**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.**  |
|------------|------------|------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                           |
| ** ** | ** ** | **For the quarterly period ended:  June 30, 2005**                                                   |
| ** ** | ** ** | ** **                                                                                           |
| **OR**     |
| ** ** | ** ** | ** **                                                                                           |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
| ** ** | ** ** | ** **                                                                                           |
| ** ** | ** ** | **Commission File Number: 1-13485**                                                                  |

 

**AMNET MORTGAGE, INC.**

(Exact name of registrant as specified in itscharter)

 
| **Maryland**                                                                        | ** ** | **33-0741174**                        |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                    |       | (I.R.S. Employer  Identification No.) |
|                                                                                |       |                                  |
| **10421 Wateridge Circle, Suite  250  San Diego, California**                       | ** ** | **92121**                             |
| (Address of principal  executive offices)                                           |       | (Zip Code)                            |
|                                                                                |       |                                  |
| **(858) 909-1200**                                                                  |
| (Registrant’s telephone  number, including area code)                          |
|                                                                                |       |                                  |
|                                                                                |
| (Former name, former  address and former fiscal year, if changed since last report) |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

ý  YES    o  NO

 

Indicateby check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct). Yes o No ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| Common Stock ($0.01) |   | 7,433,407 as of July 29, 2005 |
|----------------------|--------|-------------------------------|

 

 

----

 
| INDEX                                                                                                                                                                                                                 |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                                  |   |
| PART I. FINANCIAL  INFORMATION                                                                                                                                                                                        | 3      |
|                                                                                                                                                                                                                  |   |
| Item 1.  Consolidated Financial Statements                                                                                                                                                                            | 3      |
|                                                                                                                                                                                                                  |   |
| Consolidated  Balance Sheets at June 30, 2005 and December 31, 2004                                                                                                                                                   | 3      |
|                                                                                                                                                                                                                  |   |
| Consolidated  Statements of Operations and Comprehensive (Loss) Income for the three months  ended June 30, 2005 and June 30, 2004 and for the six months ended  June 30, 2005 and June 30, 2004. | 4      |
|                                                                                                                                                                                                                  |   |
| Consolidated  Statements of Cash Flows for the six months ended June 30, 2005 and June 30,  2004.                                                                                                                     | 5      |
|                                                                                                                                                                                                                  |   |
| Notes to  Consolidated Financial Statements                                                                                                                                                                           | 6      |
|                                                                                                                                                                                                                  |   |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                                                                                                  | 14     |
|                                                                                                                                                                                                                  |   |
| Item 3. Quantitative and  Qualitative Disclosures about Market Risk                                                                                                                                                   | 39     |
|                                                                                                                                                                                                                  |   |
| Item 4. Controls and  Procedures                                                                                                                                                                                      | 40     |
|                                                                                                                                                                                                                  |   |
| PART II. OTHER INFORMATION                                                                                                                                                                                            | 41     |
|                                                                                                                                                                                                                  |   |
| Item 1. Legal Proceedings                                                                                                                                                                                             | 41     |
|                                                                                                                                                                                                                  |   |
| Item 2. Unregistered Sales  of Equity Securities and Use of Proceeds                                                                                                                                                  | 41     |
|                                                                                                                                                                                                                  |   |
| Item 3. Defaults Upon  Senior Securities                                                                                                                                                                              | 41     |
|                                                                                                                                                                                                                  |   |
| Item 4. Submission of  Matters to a Vote of Security Holders                                                                                                                                                          | 41     |
|                                                                                                                                                                                                                  |   |
| Item 5. Other Information                                                                                                                                                                                             | 41     |
|                                                                                                                                                                                                                  |   |
| Item 6. Exhibits                                                                                                                                                                                                      | 41     |

 

2

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PARTI.  FINANCIAL INFORMATION

Item1.  Consolidated Financial Statements

 

AmNet Mortgage,Inc. and Subsidiaries

ConsolidatedBalance Sheets, unaudited

(in thousands, except share and per sharedata)

 
| ** **                                                                                                                                                                   | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                                                                                                                                                         |       |              |       |                  |       |
| **ASSETS**                                                                                                                                                                   |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                    |       | $                 | 28,636     |                  | $          | 50,600 |   |
| Cash and cash equivalents—restricted                                                                                                                                    |       | 2,850             |       | 2,100                 |       |
| Mortgage loans held for sale, net, pledged  (lower of cost or market)                                                                                                        |       | 512,394           |       | 238,440               |       |
| Bond collateral, mortgage loans, net                                                                                                                                         |       | 11,381            |       | 14,509                |       |
| Bond collateral, real estate owned, net                                                                                                                                      |       | 254               |       | 479                   |       |
| Accounts receivable—mortgage loans  sold/funded                                                                                                                         |       | 36,092            |       | 16,167                |       |
| Derivative financial instruments                                                                                                                                             |       | —            |       | 616                   |       |
| Accrued interest receivable                                                                                                                                                  |       | 1,018             |       | 819                   |       |
| Deferred taxes                                                                                                                                                               |       | 11,535            |       | 10,694                |       |
| Other assets                                                                                                                                                                 |       | 6,410             |       | 6,055                 |       |
|                                                                                                                                                                         |       | $                 | 610,570    |                  | $          | 340,479 |   |
|                                                                                                                                                                         |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                               |       |              |       |                  |       |
| Liabilities:                                                                                                                                                                 |       |              |       |                  |       |
| Short-term debt                                                                                                                                                              |       | $                 | 500,786    |                  | $          | 232,236 |   |
| Long-term debt, net                                                                                                                                                          |       | 10,057            |       | 13,500                |       |
| Derivative financial instruments                                                                                                                                             |       | 568               |       | —                |       |
| Accounts payable—derivative financial  instruments                                                                                                                      |       | 2,262             |       | 37                    |       |
| Accrued interest payable                                                                                                                                                     |       | 1,374             |       | 515                   |       |
| Accrued commissions and payroll                                                                                                                                              |       | 7,955             |       | 5,218                 |       |
| Recourse liabilities associated with loan  sales                                                                                                                             |       | 5,724             |       | 5,480                 |       |
| Accrued expenses and other liabilities                                                                                                                                       |       | 5,285             |       | 6,212                 |       |
| Total liabilities                                                                                                                                                            |       | 534,011           |       | 263,198               |       |
| Commitments and contingencies (Note 12)                                                                                                                                      |       |              |       |                  |       |
| Minority interest                                                                                                                                                            |       | 97                |       | 100                   |       |
| Stockholders’ Equity:                                                                                                                                                   |       |              |       |                  |       |
| Preferred stock, par value $.01 per share;  100,000 shares authorized; no shares issued and outstanding                                                                      |       | —            |       | —                |       |
| Common stock, par value $.01 per share;  24,900,000 shares authorized; 7,433,407 shares issued and outstanding in 2005,  and 7,389,133 shares issued and outstanding in 2004 |       | 73                |       | 73                    |       |
| Additional paid-in-capital                                                                                                                                                   |       | 105,253           |       | 103,718               |       |
| Deferred compensation                                                                                                                                                        |       | (1,190            | )          | —                |       |
| Accumulated deficit                                                                                                                                                          |       | (27,674           | )          | (26,610               | )          |
| Total stockholders’ equity                                                                                                                                              |       | 76,462            |       | 77,181                |       |
|                                                                                                                                                                         |       | $                 | 610,570    |                  | $          | 340,479 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

3

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AmNet Mortgage, Inc. and Subsidiaries

ConsolidatedStatements of Operations and Comprehensive (Loss) Income, unaudited

(in thousands, except per share data)

 
| ** **                                                                                                                         | ** ** | **For the  Three Months  Ended June 30, 2005** | ** ** | **For the  Three Months  Ended June 30, 2004** | ** ** | **For the  Six Months  Ended June 30, 2005** | ** ** | **For the  Six Months  Ended June 30, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                                                                               |       |                                                |       |                                                |       |                                              |       |                                              |       |
| **Revenues**                                                                                                                       |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Gain on sales of  loans                                                                                                            |       | $                                                   | 32,635     |                                                | $          | 2,323                                             |       | $                                                 | 50,908     |   | $ | 17,839 |   |
| Derivative  financial instruments and market adjustments                                                                           |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Derivative  financial instruments—forward sales of mortgage-backed securities and options  to sell mortgage-backed securities |       | (11,421                                             | )          | 10,857                                              |       | (8,366                                            | )          | 5,370                                             |       |
| Market adjustment  on interest rate lock commitments                                                                               |       | 1,635                                               |       | 4,390                                               |       | 1,639                                             |       | 3,233                                             |       |
| Total derivative  financial instruments and market adjustments                                                                     |       | (9,786                                              | )          | 15,247                                              |       | (6,727                                            | )          | 8,603                                             |       |
| Interest on  mortgage assets                                                                                                       |       | 15,321                                              |       | 9,569                                               |       | 25,440                                            |       | 16,211                                            |       |
| Other income                                                                                                                       |       | 182                                                 |       | 434                                                 |       | 384                                               |       | 729                                               |       |
| Total revenue,  net of derivative financial instruments and adjustments                                                            |       | 38,352                                              |       | 27,573                                              |       | 70,005                                            |       | 43,382                                            |       |
| **Expenses**                                                                                                                       |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Employee  compensation and benefits                                                                                                |       | 21,266                                              |       | 14,399                                              |       | 38,531                                            |       | 26,242                                            |       |
| Interest expense                                                                                                                   |       | 11,886                                              |       | 4,754                                               |       | 18,747                                            |       | 7,994                                             |       |
| Office and  occupancy expense                                                                                                      |       | 947                                                 |       | 959                                                 |       | 2,050                                             |       | 1,795                                             |       |
| Provision for  loan losses (bond collateral)                                                                                       |       | 170                                                 |       | 128                                                 |       | 232                                               |       | 128                                               |       |
| Loss/(gain) on  sale of real estate owned, net                                                                                     |       | 12                                                  |       | (61                                                 | )          | 9                                                 |       | (320                                              | )          |
| (Gain)/loss on  bond collateral sold                                                                                               |       | (38                                                 | )          | 880                                                 |       | (38                                               | )          | 5,309                                             |       |
| Professional fees                                                                                                                  |       | 1,893                                               |       | 1,369                                               |       | 3,034                                             |       | 2,404                                             |       |
| Other operating  expenses                                                                                                          |       | 5,095                                               |       | 4,687                                               |       | 9,415                                             |       | 8,940                                             |       |
| Total expenses                                                                                                                     |       | 41,231                                              |       | 27,115                                              |       | 71,980                                            |       | 52,492                                            |       |
| (Loss) income  before income taxes                                                                                                 |       | (2,879                                              | )          | 458                                                 |       | (1,975                                            | )          | (9,110                                            | )          |
| Income tax  (benefit) provision                                                                                                    |       | (1,307                                              | )          | 250                                                 |       | (910                                              | )          | (3,646                                            | )          |
| Net (loss) income                                                                                                                  |       | $                                                   | (1,572     | )                                                   | $          | 208                                               |       | $                                                 | (1,065     | ) | $ | (5,464 | ) |
|                                                                                                                               |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Basic weighted  average shares outstanding                                                                                         |       | 7,431,581                                           |       | 7,838,504                                           |       | 7,396,661                                         |       | 7,856,426                                         |       |
| Diluted weighted  average shares outstanding                                                                                       |       | 7,431,581                                           |       | 8,582,572                                           |       | 7,396,661                                         |       | 7,856,426                                         |       |
|                                                                                                                               |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Net (loss) income  per share-basic                                                                                                 |       | $                                                   | (0.21      | )                                                   | $          | 0.03                                              |       | $                                                 | (0.14      | ) | $ | (0.70 | ) |
|                                                                                                                               |       |                                                |       |                                                |       |                                              |       |                                              |       |
| Net (loss) income  per share-diluted                                                                                               |       | $                                                   | (0.21      | )                                                   | $          | 0.02                                              |       | $                                                 | (0.14      | ) | $ | (0.70 | ) |

 

See accompanying notes to consolidatedfinancial statements.

 

4

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AmNet Mortgage, Inc. and Subsidiaries

ConsolidatedStatements of Cash Flows, unaudited

(in thousands)

 
| ** **                                                                                       | ** ** | **For the Six Months  Ended June 30, 2005** | ** ** | **For the Six Months  Ended June 30, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                            |       |                                        |       |                                        |       |
| Net loss                                                                                         |       | $                                           | (1,065     | )                                           | $          | (5,464 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                     |       |                                        |       |                                        |       |
| Loss on bond collateral sold                                                                     |       | —                                      |       | 5,309                                       |       |
| Amortization of mortgage assets premiums                                                         |       | 7                                           |       | 980                                         |       |
| Amortization of capitalized costs                                                                |       | —                                      |       | 474                                         |       |
| Amortization of deferred compensation                                                            |       | 242                                         |       | —                                      |       |
| Provision for loan losses (bond collateral)                                                      |       | 232                                         |       | 128                                         |       |
| Change in real estate owned provision (bond  collateral)                                         |       | 23                                          |       | 401                                         |       |
| Loss/(gain) on sale of real estate owned,  net                                                   |       | 9                                           |       | (320                                        | )          |
| Proceeds from sale of mortgage loans held  for sale                                              |       | 6,133,187                                   |       | 4,250,085                                   |       |
| Mortgage loan originations                                                                       |       | (6,407,140                                  | )          | (4,439,585                                  | )          |
| Increase in restricted cash                                                                      |       | (750                                        | )          | (190                                        | )          |
| Increase in loans held for sale, not  pledged (formerly bond collateral)                         |       | —                                      |       | (7,016                                      | )          |
| Increase in accounts receivable—mortgage  loans sold/funded                                 |       | (19,925                                     | )          | (1,702                                      | )          |
| Decrease in derivative financial  instruments, net                                               |       | 1,184                                       |       | 877                                         |       |
| (Increase)/decrease in accrued interest  receivable                                              |       | (199                                        | )          | 1,580                                       |       |
| Increase in deferred taxes                                                                       |       | (841                                        | )          | (1,803                                      | )          |
| Increase in other assets                                                                         |       | (355                                        | )          | (678                                        | )          |
| Increase in accrued interest payable                                                             |       | 859                                         |       | 97                                          |       |
| Increase/(decrease) in accounts payable—derivative  financial instruments                   |       | 2,225                                       |       | (1,139                                      | )          |
| Increase in loss reserve, mortgage loans  sold                                                   |       | 243                                         |       | 1,016                                       |       |
| Increase/(decrease) in accrued commissions  and payroll                                          |       | 2,737                                       |       | (478                                        | )          |
| Decrease in accrued expenses and other  liabilities                                              |       | (927                                        | )          | (4,855                                      | )          |
| (Decrease)/increase in minority interest                                                         |       | (3                                          | )          | 26                                          |       |
| Net cash used in operating activities                                                            |       | (290,257                                    | )          | (202,257                                    | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                            |       |                                        |       |                                        |       |
| Principal payments on bond collateral, mortgage  loans held or pending sale (June 30, 2004) |       | 2,907                                       |       | 26,761                                      |       |
| Proceeds from sale of bond collateral                                                            |       | —                                      |       | 112,456                                     |       |
| Proceeds from sale of real estate owned                                                          |       | 175                                         |       | 1,589                                       |       |
| Net cash provided by investing activities                                                        |       | 3,082                                       |       | 140,806                                     |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                            |       |                                        |       |                                        |       |
| Payments on long-term debt related to bond  collateral held or pending sale (June 30, 2004) |       | (3,443                                      | )          | (26,849                                     | )          |
| Payments on long-term debt from sale of  bond collateral                                         |       | —                                      |       | (85,878                                     | )          |
| Increase in net borrowings from short-term  debt                                                 |       | 268,550                                     |       | 185,189                                     |       |
| Stock options exercised                                                                          |       | 104                                         |       | 33                                          |       |
| Purchase of treasury stock                                                                       |       | —                                      |       | (4,500                                      | )          |
| Net cash provided by financing activities                                                        |       | 265,211                                     |       | 67,995                                      |       |
| Net (decrease) increase in cash and cash  equivalents                                            |       | (21,964                                     | )          | 6,544                                       |       |
| Cash and cash equivalents at beginning of  year                                                  |       | 50,600                                      |       | 44,400                                      |       |
| Cash and cash equivalents at end of period                                                       |       | $                                           | 28,636     |                                        | $          | 50,944 |   |
| Supplemental information:                                                                        |       |                                        |       |                                        |       |
| Interest paid                                                                                    |       | $                                           | 17,888     |                                        | $          | 7,898 |   |
| Taxes paid                                                                                       |       | $                                           | 820        |                                        | $          | 2,784 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

5

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**AMNETMORTGAGE, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1.  Summary of SignificantAccounting Policies and Practices**

 

*Basis of Financial Statement Presentation*

 

The consolidated financial statements include theaccounts of AmNet Mortgage, Inc., a Maryland corporation, American MortgageNetwork, Inc., a Delaware corporation and wholly-owned subsidiary of AmNetMortgage, Inc., American Residential Eagle, Inc., a Delaware specialpurpose corporation and wholly-owned subsidiary of AmNet Mortgage, Inc. andAmerican Residential Eagle 2, Inc., a Delaware limited purposecorporation and wholly-owned subsidiary of American ResidentialEagle, Inc. Substantially all of the assets of American Residential Eagle,Inc. are pledged to support long-term debt in the form of a collateralizedmortgage bond and is not available for the satisfaction of general claims ofAmNet Mortgage, Inc. American Residential Holdings, Inc. is an affiliateof AmNet Mortgage, Inc. that is consolidated in accordance with FASBInterpretation No. 46R “Consolidation of Variable Interest Entities.” Allentities are together referred to as the “Company” or “AmNet.” The Company’sexposure to loss on the assets pledged as collateral is limited to its netinvestment, as the collateralized mortgage bond is non-recourse to the Company.All significant intercompany balances and transactions have been eliminated inthe consolidation of AmNet. Certain reclassifications have been made to priorperiod amounts to conform to the current presentation.

 

In management’s opinion, all adjustments necessaryfor a fair statement are reflected in the interim period presented. Theseadjustments are of a normal recurring nature. The interim financial data as ofJune 30, 2005 and June 30, 2004 is unaudited; however, in the opinion of theCompany, the interim data includes all adjustments, consisting only of normalrecurring adjustments, necessary for a fair statement of the results for theinterim periods.

 

Sales of mortgage loans are accounted for underStatement of Financial Accounting Standards (SFAS) No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.” Mortgage loans are sold with the mortgage servicing rightsreleased. Gains or losses on sales of mortgage loans are recognized based onthe difference between the selling prices and the carrying value of the relatedmortgage loans sold. Deferred origination fees and expenses are recognized atthe time of sale.

 

Please refer to the Company’s Form 10-K for the yearending December 31, 2004, for a detailed discussion of all significantaccounting policies.

 

*Accounting For Changes and Error Corrections*

 

During the quarter endingJune 30, 2005, the FASB issued “FAS No. 154, Accounting Changes and ErrorCorrections – a replacement of APB No. 20 and FAS No. 3”.  This Statement replaces APB Opinion No. 20,Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes inInterim Financial Statements, and changes the requirements for the accountingfor and reporting of a change in accounting principle. Opinion 20 previouslyrequired that most voluntary changes in accounting principle be recognized byincluding in net income of the period of the change the cumulative effect ofchanging to the new accounting principle. This Statement requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. In the future, if changes orcorrections are necessary, the Company will be guided by FAS No. 154.

 

*Stock Options and Restricted Stock*

 

The Company elected to apply APB OpinionNo. 25, “Accounting for Stock Issued to Employees,” in accounting for itsstock-based compensation plans: the 2004 Equity Incentive Plan and 1997Employee Stock Purchase Plan. Accordingly, no compensation cost has beenrecognized in the financial statements for stock options. Compensation in theform of restricted stock is recognized through amortization of deferredcompensation. SFAS No. 123 “Accounting for Stock Based Compensation”requires pro forma disclosures of expense computed as if the fair value-basedmethod had been applied in the financial statements of companies that continueto account for such arrangements under Opinion No. 25.

 

In December 2002, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 148, “Accounting For Stock BasedCompensation Transition and Disclosure,” which amends SFAS No. 123. SFASNo. 148 requires more prominent and frequent disclosures about the effectsof stock-based compensation. The Company continues to account for its stockbased compensation according to the provisions of APB Opinion No. 25.

 

The FASB amended SFAS No. 123, “Accounting forStock-Based Compensation,” which supersedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees” in December, 2004. The amendment requires theCompany to record compensation expense

 

6

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for all share-based compensation beginningJanuary 1, 2006. When adopted, this standard will have a negative impacton earnings of approximately $66 thousand per month in future periods sincestock options already issued will vest in future periods and be expensed.

 

During the six month period ending June 30, 2005 theCompany authorized the issuance of 92,684 shares of restricted stock to executives within the Company whichwill vest over a three year period beginning in February of 2005. The Company alsoauthorized the issuance of 18,400 shares of restricted stock to outside boardmembers of the Company which will vest August 12, 2005. The value of theseshares is being expensed over the vesting period.  On March 31, 2005 the Company authorized47,900 restricted stock units to eleven senior executives of the Company with50% vesting on December 31, 2008 and 2009 respectively.

