Our inability to access the capital markets will have a negative impact on our earnings and ability to pay dividends. REIT provisions of the Internal Revenue Code require us to distribute to our stockholders substantially all of our taxable income. These provisions restrict our ability to retain earnings at our long term-investment operations and renew capital for our business activities. We may decide in future periods not to be treated as a REIT which would cause us to be taxed at the corporate level and to cease paying regular dividends. Also, to date a large portion of our dividends to stockholders consisted of distributions by our conduit operations subsidiary to our long-term investment operations entity. However, our conduit operations was not and is not required under the REIT provisions to make these distributions. Since we are trying to retain earnings for future growth and due to liquidity concerns, we may not cause our conduit operations subsidiary to make these distributions in the future. This would materially affect the amount of dividends, if any, paid by us to our stockholders. Our Prior History is Not Reflective of Future Performance Our historical financial performance is of limited relevance in predicting our future performance. We began our operations in January 1997. Although our mortgage loan originations and total revenues have grown substantially, we had a net loss for the year ended December 31, 1998. We believe that our origination levels and profitability will continue to be adversely affected if the turmoil in the mortgage industry continues. Our future operating results will depend largely upon our ability to expand our long-term investment operations and our conduit operations. We cannot assure you that we will be able to successfully grow or that our operations will be profitable in the future. We cannot assure you that any prior rates of growth can be sustained or that they are indicative of future results. It is unlikely that any of our future dividends will be equal to or more than those dividends we have paid in the past. The loans we purchased to date and included in our securitizations have been outstanding for a relatively short period of time and our delinquency and loss experience to date may not be indicative of future results. It is unlikely that we will be able to maintain our delinquency and loan loss ratios at their present levels as our portfolio becomes more seasoned. Our Borrowings and Substantial Leverage May Cause Losses Risks of Use of Collateralized Mortgage Obligations To grow our investment portfolio, we borrow a substantial portion of the market value of substantially all of our investments in mortgage loans and mortgage-backed securities. We currently prefer to use collateralized mortgage obligations as financing vehicles to increase our leverage, since mortgage loans held for collateralized mortgage obligation collateral are retained for investment rather than sold in a secondary market transaction. Retaining mortgage loans as collateralized mortgage obligation collateral exposes our operations to greater credit losses than the use of securitization techniques that are treated as sales. In creating a collateralized mortgage obligation, we make a cash equity investment to fund collateral in excess of the amount of the securities issued. If we experience credit losses on the pool of loans subject to the collateralized mortgage obligation greater than we expected, the value of our equity investment decreases and we would have to adjust the value of the investment in our financial statements. 17 Renewal Risks of Financing Facilities We rely on short-term borrowings to purchase long-term mortgage loans and mortgage-backed securities. If we cannot renew or replace borrowings that are about to expire, we may have to sell all or a portion of these loans and investment securities. We could incur losses in this event depending upon market conditions. In addition, we may have to terminate hedge positions, which could result in further losses. Cost of Borrowings May Exceed Return on Assets The cost of borrowings under our financing facilities corresponds to a referenced interest rate plus or minus a margin. The margin varies depending on factors such as the nature and liquidity of the underlying collateral and the availability of financing in the market. We will experience net interest losses if the returns on our assets financed with borrowed funds fail to cover the cost of our borrowings. Default Risks Under Financing Facilities If we default under our collateralized borrowings, our lenders could force us to liquidate the collateral. If the value of the collateral is less than the amount borrowed, we would be required to pay the difference in cash. If we were to declare bankruptcy, some of our reverse repurchase agreements may obtain special treatment and our creditors would then be allowed to liquidate the collateral without any delay. On the other hand, if a lender with whom we have a reverse repurchase agreement declares bankruptcy, we might experience difficulty repurchasing our collateral, or enforcing our claim for damages, and it is possible that our claim could be repudiated and we could be treated as an unsecured creditor. If this occurs, our claims would be subject to significant delay and we may receive substantially less than our actual damages. Risk of Lack of Return of Investment on Liquidation We have pledged a substantial portion of our assets to secure the repayment of collateralized mortgage obligations issued in securitizations, our financing facilities or other borrowings. We will also pledge substantially all of our current and future commercial mortgages to secure borrowings pending their securitization or sale. The cash flows we receive from our investments that have not yet been distributed, pledged or used to acquire commercial mortgages or other investments may be the only unpledged assets available to our unsecured creditors and you if our company were liquidated. Interest Rate Fluctuations May Adversely Affect Our Operating Results Our operations may be adversely affected by rising and falling interest rates. Higher interest rates may discourage potential borrowers from refinancing mortgages or borrowing to purchase or expand commercial property. This may decrease the amount of mortgages available to be acquired by our conduit operations. If short-term interest rates exceed long-term interest rates, there is a higher risk of increased loan prepayments, as borrowers may seek to refinance their mortgage loans at lower long-term interest rates. Increased loan prepayments could lead to a reduction in the number of loans we service, the fees we receive for loan servicing and our loan servicing income. We are subject to the risk of rising mortgage interest rates between the time we commit to purchase commercial mortgages at a fixed price and the time we sell or securitize those mortgages. An increase in interest rates will generally result in a decrease in the market value of commercial mortgages that we have committed to purchase at a fixed price, but have not yet sold or securitized. Risks of Repricing of Assets and Liabilities Our principal source of revenue is net interest income or net interest spread, which is the difference between the interest we earn on our interest earning assets and the interest we pay on our interest bearing liabilities. The rates we pay on our borrowings are independent of the rates we earn on our assets and may be subject to more frequent periodic rate adjustments. Therefore, we could experience a decrease in net interest income or a net interest loss because the interest rates on our borrowings could increase faster than the interest rates on our assets. If our net interest spread becomes negative, we will be paying more interest on our borrowings than we will be earning on our assets and we will be exposed to a significant risk of loss. 18 Additionally, the rates paid on our borrowings and the rates received on our assets may be based upon different indices (i.e., LIBOR, U.S. Treasuries, etc.). If the index used to determine the rate on our borrowings increases faster than the index used to determine the rate on our assets, we will experience a declining net interest spread which will have a negative impact on our profitability and may result in losses. Risks of Adjustable Rate Mortgages A significant portion of the mortgage assets held by our long-term investment operations are adjustable rate mortgages or bear interest based upon short-term interest rate indices. We generally fund these mortgage assets with borrowings. To the extent that there is a difference between the interest rate index used to determine the interest rate on our adjustable rate mortgage assets and the interest rate index used to determine the borrowing rate for our related financing, our business may be negatively impacted. Interest Rate Caps Adjustable rate mortgages typically have interest rate caps which limit interest rates charged to the borrower during any given period. Our borrowings are not subject to similar restrictions. In a period of rapidly increasing interest rates, the interest rates we pay on our borrowings could increase without limitation, while the interest rates we earn on our adjustable rate mortgage assets would be capped. If this occurs, our net earnings could be significantly reduced or we could suffer a net interest loss. Payment Caps Some of our adjustable rate mortgages may be subject to payment caps meaning some portion of the interest accruing on the mortgage is deferred and added to the outstanding principal. Our borrowings do not have similar provisions. This could cause us to receive less cash on our adjustable rate assets than the interest due on our related borrowings. Also, the increased principal amount outstanding as a result of interest deferral may result in a higher rate of defaults on these loans. Our Quarterly Operating Results May Fluctuate Our results of operations, and more specifically our earnings, may significantly fluctuate from quarter to quarter based on several factors, including: . changes in the amount of loans we originate; . differences between our cost of funds on borrowings and the average interest rates earned on our loans; . inability or decisions not to complete significant bulk whole loan sales or securitizations in a particular quarter, and . problems generally affecting the mortgage loan industry. A delay in closing a particular mortgage loan sale or securitization would also increase our exposure to interest rate fluctuations by lengthening the period during which our variable rate borrowings under our warehouse facilities are outstanding. If we were unable to sell a sufficient number of mortgage loans at a premium during a particular reporting period, our revenues for that period would decline, which could have a material adverse affect on our operations. As a result, our stock price could also fluctuate. Our Share Prices Have Been and May Continue to be Highly Volatile The market price of our common stock has been extremely volatile. During the third quarter of 1998 our stock reached a high of $11.63 and a low of $1.81. On December 31, 1998, the closing sale price was $5.38. The market price of our common stock is likely to continue to be highly volatile and could be significantly affected by factors including: . availability of liquidity; . volatility in the securitization market; . whole loan sale pricing; . margin calls by warehouse lenders; . actual or anticipated fluctuations in our operating results; 19 . interest rates; . prepayments on mortgages; . valuations of securitization related assets; . cost of funds, and . general market conditions. In addition, significant price and volume fluctuations in the stock market have particularly affected the market prices for the common stocks of specialty finance companies such as ours. These broad market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. If our results of operations fail to meet the expectations of securities analysts or investors in a future quarter, the market price of our common stock could also be materially adversely affected. Prepayments of Commercial Mortgages May Adversely Affect Our Operations To reduce our exposure on prepayment, we generally prohibit our commercial mortgage borrowers (other than condo-conversions and other multi-family properties) from prepaying the mortgage for a period of time and penalize the borrowers for early prepayment. However, mortgage prepayment rates vary from time to time which may change the amount of our net interest income. Mortgage prepayments generally increase when fixed mortgage interest rates fall below the then-current interest rates on outstanding adjustable rate mortgage loans. Prepayments on mortgage loans are also affected by the terms and credit grades of the loans and general economic conditions. Most of our adjustable rate mortgages and those backing mortgage-backed securities are originated within six months of the time we purchased the mortgages and generally bear initial interest rates which are lower than their "fully-indexed" amount (the applicable index plus the margin). If we acquire these mortgages at a premium and they are prepaid prior to or soon after the time of adjustment to a fully-indexed rate, we would not have received interest at the fully-indexed rate during such period. This means we would lose the opportunity to earn interest at that rate over the expected life of the mortgage. Also, if prepayments on our adjustable rate mortgage loans increase when interest rates are declining, our net interest income may decrease if we cannot reinvest the prepayments in mortgage assets bearing comparable rates. Such prepayment restrictions can, but do not necessarily, provide a deterrent to prepayments. In addition, the borrower on a commercial mortgage may not be able to pay all or a portion of any required prepayment charges. This may occur where the prepayment results from acceleration of the commercial mortgage following a payment default. At the time any prepayment charges are required to be made in connection with a defaulted commercial mortgage, foreclosure proceeds may not be sufficient to make such payments. We also do not know that the obligation to pay such prepayment charge will be enforceable under applicable law. We currently acquire mortgages on a "servicing released" basis, meaning we acquire both the mortgages and the rights to service them. This strategy requires us to pay a higher purchase price or premium for the mortgages. If any mortgage loans that we acquired at a premium are prepaid, generally accepted accounting principles require us to immediately write off any remaining capitalized premium amount, which would decrease our interest income. Value of Our Portfolio of Mortgage-Backed Securities May be Adversely Affected We invest in mortgage-backed securities known as "interest-only," "principal- only," residual interest and subordinated securities. These securities are either created through our own securitizations or those of third parties. Investments in residual interest and subordinated securities are much riskier than investments in senior mortgage-backed securities because these subordinated securities bear all credit losses prior to the related senior securities. On a percentage basis, the risk associated with holding residual interest and subordinated securities is greater than holding the underlying mortgage loans directly due to the concentration of losses in the subordinated securities. We estimate future cash flows from these securities and value them utilizing assumptions based in part on projected discount rates, mortgage loan prepayments and credit losses. If our actual experience differs from our assumptions, we would be required to reduce the value of these securities. The market for our asset-backed securities is extremely limited and we cannot assure you that we could sell these securities at their reported value or at all or that we could recoup our initial investment. 20 We also bear the risk of loss on any mortgage-backed securities we purchase in the secondary mortgage market. If third parties have been contracted to insure against these types of losses, we would be dependent in part upon the creditworthiness and claims paying ability of the insurer and the timeliness of reimbursement in the event of a default on the underlying obligations. The insurance coverage for various types of losses is limited, and we bear the risk of any losses in excess of the limitation or outside of the insurance coverage. In addition, we may not obtain our anticipated yield or we may incur losses if the credit support available within certain mortgage-backed securities is inadequate due to unanticipated levels of losses, or due to difficulties experienced by the credit support provider. If we encounter delays or difficulties in servicing mortgage-backed securities, it may cause greater losses and, therefore, greater resort to credit support than was originally anticipated, and may cause a rating agency to downgrade certain classes of our securities. The commercial mortgage-backed security market is newer and has a relatively small amount of total outstanding principal amount of issues compared to the market for residential mortgage-backed securities. Thus, rating agencies have not had substantial experience over a long period through different economic cycles in assigning ratings to commercial mortgage-backed securities or monitoring previously rated commercial mortgage-backed securities. Difficulties encountered in servicing may cause a rating agency to reevaluate or downgrade the credit quality of an issue of commercial mortgage-backed securities. We May Undertake Additional Risks by Depending on Securitizations Potential Losses Related to Recourse Obligations Mortgage-backed securities issued in connection with our securitizations have been non-recourse to us, except in the case of a breach of standard representations and warranties made by us when the loans are securitized. While we have recourse against the sellers of mortgage loans, we cannot assure you that they will honor their obligations. We also engaged in bulk whole loan sales pursuant to agreements that provide for recourse by the purchaser against us. In some cases, the remedies available to a purchaser of mortgage loans from us are broader than those available to us against those who sell us these loans. If a purchaser exercises its rights against us, we may not always be able to enforce whatever remedies we may have against our sellers. Dependence on Securitizations for Liquidity We rely significantly upon securitizations to generate cash proceeds to repay borrowings and to create credit availability. Gains on sales from our securitizations represent a significant portion of our earnings. Several factors are expected to affect our ability to complete securitizations of our commercial mortgages, including: . conditions in the securities markets; . the credit quality of the commercial mortgages originated or purchased by our conduit operations; . the volume of our commercial mortgage originations and purchases, and . our ability to obtain credit enhancement. If we were unable to securitize profitably a sufficient number of our commercial mortgages in a particular financial reporting period, then it could result in lower income or a loss for that period. During the fourth quarter of 1998, we did not perform any securitizations. Any reduction in our ability to complete securitizations would require us to utilize other sources of financing which may be on less favorable terms. First Loss Risk Securities The market for first loss risk securities (securities that first take a loss when mortgages are not paid by the borrowers) is generally limited. In connection with our securitizations, we will endeavor to sell all securities subjecting us to a first loss risk. If we cannot sell these securities, then we may be required to hold them for an extended period, subjecting us to a first loss risk. 21 Risk in Reduction in Demand for Commercial Mortgages If we cannot obtain a sufficient amount of commercial mortgages meeting our criteria, our operations will be adversely affected. The availability of these commercial mortgages is dependent in part upon the size and level of activity in the commercial and multifamily real estate lending market which is affected by: . interest rates; . regional and national economic conditions; . fluctuations in commercial and multifamily property values, and . general regulatory and tax developments. If our mortgage loan purchases decrease, we will have: . decreased economies of scale; . higher origination costs per loan; . reduced fee income; . smaller gains on the sale of commercial mortgages, and . an insufficient volume of loans to effect securitizations which requires us to accumulate loans over a longer period. The Value of our Mortgage Servicing Rights is Subject to Adjustment When we purchase loans that include the associated servicing rights, the allocated cost of the servicing rights is reflected on our financial statements as mortgage servicing rights. To determine the fair value of these servicing rights, we use assumptions to estimate future net servicing income including projected discount rates, mortgage loan prepayments and credit losses. If actual prepayments or defaults with respect to loans serviced occur more quickly than we originally assumed, we would have to reduce the carrying value of our mortgage servicing rights. We do not know if our assumptions will prove correct. Our Operating Results Will be Affected by the Results of Our Hedging Activities To offset the risks associated with our conduit operations, we enter into transactions designed to hedge our interest rate risks. To offset the risks associated with our long-term investment operations, we attempt to match the interest rate sensitivities of our adjustable rate mortgage assets held for investment with the associated financing liabilities. Our management determines the nature and quantity of the hedging transactions based on various factors, including market conditions and the expected volume of commercial mortgage loan originations and purchases. We do not limit management's use of certain instruments in such hedging transactions. Although our hedging program currently qualifies for hedge accounting under generally accepted accounting principles, we cannot assure you that our hedging transactions will offset our risks of loss, and we could incur significant losses. Our Delinquency Ratios and Our Performance May be Adversely Affected by the Performance of Parties Who Sub-Service Our Loans We contract with third-party sub-servicers for the sub-servicing of all our mortgage loans, including those in our securitizations, and our operations are subject to risks associated with inadequate or untimely servicing. Poor performance by a sub-servicer may result in greater than expected delinquencies and losses on our loans. A substantial increase in our delinquency or foreclosure rate could adversely affect our ability to access the capital and secondary markets for our financing needs. Also, with respect to loans subject to a securitization, greater delinquencies would adversely impact the value of any "interest-only," "principal-only" and subordinated securities we hold in connection with that securitization. In a securitization, relevant agreements permit us to be terminated as servicer under specific conditions described in those agreements, such as the failure of a sub-servicer to perform certain functions within specific time periods. If, as a result of a sub-servicer's failure to perform adequately, we were terminated as servicer of a securitization, the value of any servicing rights held by us would be adversely impacted. 22 Costs of Compliance with Americans with Disabilities Act of 1990 May Be Substantial Under the Americans with Disabilities Act of 1990 all public accommodations are required to meet certain federal requirements related to access and use by disabled persons. If a mortgaged property securing one of our commercial mortgages does not comply with the Disabilities Act, we, or the borrower, as the case may be, is likely to incur costs of complying with the Act. In addition, noncompliance could result in the imposition of fines by the federal government or an award of damages to private litigants. Risks of Originating and Investing in Mortgages and Commercial Mortgages General Risk of Borrower Defaults During the time we hold commercial mortgages for investment we are subject to risks of borrower defaults, bankruptcies and losses that are not covered by insurance (such as those occurring from earthquakes or floods). Commercial mortgage lending is generally viewed as a greater risk than residential mortgage lending partly because it typically involves larger loans. Further, the repayment of commercial mortgages secured by income-producing properties is typically dependent upon the tenant's ability to meet its obligations under the lease relating to the property. A borrower default may subject us to a loss on the mortgage. Defaulted commercial mortgages will also cease to be eligible collateral for borrowings, and they we will have to be financed out of other funds until they are ultimately sold. Profitability of Property Profits of commercial properties are dependent on the performance and viability of the property. The property manager is responsible for: . responding to changes in the local market; . planning and implementing the rental structure, and . advising the borrower so that maintenance and capital improvements can be carried out in a timely fashion. All of these factors may impact the borrower's ability to make payments under the commercial mortgage, which may adversely affect the timing and amount of payments we receive with respect to the commercial mortgages. Foreclosure Commercial mortgages generally are non-recourse to the borrower. In the event of foreclosure on a commercial mortgage, we may experience a loss if the value of the property and other collateral securing the commercial mortgage is less than the unpaid amount on the mortgage. Also, we may experience costs and delays involved in enforcing rights of a property owner against tenants in default under the terms of their leases. These factors may adversely affect the timing and amount of payment we receive on foreclosed commercial mortgages. The Value of Our Commercial Mortgages May Be Adversely Affected Due to the Underlying Commercial Properties A borrower's ability to meet its obligations under a commercial mortgage is affected by several factors. These factors include the ability to lease, renew and relet the space, regional and national economic conditions, increased costs of operating a property and the following: Multifamily Properties: . construction of additional housing units; . local military base closings; . current or future rent stabilization and rent control laws, and . the level of mortgage interest rates which may encourage tenants to purchase homes. Retail, Office and Industrial Properties: . tenants' inability to meet lease obligations; . bankruptcy of a tenant; 23 . decline in sales in the retail properties; . delays in enforcing the lessor's rights; . costs associated with reletting; . health of the retail industry; . operations of an anchor tenant; . a shift in consumer demand due to demographic changes; . changes in consumer preference; . dependency on a single tenant; . a significant concentration of tenants in a particular business or industry; . cash for general capital improvements, and . reduced demand for industrial space or decline in a particular industry segment. Self-Storage Facilities: . low acquisition costs and break-even occupancy; . conversion of self-storage facilities requiring substantial improvements and repairs; . decreased demand; . increased competition; . the liquidation value, and . environmental risks. Congregate Care Facilities: . significant governmental regulation of the ownership, operation, maintenance and financing. Geographic Concentration of Mortgage Loans Has Higher Risks We do not set limitations on the percentage of our mortgage asset portfolio composed of properties located in any one area (whether by state, zip code or other geographic measure). Concentration in any one area increases our passive exposure to the economic and natural hazard risks associated with that area. We estimate that a high concentration of the loans included in securitizations in which we hold subordinated interests are secured by properties in California. Certain parts of California have experienced an economic downturn in past years and have suffered the effects of certain natural hazards. Risks of Balloon Payments A substantial percentage of our commercial mortgages have a balloon payment due at its maturity date. These loans involve a greater risk than loans which are paid off gradually since the borrower will typically depend on its ability to fully refinance the commercial mortgage or sell the related property at a price sufficient to permit the borrower to make the balloon payment. Environmental Risks May Adversely Affect Value of Underlying Commercial Mortgages Contamination of real property may give rise to a lien on that property to assure payment of the cost of clean up. Contamination may also result in liability to the lender for that cost. Such contamination may also reduce the value of the property. Our servicing guidelines require us to obtain an environmental site assessment of a mortgaged property prior to acquiring title or assuming its operation. However, this may not protect us from potential liability for an adverse environmental condition at any mortgaged property. If we are or become liable, we can bring an action for contribution against the owner or operator who created the environmental hazard, but that person or entity may be bankrupt or otherwise judgment proof. We Undertake Additional Risks by Acquiring and Investing in Residential Mortgage Loans We may also make investments in residential mortgage loans and mortgage-backed securities on residential properties. Some of the risks applicable to commercial mortgages are also applicable to residential mortgage loans, which include the following: 24 Risk of Failure to Obtain Credit Enhancements We do not obtain credit enhancements such as mortgage pool or special hazard insurance for all of our mortgage loans and investments. Borrowers may obtain private mortgage insurance, but we only require this insurance in limited circumstances. During the time we hold mortgage loans for investment, we are subject to risks of borrower defaults and bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as losses occurring from earthquakes or floods). If a borrower defaults on a mortgage loan that we hold, we bear the risk of loss of principal to the extent there is any deficiency between the value of the related mortgaged property and the amount owing on the mortgage loan. In addition, since defaulted mortgage loans are not considered eligible collateral under our borrowing arrangements, we bear the risk of being required to finance these loans with funds other than borrowed funds until they are ultimately liquidated. Risks of Delay in Collecting Mortgage Loan Proceeds We could encounter substantial delays in the foreclosure of defaulted mortgage loans, with corresponding delays in our receipt of related proceeds. State and local statutes may delay or prevent our foreclosure on, or sale of, the residential mortgaged property and they may prevent us from receiving proceeds sufficient to repay all amounts due on the related mortgage loan. Some properties that may collateralize our residential mortgage loans may have unique characteristics or may be subject to seasonal factors that could materially prolong the time period required to resell the property. Seller's Inability to Repurchase Residential Mortgage Loans Following Breach of Representations Could Cause Loan Losses When we buy residential mortgage loans, we anticipate that the seller will agree to repurchase any mortgage loan if there is fraud or misrepresentation with respect to the sale of the mortgage loan. We will provide similar representations and warranties when we sell or pledge the residential mortgage loans as collateral for mortgage-backed securities. However, we will be at a risk for loss if the seller does not perform its repurchase obligations. Risk of Inadequate Sub-servicing Could Negatively Impact Mortgage Loan Repayments We intend to contract with third-party sub-servicers for the sub-servicing of all residential mortgage loans we hold for investment. We will be subject to risks associated with inadequate or untimely services, such as the risk that a sub-servicer becomes financially unsound or cannot perform its duties. Additionally, each of our sub-servicing agreements with our third-party sub- servicers will likely provide a termination fee if the sub-servicer is terminated without cause. This will limit our alternatives in the event we desire to change sub-servicers. Competition In acquiring residential mortgage loans and securities we will generally compete with the same type of entities that purchase commercial mortgages. The existence of these competitors may increase competition for the available supply of residential mortgage loans. Increased competition for the acquisition of eligible residential mortgage loans or mortgage-backed securities or a decrease in the supply could result in higher prices and, thus, lower yields on such residential mortgage assets. Intense Competition for Commercial Mortgage Loans May Adversely Affect Our Operations We compete in purchasing commercial mortgages and issuing commercial mortgage- backed securities with: . other mortgage conduit programs; . investment banking firms; . savings and loan associations; . banks; . thrift and loan associations; . finance companies; . mortgage bankers; 25 . insurance companies; . other lenders, and . other entities purchasing mortgage assets. Continued consolidation in the mortgage banking industry may adversely affect us by reducing the number of current sellers to our conduit operations and our potential customer base. As a result, we may have to purchase a larger percentage of mortgage loans from a smaller number of sellers which could cause us to have to pay higher premiums for loans. Furthermore, a borrower under a commercial mortgage competes with all lessors and developers of comparable types of real estate in the area in which the mortgaged property is located to attract residents, retail correspondents, tenants and customers. The principal means of competition are price, location and the nature and condition of the facility to be leased. Increased competition could adversely affect income from the market value of the mortgaged property. In addition, the business conducted at each mortgaged property may face competition from other industries and industry segments. Lease Terms May Affect Value of Commercial Mortgage In some cases, lease terms and conditions of commercial and multifamily properties could have a material adverse effect on the value of the commercial mortgage. If the lease contains provisions inconsistent with the commercial mortgage then the lease will have priority over the commercial mortgage. Junior Mortgages May Affect Our Rights In some circumstances, our commercial mortgages may be secured by junior mortgages which are subordinate to senior mortgages or deeds of trust held by other lenders or institutional investors. In these cases, our rights would be inferior to the holders of the senior mortgage or deed of trust. This includes rights to receive rents, hazard insurance and condemnation and foreclosure proceeds and satisfaction of the mortgage in foreclosure litigation or a defaulted senior loan. Lack of Experience of the Manager in Managing a Commercial Mortgage REIT We depend on the Manager, and the skill of its officers and employees, to monitor our day-to-day operations, including, selecting, structuring and monitoring our assets and borrowings. The Manager is a recently formed company with no significant assets and no significant prior history of operations. The Manager has not previously acted as a Manager or advisor for any other company. Although the officers of the Manager have experience operating Impac Mortgage, also a REIT, none of them has any prior experience in managing a commercial mortgage REIT. Termination of the Management Agreement Could Adversely Affect Our Operating Results We may terminate the Management Agreement with the Manager for any reason with 60 days' written notice. If we terminate or do not continue the agreement without a reason, then we will have to pay the Manager a termination or non- renewal fee. The fee is determined by an independent appraisal. If we pay this fee it could have an adverse effect on our business and results of operations and reduce our distributions. If We Fail to Maintain Our REIT Status We May be Subject to Taxation as a Regular Corporation Consequences if We Fail to Qualify as a REIT We believe that we have operated and intend to continue to operate in a manner that enables us to meet the requirements for qualification as a REIT for Federal income tax purposes. We have not requested, and do not plan to request, a ruling from the Internal Revenue Service that we qualify as a REIT. You should be aware that opinions of counsel are not binding on the IRS or any court. Moreover, no assurance can be given that legislation, new regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to qualification as a REIT or the federal income tax consequences of such qualification. Both 26 the validity of the opinion of counsel and our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational and stockholder ownership requirements on a continuing basis. If we fail to qualify as a REIT, we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to Federal income tax at regular corporate rates. We also could be subject to the Federal alternative minimum tax. Unless we are entitled to relief under specific statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified. Therefore, if we lose our REIT status, the funds available for distribution to you would be reduced substantially for each of the years involved. Effect of Distribution Requirements As a REIT, we are subject to annual distribution requirements, which limit the amount of cash we have available for other business purposes, including amounts to fund our growth. Other Tax Liabilities Even if we qualify as a REIT, we may be subject to certain Federal, state, and local taxes on our income, property and operations that could reduce operating cash flow. Recent Developments On February 1, 1999, President Clinton announced his Fiscal Year 2000 Budget Proposal. The Budget Proposal includes a provision that would prohibit a REIT from holding securities representing more than 10% of the vote or value of all classes of stock of an issuer, other than a qualified REIT subsidiary or another REIT. The proposal, however, would provide an exception so that REITs could have certain types of "taxable REIT subsidiaries." Under the proposal, there would be two types of taxable REIT subsidiaries, a "qualified independent contractor subsidiary" and a "qualified business subsidiary." A number of constraints would be imposed on a taxable REIT subsidiary to ensure that a REIT could not, through a taxable REIT subsidiary, engage in substantial non-real estate activities, and also to ensure that the taxable REIT subsidiary pays a corporate level tax on its earnings. For example, the value of all taxable REIT subsidiaries owned by a REIT could not represent more that 15% of the value of the REIT's total assets and a taxable REIT subsidiary would not be entitled to deduct any interest incurred on debt funded directly or indirectly by the REIT. This proposal would be effective after the date of enactment. REITs would be allowed to combine and convert preferred stock subsidiaries into taxable REIT subsidiaries tax-free prior to a certain date. There would be a transition period to allow for conversion of preferred stock subsidiaries before the 10% vote or value test would become effective. Because we own 100% of the nonvoting preferred stock of Impac Commercial Capital Corporation which represents approximately 95% of the economic value of all classes of stock of Impac Commercial, we could not satisfy the proposed 10% vote or value test. Our continued ownership of greater than 10% of the value of Impac Commercial Capital Corporation could cause us to fail to qualify as a REIT. Thus, if enacted in its present form, the proposal may limit Impac Commercial's future activities and growth. We do not know if this proposal will be introduced as a bill in Congress or, if it were introduced, whether it would be enacted. Potential Characterization of Distributions or Gain on Sale as Unrelated Business Taxable Income to Tax-Exempt Investors If (1) we are subject to the rules relating to taxable mortgage pools or we are a "pension-held REIT," or (2) a tax-exempt stockholder has incurred debt to purchase or hold our common stock or is not exempt from federal income taxation under certain special sections of the Internal Revenue Code, or (3) the residual REMIC interests we buy generate "excess inclusion income," then distributions to and, in the case of a stockholder described in (2), gains realized on the sale of common stock by, such tax-exempt stockholder may be subject to federal income tax as unrelated business taxable income under the Internal Revenue Code. Classification as a Taxable Mortgage Pool Could Subject Us to Increased Taxation If we have borrowings with two or more maturities and it is secured by mortgage loans or mortgage-backed securities and the payments made on the borrowings are related to the payments received on the underlying assets, then 27 the borrowings may be classified as a "taxable mortgage pool" under the Internal Revenue Code. If any part of our company was treated as a taxable mortgage pool, then our REIT status would not be impaired, but a portion of the taxable income we generated may, under regulations to be issued by the Treasury Department, be characterized as "excess inclusion" income and allocated to our stockholders. Any excess inclusion income would 1. not be allowed to be offset by a stockholder's net operating losses; 2. be subject to tax as unrelated business income if a stockholder were a tax- exempt stockholder; 3. be subject to the application of federal income tax withholding at the maximum rate (without reduction for any otherwise applicable income tax treaty) with respect to amounts allocable to foreign stockholders, and 4. be taxable (at the highest corporate tax rate) to us, rather than to our stockholders, to the extent the excess inclusion income relates to stock held by disqualified organizations (generally, tax-exempt companies not subject to tax on unrelated business income, including governmental organizations). We take the position that our existing financing arrangements do not create a taxable mortgage pool. However, the IRS may successfully maintain that our financing arrangements do qualify as a taxable mortgage pool. In addition, we may enter into arrangements creating excess inclusion income in the future. Our Operations May be Adversely Affected if We are Subject to the Investment Company Act We intend to conduct our business at all times so as not to become regulated as an investment company under the Investment Company Act. The Investment Company Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. In order to qualify for this exemption we must maintain at least 55% of our assets directly in mortgage loans, qualifying pass-through certificates and certain other qualifying interests in real estate. Our ownership of certain mortgage assets may be limited by the provisions of the Investment Company Act. If the Securities and Exchange Commission adopts a contrary interpretation with respect to these securities or otherwise believes we do not satisfy the above exception, we could be required to restructure our activities or sell certain of our assets. To insure that we continue to qualify for the exemption we may be required at times to adopt less efficient methods of financing certain of our mortgage assets and we may be precluded from acquiring certain types of higher-yielding mortgage assets. The net effect of these factors will be to lower at times our net interest income. If we fail to qualify for exemption from registration as an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described. Our business will be materially and adversely affected if we fail to qualify for this exemption. Future Revisions in Policies and Strategies at the Discretion of our Board of Directors May be Effected Without Stockholder Consent Our board of directors, including a majority of our unaffiliated directors, has established our investment and operating policies and strategies. We may: . invest in the securities of other REITs for the purpose of exercising control; . offer securities in exchange for property, and . offer to repurchase or otherwise reacquire our shares or other securities in the future. In October 1998, we adopted a repurchase plan to repurchase up to $5.0 million of our common stock in the open market. As of December 31, 1998, we had not repurchased any shares. We may also underwrite the securities of other issuers, although we have no present intention to do so. Any of the policies, strategies and activities may be modified or waived by our board of directors, subject in certain cases to approval by a majority of our unaffiliated directors, without stockholder consent. Effect of Future Offerings May Adversely Affect Market Price of our Securities We intend to increase our capital resources by making additional private or public offerings of securities in the future. We do not know: . the actual or perceived effect of these offerings; . the timing of these offerings; . the dilution of the book value or earnings per share of our securities then outstanding, and 28 . the effect on the market price of our securities then outstanding. Risk Relating to Common Stock The sale or the proposed sale of substantial amounts of our common stock in the public market could materially adversely affect the market price of our common stock or other outstanding securities. Risk Relating to Preferred Stock Our charter authorizes our board of directors to issue shares of preferred stock and to classify or reclassify any unissued shares of common stock or preferred stock into one or more classes or series of stock. The preferred stock may be issued from time to time with terms as determined by our board of directors. Our preferred stock is available for our possible future financing of acquisitions and for our general corporate purposes without further stockholder authorization. In October 1998, our board announced a dividend to all common stockholders of certain shares of our Series A Junior Preferred Stock. Our Series A Junior Preferred Stock has terms and conditions which could have the effect of delaying, deferring or preventing a hostile change in control of our company. Our board could authorize the issuance of shares of another class or series of preferred stock with terms and conditions which could also have the effect of delaying, deferring or preventing a change in control of our company which could involve a premium price for holders of common stock or otherwise be in their best interest. The preferred stock, if issued, may have a preference on dividend payments which could reduce the assets we have available to make distributions to our common stockholders. Maryland Business Combination Statute The Maryland General Corporation Law establishes special requirements for "business combinations" between a Maryland corporation and "interested shareholders" unless exemptions are applicable. An interested shareholder is any person who beneficially owns ten percent or more of the voting power of our then-outstanding voting stock. Among other things, the law prohibits for a period of five years a merger and other similar transactions between us and an interested shareholder unless the Board approved the transaction prior to the party becoming an interested shareholder. The five-year period runs from the most recent date on which the interested shareholder became an interested shareholder. The law also requires a supermajority shareholder vote for such transactions after the end of the five-year period. This means that the transaction must be approved by at least: . 80% of the votes entitled to be cast by holders of outstanding voting shares, and . 66% of the votes entitled to be cast by holders of outstanding voting shares other than shares held by the interested shareholder with whom the business combination is to be effected. The business combination statute could have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers, even if our acquisition would be in our shareholders' best interests. Maryland Control Share Acquisition Statute Maryland law provides that "control shares" of a Maryland corporation acquired in a "control share acquisition" have no voting rights except to the extent approved by a shareholder vote. Two-thirds of the shares eligible to vote must vote in favor of granting the "control shares" voting rights. "Control shares" are shares of stock that, taken together with all other shares of stock the acquirer previously acquired, would entitle the acquirer to exercise at least 20% of the voting power in electing directors. Control shares do not include shares of stock the acquiring person is entitled to vote as a result of having previously obtained shareholder approval. A "control share acquisition" means the acquisition of control shares, subject to certain exceptions. If a person who has made (or proposes to make) a control share acquisition satisfies certain conditions (including agreeing to pay expenses), he may compel the Board of Directors to call a special meeting of shareholders to be held within 50 days to consider the voting rights of the shares. If such a person makes no request for a meeting, we have the option to present the question at any shareholders' meeting. If voting rights are not approved at a meeting of shareholders then we may redeem any or all of the control shares (except those for which voting rights have previously been approved) for fair value. We will determine the fair value of the shares, without regard to voting rights, as of the date of either: 29 . the last control share acquisition, or . any meeting where shareholders considered and did not approve voting rights of the control shares. If voting rights for control shares are approved at a shareholders' meeting and the acquirer becomes entitled to vote a majority of the shares of stock entitled to vote, all other shareholders may exercise appraisal rights. This means that you would be able to redeem your stock back to us for fair value. Under Maryland law, the fair value may not be less than the highest price per share paid in the control share acquisition. Furthermore, certain limitations otherwise applicable to the exercise of dissenters' rights would not apply in the context of a control share acquisition. The control share acquisition statute would not apply to shares acquired in a merger, consolidation or share exchange if we were a party to the transaction. The control share acquisition statute could have the effect of discouraging offers to acquire us and of increasing the difficulty of consummating any such offers, even if our acquisition would be in our shareholders' best interests. Possible Adverse Consequences of Limits on Ownership of Shares Our Articles of Incorporation limit ownership of our capital stock by any single shareholder to 9.8% of the outstanding shares. The Articles also prohibit anyone from buying shares if the purchase would result in us losing our REIT status. This could happen if a share transaction results in fewer than 100 persons owning all of our shares or in five or fewer persons, applying certain broad attribution rules of the Internal Revenue Code, owning 50% or more of our shares. If you or anyone else acquires shares in excess of the ownership limit or in violation of the ownership requirements of the Internal Revenue Code for REITs, we: . will consider the transfer to be null and void; . will not reflect the transaction on our books; . may institute legal action to enjoin the transaction; . will not pay dividends or other distributions with respect to those shares; . will not recognize any voting rights for those shares; . will consider the shares held in trust for the benefit of the Company, and . will either direct the affected person to sell the shares and turn over any profit to us, or we will redeem the shares. If we redeem the shares, it will be at a price equal to the lesser of: (a) the price paid by the transferee of the shares, or (b) the average of the last reported sales prices on the American Stock Exchange on the ten trading days immediately preceding the date fixed for redemption by our Board of Directors. An individual who acquires shares that violate the above rules bears the risk that (i) he may lose control over the power to dispose of the shares, (ii) he may not recognize profit from the sale of such shares if the market price of the shares increases and (iii) he may be required to recognize a loss from the sale of such shares if the market price decreases. Failure to Comply with Year 2000 Computer Standards We are not aware of any material operational issues or costs associated with preparing our internal systems for the year 2000. However, we may have operational problems or increased costs because of our implementation of systems and changes necessary to address year 2000 issues. Our inability to implement such systems and changes in a timely manner could have a material adverse effect on our business, financial condition and results of operations. See "Item 7. Management's Discussion and Analysis and Financial Condition and Results of Operations--Year 2000 Compliance" for a description of our compliance program. We also rely, directly and indirectly, on external systems of business enterprises such as financial institutions, third party mortgage banks, correspondent loan originators and government agencies for accurate exchange of data. Even if the year 2000 issue does not materially affect our internal systems, disruptions in the operation of the enterprises with which we interact could adversely affect us. 30 Limitations on Acquisition and Change in Control Ownership Limit The 9.8% ownership limit discussed above may have the effect of precluding acquisition of control of us by a third party without consent of the board of directors. ITEM 2. PROPERTIES Pursuant to the management agreement, RAI contracts with IMH to provide space for the Company's executive offices and administrative facilities at IMH's executive offices in Santa Ana Heights, California. In addition, ICCC currently occupies, and is fully utilizing, approximately 18,000 square feet of office space in Irvine, California, under a premises operating lease expiring in November 2000. ICCC currently occupies approximately 3,600 square feet in Sherman Oaks, California and approximately 4,300 square feet in Dallas, Texas under premises operating leases expiring in May 2001 and August 2003, respectively. The Company believes that these facilities will adequately provide for the Company's future growth needs. The Company owns a commercial office building located in Newport Beach, California. The commercial office building has approximately 74,000 square feet of rentable office space. The Company currently leases office space in the building to IMH and IFC and other third party tenants. ITEM 3. LEGAL PROCEEDINGS SPI Danvers, LLC v. Impac Commercial Capital Corporation, William D. Endresen and Lawrence R. Goswiller, Orange County Superior Court Case No. 802070 On November 13, 1998, SPI Danvers, LLC ("Danvers") filed a complaint against the above defendants alleging 13 causes of action including breach of contract and numerous tort causes of action, including fraud. Danvers seeks approximately $312,000 against all defendants, which allegedly represents its deposits, plus 10% lost opportunity costs, $840,000 in alternative financing costs, lost profits in an unspecified amount, and punitive damages and attorneys fees according to proof. Danvers' allegations set forth generally that it sought refinancing of an existing loan as well as obtaining a new loan in the amount of $4.2 million, and thus entered into certain discussions and negotiations with ICCC. The purpose of the loan was to conclude the purchase of property. Danvers alleges that it paid ICCC certain "good faith" and "rate lock deposits" totaling an aggregate of approximately $312,000. It is alleged that ICCC entered into a loan agreement, defined as the letter of interest, rate lock agreement, and loan commitment letter, with Danvers. Following plaintiff's alleged continual compliance with requests for information and other loan conditions from ICCC, ICCC did not close and fund the loan. In February 1999, the court granted ICCC's and the other defendant's demurrer to most of the tort causes of action and granted a motion to strike the punitive damages and attorney fees allegation. However, the court also granted Danvers an opportunity to file an amended complaint to attempt to reassert all the claims and damages in a proper pleading. The Company believes that this case is without merit and intends to vigorously defend the action. Other than the foregoing, the Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to security holders for vote during the fourth quarter of 1998. 31 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is listed on the American Stock Exchange ("AMEX") under the symbol ICH. The following table sets forth for the high, low and closing sale prices for ICH's Common Stock as reported by the AMEX for the periods indicated:
1998 1997 --------------------------------- --------------------------------- High Low Close High Low Close --------- -------- -------- --------- ---------- --------- First Quarter (1)................ $ 19.75 $ 17.00 $ 17.88 $ -- $ -- $ -- Second Quarter (1)............... 18.13 14.00 14.38 -- -- -- Third Quarter.................... 15.25 8.81 11.63 20.75 16.56 18.63 Fourth Quarter................... 11.63 1.88 5.38 19.31 15.25 17.63
- ----------- (1) ICH became a public entity on August 4, 1997. On February 16, 1999, the last reported sales price of the Common Stock on the AMEX was $5.94 per share. As of February 16, 1999, there were 877 holders of record (including holders who are nominees for an undetermined number of beneficial owners) of the Company's Common Stock. Share Repurchase Program. On September 25, 1998, the Company's Board of Directors authorized the Company to repurchase up to $5.0 million of the Company's common stock, $.01 par value, in open market purchases from time to time at the discretion of the Company's management; the timing and extent of the repurchases will depend on market conditions. The Company intends to effect such repurchases, if any, in compliance with the Rule 10b-18 under the Securities Exchange Act of 1934. Any acquired shares will be canceled. Through February 16, 1999, the Company had not repurchased any shares under this program. Stockholder Rights Plan. On October 7, 1998, the Company's Board of Directors adopted a Stockholder Rights Plan in which Preferred Stock Purchase Rights were distributed as a dividend at the rate of one Right for each outstanding share of common stock. The dividend distribution was made on October 19, 1998, payable to stockholders of record on that date. The Rights are attached to the Company's common stock. The Rights will be exercisable and trade separately only in the event that a person or group acquires or announces the intent to acquire 10 percent or more of the Company's common stock. Each Right will entitle stockholders to buy one one-hundredth of a share of a new series of Series A junior participating preferred stock at an exercise price of $16.25. If the Company is acquired in a merger or other transaction after a person has acquired 10 percent or more of the Company's outstanding common stock, each Right will entitle the stockholder to purchase, at the Right's then-current exercise price, a number of the acquiring Company's common shares having a market value of twice such price. In addition, if a person or group acquires 10 percent or more of the Company's common stock, each Right will entitle the stockholder (other than the acquiring person) to purchase, at the Right's then-current exercise price, a number of shares of the Company's common stock having a market value of twice such price. Following the acquisition by a person of 10 percent or more of the Company's common stock and before an acquisition of 50 percent or more of the common stock, the Board of Directors may exchange the Rights (other than the Rights owned by such person) at an exchange ratio of one share of common stock per Right. Before a person or group acquires beneficial ownership of 10 percent or more of the Company's common stock, the Rights are redeemable for $.0001 per right at the option of the Board of Directors. The Rights will expire on October 19, 2008. The Rights distribution is not taxable to stockholders. The Rights are intended to enable all the Company stockholders to realize the long-term value of their investment in the Company. On October 21, 1998, ICH repurchased from IMH 937,084 shares of Common Stock and 456,916 shares of Class A Common Stock at a per share price of $4.375, based upon the closing sales price of the Common Stock on the AMEX on October 19, 1998, for a total repurchase of $6.1 million. The repurchase of Common Stock and Class A Common Stock was not part of the share repurchase program described above. 32 Dividends To maintain its qualification as a REIT, ICH intends to make annual distributions to stockholders of at least 95% of its taxable income (which may not necessarily equal net earnings as calculated in accordance with generally accepted accounting principles ("GAAP")), determined without regard to the deduction for dividends paid and excluding any net capital gains. ICH declares regular quarterly dividend distributions. Any taxable income remaining after the distribution of the regular quarterly or other dividends will be distributed annually on or prior to the date of the first regular quarterly dividend payment date of the following taxable year. The dividend policy is subject to revision at the discretion of the Board of Directors. All distributions in excess of those required for ICH to maintain REIT status will be made by ICH at the discretion of the Board of Directors and will depend on the taxable earnings of ICH, the financial condition of ICH and such other factors as the Board of Directors deems relevant. The Board of Directors has not established a minimum distribution level. Distributions to stockholders will generally be taxable as ordinary income, although a portion of such distributions may be designated by ICH as capital gain or may constitute a tax-free return of capital. ICH will annually furnish to each of its stockholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, capital gains or return of capital. Of the dividends paid for the 1998 tax year, approximately $1.0 million represented a tax-free return of capital. The following table sets forth dividends paid or declared by ICH:
Per Share Stockholder Dividend Period Covered Record Date Amount - --------------------------------------------------- ----------------------- --------------- Quarter ended September 30, 1997 (1)............... October 21, 1997 $ 0.15 Quarter ended December 31, 1997.................... December 31, 1997 0.38 Quarter ended March 31, 1998....................... April 9, 1998 0.40 Quarter ended June 30, 1998........................ June 19, 1998 0.45 Quarter ended September 30, 1998(2)................ October 9, 1998 0.45
- ------------- (1) ICH became a public entity on August 4, 1997. (2) ICH paid interest in the form of an additional cash dividend at an interest rate of 4% per annum for the period from the previously announced payment date of October 26, 1998 through November 6, 1998. The total amount of interest paid by the Company was $6,000 or $0.0006 per common share outstanding. The Company did not declare a dividend for the quarter ended December 31, 1998. See "Item 1. Business--Risk Factors--Current Conditions of Mortgage Industry Adversely Affect Our Liquidity and Our Ability to Pay Dividends." 33 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES (in thousands, except per share data)
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 --------------------- ---------------------- Statement of Operations Data: Interest income: Commercial Mortgage Assets................................................. $ 32,933 $ 6,720 Cash equivalents and due from affiliates................................... 2,912 739 ----------- ----------- Total interest income..................................................... 35,845 7,459 Interest expense: Warehouse line and reverse repurchase agreements........................... 13,461 1,962 CMO borrowings............................................................. 7,203 15 Other borrowings........................................................... 912 373 ----------- ----------- Total interest expense.................................................... 21,576 2,350 ----------- ----------- Net interest income........................................................ 14,269 5,109 Provision for loan losses................................................. 1,546 564 ----------- ----------- Net interest income after provision for loan losses........................ 12,723 4,545 Non-interest income: Equity in net earnings (loss) of Impac Commercial Capital Corporation...... (19,199) 1,694 Other income............................................................... 701 174 ----------- ----------- Total non-interest income................................................. (18,498) 1,868 Non-interest expense: General and administrative and other expense............................... 2,803 905 Write-down of residual interest in securitization, held-for-trading........ 1,690 -- Advisory fees.............................................................. 745 -- Stock compensation expense................................................. -- 2,697 ----------- ----------- Total non-interest expense.............................................. 5,238 3,602 ----------- ----------- Net earnings (loss)....................................................... $ (11,013) $ 2,811 =========== =========== Net earnings (loss) per share--basic and diluted.......................... $ (1.26) $ 0.61 =========== =========== Dividends declared per share.............................................. $ 1.30 $ 0.53 =========== ===========
At December 31, -------------------------------------------- 1998 1997 ------------------ ------------------ Balance Sheet Data: Investment securities available-for-sale........................................ $ 17,154 $ 19,353 Residual interest in securitization, held-for-trading........................... 8,790 9,936 CMO collateral.................................................................. 326,559 4,255 Finance receivables............................................................. 40,972 95,711 Commercial Mortgages held-for-investment........................................ 24,569 62,790 Total assets.................................................................... 451,219 218,839 CMO borrowings.................................................................. 285,021 4,176 Warehouse line agreements....................................................... 45,654 90,374 Total borrowings................................................................ 335,544 104,391 Total stockholders' equity...................................................... 103,337 103,242
34 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY (in thousands, except Operating Data)
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ---------------------- ---------------------- Statement of Operations Data: Interest income: Commercial Mortgages held-for-sale....................................... $ 9,573 $ 2,787 Cash and due from affiliates............................................. 205 17 ----------- ------------ Total interest income.................................................. 9,778 2,804 Interest expense: Borrowings from ICH...................................................... 9,064 2,372 Other affiliated borrowings.............................................. 1,739 375 ----------- ------------ Total interest expense................................................. 10,803 2,747 ----------- ------------ Net interest income (expense)............................................ (1,025) 57 Non-interest income: Gain (loss) on sale of loans............................................. (14,345) 3,657 Other income............................................................. 24 62 ----------- ------------ Total non-interest income (expense).................................... (14,321) 3,719 Non-interest expense: Other operating expense.................................................. 5,365 1,176 Provision for repurchases................................................ 176 201 ----------- ------------ Total non-interest expense............................................. 5,541 1,377 ----------- ------------ Net earnings (loss) before income taxes.................................. (20,887) 2,399 Income taxes (benefit)................................................... (680) 1,022 ----------- ------------ Net earnings (loss)...................................................... $ (20,207) $ 1,377 =========== ============
