**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, 2003**                                         |
|       |   |                                                                                            |
| **OR**     |
|       |   |                                                                                            |
| **o**      |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|       |   |                                                                                            |
|       |   | **Commission File Number:  1-13485**                                                       |

 

**AMERICANRESIDENTIAL INVESTMENT TRUST, 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 since  last report) |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 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 theAct). 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) |   | 7,855,547 as of October 16, 2003 |
|----------------------|--------|----------------------------------|

 

 

----

 
| INDEX                                                                                                                                                                                                                 |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                  |
| PART I.  FINANCIAL  INFORMATION                                                                                                                                                                                  |
|                                                                                                                                                                                                                  |
| Item 1. Consolidated Financial  Statements                                                                                                                                                                            |
|                                                                                                                                                                                                                  |
| Consolidated Balance Sheets at September 30, 2003  and September 30, 2002                                                                                                                                             |
|                                                                                                                                                                                                                  |
| Consolidated Statements of  Operations and Comprehensive Income (Loss) for the three months ended  September 30, 2003 and September 30, 2002 and for the nine months ended  September 30, 2003 and September 30, 2002 |
|                                                                                                                                                                                                                  |
| Consolidated Statements of Cash Flows for the nine  months ended September 30, 2003 and September 30, 2002.                                                                                                           |
|                                                                                                                                                                                                                  |
| 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. Changes in 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 and Reports on Form 8-K                                                                                                                                                                              |

 

----

 

PART I.  FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

 

**AmericanResidential Investment Trust, Inc. and Subsidiaries**

Consolidated Balance Sheets

(in thousands, except share and per share data)

 
|                                                                                                                                                                                                    |   | **(unaudited)**         |       |                   |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|------------|
|                                                                                                                                                                                                    |   | **September  30, 2003** |       | **December  31, 2002** |       |
| ASSETS                                                                                                                                                                                                  |   |                    | ** ** |                   | ** ** |
| Cash  and cash equivalents                                                                                                                                                                              |   | $                       | 44,357     |                   | $          | 13,647 |   |
| Cash  and cash equivalents – restricted                                                                                                                                                            |   | 2,100                   |       | 1,125                  |       |
| Mortgage  loans held for sale, net, pledged, (lower of cost or market)                                                                                                                                  |   | 367,013                 |       | 390,125                |       |
| Bond  collateral, mortgage loans, net                                                                                                                                                                   |   | 181,551                 |       | 259,851                |       |
| Bond  collateral, real estate owned                                                                                                                                                                     |   | 4,380                   |       | 9,527                  |       |
| Accounts  receivable – mortgage loans sold/funded                                                                                                                                                  |   | 4,552                   |       | 6,205                  |       |
| Accrued  interest receivable                                                                                                                                                                            |   | 1,387                   |       | 1,852                  |       |
| Deferred  tax asset                                                                                                                                                                                     |   | 9,865                   |       | 43                     |       |
| Other  assets                                                                                                                                                                                           |   | 5,297                   |       | 2,932                  |       |
|                                                                                                                                                                                                    |   | $                       | 620,502    |                   | $          | 685,307 |   |
|                                                                                                                                                                                                    |   |                    |       |                   |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                              |   |                    |       |                   |       |
| Liabilities:                                                                                                                                                                                            |   |                    |       |                   |       |
| Short-term  debt                                                                                                                                                                                        |   | $                       | 352,777    |                   | $          | 378,553 |   |
| Long-term  debt, net                                                                                                                                                                                    |   | 153,284                 |       | 237,456                |       |
| Derivative  financial instruments                                                                                                                                                                       |   | 3,826                   |       | 2,307                  |       |
| Accrued  interest payable                                                                                                                                                                               |   | 543                     |       | 582                    |       |
| Accrued  expenses and other liabilities                                                                                                                                                                 |   | 21,123                  |       | 6,811                  |       |
| Total  liabilities                                                                                                                                                                                      |   | 531,553                 |       | 625,709                |       |
|                                                                                                                                                                                                    |   |                    |       |                   |       |
| Commitments  and contingencies (Note 15)                                                                                                                                                                |   | —                  |       | —                 |       |
|                                                                                                                                                                                                    |   |                    |       |                   |       |
| Minority  interest                                                                                                                                                                                      |   | 122                     |       | 113                    |       |
|                                                                                                                                                                                                    |   |                    |       |                   |       |
| Stockholders’  Equity:                                                                                                                                                                             |   |                    |       |                   |       |
| Preferred  stock, par value $.01 per share; 1,000 shares authorized; no shares issued  and outstanding                                                                                                  |   | —                  |       | —                 |       |
| Common  stock, par value $.01 per share; 25,000,000 shares authorized; 7,855,547  shares issued and outstanding at September 30, 2003 and 7,862,490 shares  issued and outstanding at December 31, 2002 |   | 79                      |       | 79                     |       |
| Additional  paid-in-capital                                                                                                                                                                             |   | 108,655                 |       | 108,760                |       |
| Accumulated  deficit                                                                                                                                                                                    |   | (19,907                 | )          | (49,354                | )          |
| Total  stockholders’ equity                                                                                                                                                                        |   | 88,827                  |       | 59,485                 |       |
|                                                                                                                                                                                                    |   | $                       | 620,502    |                   | $          | 685,307 |   |

 

See accompanying notes to consolidated financial statements.

 

3

----

 

American Residential Investment Trust, Inc. and Subsidiaries

Consolidated Statements ofOperations and Comprehensive Income, unaudited

(in thousands, except per share data)

 
|                                                                    |   | **For the  Three Months   Ended   September 30,   2003** |       | **For the  Three Months   Ended  September 30,  2002** |       | **For the  Nine Months   Ended  September 30,  2003** |       | **For the  Nine Months   Ended   September 30,   2002** |       |
|-------------------------------------------------------------------------|--------|----------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Revenues**                                                            |   |                                                     | ** ** |                                                   | ** ** |                                                  | ** ** |                                                    | ** ** |
| Gain  on sales of loans                                                 |   | $                                                        | 9,580      |                                                   | $          | 18,808                                                |       | $                                                       | 62,760     |   | $ | 25,254 | ** ** |
| Derivative  financial instruments and market adjustments                |   | 15,149                                                   |       | (15,202                                                | )          | 3,654                                                 |       | (23,603                                                 | )          |
| Interest  on mortgage assets, net of premium amortization               |   | 13,046                                                   |       | 7,155                                                  |       | 32,684                                                |       | 21,571                                                  |       |
| Litigation  settlement                                                  |   | —                                                   |       | —                                                 |       | —                                                |       | 10,281                                                  |       |
| Other  income                                                           |   | 558                                                      |       | 245                                                    |       | 1,021                                                 |       | 1,081                                                   |       |
| Total  revenue, net of derivative financial instruments and adjustments |   | 38,333                                                   |       | 11,006                                                 |       | 100,119                                               |       | 34,584                                                  |       |
|                                                                    |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| **Expenses**                                                            |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| Employee  compensation and benefits                                     |   | 14,030                                                   |       | 5,170                                                  |       | 36,100                                                |       | 11,868                                                  |       |
| Interest  expense                                                       |   | 5,646                                                    |       | 4,792                                                  |       | 14,456                                                |       | 12,691                                                  |       |
| Office  and occupancy expense                                           |   | 706                                                      |       | 383                                                    |       | 1,894                                                 |       | 1,073                                                   |       |
| Provision  for loan losses                                              |   | 764                                                      |       | 1,492                                                  |       | 2,478                                                 |       | 4,619                                                   |       |
| (Gain)  loss on sale of real estate owned, net                          |   | (236                                                     | )          | (281                                                   | )          | (751                                                  | )          | 152                                                     |       |
| Professional  fees                                                      |   | 1,432                                                    |       | 1,225                                                  |       | 4,174                                                 |       | 3,087                                                   |       |
| Other  operating expenses                                               |   | 5,002                                                    |       | 1,771                                                  |       | 12,781                                                |       | 4,204                                                   |       |
| Total  expenses                                                         |   | 27,344                                                   |       | 14,552                                                 |       | 71,132                                                |       | 37,694                                                  |       |
|                                                                    |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| Income  before income taxes                                             |   | 10,989                                                   |       | (3,546                                                 | )          | 28,987                                                |       | (3,110                                                  | )          |
| Income  taxes                                                           |   | 3,945                                                    |       | —                                                 |       | 9,423                                                 |       | 7                                                       |       |
| Income  tax benefit from utilization of REIT net operating losses       |   | (724                                                     | )          | —                                                 |       | (9,865                                                | )          | —                                                  |       |
| Net  income (loss)                                                      |   | 7,768                                                    |       | (3,546                                                 | )          | 29,429                                                |       | (3,117                                                  | )          |
|                                                                    |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| Other  comprehensive loss                                               |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| Unrealized  loss on retained interest in securitization, net of tax     |   | —                                                   |       | (32                                                    | )          | —                                                |       | (449                                                    | )          |
| Total  comprehensive income (loss)                                      |   | $                                                        | 7,768      |                                                   | $          | (3,578                                                | )          | $                                                       | 29,429     |   | $ | (3,566 | ) |
|                                                                    |   |                                                     |       |                                                   |       |                                                  |       |                                                    |       |
| Net  income (loss) per share of common stock – basic               |   | $                                                        | 0.99       |                                                   | $          | (0.45                                                 | )          | $                                                       | 3.74       |   | $ | (0.39 | ) |
| Net  income (loss) per share of common stock - diluted                  |   | $                                                        | 0.91       |                                                   | $          | (0.45                                                 | )          | $                                                       | 3.45       |   | $ | (0.39 | ) |

