**UNITEDSTATES 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: September 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**                                                                 |

 

**AMNETMORTGAGE, INC.**

(Exact name of registrant as specified in its charter)

 
| **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 sincelast 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

Indicateby check mark whether the registrantis a shell company (as defined in Rule 12b of the Exchange Act).       . 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) |   | 7,487,399 as of October 28, 2005 |
|----------------------|--------|----------------------------------|

 

 

----

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

 

2

----

 

PART I.  FINANCIAL INFORMATION

Item1.  Consolidated Financial Statements

 

AmNet Mortgage, Inc. and Subsidiaries

Consolidated Balance Sheets, unaudited

(in thousands, except share and per share data)

 
| ** **                                                                                                                                                                   | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                                                                                                                                         |       |                   |       |                  |       |
| **ASSETS**                                                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                    |       | $                      | 21,663     |                  | $          | 50,600 |   |
| Cash and cash equivalents—restricted                                                                                                                                    |       | 3,100                  |       | 2,100                 |       |
| Mortgage loans held for sale, net, pledged  (lower of cost or market)                                                                                                        |       | 736,886                |       | 238,440               |       |
| Bond collateral, mortgage loans, net                                                                                                                                         |       | 10,886                 |       | 14,509                |       |
| Bond collateral, real estate owned, net                                                                                                                                      |       | 219                    |       | 479                   |       |
| Accounts receivable—mortgage loans  sold/funded                                                                                                                         |       | 30,369                 |       | 16,167                |       |
| Accounts receivable—derivative financial  instruments                                                                                                                   |       | 230                    |       | —                |       |
| Derivative financial instruments                                                                                                                                             |       | 851                    |       | 616                   |       |
| Accrued interest receivable                                                                                                                                                  |       | 1,732                  |       | 819                   |       |
| Deferred taxes                                                                                                                                                               |       | 10,083                 |       | 10,694                |       |
| Other assets                                                                                                                                                                 |       | 6,122                  |       | 6,055                 |       |
|                                                                                                                                                                         |       | $                      | 822,141    |                  | $          | 340,479 |   |
|                                                                                                                                                                         |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                               |       |                   |       |                  |       |
| Liabilities:                                                                                                                                                                 |       |                   |       |                  |       |
| Short-term debt                                                                                                                                                              |       | $                      | 710,951    |                  | $          | 232,236 |   |
| Long-term debt                                                                                                                                                               |       | 9,317                  |       | 13,500                |       |
| Accounts payable—derivative financial  instruments                                                                                                                      |       | —                 |       | 37                    |       |
| Accrued interest payable                                                                                                                                                     |       | 1,653                  |       | 515                   |       |
| Accrued commissions and payroll                                                                                                                                              |       | 9,253                  |       | 5,218                 |       |
| Recourse liabilities associated with loan  sales                                                                                                                             |       | 6,699                  |       | 5,480                 |       |
| Accrued expenses and other liabilities                                                                                                                                       |       | 5,540                  |       | 6,212                 |       |
| Total liabilities                                                                                                                                                            |       | 743,413                |       | 263,198               |       |
| Commitments and contingencies (Note 13)                                                                                                                                      |       |                   |       |                  |       |
| 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; 7,484,510 shares issued and outstanding in  2005, and 7,303,825 shares issued and outstanding in 2004 |       | 74                     |       | 73                    |       |
| Additional paid-in-capital                                                                                                                                                   |       | 105,585                |       | 103,718               |       |
| Deferred compensation                                                                                                                                                        |       | (1,204                 | )          | —                |       |
| Accumulated deficit                                                                                                                                                          |       | (25,824                | )          | (26,610               | )          |
| Total stockholders’ equity                                                                                                                                              |       | 78,631                 |       | 77,181                |       |
|                                                                                                                                                                         |       | $                      | 822,141    |                  | $          | 340,479 |   |

 

See accompanying notes to consolidated financial statements.

 

3

----

 

AmNet Mortgage, Inc. and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income (Loss),unaudited

(in thousands, except per share data)

 
| ** **                                                                                                                         | ** ** | **For the Three Months  Ended  September 30, 2005** | ** ** | **For the Three Months  Ended  September 30, 2004** | ** ** | **For the Nine Months  Ended  September 30, 2005** | ** ** | **For the Nine Months  Ended  September 30, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                                                                               |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| **Revenues**                                                                                                                       |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Gain on sales of loans                                                                                                             |       | $                                                        | 30,070     |                                                     | $          | 24,198                                                  |       | $                                                       | 80,978     |   | $ | 42,037 |   |
| Derivative financial instruments and market  adjustments                                                                           |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Derivative financial instruments—forward  sales of mortgage-backed securities and options to sell mortgage-backed  securities |       | 9,610                                                    |       | (7,793                                                   | )          | 1,245                                                   |       | (2,423                                                  | )          |
| Market adjustment on interest rate lock  commitments                                                                               |       | (6,197                                                   | )          | (3,753                                                   | )          | (4,558                                                  | )          | (520                                                    | )          |
| Total derivative financial instruments and  market adjustments                                                                     |       | 3,413                                                    |       | (11,546                                                  | )          | (3,313                                                  | )          | (2,943                                                  | )          |
| Interest on mortgage assets                                                                                                        |       | 22,397                                                   |       | 8,227                                                    |       | 47,837                                                  |       | 24,437                                                  |       |
| Other income                                                                                                                       |       | 147                                                      |       | 281                                                      |       | 599                                                     |       | 1,010                                                   |       |
| Total revenue, net of derivative financial  instruments and adjustments                                                            |       | 56,027                                                   |       | 21,160                                                   |       | 126,101                                                 |       | 64,541                                                  |       |
| **Expenses**                                                                                                                       |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Employee compensation and benefits                                                                                                 |       | 24,387                                                   |       | 12,752                                                   |       | 62,917                                                  |       | 38,994                                                  |       |
| Interest expense                                                                                                                   |       | 18,702                                                   |       | 4,420                                                    |       | 37,450                                                  |       | 12,414                                                  |       |
| Office and occupancy expense                                                                                                       |       | 1,219                                                    |       | 1,076                                                    |       | 3,269                                                   |       | 2,871                                                   |       |
| Provision for loan losses (bond collateral)                                                                                        |       | (64                                                      | )          | 80                                                       |       | 167                                                     |       | 208                                                     |       |
| (Gain) on sale of real estate owned                                                                                                |       | (10                                                      | )          | (86                                                      | )          | (1                                                      | )          | (406                                                    | )          |
| (Gain)/loss on bond collateral sold                                                                                                |       | —                                                   |       | (437                                                     | )          | (38                                                     | )          | 4,872                                                   |       |
| Professional fees                                                                                                                  |       | 2,755                                                    |       | 925                                                      |       | 5,789                                                   |       | 3,329                                                   |       |
| Other operating expenses                                                                                                           |       | 5,737                                                    |       | 4,098                                                    |       | 15,153                                                  |       | 13,038                                                  |       |
| Total expenses                                                                                                                     |       | 52,726                                                   |       | 22,828                                                   |       | 124,706                                                 |       | 75,320                                                  |       |
| Income (loss) before income taxes                                                                                                  |       | 3,301                                                    |       | (1,668                                                   | )          | 1,395                                                   |       | (10,779                                                 | )          |
| Income tax provision (benefit)                                                                                                     |       | 1,451                                                    |       | (683                                                     | )          | 610                                                     |       | (4,328                                                  | )          |
| Net income (loss)                                                                                                                  |       | $                                                        | 1,850      |                                                     | $          | (985                                                    | )          | $                                                       | 785        |   | $ | (6,451 | ) |
|                                                                                                                               |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Basic weighted average shares outstanding                                                                                          |       | 7,209,984                                                |       | 7,364,244                                                |       | 7,334,206                                               |       | 7,716,079                                               |       |
| Diluted weighted average shares outstanding                                                                                        |       | 8,136,250                                                |       | 7,364,244                                                |       | 8,260,472                                               |       | 7,716,079                                               |       |
|                                                                                                                               |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Net income (loss) per share-basic                                                                                                  |       | $                                                        | 0.26       |                                                     | $          | (0.13                                                   | )          | $                                                       | 0.11       |   | $ | (0.84 | ) |
|                                                                                                                               |       |                                                     |       |                                                     |       |                                                    |       |                                                    |       |
| Net income (loss) per share-diluted                                                                                                |       | $                                                        | 0.23       |                                                     | $          | (0.13                                                   | )          | $                                                       | 0.10       |   | $ | (0.84 | ) |

 

See accompanying notes to consolidated financial statements.

 

4

----

 

AmNet Mortgage, Inc. and Subsidiaries

Consolidated Statements of Cash Flows, unaudited

(in thousands)

 
| ** **                                                                     | ** ** | **For the Nine Months  Ended  September 30, 2005** | ** ** | **For the Nine Months  Ended  September 30, 2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                          |       |                                               |       |                                               |       |
| Net income (loss)                                                              |       | $                                                  | 785        |                                               | $          | (6,451 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:   |       |                                               |       |                                               |       |
| Loss on bond collateral sold                                                   |       | —                                             |       | 4,872                                              |       |
| Amortization of mortgage assets premiums                                       |       | 7                                                  |       | 995                                                |       |
| Amortization of capitalized costs                                              |       | —                                             |       | 474                                                |       |
| Amortization of deferred compensation                                          |       | 412                                                |       | —                                             |       |
| Provision for loan losses (bond collateral)                                    |       | 167                                                |       | 208                                                |       |
| Change in real estate owned provision for  losses upon sale (bond collateral)  |       | 34                                                 |       | 473                                                |       |
| Gain on sale of real estate owned, net                                         |       | (1                                                 | )          | (406                                               | )          |
| Proceeds from sale of mortgage loans held  for sale                            |       | 10,289,926                                         |       | 6,402,844                                          |       |
| Mortgage loan originations                                                     |       | (10,788,372                                        | )          | (6,520,430                                         | )          |
| Increase in restricted cash                                                    |       | (1,000                                             | )          | —                                             |       |
| Increase in accounts receivable—mortgage  loans sold/funded               |       | (14,202                                            | )          | (4,999                                             | )          |
| Increase in accounts receivable—derivatives                               |       | (230                                               | )          | —                                             |       |
| Increase in income tax refunds receivable                                      |       | —                                             |       | (3,488                                             | )          |
| Decrease in derivative financial  instruments, net                             |       | (235                                               | )          | (1,461                                             | )          |
| (Increase)/decrease in accrued interest  receivable                            |       | (914                                               | )          | 1,695                                              |       |
| Decrease in deferred taxes                                                     |       | 611                                                |       | 702                                                |       |
| Increase in other assets                                                       |       | (67                                                | )          | (661                                               | )          |
| Increase in accrued interest payable                                           |       | 1,138                                              |       | 183                                                |       |
| (Decrease)/increase in accounts  payable—derivative financial instruments |       | (37                                                | )          | 111                                                |       |
| Increase in loss reserve, mortgage loans  sold                                 |       | 1,219                                              |       | 1,365                                              |       |
| Increase/(decrease) in accrued commissions  and payroll                        |       | 4,035                                              |       | (707                                               | )          |
| Decrease in accrued expenses and other  liabilities                            |       | (671                                               | )          | (3,814                                             | )          |
| (Decrease)/increase in minority interest                                       |       | (3                                                 | )          | 32                                                 |       |
| Net cash used in operating activities                                          |       | (507,398                                           | )          | (128,463                                           | )          |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                          |       |                                               |       |                                               |       |
| Principal payments on bond collateral,  mortgage loans                         |       | 3,467                                              |       | 24,991                                             |       |
| Proceeds from sale of bond collateral                                          |       | —                                             |       | 111,150                                            |       |
| Proceeds from sale of real estate owned                                        |       | 209                                                |       | 1,771                                              |       |
| Net cash provided by investing activities                                      |       | 3,676                                              |       | 137,912                                            |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                          |       |                                               |       |                                               |       |
| Payments on long-term debt                                                     |       | (4,183                                             | )          | (29,410                                            | )          |
| Payments on long-term debt from sale of  bond collateral                       |       | —                                             |       | (85,491                                            | )          |
| Increase in net borrowings from short-term  debt                               |       | 478,715                                            |       | 112,172                                            |       |
| Stock options exercised                                                        |       | 253                                                |       | 158                                                |       |
| Purchase of treasury stock                                                     |       | —                                             |       | (5,145                                             | )          |
| Net cash provided by (used in) financing  activities                           |       | 474,785                                            |       | (7,716                                             | )          |
| Net (decrease)/ increase in cash and cash  equivalents                         |       | (28,937                                            | )          | 1,733                                              |       |
| Cash and cash equivalents at beginning of  year                                |       | 50,600                                             |       | 44,400                                             |       |
| Cash and cash equivalents at end of period                                     |       | $                                                  | 21,663     |                                               | $          | 46,133 |   |
| Supplemental information:                                                      |       |                                               |       |                                               |       |
| Interest paid                                                                  |       | $                                                  | 36,312     |                                               | $          | 12,232 |   |
| Taxes paid                                                                     |       | $                                                  | 820        |                                               | $          | 2,832 |   |

 

See accompanying notes to consolidated financial statements.

 

5

----

 

**AMNET MORTGAGE, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1.  Sale of AmNet Mortgage, Inc. toWachovia Bank**

 

The Company has entered into an Amended and Restated Agreement and Planof Merger dated as of September 13, 2005, with Wachovia Bank, NationalAssociation, a national banking association organized under the laws of theUnited States of America, and PTI, Inc., a Delaware corporation and whollyowned subsidiary of Wachovia, pursuant to which PTI will merge with and intothe Company, with the Company being the surviving corporation (the “merger”)and becoming a wholly owned subsidiary of Wachovia.  Any references to the “merger” or the “pendingmerger” in this report refer to the transaction contemplated by the mergeragreement.  In the merger, each issuedand outstanding share of the Company’s common stock, par value $0.01 per share,is to be canceled and converted automatically into the right to receive $10.30per share in cash.  The aggregate mergerconsideration (on a fully diluted basis) is approximately $83 million.  The merger remains subject to customaryclosing conditions, including approval of the merger by the Company’sstockholders.  Upon the unanimousrecommendation of a special committee comprised of non-employee directors, theboard of directors has unanimously approved the merger and recommended that theCompany’s stockholders approve it.  TheCompany expects to hold a special meeting of stockholders to vote on the mergerand the merger agreement in December 2005. In connection with the meeting, we issued a definitive proxy statementdated November 7, 2005 that has been filed with the Securities and ExchangeCommission.

 

**Note 2.  Summary of Significant Accounting Policiesand Practices**

 

*Basisof Financial Statement Presentation*

 

Theconsolidated financial statements include the accounts of AmNet Mortgage, Inc.,a Maryland corporation, American Mortgage Network, Inc., a Delawarecorporation and wholly-owned subsidiary of AmNet Mortgage, Inc., AmericanResidential Eagle, Inc., a Delaware special purpose corporation andwholly-owned subsidiary of AmNet Mortgage, Inc. and American ResidentialEagle 2, Inc., a Delaware limited purpose corporation andwholly-owned subsidiary of American Residential Eagle, Inc. Substantiallyall of the assets of American Residential Eagle, Inc. are pledged to supportlong-term debt in the form of a collateralized mortgage bond and is notavailable for the satisfaction of general claims of AmNet Mortgage, Inc. AmericanResidential Holdings, Inc. is an affiliate of AmNet Mortgage, Inc. that isconsolidated in accordance with FASB Interpretation No. 46R “Consolidationof Variable Interest Entities.” All entities are together referred to as the “Company”or “AmNet.” The Company’s exposure to loss on the assets pledged as collateralis limited to its net investment, as the collateralized mortgage bond isnon-recourse to the Company. All significant intercompany balances andtransactions have been eliminated in the consolidation of AmNet. Certainreclassifications have been made to prior period amounts to conform to thecurrent presentation.

 

Inmanagement’s opinion, all adjustments necessary for a fair statement arereflected in the interim period presented. These adjustments are of a normalrecurring nature. The interim financial data as of September 30, 2005 and September30, 2004 is unaudited; however, in the opinion of the Company, the interim dataincludes all adjustments, consisting only of normal recurring adjustments,necessary for a fair statement of the results for the interim periods.

 

Salesof mortgage loans are accounted for under Statement of Financial AccountingStandards (SFAS) No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.” Mortgage loans are soldwith the mortgage servicing rights released. Gains or losses on sales ofmortgage loans are recognized based on the difference between the sellingprices and the carrying value of the related mortgage loans sold. Deferredorigination fees and expenses are recognized at the time of sale.

 

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

 

6

----

 

*Stock Options and Restricted Stock*

 

TheCompany elected to apply APB Opinion No. 25, “Accounting for Stock Issuedto Employees,” in accounting for its stock-based compensation plans: the 2004Equity Incentive Plan and 1997 Employee Stock Purchase Plan. Accordingly, nocompensation cost has been recognized in the financial statements for stockoptions. Compensation in the form of restricted stock is recognized throughamortization of deferred compensation. SFAS No. 123 “Accounting for StockBased Compensation” requires pro forma disclosures of expense computed as ifthe fair value-based method had been applied in the financial statements ofcompanies that continue to account for such arrangements under OpinionNo. 25.

 

InDecember 2002, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 148, “Accounting For Stock Based Compensation Transition andDisclosure,” which amends SFAS No. 123. SFAS No. 148 requires moreprominent and frequent disclosures about the effects of stock-based compensation.The Company continues to account for its stock based compensation according tothe provisions of APB Opinion No. 25.

 

TheFASB amended SFAS No. 123, “Accounting for Stock-Based Compensation,”which supersedes APB Opinion No. 25, “Accounting for Stock Issued toEmployees” in December, 2004. The amendment requires the Company to recordcompensation expense for all share-based compensation beginning January 1,2006. When adopted, this standard will have a negative impact on earnings ofapproximately $47 thousand per month in future periods since stock optionsalready issued will vest in future periods and be expensed.

 

Duringthe nine month period ending September 30, 2005 the Company authorized theissuance of 92,684 shares of restricted stock to executives within the Companywhich will vest over a three year period beginning in February of 2005. TheCompany also authorized the issuance of 18,400 shares of restricted stock tooutside board members of the Company which vested August 12, 2005. An additional18,400 shares of restricted stock were authorized to be issued to outside boardmembers of the Company which will vest August 10, 2006.  The value of these restricted shares is beingexpensed over the vesting period.  OnMarch 31, 2005 the Company authorized 47,900 restricted stock units to elevensenior executives of the Company with 50% vesting on December 31, 2008 and 2009respectively.