At December 31, -------------------------------------- 1998 1997 ---------------- ----------------- Balance Sheet Data: Commercial Mortgages held-for-sale................................................ $ 44,854 $ 106,654 Total assets...................................................................... 54,200 112,635 Warehouse line agreements......................................................... 44,881 104,219 Total shareholders' equity (deficit).............................................. (15,804) 4,403 Operating Data (in millions): Commercial Mortgage acquisitions (volume)......................................... $ 425.1 $ 233.5 Servicing portfolio at period-end................................................. 379.0 169.2
35 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain information contained in the following Management's Discussion and Analysis of Financial Condition and Results of Operations constitute forward- looking statements within the meaning of the Securities Act of 1933 and Section 21e of the Exchange Act of 1934 which can be identified by the use of forward- looking terminology such as "may," "will," "expect," "intend," "anticipate," "estimate," "believe" or "should" or the negatives thereof or other variations thereon or comparable terminology. The Company's actual results may differ materially from those contained in the forward-looking statements. Factors which may cause differences to occur include those described in "Item 1. Business-- Risk Factors" as well as those factors discussed below. General ICH was formed to seek opportunities in the commercial mortgage market, including the origination, purchase, securitization and sale of commercial mortgages and investment in commercial mortgages and commercial mortgage-backed securities. The Company's commercial mortgage assets include mortgage loans on condominium-conversions, commercial properties, such as industrial and warehouse space, office buildings, retail space and shopping malls, hotels and motels, nursing homes, hospitals, multifamily, congregate care facilities and senior living centers. The Company operates the Long-Term Investment Operations, which invests primarily in mortgage loans and MBSs (to date, the Long-Term Investment Operations has invested primarily in Commercial Mortgages and CMBSs) and the Conduit Operations, conducted by ICCC, which originates, purchases, securitizes and sells Commercial Mortgages. The Company's Conduit Operations operates three divisions: the CommercialExpress Division, the ConduitExpress Division, and the CondoSelect Division. The Company is entitled to 95% of the earnings or losses of ICCC through its ownership of all of the non-voting preferred stock of ICCC. As such, the Company records its investment in ICCC using the equity method. Under this method, original investments are recorded at cost and adjusted by the Company's share of earnings or losses. The Company is a specialty commercial property finance company that elects to be taxed at the corporate level as a REIT for federal income tax purposes, which generally allows the Company to pass through income to stockholders without payment of federal income tax at the corporate level. The Contribution In February 1997, certain officers and directors of the Company, as a group, and IMH purchased 300,000 and 299,000 shares of the Common Stock of ICH, respectively. In addition, IMH purchased all of the non-voting preferred stock of ICCC, which represents 95% of the economic interest in ICCC, for $500,000, and certain of the Company's officers purchased all of the outstanding shares of common stock of ICCC, which represents 5% of the economic interest in ICCC. In addition, ICCC brokered ICH's purchase of $7.3 million and $10.2 million of condominium conversion loans which were financed with $16.6 million in borrowings under a warehouse lending facility provided by a subsidiary of IMH and $900,000 in borrowings from IMH. In March 1997, IMH loaned ICH $15.0 million evidenced by a promissory note convertible into shares of non-voting preferred stock of ICH at the rate of one share of ICH Preferred Stock for each $5.00 principal amount of said note. IMH converted the aforementioned $15.0 million principal amount promissory note into an aggregate of 3,000,000 shares of ICH Preferred Stock. All shares of ICH Preferred Stock were automatically converted upon the closing of the IPO into shares of ICH Common Stock determined by multiplying the number of shares of ICH Preferred Stock to be converted by a fraction, the numerator of which was $5.00 and the denominator of which was $15.00. Notwithstanding the foregoing, consistent with IMH's classification as a REIT, IMH was not entitled to convert into ICH Common Stock more than that number of shares of ICH Preferred Stock whereby IMH would own, immediately after such conversion, greater than 9.8% of ICH's outstanding Common Stock. Any shares of ICH Preferred Stock not converted into ICH Common Stock upon the closing of the IPO were automatically converted into shares of ICH non-voting Class A Common Stock at the same rate as the ICH Preferred Stock converted into ICH Common Stock. Shares of ICH Class A Common Stock convert into shares of ICH Common Stock on a one-for-one basis and each such class of Common Stock is entitled to cash dividends on a pro rata basis. Upon any subsequent issuances of Common Stock by ICH or sale of ICH Common Stock held by IMH, shares of ICH Class A Common Stock will automatically convert into additional shares of the Common Stock of ICH, subject to a 9.8% limitation. In addition, ICH purchased $10.1 million in CMBSs from IFC which was financed with a promissory note. The promissory note was repaid to IFC with cash from IMH's 36 above-referenced $15.0 million investment. Concurrently, ICH repaid the $900,000 owed to IMH in connection with its purchase of condominium conversion loans. ICH entered into a borrowing agreement with Imperial Credit Industries Inc. ("ICII") for $7.9 million secured by $10.1 million in CMBSs. The loan was repaid upon ICH's IPO. In April 1997, IMH exchanged the 299,000 shares of ICH Common Stock held by it for an equivalent number of shares of ICH Class A Common Stock. Relationships with Impac Entities Many of the officers and directors of the Company are officers, directors and owners of IMH, IFC, RAI and ICCC. The Company and IMH have entered into various financing arrangements. Certain of the officers and directors of the Company own RAI, which provides management services to the Company. RAI has also entered into a Submanagment Agreement with IFC whereby the Company pays IFC (through RAI) for all costs and services under contract, plus a 15% service charge. The Company owns all of the preferred stock of, and 95% of the economic interest in, ICCC. Significant Transactions On October 21, 1998, ICH repurchased from IMH 937,084 shares of Common Stock and 456,916 shares of Class A Common Stock at a per share price of $4.375, based upon the closing sales price of the Common Stock on the AMEX on October 19, 1998, for a total repurchase of $6.1 million. On September 25, 1998, the Company's Board of Directors authorized the Company to repurchase up to $5.0 million of the Company's common stock, $0.01 par value, in open market purchases from time to time at the discretion of the Company's management; the timing and extent of the repurchases will depend on market conditions. The Company intends to effect such repurchases, if any, in compliance with the Rule 10b-18 under the Securities Exchange Act of 1934. Any acquired shares will be canceled. As of February 16, 1999, no shares had been repurchased. On October 27, 1998, the Company purchased from IMH its remaining 50% ownership interest in a commercial office building in Newport Beach, California for $6.0 million. After the purchase of the 50% ownership interest from IMH, the Company has a 100% ownership interest in the commercial office building. Business Operations Business Strategy. Due to the deterioration of the commercial mortgage- securitization market during the third and fourth quarters of 1998, the Company made significant changes in its business strategy and operations. The Company's business strategy was revised to focus on the origination of smaller balance loans that have higher margins, wider spreads and more profitability. Therefore, the Company is concentrating its efforts on the origination of CommercialExpress loans and de-emphasizing the origination of ConduitExpress loans until the commercial mortgage-backed securitization market stabilizes. CommercialExpress loans are Commercial Mortgages with balances generally from $500,000 to $3.0 million while ConduitExpress loans are Commercial Mortgages with balances generally from $3.0 million to $10.0 million. While this decision resulted in lower origination balances in the third and fourth quarters of 1998, the Company anticipates better results on the subsequent sale or securitization of its loans. Historically, the Company's experience has been that CommercialExpress loans have generally had better pricing in the execution of whole loan sales and structured transactions than prices received on ConduitExpress loans. A factor in the higher profitability on CommercialExpress loans is the higher interest rate margins on these loans which generally range from 100 basis points to 150 basis points more than interest rate margins on ConduitExpress loans. Therefore, in conjunction with the change in business strategy and the resulting decrease in originations during the third and fourth quarters of 1998, the Company reduced staff levels at ICCC by 35% during the fourth quarter of 1998. Long-Term Investment Operations. During the year ended December 31, 1998, the Long-Term Investment Operations, conducted by ICH, acquired $522.1 million of Commercial Mortgages as compared to $41.2 million of Commercial Mortgages acquired during the period from January 15, 1997 (commencement of operations) through December 31, 1997 ("Commencement Period"). Commercial Mortgages purchased from ICCC during 1998 consisted of $499.1 million of fixed rate mortgages ("FRMs") and $23.0 million of adjustable rate mortgages ("ARMs") secured by first liens on commercial property. Commercial Mortgages purchased from ICCC during 1998 consisted of $325.3 million of ConduitExpress loans, $184.1 million of CommercialExpress loans and $12.7 million of CondoSelect loans. As of December 31, 1998, the Long-Term Investment Operations' portfolio of Commercial Mortgages consisted of 37 $24.6 million of Commercial Mortgages held-for-investment and $326.6 million of mortgage loans held as collateral for CMOs of which approximately 85% were FRMs and 15% were ARMs. The weighted average coupon of the Long-Term Investment Operations' portfolio of Commercial Mortgages was 8.13% at December 31, 1998. During 1998, the Long-Term Investment Operations sold $172.3 million of Commercial Mortgages to third party investors and $43.2 million of Commercial Mortgages to ICCC as compared to none during the Commencement Period. In addition, the Long-Term Investment Operations had outstanding finance receivables of $41.0 million, investment securities available-for sale of $17.2 million and residual interest in securitization held-for-trading of $8.8 million at December 31, 1998. Conduit Operations. The Conduit Operations, conducted by ICCC, supports the Long-Term Investment Operations of the Company by supplying ICH with Commercial Mortgages for its long-term investment portfolio. ICCC originated $425.1 million of Commercial Mortgages during 1998 as compared to $233.5 million of Commercial Mortgages originated during the Commencement Period. ICCC originated $239.7 million of ConduitExpress loans during the year ended December 31, 1998 as compared to $159.2 million during the Commencement Period. The CommercialExpress Division originated $172.7 million of CommercialExpress loans during 1998 as compared to $50.7 million during the Commencement Period. The CondoSelect Division originated $12.7 million of CondoSelect loans during 1998 as compared to $23.6 million during the Commencement Period. During the year ended December 31, 1998 and the Commencement Period, ICCC sold $525.2 million and $23.7 million, respectively, of Commercial Mortgages to ICH and none and $73.4 million, respectively, to third parties. ICCC's servicing portfolio increased 124% to $379.0 million as of December 31, 1998 as compared to $169.2 million as of December 31, 1997. The loan delinquency rate of Commercial Mortgages in ICCC's servicing portfolio was 1.13% at December 31, 1998 as compared to none at December 31, 1997. RESULTS OF OPERATIONS-- IMPAC COMMERCIAL HOLDINGS, INC. Year Ended December 31, 1998 as compared to the period from January 15, 1997 (commencement of operations) through December 31, 1997 Net Earnings The Company recorded a net loss of $(11.0) million, or $(1.26) basic and diluted loss per common share, during the year ended December 31, 1998 as compared to net earnings of $2.8 million, or $0.61 basic and diluted earnings per common share, for the Commencement Period. The Company's net loss for 1998 was primarily the result of an increase of $18.0 million in loss on sale of Commercial Mortgages held-for-sale by ICCC, a non-cash charge of $1.7 million on the write-down of the residual interest in securitization held-for-trading and an increase of $982,000 in provision for loan losses. These increases to 1998 net loss were partially offset by an increase of 180% in net interest income to $14.3 million during 1998 as compared to $5.1 million during the Commencement Period. The loss on sale of Commercial Mortgages held-for-sale by the Conduit Operations during 1998 was $14.3 million as compared to a gain on sale of Commercial Mortgages held-for-sale of $3.7 million during the Commencement Period. The loss on sale of Commercial Mortgages held-for-sale resulted in a deficit in equity in net loss of ICCC of $(19.2) million for 1998 as compared to equity in net earnings of ICCC of $1.7 million during the Commencement Period. The loss on sale of Commercial Mortgages held-for-sale was the result of the sale of Commercial Mortgages during the fourth quarter of 1998 in order to generate liquidity and help to protect the Company against any future margin calls on borrowings under warehouse line and reverse repurchase facilities. The Company's lenders required margin calls on the Company's warehouse line and reverse repurchase facilities due to turmoil in the commercial mortgage market- backed securitization during the third and fourth quarters of 1998. Therefore, in order to meet those margin calls and provide the Company additional liquidity, the Company completed the sale of $172.3 million of Commercial Mortgages during the fourth quarter of 1998, which increased the Company's liquidity by $25.6 million, at the time of sale, after paying down borrowings on warehouse lines and reverse repurchase facilities. With net proceeds from the sale of Commercial Mortgages, the Company was able to use these funds to pay its third quarter dividend, which had been suspended, repurchase shares of its capital stock at a price significantly below book value, purchase the remaining 50% ownership interest in its commercial office building from IMH and have additional liquidity for general working capital needs. 38 Net Interest Income Net interest income increased 180% to $14.3 million during 1998 as compared to $5.1 million during the Commencement Period. Interest income is primarily interest on Commercial Mortgage Assets and includes interest income on cash and cash equivalents and amounts due from affiliates. Interest expense is primarily borrowings on Commercial Mortgage Assets and includes interest expense on due to affiliates. Commercial Mortgage Assets include investment securities available- for-sale, residual interest in securitization held-for-trading, Commercial Mortgages held-for-investment, CMO collateral and finance receivables. The increase in net interest income during 1998 as compared to the Commencement Period was primarily the result of higher average Commercial Mortgage Assets, which increased to $385.3 million during 1998 as compared to $63.0 million during the Commencement Period. The net interest spread on Commercial Mortgage Assets decreased to 1.77% during 1998 as compared to 3.15% during the Commencement Period. The decrease in net interest spread on Commercial Mortgage Assets during 1998 as compared to the Commencement Period was primarily due to an increase in lower yielding finance receivables outstanding with ICCC and a decrease in the ten-year treasury yield, which the Company uses as an index to determine initial interest rates on its Commercial Mortgages. The following table summarizes average balance, interest and weighted-average yield on Commercial Mortgage Assets and borrowings for the year ended December 31, 1998 and the Commencement Period and includes interest income on Commercial Mortgage Assets and interest expense related to borrowings on Commercial Mortgage Assets only (dollars in thousands):
For the year ended December 31, 1998 For the Commencement Period ----------------------------------------------- ------------------------------------------ Average Weighted % of Average Weighted % of Balance Interest Avg Yield Portfolio Balance Interest Avg Yield Portfolio ------------- ---------- --------- ---------- ----------- ---------- --------- --------- COMMERCIAL MORTGAGE ASSETS --------------- Investment and $ 28,349 $ 4,357 15.37% 7.36% $ 12,786 $ 2,234 17.47% 20.29% residual securities Loan receivables: Commercial Mortgages held-for-investment 127,015 10,452 8.23 32.97 22,030 2,066 9.38 34.97 CMO collateral 122,122 9,061 7.42 31.70 233 48 20.60 0.37 Finance receivables 107,777 9,063 8.41 27.97 27,956 2,372 8.48 44.37 ----------- ---------- ---------- --------- Total Loan Receivables 356,914 28,576 8.01 92.64 50,219 4,486 8.93 79.71 ----------- ---------- ---------- --------- Total Commercial $ 385,263 $ 32,933 8.55% 100.00% $ 63,005 $ 6,720 10.67% 100.00% Mortgage Assets =========== ========== ========== ========= BORROWINGS ---------- Warehouse line agreements $ 193,370 $ 12,947 6.70% 63.44% $ 25,463 $ 1,847 7.25% 85.06% CMO borrowings 103,180 7,203 6.98 33.85 228 15 6.58 0.76 Reverse repurchase 8,270 514 6.22 2.71 1,938 115 5.93 6.47 agreements Borrowings on residual -- -- -- -- 2,307 275 11.92 7.71 interest in securitization ----------- ---------- ---------- --------- Total Borrowings $ 304,820 $ 20,664 6.78% 100.00% $ 29,936 $ 2,252 7.52% 100.00% =========== ========== ========== ========= Net Interest Spread 1.77% 3.15% Net Interest Margin 3.18% 7.09%
Interest income on Commercial Mortgage Assets: Interest income on Commercial Mortgages held-for-investment increased to $10.5 million during 1998 as compared to $2.1 million during the Commencement Period as average Commercial Mortgages held-for-investment increased to $127.0 million as compared to $22.0 million, respectively. The increase in average Commercial Mortgages held-for-investment was the result of the Long-Term Investment Operations acquiring $522.1 million of Commercial Mortgages during 1998 as compared to $41.2 million during the Commencement Period. The weighted-average yield on Commercial Mortgages held- for-investment decreased to 8.23% during 1998 as compared to 9.38% during the Commencement Period. The decrease in the weighted-average 39 yield during 1998 was due to the acquisition of lower yielding ConduitExpress loans as compared to the Commencement Period and the decrease in the ten-year treasury yield, which the Company uses as an index to determine initial interest rates on its Commercial Mortgages. Interest income on finance receivables increased to $9.1 million during 1998 as compared to $2.4 million during the Commencement Period as average finance receivables increased to $107.8 million as compared to $28.0 million, respectively. The increase was primarily the result of an increase in ICCC's loan originations, which are financed by the Long-Term Investment Operations until ICCC sells the loans to third party investors or to ICH. ICCC originated $425.1 million of Commercial Mortgages during 1998 as compared to $233.5 million of Commercial Mortgages originated during the Commencement Period. The weighted- average yield on finance receivables decreased to 8.41% during 1998 as compared to 8.48% during the Commencement Period as the prime rate decreased during 1998. The prime rate is used as the index to determine the interest rate on finance receivables. Interest income on CMO collateral increased to $9.1 million during 1998 as compared to $48,000 during the Commencement Period as average CMO collateral increased to $122.1 million as compared to $233,000, respectively. Average CMO collateral increased as the Long-Term Investment Operations issued CMOs totaling $301.8 million, which were collateralized by $325.0 million in Commercial Mortgages, in August 1998. The weighted-average yield on CMO collateral was 7.42% during 1998. Interest income on investment securities available-for-sale increased to $4.4 million during 1998 as compared to $2.2 during the Commencement Period as average investment securities available-for-sale, net of securities valuation allowance, increased to $28.3 million as compared to $12.8 million, respectively. The weighted-average yield on investment securities available-for- sale decreased to 15.37% during 1998 as compared to 17.47% during the Commencement Period. Interest expense on borrowings: Interest expense on warehouse line agreements used to fund finance receivables to ICCC and Commercial Mortgages held-for- investment increased to $12.9 million during 1998 as compared to $1.8 million during the Commencement Period as the average balance of warehouse line agreements increased to $193.4 million and $25.5 million, respectively. The increase was a result of an increase in finance receivables made to ICCC to fund the acquisition of Commercial Mortgages and to also fund the Long-Term Investment Operations Commercial Mortgages held-for-investment, which were acquired from ICCC. The weighted-average yield of warehouse line agreements decreased to 6.70% during 1998 as compared to 7.25% during the Commencement Period. Interest expense on CMO borrowings increased to $7.2 million during 1998 as compared to $15,000 during the Commencement Period as average borrowings on CMO collateral increased to $103.2 million as compared to $228,000, respectively. Average CMO borrowings increased as the Long-Term Investment Operations issued CMOs totaling $301.8 million during 1998. The weighted-average yield of CMO borrowings was 6.98% during 1998. Interest expense on borrowings on residual interest in securitization, held- for-trading decreased to none during 1998 as compared to $275,000 during the Commencement Period as the borrowings against the residual interest were repaid with proceeds received from the Company's IPO on August 5, 1997. The weighted- average yield of borrowings on residual interest in securitization, held-for- trading was 11.92% during the Commencement Period. The Company also uses CMBSs as collateral to borrow under reverse repurchase agreements to fund the purchase of CMBSs and to act as an additional source of liquidity for the Company's operations. Interest expense on these reverse repurchase agreements increased to $514,000 during 1998 as compared to $115,000 during the Commencement Period as the average balance on these reverse repurchase agreements increased to $8.3 million as compared to $1.9 million, respectively. The weighted-average yield of these reverse repurchase agreements was 6.22% during 1998 as compared to 5.93% during the Commencement Period. Equity in net earnings (loss) of Impac Commercial Capital Corporation Equity in net loss of ICCC for 1998 was $(19.2) million as compared to equity in net earnings of ICCC of $1.7 million for the Commencement Period. The decrease in equity in net earnings (loss) of ICCC for 1998 was primarily the result of the aforementioned $14.3 million loss on sale of Commercial Mortgages during 1998 as compared to a gain on sale of Commercial Mortgages of $3.7 million during the Commencement Period. For more information on the results of operations of ICCC refer to "--Results of Operations--Impac Commercial Capital Corporation." The Company 40 records 95% of the earnings or losses from ICCC as the Company owns 100% of ICCC's preferred stock of, which represents 95% of the economic interest in, ICCC. Expenses General and Administrative and Other Expense General and administrative and other expense increased to $1.2 million during 1998 as compared to $156,000 during the Commencement Period. The increase in general and administrative expense was primarily related to operational expenses the Company incurred subsequent to August of 1997 as a result of becoming a public company. Additionally, property expense on a commercial office building which the Company owns, increased to $779,000 during 1998 as compared to $109,000 during the Commencement Period. Advisory Fees Advisory fees are computed quarterly on tax basis earnings, which are calculated by adjusting the Company's book basis earnings by various differences between book basis earnings and tax basis earnings. Differences between book basis earnings and tax basis earnings are estimates that are derived from management's best knowledge. Although the Company recorded a net loss during 1998, the Company recorded advisory fees based on tax basis earnings, which were approximately $11.7 million. Therefore, the Company recorded an expense of $745,000 during 1998 as compared to none during the Commencement Period. Credit Exposures The Company recorded provision for loan losses of $1.5 million during 1998 as compared to $564,000 during the Commencement Period. Correspondingly, the allowance for loan losses increased to $2.1 million at December 31, 1998 as compared to $564,000 at December 31, 1997. At December 31, 1998 and 1997, the Company's allowance for loan losses expressed as a percentage of Commercial Mortgages held-for-investment, CMO collateral and finance receivables (collectively "Gross Loan Receivables") was 0.54% and 0.35%, respectively. The allowance for loan losses is determined primarily on management's judgment of net loss potential including specific allowances for any known impaired loans, changes in the nature and volume of the portfolio, value of the collateral and current economic conditions that may affect the borrowers' ability to pay. Delinquencies. The following table sets forth delinquency statistics for the Long-Term Investment Operations' portfolio of Commercial Mortgages held-for- investment and CMO collateral for the periods shown:
At December 31, 1998 At December 31, 1997 ----------------------- ---------------------------- Number % of Number % of of Servicing of Servicing Loans Portfolio Loans Portfolio -------- --------- ----------- ------------ Loans delinquent for: 90 days............................................................. 5 1.21 -- 0.0 -------- ---------- ----------- ------------ Total delinquencies, foreclosures and bankruptcies............... 5 1.21% -- 0.0% ======== ========== =========== ============
RESULTS OF OPERATIONS-- IMPAC COMMERCIAL CAPITAL CORPORATION Year Ended December 31, 1998 as compared to the period from January 15, 1997 (commencement of operations) through December 31, 1997 Net Earnings ICCC recorded a net loss of $(20.2) million during the year ended December 31, 1998 as compared to net earnings of $1.4 million for the Commencement Period. The Company's net loss for 1998 was primarily the result of an increase of $18.0 million in loss on sale of Commercial Mortgages held-for-sale, an increase of $1.0 million in net interest loss and an increase of $4.3 million in other operating expense. 41 Net Interest Income (Expense) ICCC's net interest expense increased by $1.0 million to $(1.0) million during 1998 as compared to $57,000 during the Commencement Period as the deterioration of the commercial mortgage-backed securitization market forced ICCC to hold Commercial Mortgages in its portfolio during 1998. Commercial Mortgages held- for-sale earned lower yields than interest rates paid on borrowings used to finance the Commercial Mortgages. The average yield earned on Commercial Mortgages held-for-sale was 7.88% during 1998 as compared to financing costs of 8.40%. During the fourth quarter of 1998, the Company began concentrating its efforts on the origination of higher yielding CommercialExpress loans and de- emphasizing the origination of lower yielding ConduitExpress loans. Non-Interest Income The loss on sale of Commercial Mortgages held-for-sale during 1998 was $14.3 million as compared to a gain on sale of Commercial Mortgages held-for-sale of $3.7 million during the Commencement Period. The loss on sale of Commercial Mortgages held-for-sale was the result of the sale of Commercial Mortgages during the fourth quarter of 1998 in order to generate liquidity and help to protect the Company against any future margin calls on borrowings under warehouse line and reverse repurchase facilities. The Company's lenders required margin calls on the Company's warehouse line and reverse repurchase facilities due to turmoil in the commercial mortgage-backed securitization market during the third and fourth quarters of 1998. In order to meet those margin calls and provide the Company additional liquidity, ICCC completed the sale of $172.3 million of Commercial Mortgages during the fourth quarter of 1998. Non-Interest Expense Other operating expense increased to $5.4 million during 1998 as compared to $1.0 million during the Commencement Period as ICCC's loan originations increased to $425.1 million as compared to $233.5 million, respectively. Personnel expense increased to $2.5 million during 1998 as compared to $38,000 during the Commencement Period as ICCC's staffing increased to 89 employees at September 30, 1998 as compared to 50 employees at December 31, 1997 and 27 employees at September 30, 1997. During the fourth quarter of 1998, ICCC reduced its staff levels by 35% due to the decrease in loan originations during the second half of 1998 as compared to the first half of 1998. In addition, occupancy expense increased to $1.0 million during 1998 as compared to $160,000 during the Commencement Period and general and administrative and other expense increased to $1.1 million as compared to $288,000, respectively, due to the increase in ICCC's staffing levels and the expansion of its loan origination operations. Liquidity and Capital Resources Overview. The Company's business operations are primarily funded from monthly interest and principal payments from its Commercial Mortgages and CMBS portfolios, warehouse line and reverse repurchase agreements secured by Commercial Mortgages and CMBS, CMO financing, proceeds from the sale of Commercial Mortgages, short-term unsecured borrowings and proceeds from the issuance of Common Stock. The acquisition of Commercial Mortgages and CMBS by the Long-Term Investment Operations are primarily funded from monthly principal and interest payments, warehouse and reverse repurchase agreements, CMO financing, short-term unsecured borrowings and proceeds from the sale of Common Stock. The acquisition of Commercial Mortgages by the Conduit Operations are funded from reverse repurchase agreements and the sale of Commercial Mortgages. The Company'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 the Company's lenders and/or investors to make additional funds available to the Company in the future will depend upon a number of factors, such as compliance with the terms of its existing credit arrangements, financial performance, industry and market trends in various businesses, the general availability of and rates applicable to financing and investments, lenders' and/or investors' own resources and policies concerning loans and investments and the relative attractiveness of alternative investment or lending opportunities. During the third and fourth quarters of 1998, the deterioration of the CMBS market created a lack of liquidity for the Company as the Company's lenders made margin calls on their warehouse and reverse repurchase lines. Margin calls result from the Company's lenders evaluating the market value of underlying collateral securing the warehouse 42 lines of credit and requiring additional equity or collateral on the warehouse lines. These margin calls resulted in the Company delaying its third quarter dividend and selling $172.3 million of Commercial Mortgages in order to meet its margin calls and provide additional working capital. The sale of the Commercial Mortgages increased the Company's liquidity by $25.6 million, at the time of sale, after paying down borrowings on warehouse and reverse repurchase lines. With net proceeds from the sale of Commercial Mortgages, the Company was able to use these funds to pay its third quarter dividend, which had been suspended, repurchase shares of its capital stock at a price significantly below book value, purchase the remaining 50% ownership interest in its commercial office building from IMH and have additional liquidity for general working capital needs. By selling Commercial Mortgages, the Company reduced its exposure to future margin calls on existing borrowings under its current warehouse lines and repurchase facilities by paying down outstanding borrowings on these facilities. In addition, by concentrating on the origination of CommercialExpress loans which have lower loan balances and higher interest margins, the Company's liquidity improved during the fourth quarter of 1998. Based upon past experience, the Company has received better execution, both in terms of price and completion time, on both securitizations and whole loan sales on CommercialExpress loans than on ConduitExpress loans, which have larger loan balances and smaller interest margins. Also, by de-emphasizing originations of ConduitExpress loans, loan originations decreased in the third and fourth quarters of 1998 and reduced borrowing needs during these periods of market volatility. The Company expects that by originating primarily CommercialExpress loans, the length of time specific loans are outstanding on the Company's warehouse lines will be reduced. In addition, the reduction in staff during the fourth quarter of 1998 provided additional liquidity from operating activities. However, cash flows were negatively impacted by the deterioration of the CMBS market and the subsequent sale of Commercial Mortgages as the Company did not benefit from the positive cash flows generated by these financial instruments. In addition, any future margin calls or termination of warehouse lines or repurchase facilities by the Company's lenders may adversely affect the Company's future operations. Many former lenders to other companies in the same business as ICH are no longer in the business of providing warehouse lines for the funding of Commercial Mortgages. This may affect the Company's ability to obtain new financing at comparable rates and terms or any new financing at all. Long-Term Investment Operations. ICH has a warehouse line agreement with an investment bank, which expires in May 1999, unless terminated earlier, which provides up to an aggregate of $300.0 million, of which $100.0 million is uncommitted, to finance the Company's operations as needed. Terms of the warehouse line agreement requires that the Commercial Mortgages be held by an independent third party custodian, which gives the Company the ability to borrow against the collateral provided as a percentage of the fair market value of the Commercial Mortgages. The borrowing rates are expressed in basis points over the one-month LIBOR. The margins on the warehouse line agreements are based on the type of mortgage collateral provided, with loan amounts generally range from 75% to 92% of the fair market value of the collateral. As of December 31, 1998, an aggregate of $45.7 million was outstanding under the warehouse line agreements. ICH has entered into reverse repurchase agreements whereby ICH pledges specific CMBSs as collateral to secure short-term loans. The interest rates on the loans are based on one-month LIBOR plus a margin depending on the type of collateral provided, with loan amounts generally range from 50% to 75% of the fair market value of the collateral. As of December 31, 1998, amounts outstanding on the reverse repurchase agreements were $4.9 million. The Long-Term Investment Operations uses CMO borrowings to finance Commercial Mortgages as a means of eliminating certain risks associated with warehouse line and reverse repurchase agreements, such as the potential need for deposits of additional collateral, that are not present with CMO borrowings. Terms of the CMO borrowings require that an independent third party custodian hold the mortgages. The maturity of each class is directly affected by the rate of principal prepayments on the related collateral. Equity in the CMOs is established at the time the CMOs are issued at levels sufficient to achieve desired credit ratings on the securities from rating agencies. The amount of equity invested in CMOs by the Long-Term Investment Operations is also determined by the Company based upon the anticipated return on equity as compared to the estimated proceeds from additional debt issuance. Total credit loss exposure is limited to the equity invested in the CMOs at any point in time. At December 31, 1998, the Long-Term Investment Operations had $285.0 million of CMO borrowings used to finance $326.6 million of CMO collateral. In 1998, ICH entered into a revolving credit arrangement with a commercial bank whereby ICH can borrow up to maximum amount of $10.0 million for general working capital needs. The revolving credit agreement expires on March 43 29, 1999. Advances under the revolving credit arrangement are at an interest rate of prime plus 0.25%. Interest is paid monthly and as an open-ended revolving line of credit there is no set principal payment schedule. As of December 31, 1998, ICH had no outstanding borrowings under the revolving credit arrangement. During 1998, ICH had a credit arrangement with IMH whereby IMH advanced to ICH up to maximum amount of $15.0 million for general working capital needs. Subsequent to 1998, the credit agreement was terminated and will no longer be used by ICH. Advances under the credit arrangement were at an interest rate and maturity determined at the time of each advance with interest and principal paid monthly. As of December 31, 1998 and 1997, ICH's outstanding borrowings under the credit arrangement were none and $9.1 million, respectively, with an interest rate of prime plus 1% at the time of each advance. During 1998, pursuant to a public offering, ICH sold 2,000,0000 shares of Common Stock at $15.3125 per share, which raised additional capital of $28.4 million, net of underwriting discounts and other expenses. Conduit Operations. ICCC has entered into uncommitted warehouse line agreements with ICH which provide up to an aggregate of $900.0 million to finance ICCC's operations as needed. Terms of the warehouse line agreements require that the Commercial Mortgages be held by an independent third party custodian, which gives the Company the ability to borrow against the collateral provided as a percentage of the fair market value of the Commercial Mortgages. The borrowing rates on the warehouse line agreements are at Bank of America's prime rate, which was 7.75% at December 31, 1998. The margins on the warehouse line agreements are up to 90% of the fair market value of the collateral provided. As of December 31, 1998 and 1997, amounts outstanding on ICCC's warehouse line agreements with ICH were $41.2 million and $95.7 million, respectively. ICCC has entered into an uncommitted warehouse line agreement with IMH to provide financing as needed. The margins on the warehouse line agreement are at 8% of the fair market value of the collateral provided. The interest rates on the borrowings are indexed to Bank of America's prime rate, which was 7.75% at December 31, 1998. As of December 31, 1998 and 1997, outstanding amounts on the warehouse line agreement were $3.7 million and $8.5 million, respectively. Cash Flows Operating Activities--During 1998, net cash used in operating activities was $18.0 million. Net cash used in operating activities was primarily the result of a net loss of $11.0 million and a net decrease of $29.5 million in due from affiliates and due to affiliates, which was primarily due to an increase of $13.4 million related to advances to finance the operations of ICCC. Investing Activities--During 1998, net cash used in investing activities was $228.8 million. Net cash used in investing activities was primarily the result of the acquisition and subsequent securitization of $325.0 million of Commercial Mortgages. The increase in CMO collateral was partially offset by a decrease of $54.7 million in finance receivables and a decrease of $38.2 million in Commercial Mortgages held-for-investment. Financing Activities--During 1998, net cash provided by financing activities was $245.1 million. Net cash provided by financing activities was primarily the result of proceeds from CMO borrowings of $301.8 million, which was partially offset by a decrease in warehouse line agreements of $44.7 million. Inflation The Financial Statements and Notes thereto presented herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased costs of the Company's operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company's operations are monetary in nature. As a result, interest rates have a greater impact on the Company's operations' performance than do the effects of general levels of inflation. Inflation affects the Company's operations primarily through its effect on interest rates, since interest rates normally increase during periods of high inflation and decrease during periods of low inflation. During periods of increasing interest rates, demand for mortgage loans and a borrower's ability to qualify for mortgage financing in a purchase transaction may be adversely affected. During periods 44 of decreasing interest rates, borrowers may prepay their mortgages, which in turn may adversely affect the Company's yield and consequently the value of its portfolio of Mortgage Assets. YEAR 2000 COMPLIANCE PROJECT STATUS The Company's Year 2000 project was approximately 75% complete as of the end of December 1998. The Company has contracted with an outside vendor to provide coordination, support, testing and implementation in regards to Year 2000 compliance of hardware and software systems, both on an information technology ("IT") and non-IT level. The Company also has its own in-house IT department and is currently assisting the outside vendor with Year 2000 compliance issues. The Company's primary IT systems include loan servicing, which is contracted to an outside vendor, loan tracking, and accounting and reporting. The Company has received a Year 2000 compliance plan from its loan servicing vendor and receives monthly status reports. As of December 31, 1998 and according to its last status report, the loan servicing vendor is on track with its Year 2000 compliance plan and expects to be in Year 2000 compliance by the first half of 1999. The loan tracking system is a proprietary system that was written using Microsoft Access, which is Year 2000 compliant. The accounting and reporting systems have been upgraded to versions that are currently Year 2000 compliant. The Company's non-IT systems include its file servers, network systems, workstations and communication systems. Testing on all other in-house hardware is currently underway and is expected to be complete by the end of the second quarter of 1999. The Year 2000 project is divided into two primary phases, as follows: (1) define scope of project and identify all IT and non-IT systems, and (2) testing of existing systems and implementation of new systems, if required. The outside contractor on the Year 2000 project submits monthly status reports to the Company's IT manager and communicates with the IT department on a daily basis. The Company's executive committee, which includes the CEO and Chairman, President, and Chief Financial Officer, reviews the progress of the Company's Year 2000 project through monthly status reports from the Company's IT manager. Phase I-Define Scope of Project - -------------------------------- This phase primarily included the inventorying of Year 2000 items, contacting outside vendors, including reviewing contractual terms and conditions, reviewing internal software for compliance and determining costs to complete the project. Phase I of the project also included the testing and implementation or upgrade of non-IT systems. As of the end of October 1998, Phase I of the project had been completed. Phase II-Testing of Systems - ---------------------------- This phase of the Year 2000 project can be divided into four separate processes, as follows: (1) Compliance Questionnaires, (2) Hardware Certification Information, (3) Software/Data Testing, and (4) Hardware Testing. Compliance Questionnaires and Hardware Certification Information. As of the end of October 1998, these portions of Phase II were complete. Software/Data Testing. As of the end of December 1998, this portion of Phase II was approximately 80% complete. The remaining tasks within this process include analyzing list of software being used, testing all software programs, testing all data from incoming sources, testing all outgoing data processes and reporting. The Company expects that this process will be complete by March 31, 1999. Hardware Testing. As of the end of December 1998, this portion of Phase II had not been started. This phase is contingent on the completion of software/data testing. Tasks yet to be started include testing all workstation, servers and network systems. The Company expects to be compliant with all internal Year 2000 issues by the end of the second quarter of 1999. 45 COSTS The total cost associated with required modifications or installations to become Year 2000 compliant is not expected to be material to the Company's financial condition. The estimated cost of the project is expected to be approximately $108,000. As of the end of December 1998, the Company had paid $34,000 to the outside vendor for completed work on the project. The majority of the Company's estimated cost for the Year 2000 compliance has been or will be spent on software upgrades and writing new program code to existing proprietary software. Since most of the Company's hardware has been purchased within the last two years, the cost of replacing hardware will be minimal. RISKS The Company does not anticipate any material disruption of its operations as a result of any failure by the Company to be compliant. However, there can be no assurance that there will not be a delay in, or increased costs associated with, the need to address the Year 2000 issue. The Company also relies, directly and indirectly, on other businesses such as third party service providers, creditors and financial organizations and governmental entities. Even if the Company's computer systems are not materially adversely affected by the Year 2000 issue, the Company's business and operations could be materially adversely affected by disruptions in the operations of the enterprises with which the Company interacts. CONTINGENCY PLANS The Company believes its Year 2000 compliance process should enable it to be successful in modifying its computer systems to be Year 2000 compliant. As previously stated, acceptance testing and sign-off has begun with respect to the Company's in-house systems. In addition to Year 2000 system modification plans, the Company has also developed contingency plans for all other systems classified as critical and high risk. These contingency plans provide timetables to pursue various alternatives based upon the failure of a system to be adequately modified and/or sufficiently tested and validated to ensure Year 2000 compliance. However, there can be no assurance that either the compliance process or contingency plans will avoid partial or total system interruptions or the costs necessary to update hardware and software would not have a material adverse effect upon the Company's financial condition. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK General A significant portion of the Company's revenues and earnings are derived from net interest income and, accordingly, the Company strives to manage its interest-earning assets and interest-bearing liabilities to generate what management believes to be an appropriate contribution from net interest income. Asset and liability management seeks to control the volatility of the Company's performance due to changes in interest rates. The Company attempts to achieve an appropriate relationship between rate sensitive assets and rate sensitive liabilities. Although the Company manages other risks, such as credit, operational and liquidity risk in the normal course of business, management considers interest rate risk to be a significant market risk which could potentially have the largest material effect on the Company's financial condition and results of operations. Rate Sensitive Assets and Liabilities Interest rate risk is the responsibility of the Asset and Liability Committee ("ALCO"), which reports to the Board of Director's of the Company. ALCO establishes policies that monitor and coordinate the Company's sources, uses and pricing of its funds. The Company attempts to reduce the volatility in net interest income by managing the relationship of interest rate sensitive assets to interest rate sensitive liabilities. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest- bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds that amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of falling interest rates, the net earnings of an institution with a 46 positive gap theoretically may be adversely affected due to its interest-earning assets repricing to a greater extent than its interest-bearing liabilities. Conversely, during a period of rising interest rates, theoretically, the net earnings of an institution with a positive gap position may increase as it is able to invest in higher yielding interest-earning assets at a more rapid rate than its interest-bearing liabilities reprice. The Company manages its interest rate risk by, (1) retaining adjustable-rate Commercial Mortgages to be held for long-term investment, (2) selling fixed-rate Commercial Mortgages on a whole-loan basis, and (3) securitizing both adjustable- and fixed-rate Commercial Mortgages through the issuance of CMOs. The Company retains adjustable-rate Commercial Mortgages, which are generally indexed to six-month LIBOR and reprice every six months, to be held for investment or as CMO collateral. The index on adjustable rate Commercial Mortgages provide a comparable match to the one-month LIBOR index that is used for the funding of Commercial Mortgages on the Company's warehouse line agreements. In addition, the Company securitizes both variable- fixed-rate Commercial Mortgages as CMOs to reduce its interest rate risk as CMOs provide a net interest spread between the interest income on the Commercial Mortgages and the interest and other expenses associated with the CMO financing. To a great extent, market risk arising from early prepayment of Commercial Mortgages is minimized as the Company uses short-term prepayment lock-outs and prepayment penalties. As a result of this strategy, the Company's total interest-earning assets maturing or repricing within one year exceed interest-bearing liabilities maturing or repricing in one year by $58.9 million, representing a positive gap. Therefore, the Company's net interest income would be negatively affected by decreases in interest rates as interest-earning assets would reprice to lower interest rates faster than would interest-bearing liabilities. Conversely, in an increasing interest rate environment the Company's net interest income would increase as more interest-earning assets would reprice to higher rates faster than would interest-bearing liabilities. As a rule, the Company attempts to keep the cumulative difference between interest-earning assets and interest-bearing liabilities as low as possible over a one year cycle. The Company currently does not maintain a trading portfolio. As a result, the Company is not exposed to market risk as it relates to trading activities. The Company's investment securities portfolio are held for sale which requires the Company to perform market valuations of the portfolio in order to properly record the portfolio at the lower of cost or market. Therefore, the Company continually monitors the interest rates of its investment securities portfolio as compared to prevalent interest rates in the market. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1998, which are anticipated by the Company to reprice or mature in each of the future time periods shown. The amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual terms of the asset or liability.
Greater than 1999 2000 2001 2002 2003 5 Years Total --------- --------- --------- --------- --------- --------- --------- INTEREST-SENSITIVE ASSETS: Cash equivalents $ 14,161 $ -- $ -- $ -- $ -- $ -- $ 14,161 Average interest rate 5.03% 5.03% Investment and residual securities 25,944 -- -- -- -- -- 25,944 Average interest rate 14.01% 14.01% Finance receivables 40,972 -- -- -- -- -- 40,972 Average interest rate 7.75% 7.75% Commercial Mortgages: Adjustable (3) 50,767 -- -- -- -- -- 50,767 Average interest rate 9.28% 9.28% Fixed (3) -- -- -- -- -- 281,393 281,393 Average interest rate 7.91% 7.91% Due from affiliates 22,131 -- -- -- -- -- 22,131 Average interest rate 8.00% 8.00% --------- --------- --------- --------- --------- --------- --------- Total interest-sensitive assets $ 153,975 $ -- $ -- $ -- $ -- $ 281,393 $ 435,368 --------- --------- --------- --------- --------- --------- ---------
47
Greater than 1999 2000 2001 2002 2003 5 Years Total --------- --------- --------- --------- --------- --------- --------- INTEREST-SENSITIVE LIABILITIES: Warehouse facilities $ 45,654 $ -- $ -- $ -- $ -- $ -- $ 45,654 Average interest rate 6.12% 6.12% Reverse repurchase agreements 4,869 -- -- -- -- -- 4,869 Average interest rate 6.10% 6.10% CMO borrowings (4) 33,336 -- -- -- -- 257,881 291,217 Average interest rate 5.34% 6.59% 6.45% Due to affiliates 11,170 -- -- -- -- -- 11,170 Average interest rate 8.46% 8.46% --------- --------- --------- --------- --------- --------- --------- Total interest-sensitive liabilities $ 95,029 $ -- $ -- $ -- $ -- $ 257,881 $ 352,910 --------- --------- --------- --------- --------- --------- --------- Interest rate sensitivity gap $ 58,946 $ -- $ -- $ -- $ -- $ 23,512 $ 82,458 Cumulative interest sensitivity gap $ 58,946 $ 58,946 $ 58,946 $ 58,946 $ 58,946 $ 82,458
___________________ (1) Interest sensitivity gap represents the difference between net interest- earning assets and interest-bearing liabilities. (2) Interest-sensitive assets and liabilities are based upon contractual maturity and repricing date. (3) Amounts are based on the unpaid principal balance of Commercial Mortgages at December 31, 1998. (4) Excludes bond discount. In addition to measuring interest rate risk via a GAP analysis, the Company measures the sensitivity of its net interest income to changes in interest rates. Changes in interest rates are defined as instantaneous and sustained movements in interest rates in 100 basis point increments. The Company estimates its interest income for the next twelve months assuming no changes in interest rates from those at period end. Once the base case has been estimated, calculations are made for each of the defined changes in interest rates. Those results are then compared against the base case to determine the estimated change to net interest income. Assuming immediate interest rate decreases of 100 and 200 basis points, the Company estimates that the decrease in net interest income would be $825,000, or 6%, and $1.7 million, or 12%, respectively. The following table presents the extent to which changes in interest rates and changes in the volume of interest-sensitive assets and interest-sensitive liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided on Commercial Mortgage Assets and borrowings on Commercial Mortgage Assets, only, with respect to (1) changes attributable to changes in volume (changes in volume multiplied by prior rate), (2) changes attributable to changes in rate (changes in volume multiplied by prior volume), (3) changes in interest due to both rate and volume and (4) the net change.
YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 1998 OVER 1997 --------------------------------------------------------------- RATE/ VOLUME RATE VOLUME TOTAL --------- ------- ---------- --------- (IN THOUSANDS) Increase (decrease) in: Investment and residual securities..................... $ 2,719 $ (269) $ (327) $ 2,123 Commercial Mortgages held-for-investment............... 9,848 (253) (1,209) 8,386 CMO collateral......................................... 25,109 (31) (16,065) 9,013 Finance receivables.................................... 6,769 (20) (58) 6,691 --------- ------- ---------- --------- TOTAL INTEREST INCOME................................. $ 44,445 $ (573) $ (17,659) $ 26,213 ========= ======= ========== ========= Warehouse line agreements.............................. $ 12,173 $ (140) $ (933) $ 11,100 CMO borrowings......................................... 6,774 1 413 7,188 Reverse repurchase agreements.......................... 375 6 18 399 Borrowings on residual interest in securitization...... (275) -- -- (275) --------- ------- ---------- --------- TOTAL INTEREST EXPENSE................................ $ 19,047 $ (133) $ (502) $ 18,412 ========= ======= ========== =========
48 Hedging The Company conducts certain hedging activities in connection with both its Long-Term Investment Operations, only with respect to its liabilities, and its Conduit Operations. Long-Term Investment Operations: To the extent consistent with ICH's election to qualify as a REIT, the Company follows a hedging program intended to protect against interest rate changes and to enable the Company to earn net interest income in periods of generally rising, as well as declining or static, interest rates. Specifically, the Company's hedging program is formulated with the intent to offset the potential adverse effects resulting from (1) interest rate adjustment limitations on its mortgage loans and MBSs and (2) the differences between the interest rate adjustment indices and interest rate adjustment periods of its adjustable rate mortgage loans secured by such loans and related borrowings. As part of its hedging program, the Company also monitors on an ongoing basis the prepayment risks that arise in fluctuating interest rate environments. The Company's hedging program encompasses a number of procedures. The Company will structure its borrowing agreements to have a range of different maturities. As a result, the Company may adjust the average maturity of its borrowings on an ongoing basis by changing the mix of maturities as borrowings come due and are renewed. In this way, the Company would minimize any differences between interest rate adjustment periods of mortgage loans and related borrowings that may occur due to prepayments of mortgage loans or other factors. The Company may occasionally purchase interest rate caps to limit or partially offset adverse changes in interest rates associated with its borrowings. In a typical interest rate cap agreement, the cap purchaser makes an initial lump sum cash payment to the cap seller in exchange for the seller's promise to make cash payments to the purchaser on fixed dates during the contract term if prevailing interest rates exceed the rate specified in the contract. In this way, the Company generally hedges as much of the interest rate risk arising from lifetime rate caps on mortgage loans and from periodic rate and/or payment caps as the Company determines is in the best interests of the Company, given the cost of such hedging transactions and the need to maintain ICH's status as a REIT. Such periodic caps on the Company's mortgage loans may also be hedged by the purchase of mortgage derivative securities. Mortgage derivative securities can be effective hedging instruments in certain situations as the value and yields of some of these instruments tend to increase as interest rates rise and tend to decrease in value and yields as interest rates decline, while the experience for others is the converse. The Company intends to limit its purchases of mortgage derivative securities to investments that qualify as qualified REIT assets or qualified hedges so that income from such investments will constitute qualifying income for purposes of the 95% and 75% gross income tests. To a lesser extent, the Company, through its Conduit Operations, may enter into interest rate swap agreements, buy and sell financial futures contracts and options on financial futures contracts and trade forward contracts as a hedge against future interest rate changes; however, the Company will not invest in these instruments unless the Company and the Manager are exempt from the registration requirements of the Commodity Exchange Act or otherwise comply with the provisions of that Act. The REIT provisions of the Internal Revenue Code of 1986 may restrict the Company's ability to purchase certain instruments and may severely restrict the Company's ability to employ other strategies. In all its hedging transactions, the Company deals only with counterparties that the Company believes are sound credit risks. As of December 31, 1998 and 1997, the Company had no outstanding interest rate cap or interest rate swap agreements or other derivative instruments. Conduit Operations: In conducting its Conduit Operations, ICCC is subject to the risk of rising mortgage interest rates between the time it commits to originate or purchase Commercial Mortgages at a fixed price or rate and the time it sells or securitizes those Commercial Mortgages. To mitigate this risk, ICCC enters into transactions designed to hedge interest rate risks, which may include mandatory and optional forward selling of Commercial Mortgages and buying and selling of futures and options on futures and U.S. Treasury obligations. The nature and quantity of these hedging transactions are determined by the management of ICCC or the Manager, based on various factors, including market conditions and the average duration of the mortgage loans and the expected subordination of the mortgage loans upon securitization. Futures Contracts To remain competitive and control risk, ICCC uses futures and options on futures. The use of these instruments provides for increased liquidity, lower transaction costs and more effective short-term coverage than cash and mortgage- backed securities. However, ICCC is vulnerable to the basis risk that is inherent in cross-hedging. ICCC uses the buying and selling of futures contracts on Treasury bonds and Treasury notes when the market is vulnerable to day-to-day corrections. Executing hedges with these instruments allows ICCC to more effectively hedge the risks of corrections or reverses in the market without committing mandatory sales on mortgage-backed securities or cash. ICCC 49 utilizes these instruments on a short-term basis to fine tune its overall hedge position at a lower cost. The Company sells future contracts against five- and ten-year Treasury notes with major dealers in such securities. At December 31, 1998 and 1997, the Company had $20.0 million and $105.1 million, respectively, in outstanding commitments to sell U.S. Treasury notes. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item 8 is incorporated by reference to Impac Commercial Holdings, Inc.'s Consolidated Financial Statements and Independent Auditors' Report beginning at page F-1 of this Form 10-K. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 is hereby incorporated by reference to Impac Commercial Holdings, Inc.'s definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of Impac Commercial Holdings, Inc.'s 1998 fiscal year. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is hereby incorporated by reference to Impac Commercial Holdings, Inc.'s definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of Impac Commercial Holdings, Inc.'s 1998 fiscal year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is hereby incorporated by reference to Impac Commercial Holdings, Inc.'s definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of Impac Commercial Holdings, Inc.'s 1998 fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is hereby incorporated by reference to Impac Commercial Holdings, Inc.'s definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of Impac Commercial Holdings, Inc.'s 1998 fiscal year. 50 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) All schedules have been omitted because they are either not applicable, not required or the information required has been disclosed in the Consolidated Financial Statements and related Notes to Consolidated Financial Statements at page F-1, or are otherwise included in Form 10-K. (b) Reports on Form 8-K-- A current report on Form 8-K, dated October 7, 1998, was filed on October 14, 1998 reporting on Items 5 and 7. (c) Exhibits Exhibit Number Description ------- ----------- 3.1 Charter of the Registrant.(1) 3.1(a) Articles of Amendment of Registrant.(1) 3.1(b) Articles of Amendment of Registrant.(2) 3.1(c) Articles of Amendment of Registrant.(3) 3.1(d) Articles Supplementary and Certificate of Correction for Series A Junior Participating Preferred Stock of Registrant. 3.2 Bylaws of the Registrant.(1) 4.1 Form of Common Stock Certificate of the Company.(1) 4.2 Rights Agreement, dated October 7, 1998, between the Registrant and BankBoston, N.A.(4) 10.1 Management Agreement among the Registrant and RAI Advisors, LLC. 10.2 Submanagement Agreement among RAI Advisors, LLC, Impac Mortgage Holdings, Inc. and Impac Funding Corporation. 10.3 1997 Stock Option and Awards Plan.(1) 10.4 Lease dated December 8, 1997, among the Registrant, Impac Commercial Capital Corporation and The Irvine Company.(1) 10.5 Contribution Agreement among the Registrant, Impac Mortgage Holdings, Inc., and Impac Commercial Capital Corporation. 10.6 Non-Competition Agreement among the Registrant, Impac Mortgage Holdings, Inc., Impac Commercial Capital Corporation and Impac Funding Corporation. 10.7 Right of First Refusal Agreement between the Registrant, RAI Advisors, LLC, Impac Mortgage Holdings, Inc., Impac Commercial Capital Corporation, and Impac Funding Corporation. 10.8 Servicing Agreement between the Registrant and Impac Commercial Capital Corporation.(1) 10.9 Revolving Credit and Term Loan Agreement, dated August 21, 1997, between the Registrant and Impac Mortgage Holdings, Inc.(5) 51 10.10 Real Estate Purchase, Sale and Escrow Agreement, dated August 25, 1997, by and between TW/BRP Dove, LLC and IMH/ICH Dove Street, LLC. (5) 10.10(a) Contract of Sale, dated October 27, 1998, between the Registrant and Impac Mortgage Holdings, Inc. 10.11 Employment Agreement, dated August 8, 1997, between William D. Endresen and Impac Commercial Capital Corporation. 10.12 Servicing Agreement, dated July 31, 1998, among the Registrant, ICCC and Midland Loan Services, Inc. 21 Subsidiaries of the Registrant. 23.1 Consent of KPMG LLP re: Registrant. 23.2 Consent of KPMG LLP re: Impac Commercial Capital Corporation. 24.1 Power of Attorney (included on signature page). 27 Financial Data Schedule. _______________ (1) Incorporated by reference to, and all such exhibits have the corresponding exhibit number filed as part of the Registrant's registration statement on Form S-11 (File No. 333-25423) and Amendments Nos. 1, 2, 3, 4 and 5 filed with the Securities and Exchange Commission on April 18, June 10, June 30, July 8, July 17 and July 29, 1997, respectively. (2) Incorporated by reference to exhibit number 3.1(a) of the Registrant's Current Report on Form 8-K, as amended, dated January 28, 1998. (3) Incorporated by reference to the corresponding exhibit number of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997. (4) Incorporated by reference to the corresponding exhibit number of the Registrant's Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on October 14, 1998. (5) Incorporated by reference to the corresponding exhibit number of the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1997. 52 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 in the City of Irvine, State of California, on the 26th day of February, 1999. IMPAC COMMERCIAL HOLDINGS, INC. By: /s/ JOSEPH R. TOMKINSON ------------------------- Joseph R. Tomkinson Chairman of the Board and Chief Executive Officer We, the undersigned directors and officers of Impac Commercial Holdings, Inc., do hereby constitute and appoint Joseph R. Tomkinson and Richard J. Johnson, or either of them, our true and lawful attorneys and agents, to do any and all acts and things in our name and behalf in our capacities as directors and officers and to execute any and all instruments for us and in our names in the capacities indicated below, which said attorneys and agents, or either of them, may deem necessary or advisable to enable said corporation to comply with the Securities Exchange Act of 1933, as amended, and any rules, regulations, and requirements of the Securities and Exchange Commission, in connection with this report, including specifically, but without limitation, power and authority to sign for us or any of us in our names and in the capacities indicated below, any and all amendments to this report; and we do hereby ratify and confirm all that the said attorneys and agents, or either of them, shall do or cause to be done by virtue hereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED.