 

See accompanying notes to consolidated financial statements

 

4

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American Residential Investment Trust, Inc. and Subsidiaries

Consolidated Statements of Cash Flows, unaudited

(in thousands)

 
|                                                                           |   | **For the****Nine Months   EndedSeptember 30,  2003** |   | **For the   Nine Months   Ended****September 30,  2002** |   |
|--------------------------------------------------------------------------------|--------|-------------------------------------------------------|--------|----------------------------------------------------------|--------|
|                                                                           |   |                                                  |   |                                                     |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                           |   |                                                  |   |                                                     |   |
| Net income (loss)                                                              |   | $                                                     | 29,429 |                                                     | $      | (3,117 | ) |
| Adjustments to reconcile net income to net cash  used in operating activities: |   |                                                  |   |                                                     |   |
| Amortization of mortgage assets premiums                                       |   | 2,663                                                 |   | 7,619                                                    |   |
| Amortization of CMO capitalized costs                                          |   | 265                                                   |   | 455                                                      |   |
| Provision for loan losses                                                      |   | 2,477                                                 |   | 4,619                                                    |   |
| Decrease on retained interest in securitization                                |   | —                                                |   | 676                                                      |   |
| Loss (gain) on sale of real estate owned                                       |   | (751                                                  | )      | 152                                                      |   |
| Proceeds from sale of mortgage loans held for sale                             |   | 8,345,391                                             |   | 2,014,496                                                |   |
| Mortgage loan originations                                                     |   | (8,322,279                                            | )      | (2,220,329                                               | )      |
| Decrease (increase) in accounts  receivable-mortgage loans sold/funded         |   | 1,653                                                 |   | (21,848                                                  | )      |
| Increase in restricted cash                                                    |   | (975                                                  | )      | (750                                                     | )      |
| Decrease (increase) in derivative financial  instruments                       |   | 1,519                                                 |   | (1,171                                                   | )      |
| Decrease in accrued interest receivable                                        |   | 465                                                   |   | 1,024                                                    |   |
| Decrease in due from affiliate                                                 |   | —                                                |   | 159                                                      |   |
| Increase in deferred tax asset                                                 |   | (9,822                                                | )      | —                                                   |   |
| Increase in other assets                                                       |   | (2,347                                                | )      | (933                                                     | )      |
| Increase (decrease) in accrued interest payable                                |   | (39                                                   | )      | 373                                                      |   |
| Increase in accrued and other expenses                                         |   | 14,312                                                |   | 5,366                                                    |   |
| Decrease in due to affiliate                                                   |   | —                                                |   | (10                                                      | )      |
| Increase in minority interest                                                  |   | 9                                                     |   | 14                                                       |   |
| Net cash provided by /(used) in operating  activities                          |   | 61,970                                                |   | (213,205                                                 | )      |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                          |   |                                                  |   |                                                     |   |
| Principal payments on bond collateral, mortgage  loans, net                    |   | 68,782                                                |   | 131,987                                                  |   |
| Proceeds from sale of real estate owned                                        |   | 10,276                                                |   | 11,319                                                   |   |
| Net cash provided by investing activities                                      |   | 79,058                                                |   | 143,306                                                  |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                          |   |                                                  |   |                                                     |   |
| Payments on long-term debt                                                     |   | (25,776                                               | )      | (149,788                                                 | )      |
| Increase in net borrowings from short-term debt                                |   | (84,437                                               | )      | 220,625                                                  |   |
| Stock options exercised                                                        |   | (40                                                   | )      | —                                                   |   |
| Purchase treasury stock                                                        |   | (145                                                  | )      | (236                                                     | )      |
| Net cash (used in)/provided by financing  activities                           |   | (110,318                                              | )      | 70,601                                                   |   |
| Net increase in cash and cash equivalents                                      |   | 30,717                                                |   | 702                                                      |   |
| Cash and cash equivalents at beginning of period                               |   | 13,647                                                |   | 10,726                                                   |   |
| Cash and cash equivalents at end of period                                     |   | $                                                     | 44,357 |                                                     | $      | 11,428 |   |
| Supplemental information-interest paid                                         |   | $                                                     | 15,579 |                                                     | $      | 12,917 |   |
|                                                                           |   |                                                  |   |                                                     |   |
| Non-cash transactions:                                                         |   |                                                  |   |                                                     |   |
| Transfers from bond collateral, mortgage loans,  net to real estate owned      |   | $                                                     | 4,378  |                                                     | $      | 13,514 |   |

 

See accompanying notes to consolidated financial statements.

 

5

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AMERICANRESIDENTIAL INVESTMENT TRUST, INC.

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

 

**Note 1.  Summary of Significant Accounting Policies and Practices**

 

*Basis of Financial StatementPresentation*

 

Theinterim financial statements included herein have been prepared by AmericanResidential Investment Trust, Inc., (“AmRIT” or the “Company”) without audit,pursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”).  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) have been condensed or omitted pursuant to such SEC rulesand regulations.  These financialstatements should be read in conjunction with the audited financial statementsand notes thereto included in the Company’s latest Annual Report.  In the opinion of management, alladjustments, including normal recurring adjustments necessary to present fairlythe consolidated financial position of the Company with respect to the interimfinancial statements and the results of the operations for the interim periodended September 30, 2003, have been included. Certain reclassifications may have been made to prior interim periodamounts to conform to the current presentation.  The results of operations for interim periods are not necessarilyindicative of results for the full year.

 

TheCompany reports segments in accordance with SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information”.  SFAS 131 establishes standards for the way companies reportinformation about operating segments in annual financial statements. EffectiveJanuary 1, 2002, the Company began reporting in two segments: the MortgageBanking Business and the Mortgage Asset Portfolio Business.

 

Duringthe first half of 1998, AmRIT formed American Residential Holdings, Inc.(“Holdings”).  Holdings was created toenable a mortgage backed securitization. More specifically, a portion of the AmRIT’s non-conformingadjustable-rate and fixed-rate, single-family whole loans (collectively,“Mortgage Loans”), acquisition and finance activities were conducted throughHoldings.  AmRIT owns all of thepreferred stock of Holdings and has a non-voting 95% economic interest inHoldings. Because AmRIT does not have voting control of Holdings, itsinvestment in Holdings was accounted for under the equity method prior toJanuary 1, 2003. Under the equity method, original equity investments inHoldings were recorded at cost and adjusted by AmRIT’s share of earnings orlosses and decreased by dividends received. In January 2003, the FASBissued FIN 46, “Consolidation of Variable Interest Entities—an interpretationof ARB No. 51.  FIN 46 addressesconsolidation by business enterprises of variable interest entities, which haveone or both of the following characteristics: 1) the equity investment atrisk is not sufficient to permit the entity to finance its activities withoutadditional subordinated financial support from other parties, which is providedthrough other interests that will absorb some or all of the expected losses ofthe entity; and 2) the equity investors lack an essential characteristicof a controlling financial interest. The Company interprets FIN 46 to requirethe consolidation of Holdings rather than accounting for Holdings under theequity method.  Prior period financialstatements have been restated to include Holdings as a consolidated entity.

 

InApril 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities,” (“SFAS 149”).  SFAS 149 amends and clarifies financial accounting and reportingfor derivative instruments and for hedging activities under FAS 133, Accountingfor Derivative Instruments and Hedging Activities.  In particular, SFAS 149 (1) clarifies under what circumstances acontract with an initial net investment meets the characteristic of aderivative discussed in paragraph 6(b) of Statement 133, (2) clarifies when aderivative contains a financing component, (3) amends the definition of an“underlying” to conform it to language used in FASB Interpretation No. 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others, and (4) amends certain otherexisting pronouncements.  Those changeswill result in more consistent reporting of contracts as either derivatives orhybrid instruments.  SFAS 149 iseffective for contracts entered into or modified after September 30, 2003,except for certain exceptions, and for hedging relationships designated afterSeptember 30, 2003.  The Company hasdetermined that SFAS 149 will not have a significant impact on its consolidatedfinancial statements.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity”(“SFAS 150”).  SFAS 150 establishesstandards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity.  SFAS 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003.  On October 29, 2003, the FASBdecided to defer certain provisions of this statement, primarily related tocertain mandatorily redeemable interests. The adoption of this standard had no material impact on the Company’sfinancial position, results of operations, or cash flows.

 

Gain on sale as presented in the Consolidated Statements of Operationsand Comprehensive Income, contains an allowance for loans which become problemloans prior to sale, as well as reserves for 1) loans which must be repurchasedor indemnified under loan sale agreements, and 2) for loans which prepay duringthe rescission period of investor loan sales.