 

Had compensation cost for the Company’s stock options been recognizedbased upon the estimated fair value on the grant date under the fair valuemethodology, the Company’s net income and net loss would have been as follows(in thousands except income per share) (unaudited):

 
| ** **                                                                                                                  | ** ** | **Three Months Ended**       | ** ** | **Nine Months Ended**        | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                  | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                                                                                                        |       |                         |       |                         |       |   |   |   |   |
| Net income as reported                                                                                                      |       | $                            | 1,850      |                         | $          | (985 | ) | $ | 785 |   | $ | (6,451 | ) |
| Deduct: Total stock-based compensation  expense determined under fair value-based method, net of tax effects (See  Note 11) |       | (145                         | )          | (341                         | )          | (1,438 | ) | (1,154 | ) |
| Pro forma net income (loss)                                                                                                 |       | $                            | 1,705      |                         | $          | (1,326 | ) | $ | (653 | ) | $ | (7,605 | ) |
| Income (loss) per share:                                                                                                    |       |                         |       |                         |       |   |   |   |   |
| Basic as reported                                                                                                           |       | $                            | 0.26       |                         | $          | (0.13 | ) | $ | 0.11 |   | $ | (0.84 | ) |
| Basic pro forma                                                                                                             |       | $                            | 0.24       |                         | $          | (0.18 | ) | $ | (0.09 | ) | $ | (0.99 | ) |
| Diluted as reported                                                                                                         |       | $                            | 0.23       |                         | $          | (0.13 | ) | $ | 0.10 |   | $ | (0.84 | ) |
| Diluted pro forma                                                                                                           |       | $                            | 0.21       |                         | $          | (0.18 | ) | $ | (0.09 | ) | $ | (0.99 | ) |

 

Theassumptions used to calculate the fair value of options granted are evaluatedand revised as necessary to reflect market conditions and the Company’sexperience. The volatility component of the calculation to establish stockoption value has been revised and is reflected in stock based compensationexpense for the three months and nine months ended September 30, 2005 and 2004.

 

7

----

 

**Note 3.  Income Per Share**

 

Thefollowing table illustrates the computation of basic and diluted income pershare (in thousands, except share and per share data) (unaudited):

 
| ** **                                                                                                               | ** ** | **For the Three  Months Ended  September 30,  2005** | ** ** | **For the Three  Months Ended  September 30,  2004** | ** ** | **For the Nine  Months Ended  September 30,  2005** | ** ** | **For the Nine  Months Ended  September 30,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Numerator:                                                                                                               |       |                                                      |       |                                                 |       |                                                     |       |                                                     |       |
| Numerator for basic income (loss) per share                                                                              |       | $                                                         | 1,850      |                                                 | $          | (985                                                     | )          | $                                                        | 785        |   | $ | (6,451 | ) |
| Denominator:                                                                                                             |       |                                                      |       |                                                 |       |                                                     |       |                                                     |       |
| Denominator for basic income (loss) per  share - weighted average number of common shares outstanding during the  period |       | 7,209,984                                                 |       | 7,364,244                                            |       | 7,334,206                                                |       | 7,716,079                                                |       |
| Denominator for diluted income (loss) per  share                                                                         |       | 8,136,250                                                 |       | 7,364,244                                            |       | 8,260,472                                                |       | 7,716,079                                                |       |
|                                                                                                                     |       |                                                      |       |                                                 |       |                                                     |       |                                                     |       |
| Income (loss) per share - basic                                                                                          |       | $                                                         | 0.26       |                                                 | $          | (0.13                                                    | )          | $                                                        | 0.11       |   | $ | (0.84 | ) |
| Income (loss) per share - diluted                                                                                        |       | $                                                         | 0.23       |                                                 | $          | (0.13                                                    | )          | $                                                        | 0.10       |   | $ | (0.84 | ) |

 

Forthe nine months ended September 30, 2005 and 2004 there were 1,064,869 and 1,132,729 options, respectively, that wereantidilutive and, therefore, not included in the calculations above.

 

**Note 4.  Concentrations**

 

Forthe nine months ending September 30, 2005, the Company sold the majority of itsloans (by volume) to three correspondent investors, Countrywide HomeLoans, Inc. (44.7%), Morgan Stanley Mortgage Capital Inc. (18.5%) andWells Fargo Funding, Inc. (12.5%). The Company’s considerations indeciding where to sell loans are price and operational efficiency.  The Company also considers speed of executionand loan product guidelines.  The Companybelieves that all of the loans it sells currently could be sold to a number ofother investors.

 

Inaddition, approximately 33% of the dollar value of loans generated were derivedfrom loans originated in California. While the Company generates loans on a nationwide basis, it isanticipated that the Company will continue to have a significant concentrationof loans originated from California.

 

**Note 5.  Mortgage Loans Held for Sale, net, pledged**

 

AmNet has pledged loans held for sale totaling approximately $736.8 million to secure credit lines(warehouse facilities) from fourfinancial institutions. (See Note 8. “Short-TermDebt.”). Mortgage loans held for sale at September 30, 2005 consist of loanswhich have been committed for sale of approximately$507.3 million and loans available for sale of approximately $229.5 million,all of which are carried at the lower of cost or market value.

 

**Note 6.  Bond Collateral, Mortgage Loans, net**

 

AmNethas pledged collateral in order to secure the long-term debt issued in the formof CMOs. Bond Collateral Mortgage Loans consist primarily of subprime credit,30-year mortgage loans secured by first liens on one-to-four family residentialproperties. As of September 30, 2005 and 2004,100% of the bond collateral mortgage loans are adjustable-ratemortgages. All Bond Collateral Mortgage Loans are pledged to secure repaymentof the related long-term debt obligation. All principal and interest (lessservicing and related fees) on the bond collateral is remitted to a trustee andis available for payment of the long-term debt obligation. The obligationsunder the long-term debt are payable solely from the bond collateral and areotherwise non-recourse to AmNet.

 

In March of 2004, approximately $113.9 million in Bond CollateralMortgage Loans and approximately $2.3 million in REO bond collateral werereclassified as held for sale.  BySeptember 30, 2004 all of these mortgage loans including real estateowned, had been sold.  One remainingportfolio (CMO/FASIT 1998-1) was not sold. Bond collateral for this structure is shown in the Consolidated BalanceSheets as Bond collateral, mortgage loans, net and Bond collateral, real estateowned, net.

 

8

----

 

**Note 7.  Derivative FinancialInstruments**

 

AmNetmakes commitments to fund mortgages at set interest rates, which are referredto as rate locked loan commitments. Additionally, most of the Company’s loansare not yet committed for sale at the time of funding. Collectively, ratelocked loan commitments and funded loans not yet committed for sale (closedloans) are the Company’s pipeline.  Thevalue of the pipeline will vary depending on changes in market interest ratesbetween the time that a rate locked loan commitment is made and the time thatthe loan funds and is committed for sale to an investor.

 

AmNetestimates the number of rate locked loan commitments in the pipeline that willnot close in order to calculate its interest rate exposure on a daily basis.AmNet then purchases hedging instruments in order to try to protect profitmargins on the pipeline. The hedging instruments typically used are forwardsales of mortgage-backed securities (“TBA”) and options on forward sales ofmortgage-backed securities. Historically, changes in the price of theseinstruments closely relate to changes in the value (price) of loans in thepipeline. The Company has elected not to apply hedge accounting for thederivative financial instruments.

 

AtSeptember 30, 2005 and December 31, 2004 AmNet had the following commitments tooriginate loans and loans not yet committed for sale to investors, andoffsetting hedge coverage; (dollars in thousands) (unaudited).  (Note that interest rate exposure does notdirectly correspond to the notional amounts of hedge coverage without applyingan option adjusted spread factor to the pipeline and hedges):

 
| ** **                                                                                      | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **Interest rate exposure:**                                                                     |       |                   |       |                  |       |
|                                                                                            |       |                   |       |                  |       |
| Commitments to originate loans at set  interest rates (after applying estimated fallout)        |       | $                      | 964,691    |                  | $          | 471,884 |   |
|                                                                                            |       |                   |       |                  |       |
| Funded loans not yet committed for sale to  investors (closed loans)                            |       | 229,492                |       | 138,250               |       |
|                                                                                            |       | 1,194,183              |       | 610,134               |       |
| **Hedge coverage:**                                                                             |       |                   |       |                  |       |
|                                                                                            |       |                   |       |                  |       |
| Forward sales of To Be Announced  mortgage-backed securities (“TBA”)(notional amount) |       | 959,000                |       | 511,000               |       |
|                                                                                            |       |                   |       |                  |       |
| Options on forward sales of mortgage-backed  securities (notional amount)                       |       | 155,000                |       | 100,000               |       |
|                                                                                            |       | 1,114,000              |       | 611,000               |       |
|                                                                                                 |            |                        |            |                       |            |  |  |

 

Thefair value of forward sales of mortgage-backed securities and options onforward sales of mortgage-backed securities are based on quoted market pricesfor these instruments. The rate locked loan commitments are also considered aderivative instrument and are assigned fair values based on the change in thequoted market value of the underlying loans due to market movements, less anestimated factor for loans that will not close (fallout ratio). The falloutratio is affected by the Company’s recent fallout history, interest ratechanges and loan characteristics.

 

Thefollowing is a summary of the carrying value of AmNet’s derivative instrumentsas of September 30, 2005 and December 31, 2004 (dollars in thousands)(unaudited):

 

| **September 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               |       | $                             | 2,000 -24,000 |           | $          | 691                           |       | Oct 18-Dec 15, 2005 |   |
| Thirty year Fannie Mae                                     |       | 4.5-6.0 MBS               |       | 500 -25,000                   |          | 2,833          |       | Oct 13-Dec 13, 2005           |       |
| Thirty year Ginnie Mae                                     |       | 5.0-5.5 MBS               |       | 500 - 5,000                   |          | 93             |       | Oct 20-Oct 21, 2005           |       |
| Forward commitments by investor                            |       | 5.5-5.75                  |       | 3,000 - 25,000                |          | 552            |       | Oct 21-Nov 30, 2005           |       |
| ***Options on TBAs:***                                     |       |                      |       |                          |          |           |       |                          |       |
| Thirty year Fannie Mae                                     |       | 5.5 Puts                  |       | 25,000 - 40,000               |          | 803            |       | Oct 6 – Nov 7, 2005      |       |
| ***Rate locked loan commitments***                         |       |                      |       |                          |          | (4,121         | )          |                          |       |
| ***Total derivative financial instruments***               |       |                      |       |                          |          | $              | 851        |                          |       |   |
|                                                            |            |                           |            |                               |               |                |            |                               |            |  |  |

 

9

----

 

| **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 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 summary of the components within Totalderivative financial instruments and market adjustments (expense) income(dollars in thousands) (unaudited):

 
| ** **                                                                       | ** ** | **For the Three  Months Ended  September 30,  2005** | ** ** | **For the Three  Months Ended  September 30,  2004** | ** ** | **For the Nine  Months Ended  September 30,  2005** | ** ** | **For the Nine  Months Ended  September 30,  2004** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Derivative financial instruments -  (expense) income:                            |       |                                                 |       |                                                 |       |                                                     |       |                                                     |       |
| Change in value of Options - open positions                                      |       | $                                                    | (326       | )                                                    | $          | (857                                                     | )          | $                                                        | (2,020     | ) | $ | (3,954 | ) |
| Options gain - closed positions                                                  |       | 73                                                   |       | —                                               |       | 333                                                      |       | 4,287                                                    |       |
| Change in value of TBAs - open positions                                         |       | 6,857                                                |       | 6,381                                                |       | 3,992                                                    |       | 2,150                                                    |       |
| Change in market adjustment on interest  rate locked loan commitments            |       | (6,197                                               | )          | (3,753                                               | )          | (4,558                                                   | )          | (520                                                     | )          |
| TBA gain/(loss) - closed positions                                               |       | 3,006                                                |       | (13,317                                              | )          | (1,060                                                   | )          | (4,906                                                   | )          |
|                                                                             |       |                                                 |       |                                                 |       |                                                     |       |                                                     |       |
| Total derivative financial instruments and  market adjustments (expense) income: |       | $                                                    | 3,413      |                                                 | $          | (11,546                                                  | )          | $                                                        | (3,313     | ) | $ | (2,943 | ) |

 

**Note 8.  Short-Term Debt**

 

Asof September 30, 2005, mortgage loans held for sale totaling $736.8 million were pledged as collateralfor warehouse facility borrowings of $711.0 millionunder four warehouse facilities. At September 30, 2005, the Company’s maximumborrowing capacity combined from these four financial institutions was $1.9 billion.  The table below shows the age of pledgedmortgage loans as of September 30, 2005 (in thousands) (unaudited):

 
| **Aging Range**    | ** ** | **Number of Loans** | ** ** | **Warehouse Line Usage** | ** ** | **% of Total** | ** ** |
|--------------------|------------|---------------------|------------|--------------------------|------------|----------------|------------|
| ** **         | ** ** | ** **          | ** ** | ** **               | ** ** | ** **     | ** ** |
| Less than 30  days |       | 3,288               |       | $                        | 665,122    |           | 93.6       | % |
| 30 to 60  days     |       | 51                  |       | 9,299                    |       | 1.3            | %          |
| 61 to 90  days     |       | 209                 |       | 32,395                   |       | 4.5            | %          |
| 91 to 120  days    |       | 33                  |       | 4,135                    |       | 0.6            | %          |
| Total              |       | 3,581               |       | $                        | 710,951    |           | 100.0      | % |

 

Ofthe $711.0 million of warehouse line usage at September 30, 2005, $234.9 million was funded through uncommittedwarehouse facilities.

 

Thewarehouse facilities mature on various dates in 2005 and 2006, and generallybear interest at one-month LIBOR plus spread. The weighted average borrowingrates were 5.02% and 3.08% for the three months ending September 30, 2005 and September30, 2004 respectively. The weighted-average borrowing rate was 4.60% for the ninemonths ending September 30, 2005 and 2.74% for the nine months ending September30, 2004. The weighted-average facility fee was .24% for the nine months endingSeptember 30, 2005 and .23% for the nine months ending September 30, 2004 onthe aggregate committed amount of the warehouse facilities. The warehousefacilities are repaid as principal payments on mortgage loans are received, oras the mortgage loans are sold. We are generally allowed to borrow from 96% to99% of the lesser of par or market value of the loans, and must comply withvarious lender covenants restricting, among other things, the absolute level ofleverage, minimum levels of cash reserves, profitability and stockholders’equity. We are also, in a certain instance, required to maintain a restrictedcash account with one of our warehouse lenders. During the nine months ending September30, 2005 we were required to add $675 thousand to our cash account as a resultof rising interest rates causing reduced values of warehouse line loans and$325 thousand due to a $100 million credit increase.  As of September 30, 2005 the Company was incompliance with warehouse line facility covenants. We believe we are in goodstanding with all of our warehouse lenders.

 

10

----

 

**Note 9.  Long-Term Debt Related to Securitizations,net**

 

Thecomponents of the long-term debt at September 30, 2005 and December 31,2004, along with selected other information are summarized below (dollars inthousands) (unaudited):

 
| **CMO/ FASIT 1998-1  Securitization** | ** ** | **September  30, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | ** **              | ** ** | ** **            | ** ** |
| Long-term  debt                       |       | $                       | 9,317      |                  | $          | 13,500 |   |
| ** **                            | ** ** | ** **              | ** ** | ** **            | ** ** |
| Weighted  average financing rates     |       | 4.65                    | %          | 3.46                  | %          |
|                                       |            |                         |            |                       |            |  |  |

 

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

 
| ** **                                            | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations as of  September 30, 2005** | ** ** | **Total**                  | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than 5  Years** | ** ** |
|                                                  |       |                       |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                                        |       | $                          | 9,317      |   | $ | 2,737 |   | $ | 4,882 |   | $ | 1,698 |   | $ | — |   |
|                                                       |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Note 10.  RecourseLiabilities Associated With Loan Sales**

 

Wesell loans to private investors and other financial institutions. Each loansale is subject to certain terms and conditions, which generally require us torepurchase loans or indemnify and hold the investor harmless against any lossarising from early payment default activity and errors and omissions in theorigination, processing and/or underwriting of the loans. We are subject tothis risk for loans that we originate as well as loans we acquire from brokers.At September 30, 2005 we had approximately $5.9 million and approximately $4.6million at December 31, 2004  recorded asestimates for losses that may occur as a result of the guarantees describedabove based on trends in repurchase and indemnification requests, actual lossexperience, known and inherent risks in the loans, and current economicconditions. The length of the indemnification period, which varies by investorand the nature of the potential defect, may extend to the life of the loan.

 

Undermost of our loan sale agreements, we are also obligated to refund premiums toinvestors if loans pay off within a certain number of days after the settlementof our loan sale. These refunds are referred to as early prepayment premiums or(“EPPs”). The EPP exposure period generally ranges up to 180 days afterthe settlement date. At September 30, 2005 and December 31, 2004, we hadapproximately $771 and $894 thousand, respectively, recorded as anestimated reserve for premium refunds that may occur as a result of loan saleswhich were still subject to EPP liability.

 

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

 
| ** **                     | ** ** | **Reserve For  Repurchase  Obligations and  Indemnifications** | ** ** | **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                       |       | (815                                                           | )          | (2,107                           | )          | (2,922    | )          |
| Provisions                     |       | 2,157                                                          |       | 1,984                            |       | 4,141     |       |
| Balance at  September 30, 2005 |       | $                                                              | 5,928      |                             | $          | 771       |       | $ | 6,699 |   |

 

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

 

As a result of the hurricanes (Rita and Katrina)affected area properties were re-inspected prior to loan closing. These stormshad no financial affect on the Company.

 

11

----

 

**Note 11.  StockPlans**

 

Asof September 30, 2005, shares of common stock were reserved for issuance underthe 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 |       | —                                  |       | 369,799                         |       | 1,899,496                                                            |       | 2,269,295 |       |
| Shares Reserved For Issuance at 9/30/05                                         |       | 20,000                                  |       | 230,705                         |       | —                                                               |       | 250,705   |       |

 

----

* The 1997 stock option plans continue until all options outstandingunder it are terminated or exercised. No new options will be granted.

 

Stock option activity during the nine months ending September 30, 2005was as follows (unaudited):

 
| ** **                         | ** ** | **Number of Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|------------------------------------|------------|-----------------------|------------|--------------------------------------|------------|
|                               |       |                  |       |                                 |       |
| Balance at  December 31, 2004 |       | 1,829,271             |       | $                                    | 8.12       |   |
| Granted                            |       | 265,300               |       | 10.29                                |       |
| Forfeited                          |       | (52,235               | )          | 7.56                                 |       |
| Exercised                          |       | (51,201               | )          | 4.41                                 |       |
| Balance at  September 30, 2005     |       | 1,991,135             |       | $                                    | 8.51       |   |

 

In the event that the merger is completed, the Company's stock planswill be cancelled. The approximate cost to Wachovia to purchase outstandingoptions will be $5.0 million. This amount is included in the approximate totalpurchase price of $83 million.