Signature Title Date --------- ----- ---- /s/ Joseph R. Tomkinson Chairman of the Board and Chief February 26, 1999 - ------------------------- Executive Officer (Principal Joseph R. Tomkinson Executive Officer) /s/ Richard J. Johnson Chief Financial Officer (Principal February 26, 1999 - ------------------------- Financial and Accounting Richard J. Johnson Officer) /s/ James Walsh Director February 26, 1999 - ------------------------- James Walsh /s/ Frank P. Filipps Director February 26, 1999 - ------------------------- Frank P. Filipps /s/ Stephan R. Peers Director February 26, 1999 - ------------------------- Stephan R. Peers /s/ Thomas J. Poletti Director February 26, 1999 - ------------------------- Thomas J. Poletti /s/ Timothy R. Busch Director February 26, 1999 - ------------------------- Timothy R. Busch
53 INDEPENDENT AUDITORS' REPORT AND CONSOLIDATED FINANCIAL STATEMENTS INDEX
Page ----- IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES ------------------------------------------------ Independent Auditors' Report................................................................................. F-2 Consolidated Balance Sheets at December 31, 1998 and 1997.................................................... F-3 Consolidated Statements of Operations and Comprehensive Earnings (Loss) for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997........ F-4 Consolidated Statement of Changes in Stockholders' Equity for the period from January 15, 1997 (commencement of operations) through December 31, 1998...................................................... F-5 Consolidated Statements of Cash Flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997...................................... F-6 Notes to Consolidated Financial Statements................................................................... F-7 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY --------------------------------------------------- Independent Auditors' Report................................................................................. F-27 Consolidated Balance Sheets at December 31, 1998 and 1997.................................................... F-28 Consolidated Statements of Operations for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997...................................... F-29 Consolidated Statement of Changes in Shareholders' Equity and for the period from January 15, 1997 (commencement of operations) through December 31, 1998...................................................... F-30 Consolidated Statements of Cash Flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997...................................... F-31 Notes to Consolidated Financial Statements................................................................... F-32
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors Impac Commercial Holdings, Inc.: We have audited the accompanying consolidated balance sheets of Impac Commercial Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive earnings (loss), changes in stockholders' equity and cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Impac Commercial Holdings, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 in conformity with generally accepted accounting principles. /s/ KPMG LLP Orange County, California February 3, 1999 F-2 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollar amounts in thousands, except per share data)
At December 31, ------------------------------------------ 1998 1997 ------------------- ------------------ ASSETS ------ Cash and cash equivalents............................................................. $ 14,161 $ 15,908 Investment securities available-for-sale.............................................. 17,154 19,353 Residual interest in securitization, held-for-trading................................. 8,790 9,936 Loan receivables: CMO collateral...................................................................... 326,559 4,255 Finance receivables................................................................. 40,972 95,711 Commercial Mortgages held-for-investment............................................ 24,569 62,790 Allowance for loan losses........................................................... (2,110) (564) ------------------- ------------------ Net loan receivables............................................................. 389,990 162,192 Investment in Impac Commercial Capital Corporation.................................... (15,016) 4,182 Due from affiliates................................................................... 22,131 1,592 Premises and equipment, net........................................................... 9,146 3,857 Accrued interest receivable........................................................... 2,627 1,361 Other assets.......................................................................... 2,236 458 ------------------- ------------------ Total assets..................................................................... $ 451,219 $ 218,839 =================== ================== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CMO borrowings........................................................................ $ 285,021 $ 4,176 Warehouse line agreements............................................................. 45,654 90,374 Reverse repurchase agreements......................................................... 4,869 9,841 Due to affiliates..................................................................... 11,170 8,067 Other liabilities..................................................................... 1,168 3,139 ------------------- ------------------ Total liabilities................................................................ 347,882 115,597 Commitments and contingencies Stockholders' Equity: Preferred Stock; $.01 par value; 9,000,000 shares authorized; no shares -- -- outstanding at December 31, 1998 and 1997......................................... Series A Junior Participating Preferred Stock; $.01 par value; 1,000,000 shares -- -- authorized; no shares outstanding at December 31, 1998 and 1997................... Common Stock; $.01 par value; 46,217,295 shares authorized; 8,625,000 86 73 and 7,344,789 shares issued and outstanding at December 31, 1998 and 1997, respectively.................................................................. Class A Common Stock; $.01 par value; 3,782,705 shares authorized; none -- 7 and 674,211 shares issued and outstanding at December 31, 1998 and 1997, respectively.................................................................. Additional paid-in-capital.......................................................... 127,004 104,761 Accumulated other comprehensive earnings (loss)..................................... 24 (160) Cumulative dividends declared....................................................... (15,575) (4,250) Retained earnings (accumulated deficit)............................................. (8,202) 2,811 ------------------- ------------------ Total stockholders' equity....................................................... 103,337 103,242 ------------------- ------------------ $ 451,219 $ 218,839 =================== ==================
See accompanying notes to consolidated financial statements. F-3 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE EARNINGS (LOSS) (in thousands, except earnings per share data)
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------------ ------------------------- INTEREST INCOME: Commercial Mortgage Assets.................................................. $ 32,933 $ 6,720 Cash equivalents and due from affiliates.................................... 2,912 739 ------------------------ ------------------------- Total interest income...................................................... 35,845 7,459 INTEREST EXPENSE: Warehouse line and reverse repurchase agreements............................ 13,461 1,962 CMO borrowings.............................................................. 7,203 15 Other borrowings............................................................ 912 373 ------------------------ ------------------------- Total interest expense..................................................... 21,576 2,350 ------------------------ ------------------------- Net interest income......................................................... 14,269 5,109 Provision for loan losses.................................................. 1,546 564 ------------------------ ------------------------- Net interest income after provision for loan losses......................... 12,723 4,545 NON-INTEREST INCOME: Equity in net earnings (loss) of Impac Commercial Capital Corporation....... (19,199) 1,694 Other income................................................................ 701 174 ------------------------ ------------------------- Total non-interest income.................................................. (18,498) 1,868 NON-INTEREST EXPENSE: Write-down of residual interest in securitization, held-for-trading......... 1,690 -- General and administrative and other expense................................ 1,227 156 Professional services....................................................... 797 640 Property expense............................................................ 779 109 Advisory fees............................................................... 745 -- Stock compensation expense.................................................. -- 2,697 ------------------------ ------------------------- Total non-interest expense................................................. 5,238 3,602 ------------------------ ------------------------- Net earnings (loss)......................................................... (11,013) 2,811 Other comprehensive earnings (loss): Unrealized gains (losses) arising during period............................. 184 (160) ------------------------ ------------------------- Comprehensive earnings (loss)............................................... $ (10,829) $ 2,651 ======================== ========================= Net earnings (loss) per share--basic and diluted........................... $ (1.26) $ 0.61 ======================== =========================
See accompanying notes to consolidated financial statements. F-4 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands, except per share data)
Class A Preferred Stock Common Stock Common Stock ------------------- ----------------- ----------------- Additional Number Number Number Paid-in of Dollar of Dollar of Dollar Capital Shares Amount Shares Amount Shares Amount (Loss) ---------------------------------------------------------------------- Balance, January 15, 1997 (commencement -- $ -- -- $ -- -- $ -- $ -- of operations) Sale of Common Stock to IMH and certain officers and directors of the Company..... 599 6 -- -- 2,697 Conversion of promissory notes to 3,000 30 -- -- -- -- 14,970 Preferred Stock........................... Dividends declared ($0.53 per share)....... -- -- -- -- -- -- Net proceeds from public stock offering.... -- -- 6,325 63 -- -- 86,961 Class A Common Stock issued to IMH for ICCC Preferred Stock...................... -- -- -- -- 95 1 113 Conversion of ICH Preferred Stock to Class A Common Stock...................... (3,000) (30) 720 7 280 3 20 Conversion of ICH Common Stock to Class A Common Stock...................... -- -- (299) (3) 299 3 -- Other comprehensive loss................... -- -- -- -- -- -- Net earnings from January 15, 1997 -- -- -- -- -- -- -- (commencement of operations) through December 31, 1997......................... -- -- -- -- -- -- -- ---------------------------------------------------------------------- Balance, December 31, 1997................. -- -- 7,345 73 674 7 104,761 Dividends declared ($1.30 per share)....... -- -- -- -- -- -- -- Net proceeds from public stock offering.... -- -- 2,217 22 (217) (2) 28,368 Repurchase of capital stock................ -- -- (937) (9) (457) (5) (6,125) Other comprehensive earnings............... -- -- -- -- -- -- -- Net loss for the year ended December 31, 1998...................................... -- -- -- -- -- -- -- ---------------------------------------------------------------------- Balance, December 31, 1998................. -- $ -- 8,625 $ 86 -- $ -- 127,004 ====================================================================== Acumulated Retained Other Cumulative Earnings Total Comprehensive Dividends (Accumulated Stockholder's Earnings (Loss) Declared Deficit) Equity -------------------------------------------------------------------- Balance, January 15, 1997 (commencement $ -- $ -- $ -- $ -- of operations) Sale of Common Stock to IMH and certain officers and directors of the Company..... -- -- -- 2,703 Conversion of promissory notes to -- -- -- 15,000 Preferred Stock........................... Dividends declared ($0.53 per share)....... -- (4,250) -- (4,250) Net proceeds from public stock offering.... -- -- -- 87,024 Class A Common Stock issued to IMH for ICCC Preferred Stock...................... -- -- -- 114 Conversion of ICH Preferred Stock to Class A Common Stock...................... -- -- -- -- Conversion of ICH Common Stock to Class A Common Stock...................... -- -- -- -- Other comprehensive loss................... (160) -- -- (160) Net earnings from January 15, 1997 -- -- 2,811 2,811 (commencement of operations) through December 31, 1997......................... ------------------------------------------------------------------ Balance, December 31, 1997................. (160) (4,250) 2,811 103,242 Dividends declared ($1.30 per share)....... -- (11,325) -- (11,325) Net proceeds from public stock offering.... -- -- -- 28,388 Repurchase of capital stock................ -- -- -- (6,139) Other comprehensive earnings............... 184 -- -- 184 Net loss for the year ended December 31, 1998...................................... -- -- (11,013) (11,013) ------------------------------------------------------------------ Balance, December 31, 1998.................$ 24 $ (15,575) $ (8,202) $ 103,337 ==================================================================
See accompanying notes to consolidated financial statements. F-5 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
For the period from For the January 15, 1997 year ended (commencement of December 31, operations) through 1998 December 31, 1997 ------------------- ------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss)................................................................ $ (11,013) $ 2,811 Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Equity in net (earnings) loss of Impac Commercial Capital Corporation........... 19,199 (1,694) Stock compensation expense...................................................... -- 2,697 Provision for loan losses....................................................... 1,546 564 Write-down of residual interest in securitization, held-for-trading............. 1,690 -- Depreciation and amortization................................................... 499 65 Net change in accrued interest on receivables................................... (1,266) (1,361) Net change in other assets and liabilities...................................... 848 (366) Net change in due from affiliates and due to affiliates......................... (29,536) 6,475 ------------------- ------------------- Net cash provided by (used in) operating activities............................. (18,033) 9,191 ------------------- ------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net change in Commercial Mortgages held-for-investment............................. 38,221 (62,790) Net change in finance receivables.................................................. 54,739 (95,711) Net change in CMO collateral....................................................... (322,304) (4,255) Purchase of investment securities available-for-sale............................... -- (20,202) Principal reductions on investment securities available-for-sale................... 2,383 689 Purchase of residual interest in securitization, held-for-trading.................. -- (10,098) Principal reductions on residual interest in securitization, held-for-trading...... (544) 162 Purchase of premises and equipment................................................. (1,338) (3,922) Contributions to Impac Commercial Capital Corporation.............................. -- (2,375) ------------------- ------------------- Net cash used in investing activities.......................................... (228,843) (198,502) ------------------- ------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in warehouse line agreements............................................ (44,720) 90,374 Net change in reverse repurchase agreements........................................ (4,972) 9,841 Proceeds from CMO borrowings....................................................... 301,800 4,176 Repayments of CMO borrowings....................................................... (20,955) -- Issuance of Common Stock........................................................... 28,348 87,024 Issuance of promissory notes....................................................... -- 15,000 Issuance of Class A Common Stock................................................... -- 7 Dividends paid..................................................................... (14,372) (1,203) ------------------- ------------------- Net cash provided by financing activities...................................... 245,129 205,219 ------------------- ------------------- Net change in cash and cash equivalents............................................. (1,747) 15,908 Cash and cash equivalents at beginning of period.................................... 15,908 -- ------------------- ------------------- Cash and cash equivalents at end of period.......................................... $ 14,161 $ 15,908 =================== =================== SUPPLEMENTARY INFORMATION: Interest paid...................................................................... $ 20,236 $ 1,974 NON-CASH TRANSACTIONS: Repurchase of Common Stock and Class A Common Stock................................ $ 6,099 $ -- Acquisition of Dove St. building and other assets in exchange for debt............. 6,000 -- Increase (decrease) in accumulated other comprehensive earnings................... 184 (160) Class A Common Stock issued to IMH for ICCC Preferred Stock........................ -- 114 Conversion of promissory notes to ICH Preferred Stock.............................. -- 15,000 Conversion of ICH Preferred Stock to Class A Common Stock.......................... -- 15,000 Conversion of ICH Common Stock to Class A Common Stock............................. -- 3 Dividends declared and unpaid...................................................... -- (3,047)
See accompanying notes to consolidated financial statements. F-6 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note A--Summary of Significant Accounting Policies 1. Financial Statement Presentation The operations of the Company have been presented in the consolidated financial statements for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 and include the financial results of Impac Commercial Holdings, Inc. (ICH), Impac Commercial Assets Corporation (ICH Assets) and ICH/IMH Dove St. LLC (Dove) as stand-alone entities and the financial results of ICH's equity interest in net earnings (loss) in Impac Commercial Capital Corporation (ICCC) as a stand-alone entity, subsequent to the Contribution (the Contribution). The Company is entitled to 95% of the earnings or losses of ICCC through its ownership of all of the non-voting preferred stock of ICCC. As such, the Company records its investment in ICCC using the equity method. Under this method, original investments are recorded at cost and adjusted by the Company's share of earnings or losses. Certain officers and directors of the Company and ICCC own all of the common stock of ICCC and are entitled to 5% of the earnings or loss of ICCC. Gain on the sale of loans or securities by ICCC to ICH are deferred and accreted over the estimated life of the loans or securities using the interest method. All significant intercompany balances and transactions with ICH's consolidated subsidiaries have been eliminated in consolidation. Interest income on affiliated short-term advances, due from affiliates, has been earned at the rate of 8% per annum. Interest expense on affiliated short-term borrowings, due to affiliates, has been incurred at the rate of 8% per annum. Costs and expenses of IMH have been allocated to ICH in proportion to services provided, plus a 15% service charge. Certain amounts in the prior period's consolidated financial statements have been reclassified to conform to the current presentation. Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. 2. Cash and Cash Equivalents For purposes of the statement of cash flows, cash and cash equivalents consist of cash and money market mutual funds. The Company considers investments with maturities of three months or less at date of purchase to be cash equivalents. 3. Investment Securities Available-for-Sale The Company classifies commercial mortgage-backed securities (CMBSs) as held- to-maturity, available-for-sale, and/or trading securities. Held-to-maturity securities are reported at amortized cost, available-for-sale securities are reported at fair value with unrealized gains and losses as a separate component of stockholders' equity, and trading securities are reported at fair value with unrealized gains and losses included in earnings. The Company's investment securities are held as available-for-sale, reported at fair value with unrealized gains and losses reported as a separate component of stockholders' equity. As the Company qualifies as a REIT and no income taxes are paid, the unrealized gains and losses are reported gross in stockholders' equity. Premiums or discounts obtained on investment securities are accreted or amortized to interest income over the estimated life of the investment securities using the interest method. Such investments may subject the Company to credit, interest rate and/or prepayment risk. F-7 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 4. Residual Interest in Securitization, held-for-trading ICH has estimated future cash flows from residual interest in securitization, held for trading (Residual) utilizing assumptions that they believe are commensurate with the risk inherent in the investment and consistent with those that they believe would be utilized by an unaffiliated third-party purchaser and discounted at a rate commensurate with the risk involved. The Company has classified the Residual as a held-for-trading security. Unrealized gains and losses will be included in current operations. To the Company's knowledge, there is currently no active market for the purchase or sale of the Residual. The fair value of the Residual is determined by computing the present value of the excess of the weighted-average coupon on the Commercial Mortgages sold (10.6%) over the sum of: (1) the coupon on the senior interest (5.9%), (2) a base servicing fee paid to servicer of the Commercial Mortgages (0.50%) and other fees, (3) expected estimated losses (0.60%) to be incurred on the portfolio of Commercial Mortgages sold over the estimated lives of the Commercial Mortgages and using an estimated future prepayment assumption (15%). The prepayment assumption used in estimating the cash flows is based on recent evaluations of the actual prepayments of the related portfolio and on market prepayment rates on new portfolios of similar Commercial Mortgages, taking into consideration the current interest rate environment and its expected impact on the estimated future prepayment rate. The estimated cash flows expected to be received by the Company are discounted at an interest rate that the Company believes an unaffiliated third-party purchaser would require as a rate of return commensurate with the risk of holding such a financial instrument. The rate used to discount the cash flows coming out of the trust was approximately 14.9%. To the extent that actual future excess cash flows are different from estimated excess cash flows, the fair value of the Company's residual could decline. Under the terms of the securitization, the Residual is required to build over- collateralization to specified levels using the excess cash flows described above until set percentages of the securitized portfolio are attained. Future cash flows to the residual holder are all held by the real estate mortgage investment conduit (REMIC) trust until a specific percentage of either the original or current certificate balance is attained which percentage can be raised if certain charge-offs and delinquency ratios are exceeded. The certificate holders' recourse for credit losses is limited to the amount of over-collateralization held by the Residual in the REMIC trust. Upon maturity of the certificates or upon exercise of an option ("clean up call") to repurchase all the remaining Commercial Mortgages once the balance of the Commercial Mortgages in the trust are reduced to 10% of a specified balance of the original Commercial Mortgages in the trust, any remaining amounts in the trust are distributed. The current amount of any over-collateralization balance held by the trust are recorded as part of the Residual. 5. CMO Collateral and Commercial Mortgages Heldfor-Investment The Company purchases Commercial Mortgages to be held as long-term investments or as CMO collateral. Commercial Mortgages held-for-investment and CMO collateral are recorded at cost at the date of purchase. Commercial Mortgages held-for-investment and CMO collateral include various types of loans secured by mortgages on commercial real property and loans to developers secured by first liens on converted condominium complexes. Premiums and discounts, which may result from the purchase or acquisition of Commercial Mortgages in excess of the outstanding principal balance, are amortized to interest income over their estimated lives using the interest method as an adjustment to the carrying amount of the loan. Prepaid securitization costs related to the issuance of CMOs are amortized to interest expense over their estimated lives using the interest method as an adjustment to the carrying amount of the loan. Commercial Mortgages are continually evaluated for collectibility and, if appropriate, the Commercial Mortgages may be placed on nonaccrual status, generally when the mortgage is 90 days past due, and previously accrued interest reversed from income. Other than temporary impairment in the carrying value of Commercial Mortgages held-for- investment, if any, will be recognized as a reduction to current operations. F-8 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 6. Finance Receivables Finance receivables represent transactions with ICCC involving commercial real estate lending. As a warehouse lender, the Company is a secured creditor and is subject to the risks inherent in that status, including, the risk of borrower default and bankruptcy. Any claim of the Company as a secured lender in a bankruptcy proceeding may be subject to adjustment and delay. The Company's finance receivables represent warehouse lines of credit with ICCC collateralized by Commercial Mortgages on commercial real property. Finance receivables are stated at the principal balance outstanding. Interest income is recorded on the accrual basis in accordance with the terms of the loans. Finance receivables are continually evaluated for collectibility and, if appropriate, the receivable is placed on non-accrual status, generally when the receivable is 90 days past due. Future collections of interest income are included in interest income or applied to the loan balance based on an assessment of the likelihood that the loans will be repaid. 7. Allowance for Loan Losses The Company maintains an allowance for losses on Commercial Mortgages held- for-investment, collateral for CMOs and finance receivables at an amount which it believes is sufficient to provide adequate protection against future losses in the Commercial Mortgage portfolio. The allowance for losses is determined primarily on management's judgment of net loss potential, including specific allowances for known impaired loans and other factors such as changes in the nature and volume of the portfolio, value of the collateral and current economic conditions that may affect the borrower's ability to pay. A provision is recorded for all loans or portions thereof deemed to be uncollectible thereby increasing the allowance for loan losses. Subsequent recoveries on Commercial Mortgages previously charged off are credited back to the allowance. 8. CMO Borrowings The Company issues CMOs, which are secured by Commercial Mortgages as a means of financing its Long-Term Investment Operations. CMOs are carried at their outstanding principal balances including accrued interest on such obligations. For accounting and tax purposes, Commercial Mortgages financed through the issuance of CMOs are treated as assets of the Company and the CMOs are treated as debt of the Company. Each issue of CMOs are fully payable from the principal and interest payments on the underlying mortgage loans collateralizing such debt and any investment income on such collateral. The maturity of each class of CMO is directly affected by the rate of principal prepayments on the related CMO collateral. Each CMO series is also subject to redemption according to specific terms of the respective indentures. As a result, the actual maturity of any class of a CMO series is likely to occur earlier than the stated maturities of the underlying mortgage loans. 9. Income Taxes ICH operates so as to qualify as a real estate investment trust (REIT) under the requirements of the Internal Revenue Code (the Code). Requirements for qualification as a REIT include various restrictions on ownership of ICH's stock, requirements concerning distribution of taxable income and certain restrictions on the nature of assets and sources of income. A REIT must distribute at least 95% of its taxable income to its stockholders, of which 85% must be distributed within the taxable year in order to avoid the imposition of an excise tax and the remaining balance may extend until timely filing of its tax return in the subsequent taxable year. Qualifying distributions of its taxable income are deductible by a REIT in computing its taxable income. If in any tax year ICH should not qualify as a REIT, it would be taxed as a corporation and distributions to the stockholders would not be deductible in computing taxable income. If ICH were to fail to qualify as a REIT in any tax year, it would not be permitted to qualify for that year and the succeeding four years. In any year in which the Company qualifies as a REIT, it generally will not be subject to Federal income tax on that portion of its taxable income or net capital gain that is distributed to its stockholders. The Company will, however, be subject to tax at normal corporate rates upon any net income or net capital gain not distributed. The Company intends to distribute substantially all of its taxable income to its stockholders. F-9 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 10. Net Earnings (Loss) per Share Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share" (SFAS 128). SFAS 128 replaces the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earning per share, basic earnings per share excludes any dilutive effects of stock options. Diluted earnings per share are very similar to the previously reported fully diluted earnings per share. Basic net earnings per share are computed on the basis of the weighted average number of shares outstanding for the period. Diluted net earnings per share are computed on the basis of the weighted average number of shares and common equivalent shares outstanding for the period. The following table represents the computation of basic and diluted earnings per share for the periods presented (in thousands, except per share data):
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 --------------------- --------------------- NUMERATOR: Numerator for basic earnings per share-- Net earnings (loss)................................................... $ (11,013) $ 2,811 ===================== ====================== DENOMINATOR: Denominator for basic earnings per share-- Weighted average number of common shares outstanding during the period.......................................................... 8,773 4,631 Net effect of dilutive stock options.................................. -- 14 --------------------- ---------------------- Denominator for diluted earnings per share............................... 8,773 4,645 ===================== ====================== Net earnings (loss) per share--basic..................................... $ (1.26) $ 0.61 ===================== ====================== Net earnings (loss) per share--diluted................................... $ (1.26) $ 0.61 ===================== ======================
11. Recent Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 is effective for fiscal years beginning after December 15, 1997. SFAS 131 establishes standards for reporting financial and descriptive information about an enterprise's operating segments in its annual financial statements and selected segment information in interim financial reports. Reclassification or restatement of comparative financial statements or financial information for earlier periods is required upon adoption of SFAS 131. The Company recognizes the Long-Term Investment Operations and the Conduit Operations as two distinct reporting segments. The consolidated financial statements of Impac Commercial Holdings, Inc. is considered the Long-Term Investment Operations while the financial statements of Impac Commercial Capital Corporation is considered the Conduit Operations. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a F-10 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) foreign-currency-denominated forecasted transaction. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." SFAS No. 134 is an amendment to SFAS 65, which required that after the securitization of a mortgage loan held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage- backed security as a trading security. SFAS No. 134 further amends SFAS No. 65 and requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage- backed securities or other retained interests based on its ability and intent to sell or to hold those investments. SFAS 134 conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by non-mortgage banking enterprises. SFAS 134 is effective for the first fiscal quarter beginning first quarter 1999. The Company believes that the adoption of SFAS No. 134 will not have a material impact on the Company's financial position or results of operations. NOTE B--INVESTMENT SECURITIES AVAILABLE-FOR-SALE The Company's mortgage-backed securities are primarily 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. The Company's interest in these securities is subordinated so that, in the event of a loss, payments to senior certificate holders will be made before the Company receives its payments. The amortized cost and estimated fair value of investment securities available-for-sale are summarized as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAIN LOSS FAIR VALUE ---------- --------- --------- ---------- (IN THOUSANDS) At December 31, 1998: Commercial mortgage-backed securities................... $ 6,515 $ -- $ -- $ 6,515 Interest only securities................................ 10,615 24 -- 10,639 ---------- --------- --------- ---------- Total investment securities available-for-sale........ $ 17,130 $ 24 $ -- $ 17,154 ========== ========= ========= ========== At December 31, 1997: Commercial mortgage-backed securities................... $ 6,363 $ -- $ -- $ 6,363 Interest only securities................................ 13,150 -- 160 12,990 ---------- --------- --------- ---------- Total investment securities available-for-sale........ $ 19,513 $ -- $ 160 $ 19,353 ========== ========= ========= ==========
NOTE C--RESIDUAL INTEREST IN SECURITIZATION, HELD-FOR-TRADING The accompanying 1998 and 1997 balance sheets include one Residual which was recorded as a result of a 1995 securitization by Imperial Credit Industries, Inc. (ICII) of commercial loans issued through a special purpose trust vehicle. As of December 31, 1998 and 1997, the carrying amount of the residual was $8.8 million and $9.9 million, respectively. NOTE D--COMMERCIAL MORTGAGES HELD-FOR-INVESTMENT The Company purchases Commercial Mortgages to be held as long-term investment. Commercial Mortgages held-for-investment include various types of loans secured by mortgages on commercial real property and loans to developers secured by first liens on condominium complexes. Approximately 47% and 65%, respectively, of the F-11 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) principal amount of Commercial Mortgages held-for-investment at December 31, 1998 and 1997 were collateralized by properties located in Arizona. During 1998 and 1997, the Long-Term Investment Operations purchased $522.1 million and $41.2 million, respectively, of Commercial Mortgages. As of December 31, 1998 and 1997, Commercial Mortgages held-for-investment were $24.6 million and $62.8 million, respectively, which include premiums of $42,000 and $111,000, respectively. NOTE E--CMO COLLATERAL CMO collateral includes various types of loans secured by mortgages on commercial real property and loans to developers secured by first liens on condominium complexes. Approximately 50% of the principal amount of CMO collateral at December 31, 1998 were collateralized by properties located in California. During 1998 and 1997, the Long-Term Investment Operations originally issued $301.8 million and $4.2 million, respectively, of CMOs which were collateralized by $325.0 million and $4.3 million, respectively, of Commercial Mortgages. The following table represents the outstanding amounts for the periods shown:
AT DECEMBER 31, ------------------------------------- 1998 1997 -------------- --------------- (IN THOUSANDS) CMO collateral....................................................................... $ 313,211 $ 4,255 Unamortized net premiums on Commercial Mortgages..................................... 6,134 -- Prepaid securitization costs......................................................... 7,214 -- -------------- --------------- $ 326,559 $ 4,255 ============== ===============
NOTE F--FINANCE RECEIVABLES Terms of the Company's warehouse lines to ICCC are at Bank of America's prime rate, which was 7.75% at December 31, 1998, with advance rates to 90% of the fair value of the Commercial Mortgages outstanding. The maximum available on ICCC's warehouse line agreements as of December 31, 1998 and 1997 was $900.0 million and $900.0 million, respectively, of which $41.0 million and $95.7 million, respectively, was outstanding. NOTE G--ALLOWANCE FOR LOAN LOSSES Activity in the allowance for loan losses were as follows:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 --------------------- ---------------------- (IN THOUSANDS) Balance, beginning of period............................................ $ 564 $ -- Provision for loan losses............................................... 1,546 564 Charge-offs............................................................. -- -- --------------------- ---------------------- Balance, end of period.................................................. $ 2,110 $ 564 ===================== ======================
F-12 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE H--PREMISES AND EQUIPMENT, NET Premises and equipment are stated at cost, less accumulated depreciation or amortization. Depreciation on premises and equipment is recorded using the straight-line method over the estimated useful lives of individual assets (three to twenty years).
AT DECEMBER 31, ------------------------------------- 1998 1997 -------------- -------------- (IN THOUSANDS) Premises and equipment................................................................ $ 9,710 $ 3,922 Less accumulated depreciation......................................................... (564) (65) -------------- -------------- $ 9,146 $ 3,857 ============== ==============
NOTE I--CMO BORROWINGS The following table sets forth CMOs issued by the Company, CMOs outstanding as of December 31, 1998, and certain interest rate information:
Range of Interest Range of Range of Interest Rate Rate Interest Rate Fixed Margins Over Margin Margins After Issue Issuance CMOs Interest One-Month Adjustment Adjustment Date Issuance Name Amount Outstanding Rates LIBOR Date Date - -------- ------------------- --------- ----------- ---------- ------------- ---------- ---------------- (in thousands) 12/10/97 Imperial CMB Trust Series 1997-2 $ 4,255 $ 738 N/A 0.26-1.30% 2/2004 0.52-2.60% 6/23/98 Impac CMB Trust Series 1998-3 7,069 1,275 N/A 0.18-1.24% 7/2005 0.36-2.48% 8/20/98 Impac CMB Trust 1998 C-1 (1) 294,731 283,008 6.06-7.58% 0.28% N/A N/A ----------- $ 285,021 ===========
________________ (1) The variable rate portion of CMOs outstanding as of December 31, 1998 were $31.3 million. The issuance amount includes an additional bond class of $18.3 million, which was subsequently issued in December 1998. The weighted average coupon on CMOs was 8.32% and 6.58% at December 31, 1998 and December 31, 1997. At December 31, 1998 and 1997, CMO borrowings include accrued interest payable of $1.5 million and $4,000, respectively. NOTE J--WAREHOUSE LINE AGREEMENTS ICH entered into warehouse line agreements with investment banks to fund the purchase of Commercial Mortgages. Terms of the warehouse line agreements require that the Commercial Mortgages be held by an independent third party custodian, which gives the Company the ability to borrow against the collateral as a percentage of the fair market value of the Commercial Mortgages. The interest rates on the loans are based on one-month LIBOR or Eurodollar Rate plus a margin depending on the type of mortgage collateral provided. The loan amounts generally range from 75% to 92% of the fair market value of the collateral. F-13 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following tables set forth information regarding warehouse line agreements (in thousands):
At December 31, 1998 ------------------------------------------------------------------------------------ Maximum Maximum Warehouse Underlying Type of Committed Uncommitted Line Collateral Maturity Collateral Amount Amount Liability (1) Date ---------- --------- ----------- ---------- ---------- -------- Lender 1............................... Mortgages $ 200,000 $ 100,000 $ 45,208 $ 59,322 5/1999 Lender 2............................... Mortgages 446 (2) N/A 446 459 N/A ---------- ---------- $ 45,654 $ 59,781 ========== ========== At December 31, 1997 ------------------------------------------------------------------------------------ Maximum Maximum Warehouse Underlying Type of Committed Uncommitted Line Collateral Maturity Collateral Amount Amount Liability (1) Date ---------- --------- ----------- ---------- ---------- -------- Lender 1............................... Mortgages $ 200,000 N/A $ 8,529 $ 9,458 4/1998 Lender 2............................... Mortgages 200,000 N/A 81,845 98,750 2/1999 ---------- ---------- $ 90,374 $ 108,208 ========== ==========
_______________ (1) The amount of underlying collateral represents the unpaid principal balance of Commercial Mortgages provided as collateral for the warehouse lines. (2) There is no formal warehouse line agreement with Lender 2. Advances are provided to the Company at the discretion of the lender. During 1998, the warehouse line agreement was modified from a committed to an uncommitted warehouse line. At December 31, 1998 and 1997, warehouse line agreements include accrued interest payable of $244,000 and $309,000, respectively. The following table presents certain information on warehouse line agreements, excluding accrued interest payable:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------ ------------------- (dollars in thousands) Maximum Month-End Outstanding Balance.................................... $ 376,247 $ 90,374 Average Balance Outstanding.............................................. $ 193,370 $ 25,463 Weighted Average Rate.................................................... 6.70% 7.25%
NOTE K--REVERSE REPURCHASE AGREEMENTS ICH entered into reverse repurchase agreements whereby ICH pledged specific CMBSs as collateral to secure short-term loans. Interest is payable upon the maturity of the loans. The interest rates on the loans are based on one-month LIBOR plus a margin depending on the type of collateral provided by the Company. The following table sets forth information regarding reverse repurchase agreements (in thousands):
At December 31, 1998 ----------------------------------------------------------------- Reverse Type of Repurchase Underlying Maturity Collateral Liability Collateral Date ---------- ---------- ---------- -------- Lender 1..................................................... Securities $ 2,322 $ 5,316 1/20/99 Lender 2..................................................... Securities 1,953 6,515 1/5/99 Lender 3..................................................... Securities 594 1,008 1/20/99 ---------- ---------- $ 4,869 $ 12,839 ========== ========== At December 31, 1998 ----------------------------------------------------- Reverse Type of Repurchase Underlying Maturity Collateral Liability Collateral Date ---------- ---------- ---------- -------- Lender 1..................................................... Securities $ 6,185 $ 7,137 1/21/98 Lender 2..................................................... Securities 831 1,037 1/2/98 Lender 3..................................................... Securities 2,825 4,708 1/30/98 ---------- ---------- $ 9,841 $ 12,882 ========== ==========
F-14 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) At December 31, 1998 and 1997, reverse repurchase agreements included accrued interest payable of $15,000 and $48,000, respectively. NOTE L--DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value of financial instruments have been determined by ICH using available market information and appropriate valuation methodologies; however, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts ICH could realize 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.
At December 31, 1998 At December 31, 1997 ---------------------------- -------------------------- Carrying Estimated Carrying Estimated Amount Fair value Amount Fair value ----------- ----------- ---------- ---------- (in thousands) ASSETS ------ Cash and cash equivalents...................................... $ 14,161 $ 14,161 $ 15,908 $ 15,908 Investment securities available-for-sale....................... 17,154 17,154 19,353 19,353 Residual interest in securitization, held-for-trading.......... 8,790 8,790 9,936 9,936 Commercial Mortgages held-for-investment....................... 24,569 23,941 62,790 62,867 Finance receivables............................................ 40,972 40,972 95,711 95,711 CMO collateral................................................. 326,559 324,923 4,255 4,298 Due from affiliates............................................ 22,131 22,131 1,592 1,592 LIABILITIES ----------- Warehouse line agreements...................................... 45,654 45,654 90,374 90,374 Reverse repurchase agreements.................................. 4,869 4,869 9,841 9,841 CMO borrowings................................................. 285,021 286,637 4,176 4,176 Due to affiliates.............................................. 11,170 11,170 8,067 8,067 Short-term commitments to extend credit........................ -- -- -- --
The fair value estimates as of December 31, 1998 and 1997 are based on pertinent information available to management as of that date. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. The following describes the methods and assumptions used by ICH in estimating fair values: Cash and Cash Equivalents Fair value approximates carrying amount as these instruments are demand deposits and money market mutual funds and do not present unanticipated interest rate or credit concerns. Investment Securities Available-for-Sale Fair value is estimated using a bond model, which incorporates certain assumptions such as prepayment, yield and losses. Residual Interest in Securitization, Held-for-Trading F-15 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Fair value approximates carrying amount as the fair value was estimated by discounting future cash flows using rates that the Company believes are commensurate with the risk inherent in these investments, and consistent with those that the Company believes would be utilized by an unaffiliated third party for financial instruments with similar terms and remaining maturities. Commercial Mortgages Held-for-Investment Fair value is determined based upon the Company's estimate of the proceeds that would be realized on a whole loan sale. Finance Receivables Fair value is determined based upon current market conditions and estimated interest rates associated with similar financial instruments. CMO Collateral Fair value is based on estimated quoted market prices from dealers and brokers for similar types of mortgage loans. Due From / To Affiliates Fair value approximates carrying amount because of the short-term maturity of the liabilities and does not present unanticipated interest rate or credit concerns. Warehouse Line Agreements Fair value approximates carrying amount because of the short-term maturity of the liabilities and does not present unanticipated interest rate or credit concerns. Reverse Repurchase Agreements Fair value approximates carrying amount because of the short-term maturity of the liabilities and does not present unanticipated interest rate or credit concerns. CMO Borrowings Fair value of fixed rate borrowings is estimated based on the use of a bond model, which incorporates certain assumptions such as yield, prepayment and losses. Fair value of variable rate borrowings approximate carrying amount because of the variable interest rate nature of the borrowings. Short-term Commitments to Extend Credit The Company does not collect fees associated with its warehouse lines of credit. Accordingly, these commitments do not have an estimated fair value. NOTE M--LIQUIDITY Management of ICH is committed to funding any potential operating cash flow deficiencies of ICCC to the extent necessary through December 31, 1999. ICCC recorded a net loss for the year ended December 31, 1998 of $20.2 F-16 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) million resulting in negative net worth of $15.8 million as of December 31, 1998. The loss was primarily due to the deterioration of the commercial mortgage-backed securitization market in the third and fourth quarters of 1998. During the first quarter of 1999, ICCC anticipates selling a significant portion of its Commercial Mortgage portfolio thus eliminating related net interest expense. In addition, ICCC may pursue opportunities in retail loan originations operations, which could generate loan origination fees. Management is also exploring opportunities to form an alliance with one or more strategic partners which allow ICCC to fund the growth its operations. Management anticipates the alliance will also enable ICCC to access the securitization marketplace and achieve better sale execution. NOTE N--RELATED PARTY TRANSACTIONS Credit Arrangements ICCC has uncommitted warehouse financing facilities with ICH up to a maximum aggregate amount of $900.0 million. Advances under such warehouse facilities bear interest at Bank of America's prime rate, which was 7.75% at December 31, 1998. As of December 31, 1998 and 1997, amounts outstanding on ICH's warehouse line agreements to ICCC were $41.0 million and $95.7 million, respectively. Interest income recorded by ICH related to warehouse line agreements to ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $9.1 million and $2.4 million, respectively. During 1997 and 1998, ICH had a credit arrangement with IMH whereby ICH advanced to IMH up to maximum amount of $15.0 million for general working capital needs. Subsequent to 1998, the credit agreement was terminated and will no longer be used by ICH. Advances under the credit arrangement were at an interest rate and maturity determined at the time of each advance with interest and principal paid monthly. As of December 31, 1998 and 1997, IMH had no outstanding borrowings under the credit arrangement. Interest income recorded by ICH for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $295,000 and $68,000, respectively. During 1997 and 1998, ICH had a credit arrangement with IMH whereby IMH advanced to ICH up to maximum amount of $15.0 million for general working capital needs. Subsequent to 1998, the credit agreement was terminated and will no longer be used by ICH. Advances under the credit arrangement were at an interest rate and maturity determined at the time of each advance with interest and principal paid monthly. As of December 31, 1998 and 1997, ICH's outstanding borrowings under the credit arrangement were none and $9.1 million, respectively. Interest expense recorded by ICH for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $43,000 and $55,000, respectively. On November 9, 1998, IFC borrowed $5.0 million from ICH on a demand note secured by mortgage servicing rights of $1.1 billion at an interest rate of 10%. This rate was adjusted to 15% on December 15, 1998. On December 22, 1998, this note was paid in full. Interest income recorded by ICH for 1998 was $66,000. ICH entered into a credit arrangement with IFC whereby ICH would advance to IFC up to a maximum amount of $15.0 million. Advances under the revolving credit arrangement are at an interest rate and maturity to be determined at the time of each advance with interest and principal paid monthly. The revolving credit arrangement expired in December 1997. Interest income recorded by ICH for 1997 was $66,000. On December 31, 1997, ICH financed its 50% interest in a commercial office building located in Newport Beach, California with a loan for $5.2 million from ICCC. The loan was repaid by ICH in the fourth quarter of 1998 with proceeds from the sale of Commercial Mortgages. ICCC received loan fees of $71,000 upon origination of the loan. During the normal course of business, ICH may advance or borrow funds on a short-term basis with affiliated companies. Advances to affiliates are reflected as "Due from affiliates" while borrowings are reflected as "Due to affiliates" on the Company's balance sheet. These short-term advances and borrowings bear interest at a fixed rate of F-17 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 8.00% per annum. Interest income recorded by ICH related to short-term advances due from affiliates for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $2.1 million and $268,000, respectively. Interest expense recorded by ICH related to short-term advances due to affiliates for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $825,000 and $45,000, respectively. Lease Agreement During 1998, ICH entered into a premises operating lease with IMH and IFC to rent approximately 74,000 square feet of office space. The lease agreement is for a term of ten years expiring in May 2008 with monthly lease payments of $145,000 per month. Purchase of Commercial Mortgages During the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997, ICH purchased $525.2 million and $23.7 million, respectively, of Commercial Mortgages from ICCC at net discounts of $3.1 million and net premiums of $111,000, respectively. Purchase of Commercial Office Building On October 27, 1998, the Company purchased from IMH its remaining 50% ownership interest in a commercial office building located in Newport Beach, California for $6.0 million. After the purchase of the 50% ownership interest from IMH, the Company has a 100% ownership interest in the building. Repurchase of Capital Stock On October 21, 1998, the Company repurchased from IMH 937,084 shares of Common Stock and 456,916 shares of Class A Common Stock at a per share price of $4.375, based upon the closing price of the Common Stock on AMEX on October 19, 1998, for a total repurchase of $6.1 million. Sale of Commercial Mortgages During the year ended December 31, 1998, ICH sold $43.2 million of Commercial Mortgages to ICCC at no gain or loss. Stock Compensation Expense Stock compensation expense of $2.7 million represents the difference between the price at which ICH issued 300,000 shares of common stock to directors and officers of IMH and ICH on February 3, 1997 ($.01 per share) and the estimated fair value for financial reporting purposes of such shares as determined by the Company's management, as of February 3, 1997 ($9.00 per share). Fair value was based primarily on management's projection of the Company's future cash flow and net income, as well as the lack of liquidity of the shares at the date of issuance and the uncertainty of certain future events regarding the development of the Company's business and organization structure including, but not limited to, obtaining independent financing for the organization and purchase of Commercial Mortgages, funding and closing Commercial Loans, and developing a pipeline of future Commercial Loan originations. Submanagement Agreement IFC entered into a submanagement agreement with RAI under which IMH and IFC provide various services to ICH as RAI deems necessary, including facilities and costs associated therewith, technology, human resources, management information systems, general ledger accounts, check processing and accounts payable, plus a 15% service F-18 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) charge. RAI charges ICH for these services based upon usage. Total cost allocations RAI charged to ICH for the year ended December 31, 1998 and the period from January 15, 1997 (commencement of operations) through December 31, 1997 were $521,000 and $525,000, respectively. Unsecured Promissory Note In July 1998, William D. Endresen and Rae Ann Endresen, the makers, signed an unsecured promissory note for $100,000 with ICH, the holder, which was modified in November 1998 and states that the makers are to repay the note and accrued interest at a rate of nine percent (9%) per annum with 50% of the after tax dividend equivalent payments made to Mr. Endresen in accordance with the Stock Options and Awards Plan. As of December 31, 1998, the balance outstanding on the note was $101,000. Non-Compete Agreement and Right of First Refusal Agreement Pursuant to the Non-Compete Agreement executed on the date of the ICH initial public offering, IFC will not acquire any commercial mortgages for a period of the earlier of nine months from the closing of the ICH initial public offering or the date upon which ICH and/or ICCC accumulates (for investment or sale) $300.0 million of commercial mortgages or commercial mortgage-backed securities. This agreement expired in March 1998. Pursuant to the Right of First Refusal Agreement by and among ICH, IMH, IFC, ICCC and RAI, pursuant to which, in part, RAI will agree that any mortgage loan or mortgage-backed security investment opportunity which is offered to it on behalf of either ICH, IMH any affiliated REIT will first be offered to that entity whose initial primary business as described in its initial public offering documentation most closely aligns with such investment opportunity. NOTE O--COMMITMENTS AND CONTINGENCIES ICH is a party to financial instruments with off-balance sheet risk in the normal course of business. Such instruments include short-term commitments to extend credit to borrowers under warehouse lines of credit which involve elements of credit risk. In addition, ICH is exposed to credit loss in the event of non-performance by the counterparties to the various agreements associated with loan purchases. However, ICH does not anticipate non-performance by such borrowers or counterparties. Unless noted otherwise, ICH does not require collateral or other security to support such commitments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The contract or notional amounts of forward contracts do not represent exposure to credit loss. The Company controls the credit risk of its forward contracts through credit approvals, limits and monitoring procedures. Commercial Mortgage Loan Sales Commitments In the ordinary course of business, ICCC is exposed to liability under representations and warranties made to purchasers and insurers of mortgage loans and the purchasers of servicing rights. Under certain circumstances, ICCC is required to repurchase mortgage loans if there had been a breach of representations or warranties. ICH has guaranteed the performance obligation of ICCC under such representation and warranties related to loans included in securitizations. Lease Commitments ICH and ICCC, as tenants in common, lease approximately 18,000 square feet of office space in Irvine, California,, approximately 3,600 square feet in Sherman Oaks, California and approximately 4,300 square feet in Dallas, Texas under premises operating leases expiring in November 2000, May 2001 and August 2003, respectively. Minimum premises rental commitments are as follows (in thousands): F-19 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1999.......................................................... $ 734 2000.......................................................... 691 2001.......................................................... 166 2002.......................................................... 126 2003.......................................................... 84 ------- Total.................................................... $ 1,801 ======= All rent expense associated with the lease is charged to ICCC as ICCC's employees occupy 100% of the office space. Loan Commitments ICH provides secured short-term non-recourse revolving financing to ICCC to a maximum of $900.0 million to finance the acquisition of Commercial Mortgages from the closing of the loans until sold to permanent investors. As of December 31, 1998 and 1997, ICH's outstanding balances on warehouse lines to ICCC was $41.2 million and $95.7 million, respectively. Litigation SPI Danvers, LLC v. Impac Commercial Capital Corporation, William D. Endresen and Lawrence R. Goswiller, Orange County Superior Court Case No. 802070 On November 13, 1998, SPI Danvers, LLC (Danvers) filed a complaint against the above defendants alleging 13 causes of action including breach of contract and numerous tort causes of action, including fraud. Danvers seeks approximately $312,000 against all defendants, which allegedly represents its deposits, plus 10% lost opportunity costs, $840,000 in alternative financing costs, lost profits in an unspecified amount, and punitive damages and attorneys fees according to proof. Danvers' allegations set forth generally that it sought refinancing of an existing loan as well as obtaining a new loan in the amount of $4.2 million, and thus entered into certain discussions and negotiations with ICCC. The purpose of the loan was to conclude the purchase of property. Danvers alleges that it paid ICCC certain "good faith" and "rate lock deposits" totaling an aggregate of approximately $312,000. It is alleged that ICCC entered into a loan agreement, defined as the letter of interest, rate lock agreement, and loan commitment letter, with Danvers. Following plaintiff's alleged continual compliance with requests for information and other loan conditions from ICCC, ICCC did not close and fund the loan. In February 1999, the court granted ICCC's and the other defendant's demurrer to most of the tort causes of action and granted a motion to strike the punitive damages and attorney fees allegation. However, the court also granted Danvers an opportunity to file an amended complaint to attempt to reassert all the claims and damages in a proper pleading. The Company believes that this case is without merit and intends to vigorously defend the action. Note P--Management Contract As Manager of the Company, RAI, is entitled to receive for each fiscal quarter, an amount equal to 25% of the net income of the Company, before deduction of such compensation, in excess of the amount that would produce an annualized return on equity equal to the daily average ten year U.S. Treasury rate plus 2% (the 25% Payment). The term "return on equity" is calculated for any quarter by dividing the Company's net income for the quarter by its average net worth for the quarter. For such calculations, the "net income" of the Company means the net income of the Company determined in accordance with the Code before the Manager's compensation, the deduction for dividends paid and any net operating loss deductions arising from losses in prior periods. A deduction for all of the Company's interest expenses for borrowed money is also taken in calculating net income. "Average net worth" for any period means the arithmetic average of the sum of the gross proceeds from any offering of its equity securities by the F-20 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Company, before deducting any underwriting discounts and commissions and other expenses and costs relating to the offering, plus the Company's retained earnings less dividends declared (without taking into account any losses incurred in prior periods) computed by taking the daily average of such values during such period. The 25% payment to the Manager will be calculated quarterly in arrears before any income distributions are made to stockholders for the corresponding period. The Manager's fees will be calculated by the Manager within 60 days after the end of each calendar quarter, with the exception of the fourth quarter for which compensation will be computed within 30 days, and such calculation shall be promptly delivered to the Company. The Company will be obligated to pay the fee within 90 days after the end of each calendar quarter. Management fees paid to RAI during the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 were $745,000 and none, respectively. In order to utilize the IMH infrastructure, RAI entered into a submanagement agreement with IFC to provide substantially all of the administrative services required by the Company including facilities and costs associated therewith, technology, human resources, management information systems, general ledger accounts, check processing and accounts payable as RAI deems necessary. The Manager may also enter into additional contracts with other parties, which may include IMH or its affiliates, to provide any such services for the Manager, which third party shall be approved by the Company's Board of Directors. RAI currently has a total of four officers and three managers who participate in the oversight of the Company's operations. Note Q--Stock Option and Awards Plan The Company adopted a Stock Option and Awards Plan (the Stock Option and Awards Plan) which provides for the grant of qualified incentive stock options (ISOs), options not qualified (NQSOs) and deferred stock, restricted stock, stock appreciation, and limited stock appreciation rights awards (Awards) and dividend equivalent rights. The Stock Option and Awards Plan is administered by the Board of Directors or a committee of directors appointed by the Board of Directors. ISOs may be granted to the officers and key employees of the Company. NQSOs and Awards may be granted to the directors, officers and key employees of the Company or its subsidiaries, and to the directors, officers and key employees of ICCC. The exercise price for any NQSO or ISO granted under the Stock Option and Awards Plan may not be less than 100% (or 110% in the case of ISOs granted to an employee who is deemed to own in excess of 10% of the outstanding Common Stock) of the fair market value of the shares of Common Stock at the time the NQSO or ISO is granted. Under the Stock Option and Awards Plan, the Company may make loans available to stock option holders in connection with the exercise of stock options granted under the Stock Option and Awards Plan. If shares of Common Stock are pledged as collateral for such indebtedness, the shares may be returned to the Company in satisfaction of the indebtedness. If returned, the shares become available for issuance in connection with future stock options and awards under the Stock Option and Awards Plan. Unless previously terminated by the Board of Directors, the Stock Option and Awards Plan will terminate in April of 2007. Options granted under the Stock Option and Awards Plan will become exercisable as directed by the administrator. As of December 31, 1998 and 1997, options to purchase 65,663 shares and none, respectively, were exercisable and 214,078 shares and 420,250 shares, respectively, were available for future grants under the Stock Option and Awards Plan. F-21 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Option transactions for the periods shown are summarized as follows:
At December 31, ----------------------------------------------------------------------------------------- 1998 1997 ----------------------------------------------------------------------------------------- Weighted- Weighted- Number Average Range of Number Average Range of Of Exercise Exercise Of Exercise Exercise Shares Price Prices Shares Price Prices ----------------------------------------------------------------------------------------- Options outstanding at beginning of year.. 212,250 $ 15.41 $ 15.018.8 -- -- -- Options granted........................... 293,510 9.77 6.017.6 222,250 $ 15.41 $15.0-18.8 Options forfeited or cancelled............ (87,338) 16.76 6.018.8 (10,000) 15.41 15.0-18.8 ------- ------- Options outstanding at end of year........ 418,422 11.17 6.018.8 212,250 15.41 15.0-18.8 ======= =======
In November 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). SFAS 123 permits the Company to either recognize as expense over the vesting period, the fair market value of all stock based compensation awards on the date of grant, or continue to apply the provisions of APB Opinion No. 25 and provide pro forma disclosures of net earnings (loss) computed as if the fair value based method as defined in SFAS 123 had been applied. The Company elected to continue to apply APB Opinion No. 25 in accounting for its Stock Options and Awards Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options exercisable under SFAS No. 123, the Company's net earnings and earnings per share would have decreased to the pro forma amounts indicated below:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------ --------------------- (in thousands) Net earnings (loss) as reported....................................... $ (11,013) $ 2,811 Pro forma net earnings (loss)......................................... (12,010) 2,280 Basic earnings (loss) per share as reported........................... (1.26) 0.61 Diluted earnings (loss) per share as reported......................... (1.26) 0.61 Basic pro forma earnings (loss) per share............................. (1.37) 0.49 Diluted pro forma earnings (loss) per share........................... (1.37) 0.49
The derived fair value of the options granted during 1998 and 1997 was approximately $3.90 and $2.39 per share, respectively, using the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 5.10% and 5.84%, respectively, dividend yield of 8.1% and 8.7%, respectively, expected lives of 3.9 and 9.3 years and expected volatility of 92.7% and 37.2%, respectively. Note R--Stockholders' Equity On November 6, 1998, the Company paid the previously announced third quarter dividend of $0.45 per share to stockholders of record on October 9, 1998. The Company paid interest in the form of an additional cash dividend at an interest rate of 4% per annum for the period from the previously announced payment date of October 26, 1998 through November 6, 1998. The total amount of the interest the Company paid as a result of the dividend payment delay was $6,000 or $0.0006 per common share outstanding. On October 21, 1998, the Company repurchased from IMH 937,084 shares of Common Stock and 456,916 shares of Class A Common Stock at a per share price of $4.375, which was based upon the closing price of the Common Stock on AMEX on October 19, 1998, for a total repurchase of $6.1 million. On October 7, 1998, the Company's Board of Directors adopted a Stockholder Rights Plan in which Preferred Stock Purchase Rights were distributed as a dividend at the rate of one Right for each outstanding share of common stock. The dividend distribution was made on October 19, 1998, payable to stockholders of record on that date. The F-22 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Rights are attached to the Company's common stock. The Rights will be exercisable and trade separately only in the event that a person or group acquires or announces the intent to acquire 10 percent or more of the Company's common stock. Each Right will entitle stockholders to buy one one-hundredth of a share of a new series of Series A junior participating preferred stock at an exercise price of $16.25. If the Company is acquired in a merger or other transaction after a person has acquired 10 percent or more of the Company's outstanding common stock, each Right will entitle the stockholder to purchase, at the Right's then-current exercise price, a number of the acquiring Company's common shares having a market value of twice such price. In addition, if a person or group acquires 10 percent or more of the Company's common stock, each Right will entitle the stockholder (other than the acquiring person) to purchase, at the Right's then-current exercise price, a number of shares of the Company's common stock having a market value of twice such price. Following the acquisition by a person of 10 percent or more of the Company's common stock and before an acquisition of 50 percent or more of the common stock, the Board of Directors may exchange the Rights (other than the Rights owned by such person) at an exchange ratio of one share of common stock per Right. Before a person or group acquires beneficial ownership of 10 percent or more of the Company's common stock, the Rights are redeemable for $.0001 per right at the option of the Board of Directors. The Rights will expire on October 19, 2008. The Rights distribution is not taxable to stockholders. The Rights are intended to enable all the Company stockholders to realize the long-term value of their investment in the Company. On September 28, 1998, the Company declared a third quarter dividend of $4.5 million, or $0.45 per share. The original payment date of this dividend was set for October 26, 1998 to stockholders of record on October 9, 1998 but was delayed until November 6, 1998. On September 25, 1998, the Company's Board of Directors authorized the Company to repurchase up to $5.0 million of the Company's common stock, $.01 par value, in open market purchases from time to time at the discretion of the Company's management; the timing and extent of the repurchases will depend on market conditions. The Company intends to effect such repurchases, if any, in compliance with the Rule 10b-18 under the Securities Exchange Act of 1934. Any acquired shares will be canceled. Through February 16, 1999, the Company had not repurchased any shares under this program. On June 22, 1998, the Company completed a common stock offering. The Company raised additional capital of $28.4 million, net of underwriting discounts and other expenses, as stockholders purchased 2,000,000 shares of common stock at a price of $15.3125 per share. On June 8, 1998, the Company declared a second quarter dividend of $3.6 million, or $0.45 per share. This dividend was paid on July 15, 1998 to stockholders of record on June 19, 1998. On April 1, 1998, the Company declared a first quarter dividend of $3.2 million, or $0.40 per share. This dividend was paid on April 24, 1998 to stockholders of record on April 9, 1998. Note S--Quarterly Financial Data (unaudited) Selected quarterly financial data for the year ended December 31, 1998 follows (in thousands, except per share data):
For the Three Months Ended, ---------------------------------------------------------------- December 31, September 30, June 30, March 31, ---------------------------------------------------------------- Net interest income after provision for loan losses (1)... $ 2,837 $ 3,306 $ 3,570 $ 3,010 Non-interest income (1)................................... (3,805) (14,243) (105) (345) Non-interest expense (1).................................. 1,670 2,288 792 488 Net earnings (loss)....................................... (2,638) (13,225) 2,673 2,177 Net earnings (loss) per share basic and diluted (2)...... (0.30) (1.32) 0.33 0.27 Dividends declared per share.............................. -- 0.45 0.45 0.40
F-23 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Selected quarterly financial data for the period from January 15, 1997 (commencement of operations) through December 31, 1997 follows (in thousands, except per share data):
For the Three Months Ended, ------------------------------------------------------------ December 31, September 30, June 30, March 31, ------------------------------------------------------------ Net interest income after provision for loan losses (1).. $ 2,338 $ 1,690 $ 443 $ 74 Non-interest income (1).................................. 1,183 685 -- -- Non-interest expense (1)................................. 440 278 124 2,760 Net earnings (loss)...................................... 3,081 2,097 319 (2,686) Net earnings (loss) per share basic and diluted (2)..... 0.38 0.38 N/A N/A Dividends declared per share (3)......................... 0.38 0.15 N/A N/A
- ----------------- (1) Conforms to current year presentation. (2) Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share may not equal the total for the year. (3) ICH became a public company on August 5, 1997, therefore per share amounts for the quarters ended June 30, 1997 and March 31, 1997 are not applicable. F-24 IMPAC COMMERCIAL HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Note T--Impac Commercial Capital Corporation and Subsidiary The following condensed consolidated financial information summarizes the consolidated financial position and consolidated results of operations of Impac Commercial Capital Corporation (in thousands): Condensed Consolidated Balance Sheets
At December 31, --------------------------------- 1998 1997 ----------- ------------ ASSETS ------ Cash.................................................................................... $ 692 $ 2,273 Commercial Mortgages held-for-sale...................................................... 44,854 106,654 Due from affiliates..................................................................... 5,740 1,538 Premises and equipment, net............................................................. 909 381 Other assets............................................................................ 2,005 1,789 ----------- ------------ Total assets....................................................................... $ 54,200 $ 112,635 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------- Warehouse line agreements............................................................... $ 44,881 $ 104,219 Due to affiliates....................................................................... 21,101 758 Other liabilities....................................................................... 4,022 3,255 ----------- ------------ Total liabilities.................................................................. 70,004 108,232 ----------- ------------ Shareholders' Equity: Preferred Stock....................................................................... 2,875 2,875 Common Stock.......................................................................... 1 1 Contributed capital................................................................... 150 150 Retained earnings (accumulated deficit)............................................... (18,830) 1,377 ----------- ------------ Total shareholders' equity......................................................... (15,804) 4,403 ----------- ------------ $ 54,200 $ 112,635 =========== ============
Condensed Consolidated Statements of Operations
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------- ------------------- Net interest income: Total interest income.................................................... $ 9,778 $ 2,804 Total interest expense................................................... 10,803 2,747 ------------------- ------------------- Net interest income (expense).......................................... (1,025) 57 Non-interest income: Gain (loss) on sale of loans............................................. (14,345) 3,657 Other income............................................................. 24 62 ------------------- ------------------- Total non-interest income.............................................. (14,321) 3,719 Non-interest expense: Other operating expense.................................................. 5,365 1,176 Provision for repurchases................................................ 176 201 ------------------- ------------------- Total non-interest expense............................................. 5,541 1,377 ------------------- ------------------- Net earnings (loss) before income taxes.................................. (20,887) 2,399 Income taxes (benefit)................................................... (680) 1,022 ------------------- ------------------- Net earnings (loss)...................................................... $ (20,207) $ 1,377 =================== ===================
F-25 INDEPENDENT AUDITORS' REPORT The Board of Directors Impac Commercial Capital Corporation: We have audited the accompanying consolidated balance sheets of Impac Commercial Capital Corporation and subsidiary as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Impac Commercial Capital Corporation and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 in conformity with generally accepted accounting principles. /s/ KPMG LLP Orange County, California February 3, 1999 F-26 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (dollar amounts in thousands)
At December 31, ------------------------------------- 1998 1997 -------------- -------------- ASSETS ------ Cash................................................................................... $ 692 $ 2,273 Commercial Mortgages held-for-sale..................................................... 44,854 106,654 Due from affiliates.................................................................... 5,740 1,538 Premises and equipment, net............................................................ 909 381 Accrued interest receivable............................................................ 272 337 Deferred tax asset..................................................................... -- 924 Other assets........................................................................... 1,733 528 -------------- -------------- Total assets......................................................................... $ 54,200 $ 112,635 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Warehouse line agreements.............................................................. $ 44,881 $ 104,219 Due to affiliates...................................................................... 21,101 758 Other liabilities...................................................................... 4,022 3,255 -------------- -------------- Total liabilities.................................................................... 70,004 108,232 -------------- -------------- Commitments and contingencies Shareholders' Equity: Preferred stock; no par value; 50,000 shares authorized; 2,875 2,875 9,500 shares issued and outstanding at December 31, 1998 and 1997.................... Common stock; no par value; 50,000 shares authorized; 1 1 500 shares issued and outstanding at December 31, 1998 and 1997...................... Contributed capital................................................................... 150 150 Retained earnings (accumulated deficit)............................................... (18,830) 1,377 -------------- -------------- Total shareholders' equity........................................................... (15,804) 4,403 -------------- -------------- $ 54,200 $ 112,635 ============== ==============
See accompanying notes to consolidated financial statements. F-27 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands)
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------ ------------------- INTEREST INCOME: Commercial Mortgages held-for-sale....................................... $ 9,573 $ 2,787 Cash and due from affiliates............................................. 205 17 ------------------ ----------------- Total interest income.................................................. 9,778 2,804 INTEREST EXPENSE: Borrowings from ICH...................................................... 9,064 2,372 Other affiliated borrowings.............................................. 1,739 375 ------------------ ----------------- Total interest expense................................................. 10,803 2,747 ------------------ ----------------- Net interest income (expense)............................................ (1,025) 57 NON-INTEREST INCOME: Gain (loss) on sale of loans............................................. (14,345) 3,657 Other income............................................................. 24 62 ------------------ ----------------- Total non-interest income.............................................. (14,321) 3,719 NON-INTEREST EXPENSE: Personnel expense........................................................ 2,507 38 General and administrative and other expense............................. 1,070 288 Occupancy expense........................................................ 1,036 160 Professional services.................................................... 752 540 Provision for repurchases................................................ 176 201 Stock compensation expense............................................... -- 150 ------------------ ----------------- Total non-interest expense............................................. 5,541 1,377 ------------------ ----------------- Net earnings (loss) before income taxes.................................. (20,887) 2,399 Income taxes (benefit)................................................... (680) 1,022 ------------------ ----------------- Net earnings (loss)...................................................... $ (20,207) $ 1,377 ================== =================
See accompanying notes to consolidated financial statements. F-28 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (dollar amounts in thousands)
Preferred Stock Common Stock -------------------- ----------------- Retained Number Number Earnings Total of Dollar of Dollar Contributed (Accumulated Shareholders Shares Amount Shares Amount Capital (Deficit) Equity -------------------- ------------------ ----------- ------------ ------------ Balance, January 15, 1997 -- $ -- -- $ -- $ -- $ -- $ -- (commencement of operations)..... Issuance of common stock........... -- -- 500 1 25 -- 26 Issuance of preferred stock........ 9,500 500 -- -- -- -- 500 Capital contribution............... -- 2,375 -- -- 125 -- 2,500 Net earnings for the period from January 15, 1997 (commencement of operations) through December 31,1997.......... -- -- -- -- -- 1,377 1,377 ------------------------------------------------------------------------------------------- Balance, December 31, 1997......... 9,500 2,875 500 1 150 1,377 4,403 ------------------------------------------------------------------------------------------- Net loss for the year ended December 31, 1998................. -- -- -- -- -- (20,207) (20,207) ------------------------------------------------------------------------------------------- Balance, December 31, 1998......... 9,500 $ 2,875 500 $ 1 $ 150 $ (18,830) $ (15,804) ===========================================================================================
See accompanying notes to consolidated financial statements. F-29 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------------ ------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings (loss)....................................................... $ (20,207) $ 1,377 Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation............................................................. 226 50 Deferred income taxes.................................................... 924 (924) Stock compensation expense............................................... -- 150 Provision for repurchases................................................ 176 201 Net change in accrued interest receivable................................ 65 (337) Net change in due from affiliates and due to affiliates.................. 16,141 (780) Net change in other assets and liabilities............................... (614) 2,526 ------------------------ ------------------------- Net cash provided by (used in) operating activities.................... (3,289) 2,263 ------------------------ ------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Originations of Commercial Mortgages held-for-sale....................... (425,096) (233,545) Sale of Commercial Mortgages held-for-sale................................ 486,896 126,891 Purchases of premises and equipment....................................... (754) (431) ------------------------ ------------------------- Net cash provided by (used) in investing activities.................... 61,046 (107,085) ------------------------ ------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in warehouse line agreements................................... (59,338) 104,219 Issuance of preferred stock............................................... -- 500 Issuance of common stock.................................................. -- 1 Contributions from ICH.................................................... -- 2,375 ------------------------ ------------------------- Net cash provided by (used in) financing activities.................... (59,338) 107,095 ------------------------ ------------------------- Net change in cash and cash equivalents.................................... (1,581) 2,273 Cash and cash equivalents at beginning of period........................... 2,273 -- ------------------------ ------------------------- Cash and cash equivalents at end of period................................. $ 692 $ 2,273 ======================== ========================= SUPPLEMENTARY INFORMATION: Interest paid............................................................. $ 11,779 $ 2,276 Taxes paid................................................................ 486 422 NON-CASH TRANSACTIONS: Issuance of Common Stock.................................................. $ -- $ 25 Capital contribution of common stockholders............................... -- 125
See accompanying notes to consolidated financial statements. F-30 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note A--Summary of Business and Significant Accounting Policies 1. Basis of Financial Statement Presentation The operations of the Company have been presented in the consolidated financial statements for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 and include the financial results of Impac Commercial Capital Corporation (ICCC) as a stand-alone company. Interest income on affiliated short-term advances (Due from affiliates) has been earned at the rate of 8% per annum. Interest expense on affiliated short- term borrowings (Due to affiliates), has been incurred at the rate of 8% per annum. Costs and expenses of IMH have been allocated to ICCC in proportion to services provided, plus a 15% service charge. Certain amounts in the prior period's consolidated financial statements have been reclassified to conform to the current presentation. Management of ICCC has made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. 2. Cash and cash equivalents For purposes of the statement of cash flows, cash and cash equivalents consist of cash and money market mutual funds. The Company considers investments with maturities of three months or less at date of purchase to be cash equivalents. 3. Commercial Mortgages Held-for-Sale Commercial Mortgages held-for-sale are stated at the lower of cost or market in the aggregate as determined by outstanding commitments from investors or current investor yield requirements. Interest is recognized as revenue when earned according to the terms of the Commercial Mortgages and when, in the opinion of management, it is collectible. Nonrefundable fees and direct costs associated with the origination or purchase of loans are deferred and recognized when the loans are sold as gain or loss on sale of mortgage loans, except related to loans sold to ICH, which nonrefundable fees and costs fees are deferred and recognized over the life of the loans using the interest method. 4. Gain on Sale of Loans ICCC recognizes gains or losses on sale of loans when the sales transaction settles and the risks and rewards of ownership are determined to have passed to the purchasing party. Gains on sale of loans or securities to ICH are deferred and accreted over the estimated life of the loans or securities using the interest method. 5. Income Taxes Income taxes are accounted for under the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. F-31 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 6. Commercial Mortgage Servicing Income Servicing income is reported as earned, principally on a cash basis when the majority of the service process is completed. Note B--Commercial Mortgages Held-for-Sale Substantially all Commercial Mortgages originated by ICCC are fixed-rate or adjustable-rate commercial mortgage loans secured by first liens on commercial properties. Approximately 32% and 51%, respectively, of Commercial Mortgages held-for-sale at December 31, 1998 and 1997, respectively, are collateralized by commercial real properties located in California. During the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997, ICCC originated $425.1 million and $233.5 million, respectively, of Commercial Mortgages and sold none and $73.4 million, respectively, of Commercial Mortgages to third party investors. In addition, ICCC sold $525.2 million and $23.7 million, respectively, of Commercial Mortgages to ICH during the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997.
