According to Impac Mortgage Holdings Inc. (NYSEMKT:IMH) recent 10-Q report for the quarterly period ended September 30, 2012, estimated fair value of financial instruments included in the consolidated financial statement are:
Securitized mortgage collateral 5,738,150K
Securitized mortgage borrowings 5,725,469K
and the total Impac Mortgage Holdings, Inc. stockholders' equity is 28,055K.
According to the above numbers, the company is currently using a leverage of 204. In other words, a merely 0.49% loss will destroy the company.
In addition, as of September 30, 2012, securitized mortgage collateral and securitized mortgage borrowings had a principal balance of $8.7 billion.
The company claims that securitized trusts are non-recourse.
But wait a minute.
Normally, if an item is listed as a debt, it should be considered to be paid in full. Since securitized trusts are non-recourse, the company recorded them in fair value.
Anyway, the company admits 3 billion losses on book and it may have more since the value of assets is estimated (See discussion on level 3 assets at the end of this article).
It seems that the company thought the securitized trust buyers are going to pay the loss and it is not related to the company at all. The company only collects the "residual interest".
Is that true?
Once upon a time, this is a $250 stock (considering 1:10 reverse split) worth a billion dollar market capitalization.
At that time, what is their business? Simply the company is building their long term mortgage portfolio, a.k.a. securitized trusts.
Are the securitized trusts non-recourse at that time? Yes.
And this portfolio is still there on their balance sheets today! No changes!
So what did the billionaire common stock investors do at that time? Sell, sell, sell.
Do they know that the securitized trusts are non-recourse? Of course yes!
So why did they sell at that time? Because they knew that securitized trust investors will sue the company for all kinds of reasons to mitigate their loss even if they are non-recourse.
Where does the loss come from? We know that non-conforming mortgage issuers lose money during house market collapse since housing value drops much more than the interest spread they collect since the spread is charged based on normal house market condition.
That's why the company recorded $6.1M loss to settle two litigations reported in their 10-Q report.
If you have read the risk section of their 10-K report, you will not be surprised to see the settlement in their recent 10-Q report.
Here is the wording:
Representations and warranties made by us in our loan sales and securitizations may subject us to liability.
The trustee, purchaser, bondholder, or other entities involved in the issuance of the securities (which may include bond insurers) may have recourse to us with respect to the breach of the representations, and warranties made by us at the time such mortgages are transferred or when the securities are sold.
Those representations and warranties may include, but are not limited to, issues such as the validity of the lien, the absence of liens or delinquent taxes, the validity of the appraisal obtained in conjunction with the loan, the truthfulness of information used in the loan approval process, the loans compliance with all local, state and federal laws, the delivery of all documents required to perfect title to the lien, the loan meeting all underwriting criteria and the selection process used to include the loans in any particular transaction.
Also, we previously engaged in bulk whole loan sales pursuant to agreements that generally provide for recourse by the purchaser against us in the event of a breach of one of our representations or warranties, any fraud or misrepresentation during the mortgage origination process, or upon early default on such mortgage.
Also， reading the following words from the 10-K
There is recent litigation in the mortgage industry related to securitizations against issuers, sellers, originators, underwriters and other.We have discovered discrepancies in our securitization documents and are working with the parties involved, including bondholders, on the issue.
The Company has also received notices of claims for indemnification relating to mortgage backed securities bonds issued, originated or sold by the Company from Countrywide and Merrill Lynch.
In connection with these potential claims, we may become subject to litigation related to the securitizations. As a result, we may incur significant legal and other expenses in defending against claims and litigation and we may be required to pay settlement costs, damages, penalties or other charges which could adversely affect our financial results.
Now the question is how many litigations will follow? Nobody knows. But we do know that the company considered 3 billion losses on the portfolio. Maybe right now only a faction of investors are considering to sue the company since the company literally has 28 million assets only and it is better to save the litigation cost.
What is the impact of the litigations? Read the following:
We may become, and in some cases are a defendant in purported class action lawsuits and may not prevail in these matters.If the final resolution of this litigation is unfavorable to us, our financial condition, results of operations and cash flows might be materially adversely affected.
We believe we have meritorious defenses to the actions and intend to defend against them vigorously; however, an adverse judgment in any of these matters could have a material adverse effect on us.
Notice the last sentence "an adverse judgment in any of these matters could have a material adverse effect on us". The word is "any", not the "most" or "some".
Now read the bottom line from 10-K:
If we are forced to liquidate, we may have few unpledged assets for distribution to unsecured creditors or equity holders.
In the event we are forced to liquidate, the majority of our assets are either collateral for specific borrowings or pledged as collateral for secured liabilities. We may have few remaining assets available for unsecured creditors and equity holders.
And now new common stock investors is buying this stock from $2 to $17, and trying to say: You, billionaire common stock investor, are wrong!!!
We think any common stock investor should ask himself these two questions:
Why billionaire common stock investors sold when they knew securitized trusts are non-recourse?
Will litigations destroy Impac Mortgage Holdings?
Finally, we want to take a note on level 3 assets and liabilities since the fair value of the long term mortgage portfolio is estimated and the real value could be significantly less.
From company's 10-K report
Level 3 assets trade infrequently, as a result there are not many reliable market prices for them. Valuations of these assets are typically based on management assumptions or expectations. Level 3 assets and liabilities were 99% and 100%, respectively, of total assets and total liabilities measured at estimated fair value at December 31, 2011 and 2010.
The estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The Company believes that the imprecision of an estimate could be significant.
Disclosure: I am short IMH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.