 

AtSeptember 30, 2005, the range of exercise prices for outstanding options was$1.75 to $15.00 and the weighted-average remaining contractual life ofoutstanding options was 5.71 years.The weighted average exercise price of exercisable outstanding options was $8.90. The table below shows options and prices for all outstanding options at September30, 2005 (unaudited):

 
| **Option Exercise Price Range** | ** ** | **Vested** | ** ** | **Unvested** | ** ** | **Number of  Options** | ** ** |
|---------------------------------|------------|------------|------------|--------------|------------|------------------------|------------|
|                            |       |       |       |         |       |                   |       |
| $1.75 to  $3.00                 |       | 135,984    |       | 19,965       |       | 155,949                |       |
| $3.01 to  $5.00                 |       | 294,863    |       | 124,673      |       | 419,536                |       |
| $5.01 to  $7.50                 |       | 317,136    |       | 32,064       |       | 349,200                |       |
| $7.51 to  $10.00                |       | 176,825    |       | 139,225      |       | 316,050                |       |
| $10.01 to  $12.50               |       | 489,153    |       | 5,147        |       | 494,300                |       |
| $12.51 to  $15.00               |       | 256,100    |       | —       |       | 256,100                |       |
|                            |       | 1,670,061  |       | 321,074      |       | 1,991,135              |       |

 

Theper share weighted-average fair value of stock options granted betweenJanuary 1, 2005 and September 30, 2005 is computed quarterly.  For the first quarter ending March 31,2005 the per share weighted-average fair value of stock options granted was$5.82. For the second quarter ending June 30, 2005 the value was $4.90. For the third quarter ending September 30, 2005 thevalue was $5.48. These values were calculated using the Black-Scholesoption-pricing model, using the following weighted-average assumptions(unaudited):

 
| ** **               | ** ** | **Three Months  Ending  September 30, 2005** | ** ** | **Three Months  Ending  June 30, 2005** | ** ** | **Three Months  Ending  March 31, 2005** | ** ** |
|--------------------------|------------|----------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| Expected  dividend yield |       | 0.00                                         | %          | 0.00                                    | %          | 0.00                                     | %          |
| Risk-free  interest rate |       | 4.18                                         | %          | 3.72                                    | %          | 4.18                                     | %          |
| Expected  volatility     |       | 60.25                                        | %          | 60.20                                   | %          | 60.87                                    | %          |
| Expected  life (years)   |       | 5                                            |       | 5                                       |       | 5                                        |       |

 

12

----

 

OnFebruary 7, 2005 the Company’s Compensation Committee authorized paymentsunder the Long-Term Incentive Cash Plan. However, the Committee determined thatit is in the best interests of the Company to pay half of each award value incash and half in restricted stock of the Company. Consequently, 92,684restricted shares of the Company’s stock were authorized to be issued to theexecutives of the Company with a three year vesting period. Issuance of therestricted stock was authorized in April 2005. The cost to the Company isapproximately $278 thousand per year for three years beginning in 2005. OnMarch 31, 2005 the Committee authorized 47,900 restricted stock units to elevensenior executives of the Company with 50% vesting on December 31, 2008 and 2009,respectively. On April 4, the Committee granted 18,400 restricted shares to theoutside members of the Board of Directors vested August 12, 2005. On August 10,2005 the Committee granted 18,400 restricted shares to the outside members ofthe Board of Directors vesting August 10, 2006. The result of these awards was$1.6 million of deferred compensation which was reduced during the nine monthsending September 30, 2005 to $1.2 million by monthly amortization and isincluded in the equity section of the Consolidated Balance Sheets.

 

**Note 12.  Income Taxes**

 

During1997, the Company elected to be taxed as a Real Estate Investment Trust (“REIT”)under the Internal Revenue Code of 1986, as amended. As a result of thiselection, the Company was not, with certain exceptions, taxed at the corporatelevel on the net income distributed to the Company’s stockholders. OnJuly 19, 2002, the stockholders of the Company approved two proposals thatallowed for the conversion of the Company from a REIT to a fully taxable entity.On February 7, 2003, the Company filed a notice with the Internal RevenueService of its decision to relinquish its REIT status, effectiveJanuary 1, 2003.

 

Asa result of the conversion to a fully taxable status, an income tax benefit andrelated deferred tax asset of $5.7 million was recorded in 2003. As of September30, 2005, our deferred tax asset is approximately $10.1 million whichreflects a change in the tax provision from December 31, 2004. The taxprovision was calculated based on an assumed income tax rate of 44% for 2005.

 

AtSeptember 30, 2005, in determining the possible future realization of deferredtax assets, management considered future taxable income from the followingsources: (a) reversal of taxable temporary differences, (b) futureoperations exclusive of reversing temporary differences, and (c) taxplanning strategies that, if necessary, would be implemented to acceleratetaxable income into years in which net operating losses might otherwise expire.

 

Asthe Company’s net income and its projections of net income vary over time, theexpected realizability of its deferred tax assets may change. If the Companydetermines that its ability to realize all of its deferred taxes is unlikely,the Company will set up certain valuation allowances against those assets,which would negatively affect its net income. However, currently, we expect tofully utilize our deferred tax assets.

 

**Note 13.  Commitments and Contingencies**

 

*Lease Commitments*

 

TheCompany rents certain premises and equipment under non-cancelable operatingleases expiring at various dates through the year 2011. Rental expense undersuch leases is included in office and occupancy expense, and other operatingexpenses. Lease costs totaled $3.1 million inthe nine months ending September 30, 2005 and $3.0 million in the ninemonths ending September 30, 2004. Future minimum lease payments under theseleases as of September 30, 2005, are as follows (dollars in thousands)(unaudited):

 
| **Year ending September 30:** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2006                          |       | $          | 3,241      |   |
| 2007                          |       | 2,511      |       |
| 2008                          |       | 1,822      |       |
| 2009                          |       | 1,193      |       |
| 2010                          |       | 363        |       |
| After  September 30, 2010     |       | 41         |       |
|                          |       | $          | 9,171      |   |

 

*Wachovia Merger – Termination Fee*

 

The pending merger agreement discussed in Note 1 provides that if themerger agreement is terminated under certain specific circumstances as setforth in the merger agreement, the Company will be liable to pay Wachovia anaggregate termination fee of up to $3.5 million.

 

13

----

 

ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

*The statements contained in this Form 10-Q thatare not purely historical are forward looking statements, including statementsregarding our expectations, hopes, beliefs, intentions, or strategies regardingthe future. Such statements use words such as “expect,” “will,” “may,” “anticipate,”“goal,” “intend,” “seek,” “believe,” “target,” “ “plan,” “strategy” andderivatives of such words. Forward looking statements in this report includethose statements regarding:*

 

•      *Our future results of operations and the factors thatcould impact our results;*

 

•      *The factors that may impact our future liquidity;*

 

•      *Our strategies;*

 

•      *Changes in the mortgage market and competitivefactors;*

 

•      *The estimates we use in preparing our financialstatements and the impact of accounting standards;*

 

•      *The risks that may impact our business.*

 

*These forward looking statements are based oninformation available to us on the date hereof, and we assume no obligation toupdate any such forward looking statements. It is important to note that ouractual results and timing of certain events could differ materially from thosein such forward looking statements.  Someof the most significant risks that we face that could harm our future operatingresults or prevent us from meeting our goals and objectives are the following:*

 

•      *We haveentered into an Amended and Restated Agreement and Plan of Merger with WachoviaBank, National Association and a wholly owned merger subsidiary of Wachovia,pursuant to which the merger subsidiary will merge with**and**into AmNet and AmNet will be the surviving corporation and become awholly owned subsidiary of Wachovia. Completion of the merger is expected to occur no later than the firstquarter of 2006; however, there can be no assurance that the merger will becompleted.*

 

•      *We aremaximizing the utilization of our existing infrastructure while managing ourstaffing levels and growing our sales presence in**existing and new markets.Our strategy requires us to capture an increasing percentage of the market in ahighly competitive environment, which will put pressure on our gross margins.If we are not able to do this, we would likely experience losses (due to ourincreased level of expenses or lower gross margins).*

 

*•**     **Our market share increases are dependent on retaining andexpanding our sales force and broker customer base, which is more challengingin a highly competitive market environment. In particular we must remaincompetitive relative to our pricing of loans, which could cause us to lower ourgross margins.*

 

*•**     **We sell a substantial portion of our loans to two of ourcompetitors.  If these competitors stoppurchasing our loans on favorable terms, we could be required to find alternatepurchasers and/or accept unfavorable terms. In either case, this could reduce our revenues and earnings.*

 

*•**     **In 2004 we began offering subprime loans to wholesalebrokers, and we intend to increase our proportion of subprime loanssignificantly by hiring additional account executives to call on mortgagebrokers who specialize in subprime loans. While we have a centralizedunderwriting and funding center to process these loans and have hiredexperienced personnel, subprime loans are more complex and any errors we makein underwriting or funding these loans could cause loans to be un-saleable orto 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 our warehouse lending facilities tooperate our business.  We must maintain,renew or replace our warehouse lines of credit in order to continue to fundloans.  We believe we are in goodstanding with our warehouse lenders, however, any future reductions orrestrictions in our warehouse capacity would reduce the volume of loans that wecould fund and would therefore reduce our revenues and earnings.*

 

*•**     **A significant source of revenue is derived from the netinterest spread we earn on loans held for sale and financed with short termwarehouse lending facilities. Continued flattening of the interest rate yieldcurve (decreased difference between long term interest rates and short terminterest rates)  has reduced net interestrate spread significantly over the*

 

14

----

 

*past year. Further flattening and potential inversion of the yield curve couldsignificantly impact this revenue source and jeopardize our ability to sustainprofitability.*

 

*•**     **A large portion of the loans we fund are concentrated inCalifornia and therefore our results are subject to adverse economic conditionsin California.*

 

*•**     **Our hedging strategies may not be successful in mitigatingrisks associated with interest rate changes. In particular, for new loan products with shorter terms and loanproducts with adjustable rates, hedging strategies may not be effective atcertain times.*

 

*Other factors that may impact our results, includebut are not limited to, general economic conditions, the world politicalclimate, unexpected expense increases, overall interest rates, volatility ininterest rates, the shape of the yield curve, changes in accounting rules ortheir application, changes in the margins for gains on sale of originatedloans, changes in the demand of mortgage brokers for our loan products andservices or of loan purchasers for originated loans, undetected fraud on thepart of borrowers, brokers, appraisers or our employees, changes in themortgage industry regulatory environment, increases in prepayment 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.”*

 

**Introduction**

 

OurCompany was founded in 1997 as an externally managed Real Estate InvestmentTrust. Until 2001, substantially all of our operations consisted of theacquisition of residential mortgages for investment purposes. In mid-2001, ourBoard of Directors and management determined that it was in the best interestof the stockholders to fundamentally shift our strategic direction to mortgagebanking. We started the transition in 2001 by forming a subsidiary, AmericanMortgage Network, Inc., to engage in the wholesale lending segment of themortgage banking industry. In January of 2003 we elected to relinquish our REITstatus with the Internal Revenue Service (previously approved by ourstockholders). In order to more closely align our name with our mortgagebanking focus, we changed our name from American Residential InvestmentTrust, Inc. to AmNet Mortgage, Inc., as of May 5, 2004. On September 29,2004 our Company’s stock began trading on the NASDAQ National Market Systemunder the trading symbol AMNT. Previously we were listed on the American StockExchange under the trading symbol INV and prior to that we were listed on theNYSE.

 

InMarch of 2004, we began providing loan programs tailored to subprime borrowerswith credit that does not meet conventional guidelines or who requirenon-conventional loan terms with respect to loan-to-value, debt ratio, cash-outor documentation. We offer subprime loans through several different loanprograms. However, our Company policy is not to provide high cost loans whichare defined as mortgage loans that feature either an interest rate or pointsand fees charged in connection with loans that exceed certain thresholdsprescribed by federal or state law or local ordinances. Subprime lendingprovides loan solutions for borrowers with credit problems who would notqualify for other lending products we offer. The unit cost to originate theseloans is higher due to more labor intensive underwriting and funding processes,higher sales commission rates and a higher percentage of loan applications thatare not approved or funded. As a result of higher credit risk and cost, we mustcharge higher interest rates for assuming this risk. To help mitigate theadditional risks while our systems and processes are being refined,underwriting for these loans is performed at our centralized subprimeoperations center located in our San Diego headquarters office as opposed tothe regional underwriting and funding we utilize for all other wholesale loanproducts we offer. Our long-term strategy is to grow this segment of ourbusiness to up to 20 percent of our total loan funding volume. Our subprimevolume was 2.3 percent of total loan volume funded in the first nine months of2005 and is expected to reach four percent of total loan volume by the end of2005. We have hired seasoned staff to augment our expertise in this area oflending. We also have negotiated with investors to buy the loans we generateand amended our agreements with existing warehouse lenders to finance theseloans.

 

Inthe second half of 2004 we made a strategic decision to create a correspondentlending channel. We began originating loans through this channel in the firstquarter of 2005. Progress in building loan volume was slower than projectedwith a resulting increased investment required to attain profitability. Profitmargins being very thin in this type of lending, the lack of volume increasemeant a protracted time of unprofitability. During the third quarter of 2005 thedecision was made to close our Correspondent lending channel.

 

Weoriginate mortgage loans predominately to prime quality borrowers (except oursubprime division) secured by first trust deeds through a network ofindependent mortgage brokers. A concentration of our business is in California(33% of loans [by volume] originated in the nine months ending September 30,2005); however, we do business on a nationwide basis. We sell the loans that weoriginate to institutional purchasers on a servicing-released basis.

 

Weuse a dedicated sales force to offer our loan products to approved wholesalemortgage brokers, who refer their clients’ loans to us for underwriting andfunding. Loans meeting our underwriting criteria are generally approved andfunded at our regional underwriting loan centers. Our headquarters officeperforms various functions through multiple departments including establishment

 

15

----

 

of policy, risk management, secondarymarketing, loan delivery to investors, finance, accounting, administration,marketing, human resources, and information technology.

 

The Company has entered into an Amended and Restated Agreement and Planof Merger dated as of September 13, 2005, with Wachovia Bank, NationalAssociation, a national banking association organized under the laws of theUnited States of America, and PTI, Inc., a Delaware corporation and whollyowned subsidiary of Wachovia, pursuant to which PTI will merge with and intothe Company, with the Company being the surviving corporation (the “merger”)and becoming a wholly owned subsidiary of Wachovia.  Any references to the “merger” or the “pendingmerger” in this report refer to the transaction contemplated by the mergeragreement.  In the merger, each issuedand outstanding share of the Company’s common stock, par value $0.01 per share,is to be canceled and converted automatically into the right to receive $10.30per share in cash.  The aggregate mergerconsideration (on a fully diluted basis) is approximately $83 million.  The merger remains subject to customaryclosing conditions, including approval of the merger by the Company’sstockholders.  Upon the unanimousrecommendation of a special committee comprised of non-employee directors, theboard of directors has unanimously approved the merger and recommended that theCompany’s stockholders approve it.  TheCompany expects to hold a special meeting of stockholders to vote on the mergerand the merger agreement in December 2005. In connection with the meeting, we issued a definitive proxy statementdated November 7, 2005 that has been filed with the Securities and ExchangeCommission.

 

At September  30,2005, we are operational in thirty office locations which represents a netreduction of two offices from December 31, 2004. We had a total of 956employees at September 30, 2005 which is an increase of 197 employees fromDecember 31, 2004.

 

Weborrow funds under our warehouse credit facilities to fund and accumulate loansprior to sale to correspondent investors on a servicing-released basis. As of September30, 2005 we had four warehouse facilities that enabled us to borrow up to anaggregate of $2.2 billion. We are generally allowed to borrow from 96% to99% of the lesser of par or market value of the loans, and must comply withvarious lender covenants requiring, among other things, minimum levels of cashreserves, certain levels of profitability and restricted leverage ratios.  See Part II Item 5(a), regarding a newwarehouse facility.

 

Wegenerate revenue, net of hedging and market adjustments in our mortgage bankingbusiness in three principal ways (gain on loan sales net of hedging and marketadjustments, and interest income):

 

•              *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 institutionalpurchasers on a servicing-released basis for cash. We record the differencebetween the sale price of loans that we have sold and our cost to originate theloans sold as gain on loan sales. We recognize revenue at the time that wecomplete the loan sale, which is generally when we receive loan sale proceedsfrom the purchaser.  Gain on loan salesalso includes fees we charge for loan origination such as underwriting fees,loan document preparation fees and wiring fees, net of premiums we pay tobrokers.

 

•              *Hedging and market adjustments.* Hedging instruments are used to help mitigate exposure to interestrate fluctuations and protect our pricing margins. The gains or losses fromthis activity will be highly negatively correlated to revenue derived from loansales. Typically higher than expected gains from the sale of loans will beoffset by hedging losses and market adjustments, while lower than expectedgains from the sale of loans will be offset by hedging gains. The value of ourrate lock loan commitments are measured at the end of each accounting period.The change from the prior period is recorded as a market adjustment. Hedginggains or losses and market adjustments are included in the consolidatedstatements of operations and comprehensive income as derivative financialinstruments 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 $11.1 million are pledged to secure long term debt totalingapproximately $9.3 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 September 30, 2005, our bond collateral assets were carried on ourbalance sheet at approximately

 

16

----

 

$1.8million 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.

 

Theexpenses of our business include variable costs such as commissions, loanexpenses and contract labor, as well as fixed overhead expenses such aspersonnel, rent, supplies and utilities.

 

Due to the immateriality of our mortgage asset portfolio business, wediscontinued business segment reporting as of January 1, 2005.  As such, we began presenting management’sdiscussion and analysis of financial condition and our results of operations ona consolidated basis beginning, the three months ended March 31, 2005.

 

***Our 3rd Quarter 2005 Highlights (Executive Overview)***

 

Ourconsolidated operating results for the third quarter of 2005 were dominated bythe following:

 

•      We funded approximately $4.5 billion inloan volume for the period while fundings for the same period in 2004 were $2.1billion.  This represents an increase ofapproximately 119% while the overall mortgage market increased fromapproximately $646 billion for the quarter ending September 30, 2004 toapproximately $775 billion for the quarter ending September 30, 2005 (anincrease of approximately 20%), according to the Mortgage Bankers Association (“MBA”)Mortgage Finance Forecast dated October 26, 2005. For all of 2005, the MBA isprojecting $2.8 trillion in residential mortgage lending which approximatelyequals 2004. Key reasons for our loan production increase are: a sales forceincrease (267 account executives at September 30, 2005 compared to 145 accountexecutives at September 30, 2004), a maturing of our branch network resultingin better market penetration and a broader range of loan products offered bythe Company. The graph below shows monthly loan production comparisons betweenthe third quarters of 2005 and 2004.

 

2005 & 2004 Loan Fundings by Month -Second Quarter

 

 

| ** **                                  | ** ** | **(in millions)** | ** ** |
|---------------------------------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **2005**          | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | ** **        | ** ** | ** ** | ** ** |
| July                                        |       | $                 | 1,500      |   | $ | 623 |   |
| August                                      |       | 1,629             |       | 741 |   |
| September                                   |       | 1,417             |       | 711 |   |
| Totals –  Quarters ending September 30 |       | $                 | 4,546      |   | $ | 2,075 |   |

 

17

----

 

•              Total revenue was $56.0 million whichrepresented a 165% increase from the quarter ending September 30, 2004. Netinterest income (interest income less interest expense) decreased for thequarter ending September 30, 2005 versus the quarter ending for the same periodin 2004. Net interest income in the third quarter of 2005 was $3.7 million(interest income of $22.4 million less interest expense of $18.7 million). Netinterest income in third quarter of 2004 was $3.8 million (interest income of$8.2 million less interest expense of $4.4 million).