At December 31, ----------------------------------------------------- 1998 1997 ----------------------- ------------------------ (in thousands) Commercial Mortgages.................................... $ 45,524 $ 106,346 Unamortized net discounts on Commercial Mortgages....... (721) -- Deferred loan fees...................................... 77 308 Deferred hedging........................................ (26) -- ----------------------- ------------------------ $ 44,854 $ 106,654 ======================= ========================
At December 31, 1998 and 1997, other liabilities includes an allowance for repurchases of $377,000 and $201,000, respectively. Note C--Premises and Equipment, net Premises and equipment are stated at cost, less accumulated depreciation. Depreciation on premises and equipment is recorded using the straight-line method over the estimated useful lives of individual assets (three to seven years).
At December 31, ----------------------------------------------------- 1998 1997 ----------------------- ------------------------ (in thousands) Premises and equipment................... $ 1,185 $ 431 Less accumulated depreciation............ (276) (50) ----------------------- ------------------------ $ 909 $ 381 ======================= ========================
Note D--Warehouse Line Agreements ICCC enters into warehouse line agreements with ICH and IMH to fund the origination and purchase of Commercial Mortgages. Terms of the warehouse line agreements require that the Commercial Mortgages be held by an independent third party custodian, which gives the Company the ability to borrow against the collateral as a percentage of the fair market value of the Commercial Mortgages. ICCC has entered into warehouse facilities with ICH to obtain financing up to an aggregate of $900.0 million. The margins on the warehouse facility are at 90% of the fair market value of the collateral. The interest rates on the borrowings are at Bank of America's prime rate. ICCC has entered into a warehouse facility with IMH to provide F-32 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) financing as needed. The margins on the warehouse line agreement are at 8% of the fair market value of the collateral. The interest rates on the borrowings are Bank of America's prime rate. The following tables set forth information regarding warehouse line agreements (in thousands):
At December 31, 1998 ---------------------------------------------------------------------------- Maximum Warehouse Underlying Type of Uncommitted Line Collateral Maturity Collateral Amount Liability (1) Date ---------------------------------------------------------------------------- Impac Commercial Holdings, Inc..................... Mortgages $900,000 $ 41,217 $ 41,963 N/A Impac Mortgage Holdings, Inc....................... Mortgages N/A 3,664 3,730 N/A -------------------------------- Total............................................ $ 44,881 $ 45,693 ================================ At December 31, 1997 ------------------------------------------------------------------------------ Maximum Warehouse Underlying Type of Uncommitted Line Collateral Maturity Collateral Amount Liability (1) Date ------------------------------------------------------------------------------ Impac Commercial Holdings, Inc..................... Mortgages $900,000 $ 95,711 $ 103,280 N/A Impac Mortgage Holdings, Inc....................... Mortgages N/A 8,508 9,181 N/A ---------------------------------- Total............................................ $ 104,219 $ 112,461 ==================================
- --------------------- (1) The amount of underlying collateral represents the unpaid principal balance of Commercial Mortgages provided as collateral for the warehouse lines. Note E--Income Taxes The components of income taxes consist of the following:
For the period from January 15, 1997 (commencement of For the year ended operations) through December 31, 1998 December 31, 1997 ------------------------ ------------------------- (in thousands) Current income taxes: Federal................................................................ $ (1,604) $ 1,483 State.................................................................. -- 463 ------------------------ ------------------------- Total current income taxes............................................ (1,604) 1,946 ------------------------ ------------------------- Deferred income taxes: Federal................................................................ 724 (723) State.................................................................. 200 (201) ------------------------ ------------------------- Total deferred income taxes........................................... 924 (924) ------------------------ ------------------------- Total income taxes.................................................. $ (680) $ 1,022 ======================== =========================
The Company's effective income taxes differ from the amount computed by applying the federal income tax rate of 34% to income before income taxes as a result of the following:
1998 1997 ----------------- ----------------- (in thousands) Computed "expected" income tax (benefit) at federal rate.............................. $ (7,102) $ 816 California franchise tax, net of federal income tax (benefit)......................... (727) 173 Valuation allowance................................................................... 7,779 -- Effect of change in state valuation allowance......................................... (443) -- Other................................................................................. (187) 33 ----------------- ----------------- $ (680) $ 1,022 ================= =================
F-33 The tax effects that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
1998 1997 ----------------- ----------------- (in thousands) Deferred tax assets: -------------------- Deferred revenue.......................... $ 1,346 $ 551 Future state tax benefit.................. -- 89 Loan mark-to-market....................... -- 844 Provision for repurchases................. 167 90 Non-accrual loan.......................... 96 -- Accrued vacation.......................... 31 -- Minimum tax credit........................ 86 -- Net operating losses...................... 7,045 -- ----------------- ------------------ Total gross deferred tax assets........ 8,771 1,574 Valuation allowance.................... 7,779 -- Deferred tax liabilities: ------------------------- Mortgage servicing rights................. 985 (650) Depreciation.............................. 7 -- ----------------- ----------------- Net deferred tax asset................. $ -- $ 924 ================= =================
As of December 31, 1998, the Company has net operating loss carry-forwards for federal and state income tax purposes of $17.5 million and $10.7 million, respectively, which are available to offset future taxable income, if any, through 2018 and 2003, respectively. In addition, the Company has an alternative minimum tax credit carry-forward of approximately $86,000 which is available to reduce future federal regular income taxes, if any, over an indefinite period. The Company believes that the deferred tax asset will not be realized with the reversal of the deferred tax liability and expected future taxable income, and therefore, the Company has established a valuation allowance of $7.8 million. ICCC does not have a current tax payable as of December 31, 1998. Note F--Disclosures About Fair Value of Financial Instruments The estimated fair value of financial instruments have been determined by ICCC using available market information and appropriate valuation methodologies, however, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts ICCC could realize 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. F-34 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At December 31, ------------------------------------------------------------------ 1998 1997 --------------------------------- ------------------------------ Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------------------------------- ------------------------------- (in thousands) Assets: Cash and cash equivalents................................... $ 692 $ 692 $ 2,273 $ 2,273 Commercial Mortgages held-for-sale.......................... 44,854 46,625 106,654 112,461 Due from affiliates......................................... 5,740 5,740 1,538 1,538 Liabilities: Warehouse line agreements................................... 44,881 44,881 104,219 104,219 Due to affiliates........................................... 21,101 21,101 758 758 Futures contracts........................................... -- 97 -- 510 Off balance-sheet loan commitments.......................... -- -- -- --
The fair value estimates as of December 31, 1998 and 1997 are based on pertinent information available to management as of that date. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. The following describes the methods and assumptions used by ICCC in estimating fair values: Cash and Cash Equivalents Fair value approximates carrying amount as these instruments are demand deposits and do not present unanticipated interest rate or credit concerns. Commercial Mortgages Held-for-Sale Fair value is based on estimated quoted market prices from dealers and brokers for similar types of mortgage loans. Due From / To Affiliates Fair value approximates carrying amount because of the short-term maturity of the liabilities and does not present unanticipated interest rate or credit concerns. Warehouse Line Agreements Fair value approximates carrying amount because of the short-term maturity of the liabilities. Futures Contracts Fair value is based on estimated quoted market prices from dealers and brokers for similar types of instruments. Off Balance-Sheet Loan Commitments Fair value of commitments, including hedging position, is determined in the aggregate on current investor yield requirements. F-35 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Note G--Employee Benefit Plans Profit Sharing and 401(k) Plan ICCC does not have its own 401(k) or profit sharing plan. As such, employees of ICCC participate in ICII's 401(k) plan. The 401(k) plan provides that each participant may contribute from 2% to 14% of his or her salary and the Company will contribute to the participant's plan account at the end of each plan year 50% of the first 4% of salary contributed by a participant. Under the 401(k) plan, employees may elect to enroll on the first day of any month, provided that they have been employed for at least six months. Subject to the rules for maintaining the tax status of the 401(k) plan, an additional Company contribution may be made at the discretion of the Company, as determined by the Unaffiliated Directors. Should a discretionary contribution be made, the contribution would first be allocated to those employees deferring salaries in excess of 4%. The matching contribution would be 50% of any deferral in excess of 4% up to a maximum deferral of 8%. If discretionary contribution funds remain following the allocation outlined above, any remaining Company matching funds would be allocated as a 50% match of employee contributions on the first 4% of the employee's deferrals. Company matching contributions will be made as of December 31st of each year in the form of Company Common Stock. The Company contributed matching and discretionary amounts to the 401(k) plan for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 of $63,000 and $17,000, respectively. Note H--Liquidity ICCC recorded a net loss for the year ended December 31, 1998 of $20.2 million resulting in negative net worth of $15.8 million as of December 31, 1998. The loss for 1998 was primarily due to the deterioration of the commercial mortgage backed securitization market in the third and fourth quarters of 1998. To the extent necessary, ICH intends to support and fund the cash flow requirements of ICCC for the next twelve months through December 31, 1999. During the first quarter of 1999, ICCC anticipates selling a significant portion of its Commercial Mortgage portfolio thus eliminating related net interest expense. In addition, ICCC may pursue opportunities in retail loan originations operations, which could generate loan origination fees. Management is also exploring opportunities to form an alliance with one or more strategic partners which will allow ICCC to fund the growth its operations. Management anticipates the alliance will also enable ICCC to access the securitization marketplace and achieve better sale execution. Note I--Related Party Transactions Credit Arrangements ICCC has entered into warehouse line agreements with ICH which provide up to an aggregate of $900.0 million to finance ICCC's operations as needed. The interest rates on the borrowings are at Bank of America's prime rate, which was 7.75% at December 31, 1998. The margins on the warehouse line agreements are up to 90% of the fair market value of the collateral provided. As of December 31, 1998 and 1997, amounts outstanding on ICCC's warehouse line agreements with ICH were $41.2 million and $95.7 million, respectively. Interest expense recorded by ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $9.1 million and $2.4 million, respectively. ICCC has entered into an uncommitted warehouse line agreement with IMH to provide financing as needed. The margins on the warehouse line agreement are at 8% of the fair market value of the collateral provided. The interest rates on the borrowings are at Bank of America's prime rate. As of December 31, 1998 and 1997, outstanding amounts on the warehouse line agreement were $3.7 million and $8.5 million, respectively. Interest expense recorded by ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 was $785,000 and $262,000, respectively. During the normal course of business, ICCC may advance or borrow funds on a short-term basis with affiliated companies. Advances to affiliates are reflected as "Due from affiliates" while borrowings are reflected as "Due to affiliates" on ICCC's balance sheet. These short-term advances and borrowings bear interest at a fixed rate of 8.00% per F-36 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) annum. Interest income recorded by ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 related to short-term advances due from affiliates was $204,000 and $16,000, respectively. Interest expense recorded by ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 related to short-term advances due to affiliates was $954,000 and $113,000, respectively. Repurchase of Commercial Mortgages During the year ended December 31, 1998, ICCC purchased $43.2 million of Commercial Mortgages from ICH at no gain or loss. Sale of Commercial Mortgages During the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997, ICCC sold $525.2 million and $23.7 million, respectively, in principal balance of Commercial Mortgages to ICH at a net discount of $3.1 million and a net premium of $111,000, respectively. Stock Compensation Expense Stock compensation expense of $25,000 represents the difference between the price at which ICCC issued 500 shares of Common Stock to directors and officers of IMH and ICH on February 10, 1997, and the net book value, which the Company's management believes approximated the difference between fair value and the amount of the 5% economic interest in ICCC purchased by the common shareholders. Submanagement Agreement IFC entered into a submanagement agreement with RAI under which, IMH and IFC provide various services to ICCC as RAI deems necessary, including facilities and costs associated therewith, technology, human resources, management information systems, general ledger accounts, check processing and accounts payable, plus a 15% service charge. RAI charges ICCC for these services based upon usage. Total cost allocations IFC charged to ICCC for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997 were $574,000 and $456,000, respectively. Non-Compete Agreement and Right of First Refusal Agreement Pursuant to the Non-Compete Agreement executed on the date of the ICH initial public offering, IFC will not acquire any commercial mortgages for a period of the earlier of nine months from the closing of the ICH initial public offering or the date upon which ICH and/or ICCC accumulates (for investment or sale) $300.0 million of commercial mortgages or commercial mortgage-backed securities. This agreement expired in March 1998. Pursuant to the Right of First Refusal Agreement by and among ICH, IMH, IFC, ICCC and RAI, pursuant to which, in part, RAI will agree that any mortgage loan or mortgage-backed security investment opportunity which is offered to it on behalf of either ICH, IMH any affiliated REIT will first be offered to that entity whose initial primary business as described in its initial public offering documentation most closely aligns with such investment opportunity. Note J--Commitments and Contingencies Commercial Mortgage Loan Sales Commitments In the ordinary course of business, ICCC is exposed to liability under representations and warranties made to purchasers and insurers of mortgage loans and the purchasers of servicing rights. Under certain circumstances, ICCC is F-37 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) required to repurchase mortgage loans if there had been a breach of representations or warranties. ICH has guaranteed the performance obligation of ICCC under such representation and warranties related to loans included in securitizations. Futures Contracts To remain competitive and control risk, ICCC uses futures and options on futures. The use of these instruments provides for increased liquidity, lower transaction costs and more effective short-term coverage than cash and mortgage- backed securities. However, ICCC is vulnerable to the basis risk that is inherent in cross-hedging. ICCC uses the buying and selling of futures contracts on Treasury bonds and Treasury notes when the market is vulnerable to day-to-day corrections. Executing hedges with these instruments allows ICCC to more effectively hedge the risks of corrections or reverses in the market without committing mandatory sales on mortgage-backed securities or cash. ICCC utilizes these instruments on a short-term basis to fine tune its overall hedge position at a lower cost. The unrealized gains and losses on the hedging transactions are recorded as an adjustment to the basis of the loans. Gains and losses are recognized upon the sale of loans. The Company sells future contracts against five- and ten-year Treasury notes with major dealers in such securities. At December 31, 1998 and 1997, the Company had $20.0 million and $105.1 million, respectively, in outstanding commitments to sell U.S. Treasury notes. Lease Commitments ICH and ICCC, as tenants in common, lease approximately 18,000 square feet of office space in Irvine, California, approximately 3,600 square feet in Sherman Oaks, California and approximately 4,300 square feet in Dallas, Texas under premises operating leases expiring in November 2000, May 2001 and August 2003, respectively. Minimum premises rental commitments are as follows (in thousands): 1999.................................................... $ 734 2000.................................................... 691 2001.................................................... 166 2002.................................................... 126 2003.................................................... 84 ------------ Total................................................... $ 1,801 ============
All rent expense associated with the lease is charged to ICCC as ICCC's employees occupy 100% of office space. Note K--Quarterly Financial Data (unaudited)
For the Three Months Ended, ------------------------------------------------------------------ December 31, September 30, June 30, March 31, ------------------------------------------------------------------ Net interest expense (1)............ $ (319) $ (369) $ (264) $ (73) Non-interest income (1)............. 264 (14,932) 263 84 Non-interest expense (1)............ 3,613 315 444 489 Net loss............................ (3,668) (15,616) (445) (478)
F-38 IMPAC COMMERCIAL CAPITAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Selected quarterly financial data for the period from January 15, 1997 (commencement of operations) through December 31, 1997 follows (in thousands, except per share data):
For the Three Months Ended, -------------------------------------------------------------- December 31, September 30, June 30, March 31, Net interest income (1).............................. $ 27 $ 14 $ 15 $ 1 Non-interest income (1).............................. 2,156 1,524 37 2 Non-interest expense (1)............................. 1,059 1,009 142 189 Net earnings (loss).................................. 1,124 529 (90) (186)
- ---------------- (1) Conforms to current year presentation. F-39 EX-3.1(D) 2 ARTICLES SUPPLEMENTARY AND CERTIFICATE EXHIBIT 3.1(d) STATE OF MARYLAND 672000 STATE DEPARTMENT OF ASSESSMENTS AND TAXATION 301 West Preston Street Baltimore, Maryland 21201 DATE: OCTOBER 14, 1998 THIS IS TO ADVISE YOU THAT THE ARTICLES OF CONSOLIDATION FOR IMPAC COMMERCIAL HOLDINGS, INC. WERE RECEIVED AND APPROVED FOR RECORD ON OCTOBER 14, 1998 AT 11:48 AM. FEE PAID: 82.00 [SEAL] JOSEPH V. STEWART CHARTER SPECIALIST ARTICLES SUPPLEMENTARY OF SERIES A JUNIOR PARTICIPATING PREFERRED STOCK OF IMPAC COMMERCIAL HOLDINGS, INC. Impac CommercialHoldings, Inc., a corporation organized and existing under the laws of the State of Maryland (the "Corporation"), hereby certifies to the State Department of Assessments and Taxation of Maryland that: FIRST: Pursuant to the authority granted to and vested in the Board of Directors of the Corporation (the "Board of Directors") in accordance with Article VI of the charter of the Corporation, including these Articles Supplementary (the "Charter"), the Board of Directors adopted resolutions reclassifying 1,000,000 shares (the "Shares") of Preferred Stock (as defined in the Charter) as a separate class of stock, Series A Junior Participating Preferred Stock, $.01 par value per share (the "Series A Preferred Stock"), with the preferences, conversion and other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms and conditions of redemption set forth below. Upon any restatement of the Charter, the immediately following heading and Sections 1 through 10 of this Article FIRST shall become Section 6.9 of Article VI of the Charter. Series A Junior Participating Preferred Stock. Section 1. Designation and Amount. There shall be a series of Preferred Stock that shall be designated as "Series A Junior Participating Preferred Stock" (hereinafter referred to as "Series A Preferred Stock") and the number of shares constituting such series shall be 1,000,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, however, that no decrease shall reduce the number of shares of Series A Junior Participating Preferred Stock to less than the number of shares then issued and outstanding plus the number of shares issuable upon exercise of outstanding rights, options or warrants or upon conversion of outstanding securities issued by the Corporation. Section 2. Dividends and Distributions. (a) Subject to the prior and superior rights of the holders of any shares of any series of Preferred Stock ranking prior and superior to the shares of Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of assets legally available for the purpose, quarterly dividends payable in cash on the first business day of January, April, July and October in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1.00 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock, $.01 par value per share, of the Corporation (the "Common Stock") or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock. (b) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (a) above immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1.00 per share on the Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (c) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares of Series A Preferred Stock, unless the date of issue of such shares is before the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days before the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (a) Except as provided in paragraph (c) of this Section 3 and subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 1,000 votes on all matters submitted to a vote of the stockholders of the Corporation. (b) Except as otherwise provided herein or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (c) (i) If, on the date used to determine stockholders of record for any meeting of stockholders for the election of directors, a default in preference dividends (as defined in subparagraph (v) below) on the Series A Preferred Stock shall exist, the holders of the Series A Preferred Stock shall have the right, voting as a class as described in subparagraph (ii) below, to elect two directors, and the holders of shares of Common Stock shall have the right to elect the remaining directors. Such right may be exercised at any meeting of stockholders for the election of directors until all such cumulative dividends (referred to above) shall have been paid in full or until noncumulative dividends have been paid regularly for at least one year. (ii) The right of the holders of Series A Preferred Stock to elect two directors, as described above, shall be exercised as a class concurrently with the rights of holders of any other series of Preferred Stock upon which voting rights to elect such directors have been conferred and are then exercisable. The Series A Preferred Stock and any additional series of Preferred Stock which the Corporation may issue and which may provide for the right to vote with the foregoing series of Preferred Stock are collectively referred to herein as "Voting Preferred Stock." (iii) Each director elected by the holders of shares of Voting Preferred Stock shall be referred to herein as a "Preferred Director." A Preferred Director so elected shall continue to serve as such director for a term of one year, except that upon any termination of the right of all of such holders to vote as a class for Preferred Directors, the term of office of such directors shall terminate. Any Preferred Director may be removed by, and shall not be removed except by, the vote of the holders of record of a majority of the outstanding shares of Voting Preferred Stock then entitled to vote for the election of directors, present (in person or by proxy) and voting together as a single class (a) at a meeting of the stockholders, or (b) at a meeting of the holders of shares of such Voting Preferred Stock, called for the purpose in accordance with the Bylaws of the Corporation, or (c) by written consent signed by the holders of a majority of the then outstanding shares of Voting Preferred Stock then entitled to vote for the election of directors, taken together as a single class. (iv) So long as a default in any preference dividends on the Series A Preferred Stock shall exist or the holders of any other series of Voting Preferred Stock shall be entitled to elect Preferred Directors, (a) any vacancy in the office of a Preferred Director may be filled (except as provided in the following clause (b)) by an instrument in writing signed by the remaining Preferred Director and filed with the Corporation and (b) in the case of the removal of any Preferred Director, the vacancy may be filled by the vote or written consent of the holders of a majority of the outstanding shares of Voting Preferred Stock then entitled to vote for the election of directors, present (in person or by proxy) and voting together as a single class, at such time as the removal shall be effected. Each director appointed as aforesaid by the remaining Preferred Director shall be deemed, for all purposes hereof, to be a Preferred Director. Whenever (x) no default in preference dividends on the Series A Preferred Stock shall exist and (y) the holders of any other Series of Voting Preferred Stock shall no longer be entitled to elect such Preferred Directors, then the number of directors of the Corporation shall be reduced by two. (v) For purposes hereof, a "default in preference dividends" on the Series A Preferred Stock shall be deemed to have occurred whenever the amount of cumulative and unpaid dividends on the Series A Preferred Stock shall be equivalent to six full quarterly dividends or more (whether or not consecutive), and, having so occurred, such default shall be deemed to exist thereafter until, but only until, all cumulative dividends on all shares of the Series A Preferred Stock then outstanding shall have been paid through the last Quarterly Dividend Payment Date or until, but only until, non-cumulative dividends have been paid regularly for at least one year. (d) Except as set forth herein (or as otherwise required by applicable law), holders of Series A Preferred Stock shall have no general or special voting rights and their consent shall not be required for taking any corporate action Section 4. Certain Restrictions. (a) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration (except as provided in (iv) below) shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (b) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (a) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Certificate of Incorporation, in any other Certificate of Amendment creating a series of Preferred Stock or as otherwise required by law. Section 6. Liquidation, Dissolution or Winding Up. (a) Subject to the prior and superior rights of holders of any shares of any series of Preferred Stock ranking prior and superior to the shares of Series A Preferred Stock with respect to rights upon liquidation, dissolution or winding up (voluntary or otherwise), no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment (the "Series A Liquidation Preference"). Following the payment of the full amount of the Series A Liquidation Preference, no additional distributions shall be made to the holders of shares of Series A Preferred Stock unless, prior thereto, the holders of shares of Common Stock shall have received an amount per share (the "Capital Adjustment") equal to the quotient obtained by dividing (i) the Series A Liquidation Preference by (ii) 100 (such number in clause (ii), the "Adjustment Number"). Following the payment of the full amount of the Series A Liquidation Preference and the Capital Adjustment in respect of all outstanding shares of Series A Preferred Stock and Common Stock, respectively, holders of Series A Preferred Stock and holders of Common Stock shall receive their ratable and proportionate share of the remaining assets to be distributed in the ratio of the Adjustment Number to 1 with respect to such Preferred Stock and Common Stock, on a per share basis, respectively. (b) In the event, however, that there are not sufficient assets available to permit payment in full of the Series A Liquidation Preference and the liquidation preferences of all other series of preferred stock, if any, which rank on a parity with the Series A Preferred Stock, then such remaining assets shall be distributed ratably to the holders of Series A Preferred Stock and the holders of such parity shares in proportion to their respective liquidation preferences. In the event, however, that there are not sufficient assets available to permit payment in full of the Capital Adjustment, then such remaining assets shall be distributed ratably to the holders of Common Stock. Section 7. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case the shares of Series A Preferred Stock shall at the same time be similarly exchanged or changed in an amount per share (subject to the provision for adjustment hereinafter set forth) equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. Section 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. Section 9. Ranking. The Series A Preferred Stock shall rank junior to all other series of the Corporation's Preferred Stock as to the payment of dividends and the distribution of assets, unless the terms of any such series shall provide otherwise. Section 10. Amendment. The Certificate of Incorporation of the Corporation shall not be further amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of a majority or more of the outstanding shares of Series A Preferred Stock, voting separately as a class. SECOND: The Shares have been reclassified by the Board of Directors pursuant ------ to Article VI of the Charter. THIRD: These Articles Supplementary have been approved by the Board of ----- Directors in the manner and by the vote required by law. FOURTH: The undersigned Chairman of the Corporation acknowledges these ------ Articles Supplementary to be the corporate act of the Corporation and, as to all matters or facts required to be verified under oath, the undersigned President acknowledges that to the best of his knowledge, information and belief, these matters and facts are true in all material respects and that this statement is made under the penalties for perjury. IN WITNESS WHEREOF, the Corporation has caused these Articles Supplementary to be signed in its name and on its behalf by its Chairman and attested to by its Secretary on this 13th day of October, 1998. ATTEST: By: /s/ Ronald Morrison By: /s/ Joseph R. Tomkinson (SEAL) ------------------- ----------------------- Ronald Morrison Joseph R. Tomkinson Secretary Chairman STATE OF MARYLAND 682697 STATE DEPARTMENT OF ASSESSMENTS AND TAXATION 301 West Preston Street Baltimore, Maryland 21201 DATE: NOVEMBER 20, 1998 THIS IS TO ADVISE YOU THAT THE CERTIFICATE OF CORRECTION FOR IMPAC COMMERCIAL HOLDINGS, INC. WAS RECEIVED AND APPROVED FOR RECORD ON NOVEMBER 20, 1998 AT 12:51 PM. FEE PAID: 68.00 [SEAL] JOSEPH V. STEWART CHARTER SPECIALIST IMPAC COMMERCIAL HOLDINGS, INC. Certificate of Correction THIS IS TO CERTIFY THAT: Impac Commercial Holdings Inc., a Maryland corporation (the "Corporation"), hereby certifies to the State Department of Assessments and Taxation of Maryland that: FIRST: The title of the document being is: Articles Supplementary. SECOND: The name of the corporation for with the Articles Supplementary were filed is: Impac Commercial Holdings, Inc. THIRD: The document being corrected was filed on October 14, 1998. FOURTH: Section 3(a) of the Articles Supplementary as previously filed reads as follows: Except as provided in paragraph (c) of this Section 3 and subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 1,000 votes on all matters submitted to a vote of the stockholders of the Corporation. FIFTH: Section 3(a) of the Articles Supplementary as correct reads as follows: Except as provided in paragraph (c) of this Section 3 and subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the stockholders of the Corporation. SIXTH: The undersigned President of the Corporation acknowledges this Certificate of Correction to be the corporation act of the Corporation and, as to all matters and facts required to be verified under oath, the undersigned President acknowledges to the best of his knowledge, information and belief, these matters and facts are true in all material respect and that this statement is made under the penalties for perjury. IN WITNESS WHEREOF, the Corporation has caused this Certificate of Correction to be signed in its name and on its behalf by its president and attested by its secretary on November 19, 1998. ATTEST: IMPAC COMMERCIAL HOLDINGS, INC. By: /s/ Ronald Morrison By: /s/ William S. Ashmore ----------------------------- ----------------------------- Ronald Morrison William S. Ashmore, President EX-10.1 3 MANAGEMENT AGREEMENT WITH RAI ADVISORS, LLC. EXHIBIT 10.1 MANAGEMENT AGREEMENT THIS AGREEMENT, entered into as of August 4, 1997, to be effective as of August 8, 1997, the closing date of the public offering of Common Stock on a Registration Statement Form S-11 (No. 333-25423) of IMH COMMERCIAL HOLDINGS, INC., a Maryland corporation (the "Company"), is by and between the Company, and RAI ADVISORS, LLC (the "Manager"); WITNESSETH: WHEREAS, the Company is a recently-formed corporation that intends to be taxed as a real estate investment trust; WHEREAS, the Company operates the Long-Term Investment Operations, which invests primarily in Commercial Mortgages and CMBSs, and the Conduit Operations, conducted by Imperial Commercial Capital Corporation ("ICCC"), which originates, purchases and sells or securitizes Commercial Mortgages; WHEREAS, the Manager's personnel have substantial experience in the purchase, financing, servicing and administration of mortgage loans and mortgage securities, and the Company would like to benefit from such experience in conducting its operations; WHEREAS, in order to obtain the benefit of the Manager's experience and to enhance the success of its operations, the Company desires to retain the Manager, at competitive rates and fees, primarily to perform capital, asset and operations management services in the manner and on the terms hereinafter set forth. NOW, THEREFORE, in consideration of the mutual agreements herein set forth, the parties hereto agree as follows: 1. Definitions. Whenever used in this Agreement, the following terms, ----------- unless the context otherwise requires, shall have the following meanings: (a) "Affiliate" of any entity means (i) any person directly or indirectly owning, controlling or holding with power to vote, five percent (5%) or more of the outstanding voting securities of such entity; (ii) any person five percent (5%) or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by such entity; (iii) any person directly or indirectly controlling, controlled by, or under common control with, such entity; or (iv) any officer, director, partner or employee of such entity or any person set forth in (i) - (iii) above. Any person who owns beneficially, either directly or through one or more controlled companies, more than twenty- five percent (25%) of the voting securities of any entity shall be presumed to control such entity. Any person who does not so own more than twenty-five percent (25%) of the voting securities of any entity shall be presumed not to control such entity. A natural person shall be presumed not to be a controlled entity. (b) "Affiliated REIT" means any other REIT that may have been or will be affiliated with the Company or IMH and for which the Manager will provide services pursuant to a management agreement that is similar to this Agreement. (c) "Agreement" means this Management Agreement. (d) "Average Net Worth" for any period means the arithmetic average of the sum of the gross proceeds from any sale of the Company's equity securities, before deducting any underwriting discounts and commissions and other expenses and costs relative to the offering, plus the Company's retained earnings less dividends declared (without taking into account any losses incurred in prior periods) computed by taking the daily average of such values during such period. (e) "Board of Directors" means the Board of Directors of the Company. (f) "CMBSs" means (1) Pass-Through Certificates and (2) REMICs. (g) "CMO" means an adjustable or fixed-rate debt obligation (bond) that is collateralized by Commercial Mortgages or mortgage certificates and issued by private institutions. (h) "Code" means the Internal Revenue Code of 1986, as amended. (i) "Commercial Mortgages" mean commercial mortgage assets including condo-conversion, multi-family property and cooperative apartment mortgage loans on commercial real property such as industrial and warehouse properties, office buildings, retail space and shopping malls, hotels and motels, nursing homes, hospitals, congregate care facilities and senior living centers. (j) "Commitment" means the document containing the terms pursuant to which the Company purchases on a forward basis Mortgage Loans from various originators, including Affiliates of the Manager. (k) "Company" means IMH Commercial Holdings, Inc., a Maryland corporation. (l) "GAAP" means generally accepted accounting principles. (m) "Governing Instruments" means the articles of incorporation or charter, as the case may be, and bylaws of the Company or its subsidiary. (n) "ICCC" means Imperial Commercial Capital Corporation, a California corporation that conducts the Conduit Operations. (o) "ICIFC" means ICI Funding Corporation, a California corporation. (p) "IMH" means Imperial Credit Mortgage Holdings, Inc., a Maryland corporation. (q) "Manager" means RAI Advisors, LLC, a California limited liability company. (r) "Net Income" means the net income of the Company as determined by the Code before the Manager's incentive compensation, the deduction for dividends paid and any net operating loss deductions arising from losses in prior periods. The Company's interest expenses for borrowed money shall be deducted in calculating Net Income. (s) "Offering" means the public offering of the Company's Common Stock pursuant to a Registration Statement on Form S-11 pursuant to the Securities Act of 1933, as amended. (t) "Pass-Through Certificates" means securities (or interests therein) which are Qualified REIT Assets evidencing undivided ownership interests in a pool of mortgage loans, the holders of which receive a "pass-through" of the principal and interest paid in connection with the underlying mortgage loans in accordance with the holders' respective, undivided interests in the pool. Pass- Through Certificates evidence interests in loans secured by single family, but not multifamily or commercial, real estate properties. (u) "Qualified REIT Assets" means (i) real property (including interests in real property and interests in mortgages on real property), (ii) shares (or transferable certificates of beneficial interest) in other REITs which meet the requirements of Sections 856-859 of the Code, (iii) stock or debt instruments (not otherwise described in (i), (ii) or (iv)) held for not more than one year that were purchased with the proceeds of (a) an offering of stock in the Company (other than amounts received pursuant to a dividend reinvestment plan) or (b) a public offering of debt obligations of the Company which have maturities of at least 5 years, and (iv) a regular or residual interest in a REMIC, but only if 95% or more of the assets of such REMIC are assets described in (i) through (iii). (v) "REIT" means Real Estate Investment Trust as defined under Section 856 of the Code. (w) "REMICs" means serially maturing debt securities secured by a pool of mortgage loans, the payments on which bear a relationship to the debt securities, and the issuer of which qualifies as a Real Estate Mortgage Investment Conduit under Section 860D of the Code. (x) "Reimbursable Expenses" shall have the meaning set forth in Section 7 hereof. (y) "Reimbursable Executive Amounts" means that amount which the Company will reimburse the Manager, on a dollar for dollar basis, for the actual costs of the services provided by the officers of the Company to the Manager based upon the compensation payable to them by ICIFC pursuant to employment agreements. (z) "Return on Equity" means return calculated for any quarter by dividing the Company's Net Income for such quarter by the Company's Average Net Worth for such quarter. (aa) "Stockholders" shall mean the owners of the stock of the Company. (bb) "Ten Year U.S. Treasury Rate" for a quarterly period shall mean the arithmetic average of the weekly per annum Ten Year Average Yields published by the Federal Reserve Board during such quarter. In the event that the Federal Reserve Board does not publish a weekly per annum Ten Year Average Yield during any week in a quarter, then the Ten Year U.S. Treasury Rate for such week shall be the weekly per annum Ten Year Average Yields published by any Federal Reserve Bank or by any U.S. Government department or agency selected by the Company for such week. In the event that the Company determines in good faith that for any reason the Company cannot determine the Ten Year U.S. Treasury Rate for any quarter as provided above, then the Ten Year U.S. Treasury Rate for such quarter shall be the arithmetic average of the per annum average yields to maturity based upon the daily closing bids during such quarter for each of the issues of actively traded marketable U.S. Treasury fixed interest rate securities (other than securities which can, at the option of the holder, be surrendered at face value in payment of any federal estate tax) with a final maturity date not less than eight nor more than twelve years from the date of each such quotation, as chosen and for each business day (or less frequently if daily quotations shall not be generally available) in each such quarterly period in New York City to the Company by at least three recognized dealers in U.S. Government securities selected by the Company. (cc) "Unaffiliated Director" means a Director who is independent of the Company, any manager of the Company (including the Manager) and IMH and its Affiliates. 2. General Duties of the Manager. Subject to the supervision and approval ----------------------------- of the Board of Directors, the Manager shall provide services to the Company, and to the extent directed by the Board of Directors, shall provide similar services to any subsidiary or Affiliate of the Company, which includes ICCC and may also include Affiliated REITs, as follows: (a) serve as the Company's consultant with respect to formulation of investment criteria by the Board of Directors; (b) advise as to the issuance of Commitments on behalf of the Company to purchase Commercial Mortgages or purchasing Commercial Mortgages and CMBSs meeting the investment criteria set from time to time by the Board of Directors; (c) advise, negotiate and oversee the securitization of the Company's Commercial Mortgages in REMICs or CMOs and negotiate terms with rating agencies and coordinate with investment-bankers as to structure and pricing of the securities formed by the Company as directed by the Board of Directors; (d) advise the Company in connection with and assist in its Long-Term Investment Operations; (e) furnish reports and statistical and economic research to the Company regarding the Company's activities and the services performed for the Company by the Manager; (f) monitor and provide to the Board of Directors on an on-going basis price information and other data, obtained from certain nationally-recognized dealers who maintain markets in Commercial Mortgages identified by the Board of Directors from time to time, and provide data and advice to the Board of Directors in connection with the selection and identification of such dealers. (g) provide the executive and administrative personnel, office space and services required in rendering services to the Company, which includes contracting with appropriate third parties, which may include IMH and its Affiliates, or any Affiliated REIT, to provide various services including facilities and costs related therewith, technology, management information systems, human resource administration, general ledger accounts, check processing, accounts payable and other similar operational or administrative services; (h) oversee the day-to-day operations of the Company and supervise the performance of such other administrative functions necessary in the management of the Company as directed by the Board of Directors; (i) advise and negotiate agreements on behalf of the Company with banking institutions and other lenders to provide for the short-term borrowing of funds by the Company, as directed by the Board of Directors; (j) communicate on behalf of the Company with the holders of the equity and debt securities of the Company as required to satisfy the reporting and other requirements of any governmental bodies or agencies and maintain effective relations with such holders of the Company's securities, as directed by the Board of Directors; (k) subject to an agreement executed by the Company, advise as to the designation of a servicer for those loans sold by ICCC whereby ICCC has elected not to service such loans; (l) counsel the Company in connection with policy decisions to be made by the Board of Directors; (m) upon request by and in accordance with the direction of the Board of Directors, invest or reinvest any money of the Company; and (n) as approved and directed by the Board of Directors, perform such other services as may be required for management and other activities relating to the assets of the Company as the Manager shall deem appropriate under the particular circumstances. 3. Additional Activities of Manager. Subject to the Non-Competition -------------------------------- Agreement, dated the date hereof, by and among the Company, ICCC, IMH and ICIFC, and the Right of First Refusal Agreement, dated the date hereof, by and among the Company, ICCC, the Manager, IMH and ICIFC, nothing herein shall prevent the Manager or its Affiliates from engaging in other businesses or from rendering services of any kind to any other person or entity, including investment in or advisory service to others investing in any type of real estate investment, including investments which meet the principal investment objectives of the Company, ICCC or their respective Affiliates. Directors, officers, employees and agents of the Manager or Affiliates of the Manager may serve as directors, officers, employees, agents, nominees or signatories for the Company, any subsidiary or Affiliate of the Company or any Affiliated REIT, to the extent permitted by its Governing Instruments, as from time to time amended, or by any resolutions duly adopted by the Board of Directors pursuant to its Governing Instruments. When executing documents or otherwise acting in such capacities for the Company, such persons shall use their respective titles in the Company. 4. Records; Confidentiality. The Manager shall maintain appropriate books of account and records relating to services performed hereunder, which books of account and records shall be accessible for inspection by officers of the Company or officers of any subsidiary of the Company at any time during normal business hours. The Manager agrees to keep confidential any and all information it obtains from time to time in connection with the services it renders hereunder and shall not disclose any portion thereof to non-affiliated third parties except with the prior written consent of the Company, any subsidiary of the Company and any entity of which the Company owns an economic interest. In addition, to the extent executive officers of the Manager provide services to the Company and its Affiliates through this Agreement, the Manager will cause such executive officers to enter into non-competition and confidentiality agreements so that they will not, directly or indirectly, compete with the business of the Company and its Affiliates, including ICCC; provided, however, that the executive officers may provide services to IMH, any Affiliated REIT, the Manager, and the executive officers may perform the duties set forth in their respective employment agreements with ICIFC. 5. Obligations of Manager. Anything else in this Agreement to the contrary notwithstanding, the Manager shall refrain from any action which in its sole judgment made in good faith (i) would adversely affect the status of the Company and any subsidiary of the Company as a real estate investment trust as defined and limited in sections 856 through 860 of the Code, (ii) would violate any law, rule or regulation of any governmental body or agency having jurisdiction over the Company and such subsidiary, or (iii) which would otherwise not be permitted by the Company's or its subsidiary's Governing Instruments, except if any of such actions shall be ordered by the Board of Directors, in which event the Manager shall promptly notify the Board of Directors of the Manager's judgment that such action would adversely affect such status or violate any such law, rule or regulation or the Governing Instruments and shall refrain from taking such action pending further clarification or instructions from the Board of Directors. If the Board of Directors thereafter instructs the Manager, despite the Manager's notification as provided herein, to take any such action and the Manager so acts upon the instructions given, the Manager shall not be responsible for any loss of the Company's or its subsidiary's status as a REIT or violation of any law, rule or regulation or the Governing Instruments caused thereby. 6. Compensation. (a) If the Company's annualized Return on Equity during any fiscal quarter (computed by multiplying the Return on Equity for such fiscal quarter by four) is in excess of the Ten Year U.S. Treasury Rate plus 2%, the Company will pay the Manager, for such quarter, an amount equal to 25% of such excess, but in no event shall any payment of compensation under this subsection reduce the Company's annualized Return on Equity for such quarter to less than the Ten Year U.S. Treasury Rate plus 2%. (b) The Manager shall compute the compensation payable under Subsection (a) within 60 days after the end of each calendar quarter, with the exception of the fourth quarter for which compensation shall be computed within 30 days. In any event, the compensation payable under Subsection (a) shall be calculated before any income distributions are made to stockholders for the corresponding period. A copy of the computations made by the Manager to calculate its compensation shall thereafter be promptly delivered to any executive officer of the Company and, upon such delivery, payment of the compensation earned under Subsection (a) shown therein shall be due and payable within 90 days after the end of such calendar quarter. The compensation due and payable to the Manager under Subsection (a) shall be paid to the Manager in the subsequent quarter in which the incentive compensation was earned. The aggregate amount of the Manager's compensation for each fiscal year shall be adjusted within 120 days after the end of such fiscal year so as to provide compensation for such year in the annual amounts stated in Subsection (a) and any excess owed to, or shortfall owed by, the Manager with respect to such compensation, collectively, shall be promptly remitted by, or paid to, the Company. In the event that the time in which the compensation is paid by the Company to the Manager violates the Company's status to be taxed as a REIT, both parties shall mutually agree to modify the time set forth in this Section in which the Manager will be paid the compensation earned under Subsection (a). 7. Reimbursable Expenses of the Manager. Without regard to the compensation received hereunder by the Manager, the Company or any subsidiary of the Company shall reimburse the Manager of its expenses, as set forth in Section 8, and without limiting the generality of the foregoing, it is specifically agreed that the following expenses of the Company or any subsidiary of the Company (including ICCC) shall not be paid by the Manager (collectively, "Reimbursable Expenses"): (a) The pro rata employment expenses of the personnel and executive officers (who are governed by employment agreements with ICIFC, and thus, deemed "Reimbursable Executive Amounts") employed by the Manager, including, but not limited to, salaries, wages, payroll taxes, and the cost of employee benefit plans; (b) Travel and other expenses of directors, officers and employees of the Manager and of directors, officers, or employees of the Company or any subsidiary of the Company who are also directors, officers or employees of the Manager, except expenses of such persons who are directors of the Company or any subsidiary of the Company incurred in connection with attending meetings of the Board of Directors or meetings of holders of the securities of the Company or any subsidiary of the Company or expenses of persons who are directors, officers, or employees of the Company or any subsidiary of the Company incurred in connection with attending meetings, conferences or conventions which relate solely to the business affairs of the Company or any subsidiary of the Company; (c) Rent, telephone, utilities, office furniture, equipment and machinery (including computers, to the extent utilized) and other office expenses (such as asset/liability software, modeling software and other software and hardware) of the Manager needed in order to perform its duties as set forth in Section 2 herein; (d) Bookkeeping fees and expenses of the Company and the Manager including any costs of computer services in connection with this function; (e) Amounts payable by the Manager pursuant to submanagement agreements with outside third parties to provide various services to the Company including facilities and costs related therewith, technology, management information systems, human resource administration, general ledger accounts, check processing, accounts payable and other similar operational services ; (f) Miscellaneous administrative expenses incurred in supervising and monitoring the Company's investments or any subsidiary's investments of relating to performance by the Manager of its functions hereunder; (g) The cost of borrowed money of the Company; (h) All taxes applicable to the Company or any subsidiary of the Company including interest and penalties thereon; (i) Legal audit, accounting, underwriting, brokerage, listing, rating agency, registration and other fees, printing, engraving and other expenses and taxes incurred in connection with the issuance, distribution, transfer, registration and stock exchange listing of the Company's or any subsidiary's equity securities or debt securities; (j) Fees and expenses paid to independent contractors, consultants, managers, and other agents employed directly by the Company or any subsidiary of the Company or by the Manager at the Company's or such subsidiary's request for the account of the Company or any subsidiary of the Company (other than the Manager); (k) Expenses connected with the acquisition, disposition and ownership of the Company's or any subsidiary's investment assets (including without limitation commitment fees, brokerage fees, guaranty fees and hedging fees), including but not limited to ad valorem taxes, costs of foreclosure, maintenance, repair and improvement of property and premiums for insurance on property owned by the Company or any subsidiary of the Company; and with regard to brokerage fees, it is understood that neither the Manager nor any of its Affiliates shall charge a brokerage commission or similar fee to the Company or any subsidiary of the Company in connection with the acquisition, disposition or ownership of the Company's or any subsidiary's investment assets; (l) The expenses of organizing, modifying or dissolving the Company or any subsidiary of the Company; (m) All insurance costs incurred in connection with the Company or any subsidiary of the Company; (n) Expenses connected with payments of dividends or interest or distributions in each or any other form made or caused to be made by the Board of Directors to holders of the securities of the Company or any subsidiary of the Company; (o) Expenses connected with the structuring of the issuance of CMBSs by the Company or any subsidiary of the Company, including but not limited to trustee's fees, insurance premiums, and costs of required credit enhancements; (p) All expenses by third parties connected with communications to holders of equity securities or debt securities of the Company or any subsidiary of the Company and the other bookkeeping and clerical work necessary in maintaining relations with holders of such securities and in complying with the continuous reporting and other requirements of governmental bodies or agencies, including any costs of computer services in connection with this function, the cost of printing and mailing certificates for such securities and proxy solicitation materials and reports to holders of the Company's or any subsidiary's securities and reports to third parties required under any indenture to which the Company or any subsidiary of the Company is a party; (q) Transfer agent's and registrar's fees and charges; (r) Fees and expenses paid to directors of the Company or any subsidiary of the Company, the cost of director and officer liability insurance and premiums for fidelity and errors and omissions insurance; (s) Legal, accounting and auditing fees and expenses relating to the Company's or any subsidiary's operations; (t) Any judgment rendered against the Company or any subsidiary of the Company, or against any director of the Company or any subsidiary of the Company in his capacity as such for which the Company or any subsidiary of the Company is required to indemnify such director, by any court or governmental agency; (u) Expenses relating to any office or office facilities maintained by the Company or any subsidiary of the Company separate from the office of the Manager; (v) Expenses related to the servicing and subservicing of Commercial Mortgages; (w) All offering expenses (including accounting, legal, printing, clerical, personnel, filing and other expenses) incurred by the Company, the Manager or its Affiliates on behalf of the Company in connection with the Offering; and (x) Other miscellaneous expenses of the Company or any subsidiary of the Company. 8. Computation of Reimbursable Expenses. ------------------------------------ (a) The Company shall reimburse the Manager for all Reimbursable Expenses and Reimbursable Executive Amounts on a dollar for dollar basis. Furthermore, with respect to Reimbursable Expenses and Reimbursable Executive Amounts owed by the Manager to IMH for costs and services rendered under any submanagement agreement with the Manager, the Company shall pay an additional service charge of 15% on such amounts. Pursuant to submanagement agreements, the Manager shall pay all third party service providers, on a dollar-for-dollar basis, the aforementioned amounts received by the Manager from the Company, provided, however, that no such 15% service charge will be paid to third party service providers other than ICIFC. (b) For the first three years of this Agreement, there will be a minimum amount of $500,000 per annum (which includes the 15% service charge) payable by the Company to the Manager for Reimbursable Expenses and Reimbursable Executive Amounts. Thereafter, the Company shall only be responsible for the Reimbursable Expenses and Reimbursable Executive Amounts incurred, plus the additional 15% service charge amount due to the Manager in connection with services rendered by ICIFC under any submanagement agreement. (c) The Manager shall compute the Reimbursable Expenses and Reimbursable Executive Amounts payable under Subsections (a) and (b) within 10 days after the end of each month. A copy of the computations made by the Manager to calculate its compensation shall thereafter be promptly delivered to any executive officer of the Company and, upon such delivery, payment of the compensation earned under Subsection (a) and (b) shown therein shall be due and payable within 15 days after the end of such month. The Reimbursable Expenses and Reimbursable Executive Amounts due and payable to the Manager under Subsections (a) and (b) shall be paid to the Manager in the subsequent month in which the Reimbursable Expenses and the Reimbursable Executive Amounts were incurred. 9. Limits of Manager Responsibility. (a) The Manager assumes no -------------------------------- responsibility under this Agreement other than to render the services called for hereunder in good faith and shall not be responsible for any action of the Board of Directors in following or declining to follow any advice or recommendations of the Manager, including as set forth in Section 5 above. The Manager, its directors, officers, shareholders and employees will not be liable to the Company, any subsidiary of the Company (including ICCC), the Unaffiliated Directors or the Company's or its subsidiary's stockholders for any acts performed by the Manager, its directors, officers, shareholders and employees in accordance with this Agreement, except by reason of acts or omissions constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties. The Company or its subsidiaries (including ICCC) shall reimburse, indemnify and hold harmless the Manager, its shareholders, directors, officers and employees of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever in respect of or arising from any acts or omissions of the Manager, its shareholders, directors, officers and employees made in good faith in the performance of the Manager's duties under this Agreement and not constituting bad faith, willful misconduct, gross negligence or reckless disregard of its duties. (b) The Manager shall reimburse, indemnify and hold harmless the Company, any subsidiaries (including ICCC), or any of their stockholders, directors, officers and employees of and from any and all expenses, losses, damages, liabilities, demands, charges and claims (including, without limitation, reasonable attorneys fees) arising out of any willful and intentional misstatements of fact made by the Manager in connection with this Agreement and the services to be rendered hereunder. 10. No Joint Venture. The Company and the Manager are not partners or joint ---------------- venturers with each other and nothing herein shall be construed to make them such partners or joint venturers or impose any liabilities as such on either of them. 11. Term. This Agreement shall continue in force until December 31, 2002 ---- and thereafter it may be extended with the consent of the Manager and by the affirmative vote of a majority of the Unaffiliated Directors or by a vote of the holders of a majority of the outstanding shares of Common Stock of the Company. Each extension shall be executed in writing by all parties hereto before the expiration of this Agreement or of any extension thereof. Each such extension shall be effective for a period corresponding to the fiscal year of the Company, but in no case exceeding twelve months. 12. Termination for Cause. This Agreement, or any extension hereof, may be --------------------- terminated by either party for cause immediately upon written notice, (i) by a majority vote of the Unaffiliated Directors or by a vote of a majority of the holders of the Company's Common Stock, in the case of termination by the Company, or, (ii) in the case of termination by the Manager, by a majority vote of the directors of the Manager. Grounds for termination for cause will occur with respect to a party if: (a) Such party shall have violated any provision of this Agreement and, after notice of such violation, shall not cure such default within 30 days; or (b) There is entered an order for relief or similar decree or order with respect to such party by a court having jurisdiction in the premises in an involuntary case under the federal bankruptcy laws as now or hereafter constituted or under any applicable federal or state bankruptcy, insolvency or other similar laws; or such party (A) ceases or admits in writing its inability to pay its debts as they become due and payable, or makes a general assignment for the benefit of, or enters into any composition or arrangement with, creditors; (B) applies for, or consents (by admission of material allegations of a petition or otherwise) to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator (or other similar official) of such party or of any substantial part of its properties or assets, or authorizes such an application or consent, or proceedings seeking such appointment are commenced without such authorization, consent or application against such party and continue undismissed for 30 days; (C) authorizes or files a voluntary petition in bankruptcy, or applies for or consents (by admission of material allegations of a petition or otherwise) to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law of any jurisdiction, or authorizes such application or consent, or proceedings to such end are instituted against such party without such authorization, application or consent and are approved as properly instituted and remain undismissed for 30 days or results in adjudication of bankruptcy or insolvency; or (D) permits or suffer all or any substantial part of its properties or assets to be sequestered or attached by court order and the order remains undismissed for 30 days. (c) Each party agrees that if any of the events specified in this Section 12 shall occur, it will give prompt written notice thereof to the other party's Board of Directors after the happening of such event. In addition to the foregoing, grounds for termination for cause will occur with respect to the Manager if the Manager has engaged in willful misconduct in the performance of its duties hereunder, the effect of which has a direct material adverse effect on the financial condition and operations of the Company and ICCC in the aggregate. If this Agreement is terminated pursuant to this Section, such termination shall be without any further liability or obligation of either party to the other, except as provided in Section 15. 13. Termination Without Cause. The Company may terminate this Agreement ------------------------- without cause upon 60 days prior written notice, by a majority vote of the Unaffiliated Directors or by a vote of the holders of a majority of the outstanding shares of the Company's Common Stock. In the event this Agreement is terminated by the Company without cause, or in the event this Agreement is not renewed by the Company without cause, the Company, in addition to its obligations under Section 15, shall pay the Manager a termination or non-renewal fee determined by an independent appraisal. Such appraisal shall be conducted by a nationally-recognized appraisal firm mutually agreed upon by the parties and the costs of such appraisal shall be borne equally by the parties. If the parties are unable to agree upon such appraisal firm within 30 days following notice of termination or, in the event of non-renewal, the termination date, then each party shall as soon as reasonably practicable, but in no event more than 45 days following notice of termination or, in the event of non-renewal, the termination date, choose a nationally-recognized independent appraisal firm to conduct an appraisal. In such event, (i) the termination fee shall be deemed to be the average of the appraisals as conducted by each party's chosen appraiser and (ii) each party shall pay the costs of its appraiser so chosen. Any appraisal conducted hereunder shall be performed no later than 45 days following selection of the appraiser or appraisers. 