 

Had compensation cost for the Company’s stockoptions been recognized based upon the estimated fair value on the grant dateunder the fair value methodology, the Company’s net loss would have been asfollows (in thousands except income per share) (unaudited):

 
| ** **                                                                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                  | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
|                                                                                                                        |       |                   |       |                   |       |   |   |   |   |
| Net (loss) income as reported                                                                                               |       | $                      | (1,572     | )                      | $          | 208 |   | $ | (1,065 | ) | $ | (5,464 | ) |
| Deduct: Total stock-based compensation  expense determined under fair value-based method, net of tax effects (See  Note 10) |       | (129                   | )          | (193                   | )          | (1,293 | ) | (814 | ) |
| Pro forma net (loss) income                                                                                                 |       | $                      | (1,701     | )                      | $          | 15 |   | $ | (2,358 | ) | $ | (6,278 | ) |
| (Loss) income per share:                                                                                                    |       |                   |       |                   |       |   |   |   |   |
| Basic as reported                                                                                                           |       | $                      | (0.21      | )                      | $          | 0.03 |   | $ | (0.14 | ) | $ | (0.70 | ) |
| Basic pro forma                                                                                                             |       | $                      | (0.23      | )                      | $          | 0.00 |   | $ | (0.32 | ) | $ | (0.80 | ) |
| Diluted as reported                                                                                                         |       | $                      | (0.21      | )                      | $          | 0.02 |   | $ | (0.14 | ) | $ | (0.70 | ) |
| Diluted pro forma                                                                                                           |       | $                      | (0.23      | )                      | $          | 0.00 |   | $ | (0.32 | ) | $ | (0.80 | ) |

 

The assumptions used to calculate the fair value ofoptions granted are evaluated and revised as necessary to reflect marketconditions and the Company’s experience. The volatility component of the calculationto establish stock option value has been revised and is reflected in stockbased compensation expense for the three months and six months ended June 30,2005 and 2004.

 

**Note 2.  Income Per Share**

 

The following table illustrates the computation ofbasic and diluted income per share (in thousands, except share and per sharedata) (unaudited):

 
| ** **                                                                                                               | ** ** | **For the Three  Months Ended  June 30,  2005** | ** ** | **For the Three  Months Ended  June 30,  2004** | ** ** | **For the Six  Months Ended  June 30,  2005** | ** ** | **For the Six  Months Ended  June 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| Numerator:                                                                                                               |       |                                                 |       |                                            |       |                                               |       |                                               |       |
| Numerator for basic (loss) income per share                                                                              |       | $                                                    | (1,572     | )                                               | $          | 208                                                |       | $                                                  | (1,065     | ) | $ | (5,464 | ) |
| Denominator:                                                                                                             |       |                                                 |       |                                            |       |                                               |       |                                               |       |
| Denominator for basic (loss) income per  share - weighted average number of common shares outstanding during the  period |       | 7,431,581                                            |       | 7,838,504                                       |       | 7,396,661                                          |       | 7,856,426                                          |       |
| Denominator for diluted (loss) income per  share                                                                         |       | 7,431,581                                            |       | 8,582,572                                       |       | 7,396,661                                          |       | 7,856,426                                          |       |
|                                                                                                                     |       |                                                 |       |                                            |       |                                               |       |                                               |       |
| (Loss) income per share - basic                                                                                          |       | $                                                    | (0.21      | )                                               | $          | 0.03                                               |       | $                                                  | (0.14      | ) | $ | (0.70 | ) |
| (Loss) income per share - diluted                                                                                        |       | $                                                    | (0.21      | )                                               | $          | 0.02                                               |       | $                                                  | (0.14      | ) | $ | (0.70 | ) |

 

For the six months ended June 30, 2005 and 2004there were 1,150,263 and 1,083,149 options,respectively, that were antidilutive and, therefore, not included in thecalculations above.

 

**Note 3.  Concentrations**

 

For the six months ending June 30, 2005, the Companysold the majority of its loans (by volume) to three correspondent investors,Countrywide Home Loans, Inc. (45.2%), Morgan Stanley MortgageCapital Inc. (18.2%) and Wells Fargo Funding, Inc. (12.9%). TheCompany’s considerations in deciding where to sell loans are price andoperational efficiency.  The Company alsoconsiders speed of execution and loan product guidelines.  The Company believes that all of the loans itsells currently could be sold to a number of other investors.

 

7

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In addition, approximately 32% of the dollar valueof loans generated were derived from loans originated in California.  While the Company generates loans on anationwide basis, it is anticipated that the Company will continue to have asignificant concentration of loans originated from California.

 

**Note 4.  Mortgage Loans Held forSale, net, pledged**

 

AmNet has pledged loans held for sale totalingapproximately $512.4 million to securecredit lines (warehouse facilities) from fourfinancial institutions. (See Note 7. “Short-TermDebt.”). Mortgage loans held for sale at June 30, 2005 consist of loans whichhave been committed for sale of approximately$337.2 million and loans available for sale of approximately $175.2 million,all of which are carried at the lower of cost or market value.

 

**Note 5.  Bond Collateral,Mortgage Loans, net**

 

AmNet has pledged collateral in order to secure thelong-term debt issued in the form of CMOs. Bond Collateral Mortgage Loansconsist primarily of subprime credit, 30-year mortgage loans secured by firstliens on one-to-four family residential properties. As of June 30, 2005 and2004, 100% of the bond collateralmortgage loans are adjustable-rate mortgages. All Bond Collateral MortgageLoans are pledged to secure repayment of the related long-term debt obligation.All principal and interest (less servicing and related fees) on the bondcollateral is remitted to a trustee and is available for payment of thelong-term debt obligation. The obligations under the long-term debt are payablesolely from the bond collateral and are otherwise non-recourse to AmNet.

 

In March of 2004, approximately $113.9million in Bond Collateral Mortgage Loans and approximately $2.3 million in REObond collateral were reclassified as held for sale.  By September 30, 2004 all of thesemortgage loans including real estate owned, had been sold.  One remaining portfolio (CMO/FASIT 1998-1)was not sold.  Bond collateral for thisstructure is shown in the Consolidated Balance Sheets as Bond collateral,mortgage loans, net and Bond collateral, real estate owned, net.

 

**Note 6.  Derivative FinancialInstruments**

 

AmNet makes commitments to fund mortgages at setinterest rates, which are referred to as rate locked loan commitments.Additionally, most of the Company’s loans are not yet committed for sale at thetime of funding. Collectively, rate locked loan commitments and funded loansnot yet committed for sale (closed loans) are the Company’s pipeline.  The value of the pipeline will vary dependingon changes in market interest rates between the time that a rate locked loancommitment is made and the time that the loan funds and is committed for saleto an investor.

 

AmNet estimates the number of rate locked loancommitments in the pipeline that will not close in order to calculate itsinterest rate exposure on a daily basis. AmNet then purchases hedginginstruments in order to try to protect profit margins on the pipeline. Thehedging instruments typically used are forward sales of mortgage-backedsecurities (“TBA”) and options on forward sales of mortgage-backed securities.Historically, changes in the price of these instruments closely relate tochanges in the value (price) of loans in the pipeline. The Company has electednot to apply hedge accounting for the derivative financial instruments.

 

At June 30, 2005 and December 31, 2004 AmNet had thefollowing commitments to originate loans and loans not yet committed for saleto investors, and offsetting hedge coverage; (dollars in thousands)(unaudited).  (Note that interest rateexposure does not directly correspond to the notional amounts of hedge coveragewithout applying an option adjusted spread factor to the pipeline and hedges):

 
| ** **                                                                                      | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **Interest rate exposure:**                                                                     |       |              |       |                  |       |
|                                                                                            |       |              |       |                  |       |
| Commitments to originate loans at set  interest rates (after applying estimated fallout)        |       | $                 | 1,003,410  |                  | $          | 471,884 |   |
|                                                                                            |       |              |       |                  |       |
| Funded loans not yet committed for sale to  investors (closed loans)                            |       | 175,199           |       | 138,250               |       |
|                                                                                            |       | 1,178,609         |       | 610,134               |       |
| **Hedge coverage:**                                                                             |       |              |       |                  |       |
|                                                                                            |       |              |       |                  |       |
| Forward sales of To Be Announced  mortgage-backed securities (“TBA”)(notional amount) |       | 1,055,500         |       | 511,000               |       |
|                                                                                            |       |              |       |                  |       |
| Options on forward sales of mortgage-backed  securities (notional amount)                       |       | 190,000           |       | 100,000               |       |
|                                                                                            |       | 1,245,500         |       | 611,000               |       |
|                                                                                                 |            |                   |            |                       |            |  |  |

 

8

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The fair value of forward sales of mortgage-backedsecurities and options on forward sales of mortgage-backed securities are basedon quoted market prices for these instruments. The rate locked loan commitmentsare also considered a derivative instrument and are assigned fair values basedon the change in the quoted market value of the underlying loans due to marketmovements, less an estimated factor for loans that will not close (falloutratio). The fallout ratio is affected by the Company’s recent fallout history,interest rate changes and loan characteristics.

 

The following is a summary of the carrying value ofAmNet’s derivative instruments as of June 30, 2005 and December 31, 2004(dollars in thousands) (unaudited):

 
| **June 30, 2005**                                          | ** ** | **Range of Coupon  Rate** | ** ** | **Range of Notional  Amount** | ** **  | **Fair Value** | ** ** | **Range of Expiration Dates** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|-------------|----------------|------------|-------------------------------|------------|
| ***Forward sales of mortgage-backed securities  (TBAs):*** |       |                      |       |                          |        |           |       |                          |       |
| Fifteen year Fannie Mae                                    |       | 4.5-5.5 MBS               |       | $                             | 500 -20,000 |           | $          |  (401                    | )          | Jul 19-Sept 19, 2005 |   |
| Thirty year Fannie Mae                                     |       | 4.5-6.0 MBS               |       | 1,000 -30,000                 |        | (1,759         | )          | Aug 11-Sept 14, 2005          |       |
| Thirty year Ginnie Mae                                     |       | 5.0-6.0 MBS               |       | 500 - 8,000                   |        | (101           | )          | Jul 21-Sept 21, 2005          |       |
| Forward commitments by investor                            |       | 5.125-5.5                 |       | 1,200 - 10,000                |        | (429           | )          | Jul 22-Aug 31, 2005           |       |
| ***Options on TBAs:***                                     |       |                      |       |                          |        |           |       |                          |       |
| Thirty year Fannie Mae                                     |       | 5.0 - 5.5 Puts            |       | 10,000 - 40,000               |        | 45             |       | Jul 7 - Aug 5, 2005           |       |
| ***Rate locked loan commitments***                         |       |                      |       |                          |        | 2,077          |       |                          |       |
| ***Total derivative financial instruments***               |       |                      |       |                          |        | $              | (568       | )                             |       |   |
|                                                            |            |                           |            |                               |             |                |            |                               |            |  |  |

 
| **December  31, 2004**                                | ** ** | **Range of Coupon  Rate** | ** ** | **Range of Notional  Amount** | ** **     | **Fair Value** | ** ** | **Range of Expiration  Date** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|----------------|----------------|------------|-------------------------------|------------|
| ***Forward sales of mortgage-backed securities  (TBAs):*** |       |                      |       |                          |           |           |       |                          |       |
| Fifteen year Fannie Mae                                    |       | 4.5-5.5 MBS               |       | $                             | 1,000 - 20,000 |           | $          | (101                          | )          | Jan 19-Mar 17, 2005 |   |
| Thirty year Fannie Mae                                     |       | 5.0-6.0 MBS               |       | 500 - 20,000                  |           | (224           | )          | Jan 3-Mar 14, 2005            |       |
| Thirty year Ginnie Mae                                     |       | 5.0-5.5 MBS               |       | 500 - 6,000                   |           | (82            | )          | Jan 20-Mar 22, 2005           |       |
| Forward commitments by an investor                         |       | 4.625-5.75                |       | 2,000 - 20,000                |           | 584            |       | Jan 14-Feb 15, 2005           |       |
| ***Options on TBAs:***                                     |       |                      |       |                          |           |           |       |                          |       |
| Thirty year Fannie Mae                                     |       | 5.0-5.5 Puts              |       | 20,000 - 30,000               |           | 2              |       | Jan 13, 2005                  |       |
| ***Rate locked loan commitments***                         |       |                      |       |                          |           | 437            |       |                          |       |
| ***Total derivative financial instruments***               |       |                      |       |                          |           | $              | 616        |                          |       |   |
|                                                            |            |                           |            |                               |                |                |            |                               |            |  |  |

 

The following is a summaryof the components within Total derivative financial instruments and marketadjustments (expense) income (dollars in thousands) (unaudited):

 
| ** **                                                                       | ** ** | **For the Three  Months Ended  June 30, 2005** | ** ** | **For the Three  Months Ended  June 30, 2004** | ** ** | **For the Six  Months Ended  June 30, 2005** | ** ** | **For the Six  Months Ended  June 30, 2004** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| Derivative financial instruments -  (expense) income:                            |       |                                           |       |                                           |       |                                              |       |                                              |       |
| Change in value of Options - open positions                                      |       | $                                              | (1,854     | )                                              | $          | (2,138                                            | )          | $                                                 | (1,694     | ) | $ | (3,097 | ) |
| Options (loss)/gain - closed positions                                           |       | 228                                            |       | 4,287                                          |       | 259                                               |       | 4,287                                             |       |
| Change in value of TBAs - open positions                                         |       | (1,762                                         | )          | (5,698                                         | )          | (2,866                                            | )          | (4,231                                            | )          |
| Change in market adjustment on interest  rate locked loan commitments            |       | 1,635                                          |       | 4,390                                          |       | 1,639                                             |       | 3,233                                             |       |
| TBA gain - closed positions                                                      |       | (8,033                                         | )          | 14,406                                         |       | (4,065                                            | )          | 8,411                                             |       |
|                                                                             |       |                                           |       |                                           |       |                                              |       |                                              |       |
| Total derivative financial instruments and  market adjustments (expense) income: |       | $                                              | (9,786     | )                                              | $          | 15,247                                            |       | $                                                 | (6,727     | ) | $ | 8,603 |   |

 

**Note7.  Short-Term Debt**

 

As of June 30, 2005, mortgage loans held for saletotaling $512.4 million were pledgedas collateral for warehouse facility borrowings of $500.8 million with four financial institutions. At June 30,2005, the Company’s maximum borrowing capacity

 

9

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combined from these four financialinstitutions was $2.1 billion (including $500 million through temporaryfacilities).  The table below shows theage of pledged mortgage loans as of June 30, 2005 (in thousands) (unaudited):

 
| **Aging Range**   | ** ** | **Number of Loans** | ** ** | **Warehouse Line Usage** | ** ** | **% of Total** | ** ** |
|-------------------|------------|---------------------|------------|--------------------------|------------|----------------|------------|
| ** **        | ** ** | ** **          | ** ** | ** **               | ** ** | ** **     | ** ** |
| Less than 30 days |       | 2,255               |       | $                        | 456,580    |           | 91.2       | % |
| 30 to 60 days     |       | 19                  |       | 4,396                    |       | 0.9            | %          |
| 61 to 90 days     |       | 244                 |       | 39,102                   |       | 7.8            | %          |
| 91 to 120 days    |       | 10                  |       | 708                      |       | 0.1            | %          |
| Total             |       | 2,528               |       | $                        | 500,786    |           | 100.0      | % |

 

Of the $500.8 million of warehouse line usage atJune 30, 2005, $212.7 million was fundedthrough uncommitted warehouse facilities.

 

The warehouse facilities mature on various dates in2005 and 2006, and generally bear interest at one-month LIBOR plus spread. Theweighted average borrowing rates were 4.49% and 2.63% for the three monthsending June 30, 2005 and June 30, 2004 respectively. The weighted-averageborrowing rate was 4.27% for the six months ending June 30, 2005 and 2.56% forthe six months ending June 30, 2004. The weighted-average facility fee was .23%for the six months ending June 30, 2005 and June 30, 2004 on the aggregatecommitted amount of the warehouse facilities. The warehouse facilities arerepaid as principal payments on mortgage loans are received, or as the mortgageloans are sold. We are generally allowed to borrow from 96% to 99% of thelesser of par or market value of the loans, and must comply with various lendercovenants restricting, among other things, the absolute level of leverage,minimum levels of cash reserves, profitability and stockholders’ equity. We arealso, in a certain instance, required to maintain a restricted cash accountwith one of our warehouse lenders. During the six months ending June 30, 2005we were required to add $425 thousand to our cash account due to generalbusiness conditions and $325 thousand due to a $100 million creditincrease.  There were no changes in therestricted cash account during the quarter ending June 30, 2005.  As of June 30, 2005 the Company was out ofcompliance with certain warehouse line facility covenants. Waivers wereobtained from three of our four warehouse providers and we believe we are ingood standing with all of our warehouse lenders. The Company is in the processof obtaining the final waiver and is expected to be received by August 22,2005.

 

**Note 8.  Long-Term Debt Relatedto Securitizations, net**

 

The components of the long-term debt at June 30,2005 and December 31, 2004, along with selected other information aresummarized below (dollars in thousands) (unaudited):

 
| **CMO/ FASIT 1998-1  Securitization** | ** ** | **June 30,  2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                            | ** ** | ** **         | ** ** | ** **            | ** ** |
| Long-term debt                        |       | $                  | 10,057     |                  | $          | 13,500 |   |
| ** **                            | ** ** | ** **         | ** ** | ** **            | ** ** |
| Weighted average financing rates      |       | 4.71               | %          | 3.46                  | %          |
|                                       |            |                    |            |                       |            |  |  |

 

The table below shows the Company’s expected futurepayments for future obligations under the long-term debt agreement (000’s):

 
| ** **                                       | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations as of  June 30, 2005** | ** ** | **Total**                  | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than 5  Years** | ** ** |
|                                             |       |                       |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                                   |       | $                          | 10,057     |   | $ | 3,477 |   | $ | 4,882 |   | $ | 1,698 |   | $ | — |   |
|                                                  |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 9. Recourse Liabilities Associated With Loan Sales**

 

We sell loans to private investors and otherfinancial institutions. Each loan sale is subject to certain terms andconditions, which generally require us to repurchase loans or indemnify andhold the investor harmless against any loss arising from early payment defaultactivity and errors and omissions in the origination, processing and/orunderwriting of the loans. We are subject to this risk for loans that weoriginate as well as loans we acquire from brokers and correspondents. At June30, 2005 and December 31, 2004, we had approximately $4.6 million at bothdates, recorded as an estimate for losses that may occur as a result of theguarantees described above based on trends in repurchase and indemnificationrequests, actual loss experience, known and inherent risks in the loans, andcurrent economic conditions. The length of the indemnification period, which variesby investor and the nature of the potential defect, may extend to the life ofthe loan.

 

10

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Under most of our loan sale agreements, we are alsoobligated to refund premiums to investors if loans pay off within a certainnumber of days after the settlement of our loan sale. These refunds arereferred to as early prepayment premiums or (“EPPs”). The EPP exposure periodgenerally ranges up to 180 days after the settlement date. At June 30,2005 and December 31, 2004, we had approximately $980 and $894 thousand,respectively, recorded as an estimated reserve for premium refunds that mayoccur as a result of loans sales which were still subject to EPP liability.

 

Reserve activity for the periods presented is as follows(dollars in thousands):

 
| ** **                   | ** ** | **Reserve For  Repurchase  Obligations** | ** ** | **Premium  Prepayment  Reserve** | ** ** | **Total** | ** ** |
|------------------------------|------------|------------------------------------------|------------|----------------------------------|------------|-----------|------------|
| Balance at December 31, 2003 |       | $                                        | 2,841      |                             | $          | 298       |       | $ | 3,139 |   |
| Payments                     |       | (1,784                                   | )          | (2,519                           | )          | (4,303    | )          |
| Provisions                   |       | 3,529                                    |       | 3,115                            |       | 6,644     |       |
| Balance at December 31, 2004 |       | 4,586                                    |       | 894                              |       | 5,480     |       |
| Payments                     |       | (632                                     | )          | (1,388                           | )          | (2,020    | )          |
| Provisions                   |       | 790                                      |       | 1,474                            |       | 2,264     |       |
| Balance at June 30, 2005     |       | $                                        | 4,744      |                             | $          | 980       |       | $ | 5,724 |   |

 

The balances for the Reserve For RepurchaseObligations and Premium Prepayment Reserve are included in the ConsolidatedBalance Sheets in the Recourse liabilities associated with loan sales lineitem. The payments and provisions represent the yearly change of the balancesheet accounts. The related expense for the three months ending June 30, 2005and June 30, 2004 is included in the Consolidated Statements of Operations andComprehensive (Loss) Income in the revenue section, gain on sales of loans lineitem.