 

•              Total revenue inclusive of the benefits ofrevenue timing differences, was sufficient to cover variable and fixed expensestotaling $52.7 million resulting in pretax income of $3.3 million.  We had favorable impacts from timingdifferences, as more fully described below in the section entitled “InterestRate Risk Management and the Relationship Between Our Hedging Instruments and theMarket Adjustments and Gain on Sale that We May Record for a Period”.

 

•              Employee compensation and benefitsincreased by $11.6 million in the 3rd quarter of 2005 compared to the same periodin 2004.  Approximately $5.5 million ofthis increase was directly the result of higher commissions on incremental loanfunding volume.  Another $2.4 million isassociated with an overall higher commission rate driven by higher commissionguaranty payments and a change in the commission rates on some products.  The balance of the increase in compensationtotaled $3.7 million and was associated with increases in staffing to handlelarger loan funding levels and a higher proportion of loans requiring complexunderwriting.  These higher overheadexpenses have served to significantly reduce the positive impact of loanfunding volume growth, and the company is attempting to implement technologyenhancements which would improve efficiencies. However these process improvements are not expected to benefit theCompany's cost structure until late 2006.

 

•              Professional feestotaled approximately $2.8 million for the third quarter of 2005 while for thesame period in 2004 professional fees totaled approximately $0.9 million. Themajority of this increase relate directly to the cost of the merger.  The merger-related fees are comprisedprimarily of legal and accounting services, and other related transactioncosts.  These expenses are expected tocontinue until the merger is completed. The total amount of these merger-related fees are not determinable atthis time.  We also had higher contract laborexpenses due to higher loan production levels.

 

•              Correspondentlending activity was discontinued during the quarter. The financial impact wasless than $50 thousand of expense for employee severance costs and subleasingoffice space.

 

•              Total expensesincreased 6 basis points largely due to increased interest rates and theresulting increase in interest expense. Total expense dollars also increased asa result of increased commission costs related to loan volume increases andpayment guarantees for new account executives.

 

**•**              Net interestincome (interest income less interest expense) decreased largely as a result ofthe flattening of the yield curve (the difference between long term interestrates and short term interest rates has been decreasing).

 

•              Unrestricted cash and cash equivalentsdecreased by $6.9 million during the third quarter of 2005 from $28.6 millionat June 30, 2005, to $21.7 million at September 30, 2005. The key factors in the cash decrease were additionalcash invested in higher loan inventories and related loan sale receivablesrelated to loan production increases.

 

•              Our mortgage asset portfolio receivedapproximately $0.7 million in principal and REO sale proceeds. The Companyreduced related long term debt by approximately $0.7 million.

 

**CriticalAccounting Policies**

 

Thefollowing analysis of financial condition and results of operations are basedupon our consolidated financial statements and the notes thereto, which havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (“GAAP”). The preparation of these consolidatedfinancial statements requires us to make a number of estimates and assumptionsthat affect the reported amounts and disclosures in the consolidated financialstatements. On an ongoing basis, we evaluate our estimates and assumptionsbased upon historical experience and various other factors and circumstances.We believe that our estimates and assumptions are reasonable in thecircumstances; however, actual results may differ significantly from theseestimates and assumptions, which could have a material impact on the carryingvalue of assets and liabilities at the balance sheet dates and our results ofoperations for the reporting periods.

 

We believe that estimates and assumptions are important factors in theportrayal of our financial condition and results of operations. Our criticalaccounting policies that require management’s most subjective judgments includethe following:

 

•      Derivative hedging activities / determinationof fair values

•      Fair value of mortgage loans held for sale

•      Income taxes and benefits

•      Recourse liabilities associated with loansales

 

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

 

18

----

 

**Management’sFinancial Analysis**

 

We present non-GAAP financial measures inthis report. We believe that these measures are helpful in understanding ourbusiness and operating results. You should not consider our non-GAAP financialmeasures as a replacement for any GAAP financial measures. The non-GAAPfinancial measures that we present are as follows:

 

*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, we incorporate a target grossmargin percentage that we expect to obtain. We then provide rate lock commitments to borrowers based on that pricingand the related target gross margin percentage. However, if market interest rates increase between the time we make arate lock commitment and commit a loan for sale, then the market value of theloan would be reduced and we would not achieve our target marginpercentage.  If interest rates decrease,then the opposite would be true. Accordingly, we acquire derivative financialinstruments to hedge, or protect our target margins from interest rateincreases.  We hedge our loans from thetime of a rate lock commitment to the time the loan is committed for sale to aninvestor.

 

If our hedging is effective, as the value of our pipeline decreases andwe record a lower gain on sale, our hedge instruments increase in value tooffset the reduced gain.  Alternatively,as the value of our pipeline increases, we record a larger gain on sale but thelarger gain is offset by a loss on our hedges. Accordingly, if we successfully hedge our pipeline, the gross marginpercentage that we ultimately earn will be close to our target gross margin percentageand we will not be significantly 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 weincur interest expense on the borrowings used to finance our loan fundings andbond collateral.

 

Becausethe interest income and interest expense of our business are closely relatedand dependant on many of the same factors, in particular the volume of loans weoriginate, management believes that it is helpful in understanding ouroperations to analyze the impact of interest income on mortgage loans held for saleand related short term debt expense together. For this reason, the discussionbelow provides information regarding the net interest income (interest incomeless interest expense). Management believes that this is consistent with howfinancial analysts typically consider interest in analyzing mortgage bankingoperations.

 

*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 anestimated breakdown between variable and fixed amounts for each category of ouroperating expenses. Management believes that this will enable a betterunderstanding of our results and the likely impact of future changes in ourorigination 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**

 

Ourmortgage banking business is subject to the risk of changing interest ratesbetween the time we commit to extend credit at a set interest rate (rate lock)and the time we commit the mortgage loans for sale. Our pipeline consists ofloans for which we have provided a rate lock but which we have not yet closed(rate locked loan commitments) and closed loans that have not yet beencommitted for sale (closed loans). Generally, as market interest rates rise,our pipeline, which then has lower interest rates than the prevailing market,is not as attractive to investors and therefore we lose value in the pipeline.Conversely, as market interest rates fall, our pipeline is more attractive toinvestors and we gain value in the pipeline. However, some of this gain invalue may be offset by an increase in the fallout of our rate locked loans asborrowers choose not to fund their loan with us and seek alternative loans withthe 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

 

19

----

 

commitments and losses or gains that werecord on sales of our closed loans. Typically, higher than expected marketadjustments and gains from the sale of loans will be offset by hedging losses,while lower than expected market adjustments and gains from the sale of loanswill be offset by hedging gains. However, the correlated gains and losses arenot always recorded in the same accounting period because of timingdifferences.

 

Utilizingpast loan fallout history, we estimate the percentage of our rate lock loancommitments that will close, but these projections are difficult, especiallyduring periods of volatile interest rates. We hedge (or protect) our loan salemargin in the pipeline using forward sales of mortgage-backed securities (“TBA’s”),options on mortgage-backed securities (“MBS”) and similar agreements.

 

Wegenerally adjust our hedge coverage on a daily basis based upon changes in thesize and composition of the pipeline and resultant changes to our estimatedpipeline exposure, seeking to protect our loan sale margin targets. SinceAugust of 2002, we have used an outside company, Mortgage CapitalManagement, Inc. (“MCM”), to help us manage our interest rate risks. MCMis a quantitative software and advisory service firm that currently serves anumber of clients in the mortgage banking industry. MCM performs pipelineexposure analysis and provides hedging recommendations on a daily basis. Ourloan pipeline at September 30, 2005 was approximately $1.6 billion, at December31, 2004 our pipeline was approximately $0.8 billion and at September 30, 2004our pipeline was approximately $0.9 billion. We believe our hedges havecorrelated to both increases and decreases in the value of our rate lockedloans and uncommitted closed loans. In the future, as our loan products changeand our subprime channel increases production, our hedging strategies, falloutassumptions and hedging instruments may change to better mitigate the risk ofinterest rate changes.

 

Theaggregate gains or losses that we ultimately recognize on our rate locked loans,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 change in the value of our rate lockedloan commitments, from the expected value of the loan at the time the rate lockcommitment was made to the end of the period is measured at the end of eachaccounting period, and is recorded as a market adjustment. Both increases anddecreases in value are recorded at the end of a period. These changes arerecorded as a “market adjustment on interest rate lock commitments” in ourStatement of Operations.

 

•      **Closed loans.**  We do not recognize any increase in the fairvalue in our closed loan inventory until a true sale has taken place, nor do werecognize a decline in the fair value of our loans if that decline is not morethan our expected gain on sale profit margin on the loan.   However, if the cost basis of the loan ismore than could be obtained by sale in the marketplace, a market adjustment isrecorded (referred to as the lower of cost or market, or “LOCOM”). Accordingly,decreases in the fair value as of the end of the period are not recorded in thecurrent period unless the fair value of our closed loans fall below our costbasis.  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 hedging instruments (forward sales ofmortgage backed securities and options on forward sales of mortgage backedsecurities) are marked to market at the end of each period and both increasesand decreases in value are recorded. These changes in value are recorded as “derivativefinancial instruments” in our Statement of Operations.

 

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 increasein the fair value of our closed loans. But this increase is not recognized inour operating income until the loan sales have settled.  As aresult of revenue recognition differences between our hedges and our closedloans, we may recognize a hedge loss in one quarter and not recognize thecorresponding increase in the fair value 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 our loans is not below our carrying value, we willrealize the reduced profit margin on our loans in the subsequent period whenthe loans are sold.

 

20

----

 

Dependingon the movement in interest rates and the hedge ratios in place, this timingdifference may have a positive or negative impact on the Company’s reportedresults of operations with a positive impact at quarter end resulting in anegative impact in the subsequent quarter [and vice versa]. The net impact ofthese timing differences is shown in the table below (positive numbers indicatean increase in fair value loans held for sale while negative numbers representthe opposite):

 
| **Period**        | ** ** | **Estimated Current  Period  Unrecognized  Timing Difference** | ** ** | **Reverse Prior  Period Estimated  Unrecognized  Timing  Difference** | ** ** | **Estimated Net  Change In Fair  Value Of Loans  Held For Sale** | ** ** |
|-------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| 4th  Quarter 2003 |       | $                                                              | 1,733,639  |                                                                  | $          | —                                                           |       | $ | — |   |
| 1st Quarter  2004 |       | 1,024,363                                                      |       | (1,733,639                                                            | )          | (709,276                                                         | )          |
| 2nd  Quarter 2004 |       | 2,244,147                                                      |       | (1,024,363                                                            | )          | 1,219,784                                                        |       |
| 3rd  Quarter 2004 |       | 2,271,162                                                      |       | (2,244,147                                                            | )          | 27,015                                                           |       |
| 4th  Quarter 2004 |       | 312,175                                                        |       | (2,271,162                                                            | )          | (1,958,987                                                       | )          |
| 1st  Quarter 2005 |       | (1,800,000                                                     | )          | (312,175                                                              | )          | (2,112,175                                                       | )          |
| 2nd  Quarter 2005 |       | 2,286,076                                                      |       | 1,800,000                                                             |       | 4,086,076                                                        |       |
| 3rd  Quarter 2005 |       | (274,730                                                       | )          | (2,286,076                                                            | )          | (2,560,806                                                       | )          |
|                   |            |                                                                |            |                                                                       |            |                                                                  |            |  |  |  |

 

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”*.

 

**Resultsof Operations**

 

***Three Month Results***

 

Werecorded net income of $1.9 million for the three-month period ending September30, 2005 as compared to a net loss of $985 thousand in 2004 for the sameperiod.  Our loan production increased 119.0%for the quarter ending September 30, 2005 over the quarter ending September 30,2004.  Higher loan production andinproved margins drove a total revenue increase of 163.9% from $21.2 million to$56.0 million for the quarter ended September 30, 2005 as compared to the sameperiod in 2004.  Our expenses increased 130.8%from $22.8 million for the three months ended September 30, 2004 to $52.7million for the same period in 2005. The surge in volume period over perioddirectly relates to a 50.8% increase in account executives and loan programswhich provide alternatives to traditional fixed rate programs in a risinginterest rate environment. Increased expenses directly relate to volumeincreases especially in commission and compensation. The professionalfee expense increase for the three-month period ending September 30, 2005compared to the same period ending September 30, 2004, relates primarily thelegal and accounting fees incurred in connection with the pending merger. Discontinuation of our correspondentdivision resulted in an expense of less than $50 thousand.

 

Timingdifferences described above favorably impacted our revenues in the thirdquarter of 2005 (fully described above in the section entitled “Interest RateRisk Management and the Relationship Between our Hedging Instruments and themarket adjustments and gain on Sale That we may Record for a Period”).

 
| ** **           | ** ** | **($ amounts in 000’s) (unaudited)** | ** **    | ** **                                 | ** ** |
|----------------------|------------|------------------------------------------------|---------------|--------------------------------------------|------------|
| ** **           | ** ** | **Three Months Ended  September 30, 2005**     | ** **    | **Three Months Ended  September 30, 2004** | ** ** | **2005 Increase (Decrease)** | ** ** |
| ** **           | ** ** | ** **                                     | ** **    | ** **                                 | ** ** | ** ** | ** ** |
| **Loans  sold, net** | ** ** | **$**                                          | **4,156,739** | ** **                                 | **$**      | **2,147,372** | ** ** | **$** | **2,009,367** | ** ** |
|                      |            |                                                |               |                                            |            |  |  |  |  |  |

 

21

----

 
| ** **                                                                                                            | ** ** | **Amount of  Income  (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Amount of  Income  (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Increase  (Decrease)  Amount** | ** ** | **Increase  (Decrease)  Basis Points  (Loans Sold)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|----------------------------------|------------|--------------------------------|------------|----------------------------------|------------|------------------------------------------------------|------------|
|                                                                                                                  |       |                             |       |                           |       |                             |       |                           |       |                             |       |                                                 |       |
| Revenues:                                                                                                             |       |                             |       |                           |       |                             |       |                           |       |                             |       |                                                 |       |
| Premiums                                                                                                              |       | $                                | 71,663     |                           | 172.40     |                             | $          | 50,327                         |       | 234.37                           |       | $                                                    | 21,335     |   | (61.97 | ) |
| Broker fees                                                                                                           |       | 10,804                           |       | 25.99                          |       | 5,335                            |       | 24.85                          |       | 5,469                            |       | 1.14                                                 |       |
| Mortgage broker premiums                                                                                              |       | (46,318                          | )          | (111.43                        | )          | (27,265                          | )          | (126.97                        | )          | (19,054                          | )          | 15.54                                                |       |
| Premium recapture and loan loss provisions                                                                            |       | (2,017                           | )          | (4.85                          | )          | (1,420                           | )          | (6.61                          | )          | (597                             | )          | 1.76                                                 |       |
| Deferred origination costs                                                                                            |       | (4,062                           | )          | (9.77                          | )          | (2,779                           | )          | (12.94                         | )          | (1,281                           | )          | 3.17                                                 |       |
| **Gain on sales of loans**                                                                                            | ** ** | **$**                            | **30,070** | ** **                     | **72.34**  | ** **                       | **$**      | **24,198**                     | ** ** | **112.70**                       | ** ** | **$**                                                | **5,872**  | ** ** | **(40.36** | **)** |
| Derivative financial instruments and market  adjustments                                                              |       | 3,413                            |       | 8.21                           |       | (11,546                          | )          | (53.77                         | )          | 14,959                           |       | 61.98                                                |       |
| **Gain on sales of loans, after derivative  financial instruments and market adjustments (“gross margin”)** | ** ** | **$**                            | **33,483** | ** **                     | **80.55**  | ** **                       | **$**      | **12,652**                     | ** ** | **58.93**                        | ** ** | **$**                                                | **20,831** | ** ** | **21.62** | ** ** |
| Interest on mortgage loans held for sale                                                                              |       | 22,152                           |       | 53.29                          |       | 8,200                            |       | 38.19                          |       | 13,952                           |       | 15.10                                                |       |
| Interest on bond collateral                                                                                           |       | 245                              |       | 0.59                           |       | 27                               |       | 0.12                           |       | 218                              |       | .47                                                  |       |
| **Total interest income**                                                                                             | ** ** | **22,397**                       | ** ** | **53.88**                      | ** ** | **8,227**                        | ** ** | **38.31**                      | ** ** | **14,170**                       | ** ** | **15.57**                                            | ** ** |
| Other income                                                                                                          |       | 147                              |       | 0.35                           |       | 281                              |       | 1.31                           |       | (134                             | )          | (0.96                                                | )          |
| **Total revenue**                                                                                                     | ** ** | **$**                            | **56,027** | ** **                     | **134.78** | ** **                       | **$**      | **21,160**                     | ** ** | **98.55**                        | ** ** | **$**                                                | **34,867** | ** ** | **36.23** | ** ** |

 

Theoverall mortgage loan market in 2005 is expected to reach $2.8 trillion whichwill match the $2.8 trillion in 2004 according to the MBA forecasts dated October26, 2005. While the overall market is anticipated to equal 2004, 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 third quarter of2005, we increased loan production 26.1%, from $3.7 billion in the quarterending June 30, 2005, to $4.5 billion for the quarter ending September 30,2005.

 

Gross margin increased (in dollar terms) for the quarter ended September30, 2005 over the quarter ended September 30, 2004 due to a higher volume ofloans sold and origination of more profitable loans.  Note that increasing interest rates for thequarter ended September 30, 2005 increased the gain on derivative financialinstruments and market adjustments and increased the gain on sale margins. Forthe quarter ended September 30, 2004 decreasing interest rates during thequarter conversely decreased the value of derivative financial instruments but increasedour 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 togain on sale include (i) loan premiums repaid to investors (“premiumrecapture”) and loan lossprovisions and (ii) deferred origination costs, which are recognized atthe time of loan sale. Premium recapture expenses represent repayment of aportion of certain loan sale premiums to investors on previously sold loanswhich subsequently payoff within six months of loan sale. 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 less favorableterms.  In either case, this could reduceour revenues and earnings.

 

Premium recapture and loan loss provisions increased by $597 thousandin the third quarter of 2005 compared to the same period in 2004. The increasewas mainly due to increased loan volume however the basis point (percentage ofloans sold) decreased. This reduction in loan loss reserves as a percentage ofloans sold reflects a change in estimate (as a result of new informationshowing a reduced exposure to loss) for loan reserves on loans guaranteed bythe Federal Housing Administration. Premium recapture expense increased in the thirdquarter of 2005 compared to the same period in 2004 due to loan volumeincreases, however this expense is expected to decline (as a basis point percentageof loans sold) as interest rates rise and refinance activity declines.Conversely while we believe that our underwriting process is sound andeffective, loan loss provisions may increase in the future due to a higher mixof Alt-A and subprime loans which have more complex underwriting criteria andare more likely to be rejected by investors if unintentionally we sell themloans which do not meet their underwriting guidelines.