 

**Stock Options**

 

TheCompany elected to apply APB Opinion No. 25 in accounting for its equitycompensation plans: the 1997 Stock Incentive Plan, 1997 Stock Option Plan, 1997Employee Stock Purchase Plan and 1997 Outside Directors Stock Option Plan and,accordingly, no compensation cost has been recognized in the financialstatements. SFAS 123 requires pro forma disclosures of expense computed asif the fair value based method had been applied in financial statements ofcompanies that continue to follow current practice in accounting for sucharrangements under Opinion No. 25.

 

InDecember 2002 the Financial Accounting Standards Board (“FASB”) issuedSFAS 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-basedcompensation, which the Company elected to early adopt for the twelve monthperiod ending December 31, 2002. The Company will continue to account forits stock based compensation according to the provisions of APB OpinionNo. 25.

 

6

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TheCompany does not recognize compensation cost of stock options, but hadcompensation cost for the Company’s stock options been recognized based uponthe estimated fair value on the grant date under the fair value methodologyprescribed by SFAS No. 123 as amended by SFAS No. 148, the Company’snet income and earnings per share would have been as follows (in thousands exceptearnings per share):

 
| **Nine Months Ended (unaudited) (in thousands except share  data)**                                          |   | **September 30,   2003** |   | **September 30,   2002** |   |
|--------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                                                                                         |   |                     |   |                     |   |
| Net earnings (loss) as reported                                                                              |   | $                        | 29,429 |                     | $      | (3,117 | ) |
| Deduct: Total stock-based compensation expense  determined under fair value based method, net of tax effects |   | (1,208                   | )      | (586                     | )      |
|                                                                                                         |   |                     |   |                     |   |
| Pro forma net earnings (loss)                                                                                |   | $                        | 28,221 |                     | $      | (3,703 | ) |
| Earnings (loss) per share                                                                                    |   |                     |   |                     |   |
| Basic as reported                                                                                            |   | $                        | 3.74   |                     | $      | (0.39 | ) |
| Basic pro forma                                                                                              |   | $                        | 3.59   |                     | $      | (0.47 | ) |
| Diluted as reported                                                                                          |   | $                        | 3.45   |                     | $      | (0.39 | ) |
| Diluted pro forma                                                                                            |   | $                        | 3.31   |                     | $      | (0.47 | ) |

 

Theassumptions used to calculate the fair value of options granted are evaluatedand revised as necessary to reflect market conditions and the Company’sexperience.

 

**Note 2.  Concentration of Mortgage Loan Sales**

 

Forthe nine months ending September 30, 2003, the Company has sold a majority(78%) of the mortgage loans it originates to Countrywide Home Loans, Inc. TheCompany’s considerations in deciding where to sell loans are price andoperational efficiency.  The Companyalso considers speed of execution and loan product guidelines.  The Company believes that all of the loansit sells currently could be sold to a number of other investors.

 

**Note 3.  Income Per Share**

 

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

 
|                                                                                                              |   | **For the  Three months   ended   September 30,   2003** |   | **For the  Three months   ended   September 30,   2002** |   | **For the  Nine months   ended   September 30,   2003** |   | **For the  Nine months   ended   September 30,   2002** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                                                                              |   | **(in thousands, except share data)**                    |   |
|                                                                                                              |   | **(unaudited)**                                          |   |
| Numerator:                                                                                                        |   |                                                     |   |                                                     |   |                                                    |   |                                                    |   |
| Numerator  for basic income (loss) per share                                                                      |   | $                                                        | 7,768  |                                                     | $      | (3,546                                                  | )      | $                                                       | 29,429 |   | $ | (3,117 | ) |
| Denominator:                                                                                                      |   |                                                     |   |                                                     |   |                                                    |   |                                                    |   |
| Denominator  for basic income per share - weighted average number of common shares  outstanding during the period |   | 7,858,733                                                |   | 7,879,229                                                |   | 7,861,665                                               |   | 7,892,563                                               |   |
| Denominator for diluted income (loss) per share                                                                   |   | 8,521,286                                                |   | 7,879,229                                                |   | 8,524,218                                               |   | 7,892,563                                               |   |
|                                                                                                              |   |                                                     |   |                                                     |   |                                                    |   |                                                    |   |
| Income  per share - basic                                                                                         |   | $                                                        | 0.99   |                                                     | $      | (0.45                                                   | )      | $                                                       | 3.74   |   | $ | (0.39 | ) |
| Income  per share - diluted                                                                                       |   | $                                                        | 0.91   |                                                     | $      | (0.45                                                   | )      | $                                                       | 3.45   |   | $ | (0.39 | ) |

 

Forthe nine months ended September 30, 2003 and 2002 there were 1,119,047 and1,342,100 options, respectively, that were antidilutive and, therefore, notincluded in the calculations above.

 

**Note 4.  Mortgage Loans Held for Sale, net, pledged**

 

AmRIT’ssubsidiary, American Mortgage Network, Inc. (“AmNet”) has pledged loans heldfor sale totaling approximately $367.0 million to secure credit lines(warehouse facilities) from three financial institutions. See Note 8,“Short-Term Debt.” Mortgage loans held for sale at September 30, 2003 consistof loans which have been committed for sale of approximately $158.7 million andloans available for sale at approximately $208.3 million, all of which arecarried at the lower of cost or market.

 

7

----

 

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

 

AmRIThas pledged mortgage loans as collateral in order to secure long-termdebt.  Mortgage loan bond collateralconsists primarily of adjustable-rate, conventional, 30-year mortgage loanssecured by first liens on one to four-family residential properties.  All such mortgage loan bond collateral is pledgedto secure repayment of the related long-term debt obligation.  All principal and interest (less servicingand related fees) on this bond collateral is remitted to a trustee and isavailable for payment on the long-term debt obligation.  The obligation under the long-term debt ispayable solely from the bond collateral and is otherwise non-recourse to AmRIT.The components of this bond collateral at September 30, 2003 and December 31,2002 are summarized as follows (dollars in thousands) (unaudited):

 
|                                                 |   | **CMO/REMIC  2000-2  Securitization** |       | **CMO/REMIC  1999-A  Securitization** |       | **CMO  1999-2  Securitization** |       | **CMO  1999-1  Securitization** |       | **CMO/FASIT  1998-1   Securitization** |       | **TOTAL  Bond  Collateral** |       |
|------------------------------------------------------|--------|---------------------------------------|------------|---------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|
| **At September 30, 2003**                            |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                   | ** ** |                        | ** ** |
| Mortgage loans                                       |   | $                                     | 9,068      |                                  | $          | 44,682                          |       | $                               | 68,690     |                                   | $          | 31,094                      |       | $ | 25,571 |   | $ | 179,105 |   |
| Unamortized premium                                  |   | 476                                   |       | 998                                   |       | 2,128                           |       | 909                             |       | 137                                    |       | 4,648                       |       |
| Allowance for loan losses                            |   | (93                                   | )          | (476                                  | )          | (866                            | )          | (226                            | )          | (541                                   | )          | (2,202                      | )          |
|                                                 |   | $                                     | 9,451      |                                  | $          | 45,204                          |       | $                               | 69,952     |                                   | $          | 31,777                      |       | $ | 25,167 |   | $ | 181,551 |   |
|                                                 |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                   | ** ** |                        | ** ** |
| Weighted average net coupon                          |   | 9.13                                  | %          | 9.47                                  | %          | 8.98                            | %          | 8.86                            | %          | 9.38                                   | %          | 9.15                        | %          |
| Unamortized premiums as a percent of mortgage  loans |   | 5.25                                  | %          | 2.23                                  | %          | 3.10                            | %          | 2.92                            | %          | 0.54                                   | %          | 2.59                        | %          |
|                                                 |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                   | ** ** |                        | ** ** |
| **At December 31, 2002**                             |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                   | ** ** |                        | ** ** |
| Mortgage loans                                       |   | $                                     | 15,590     |                                  | $          | 63,155                          |       | $                               | 99,214     |                                   | $          | 45,329                      |       | $ | 32,726 |   | $ | 256,014 |   |
| Unamortized premium                                  |   | 602                                   |       | 1,462                                 |       | 3,481                           |       | 1,355                           |       | 409                                    |       | 7,309                       |       |
| Allowance for loan losses                            |   | (116                                  | )          | (1,112                                | )          | (771                            | )          | (838                            | )          | (635                                   | )          | (3,472                      | )          |
|                                                 |   | $                                     | 16,076     |                                  | $          | 63,505                          |       | $                               | 101,924    |                                   | $          | 45,846                      |       | $ | 32,500 |   | $ | 259,851 | ** ** |
|                                                 |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                   | ** ** |                        | ** ** |
| Weighted average net coupon                          |   | 9.17                                  | %          | 9.50                                  | %          | 8.99                            | %          | 8.86                            | %          | 9.71                                   | %          | 9.20                        | %          |
| Unamortized premiums as a percent of mortgage  loans |   | 3.86                                  | %          | 2.31                                  | %          | 3.51                            | %          | 2.99                            | %          | 1.25                                   | %          | 2.85                        | %          |

 

TheCompany maintains an allowance for losses on mortgage loan bond collateral atan amount which it believes is sufficient to provide adequate protectionagainst losses in the mortgage loan portfolio.