 

**Note 10.  StockPlans**

 

As of June 30, 2005, shares of common stock werereserved for issuance under the Company’s stock plans as follows (unaudited):

 
| ** **                                                                      | ** ** | **1997 Employee  Stock Purchase  Plan** | ** ** | **2004 Equity  Incentive Plan** | ** ** | **1997 Stock  Option Plans  (New  issuances  terminated in 2004*)** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|---------------------------------------------------------------------|------------|-----------|------------|
|                                                                            |       |                                    |       |                            |       |                                                                |       |      |       |
| Total Stock Authorized at 1/1/2005                                              |       | 20,000                                  |       | 600,504                         |       | 1,899,496                                                           |       | 2,520,000 |       |
| Total Options, Restricted Stock, Restricted  Stock Units Issued or to be issued |       | —                                  |       | 345,108                         |       | 1,899,496                                                           |       | 2,244,604 |       |
| Shares Reserved For Issuance at 6/30/05                                         |       | 20,000                                  |       | 255,396                         |       | —                                                              |       | 275,396   |       |

 

----

* The 1997 Stock Plan continues until all options outstanding under itare terminated or exercised. No new options will be granted.

 

Stock option activity during the six months endingJune 30, 2005 was as follows (unaudited):

 
| ** **                        | ** ** | **Number of Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|-----------------------------------|------------|-----------------------|------------|--------------------------------------|------------|
|                              |       |                  |       |                                 |       |
| Balance at December 31, 2004 |       | 1,829,271             |       | $                                    | 8.12       |   |
| Granted                           |       | 238,900               |       | 10.33                                |       |
| Forfeited                         |       | (50,526               | )          | 7.61                                 |       |
| Exercised                         |       | (18,498               | )          | 3.67                                 |       |
| Balance at June 30, 2005          |       | 1,999,147             |       | $                                    | 8.43       |   |

 

11

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At June 30, 2005, the range of exercise prices foroutstanding options was $1.75 to $15.00 and the weighted-average remainingcontractual life of outstanding options was 5.92 years.The weighted average exercise price of exercisable outstanding options was $8.94. The table below shows options and prices for all outstanding options atJune 30, 2005 (unaudited):

 
| **Option Exercise Price Range** | ** ** | **Vested** | ** ** | **Unvested** | ** ** | **Number of  Options** | ** ** |
|---------------------------------|------------|------------|------------|--------------|------------|------------------------|------------|
|                            |       |       |       |         |       |                   |       |
| $1.75 to $3.00                  |       | 131,334    |       | 29,146       |       | 160,480                |       |
| $3.01 to $5.00                  |       | 289,583    |       | 151,334      |       | 440,917                |       |
| $5.01 to $7.50                  |       | 313,447    |       | 35,753       |       | 349,200                |       |
| $7.51 to $10.00                 |       | 151,520    |       | 146,630      |       | 298,150                |       |
| $10.01 to $12.50                |       | 488,727    |       | 5,573        |       | 494,300                |       |
| $12.51 to $15.00                |       | 256,100    |       | —       |       | 256,100                |       |
|                            |       | 1,630,711  |       | 368,436      |       | 1,999,147              |       |

 

The per share weighted-average fair value of stockoptions granted between January 1, 2005 and June 30, 2005 is computedquarterly.  For the first quarter endingMarch 31, 2005 the per share weighted-average fair value of stock optionsgranted was $5.82. For the second quarter ending June 30, 2005 the valuewas $4.90. These values were calculatedusing the Black-Scholes option-pricing model, using the followingweighted-average assumptions (unaudited):

 
| ** **              | ** ** | **Three Months  Ending  June 30, 2005** | ** ** | **Three Months  Ending  March 31, 2005** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| Expected dividend yield |       | 0.00                                    | %          | 0.00                                     | %          |
| Risk-free interest rate |       | 3.72                                    | %          | 4.18                                     | %          |
| Expected volatility     |       | 60.20                                   | %          | 60.87                                    | %          |
| Expected life (years)   |       | 5                                       |       | 5                                        |       |

 

On February 7, 2005 the Company’s CompensationCommittee authorized payments under the Long-Term Incentive Cash Plan. However,the Committee determined that it is in the best interests of the Company to payhalf of each award value in cash and half in restricted stock of the Company.Consequently, 92,684 restricted shares of the Company’s stock were authorizedto be issued to the executives of the Company with a three year vesting period.Issuance of the restricted stock was authorized in April 2005 and is to beissued. The cost to the Company will be approximately $278 thousand per yearfor three years beginning in 2005. On March 31, 2005 the Committee authorized47,900 restricted stock units to eleven senior executives of the Company with50% vesting on December 31, 2008 and 2009, respectively. On April 4, theCommittee granted 18,400 restricted shares to the outside members of the Boardof Directors vesting August 12, 2005. The result of these awards was $1.4million of deferred compensation which was reduced during the six months endingJune 30, 2005 to $1.2 million by monthly amortization and is included in theequity section of the Consolidated Balance Sheets.

 

**Note 11.  Income Taxes**

 

During 1997, the Company elected to be taxed as aReal Estate Investment Trust (“REIT”) under the Internal Revenue Code of 1986,as amended. As a result of this election, the Company was not, with certainexceptions, taxed at the corporate level on the net income distributed to theCompany’s stockholders. On July 19, 2002, the stockholders of the Companyapproved two proposals that allowed for the conversion of the Company from aREIT to a fully taxable entity. On February 7, 2003, the Company filed anotice with the Internal Revenue Service of its decision to relinquish its REITstatus, effective January 1, 2003.

 

As a result of the conversion to a fully taxablestatus, an income tax benefit and related deferred tax asset of$5.7 million was recorded in 2003. As of June 30, 2005, our deferred taxasset amounts to $11.5 million which reflects a change in the taxprovision from December 31, 2004. The tax provision was calculated based on anassumed income tax rate of 44% for 2005.

 

At June 30, 2005, in determining the possible futurerealization of deferred tax assets, management considers future taxable incomefrom the following sources: (a) reversal of taxable temporary differences,(b) future operations exclusive of reversing temporary differences, and(c) tax planning strategies that, if necessary, would be implemented toaccelerate taxable income into years in which net operating losses mightotherwise expire.

 

As the Company’s net income and its projections ofnet income vary over time, the expected realizability of its deferred taxassets may change. If the Company determines that its ability to realize all ofits deferred taxes is unlikely, the Company will set up certain valuationallowances against those assets, which would negatively affect its net income.However, currently, we expect to fully utilize our deferred tax assets.

 

12

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**Note 12.  Commitments andContingencies**

 

*Lease Commitments*

 

The Company rents certain premises and equipmentunder non-cancelable operating leases expiring at various dates through theyear 2010. Rental expense under such leases is included in office and occupancyexpense, and other operating expenses. Lease costs totaled $2.1 million in the six months ending June 30, 2005 and $1.9million in the six months ending June 30, 2004. Future minimum leasepayments under these leases as of June 30, 2005, are as follows (dollars inthousands) (unaudited):

 
| **Year ending June 30:** | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2006                     |       | $          | 3,530      |   |
| 2007                     |       | 2,562      |       |
| 2008                     |       | 1,868      |       |
| 2009                     |       | 1,226      |       |
| 2010                     |       | 370        |       |
| After June 30, 2010      |       | —     |       |
|                     |       | $          | 9,556      |   |

 

13

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS.

 

*The statements contained in thisForm 10-Q that are not purely historical are forward looking statements,including statements regarding our expectations, hopes, beliefs, intentions, orstrategies regarding the future. Such statements use words such as “expect,” “will,”“may,” “anticipate,” “goal,” “intend,” “seek,” “believe, “target”, “ “plan,” “strategy”and derivatives of such words. Forward looking statements in this reportinclude those statements regarding:*

 

•                  *Our future results ofoperations and the factors that could impact our results;*

 

•                  *The factors that may impactour future liquidity;*

 

•                  *Our strategies;*

 

•                  *Changes in the mortgagemarket and competitive factors;*

 

•                  *The estimates we use inpreparing our financial statements and the impact of accounting standards;*

 

•                  *The risks that may impactour business.*

 

*These forward looking statementsare based on information available to us on the date hereof, and we assume noobligation to update any such forward looking statements. It is important tonote that our actual results and timing of certain events could differmaterially from those in such forward looking statements.  Some of the most significant risks that weface that could harm our future operating results or prevent us from meetingour goals and objectives are the following:*

 

•                  *We are maximizing the utilization of our existing infrastructure whilemanaging our staffing levels and growing our sales presence in existing and newmarkets. Our strategy requires us to capture an increasing percentage of themarket in a highly competitive environment, which will put pressure on ourgross margins. If we are not able to do this, we would likely experience losses(due to our increased level of expenses or lower gross margins).*

 

•                  O*ur market share increases are dependent on retainingand expanding our sales force and broker customer base, which is morechallenging in a highly competitive market environment. In particular we mustremain competitive relative to our pricing of loans, which could cause us tolower our gross margins.*

 

•                  *We sell a substantialportion of our loans to two of our competitors. If these competitors stop purchasing our loans on favorable terms, wecould be required to find alternate purchasers and/or accept unfavorableterms.  In either case, this could reduceour revenues and earnings.*

 

•                  *In 2004 we made thestrategic decision to create a correspondent lending operating platform and in2005 we began purchasing closed loans from small mortgage bankers and otherfinancial institutions.  Some of therisks associated with this channel are different from our wholesale lendingbusiness, and our Company has no experience competing in this highlycompetitive segment of the mortgage market. We have committed overhead to this new channel, and expect to makeadditional investments in the remainder of 2005 to try to build this new sourceof revenue.  However it is difficult toevaluate our competitive posture and growth prospects for this channel, and wemay not be able to compete effectively against larger, well establishedcorrespondent lenders.*

 

•                  *In 2004 we began offeringsubprime loans to wholesale brokers, and we intend to increase our proportionof subrpime loans significantly in 2005 as we hire dedicated account executivesto call on mortgage brokers who specialize in subprime loans. While we have acentralized underwriting and funding center to process these loans and havehired experienced personnel, subprime loans are more complex and any errors wemake in underwriting or funding these loans could cause loans to be un-saleableor to be sold at a significant loss. Additionally subprime lending is extremely competitive making itdifficult to evaluate the potential growth prospects and profit margins forthis product line.*

 

•                  *We are dependent on ourwarehouse lending facilities to operate our business.  We must maintain, renew or replace ourwarehouse lines of credit in order to continue to fund loans.  We believe we are in good standing with ourwarehouse lenders, however, any future reductions or restrictions in ourwarehouse capacity would reduce the volume of loans that we could fund andwould therefore reduce our revenues and earnings.*

 

•                  *A large portion of theloans we fund are concentrated in California and therefore our results aresubject to adverse economic conditions in California.*

 

•                  *Our hedging strategies maynot be successful in mitigating risks associated with interest ratechanges.  In particular, for new loanproducts with shorter terms and loan products with adjustable rates, hedgingstrategies may not be effective at certain times.*

 

*Other factors that may impact ourresults, include but are not limited to, general economic conditions, the worldpolitical climate, unexpected expense increases, overall interest rates,volatility in interest rates, the shape of the yield curve,  changes in accounting rules or theirapplication, changes in the margins for gains on sale of originated loans,changes in the demand of mortgage brokers for our loan products and services orof loan purchasers for originated loans, undetected fraud on the part ofborrowers, brokers, appraisers or our employees, changes in the mortgageindustry regulatory environment, increases in prepayment*

 

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*rates anddefault rates, changes in the requirements of correspondent loan programs orour ability to meet such requirements and changes in our anticipated cashrequirements. These and other risk factors that could cause actual results todiffer materially are set forth in more detail in this item under the heading “BusinessRisk Factors.”*

 

15

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**Introduction**

 

Our Company was founded in 1997 as an externallymanaged Real Estate Investment Trust. Until 2001, substantially all of ouroperations consisted of the acquisition of residential mortgages for investmentpurposes. In mid-2001, our Board of Directors and management determined that itwas in the best interest of the stockholders to fundamentally shift ourstrategic direction to mortgage banking. We started the transition in 2001 byforming a subsidiary, American Mortgage Network, Inc., to engage in thewholesale lending segment of the mortgage banking industry. In January of 2003we elected to relinquish our REIT status with the Internal Revenue Service(previously approved by our stockholders). In order to more closely align ourname with our mortgage banking focus, we changed our name from AmericanResidential Investment Trust, Inc. to AmNet Mortgage, Inc., as ofMay 5, 2004. On September 29, 2004 our Company’s stock began tradingon the NASDAQ National Market System under the trading symbol AMNT. Previouslywe were listed on the American Stock Exchange under the trading symbol INV andprior to that we were listed on the NYSE.

 

In March of 2004, we began providing loan programstailored to subprime borrowers with credit that does not meet conventionalguidelines or who require non-conventional loan terms with respect toloan-to-value, debt ratio, cash-out or documentation. We offer subprime loansthrough several different loan programs. However, our Company policy is not toprovide high cost loans which are defined as mortgage loans that feature eitheran interest rate or points and fees charged in connection with loans thatexceed certain thresholds prescribed by federal or state law or localordinances. Subprime lending provides loan solutions for borrowers with creditproblems who would not qualify for other lending products we offer. The unitcost to originate these loans is higher due to more labor intensiveunderwriting and funding processes, higher sales commission rates and a higherpercentage of loan applications that are not approved or funded. As a result ofhigher credit risk and cost, we must charge higher interest rates for assumingthis risk. To help mitigate the additional risks while our systems andprocesses are being refined, underwriting for these loans is performed at ourcentralized subprime operations center located in our San Diego headquartersoffice as opposed to the regional underwriting and funding we utilize for allother wholesale loan products we offer. Our long-term strategy is to grow thissegment of our business to up to 20 percent of our loan funding volume. Oursubprime volume was 1.7 percent of total loan volume funded in the first sixmonths of 2005 and is expected to reach four percent of total loan volume bythe end of 2005. We have hired seasoned staff to augment our expertise in thisarea of lending. We also have negotiated with investors to buy the loans wegenerate and amended our agreements with existing warehouse lenders to financethese loans.

 

In the second half of 2004 we made a strategicdecision to create a correspondent lending channel. Incremental revenues fromthis channel will help us to more fully leverage our wholesale lendinginfrastructure, particularly our headquarters administrative costs.Correspondents are larger brokers, mortgage bankers or other financialinstitutions who originate and fund loans and sell closed loans on aservicing-released basis. We have hired an experienced sales team andestablished an operations center in Columbia, Maryland to process these loanpurchases. We began originating loans through this channel in the first quarterof 2005 and in the second quarter funded loan volume was less than 1.5% oftotal funded volume for the Company.

 

We originate mortgage loans predominately to primequality borrowers (except our subprime division) secured by first trust deedsthrough a network of independent mortgage brokers. A concentration of ourbusiness is in California (32% of loans originated in the six months endingJune 30, 2005); however, we do business on a nationwide basis. We sell theloans that we originate to institutional purchasers on a servicing-releasedbasis.

 

We use a dedicated sales force to offer our loanproducts to approved wholesale mortgage brokers, who refer their clients’ loansto us for underwriting and funding. Loans meeting our underwriting criteria aregenerally approved and funded at our regional underwriting loan centers. Ourheadquarters office performs various functions through multiple departmentsincluding establishment of policy, risk management, secondary marketing, loandelivery to investors, finance, accounting, administration, marketing, humanresources, and information technology.

 

At June 30, 2005, weare operational in thirty-one office locations which represents a net reductionof one office from December 31, 2004. We had a total of 885 employees at June30, 2005 which is an increase of 126 employees from December 31, 2004.

 

We borrow funds under our warehouse creditfacilities to fund and accumulate loans prior to sale to correspondentinvestors on a servicing-released basis. As of June 30, 2005 we had fourwarehouse facilities that enabled us to borrow up to an aggregate of$2.1 billion (including $500 million through temporary facilities). We aregenerally allowed to borrow from 96% to 99% of the lesser of par or marketvalue of the loans, and must comply with various lender covenants requiring,among other things, minimum levels of cash reserves, certain levels ofprofitability and restricted leverage ratios.

 

We generate revenue, net of hedging and marketadjustments in our mortgage banking business in three principal ways:

 

•                                          *Gain on loan sales*. Loan rates, fees and discount points areset based on our targeted gain on sale. This is referred to as our pricingmargin. We currently sell the loans that we originate to institutional purchaserson a servicing-released basis for cash. We record the difference between thesale price of loans that we have sold and our cost to

 

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originate the loans sold as gain on loan sales. Werecognize revenue at the time that we complete the loan sale, which isgenerally when we receive loan sale proceeds from the purchaser.  Gain on loan sales also includes fees wecharge for loan origination such as underwriting fees, loan documentpreparation fees and wiring fees, net of premiums we pay to brokers.

 

*Hedging and market adjustments.* Hedging instruments are used to helpmitigate exposure to interest rate fluctuations and protect our pricing margins.The gains or losses from this activity will be highly negatively correlated torevenue derived from loan sales. Typically higher than expected gains from thesale of loans will be offset by hedging losses and market adjustments, whilelower than expected gains from the sale of loans will be offset by hedginggains. The value of our rate lock loan commitments are measured at the end ofeach accounting period. The change from the prior period is recorded as amarket adjustment. Hedging gains or losses and market adjustments are includedin the consolidated statements of operations and comprehensive income asderivative financial instruments and market adjustments.

 

•                                          *Interest income*. We earn interest on a loan from the time wefund it until the time we sell it. The interest that we earn is partiallyoffset by the interest we pay under our warehouse credit facilities used tofinance our mortgage originations.

 

Relativeto our Mortgage Asset Portfolio, we made a strategic decision to sell the vastmajority of our mortgage portfolio assets in the first quarter of 2004 and wecompleted the sales in the third quarter of 2004. The remaining mortgage assetsof approximately $11.6 million are pledged to secure long term debt totalingapproximately $10.1 million. These assets are referred to as our CMO/FASIT1998-1 Securitization and are referred to on the balance sheet as bondcollateral. Our Company over-collateralized the bonds at the time of issuanceby pledging assets in excess of new liabilities.  These bond collateral assets are carried atthe lower of cost or net realizable value. At June 30, 2005, our bond collateral assets were carried on our balancesheet at approximately $1.5 million more than our remaining long term debt.

 

On a cash basis, we continue to receive principal and interest paymentson the bond collateral assets and these proceeds are used by the bond trusteeto service and pay down the long term debt. Any excess cash flow is remitted tous on a monthly basis. The long term debt is non-recourse to our Company,meaning that only the principal and interest received from the bond collateralassets, combined with any proceeds from the sale of REO loans, can be used toservice the bond liabilities.  As such,while we do generally receive some net cash flow from the bond collateralassets each month, we will never be required to have any cash outlay associatedwith these assets and the related long term liability.

 

The expenses of our business include variable costssuch as commissions, loan expenses and contract labor, as well as fixedoverhead expenses such as personnel, rent, supplies and utilities.

 

Due to the immateriality of our mortgageasset portfolio business, we discontinued business segment reporting as ofJanuary 1, 2005.  As such, we beganpresenting management’s discussion and analysis of financial condition and ourresults of operations on a consolidated basis beginning, the three months endedMarch 31, 2005.

 

***Our 2nd Quarter 2005 Highlights (Executive Overview)***

Our consolidated operating results for the secondquarter of 2005 were dominated by the following:

 

•                  We funded approximately $3.7 billion inloan volume for the period while fundings for the same period in 2004 were $2.6billion.  This represents an increase ofapproximately 44.1% while the overall mortgage market declined fromapproximately $802 billion for the quarter ending June 30, 2004 toapproximately $779 billion for the quarter ending June 30, 2005, according tothe Mortgage Bankers Association (“MBA”) Mortgage Finance Forecast dated July12, 2005.  Also, according to the MBA,loan volume is projected to increase from $2.6 trillion for all of 2004 to $2.7trillion for all of 2005. Key reasons for our loan production increase are: asales force increase (204 at June 30, 2005 compared to 121 account executivesat June 30, 2004), a maturing of our branch network resulting in better marketpenetration and a broader range of loan products offered by the Company. Thegraph below shows monthly loan production comparisons between the secondquarters of 2005 and 2004.

 

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2005 & 2004 Loan Fundings by Month - Second Quarter

 

 
| ** **                            | ** ** | **(in millions)** | ** ** |
|---------------------------------------|------------|-------------------|------------|
| ** **                            | ** ** | **2005**          | ** ** | **2004** | ** ** |
| April                                 |       | $                 | 986        |   | $ | 1,147 |   |
| May                                   |       | 1,224             |       | 751 |   |
| June                                  |       | 1,488             |       | 668 |   |
| Totals – Quarters ending June 30 |       | $                 | 3,698      |   | $ | 2,566 |   |

 

•                                          Total revenues, net of derivative financialinstruments and market adjustments, were $38.4 million which represented a 39%increase from the quarter ending June 30, 2004. Net revenue from interestincome of $9.6 million and $15.3 million less interest expense of $4.8 millionand $11.9 million decreased from $4.8 million to $3.4 million (quarters endingJune 30, 2004 and June 30, 2005 respectively) as a result of interest spreadcompression.