14. Assignment; Subcontract. (a) This Agreement shall terminate ----------------------- automatically in the event of its assignment, in whole or in part, by the Manager unless such assignment is consented to in writing by the Company with the consent of a majority of the Unaffiliated Directors. Such an assignment shall bind the assignee hereunder in the same manner as the Manager is bound hereunder and, to further evidence its obligations hereunder, the assignee shall execute and deliver to the Company a counterpart of this Agreement. This Agreement shall not be assignable by the Company without the consent of the Manager, except in the case of assignment by the Company to a real estate investment trust or other organization which is a successor (by merger, consolidation or purchase of assets) to the Company, in which case such successor organization shall be bound hereunder and by the terms of said assignment in the same manner as the Company is bound hereunder. (b) Notwithstanding the foregoing, the Company and the Manager agree that the Manager may enter into a subcontract with any third party, including IMH, which third party shall be approved by the Company's Board of Directors, pursuant to which such third party will provide such of the management services required hereunder as the Manager deems necessary, and the Company hereby consents to the entering into and performance of such subcontract; provided, however, that no such arrangement between the Manager and IMH or any third party shall relieve the Manager of any of its duties or obligations hereunder. 15. Action Upon Termination. From and after the effective date of ----------------------- termination of this Agreement, pursuant to Sections 12, 13 and 14 hereof, the Manager shall not be entitled to compensation for further services hereunder, but shall be paid all compensation accruing to the date of termination, subject to adjustments on an annualized basis in accordance with Section 6(b) and subject to the minimum amount of $500,000 per annum for the first three years. The Manager shall forthwith upon such termination deliver to the Board of Directors all property and documents, corporate records, reports and software of the Company or any subsidiary of the Company then in the custody of the Manager. 16. Representations and Warranties. ------------------------------ (a) The Company hereby represents and warrants to the Manager as follows: (i) Corporate Existence. The Company is duly organized, validly ------------------- existing and in good standing under the laws of Maryland, has the power to own its assets and to transact the business in which it is now engaged and is duly qualified as a foreign corporation and in good standing under the laws of such jurisdictions where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole. (ii) Corporate Power; Authorization; Enforceable Obligations. The ------------------------------------------------------- Company has the corporate power, authority and legal right to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary corporate action to authorize this Agreement on the terms and conditions hereof and the execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitation, stockholders and creditors of the Company, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by the Company in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized officer of the Company, and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, moratorium or similar laws now or hereafter in effect relating to the rights and remedies of creditors generally, and general principles of equity. (iii) No Legal Bar to This Agreement. The execution, delivery and performance of this Agreement and the documents or instruments required hereunder, will not violate any provision of any existing law or regulation binding on the Company, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on the Company, or the charter or Bylaws of, or any securities issued by the Company or any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Company is a party or by which the Company or any of its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provisions of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking. (b) The Manager hereby represents and warrants to the Company as follows: (i) Corporate Existence. The Manager is duly organized, validly ------------------- existing and in good standing under the laws of California, has the power to own its assets and to transact the business in which it is now engaged and is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of the Manager and its subsidiaries, taken as a whole. The Manager does not do business under any fictitious business name. (ii) Company Power; Authorization; Enforceable Obligations. The ----------------------------------------------------- Manager has the power, authority and legal right to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary action to authorize this Agreement on the terms and conditions hereof and its execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitations, shareholders and creditors of the Manager, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by the Manager in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized officer of the Manager, and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of the Manager enforceable against the Manager in accordance with its terms. (iii) No Legal Bar to This Agreement. The execution, delivery and ------------------------------ performance of this Agreement and the documents or instruments required hereunder, will not violate any provision of any existing law or regulation binding on the Manager, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on the Manager, or the certificate of incorporation or by-laws of, or any securities issued by the Manager or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Manager is a party or by which the Manager or any of its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of the Manager and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provision of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking. 17. Arbitration. ------------ (a) Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to this Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the Judicial Arbitration and Mediation Services, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to the California Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. (b) Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. (c) The arbitrator shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the state of California will be applicable to the reference proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgment at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 18. Notices. All notices, requests, demands and other communications ------- provided for hereunder shall be in writing (including telegraphic or facsimile communications) and shall be in mailed (return receipt requested), telegraphed, sent by facsimile, overnight courier or hand delivered to each party at the address set forth as follows, or at such other address as either party may designate by notice to the others, and any such notice, request, demand or other communication shall be effective upon receipt: The Company: IMH Commercial Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, California 92707 Telephone: (714) 556-0122 Facsimile: (714) 433-2122 Attention: Joseph R. Tomkinson, Chief Executive Officer The Manager: RAI Advisors, LLC 20371 Irvine Avenue Santa Ana Heights, California 92707 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: William S. Ashmore President Either party may at any time give notice in writing to the other party of a change of its address for the purpose of this Section 18. 19. Amendments. This Agreement shall not be amended, changed, modified, ---------- terminated or discharged in whole or in part except by an instrument in writing signed by all parties hereto, or their respective successors or assigns, or otherwise as provided herein. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 20. Successors and Assigns. This Agreement shall become effective when it is ---------------------- executed by all parties and thereafter shall be binding upon and inure to the benefit of the parties and their respective successors and assigns. 21. Attorneys' Fees. In the event that any party shall bring an action or --------------- proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such proceeding. 22. Governing Law. This Agreement shall be governed, construed and ------------- interpreted in accordance with the laws of the State of California. 23. Headings and Cross References. The section headings hereof have been ----------------------------- inserted for convenience of reference only and shall not be construed to affect the meaning, construction or effect of this Agreement. Any reference in this Agreement to a "Section" or "Subsection" shall be construed, respectively, as referring to a section of this Agreement or a subsection of a section of this Agreement. 24. Severability. The invalidity or unenforceability of any provision of ------------ this Agreement shall not affect the validity of any other provision, and all other provisions shall remain in full force and effect. 25. Entire Agreement. This Agreement contains the entire agreement of the ---------------- parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the parties hereto. 26. Waiver. Any forbearance by a party to this Agreement in exercising any ------ right or remedy under this Agreement or otherwise afforded by applicable law shall not by a waiver of or preclude the exercise of that or any other right or remedy. 27. Execution in Counterparts. This Agreement may be executed in one or ------------------------- more counterparts, any of which shall constitute an original as against any party whose signature appears on it, and all of which shall together constitute a single instrument. This Agreement shall become binding when one or more counterpart, individually or taken together, bear the signatures of both parties. [The remainder of this page intentionally left blank.] IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their officers thereunto duly authorized as of the day and year first above written. IMH COMMERCIAL HOLDINGS, INC. By: /s/ Joseph R. Tomkinson ----------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer RAI ADVISORS, LLC By: /s/ William S. Ashmore --------------------------------- Name: William S. Ashmore Title: President EX-10.2 4 SUBMANAGEMENT AGREEMENT WITH RAI ADVISORS, LLC. SUBMANAGEMENT AGREEMENT EXHIBIT 10.2 THIS AGREEMENT (the "Agreement") entered into as of August 4, 1997 to be effective as of August 8, 1997, the closing date of the public offering of Common Stock, $.01 par value per share, on Registration Statement Form S-11 (No. 333-25423) of IMH Commercial Holdings, Inc. (the "Company") is by and between RAI ADVISORS, LLC, (the "Manager"), IMPERIAL CREDIT MORTGAGE HOLDINGS, INC., a Maryland corporation ("IMH") and ICI FUNDING CORPORATION, a California corporation ("ICIFC"). BACKGROUND A. The Manager and the Company have entered into an agreement as of the date hereof (the "Management Agreement") pursuant to which the Manager will provide certain management services to IMH and any subsidiary or Affiliate (as defined therein) of the Company, including its conduit operations Imperial Commercial Capital Corporation, a California corporation ("ICCC") (the "Management Services") for which the Manager will be paid certain compensation as described therein; and B. The Manager desires to retain ICIFC to assist it in the performance of its duties and obligations under the Management Agreement in the manner and on the terms hereinafter set forth. C. ICIFC has agreed that it will take no action to modify this agreement without the prior written consent of IMH. NOW THEREFORE, in consideration of the mutual agreements herein set forth, the parties hereto agree as follows: 1. Duties and Obligations of ICIFC. ICIFC shall provide any and all ------------------------------- administrative services required by the Company including facilities and costs associated therewith, technology, management information systems, general ledger accounts, human resources and payroll, check processing and accounts payable and other services as the Manager may reasonably request from time to time in order to assist the Manager in discharging its obligation to provide the Management Services. 2. Additional Activities of IMH. Except to the extent limited by the ---------------------------- Management Agreement or that certain Non-Competition Agreement dated the date hereof and entered into by and among IMH, ICIFC, the Company and ICCC (the "Non- Competition Agreement"), nothing herein shall prevent IMH, ICIFC or their respective Affiliates (as defined in the Management Agreement) from engaging in any business or from rendering services of any kind to any other person or entity, including investment in or advisory service to others investing in any type of real estate investment including investments which meet the principal investment objectives of the Company. Directors, officers, employees and agents of IMH, ICIFC or their respective Affiliates may serve as directors, officers, employees, agents, nominees or signatories for the Manager. When executing documents or otherwise acting in such capacities for the Manager, such persons shall use their respective titles in the Manager. 3. Records; Confidentiality. ICIFC shall maintain appropriate books ------------------------ of account and records relating to services performed hereunder, which books of account and records shall be accessible for inspection and copying by the Manager at any time during normal business hours. ICIFC agrees to keep confidential any and all information it obtains from time to time in connection with the services it renders hereunder and shall not disclose any portion thereof to non-affiliated third parties except with the prior written consent of the Manager. 4. Obligations of ICIFC. Anything else in this Agreement to the -------------------- contrary notwithstanding, ICIFC shall refrain from any action which it reasonably believes would adversely affect the status of the Company or any subsidiary of the Company as a real estate investment trust as defined in and limited by Sections 856 to 860 of the Internal Revenue Code of 1986, as amended, or which in its sole judgment made in good faith would violate any law, rule or regulation of any government body or agency having jurisdiction over the Company and such subsidiary or which would otherwise not be permitted by the Company's or such subsidiary's Governing Instruments (as defined in the Management Agreement), except if such action shall be ordered by the Manager, in which event ICIFC shall promptly notify the Manager of ICIFC's judgment that such action would adversely affect such status or violate any such law, rule or regulation or the Company's or such subsidiary's Governing Instruments, and shall refrain from taking such action pending further clarification or instructions from the Manager. If the Manager thereafter instructs ICIFC despite ICIFC's notification as provided herein, to take any such action and ICIFC so acts upon the instructions given, ICIFC shall not be responsible or have any liability for any loss of the Company's or such subsidiary's status as a real estate investment trust or violation of any law, rule or regulation or the Governing Instruments caused thereby. 5. Compensation. ICIFC shall be paid for services rendered by it ------------ under this Agreement commensurate with the services rendered by the Manager on a dollar for dollar basis plus a service charge of 15% to the extent such services are rendered under the Management Agreement. ICIFC shall also be paid on a dollar for dollar basis plus a service charge of 15% for the actual cost of the services provided by the executive officers of the Company based upon the compensation payable to them by ICIFC pursuant to certain employment agreements. For the first three years of the Submanagement Agreement, there will be a minimum amount of $500,000 per annum (which includes the 15% service charge) payable by the Manager to ICIFC. Such fee or any incremental part thereof shall be payable within 30 days of the receipt of any such compensation or any part thereof by the Manager. ICIFC agrees that the Manager shall not be obligated to make any payment to it under this Agreement if to do so would cause the Manager's liabilities to exceed its assets or would cause the Manager to be unable to meet its debts as they become due and payable. 6. Limits of ICIFC Responsibility. ICIFC assumes no responsibility ------------------------------ under this Agreement other than to render the services called for hereunder in good faith and shall not be responsible for any action of the Manager in following or declining to follow any advice or recommendations of ICIFC, including, without limitation, actions described in Section 4 above. ICIFC, its directors, officers, shareholders and employees and its Affiliates will not be liable to the Manager or the Manager's shareholders for any acts performed by ICIFC, its directors, officers, shareholders and employees in accordance with this Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties. The Manager shall reimburse, indemnify and hold harmless ICIFC, and its Affiliates, shareholders, directors, officers and employees of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever in respect of or arising from any acts or omissions of ICIFC, its Affiliates, shareholders, directors, officers and employees made in good faith in the performance of IMH's duties under this Agreement and not constituting bad faith, willful misconduct, gross negligence and reckless disregard of its duties. 7. No Joint Venture. The Manager and ICIFC are not partners or joint ---------------- venturers with each other and nothing herein shall be construed to make them such partners or joint venturers or impose any liability as such on either of them. 8. Term; Termination. ----------------- (a) This Agreement shall continue in force until December 31, 2002, and thereafter it may be extended only with the affirmative vote of a majority of the Unaffiliated Directors of IMH and by the affirmative vote of a majority of the directors of the Manager. "Unaffiliated Directors" means a Director who is independent of the Company, the Manager and IMH and its Affiliates. (b) Each extension shall be executed in writing by all parties hereto before the expiration of this Agreement or of any extension thereof. Each such extension shall be effective for a period corresponding to the fiscal year of the Manager, but in no case exceeding 12 months, excluding the first year. (c) Notwithstanding any other provision herein to the contrary, this Agreement, or any extension hereof, shall terminate automatically upon the termination of the Management Agreement and may be terminated without cause by the Manager upon 60 days' prior written notice, by a majority vote of the directors of the Manager. 9. Assignment. This Agreement shall terminate automatically in the ---------- event of its assignment, in whole or in part, by ICIFC, unless such assignment is to a corporation, association, trust or other organization which shall acquire the property and carry on the business of ICIFC, if at the time of such assignment a majority of the voting stock of such assignee organization shall be owned, directly or indirectly, by ICIFC or unless such assignment is consented to in writing by the Manager, which consent may be unreasonably withheld in the Manager's sole discretion. Such an assignment shall bind the assignee hereunder in the same manner as ICIFC is bound hereunder, and, to further evidence its obligations hereunder, the assignee shall execute and deliver a counterpart of this Agreement. This Agreement shall not be assignable by the Manager without the consent of ICIFC, except in the case of assignment by the Manager to a corporation or other organization which is a successor (by merger, consolidation or purchase of assets) to the Manager, in which case such successor organization shall be bound hereunder by the terms of said assignment in the same manner as the Manager is bound hereunder. 10. Default, Bankruptcy or Insolvency of ICIFC. At the option solely ------------------------------------------ of the Manager, this Agreement may be and become terminated immediately upon written notice of termination from the Manager to ICIFC if any of the following events shall occur: (a) If ICIFC shall violate any provision of this Agreement and, after notice of such violation, has not cured such default within 30 days; or (b) There is entered an order for relief or similar decree or order with respect to IMH or ICIFC by a court having jurisdiction in the premises in an involuntary case under the federal bankruptcy laws as now or hereafter constituted or under any applicable federal or state bankruptcy, insolvency or other similar laws; or IMH (i) ceases or admits in writing its inability to pay its debts as they become due and payable, or makes a general assignment for the benefit of, or enters into any composition or arrangement with, creditors; (ii) applies for, or consents (by admission of material allegations of a petition or otherwise) to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator (or other similar official) of either IMH or ICIFC or of any substantial part of their properties or assets, or authorizes such an application or consent, or proceeding seeking such appointment are commenced without such authorization, consent or application against IMH or ICIFC and continue undismissed for 30 days; (iii) authorizes or files a voluntary petition in bankruptcy, or applies for or consents (by admission of material allegations of a petition or otherwise) to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law of any jurisdiction, or authorizes such application or consent, or proceedings to such and are instituted against IMH without such authorization, application or consent and are approved as properly instituted and remain undismissed for 30 days or result in adjudication or bankruptcy or insolvency; or (iv) permits or suffers all or any substantial part of its properties or assets to be sequestered or attached by court order and the order remains undismissed for 30 days. (c) Each of IMH and ICIFC agrees that if any of the events specified in paragraph (b) of this Section 10, shall occur, it will give prompt written notice thereof to the board of directors of the Manager after the happening of such event. 11. Action Upon Termination. From and after the effective date of ----------------------- termination pursuant to Sections 8, 9 or 10 hereof, ICIFC shall not be entitled to compensation for further services hereunder, but shall be paid all compensation accruing to the date of termination subject to adjustments on an annualized basis; provided, however, that if this Agreement is terminated within three years of its effective date, then ICIFC shall be entitled to receive from the Manager the remaining minimum amount of $500,000 per annum which would have been paid for such year of termination. ICIFC shall forthwith upon such termination: (a) Pay over to the Manager all money collected and held for the account of the Manager pursuant to this Agreement, after deducting any accrued compensation and reimbursement for its expenses to which it is then entitled; (b) Deliver to the Manager a full accounting, including a statement showing all payments collected by it and a statement of all money held by it, covering the period following the date of the last accounting furnished to the Manager; and (c) Deliver to the Manager all property and documents of the Manager then in custody of IMH or ICIFC. 12. Arbitration. ------------ (a) Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to this Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the Judicial Arbitration and Mediation Services, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to the California Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. (b) Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. (c) The arbitrator shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the state of California will be applicable to the reference proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgment at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 13. Notices. All notices, requests, demands and other communications ------- provided for hereunder shall be in writing (including telegraphic or facsimile communications) and shall be in mailed (return receipt requested), telegraphed, sent by facsimile, overnight courier or hand delivered to each party at the address set forth as follows, or at such other address as either party may designate by notice to the others, and any such notice, request, demand or other communication shall be effective upon receipt: The Manager: RAI Advisors, LLC 20371 Irvine Avenue Santa Ana Heights, CA 92707 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: William S. Ashmore President IMH: Imperial Credit Mortgage Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, CA 92707 Telephone: (714) 556-0122 Facsimile: (714) 433-2122 Attention: Joseph R. Tomkinson Chief Executive Officer ICIFC: ICI Funding Corporation Telephone: (714) 556-0122 Facsimile: (714) 433-2122 Attention: Joseph R. Tomkinson Chief Executive Officer Either party may at any time give notice in writing to the other party of a change of its address for the purpose of this Section 13. 14. Amendments. This Agreement shall not be amended, changed, ---------- modified, terminated or discharged in whole or in part, and the performance of any obligation hereunder may not be waived, except by an instrument in writing signed by both parties hereto, or their respective successors or permitted assigns, or otherwise as provided herein; provided, however, that ICIFC agrees to take no action further to this Section 14 without the prior written consent of IMH evidenced by a majority vote of the directors of IMH who are not directors of ICCC and that any action taken by ICIFC further to this Section 14 in contravention of said provision shall be null and void. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 15. Successors and Assigns. This Agreement shall bind any successors ---------------------- or permitted assigns of the parties hereto as herein provided. 16. Severability. The invalidity or unenforceability of any ------------ provision of this Agreement shall not affect the validity of any other provision, and all other provisions shall remain in full force and effect. 17. Entire Agreement. This Agreement contains the entire agreement of ---------------- the parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the parties hereto. 18. Waiver. Any forbearance by a party to this Agreement in ------ exercising any right or remedy under this Agreement or otherwise afforded by applicable laws shall not be a waiver of or preclude the exercise of that or any other right or remedy. 19. Governing Law. The provisions of this Agreement shall be ------------- governed by, construed under and interpreted in accordance with the laws of the State of California as at the time in effect. 20. Headings and Cross References. The section headings hereof have ----------------------------- been inserted for convenience of reference only and shall not be construed to affect the meaning, construction or effect of this Agreement. Any reference in this Agreement to a "Section" or "Subsection" shall be construed, respectively, as referring to a section of this Agreement or a subsection of a section of this Agreement. 21. Attorneys' Fees. In the event that any party shall bring an --------------- action or proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such proceeding. 22. Execution in Counterparts. This Agreement may be executed in one ------------------------- or more counterparts, any of which shall constitute an original as against any party whose signature appears on it, and all of which shall together constitute a single instrument. This Agreement shall become binding when one or more counterparts, individually or taken together, bear the signatures of both parties. [The remainder of this page is intentionally left blank.] IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their officers thereunto duly authorized as of the day and year written above. RAI ADVISORS, LLC By: /s/ William S. Ashmore --------------------------------------- Name: William S. Ashmore Title: President ICI FUNDING CORPORATION By: /s/ Joseph R. Tomkinson ------------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer IMPERIAL CREDIT MORTGAGE HOLDINGS, INC. By: /s/ Joseph R. Tomkinson -------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer EX-10.5 5 CONTRIBUTION AGREEMENT CONTRIBUTION AGREEMENT EXHIBIT 10.5 This CONTRIBUTION AGREEMENT (this "Agreement") entered into as of August 4, 1997 to be effective as of August 8, 1997, the closing date (the "Closing Date") of the public offering of Common Stock, $.01 par value per share, (the "Offering") on a Form S-11 Registration Statement (the "Registration Statement") of IMH COMMERCIAL HOLDINGS, INC., a Maryland corporation (the "Company"), is by and between the Company and IMPERIAL CREDIT MORTGAGE HOLDINGS, INC., a Maryland corporation ("IMH"). BACKGROUND A. In January 1997, Imperial Commercial Capital Corporation was incorporated under the laws of the state of California ("ICCC"). B. In February 1997, IMH purchased all of the non-voting Preferred Stock (the "Preferred Stock") of ICCC, which represents 95% of the economic interest in ICCC, for $500,000. C. ICCC, through three divisions, operates as the conduit operations of the Company by originating, purchasing, and selling or securitizing Commercial Mortgages, as defined in the Registration Statement. D. In furtherance of the foregoing, on the Closing Date, IMH will contribute to the Company, and the Company will accept, 100% of the Preferred Stock presently owned by IMH in exchange for that number of shares of the Company's Class A Common Stock (the "Class A Stock") equal to the product of 95% of the estimated fair value of ICCC on the Closing Date divided by the IPO Price (as defined in the Registration Statement) of the Company's Common Stock issued in the Offering. E. This Agreement is intended to accomplish and memorialize the above contribution, to provide certain agreements applicable to the relationship between the Company and IMH, and thereby effectuate the intent of the parties hereto. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and in consideration of the mutual covenants and conditions hereof, the parties agree as follows: 1. Contribution. Subject to and upon the terms and conditions hereof, on ------------ the date hereof, (a) IMH shall contribute (the "Contribution") to the Company, and the Company agrees to accept from IMH, free and clear of all liens, claims and encumbrances thereon, all of the Preferred Stock of ICCC presently owned by IMH and (b) in consideration therefor, the Company hereby covenants that on the date hereof, the Company shall issue or cause to be issued to IMH, 95,000 validly issued, fully paid and nonassessable shares of its Class A Stock, which number is equal to the product of 95% of the estimated fair value of ICCC on the date hereof divided by the IPO Price of the Company's Common Stock issued in the Offering. 2. Transfer of Stock. ----------------- (a) On the Closing Date, IMH conveys, assigns, transfers and delivers to the Company and the Company hereby acquires from IMH all of its rights, title and interest in and to the Preferred Stock. (b) The Contribution in Subsection (a) above, shall only be effective upon the issuance by the Company to IMH of 95,000 shares of its Class A Stock, as determined in Section 1 on the Closing Date. (c) Following the Contribution, IMH shall take all necessary steps to register the transfer of the Preferred Stock in the shareholder ledger of ICCC. Any stock transfer or other taxes payable in connection with the Contribution pursuant to this Agreement shall be paid by IMH. IMH shall also provide the Company with such further documents as the Company may reasonably request to effectuate the Contribution. From time to time, at the request of the Company whether at or after the Closing Date, IMH shall execute and deliver such instruments of conveyance of the Preferred Stock as the Company may need in order to more effectively convey the Preferred Stock to the Company. 3. Indemnification. --------------- (a) The Company shall indemnify and hold harmless IMH against and in respect of any and all damages, claims, losses, liabilities and expenses incurred by IMH which arise out of or relate to (i) any breach or violation of this Agreement by the Company, (ii) any breach of any of the representations or warranties made in this Agreement by the Company, and (iii) the ownership of the Preferred Stock on or after the Closing Date. (b) IMH shall indemnify and hold harmless the Company against and in respect of any and all damages, claims, losses, liabilities and expenses incurred by the Company which arise out of or relate to (i) any breach or violation of this Agreement by IMH, (ii) any breach of any of the representations or warranties made in this Agreement by IMH, and (iii) the ownership of the Class A Stock on or after the Closing Date. 4. Representations and Warranties. ------------------------------ (a) IMH hereby represents and warrants to the Company as follows: (1) Corporate Existence. IMH is duly organized, validly existing ------------------- and in good standing under the laws of Maryland, has the corporate power to own its assets and to transact the business in which it is now engaged and is duly qualified as a foreign corporation and in good standing under the laws of such jurisdictions where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of IMH and its subsidiaries, taken as a whole. (2) Corporate Power; Authorization; Enforceable Obligations. IMH ------------------------------------------------------- has the power, authority and legal right to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary corporate action to authorize this Agreement on the terms and conditions hereof and the execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitation, stockholders and creditors of IMH, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by IMH in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized officer of IMH and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of IMH enforceable against IMH in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, moratorium or similar laws now or hereafter in effect relating to the rights and remedies of creditors generally, and general principles of equity. (3) No Legal Bar to This Agreement. The execution, delivery and ------------------------------ performance of this Agreement and the documents or instruments required hereunder, will not violate any provision of any existing law or regulation binding on IMH, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding IMH, or the charter or bylaws of, or any securities issued by IMH, or of any mortgage, indenture, lease, contract, or other agreement, instrument, undertaking or other arrangement of any character or nature whatsoever to which IMH is a party or by which it or its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of IMH and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provisions of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking. (4) Marketable Title. Upon consummation of the transaction ---------------- contemplated by this Agreement, the Company will have good and marketable title in and to the Preferred Stock, free and clear of all liens, charges, claims, pledges, options, security interests, encumbrances and restrictions of every kind. (5) Issued and Outstanding Preferred Stock. The issued and -------------------------------------- outstanding Preferred Stock of ICCC consists of 9,500 shares, of which, prior to the Closing Date, IMH is the sole lawful record and beneficial owner. The Preferred Stock has been duly authorized and validly issued and is free of any pre-emptive rights and is entitled to the rights, privileges and preferences set forth in ICCC's Articles of Incorporation attached as Exhibit "A" hereto. (b) The Company hereby represents and warrants to IMH as follows: (1) Corporate Existence. The Company is duly organized, validly ------------------- existing and in good standing under the laws of Maryland, has the corporate power to own its assets and to transact the business in which it is now engaged and is duly qualified as a foreign corporation and in good standing under the laws of each jurisdiction where its ownership or lease of property or the conduct of its business requires such qualification, except for failures to be so qualified, authorized or licensed that could not in the aggregate have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole. (2) Corporate Power; Authorization; Enforceable Obligations. The ------------------------------------------------------- Company has the corporate power, authority and legal right to execute, deliver and perform this Agreement and all obligations required hereunder and has taken all necessary corporate action to authorize this Agreement on the terms and conditions hereof and its execution, delivery and performance of this Agreement and all obligations required hereunder. No consent of any other person including, without limitation, stockholders and creditors of the Company, and no license, permit, approval or authorization of, exemption by, notice or report to, or registration, filing or declaration with, any governmental authority is required by the Company in connection with this Agreement or the execution, delivery, performance, validity or enforceability of this Agreement and all obligations required hereunder. This Agreement has been, and each instrument or document required hereunder will be, executed and delivered by a duly authorized officer of the Company, and this Agreement constitutes, and each instrument or document required hereunder when executed and delivered hereunder will constitute, the legally valid and binding obligation of the Company enforceable against the Company in accordance with its terms. (3) No Legal Bar to This Agreement. The execution, delivery and ------------------------------ performance of this Agreement and the documents or instruments required hereunder, will not violate any provision of any existing law or regulation binding on the Company, or any order, judgment, award or decree of any court, arbitrator or governmental authority binding on the Company, or the charter or bylaws of, or any securities issued by the Company, or of any mortgage, indenture, lease, contract or other agreement, instrument or undertaking to which the Company is a party or by which the Company or any of its assets may be bound, the violation of which would have a material adverse effect on the business operations, assets or financial condition of the Company and its subsidiaries, taken as a whole, and will not result in, or require, the creation or imposition of any lien on any of its property, assets or revenues pursuant to the provision of any such mortgage, indenture, lease, contract or other agreement, instrument or undertaking. (4) Validly Issued. The Class A Stock has been duly authorized, -------------- validly issued and, upon consummation of the transaction contemplated by this Agreement, fully paid and non-assessable. 5. Arbitration. ----------- (a) Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to this Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the Judicial Arbitration and Mediation Services, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to the California Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. (b) Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. (c) The arbitrator shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the state of California will be applicable to the proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgment at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 6. Notices. All notices, requests, demands and other communications ------- provided for hereunder shall be in writing (including telegraphic or facsimile communications) and shall be in mailed (return receipt requested), telegraphed, sent by facsimile, overnight courier or hand delivered to each party at the address set forth as follows, or at such other address as either party may designate by notice to the others, and any such notice, request, demand or other communication shall be effective upon receipt: The Company: IMH Commercial Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, CA 92707 Telephone: (714) 556-0122 Facsimile: (714) 433-2122 Attention: Joseph R. Tomkinson Chief Executive Officer IMH: Imperial Credit Mortgage Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, CA 92707 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: William S. Ashmore President 7. Amendments. This Agreement shall not be amended, changed, modified, ---------- terminated or discharged in whole or in part except by an instrument in writing signed by all parties hereto, or their respective successors or assigns, or otherwise as provided herein. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 8. Attorneys' Fees. In the event that any party shall bring an action or --------------- proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such proceeding. 9. Successors and Assigns. This Agreement shall become effective when it ---------------------- is executed by all parties and thereafter shall be binding upon and inure to the benefit of the parties and their respective successors and assigns. 10. Entire Agreement. This Agreement contains the entire agreement of the ---------------- parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the parties hereto. 11. Waiver. Any forbearance by a party to this Agreement in exercising ------ any right or remedy under this Agreement or otherwise afforded by applicable law shall not be a waiver of or preclude the exercise of that or any other right or remedy. 12. Headings and Cross References. The section headings hereof have been ----------------------------- inserted for convenience of reference only and shall not be construed to affect the meaning, construction or effect of this Agreement. Any reference in this Agreement to a "Section" or "Subsection" shall be construed, respectively, as referring to a section of this Agreement or a subsection of a section of this Agreement. 13. Severability. The invalidity or unenforceability of any provision of ------------ this Agreement shall not affect the validity of any other provision, and all other provisions shall remain in full force and effect. 14. Choice of Law. This Agreement shall be governed by and construed in ------------- accordance with the laws of the State of California applicable to contracts made and performed in said State, without regard to conflicts of laws principals. 15. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which when so executed shall be deemed an original, and which taken together shall constitute one and the same instrument. [The remainder of this page intentionally left blank.] IN WITNESS WHEREOF, this Agreement is executed on behalf of the parties by duly authorized representatives as of the date first above written. IMH COMMERCIAL HOLDINGS, INC. By: /s/ Joseph R. Tomkinson --------------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer IMPERIAL CREDIT MORTGAGE HOLDINGS, INC. By: /s/ William S. Ashmore ---------------------------------- Name: William S. Ashmore Title: President EX-10.6 6 NON-COMPETITION AGREEMENT NON-COMPETITION AGREEMENT EXHIBIT 10.6 This NON-COMPETITION AGREEMENT (this "Agreement"), entered into as of August 4, 1997 to be effective as of August 8, 1997, the closing date (the "Closing Date") of the public offering of Common Stock on a Form S-11 Registration Statement (No. 333-25423) (the "Registration Statement") of IMH COMMERCIAL HOLDINGS, INC., a Maryland corporation (the "Company" or "ICH"), is by and between IMPERIAL CREDIT MORTGAGE HOLDINGS, INC., a Maryland corporation ("IMH"), ICI Funding Corporation, a California corporation ("ICIFC"), the Company, and Imperial Commercial Capital Corporation, a California corporation ("ICCC") with reference to the following facts: BACKGROUND A. The Company has filed a Registration Statement on Form S-11 pursuant to the Securities Act of 1933, as amended (the "Offering"). B. Pursuant to that certain Contribution Agreement, effective as of the Closing Date, between the Company and IMH (the "Contribution Agreement"), in exchange for the transfer by IMH to the Company of 100% of the non-voting Preferred Stock of ICCC presently owned by IMH, the Company has agreed to issue to IMH 95,000 shares of ICH Class A Common Stock (the "Shares"). The transactions described in this paragraph are referred to herein as the "Contribution Transaction." C. The Company was formed for the purpose of originating, purchasing, securitizing and selling Commercial Mortgages (as defined in the Registration Statement) and investing in Commercial Mortgages and commercial mortgage-backed securities ("CMBSs"). D. ICCC is the conduit operations of ICH; ICH owns 100% of the non- voting Preferred Stock of ICCC which represents 95% of the economic interest. ICIFC is the conduit operations of IMH; IMH owns 100% of the non-voting Preferred Stock of ICIFC which represents 99% of the economic interest. E. IMH and ICIFC have agreed not to compete with the Company and ICCC in the certain businesses that are more particularly described herein, in the geographical locations and for the term described herein. F. IMH's trade secrets in those businesses in which it has agreed not to compete include certain non-public, confidential information concerning product and service marketing plans and strategy, customer needs and peculiarities, customer lists and other detailed information (the "Trade Secrets"). G. The Company would not enter into the Contribution Agreement unless it was assured that IMH and ICIFC would execute this Agreement. NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter contained, and for other good and valuable consideration, it is hereby agreed by and between the parties hereto as follows: 1. Non-Competition. --------------- (a) Except as set forth below, for a period of the earlier of nine (9) months from the Closing Date of the Company's Offering or the date on which the Company accumulates (for investment or sale) $300,000,000 of Commercial Mortgages and/or CMBSs, neither IMH nor any of its affiliate companies, including ICIFC, shall originate, purchase or otherwise acquire or sell any Commercial Mortgages and/or CMBSs. Notwithstanding the foregoing, this Agreement shall not preclude IMH or ICIFC from purchasing any Commercial Mortgages or CMBSs as permitted under that certain Right of First Refusal Agreement by and among IMH, ICIFC, the Company, ICCC and RAI Advisors, LLC, of even date herewith, a copy of which is attached hereto as Exhibit "A." This covenant not to compete shall be limited to those states and those counties and cities set forth on Exhibit "B" attached hereto. The aforementioned businesses in which IMH has agreed not to compete shall be referred to herein as the "Businesses." (b) The parties intend that the covenant contained in this Section 1 shall be construed as a series of separate covenants, one for each county specified in Exhibit "B" hereto. Except for geographic coverage, each such separate covenant shall be deemed identical in terms to the covenant contained in this Section 1. If, in any judicial proceedings, a court shall refuse to enforce any of the separate covenants deemed included in this paragraph, then such unenforceable covenant shall be deemed eliminated from these provisions for the purpose of those proceedings to the extent necessary to permit the remaining separate covenants to be enforced. (c) Nothing contained in this Agreement shall be deemed to preclude IMH or ICIFC from purchasing or owning, directly or beneficially, as a passive investment, five percent (5%) or less of any class of a publicly traded securities of any entity if it does not actively participate in or control, directly or indirectly, any investment or other decisions with respect to such entity. 2. Trade Secrets. ------------- Each of IMH and ICIFC recognizes and acknowledges that the Trade Secrets are valuable, special and unique assets of the Businesses. Each of IMH and ICIFC shall keep all Trade Secrets confidential and not disclose such Trade Secrets or any part thereof to any person, firm, corporation, association or other entity for any reason or purpose whatsoever. 3. Acknowledgment. -------------- Each of IMH and ICIFC acknowledges and agrees that the covenants referred to in Sections 1 and 2 hereof are given in consideration of the issuance by the Company of the Shares to IMH pursuant to the Contribution Agreement. 4. Injunctive Relief. ----------------- Each of IMH and ICIFC hereby acknowledges and agrees that it would be difficult to fully compensate the Company for damages resulting from the breach or threatened breach of Sections 1 and 2, herein and, accordingly, that the Company shall be entitled to temporary and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, to enforce such Sections without the necessity of proving actual damages therewith. This provision with respect to injunctive relief shall not, however, diminish the Company's right to claim and recover damages or enforce any other of its legal and/or equitable rights or defenses. 5. Severable Provisions. -------------------- The provisions of this Agreement are severable and if any one or more provisions may be determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions, and any partially unenforceable provisions to the extent enforceable, shall nevertheless be binding and enforceable. 6. Reference Provision. ------------------- (a) Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to this Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the Judicial Arbitration and Mediation Services, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to the California Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. (b) Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. (c) The arbitrator shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the state of California will be applicable to the reference proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgment at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 7. Binding Agreement. This Agreement shall inure to the benefit of ----------------- and shall be binding upon the parties hereto and their successors and assigns. 8. Captions. The Section captions are inserted only as a matter of -------- convenience and reference and in no way define, limit or describe the scope of this Agreement or the intent of any provisions hereof. 9. Entire Agreement. This Agreement contains the entire agreement of ---------------- the parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the parties hereto. 10. Amendments. This Agreement shall not be amended, changed, ---------- modified, terminated or discharged in whole or in part except by an instrument in writing signed by all parties hereto, or their respective successors or assigns, or otherwise as provided herein. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 11. Governing Law. This Agreement shall be governed and construed in ------------- accordance with the laws of the State of California applicable to contracts made and performed in said state, without regard to conflicts of laws principals. 12. Notices. All notices and other communications under this ------- Agreement shall be in writing (including, without limitation, telegraphic, telex, telecopy or cable communication) and mailed, telegraphed, telexed, telecopied, cabled or delivered by hand or by a nationally recognized courier service guaranteeing overnight delivery to a party at the following address (or to such other address as such party may have specified by notice given to the other party pursuant to this provision): If to the Company or ICCC, to: c/o IMH Commercial Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, California 92707 Telephone: (714) 556-0122 Facsimile: (714) 438-2699 Attention: Joseph R. Tomkinson Chief Executive Officer If to IMH or ICIFC, to: c/o Imperial Credit Mortgage Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, California 92702 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: William S. Ashmore President All such notices and communications shall, when mailed, telegraphed, telexed, telecopied, cabled or delivered, be effective three days after deposit in the mails, delivered to the telegraph company, confirmed by telex answerback, telecopied with confirmation of receipt, delivered to the cable company, delivered by hand to the addressee or one day after delivery to the courier service. 13. Waiver. Any forbearance by a party to this Agreement in ------ exercising any right or remedy under this Agreement or otherwise afforded by applicable law shall not be a waiver of or preclude the exercise of that or any other right or remedy. 14. Severability. The invalidity or unenforceability of any ------------ provision of this Agreement shall not affect the validity of any other provision, and all other provisions shall remain in full force and effect. 15. Attorney's Fees. In the event that any party shall bring an --------------- action or proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such proceeding. 16. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which when so executed shall be deemed to be an original, and which taken together shall constitute one and the same instrument. IN WITNESS WHEREOF, this Agreement is made as of the day and year first above written. Imperial Credit Mortgage Holdings, Inc. a Maryland corporation By: /s/ William S. Ashmore -------------------------------- Name: William S. Ashmore Title: President ICI Funding Corporation a California corporation By: /s/ William S. Ashmore -------------------------------- Name: William S. Ashmore Title: President IMH Commercial Holdings, Inc. a Maryland corporation By: /s/ Joseph R. Tomkinson ---------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer Imperial Commercial Capital Corporation a California corporation By: /s/ Joseph R. Tomkinson ---------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer EXHIBIT "A" ----------- RIGHT OF FIRST REFUSAL AGREEMENT EXHIBIT "B" ----------- The geographic areas to which the non-competition provisions of Section 1 apply are as follows: EX-10.7 7 RIGHT OF FIRST REFUSAL AGREEMENT EXHIBIT 10.7 RIGHT OF FIRST REFUSAL AGREEMENT This RIGHT OF FIRST REFUSAL AGREEMENT (THIS "AGREEMENT"), entered into as of August 4, 1997 to be effective as of August 8, 1997, the closing date (THE "CLOSING DATE") of the public offering of Common Stock, $.01 par value per share, on Form S-11 Registration Statement (THE "REGISTRATION STATEMENT") of IMH COMMERCIAL HOLDINGS, INC., a Maryland corporation ("ICH"), by and among ICH, ICI FUNDING CORPORATION, a California corporation ("ICIFC"), IMPERIAL CREDIT MORTGAGE HOLDINGS, INC., a Maryland corporation ("IMH"), IMPERIAL COMMERCIAL CAPITAL CORPORATION, a California corporation ("ICCC") and RAI ADVISORS, LLC ("RAI"). BACKGROUND A. Pursuant to that certain Contribution Agreement, effective as of the Closing Date, between ICH and IMH, in exchange for (i) the transfer by IMH to ICH of 100% of the non-voting Preferred Stock of ICCC presently owned by IMH, and (ii) the execution of that certain Non-Competition Agreement, effective as of the Closing Date, by and between ICH, ICCC, ICIFC and IMH, and this Agreement, the Company has agreed to issue to IMH that number of shares of ICH Class A Common Stock equal to the product of 95% of the estimated fair value of ICCC on the Closing Date divided by the IPO Price (as defined in the Registration Statement). B. ICH is involved primarily in originating, purchasing, securitizing and selling commercial mortgages and investing in Commercial Mortgages and CMBSs (as defined below). ICCC is the conduit operations of ICH; ICH owns all of the outstanding non-voting preferred stock of ICCC, which represents 95% of the economic interest in ICH. IMH's primary business is purchasing, selling, securitizing and investing in residential mortgage loans that do not qualify for purchase by government-sponsored agencies such as the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC") ("NON-CONFORMING MORTGAGE LOANS") and such mortgage loans and securities backed by Non-Conforming Mortgage Loans. ICIFC is the conduit operations of IMH. IMH owns all of the outstanding non-voting preferred stock of ICIFC which represents 99% of the economic interest in ICIFC. On the date of this Agreement, RAI will be involved primarily in overseeing the day-to-day operations of ICH, subject to supervision of ICH's board of directors, including (i) asset-liability management - primarily the analysis and oversight of the purchasing, financing and disposition of ICH assets, (ii) capital management-the oversight of ICH's structuring, analysis, capital raising and investor relations activities, and (iii) operations management-primarily the oversight of ICH's operating subsidiaries, including ICCC. C. Due to the nature of the specialty finance business and the parties' past experience, it is likely that RAI will have opportunities to act as the manager of other REITs, some of which may have been or will be affiliated with ICH, ICIFC, IMH or ICCC (such REIT utilizing RAI as its manager and is a party to this Agreement, an "AFFILIATED REIT"), and will have opportunities to acquire and will acquire Commercial Mortgages and CMBSs on behalf of said parties. D. To enhance the business opportunities of each of ICH, IMH and any Affiliated REIT, the parties have agreed it would be in their respective best interests to utilize one another as sources to purchase Mortgage Loans (as defined below). In that regard, RAI has agreed that any mortgage loan or mortgage-backed security investment opportunity (AN "INVESTMENT OPPORTUNITY") which is offered to it on behalf of either ICH, IMH or any Affiliated REIT (A "REIT ENTITY") either directly for such REIT Entity or for such REIT Entity through any of its operating subsidiaries, including its conduit operations or that C corporation through which it conducts certain of its operations (each an "OPERATING SUBSIDIARY"), will first be offered to that REIT Entity (THE "PRINCIPAL PARTY") for exploitation either directly by such REIT Entity or through any of its Operating Subsidiaries, whose initial primary business as described in said Principal Party's initial public offering documentation (THE "INITIAL PRIMARY BUSINESS") most closely aligns with such Investment Opportunity. NOW THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements hereinafter contained, the parties hereto agree as follows: 1. Definitions. ----------- "AGENCY CERTIFICATES" means Pass-Through Certificates guaranteed by the FNMA, FHLMC or the Government National Mortgage Association ("GNMA"). "BUSINESS DAY" means any day, other than Saturday or Sunday, that is neither a legal holiday nor a day on which banking institutions are authorized or required by law, regulation or executive order to close. "CMBSs" means (1) Pass-Through Certificates and (2) REMICs. "CMO" means an adjustable or fixed-rate debt obligation (bond) that is collateralized by mortgage loans or mortgage certificates and issued by private institutions. "CODE" means the Internal Revenue Code of 1986, as amended. "COMMERCIAL MORTGAGES" means commercial mortgage assets including condo-conversion, multi-family property and cooperative apartment mortgage loans on commercial real property such as industrial and warehouse properties, office buildings, retail space and shopping malls, hotels and motels, nursing homes, hospitals, congregate care facilities and senior living centers. "CONFORMING MORTGAGE LOANS" mean mortgage loans that qualify for purchase by FNMA and FHLMC. "MORTGAGE LOANS" means Conforming Mortgage Loans, Non-Conforming Mortgage Loans, Commercial Mortgages and any financing offered by any Affiliated REIT. "nOTICE OF FIRST REFUSAL" means a written notice to be delivered by or for RAI to ICH, IMH or any Affiliated REIT or by or for ICH, IMH or any Affiliated REIT to RAI, as applicable, setting forth the option to enter into an Investment Opportunity, provided in Section 2 hereof, which notice shall specify in reasonable detail the price, terms and conditions of the Investment Opportunity. "PARTICIPANT" means any of ICH, IMH or any Affiliated REIT which is not a Principal Party with respect to an Investment Opportunity. "PASS-THROUGH CERTIFICATES" means securities (or interests therein) which are Qualified REIT Assets evidencing undivided ownership interests in a pool of Mortgage Loans, the holders of which receive a "pass-through" of the principal and interest paid in connection with the underlying mortgage loans in accordance with the holders' respective, undivided interests in the pool. Pass- Through Certificates evidence interests in loans secured by multi-family or commercial real estate properties. "PURCHASE PRICE" means the price to be paid for loans specified in a Notice of First Refusal. "QUALIFIED REIT ASSETS" means Pass-Through Certificates, Mortgage Loans, Agency Certificates and other assets of the type described in Code Section 856(c)(6)(B). "REMICs" means serially maturing debt securities secured by a pool of Mortgage Loans, the payments on which bear a relationship to the debt securities, and the issuer of which qualifies as a Real Estate Mortgage Investment Conduit under Section 860D of the Code. "RESPONSE" means a written letter of acceptance or rejection of a Notice of First Refusal by either ICH, IMH or any Affiliated REIT, as applicable, as set forth in Section 2.2 hereof. "THIRD PARTY" means any individual, corporation, partnership, association, limited liability company, trust or any unincorporated organization other than ICH, IMH, RAI or any Affiliated REIT or their Operating Subsidiaries. 2. RAI Offer of Investment Opportunities to ICH, IMH and any --------------------------------------------------------- Affiliated REITs. - ---------------- 2.1 If RAI is offered an Investment Opportunity on behalf of any of ICH, IMH or an Affiliated REIT, for exploitation either directly by such REIT Entity or by such REIT Entity through any of its Operating Subsidiaries, RAI agrees to first offer such Investment Opportunity to the Principal Party, for exploitation either directly by the Principal Party or through any of its Operating Subsidiaries whose Initial Primary Business most closely aligns with such Investment Opportunity on terms and conditions no less favorable than as first presented to RAI and deliver to the Principal Party a Notice of First Refusal within 2 days of its receipt of the Investment Opportunity. 2.2 Upon receipt of a Notice of First Refusal from RAI, ICH, IMH or any Affiliated REIT, as the case may be, shall have five (5) Business Days to either accept or reject the Notice of First Refusal by delivering a Response to RAI. Upon acceptance by ICH, IMH or any Affiliated REIT, as the case may be, through a Response, the Notice of First Refusal shall constitute the binding agreement of RAI to pursue with commercially reasonable efforts such Investment Opportunity on the terms and subject to the conditions set forth therein, either directly by such party or through any of its Operating Subsidiaries. Each applicable, Operating Subsidiary agrees to take all action necessary to effectuate the pursuit of such Investment Opportunity. If RAI does not receive a Response from ICH, IMH or any Affiliated REIT, as the case may be, or the Principal Party declines the Investment Opportunity within five (5) Business Days, RAI will make an independent evaluation of which Participant's business is more greatly enhanced by such opportunity. A similar Notice of First Refusal shall be forwarded by RAI to such Participant and said Participant shall have five (5) Business Days in which to respond to its Notice of First Refusal. Should such Participant decline to pursue the Investment Opportunity, RAI, in its discretion, shall (a) make another independent evaluation of which remaining Participant's business is more greatly enhanced by such opportunity and (b) deliver a Notice of First Refusal to such Participant. Such Participant shall have five (5) Business Days to accept or reject the Notice of First Refusal by delivering a Response to RAI. Should all Participants decline to pursue the Investment Opportunity, then RAI shall have the right to present such Investment Opportunity to a Third Party. The five (5) Business Day periods specified in this Subsection 2.2 may be extended upon mutual written agreement of the parties. 2.3 RAI may only present an Investment Opportunity contained in a Notice of First Refusal to IMH, ICH, any Affiliated REIT or Third Party on terms no less favorable than as first presented to RAI and then as set forth to ICH, IMH or any Affiliated REIT, as the case may be, in said Notice of First Refusal. 3. IMH, ICH and Any Affiliated REIT Right of First Refusal. ------------------------------------------------------- 3.1 Should either of IMH, ICH or any Affiliated REIT, or any of their Operating Subsidiaries, be offered an Investment Opportunity which falls outside the scope of the Initial Primary Business of IMH, ICH or any Affiliated REIT or the Initial Primary Business of the REIT Entity associated with the applicable Operating Subsidiary, as the case may be, it will first be offered to the Principal Party whose Initial Primary Business most closely aligns with such Investment Opportunity on terms and conditions no less favorable as first presented to IMH, ICH or any Affiliated REIT or any of their Operating Subsidiaries, as the case may be, and a Notice of First Refusal shall be delivered to the Principal Party with 2 days of the receipt of such Investment Opportunity. 3.2 Upon receipt of a Notice of First Refusal from either of IMH, ICH or any Affiliated REIT, as the case may be, the Principal Party shall have five (5) Business Days to either accept or reject the Notice of First Refusal by delivering a Response to IMH, ICH or any Affiliated REIT, as the case may be. Upon acceptance by the Principal Party through a Response, the Notice of First Refusal shall constitute the binding agreement of IMH, ICH or any Affiliated REIT as the case may be, to pursue with commercially responsible efforts such Investment Opportunity in the terms and conditions set forth therein either directly by such party or through any of its Operating Subsidiaries. Each applicable Operating Subsidiary agrees to take all action necessary to effectuate the pursuit of such Investment Opportunity. If IMH, ICH or any Affiliated REIT does not receive a Response from the Principal Party, within five (5) Business Days, or such Principal Party declines such Notice of First Refusal, IMH, ICH or any Affiliated REIT, as the case may be shall have the right to pursue such Investment Opportunity, either directly or through any of their respective Operating Subsidiaries. The five (5) Business Day period specified in this subsection 3.2 may be extended upon mutual written agreement of the parties. 3.3 IMH, ICH or any Affiliated REIT may only pursue an Investment Opportunity contained in a Notice of First Refusal to the Principal Party on terms no less favorable than as presented to IMH, ICH or any Affiliated REIT, or any of their Operating Subsidiaries, and then as set forth to the Principal Party on said Notice of First Refusal. 4. Term. The term of this Agreement shall be ten (10) years from ---- the date hereof. 5. Affiliated REITs to be Parties. The parties hereto agree to use ------------------------------ all reasonable efforts to cause each Affiliated REIT, if any, to become parties to this Agreement. 6. Injunctive Relief. Each of RAI, ICH, IMH and any Affiliated REIT ----------------- hereby acknowledges and agrees that it would be difficult to fully compensate each other for damages resulting from the breach or threatened breach of Sections 2 and 3, as they apply to each party herein and, accordingly, that each of RAI, ICH, IMH and any Affiliated REIT shall be entitled to temporary and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, to enforce such Sections without the necessity of proving actual damages therewith. This provision with respect to injunctive relief shall not, however, diminish each of RAI's, ICH's, IMH's and any Affiliated REIT's right to claim and recover damages or enforce any other of its legal and/or equitable rights or defenses. 7. Severable Provisions. The provisions of this Agreement are -------------------- severable and if any one or more provisions may be determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions, and any partially unenforceable provisions to the extent enforceable, shall nevertheless be binding and enforceable. 8. Binding Agreement. This Agreement shall inure to the benefit of ----------------- and shall be binding upon the parties hereto and their successors and assigns. 9. Captions. The Section captions are inserted only as a matter of -------- convenience and reference and in no way define, limit or describe the scope of this Agreement or the intent of any provisions hereof. 10. Entire Agreement. This Agreement contains the entire agreement ---------------- of the parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, between the parties hereto. 