 

**Note 6.  Derivative Financial Instruments**

 

Thevalue of the mortgage loans that AmNet originates is at risk due tofluctuations in interest rates during two time periods: (1) the periodbeginning when AmNet has committed to funding the loan and ending when the loancloses, or funds; and (2) the time period beginning when the loan closes and endingwhen AmNet commits to sell or sells the loan to third-party purchasers. Theseloans are collectively referred to as the loan pipeline. AmNet uses TBA’s andoptions, or “hedges”, to mitigate the adverse impact interest rate fluctuationscan have on the value of the loan pipeline. AmNet’s hedges are designed toprotect profit margins on the loan pipeline. Changes in the value of these derivative instruments closely relate tochanges in the value of the loan pipeline. The Company cannot assure however,that AmNet’s use of derivative securities will fully offset the risk of changesin interest rates. See Management’s Discussion and Analysis of FinancialCondition and Results of Operations – Business Risks Factors

 

Thefollowing is a summary of AmNet’s forward sales of mortgage- backed securities(MBS) and options on mortgage-backed securities (dollars in thousands)(unaudited):

 
| **Security**             |   | **Notional  Amount** |    | **Derivative** |   | **Short  Long** |   | **Expiration** |                                        |
|--------------------------|--------|----------------------|---------|----------------|--------|-----------------|--------|----------------|---------------------------------------------|
| FNMA 15  – Year MBS |   | $                    | 223,000 |           | TBA    |            | Short  |           | November 18, 2003 – December  16, 2003 |   |
| FNMA 30  – Year MBS |   | $                    | 367,500 |           | TBA    |            | Short  |           | October 15, 2003 –  December 11, 2003  |   |
| GNMA 15  – Year MBS |   | $                    | 3,000   |           | TBA    |            | Short  |           | October 20, 2003                            |   |
| GNMA 30  – Year MBS |   | $                    | 88,500  |           | TBA    |            | Short  |           | October 22, 2003 –  December 18, 2003  |   |
| FNMA 30  – Options  |   | $                    | 180,000 |           | Puts   |            | Long   |           | November 6, 2003 –  December 4, 2003   |   |

 

Thesederivatives are accounted for as trading securities in the accompanyingconsolidated financial statements. The increase in fair market value ofderivative financial instruments is included in the Consolidated Statements ofOperations and Comprehensive Income.

 

Theshort and long positions noted in the schedule above represent forward loansale commitments (TBA’s) (agreements to sell mortgage loans at a future date ata specified rate, a specified price and by a specified time deadline) oroptions to purchase or sell the underlying security.  Generally, long put and short TBA positions gain in value asmarket interest rates increase.

 

8

----

 

AtSeptember 30, 2003, AmNet had (i) approximately $158.7 million in mortgageloans committed for sale to specific investors, (ii) $208.3 million in fundedloans that had not yet been committed for sale or sold and, (iii) $937 millionin rate lock commitments to borrowers. These mortgage loans are for single-family residences collateralized byfirst trust deeds.

 

Derivativefinancial instruments have several components which total the amount shown onthe Consolidated Balance Sheets.  The tablebelow shows these components. (000’s)

 
| **Derivative Financial********Instruments  Components** |   | **(unaudited)** |   | **December  31, 2002** |   |
|---------------------------------------------------------|--------|-----------------|--------|------------------------|--------|
| **September  30, 2003**                                 |
| TBA’s                                              |   | $               | (9,959 | )                      | $      | (5,424 | ) |
| Options                                                 |   | 628             |   | 151                    |   |
| Fair value of rate lock commitments                     |   | 5,505           |   | 2,966                  |   |
| Total                                                   |   | $               | (3,826 | )                      | $      | (2,307 | ) |

 

Inthe Company’s mortgage banking business, determinations of fair market value(“FMV”) are made for hedging instruments the loan pipeline (collectivelyclassified as derivatives).  FMVdecisions are made based on consistently applied methods accepted within thefinancial industry in which the Company operates.  Hedging instruments are marked to market according to similar oridentical financial instruments available in the market place at the time ofthe mark. The loan pipeline mark is determined by recording market pricesavailable for loan sales and deriving a value for those loans, less a factorfor loans which will not close (loan fallout) based on Company’s history ofloan fallout. By accounting standards, the Company does not recognize anyrevenue from loan sales until a true sale has taken place. However, if theseloans are stated at a value more than could be obtained by sale in themarketplace, a valuation reserve is recorded.

 

**Note 7.  Bond Collateral, Real Estate Owned**

 

TheCompany owned 80 properties and 148 properties as of September 30, 2003 andDecember 31, 2002, respectively.  Upontransfer of loans to real estate owned (as a result of default or foreclosure),the Company records a corresponding charge against the allowance for loanlosses to write-down the real estate owned to fair value less estimated cost ofdisposal.  As of September 30, 2003 andDecember 31, 2002, real estate owned, net loss of reserves, totaled approximately$4.4 million and $9.5 million, respectively.

 

**Note 8.  Short-Term Debt**

 

Asof September 30, 2003, short-term debt consisted of revolving credit lines(warehouse facilities) used to fund the Company’s lending activities. As ofSeptember 30, 2003, mortgage loans held for sale were pledged as collateral forthe warehouse facilities. The warehouse facilities of $349.8 million withfinancial institutions provide for a maximum amount of borrowing capacity of$1.3 billion as of September 30, 2003, with outstanding amounts maturingon various dates within one year secured by mortgage loans held for sale. Thetable below shows the age of funded loans as of September 30, 2003 (unaudited).

 
| **Aging Range**    |   | **Number of  Loans** |       | **Warehouse  line usage   (000’s)** |        | **Average  Loan Balance   (000’s)** |   | **% of Total** |       |
|--------------------|--------|----------------------|------------|------------------------------------------|-------------|------------------------------------------|--------|----------------|------------|
| Less than 30 days  |   | 1,867                |       | $                                        | 307,700     |                                     | $      | 165            |       | 88.0 | % |
| 30 to 60 days      |   | 207                  |       | $                                        | 36,919      |                                     | $      | 178            |       | 10.5 | % |
| 61 days to 90 days |   | 31                   |       | $                                        | 5,158       |                                     | $      | 166            |       | 1.5 | % |
| **TOTAL**          |   | **2,105**            | ** ** | **$**                                    | **349,777** | ** **                               | **$**  | **166**        | ** ** | **100.0** | **%** |

 

Ofthe $349.8 million of warehouse line usage at September 30, 2003, $208.6million was funded through uncommitted warehouse facilities.

 

Warehousefacilities generally bear interest at LIBOR plus spread (ranging from 2.61% to2.66% [LIBOR plus spread] per annum average at September 30, 2003). Theweighted-average interest rate was 2.63% per annum for the first nine months of2003 and the facility fee was 0.25% per annum on the aggregate committed amountof the warehouse facilities. The warehouse facilities are repaid as principalpayments on mortgage loans are received, or as the mortgage loans are sold. Theagreements governing these facilities contain a number of covenants, includingcovenants based on tangible net worth, cash flows, net income, and liquidity ofthe Company. The Company is in compliance with these covenants at September 30,2003.

 

In2001, the Company also entered into a $5 million senior subordinatedsecured revolving loan agreement (Subordinated Loan Agreement). TheSubordinated Loan Agreement bears interest at 12% and matured inDecember 2002, with provisions for extension of two additional one-yearperiods at the Company’s option. The Company extended the loan for one year.The Subordinated Loan Agreement contains a number of covenants, includingcovenants based on tangible net worth, cash flows, net income and liquidity ofthe Company. The Company is in compliance with these covenants at September 30,2003. As of September 30, 2003, there was $3 million in borrowings on theSubordinated Loan Agreement.  The maturitydate of this loan has been revised by mutual agreement to April 23, 2004.

 

**Note 9.  Long-Term Debt, net**

 

Thecomponents of the long-term debt at September 30, 2003 and December 31, 2002,along with selected other information are summarized below (dollars inthousands) (unaudited):

 