 

•                                          Total revenue was insufficient to covervariable and fixed expenses totaling $41.2 million resulting in a pretax lossof $2.9 million.  We had adverse impactsfrom timing differences, as more fully described below in the section entitled“Interest Rate Risk Management and the Relationship Between our HedgingInstruments and the market adjustments and gain on Sale That we may Record for aPeriod”.

 

•                                          Unrestricted cash and cash equivalentsdecreased by $8.7 million during the second quarter of 2005 from $37.3 millionat March 31, 2005, to $28.6 million at June 30, 2005. The key factors in the decrease were (i) additional cash invested inhigher loan  inventories including ourwarehouse haircuts (1% to 4% of loans held for sale) was approximately $5.1million and premiums paid to mortgage brokers which are not recouped until wesell our loans to investors was approximately $6.8, and (ii) increased accountsreceivable from loans was approximately $18.2 million. These decreases werepartially offset by decreases in certain receivables and increases in variousaccrued expenses.

 

•                                          Our mortgage asset portfolio receivedapproximately $2.1 million in principal and REO sale proceeds. The Companyreduced related long term debt by approximately $2.1 million.

 

**Critical Accounting Policies**

 

The following analysis of financial condition andresults of operations are based upon our consolidated financial statements andthe notes thereto, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”). Thepreparation of these consolidated financial statements requires us to make anumber of estimates and assumptions that affect the reported amounts anddisclosures in the consolidated financial statements. On an ongoing basis, weevaluate our estimates and assumptions based upon historical experience andvarious other factors and circumstances. We believe that our estimates andassumptions are reasonable in the circumstances; however, actual results maydiffer significantly from these estimates and assumptions, which could have amaterial impact on the carrying value of assets and liabilities at the balancesheet dates and our results of operations for the reporting periods.

 

We believe that estimates and assumptions areimportant factors in the portrayal of our financial condition and results ofoperations. Our critical accounting policies that require management’s mostsubjective judgments include the following:

 

•                  Derivative hedging activities / determinationof fair values

•                  Fair value of mortgage loans held for sale

•                  Income taxes and benefits

•                  Recourse liabilities associated with loansales

 

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Pleaserefer to the Company’s Form 10-K for the year ending December 31, 2004,for a detailed discussion of these policies.

 

**Management’s Financial Analysis**

 

We presentnon-GAAP financial measures in this report. We believe that these measures arehelpful in understanding our business and operating results. You should notconsider our non-GAAP financial measures as a replacement for any GAAPfinancial measures. The non-GAAP financial measures that we present are asfollows:

 

*Gross Margins -*Gainsfrom the sale of loans are a function of the volume of loans sold in theperiod, and the value of the loans at the time these loans are committed forsale to an investor.  We also generategains and losses on the derivative financial instruments that we acquire tohedge our targeted gain on sale of the loans. We consider our gross margin to be the sum of our (i) gain on sales ofloans and (ii) total derivative financial instruments and marketadjustments.  This sum expressed as apercentage of our loan sales volume is our gross margin percentage (or basispoint gross margin).

 

When we develop the pricing of our loans, weincorporate a target gross margin percentage that we expect to obtain.  We then provide rate lock commitments toborrowers based on that pricing and the related target gross marginpercentage.  However, if market interestrates increase between the time we make a rate lock commitment and commit aloan for sale, then the market value of the loan would be reduced and we wouldnot achieve our target margin percentage. If interest rates decrease, then the opposite would be true.Accordingly, we acquire derivative financial instruments to hedge, or protectour target margins from interest rate increases.  We hedge our loans from the time of a ratelock commitment to the time the loan is committed for sale to an investor.

 

If our hedging is effective, as the value ofour pipeline decreases and we record a lower gain on sale, our hedgeinstruments increase in value to offset the reduced gain.  Alternatively, as the value of our pipelineincreases, we record a larger gain on sale but the larger gain is offset by aloss on our hedges.  Accordingly, if wesuccessfully hedge our pipeline, the gross margin percentage that we ultimatelyearn will be close to our target gross margin percentage and we will not besignificantly impacted by interest rate changes.  In order to evaluate the effectiveness of ourhedging program, management believes that it is important to evaluate our grossmargins and then compare our actual gross margin percentage against our targetgross margin percentage.

 

*Net Interest Income*- We earn interest income and incurinterest expense in our operations. We earn interest on a loan from the datethe loan is funded until its sale to an investor. Accordingly, interest incomeis a function of the volume of loans funded, the interest rate on the loans andthe length of time the loans are held prior to sale. To the extent we fundloans with borrowings under our warehouse facilities, we record interestexpense based on the same factors. We also generate revenue from the interestwe receive on the bond collateral mortgage loans we hold for investment and we incurinterest expense on the borrowings used to finance our loan fundings and bondcollateral.

 

Because the interest income and interest expense ofour business are closely related and dependant on many of the same factors, inparticular the volume of loans we originate, management believes that it ishelpful in understanding our operations to analyze the impact of interestincome on mortgage loans held for sale and related short term debt expensetogether. For this reason, the discussion below provides information regardingthe net interest income (interest income less interest expense). Managementbelieves that this is consistent with how financial analysts typically considerinterest in analyzing mortgage banking operations.

 

*Fixed and Variable Operating Expenses*— For the same reasons described in “NetInterest Income” above, the explanation of expenses includes a discussion ofour operating expenses, excluding interest expense. Because certain otherexpenses we incur in the mortgage banking business, such as commissions andcontract labor, also vary with the volume of our loan originations, managementbelieves that it is important in understanding our business to consider thevariable and fixed expenses separately. Accordingly, we have included an estimatedbreakdown between variable and fixed amounts for each category of our operatingexpenses. Management believes that this will enable a better understanding ofour results and the likely impact of future changes in our origination volumes.

 

**InterestRate Risk Management And The Relationship Between Our Hedging Instruments AndThe Market Adjustments And Gain On Sale That We May Record For A Period**

 

Our mortgage banking business is subject to the riskof changing interest rates between the time we commit to extend credit at a setinterest rate (rate lock) and the time we commit the mortgage loans for sale.Our pipeline consists of loans for which we have provided a rate lock but whichwe have not yet closed (rate locked loan commitments) and closed loans that havenot yet been committed for sale (closed loans). Generally, as market interestrates rise, our pipeline, which then has lower interest rates than theprevailing market, is not as attractive to investors and therefore we losevalue in the pipeline. Conversely, as market interest rates fall, our pipelineis more attractive to investors and we gain value in the pipeline. However,some of this gain in value may be offset by an increase in the fallout of ourrate locked loans as borrowers choose not to fund their loan with us and seekalternative loans with the new, lower interest rates.

 

Tomitigate the risk of rising interest rates and protect our pricing margins, wepurchase hedge instruments.  The gains orlosses from this activity will generally correlate to losses or gains derivedfrom market adjustments on our rate locked loan commitments and losses or gainsthat we record on sales of our closed loans. Typically, higher than expectedmarket adjustments and

 

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gains from the sale of loans will be offsetby hedging losses, while lower than expected market adjustments and gains fromthe sale of loans will be offset by hedging gains. However, the correlatedgains and losses are not always recorded in the same accounting period becauseof timing differences.

 

Utilizing past loan fallout history, we estimate thepercentage of our rate lock loan commitments that will close, but theseprojections are difficult, especially during periods of volatile interestrates. We hedge (or protect) our loan sale margin in the pipeline using forwardsales of mortgage-backed securities (“TBA’s”), options on mortgage-backedsecurities (“MBS”) and similar agreements.

 

We generally adjust our hedge coverage on a dailybasis based upon changes in the size and composition of the pipeline andresultant changes to our estimated pipeline exposure, seeking to protect ourloan sale margin targets. Since August of 2002, we have used an outsidecompany, Mortgage Capital Management, Inc. (“MCM”), to help us manage ourinterest rate risks. MCM is a quantitative software and advisory service firmthat currently serves a number of clients in the mortgage banking industry. MCMperforms pipeline exposure analysis and provides hedging recommendations on adaily basis. Our loan pipeline at June 30, 2005 was approximately $1.9 billion,at December 31, 2004 and June 30, 2004 our pipeline was approximately $0.8billion. We believe our hedges have correlated to both increases and decreasesin the value of our loan rate locked loans and uncommitted closed loans. In thefuture, as our loan products change and our subprime and correspondent channelsincrease production, our hedging strategies, fallout assumptions and hedginginstruments may change to better mitigate the risk of interest rate changes.

 

Theaggregate gains or losses that we ultimately recognize on our rate lockedloans, closed loans and hedge instruments, is our gross margin. We record gains or losses on the three componentsof our gross margin as follows:

 

•                  **Rate locked loan commitments.**  Any changein the value of our rate locked loan commitments, from the expected value ofthe loan at the time the rate lock commitment was made to the end of the periodis measured at the end of each accounting period, and is recorded as a marketadjustment. Both increases and decreases in value are recorded at the end of aperiod. These changes are recorded as a “market adjustment on interest ratelock commitments” in our Statement of Operations.

 

•                  **Closed loans.**  We do notrecognize any increase in the fair value in our closed loan inventory until atrue sale has taken place, nor do we recognize a decline in the fair value ofour loans if that decline is not more that our expected gain on sale profitmargin on the loan.   However, if thecost basis of the loan is more than could be obtained by sale in themarketplace, a market adjustment is recorded (referred to as the lower of costor market, or “LOCOM”). Accordingly, decreases in the fair value as of the endof the period are not recorded in the current period unless the fair value ofour closed loans fall below our cost basis. Any  such declines in value arerecorded in our Statement of Operations as an adjustment to our “gain on saleof loans” revenue at the time they are recognized.

 

•                  **Hedge instruments.**  Our hedginginstruments (forward sales of mortgage backed securities and options on forwardsales of mortgage backed securities) are marked to market at the end of eachperiod and both increases and decreases in value are recorded. These changes invalue are recorded as “derivative financial instruments” in our Statement ofOperations.

 

Allincreases or decreases in the value of our hedges and rate lock commitments arerecorded in the current period. However because the Company has chosen to notapply hedge accounting under the provisions of FAS 133 as it relates to itshedges of the pipeline and loans committed for sale, the Company does not recognizechanges in the fair value of its closed loans (unless lower than cost) at theend of the quarter.  Accordingly theremay be a timing difference between the recognition of the gain on the loans andthe gain/loss associated with the hedging instruments which are carried at fairvalue.  In two circumstances we may havetiming differences that impact our operating results:

 

•                  A decrease in market interest rates willgenerate a hedge loss recorded in the current period, with an offsetting  increase in the fair value of our closedloans. But this increase is not recognized in our operating income until theloan sales have settled.  As a result of revenue recognitiondifferences between our hedges and our closed loans, we may recognize a hedgeloss in one quarter and not recognize the corresponding increase in the fairvalue of loans until the next quarter.

 

•                  An increase in market interest rates willcause the fair value of our uncommitted loans to decline, with such declinesoffset by increases in the value of our hedges. Since we recognize hedging gains in the current period, we accelerateall or a portion of the expected pricing margin we have in our loans. When thedecline in the fair  value of ourloans  is not below our carrying value,we will  realize the reduced profitmargin on our loans in the subsequesnt period when the loans are sold.

 

Depending on the movement in interest rates and thehedge ratios in place, this timing difference may have a positive or negativeimpact on the Company’s reported results of operations with a positive impactat quarter end resulting in a negative impact in the subsequent quarter [andvice versa]. The net impact of these timing differences is shown in the tablebelow (positive numbers indicate an increase in fair value loans held for salewhile negative numbers represent the opposite):

 

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| **Period**        | ** ** | **Estimated   Net Change In Fair Value** | ** ** |
|-------------------|------------|------------------------------------------|------------|
| 1st Quarter  2004 |       | $                                        | (709,276   | ) |
| 2nd Quarter 2004  |       | 1,219,784                                |       |
| 3rd Quarter 2004  |       | 27,015                                   |       |
| 4th Quarter 2004  |       | (1,958,987                               | )          |
| 1st Quarter 2005  |       | (2,112,175                               | )          |
| 2nd Quarter 2005  |       | 4,086,076                                |       |
|                   |            |                                          |            |  |

 

Notethat the third quarter of 2005 has been positively impacted by approximately$2.3 million fair value not recognized in the second quarter of 2005 howeverthis could be offset or enhanced by any unrecognized changes in fair value thatoccur at the end of the third quarter.

 

Wehave provided a more detailed description of the methods and estimates we useto calculate the value of our derivative instruments and gain on sale in ourAnnual Report on form 10-K under the heading “*Derivativeand Hedging Activities / Determination of Fair Values”*.

 

**Results of Operations**

 

***Three Month Results***

 

Werecorded a net loss of $1.6 million for the three-month period ending June 30,2005 as compared to net income of $208 thousand in 2004 for the sameperiod.   Our loan production increased44.1% for the quarter ending June 30, 2005 over the quarter ending June 30,2004.  Consequently, total revenuesincreased 39% from $27.6 million to $38.4 million for the quarter ended June30, 2005 as compared to the same period in 2004.  Our expenses increase 52% from $27.1million  for the three months ended June30, 2004 to $41.2 million for the sale period in 2005, due to a largerbranching system and associated fixed expenses as well as higher variable costsassociated with higher loan production levels. Additionally, we incurred costs in 2005 for the continued startupoperations in our subprime and correspondent divisions.  Interest expenses increased by virtue ofhigher levels of warehouse borrowings to support higher prodiction levels and ahigher borrowing rate due to increases in the short term interest rates.

 

Timing differences described above adverselyimpacted our revenues in both the second quarter of 2005 and 2004, however theimpact on the 2nd quarter 2005 was significantly larger ($4.1million for the quarter ended June 30, 2005 and $1.2 million for the quarterended June 30, 2004).

 
| ** **          | ** ** | **($ amounts in 000’s) (unaudited)** | ** **    | ** **                           | ** ** |
|---------------------|------------|------------------------------------------------|---------------|--------------------------------------|------------|
| ** **          | ** ** | **Three Months Ended June 30, 2005**           | ** **    | **Three Months Ended June 30, 2004** | ** ** | **2005 Increase (Decrease)** | ** ** |
| ** **          | ** ** | ** **                                     | ** **    | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loans sold, net** | ** ** | **$**                                          | **3,605,854** | ** **                           | **$**      | **2,610,669** | ** ** | **$** | **995,185** | ** ** |
|                     |            |                                                |               |                                      |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                                                            | ** ** | **Amount Income  (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Amount Income  (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Amount** | ** ** | **Basis Points  (Loans Sold)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|------------------------------|------------|--------------------------------|------------|------------|------------|--------------------------------|------------|
|                                                                                                                  |       |                         |       |                           |       |                         |       |                           |       |       |       |                           |       |
| Revenues:                                                                                                             |       |                         |       |                           |       |                         |       |                           |       |       |       |                           |       |
| Premiums                                                                                                              |       | $                            | 69,144     |                           | 191.75     |                         | $          | 33,200                         |       | 127.17     |       | $                              | 35,944     |   | 64.58 |   |
| Broker fees                                                                                                           |       | 9,665                        |       | 26.80                          |       | 5,986                        |       | 22.93                          |       | 3,679      |       | 3.87                           |       |
| Mortgage broker premiums                                                                                              |       | (41,821                      | )          | (115.98                        | )          | (31,786                      | )          | (121.76                        | )          | (10,035    | )          | 5.78                           |       |
| Premium recapture and loan loss provisions                                                                            |       | (1,142                       | )          | (3.17                          | )          | (1,871                       | )          | (7.17                          | )          | 729        |       | 4.00                           |       |
| Deferred origination costs                                                                                            |       | (3,211                       | )          | (8.90                          | )          | (3,206                       | )          | (12.28                         | )          | (5         | )          | 3.38                           |       |
| **Gain on sales of loans**                                                                                            | ** ** | **$**                        | **32,635** | ** **                     | **90.50**  | ** **                   | **$**      | **2,323**                      | ** ** | **8.89**   | ** ** | **$**                          | **30,312** | ** ** | **81.61** | ** ** |
| Derivative financial instruments and market  adjustments                                                              |       | (9,786                       | )          | (27.14                         | )          | 15,247                       |       | 58.40                          |       | (25,033    | )          | (85.54                         | )          |
| **Gain on sales of loans, after derivative  financial instruments and market adjustments (“gross margin”)** | ** ** | **$**                        | **22,849** | ** **                     | **63.36**  | ** **                   | **$**      | **17,570**                     | ** ** | **67.29**  | ** ** | **$**                          | **5,279**  | ** ** | **(3.93** | **)** |
| Interest on mortgage loans held for sale                                                                              |       | 15,175                       |       | 42.08                          |       | 8,994                        |       | 34.45                          |       | 6,181      |       | 7.63                           |       |
| Interest on bond collateral                                                                                           |       | 146                          |       | 0.41                           |       | 575                          |       | 2.21                           |       | (429       | )          | (1.80                          | )          |
| **Total interest income**                                                                                             | ** ** | **15,321**                   | ** ** | **42.49**                      | ** ** | **9,569**                    | ** ** | **36.66**                      | ** ** | **5,752**  | ** ** | **5.83**                       | ** ** |
| Other income                                                                                                          |       | 182                          |       | 0.51                           |       | 434                          |       | 1.66                           |       | (252       | )          | (1.15                          | )          |
| **Total revenue**                                                                                                     | ** ** | **$**                        | **38,352** | ** **                     | **106.36** | ** **                   | **$**      | **27,573**                     | ** ** | **105.61** | ** ** | **$**                          | **10,779** | ** ** | **0.75** | ** ** |

 

21

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Theoverall mortgage loan market in 2005 is expected to increase from $2.6 trillionin 2004, to $2.7 trillion in 2005 according to the MBA forecast dated July 12,2005. While the overall market is anticipated to slightly expand, we arecontinuing to concentrate on gaining market share over our competitors.  Our strategy is to capture an increasingpercentage of the market through sales force expansion. In the second quarterof 2005, we increased loan production 44.1%, from $2.6 billion in the quarterending March 31, 2005, to $3.7 billion for the quarter ending June 30, 2005.

 

Gain on sales of loans recognized on a GAAP basis, after derivativefinancial instruments and market adjustments, increased (in dollar terms) forthe quarter ended June 30, 2005 over the quarter ended June 30, 2004 due to ahigher volume of loans sold and origination of more profitable loans.  Note that decreasing interest rates for thequarter ended June 30, 2005 decreased the gain on derivative financialinstruments and market adjustments and increased the gain on sale margins. Forthe quarter ended June 30, 2004 increasing interest rates during the quarterconversely increased the value of derivative financial instruments butdecreased our gain on sale margins.

 

Ourgain on the sale of loans consisted of a combination of various accountcategories which are summarized in the chart above, and quantified in basispoints of loan sales volume. Premiums represent the price at which we sell theloans to investors in excess of the principal balance of loans sold. Brokerfees represent various charges to brokers for services rendered by us which aredeferred at loan origination and recognized as part of the gain on the sales ofthe loans. Premiums and broker fees are offset by capitalized (deferred) loanorigination costs. The largest deferred cost associated with loan production ismortgage broker premiums, or yield spread premiums. Other offsets to gain onsale include (i) loan premiums repaid to investors (“premium recapture”)and loan loss provisions and (ii) deferred origination costs, which arerecognized at the time of loan sale. Premium recapture expenses representrepayment of a portion of certain loan sale premiums to investors on previouslysold loans which subsequently payoff within six months of loan sale. We sell asubstantial portion of our loans to two of our competitors.  If these competitors stop purchasing ourloans on favorable terms, we could be required to find alternate purchasersand/or accept  less favorable terms.  In either case, this could reduce ourrevenues and earnings.

 

Premium recapture and loan loss provisionsdecreased by $729 thousand in the second quarter of 2005 compared to the sameperiod in 2004. The decrease was mainly due to a reduction in loan lossreserves in the second quarter of 2005 which was the result of  a change in estimate (as a result of newinformation showing a reduced exposure to loss) for loan reserves on loansguaranteed by the Federal Housing Administration of approximately $436thousand. Premium recapture expense increased in the second quarter of 2005compared to the same period in 2004 due to loan volume increases, however thisexpense is expected to decline (as a percentage of loans sold) as interestrates rise and refinance activity declines. Conversely while we believe thatour underwriting process is sound and effective, loan loss provisions mayincrease in the future due to a higher mix of Alt-A and subprime loans whichhave more complex underwriting criteria and are more likely to be rejected byinvestors if unintentionally we sell them loans which do not meet their underwritingguidelines.