11. Amendments. This Agreement shall not be amended, changed, ---------- modified, terminated or discharged in whole or in part except by an instrument in writing signed by all parties hereto, or their respective successors or assigns, or otherwise as provided herein. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 12. Governing Law. This Agreement shall be governed and construed in ------------- accordance with the laws of the State of California applicable to contracts made and performed in said state, without regard to conflicts of laws principles. 13. Notices. ------- 13.1 All notices and other communications under this Agreement, other than Notices of First Refusal and Responses (which shall be governed by subsection 13.2 below), shall be in writing (including, without limitation, telegraphic, telex, telecopy or cable communication) and mailed, telegraphed, telexed, telecopied, cabled or delivered by hand or by a nationally recognized courier service guaranteeing overnight delivery to a party at the following address (or to such other address as such party may have specified by notice given to the other party pursuant to this provision): If to ICH or ICCC, to: c/o IMH Commercial Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, California 92702 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: Joseph R. Tomkinson Chief Executive Officer If to IMH or ICIFC, to: c/o Imperial Credit Mortgage Holdings, Inc. 20371 Irvine Avenue Santa Ana Heights, California 92702 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: William S. Ashmore President If to RAI, to: RAI Advisors, LLC 20371 Irvine Avenue Santa Ana Heights, California 92702 Telephone: (714) 556-0122 Facsimile: (714) 438-2150 Attention: Richard J. Johnson Chief Financial Officer All such notices and communications shall, when mailed, telegraphed, telexed, telecopied, cabled or delivered, be effective three days after deposit in the mails, delivered to the telegraph company, confirmed by telex answerback, telecopied with confirmation of receipt, delivered to the cable company, delivered by hand to the addressee or one day after delivery to the courier service. 13.2 Each Notice of First Refusal and Response under this Agreement shall be in writing and telecopied or delivered by hand during normal business hours (i.e., 9:00 a.m. - 5:00 p.m. California time) to an officer of the party to whom it is addressed at the address specified in subsection 13.1 above (or to such other address as such party may have specified by notice given to the other party pursuant to subsection 13.1), or in the case of any Affiliated REIT, to an address specified by such Affiliated REIT. Each such Notice of First Refusal and Response shall be effective immediately when telecopied with confirmation of receipt or delivered by hand to the addressee. 14. Arbitration. ----------- (a) Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to this Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the Judicial Arbitration and Mediation Services, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to the California Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. (b) Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. (c) The arbitrator shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the state of California will be applicable to the proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgment at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 15. Attorneys' Fees. In the event that any party shall bring an --------------- action or proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorneys', fees, court costs, costs of investigation and other costs reasonably related to such proceeding. 16. Waiver. Any forbearance by a party to this Agreement in ------ exercising any right or remedy under this Agreement or otherwise afforded by applicable law shall not be a waiver of or preclude the exercise of that or any other right or remedy. 17. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which when so executed shall be deemed to be an original, and all of which when taken together shall constitute one and the same agreement. [The remainder of this page intentionally left blank.] IN WITNESS WHEREOF, this Agreement is made as of the day and year first above written. IMH COMMERCIAL HOLDINGS, INC., a Maryland corporation By: /s/ Joseph R. Tomkinson ---------------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer IMPERIAL COMMERCIAL CAPITAL CORPORATION a California corporation By: /s/ Joseph R. Tomkinson -------------------------------------- Name: Joseph R. Tomkinson Title: Chief Executive Officer IMPERIAL CREDIT MORTGAGE HOLDINGS, INC., a Maryland corporation By: /s/ William S. Ashmore --------------------------------- Name: William S. Ashmore Title: President ICI FUNDING CORPORATION, a California corporation By: /s/ William S. Ashmore ---------------------------------- Name: William S. Ashmore Title: President RAI ADVISORS, LLC, a California limited liability company By: /s/ Mary C. Glass-Schannault ------------------------------------- Name: Mary C. Glass-Schannault Title: Senior Vice President EX-10.10(A) 8 CONTRACT OF SALE EXHIBIT 10.10(a) CONTRACT OF SALE IMPAC Commercial Holdings, Inc. fdba IMH Commercial Holdings, Inc., a Maryland corporation, herein called "Buyer" and IMPAC Mortgage Holding, Inc. fdba Imperial Credit Mortgage Holding, Inc., a Maryland corporation, herein called " Seller", hereby agree as follows: RECITALS WHEREAS, Buyer and Seller were the sole members of a California Limited Liability Company by the name of IMH/ICH Dove Street, LLC (herein called "Limited Liability Company") which was created on August 25, 1997; WHEREAS, Buyer and Seller have entered into a Limited Liability Operating Agreement dated August 25, 1997 (herein called "Operating Agreement", a copy of which is attached hereto as Exhibit "N'); WHEREAS, Buyer and Seller have entered into an agreement to distribute from the Limited Liability Company to the members the real property owned by the Limited Liability Company, commonly known as 1401 Dove Street, Newport Beach. WHEREAS, Seller and Buyer will have a fifty percent (50%) interest in the real property previously owned by the Limited Liability Company hereinafter referred to as "Asset". WHEREAS, Buyer is desirous of purchasing Seller's interest in the Asset; WHEREAS, Seller is desirous of selling Buyer's interest in the Asset. ARTICLE 1. PURCHASE AND SALE ----------------- OF PARTIAL INTEREST OF SELLER ----------------------------- IN ASSET -------- Partial Interest Being Purchased Section 1.01. Seller shall sell to Buyer and Buyer shall purchase from Seller on the terms specified in this contract fifty percent (50%) interest in the Asset from Seller. Purchase Price Section 1.02. Buyer shall pay to Seller on October 31, 1998, $6,000,000.00 less one half of the present principal due on the property's first mortgage in cash in lawful money of the United States in full payment of the purchase price. Conditions of Sale Section 1.03. The purchase and sale described in and covered by this contract shall be conducted and consummated in full compliance with all the requirements of the laws of the State of California. ARTICLE 2 WARRANTIES BY SELLER -------------------- Due Organization Section 2.01. Seller warrants to Buyer that it, Seller, is a corporation duly organized and existing under the General Corporation Law of the State of Maryland and that its powers as a corporation have never been and are not now suspended or limited in anyway. Title to Assets Section 2.02. Seller warrants it will convey good and marketable title to Seller of the Asset covered by this contract. Seller further warrants that its title to its interest in the Asset is free and clear of any liens, encumbrances, or other defects except for an existing first mortgage. Authority to Sell Section 2.03. Seller warrants and represents it has complied with all the requirements of the laws of the State of California relative to the sale of its interest in the Asset described in this contract and that the principal terms of the sale as set forth in this contract were duly approved by Seller's board of directors on October 19, 1998. Seller shall transfer title and interest in the Asset, including all leases, income or revenue of any nature generated by the Asset after delivery of the Quitclaim Deed, attached hereto as Exhibit "B". Survival of Warranties Section 2.04. Seller agrees that all warranties made by it in this contract shall survive the consummation of the sale. ARTICLE 3 WARRANTIES BY BUYER ------------------- Due Organization Section 3.01. Buyer warrants to Seller that it, Buyer, is a corporation duly organized and existing under the General Corporation Law of the State of Maryland and that its power as a corporation has never been and is not now suspended. Authority to Buy Section 3.02. Buyer further warrants to Seller that this contract has been approved by its Board of Directors and that Buyer has full power and authority to both execute and perform this contract. Section 3.03. Buyer agrees that all warranties made by it in this contract shall survive the consummation of the sale. ARTICLE 4 ASSUMPTION OF LIABILITIES ------------------------- Acknowledgment of Assumption of Liability Section 4.01. Buyer hereby acknowledges and agrees to assume all of the expenses and costs associated with the Asset and in the sale set forth in this contract. This assumption of liability will be effective upon execution of this contract. However, this shall not include the costs of completing the current modifications and capital improvements being made to the building. Seller shall remain responsible for 1/2 the costs of completing the exterior modifications and the interior improvements needed to make the building ready under the IMPAC Funding Corp. lease. Section 4.02. All costs and expenses of the sale described in this contract shall be borne by Buyer and Seller in equal proportions. ARTICLE 5 MISCELLANEOUS PROVISIONS ------------------------ Indemnity Agreement Section 5.01. The Buyer shall indemnify and hold Seller free and harmless from any and all claims, liability, loss, damage, or expense resulting from the Buyer's ownership of the Asset , including any claim, liability, loss or damage arising by reason of the injury to or death of any person or persons, or the damage of any property, caused by the Buyer's use of said Asset, including the cost of defense, for any claim arising after execution of this contract. Section 5.02. This instrument with its attachment constitutes the entire agreement between Buyer and Seller respecting the sale of the Asset to the Seller and any agreement or representation respecting said sale by Seller to Buyer not expressly set forth in this instrument is null and void. Notices Section 5.03. Any and all notices or other communications- required or permitted by this contract or by law to be served on or given to either party hereto, Buyer or Seller, by the other party shall be, unless otherwise required by law, in writing and deemed duly served and given when personally delivered to the party to whom directed or any of its officers or, in lieu of such personal service, when deposited in the United States mail, first class postage prepaid, addressed to Buyer at I Park Plaza, Suite 1100 Irvine, California 92614 or Seller at 20371 Irvine Ave. Santa Ana Heights, California 92707 Attorney's Fees Section 5.04. Should any litigation be commenced between the parties hereto, Buyer and Seller, concerning this contract, the sale and purchase described in this contract or the rights and duties of either in relation to this contract, the party Buyer or Seller, prevailing in that litigation shall be entitled, in addition to any other relief that may be granted, to a reasonable sum as and for its attorneys' fees in that litigation which shall be determined by the court in that litigation or in a separate action brought for that purpose. Cooperation in Execution of Documents Section 5.05 Buyer and Seller agree to execute any documents necessary to carry out the terms of this contract, including but not limited to, assignment of leases, assignment of deposits, change of ownership declaration, or other documents required by any governmental agency. Assignment Section 5.06. Neither this contract nor any right or interest in it may be assigned by either party to any other person or corporation without the express written consent of the other party to this contract. Governing Law Section 5.07. This contract shall be governed and all rights and liabilities under it determined in accordance with the laws of the State of California in effect on this date. EXECUTED on October 27 , 1998, at Orange County, California. "BUYER" IMPAC COMMERCIAL HOLDINGS, INC. fdba IMH COMMERCIAL HOLDINGS, INC. by: /s/ William D. Endersen --------------------------- William D. Endresen, President "SELLER" IMPAC MORTGAGE HOLDING, INC. fdba IMPERIAL CREDIT MORTGAGE HOLDING, INC. by: /s/ William S. Ashmore -------------------------- William S. Ashmore, President IMH/ICH DOVE STREET LIMITED LIABILITY OPERATING AGREEMENT This Operating Agreement (this "Agreement") is entered into this 25th day of August, 1997 by and among Imperial Credit Mortgage Holdings, Inc., a Maryland corporation and IMH Commercial Holdings, Inc., a Maryland corporation. Explanatory Statement The parties have agreed to organize a limited liability company in accordance with the terms and subject to the conditions set forth in this Agreement. NOW, THEREFORE, the parties agree as follows: ARTICLE I DEFINITIONS Capitalized terms used in this Agreement have the meanings specified in this Article or elsewhere in this Agreement and when not so defined shall have the meanings set forth in California Corporations Code section 17001. 1.1. "Act" means the Beverly-Killea Limited Liability Company Act (California Corporations Code (S) (S) 17000-17705), including amendments from time to time. 1.2. "Adjusted Capital Contribution" is defined in Article IV, Section 4.6(a). 1.3. "Affiliate" of a Member means (1) any Person directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the Member. The term "control" (including the terms "controlled by" and "funder common control with") means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a Person, whether through membership, ownership of voting securities, by contract, or otherwise. 1.4. "Agreement" means this operating agreement, as originally executed and as amended from time to time. 1.5. "Articles of Organization" is defined in Corporations Code section 17001(b) as applied to this Company. 1.6. "Assignee" means a person who has acquired a Member's Economic Interest in the Company, by way of a Transfer in accordance with the terms of this Agreement, but who has not become a Member. 1.7. "Assigning Member" means a Member who by means of a Transfer has transferred an Economic Interest in the Company to an Assignee. 1.8. "Available Cash" means all net revenues from the Company's operations, including net proceeds from all sales, refinancings, and other dispositions of Company property that the Manager, in the Manager's sole discretion, deems in excess of the amount reasonably necessary for the operating requirements of the Company, including debt reduction and Reserves. 1.9. "Capital Account" means, with respect to any Member, the account reflecting the capital interest of the Member in the Company, consisting of the Member's initial Capital Contribution maintained and adjusted in accordance with Article III, Section 3.6. 1.10. "Capital Contribution" means, with respect to any Member, the amount of the money and the Fair Market Value of any property (other than money) contributed to the Company (net of liabilities secured by such contributed property that the Company is considered to assume or take "subject to" under IRC section 752) in consideration of a Percentage Interest held by such Member. A Capital Contribution shall not be deemed a loan. 1.11. "Capital Event" means a sale or disposition of any of the Company's capital assets, the receipt of insurance and other proceeds derived from the involuntary conversion of Company property, the receipt of proceeds from a refinancing of Company property, or a similar event with respect to Company property or assets. 1.12. "Code" or "IRC' means the Internal Revenue Code of 1986, as amended, and any successor provision. 1.13. "Company" means the company named in Article II, Section 2.2 of this Agreement. 1.14. "Corporations Code" ("Corp C") means the California Corporations Code. 1.15. "Economic Interest" means a Person's right to share in the income, gains, losses, deductions, credit or similar items of, and to receive distributions from, the Company, but does not include any other rights of a Member, including the right to vote or to participate in management. 1.16. "Encumber" means the act of creating or purporting to create an Encumbrance, whether or not perfected under applicable law. 1.17. "Encumbrance" means, with respect to any Membership Interest, or any element thereof, a mortgage, pledge, security interest, lien, proxy coupled with an interest (other than as contemplated in this Agreement), option, or preferential right to purchase. 1.18. "Fair Market Value" means, with respect to any item of property of the Company, the item's adjusted basis for federal income tax purposes, except as follows: (a) The Fair Market Value of any property contributed by a Member to the Company shall be the value of such property, as mutually agreed by the contributing Member and the Company; (b) The Fair Market Value of any item of Company property distributed to any Member shall be the value of such item of property on the date of distribution as mutually agreed by the distributes Member and the Company; and (c) The Fair Market Value for purposes of Article VIII, Section 8.7, shall be as determined in that section. 1.19. "Initial Members" means those Persons whose names are set forth in the first sentence of this Agreement. A reference to an "Initial Member" means any of the Initial Members. 1.20. "Involuntary Transfer' means, with respect to any Membership Interest, or any element thereof, any Transfer or Encumbrance, whether by operation of law, pursuant to court order, foreclosure of a security interest, execution of a judgment or other legal process, or otherwise, including a purported transfer to or from a trustee in bankruptcy, receiver, or assignee for the benefit of creditors. 1.21. "Losses. " See Article IV, Section 4.2. 1.22. "Majority of Members" means a Member or Members whose Percentage Interests represent more than 50 percent of the Percentage Interests of all the Members. 1.23. "Manager" or "Managers" means the Person(s) named as such in Article H or the Persons who from time to time succeed any Person as a Manager and who, in either case, are serving at the relevant time as a Manager. 1.24. "Member" means an Initial Member or a Person who otherwise acquires a Membership Interest, as permitted under this Agreement, and who remains a Member. 1.25. "Membership Interest" means a Member's rights in the Company, collectively, including the Member's Economic Interest, any right to Vote or participate in management, and any right to information concerning the business and affairs of the Company. 1.26. "Notice" means a written notice required or permitted under this Agreement. A notice shall be deemed given or sent when deposited, as certified mail or for overnight delivery, postage and fees prepaid, in the United States mails; when delivered to Federal Express, United Parcel Service, DHL WorldWide Express, or Airborne Express, for overnight delivery, charges prepaid or charged to the sender's account; when personally delivered to the recipient; when transmitted by electronic means, and such transmission is electronically confirmed as having been successfully transmitted; or when delivered to the home or office of a recipient in the care of a person whom the sender has reason to believe will promptly communicate the notice to the recipient. 1.27. "Percent of the Members" means the specified total of Percentage Interests of all the Members. 1.28. "Percentage Interest" means a fraction, expressed as a percentage, the numerator of which is the total of a Member's Capital Account and the denominator of which is the total of all Capital Accounts of all Members. 1.29. "Person" means an individual, partnership, limited partnership, trust, estate, association, corporation, limited liability company, or other entity, whether domestic or foreign. 1.30. "Profits" and "Losses" are defined in Article IV, Section 4.2. 1.31. "Proxy" has the meaning set forth in the first paragraph of Corp C 1001(ai). A Proxy may not be transmitted orally. 1.32. "Regulations" ("Reg") means the income tax regulations promulgated by the United States Department of the Treasury and published in the Federal Register for the purpose of interpreting and applying the provisions of the Code, as such Regulations may be amended from time to time, including corresponding provisions of applicable successor regulations. 1.33. "Reserves" means the aggregate of reserve accounts that the Manager, in the Manager's sole discretion, deems reasonably necessary to most accrued or contingent liabilities of the Company, reasonably anticipated operating expenses, and working capital requirements. 1.34. "Successor in Interest" means an Assignee, a successor of a Person by merger or otherwise by operation of law, or a transferee of all or substantially all of the business or assets of a Person. 1.35. "Tax Item" means each item of income, gain, loss, deduction, or credit of the Company. 1.36. "Transfer" means, with respect to a Membership Interest or any element of a Membership interest, any sale, assignment, gift, Involuntary Transfer, Encumbrance, or other disposition of such a Membership Interest or any element of such Membership Interest, directly or indirectly, other than an Encumbrance that is expressly permitted under this Agreement. 1.37. "Triggering Event" is defined in Article VIII, Section 8.4. 1.38. "Vote" means a written consent or approval, a ballot cast at a meeting, or voice vote. 1.39. "Voting Interest" means, with respect to a Member, the right to Vote or participate in management and any right to information concerning the business and affairs of the Company provided under the Act, except as limited by the provisions of this Agreement. A Member's Voting Interest shall be directly proportional to that Member's Percentage Interest. ARTICLE II ARTICLES OF ORGANIZATION 2.1 The Articles of Organization were filed with the California Secretary of State on August 25, 1997, File Number 101997237028. A copy of the Articles of Organization as filed is attached to this Agreement as Exhibit "A". 2.2 The name of the Company is IMH/ICH Dove Street, LLC. 2.3. The principal executive office of the Company shall be at 1401 Dove Street, Newport Beach, California, 92660, or such other place or places as may be determined by the Manager from time to time. 2.4. The initial agent for service of process on the Company shall be Douglas S. Smith, whose address is 5 Hutton Centre Drive, Suite 600, Santa Ana, California 92707. The Managers may from time to time change the Company's agent for service of process. 2.5 The Company will be formed for the purposes of engaging in the business of managing and operating the real property owned by the Company. 2.6. The Members intend the Company to be a limited liability company under the Act. Neither the Manager nor any Member shall take any action inconsistent with the express intent of the parties to this Agreement. 2.7. The term of existence of the Company shall commence on the effective date of filing of Articles of Organization with the California Secretary of State, and shall continue until August 25, 2047 unless sooner terminated by the provisions of this Agreement or as provided by law. 2.8. The names and addresses of the Initial Members are as follows: Imperial Credit Mortgage Holding, Inc. 20371 Irvine Ave. Santa Ana Heights, CA 92707 and IMH Commercial Holdings, Inc. 20371 Irvine Ave. Santa Ana Heights, CA 92707 2.9. The Members shall be the Managers of the Company. ARTICLE III CAPITAL AND CAPITAL CONTRIBUTIONS 3.1. Each Member shall, contribute to the capital of the Company as the Member's initial Capital Contribution the money and property specified in Exhibit 'B'. If a Member fails to make the initial Capital Contributions specified in this Section within 30 days after the effective date of this Agreement, that Member's entire Membership Interest shall terminate, and that Member shall indemnify and hold the Company and the other Members harmless from any loss, cost, or expense, including reasonable attorney fees caused by the failure to make the initial Capital Contribution. 3.2. The Manager may determine from time to time that Capital Contributions in addition to the Members' initial Capital Contributions are needed to enable the Company to conduct its business. On making such a determination, the Manager shall give notice to all Members in writing at least 90 days before the date on which such additional Capital Contribution is due. The Notice shall set forth the amount of additional Capital Contribution needed, the purpose for which it is needed, and the date by which the Members shall contribute. Each Member shall be required to make an additional Capital Contribution in an amount that bears the same proportion to the total additional Capital Contribution that such Member's Capital Account balance bears to the total Capital Account balances of all Members. No Member may voluntarily make any additional Capital Contribution. 3.3 If a Member fails to make an additional Capital Contribution required under Section 3.2 above within 30 days after it is required to be made (a Defaulting Member), the Manager shall within five days after said failure notify each other Member (a Nondefaulting Member) in writing of the total amount of Defaulting Member Capital Contributions not made (the Additional Capital Shortfall), and shall specify a number of days within which each Nondefaulting Member may make an additional Capital Contribution, which shall not be less than an amount bearing the same ratio to the amount of Additional Capital Shortfall as the Nondefaulting Member's Capital Account balance bears to the total Capital Accounts of all Nondefaulting Members. If the total amount of Additional Capital Shortfall is not so contributed, the Manager may use any reasonable method to provide Members the opportunity to make additional Capital Contributions, until the Additional Capital Shortfall is as fully contributed as possible. Following the Nondefaulting Members' making of such additional Capital Contributions, each Member's Percentage Interest shall be adjusted to reflect the ratio that the Member's Capital Account bears to the total Capital Accounts of all of the Members. 3.4. If a Member fails for 30 days to make an additional Capital Contribution required under Section 3.2 (a Defaulting Member): (a) The Defaulting Member shall indemnify and hold the Company and the other Members harmless from any loss, cost, or expense, including reasonable attorney fees caused by the failure to make the additional Capital Contribution. Such additional Capital Contributions that are not made by a Defaulting Member are referred to as Additional Capital Shortfall. A Member who makes the respective required additional Capital Contributions (Nondefaulting Member) shall have the right, but not the obligation, to advance an amount bearing the same ratio to the total amount of the Additional Capital Shortfall as a Nondefaulting Member's Capital Account bears to the total Capital Accounts of all Nondefaulting Members. A Member advancing an additional a Defaulting Member under this Section 3.4(a) shall: (1) be paid interest by the Defaulting Member on the amount of such advance at an annual rate, from the date of the advance until paid, equal to the floating rate of three percent (3%) over the prime rate charged by Imperial Bank or the highest rate permitted by applicable law, whichever rate is lower; and (2) receive all distributions that the Defaulting Member would otherwise be entitled to receive under the provisions of this Agreement as though the advances by the Nondefaulting Member were Capital Contributions made by such Nondefaulting Member, which distributions shall be applied first to attorneys' fees, costs,, and expenses, if any; then to accrued and unpaid interest, and, finally, in reduction of the principal amount of such advance. The Defaulting Member grants any Nondefaulting Members who make advances to the Company in accordance with this Subsection 3.4(a) a security interest in the Defaulting Member's Membership Interest to secure the Defaulting Member's obligations under this Subsection 3.4(a). The Defaulting Member shall, within five days of written notice, execute any documents or instruments reasonably necessary to enable Nondefaulting Members who make advances hereunder to perfect the foregoing security interests. Each Member irrevocably appoints each other Member, and any one of them acting alone, as his, her, or its attorney-in-fact for the limited purpose of executing, on behalf of such Member, if such Member becomes a Defaulting Member, any of the foregoing documents or instruments. 3.5 An individual Capital Account for each Member shall be maintained in accordance with the requirements of Reg 1.704-1(b)(2)(iv) and adjusted in accordance with the following provisions: (a) A Member's Capital Account shall be increased by that Member's Capital Contributions, that Member's share of Profits, and any items in the nature of income or gain that are specially allocated to that Member pursuant to Article IV. (b) A Member's Capital Account shall be increased by the amount of any Company liabilities assumed by that Member subject to and in accordance with the provisions of Reg 1.704-1(b)(2)(iv)(c). (c) A Member's Capital Account shall be decreased by (a) the amount of cash distributed to that Member; (b) the Fair Market Value of any property of the Company so distributed, net of liabilities secured by such distributed property that the distributes Member is considered to assume or to be subject to under IRC section 752; and (c) the amount of any items in the nature of expenses or losses that are specially allocated to that Member pursuant to Article IV. (d) A Member 's Capital Account shall be reduced by the Member's share of any expenditures of the Company described in IRC section 705(a)(2)(B) or which are treated as IRC section 705(a)(2)(B) expenditures pursuant to Reg section 1.704l(b)(2)(iv)(i) (including syndication expenses and losses nondeductible under IRC sections 267(a)(1) or 707(b)). (e) If any Economic Interest (or portion thereof) is transferred, the transferee of such Economic Interest or portion shall succeed to the transferor's Capital Account attributable to such interest or portion. (f) The principal amount of a promissory note that is not readily traded on an established securities market and that is contributed to the Company by the maker of the note shall not be included in the Capital Account of any Person until the Company makes a taxable disposition of the note or until (and to the extent) principal payments are made on the note, all in accordance with Reg section 1.704-1 (b)(2)(iv)(d)(2). (g) Each Member's Capital Account shall be increased or decreased as necessary to reflect a revaluation of the Company's property assets in accordance with the requirements of Reg sections 1.704-1(b)(2)(iv)(f) and 1.704-1(b)(2)(iv)(g), including the special rules under Reg section 1.701-1(b)(4), as applicable. The provisions of this Agreement respecting the maintenance of Capital Accounts are intended to comply with Reg section 1.704-1(b) and shall be interpreted and applied in a manner consistent with those Regulations. 3.6. A Member shall not be entitled to withdraw any part of the Member's Capital Contribution or to receive any distributions, whether of money or property, from the Company except as provided in this Agreement. 3.7 No interest shall be paid on Capital Contributions or on the balance of a Member's Capital Account. 3.8 A Member shall not be bound by, or be personally liable for, the expenses, liabilities, or obligations of the Company except as otherwise provided in the Act or in this Agreement. 3.9. Except as otherwise provided in this Agreement, no member shall have priority over any other Member with respect to the return of a Capital Contribution or distributions or allocations of income, gain, losses, deductions, credits, or items thereof. ARTICLE IV ALLOCATIONS AND DISTRIBUTIONS 4.1. The Profits and Losses of the Company and all items of Company income, gain, loss, deduction, or credit shall be allocated, for Company book purposes and for tax purposes, to a Member in accordance with the Member's Percentage Interest. 4.2 As used in this Agreement, "Profits and Losses" means, for each fiscal year or other period specified in this Agreement, an amount equal to the Company's taxable income or loss for such year or period, determined in accordance with IRC section 703(a), including all Tax Items required to be stated separately pursuant to IRC section 703(a)(1), with the following adjustments: (a) Any income of the Company that is exempt from federal income tax and not otherwise taken into account in computing Profits or Losses shall be added to such taxable income or loss; (b) Any expenditures of the Company described in IRC section 705(a)(2)(B) or treated as IRC section 705(a)(2)(8) expenditures pursuant to Reg section 1.704-l(b)(2)(iv)(i) and not otherwise taken into account in computing Profits or Losses shall be subtracted from such taxable income or shall increase such loss; 4.3. In any fiscal year of the Company, Profits in excess of Losses of the Company resulting from a Capital Event in that Fiscal Year shall be allocated to the Members in the following order: (a) To Members whose Adjusted Capital Contributions are in excess of their Capital Accounts, in proportion to those excesses, until all of those excesses have been eliminated. "Adjusted Capital Contributions" means, with respect to each Member, the excess of such Member's contribution to the capital of the Company over all prior distributions to the Member that have resulted from Capital Events. (b) Among the Members in the proportion that the Capital Contribution of each Member bears to the total Capital Contributions of all Members. 4.4 In any fiscal year of the Company, Losses in excess of Profits of the Company, resulting from a Capital Event in that fiscal year, shall be allocated to the Members with positive Capital Accounts, in proportion to their positive Capital Account balances, until no Member has a positive Capital Account. For this purpose, Capital Accounts shall be reduced by the adjustments set forth in Reg sections 1.704-1(b)(2)(ii)(d)(4), (5), and (6). 4.5. Any unrealized appreciation or unrealized depreciation in the values of Company property distributed in kind to Members shall be deemed to be Profits or Losses realized by the Company immediately prior to the distribution of the property and such Profits or Losses shall be allocated to the Capital Accounts in the same proportions as Profits are allocated under Section 4. 1. Any property so distributed shall be treated as a distribution to the Members to the extent of the Fair Market Value of the property, less the amount of any liability secured by and related to the property. Nothing contained in this Agreement is intended to treat or cause such distributions to be treated as sales for value. For the purposes of this Section 4.5 "unrealized appreciation" or "unrealized depreciation" shall mean the difference between the Fair Market Value of such property and the Company's federal adjusted tax basis for such property. 4.6. In the case of a Transfer of an Economic Interest during any fiscal year of the Company, the Assigning Member and Assignee shall each be allocated Profits or Losses based on the number of days each held the Economic Interest during that fiscal year. If the Assigning Member and Assignee agree to a different proration and advise the Manager of the agreed proration before the date of the Transfer, Profits or Losses from a Capital Event during that fiscal year shall be allocated to the holder of the Interest on the day such Capital Event occurred. If an Assignee makes a subsequent Assignment, said Assignee shall be considered an "Assigning Member" with respect to the subsequent Assignee for purposes of the aforesaid allocations. 4.7. It is the intent of the Members that each Member's allocated share of Company Tax Items be determined in accordance with this Agreement to the fullest extent permitted by IRC sections 704(b) and 704(c). Notwithstanding anything to the contrary contained in this Agreement, if the Company is advised that, as a result of the adoption of new or amended regulations pursuant to IRC sections 704(b) and 704(c), or the issuance of authorized interpretations, the allocations provided in this Agreement are unlikely to be respected for federal income tax purposes, the Manager is hereby granted the power to amend the allocation provisions of this Agreement, on advice of accountants and legal counsel, to the minimum extent necessary to cause such allocation provisions to be respected for federal income tax purposes. 4.8. All available cash, other than revenues or proceeds from a Capital Event or the dissolution of the Company, shall be distributed among the Members in the same manner as Profits. The parties intend that Available Cash shall be distributed as soon as practicable following the Manager's determination that such cash is available for distribution. The parties acknowledge that no assurances can be given with respect to when or whether said cash will be available for distributions to the Members. 4.9. All Available Cash resulting from a Capital Event (as distinguished from normal business operations or the dissolution of the Company) shall be distributed to the Members in accordance with their respective Percentage Interests as soon as practicable following the Manager's determination that such cash is available for distribution. 4.10. If the proceeds from a sale or other disposition of an item of Company property consist of property other than cash, the value of that property shall be as determined by the Manager. If such noncash proceeds are subsequently reduced to cash, such cash shall be taken into account by the Manager in determining Available Cash and the Manager shall determine whether such cash has resulted from operations or from a Capital Event. 4.11. Notwithstanding any other provisions of this Agreement to the contrary, when there is a distribution in liquidation of the Company, or when any Member's interest is liquidated, all items of income and loss first shall be allocated to the Members' Capital Accounts under this Article IV, and other credits and deductions to the Members' Capital Accounts shall be made before the final distribution is made. The final distribution to the Members shall be made as provided in Article IX, Section 9.2(d) of this Agreement. The provisions of this Section 4. 11 and Article IX, Section 9.2(d) shall be construed in accordance with the requirements of Reg section 1.704-1(b)(2)(ii)(b)(2). ARTICLE V MANAGEMENT 5.1. The business of the Company shall be managed by all the Members. A Member shall be a Manager only during the time the Member is a Member of the Company. AU decisions concerning the management of the Company's business shall be made by the Vote of a Majority of Members. 5.2. Each manager shall serve until the earlier of (1) the Manager's resignation; (2) the Manager's removal by the Members; and (3) the expiration of the Manager's term as Manager, if a term has been designated by a Majority of Members. A new Manager shall be appointed by a Majority of Members on the occurrence of any of the foregoing events. 5.3. Each Manager shall be appointed by a Majority of Members for (a) a term expiring with the appointment of a successor, or (b) a term expiring at a definite time specified by a Majority of Members in connection with such an appointment. A Manager who is not also a Member may be removed with or without cause at any time by action of a Majority of Members. A Manager who is a Member may be removed only on the Vote of all other Members and the execution and filing of a Certificate of Amendment of the Articles of Organization of the Company in conformity with Corp C section 17054, if necessary, to provide that the Company is to be managed by managers. 5.4. The Managers shall be the chief executive officers of the Company and shall have the powers and duties described in Section 5.8 hereof and such other powers and duties as may be prescribed in this Agreement or by the Members. Notwithstanding the foregoing, the Manager shall not take any of the following actions on behalf of the Company unless all Members has consented to the taking of such action: (a) Any act that would make it impossible to carry on the ordinary business of the Company; (b) Any confession of a judgment against the Company; (c) The dissolution of the Company; (d) The disposition of all or a substantial part of the Company's assets not in the ordinary course of business; (e) The incurring of any debt not in the ordinary course of business; A change in the nature of the principal business of the Company; (g) The incurring of any contractual obligation or the making of any capital expenditure with a total cost of more than $100,000.00; (h) The filing of a petition in bankruptcy or the entering into of an arrangement among creditors; and (i) The entering into, on behalf of the Company, of any transaction constituting a "reorganization" within the meaning of Corp C 17600. 5.5. Actions of the Managers shall be taken at meetings or as otherwise provided in this Section 5.5 by a majority. No regular meetings of the Managers need be held. The President or any two Managers may call a meeting of the Managers by giving Notice of the time and place of the meeting at least 48 hours prior to the time of the holding of the meeting. The Notice need not specify the purpose of the meeting, nor the location if the meeting is to be held at the principal executive office of the Company. A majority of Managers shall constitute a quorum for the transaction of business at any meeting of the Managers. The transactions of the Managers at any meeting, however called or noticed, or wherever held, shall be as valid as though transacted at a meeting duly held after call and notice if a quorum is present and if, either before or after the meeting, each Manager not present signs a written waiver of notice or a consent to the holding of such meeting or an approval of the minutes of such meeting. Any action required or permitted to be taken by the Managers under this Agreement may be taken without a meeting if a majority of the Managers individually or collectively consent in writing to such action. Managers may participate in the meeting through the use of a conference telephone or similar communications equipment, provided that all Managers participating in the meeting can hear one another. The Managers shall keep or cause to be kept with the books and records of the Company full and accurate minutes of all meetings, notices and waivers of notices of meetings, and all written consents to actions of the Managers. 5.6. It is acknowledged that the Manager has other business interests to which the Manager devotes part of the Manager's time. The Manager shall devote such time to the conduct of the business of the Company as the Manager, in the Manager's own good faith and discretion, deems necessary. 5.7. The Manager shall be entitled to compensation for the Manager's services as determined by the Members, and to reimbursement for all expenses reasonably incurred by the Manager in the performance of the Manager's duties. 5.8 The Company shall have a President, who shall be a Manager. The President shall have general supervision of the business and affairs of the Company, shall preside at all meetings of Members and of Managers, and shall have such other powers and duties usually vested in a president. A Majority of the Members may provide for additional officers of the Company, may alter the powers and duties of the President, and shall establish the powers and duties of all other officers and the compensation of all company officers. 5.9. The Manager shall cause all assets of the Company, whether real or personal, to be held in the name of the Company. 5.10. All funds of the Company shall be deposited in one or more accounts with one or more recognized financial institutions in the name of the Company, at such locations as shall be determined by the Manager. Withdrawal from such accounts shall require only the signature of the Manager or such other person or persons as the Manager may designate. ARTICLE VI ACCOUNTS AND ACCOUNTING 6.1. Complete books of account of the Company's business, in which each Company transaction shall be fully and accurately entered, shall be kept at the Company's principal executive office and at such other locations as the Manager shall determine from time to time and shall be open to inspection and copying on reasonable Notice by any Member or the Member's authorized representatives during normal business hours. The costs of such inspection and copying shall be borne by the Member. 6.2. Financial books and records of the Company shall be kept on the accrual/cash method of accounting, which shall be the method of accounting followed by the Company for federal income tax purposes. The financial statements of the Company shall be prepared in accordance with generally accepted accounting principles and shall be appropriate and adequate for the Company's business and for carrying out the provisions of this Agreement. The fiscal year of the Company shall be January 1 through December 31. 6.3. At all times during the term of existence of the Company, and beyond that term if the Manager deems it necessary, the Manager shall keep or cause to be kept the books of account referred to in Section 6.2, together with: (a) A current list of the full name and last known business or residence address of each Member, together with the Capital Contribution and the share in Profits and Losses of each Member; (b) A current list of the full name and business or residence address of each Manager; (c) A copy of the Articles of Organization, as amended; (d) Copies of the Company's federal, state, and local income tax or information returns and reports, if any, for the six most recent taxable years; (e) An original executed copy or counterparts of this Agreement, as amended; (f) Any powers of attorney under which the Articles of Organization or any amendments to said articles were executed; (g) Financial statements of the Company for the six most recent fiscal years; and (h) The books and Records of the Company as they relate to the Company's internal affairs for the current and past four fiscal years. If the Manager deems that any of the foregoing items shall be kept beyond the term of existence of the Company, the repository of said items shall be as designated by the Manager. 6.4 All Members shall receive not less frequently than at the end of each calendar quarter, copies of such financial statements regarding the previous calendar quarter, as may be prepared in the ordinary course of business, by the Manager or accountants selected by the Manager. The Manager shall deliver to each Member, within 120 days after the end of the fiscal year of the Company, a financial statement that shall include: (a) A balance sheet and income statement, and a statement of changes in the financial position of the Company as of the close of the fiscal year; (b) A statement showing the Capital Account of each Member as of the close of the fiscal year and the distributions, if any, made to each Member during the fiscal year. Members representing at least 30 percent of the Members, by number, may request interim balance sheets and income statements, and may, at their own discretion and expense, obtain an audit of the Company books, by certified public accountants selected by them; provided, however, that not more than one such audit shall be made during any fiscal year of the Company. 6.5. Within 90 days after the end of each taxable year of the Company the Manager shall send to each of the Members all information necessary for the Members to complete their federal and state income tax or information returns and a copy of the Company's federal, state, and local income tax or information returns for such year. ARTICLE VII MEMBERSHIP MEETINGS, VOTING, INDEMNITY 7.1. There shall be only one class of membership and no Member shall have any rights or preferences in addition to or different from those possessed by any other Member except as specifically provided for in Article IV. Members shall have the right and power to appoint, remove, and replace Managers and officers of the Company and the right to Vote on all other matters with respect to which this Agreement or the Act requires or permits such Member action. Each Member shall Vote in proportion to the Member's Percentage Interest as of the governing record date, determined in accordance with Section 7.2. If a Member has assigned all or part of the Member's Economic Interest to a person who has not been admitted as a Member, the Assigning Member shall Vote in proportion to the Percentage Interest that the Assigning Member would have had, if the assignment had not been made. Without limiting the foregoing, all of the following acts shall require the unanimous Vote of the Members: (a) A decision to continue the business of the Company after any event mentioned in Article IX, Section 9.1; (b) The Transfer of a Membership Interest and the admission of the Assignee as a Member of the Company; (c) Any amendment of the articles of organization or this Agreement; and (d) A compromise of the obligation of a Member to make a Capital Contribution under Article III. 7.2. The record date for determining the Members entitled to receive Notice of any meeting, to Vote, to receive any distribution, or to exercise any right in respect of any other lawful action, shall be the date set by the Manager or by a Majority of Members; provided that such record date shall not be more than 60, or less than ten calendar days prior to the date of the meeting and not more than 60 calendar days prior to any other action. In the absence of any action setting a record date, the record date shall be determined in accordance with Corp C section 17104(k). 7.3. The Company may, but shall not be required, to issue certificates evidencing membership Interests (Membership Interest Certificates) to Members of the Company. Once Membership Interest Certificates have been issued, they shall continue to be issued as necessary to reflect current Membership Interests held by Members. Membership Interest Certificates shall be in such form as may be approved by the Manager, shall be manually signed by the Manager, and shall bear conspicuous legends evidencing the restrictions on Transfer and the purchase rights of the Company and Members set forth in Article VIII. All issuances, reissuances, exchanges, and other transactions in Membership Interests involving Members shall be recorded in a permanent ledger as part of the books and records of the Company. 7.4. Meetings of the Members may be called at any time by the Manager, or by Members representing more than 10 percent of the Interests of the Members for the purpose of addressing any matters on which the Members may Vote. If a meeting of the Members is called by the Members, Notice of the call shall be delivered to the Manager. Meetings may be held at the principal executive office of the Company or at such other location as may be designated by the Manager. Following the call of a meeting, the Manager shall give Notice of the meeting not less than ten, or more than 60 calendar days prior to the date of the meeting to all Members entitled to Vote at the meeting. The Notice shall state the place, date, and hour of the meeting and the general nature of business to be transacted. No other business may be transacted at the meeting. A quorum at any meeting of Members shall consist of a Majority of Members, represented in person or by Proxy. The Members present at a duly called or held meeting at which a quorum is present may continue to transact business until adjournment, notwithstanding the withdrawal of a sufficient number of Members to leave less than a quorum, if the action taken, other than adjournment, is approved by the requisite Percentage of Members as specified in this Agreement or the Act. 7.5. A meeting of Members at which a quorum is present may be adjourned to another time or place and any business which might have been transacted at the original meeting may be transacted at the adjourned meeting. If a quorum is not present at an original meeting, that meeting may be adjourned by the Vote of a majority of Voting Interests represented either in person or by Proxy. Notice of the adjourned meeting need not be given to Members entitled to Notice it the time and place of the adjourned meeting are announced at the meeting at which the adjournment is taken, unless (a) the adjournment is for more than 45 days, or (b) after the adjournment, a new record date is fixed for the adjourned meeting. in the situations described in clauses (a) and (b), Notice of the adjourned meeting shall be given to each Member of record entitled to Vote at the adjourned meeting 7.6. The transactions of any meeting of Members, however called and noticed, and wherever held, shall be as valid as though consummated at a meeting duly held after regular call and notice, it (a) a quorum is present at that meeting, either in person or by Proxy, and (b) either before or after the meeting, each of the persons entitled to Vote, not present in person or by Proxy, signs either a written waiver of notice, a consent to the holding of the meeting, or an approval of the minutes of the meeting. Attendance of a Member at a meeting shall constitute waiver of notice, unless that Member objects, at the beginning of the meeting, to the transaction of any business on the ground that the meeting was not lawfully called or convened. Attendance at a meeting is not a waiver of any right to object to the consideration of matters required to be described in the notice of the meeting and not so included, if the objection is expressly made at the meeting. 7.7. At all meetings of Members, a Member may Vote in person or by Proxy. Such Proxy shall be filed with the Manager before or at the time of the meeting, and may be filed by facsimile transmission to the Manager at the principal executive office of the Company or such other address as may be given by the Manager to the Members for such purposes. 7.8. Members may participate in a meeting through use of conference telephone or similar communications equipment, provided that all Members participating in such meeting can hear one another. Such participation shall be deemed attendance at the meeting. 7.9. Any action that may be taken at any meeting of the Members may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by Members having not less than the minimum number of Votes that would be necessary to authorize or take that action at a meeting at which all Members entitled to Vote thereon were present and voted. If the Members are requested to consent to a matter without a meeting, each Member shall be given notice of the matter to be voted upon in the manner described in Section 7.4. Any action taken without a meeting shall be effective when the required minimum number of Votes have been received. Prompt Notice of the action taken shall be given to all Members who have not consented to the action. 7.10. No Member acting solely in the capacity of a Member is an agent of the Company, nor can any Member acting solely in the capacity of a Member bind the Company or execute any instrument on behalf of the Company. Accordingly, each Member shall indemnify, defend, and save harmless each other Member and the Company from and against any and all loss, cost, expense, liability or damage arising from or out of any claim based upon any action by such Member in contravention of the first sentence of this Section 7.10. ARTICLE VIII TRANSFERS OF MEMBERSHIP INTERESTS 8.1. A Member may withdraw from the Company at any time by giving Notice of withdrawal to all other Members at least 180 calendar days before the effective date of withdrawal. Withdrawal shall not release a Member from any obligations and liabilities under this Agreement accrued or incurred before the effective date of withdrawal. A withdrawing Member shall divest the Member's entire Membership Interest before the effective date of withdrawal in accordance with and subject to the provisions of this Article VIII. 8.2. Except as expressly provided in this Agreement, a Member shall not transfer any part of the Member's Membership Interest in the Company, whether now owned or later acquired, unless (a) the other Members unanimously approve the transferee's admission to the Company as a Member upon such Transfer, which approval shall be given or withheld by each Member in its sole and absolute discretion, and (b) the Membership Interest to be transferred, when added to the total of all other Membership Interests transferred in the preceding 12 months, will not cause the termination of the Company under the Code. No Member may Encumber or permit or suffer any Encumbrance of all or any part of the Member's Membership Interest in the Company unless such Encumbrance has been approved in writing by the Manager. Such approval may be granted or withheld in the Manager's sole discretion. Any Transfer or Encumbrance of a Membership Interest without such approval shall be void. Notwithstanding any other provision of this Agreement to the contrary, a Member who is a natural person may transfer all or any portion of his or her Membership Interest to any revocable trust created for the benefit of the Member, or any combination between or among the Member, the Member's spouse, and the Member's issue; provided that the Member retains a beneficial interest in the trust and all of the Voting Interest included in such Membership Interest. A Transfer of a Member's beneficial interest in such trust, or failure to retain such Voting Interest, shall be deemed a Transfer of a Membership Interest. 8.3. If a Member wishes to transfer any or all of the Member's Membership Interest in the Company pursuant to a Bona Fide Offer (as defined below), the Member shall give Notice to all other Members at least 30 days in advance of the proposed sale or Transfer, indicating the terms of the Bona Fide Offer and the identity of the offeror. The Company and the other Members shall have the option to purchase the Membership Interest proposed to be transferred at the price and on the terms provided in this Agreement. If the price for the Membership Interest is other than cash, the fair value in dollars of the price shall be as established in good faith by the Company. For purposes of this Agreement, "Bona Fide Offer" means an offer in writing setting forth all relevant terms and conditions of purchase from an offeror who is ready, willing, and able to consummate the purchase and who is not an Affiliate of the selling Member. For 30 days after the Notice is given, the Company shall have the right to purchase the Membership Interest offered, on the terms stated in the Notice, for the lesser of (a) the price stated in the Notice (or the price plus the dollar value of noncash consideration, as the case may be) and (b) the price determined under the appraisal procedures set forth in Section 8.8. If the Company does not exercise the right to purchase all of the Membership Interest, then, with respect to the portion of the Membership Interest that the Company does not elect to purchase, that right shall be given to the other Members for an additional 30-day period, beginning on the day that the Company's right to purchase expires. Each of the other Members shall have the right to purchase, on the same terms, a part of the interest of the offering Member in the proportion that the Member's Percentage Interest bears to the total Percentage Interests of all of the Members who choose to participate in the purchase; provided, however, that the Company and the participating Members may not, in the aggregate, purchase less than the entire interest to be sold by the offering Member. If the Company and the other Members do not exercise their rights to purchase all of the Membership Interest, the offering Member may, within 90 days from the date the Notice is given and on the terms and conditions stated in the Notice, sell or exchange that Membership Interest to the offeror named in the Notice. Unless the requirements of Section 8.2 are met, the offeror under this section shall become an Assignee, and shall be entitled to receive only the share of Profits or other compensation by way of income and the return of Capital Contribution to which the assigning Member would have been entitled. 8.4. On the happening of any of the following events (Triggering Events) with respect to a Member, the Company and the other Members shall have the option to purchase the Membership Interest in the Company of such Member (Selling Member) at the price and on the terms provided in Section 8.7 of this Agreement: (a) The bankruptcy or withdrawal of a Member, or the winding up and dissolution of a corporate Member, or merger or other corporate reorganization of a corporate Member as a result of which the corporate Member does not survive as an entity; provided that the remaining Members have elected to continue the business of the Company as provided in Article IX, Section 9.l(a). (b) The occurrence of any other event that is, or that would cause, a Transfer in contravention of this Agreement. Each member agrees to promptly give Notice of a Triggering Event to all other Members. 8.5. On the receipt of Notice by the Manager and the other Members as contemplated by Sections 8.1 or 8.3, and on receipt of actual notice of any Triggering Event as determined in good faith by the Manager, the Company shall have the option, for a period ending 30 calendar days following the determination of the purchase price as provided in Section 8.8, to purchase the Membership Interest in the Company to which the option relates, at the price and on the terms set forth in Section 8.7 of this Agreement, and the other Members, pro rata in accordance with their prior Membership Interests in the Company, shall then have the option, for a period of 30 days thereafter, to purchase the Membership Interest in the Company not purchased by the Company, on the same terms and conditions as apply to the Company. If all other Members do not elect to purchase the entire remaining Membership Interest in the Company, then the Members electing to purchase shall have the right, pro rata in accordance with their prior Membership Interest in the Company, to purchase the additional Membership Interest in the Company available for purchase. The transferee of the Membership Interest in the Company that is not purchased shall hold such Membership Interest in the Company subject to all of the provisions of this Agreement. 8.6 Neither the Member whose interest is subject to purchase under this Article, nor such Member's Affiliate, shall participate in any Vote or discussion of any matter pertaining to the disposition of the Member's Membership Interest in the Company under this Agreement. 8.7. The purchase price of the Membership Interest that is the subject of an option under Section 8.5 shall be the "Fair Option Price" of the interest as determined under this Section 8.7. "Fair Option Price" means the cash price that a willing buyer would pay to a willing seller when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts on the date the option is first execrable (the Option Date). Each of the selling and purchasing parties shall use his, her, or its best efforts to mutually agree upon the Fair Option Price. If the parties are unable to so agree within 30 days of the Option Date, the selling party shall appoint, within 40 days of the Option Date, one appraiser, and the purchasing party shall appoint within 40 days of the Option Date, one appraiser. The two appraisers shall within a period of five additional days, agree upon and appoint an additional appraiser. The three appraisers shall, within 60 days after the appointment of the third appraiser, determine the Fair Option Price of the Membership Interest in writing and submit their report to all the parties. The Fair Option Price shall be determined by disregarding the appraiser's valuation that diverges the greatest from each of the other two appraisers' valuations, and the arithmetic mean of the remaining two appraisers' valuations shall be the Fair Option Price. Each purchasing party shall pay for the services of the appraiser selected by it, plus one half of the fee charged by the third appraiser, and one half of all other costs relating to the determination of Fair Option Price. The Fair Option Price as so determined shall be payable in cash. 8.8. Except as expressly permitted under Section 8.2, a prospective transferee (other than an existing Member) of a Membership Interest may be admitted as a Member with respect to such Membership Interest (Substituted Member) only (a) on the unanimous Vote of the other Members in favor of the prospective transferee's admission as a Member, which approval shall be given or withheld by each Member in its sole and absolute discretion, and (b) on such prospective transferee executing a counterpart of this Agreement as a party hereto. Any prospective transferee of a Membership Interest shall be deemed an Assignee, and, therefore, the owner of only an Economic Interest until such prospective transferee has been admitted as a Substituted Member. Except as otherwise permitted in the Act, any such Assignee shall be entitled only to receive allocations and distributions under this Agreement with respect to such Membership Interest and shall have no right to Vote or exercise any rights of a Member until such Assignee has been admitted as a Substituted Member. Until the Assignee becomes a Substituted Member, the Assigning Member will continue to be a Member and to have the power to exercise any rights and powers of a Member under this Agreement, including the right to Vote in proportion to the Percentage Interest that the Assigning Member would have had in the event that the assignment had not been made. 8.9 Any person admitted to the Company as a Substituted Member shall be subject to all the provisions of this Agreement that apply to the Member from whom the Membership Interest was assigned, provided, however, that the assigning Member shall not be released from liabilities as a Member solely as a result of the assignment, both with respect to obligations to the Company and to third parties, incurred prior to the assignment. 8.10. The initial sale of Membership Interests in the Company to the Initial Members has not been qualified or registered under the securities laws of any state, including California, or registered under the Securities Act of 1933, in reliance upon exemptions from the registration provisions of those laws. Notwithstanding any other provision of this Agreement, Membership Interests may not be Transferred unless registered or qualified under applicable state and federal securities law unless, in the opinion of legal counsel satisfactory to the Company, such qualification or registration is not required. The Member who desires to transfer a Membership Interest shall be responsible for all legal fees incurred in connection with said opinion. ARTICLE IX DISSOLUTION AND WINDING UP 9.1. The Company shall be dissolved upon the first to occur of the following events: (a) The bankruptcy, withdrawal, or dissolution of a Member, provided, however, that the remaining Members may by the Vote of a Majority of Members within 90 days of the happening of that event Vote to continue the business of the Company, in which case, the Company shall not dissolve. If the remaining Members fail to so Vote, the remaining Members shall wind up the Company. For purposes of this Paragraph (a), in determining a Majority of Members, the Percentage Interest of the Member who has died, become incapacitated, withdrawn, or who has become bankrupt or dissolved shall not be taken into account. (b) The expiration of the term of existence of the Company. (c) The written agreement of all Members to dissolve the Company. (d) The sale or other disposition of substantially all of the Company's assets. (e) Entry of a decree of judicial dissolution under Corp C section 17351. 