9

----

 
|                                |   | **CMO/REMIC********2000-2********Securitization** |    | **CMO/REMIC********1999-A********Securitization** |   | **CMO********1999-2********Securitization** |   | **CMO********1999-1********Securitization** |   | **CMO/FASIT********1998-1********Securitization** |   | **Total********Long-Term  Debt** |   |
|-------------------------------------|--------|---------------------------------------------------|---------|---------------------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------------|--------|----------------------------------|--------|
| **At September 30, 2003**           |   |                                              |    |                                              |   |                                        |   |                                        |   |                                              |   |                             |   |
| Long-term debt                      |   | $                                                 | 8,926   |                                              | $      | 37,326                                      |   | $                                           | 61,667 |                                              | $      | 21,140                           |   | $ | 24,778 |   | $ | 153,837 |   |
| Capitalized costs on long-term debt |   | (37                                               | )       | —                                            |   | (313                                        | )      | (203                                        | )      | —                                            |   | (553                             | )      |
| Total long-term debt                |   | $                                                 | 8,889   |                                              | $      | 37,326                                      |   | $                                           | 61,355 |                                              | $      | 20,937                           |   | $ | 24,778 |   | $ | 153,284 |   |
|                                |   |                                              |    |                                              |   |                                        |   |                                        |   |                                              |   |                             |   |
| Weighted average financing rates    |   | 2.26                                              | %       | 1.28                                              | %      | 3.27                                        | %      | 1.81                                        | %      | 2.14                                              | %      | 2.34                             | %      |
|                                |   |                                              |    |                                              |   |                                        |   |                                        |   |                                              |   |                             |   |
| **At December 31, 2002**            |   |                                              |    |                                              |   |                                        |   |                                        |   |                                              |   |                             |   |
| Long-term debt                      |   | $                                                 | 15,520  |                                              | $      | 58,369                                      |   | $                                           | 94,411 |                                              | $      | 36,855                           |   | $ | 33,116 |   | $ | 238,271 |   |
| Capitalized costs on long-term debt |   | (59                                               | )       | (5                                                | )      | (447                                        | )      | (304                                        | )      | —                                            |   | (815                             | )      |
| Total long-term debt                |   | $                                                 | 15, 461 |                                              | $      | 58,364                                      |   | $                                           | 93,964 |                                              | $      | 36,551                           |   | $ | 33,116 |   | $ | 237,456 |   |
|                                |   |                                              |    |                                              |   |                                        |   |                                        |   |                                              |   |                             |   |
| Weighted average financing rates    |   | 2.04                                              | %       | 1.55                                              | %      | 3.10                                        | %      | 1.73                                        | %      | 2.44                                              | %      | 2.35                             | %      |

 

**Note 10. Stock Option Plans**

 

Asof September 30, 2003, shares of common stock were reserved for issuance underthe Company’s option plans as follows (unaudited):

 
|                                 |   | **1997   Stock   Incentive   Plan** |   | **1997   Stock   Option   Plan** |   | **1997   Employee   Stock   Purchase   Plan** |   | **1997   Outside   Director   Stock   Option****Plan** |   | **Total** |   |
|--------------------------------------|--------|-------------------------------------|--------|----------------------------------|--------|-----------------------------------------------|--------|--------------------------------------------------------|--------|-----------|--------|
|                                 |   |                                |   |                             |   |                                          |   |                                                   |   |      |   |
| Total Options Authorized at 1/1/2003 |   | 315,200                             |   | 1,474,800                        |   | 20,000                                        |   | 210,000                                                |   | 2,020,000 |   |
| Total Options Issued                 |   | 284,800                             |   | 1,286,800                        |   | —                                        |   | 210,000                                                |   | 1,781,600 |   |
| Options Reserved for Issuance        |   | 30,400                              |   | 188,000                          |   | 20,000                                        |   | —                                                 |   | 238,400   |   |

 

Stockoption activity during the periods presented is as follows (unaudited):

 

|                          |   | **Number of****Options** |   | **Weighted-Average  Exercise Price** |   |
|-------------------------------|--------|--------------------------|--------|--------------------------------------|--------|
|                          |   |                     |   |                                 |   |
| Balance at December 31, 2002  |   | 1,244,600                |   | $                                    | 9.01   |   |
| Granted                       |   | 560,500                  |   | 4.80                                 |   |
| Forfeited                     |   | (23,500                  | )      | (3.17                                | )      |
| Exercised                     |   | (13,057                  | )      | (3.03                                | )      |
| Balance at September 30, 2003 |   | 1,768,543                |   | $                                    | 7.89   |   |

 

AtSeptember 30, 2003, the range of exercise prices for outstanding options was$1.75 to $15.00 and the weighted-average remaining contractual life ofoutstanding options was 6.69 years. The weighted average exercise price ofexercisable outstanding options was $9.32. At September 30, 2003, 662,553 of the outstanding options were exercisableat prices at or below the current market value for the Company’s Stock and thusare used to calculate earnings per share dilution.  The table below shows options and prices for all outstandingoptions at September 30, 2003:

 
| **Option Exercise Price Range** |   | **Vested** |   | **Unvested** |   | **Number of  Options** |   |
|---------------------------------|--------|------------|--------|--------------|--------|------------------------|--------|
|                            |   |       |   |         |   |                   |   |
| $1.75 to $3.00                  |   | 89,285     |   | 105,215      |   | 194,500                |   |
| $3.01 to $5.00                  |   | 196,568    |   | 335,432      |   | 532,000                |   |
| $5.01 to $7.50                  |   | 302,825    |   | 22,875       |   | 325,700                |   |
| $7.51 to $10.00                 |   | 83,500     |   | 93,000       |   | 176,500                |   |
| $10.01 to $12.50                |   | 286,675    |   | 2,625        |   | 289,300                |   |
| $12.51 to $15.00                |   | 263,600    |   | 0            |   | 263,600                |   |
|                            |   | 1,222,453  |   | 559,147      |   | 1,781,600              |   |

 

Theper share weighted-average fair value of stock options granted between July 1,2003 and September 30, 2003 was $8.17; April 1, 2003 and June 30, 2003 was$5.03; and between January 1 and March 31, 2003 was $1.33 on the dates of grantusing the Black-Scholes option-pricing model, applied through Equity Edgeprogram software using the following weighted-average assumptions (unaudited):

 

10

----

 
|                    |   | **March 31,   2003** |   | **June 30, 2003** |   | **September  30,  2003** |   |
|-------------------------|--------|----------------------|--------|-------------------|--------|--------------------------|--------|
|                    |   |                 |   |              |   |                     |   |
| Expected dividend yield |   | 0.00                 | %      | 0.00              | %      | 0.00                     | %      |
| Risk-free interest rate |   | 2.78                 | %      | 2.46              | %      | 2.85                     | %      |
| Expected volatility     |   | 31.50                | %      | 45.92             | %      | 59.83                    | %      |
| Expected life (years)   |   | 5                    |   | 5                 |   | 5                        |   |

.

**Note 11.  Business Segments**

 

TheCompany reports its financial results in two segments: the Mortgage BankingBusiness and the Mortgage Asset Portfolio Business. The Mortgage BankingBusiness originates home mortgage loans through a network of independentmortgage loan brokers.  These mortgageloans are subsequently sold to financial institutions. The Mortgage AssetPortfolio Business segment manages a portfolio of mortgage loans pledged ascollateral for long-term debt.

 

Theaccounting policies of the segments are the same as described in Note 1,“Summary of Significant Accounting Policies and Practices.” The Companyevaluates the performance of its business segments based on income beforeincome taxes. Expenses under the direct control of each business segment andthe expense of premises and equipment incurred to support business operationsare allocated accordingly, by segment.

 

Thetable below reflects the third quarter and nine month statement of operationsactivity by segment.

 

American Residential Investment Trust, Inc. and SubsidiariesConsolidated Statements of Operations by Business Segment, unaudited(in thousands)