 

The use of hedges (recorded as derivative financialinstruments) is key to protecting our profit margins between the time of theinterest rate lock and when the loan is committed for sale to an investor.Generally when mortgage interest rates rise, the value of loans we have in ourpipeline declines, and when interest rates decline the opposite is true.  We utilize hedge instruments to help protectthe value of loans in our pipeline from increases in interest rates.  Consequently, basis point loan premiums, andgain on sales of loans, are best analyzed in conjunction with the basis pointgain or loss from our derivative financial instruments and market adjustmentson our pipeline. We continued to use forward sales of mortgage-backed securities(TBA) and options on forward sales of mortgage-backed securities as our primaryhedging instruments. Due to decreases in mortgage interest rates during thesecond quarter of 2005 we recorded losses on derivative financial instrumentsof $9.8 million. For the second quarter of 2004 we recorded net gains of $15.2million due to increasing mortgage interest rates during the quarter.

 

Our gross margins, before considering theimpacts of timing differences, were $22.8 million for the three months endedJune 30, 2005 or 63 basis points (.63%) on $3.6 billion in loan sales volume,representing an increase of $5.3 million from $17.6 million on $2.6 billion inloan sales volume for the comparable period in 2004. Loan sales volumeincreased $1.0 billion. Overall competitive pressure remains intense althoughnot at levels seen in 2004. There can be no assurances that margins will remainat current levels and accordingly our gross margins would be affected ifcompetitive pressures increase or decrease.

 

Our overall actual gross margin percentages,after considering timing differences, in the quarter ending June 30, 2005approximated our target gross margin percentages, indicating that our hedgingstrategies were effective in protecting our pricing margins.  We believe that our hedging program wasgenerally successful in protecting profit margins on our loan originations.However, our hedging strategies may not be successful in mitigating our risksassociated with interest rate changes in future periods. In particular, for newloan products with large loan balances, short terms, and loan products withadjustable rates, our hedging process may be less effective at certain times.

 

22

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We recorded interest income on mortgage loans heldfor sale of $15.2 million for the three months ended June 30, 2005. Forour mortgage loans held for sale we earn interest on a loan from the date theloan is funded until sale. Accordingly, interest income related to our mortgageloans held for sale is a function of the volume of loan production, theinterest rate on the loans and the length of time the loans are held prior tosale. To the extent we fund loans with borrowings under our warehouse facilities,we record interest expense based on the same factors. Interest expense on ourwarehouse borrowings for the period was $11.8 million. Interest income of$15.2 million less interest expense of $11.8 million results in net interestincome of $3.4 million 9 basis points (.9%) on second quarter 2005 loanproduction of $3.7 billion. For the comparable period ended June 30, 2004interest income was $9.0 million and interest expense was$4.4 million. This resulted in net interest earned of $4.6 million,representing 18 basis points on second quarter 2004 loan production of $2.6billion. The reason for the basis point decline in net interest spread for 2005was a flattening of the yield curve and a higher proportion of adjustable rateloans in our loan inventories. Interest income on bond collateral decreased inthe three month period ending June 30, 2005 to approximately $0.15 million from$0.58 million in the three month period ending June 30, 2004. This reductionwas a direct result of the sale of a majority of bond collateral in 2004.

 

The table below provides the relationship betweenestimated fixed, variable and total consolidated expenses to loan productionfor the three months ended June 30, 2005 and 2004 (dollars in thousands)(unaudited): 

 
| ** **          | ** ** | **Three months ending June 30, 2005** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loan production** | ** ** | ** **                            | ** ** | **$** | **3,696,807** | ** ** | ** ** | ** ** |
|                     |            |                                       |            |  |  |  |  |  |

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                    |       |                           |       |                                 |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 10,224     |                                    | 27.66      |                           | $          | 11,042                               |       | 29.87               |       | $                          | 21,266     |   | 57.53 |   |
| Office and occupancy expense                |       | —                            |       | —                                  |       | 947                            |       | 2.56                                 |       | 947                 |       | 2.56                       |       |
| Professional fees and contract labor        |       | 366                               |       | 0.99                                    |       | 1,527                          |       | 4.13                                 |       | 1,893               |       | 5.12                       |       |
| Other operating expense                     |       | 1,647                             |       | 4.46                                    |       | 3,448                          |       | 9.33                                 |       | 5,095               |       | 13.79                      |       |
| **Total operating expenses**                | ** ** | **12,237**                        | ** ** | **33.11**                               | ** ** | **16,964**                     | ** ** | **45.89**                            | ** ** | **29,201**          | ** ** | **79.00**                  | ** ** |
| Interest expense – short term debt     |       | 11,769                            |       | 31.83                                   |       | —                         |       | —                               |       | 11,769              |       | 31.83                      |       |
| Interest expense – long term debt      |       | 117                               |       | 0.32                                    |       | —                         |       | —                               |       | 117                 |       | 0.32                       |       |
| **Total interest expense**                  | ** ** | **11,886**                        | ** ** | **32.15**                               | ** ** | **—**                     | ** ** | **—**                           | ** ** | **11,886**          | ** ** | **32.15**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                  |       | 170                            |       | 0.46                                 |       | 170                 |       | 0.46                       |       |
| Gain on REO, net                            |       | —                            |       | —                                  |       | 12                             |       | 0.03                                 |       | 12                  |       | 0.03                       |       |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                  |       | (38                            | )          | (0.10                                | )          | (38                 | )          | (0.10                      | )          |
| **Total consolidated expenses**             | ** ** | **$**                             | **24,123** | ** **                              | **65.26**  | ** **                     | **$**      | **17,108**                           | ** ** | **46.28**           | ** ** | **$**                      | **41,231** | ** ** | **111.54** | ** ** |

 
| ** **          | ** ** | **Three months ending June 30, 2004** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loan production** | ** ** | ** **                            | ** ** | **$** | **2,566,360** | ** ** | ** ** | ** ** |
|                     |            |                                       |            |  |  |  |  |  |

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses  Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses  Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                     |       |                           |       |                                  |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 6,067      |                                     | 23.64      |                           | $          | 8,332                                 |       | 32.47               |       | $                          | 14,399     |   | 56.11 |   |
| Office and occupancy expense                |       | —                            |       | —                                   |       | 959                            |       | 3.74                                  |       | 959                 |       | 3.74                       |       |
| Professional fees and contract labor        |       | 197                               |       | 0.77                                     |       | 1,172                          |       | 4.57                                  |       | 1,369               |       | 5.34                       |       |
| Other operating expense                     |       | 1,236                             |       | 4.81                                     |       | 3,451                          |       | 13.45                                 |       | 4,687               |       | 18.26                      |       |
| **Total operating expenses**                | ** ** | **7,500**                         | ** ** | **29.22**                                | ** ** | **13,914**                     | ** ** | **54.23**                             | ** ** | **21,414**          | ** ** | **83.45**                  | ** ** |
| Interest expense – short term debt     |       | 4,422                             |       | 17.23                                    |       | —                         |       | —                                |       | 4,422               |       | 17.23                      |       |
| Interest expense – long term debt      |       | 332                               |       | 1.29                                     |       | —                         |       | —                                |       | 332                 |       | 1.29                       |       |
| **Total interest expense**                  | ** ** | **4,754**                         | ** ** | **18.52**                                | ** ** | **—**                     | ** ** | **—**                            | ** ** | **4,754**           | ** ** | **18.52**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                   |       | 128                            |       | 0.50                                  |       | 128                 |       | 0.50                       |       |
| Gain on REO, net                            |       | —                            |       | —                                   |       | (61                            | )          | (0.24                                 | )          | (61                 | )          | (0.24                      | )          |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                   |       | 880                            |       | 3.43                                  |       | 880                 |       | 3.43                       |       |
| **Total consolidated expenses**             | ** ** | **$**                             | **12,254** | ** **                               | **47.74**  | ** **                     | **$**      | **14,861**                            | ** ** | **57.92**           | ** ** | **$**                      | **27,115** | ** ** | **105.66** | ** ** |

 

Total expenses incurred for the three months endedJune 30, 2005 were approximately $41.2 million. Operating expenses, whichincluded all expenses except interest expense (employee compensation andbenefits, office and occupancy expense, professional fees and contract laborand other operating expenses), were approximately $29.2 million orapproximately 79 basis points (.79%) for the three months ended June 30, 2005.For the comparable period ended June 30, 2004, there were approximately$27.1 million of total expenses, of which approximately $21.4 millionor approximately 83 basis points (.83%) were operating

 

23

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expenses(which excludes interest expense, provision for loan losses, gain on REO andvaluation adjustment). The increase in operating expenses in the second quarterof 2005 was primarily due to the increase in loan production and loanproduction-related expenses and increases in the number of branch and corporateheadquarters personnel. Although operating expenses increased for the threemonths ended June 30, 2005 the basis points declined because fixed costs didnot rise in relation to increased loan volume. For the three months ended June30, 2005, expenses included approximately $9.2 million in sales commissions,which vary in proportion to the volume of loan production, or approximately 25basis points (.25%) on $3.7 billion in funded loans. The basis pointcommissions expense increase in 2005 was due to a higher proportion of newaccount executives receiving guaranteed commissions during their first threemonths with our Company and higher commissioned product type volume.

 

Operating expenses totaled $29.2 million orapproximately 79 basis points (.79%), on $3.7 billion in loan productionin the second quarter of 2005 which is an increase from the same period in 2004but a decrease in basis points. The operating cost per loan produced increasedfrom $1,466 in the second quarter of 2004 to $1,515 per loan in the secondquarter of 2005. Although greater production efficiency may have been expectedwith a 44.9% increase in loan production, our branch system is larger and ouremployee counts are higher. Also, a change in our product mix and a higherproportion of purchase loan transactions have required more staffing. Newbranches being less efficient offset volume efficiency gains by maturebranches.  Our commission rates arehigher due to a change in the mix of loan product (with offsetting revenuebenefit) and a higher proportion of commission guarantees (which are temporary)due to higher recruiting levels. Also, our new Correspondent and Subprimelending channels continue to incur losses while ramping up infrastructure andloan production volume.

 

The effective combined federal and state tax ratesare estimated to be 44%.  In 2004, lossesincreased our deferred income tax benefit to approximately $10.7 million atDecember 31, 2004. At June 30, 2005 our deferred income tax benefit balance wasincreased to $11.6 million.  This benefitis expected to be realized in future periods through the utilization of netoperating loss carryforwards; however should the Company not generatesufficient operating profits, our deferred tax benefits may have to bereversed.  There can be no assurancesthat all of the Company’s deferred tax assets, totaling $11.5 million, will berealized in future periods.

 

Interest rate movements are difficult to predict,but mortgage interest rates generally declined during the second quarter of2005. Projections by the MBA (July 2005) for the remainder of 2005indicate an increase in interest rates and slight increase in loan volume ($2.6trillion for 2004 and $2.7 trillion for 2005). Wherever possible we aremanaging staffing levels and utilizing as much of our existinginfrastructure to process our loan production (adjust staffing size to anoptimal level of efficiency) while growing our sales presence in existing andnew markets. We have beeninvesting in growth and expanding and will continue to expand our businessoperations, primarily in sales areas, while we focus on controlling our fixedexpenses. Our strategy requires us to capture an increasing percentage of themarket in a highly competitive environment, which will put pressure on ourgross margins.  If we are not able to dothis, we would likely experience losses due to our current level of operatingexpenses.

 

We continue to hold a small portfolio of bondcollateral mortgage loans ($11.6 million) and related debt ($10.1 million).

 

***Six Month Results***

 

Werecorded a net loss of $1.1 million for the six-month period ending June 30,2005 as compared to a net loss of $5.5 million in 2004 for the same period.These results were due in large part to (i) the same reasons described inthe “*Three Month Results”* and (ii) for thesix month period ending June 30, 2004 we recorded a $5.3 million loss on thesale of portfolio assets.

 

Timingdifferences described above adversely impacted our revenues in the both the sixmonth period ending June 30, 2005 and 2004, For the six months ending June 30,2005 the adverse impact was estimated to be $2.0 million and the adverse impactwas approximately $0.5 million for the same six month period in 2004.

 
| ** ** | ** ** | **2005**       | ** **            | **2004**        | ** **            |
|------------|------------|----------------|-----------------------|-----------------|-----------------------|
| ** ** | ** ** | **6 months**   | ** **            | **6 months**    | ** **            |
| ** ** | ** ** | **(millions)** | ** **            | **(millions)**  | ** **            |
| 12/31/04   |       | $              | (0.3                  | ) reverse prior | $                     | (1.7 | ) reverse prior |
| 6/30/05    |       | 2.3            |   at quarter end | 2.2             |   at quarter end |
| Net        |       | $              | 2.0                   |            | $                     | 0.5 |   |

 

 

24

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The table below provides a six month comparativeview of loan production for 2005 and 2004 (unaudited):

 

2005 & 2004 YTD Loan Fundings by Month

 

 
| ** **          | ** ** | **(in millions)** | ** ** |
|---------------------|------------|-------------------|------------|
| ** **          | ** ** | **2005**          | ** ** | **2004** | ** ** |
| January             |       | $                 | 727        |   | $ | 436 |   |
| February            |       | 816               |       | 558 |   |
| March               |       | 1,164             |       | 877 |   |
| April               |       | 986               |       | 1,147 |   |
| May                 |       | 1,223             |       | 751 |   |
| June                |       | 1,488             |       | 668 |   |
| Year to date totals |       | $                 | 6,404      |   | $ | 4,437 |   |

 

25

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The chart below compares our revenue categories tobasis points of loans sold for the six month periods ending June 30, 2005 andJune 30, 2004.

 

**($ amounts in 000’s) (unaudited)**

 
| ** **          | ** ** | **Six Months Ended June 30, 2005** | ** **    | **Six Months Ended June 30, 2004** | ** ** | **2005 Increase (Decrease)** | ** ** |
|---------------------|------------|------------------------------------|---------------|------------------------------------|------------|------------------------------|------------|
| ** **          | ** ** | ** **                         | ** **    | ** **                         | ** ** | ** **                   | ** ** |
| **Loans sold, net** | ** ** | **$**                              | **6,133,187** | ** **                         | **$**      | **4,251,688**                | ** ** | **$** | **1,881,499** | ** ** |
|                     |            |                                    |               |                                    |            |                              |            |  |  |  |

 
| ** **                                                                                                            | ** ** | **Amount Income   (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Amount Income   (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Amount** | ** ** | **Basis Points  (Loans Sold)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|-------------------------------|------------|--------------------------------|------------|------------|------------|--------------------------------|------------|
|                                                                                                                  |       |                          |       |                           |       |                          |       |                           |       |       |       |                           |       |
| Revenues:                                                                                                             |       |                          |       |                           |       |                          |       |                           |       |       |       |                           |       |
| Premiums                                                                                                              |       | $                             | 114,782    |                           | 187.15     |                          | $          | 71,942                         |       | 169.21     |       | $                              | 42,840     |   | 17.94 |   |
| Broker fees                                                                                                           |       | 16,374                        |       | 26.70                          |       | 10,168                        |       | 23.92                          |       | 6,206      |       | 2.78                           |       |
| Mortgage broker premiums                                                                                              |       | (72,013                       | )          | (117.42                        | )          | (55,440                       | )          | (130.39                        | )          | (16,573    | )          | 12.97                          |       |
| Premium recapture and loan loss provisions                                                                            |       | (2,152                        | )          | (3.51                          | )          | (3,195                        | )          | (7.51                          | )          | 1,043      |       | 4.00                           |       |
| Deferred origination costs                                                                                            |       | (6,083                        | )          | (9.92                          | )          | (5,636                        | )          | (13.26                         | )          | (447       | )          | 3.34                           |       |
| **Gain on sales of loans**                                                                                            | ** ** | **$**                         | **50,908** | ** **                     | **83.00**  | ** **                    | **$**      | **17,839**                     | ** ** | **41.97**  | ** ** | **$**                          | **33,069** | ** ** | **41.03** | ** ** |
| Derivative financial instruments and market  adjustments                                                              |       | (6,727                        | )          | (10.97                         | )          | 8,603                         |       | 20.23                          |       | (15,330    | )          | (31.02                         | )          |
| **Gain on sales of loans, after derivative  financial instruments and market adjustments (“gross margin”)** | ** ** | **$**                         | **44,181** | ** **                     | **72.04**  | ** **                    | **$**      | **26,442**                     | ** ** | **62.20**  | ** ** | **$**                          | **17,739** | ** ** | **9.83** | ** ** |
| Interest on mortgage loans held for sale                                                                              |       | 25,007                        |       | 40.77                          |       | 14,008                        |       | 32.95                          |       | 10,999     |       | 7.82                           |       |
| Interest on bond collateral                                                                                           |       | 433                           |       | 0.71                           |       | 2,203                         |       | 5.18                           |       | (1,770     | )          | (4.47                          | )          |
| **Total interest income**                                                                                             | ** ** | **25,440**                    | ** ** | **41.48**                      | ** ** | **16,211**                    | ** ** | **38.13**                      | ** ** | **9,229**  | ** ** | **3.35**                       | ** ** |
|                                                                                                                  |       |                          |       |                           |       |                          |       |                           |       |       |       |                           |       |
| Other income                                                                                                          |       | 384                           |       | 0.63                           |       | 729                           |       | 1.72                           |       | (345       | )          | (1.09                          | )          |
| **Total revenue**                                                                                                     | ** ** | **$**                         | **70.005** | ** **                     | **114.14** | ** **                    | **$**      | **43,382**                     | ** ** | **102.05** | ** ** | **$**                          | **26,623** | ** ** | **12.09** | ** ** |
|                                                                                                                       |            |                               |            |                                |            |                               |            |                                |            |            |            |                                |            |  |  |  |  |

 

Gain on sales of loans after derivative financial instruments andmarket adjustments, increased for the six months ended June 30, 2005 over thesame period ended June 30, 2004 due to a higher level of loans sold and bettergross margins due to changes in our product mix. Decreasing interest rates forthe six months ended June 30, 2005 increased the gain on sales of loans anddecreased the value of derivative financial instruments and market adjustments.For the six months ended June 30, 2004 increasing interest rates increasedthe value of derivative financial instruments but decreased our gain on salemargins.

 

Premium recapture and loan loss provisionsdecreased by $1.0 million in the six months ended June 30, 2005 compared to thesame period in 2004. The decrease was mainly due to a reduction in loan lossreserves in the first six months of 2005 which was the result of a change inestimate for FHA loan reserves (as a result of new information showing areduced exposure to loss). Premium recapture expense decreased in the first sixmonths of 2005 compared to the same period in 2004 which overcame secondquarter increases due to second quarter loan production volume increases. Ifinterest rates rise and refinancing activity decreases, premium recaptureexpense will decline as a percentage of loans sold.

 

Due to decreases in mortgage interest ratesduring the first six months of 2005 we recorded losses on derivative financialinstruments of $6.7 million. For the same period in 2004 we recorded netgains of $8.6 million due to increasing mortgage interest rates.

 

26

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Our gross margins were $44.1 million for thesix months ended June 30, 2005 or 72 basis points (.72%) on $6.1 billion inloan sales volume, representing an increase of $17.7 million from $26.4 millionon $4.3 billion in loan sales volume for the comparable period in 2004. Loansales volume increased $1.9 billion.

 

We recorded interest income on mortgage loans heldfor sale of $25.0 million for the six months ended June 30, 2005. Interestexpense on our warehouse borrowings for the period was $18.5 million. Theresulting net interest income earned on loan inventories was $6.5 million(interest income of $25.0 million less $18.5 million of interest expense),representing 10 basis points (.10%) on first six months of 2005 loan productionof $6.4 billion. For the comparable period ended June 30, 2004 interestincome was $14.0 million and interest expense was $6.8 million. Thisresulted in net interest earned of $7.2 million, representing 17 basispoints (.17%) on the first six months 2004 loan production of $4.4 billion. Thereason for the net interest decrease for 2005 was a flattening of the yieldcurve. Interest income on bond collateral decreased in the six month periodending June 30, 2005 to approximately $0.43 million from $2.2 million in thesix month period ending June 30, 2004. This reduction was a direct result ofthe sale of a majority of bond collateral in 2004.