 

Theuse of hedges (recorded as derivative financial instruments) is key toprotecting our profit margins between the time of the interest rate lock andwhen the loan is committed for sale to an investor. Generally when mortgageinterest rates rise, the value of loans we have in our pipeline declines, andwhen 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-backedsecurities (TBA) and options on forward sales of mortgage-backed securities asour primary hedging instruments. Due to increases in mortgage interest ratesduring the third quarter of 2005 we recorded gains on derivative financialinstruments of $3.4 million. For the third quarter of 2004 we recorded net losseson derivative financial instruments of $11.5 million due to decreasing mortgageinterest rates during the quarter.

 

Our gross margins, before considering the impacts of timingdifferences, were $33.5 million for the three months ended September 30, 2005or 81 basis points (.81%) on $4.2 billion in loan sales volume, representing anincrease of $20.8 million from $12.7 million on $2.1 billion in loan salesvolume (59 basis points [.59%]) for the comparable period in 2004. The grossmargin

 

22

----

 

improvement is a result ofhigher margin loan products being originated and sold plus favorable timingdifferences (See previous section – Interest Rate Risk Management And TheRelationship Between Our Hedging Instruments And The Market Adjustments AndGain On Sale That We May Record For A Period). Loan sales volume increased $2.0billion. Overall competitive pressure remains high and is expected to intensifyas interest rates rise and the overall market shrinks in 2006. There can be noassurances that margins will remain at current levels and accordingly our grossmargins would be affected if competitive pressures increase or decrease.

 

Our overall actual gross margin percentages, after considering timingdifferences, in the quarter ending September 30, 2005 approximated our targetgross margin percentages, indicating that our hedging strategies were effectivein protecting our pricing margins.  Webelieve that our hedging program was generally successful in protecting profitmargins on our loan originations. However, our hedging strategies may not besuccessful in mitigating our risks associated with interest rate changes infuture periods. In particular, for new loan products with large loan balances,short terms, and loan products with adjustable rates, our hedging process maybe less effective at certain times.

 

 We recorded interest income on mortgage loansheld for sale of $22.2 million for the three months ended September 30, 2005.For our mortgage loans held for sale we earn interest on a loan from the datethe loan is funded until sale. Accordingly, interest income related to ourmortgage loans held for sale is a function of the volume of loan production,the interest rate on the loans and the length of time the loans are held priorto sale. To the extent we fund loans with borrowings under our warehousefacilities, we record interest expense based on the same factors. Interestexpense on our warehouse borrowings for the period was $18.6 million.Interest income of $22.2 million less interest expense of $18.6 million resultsin net interest income of $3.6 million. This equals approximately 8 basispoints (.08%) on third quarter 2005 loan sales of $4.2 billion. For thecomparable period ended September 30, 2004 interest income was $8.2 millionand interest expense was $4.3 million. This resulted in net interestearned of $3.9 million, representing 19 basis points (.19%) on thirdquarter 2004 loan sales of $2.1 billion. The reason for the basis point declinein net interest spread for 2005 was a flattening of the yield curve and ahigher proportion of adjustable rate loans in our loan inventories. As a directresult of the sale of the majority of our bond collateral in 2004, net interestincome ($134.3 thousand) is reduced from pre-portfolio sale amounts for thequarter ending September 30, 2005.

 

Thetable below provides the relationship between estimated fixed, variable andtotal consolidated expenses to loan production for the three months ended September30, 2005 and 2004 (dollars in thousands) (unaudited):

 
| ** **           | ** ** | **Three months ending September 30, 2005** | ** **    |
|----------------------|------------|--------------------------------------------|---------------|
| ** **           | ** ** | ** **                                 | ** **    |
| **Loan  production** | ** ** | **$**                                      | **4,545,436** | ** ** |
|                      |            |                                            |               |  |

 
| ** **                              | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses  Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses  Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                    |       |                              |       |                                     |       |                           |       |                                  |       |                |       |                       |       |
| Employee compensation and benefits      |       | $                                 | 12,498     |                                     | 27.49      |                           | $          | 11,889                                |       | 26.16               |       | $                          | 24,387     |   | 53.65 |   |
| Office and occupancy expense            |       | —                            |       | —                                   |       | 1,219                          |       | 2.68                                  |       | 1,219               |       | 2.68                       |       |
| Professional fees and contract labor    |       | 477                               |       | 1.05                                     |       | 2,278                          |       | 5.01                                  |       | 2,755               |       | 6.06                       |       |
| Other operating expense                 |       | 1,855                             |       | 4.08                                     |       | 3,882                          |       | 8.54                                  |       | 5,737               |       | 12.62                      |       |
| **Total operating expenses**            | ** ** | **14,830**                        | ** ** | **32.63**                                | ** ** | **19,268**                     | ** ** | **42.39**                             | ** ** | **34,098**          | ** ** | **75.02**                  | ** ** |
| Interest expense – short term debt |       | 18,591                            |       | 40.90                                    |       | —                         |       | —                                |       | 18,591              |       | 40.90                      |       |
| Interest expense – long term debt  |       | 111                               |       | 0.25                                     |       | —                         |       | —                                |       | 111                 |       | 0.25                       |       |
| **Total interest expense**              | ** ** | **18,702**                        | ** ** | **41.15**                                | ** ** | **—**                     | ** ** | **—**                            | ** ** | **18,702**          | ** ** | **41.15**                  | ** ** |
| Provision for loan losses               |       | —                            |       | —                                   |       | (64                            | )          | (0.14                                 |       | (64                 | )          | (0.14                      | )          |
| Gain on REO, net                        |       | —                            |       | —                                   |       | (10                            | )          | (0.02                                 | )          | (10                 | )          | (0.02                      | )          |
| **Total consolidated expenses**         | ** ** | **$**                             | **33,532** | ** **                               | **73.77**  | ** **                     | **$**      | **19,194**                            | ** ** | **42.23**           | ** ** | **$**                      | **52,726** | ** ** | **116.00** | ** ** |

 
| ** **           | ** ** | **Three months ending September 30, 2004** | ** **    |
|----------------------|------------|--------------------------------------------|---------------|
| ** **           | ** ** | ** **                                 | ** **    |
| **Loan  production** | ** ** | **$**                                      | **2,075,698** | ** ** |
|                      |            |                                            |               |  |

 

23

----

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses  Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses  Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                     |       |                           |       |                                  |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 4,639      |                                     | 22.35      |                           | $          | 8,113                                 |       | 39.08               |       | $                          | 12,752     |   | 61.43 |   |
| Office and occupancy expense                |       | —                            |       | —                                   |       | 1,076                          |       | 5.18                                  |       | 1,076               |       | 5.18                       |       |
| Professional fees and contract labor        |       | 186                               |       | 0.90                                     |       | 739                            |       | 3.56                                  |       | 925                 |       | 4.46                       |       |
| Other operating expense                     |       | 1,220                             |       | 5.88                                     |       | 2,878                          |       | 13.86                                 |       | 4,098               |       | 19.74                      |       |
| **Total operating expenses**                | ** ** | **6,045**                         | ** ** | **29.13**                                | ** ** | **12,806**                     | ** ** | **61.68**                             | ** ** | **18,851**          | ** ** | **90.81**                  | ** ** |
| Interest expense – short term debt     |       | 4,308                             |       | 20.75                                    |       | —                         |       | —                                |       | 4,308               |       | 20.75                      |       |
| Interest expense – long term debt      |       | 112                               |       | 0.54                                     |       | —                         |       | —                                |       | 112                 |       | 0.54                       |       |
| **Total interest expense**                  | ** ** | **4,420**                         | ** ** | **21.29**                                | ** ** | **—**                     | ** ** | **—**                            | ** ** | **4,420**           | ** ** | **21.29**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                   |       | 80                             |       | 0.39                                  |       | 80                  |       | 0.39                       |       |
| Gain on REO, net                            |       | —                            |       | —                                   |       | (86                            | )          | (0.41                                 | )          | (86                 | )          | (0.41                      | )          |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                   |       | (437                           | )          | (2.10                                 | )          | (437                | )          | (2.10                      | )          |
| **Total consolidated expenses**             | ** ** | **$**                             | **10,465** | ** **                               | **50.42**  | ** **                     | **$**      | **12,363**                            | ** ** | **59.56**           | ** ** | **$**                      | **22,828** | ** ** | **109.98** | ** ** |

 

Total expenses incurred for the three months ended September 30, 2005were approximately $52.7 million. Operating expenses, which included allexpenses except interest expense (employee compensation and benefits, officeand occupancy expense, professional fees and contract labor and other operatingexpenses), were approximately $34.1 million or approximately 75 basispoints (.75%) for the three months ended September 30, 2005. For the comparableperiod ended September 30, 2004, there were approximately $22.8 million oftotal expenses, of which approximately $18.9 million or approximately 91basis points (.91%) were operating expenses (which excludes interest expense,provision for loan losses, gain on REO and valuation adjustment). The increasein operating expenses in the third quarter of 2005 was primarily due to theincrease in loan production; loan production-related expenses andincreases in the number of branch and corporate headquarters personnel.Although operating expenses increased for the three months ended September 30,2005 the basis points (percentage of loan production) declined because fixedcosts did not rise in relation to increased loan volume. For the three monthsended September 30, 2005, expenses included approximately $11.1 million insales commissions, which vary in proportion to the volume of loan production,or approximately 24 basis points (.24%) on $4.5 billion in funded loans.The basis point commissions expense increase in 2005 was due to a higherproportion of new account executives receiving guaranteed commissions duringtheir first three months with our Company and higher commissioned product typevolume.

 

Operatingexpenses totaled $34.1 million or approximately 75 basis points (.75%), on $4.6 billionin loan production in the third quarter of 2005 which is an increase from thesame period in 2004 but a decrease in basis points. As such, the operating costper loan produced decreased from $1,550 in the third quarter of 2004 to $1,466per loan in the third quarter of 2005. Greater production efficiency wasachieved as a result of the 119% increase in loan production while limitingfixed costs increases to minimal levels.

 

Professional fees increased from approximately $0.9 million to $2.8million. The majority of this increase is attributable to the legal andaccounting fees incurred in connection with the pending merger. We expect thesefees to continue at higher levels in the next quarter for the same reason.

 

We discontinued Correspondent lending activity in the third quarter of2005. Costs associated with this closure were less than $50 thousand.

 

The effective combined federal and state tax rates are estimated to be44%.  In 2004, losses increased ourdeferred income tax benefit to approximately $10.7 million at December 31,2004. At September 30, 2005 our deferred income tax benefit balance was decreasedto $10.1 million.  This benefit isexpected 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 approximately $10.1million, will be realized in future periods.

 

Interestrate movements are difficult to predict, but mortgage interest rates generally increasedduring the third quarter of 2005. Projections by the MBA (October 26, 2005)for the remainder of 2005 indicate an increase in interest rates and a decreasein loan volume for the fourth quarter although loan volume estimated for all of2005 is the same as 2004 ($2.8 trillion for 2004 and $2.8 trillion for 2005).Wherever possible we are managing staffing levels and utilizing as muchof our existing infrastructure to process our loan production (adjust staffingsize to an optimal level of efficiency) while growing our sales presence inexisting and new markets. Wehave been investing in growth and expanding and will continue to expand ourbusiness operations, primarily in sales areas, while we focus on controllingour fixed expenses. Our strategy requires us to capture an increasingpercentage of the market in a highly competitive environment, which will putpressure on our gross margins.  If we arenot able to do this, we would likely experience losses due to our current levelof operating expenses.

 

We continue to hold a small portfolio of bond collateral mortgage loans($11.1 million) and related debt ($9.3 million).

 

***Nine Month Results***

 

Werecorded net income of $0.8 million for the nine month period ending September30, 2005 as compared to a net loss of $6.5 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 the ninemonth period ending September 30, 2004 we recorded a $5.3 million loss on thesale of portfolio assets.

 

Timingdifferences described above (fully described above in the section entitled “InterestRate Risk Management And The Relationship Between Our Hedging Instruments And TheMarket Adjustments And Gain On Sale That We May Record for a Period”)

 

24

----

 

favorably impacted our revenues in the ninemonth period ending September 30, 2005 and adversely impacted the same periodin 2004. For the nine months ending September 30, 2005 the favorable impact wasestimated to be $0.6 million and the adverse impact was approximately $0.6million for the same nine month period in 2004. While these timing differencescan be very significant in any single quarter our nine month results are morereflective of margins due to the fact that timing differences offset.

 

Thetable below provides a nine month comparative view of loan production for 2005and 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 |   |
| July                 |       | 1,500             |       | 623 |   |
| August               |       | 1,629             |       | 741 |   |
| September            |       | 1,417             |       | 711 |   |
| Year to date  totals |       | $                 | 10,950     |   | $ | 6,512 |   |

 

Thetable below compares our revenue categories to basis points of loans sold forthe nine month periods ending September 30, 2005 and September 30, 2004(dollars in thousands) (unaudited).

 
| ** **           | ** ** | **Nine Months Ended September  30, 2005** | ** **     | **Nine Months Ended September  30, 2004** | ** ** | **2005 Increase (Decrease)** | ** ** |
|----------------------|------------|-------------------------------------------|----------------|-------------------------------------------|------------|------------------------------|------------|
| ** **           | ** ** | ** **                                | ** **     | ** **                                | ** ** | ** **                   | ** ** |
| **Loans  sold, net** | ** ** | **$**                                     | **10,289,926** | ** **                                | **$**      | **6,399,060**                | ** ** | **$** | **3,890,866** | ** ** |
|                      |            |                                           |                |                                           |            |                              |            |  |  |  |

 

25

----

 
| ** **                                                                                                            | ** ** | **Amount of  Income   (Expense)** | ** **  | **Basis Points  (Loans Sold)** | ** ** | **Amount of  Income  (Expense)** | ** ** | **Basis Points  (Loans Sold)** | ** ** | **Increase  (Decrease)  Amount** | ** ** | **Increase  (Decrease)  Basis Points  (Loans Sold)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|-------------|--------------------------------|------------|----------------------------------|------------|--------------------------------|------------|----------------------------------|------------|------------------------------------------------------|------------|
|                                                                                                                  |       |                              |        |                           |       |                             |       |                           |       |                             |       |                                                 |       |
| Revenues:                                                                                                             |       |                              |        |                           |       |                             |       |                           |       |                             |       |                                                 |       |
| Premiums                                                                                                              |       | $                                 | 186,445     |                           | 181.19     |                             | $          | 122,269                        |       | 191.07                           |       | $                                                    | 64,176     |   | (9.88 | ) |
| Broker fees                                                                                                           |       | 27,179                            |        | 26.41                          |       | 15,503                           |       | 24.23                          |       | 11,676                           |       | 2.18                                                 |       |
| Mortgage broker premiums                                                                                              |       | (118,332                          | )           | (115.00                        | )          | (82,704                          | )          | (129.24                        | )          | (35,628                          | )          | 14.24                                                |       |
| Premium recapture and loan loss provisions                                                                            |       | (4,169                            | )           | (4.05                          | )          | (4,615                           | )          | (7.21                          | )          | 446                              |       | 3.16                                                 |       |
| Deferred origination costs                                                                                            |       | (10,145                           | )           | (9.86                          | )          | (8,416                           | )          | (13.15                         | )          | (1,729                           | )          | 3.29                                                 |       |
| **Gain on sales of loans**                                                                                            | ** ** | **$**                             | **80,978**  | ** **                     | **78.69**  | ** **                       | **$**      | **42,037**                     | ** ** | **65.70**                        | ** ** | **$**                                                | **38,941** | ** ** | **12.99** | ** ** |
| Derivative financial instruments and market  adjustments                                                              |       | (3,313                            | )           | (3.22                          | )          | (2,943                           | )          | (4.60                          | )          | (370                             | )          | 1.38                                                 |       |
| **Gain on sales of loans, after derivative  financial instruments and market adjustments (“gross margin”)** | ** ** | **$**                             | **77,665**  | ** **                     | **75.47**  | ** **                       | **$**      | **39,094**                     | ** ** | **61.10**                        | ** ** | **$**                                                | **38,571** | ** ** | **14.37** | ** ** |
| Interest on mortgage loans held for sale                                                                              |       | 47,159                            |        | 45.83                          |       | 22,208                           |       | 34.71                          |       | 24,951                           |       | 11.12                                                |       |
| Interest on bond collateral                                                                                           |       | 678                               |        | 0.66                           |       | 2,229                            |       | 3.48                           |       | (1,551                           | )          | (2.82                                                | )          |
| **Total interest income**                                                                                             | ** ** | **47,837**                        | ** **  | **46.49**                      | ** ** | **24,437**                       | ** ** | **38.19**                      | ** ** | **23,400**                       | ** ** | **8.30**                                             | ** ** |
|                                                                                                                  |       |                              |        |                           |       |                             |       |                           |       |                             |       |                                                 |       |
| Other income                                                                                                          |       | 599                               |        | 0.58                           |       | 1,010                            |       | 1.58                           |       | (411                             | )          | (1.00                                                | )          |
| **Total revenue**                                                                                                     | ** ** | **$**                             | **126,101** | ** **                     | **122.54** | ** **                       | **$**      | **64,541**                     | ** ** | **100.87**                       | ** ** | **$**                                                | **61,560** | ** ** | **21.67** | ** ** |

 

Gross margins increased for the nine months ended September 30, 2005over the same period ended September 30, 2004 due to a higher level of loanssold and better gross margins due to changes in our product mix. Increasinginterest rates for the nine months ended September 30, 2005 decreased the gainon sales of loans and increased the value of derivative financial instrumentsand market adjustments. This trend cannot clearly be seen for the nine monthperiod ending September of 2005 because interest rates initially decreasedduring the period (causing losses on derivative instruments) and then increasedat the end of the period (causing gains on derivative instruments). The neteffect on derivative instruments was an overall loss for the period ofapproximately $3.3 million. During the nine month period ending September 2004the opposite was true in that interest rates initially increased and thendecreased at the end of the period. The net effect on derivative instrumentswas an overall loss for the period of approximately $2.9 million.

 

Premium recapture and loan loss provisions decreased by $0.4 million inthe nine months ended September 30, 2005 compared to the same period in 2004.The decrease was mainly due to a reduction in loan loss reserves in the first ninemonths of 2005 which was the result of a change in estimate for FHA loanreserves (as a result of new information showing a reduced exposure to loss).Premium recapture expense decreased in the first nine months of 2005 comparedto the same period in 2004 which overcame third quarter increases due to thirdquarter loan production volume increases. If interest rates rise andrefinancing activity decreases, premium recapture expense will decline as apercentage of loans sold.