 
|                                                                |   | **For the   Three   Months   ended September   30, 2003   Mortgage   Banking** |   | **For  the    Three   Months   Ended   September   30, 2003   Mortgage  Asset   Portfolio** |   | **For the   Three   Months   Ended   September   30, 2003   Combined   Segments** |   | **For the   Nine   Months   Ended   September   30, 2003   Mortgage   Banking** |   | **For the   Nine   Months   Ended   September   30, 2003   Mortgage   Asset   Portfolio** |   | **For the   Nine   Months   Ended September   30, 2003   Combined   Segments** |   |
|---------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|--------|
| **Revenues**                                                        |   |                                                                           |   |                                                                                             |   |                                                                              |   |                                                                            |   |                                                                                      |   |                                                                           |   |
| Gain  on sales of loans, net                                        |   | $                                                                              | 9,580  |                                                                                             | $      | —                                                                            |   | $                                                                               | 9,580  |                                                                                      | $      | 62,760                                                                         |   | $ | — |   | $ | 62,760 |   |
| Derivative  financial instruments and market adjustments, net:      |   |                                                                           |   |                                                                                             |   |                                                                              |   |                                                                            |   |                                                                                      |   |                                                                           |   |
| Derivative  financial instruments - forward commitments and options |   | 4,194                                                                          |   | —                                                                                           |   | 4,194                                                                             |   | 1,115                                                                           |   | —                                                                                    |   | 1,115                                                                          |   |
| Market  adjustment on interest rate lock commitments                |   | 10,955                                                                         |   | —                                                                                           |   | 10,955                                                                            |   | 2,539                                                                           |   | —                                                                                    |   | 2,539                                                                          |   |
| Total  derivative financial instruments and market adjustments      |   | 15,149                                                                         |   | —                                                                                           |   | 15,149                                                                            |   | 3,654                                                                           |   | —                                                                                    |   | 3,654                                                                          |   |
| Interest  on mortgage assets, net of premium amortization           |   | 10,381                                                                         |   | 2,665                                                                                            |   | 13,046                                                                            |   | 23,843                                                                          |   | 8,841                                                                                     |   | 32,684                                                                         |   |
| Other  income                                                       |   | 24                                                                             |   | 534                                                                                              |   | 558                                                                               |   | 76                                                                              |   | 945                                                                                       |   | 1,021                                                                          |   |
| Total  revenue                                                      |   | 35,134                                                                         |   | 3,199                                                                                            |   | 38,333                                                                            |   | 90,333                                                                          |   | 9,786                                                                                     |   | 100,119                                                                        |   |
|                                                                |   |                                                                           |   |                                                                                             |   |                                                                              |   |                                                                            |   |                                                                                      |   |                                                                           |   |
| **Expenses**                                                        |   |                                                                           |   |                                                                                             |   |                                                                              |   |                                                                            |   |                                                                                      |   |                                                                           |   |
| Employee  compensation and benefits                                 |   | 13,893                                                                         |   | 137                                                                                              |   | 14,030                                                                            |   | 35,487                                                                          |   | 613                                                                                       |   | 36,100                                                                         |   |
| Interest  expense                                                   |   | 4,535                                                                          |   | 1,111                                                                                            |   | 5,646                                                                             |   | 10,656                                                                          |   | 3,800                                                                                     |   | 14,456                                                                         |   |
| Office  and occupancy expense                                       |   | 706                                                                            |   | —                                                                                           |   | 706                                                                               |   | 1,894                                                                           |   | —                                                                                    |   | 1,894                                                                          |   |
| Provision  for loan losses                                          |   | —                                                                         |   | 764                                                                                              |   | 764                                                                               |   | —                                                                          |   | 2,478                                                                                     |   | 2,478                                                                          |   |
| Gain  on sale of real estate owned, net                             |   | —                                                                         |   | (236                                                                                             | )      | (236                                                                              | )      | —                                                                          |   | (751                                                                                      | )      | (751                                                                           | )      |
| Professional  fees                                                  |   | 1,455                                                                          |   | (23                                                                                              | )      | 1,432                                                                             |   | 3,728                                                                           |   | 446                                                                                       |   | 4,174                                                                          |   |
| Other  operating expenses                                           |   | 4,786                                                                          |   | 216                                                                                              |   | 5,002                                                                             |   | 12,107                                                                          |   | 674                                                                                       |   | 12,781                                                                         |   |
| Total  expenses                                                     |   | 25,375                                                                         |   | 1,969                                                                                            |   | 27,344                                                                            |   | 63,872                                                                          |   | 7,260                                                                                     |   | 71,132                                                                         |   |
|                                                                |   |                                                                           |   |                                                                                             |   |                                                                              |   |                                                                            |   |                                                                                      |   |                                                                           |   |
| Income  before income taxes                                         |   | 9,759                                                                          |   | 1,230                                                                                            |   | 10,989                                                                            |   | 26,461                                                                          |   | 2,526                                                                                     |   | 28,987                                                                         |   |
| Income  taxes                                                       |   | 3,547                                                                          |   | 398                                                                                              |   | 3,945                                                                             |   | 8,596                                                                           |   | 827                                                                                       |   | 9,423                                                                          |   |
| Income  tax benefit from utilization of REIT net operating losses   |   | (724                                                                           | )      | —                                                                                           |   | (724                                                                              | )      | (9,865                                                                          | )      | —                                                                                    |   | (9,865                                                                         | )      |
| Net  income                                                         |   | $                                                                              | 6,936  |                                                                                             | $      | 832                                                                               |   | $                                                                               | 7,768  |                                                                                      | $      | 27,730                                                                         |   | $ | 1,699 |   | $ | 29,429 |   |

 

Anincome tax benefit from utilization of REIT net operating losses is expectedfor 2003 due to the taxable income generated by the mortgage banking business,and accordingly this benefit is attributable to the mortgage banking segment.

 

11

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|                                                                |   | **For the   Three   Months    ended September   30, 2002   Mortgage   Banking** |   | **For the   Three   Months   Ended   September    30, 2002   Mortgage   Asset   Portfolio** |   | **For the   Three   Months   Ended   September    30, 2002   Combined   Segments** |   | **For the   Nine   Months   ended September    30, 2002 Mortgage Banking** |   | **For the   Nine   Months   Ended September    30, 2002   Mortgage   Asset   Portfolio** |   | **For the   Nine   Months   Ended September    30, 2002   Combined   Segments** |   |
|---------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|
| **Revenues**                                                        |   |                                                                                 |   |                                                                                             |   |                                                                                    |   |                                                                                 |   |                                                                                          |   |                                                                                 |   |
| Gain  on sales of loans, net                                        |   | $                                                                                    | 18,808 |                                                                                             | $      | —                                                                                  |   | $                                                                                    | 18,808 |                                                                                          | $      | 25,254                                                                               |   | $ | — |   | $ | 25,254 |   |
| Derivative  financial instruments and market adjustments, net:      |   |                                                                                 |   |                                                                                             |   |                                                                                    |   |                                                                                 |   |                                                                                          |   |                                                                                 |   |
| Derivative  financial instruments Treasury futures                  |   | (8,000                                                                               | )      | —                                                                                           |   | (8,000                                                                                  | )      | (18,123                                                                              | )      | —                                                                                        |   | (18,123                                                                              | )      |
| Derivative  financial instruments - forward commitments and options |   | (9,668                                                                               | )      | —                                                                                           |   | (9,668                                                                                  | )      | (9,791                                                                               | )      | —                                                                                        |   | (9,791                                                                               | )      |
| Market  adjustment on interest rate lock commitments                |   | 2,466                                                                                |   | —                                                                                           |   | 2,466                                                                                   |   | 4,311                                                                                |   | —                                                                                        |   | 4,311                                                                                |   |
| Total  derivative financial instruments and market adjustments      |   | (15,202                                                                              | )      | —                                                                                           |   | (15,202                                                                                 | )      | (23,603                                                                              | )      | —                                                                                        |   | (23,603                                                                              | )      |
| Interest  on mortgage assets, net of premium amortization           |   | 4,159                                                                                |   | 2,998                                                                                            |   | 7,155                                                                                   |   | 8,051                                                                                |   | 13,520                                                                                        |   | 21,571                                                                               |   |
| Litigation  settlement                                              |   | —                                                                               |   | —                                                                                           |   | —                                                                                  |   | —                                                                               |   | 10,281                                                                                        |   | 10,281                                                                               |   |
| Other  income                                                       |   | 2                                                                                    |   | 243                                                                                              |   | 245                                                                                     |   | 8                                                                                    |   | 1,073                                                                                         |   | 1,081                                                                                |   |
| Total  revenue                                                      |   | 7,767                                                                                |   | 3,241                                                                                            |   | 11,006                                                                                  |   | 9,710                                                                                |   | 24,874                                                                                        |   | 34,584                                                                               |   |
|                                                                |   |                                                                                 |   |                                                                                             |   |                                                                                    |   |                                                                                 |   |                                                                                          |   |                                                                                 |   |
| **Expenses**                                                        |   |                                                                                 |   |                                                                                             |   |                                                                                    |   |                                                                                 |   |                                                                                          |   |                                                                                 |   |
| Employee  compensation and benefits                                 |   | 5,034                                                                                |   | 136                                                                                              |   | 5,170                                                                                   |   | 11,578                                                                               |   | 290                                                                                           |   | 11,868                                                                               |   |
| Interest  expense                                                   |   | 2,409                                                                                |   | 2,383                                                                                            |   | 4,792                                                                                   |   | 4,234                                                                                |   | 8,457                                                                                         |   | 12,691                                                                               |   |
| Office  and occupancy expense                                       |   | 383                                                                                  |   | —                                                                                           |   | 383                                                                                     |   | 1,073                                                                                |   | —                                                                                        |   | 1,073                                                                                |   |
| Provision  for loan losses                                          |   | —                                                                               |   | 1,492                                                                                            |   | 1,492                                                                                   |   | —                                                                               |   | 4,619                                                                                         |   | 4,619                                                                                |   |
| Loss  on sale of real estate owned, net                             |   | —                                                                               |   | (281                                                                                             | )      | (281                                                                                    | )      | —                                                                               |   | 152                                                                                           |   | 152                                                                                  |   |
| Professional  fees                                                  |   | 717                                                                                  |   | 508                                                                                              |   | 1,225                                                                                   |   | 1,682                                                                                |   | 1,405                                                                                         |   | 3,087                                                                                |   |
| Other  operating expenses                                           |   | 1,573                                                                                |   | 200                                                                                              |   | 1,771                                                                                   |   | 3,618                                                                                |   | 586                                                                                           |   | 4,204                                                                                |   |
| Total  expenses                                                     |   | 10,116                                                                               |   | 4,438                                                                                            |   | 14,552                                                                                  |   | 22,185                                                                               |   | 15,509                                                                                        |   | 37,694                                                                               |   |
|                                                                |   |                                                                                 |   |                                                                                             |   |                                                                                    |   |                                                                                 |   |                                                                                          |   |                                                                                 |   |
| Income  before income taxes                                         |   | (2,350                                                                               | )      | (1,197                                                                                           | )      | (3,546                                                                                  | )      | (12,475                                                                              | )      | 9,365                                                                                         |   | (3,110                                                                               | )      |
| Income  taxes                                                       |   | —                                                                               |   | —                                                                                           |   | —                                                                                  |   | 1                                                                                    |   | 6                                                                                             |   | 7                                                                                    |   |
| Net  income (loss)                                                  |   | $                                                                                    | (2,350 | )                                                                                                | $      | (1,197                                                                                  | )      | $                                                                                    | (3,546 | )                                                                                             | $      | (12,476                                                                              | )      | $ | 9,359 |   | $ | (3,117 | ) |

 

Forthe purpose of internal management reporting, the Company records intersegmentfunds transfers and eliminates these transfers on a consolidated basis for GAAPreporting. Intersegment assets and liabilities eliminated for consolidationpurposes were $24.4 million for the three month period ending September 30,2003.