 

The table below provides the relationship betweenestimated fixed, variable and total consolidated expenses to loan productionfor the six months ended June 30, 2005 and 2004 (dollars in thousands)(unaudited): 

 
| ** **          | ** ** | **Six months ending June 30, 2005** | ** ** |
|---------------------|------------|-------------------------------------|------------|
| ** **          | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loan production** | ** ** | ** **                          | ** ** | **$** | **6,404,459** | ** ** | ** ** | ** ** |
|                     |            |                                     |            |  |  |  |  |  |

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                    |       |                           |       |                                 |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 17,413     |                                    | 27.19      |                           | $          | 21,118                               |       | 32.97               |       | $                          | 38,531     |   | 60.16 |   |
| Office and occupancy expense                |       | —                            |       | —                                  |       | 2,050                          |       | 3.20                                 |       | 2,050               |       | 3.20                       |       |
| Professional fees and contract labor        |       | 633                               |       | 0.99                                    |       | 2,401                          |       | 3.75                                 |       | 3,034               |       | 4.74                       |       |
| Other operating expense                     |       | 3,035                             |       | 4.74                                    |       | 6,380                          |       | 9.96                                 |       | 9,415               |       | 14.70                      |       |
| **Total operating expenses**                | ** ** | **21,081**                        | ** ** | **32.92**                               | ** ** | **31,949**                     | ** ** | **49.88**                            | ** ** | **53,030**          | ** ** | **82.80**                  | ** ** |
| Interest expense – short term debt     |       | 18,518                            |       | 28.91                                   |       | —                         |       | —                               |       | 18,518              |       | 28.91                      |       |
| Interest expense – long term debt      |       | 229                               |       | 0.36                                    |       | —                         |       | —                               |       | 229                 |       | 0.36                       |       |
| **Total interest expense**                  | ** ** | **18,747**                        | ** ** | **29.27**                               | ** ** | **—**                     | ** ** | **—**                           | ** ** | **18,747**          | ** ** | **29.27**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                  |       | 232                            |       | 0.36                                 |       | 232                 |       | 0.36                       |       |
| Gain on REO, net                            |       | —                            |       | —                                  |       | 9                              |       | 0.01                                 |       | 9                   |       | 0.01                       |       |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                  |       | (38                            | )          | (0.06                                | )          | (38                 | )          | (0.06                      | )          |
| **Total consolidated expenses**             | ** ** | **$**                             | **39,828** | ** **                              | **62.19**  | ** **                     | **$**      | **32,152**                           | ** ** | **50.19**           | ** ** | **$**                      | **71,980** | ** ** | **112.38** | ** ** |

 
| ** **          | ** ** | **Six months ending June 30, 2004** | ** ** |
|---------------------|------------|-------------------------------------|------------|
| ** **          | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loan production** | ** ** | ** **                          | ** ** | **$** | **4,435,807** | ** ** | ** ** | ** ** |
|                     |            |                                     |            |  |  |  |  |  |

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses  Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses  Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                     |       |                           |       |                                  |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 9,868      |                                     | 22.25      |                           | $          | 16,374                                |       | 36.91               |       | $                          | 26,242     |   | 59.16 |   |
| Office and occupancy expense                |       | —                            |       | —                                   |       | 1,795                          |       | 4.05                                  |       | 1,795               |       | 4.05                       |       |
| Professional fees and contract labor        |       | 358                               |       | 0.81                                     |       | 2,046                          |       | 4.61                                  |       | 2,404               |       | 5.42                       |       |
| Other operating expense                     |       | 2,618                             |       | 5.90                                     |       | 6,322                          |       | 14.25                                 |       | 8,940               |       | 20.15                      |       |
| **Total operating expenses**                | ** ** | **12,844**                        | ** ** | **28.96**                                | ** ** | **26,537**                     | ** ** | **59.82**                             | ** ** | **39,381**          | ** ** | **88.78**                  | ** ** |
| Interest expense – short term debt     |       | 6,767                             |       | 15.25                                    |       | —                         |       | —                                |       | 6,767               |       | 15.25                      |       |
| Interest expense – long term debt      |       | 1,227                             |       | 2.77                                     |       | —                         |       | —                                |       | 1,227               |       | 2.77                       |       |
| **Total interest expense**                  | ** ** | **7,994**                         | ** ** | **18.02**                                | ** ** | **—**                     | ** ** | **—**                            | ** ** | **7,994**           | ** ** | **18.02**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                   |       | 128                            |       | 0.29                                  |       | 128                 |       | 0.29                       |       |
| Gain on REO, net                            |       | —                            |       | —                                   |       | (320                           | )          | (0.72                                 | )          | (320                | )          | (0.72                      | )          |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                   |       | 5,309                          |       | 11.97                                 |       | 5,309               |       | 11.97                      |       |
| **Total consolidated expenses**             | ** ** | **$**                             | **20,838** | ** **                               | **46.98**  | ** **                     | **$**      | **31,654**                            | ** ** | **71.36**           | ** ** | **$**                      | **52,492** | ** ** | **118.34** | ** ** |

 

Total expenses incurred for the six months endedJune 30, 2005 were approximately $72.0 million. Operating expenses, whichincluded all expenses except interest expense (employee compensation andbenefits, office and occupancy expense,

 

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professionalfees and contract labor and other operating expenses), were approximately$53.0 million for the six months ended June 30, 2005. For the comparableperiod ended June 30, 2004, there were approximately $52.5 million oftotal expenses, of which approximately $39.4 million were operatingexpenses. The increase in operating expenses in 2005 was primarily due to theincrease in loan production and loan production-related expenses and increasesin the number of branch and corporate headquarters personnel. For the sixmonths ended June 30, 2005, expenses included approximately $15.2 millionin sales commissions, which vary in proportion to the volume of loanproduction, or approximately 24 basis points (.24%) on $6.4 billion infunded loans. The basis point commissions expense increased in 2005 due to ahigher proportion of new account executives receiving guaranteed commissionsduring their first three months with our Company and higher commissionedproduct type volume.

 

Operating expenses totaled $53.0 million orapproximately 83 basis points (.83%), on $6.4 billion in loan productionin the first six months of 2005. Total operating expenses in basis points ofloan production (which is a measurement of the cost per loan) decreased for thesix months ended June 30, 2005 compared to the same period in 2004 (from 89basis points (.89%) in 2004 to 83 basis points (.83%) in 2005). The operatingcost per loan produced increased from $1,561 in the first six months of 2004 to$1,571 per loan in the first six months of 2005. Although greater productionefficiency may have been expected with a 44.4% increase in loan production, ourbranch system is still maturing. New branches being less efficient offsetvolume efficiency gains by mature branches. Also, our new Correspondent and Subprime lending channels continue toincur losses while building loan production volume.

 

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***Liquidity andCapital Resources***

 

*General*

 

Our sources of liquidity during the sixmonths ended June 30, 2005 primarily consisted of the following:

 

•              borrowings under our warehousefacilities;

•              revenuesgenerated by our mortgage banking operating activities including interestincome, broker fees, loan sale proceeds and hedge proceeds;

•              hedging gains;

•              excessinterest spread in the Mortgage Asset Portfolio Business, net of repayments toservicers for past principal and interest advances on completed real estateowned dispositions.

 

Our primary cash requirements included:

 

•              fundingour mortgage loan originations;

•              interestexpense under our warehouse facilities;

•              operatingexpenses, including commissions;

•              repaymentof our warehouse borrowings;

•              increasingand maintaining a “restricted cash” account, which includes amounts required tobe held by certain warehouse line providers that may not be used in ouroperations or as equity for other warehouse lines of credit and;

•              fundingcertain mortgage originations without the use of warehouse financing.

 

*Cash Generated By and Used In Our Operations*

 

During the six months ended June 30, 2005, ona consolidated basis we had net negative cash flow of $22.0 million. The principalfactors impacting our negative cash flow are:

 

•                  Netincreases in our cash investment in loan inventories and loan sale receivablestotaled approximately $25.0 million.  Ourwarehouse line lending agreements typically allow us to borrow from 96% to 99%of the lesser of par or market value for each mortgage loan. We pay anadditional 1% to 2% of the loan principal amount in fees or yield spreadpremium to the mortgage brokers. Lastly, a small portion of our loan inventoryis funded entirely with equity capital. We typically have cash investedtotaling between 1% to 4% of the principal amount of loans held for sale, whichis recouped when the loans are purchased by investors. Mortgage loans held forsale increased from approximately $238.4 million at December 31, 2004 toapproximately $512.4 million at June 30, 2005. An increase in the amount ofloan inventory, either by holding loans for longer periods, or due to increasedloan funding volume, will cause cash utilization to carry loan inventories toincrease in direct proportion to the inventory held.

 

•      Cashusage for capital expenditures totaled approximately $0.8 million.

 

•      Transfers of cash to restricted cashaccounts totaled $0.8 million. Restricted cash increased to $2.85 million representing Company cashaccounts required to be maintained under certain warehouse lending agreements.

 

•      Other consolidated operating cash flowtotaled $4.5 million during the six months ended June 30, 2005.

 

Forthe remainder of 2005, wherever possible, we are attempting to utilize ourcurrent support staffing levels (except for increases in the number of accountexecutives) and existing infrastructure to balance our loan production whilegrowing our sales presence in existing and new markets. Our market share growthstrategy is designed to generate loan volumes from new customers and increasedbusiness with existing customers in order to increase loan production, despiteminimal growth in the overall loan origination market from calendar year 2004to 2005 and to react more quickly to volume changes. We will attempt toincrease the proportion of variable costs while controlling fixed costs tomaintain flexibility in the cost structure which will react more quickly tovolume changes. For the remainder of 2005, we expect to average greater thanone billion dollars per month of new mortgage loans and fund these originationswith equity capital and warehouse facility borrowings. We expect our loaninventory balances to generally increase during the remainder of 2005.  We also expect to continue to engage inhedging transactions that may require cash investment to maintain or adjusthedged positions. If our funding volumes do not generate sufficient revenues orshould gain on sale margins or interest spreads on our warehouse loans decline,we may utilize cash to fund operating losses. We intend to use cash reserves,borrowings under the warehouse facilities as well as cash flow generated fromthe origination and sale of mortgage loans, to fund our operations which willinclude continued support for Subprime and Correspondent Lending activitieswhich are not expected to be profitable until the fourth quarter of 2005. Weare therefore dependent on significant levels of warehouse financing to helpexecute our mortgage banking strategy. Considering investments in Correspondentand Subprime lending activities, timing differences for revenue and expenserecognition,  and given margin stability(without extraordinary charges) we must generate approximately $1.1 billion to$1.2 billion in loan sales per month to avoid negative operating cash flow.

 

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Duringthe three months ending June 30, 2005 we averaged $1.2 billion per month inloan production and during the six months ending June 30, 2005 we averaged $1.0billion per month in loan production. See Business Risk Factors in Item 2 below. Management believes thatour Company has sufficient sources of liquidity at June 30, 2005 to meetanticipated business requirements for the foreseeable future.

 

*Short-Term Debt*

 

As of June 30, 2005, short-term debt consists of$500.8 million of revolving credit lines (warehouse facilities) used to fundour lending activities. As of June 30, 2005, mortgage loans held for saletotaling $512.4 million were pledged as collateral for the warehousefacilities. We are dependent on our warehouse lending facilities to operate ourbusiness.  We must maintain, renew orreplace our warehouse lines of credit in order to continue to fund loans.  Our warehouse facilities consist ofborrowings of $500.8 million with four financial institutions. At June 30,2005, our maximum permanent combined borrowings from these four financialinstitutions are $1.6 billion. As of June 30, 2005 we also had access toan additional $500 million in temporary borrowing capacity, of which $300million subsequently became permanent and $200 million expired in early July2005. These facilities typically advance 96% to 99% of the lesser of par ormarket value of the loans pledged as collateral. Such financing is currentlyprovided primarily under (i) a 364-day secured mortgage warehousingrevolving credit agreement, originally dated as of November 26, 2001(current expiration date is May 22, 2006), (the “Bank Credit Agreement”)with JPMorgan Chase Bank; (ii) a secured mortgage warehousing revolvingcredit agreement, originally dated as of March 28, 2002 (there is noexpiration date as this is an uncommitted facility) (the “UBS Agreement”) withUBS Real Estate Securities Inc.; (iii) a secured mortgage warehousingrevolving credit agreement, originally dated as of October 11, 2002(current expiration date of December 31, 2005), (the “CountrywideAgreement”) with Countrywide Warehouse Lending; and (iv) a 729-day securedmortgage warehousing revolving credit agreement, originally dated as ofSeptember 15, 2003 (current expiration date of July 31, 2006), (the “Agreement”)with Residential Funding Corporation. Each warehouse facility is entered intoby our subsidiary American Mortgage Network, Inc. and guaranteed by AmNetMortgage, Inc. or entered into by both corporations. These warehouse facilitiesare repaid as principal payments on mortgage loans are received, or as themortgage loans are sold. The agreements governing these facilities contain anumber of covenants, including but not limited to covenants based on tangiblenet worth, cash flows, net income, and liquidity of our Company. As of June 30,2005 the Company was not in compliance with certain warehouse line facilitycovenants due to GAAP losses in the second quarter of 2005. Waivers wereobtained from three of our four warehouse providers and we believe we are ingood standing with all of our warehouse lenders. The Company is in the processof obtaining the final waiver and is expected to be received by August 22,2005.

 

*Long-Term Debt—Non Recourse Mortgage-Backed Notes*

 

Our long-term debt consists of CMO/FASIT 1998-1mortgage-backed notes, which are collateralized by bond collateral mortgageloans and bond collateral real estate owned. Obligations under themortgage-backed notes are payable solely from the proceeds from the bondcollateral and are otherwise non-recourse to the Company.

 

*Rate Lock Loan Commitments to Borrowers andCommitments to Sell Loans and Mortgage Backed Securities*

 

In the ordinary course of business, we make ratelock commitments to borrowers which obligate us to fund mortgages at setinterest rates. The values of the underlying loans, and thus our expected gainon the subsequent funding and sale of these loans, may be impacted bysubsequent changes in market interest rates. Accordingly, we attempt to protect(or hedge) our pricing margins by utilizing forward sales of TBAs and optionson TBAs. The hedges typically increase or decrease in value in correlation tooffsetting decreases or increases in the value of the loans. For the purposesof hedging our interest rate exposure on our pipeline, we make variousassumptions in order to estimate the rate lock commitments which will not close(fallout ratio). The fallout ratio is applied to total rate lock commitments toarrive at the net exposure to interest rate changes in the market. As loansfund, we typically sell or assign our hedges and enter into mandatory loan salecommitments with our correspondent investors. The following is a summary of ourcommitments to fund and commitments to sell loans and mortgage backedsecurities at June 30, 2005 and December 31, 2004 (dollars in thousands):

 
| ** **                                                                                | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **Commitments to Fund Loans:**                                                            |       |               |       |                   |       |
| Commitments to originate loans at set  interest rates (before applying estimated fallout) |       | $                  | 1,874,289  |                   | $          | 813,081 |   |
| Commitments to originate loans at set  interest rates (after applying estimated fallout)  |       | 1,003,410          |       | 471,884                |       |
| **Commitment to Sell Loans or Mortgage Backed  Securities:**                              |       |               |       |                   |       |
| Mandatory commitments to sell mortgage  loans held for sale                               |       | 337,195            |       | 100,798                |       |
| Forward sales of mortgage backed securities  (TBA) and options on forward sales           |       | 1,245,500          |       | 611,000                |       |
|                                                                                           |            |                    |            |                        |            |  |  |

 

The above table merely lists the commitments we haveto fund loans and sell loans or mortgage backed securities and is notreferencing any of our closed loan inventory. In Note 6 to our auditedfinancial statements we have quantified the interest rate exposure we have onour pipeline and compare this exposure to our hedge coverage.

 

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*Lease and Long-TermDebt Commitments*

 

In order to better understand our futureobligations under our leases and long-term debt agreements, the table belowshows our expected future payments for these debt instruments.

 
| ** **                                      | ** ** | **Payments Due by Period  (dollars in thousands) (unaudited)** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| **Contractual Obligations as of June 30, 2005** | ** ** | **Total**                                                      | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than 5  Years** | ** ** |
|                                            |       |                                                           |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                                  |       | $                                                              | 10,057     |   | $ | 3,477 |   | $ | 4,882 |   | $ | 1,698 |   | $ | — |   |
| Operating Leases                                |       | 9,556                                                          |       | 3,530 |   | 4,430 |   | 1,596 |   | — |   |
| Total                                           |       | $                                                              | 19,613     |   | $ | 7,007 |   | $ | 9,312 |   | $ | 3,294 |   | $ | — |   |

 

Long-termdebt is in the form of a bond which is directly tied to bond collateral(assets) in the form of mortgage loans.

 

**Business Risk Factors**

 

*Failure to Achieve and Maintain Effective InternalControls In Accordance With Section 404 of the Sarbanes-Oxley Act CouldHave a Material Adverse Effect on Our Business, Operating Results and StockPrice*

 

We are in the process of documenting and testing ourinternal control procedures in order to satisfy the requirements ofSection 404 of the Sarbanes-Oxley Act. Under Section 404 ourmanagement will be required to assess the effectiveness of our internalcontrols over financial reporting and our independent auditors will be requiredto issue an attestation report on management’s assessment. Our loan originationsoftware consists of proprietary programs which are not completely documented,and we are currently implementing additional control measures in order tostrengthen various aspects of our technology infrastructure. During the courseof our testing we may identify deficiencies which we may not be able toremediate in time to meet the deadline imposed by the Sarbanes-Oxley Act forcompliance with the requirements of Section 404. In addition, if we failto maintain adequate internal controls, we may not be able to ensure that wecan conclude on an ongoing basis that we have effective internal controls overfinancial reporting in accordance with Section 404 of the Sarbanes-OxleyAct. Failure to achieve and maintain an effective internal control environmentcould have a material adverse effect on our business, operating results and thetrading price of our stock.

 

*We Have a Limited Operating History in CorrespondentLending, Which Makes it Difficult to Predict our Future Prospects for thisLending Channel*

 

In 2001 we began our mortgage banking operations andoperated exclusively as a wholesale lender. As such we have worked with ourapproved broker clients, who refer loans to the Company for underwriting andfunding. In 2004 we made a strategic decision to create a correspondent lendingchannel. Incremental revenues from this channel will help us to more fullyleverage our wholesale lending infrastructure, particularly our headquartersadministrative costs. Correspondents are larger brokers, mortgage bankers orother financial institutions who originate and fund loans and sell closed loanson a service released basis. We have hired an experienced sales team andestablished an operations center in Columbia, Maryland to process these loanpurchases. We began operations in the first quarter of 2005. The correspondentsegment of the mortgage banking market is highly competitive, particularlyrelative to the pricing of loans, and is dominated by large financialinstitutions that have large and well established correspondent lending salesand operating platforms. Additionally, many of these competitors retain theservicing on the loans they purchase, and may offer their clients moreoperational flexibility than we intend to offer since we sell all of the loanswe fund or purchase on a servicing released basis. As a result of our Company’slimited experience in correspondent lending and formidable competitors in thissegment of the industry, it is difficult to evaluate our growth prospects forthis new channel. Overhead expenses directly attributable to the correspondentchannel are currently in the range of $39,000 to $122,000 per month. While wecontinue to dedicate overhead expense to create additional capabilities andbuild our market presence in this new channel, we may not be able to achievethe level of anticipated loan fundings to cover our direct overhead, or it maytake longer than we have anticipated.

 

*We Have a Limited Operating History in SubprimeLending, Which Makes it Difficult to Predict our Future Prospects for thisLending Channel*

 

In 2004 we made a strategic decision to build theinfrastructure and hire executives to enable our Company to build our subprimevolume to 20% of total volume by the end of 2007. We created a subprime loanunderwriting center and began to hire dedicated subprime wholesale accountexecutives. Incremental revenues from this channel will help us to more fullyleverage our existing lending infrastructure, particularly our headquartersadministrative costs. The subprime segment of the mortgage banking market ishighly competitive, and is dominated by large, well-established firms whospecialize in this segment of the market. Additionally, many of these subprimelenders have portfolio capabilities and may offer their clients moreoperational flexibility that we intend to offer since we sell all of the loanswe fund or purchase on a servicing released basis. As a result of the increasinglycompetitive nature of this market segment and our Company’s limited experiencein subprime lending, it is difficult to evaluate our growth prospects for thisproduct line. Overhead expense directly attributable to the subprime businessis currently in the range of $250,000 month. While we will continue to dedicateoverhead expense and intend to increase our overhead expenses in 2005 torecruit sales professionals and build our market

 

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presencein this new channel, we may not be able to achieve the level of anticipatedfundings to cover our direct overhead, or it may take longer than we haveanticipated.

 

*We Have a Limited Operating History in the MortgageOrigination Industry, Which Makes it Difficult to Evaluate Our Current BusinessPerformance and Future Prospects*

 

Our Company was formed in 1997 and operated as amortgage REIT (mortgage portfolio investment) until the fourth quarter of 2001,at which time we began originating and selling residential mortgages (mortgagebanking). As a result, comparisons between financial performance in currentquarters and past quarters may not be helpful in evaluating our currentperformance or our future prospects. The market for mortgage originations wasdominated by unprecedented levels of refinances in 2002 and 2003 due tohistorically low interest rates. While our executive officers have extensivemortgage origination and mortgage banking experience, and we have hiredexperienced personnel in our mortgage banking subsidiary, the Company does nothave a significant history as a mortgage banking company. This may limit ourability to evaluate our current performance and project our future performance.

 

*We Expect Our Fixed Operating Expenses to Continue toIncrease, Which May Adversely Affect Our Results of Operations*

 

 We expect toincur additional costs and expenses related to the expansion of our salesforce, development of our correspondent and subprime lending channels, and investmentin our information technology capabilities. If this expansion does not resultin adequate revenues, our financial performance will suffer. We must generateapproximately $1.1 billion to $1.2 billion in sales volume per monthin 2005, absent further declines in revenue margins due to competitivepressures or spread compression, to meet our expense obligations. We areexpanding our business operations and increasing our fixed expenses.  Our strategy requires us to capture anincreasing percentage of the market in wholesale lending, correspondent lendingand subprime lending, in a highly competitive environment which will putpressure on our gross margins. If we are not able to do this, we would likelyexperience losses due to our increased level of expenses. In addition, weexpect to utilize income tax benefits against future profits and taxes. Some ofthe tax benefits may have to be reversed (valuation account established) in thefuture if significant operating losses occur, or if we determine at a futuredate that forecasted operating profits may not be sufficient to fully utilizedeferred tax assets. See “Overhead Expenses May Not Be Covered by SufficientRevenues to Sustain Profitable Operations.”