9.2. On the dissolution of the Company, the Company shall engage in no further business other than that necessary to wind up the business and affairs of the Company. The Managers who have not wrongfully dissolved the Company or, if there is no such Manager, the Members, shall wind up the affairs of the Company. The Delegates winding up the affairs of the Company shall give Notice of the commencement of winding up by mail to all known creditors and claimants against the Company whose addresses appear in the records of the Company. After paying or adequately providing for the payment of all known debts of the Company (except debts owing to Members), the remaining assets of the Company shall be distributed or applied in the following order: (a) To pay the expenses of liquidation. (b) To the establishment of reasonable reserves by the Delegate for contingent liabilities or obligations of the Company. Upon the Delegate's determination that such reserves are no longer necessary, said reserves shall be distributed as provided in this Section 9.2. - (c) To repay outstanding loans to Members. If there are insufficient funds to pay such loans in full, each Member shall be repaid in the ratio that the Member's loan, together with interest accrued and unpaid thereon, bears to the total of all such loans from Members, including all interest accrued and unpaid thereon. Such repayment shall first be credited to unpaid principal and the remainder shall be credited to accrued and unpaid interest. (d) Among the Members with Positive Capital Account Balances as provided in Article IV. 9.3. Each Member shall look solely to the assets of the Company for the return of the Member's investment, and if the Company property remaining after the payment or discharge of the debts and liabilities of the Company is insufficient to return the investment of each Member, such Member shall have no recourse against any other Members for indemnification, contribution, or reimbursement, except as specifically provided in this Agreement. ARTICLE X INDEMNIFICATION AND ARBITRATION 10.1. The Company shall have the power to indemnify any Person who was or is a party, or who is threatened to be made a party, to any Proceeding by reason of the fact that such Person was or is a Member, Manager, officer, employee, or other agent of the Company, or was or is serving at the request of the Company as a director, officer, employee, or other Agent of another limited liability company, corporation, partnership, joint venture, trust, or other enterprise, against expenses, judgments, fines, settlements, and other amounts actually and reasonably incurred by such Person in connection with such proceeding, if such Person acted in good faith and in a manner that such Person reasonably believed to be in the best interests of the Company, and, in the case of a criminal proceeding, such Person had no reasonable cause to believe that the Person's conduct was unlawful. The termination of any proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contenders or its equivalent, shall not, of itself, create a presumption that the Person did not act in good faith and in a manner that such Person reasonably believed to be in the best interests of the Company, or that the Person had reasonable cause to believe that the Person's conduct was unlawful. To the extent that an agent of the Company has been successful on the merits in defense of any Proceeding, or in defense of any claim, issue, or matter in any such Proceeding, the agent shall be indemnified against expenses actually and reasonably incurred in connection with the Proceeding. In all other cases, indemnification shall be provided by the Company only if authorized in the specific case by a Majority of Members. "Agent," as used in this Section 10.1, shall include a trustee or other fiduciary of a plan, trust, or other entity or arrangement described in Corp C section 207(f). "Proceeding," as used in this Section 10.1, means any threatened, pending, or completed action or proceeding, whether civil, criminal, administrative, or investigative. Expenses of each Person indemnified under this Agreement actually and reasonably incurred in connection with the defense or settlement of a proceeding may be paid by the Company in advance of the final disposition of such proceeding, as authorized by the Managers who are not seeking indemnification or, if there are none, by a Majority of the Members, upon receipt of an undertaking by such Person to repay such amount unless it shall ultimately be determined that such Person is entitled to be indemnified by the Company. "Expenses," as used in this Section 10.1, includes, without limitation, attorney fees and expenses of establishing a right to indemnification, if any, under this Section 10.1 10.2. Any action to enforce or interpret this Agreement, or to resolve disputes with respect to this Agreement as between the Company and a Member, or between or among the Members, shall be settled by arbitration in accordance with the rules of the American Arbitration Association. Arbitration shall be the exclusive dispute resolution process in the State of California, but arbitration shall be a nonexclusive process elsewhere. Any party may commence arbitration by sending a written demand for arbitration to the other parties. Such demand shall set forth the nature of the matter to be resolved by arbitration. The Manager shall select the place of arbitration. The substantive law of the State of California shall be applied by the arbitrator to the resolution of the dispute. The parties shall share equally all initial costs of arbitration. The prevailing party shall be entitled to reimbursement of attorney fees, costs, and expenses incurred in connection with the arbitration. AR decisions of the arbitrator shall be final, binding, and conclusive on all parties. Judgment may be entered upon any such decision in accordance with applicable law in any court having jurisdiction thereof. The arbitrator (if permitted under applicable law) or such court may issue a writ of execution to enforce the arbitrator's decision. ARTICLE XI ATTORNEY-IN-FACT AND AGENT 11.1. Each Member, by execution of this Agreement, irrevocably constitutes and appoints each Manager and any of them acting alone as such Member's true and lawful attorney-in-fact and agent, with full power and authority in such Member's name, place, and stead to execute, acknowledge, and deliver, and to file or record in any appropriate public office: (a) any certificate or other instrument that may be necessary, desirable, or appropriate to qualify the Company as a limited liability company or to transact business as such in any jurisdiction in which the Company conducts business; (b) any certificate or amendment to the Company's articles of organization or to any certificate or other instrument that may be necessary, desirable, or appropriate to reflect an amendment approved by the Members in accordance with the provisions of this Agreement; (c) any certificates or instruments that may be necessary, desirable, or appropriate to reflect the dissolution and winding up of the Company; and (d) any certificates necessary to comply with the provisions of this Agreement. This power of attorney will be deemed to be coupled with an interest and 'will survive the Transfer of the Member's Economic Interest. Notwithstanding the existence of this power of attorney, each Member agrees to join in the execution, acknowledgment, and delivery of the instruments referred to above if requested to do so by a Manager. This power of attorney is a limited power of attorney and does not authorize any Manager to act on behalf of a Member except as described in this Article XI. ARTICLE XII GENERAL PROVISIONS 12.1. This Agreement constitutes the whole and entire agreement of the parties with respect to the subject matter of this Agreement, and it shall not be modified or amended in any respect except by a written instrument executed by all the parties. This Agreement replaces and supersedes all prior written and oral agreements by and among the Members and Managers or any of them. 12.2. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 12.3. This Agreement shall be construed and enforced in accordance with the internal laws of the State of California. If any provision of this Agreement is determined by any court of competent jurisdiction or arbitrator to be invalid, illegal, or unenforceable to any extent, that provision shall, if possible, be construed as though more narrowly drawn, if a narrower construction would avoid such invalidity, illegality, or unenforceability or, if that is not possible, such provision shall, to the extent of such invalidity, illegality, or unenforceability, be severed, and the remaining provisions of this Agreement shall remain in effect. 12.4. This Agreement shall be binding on and inure to the benefit of the parties and their heirs, personal representatives, and permitted successors and assigns 12.5. Whenever used in this Agreement, the singular shall include the plural and the plural shall include the singular, and the neuter gender shall include the male and female as well as a trust, firm, company, or corporation, all as the context and meaning of this Agreement may require. 12.6. The parties to this Agreement shall promptly execute and deliver any and all additional documents, instruments, notices, and other assurances, and shall do any and all other acts and things, reasonably necessary in connection with the performance of their respective obligations under this Agreement and to carry out the intent of the parties. 12.7. Except as provided in this Agreement, no provision of this Agreement shall be construed to limit in any manner the Members in the carrying on of their own respective businesses or activities. 12.8. Except as provided in this Agreement, no provision of this Agreement shall be construed to constitute a Member, in the Member's capacity as such, the agent of any other Member. 12.9. Each Member represents and warrants to the other Members that the Member has the capacity and authority to enter into this Agreement. 12.10. The article, section, and paragraph titles and headings contained in this Agreement are inserted as matter of convenience and for ease of reference only and shall be disregarded for all other purposes, including the construction or enforcement of this Agreement or any of its provisions. 12.11. This Agreement may be altered, amended, or repealed only by a writing signed by all of the Members. 12.12. Time is of the essence of every provision of this Agreement that specifies a time for performance. 12.13. This Agreement is made solely for the benefit of the parties to this Agreement and their respective permitted successors and assigns, and no other person or entity shall have or acquire any right by virtue of this Agreement. IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement on the day and year first above written. IMPERIAL CREDIT MORTGAGE HOLDING, INC. by: /s/ Joseph R. Tomkinson ------------------------------------------- JOSEPH R. TOMKINSON, CEO IMH COMMERCIAL HOLDINGS, INC. by: /s/ William S. Ashmore ------------------------------------------ WILLIAM S. ASHMORE, President EXHIBIT "A" RECORDING REQUESTED BY AND WHEN RECORDED MAIL TO: SPACE ABOVE THIS LINE FOR RECORDER'S USE ================================================================================ State of California [SEAL] Bill Jones Secretary of State SACRAMENTO I, BILL JONES, Secretary of State of California., hereby certify: That the annexed transcript of 1 page(s) was prepared by and in this office from the record on file, of which it purports to be a copy, and that it is full, true and correct. IN WITNESS WHEREOF, I execute this certificate and affix the Great Seal of the State of California [SEAL] AUG 2 6 1997 ------------------------------------ /s/ Bill Jones Secretary of State SEC STATE FORM LP-222A (Rev 5/95) [SEAL] State of California Bill Jones Secretary of State LLC-1 LIMITED LIABILITY COMPANY ARTICLES OF ORGANIZATION IMPORTANT - Read the instructions before completing the form. --------- This document is presented for filing pursuant to Section 17050 of the California Corporations Code. - -------------------------------------------------------------------------------- 1. Limited liability company name: IMH/ICH DOVE STREET, LLC ----------- - -------------------------------------------------------------------------------- 2. Latest date (month/day/year) on which the limited liability company is to dissolve: AUGUST 25, 2047 - -------------------------------------------------------------------------------- 3. The purpose of the limited liability company is to engage in any lawful act or activity for which a limited liability company may be organized under the Beverly-Killea Limited Liability Company Act. - -------------------------------------------------------------------------------- 4. Enter the name of initial agent for service of process and check the appropriate provision below: DOUG SMITH, ESQ. , which is ----------------------------------------------- [X] an individual residing in California. Proceed to Item 5. [_] a corporation which has filed a certificate pursuant to Section 1505 of the California Corporations Code. Skip Item 5 and proceed to Item 6. - -------------------------------------------------------------------------------- 5. If the initial agent for service of process is an individual, enter a ---------- business or residential street address in California: Street Address: 5 HUTTON CENTRE DRIVE, STE 600 City: SANTA ANA State: CALIFORNIA Zip Code: 92707 - -------------------------------------------------------------------------------- 6. The limited liability company will be managed by: (check one) [_] one manager [_] more than one manager [X] limited liability company members - -------------------------------------------------------------------------------- 7. If other matters are to be included in the Articles of Organization attach one or more separate pages. Number of pages attached, if any. - -------------------------------------------------------------------------------- 8. It is hereby declared that I am the person who ______________ For Secretary of State Use executed this instrument, which execution is my act and deed. 101997237028 /s/ Jeffery A. Robinson - --------------------------------------- Signature of organizer FILED In the office of the Secretary of State Jeffery A. Robinson of the State of California - --------------------------------------- Type or print name of organizer AUG 25 1997 Date: August 25, 1997 /s/ Bill Jones ------------------------------ BILL JONES, Secretary Of State - --------------------------------------- LLC-1 Approved by the Secretary of State Filing Fee $70 1/96 EXHIBIT "B" MEMBER CONTRIBUTION - ------ ------------ IMPERIAL CREDIT MORTGAGE HOLDINGS, INC. $ 3,862,500.00 IMH COMMERCIAL HOLDINGS, INC. $ 3,862,500.00 EX-10.11 9 EMPLOYMENT AGREEMENT W/ WILLIAM ENDRESEN EMPLOYMENT AGREEMENT EXHIBIT 10.11 THIS EMPLOYMENT AGREEMENT is made effective as of this 8th day of August, 1997, by and between Imperial Commercial Capital Corporation, a California corporation ("Employer"), and William D. Endresen, an individual ("Employee"), with reference to the following facts: R E C I T A L S --------------- WHEREAS, Employee is knowledgeable of and skillful in Employer's business, which includes, but is not limited to, originating, purchasing and selling or securitizing commercial mortgages and performing operations as the conduit operations for affiliates and/or related entities of Employer as described in Attachment A hereto (the "Business"); WHEREAS, Employer believes that Employee will be an integral part of its management and is and will become more knowledgeable of and be in part responsible for developing the Business; WHEREAS, Employee possesses extensive management experience and knowledge regarding the Business, including confidential information concerning service marketing plans and strategy, business plans and projections and the formulas and models pertaining thereto, customer needs and peculiarities, finances, operations, billing methods and customer lists and detailed information (the "Trade Secrets"); WHEREAS, in order to induce Employer to enter into this Employment Agreement and to perform its obligations hereunder, Employee agrees not to compete with Employer or use any Trade Secrets or other confidential and/or proprietary business information regarding the Business of Employer, its affiliates and/or related entities (as more specifically described in Attachment A) to the detriment of Employer during the term of this Agreement and thereafter; WHEREAS, Employer desires that Employee be employed as President of Employer; WHEREAS, Employee is willing to be employed by Employer and provide services to Employer and any affiliates or related entities of Employer (as more fully described in Attachment A) under the terms and conditions herein stated. NOW, THEREFORE, in consideration of the mutual covenants and agreements hereinafter contained, and for other good and valuable consideration, it is hereby agreed by and between the parties hereto as follows: 1. Employment, Services, and Duties. -------------------------------- 1.1 Employer hereby employs Employee and Employee hereby accepts such employment full-time (subject to those exceptions, if any, set forth below) as President of Employer, with the powers and duties consistent with such position. Employee agrees to devote one hundred percent (100%) of all working hours to rendering the services on behalf of Employer and/or its affiliates or related entities (as described in Attachment A hereto). Employee shall render his services to Employer by and subject to the instructions and directions of Employer's Board of Directors to whom Employee shall directly report. 1.2 Employee acknowledges and agrees that Employee will be required by Employer to devote as much time as reasonably necessary to perform functions for Employer's related entities and/or affiliates (as set forth in Attachment A) and that such services are to be performed pursuant to and consistent with Employee's duties and obligations under this Agreement. 2. Term and Termination. -------------------- 2.1 Unless sooner terminated pursuant to Paragraph 2.2 hereof, Employee's employment shall continue for a period of five (5) years from the date of this Agreement ("Employment Date") unless extended by the mutual written agreement of Employer and Employee. 2.2 Employee's employment shall terminate prior to the expiration of the term set forth in Section 2.1 above upon the happening of any of the following events: (a) Voluntary termination by Employee which is not subject to Section 2.2(h) herein; (b) Death of Employee; (c) Dissolution or termination of Employer; (d) The voluntary or involuntary bankruptcy of Employer; (e) For cause if any of the following occurs: (i) Employee is convicted of (or pleads nolo contendere to), or at any time prior to employment by Employer, has been convicted of (or pled nolo contendere to) a crime of dishonesty or breach of trust or crime leading to incarceration of more than ninety (90) days (including, without limitation, embezzlement or theft from Employer) or the payment of a penalty or fine of $10,000 or more; (ii) Employer determines that Employee's performance is not satisfactory or that Employee has engaged in misconduct, negligence or neglect in the performance of Employee's duties under this Agreement; (iii) Employee has materially breached any of the terms of this Agreement or any other material legal obligation to Employer including, without limitation, a breach of trust or fiduciary duty owed to Employer or a material violation of Employer's policies or procedures; or (iv) Any determination of "cause" as used in this Section 2.2(e) shall be made only in good faith by an affirmative majority vote of the Board of Directors (not counting Employee, if a director) of the Employer; (f) By mutual agreement between Employer and Employee; (g) Upon the good faith determination of the Board of Directors of Employer that Employee has become so physically or mentally disabled as to be incapable of satisfactorily performing his duties hereunder for a period of ninety (90) consecutive days, such determination based upon a certificate as to such physical or mental disability issued by a licensed physician and/or psychiatrist (as the case may be) employed by the Employer; (h) Without cause by Employer. Employee may elect by notice to Employer to treat the following acts or omissions by Employer as a "termination without cause": (i) With respect to acts or omissions other than those specifically stated in this Paragraph (h), if Employer does not substantially comply with its payment obligations under this Agreement and such failure is not be corrected within ten (10) business days after delivery of notice to Employer of the facts upon which Employee basis his claim of such non-compliance; or (ii) A charge of material breach by Employer under Section 2.2(e) hereof which is determined by a final judgment made without adequate basis in law or fact. 2.3 Except as set forth in Sections 4, 5, 6 and 7 herein, in the event that Employee's employment is terminated pursuant to Sections 2.2(a), (b), (c), (d), (e), (f) or (g) herein, neither Employer nor Employee shall have any remaining duties or obligations hereunder, except that Employer shall pay to Employee, or his representatives, on the date of termination of employment ("Termination Date") the following: (a) Such compensation as is due pursuant to Section 3.1(a) herein, prorated through the Termination Date; and (b) Any expense reimbursements due and owing to Employee as of the Termination Date. 2.4 Except as set forth in Sections 4, 5, 6 and 7 herein, in the event that Employee's employment is terminated pursuant to Section 2.2(h) herein, neither Employer nor Employee shall have any remaining duties or obligations hereunder, except that Employer shall pay to Employee, or his representatives, on the Termination Date the following: (a) All such compensation as is due pursuant to Section 3.1(a) for a period of one year following the Termination Date; (b) Any bonus or incentive compensation to which Employee is entitled as provided for by any plan for the year of termination, prorated through the Termination Date, provided that, if such bonus or incentive compensation is discretionary in amount, Employee shall receive a payment at least equal to the last previous payment made to Employee, if any, for the previous year prorated to the Termination Date; and (c) Any expense reimbursements due and owing to Employee as of the Termination Date. 2.6 This Agreement shall not be terminated by any: (a) Merger, whether or not Employer is the surviving entity; or (b) Transfer of all or substantially all of the assets of Employer. 2.7 In the event of any merger, transfer of assets, dissolution, liquidation, or consolidation, the surviving corporation or transferee, as the case may be, shall be bound by and shall have the benefits of this Agreement, and the Employer shall take all action to ensure that such corporation or transferee is bound by the provisions of this Agreement. 3. Compensation. ------------ 3.1 As the total consideration for Employee's services rendered hereunder, Employee shall be entitled to the following: (a) A salary of One Hundred Twenty Thousand Dollars ($120,000) per year ("Salary"), payable in equal installments twice monthly on those days when Employer normally pays its employees. The Salary shall (i) be subject to an annual review and upward adjustment or no adjustment in the sole discretion of Employer, and (ii) be adjusted upward by at least the minimum increase, if any, in the cost of living in an amount obtained by multiplying the referenced salary (as adjusted, if applicable) by the percentage by which the level of the Consumer Price Index in the Los Angeles Metropolitan Area, as provided for the last day of such annual period by the Bureau of Labor Statistics of the United States Department of Labor, Bureau of Labor Statistics, Consumer Price Index, Urban Wage Earners and Clerical Workers, Los Angeles - Long Beach - Anaheim Metropolitan Area, All Items (1967=100) has increased over its level as of the later of: (A) the date hereof; or (B) the date of the previous automatic adjustment pursuant to this Section 3.1(a); (b) Those bonuses as set forth in Attachment B hereto, said bonuses, if any, to be paid to Employee as set forth therein; (c) Reimbursement for reasonable and necessary business and entertainment expenses incurred by Employee in connection with the performance of Employee's duties hereunder. In the event that any federal, state or local government agency or authority determines to disallow any such expenses which are reimbursed to Employee, Employee agrees, to the extent that such determination involves the Employee. to reimburse Employer as follows: (i) for all costs in disputing such action, including reasonable attorney's fees; and (ii) for all taxes and penalties incurred by Employer in connection with such action. (d) Employee shall be entitled to four (4) weeks vacation time each year without loss of compensation. Employee may be absent from his employment only at such times as Employer shall determine from time to time. Employee's vacation shall be governed by Employer's usual policies applicable to all employees; (e) Employer agrees to provide Employee with insurance coverage and other benefits available to all employees of Employer under its group plans; and (f) Such other benefits as the Board of Directors of Employer, in its sole discretion, may from time to time provide. 3.2 Employer shall have the right to deduct from the compensation due to Employee hereunder any and all sums required for social security and withholding taxes and for any other federal, state, or local tax or charge which may be in effect or hereafter enacted or required as a charge on the compensation of Employee. 4. Non-Competition. --------------- 4.1 At all times during Employee's employment hereunder, and for a period of one (1) year from the date of the termination of Employee's employment, if Employee's employment is terminated pursuant to Section 2.2(a) or -- 2.2(d) hereof, Employee shall not, directly or indirectly, engage or participate in, prepare or set up, assist or have any interest in any person, partnership, corporation, firm, association, or other business organization, entity or enterprise (whether as an employee, officer, director, agent, security holder, creditor, consultant or otherwise) that engages in any activity in those geographic areas where Employer conducts the Business, which activity is the same as, similar to, or competitive with any activity now engaged in by Employer or its affiliates and/or related entities (see Attachment A) or in any way relating to the Business. 4.2 Nothing contained in this Agreement shall be deemed to preclude Employee from purchasing or owning, directly or beneficially, as a passive investment, less than ten percent (10%) of any class of a publicly traded securities or any corporation so long as Employee does not actively participate in or control, directly or indirectly, any investment or other decisions with respect to such corporation. 5. Confidentiality. Employee shall keep all Trade Secrets and other --------------- confidential or proprietary information of Employer and its affiliates and/or related entities and shall use such information only in the course of performing Employee's duties hereunder. Employee shall maintain in trust all such Trade Secret or other confidential or proprietary information, as Employer's property, including, but not limited to, all documents concerning Employer's Business, including Employee's work papers, telephone directories, customer information and notes, and any and all copies thereof in Employee's possession or under Employee's control. Upon cessation of Employee's employment with Employer, for any reason, or upon request by Employer, Employee shall transfer to Employer all such documents belonging to Employer, including any and all copies in Employee's possession or under Employee's control. 6. Injunctive Relief. Employee hereby acknowledges and agrees that it ----------------- would be difficult to fully compensate Employer for damages resulting from a breach or threatened breach of Sections 4 and 5 of this Agreement and, accordingly, that Employer shall be entitled to temporary and injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, to enforce such Sections without the necessity of proving actual damages in connection therewith. This provision with respect to injunctive relief shall not, however, diminish Employer's right to claim and recover damages or enforce any other of its legal and/or equitable rights or defenses. 7. Copies of Agreement. Employee authorizes Employer to send a copy of ------------------- this Agreement to any and all future employers which Employee may have, and to any and all persons, firms, and corporations, with whom Employee may become affiliated in a business or commercial enterprise, and to inform any and all such employers, persons, firms or corporations that Employer intends to exercise its legal rights should Employee breach the terms of this Agreement or should another party induce a breach on Employee's part. 8. Severable Provisions. The provisions of this Agreement are severable -------------------- and if any one or more provisions is determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions, and any partially unenforceable provisions to the extent enforceable, shall nevertheless be binding and enforceable. 9. Reference Provision. ------------------- 9.1 Each controversy, dispute or claim between the parties arising out of or relating to this Agreement, which controversy, dispute or claim is not settled in writing within thirty (30) days after the "Claim Date" (defined as the date on which a party subject to the Agreement gives written notice to the other that a controversy, dispute or claim exists), will be settled by binding arbitration in Orange County, California in accordance with the provisions of the American Arbitration Association, which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim, and the parties waive their rights to initiate any legal proceedings against each other in any court or jurisdiction other than the Superior Court of Orange County (the "Court"). Any decision rendered by the arbitrator and such arbitration will be final, binding and conclusive and judgment shall be entered pursuant to Code of Civil Procedure Section 644 in any court in the State of California having jurisdiction. 9.2 Except as expressly set forth in this Agreement, the arbitrator shall determine the manner in which the proceeding is conducted, including the time and place of all hearings, the order of presentation of evidence, and all other questions that arise with respect to the course of the proceeding. All proceedings and hearings conducted before the arbitrator, except for trial, shall be conducted without a court reporter, except that when any party so requests, a court reporter will be used at any hearing conducted before the arbitrator. The party making such a request shall have the obligation to arrange for any pay for the court reporter. The costs of the court reporter shall be borne equally by the parties. 9.3 The arbitrator shall be required to be determine in all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the State of California will be applicable to the reference proceeding. The arbitrator shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the parties. The arbitrator shall issue a single judgement at the close of the proceeding which shall dispose of all of the claims of the parties that are the subject of the proceeding. The parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgement entered by the arbitrator. The parties hereto expressly reserve the right to findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment, which new trial, if granted, is also to be a proceeding governed under this provision. 10. Binding Agreement. This Agreement shall inure to the benefit of and ----------------- shall be binding upon Employer, its successors and assigns. 11. Captions. The Section herein captions are inserted only as a matter -------- of convenience and reference and in no way define, limit or describe the scope of this Agreement or the intent of any provisions hereof. 12. Entire Agreement. This Agreement contains the entire agreement of the ---------------- parties relating to the subject matter hereof, and the parties hereto have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth otherwise herein. This Agreement supersedes any and all prior agreements, written or oral, with Employer. Any such prior agreements are hereby terminated and of no further effect and Employee by the execution hereof agrees that any compensation provided for under any such prior agreement(s) is specifically superseded and replaced by the provision of this Agreement. No modification of this Agreement shall be valid unless made in writing and signed by the parties hereto and unless such writing is made by an executive officer of Employer. The parties hereto agree that in no event shall an oral modification of this Agreement be enforceable or valid. 13. Governing Law. This Agreement is and shall be governed and construed ------------- in accordance with the laws of the State of California. 14. Notice. All notices and other communications under this Agreement ------ shall be in writing (including, without limitation, telegraphic, telex, telecopy or cable communication) and mailed, telegraphed, telexed, telecopied, cabled or delivered by hand or by a nationally recognized courier service guaranteeing overnight delivery to a party at the following address (or to such other address as such party may have specified by notice given to the other party pursuant to this provision): If to Employer: Imperial Commercial Capital Corporation 1 Park Plaza, Suite 430 Irvine, California 92614 Telephone: (714) 477-9100 Facsimile: (714) 477-9400 Attention: Richard J. Johnson Chief Financial Officer With a copy to: Freshman, Marantz, Orlanski, Cooper & Klein 9100 Wilshire Boulevard Eighth Floor-East Tower Beverly Hills, CA 90212 Telephone: (310) 273-1870 Facsimile: (310) 274-8293 Attention: Thomas J. Poletti, Esq. If to Employee: William D. Endresen Imperial Commercial Capital Corporation 1 Park Plaza, Suite 430 Irvine, California 92614 Telephone: (714) 477-9100 Facsimile: (714) 477-9400 15. Attorney's Fees. In the event that any party shall bring an action or --------------- proceeding in connection with the performance, breach or interpretation hereof, then the prevailing party in such action as determined by the court or other body having jurisdiction shall be entitled to recover from the losing party in such action, as determined by the court or other body having jurisdiction, all reasonable costs and expense of litigation or arbitration, including reasonable attorney's fees, court costs, costs of investigation and other costs reasonably related to such proceeding. IN WITNESS WHEREOF, this Agreement is executed as of the day and year first above written. "EMPLOYER" IMPERIAL COMMERCIAL CAPITAL CORPORATION a California corporation By: /s/ William S. Ashmore ------------------------------------- Name: Title: "EMPLOYEE" /s/ William D. Endresen ------------------------------------- William D. Endresen ATTACHMENT A ------------ EMPLOYER AFFILIATES AND/OR RELATED ENTITIES ------------------------------------------- Employee acknowledges and understands that Employee may be requested by Employer to devote some or all of Employee's time and effort during the term of employment pursuant to this Agreement to the businesses of Employer's affiliates and/or related entities pursuant to certain agreements between and among Employer and such affiliates and/or related entities. Said affiliates or related entities include the following: IMH Commercial Holdings, Inc. RAI Advisors, LLC Imperial Credit Mortgage Holdings, Inc. ICI Funding Corporation Employees further understands and acknowledges that, pursuant to this Agreement, Employee may be directed by Employer to provide services to additional real estate investment trusts or other entities which Employer establishes or with which Employer affiliates or becomes related and for which there exists an agreement with Employer or any of the above entities to provide such services. Employee understands and acknowledges that Employee's obligations under the Agreement, including, but not limited to, Employee's duties under Sections 4 and 5 thereof, shall apply and extend to Employee's knowledge of the business of Employer's affiliates and/or related entities and any Trade Secret or other confidential or proprietary information relating to same. Acknowledged and Agreed: Date: August 8, 1997 /s/ William D. Endresen ------------------------ William D. Endresen ATTACHMENT B ------------ BONUS SCHEDULE -------------- 1. Car Allowance: $5,000 per year 2. Annual Bonus to be determined by the Chief Executive Officer of the Company. EX-10.12 10 SERVICING AGREEMENT DATED JULY 31, 1998 EXHIBIT 10.12 SERVICING AGREEMENT Dated as of July 31, 1998 between IMPAC COMMERCIAL HOLDINGS, INC. and IMPAC COMMERCIAL CAPITAL CORPORATION, "Owner" and MIDLAND LOAN SERVICES, INC., "Servicer" TABLE OF CONTENTS ARTICLE I. DEFINITIONS Section 1.01 Defined Terms................................................ 1 ARTICLE II. RETENTION AND AUTHORITY OF SERVICER Section 2.01 Engagement; Servicing Standard............................... 6 Section 2.02 Subservicing................................................. 7 Section 2.03 Authority of the Servicer.................................... 8 ARTICLE III. SERVICES TO BE PERFORMED Section 3.01 Services as Loan Servicer.................................... 8 Section 3.02 Escrow Accounts; Collection of Taxes, Assessments and Similar Items................................................ 9 Section 3.03 Collection Accounts.......................................... 10 Section 3.03 Collection Accounts.......................................... 10 Section 3.04 Permitted Investments........................................ 10 Section 3.05 Maintenance of Insurance Policies............................ 11 Section 3.06 Delivery and Possession of Servicing Files................... 12 Section 3.07 Inspections.................................................. 12 Section 3.08 "Due-on-Sale" Clauses; Assumption Agreements................. 13 Section 3.09 Realization Upon Mortgaged Properties........................ 13 Section 3.10 Sale of Specially Serviced Mortgage Loans and REO Properties. 14 Section 3.11 Management of REO Property................................... 14 Section 3.12 Modifications, Waivers, Amendments and Consents.............. 15 ARTICLE IV. STATEMENTS AND REPORTS Section 4.01 Reporting by the Servicer.................................... 15 ARTICLE V. SERVICER'S COMPENSATION AND EXPENSES Section 5.01 Servicing Compensation....................................... 16 Section 5.02 Servicing Expenses........................................... 16 ARTICLE VI. THE SERVICER AND THE OWNER Section 6.01 Servicer Not to Assign; Merger or Consolidation of the Servicer..................................................... 17 Section 6.02 Liability and Indemnification of the Servicer and the Owner.. 17 ARTICLE VII. REPRESENTATIONS AND WARRANTIES; DEFAULT Section 7.01 Representations and Warranties............................... 17 Section 7.02 Events of Default............................................ 18 ARTICLE VIII. TERMINATION; TRANSFER OF MORTGAGE LOANS Section 8.01 Termination of Agreement..................................... 19 Section 8.02 Transfer of Mortgage Loans; Securitization................... 20 ARTICLE IX. MISCELLANEOUS PROVISIONS Section 9.01 Amendment; Waiver............................................ 21 Section 9.02 Governing Law................................................ 21 Section 9.03 Notices...................................................... 21 Section 9.04 Severability of Provisions................................... 22 Section 9.05 Inspection and Audit Rights.................................. 22 Section 9.06 Binding Effect; No Partnership; Counterparts................. 22 Section 9.07 Protection of Confidential Information; No Solicitation...... 22 Section 9.08 General Interpretive Principles.............................. 22 Section 9.09 Further Agreements........................................... 23 EXHIBIT "A" Mortgage Loan Schedule EXHIBIT "B" Servicing File Listing THIS SERVICING AGREEMENT dated as of July 31, 1998, is between IMPAC Commercial Holdings, Inc., a Maryland corporation, IMPAC Commercial Capital Corporation, a California corporation, and Midland Loan Services, Inc., a Delaware corporation. PRELIMINARY STATEMENT The Owner desires to engage the Servicer, and the Servicer desires to accept the Owner's engagement, to service the Mortgage Loans that the Owner acquires from time to time in accordance with the provisions of this Agreement. The Servicer is an independent contractor in the business of servicing mortgage loans, and is not an Affiliate of the Owner. This Agreement shall become effective with respect to each Mortgage Loan, or appropriate group or portfolio of Mortgage Loans, upon the related Servicing Transfer Date. NOW, THEREFORE, in consideration of the recitals in this Preliminary Statement which are made a contractual part hereof, and of the mutual promises contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I. ---------- DEFINITIONS Section 1.01 Defined Terms. ------------- Whenever used in this Agreement, the following words and phrases, unless the context otherwise requires, shall have the following meanings: "Accepted Servicing Practices": As defined in Section 2.01. ---------------------------- "Accounts": The Escrow Accounts, REO Accounts and the Collection Accounts. -------- "Additional Servicing Compensation": (i) amounts collected for checks or --------------------------------- other items returned for insufficient funds, (ii) late payment charges (but not default interest) with respect to the Mortgage Loans, (iii) to the extent the Servicer has been engaged by the Owner under Section 3.08 or 3.12, any modification fees, extension fees, assumption fees and similar processing fees received from or on behalf of any Borrower, (iv) subject to Section 3.04 of the Agreement, all income and gain realized from the investment of funds deposited in the Accounts, and (v) any Termination Fees. "Advance Rate": A per annum rate equal to the "Prime Rate" (as published ------------ from time to time in the "Money Rates" section of The Wall Street Journal). "Affiliate": With respect to any specified Person, any other Person --------- controlling or controlled by or under common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise and the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Agreement": This Servicing Agreement, as the same may be modified, --------- supplemented or amended from time to time. "Best Efforts": Efforts determined to be reasonably diligent by the Owner ------------ or the Servicer, as the case may be, in its reasonable discretion, which efforts do not require the Owner or the Servicer, as the case may be, to enter into any litigation, arbitration or other legal or quasi-legal proceeding. "Borrower": The obligor on a Note. -------- "Business Day": Any day other than (i) a Saturday or Sunday, or (ii) a day ------------ in which depository institutions or trust companies in the State of Missouri or in any of the States in which the Accounts or any accounts used by the Owner for remittance purposes are located, are authorized or obligated by law, regulation or executive order to remain closed. "Collection Account": As defined in Section 3.03. ------------------ "Corrected Mortgage Loan": Any Mortgage Loan which is no longer a ----------------------- Specially Serviced Mortgage Loan pursuant to the second sentence of the definition of "Specially Serviced Mortgage Loan". "Determination Date": The 12th day (or if such day is not a Business Day, ------------------ the Business Day immediately preceding such day) of the month, beginning on August 12, 1998. "Disposition Fee": In connection with the sale of any Specially Serviced --------------- Mortgage Loan or REO Property pursuant to Section 3.10, the fee payable to the Servicer in amount equal to the product of (x) the related Net Liquidation Proceeds and (y) 1.00%; provided, however, that such fee shall not exceed -------- ------- $100,000 for each Mortgage Loan. "Eligible Account": Either: (i) an account maintained with NationsBank, ---------------- N.A. or PNC Bank, National Association, or (ii) an account maintained with a depository institution or trust company which has been approved by the Owner in writing. "Environmental Laws": Any environmental law, ordinance, rule, regulation ------------------ or order of a federal, state or local governmental authority, including, without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (42 U.S.C. (S)(S) 9601 et seq.), the Hazardous Material Transportation Act, as amended (49 U.S.C. (S)(S) 1801 et seq.), the Resource Conservation and Recovery Act, as amended (42 U.S.C. (S)(S) 6901 et seq.), the Federal Water Pollution Control Act, as amended (33 U.S.C. (S)(S) 1251 et seq.), the Clean Air Act (42 U.S.C. (S)(S) 7401 et seq.) and the regulations promulgated pursuant thereto. "Escrow Account": As defined in Section 3.02. -------------- "Escrow Payment": Any payment received by the Servicer for the account of -------------- the Borrowers for application toward the payment of taxes, insurance premiums, assessments, ground rents, deferred maintenance, environmental remediation, rehabilitation costs, capital expenditures, and similar items in respect of the related Mortgaged Property. "Event of Default": As defined in Section 7.02. ---------------- "Loan Servicing": As defined in Section 3.01. -------------- "Monthly Payment": With respect to any Mortgage Loan, the scheduled --------------- monthly payment of interest or the scheduled monthly payment of principal and interest, as the case may be, on such Mortgage Loan which is payable by a Borrower on the due date under the related Note. "Mortgage": With respect to each Mortgage Loan, the mortgage, deed of -------- trust or other instrument securing the related Note, which creates a lien on the real property securing such Note. "Mortgage Loan": Each of the mortgage loans identified on the Mortgage ------------- Loan Schedule. "Mortgage Loan Documents": With respect to each Mortgage Loan, the related ----------------------- Note, the related Mortgage and any and all other documents executed and delivered in connection with the origination or subsequent modification of such Mortgage Loan. "Mortgage Loan Schedule": A schedule of certain mortgage loans owned and ---------------------- held by the Owner which sets forth information with respect to such mortgage loans, as amended from time to time by the parties. An initial Mortgage Loan Schedule shall be attached hereto as Exhibit "A". "Mortgaged Property": The real property and improvements thereon securing ------------------ repayment of the debt evidenced by the related Note. Such term shall also include any REO Property. "Net Liquidation Proceeds": The amount of proceeds received in connection ------------------------ with the liquidation or sale of any Specially Serviced Mortgage Loan or REO Property net of the amount of any liquidation expenses (including, without limitation, legal fees and expenses, brokerage commissions and conveyance taxes) incurred with respect to such liquidation or sale. "Note": With respect to any Mortgage Loan, the promissory note or other ---- evidence of indebtedness or agreements evidencing the indebtedness of a Borrower under such Mortgage Loan. "Owner": With respect to any Mortgage Loan, either (i) IMPAC Commercial ----- Holdings, Inc. if such entity is the owner and holder of such Mortgage Loan, or (ii) IMPAC Commercial Capital Corporation if such entity is the owner and holder of such Mortgage Loan, as the same may be identified in the Mortgage Loan Schedule. "Permitted Investments": Any one or more of the following obligations or --------------------- securities having at the time of purchase, or at such other time as may be specified, the required ratings, if any, provided for in this definition: (i) direct obligations of, or guaranteed as to timely payment of principal and interest by, the United States of America or any agency or instrumentality thereof provided that such obligations are backed by the full faith and credit of the United States of America; (ii) direct obligations of, or guaranteed as to timely payment of principal and interest by, the Federal Home Loan Mortgage Corporation, the Federal Home Loan Bank, the Federal National Mortgage Association or the Federal Farm Credit System, provided that any such obligation, at the time of purchase or contractual commitment providing for the purchase thereof, is qualified by any Rating Agency as an investment of funds backing securities rated "AAA" (or such comparable rating); (iii) demand and time deposits in or certificates of deposit of, or bankers' acceptances issued by, any bank or trust company, savings and loan association or savings bank, provided that, in the case of obligations that are not fully insured by the Federal Deposit Insurance Corporation, the commercial paper and/or long-term unsecured debt obligations of such depository institution or trust company (or in the case of the principal depository institution in a holding company system, the commercial paper or long-term unsecured debt obligations of such holding company) have the highest rating available for such securities by any Rating Agency; (iv) general obligations of or obligations guaranteed by any state of the United States or the District of Columbia receiving the highest long-term debt rating available for such securities by any Rating Agency; (v) commercial or finance company paper (including both non-interest- bearing discount obligations and interest-bearing obligations payable on demand or on a specified date not more than one year after the date of issuance thereof) that is rated by any Rating Agency in its highest short-term unsecured debt rating category at the time of such investment or contractual commitment providing for such investment, and is issued by a corporation the outstanding senior long-term debt obligations of which are then rated by any such Rating Agency in its highest long-term unsecured debt rating category; (vi) guaranteed reinvestment agreements issued by bank, insurance company or other corporation rated in one of the two highest long-term unsecured debt rating levels available to such issuers by any Rating Agency at the time of such investment, provided that any such agreement must by its terms provide that it is terminable by the purchaser without penalty in the event any such rating is at any time lower than such level; (vii) repurchase obligations with respect to any security described in clause (i) or (ii) above entered into with a depository institution or trust company (acting as principal) described in clause (iii) above; (viii) securities bearing interest or sold at a discount that are issued by any corporation incorporated under the laws of the United States of America or any state thereof and rated by any Rating Agency in its highest long-term unsecured rating category at the time of such investment or contractual commitment providing for such investment; (ix) units of taxable money market funds which funds are regulated investment companies, seek to maintain a constant net asset value per share and invest solely in obligations backed by the full faith and credit of the United States, and have been approved in writing by the Owner as Permitted Investments with respect to this definition; and (x) such other obligations as are acceptable as Permitted Investments to the Owner. "Person": Any individual, corporation, limited liability company, ------ partnership, joint venture, estate, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. "Qualified Affiliate": Any Person (a) that is organized and doing business ------------------- under the laws of any state of the United States or the District of Columbia, (b) that is in the business of performing the duties of a servicer of commercial mortgage loans, and (c) as to which 50% or greater of its outstanding voting stock or equity ownership interest are directly or indirectly owned by the Servicer or by any Person or Persons who directly or indirectly own equity ownership interests in the Servicer. "Rating Agency": Each of Standard & Poor's Ratings Services, a division of ------------- McGraw-Hill, Inc., Moody's Investors Service, Inc., Fitch IBCA, Inc., Duff and Phelps Credit Rating Co., or any other nationally recognized statistical rating agency. "Remittance Date": With respect to each Determination Date, the date which --------------- is five (5) Business Days after such Determination Date. "REO Account": As defined in Section 3.11(a). ----------- "REO Mortgage Loan": A Mortgage Loan deemed for the purposes hereof to be ----------------- outstanding with respect to each REO Property, as more particularly described in Section 3.09(b). "REO Property": A Mortgaged Property acquired by the Servicer on behalf of ------------ the Owner through foreclosure or by deed in lieu of foreclosure. "Responsible Officer": Any officer or employee of the Owner or the ------------------- Servicer, as the case may be, involved in or responsible for the administration, supervision or management of this Agreement and whose name and specimen signature appear on a list prepared by each party and delivered to the other party, as such list may be amended from time to time by either party. "Securitization": One or more transactions involving the issuance of -------------- certificates, bonds or other equity or debt instruments which are rated by one or more of the Rating Agencies and are collateralized by or evidence interests in a pool of one or more commercial mortgage loans that includes any or all of the Mortgage Loans. "Servicer": Midland Loan Services, Inc., a Delaware corporation, or any -------- successor Servicer as herein provided. "Servicing Expenses": All customary, reasonable and necessary out-of- ------------------ pocket costs and expenses paid or incurred in connection with the Servicer's obligations hereunder or in connection with any Special Services to be performed by the Servicer pursuant to Section 3.01, including without limitation: (a) real estate taxes, assessments and similar charges; (b) insurance premiums; (c) any expense necessary in order to prevent or cure any violation of applicable laws, regulations, codes, ordinances, rules, orders, judgments, decrees, injunctions or restrictive covenants; (d) any cost or expense necessary in order to maintain or release the lien on each Mortgaged Property and related collateral, including any mortgage registration taxes, release fees, or recording or filing fees; (e) customary expenses for the collection, enforcement or foreclosure of the Mortgage Loans and the collection of deficiency judgments against Borrowers and guarantors (including but not limited to the fees and expenses of any trustee under a deed of trust, foreclosure title searches and other lien searches); (f) subject to Section 3.07, costs and expenses of any appraisals, valuations, inspections, environmental assessments (including but not limited to the fees and expenses of environmental consultants), audits or consultations, engineers, architects, accountants, on-site property managers, market studies, title and survey work and financial investigating services; (g) customary expenses for liquidation, restructuring, modification or loan workouts, such as sales brokerage expenses and other costs of conveyance; (h) costs and expenses related to travel and lodging, subject to Section 3.07 with respect to property inspections; and (i) any other reasonable costs and expenses, including without limitation, legal fees and expenses, incurred by the Servicer under this Agreement in connection with the enforcement, collection, foreclosure, disposition, condemnation or destruction of the Mortgage Loans or related Mortgaged Properties, the maintenance, leasing, operation, management and sale of the REO Properties, and the performance of Loan Servicing by the Servicer under this Agreement. Notwithstanding the foregoing, Servicing Expenses shall not be deemed to include costs and expenses incurred by the Servicer in the performance of its Loan Servicing obligations hereunder that are in the nature of internal costs or fixed overhead of the Servicer (including, without limitation, costs and expenses relating to data processing, computer and telephone systems, office space, equipment and supplies, and employee salaries and related expenses), which shall be borne solely by the Servicer. "Servicing Fee": With respect to each Mortgage Loan, an amount equal to ------------- the product of (a) the related Servicing Fee Rate and (b) the outstanding principal balance of such Mortgage Loan, as calculated in accordance with Section 5.01. "Servicing Fee Rate": A rate equal to (a) 0.10% (10 basis points) for ------------------ those Mortgage Loans with an original principal balance of less than $2,000,000, and (b) 0.05% (5 basis points) for those Mortgage Loans with an original principal balance greater than or equal to $2,000,000, but less than or equal to $10,000,000. Notwithstanding the foregoing, for those Mortgage Loans which have multiple properties which are cross-collateralized and cross-defaulted with other mortgage loans or having lockbox or cash management arrangements, or for Mortgage Loans with an original principal balance greater than $10,000,000.00, the Servicing Fee Rate in any such event shall be negotiated in good faith by the parties hereto on a case-by-case basis. "Servicing File": With respect to each Mortgage Loan, (i) all Mortgage -------------- Loan Documents, (ii) to the extent not included as a Mortgage Loan Document, the documents, information and records set forth in the file listing attached hereto as Exhibit "B", and (iii) any additional documents or information related thereto maintained or created by the Servicer. "Servicing Transfer Date": With respect to each Mortgage Loan, the date of ----------------------- delivery by Owner to the Servicer of the related Servicing File "Specially Serviced Mortgage Loan": Any Mortgage Loan with respect to -------------------------------- which: (a) the related Borrower is at least two months delinquent (without giving effect to any grace periods permitted by the related Mortgage Loan Documents) in the payment of a Monthly Payment; (b) the related Borrower has expressed to the Servicer an inability to pay or a hardship in paying the Mortgage Loan in accordance with its terms; (c) the Servicer has received notice that the related Borrower has become the subject of any bankruptcy, insolvency or similar proceeding, or has admitted in writing the inability to pay its debts as they come due or made an assignment for the benefit of creditors; (d) the Servicer has received notice of a foreclosure or threatened foreclosure of any lien (other than the Mortgage Loan) on the related Mortgaged Property; (e) a default of which the Servicer has notice (other than a failure by the related Borrower to pay principal or interest) and which materially and adversely affects the interests of the Owner has occurred and remains unremedied for the applicable grace period specified in the Mortgage Loan; or (f) the related Borrower has failed to make a balloon payment as and when due and such default has not been cured within 30 days after such due date; provided, however, that with respect to the circumstances described in clauses - -------- ------- (b), (d) and (e), the Servicer has received written confirmation from the Owner that such Mortgage Loan shall be a Specially Serviced Mortgage Loan. To the extent no other circumstances identified in clauses (a) through (f) above exist that would cause the Mortgage Loan to continue to be characterized as a Specially Serviced Mortgage Loan, a Mortgage Loan will cease to be a Specially Serviced Mortgage Loan: (i) with respect to the circumstances described in clauses (a) or (f) above, when the related Borrower has brought the Mortgage Loan current (or, with respect to the circumstances described in clause (f), pursuant to any work-out of the Mortgage Loan) and thereafter made three consecutive full and timely Monthly Payments (including pursuant to such workout); or (ii) with respect to the circumstances described in clauses (b), (c), (d) and (e) above, when such circumstances cease to exist or such default is cured, as applicable, in the good faith judgment of the Servicer (as confirmed in writing by the Owner). "Special Servicing Fee": With respect to each Specially Serviced Mortgage --------------------- Loan or REO Mortgage Loan, an amount equal to the product of (a) the related Special Servicing Fee Rate and (b) the outstanding principal balance of such Mortgage Loan, as calculated in accordance with Section 5.01. "Special Servicing Fee Rate": A rate equal to (a) 0.25% (25 basis points) -------------------------- for those Specially Serviced Mortgage Loans with a current principal balance greater than or equal to $2,000,000 and (b) 0.35% (35 basis points) for those Specially Serviced Mortgage Loans with a current principal balance less than $2,000,000. "Termination Fee": Subject to Section 8.01, an amount equal to the excess --------------- of (i) the product of (a) the Servicing Fees payable to the Servicer with respect to the related Mortgage Loans during the month in which the effective date of termination occurs and (b) six, over (ii) the amount of Servicing Fees with respect to such Mortgage Loans received by the Servicer through such effective date of termination. "Workout Fee": In connection with the curing of any event of default under ----------- any Specially Serviced Mortgage Loan through a modification, restructuring or work-out of such Mortgage Loan effected by the Servicer and evidenced by a writing executed by the related Borrower, the fee payable to the Servicer in an amount equal to the product of (x) the outstanding principal balance of such Mortgage Loan at the time such Mortgage Loan becomes a Corrected Mortgage Loan and (y) 0.50%; provided, however that such fee shall not exceed $50,000 for each -------- ------- Mortgage Loan. ARTICLE II. ----------- RETENTION AND AUTHORITY OF SERVICER Section 2.01 Engagement; Servicing Standard. ------------------------------ The Owner hereby engages the Servicer to perform, and the Servicer hereby agrees to perform, Loan Servicing with respect to each of the Mortgage Loans throughout the term of this Agreement, upon and subject to the terms, covenants and provisions hereof. The Servicer shall perform its services hereunder (a) in accordance with (i) applicable laws, (ii) the terms and provisions of the Mortgage Loan Documents, (iii) the express terms hereof, and (iv) the customary and usual standards of practice of prudent institutional commercial mortgage loan servicers, and (b) to the extent consistent with the foregoing requirements, in the same manner in which the Servicer services commercial mortgage loans for other third party portfolios of mortgage loans similar to the Mortgage Loans, but without regard to any relationship which the Servicer or any Affiliate of the Servicer may have with the related Borrower or any Affiliate of such Borrower or to the Servicer's right to receive compensation for its services hereunder. The servicing standards described in the preceding sentence are herein referred to as "Accepted Servicing Practices". ---------------------------- Section 2.02 Subservicing. ------------ The Servicer may subservice to any Person any of its Loan Servicing obligations hereunder only with the Owner's written consent or to the extent necessary for the Servicer to comply with any applicable laws, regulations, codes or ordinances relating to the Servicer's Loan Servicing obligations hereunder; provided, however, that the Servicer shall provide oversight and -------- ------- supervision with regard to the performance of all subcontracted services and any subservicing agreement shall be consistent with and subject to the provisions of this Agreement. Neither the existence of any subservicing agreement nor any of the provisions of this Agreement relating to subservicing shall relieve the Servicer of its obligations to the Owner hereunder. Notwithstanding any such subservicing agreement, the Servicer shall be obligated to the same extent and under the same terms and conditions as if the Servicer alone was servicing the related Mortgage Loans in accordance with the terms of this Agreement. The Servicer shall be solely liable for all fees owed by it to any subservicer, regardless of whether the Servicer's compensation hereunder is sufficient to pay such fees. Section 2.03 Authority of the Servicer. ------------------------- (a) In performing its Loan Servicing obligations hereunder, the Servicer shall, except as otherwise provided herein and subject to the terms of this Agreement, have full power and authority, acting alone or through others, to take any and all actions in connection with such Loan Servicing that it deems necessary or appropriate. Without limiting the generality of the foregoing, the Servicer is hereby authorized and empowered by the Owner when the Servicer deems it appropriate in its best judgment, to execute and deliver, on behalf of the Owner, (a) any and all financing statements, continuation statements and other documents or instruments necessary to maintain the lien of each Mortgage on the related Mortgaged Property and any other related collateral; and (b) any and all instruments of satisfaction or cancellation, or of partial or full release or discharge and all other comparable instruments with respect to each of the Mortgage Loans; provided, however, that the Servicer shall notify the Owner in -------- ------- writing prior to entering into material discussions with the related Borrower with respect to any such instrument referred to in clause (b) above, and, except in connection with any payment in full of any Mortgage Loan, shall proceed with such course of action only upon receipt of the Owner's written approval thereof. The Owner agrees to cooperate with the Servicer by either executing and delivering to the Servicer from time to time (i) powers of attorney evidencing the Servicer's authority and power under this Section, or (ii) such documents or instruments deemed necessary or appropriate by the Servicer to enable the Servicer to carry out its Loan Servicing obligations hereunder. (b) In the performance of its Loan Servicing obligations hereunder, the Servicer shall take any action that is directed by the Owner which relates to the Servicer's Loan Servicing obligations under this Agreement; provided, -------- however, that the Servicer shall not be obligated to take, or to refrain from - ------- taking, any action which the Owner requests that the Servicer take or refrain from taking to the extent that the Servicer determines in its reasonable and good faith judgment that such action or inaction (i) may cause a violation of applicable laws, regulations, codes, ordinances, court orders or restrictive covenants with respect to any Mortgage Loan, Borrower, Mortgaged Property or REO Property; or (ii) may cause a violation of any provision of a Mortgage Loan Document. ARTICLE III. ------------ SERVICES TO BE PERFORMED Section 3.01 Services as Loan Servicer. ------------------------- The Servicer hereby agrees to serve as the loan servicer with respect to each of the Mortgage Loans and to perform Loan Servicing as described below and as otherwise provided herein, upon and subject to the terms of this Agreement. Subject to any limitation of authority under Section 2.03, "Loan Servicing" -------------- shall mean those services pertaining to the Mortgage Loans which, applying Accepted Servicing Practices, are required hereunder to be performed by the Servicer, and which shall include: (i) reviewing all available documents pertaining to the Mortgage Loans, organizing, administering and maintaining the Servicing Files, and inputting all relevant information into the Servicer's loan servicing computer system; (ii) preparing and filing or recording all financing statements, continuation statements and other documents or instruments and taking such other action necessary to maintain the lien of any Mortgage on the related Mortgaged Property; (iii) monitoring each Borrower's maintenance of insurance coverage on each Mortgaged Property as required by the related Mortgage Loan Documents and causing to be maintained adequate insurance coverage on each Mortgaged Property in accordance with Section 3.05; (iv) monitoring the status of real estate taxes, assessments and other similar items and verifying the payment of such items for each Mortgaged Property in accordance with Section 3.02; (v) preparing and delivering all reports and information required hereunder; (vi) procuring and supervising the services of third parties (other than subservicers pursuant to Section 2.02) necessary or appropriate in connection with the servicing of the Mortgage Loans by the Servicer; (vii) performing payment processing, record keeping, administration of escrow and other accounts, interest rate adjustment, and other routine customer service functions; (viii) monitoring any casualty losses or condemnation proceedings and administering any proceeds related thereto in accordance with the related Mortgage Loan Documents; (ix) notifying all Borrowers of the appropriate place for communications and payments, and collecting and monitoring all payments made with respect to the Mortgage Loans; (x) administering any requests for assumptions of a Mortgage Loan or transfers of ownership of or placement of subordinate financing on a Mortgaged Property in accordance with Section 3.08; (xi) commencing on behalf of the Owner any litigation or proceeding relating to the foreclosure or other realization upon the collateral under any of the Mortgage Loans, and retaining legal counsel in connection therewith, all in accordance with Section 3.09. (xii) selling or disposing of each Specially Serviced Mortgage Loan or REO Property in accordance with Section 3.10; (xiii) managing and operating each REO Property in accordance with Section 3.11; (xiv) administering any proposals for modifications, waivers, amendments or consents with respect to any term of a Mortgage Loan in accordance with Section 3.12. Notwithstanding anything herein to the contrary, the Servicer shall not be required to undertake any lease approvals, loan modifications, workouts or restructuring, loan assumptions or substitutions, processing partial releases of collateral or subordinate financing requests, provided, however, that the -------- ------- Servicer shall be responsible for acting as the intermediary between the Borrower and the Owner with respect to (x) processing Borrower requests for consents to actions and (y) the administration of the terms and provisions of the Mortgage Loan Documents, which includes, without limitation, collecting, organizing and forwarding to the Owner