Impac Mortgage, A Hidden Value?

| About: Impac Mortgage (IMH)
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Occasionally, I come across a real head-scratcher of an investment opportunity. This one recently popped up with Impac Mortgage (NYSEMKT:IMH) preferred stock, and possibly even the common stock.

This company was decimated during the financial crisis. Back in the easy lending mortgage boom days of 2005, this company actually earned $270 million in a single year. In 2012, the company recorded operating earnings of only $13 million. This isn't exactly the way you want to grow your business, but the good news is that operating earnings actually doubled from the prior year.

The bad news is that this company appears to be struggling to redefine itself after the great recession. The executives are paying themselves ridiculous sums of money to manage a business that doesn't look nearly the same as it did eight years ago. According to recent filings, last year the top two executives earned a sum of money equal to one quarter of the operating earnings. It's hard to justify this level of compensation, unless these guys are going door to door to drum up sales.

Additional head-scratchers include the reported positive book value per common share on major financial sites. Regulatory filings show that stockholders' equity on 3/31 was $29.9 million. This is being reported as book value available to the common stock, but also sitting on the balance sheet is preferred stock with a liquidation value of $51.8 million.

Some investors would argue that the preferred stockholders have no rights after approximately 2/3rds of the preferred holders accepted a tender offer and gave up their rights to a dividend. However, the preferred holders still have liquidation preference to the common stock. In fact, someone well-versed in the law may actually argue that dividends cannot be paid to the common stock until the preferred holders are dealt with fairly. Declaring a dividend to the common would be a liquidation of equity that is first available for higher preference equity holders. So, I would argue that the preferred holders are sitting on stock that is actually 57% capitalized, if the current stated equity book value is correct.

The details of the June 2009 Tender Offer include the following points (and more):

  • dividends were made non-cumulative;
  • eliminated the provisions prohibiting the payment of dividends on junior stock and prohibiting the purchase or redemption of junior or parity stock if full cumulative dividends for all past dividend periods are not paid or declared and set apart for payment;
  • eliminated any premiums payable upon the liquidation, dissolution or winding up of the Company;
  • eliminated the provision prohibiting the Company from electing to redeem Preferred Stock prior to the fifth year anniversary of the issuance of such Preferred Stock;
  • eliminated the provision prohibiting the Company from redeeming less than all of the outstanding Preferred Stock if full cumulative dividends for all past dividend periods have not been paid or declared and set apart for payment;
  • eliminated the right of holders of Preferred Stock to elect two directors if dividends are in arrears for six quarterly periods; and
  • eliminated the right of holders of Preferred Stock to consent to or approve the authorization or issuance of preferred stock senior to the Preferred Stock.

Reading this text, I believe they simply eliminated the rights of the preferred holders to cumulative dividends. They did not alter the liquidation value of the preferred stock and this is evidenced by the fact that this stock is recorded with liquidation value in the financial statements.

If this assumption about the value of preferred stock is wrong, I welcome informed opinions on the subject. It simply doesn't make sense that 2/3rds of a class of shareholders could completely wipe out value for the remaining 1/3rd, but of course, I do not practice law.

The upside to the uncertainty around the preferred and common valuation is the massive valuation allowance of $525 million on their Deferred Tax Asset. The intangible value of the DTA could fully capitalize the preferred stock and provide several million in leftover value for the common stock. However, I doubt they will ever be able to recognize a $525 million DTA with current operating earnings around $13 million for last year.

Many questions remain. For instance, management needs to answer a big question for preferred and common stockholders about the Deferred Tax Asset. Can any portion of the value of this Deferred Tax Asset be recognized? Hopefully, the answer is yes.

Additional questions about the status of preferred stockholders may be answered by the courts, but the SEC filings clearly state that liquidation value exists for the preferred stockholders and this amount is senior to the common stock's liquidation rights. For this reason, I recommend buying preferred stock, but staying clear of the common.

Disclosure: I am long IMH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long Impac Preferred Stock (IMPHO), but not the common stock. Dividends are suspended, but liquidation value is intact.