 

*We May Not Be Able to Effectively Manage the Growth ofOur Business*

 

Over the past three years, we have experienced rapidgrowth. In the beginning of 2001, we had approximately 20 employees. As of June30, 2005, we had approximately 885 employees. Many of these employees have verylimited experience with us and a limited understanding of our systems. Many ofour financial, operational and managerial systems were designed for a smallbusiness and have only recently been upgraded or replaced to support largerscale operations. If we fail to manage our growth effectively, our expensescould increase, negatively affecting our financial results.

 

*Competition in the Mortgage Banking Industry andDemand for Mortgages May Hinder Our Ability to Achieve or Sustain ProfitableOrigination Levels*

 

Our success depends, in large part, on our abilityto originate loans in sufficient quantity such that the gain on sales of loansnet of hedges and other revenue are in excess of both fixed and variableoverhead costs. There can be no assurance that we will be able to originate sufficientlevels of mortgages to achieve and sustain profitability. In originating andselling loans, we compete with investment banking firms, savings and loanassociations, banks, mortgage bankers and other entities originatingresidential 1-4 unit mortgages, many of which have greater financial resourcesthan us. We also face competition from companies already established in thesemarkets. In addition to the level of home purchase activity, the mortgage loanorigination market is directly tied to, the general level of interest rates,and refinance activity. Competitiveness has increased, putting pressure on themarket competitors to reduce revenues to sustain origination volumes and marketshare. We believe that the variety and the price competitiveness of our loanproducts and customer service levels will allow us to gain market share overthe next several years, even as the overall market for mortgages declines;however, there can be no assurance that we will be able to successfully andprofitably compete.

 

*Overhead Expenses May Not Be Covered By SufficientRevenues To Generate Profitable Operations*

 

We have made a number of fixed overhead commitmentsto establish the operational and administrative infrastructure necessary tosupport our loan origination business. At June 30, 2005, lease commitments forheadquarter and regional offices totaled approximately 209,400 square feet.There were 885 employees including 204 employees who are paid solely bycommissions. The balance of employees are salaried or hourly employees. Inorder to achieve profitability at this staffing level plus expected staffinglevels in 2005, our monthly loan sales volume must be approximately $1.1 to$1.2 billion, absent further deterioration in pricing margins due tocompetitive pressures, but there can be no assurance this can be accomplished.Since our revenues are tied directly to the level of loan production andsubsequent sale, it is imperative that we achieve a profitable level oforiginations, and the level of future profitability from mortgage banking willbe in direct correlation to the level of loan origination volume. Furthermore,should competitive pressures require us to reduce targeted gains on the sale ofloans, the volume required to sustain profitability would increase. There canbe no assurances that we will be able to

 

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maintainloan origination volumes sufficient to cover our fixed overhead costs, andshould we incur significant operating losses, our capital base and cashreserves could be materially adversely impacted.

 

*Revenues Can Fluctuate From Period to Period Based ona Number of Factors*

 

Our operating results have and may in the futurefluctuate significantly from period to period as a result of a number of factors,including; the volume of loan origination, interest rates and the level ofunrealized gains/losses in unsold loans, the value of funded loans not yetcommitted for sale or positions in derivative securities. Accordingly, theconsolidated net income of our Company may fluctuate from period to period.

 

Further, if the closing of a sale of loans ispostponed, the recognition of gain from the sale is also postponed. If such adelay causes us to recognize income in the subsequent quarter, our results ofoperations for the previous quarter could be significantly depressed.

 

*Our Financial Results Fluctuate As a Result ofSeasonality*

 

Although the refinance portion of our business isnot seasonal, our purchase business is generally subject to seasonal trends. During2003, our refinance business grew to a high of 90% of our activity. In 2004 andthe first six months of 2005, as we returned to more normal markets andpurchase and refinance activity became more equal, seasonality became asignificant factor in our business. Seasonality trends reflect the generalpattern of housing sales, which typically peak during the spring and summerseasons. Our quarterly operating results have fluctuated in the past and areexpected to fluctuate in the future, reflecting the seasonality of theindustry.

 

*Our Hedging Strategies May Not Be Successful inMitigating Our Risks Associated With Interest Rate Changes*

 

We use forward sales of mortgage-backed securities(TBA) and options on mortgage-backed securities (MBS), which are classified asderivative financial instruments, to provide a level of protection againstinterest rate risk. When rates change we expect to record a gain or loss onderivatives which would be offset by an inverse change in the value of our ratelocked loan commitments and closed loans. However, our use of derivatives maynot offset all of our risk related to changes in interest rates. In the past wehave incurred, and in the future we may incur losses after accounting for ourderivative financial instruments. The derivative financial instruments weselect may not have the desired effect of reducing our interest rate risk. Inaddition, the nature and timing of hedging transactions may influence theeffectiveness of these strategies. If we poorly design strategies or improperlyexecute transactions we could actually increase our exposure to interest raterisk and potential losses. In addition, hedging strategies involve transactionand other costs. We cannot assure you that our hedging strategy and thederivatives that we use will adequately offset the risk of interest ratevolatility or that our hedging transactions will not result in losses.

 

We offer loan programs of many terms, from thirtyyear fixed interest rate loans to one year adjustable rate loans. The hedginginstruments used, on balance, correlate satisfactorily with the thirty andfifteen year loan programs. The hedging instruments used for our shorter termloan programs and adjustable interest rate loans have a somewhat lowercorrelation to changes in market interest rates than do thirty year termprograms. Consequently, the design of our hedge strategy may be less effectiveat certain times and this occurrence could be amplified for these shorter termloan programs.

 

*Volatility in Interest Rates May Adversely Affect OurResults of Operations and Our Financial Position*

 

Our primary source of revenue is from gains on salesof loans, net of gains or losses on derivative financial instruments. We setrates and pay broker premiums for loans we fund based on a pricing processdesigned to create a targeted profit margin on each loan. Appropriately pricingthese loans can be complex, and we may not always successfully price our loanswith adequate margin to compensate us for the risk of interest rate volatility.

 

The value of the mortgage loans that we originate isat risk due to fluctuations in interest rates during two time periods:(1) the period beginning when we have committed to funding the loan (ratelocked loan commitments) and ending when the loan closes, or funds; and(2) the time period beginning when the loan closes and ending when wecommit to sell, or sell the loans to third-party purchasers of closed loans.These rate locked loan commitments and closed loans are collectively referredto as our pipeline. To manage the interest rate risk of our pipeline, wecontinuously project the percentage of rate locked loan commitments on loans weexpect to close. Because projecting a percentage of rate lock commitment loansthat will close is especially difficult during periods of volatile interestrates, we cannot assure that our projections will be accurate. On the basis ofsuch projections, we use forward sales of mortgage-backed securities (TBA) andoptions on MBS, which are classified as derivative instruments. These “hedges”are designed to mitigate the adverse impact interest rate fluctuations may haveon the value of the pipeline. Use of hedges is based in part on our estimatesas to the percentage of loans that will close, and therefore we cannot assureyou that our use of derivative instruments will offset the risk of changes ininterest rates.

 

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If interest rates change, the actual percentage ofrate lock commitment loans that close may differ from the projected percentage.A sudden significant increase in interest rates can cause a higher percentageof rate lock commitment loans to close than projected. We may not have madeforward sales commitments to sell these additional loans and consequently mayincur significant losses upon their sale at current market prices, which maynot be offset by gains in the value of derivative instruments, adverselyaffecting results of operations. Likewise, if a lower percentage of rate lockcommitment loans close than was projected, due to a sudden decrease in interestrates or otherwise; we have and may in the future adjust our hedge positions ormandatory sales commitments at a significant cost, adversely affecting ourresults of operations. This risk is greater during times of interest ratevolatility. Also, as our loan product list changes over time, our assumptionsconcerning rate locked loan closings may change. Incorrect assumptions willadversely affect results of operations.

 

*We Are Subject to Counterparty Risks on Loan SaleCommitments and Hedging Transactions*

 

In connection with our mortgage loan sales, whichinvolve the sale of mortgage loans and mortgage-backed securities on a forwardor other deferred delivery and payment basis, we may enter into forward salesof mortgage-backed securities (TBA) and options on MBS in connection with ourhedging activities. We have credit risk exposure to the extentpurchasers/sellers are unable to meet the terms of their forward purchase/salecontracts. As is customary in the marketplace, none of the forward paymentobligations of any of our counterparties is currently secured or subject tomargin requirements. We attempt to limit our credit exposure on forward salesarrangements on mortgage loans and mortgage-backed securities by entering intoforward contracts only with institutions that we believe are acceptable creditrisks, and which have substantial capital and an established track record incorrespondent lending. We further attempt to limit our credit exposure onhedging transactions by dealing with a wide variety of firms. If counterpartiesdo not perform, our results of operations may be adversely affected.

 

*Failure to Renew and Obtain Adequate Financing MayAdversely Affect Results Of Operations*

 

As of June 30, 2005 we had four revolving warehouseborrowing facilities in place totaling $2.1 billion (including $500million through temporary facilities). These facilities enable AmNet to fund inexcess of $2.1 billion per month depending on how quickly we are able to processloan fundings and subsequently sell funded loans within the month.  In order to continue our operations, we mustmaintain, renew or replace warehouse lines of credit. There are a number offinancial institutions which specialize in lending to mortgage bankingcompanies and these types of secured borrowings. We expect to renew our currentwarehouse facilities with JP Morgan/Chase Bank, UBS Real Estate Securities,Countrywide Warehouse Lending, Inc. and Residential Funding Corporation.Failure to renew facilities would limit our potential to fund loans and mayadversely affect our financial results. Among the factors that will affect ourability to renew and expand our warehouse line borrowings are financial marketconditions and the value and performance of our Company prior to the time ofsuch financing. There can be no assurance that any such financing can besuccessfully completed at advantageous rates or at all. Our warehouse creditfacilities contain extensive restrictions and covenants that, among other things,require us to satisfy specified financial, asset quality and loan performancetests. While the Company expects to be able to meet their covenants (and ifnot, obtain waivers), if we fail to meet or satisfy any of these covenantsand/or not obtain waivers, we would be in default under these agreements andour lenders could elect to declare all amounts outstanding under the agreementsto be immediately due and payable, enforce their interests against collateralpledged under such agreements and restrict our ability to make additionalborrowings. These agreements also contain cross-default provisions, so that ifa default occurs, under one agreement, the lenders under our other agreementscould also declare a default. Any uncured default under our credit facilitiescould have a materially adverse effect on our financial results. As of June 30,2005 the Company was not in compliance with certain warehouse line facilitycovenants. Waivers were obtained and we believe we are in good standing withall of our warehouse lenders.

 

The covenants and restrictions in our warehousecredit facilities may restrict our ability to, among other things:

 

•                  incur additional debt by virtue of havingwarehouse loan covenants;

 

•                  make certain investments or acquisitions;

 

•                  repurchase or redeem capital stock;

 

•                  engage in mergers or consolidations;

 

•                  finance loans with certain attributes;

 

•                  reduce liquidity below certain levels; and

 

•                  hold loans for longer than established timeperiods.

 

These restrictions may interfere with our ability toobtain financing or to engage in other business activities, which maysignificantly harm our business financial condition, liquidity and results ofoperations.

 

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*We Sell a Substantial Portion of Loans We Originateto Competitors*

 

We have warehouse line facilities with CountrywideHome Loans, Inc. (“Countrywide”). We also sell a substantial portion ofour loans to Countrywide as well as other competitors. For the six monthsending June 30, 2005 we sold (by loan volume) to Countrywide 45.2%, MorganStanley Mortgage Capital Inc. (“Morgan Stanley”) 18.2% and Wells FargoFunding Inc. (“Wells Fargo”) 12.9% of all loan sales. If Countrywide,Wells Fargo or Morgan Stanley changes its correspondent lending strategy orprocedures, or stops purchasing our loans on favorable terms, we could berequired to find alternate purchasers and/or accept unfavorable terms. We couldalso be forced to find other sources of warehouse line borrowing. Any of theseevents may have an adverse effect on our results of operations.

 

*Dependency on Correspondent Investors, SecondaryMarkets*

 

Our ability to generate gains on the sales ofmortgages is largely dependent upon the continuation of correspondent lendingprograms offered by large correspondent lenders, as well as our continuedeligibility to participate in such programs. Although we are in good standingwith a number of large correspondent lenders and are not aware of any proposeddiscontinuation of, or significant reduction in, the operation of suchprograms, any such changes could have a material adverse effect on ouroperations. We anticipate that we will continue to remain eligible toparticipate in such programs, but any significant impairment of sucheligibility would materially adversely affect our operations.

 

*Our Origination Activity Is Concentrated InCalifornia, Making Our Results Subject to Adverse Economic Conditions InCalifornia*

 

A large proportion of loans we fund are concentratedin California (32% by loan volume) of all loans closed for the six month periodended June 30, 2005. Although we have expanded our operations on the East Coastof the United States, a significant portion of our loan origination volume islikely to be based in California for the foreseeable future. Consequently, ourresults of operations and financial condition are dependent upon general trendsin the California economy and its residential real estate market. Residentialreal estate market declines may adversely affect the levels of new mortgages inCalifornia or the value paid by correspondent investors for loans inCalifornia, potentially adversely affecting our results of operations andfinancial condition.

 

*Repurchased or Non-saleable Loans May AdverselyImpact Results of Operations and Our Financial Position*

 

In connection with the sale of loans tocorrespondent investors, we make a variety of representations and warrantiesregarding the loans, including those that are customary in the industryrelating to, among other things, compliance with laws, regulations and investorprogram standards and the accuracy of information on the loan documents and inthe loan file. In the event that an investor finds that a loan or group ofloans violates our representations, the investor may require us to repurchasethe loan or loan group and bear any potential related loss on the dispositionof the loans, or provide an indemnification for any losses sustained by theinvestor on the loans. Additionally, we may inadvertently originate a loan thatdoes not meet investor underwriting criteria or has some other defect,requiring us to sell the loans at a significant discount. We have hiredexperienced personnel at all levels and have established significant controlsto ensure that all loans are originated to our underwriting standards, and aremaintained in compliance with all of the representations made by us inconnection with our loan sale agreements. However, there can be no assurancesthat mistakes will not be made or that certain employees will not deliberatelyviolate our lending policies and, accordingly, we are subject to repurchaserisk and losses on unsaleable loans. Typically, with respect to any loan thatmight be repurchased or unsaleable, we would correct the flaws if possible andre-sell the loan in the market. We have created repurchase reserves to providefor this contingency on our financial statements, but there can be noassurances that these reserves are adequate, or that loan losses associatedwith repurchased or unsaleable loans will not adversely impact results ofoperations or the financial condition of our Company. Additionally, should aninvestor or group of investors experience an adverse trend of non-compliantloans from our Company, we could lose the privilege of selling loans to theinvestor(s), which could have a material adverse impact on our ability to sellour loans and thus adversely impact the results of operations or the financialcondition of the Company.

 

*The Company Provides Loans to Subprime Borrowerswhich May Adversely Affect Earnings*

 

Credit risks associated with subprime mortgage loanswill be greater than those associated with mortgage loans that conform to FNMAand FHLMC guidelines. The principle difference between subprime mortgage loansand conforming mortgage loans is that subprime mortgage loans typically includeone or more of the following: worse credit and income histories of themortgagors, higher loan-to-value ratios, reduced or alternative documentationrequired for approval of the mortgagors, different types of properties securingthe mortgage loans, higher loan sizes and the mortgagor’s non-owner occupancystatus with respect to the mortgaged property. We have added personnel in acentralized subprime underwriting and funding center to help mitigate the risksassociated with these loans, however there can be no assurance that allsubprime loans will be able to be sold to investors at a profit. If we are notsuccessful, higher overhead incurred to produce these loans may not be coveredby the income derived from subprime lending.

 

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*The Nationwide Scope of Our Operations Exposes Us toRisks of Noncompliance with an Increasing and Inconsistent Body of Complex Lawsand Regulations at the Federal, State and Local Levels*

 

We originate mortgage loans in many states. We mustcomply with the laws and regulations, as well as judicial and administrativedecisions, of all of these jurisdictions, as well as an extensive body offederal laws and regulations. The volume of new or modified laws andregulations has increased in recent years and in addition, individual citiesand counties have begun to enact laws that restrict loan origination activitiesin those cities and counties. The laws and regulations of each of thesejurisdictions are different, complex and, in some cases, in direct conflictwith each other. As our operations continue to grow, it may be more difficultto comprehensively identify, to accurately interpret and to properly programour technology systems and effectively train our personnel with respect to allof these laws and regulations, thereby potentially increasing our exposure tothe risks of noncompliance with these laws and regulations.

 

Our failure to comply with these laws can lead tothe following consequences, any of which could have an adverse effect on ourability to operate our business and our financial results:

 

•                  civil and criminal liability;

 

•                  loss of approved status;

 

•                  demands for indemnification or loan repurchases frompurchasers of our loans;

 

•                  class action lawsuits;

 

•                  assignee liability, which may make our loans unsaleable;and

 

•                  administrative enforcement actions.

 

*The Increasing Number of State and Local “Anti-predatoryLending” Laws May Restrict Our Ability to Originate or Increase Our Risk ofLiability With Respect To Certain Mortgage Loans and Could Increase Our Costsof Doing Business*

 

In recent years, several federal, state and locallaws, rules and regulations have been adopted, or are under consideration, thatare intended to eliminate so-called “predatory” lending practices. These laws,rules and regulations impose certain restrictions on loans on which certainpoints and fees or the annual percentage rate (“APR”) exceeds specifiedthresholds. Some of these restrictions expose a lender to risks of litigationand regulatory sanction no matter how carefully a loan is underwritten. Inaddition, an increasing number of these laws, rules and regulations seek toimpose liability for violations on purchases of loans, regardless of whether apurchaser knew of or participated in the violation.

 

It is against our policy to engage in predatorylending practices and /or high cost loans which are defined as mortgage loansthat feature either an interest rate or points and fees charged in connectionwith loans that exceed certain thresholds prescribed by federal or state law orlocal ordinances. We have generally avoided originating loans that exceed theAPR or “points and fees” thresholds of these laws, rules and regulations. Thecompanies that buy our loans and/or provide financing for our loan originationoperations generally do not want to buy or finance such loans. The continuedenactment of these laws, rules and regulations may prevent us from makingcertain loans. In addition, the difficulty of managing the risks presented bythese laws, rules and regulations may decrease the availability of warehousefinancing and the overall demand for loans, making it difficult to fund, sellor securitize any of our loans. If we relax our restrictions on loans subjectto these laws, rules and regulations because the companies which buy our loansand/or provide financing for our loan origination operations relax theirrestrictions, we will be subject to greater risks for actual or perceivednon-compliance with such laws, rules and regulations, including demands forindemnification or loan repurchases from our lenders and loan purchasers, classaction lawsuits, increased defenses to foreclosure of individual loans indefault, individual claims for significant monetary damages and administrativeenforcement actions. The growing number of these laws, rules and regulationswill likely increase our cost of doing business as we are required to developsystems and procedures to ensure that we do not violate any aspect of these newrequirements. Any of the foregoing could materially and adversely affect ourbusiness, financial condition, liquidity and results of operations.

 

*An Interruption In or Breach of Our InformationSystems May Result In Lost Business*

 

We rely heavily upon communications and informationsystems to conduct our business. As we implement our growth strategy andincrease our volume of loan production, that reliance will increase. Anyfailure or interruption or breach in security of our information systems or thethird-party information systems on which we rely could cause underwriting orother delays and could result in fewer loan applications being received, slowerprocessing of applications and reduced efficiency in loan servicing. We utilizeproprietary software for our main loan origination system. This software is notfully documented and we have a limited number of employees who areknowledgeable about this application. We cannot assure you that systems failureor interruptions will not occur, or if they do occur that

 

36

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theywill be adequately addressed by us or the third parties on which we rely. Theoccurrence of any failures or interruptions could significantly harm ourbusiness.

 

*The Success and Growth of Our Business Will DependUpon Our Ability to Adapt to, Implement and Maintain Technological Changes*

 

Our mortgage loan origination business is currentlydependent upon our ability to effectively interface with our brokers, borrowersand other third parties and to efficiently process loan applications and fundloans. The origination process is becoming more dependent upon technologicaladvancement, such as the ability to process applications over the internet,accept electronic signatures, and provide process status updates instantly andother customer-expected conveniences that are cost-efficient to our process.Implementing this new technology and becoming proficient with it may alsorequire significant capital expenditures. As these requirements increase in thefuture, we will have to fully develop these technological capabilities toremain competitive or our business could be significantly harmed.

