Note A—Summary of Business, Significant Accounting Policies and Legal Proceedings

1.     Business Summary

Business Summary

Impac Mortgage Holdings, Inc. (the Company or IMH) is a Maryland corporation incorporated in August 1995 and has the following subsidiaries: Integrated Real Estate Service Corporation (IRES), IMH Assets Corp. (IMH Assets), Impac Warehouse Lending Group, Inc. (IWLG), and Impac Funding Corporation (IFC), together with its wholly-owned subsidiaries Impac Secured Assets Corp. (ISAC) and Impac Commercial Capital Corporation (ICCC).

In the first quarter of 2009, the Company created a new subsidiary, Integrated Real Estate Service Corporation, (IRES), which includes mortgage and real estate related fee-based businesses and entities.

The Company’s operations include its continuing and discontinued operations.  TheCompany's continuing operations primarily include the long-term mortgage portfolio (residual interests in securitizations reflected as net trust assets and liabilities in the consolidated balance sheets), and the mortgage and real estate related fee-based businesses.businesses conducted by IRES. The discontinued operations include the former non-conforming mortgage and retail operations conducted by IFC, commercial operations conducted by ICCC, and warehouse lending operations conducted by IWLG.

        Effective January 1, 2009, the Company revoked its election to be taxed as a REIT, effective January 1, 2009.real estate investment trust (REIT). As a result of revoking this election, the Company will beis subject to income taxes as a regular (Subchapter C) corporation. As of December 31, 2008, the Company had estimated federal and California net operating loss carryforwards of $353.6$356.2 million and $526.1$627.2 million, respectively.  These amounts are subject to change based on the completion and filing of the Company’s income tax returns.

The information contained throughout this document is presented on a continuing operations basis, unless otherwise stated.

During the first quarter of 2009, the Company initiated various mortgage and real estate related fee-based businesses, including loan modifications, real estate disposition, monitoring and surveillance services, real estate brokerage and lending services and escrow services, and has begun to generate revenues from these businesses.services. For the three and sixnine month periods ended JuneSeptember 30, 2009, mortgage and real estate services fees were $13.2$13.5 million and $18.8$32.3 million, respectively. However, since these businesses are newly formed and currently generate fees primarily from the Company’sCompany's long-term mortgage portfolio, there remains uncertainty about their future success, including providingthe ability to provide similar services to the marketplace.

In January 2009, the Company purchased and canceled $25.0 million in outstanding trust preferred securities of Impac Capital Trust #2 for $3.75 million and terminated the remaining debt.

In June 2009, the Company purchased and canceled $1.0 million in outstanding trust preferred securities of Impac Capital Trust #4 for $150 thousand.

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(dollars in thousands, except share and per share data or as otherwise indicated)

Note A—Summary of Business, Significant Accounting Policies and Legal Proceedings (Continued)

As a result of the restructuring of $51.3 million and purchase and cancelation of $36.5 million in outstanding trust preferred securities, the Company reduced its annual interest expense obligation from $7.8 million to $2.0 million. With the restructuring and purchase and cancelations of trust preferred securities, the Company has $8.5 million in outstanding trust preferred securities of Impac Capital Trust #4 and $62.0 million in outstanding junior subordinated notes.

In June 2009, the Company completed the Offer to Purchase and Consent Solicitation (the “Offer"Offer to Purchase”Purchase") of all of its 9.375% Series B Cumulative Redeemable Preferred Stock and 9.125% Series C Cumulative Redeemable Preferred Stock. The Series B Preferred Stock had a liquidation preference of $50 million and the Series C Preferred Stock had a liquidation preference of $111.8 million, for a total of $161.8 million. Upon expiration of the Offer to Purchase, holders of approximately 67.7%68% of the Preferred Stock tendered an aggregate of 4,378,880 shares. StockholdersHolders of the Company’sCompany's Series B Preferred Stock tendered 1,323,844 shares at $0.29297 per share for a total of $388 thousand. StockholdersHolders of the Company’sCompany's Series C Preferred Stock tendered 3,055,036 shares at $0.28516 per share for a total of $871 thousand. The aggregate purchase price for the Preferred Stock was $1.3 million. In addition, in connection with completing the Offer to Purchase, the Company paid $7.4 million accumulated but unpaid dividends on its Preferred Stock. With the total cash payment of $8.7 million, the Company eliminated $109.5 million of liquidation preference on its Preferred Stock. After the completion of the Offer to Purchase, the Company has outstanding $52.3 million liquidation preference of Series B and Series C noncumulative Preferred Stock.