 

**Note 12.  Subsequent Events**

 

OnOctober 1, 2003, the Company secured an additional warehouse facility of $100million from GMAC Residential Funding Corporation.  As a result, total warehouse line capacity increased to $1.4billion.

 

**Note 13.  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 this election, the Company was not, with certainexceptions, taxed at the corporate level on the net income distributed to theCompany’s shareholders.  On July 19,2002, the shareholders of the Company approved two proposals that allowed forthe conversion of the Company from a REIT to a fully taxable entity, effectiveJanuary 1, 2003.  On February 7, 2003,the Company filed a notice with the Internal Revenue Service of its decision tode-REIT, effective beginning January 1, 2003.

 

Asa result of the conversion to fully taxable status, an income tax benefit andrelated deferred tax asset of $9.9 million after valuation allowance wasrecorded through September 30, 2003. The deferred tax asset will be reduced by realization of income taxprovisions over time.  In addition, theCompany recorded an income tax expense for the nine months ended September  30, 2003 of $9.4 million.  This expense offset the income tax benefit.In calculating the Company's tax expense the Company estimated its combinedfederal and state tax rate was estimated to be 33% for this period.

 

**Note 14.  Commitments and Contingencies**

 

TheCompany has used, and will continue to use, TBA’s to help mitigate the loanpipeline exposure ($937 million in locked loans at September 30, 2003) tomarket interest rate fluctuations (See Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Mortgage Banking Business). These commitments provide that the Company agrees to sell an establishedvolume of mortgage loans to a particular institution at a fixed price.  An established time frame, or settlementdate is also agreed upon. The Company could incur a loss if the loan volumecommitted for sale is not delivered

 

Inthe normal course of business, there are various outstanding commitments andcontingent liabilities that have not been reflected in the consolidatedfinancial statements.  In addition, inthe normal course of business, there are various other outstanding legal andadministrative proceedings.  In theopinion of management, after consultation with legal counsel, the financialposition and results of operations of the Company will not be affected materiallyas a result of such commitments and contingent liabilities or by the outcome ofsuch legal or administrative proceedings.

 

**Leases –**The Company leases office space for itsheadquarters in San Diego, California; for various branch offices across thecontinental United States of America and for certain equipment under operatingleases expiring at various dates through 2008.

 

Asof September 30, 2003, the minimum future lease payments under non-cancelableoperating leases were as follows (dollars in thousands)(unaudited):

 

| **Three Months Ending:** |   |   |   |
|--------------------------|--------|--------|--------|
| 2003                     |   | $      | 605    |   |
| **Years Ending:**        |   |   |   |
| 2004                     |   | 2,521  |   |
| 2005                     |   | 2,206  |   |
| 2006                     |   | 1,070  |   |
| 2007                     |   | 777    |   |
| 2008                     |   | 362    |   |
|                     |   |   |   |
| Total                    |   | $      | 7,541  |   |

 

12

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

*The statements contained in this Quarterly Report onForm 10-Q that are not purely historical are forward lookingstatements.  Such forward lookingstatements include those regarding our expectations, hopes, beliefs, intentions,or strategies regarding the future. Such statements use the words “expect,”“will,” “may,” “anticipate,” “goal,” “intend,” “seek,” “believe,” “plan,”“strategy” and derivatives of such words. Forward looking statements in this report include those statementsregarding:*

 

*•**                                          **our expectationssurrounding the total size of the loan origination market, our ability tomaintain average monthly loan fundings in a potentially declining market andour loan origination volume;*

 

*•**                                          **our expectation ofmaintaining quarter-over-quarter profitability in the Mortgage BankingBusiness;*

 

*•**                                          **our expectationssurrounding our cash requirements, expenses, cash flow from operations, thesufficiency of our capital base, the sufficiency of our cash reserves and oursources of liquidity, including our intention to increase the size of ourwarehouse lending facilities and the factors we expect to affect our ability todo so;*

 

*•**                                          **the expected adequacy ofour various reserves;*

 

*•**                                          **AmNet’s intention to expandoperations in 2004 and the expected costs of doing so;*

 

*•**                                          **AmNet’s intention tocontinue to try and hedge against market fluctuations in interest rates andprotect profit margins on the loan pipeline, the instruments AmNet intends touse and the expected inverse relationship of gains on hedging to margins onloan sales;*

 

*•**                                          **our expectation of sellingloans on a service-released basis within approximately 30 days fromorigination;*

 

*•**                                          **the expected correlation ofour profitability to loan origination volume;*

 

*•**                                          **the anticipated impact fromthe adoption of SFAS 149 and SFAS 150;*

 

*•**                                          **management’s expectationsof what outstanding commitments and contingent liabilities and legal andadministrative proceedings will not materially affect the Company’s financialposition or results of operations;*

* *

*•              ouranticipated accounting treatment for option grants*

 

*•**                                          **AmNet’s belief that it willcontinue to qualify for correspondent lending programs and its ability to findalternative buyers for loans it originates;*

 

*•**                                          **AmNet expectationsregarding delivery of a majority of loans it originates to Countrywide HomeLoans, Inc.;*

 

*•**                                          **the expected concentrationof AmNet’s loans in California;*

 

*•**                                          **our expectation thatinterest rates may rise and the anticipated effect on various aspects of ourbusiness from changes in interest rates, including increased per loan costs ofloan generation and changes in the value of our loans and our derivatives;*

 

*•**                                          **our beliefs regardingfuture prepayment rates and their effect and anticipated prepayment penalties;*

 

*•**                                          **our expectation that revenuesand cash flow from our Mortgage Asset Portfolio Business will continue todecline;*

 

*•**                                          **our expected effective taxrates, the impact of our deferred tax asset and the reduction of that assetover time;*

 

*•**                                          **who we anticipate will beour competitors;*

 

*•**                                          **an expected increase in thelevel of our general and administrative expenses, including directors’ andprofessional fees;*

 

*•**                                          **the anticipated impact ofchanges in laws;*

 

*•**                                          **the expected effect ofseasonality on our business;*

 

*•**                                          **our intent to hold mortgageloan bond collateral to maturity; and*

 

•                                            *our expected increasingreliance on information technology systems and the necessity of developing andupgrading such systems.*

* *

*•              futureimpact of California wildfires*

 

*These forward looking statements are based on informationavailable to us on the date hereof, and we assume no obligation to update anysuch forward looking statements. It is important to note that our actualresults and timing of certain events could differ materially from those in suchforward looking statements due to a number of factors, including but notlimited to, general economic conditions, the world political climate,unexpected expense increases, overall interest rates, volatility in interestrates, the shape of the yield curve, reductions in the value of retainedinterests in securitizations, our ability to successfully grow AmNet, theability to obtain the financing necessary to fund AmNet, changes in accountingrules or their application, changes in the margins for gains on sale oforiginated loans, changes in the demand of mortgage brokers for AmNet’s loanproducts and services or of loan purchasers for originated loans, theavailability of capital and our ability to qualify for such capital, increasesin prepayment rates and default rates, the effect of terminating our status asa REIT, changes in the requirements of correspondent loan programs or ourability to meet such requirements and changes in AmNet’s and our anticipatedcash requirements. Other risk factors that could cause actual results to differmaterially are set forth in this item under the heading “Business RiskFactors.”*

 

13

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**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 the strategic direction of theCompany to mortgage banking. We began implementation in 2001 by formingAmerican Mortgage Network, Inc. (“AmNet”), a wholly owned subsidiary, to engagein mortgage banking activities. AmNet originates mortgage loans to prime creditquality borrowers secured by first trust deeds through a network of independentmortgage brokers. A concentration of our business is in California (31.0% ofloans originated in the first nine months of 2003). We sell the loans that weoriginate to institutional purchasers on a servicing-released basis.

 

Wegenerate revenue in our Mortgage Banking Business segment two principal ways:

 

•                                            *Interest income*. From the time we originate a loan until thetime we sell the loan, we earn interest on the loan, which is paid by theborrower. The interest that we earn is partially offset by the interest we payunder our warehouse credit facilities used to finance our mortgageoriginations.

 

•                                            *Gain on loan sales*. We currently sell the loans that weoriginate to institutional purchasers, on a servicing-released basis for cash.We record the difference between the sale price of loans that we have sold andour cost to originate the sold loans as gain on loan sales revenue. Werecognize revenue at the time that we complete the loan sale, which isgenerally when we receive loan sale proceeds from the purchaser.  Gain on loan sales also includes fees wecharge for loan origination such as underwriting fees, loan documentpreparation fees and wiring fees

 

•                                            *Hedging.*Hedginginstruments are used to help mitigate exposure to interest rate fluctuation.The gains or losses from this activity will correspond to revenue derived fromloan sales. Typically higher than expected gains from the sale of loans will beoffset by hedging losses, while lower than expected gains from the sale ofloans will be offset by hedging gains. Therefore hedging gains or losses areincluded in the consolidated statements of Operation and Comprehensive Incomeas derivative financial instruments and market adjustments.