 

Our gross margins were $77.7 million for the nine months ended September30, 2005 or 75 basis points (.75%) on $10.3 billion in loan sales volume,representing an increase of $38.6 million from $39.1 million on $6.4 billion inloan sales volume for the comparable period in 2004. The gross marginimprovement is a result of higher margin loan products being originated andsold. Loan sales volume increased $3.9 billion.

 

Werecorded interest income on mortgage loans held for sale of $47.2 millionfor the nine months ended September 30, 2005. Interest expense on our warehouseborrowings for the period was $37.1 million. The resulting net interestincome earned on loan inventories was $10.1 million (interest income of $47.2million less $37.1 million of interest expense), representing 9 basis points (.09%)on the first nine months of 2005 loan production of $10.9 billion. For thecomparable period ended September 30, 2004 interest income was $22.2 millionand interest expense was $11.1 million. This resulted in net interestearned of $11.1 million, representing 17 basis points (.17%) on the first ninemonths of 2004 loan production of $6.5 billion. The reason for the net interestdecrease for 2005 was a flattening of the yield curve. Interest income on bondcollateral decreased in the nine month period ending September 30, 2005 toapproximately $0.34 million from $0.89 million in the nine month period ending September30, 2004. This reduction was a direct result of the sale of a majority of bondcollateral in 2004.

 

Thetable below provides the relationship between estimated fixed, variable andtotal consolidated expenses to loan production for the nine months ended September30, 2005 and 2004 (dollars in thousands) (unaudited):

 
| ** **           | ** ** | **Nine months ending September 30, 2005** | ** **     |
|----------------------|------------|-------------------------------------------|----------------|
| ** **           | ** ** | ** **                                | ** **     |
| **Loan  production** | ** ** | **$**                                     | **10,949,895** | ** ** |
|                      |            |                                           |                |  |

 

26

----

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** **  |
|---------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|---------------------|------------|----------------------------|-------------|
|                                        |       |                              |       |                                    |       |                           |       |                                 |       |                |       |                       |        |
| Employee compensation and benefits          |       | $                                 | 29,910     |                                    | 27.32      |                           | $          | 33,007                               |       | 30.14               |       | $                          | 62,917      |   | 57.46 |   |
| Office and occupancy expense                |       | —                            |       | —                                  |       | 3,269                          |       | 2.99                                 |       | 3,269               |       | 2.99                       |        |
| Professional fees and contract labor        |       | 1,110                             |       | 1.01                                    |       | 4,679                          |       | 4.27                                 |       | 5,789               |       | 5.28                       |        |
| Other operating expense                     |       | 4,890                             |       | 4.47                                    |       | 10,263                         |       | 9.37                                 |       | 15,153              |       | 13.84                      |        |
| **Total operating expenses**                | ** ** | **35,910**                        | ** ** | **32.80**                               | ** ** | **51,218**                     | ** ** | **46.77**                            | ** ** | **87,128**          | ** ** | **79.57**                  | ** **  |
| Interest expense – short term debt     |       | 37,110                            |       | 33.89                                   |       | —                         |       | —                               |       | 37,110              |       | 33.89                      |        |
| Interest expense – long term debt      |       | 340                               |       | 0.31                                    |       | —                         |       | —                               |       | 340                 |       | 0.31                       |        |
| **Total interest expense**                  | ** ** | **37,450**                        | ** ** | **34.20**                               | ** ** | **—**                     | ** ** | **—**                           | ** ** | **37,450**          | ** ** | **34.20**                  | ** **  |
| Provision for loan losses                   |       | —                            |       | —                                  |       | 167                            |       | 0.15                                 |       | 167                 |       | 0.15                       |        |
| Gain on REO, net                            |       | —                            |       | —                                  |       | (1                             | )          | (0.00                                | )          | (1                  | )          | 0.00                       | )           |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                  |       | (38                            | )          | (0.03                                | )          | (38                 | )          | (0.03                      | )           |
| **Total consolidated expenses**             | ** ** | **$**                             | **73,360** | ** **                              | **67.00**  | ** **                     | **$**      | **51,346**                           | ** ** | **46.89**           | ** ** | **$**                      | **124,706** | ** ** | **113.89** | ** ** |

 
| ** **           | ** ** | **Nine months ending September 30, 2004** | ** **    |
|----------------------|------------|-------------------------------------------|---------------|
| ** **           | ** ** | ** **                                | ** **    |
| **Loan  production** | ** ** | **$**                                     | **6,511,505** | ** ** |
|                      |            |                                           |               |  |

 
| ** **                                  | ** ** | **Estimated  Variable  Expenses** | ** ** | **Estimated  Variable  Expenses  Bpts.** | ** ** | **Estimated  Fixed  Expenses** | ** ** | **Estimated  Fixed  Expenses  Bpts.** | ** ** | **Total  Expenses** | ** ** | **Total  Expenses  Bpts.** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|--------------------------------|------------|---------------------------------------|------------|---------------------|------------|----------------------------|------------|
|                                        |       |                              |       |                                     |       |                           |       |                                  |       |                |       |                       |       |
| Employee compensation and benefits          |       | $                                 | 14,508     |                                     | 22.28      |                           | $          | 24,486                                |       | 37.60               |       | $                          | 38,994     |   | 59.88 |   |
| Office and occupancy expense                |       | —                            |       | —                                   |       | 2,871                          |       | 4.41                                  |       | 2,871               |       | 4.41                       |       |
| Professional fees and contract labor        |       | 544                               |       | 0.83                                     |       | 2,786                          |       | 4.28                                  |       | 3,329               |       | 5.11                       |       |
| Other operating expense                     |       | 3,838                             |       | 5.89                                     |       | 9,200                          |       | 14.13                                 |       | 13,038              |       | 20.02                      |       |
| **Total operating expenses**                | ** ** | **18,890**                        | ** ** | **29.00**                                | ** ** | **39,342**                     | ** ** | **60.42**                             | ** ** | **58,233**          | ** ** | **89.42**                  | ** ** |
| Interest expense – short term debt     |       | 11,075                            |       | 17.01                                    |       | —                         |       | —                                |       | 11,075              |       | 17.01                      |       |
| Interest expense – long term debt      |       | 1,339                             |       | 2.06                                     |       | —                         |       | —                                |       | 1,339               |       | 2.06                       |       |
| **Total interest expense**                  | ** ** | **12,414**                        | ** ** | **19.07**                                | ** ** | **—**                     | ** ** | **—**                            | ** ** | **12,414**          | ** ** | **19.07**                  | ** ** |
| Provision for loan losses                   |       | —                            |       | —                                   |       | 208                            |       | 0.32                                  |       | 208                 |       | 0.32                       |       |
| Gain on REO, net                            |       | —                            |       | —                                   |       | (406                           | )          | (0.62                                 | )          | (406                | )          | (0.62                      | )          |
| Valuation adjustment – Bond Collateral |       | —                            |       | —                                   |       | 4,872                          |       | 7.48                                  |       | 4,872               |       | 7.48                       |       |
| **Total consolidated expenses**             | ** ** | **$**                             | **31,304** | ** **                               | **48.07**  | ** **                     | **$**      | **44,016**                            | ** ** | **67.60**           | ** ** | **$**                      | **75,320** | ** ** | **115.67** | ** ** |

 

Totalexpenses incurred for the nine months ended September 30, 2005 wereapproximately $124.7 million. Operating expenses, which included all expensesexcept interest expense (employee compensation and benefits, office andoccupancy expense, professional fees and contract labor and other operatingexpenses), were approximately $87.1 million for the nine months ended September30, 2005. For the comparable period ended September 30, 2004, there wereapproximately $75.3 million of total expenses, of which approximately $58.2 millionwere operating expenses. The increase in operating expenses in 2005 wasprimarily due to the increase in loan production and loan production-relatedexpenses and increases in the number of branch and corporate headquarterspersonnel. For the nine months ended September 30, 2005, expenses includedapproximately $26.3 million in sales commissions, which vary in proportionto the volume of loan production, or approximately 24 basis points (.24%) on $10.9 billionin funded 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.

 

Operatingexpenses totaled $87.1 million or approximately 80 basis points (.80%), on $10.9 billionin loan production in the first nine months of 2005. Total operating expensesin basis points of loan production (which is a measurement of the cost perloan) decreased for the nine months ended September 30, 2005 compared to thesame period in 2004 (from 89 basis points (.89%) in 2004 to 80 basis points (.80%)in 2005). The operating cost per loan produced decreased from $1,557 in thefirst nine months of 2004 to $1,533 per loan in the first nine months of 2005.Although greater production efficiency may have been expected with a 68.2%increase in loan production, our branch system is still maturing. New branchesbeing less efficient offset volume efficiency gains by mature branches.  Also, our new Subprime lending channelcontinues to incur losses while building loan production volume.

 

27

----

 

***Liquidity andCapital Resources***

 

*General*

 

Our sources of liquidity during the nine months ended September 30,2005 primarily consisted of the following:

 

•              borrowings under our warehouse facilities;

•              revenues generated by our mortgage bankingoperating activities including interest income, broker fees, loan sale proceedsand hedge proceeds;

•              hedging gains;

•              excess interest spread in the Mortgage AssetPortfolio Business, net of repayments to servicers for past principal andinterest advances on completed real estate owned dispositions.

 

Our primary cash requirements included:

 

•              funding our mortgage loan originations;

•              interest expense under our warehousefacilities;

•              operating expenses, including commissions;

•              repayment of our warehouse borrowings;

•              increasing and maintaining a “restricted cash”account, which includes amounts required to be held by certain warehouse lineproviders that may not be used in our operations or as equity for otherwarehouse lines of credit;

•              funding certain mortgage originations withoutthe use of warehouse financing and;

•              professional fees related to the sale of theCompany.

 

*Cash Generated By and Used In Our Operations*

 

During the nine months ended September 30, 2005, on a consolidatedbasis we had net negative cash flow of $28.9 million. The principal factorsimpacting our negative cash flow are:

 

•      Netincreases in our cash investment in loan inventories and loan sale receivablestotaled approximately $33.8 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 invested from 1%to 4% of the principal amount of loans held for sale, which is recouped whenthe loans are purchased by investors. Mortgage loans held for sale increasedfrom approximately $238.4 million at December 31, 2004 to approximately $736.8million at September 30, 2005. An increase in the amount of loan inventory,either by holding loans for longer periods, or due to increased loan fundingvolume, will cause cash utilization to carry loan inventories to increase indirect proportion to the inventory held as a result of the Company’s money(between 1% and 4% of loan amount) invested in each loan..

 

•      Cash usage for capital expenditures totaledapproximately $1.4 million.

 

•      Transfers of cash to restricted cash accountstotaled $1.0 million.  Restricted cashincreased to $3.1 million representing Company cash accounts required to bemaintained under certain warehouse lending agreements.

 

•      Other cash receipts in excess of cashexpenditures totaled $7.3 million.

 

Oneof our Company goals continues to be, wherever possible, to utilize our currentsupport 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 remain at current levels or slightly decrease during theremainder of 2005 as a result of the seasonal factors even though we continueto hire

 

28

----

 

more account executives.  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 Lending activities which is not expectedto be profitable until the fourth quarter of 2005. We are therefore dependenton significant levels of warehouse financing to help execute our mortgagebanking strategy. Considering investments in Subprime lending activities,timing differences for revenue and expense recognition, and given marginstability (without extraordinary charges or further compression of our interestspread on warehouse loans) we must generate approximately $1.1 billion to $1.2billion in loan sales per month to avoid negative operating cash flow.

 

Duringthe three months ending September 30, 2005 we averaged $1.5 billion per monthin loan production and during the nine months ending September 30, 2005 weaveraged $1.2 billion per month in loan production.  See Business Risk Factors in Item 2below. Management believes that our Company has sufficient sources of liquidityat September 30, 2005 to meet anticipated business requirements for theforeseeable future.

 

*Short**-Term Debt*

 

Asof September 30, 2005, short-term debt consists of $711.0 million of revolvingcredit lines (warehouse facilities) used to fund our lending activities. As of September30, 2005, mortgage loans held for sale totaling $736.8 million werepledged as collateral for the warehouse facilities. 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.  Our warehouse facilities consist ofborrowings of $711.0 million with four financial institutions. At September30, 2005, our maximum permanent combined borrowings from these four financialinstitutions are $2.2 billion. These facilities typically advance 96% to99% of the lesser of par or market value of the loans pledged as collateral.Such financing is currently provided primarily under (i) a 364-day securedmortgage warehousing revolving credit agreement, originally dated as ofNovember 26, 2001 (current expiration date is May 22, 2006), (the “BankCredit Agreement”) with JPMorgan Chase Bank; (ii) a secured mortgagewarehousing revolving credit agreement, originally dated as of March 28,2002 (there is no expiration date as this is an uncommitted facility) (the “UBSAgreement”) with UBS Real Estate Securities Inc.; (iii) a securedmortgage warehousing revolving credit agreement, originally dated as ofOctober 11, 2002 (current expiration date of December 31, 2005), (the“Countrywide Agreement”) with Countrywide Warehouse Lending; and (iv) a729-day secured mortgage warehousing revolving credit agreement, originallydated as of September 15, 2003 (current expiration date of July 31,2006), (the “Agreement”) with Residential Funding Corporation. Each warehousefacility is entered into by our subsidiary American Mortgage Network, Inc. andguaranteed by AmNet Mortgage, Inc. or entered into by both corporations. Thesewarehouse facilities are repaid as principal payments on mortgage loans arereceived, or as the mortgage loans are sold. The agreements governing thesefacilities contain a number of covenants, including but not limited tocovenants based on tangible net worth, cash flows, net income, and liquidity ofour Company. As of September 30, 2005 the Company was in compliance with warehouseline facility covenants. We believe we are in good standing with all of ourwarehouse lenders.

 

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

 

Ourlong-term debt consists of CMO/FASIT 1998-1 mortgage-backed notes, which arecollateralized by bond collateral mortgage loans and bond collateral realestate owned. Obligations under the mortgage-backed notes are payable solelyfrom the proceeds from the bond collateral and are otherwise non-recourse tothe Company.

 

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

 

Inthe ordinary course of business, we make rate lock commitments to borrowerswhich obligate us to fund mortgages at set interest rates. The values of theunderlying loans, and thus our expected gain on the subsequent funding and saleof these loans, may be impacted by subsequent changes in market interest rates.Accordingly, we attempt to protect (or hedge) our pricing margins by utilizingforward sales of TBAs and options on TBAs. The hedges typically increase ordecrease in value in correlation to offsetting decreases or increases in thevalue of the loans. For the purposes of hedging our interest rate exposure onour pipeline, we make various assumptions in order to estimate the rate lockcommitments which will not close (fallout ratio). The fallout ratio is appliedto total rate lock commitments to arrive at the net exposure to interest ratechanges in the market. As loans fund, we typically sell or assign our hedgesand enter into mandatory loan sale commitments with our correspondentinvestors. The following is a summary of our commitments to fund andcommitments to sell loans and mortgage backed securities at September 30, 2005and December 31,

 

29

----

 

2004 (dollars in thousands):

 
| ** **                                                                                | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **Commitments to Fund Loans:**                                                            |       |                    |       |                   |       |
| Commitments to originate loans at set  interest rates (before applying estimated fallout) |       | $                       | 1,638,161  |                   | $          | 813,081 |   |
| Commitments to originate loans at set  interest rates (after applying estimated fallout)  |       | 964,691                 |       | 471,884                |       |
| **Commitment to Sell Loans or Mortgage Backed  Securities:**                              |       |                    |       |                   |       |
| Mandatory commitments to sell mortgage  loans held for sale                               |       | 507,344                 |       | 100,798                |       |
| Forward sales of mortgage backed securities  (TBA) and options on forward sales           |       | 1,114,000               |       | 611,000                |       |
|                                                                                           |            |                         |            |                        |            |  |  |

 

Theabove table merely lists the commitments we have to fund loans and sell loansor mortgage backed securities and is not referencing to any of our closed loaninventory. In Note 7 to our audited financial statements we havequantified the interest rate exposure we have on our pipeline and compare thisexposure to our hedge coverage.

 

*Merger Costs*

 

The Company incurred costs related to the merger activities thatoccurred during the third quarter of fiscal 2005.  These costs include fees paid for legal andaccounting services and other transaction-related costs.  These expenses are expected to continue untilthe merger is completed.  The totalamount of these costs to be incurred is not determinable at this time.

 

Additionally, if the merger agreement is terminated under specificcircumstances as set forth in the merger agreement, the Company will be liableto pay Wachovia an aggregate termination fee of up to $3.5 million.

 

*Lease andLong-Term Debt Commitments*

 

In order to better understand our future obligations under our leasesand long-term debt agreements, the table below shows our expected futurepayments for these debt instruments.

 
| ** **                                            | ** ** | **Payments Due by Period**             | ** ** |
|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                            | ** ** | **(dollars in thousands) (unaudited)** | ** ** |
| **Contractual Obligations as of  September 30, 2005** | ** ** | **Total**                              | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More Than 5  Years** | ** ** |
|                                                  |       |                                   |       |   |   |   |   |   |   |   |   |
| Long-Term  Debt                                       |       | $                                      | 9,317      |   | $ | 2,737 |   | $ | 4,882 |   | $ | 1,698 |   | $ | — |   |
| Operating  Leases                                     |       | 9,171                                  |       | 3,241 |   | 4,333 |   | 1,556 |   | 41 |   |
| Total                                                 |       | $                                      | 18,488     |   | $ | 5,978 |   | $ | 9,215 |   | $ | 3,254 |   | $ | 41 |   |

 

Long-term debt is in theform of a bond which is directly tied to bond collateral (assets) in the formof mortgage loans.

 

**BusinessRisk Factors**

 

*Certain Risks Associated with the Merger*

 

On September 13, 2005, the Company entered into a merger agreement,pursuant to which a merger subsidiary of Wachovia will merge with and into theCompany, with the Company being the surviving corporation and becoming a whollyowned subsidiary of Wachovia.  In themerger, each issued and outstanding share of the Company’s common stock, parvalue $0.01 per share, is to be canceled and converted automatically into theright to receive $10.30 per share in cash. The merger remains subject to customary closing conditions, includingapproval of the merger by the Company’s stockholders.  The Company expects to hold a special meetingof stockholders to vote on the merger and the merger agreement in December2005.  There can be no assurance,however, that the merger will be completed. In the event the merger agreement is terminated under specificcircumstances as set forth in the merger agreement, the Company will be liableto pay Wachovia an aggregate termination fee of $3.5 million.

 

*TheChanging Shape of the Yield Curve Affects Net Interest Income*

 

Animportant source of income is net interest income which is the differencebetween interest we receive on our closed loans (affected by long term interestrates) and interest we pay to our warehouse lenders (affected by short terminterest rates). As the difference between long term interest rates and shortterm interest rates become smaller, or when short term rates exceed long termrates (inverted yield curve), we receive less net interest income. Our netincome will be negatively impacted by this adverse condition.  The can be no guarantee that this conditionwill rectify itself quickly

 

30

----

 

and therefore our lack of significant netinterest income may dramatically effect our net income and ability to sustainprofitability over an extended period.