any documents in the possession of the Servicer which relate to the Servicer's obligation to act as such intermediary; and provided, further, that, subject to the above proviso, the Owner shall be -------- ------- responsible for taking any actions regarding such Borrower requests and, therefore, shall be entitled to retain any modification fees, extension fees, assumption fees, and similar processing fees received from or on behalf of any Borrower unless and until the Owner elects to engage the Servicer to perform such services pursuant to Sections 3.08 and 3.12. When determined to be appropriate by the Owner in accordance with such reasonable policies, procedures and limitations as the parties may agree upon from time to time, all notices, correspondence and any other communication from or by the Servicer with the Borrowers shall be in the name of the Owner, provided, however, that the foregoing requirement shall not be applicable to any - -------- ------- Loan Servicing duties relating to any Specially Serviced Mortgage Loan or REO Property. The Owner shall provide the Servicer with specifications for lettering and symbols, including letterhead, to be used in any correspondence on other communication to be given by the Servicer in the name of the Owner as provided for herein, subject to the proviso in the second preceding sentence. At the written request of the Owner, the Servicer shall maintain a dedicated "800" telephone line for exclusive use with respect to Mortgage Loans, which telephone shall be answered in the name of the Owner. Section 3.02 Escrow Accounts; Collection of Taxes, Assessments and Similar ------------------------------------------------------------- Items. ----- (a) With respect to the Mortgage Loans described in the Mortgage Loan Schedule, and subject to and as required by the terms of the related Mortgage Loan Documents, the Servicer shall establish and maintain one or more Eligible Accounts (each, an "Escrow Account") into which any or all Escrow Payments shall -------------- be deposited promptly after receipt and identification. Escrow Accounts shall be denominated "Midland Loan Services, Inc. in Trust for IMPAC Commercial Capital Corporation and Various Borrowers" or in such other manner as the Owner prescribes. The Servicer shall notify the Owner in writing of the location and account number of each Escrow Account it establishes and shall notify the Owner prior to any change thereof. Withdrawals of amounts from an Escrow Account may be made, subject to any express provisions to the contrary herein, applicable laws, and to the terms of the related Mortgage Loan Documents governing the use of the Escrow Payments, only: (i) to effect payment of taxes, assessments, insurance premiums, ground rents and other items required or permitted to be paid from escrow; (ii) to refund to the Borrowers any sums determined to be in excess of the amounts required to be deposited therein; (iii) to pay interest, if required under the Mortgage Loan Documents, to the Borrowers on balances in the Escrow Accounts; (iv) to pay to the Servicer from time to time any interest or investment income earned on funds deposited therein pursuant to Section 3.04; (v) to apply funds to the indebtedness of the Mortgage Loan in accordance with the terms thereof; (vi) to reimburse the Owner for any Servicing Expense for which Escrow Payments should have been made by the Borrowers, but only from amounts received on the Mortgage Loan which represent late collections of Escrow Payments thereunder; (vii) to withdraw any amount deposited in the Escrow Accounts which was not required to be deposited therein; or (viii) to clear and terminate the Escrow Accounts at the termination of this Agreement. (b) The Servicer shall maintain accurate records with respect to each Mortgaged Property reflecting the status of taxes, assessments and other similar items that are or may become a lien thereon and the status of insurance premiums payable with respect thereto as well as the payment of ground rents with respect to each ground lease (to the extent such information is reasonably available). To the extent that the related Mortgage Loan Documents require Escrow Payments to be made by a Borrower, the Servicer shall use Best Efforts to obtain, from time to time, all bills for the payment of such items, and shall effect payment prior to the applicable penalty or termination date, employing for such purpose Escrow Payments paid by the Borrower pursuant to the terms of the Mortgage Loan and deposited in the related Escrow Account by the Servicer. To the extent that the Mortgage Loan does not require a Borrower to make Escrow Payments, the Servicer shall use its Best Efforts to require that any such payment be made by the Borrowers prior to the applicable penalty or termination date. Subject to Section 3.05 with respect to the payment of insurance premiums, if a Borrower fails to make any such payment on a timely basis or collections from the Borrower are insufficient to pay any such item when due, the amount of any shortfall shall be paid by the Servicer as a Servicing Expense, provided that the Servicer has consulted with the Owner regarding the timing for payment of taxes, assessments and other similar items. Section 3.03 Collection Accounts. ------------------- (a) With respect to the Mortgage Loans, the Servicer shall establish and maintain one or more Eligible Accounts (each, a "Collection Account") for the ------------------ benefit of the Owner for the purposes set forth herein. Collection Accounts shall be denominated "Midland Loan Services, Inc. in Trust for IMPAC Commercial Capital Corporation" or in such other manner as the Owner prescribes. The Servicer shall deposit into the Collection Accounts within one (1) Business Day after receipt all payments and collections received by it on or after the date hereof with respect to the Mortgage Loans, other than payments and collections with respect to any REO Property (which shall be deposited into the Collection Account from amounts withdrawn from the related REO Account pursuant to Section 3.11(a)), Escrow Payments or payments in the nature of Additional Servicing Compensation. (b) The Servicer shall make withdrawals from the Collection Accounts only as follows (the order set forth below not constituting an order of priority for such withdrawals): (i) to withdraw any amount deposited in the Collection Accounts which was not required to be deposited therein; (ii) pursuant to Section 5.01, to pay to the Servicer the Servicing Fee, Special Servicing Fee, Workout Fee and Disposition Fee on each Remittance Date; (iii) pursuant to Section 5.02, to pay or reimburse the Servicer for any Servicing Expenses; (iv) to pay to the Servicer from time to time any interest or investment income earned on funds deposited in the Collection Accounts pursuant to Section 3.04; (v) to remit to the Owner on each Remittance Date, pursuant to wiring instructions from the Owner, all amounts on deposit in the Collection Accounts (that represent good funds) as of the close of business on the Determination Date, net of any withdrawals from the Collection Account pursuant to this Section; and (vi) to clear and terminate the Collection Accounts upon the termination of this Agreement. Section 3.04 Permitted Investments. --------------------- The Servicer may direct any depository institution or trust company in which the Accounts are maintained to invest the funds held therein in one or more Permitted Investments; provided, however, that such funds shall be either -------- ------- (i) immediately available or (ii) available in accordance with a schedule which will permit the Servicer to meet its payment obligations hereunder. The Servicer shall be entitled to all income and gain realized from the investment of funds deposited in the Accounts. The Servicer shall deposit from its own funds in the applicable Account the amount of any loss incurred in respect of any such investment of funds immediately upon the realization of such loss. Notwithstanding the foregoing, the Servicer shall not direct the investment of funds held in any Escrow Account and retain the income and gain realized therefrom if the related Mortgage Loan Documents or applicable law permit the Borrower to be entitled to the income and gain realized from the investment of funds deposited therein. In such event, the Servicer shall direct the depository institution or trust company in which such Escrow Accounts are maintained to invest the funds held therein (1) in accordance with the Borrower's written investment instructions, if the Mortgage Loan Documents or applicable law require such funds to be invested in accordance with the Borrower's direction; and (2) in accordance with the Owner's written investment instructions, if the Mortgage Loan Documents and applicable law do not permit the Borrower to direct the investment of such funds; provided, however, that in either event (i) such -------- ------- funds shall be either (y) immediately available or (z) available in accordance with a schedule which will permit the Servicer to meet the payment obligations for which the Escrow Account was established, and (ii) the Servicer shall have no liability for any loss in investments of such funds that are invested pursuant to such written instructions. Section 3.05 Maintenance of Insurance Policies. --------------------------------- (a) The Servicer shall use its Best Efforts to cause the Borrower of each Mortgage Loan to maintain for each Mortgage Loan such insurance as is required to be maintained pursuant to the related Mortgage Loan Documents. If the Borrower fails to maintain such insurance, then the Servicer shall notify the Owner of such breach and, to the extent available at commercially reasonable rates, cause to be maintained (i) fire and hazard insurance with extended coverage in an amount which is at least equal to the lesser of the current principal balance of such Mortgage Loan and the replacement cost of the improvements which are a part of the related Mortgaged Property and (ii) to the extent that the Mortgaged Property is located in a federally designated special flood hazard area, flood insurance in respect thereof. Such flood insurance shall be in an amount equal to the lesser of (y) the unpaid principal balance of the related Mortgage Loan or (z) the maximum amount of such insurance as is available for the related Mortgaged Property under the National Flood Insurance Act. After notifying the Owner pursuant to the second preceding sentence, the Servicer shall take such action as the Owner reasonably requests with respect to the maintenance of any other forms of insurance which are required to be maintained pursuant to the related Mortgage Loan Documents, except to the extent that such insurance is not available at commercially reasonable rates or the Owner, as mortgagee, does not have an insurable interest. The Servicer shall, to the extent available at commercially reasonable rates, maintain for each REO Property no less insurance coverage than was previously required with respect to the related Mortgaged Property or as may be required at any time by the Owner in writing. All such policies shall be endorsed with standard mortgagee clauses with loss payable to the Owner, and shall be in an amount sufficient to avoid the application of any co-insurance clause. The costs of maintaining the insurance policies which the Servicer is required to maintain pursuant to this Section shall be paid by the Servicer as a Servicing Expense. (b) The Servicer may fulfill its obligation to maintain insurance, as provided in Section 3.05(a), through a master force placed insurance policy, the cost of which shall be paid by the Servicer as a Servicing Expense, provided that such cost is limited to the incremental cost of such policy allocable to such Mortgaged Property or REO Property (i.e., other than any minimum or standby premium payable for such policy whether or not any Mortgaged Property is then covered thereby, which shall be paid by the Servicer). Such master force placed insurance policy may contain a deductible clause, in which case the Servicer shall, in the event that there shall not have been maintained on the related Mortgaged Property or REO Property a policy otherwise complying with the provisions of Section 3.05(a), and there shall have been one or more losses which would have been covered by such a policy had it been maintained, immediately deposit into the related Collection Account from its own funds the amount not otherwise payable under the master force placed insurance policy because of such deductible to the extent that such deductible exceeds the deductible limitation required under the related Mortgage Loan Documents, or, in the absence of such deductible limitation, the deductible limitation which is consistent with Accepted Servicing Practices. (c) The Servicer shall maintain at its own expense a fidelity bond in form and amount that is consistent with Accepted Servicing Practices. In addition, the Servicer shall keep in force, at its own expense during the term of this Agreement, a policy or policies of insurance in form and amounts that are consistent with Accepted Servicing Practices, covering loss occasioned by the errors and omissions of the Servicer's officers and employees in connection with its obligations hereunder. Section 3.06 Delivery and Possession of Servicing Files. ------------------------------------------ On or before the related Servicing Transfer Date, the Owner shall deliver or cause to be delivered to the Servicer (i) a Servicing File with respect to each Mortgage Loan; and (ii) the amounts, if any, received by the Owner representing Escrow Payments previously made by the Borrowers. The Servicer shall promptly acknowledge receipt of the Servicing File and Escrow Payments for the Mortgage Loans and shall promptly deposit such Escrow Payments in the Escrow Accounts established pursuant to this Agreement. The contents of each Servicing File delivered to the Servicer are and shall be held in trust by the Servicer for the benefit of the Owner as the owner thereof; the Servicer's possession of the contents of each Servicing File so delivered is for the sole purpose of servicing the related Mortgage Loan; and such possession by the Servicer shall be in a custodial capacity only. The Servicer shall release its custody of the contents of any Servicing File only in accordance with written instructions from the Owner, and upon request of the Owner, the Servicer shall deliver to the Owner the Servicing File or a copy of any document contained therein; provided, -------- however, that if the Servicer is unable to perform its Loan Servicing - ------- obligations with respect to the related Mortgage Loan after any such release or delivery of the Servicing File, then the Servicer's responsibilities for Loan Servicing with respect to such Mortgage Loan may be terminated immediately by the Servicer upon written notice to the Owner. Section 3.07 Inspections. ----------- The Servicer shall perform a physical inspection of each Mortgaged Property or REO Property at least annually for Mortgage Loans with outstanding principal balance of more than $1,000,000 and every other year for Mortgage Loans with an outstanding principal balance of less than or equal to $1,000,000 or if (a) the related Mortgage Loan becomes a Specially Serviced Mortgage Loan, (b) the Owner requests such an inspection, or (c) the Servicer, with the approval of the Owner, determines that it is prudent to conduct such an inspection. The Servicer shall prepare a written report of each such inspection and shall promptly deliver a copy of such report to the Owner. The reasonable out-of-pocket expenses incurred by the Servicer in connection with any such inspections (including any out-of-pocket expenses related to travel and lodging and any charges incurred through the use of a qualified third party to perform such services) shall be paid as a Servicing Expense; provided, however, that with -------- ------- respect to the annual (or every other year) inspection of any Mortgaged Property or the initial inspection of any Mortgaged property relating to any Specially Serviced Mortgage Loan, such expenses shall be borne by the Servicer. Section 3.08 "Due-on-Sale" Clauses; Assumption Agreements. ------------------------------------------- When any Borrower proposes to convey or encumber all or any portion of its interests in a Mortgaged Property, or if such conveyance or encumbrance has actually occurred, to the extent that the Servicer has actual knowledge of such conveyance or encumbrance, the Servicer shall immediately give notice thereof to the Owner and take such related actions as the Owner reasonably directs, including (i) waiving or enforcing any due-on-sale clause or due-on-encumbrance clause contained in the related Mortgage Loan Documents, to the extent permitted under the terms of the related Mortgage Loan Documents and applicable law, (ii) taking or entering into an assumption or substitution agreement from or with the Person to whom such Mortgaged Property has been or shall be conveyed, and (iii) releasing the original Borrower from liability upon the related Mortgage Loan and substituting the new Borrower as the obligor thereon. To the extent the Servicer is engaged by the Owner to perform analysis, processing and administrative functions in connection with any request by a Borrower to waive any such due-on-sale clause or due-on-encumbrance clause and/or to enter into any such assumption or substitution agreement, the Servicer may, as a condition to granting any such request require (to the extent permitted by applicable law) that such Borrower pay to it, as Additional Servicing Compensation, a reasonable and customary fee consistent with Accepted Servicing Practices in connection with such request, together with any related costs and expenses incurred by the Servicer; provided, -------- however, that in the event that the Borrower fails or is unable to pay any such - ------- costs and expenses, or the Owner directs the Servicer to waive any requirement that the Borrower pay any such costs or expenses, the same shall be paid by the Servicer as a Servicing Expense. Section 3.09 Realization Upon Mortgaged Properties. ------------------------------------- (a) Upon the failure of any Borrower to make any required payment of principal, interest or other amounts due under a Mortgage Loan, or otherwise to perform fully any material obligations under any of the related Mortgage Loan Documents, in either case within any applicable grace period, the Servicer shall, upon discovery of such failure, promptly notify the Owner in writing. As directed in writing by the Owner in each instance, the Servicer shall issue notices of default, declare events of default, declare due the entire outstanding principal balance, and otherwise take all reasonable actions under the related Mortgage Loan in preparation for the Owner to realize upon the underlying collateral. With respect to any Specially Serviced Mortgage Loan, the Servicer shall, as permitted under the provisions of the related Mortgage Loan Documents, and subject to the Owner's prior written consent, foreclose upon or otherwise comparably convert the ownership of the related Mortgaged Property. In connection with such foreclosure or other conversion, the Servicer shall, subject to the consent or direction of the Owner, follow such practices and procedures as it shall deem necessary or advisable and as shall be consistent with Accepted Servicing Practices. All costs and expenses incurred by the Servicer in any such proceedings shall be paid by the Servicer as a Servicing Expense. (b) If title to any Mortgaged Property is acquired in foreclosure or by deed in lieu of foreclosure, the deed or certificate of sale shall be taken in the name of the Owner or its nominee, but in no event shall such deed or certificate be taken in the name of the Servicer. Notwithstanding any such acquisition of title and cancellation of the related Mortgage Loan, such Mortgage Loan shall be considered to be an REO Mortgage Loan held by the Owner until such time as the related REO Property shall be sold, transferred or conveyed by the Owner. Consistent with the foregoing, for purposes of all calculations hereunder, so long as such REO Mortgage Loan shall be considered to be an outstanding Mortgage Loan, payments and collections with respect to the related REO Property received in any month (net of related expenses) shall be applied to amounts which would have been payable under the related Note in accordance with the terms of such Note. (c) Except as otherwise provided in written instructions delivered to the Servicer by the Owner, the Servicer shall not obtain title to any Mortgaged Property as a result or in lieu of foreclosure or otherwise, and shall not otherwise acquire possession of, or take other action with respect to, any Mortgaged Property, if, as a result of any such action, the Owner would be considered to hold title to, to be a "mortgagee-in-possession" of, or to be an "owner" or "operator" of such Mortgaged Property within the meaning of any Environmental Law, or a "discharger" or "responsible party" thereunder, unless the Servicer has also previously determined, based on a report prepared by a Person who regularly conducts environmental site assessments, that: (iii) such Mortgaged Property is in compliance with applicable Environmental Laws or, if not, that taking such actions as are necessary to bring such Mortgaged Property into compliance therewith is reasonably likely to produce a greater recovery on a present value basis than not taking such actions; and (iv) there are no circumstances present on such Mortgaged Property relating to the use, management or disposal of any Hazardous Materials for which investigation, testing, monitoring, containment, clean-up or remediation could be required under any applicable Environmental Law, or that, if any such Hazardous Materials are present for which such action could be required, taking such actions with respect to the affected Mortgaged Property is reasonably likely to produce a greater recovery on a present value basis than not taking such actions. If the Servicer has so determined based on satisfaction of the criteria in clauses (i) and (ii) above that it would be in the best economic interest of the Owner to take any such actions, the Servicer shall notify the Owner of such proposed action. The Servicer shall take such action only if authorized by the Owner in writing. The costs of any such compliance, containment, clean-up or remediation shall be paid by the Servicer as a Servicing Expense. If the environmental assessment first obtained by the Servicer with respect to a Mortgaged Property indicates that such Mortgaged Property may not be in compliance with applicable Environmental Laws or that Hazardous Materials may be present but does not definitively establish such fact, the Servicer, subject to the Owner's prior written consent, shall cause such further environmental assessments to be conducted. (d) The environmental site assessments contemplated by Section 3.09(c) shall be prepared by any Person who is recommended by the Servicer and approved in writing by the Owner or such other Person as directed in writing by the Owner. The cost of preparation of any environmental assessment shall be paid by the Servicer as a Servicing Expense. (e) If the Servicer determines, pursuant to Section 3.09(c), that taking such actions as are necessary to bring any Mortgaged Property into compliance with applicable Environmental Laws, or taking such actions with respect to the containment, clean-up, removal or remediation of hazardous substances, hazardous materials, hazardous wastes, or petroleum-based materials affecting any such Mortgaged Property, is not reasonably likely to produce a greater recovery on a present value basis than not taking such actions, then the Servicer shall take such action as directed in writing by the Owner, including, without limitation, releasing the lien of the related Mortgage with respect to the affected Mortgaged Property. Section 3.10 Sale of Specially Serviced Mortgage Loans and REO Properties. ------------------------------------------------------------ (a) With respect to any Specially Serviced Mortgage Loan or REO Property, when and if directed in writing by the Owner, the Servicer shall use its Best Efforts to sell to any Person (other than an Affiliate of the Servicer) such Specially Serviced Mortgage Loan or REO Property on commercially reasonable terms which are consistent with Accepted Servicing Practices; provided, however, -------- ------- that any such sale must be approved in writing by the Owner. (b) Subject to Sections 3.10(a), the Servicer shall act on behalf of the Owner in negotiating and taking any such action necessary or appropriate in connection with the sale of any Specially Serviced Mortgage Loan or REO Property, including the collection of all amounts payable in connection therewith. Any sale of any Specially Serviced Mortgage Loan or REO Property shall be without recourse to, or representation or warranty by, the Owner or the Servicer, (except that any contract of sale and conveyance documents may contain customary warranties of title and condition). The Net Liquidation Proceeds (after deduction of the Disposition Fee) shall be promptly deposited by the Servicer in the related Collection Account. Section 3.11 Management of REO Property. -------------------------- (a) Upon the acquisition by the Owner of any REO Property, the Servicer shall have full power and authority, subject to the specific requirements and prohibitions of this Agreement, to do or authorize to be done any and all things in connection therewith as are consistent with Accepted Servicing Practices, all on terms and for such period as the Servicer deems to be in the best economic interest of the Owner. The Servicer shall segregate and hold all revenues received by it with respect to any REO Property separate and apart from its own funds and general assets and shall establish and maintain with respect to any REO Property one or more Eligible Accounts (each, an "REO Account") for the ----------- purposes set forth herein. REO Accounts shall be Eligible Accounts and shall be denominated "Midland Loan Services, Inc. in Trust for IMPAC Commercial Capital Corporation" or in such other manner as the Owner prescribes. The Servicer shall be entitled to any interest or investment income earned on funds deposited in an REO Account pursuant to Section 3.04. In connection therewith, the Servicer shall deposit or cause to be deposited in the REO Account on a daily basis within one (1) Business Day after receipt all revenues received by it with respect to any REO Property (except for any Net Liquidation Proceeds), and shall withdraw therefrom funds necessary for the proper maintenance, leasing, operation, management and sale of any REO Property, including: (i) all insurance premiums due and payable in respect of such REO Property; (ii) all taxes and assessments in respect of such REO Property that could result or have resulted in the imposition of a lien thereon; (iii) all ground rental payments, if applicable, with respect to such REO Property; and (iv) all costs and expenses necessary to maintain, lease, operate, manage and sell such REO Property, including the management fee payable to the property manager engaged by Servicer pursuant to Section 3.11(b). To the extent that amounts on deposit in any REO Account are insufficient for the purposes set forth above, the Servicer shall pay the amount of such shortfall as a Servicing Expense. The Servicer shall withdraw from each REO Account and deposit into the related Collection Account on a monthly basis on or prior to the related Remittance Date the income, net of expenses, received or collected from each REO Property; provided, however, that the Servicer may -------- ------- retain in each REO Account funds sufficient for the payment of the items set forth in clauses (i) through (iv) above, including, without limitation, the creation of reasonable reserves for repairs, replacements, and necessary capital improvements and other related expenses. (b) The Servicer may contract with any Person as a property manager for the operation and management of any REO Property; provided, however, that: -------- ------- (i) the terms and conditions of any such contract shall not be inconsistent herewith and the Owner has provided its written consent (which shall not be unreasonably withheld) with respect to such property manager; (ii) none of the provisions of this Section relating to any such contract or to actions taken through any such Person shall be deemed to relieve the Servicer of any of its duties and obligations to the Owner with respect to the operation and management of such REO Property; and (iii) the Servicer shall be obligated with respect thereto to the same extent as if it alone were performing all duties and obligations in connection with the operation and management of such REO Property. Section 3.12 Modifications, Waivers, Amendments and Consents. ----------------------------------------------- (a) When any Borrower proposes any modification, waiver or amendment of any term of any Mortgage Loan or requests any consents related thereto, the Servicer shall immediately give notice thereof to the Owner and take such related actions as the Owner reasonably directs, except with respect to any Borrower proposal or request which involves any required payment from the Borrower in the nature of Additional Servicing Compensation to which the Servicer is properly entitled. All modifications, waivers or amendments of any Mortgage Loan or consents related thereto shall be in writing. (b) To the extent the Servicer is engaged by the Owner to perform analysis, processing and administrative functions in connection with any request by a Borrower for any consent, modification, waiver or amendment the Servicer may, as a condition to granting any such request require (to the extent permitted by applicable law) that such Borrower pay to it, as Additional Servicing Compensation, a reasonable and customary fee consistent with Accepted Servicing Practices in connection with such request, together with any related costs and expenses incurred by the Servicer; provided, however, that in the -------- ------- event that the Borrower fails or is unable to pay any such costs and expenses, or the Owner directs the Servicer to waive any requirement that the Borrower pay any such costs or expenses, the same shall be paid by the Servicer as a Servicing Expense. ARTICLE IV. ----------- STATEMENTS AND REPORTS Section 4.01 Reporting by the Servicer. ------------------------- (a) On or before each Remittance Date, the Servicer shall render to the Owner a report reflecting activity with respect to the Mortgage Loans as of the close of business on the preceding Determination Date (or, in the case of the first Remittance Date, the Servicing Transfer Date) in a format and containing such information as the Owner shall reasonably require. Such report shall be made available in both written and electronic format. (b) Each year beginning in the calendar year which immediately succeeds the year hereof, the Servicer shall prepare and file the reports of foreclosures and abandonments of any Mortgaged Property and the annual information returns with respect to each Borrower's debt service payments under the Mortgage Loans as required by Sections 6050J and 6050H, respectively, of the Internal Revenue Code and the rules and regulations promulgated thereunder, as amended. (c) Not later than twenty days after each Remittance Date, the Servicer shall forward to the Owner a statement, setting forth the status of the Accounts as of the close of business on such Remittance Date showing, for the period from the preceding Remittance Date (or, in the case of the first Remittance Date, the Servicing Transfer Date) to such Remittance Date, the aggregate of deposits into and withdrawals from the Accounts. (d) The Servicer will provide the Owner with on-line telephone access to all information with respect to the Mortgage Loans which is available through the Servicer's Loan Inquiry Facility, Loans On-Line Administration System, or Loan Portfolio Analysis System, or any successor facility or system, as applicable, subject to such reasonable policies, procedures and limitations as the parties may agree upon from time to time. (e) The Servicer shall use its Best Efforts to promptly collect from each Borrower (and forward on to the Owner) the property operating statements, rent rolls, financial statements and other financial reports which are required to be delivered by the Borrower pursuant to the related Mortgage Loan Documents. The Servicer shall promptly (i) review and analyze such items as may be collected; (ii) prepare written reports based on such analysis; and (iii) deliver copies of such written reports to the Owner. (f) The Servicer shall provide the Owner with any summary reports prepared by any Rating Agency with respect to the Servicer's ranking by such Rating Agency. ARTICLE V. ---------- SERVICER'S COMPENSATION AND EXPENSES Section 5.01 Servicing Compensation. ---------------------- As consideration for servicing the Mortgage Loans subject to this Agreement, the Servicer shall be entitled to a Servicing Fee for each Mortgage Loan remaining subject to this Agreement during any calendar month or part thereof. Such Servicing Fee shall be payable monthly on the Remittance Date and shall be computed on the basis of the same outstanding principal balance and for the period with respect to which any related interest payment on the related Mortgage Loan is computed. The Servicer may pay itself the Servicing Fee on each Remittance Date from amounts on deposit in the related Collection Account. As further compensation for its activities hereunder, the Servicer shall be entitled to retain any payments or collections received by it which are in the nature of Additional Servicing Compensation. As compensation for its special servicing activities hereunder, the Servicer shall be entitled to the Special Servicing Fee for each Specially Serviced Mortgage Loan or REO Property remaining subject to this Agreement during any calendar month or part thereof. Such Special Servicing Fee shall be payable monthly on the Remittance Date and shall be computed on the basis of the same outstanding principal balance and for the period with respect to which any related interest payment on the related Mortgage Loan is computed. The Servicer may pay itself the Special Servicing Fee on each Remittance Date from amounts on deposit in the related Collection Account. The Servicer shall not be entitled to the Servicing Fee for any Mortgage Loan in the event the Servicer is entitled to receive the Special Servicing Fee for such Mortgage Loan. In addition to the other servicing compensation provided for in this Agreement, and not in lieu thereof, the Servicer shall be entitled to (i) the Disposition Fee, which shall be payable out of Net Liquidation Proceeds prior to the deposit of Net Liquidation Proceeds into the Collection Account; and (ii) the Workout Fee, 50% of which shall be payable as an initial installment from amounts on deposit in the related Collection Account on the date that the related Specially Serviced Mortgage Loan becomes a Corrected Mortgage Loan, and the remaining 50% of which shall be payable as a second installment in the same manner after the expiration of any consecutive six month period during which the related Mortgage Loan has not become 30 days delinquent in the payment of any Monthly Payment or has not otherwise become a Specially Serviced Mortgage Loan. The Servicer may earn the Workout Fee only once with respect to any Mortgage Loan. To the extent that amounts on deposit in the Collection Account are insufficient for the payment of the Servicing Fee, Special Servicing Fee or Workout Fee, the Owner shall pay any such shortfall to the Servicer within ten (10) Business Days after the Owner's receipt of an itemized invoice therefor. The Servicer shall be required to pay all expenses incurred by it in connection with its servicing activities hereunder and shall not be entitled to reimbursement thereof except as specifically provided for herein. Section 5.02 Servicing Expenses. ------------------ Notwithstanding any other provision hereof, the Servicer shall obtain the written approval of the Owner prior to incurring any Servicing Expense that is over $5,000.00 per item, except for any Servicing Expense which is (i) incurred by the Servicer pursuant to Sections 3.02(b) or 3.05 or (ii) made for any purposes other than those described in item (i) above, and is not over $25,000.00 and is made in an emergency situation to preserve and protect the Mortgaged Property or the safety of the public in connection with such Mortgaged Property. The Servicer may cause any Servicing Expenses to be paid directly from the related Collection Account. The Servicer shall have no obligation to advance its own funds for the payment of any Servicing Expenses. The Servicer may, at its option, make advances from its own funds with respect to the payment of such expenses, in which event the Servicer shall be reimbursed for such advances from the related Collection Account. In the event that there are insufficient funds in the related Collection Account to permit the payment of Servicing Expenses or to permit the Servicer to reimburse itself for such advances, the Owner shall deposit the necessary funds in the related Collection Account or reimburse the Servicer, as the case may be, for all incurred Servicing Expenses, with interest thereon at the Advance Rate, within ten Business Days after the Owner's receipt of an itemized invoice therefor. If the Servicer has provided such an invoice to the Owner, and funds are subsequently deposited into the related Collection Account from sources other than the Owner, the Servicer may pay such expenses or reimburse itself for such advances from the related Collection Account, in which event the Servicer shall promptly (i) notify the Owner of such payment or reimbursement and (ii) amend or cancel, as the case may be, such invoice. ARTICLE VI. ----------- THE SERVICER AND THE OWNER Section 6.01 Servicer Not to Assign; Merger or Consolidation of the Servicer. --------------------------------------------------------------- (a) Except as otherwise provided for in this Section or in Section 2.02, the Servicer may not assign this Agreement or any of its rights, powers, duties or obligations hereunder without the written consent of the Owner; provided, -------- however, that the Servicer may assign this Agreement to a Qualified Affiliate - ------- without the written consent of the Owner. (b) The Servicer may be merged or consolidated with or into any Person, or transfer all or substantially all of its assets to any Person, in which case any Person resulting from any merger or consolidation to which it shall be a party, or any Person succeeding to its business shall be the successor of the Servicer hereunder, and shall be deemed to have assumed all of the liabilities of the Servicer hereunder. The Servicer shall provide written notice to the Owner of any such merger, consolidation, or transfer. Section 6.02 Liability and Indemnification of the Servicer and the Owner. ----------------------------------------------------------- Neither the Servicer nor its Affiliates nor any of the directors, officers, employees or agents thereof shall be under any liability to the Owner or any third party for taking or refraining from taking any action, in good faith pursuant to or in connection with this Agreement, or for errors in judgment; provided, however, that this provision shall not protect the Servicer or any - -------- ------- such Person against any liability which would otherwise be imposed on the Servicer or any such Person by reason of the Servicer's willful misfeasance, bad faith or negligence in the performance of its duties hereunder. The Servicer and any director, officer, employee or agent thereof may rely in good faith on any document of any kind which, prima facie, is properly executed and submitted by any appropriate Person respecting any matters arising hereunder. The Servicer and any director, officer, employee or agent thereof shall be indemnified and held harmless by the Owner against any loss, liability or expense incurred, including reasonable attorneys' fees, in connection with any claim, legal action, investigation or proceeding relating to this Agreement, the Servicer's performance hereunder, or any specific action which the Owner authorized or requested the Servicer to perform pursuant to this Agreement, as such are incurred, except for any loss, liability or expense incurred by reason of the Servicer's willful misfeasance, bad faith, negligence or breach of the Servicer's representations and warranties set forth in Section 7.01. Notwithstanding the exception set forth in the preceding sentence, in the event that the Servicer sustains any loss, liability or expense by reason of such exception and which results from any overcharges to Borrowers under the Mortgage Loans, to the extent that such overcharges were collected by the Servicer and remitted to the Owner, the Owner shall promptly remit such overcharge to the related Borrower after the Owner's receipt of written notice from the Servicer regarding such overcharge. The Owner and any director, officer, employee or agent thereof shall be indemnified and held harmless by the Servicer against any loss, liability or expense incurred, including reasonable attorneys' fees, by reason of (i) the Servicer's willful misfeasance, bad faith or negligence in the performance of its duties hereunder or the failure of the Servicer to perform its duties hereunder in accordance with this Agreement or (ii) a breach of the Servicer's representations and warranties set forth in Section 7.01. The provisions of this Section shall survive any termination of the rights and obligations of the Servicer hereunder. ARTICLE VII. ------------ REPRESENTATIONS AND WARRANTIES; DEFAULT Section 7.01 Representations and Warranties. ------------------------------ (a) The Servicer hereby makes the following representations and warranties to the Owner: (i) Due Organization, Qualification and Authority. The Servicer is a --------------------------------------------- corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, and is duly qualified to transact business as a foreign corporation, in good standing and licensed in each state to the extent necessary to ensure the enforceability of each Mortgage Loan and to perform its duties and obligations under this Agreement in accordance with the terms of this Agreement; the Servicer has the full power, authority and legal right to execute and deliver this Agreement and to perform in accordance herewith; the Servicer has duly authorized the execution, delivery and performance of this Agreement and has duly executed and delivered this Agreement; this Agreement constitutes the valid, legal, binding obligation of the Servicer, except as enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other laws relating to or affecting the rights of creditors generally and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law); (ii) No Conflicts. Neither the execution and delivery of this ------------ Agreement, nor the fulfillment of or compliance with the terms and conditions of this Agreement by the Servicer, will (i) conflict with or result in a breach of any of the terms, conditions or provisions of the Servicer's certificate of incorporation, as amended, or bylaws, as amended, or any agreement or instrument to which the Servicer is now a party or by which it (or any of its properties) is bound, or constitute a default or result in an acceleration under any of the foregoing; (ii) conflict with or result in a breach of any legal restriction if compliance therewith is necessary (a) to ensure the enforceability of any Mortgage Loan, or (b) for the Servicer to perform its obligations under this Agreement in accordance with the terms hereof; (iii) result in the violation of any law, rule, regulation, order, judgment or decree to which the Servicer or its property is subject if compliance therewith is necessary (a) to ensure the enforceability of any Mortgage Loan, or (b) for the Servicer to perform its obligations under this Agreement in accordance with the terms hereof; or (iv) result in the creation or imposition of any lien, charge or encumbrance that would have a material adverse effect upon any of its properties pursuant to the terms of any mortgage, contract, deed of trust or other instrument, or materially impair the ability of the Owner to realize on the Mortgage Loans; (iii) No Litigation Pending. There is no action, suit, or proceeding --------------------- pending or to Servicer's knowledge threatened against the Servicer which, either in any one instance or in the aggregate, would draw into question the validity of this Agreement or the Mortgage Loans, or would be likely to impair materially the ability of the Servicer to perform its duties and obligations under the terms of this Agreement; (iv) No Consent Required. No consent, approval, authorization or ------------------- order of, or registration or filing with, or notice to, any court or governmental agency or body having jurisdiction or regulatory authority over the Servicer is required for (i) the Servicer's execution and delivery of, this Agreement, or (ii) the consummation of the transactions contemplated by this Agreement, or, to the extent required, such consent, approval, authorization, order, registration, filing or notice has been obtained, made or given (as applicable), except that the Servicer may not be duly qualified to transact business as a foreign corporation or licensed in one or more states if such qualification or licensing is not necessary (a) to ensure the enforceability of any Mortgage Loan, or (b) for the Servicer to perform its obligations under this Agreement in accordance with the terms hereof. (b) The Owner hereby makes the following representations and warranties to the Servicer: Due Authority. The Owner has the full power, authority and legal right to ------------- execute and deliver this Agreement and to perform in accordance herewith; the Owner has duly authorized the execution, delivery and performance of this Agreement and has duly executed and delivered this Agreement; the Owner is the owner and the holder of the Mortgage Loans and has the right to authorize the Servicer to perform the actions contemplated herein; this Agreement constitutes the valid, legal, binding obligation of the Owner, except as enforceability may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other laws relating to or affecting the rights of creditors generally and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law). Section 7.02 Events of Default. ----------------- "Event of Default", wherever used herein, means any one of the following events: (a) any failure by the Servicer to remit to the Owner any payment required to be so remitted by the Servicer under the terms of this Agreement when and as due which continues unremedied by the Servicer for a period of two (2) Business Days after the date on which such remittance was due; or (b) any failure on the part of the Servicer duly to observe or perform in any material respect any other of the covenants or agreements on the part of the Servicer contained in this Agreement, or any representation or warranty set forth by the Servicer in Section 7.01 shall be untrue or incorrect in any material respect, and, in either case, such failure or breach materially and adversely affects the value of any Mortgage Loan or Mortgaged Property or the priority of the lien on any Mortgaged Property or the interest of the Owner therein, which in either case continues unremedied for a period of thirty (30) days after the date on which written notice of such failure or breach, requiring the same to be remedied, shall have been given to the Servicer by the Owner (or such extended period of time reasonably approved by the Owner provided that the Servicer is diligently proceeding in good faith to cure such failure or breach); or (c) a decree or order of a court or agency or supervisory authority having jurisdiction in respect of the Servicer for the commencement of an involuntary case under any present or future federal or state bankruptcy, insolvency or similar law, for the appointment of a conservator or receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs shall have been entered against the Servicer, and such decree or order shall remain in force undischarged or unstayed for a period of 60 days; or (d) the Servicer shall consent to the appointment of a conservator or receiver or liquidator in any insolvency, readjustment of debt, marshalling of assets and liabilities or similar proceedings of or relating to the Servicer or of or relating to all or substantially all of its property; or (e) the Servicer shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of any applicable federal or state bankruptcy, insolvency or similar law, make an assignment for the benefit of its creditors or voluntarily suspend payment of its obligations; then, and in each and every case, so long as an Event of Default shall not have been remedied, the Owner may, by notice in writing to the Servicer, in addition to whatever rights the Owner may have at law or in equity, including injunctive relief and specific performance, terminate all of the rights and obligations of the Servicer under this Agreement and in and to the Mortgage Loans and the proceeds thereof, without the Owner incurring any penalty or fee of any kind whatsoever in connection therewith; provided, however, that such termination -------- ------- shall be without prejudice to any rights of the Servicer relating to the payment of its Servicing Fees, Special Servicing Fees, Disposition Fees, Workout Fees, Additional Servicing Compensation and the reimbursement of any Servicing Expenses which have been made by it under the terms of this Agreement through and including the date of such termination. Except as otherwise expressly provided in this Agreement, no remedy provided for by this Agreement shall be exclusive of any other remedy, and each and every remedy shall be cumulative and in addition to any other remedy, and no delay or omission to exercise any right or remedy shall impair any such right or remedy or shall be deemed to be a waiver of any Event of Default. On or after the receipt by the Servicer of such written notice of termination from the Owner, all authority and power of the Servicer under this Agreement, whether with respect to the Mortgage Loans or otherwise, shall pass to and be vested in the Owner, and the Servicer agrees to cooperate with the Owner in effecting the termination of the Servicer's responsibilities and rights hereunder, including, without limitation, the transfer of the Servicing Files and the funds held in the Accounts as set forth in Section 8.01. The Owner may waive any default by the Servicer in the performance of its obligations hereunder and its consequences. Upon any such waiver of a past default, such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been remedied for every purpose of this Agreement. No such waiver shall extend to any subsequent or other default or impair any right consequent thereon except to the extent expressly so waived. ARTICLE VIII. ------------- TERMINATION; TRANSFER OF MORTGAGE LOANS Section 8.01 Termination of Agreement. ------------------------ (a) This Agreement may be terminated by the Owner (v) without cause, upon sixty (60) days written notice to the Servicer, provided that the effective date of such termination shall be at least 42 months after the date hereof, (w) without cause, upon thirty (30) days written notice to the Servicer with respect to any Loan Servicing duties relating to any Specially Serviced Mortgage Loan or REO Property, (x) for cause with respect to any or all of the Mortgage Loans pursuant to Section 7.02, (y) without cause with respect to any or all of the Mortgage Loans, within 30 days after receipt of notice from the Servicer under Section 6.01(b) if the Owner does not approve of the successor servicer, or (z) without cause with respect to any or all of the Mortgage Loans, if the servicer ranking of the Servicer by any Rating Agency shall be downgraded to "Unacceptable" or less than "Above Average", as applicable. This Agreement may be terminated by the Servicer with respect to the Mortgage Loans, without cause, upon ninety (90) days written notice to the Owner. (b) Termination pursuant to this Section or as otherwise provided herein shall be without prejudice to any rights of the Owner or the Servicer which may have accrued through the date of termination hereunder. Upon such termination, the Servicer shall (i) remit all funds in the related Accounts to the Owner or such other Person designated by the Owner, net of accrued Servicing Fees, Special Servicing Fees, Disposition Fees, Workout Fees Additional Servicing Compensation and Servicing Expenses through the termination date to which the Servicer would be entitled to payment or reimbursement hereunder; (ii) deliver all related Servicing Files to the Owner or to Persons designated by the Owner; and (iii) fully cooperate with the Owner and any new servicer to effectuate an orderly transition of Loan Servicing of the related Mortgage Loans. Upon such termination, any Servicing Fees, Additional Servicing Compensation and Servicing Expenses (with interest thereon at the Advance Rate) which remain unpaid or unreimbursed after the Servicer has netted out such amounts pursuant to the preceding sentence shall be remitted by the Owner to the Servicer within ten (10) Business Days after the Owner's receipt of an itemized invoice therefor. (c) With respect to a termination of this Agreement by the Owner without cause as to any or all of the Mortgage Loans pursuant to clause (v) of Section 8.01(a), the Owner shall pay the Termination Fee to the Servicer within ten (10) Business Days after the effective date of such termination. Section 8.02 Transfer of Mortgage Loans; Securitization. ------------------------------------------ (a) The Servicer acknowledges that any or all of the Mortgage Loans may be sold, transferred, assigned or otherwise conveyed by the Owner to any third party without the consent or approval of the Servicer. Any such transfer shall constitute a termination of this Agreement with respect to such Mortgage Loans, subject to Section 8.02(c). (b) Until the Servicer receives written notice from the Owner of the sale, transfer, assignment or conveyance of one or more Mortgage Loans, the Owner shall be presumed to be the owner and holder of such Mortgage Loans, the Servicer shall continue to earn Servicing Fees and Additional Servicing Compensation with respect to such Mortgage Loans and the Servicer shall continue to remit payments and other collections in respect of such Mortgage Loans to the Owner pursuant to the terms and provisions hereof. (c) In the event any Mortgage Loan is sold, transferred, assigned or otherwise conveyed by the Owner to any third party in connection with a Securitization or other transaction, the Owner agrees to appoint or cause the appointment of the Servicer as the master and primary servicer of the related Mortgage Loans in accordance with a new servicing agreement to be negotiated in good faith by the Servicer and the other parties thereto, which new servicing agreement shall require the Servicer to perform substantially the same performing loan duties and obligations with respect to the related Mortgage Loans as the Servicer is required to perform hereunder; provided, however, that -------- ------- (i) the Servicer shall be entitled to receive servicing compensation under such new servicing agreement that is not less than the performing loan servicing compensation that the Servicer is entitled to receive hereunder; (ii) with respect to any Securitization, the Servicer may be required under such new servicing agreement to make advances for delinquent Monthly Payments (but not for any balloon payments or default interest) and Servicing Expenses, provided that (x) the Servicer shall be reimbursed for any such advances made with interest thereon at the "Prime Rate" (as published from time to time in the "Money Rates" section of The Wall Street Journal), such reimbursement being ----------------------- consistent with customary servicing reimbursement mechanisms, and (y) the Servicer shall not be required to make any such advances to the extent the Servicer determines that such advances shall not be recoverable from the related Mortgage Loan; (iii) with respect to any Securitization, the timing relating to remittance of funds and reports by the Servicer shall be revised (x) to provide at least five Business Days between the determination and distribution dates for a customary reporting cycle, and (y) to ensure that the determination date shall be subsequent to the expiration date of any grace periods under the related Mortgage Loans; (iv) with respect to any Securitization, in the event the Servicer is responsible for funding prepayment interest shortfalls to the extent of its monthly servicing fee, the Servicer shall be entitled to retain all excess prepayment interest as additional servicing compensation; and (v) such new servicing agreement may be revised further as the Servicer and the parties thereto agree to reflect any necessary and customary changes in connection with the Securitization or other transaction. ARTICLE IX. ----------- MISCELLANEOUS PROVISIONS Section 9.01 Amendment; Waiver. ----------------- This Agreement contains the entire agreement between the parties relating to the subject matter hereof, and no term or provision hereof may be amended or waived unless such amendment or waiver is in writing and signed by the party against whom such amendment or waiver is sought to be enforced. Section 9.02 Governing Law. ------------- This Agreement shall be construed in accordance with the laws of the State of Missouri, and the obligations, rights and remedies of the parties hereunder shall be determined in accordance with such laws, without giving effect to principles of conflicts of laws. Section 9.03 Notices. ------- All demands, notices and communications hereunder shall be in writing and addressed in each case as follows: (i) if to the Owner, at: The IMPAC Companies 20371 Irvine Avenue Santa Ana Heights, CA 92707 Attention: Mr. Ron Morrison Telecopy No.: (714) 438-2150 (ii) if to the Servicer, at: Midland Loan Services, Inc. 210 West 10th Street Kansas City, Missouri 64105 Attention: Steven W. Smith Telecopy No.: (816) 435-2326 with a copy to: Morrison & Hecker L.L.P. 2600 Grand Avenue Kansas City, Missouri 64108-4606 Attention: William A. Hirsch Telecopy No.: (816) 474-4208 Any of the above-referenced Persons may change its address for notices hereunder by giving notice of such change to the other Persons. All notices and demands shall be deemed to have been given at the time of the delivery at the address of such Person for notices hereunder if personally delivered, mailed by certified or registered mail, postage prepaid, return receipt requested, or sent by overnight courier or telecopy; provided, however, that any notice delivered -------- ------- after normal business hours of the recipient or on a day which is not a Business Day shall be deemed to have been given on the next succeeding Business Day. To the extent that any demand, notice or communication hereunder is given to the Servicer by a Responsible Officer of the Owner, such Responsible Officer shall be deemed to have the requisite power and authority to bind the Owner with respect to such communication, and the Servicer may conclusively rely upon and shall be protected in acting or refraining from acting upon any such communication. To the extent that any demand, notice or communication hereunder is given to the Owner by a Responsible Officer of the Servicer, such Responsible Officer shall be deemed to have the requisite power and authority to bind the Servicer with respect to such communication, and the Owner may conclusively rely upon and shall be protected in acting or refraining from acting upon any such communication. Section 9.04 Severability of Provisions. -------------------------- If one or more of the provisions of this Agreement shall be for any reason whatever held invalid or unenforceable, such provisions shall be deemed severable from the remaining covenants, agreements and provisions of this Agreement and such invalidity or unenforceability shall in no way affect the validity or enforceability of such remaining provisions or the rights of any parties thereunder. To the extent permitted by law, the parties hereto hereby waive any provision of law that renders any provision of this Agreement invalid or unenforceable in any respect. Section 9.05 Inspection and Audit Rights. --------------------------- The Servicer agrees that, on reasonable prior notice, it will permit any agent or representative of the Owner, during the Servicer's normal business hours, to examine all the books of account, records, reports and other papers of the Servicer relating to the Mortgage Loans, to make copies and extracts therefrom, to cause such books to be audited by accountants selected by the Owner, and to discuss matters relating to the Mortgage Loans with the Servicer's officers, employees and accountants (and by this provision the Servicer hereby authorizes such accountants to discuss with such agents or representatives such matters), all at such reasonable times and as often as may be reasonably requested. Any expense incident to the exercise by the Owner of any right under this Section shall be borne by the Owner. Section 9.06 Binding Effect; No Partnership; Counterparts. -------------------------------------------- The provisions of this Agreement shall be binding upon and inure to the benefit of the respective successors and permitted assigns of the parties hereto. Nothing herein contained shall be deemed or construed to create a partnership or joint venture between the parties hereto and the services of the Servicer shall be rendered as an independent contractor for the Owner. For the purpose of facilitating the execution of this Agreement as herein provided and for other purposes, this Agreement may be executed simultaneously in any number of counterparts, each of which counterparts shall be deemed to be an original, and such counterparts shall constitute but one and the same instrument. Section 9.07 Protection of Confidential Information; No Solicitation. ------------------------------------------------------- The Servicer shall keep confidential and shall not divulge to any party, without the Owner's prior written consent, any information pertaining to the Mortgage Loans or the Borrowers except to the extent that (a) it is appropriate for the Servicer to do so (i) in working with legal counsel, auditors, other advisors, taxing authorities or other governmental agencies, (ii) in accordance with Accepted Servicing Practices or (iii) when required by any law, regulation, ordinance, court order or subpoena or (b) the Servicer is disseminating general statistical information relating to the mortgage loans being serviced by the Servicer (including the Mortgage Loans) so long as the Servicer does not identify the Owner or the Borrowers. In addition to the foregoing, neither the Servicer nor any of its Affiliates shall (i) provide any employee of the Servicer or its Affiliates that is directly involved in the solicitation of borrowers in connection with the origination of mortgage loans by the Servicer and its Affiliates access to any reports, documents or information in respect of any Borrower, Mortgaged Property or Mortgage Loan which the Servicer has received pursuant to its Loan Servicing obligations hereunder, or (ii) use any such reports, documents or information in connection with such solicitation of borrowers. Failure of the Servicer to comply with its obligations under this Section shall result in an Event of Default hereunder. Section 9.08 General Interpretive Principles. ------------------------------- For purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Agreement have the meanings assigned to them in this Agreement and include the plural as well as the singular, and the use of any gender herein shall be deemed to include the other gender; (b) accounting terms not otherwise defined herein have the meanings assigned to them in accordance with generally accepted accounting principles; (c) references herein to an "Article," "Section," or other subdivision without reference to a document are to the designated Article, Section or other applicable subdivision of this Agreement; (d) reference to a Section, subsection, paragraph or other subdivision without further reference to a specific Section is a reference to such Section, subsection, paragraph or other subdivision, as the case may be, as contained in the same Section in which the reference appears; (e) the words "herein," "hereof," "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular provision; (f) the term "include" or "including" shall mean without limitation by reason of enumeration; and (g) the Article, Section and subsection headings herein are for convenience of reference only, and shall not limit or otherwise affect the meaning of the provisions contained therein. Section 9.09 Further Agreements. ------------------ The Servicer and the Owner each agree to execute and deliver to the other such additional documents, instruments or agreements as may be reasonably requested by the other and as may be necessary or appropriate to effectuate the purposes of this Agreement. [Signature Page Follows] IN WITNESS WHEREOF, the Owner and the Servicer have caused this Agreement to be duly executed by their respective officers thereunto duly authorized as of the date first above written. IMPAC COMMERCIAL HOLDINGS, INC. By: ________________________________ Name: ______________________________ Title: _____________________________ IMPAC COMMERCIAL CAPITAL CORPORATION By: ________________________________ Name: ______________________________ Title: _____________________________ ("Owner") MIDLAND LOAN SERVICES, INC. By: ________________________________ Name: ______________________________ Title: _____________________________ ("Servicer") EXHIBIT "A" ----------- (Mortgage Loan Schedule) EXHIBIT "B" ----------- Servicing File Listing 1) Copy of executed Note (including addendums, amendments, modifications, etc., as they may apply), Loan Agreement and Guaranty Agreement (if applicable). 2) Copy of executed and filed Deed of Trust/Mortgage (including addendums, amendments, modifications, etc., as they may apply). 3) Copy of Assignment of Leases and Rents and Security Agreement, if separate from the Deed of Trust/Mortgage. 4) Copy of any other legal document(s) referenced in the Note, Deed of Trust/Mortgage, Security Agreement, Loan Agreement or Guaranty Agreement. 5) Copies of all filed UCC Financing Statements and Lien Searches. 6) Loan Closing Statement. 7) Borrower (and Guarantor, if applicable) financial and operating statements, tax returns, tax identification number(s), mailing address(es), phone number(s), and fax number(s). Also include property operating and financial statements if prepared separately. 8) Special Reserve Agreement(s), if applicable. 9) Property Information -- paid tax receipts, insurance policy(ies), appraisal(s), flood certificate(s), and environmental reports. 10) Underwriting File. 11) Checks/Wires for prepaid interest, tax and insurance impounds, and special reserves. 12) Lockbox agreement(s), if applicable. 13) If special arrangements have been made with the borrower and/or guarantor that are not noted in the legal documents, a memorandum detailing the situation. EX-21 11 SUBSIDIARIES OF THE COMPANY EXHIBIT 21 Subsidiaries of the Registrant IMH/ICH Dove Street, LLC Impac Commercial Capital Corporation (the Registrant owns 100% of the Preferred Stock) (Impac Commercial Capital Corporation owns 100% of the Common Stock of ICCC Secured Assets Corporation) Impac Commercial Assets Corporation EX-23.1 12 CONSENT OF KPMG LLP RE: REGISTRANT EXHIBIT 23.1 Consent of Independent Auditors The Board of Directors Impac Commercial Holdings, Inc.: We consent to incorporation by reference in the registration statement (No. 333- 62979) on Form S-8 of Impac Commercial Holdings, Inc. of our report dated February 3, 1999, relating to the consolidated balance sheets of Impac Commercial Holdings, Inc. and subsidiaries as of December 31, 1998, and 1997, and the related consolidated statements of operations and comprehensive earnings (loss), changes in stockholders' equity, and cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997, which report appears in the December 31, 1998 annual report on Form 10-K of Impac Commercial Holdings, Inc. /s/ KPMG LLP Orange County, California February 25, 1999 EX-23.2 13 CONSENT OF KPMG LLP RE: ICCC EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Impac Commercial Capital Corporation: We consent to incorporation by reference in the registration statement (No. 333- 62979) on Form S-8 of Impac Commercial Holdings, Inc. of our report dated February 3, 1999, relating to the consolidated balance sheets of Impac Commercial Capital Corporation and subsidiary as of December 31, 1998, and 1997, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the year ended December 31, 1998 and for the period from January 15, 1997 (commencement of operations) through December 31, 1997, which report appears in the December 31, 1998 annual report on Form 10-K of Impac Commercial Holdings, Inc. /s/ KPMG LLP Orange County, California February 25, 1999 EX-27 14 FINANCIAL DATA SCHEDULE - ARTICLE 5
5 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 14,161 25,944 392,100 (2,110) 0 104,460 9,710 (564) 451,219 61,693 0 0 0 86 103,251 451,219 0 17,347 0 28,360 5,238 1,546 21,576 (11,013) 0 (11,013) 0 0 0 (11,013) (1.26) (1.26)
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