In April 2009, the FASB issued three FASB Staff Positions (FSP) related to fair value measurements:

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FSP No. FAS 157-4 "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" (FASB ASC 820-10-65-4)



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FSP No. FAS 107-1 and APB 28-1 "Interim Disclosures about Fair Value of Financial Instruments" (FASB ASC 825-10-65-1)



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FSP No. FAS 115-2 and FAS 124-2 "Recognition and Presentation of Other-Than-Temporary Impairments" (FASB ASC 320-10-65-1)

        FASB ASC 820-10-65-4 provides additional guidance for estimating fair value in accordance with FASB ASC 820-10 (formerly SFAS No. 157 "Fair Value Measurements" (SFAS 157)) when the volume and level of market activity for the asset or liability have significantly decreased. FSP 157-4FASB ASC 820-10-65-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. It acknowledges that in these circumstances quoted prices may not be determinative of fair value. This FSPFASB ASC 820-10-65-4 emphasizes that even if there has been a significant decrease in the volume and level of market activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. Prior to issuance of this FSP 157-4,the clarifications included in FASB ASC 820-10-65-4, many companies, including the Company, interpreted SFAS 157FASB ASC 820-10 to emphasize the use of most recently available quoted market prices in determiningestimating fair value, regardless of whether markets had experienced a significant decline in the volume and level of activity relative to normal conditions and/or increased frequency of transactions that are not orderly.

Under the provisions of FSP 157-4,FASB ASC 820-10-65-4, quoted prices for assets or liabilities in inactive markets may require adjustment due to uncertainty as to whether the underlying transactions are orderly. There is

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(dollars in thousands, except share and per share data or as otherwise indicated)

Note A—Summary of Business, Significant Accounting Policies and Legal Proceedings (Continued)

little information, if any, to evaluate if individual transactions are orderly in an inactive market. Accordingly, the Company is required to evaluate the facts and circumstances to determine whether the transaction is orderly based on the weight of the evidence. FSP 157-4FASB ASC 820-10-65-4 does not designate a specific method for adjusting a transaction or quoted price, however, it does provide guidance for determining how much weight to give a transaction or quoted price. Price quotes derived from transactions that are not orderly are not considered to be determinative of fair value and should be given less weight, if any, when measuringestimating fair value.

        FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments”, to requireASC 825-10-65-1 requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods.  FSP FAS 107-1 and APB 28-1 isThe adoption of FASB ASC 825-10-65-1, which became effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  The adoption of FSP FAS 107-1 and APB 28-1 did not have a significant effect on the Company’sCompany's consolidated financial statements.

        FASB ASC 320-10-65-1 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. For debt securities, the statementpronouncement requires that an entity assess whether it (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, the Company would be required to recognize other-than-temporary impairment. FSP FAS 115-2 and FAS 124-2 isThe adoption of FASB ASC 320-10-65-1, which became effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  The adoption of FSP FAS 115-2 and FAS 124-2 did not have a significant effect on the Company’sCompany's consolidated financial statements.

Effective January 1, 2009, the Company adopted EITF No. 08-5, “Issuer’s"Issuer's Accounting for Liabilities Measured at Fair Value with a Third-Party Credit Enhancement” (EITF 08-5). EITF 08-5Enhancement," which was incorporated into FASB ASC 820-10. FASB ASC 820-10-35 addresses whether issuer’sissuers of liabilities should consider the effect of the third-party credit enhancement when measuring the liability at fair value under FASB Statement No. 157 “Fair Value Measurements” (SFAS 157). EITF 08-5value. It requires that the issuer of a liability with a third-party credit enhancement that is inseparable from the liability shall not include the effect of the credit enhancement in the fair value measurement of the liability. The guidance in EITF 08-5 is effective in the first reporting period beginning on or after December 15, 2008, with the effect of initially applying its guidance being included in the change in fair value in the period of adoption. The adoption of EITF 08-5FASB ASC 820-10-35 did not have a significant impact on the Company’sCompany's consolidated financial statements.

Effective January 1, 2009, application of SFAS 157FASB ASC 820-10-65 to nonfinancial assets and liabilities is required. As a result of the adoption of SFAS 157FASB ASC 820-10-65 for nonfinancialsuch assets and liabilities, the Company has included additional disclosures as of and for the three and sixnine months ended JuneSeptember 30, 2009 for nonrecurring fair value measurements related to its nonfinancial assets and liabilities.