 

*Failure to Achieve and Maintain Effective Internal ControlsIn Accordance With Section 404 of the Sarbanes-Oxley Act Could Have aMaterial Adverse Effect on Our Business, Operating Results and Stock Price*

 

Weare in the process of documenting and testing our internal control proceduresin order to satisfy the requirements of Section 404 of the Sarbanes-OxleyAct. Under Section 404 our management will be required to assess theeffectiveness of our internal controls over financial reporting and ourindependent auditors will be required to issue an attestation report onmanagement’s assessment assuming the Wachovia merger is not completed. Our loanorigination software consists of proprietary programs which are not completelydocumented, and we are currently implementing additional control measures inorder to strengthen various aspects of our technology infrastructure. Duringthe course of our testing we may identify deficiencies which we may not be ableto remediate 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 Subprime Lending,Which Makes it Difficult to Predict our Future Prospects for this LendingChannel*

 

In2004 we made a strategic decision to build the infrastructure and hireexecutives to enable our Company to build our subprime volume to 20% of totalvolume by the end of 2007. We created a subprime loan underwriting center andbegan to hire dedicated subprime wholesale account executives. Incrementalrevenues from this channel will help us to more fully leverage our existinglending infrastructure, particularly our headquarters administrative costs. Thesubprime segment of the mortgage banking market is highly competitive, and isdominated by large, well-established firms who specialize in this segment ofthe market. Additionally, many of these subprime lenders have portfoliocapabilities and may offer their clients more operational flexibility than weintend to offer since we sell all of the loans we fund or purchase on aservicing released basis. As a result of the increasingly competitive nature ofthis market segment and our Company’s limited experience in subprime lending,it is difficult to evaluate our growth prospects for this product line.Overhead expense (net of revenue) directly attributable to the subprimebusiness is currently in the range of $400,000 per month. While we willcontinue to dedicate overhead expense and intend to increase our overheadexpenses (for the remainder of 2005 and continuing in 2006) to recruit salesprofessionals and build our market presence in this new channel, we may not beable to achieve the level of anticipated fundings to cover our direct overheadand become profitable in this channel. Depending on the gain on sale margins we are able to achieve, it maytake longer than we anticipated to achieve a profitable contribution from thischannel.

 

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

 

OurCompany was formed in 1997 and operated as a mortgage REIT (mortgage portfolioinvestment) until the fourth quarter of 2001, at which time we beganoriginating and selling residential mortgages (mortgage banking). As a result,comparisons between financial performance in current quarters and past quartersmay not be helpful in evaluating our current performance or our futureprospects. The market for mortgage originations was dominated by unprecedentedlevels of refinances in 2002 and 2003 due to historically low interest rates.While our executive officers have extensive mortgage origination and mortgagebanking experience, and we have hired experienced personnel in our mortgagebanking subsidiary, the Company does not have a significant history as amortgage banking company. This may limit our ability to evaluate our currentperformance and project our future performance.

 

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

 

Weexpect to incur additional costs and expenses related to the expansion of oursales force, development of our subprime lending channels, and investment inour information technology capabilities. If this expansion does not result inadequate revenues, our financial performance will suffer. We must generate approximately$1.1 billion to $1.2 billion in sales volume per month in 2005,absent declines in revenue margins due to competitive pressures or spreadcompression, to meet our expense obligations. We are expanding our businessoperations and increasing our fixed expenses. Our strategy requires us to capture an increasing percentage of themarket in wholesale lending and subprime lending, in a highly competitiveenvironment which will put pressure on our gross margins. If we are not able todo this, we would likely experience losses due to our increased level ofexpenses. In addition, we expect to utilize income tax benefits against futureprofits and taxes. Some of the tax benefits may have to be reversed (valuationaccount established) in the future if significant operating losses occur, or ifwe determine at a future date that forecasted operating profits may not besufficient to fully utilize deferred tax assets. See “Overhead Expenses May NotBe Covered by Sufficient Revenues to Sustain Profitable Operations.”

 

*We May Not Be Able to Effectively Manage the Growth of OurBusiness*

 

Overthe past three and one-half years, we have experienced rapid growth. In thebeginning of 2001, we had approximately

 

31

----

 

20 employees. As of September 30, 2005, wehad approximately 956 employees. Many of these employees have very limitedexperience with us and a limited understanding of our systems. Many of ourfinancial, 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 and Demand forMortgages May Hinder Our Ability to Achieve or Sustain Profitable OriginationLevels*

 

Oursuccess depends, in large part, on our ability to originate loans in sufficientquantity such that the gain on sales of loans net of hedges and other revenueare in excess of both fixed and variable overhead costs. There can be noassurance that we will be able to originate sufficient levels of mortgages toachieve and sustain profitability. In originating and selling loans, we competewith investment banking firms, savings and loan associations, banks, mortgagebankers and other entities originating residential 1-4 unit mortgages, many ofwhich have greater financial resources than us. We also face competition fromcompanies already established in these markets. In addition to the level ofhome purchase activity, the mortgage loan origination market is directly tiedto, the general level of interest rates, and refinance activity.Competitiveness has increased, putting pressure on the market competitors toreduce revenues to sustain origination volumes and market share. We believethat the variety and the price competitiveness of our loan products andcustomer service levels will allow us to gain market share over the nextseveral years, even as the overall market for mortgages declines; however,there can be no assurance that we will be able to successfully and profitablycompete.

 

O*verhead Expenses May Not BeCovered By Sufficient Revenues To Generate Profitable Operations*

 

Wehave made a number of fixed overhead commitments to establish the operationaland administrative infrastructure necessary to support our loan originationbusiness. At September 30, 2005, lease commitments for headquarter and regionaloffices totaled approximately 212,800 square feet. There were 956 employeesincluding 267 employees who are paid solely by commissions. The balance ofemployees are salaried or hourly employees. In order to achieve profitabilityat this staffing level plus expected staffing levels in 2005, our monthly loansales volume must be approximately $1.1 to $1.2 billion, absent furtherdeterioration in pricing margins due to competitive pressures, but there can beno assurance this can be accomplished. Since our revenues are tied directly tothe level of loan production and subsequent sale, it is imperative that weachieve a profitable level of originations, and the level of futureprofitability from mortgage banking will be in direct correlation to the levelof loan origination volume. Furthermore, should competitive pressures requireus to reduce targeted gains on the sale of loans, the volume required tosustain profitability would increase. There can be no assurances that we willbe able to maintain loan origination volumes sufficient to cover our fixedoverhead costs, and should we incur significant operating losses, our capitalbase and cash reserves could be materially adversely impacted.

 

*Revenues Can Fluctuate From Period to Period Based on aNumber of Factors*

 

Ouroperating results have and may in the future fluctuate significantly fromperiod to period as a result of a number of factors, including; the volume ofloan origination, interest rates and the level of unrealized gains/losses inunsold loans, the value of funded loans not yet committed for sale or positionsin derivative securities. Accordingly, the consolidated net income of ourCompany may fluctuate from period to period.

 

Further,if the closing of a sale of loans is postponed, the recognition of gain fromthe sale is also postponed. If such a delay causes us to recognize income inthe subsequent quarter, our results of operations for the previous quartercould be significantly depressed.

 

*Our Financial Results Fluctuate As a Result of Seasonality*

 

Althoughthe refinance portion of our business is not seasonal, our purchase business isgenerally subject to seasonal trends. During 2003, our refinance business grewto a high of 90% of our activity. In 2004 and the first nine months of 2005, aswe returned to more normal markets and purchase and refinance activity becamemore equal, seasonality became a significant factor in our business.Seasonality trends reflect the general pattern of housing sales, whichtypically peak during the spring and summer seasons. Our quarterly operatingresults have fluctuated in the past and are expected to fluctuate in thefuture, reflecting the seasonality of the industry.

 

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

 

Weuse forward sales of mortgage-backed securities (TBA) and options onmortgage-backed securities (MBS), which are classified as derivative financialinstruments, to provide a level of protection against interest rate risk. Whenrates change we expect to record a gain or loss on derivatives which would beoffset by an inverse change in the value of our rate locked loan commitmentsand closed loans. However, our use of derivatives may not offset all of ourrisk related to changes in interest rates. In the past we have incurred, and inthe future we may incur losses after accounting for our derivative financialinstruments. The derivative financial instruments we select may not have thedesired effect of reducing our interest rate risk. In addition, the nature andtiming of hedging

 

32

----

 

transactions may influence the effectivenessof these strategies. If we poorly design strategies or improperly executetransactions we could actually increase our exposure to interest rate risk andpotential losses. In addition, hedging strategies involve transaction and othercosts. We cannot assure that our hedging strategy and the derivatives that weuse will adequately offset the risk of interest rate volatility or that ourhedging transactions will not result in losses.

 

Weoffer loan programs of many terms, from thirty year fixed interest rate loansto one year adjustable rate loans. The hedging instruments used, on balance,correlate satisfactorily with the thirty and fifteen year loan programs. Thehedging instruments used for our shorter term loan programs and adjustableinterest rate loans have a somewhat lower correlation to changes in marketinterest rates than do thirty year term programs. Consequently, the design ofour hedge strategy may be less effective at certain times and this occurrencecould be amplified for these shorter term loan programs.

 

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

 

Our primary source of revenue is from gains on sales of loans, net ofgains or losses on derivative financial instruments. We set rates and paybroker premiums for loans we fund based on a pricing process designed to createa targeted profit margin on each loan. Appropriately pricing these loans can becomplex, and we may not always successfully price our loans with adequatemargin to compensate us for the risk of interest rate volatility.

 

The value of the mortgage loans that we originate is at risk due tofluctuations in interest rates during two time periods: (1) the periodbeginning when we have committed to funding the loan (rate locked loancommitments) and ending when the loan closes, or funds; and (2) the timeperiod beginning when the loan closes and ending when we commit to sell, orsell the loans to third-party purchasers of closed loans. These rate lockedloan commitments and closed loans are collectively referred to as our pipeline.To manage the interest rate risk of our pipeline, we continuously project thepercentage of rate locked loan commitments on loans we expect to close. Becauseprojecting a percentage of rate lock commitment loans that will close isespecially difficult during periods of volatile interest rates, we cannotassure that our projections will be accurate. On the basis of such projections,we use forward sales of mortgage-backed securities (TBA) and options on MBS,which are classified as derivative instruments. These “hedges” are designed tomitigate the adverse impact interest rate fluctuations may have on the value ofthe pipeline. Use of hedges is based in part on our estimates as to thepercentage of loans that will close, and therefore we cannot assure you thatour use of derivative instruments will offset the risk of changes in interestrates.

 

Ifinterest rates change, the actual percentage of rate lock commitment loans thatclose may differ from the projected percentage. A sudden significant increasein interest rates can cause a higher percentage of rate lock commitment loansto close than projected. We may not have made forward sales commitments to sellthese additional loans and consequently may incur significant losses upon theirsale at current market prices, which may not be offset by gains in the value ofderivative instruments, adversely affecting results of operations. Likewise, ifa lower percentage of rate lock commitment loans close than was projected, dueto a sudden decrease in interest rates or otherwise; we have and may in thefuture adjust our hedge positions or mandatory sales commitments at asignificant cost, adversely affecting our results of operations. This risk isgreater during times of interest rate volatility. Also, as our loan productlist changes over time, our assumptions concerning rate locked loan closingsmay change. Incorrect assumptions will adversely affect results of operations.

 

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

 

Inconnection with our mortgage loan sales, which involve the sale of mortgageloans and mortgage-backed securities on a forward or other deferred deliveryand payment basis, we may enter into forward sales of mortgage-backedsecurities (TBA) and options on MBS in connection with our hedging activities.We have credit risk exposure to the extent purchasers/sellers are unable to meetthe terms of their forward purchase/sale contracts. As is customary in themarketplace, none of the forward payment obligations of any of ourcounterparties is currently secured or subject to margin requirements. Weattempt to limit our credit exposure on forward sales arrangements on mortgageloans and mortgage-backed securities by entering into forward contracts onlywith institutions that we believe are acceptable credit risks, and which havesubstantial capital and an established track record in correspondent lending.We further attempt to limit our credit exposure on hedging transactions bydealing with a wide variety of firms. If counterparties do not perform, ourresults of operations may be adversely affected.

 

*Failure to Renew and Obtain Adequate Financing May AdverselyAffect Results Of Operations*

 

Asof September 30, 2005 we had four revolving warehouse borrowing facilities inplace totaling $2.2 billion. These facilities enable AmNet to fund inexcess of $2.5 billion per month depending on how quickly we are able toprocess loan 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

 

33

----

 

warehouse line borrowings are financialmarket conditions and the value and performance of our Company prior to thetime of such financing. There can be no assurance that any such financing canbe successfully completed at advantageous rates or at all. Our warehouse creditfacilities contain extensive restrictions and covenants that, among otherthings, require us to satisfy specified financial, asset quality and loanperformance tests. While the Company expects to be able to comply with theircovenants (and if not, obtain waivers), if we fail to meet or satisfy any ofthese covenants and/or not obtain waivers, we would be in default under theseagreements and our lenders could elect to declare all amounts outstanding underthe agreements to be immediately due and payable, enforce their interestsagainst collateral pledged under such agreements and restrict our ability tomake additional borrowings. These agreements also contain cross-defaultprovisions, so that if a default occurs, under one agreement, the lenders underour other agreements could also declare a default. Any uncured default underour credit facilities could have a materially adverse effect on our financialresults. As of September 30, 2005 the Company is in compliance with warehouse linefacility covenants and we believe we are in good standing with all of ourwarehouse lenders.

 

Thecovenants and restrictions in our warehouse credit facilities may restrict ourability 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.

 

Theserestrictions may interfere with our ability to obtain financing or to engage inother business activities, which may significantly harm our business financialcondition, liquidity and results of operations.

 

*We Sell a Substantial Portion of Loans We Originate toCompetitors*

 

Wehave warehouse line facilities with Countrywide Home Loans, Inc. (“Countrywide”).We also sell a substantial portion of our loans to Countrywide as well as othercompetitors. For the nine months ending September 30, 2005 we sold (by loanvolume) to Countrywide 44.7%, Morgan Stanley Mortgage Capital Inc. (“MorganStanley”) 18.5% and Wells Fargo Funding Inc. (“Wells Fargo”) 12.5% of allloan sales. If Countrywide, Wells Fargo or Morgan Stanley changes its correspondentlending strategy or procedures, or stops purchasing our loans on favorableterms, we could be required to find alternate purchasers and/or acceptunfavorable terms. We could also be forced to find other sources of warehouseline borrowing. Any of these events may have an adverse effect on our resultsof operations.

 

*Dependency on Correspondent Investors, Secondary Markets*

 

Ourability to generate gains on the sales of mortgages is largely dependent uponthe continuation of correspondent lending programs offered by largecorrespondent lenders, as well as our continued eligibility to participate insuch programs. Although we are in good standing with a number of largecorrespondent lenders and are not aware of any proposed discontinuation of, orsignificant reduction in, the operation of such programs, any such changescould have a material adverse effect on our operations. We anticipate that wewill continue to remain eligible to participate in such programs, but anysignificant impairment of such eligibility would materially adversely affectour operations.

 

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

 

Alarge proportion of loans we fund are concentrated in California (33% by loanvolume) of all loans closed for the nine month period ended September 30, 2005.Although we have expanded our operations on the East Coast of the UnitedStates, a significant portion of our loan origination volume is likely to bebased in California for the foreseeable future. Consequently, our results ofoperations and financial condition are dependent upon general trends in theCalifornia economy and its residential real estate market. Residential realestate 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.

 

34

----

 

*Repurchased or Non-saleable Loans May Adversely ImpactResults of Operations and Our Financial Position*

 

Inconnection with the sale of loans to correspondent investors, we make a varietyof representations and warranties regarding the loans, including those that arecustomary in the industry relating to, among other things, compliance withlaws, regulations and investor program standards and the accuracy ofinformation on the loan documents and in the loan file. In the event that aninvestor finds that a loan or group of loans violates our representations, theinvestor may require us to repurchase the loan or loan group and bear anypotential related loss on the disposition of the loans, or provide anindemnification for any losses sustained by the investor on the loans.Additionally, we may inadvertently originate a loan that does not meet investorunderwriting criteria or has some other defect, requiring us to sell the loansat a significant discount. We have hired experienced personnel at all levelsand have established significant controls to ensure that all loans areoriginated to our underwriting standards, and are maintained in compliance withall of the representations made by us in connection with our loan saleagreements. However, there can be no assurances that mistakes will not be madeor that certain employees will not deliberately violate our lending policiesand, accordingly, we are subject to repurchase risk and losses on unsaleableloans. Typically, with respect to any loan that might be repurchased orunsaleable, we would correct the flaws if possible and re-sell the loan in themarket. We have created repurchase reserves to provide for this contingency onour financial statements, but there can be no assurances that these reservesare adequate, or that loan losses associated with repurchased or unsaleableloans will not adversely impact results of operations or the financialcondition of our Company. Additionally, should an investor or group ofinvestors experience an adverse trend of non-compliant loans from our Company,we could lose the privilege of selling loans to the investor(s), which couldhave a material adverse impact on our ability to sell our loans and thusadversely impact the results of operations or the financial condition of the Company.

 

*The Company Provides Loans to Subprime Borrowers which MayAdversely Affect Earnings*

 

Creditrisks associated with subprime mortgage loans will be greater than thoseassociated with mortgage loans that conform to FNMA and FHLMC guidelines. Theprinciple difference between subprime mortgage loans and conforming mortgageloans is that subprime mortgage loans typically include one or more of thefollowing: worse credit and income histories of the mortgagors, higherloan-to-value ratios, reduced or alternative documentation required forapproval of the mortgagors, different types of properties securing the mortgageloans, higher loan sizes and the mortgagor’s non-owner occupancy status withrespect to the mortgaged property. We have added personnel in a centralizedsubprime underwriting and funding center to help mitigate the risks associatedwith these loans, however there can be no assurance that all subprime loanswill be able to be sold to investors at a profit. If we are not successful,higher overhead incurred to produce these loans may not be covered by theincome derived from subprime lending.

 

*The Nationwide Scope of Our Operations Exposes Us to Risksof Noncompliance with an Increasing and Inconsistent Body of Complex Laws andRegulations at the Federal, State and Local Levels*

 

Weoriginate mortgage loans in many states. We must comply with the laws andregulations, as well as judicial and administrative decisions, of all of thesejurisdictions, as well as an extensive body of federal laws and regulations.The volume of new or modified laws and regulations has increased in recentyears and in addition, individual cities and counties have begun to enact lawsthat restrict loan origination activities in those cities and counties. Thelaws and regulations of each of these jurisdictions are different, complex and,in some cases, in direct conflict with each other. As our operations continueto grow, it may be more difficult to comprehensively identify, to accuratelyinterpret and to properly program our technology systems and effectively trainour personnel with respect to all of these laws and regulations, therebypotentially increasing our exposure to the risks of noncompliance with theselaws and regulations.