 

*We Must Attract and Retain Qualified AccountExecutives and Qualified Personnel to Produce Our Desired Level of Revenues*

 

The Company relies on commissioned accountexecutives to generate loan referrals from professional mortgage brokers. Theseaccount executives typically have established relationships with brokers. TheCompany’s overall loan fundings are dependent upon the number of accountexecutives, and as such, sustained loan production and market share growth aredependent on the successful retention and recruitment of the sales force.Similarly, the Company relies on the expertise of its employees in other facetsof operations, including underwriting, capital markets, risk management, andfinance and accounting. Given the dependency on the job market for qualifiedemployees, to continue our growth poses the potential risk that the Companywill not be able to attract and retain qualified employees.

 

*Capital Shortages Could Impede the Ability to ExecuteOur Mortgage Banking Strategy*

 

Our mortgage banking activities require asignificant level of cash reserves and capital to support loan inventories andoverhead exposure. Additionally, while we utilize warehouse credit facilitiesto fund our loan origination activity, we must invest cash equity in our loaninventories approximating 1.0% to 4.0% of the cost basis of these loans. Whilewe believe our capital base, cash reserves and cash flow from mortgage bankingrevenues will be sufficient to enable us to execute our mortgage bankingstrategy, there can be no assurances that capital shortages will not occur,requiring us to raise additional debt or equity capital or decrease or ceaseour origination activities.

 

*We Are Subject To Losses Due To Errors or FraudulentActs On The Part Of Loan Applicants, Employees or Mortgage Brokers*

 

Mortgage brokers who assist loan applicants inobtaining mortgage loans refer all of the mortgage loans originated orpurchased by us. As such, the loan application, property appraisal, creditreport and other supporting documentation are furnished by the mortgage brokerand used by our underwriters to make approval or denial decisions. There couldalso be the potential of collusion between the broker and an employee toproduce a fraudulent loan. Our employees usually have little contact with loanapplicants, and rely on the mortgage broker to obtain and furnish all of thedocumentation supporting the mortgage loan application. Mortgage brokers maymake mistakes in completing the documentation for a loan leading to anincreased risk of our holding a non-saleable loan or of indemnifying orrepurchasing loans from investors.

 

Further, in rare cases, the mortgage broker mayknowingly or unknowingly submit an application wherein multiple parties to thetransaction (borrower, appraiser, seller, or title insurer) work in collusionto inflate the property value and/or falsify other documentation in order toobtain a mortgage loan. These types of fraudulent mortgage loans will have ahigh risk of default, and will likely not be fully recoverable throughdisposition of the underlying property securing the mortgage loans. Additionally,in the case of Alternative A loans, which in some cases permit the borrower to “state”their income but not have to provide income documentation, the mortgage brokermay intentionally coach a borrower to make material misrepresentations in orderto qualify for a loan.

 

Should material fraud be detected on a mortgage loanprior to sale to an investor, the mortgage loan may have to be sold at asignificant discount or may not be saleable. Should material fraud or mistakesin loan documentation be detected after a mortgage loan is sold to acorrespondent investor, we may be required to repurchase the loan or indemnifythe investor. While the investor and/or we can initiate foreclosure proceedingson any loan deemed to be fraudulently obtained, we could incur significantlosses on these fraudulent mortgage loans if principal or interest is not fullyrecovered through the foreclosure and disposition of the underlying propertysecuring the mortgage loan.

 

We have established risk management and qualitycontrol committees to set policy and manage exposure to credit losses due tofraud, compliance errors or non-compliance with our underwriting standards. Wehave representations and warranties agreed upon by our correspondent lendingcustomers to repurchase loans which do not meet certain standards. Regularquality control audits are done on representative samples of mortgage loans andall mortgage loans submitted by brokers who come under suspicion in the normalcourse of business. Additionally, we have numerous controls and processes toensure that all of the mortgage loans applications submitted through mortgagebrokers are not based on fraudulent or intentionally misrepresenteddocumentation. However, there can be no assurances that the broker and/orborrowers do not submit fraudulent or inaccurate documentation that is notdetected by our personnel or by electronic

 

37

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fraudchecks utilized by us. Should we originate a significant number of fraudulentloans or loans based on inaccurate documentation, and incur costs or lossesthat cannot be recovered through contractual remedies we have with our brokers,correspondents or other vendors, our results of operations and financialcondition could be materially adversely affected.

 

*If We Are Unable to Maintain and Expand Our Networkof Independent Brokers, Our Loan Origination Business Will Decrease*

 

All of our mortgage loan originations come fromindependent brokers. Our brokers are not contractually obligated to do businesswith us. Many of our brokers have not been in business more than a few years.Further, our competitors also have relationships with our brokers and activelycompete with us in our efforts to expand our broker networks. Accordingly, wecannot assure you that we will be successful in maintaining our existingrelationships or expanding our broker networks, the failure of which wouldsignificantly harm our business, financial condition, liquidity and results ofoperations.

 

*We May be Subject to Fines or Other Penalties BasedUpon the Conduct of Our Independent Brokers*

 

The mortgage brokers from which we obtain loans havelegal obligations to which they are subject. While these laws may notexplicitly hold the originating lenders responsible for the legal violations ofmortgage brokers, increasingly federal and state agencies have sought to imposesuch assignee liability. Recently, for example, the United States Federal TradeCommission (“FTC”) entered into a settlement agreement with a mortgage lenderin which the FTC characterized a broker that had placed all of its loanproduction with a single lender as the “agent” of the lender, and the FTCimposed a fine on the lender in part because, as “principal,” the lender waslegally responsible for the mortgage broker’s unfair and deceptive acts andpractices. The United States Justice Department in the past has sought to holda mortgage lender responsible for the pricing practices of its mortgagebrokers, alleging that the mortgage lender was directly responsible for thetotal fees and charges paid by the borrower under the Fair Housing Act even ifthe lender neither dictated what the mortgage broker could charge nor kept themoney for its own account. Accordingly, we may be subject to fines or otherpenalties based upon the conduct of our independent mortgage brokers.

 

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ITEM 3.

QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

A primary market risk facing our Company is interestrate risk, which is highly sensitive to many factors, including governmentalmonetary and tax policies, domestic and international economic and politicalconsiderations and other factors beyond our control. We attempt to manage thisrisk on a daily basis.

 

*Mortgage Origination – Interest Rate Risk*

 

Rate lock commitments and mortgage loans held forsale are subject to market price fluctuation until committed for sale. Thesefluctuations are primarily tied to changes in market interest rates and therelationship of short-term rates to long-term rates. In order to mitigate thisrisk, a variety of financial derivative instruments (including forwardmandatory mortgage security sales (TBA) and options on TBA sales) are utilizedto hedge or mitigate market price fluctuations. These instruments areclassified as derivative financial instruments on our financial statements. Ourhedge positions are continually adjusted based on routine and ongoingquantification of our risk, but hedges may or may not be fully successful incomplete risk mitigation. In particular, our capital markets personnel mustmake estimates of the percentage of rate lock commitments expected to closeunder different interest rate changes. Losses on the sale of mortgage loans notoffset by corresponding gains on hedge positions, or hedging activity notoffset by corresponding gains on the sale of mortgages, could adversely impactresults of operations and ourfinancial position.

 

*Other Risks*

 

Our ability to generate gains on the sales ofmortgages is largely dependent upon the continuation of correspondent investorprograms offered by large institutions. Typically these institutions havemortgage banking operations with which we compete. At any point in time aninvestor could discontinue our business relationship and therefore narrow thescope of investors available to buy our loans.

 

**Sensitivity Analysis**

 

The methods we have used in our sensitivity analysishave not changed significantly since December 31, 2004.  We have performed various sensitivityanalyses that quantify the net financial impact of changes in interest rates onour interest rate-sensitive assets, liabilities and commitments. These analysespresume an instantaneous parallel shift of the yield curve. Various techniquesare employed to value the underlying financial instruments, and thesetechniques rely upon a number of critical assumptions. The scenarios presentedin the table below are illustrative. Actual experience may differ materiallyfrom the estimated amounts presented for each scenario. To the extent thatyield curve shifts are non-parallel, and to the extent that actual variationsin significant assumptions differ from those applied for purposes of thevaluations, the resultant valuations can also be expected to vary. Suchvariances may prove material.

 
| ** **                                                             | ** ** | **(dollars in thousands)** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                             | ** ** | ** **                 | ** ** | ** ** | ** ** | **If Interest Rates Were To** | ** ** |
| ** **                                                             | ** ** | **June 30, 2005**          | ** ** | **Increase** | ** ** | **Decrease** | ** ** | **Increase** | ** ** | **Decrease** | ** ** |
| ** **                                                             | ** ** | **Carrying Amount**        | ** ** | **Estimated  Fair Value** | ** ** | **50 Basis Points  Estimated Fair Value** | ** ** | **100 Basis Points  Estimated Fair Value** | ** ** |
| Interest-earning assets:                                               |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |       | $                          | 28,636     |   | $ | 28,636 |   | $ | 28,636 |   | $ | 28,636 |   | $ | 28,636 |   | $ | 28,636 |   |
| Mortgage loans held for sale, net, pledged,  (lower of cost or market) |       | 512,394                    |       | 517,013 |   | 514,822 |   | 518,367 |   | 512,565 |   | 519,659 |   |
| Derivative financial instruments                                       |       | (568                       | )          | (568 | ) | 1,017 |   | (2,690 | ) | 1,483 |   | (6,537 | ) |
| Bond collateral and real estate owned, net                             |       | 11,635                     |       | 12,372 |   | 12,370 |   | 12,374 |   | 12,375 |   | 12,361 |   |
| Total interest-earning assets                                          |       | $                          | 552,097    |   | $ | 557,453 |   | $ | 556,845 |   | $ | 556,687 |   | $ | 555,059 |   | $ | 554,119 |   |
|                                                                   |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                          |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Short-term debt                                                        |       | $                          | 500,786    |   | $ | 500,786 |   | $ | 500,786 |   | $ | 500,786 |   | $ | 500,786 |   | $ | 500,786 |   |
| Long-term debt, net                                                    |       | 10,057                     |       | 10,057 |   | 10,057 |   | 10,057 |   | 10,057 |   | 10,057 |   |
| Total interest-bearing liabilities                                     |       | $                          | 510,843    |   | $ | 510,843 |   | $ | 510,843 |   | $ | 510,843 |   | $ | 510,843 |   | $ | 510,843 |   |

 

The following describes the methods and assumptionsused by the Company in estimating fair values.

 

*Cash and Cash Equivalents*

 

The carrying amount for cash and cash equivalentsapproximates fair value because these instruments are demand deposits and moneymarket accounts and do not present unanticipated interest rate or creditconcerns.

 

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*Mortgage Loans Held For Sale, net, pledged, (lower of cost or market)*

 

The fair value is estimated based on quoted marketprices from institutional investors for similar types of mortgage loans. Aportion of mortgage loans held for sale are committed for sale under mandatorysale arrangements and as such are not re-valued for subsequent changes ininterest rates.

 

*Derivative financial instruments*

 

Fair values of forward sales of mortgage-backedsecurities and options on mortgage-backed securities are based on quoted marketprices for these instruments. Fair values of our commitments to originate loansare based on any difference in the value of the loans expected to close betweenthe time of the rate lock commitment and the current market value.

 

*Bond Collateral, Mortgage Loans and Real Estate Owned, Net*

 

The fair value of Bond Collateral is estimated basedon quoted market prices from dealers and brokers for similar types of mortgageloans in the bulk mortgage market. Market prices reflect various assumptions asto prepayment rates, loan losses and financing costs.

 

*Short-Term Debt*

 

The fair value of the warehouse line debt andshort-term debt related to bond collateral held for sale approximates thecarrying amounts because of the short-term nature of the debt and interest onthe debt fluctuates with market interest rates.

 

*Long-Term Debt*

 

The fair value of long-term debt is estimated basedupon all long-term debt being at variable rates and therefore cost approximatesfair market value.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

(a) Under the supervisionand with the participation of our management, including our principal executiveofficer and principal financial officer, we evaluated the effectiveness of ourdisclosure controls and procedures, as such term is defined under Rule13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended.Based on this evaluation, our principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this quarterly report.

 

(b)There has been no change in our internal control over financial reportingidentified in connection with the evaluation required by paragraph (d) ofExchange Act Rule 13a-15 that occurred during the period covered by thisquarterly report that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

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| PART II.                   | OTHER  INFORMATION                                                                                                                                                                                                                                                                                       |
|---------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |                                                                                                                                                                                                                                                                                                     |
| ITEM 1.                         | LEGAL  PROCEEDINGS                                                                                                                                                                                                                                                                                       |
|                            |                                                                                                                                                                                                                                                                                                     |
|                            | None.                                                                                                                                                                                                                                                                                                    |
|                            |                                                                                                                                                                                                                                                                                                     |
| ITEM 2.     | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                                                                                                                                                                                                             |
|                            | The  Company did not repurchase any of its shares in the six months ended June 30,  2005.  The Company’s repurchase program  announced May 13, 2004 authorized the repurchase of 400,000 shares of which  294,610 remain available to be repurchased with no expiration date on this  program. |

 
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|---------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    | Not applicable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|    | None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| ITEM 5. | OTHER INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|    | (a)   On  May 10, 2005 American Mortgage Network, Inc., a subsidiary of the Company,  entered in to a Master Agreement with Fidelity Information Services, Inc. and  Addendum 1 and Addendum 2 thereto.   Pursuant to the agreement, Fidelity will service the company’s loans  from the time they are closed until the time the company sells the  loans.  The Company has agreed to pay  Fidelity for equipment use, software and processing fees based on usage along  with certain minimum monthly fees. The term of the Agreement is five years.  Termination of the agreement requires six months notice. Fidelity retains  ownership rights to all software used by the Company   A copy of the agreement is filed with this  Form 10-Q. |
|    | (b)   None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| ITEM 6. | EXHIBITS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 
|   | (a)    | ** ** | ** ** | Exhibits | ** ** | ** **                                                                                                                                                                            |
|--------|--------|------------|------------|----------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | (1)        |       | 3.1      |       | Second  Articles of Amendment and Restatement of the Registrant                                                                                                                       |
|   |   | (2)        |       | 3.1A     |       | Articles  of Amendment (regarding name change)                                                                                                                                        |
|   |   | (3)        |       | 3.2      |       | Fourth  Amended and Restated Bylaws of the Registrant                                                                                                                                 |
|   |   | (4)        |       | 4.1      |       | Registration  Rights Agreement dated February 11, 1997                                                                                                                                |
|   |   | (3)        |       | 4.3      |       | First  Amended and Restated Rights Agreement by and between the Company and American  Stock Transfer and Trust Company dated as of February 2, 1999 and amended as  of March 4, 2004. |
|   |   | (4)        |       | 10.6     |       | 1997  Stock Incentive Plan                                                                                                                                                            |
|   |   | (4)        |       | 10.7     |       | Form  of 1997 Stock Option Plan, as amended                                                                                                                                           |
|   |   | (4)        |       | 10.8     |       | Form  of 1997 Outside Directors Stock Option Plan                                                                                                                                     |
|   |   | (4)        |       | 10.9     |       | Form  of Employee Stock Purchase Plan                                                                                                                                                 |
|   |   | (4)        |       | 10.14    |       | Form  of Indemnity Agreement                                                                                                                                                          |
|   |   | (5)        |       | 10.17    |       | The  Termination and Release Agreement, dated as of December 20, 2001                                                                                                                 |
|   |   | (5)        |       | 10.18    |       | Amendment  No. 1 to the Securities Purchase Agreement, dated as of December 20, 2001                                                                                                  |
|   |   | (5)        |       | 10.19    |       | Amendment  No. 1 to the Registration Rights Agreement, dated as of December 20, 2001                                                                                                  |
|   |   | (6)        |       | 10.20    |       | Lease  between American Residential Investment Trust, Inc. and Sorrento Wateridge  Partners, L.P. dated November 30, 2001                                                             |
|   |   | (7)        |       | 10.21    |       | Executive  Employment Agreement between AmNet Mortgage, Inc. and John  Robbins dated September 30, 2004.                                                                         |
|   |   | (7)        |       | 10.22    |       | Executive  Employment Agreement between AmNet Mortgage, Inc. and Jay Fuller dated  September 30, 2004.                                                                                |
|   |   | (7)        |       | 10.23    |       | Executive  Employment Agreement between AmNet Mortgage, Inc. and Judith A. Berry dated  September 30, 2004.                                                                           |
|   |   | (7)        |       | 10.24    |       | Executive  Employment Agreement between AmNet Mortgage, Inc. and Lisa Faulk dated  September 30, 2004.                                                                                |
|   |   | (8)        |       | 10.25    |       | Long  Term Incentive Cash Plan for Executive Officers                                                                                                                                 |
|   |   | (11)       |       | 10.25A   |       | Amendment  to the Long Term Incentive Cash Plan                                                                                                                                       |

 

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|   |   | (8)    |   | 10.26   |   | 2004  Executive Bonus Plan Description                                                                   |
|--------|--------|--------|--------|---------|--------|----------------------------------------------------------------------------------------------------------|
|   |   | (9)    |   | 10.27   |   | 2004  Equity Incentive Plan                                                                              |
|   |   | (9)    |   | 10.28   |   | Stock  Repurchase Agreement dated June 24, 2004 with Home Asset  Management Corp.                   |
|   |   | (9)    |   | 10.28.1 |   | Supplemental  Executive Retirement Plan                                                                  |
|   |   | (10)   |   | 10.29   |   | Form  of Restricted Stock Agreement                                                                      |
|   |   | (10)   |   | 10.30   |   | Form  of Long Term Incentive Plan Restricted Stock Agreement                                             |
|   |   | (10)   |   | 10.31   |   | Form  of Standard Restricted Stock Unit Agreement                                                        |
|   |   | (10)   |   | 10.32   |   | Form  of Executive Restricted Stock Unit Agreement                                                       |
|   |   | (10)   |   | 10.33   |   | Form  of Stock Option Agreement                                                                          |
|   |   | (10)   |   | 10.34   |   | Executive  Officer Annual Cash Bonus Program — 2005                                                 |
|   |   | (10)   |   | 10.35   |   | Cash  Long Term Incentive Program (2005-2006)                                                            |
|   |   | (10)   |   | 10.36   |   | Cash  Long Term Incentive Program (2005-2007)                                                            |
|   |   | (10)   |   | 10.37   |   | Form  of Director Stock Option Agreement                                                                 |
|   |   | (10)   |   | 10.38   |   | Form  of Director Restricted Stock Agreement                                                             |
|   |   | (10)   |   | 10.39   |   | Schedule  of Director Compensation                                                                       |
|   |   | (12)   |   | 10.40   |   | Fidelity  Information Services Inc.  Master  Agreement, addendum 1 & 2 dated  May 10, 2005 |
|   |   |   |   | 31.1    |   | Certification of Chief Executive Officer                                                                 |
|   |   |   |   | 31.2    |   | Certification of Chief Financial Officer                                                                 |
|   |   |   |   | 32.1    |   | Certification of Chief Executive Officer                                                                 |
|   |   |   |   | 32.2    |   | Certification of Chief Financial Officer                                                                 |
|   |   |   |   |    |   |                                                                                                     |

 

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|   |   | (1)  |   | Incorporated by reference  to the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2002 filed March 31, 2003.            |
|--------|--------|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | (2)  |   | Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the quarter ended March  31, 2004 filed May 17, 2004.                  |
|   |   | (3)  |   | Incorporated by reference  to the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2003 filed March 30, 2004.            |
|   |   | (4)  |   | Incorporated by reference  to Registration Statement on Form S-11 filed September 25, 1997 (File No.  333-33679).                                         |
|   |   | (5)  |   | Incorporated by reference  to the Company’s current Report on Form 8-K filed January 9, 2002 (File No.  001-13485).                                  |
|   |   | (6)  |   | Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the quarter ended March  31, 2003 filed May 15, 2003.             |
|   |   | (7)  |   | Incorporated by reference  to the Company’s Current Report on Form 8-K filed October 6, 2004.                                                        |
|   |   | (8)  |   | Incorporated by reference  to the Company’s Amendment to Annual Report on Form 10-K/A for fiscal year  ended December 31, 2003 filed April 29, 2004. |
|   |   | (9)  |   | Incorporated by reference  to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30,  2004 filed August 16, 2004.                |
|   |   | (10) |   | Incorporated by reference  to the Company’s Current Report on Form 8-K filed April 7, 2005.                                                          |
|   |   | (11) |   | Incorporated by reference  to the Company’s Current Report on Form 8-K filed February 11, 2005.                                                      |
|   |   | (12) |   | Confidential treatment has  been requested for a portion of this contract.                                                                                |

 

42

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                   | AMNET MORTGAGE, INC. |
|------------------------|----------------------|
|                   |                 |   |   |
| Dated: August 15, 2005 | By:                  | /s/ Judith A. Berry |   |
|                   |                 | Judith A. Berry, |
|                   |                 | Executive Vice President  Chief Financial Officer |

 

43

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