In June 2009, the FASB issued SFAS No. 166, “Accounting"Accounting for Transfers of Financial Assets – Assets—An Amendment of FASB Statement 140” (SFAS 166)140" and SFAS No. 167, “Amendments"Amendments to FASB Interpretation No. 46(R)” (SFAS 167)". SFAS 166 eliminatesThese statements eliminated the concept of a qualifying special purpose entity (QSPE), createscreated more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifiesclarified other sale-accounting criteria, and changeschanged the initial measurement of a transferor’stransferor's interest in transferred financial assets. Former QSPEs will be evaluated for consolidation based on the provisions of SFAS 167,FASB ASC 810-10-25, which changes the approach to determining a VIE’svariable interest entity's (VIE) primary beneficiary and requires companies to more frequently reassess whether they must consolidate or deconsolidate VIEs. The accounting standard requires a qualitative, rather than quantitative, analysis to determine the primary beneficiary of a VIE for consolidation purposes. The primary beneficiary of a VIE is the enterprise that has (a) the power to direct the VIE activities that most significantly affect the VIE's economic performance, and (b) the right to receive benefits of the VIE that could potentially be significant to the VIE or the obligation to absorb losses of the VIE that could potentially be significant to the VIE. These statements are effective for fiscal years and interim periods ending after November 15, 2009. The Company is currently evaluating the impact of these new pronouncements on its financial statements. While management of the Company has not completed its evaluation, the Company may be required to deconsolidateconsolidate certain securitization trust assets and trust liabilities that are currently consolidated withinrelated to assets previously sold to QSPEs. As of September 30, 2009, the Company’s financial statements because certaincurrent principal balance of these trusts may be VIEs ofQSPEs to which the Company, but the Company may not be the primary beneficiary.  In addition, the Company has two unconsolidated trusts that may be VIEs of the Company and the Company may be the primary beneficiary, in which case the Company would be required to consolidate the related trustacting as principal, had transferred assets and liabilities.

3.     Income Taxes and Deferred Charge

        Effective January 1, 2009, the Company revoked its election to be taxed as a REIT, effective January 1, 2009.REIT. As a result of revoking this election, the Company will beis subject to income taxes as a regular (Subchapter C) corporation.

Prior to January 1, 2009, the Company operated as a REIT under the requirements of the Internal Revenue Code. Requirements for qualification as a REIT included various restrictions on ownership of IMH’s

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IMPAC MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(dollars in thousands, except share and per share data or as otherwise indicated)

Note A—Summary of Business, Significant Accounting Policies and Legal Proceedings (Continued)

IMH's stock, requirements concerning distribution of taxable income and certain restrictions on the nature of assets and sources of income.

As of December 31, 2008, the Company had estimated federal and California net operating loss carryforwards of $353.6$356.2 million and $526.1$627.2 million, respectively. As of December 31, 2008, the Company’sCompany's taxable REIT subsidiary had an estimated federal net operating loss tax carryforward of $293.4 million. The federal net operating loss carryforward of the Company’sCompany's taxable REIT subsidiary, utilization of which may be limited to the Company’s taxable REITsuch subsidiary, begins to expire in the year 2027. As of December 31, 2008, the Company and the Company’sCompany's taxable REIT subsidiary had netfederal deferred tax assets of approximately $547.9$629 million and $100.0$106 million, respectively. These amounts are subject to change based onrespectively, and a combined California deferred tax asset in the completion and filingamount of the Company’s income tax returns.$181.5 million. The Company recorded a full valuation allowance against the net deferred tax assets as it believes that as of JuneSeptember 30, 2009 it is more likely than not that the net deferred tax assets will not be recoverable.

In accordance with Accounting Research Bulletin No. 51, “Consolidated Financial Statements,”ASC 810-10-45-8 the Company records a deferred charge representing the deferral of income tax expense on inter-company profits that resulted from the sale of mortgages from taxable subsidiaries to IMH in prior years. The deferred charge is included in other assets in the accompanying consolidated balance sheets and is amortized as a component of income tax expense in the accompanying consolidated statements of operations over the estimated life of the mortgages retained in the securitized mortgage collateral. The Company recorded aincome tax expense of $20 thousandzero and $2.0 million for the three and sixnine months ended JuneSeptember 30, 2009, respectively, compared to $2.2$5.3 million and $8.7$14.0 million for the three and sixnine months ended JuneSeptember 30, 2008, respectively. The income tax expense is primarily the result of the amount of the deferred charge amortized and/or impaired resulting from credit losses, which does not result in any tax liability required to be paid.

4.     Legal Proceedings

The Company is party to litigation and claims which are normalarise in the ordinary course of our operations.

Please refer to IMH’sIMH's report on Form 10-K for the year ended December 31, 2008 for a description of other litigation and claims.

Note B—Fair Value of Financial Instruments

The use of fair value to measure the Company’sCompany's financial instruments is fundamental to its consolidated financial statements and is a critical accounting estimate because a substantial portion of its assets and liabilities are recorded at estimated fair value.