 

Ourfailure to comply with these laws can lead to the following consequences, anyof which could have an adverse effect on our ability to operate our businessand 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*

 

Inrecent years, several federal, state and local laws, rules and regulations havebeen adopted, or are under consideration, that are intended to eliminateso-called “predatory” lending practices. These laws, rules and regulationsimpose certain restrictions on loans on which certain points and fees or theannual percentage rate (“APR”) exceeds specified thresholds. Some of theserestrictions expose a lender to risks of litigation and regulatory sanction nomatter how carefully a loan is underwritten. In addition, an increasing

 

35

----

 

number of these laws, rules and regulationsseek to impose liability for violations on purchases of loans, regardless ofwhether a purchaser knew of or participated in the violation.

 

Itis against our policy to engage in predatory lending practices and /or originatehigh cost loans which are defined as mortgage loans that feature either aninterest rate or points and fees charged in connection with loans that exceedcertain thresholds prescribed by federal or state law or local ordinances. Wehave generally avoided originating loans that exceed the APR or “points andfees” thresholds of these laws, rules and regulations. The companies that buyour loans and/or provide financing for our loan origination operationsgenerally do not want to buy or finance such loans. The continued enactment ofthese laws, rules and regulations may prevent us from making certain loans. Inaddition, the difficulty of managing the risks presented by these laws, rulesand regulations may decrease the availability of warehouse financing and theoverall demand for loans, making it difficult to fund, sell or securitize anyof our loans. If we relax our restrictions on loans subject to these laws,rules and regulations because the companies which buy our loans and/or providefinancing for our loan origination operations relax their restrictions, we willbe subject to greater risks for actual or perceived non-compliance with suchlaws, rules and regulations, including demands for indemnification or loanrepurchases from our lenders and loan purchasers, class action lawsuits,increased defenses to foreclosure of individual loans in default, individualclaims for significant monetary damages and administrative enforcement actions.The growing number of these laws, rules and regulations will likely increaseour cost of doing business as we are required to develop systems and proceduresto ensure that we do not violate any aspect of these new requirements. Any ofthe foregoing could materially and adversely affect our business, financialcondition, liquidity and results of operations.

 

*An Interruption In or Breach of Our Information Systems MayResult In Lost Business*

 

Werely heavily upon communications and information systems to conduct ourbusiness. As we implement our growth strategy and increase our volume of loanproduction, that reliance will increase. Any failure or interruption or breachin security of our information systems or the third-party information systemson which we rely could cause underwriting or other delays and could result infewer loan applications being received, slower processing of applications andreduced efficiency in loan servicing. We utilize proprietary software for ourmain loan origination system. This software is not fully documented and we havea limited number of employees who are knowledgeable about this application. Wecannot assure you that systems failure or interruptions will not occur, or ifthey do occur that they will be adequately addressed by us or the third partieson which we rely. The occurrence of any failures or interruptions couldsignificantly harm our business.

 

*The Success and Growth of Our Business Will Depend Upon OurAbility to Adapt to, Implement and Maintain Technological Changes*

 

Ourmortgage loan origination business is currently dependent upon our ability toeffectively interface with our brokers, borrowers and other third parties andto efficiently process loan applications and fund loans. The originationprocess is becoming more dependent upon technological advancement, such as theability to process applications over the internet, accept electronicsignatures, and provide process status updates instantly and othercustomer-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 Account Executives andQualified Personnel to Produce Our Desired Level of Revenues*

 

TheCompany relies on commissioned account executives to generate loan referralsfrom professional mortgage brokers. These account executives typically haveestablished relationships with brokers. The Company’s overall loan fundings aredependent upon the number of account executives, and as such, sustained loanproduction and market share growth are dependent on the successful retentionand recruitment of the sales force. Similarly, the Company relies on theexpertise of its employees in other facets of operations, includingunderwriting, capital markets, risk management, and finance and accounting.Given the dependency on the job market for qualified employees, to continue ourgrowth poses the potential risk that the Company will not be able to attractand retain qualified employees.

 

*Capital Shortages Could Impede the Ability to Execute OurMortgage Banking Strategy*

 

Ourmortgage banking activities require a significant level of cash reserves and capitalto support loan inventories and overhead exposure. Additionally, while weutilize warehouse credit facilities to fund our loan origination activity, wemust invest cash equity in our loan inventories approximating 1.0% to 4.0% ofthe cost basis of these loans. While we believe our capital base, cash reservesand cash flow from mortgage banking revenues will be sufficient to enable us toexecute our mortgage banking strategy, there can be no assurances that capitalshortages will not occur, requiring us to raise additional debt or equitycapital or decrease or cease our origination activities.

 

*We Are Subject To Losses Due To Errors or Fraudulent Acts OnThe Part Of Loan Applicants, Employees or Mortgage Brokers*

 

Mortgagebrokers who assist loan applicants in obtaining mortgage loans refer all of themortgage loans originated or

 

36

----

 

purchased by us. As such, the loanapplication, property appraisal, credit report and other supportingdocumentation are furnished by the mortgage broker and used by our underwritersto make approval or denial decisions. There could also be the potential ofcollusion between the broker and an employee to produce a fraudulent loan. Ouremployees usually have little contact with loan applicants, and rely on themortgage broker to obtain and furnish all of the documentation supporting themortgage loan application. Mortgage brokers may make mistakes in completing thedocumentation for a loan leading to an increased risk of our holding anon-saleable loan or of indemnifying or repurchasing loans from investors.

 

Further,in rare cases, the mortgage broker may knowingly or unknowingly submit anapplication wherein multiple parties to the transaction (borrower, appraiser,seller, or title insurer) work in collusion to inflate the property valueand/or falsify other documentation in order to obtain a mortgage loan. Thesetypes of fraudulent mortgage loans will have a high risk of default, and willlikely not be fully recoverable through disposition of the underlying propertysecuring 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 toprovide income documentation, the mortgage broker may intentionally coach aborrower to make material misrepresentations in order to qualify for a loan.

 

Shouldmaterial fraud be detected on a mortgage loan prior to sale to an investor, themortgage loan may have to be sold at a significant discount or may not besaleable. Should material fraud or mistakes in loan documentation be detectedafter a mortgage loan is sold to a correspondent investor, we may be requiredto repurchase the loan or indemnify the investor. While the investor and/or wecan initiate foreclosure proceedings on any loan deemed to be fraudulentlyobtained, we could incur significant losses on these fraudulent mortgage loansif principal or interest is not fully recovered through the foreclosure anddisposition of the underlying property securing the mortgage loan.

 

Wehave established risk management and quality control committees to set policyand manage exposure to credit losses due to fraud, compliance errors ornon-compliance with our underwriting standards. We have representations andwarranties agreed upon by our correspondent lending customers to repurchaseloans which do not meet certain standards. Regular quality control audits aredone on representative samples of mortgage loans and all mortgage loanssubmitted by brokers who come under suspicion in the normal course of business.Additionally, we have numerous controls and processes to ensure that all of themortgage loan applications submitted through mortgage brokers are not based onfraudulent or intentionally misrepresented documentation. However, there can beno assurances that the broker and/or borrowers do not submit fraudulent orinaccurate documentation that is not detected by our personnel or by electronicfraud checks 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 Network ofIndependent Brokers, Our Loan Origination Business Will Decrease*

 

Allof our mortgage loan originations come from independent brokers. Our brokersare not contractually obligated to do business with us. Many of our brokershave not been in business more than a few years. Further, our competitors alsohave relationships with our brokers and actively compete with us in our effortsto expand our broker networks. Accordingly, we cannot assure you that we willbe successful in maintaining our existing relationships or expanding our brokernetworks, the failure of which would significantly harm our business, financialcondition, liquidity and results of operations.

 

*We May be Subject to Fines or Other Penalties Based Upon theConduct of Our Independent Brokers*

 

Themortgage brokers from which we obtain loans have legal obligations to whichthey are subject. While these laws may not explicitly hold the originatinglenders responsible for the legal violations of mortgage brokers, increasinglyfederal and state agencies have sought to impose such assignee liability.Recently, for example, the United States Federal Trade Commission (“FTC”)entered into a settlement agreement with a mortgage lender in which the FTCcharacterized a broker that had placed all of its loan production with a singlelender as the “agent” of the lender, and the FTC imposed a fine on the lenderin part because, as “principal,” the lender was legally responsible for themortgage broker’s unfair and deceptive acts and practices. The United StatesJustice Department in the past has sought to hold a mortgage lender responsiblefor the pricing practices of its mortgage brokers, alleging that the mortgagelender was directly responsible for the total fees and charges paid by theborrower under the Fair Housing Act even if the lender neither dictated whatthe mortgage broker could charge nor kept the money for its own account.Accordingly, we may be subject to fines or other penalties based upon theconduct of our independent mortgage brokers.

 

37

----

 

ITEM 3.

QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Aprimary market risk facing our Company is interest rate risk, which is highlysensitive to many factors, including governmental monetary and tax policies,domestic and international economic and political considerations and otherfactors beyond our control. We attempt to manage this risk on a daily basis.

 

*Mortgage Origination – Interest Rate Risk*

 

Ratelock commitments and mortgage loans held for sale are subject to market pricefluctuation until committed for sale. These fluctuations are primarily tied tochanges in market interest rates and the relationship of short-term rates tolong-term rates. In order to mitigate this risk, a variety of financialderivative instruments (including forward mandatory mortgage security sales [TBA]and options on TBA sales) are utilized to hedge or mitigate market price fluctuations.These instruments are classified as derivative financial instruments on ourfinancial statements. Our hedge positions are continually adjusted based onroutine and ongoing quantification of our risk, but hedges may or may not befully successful in complete risk mitigation. In particular, our capitalmarkets personnel must make estimates of the percentage of rate lockcommitments expected to close under different interest rate changes. Losses onthe sale of mortgage loans not offset by corresponding gains on hedgepositions, or hedging activity not offset by corresponding gains on the sale ofmortgages, could adversely impactresults of operations and our financial position.

 

*Other Risks*

 

Our ability to generate gains on the sales of mortgages is largelydependent upon the continuation of correspondent investor programs offered bylarge institutions. Typically these institutions have mortgage bankingoperations with which we compete. At any point in time an investor coulddiscontinue our business relationship and therefore narrow the scope ofinvestors available to buy our loans.

 

**SensitivityAnalysis**

 

Themethods we have used in our sensitivity analysis have not changed significantlysince December 31, 2004.  We haveperformed various sensitivity analyses that quantify the net financial impactof changes in interest rates on our interest rate-sensitive assets, liabilitiesand commitments. These analyses presume an instantaneous parallel shift of theyield curve. Various techniques are employed to value the underlying financialinstruments, and these techniques rely upon a number of critical assumptions.The scenarios presented in the table below are illustrative. Actual experiencemay differ materially from the estimated amounts presented for each scenario.To the extent that yield curve shifts are non-parallel, and to the extent thatactual variations in significant assumptions differ from those applied forpurposes of the valuations, the resultant valuations can also be expected tovary. Such variances may prove material.

 
| ** **                                                             | ** ** | **(dollars in thousands)** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                             | ** ** | ** **                 | ** ** | ** ** | ** ** | **If Interest Rates Were To** | ** ** |
| ** **                                                             | ** ** | **September 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                                              |       | $                          | 21,663     |   | $ | 21,663 |   | $ | 21,663 |   | $ | 21,663 |   | $ | 21,663 |   | $ | 21,663 |   |
| Mortgage loans held for sale, net, pledged,  (lower of cost or market) |       | 736,886                    |       | 740,497 |   | 737,453 |   | 742,849 |   | 734,323 |   | 745,117 |   |
| Derivative financial instruments                                       |       | 851                        |       | 851 |   | 4,063 |   | (2,234 | ) | 6,236 |   | (6,935 | ) |
| Bond collateral and real estate owned, net                             |       | 11,105                     |       | 11,779 |   | 11,782 |   | 11,768 |   | 11,782 |   | 11,777 |   |
| Total interest-earning assets                                          |       | $                          | 770,505    |   | $ | 774,790 |   | $ | 774,961 |   | $ | 774,046 |   | $ | 774,004 |   | $ | 771,622 |   |
|                                                                   |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                          |       |                       |       |   |   |   |   |   |   |   |   |   |   |
| Short-term debt                                                        |       | $                          | 710,951    |   | $ | 710,951 |   | $ | 710,951 |   | $ | 710,951 |   | $ | 710,951 |   | $ | 710,951 |   |
| Long-term debt, net                                                    |       | 9,317                      |       | 9,317 |   | 9,317 |   | 9,317 |   | 9,317 |   | 9,317 |   |
| Total interest-bearing liabilities                                     |       | $                          | 720,268    |   | $ | 720,268 |   | $ | 720,268 |   | $ | 720,268 |   | $ | 720,268 |   | $ | 720,268 |   |

 

Thefollowing describes the methods and assumptions used by the Company inestimating fair values.

 

*Cashand Cash Equivalents*

 

Thecarrying amount for cash and cash equivalents approximates fair value becausethese instruments are demand deposits and money market accounts and do notpresent unanticipated interest rate or credit concerns.

 

38

----

 

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

 

Thefair value is estimated based on quoted market prices from institutionalinvestors for similar types of mortgage loans. A portion of mortgage loans heldfor sale are committed for sale under mandatory sale arrangements and as suchare not re-valued for subsequent changes in interest rates.

 

*Derivativefinancial instruments*

 

Fairvalues of forward sales of mortgage-backed securities and options onmortgage-backed securities are based on quoted market prices for theseinstruments. Fair values of our commitments to originate loans are based on anydifference in the value of the loans expected to close between the time of therate lock commitment and the current market value.

 

*Bond Collateral, Mortgage Loansand Real Estate Owned, Net*

 

Thefair value of Bond Collateral is estimated based on quoted market prices fromdealers and brokers for similar types of mortgage loans in the bulk mortgagemarket. Market prices reflect various assumptions as to prepayment rates, loanlosses and financing costs.

 

*Short-TermDebt*

 

Thefair value of the warehouse line debt and short-term debt related to bondcollateral held for sale approximates the carrying amounts because of theshort-term nature of the debt and interest on the debt fluctuates with marketinterest rates.

 

*Long-TermDebt*

 

Thefair value of long-term debt is estimated based upon all long-term debt beingat variable rates and therefore cost approximates fair market value.

 

ITEM4.  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.

 
| 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 nine months ended September  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                                                                                                                                                                                                                                                                                                                                                                        |
|      | The Company distributed its Definitive Proxy Statement, Proxy and  Annual Report to Stockholders on or about July 5, 2005 for its Annual Meeting  of Stockholders held August 10, 2005.   At the Company’s Annual Meeting, the stockholders were asked to  consider one proposal.

 

The proposal considered by the stockholders of the Annual Meeting  involved the election of three Class II directors. |

 

39

----

 
|   | The existing Board of Directors selected three nominees, all of whom  ran unopposed and each of whom was then serving as a Class II director.  The nominees of the Board, and the voting  results with respect thereto, were: |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 
| **Name**          | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
|-------------------|------------|---------------|------------|--------------|------------|
|              |       |          |       |         |       |
| Robert A.  Gunst  |       | 7,104,582     |       | 0            |       |
| Keith A.  Johnson |       | 7,104,582     |       | 0            |       |
| Richard T.  Pratt |       | 7,101,330     |       | 3,252        |       |

 
|    | The following directors’ terms of office continued after the Annual  Meeting:  H. James Brown, David  Nierenberg, Herbert Tasker, John Robbins, Robert T. Barnum and Mark J. Riedy. |
|---------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                                          |
| ITEM 5. | OTHER  INFORMATION                                                                                                                                                                            |

 

(a)   On September 2, 2005, at the recommendationof the special committee of our board of directors, our board authorized us toreimburse the reasonable fees and expenses of a single law firm representingour executive officers in connection with (i) the negotiation of their employmentarrangements in connection with the proposed merger with Wachovia and (ii)related matters, including the description of those arrangements included inthe proxy statement filed with the SEC in connection with the merger.

 

We have negotiated with Wachovia Bank,National Association a master repurchase warehouse facility under which wecould borrow up to $500 million, subject to compliance with applicablefinancial covenants, to fund the origination of mortgage loans.  Subject to the receipt of written consentsunder our four existing warehouse facilities, we and Wachovia currently intendto enter into this new facility in the near future.

 

The Wachovia repurchase facility would beuncommitted and would be terminable at any time by Wachovia, in its sole discretion,subject to a 45-day period provided for us to remove collateral from thefacility.  Borrowings under the facilitywould be secured by the mortgage loans sold thereunder and would bear interestat one-month LIBOR plus a spread.  Theinterest cost to us under this facility would be less than we are obligated topay under our existing facilities.  Wewould be permitted to borrow from 96% to 98% of the lesser of par or marketvalue of the loans, depending on the lien priority of the loans.  The repurchase facility would be repaid asprincipal payments on the mortgage loans are received, or as the mortgage loansare sold.  The repurchase facility wouldhave lender covenants restricting, among other things, the absolute level ofleverage and requiring a minimum level of cash reserves, profitability andstockholders’ equity and such covenants would be comparable to those in ourother existing warehouse facilities.

 

The newWachovia warehouse facility, if put into effect, would be in addition to ourfour other existing warehouse facilities. At September 30, 2005, assuming the new Wachovia warehouse facilityhad been in place, the maximum borrowing capacity combined from the fivewarehouse facilities would have been $2.4 billion.  However, due to the restrictions imposed bythe most restrictive of the financial covenants contained in the existingfacilities, the actual maximum amount that we would have been able to borrowfrom the five warehouse facilities would have been $944 million in theaggregate*.*

 
|    | (b)   None |
|---------|---------------------------|
|    |                      |
| ITEM 6. | EXHIBITS                  |

 
|   | (a)    | ** ** | ** ** | Exhibits | ** ** | ** **                                                                                                                                                                              |
|--------|--------|------------|------------|----------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | (13)       |       | 2.1      |       | Amended and Restated Agreement and Plan of Merger dated as of  September 13, 2005, by and among AmNet Mortgage, Inc., Wachovia  Bank, National Association and PTI, Inc. |
|   |   | (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.                                                                                  |

 

40

----

 
|   |   | (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                                                             |
|   |   | (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    |
|   |   |   |   | 10.41   |   | Executive Officer Reimbursement Program – Reimbursement of Certain  Legal Expenses                     |
|   |   |   |   | 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                                                                   |

 

----

|   |   | (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) |   | Incorporated by reference to the Company’s  Quarterly Report on Form 10-Q for the quarter ended June 30, 2005 filed  August 15, 2005.                |
|   |   | (13) |   | Incorporated by reference to the Company’s current  Report on Form 8-K filed September 13, 2005 (File No. 001-13485).                                |

 

41

----

 

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:  November 14, 2005 | By:                   | /s/  Judith A. Berry |   |
|                      |                  | Judith  A. Berry, |
|                      |                  | Executive  Vice President  Chief Financial Officer |

 

42

----