 

Wecontinue to generate revenue from our Mortgage Asset Portfolio Business,although we expect that revenues from this segment of our business willcontinue to decline. We generate revenue on the interest we receive on themortgage loans we hold for investment. Our primary expense is the interest wepay on borrowings used to fund our mortgage loan portfolio.

 

Ourmortgage banking operations have grown significantly in 2002 and 2003 andrepresented 51.4% of our 2002 revenue and 90.1% of the first nine months 2003revenue. Also during the first nine months, seven branch offices were openedand the number of employees increased from over 300 to over 650 employees. Atthe same time, the Mortgage Asset Portfolio Business has significantly declinedas mortgage loans in our portfolio have prepaid and have not been replenished.

 

Asa result of the change in focus of our Company’s strategic direction and thedecision to emphasize taxable operating activities and retain earnings forgrowth, our shareholders, based upon a recommendation from our Board ofDirectors, approved two proposals that permitted us to amend our charterdocuments to terminate our status as a REIT. In February of 2003 we notifiedthe Internal Revenue Service of our decision to de-REIT, effective for the taxyear beginning January 1, 2003.  Asa REIT, we generally did not pay federal taxes at the corporate level on incomewe distributed to stockholders. We have not distributed income to our stockholderssince January of 2001.

 

EffectiveJanuary 1, 2003, we became an income tax paying entity, and as such werecognized deferred tax assets that are largely a result of previous netoperating losses.  We have also recordedsignificant tax benefits in 2003 in our Statement of Operations and ComprehensiveIncome. We do not expect to record similar significant benefits in 2004. See"Critical Accounting Policies" below.

 

Upontermination of our REIT status, we were no longer eligible for listing on theNew York Stock Exchange. As of January 31, 2003, we moved from the NewYork Stock Exchange to the American Stock Exchange. Our ticker symbol, INV,remains the same.

 

**Mortgage Banking Business**

 

*Summary*

 

AmNetoriginates mortgage loans referred by independent mortgage brokers forsubsequent sale on a servicing-released basis to large financial institutions.

 

AmNetutilizes a dedicated sales force to offer loan products to approved wholesalemortgage brokers, who refer their client’s loans to us for underwriting andfunding. Loans meeting our underwriting criteria are approved and funded at ourregional underwriting loan centers. Our headquarters office performs variousfunctions through multiple departments including establishment of policy, riskmanagement, secondary marketing, finance, accounting, administration, humanresources, and information technology.

 

14

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Wefunded $8.3 billion in home loans during the nine month period endingSeptember 30, 2003. For the twelve month period ending December 31, 2002,we funded $4.2 billion in home loans. As of September 30, 2003, we hadover 650 loan production and loan operations employees. As of September 30,2003, we operated fifteen regional centers and seven satellite centers aroundthe continental United States of America.

 

Weborrow funds under our credit facilities to fund and accumulate loans prior tosale to correspondent investors on a servicing-released basis. As of October 1,2003 we have four warehouse facilities that enable us to borrow up to anaggregate of $1.4 billion. We are allowed to borrow from 96% to 99% of theloan balance (par) and must comply with various lender covenants restricting,among other things, our absolute level of leverage and minimum levels of cashreserves. We expect to increase our warehouse borrowing facilities to enableincreased loan production.

 

Wecurrently sell all loans we fund on a servicing-released basis, usually within30 days of funding. The table below shows the age of funded loans as ofSeptember 30, 2003.

 
| **Aging Range**    |   | **Number of   Loans** |       | **Warehouse  line usage   (000’s)** |        | **% of  Total** |      |
|--------------------|--------|-----------------------|------------|------------------------------------------|-------------|-----------------|-----------|
| Less than 30 days  |   | 1,867                 |       | $                                        | 307,700     |            | 88.0      | % |
| 30 to 60 days      |   | 207                   |       | 36,919                                   |        | 10.5            | %         |
| 61 days to 90 days |   | 31                    |       | 5,158                                    |        | 1.5             | %         |
| **TOTAL**          |   | **2,105**             | ** ** | **$**                                    | **349,777** | ** **      | **100.0** | **%** |

** **

**Critical Accounting 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.

 

Ouraccounting policies relating to the valuation procedures listed below have notchanged in the nine month period ending September 30, 2003:

 

•  Provision for loan losses

•  Derivative financial instruments

•  Premium amortization on bond collateral,mortgage loans

•  Gain on sale of loans

 

Pleaserefer to the Company Form 10-K for the one-year period ending December 31,2002, for a detailed discussion of these procedures.

 

*Income taxes and benefits.*

 

During 1997, the Company elected to be taxed as a real estateinvestment trust (“REIT”) under the Internal Revenue Code of 1986, asamended.  As a result of this election, theCompany generally was not taxed at the corporate level on the incomedistributed to the Company’s shareholders. On July 19, 2002, the shareholders of the Company approved two proposalsthat allowed the conversion of the Company from a REIT to a fully taxableentity, effective January 1, 2003.  OnFebruary 7, 2003, the Company filed a notice with the Internal Revenue Serviceof its decision to de-REIT, effective beginning January 1, 2003.

 

As a result of its profitability and conversion to ataxable entity, in 2003 the Company has experienced three significant changesthat affect the taxes reported in its operating results:

 

•              Asof December 31, 2002, the Company’s AmNet division had a net deferred tax assetof $3.4 million (comprised primarily of net operating losses (“NOLs”) andallowance for loan losses) which was fully offset by a valuation allowance asmanagement believed that it was more likely than not that this deferred taxasset would not be realized.  However,as a result of AmNet’s current profitability, management believes that asignificant portion of  this deferredtax asset will be realized. Accordingly, the valuation allowance has been reduced and tax benefitshave been recorded for the first three quarters of 2003.  The income tax expense of the Company’sAmNet division has been partially reduced by these tax benefits. Moreover, asthe Company projects future taxable income, any remaining valuation allowanceif any, will be reduced accordingly, with a corresponding reduction in theCompany’s income tax expense. Management expects by year-end that there will be no remaining valuationallowance for its mortgage banking business segment.

 

•              As of January 1, 2003, theCompany’s REIT division recorded a net deferred tax asset of $12.4 million(comprised primarily of NOLs and tax assets related to the Company’ssecuritizations) as a result of the conversion of the Company to a taxablestatus.  This  deferred tax asset was fully offset by a valuation allowance asmanagement believed it was more likely than not that this deferred tax assetwould not be realized.  However, as aresult of AmNet’s current profitability management believes that this deferredtax asset will be realized.  Accordingly,the Company has reduced its valuation allowance and recorded a taxbenefit.  Although this benefit isprimarily the result of the utilization of net operating losses incurred in themortgage asset portfolio segment, because the tax benefit is the result of  taxable income generated by the mortgagebanking business segment, the benefit is recorded in this segment.  In the Company’s Consolidated Statements ofOperations, this benefit is reported as a separate line item titled “Income taxbenefit from utilization of REIT net operating losses” and is referred to belowas “the REIT related tax benefit.”  Asthe Company projects future taxable income, any remaining valuation allowancewill be reduced accordingly, with a corresponding increase to the REIT relatedtax benefit.  Management expects byyear-end that there will be no valuation allowance except for $1.9 million ofcapital losses (which will expire in 2003) for its mortgage asset portfoliobusiness.

 

•              As a result of the termination ofthe Company’s REIT status, the Company records an income tax expense on itspretax income. in both segments

 

The income tax rates used by the Company to calculate its income taxexpense and the amount recorded by the Company for the REIT related tax benefitare both determined based on management’s projected future taxable income.Because a significant portion of the Company’s income is earned from theCompany’s mortgage banking operations, which are relatively new and have beenexpanding rapidly, management’s estimates of future taxable income may not beaccurate.   Accordingly the Company’sactual income tax expense incurred could be different.

 

The Company has calculated its income tax expense for the nine monthsended September 30, 2003 using an effective tax rate of approximately 32.5%. Asa result, the Company recorded an income tax expense for the combined segmentsfor the nine months ended September 30, 2003 of $9.4 million.  The Company also recorded a  REIT related tax benefit of $9.9 million forthis period.

 

The Company does not expect to record benefits from the reduction inAmNet’s valuation allowance. in 2004. Accordingly, the Company expects to calculate its income tax expense for2004 using an effective tax rate of approximately 42%.   In addition, the Company does not expect torecord a REIT related tax benefit in 2004. These factors will result in asignificant negative impact on 2004 after tax earnings in comparison to 2003.

 

**Management’s Financial Analysis**

 

Weearn interest income and incur interest expense in both segments of ouroperations.  In the Mortgage BankingBusiness, AmNet earns interest on a loan from the date the loan is funded untilfinal disposition of the loan sale. Accordingly, interest income is a function of the volume of loansfunded, the interest rate on the loans and the length of time the loans areheld.  To the extent AmNet funds loanswith borrowings under its warehouse facilities, it records interest expensebased on the same factors.  Similarly,in the Mortgage Asset Portfolio Business, we generate revenue from the interestwe receive on the mortgage loans we hold for investment and we incur interestexpense on the borrowings used to fund our loan portfolio.

 

Becausethe interest income and interest expense in each segment of our business areclosely related and dependant on many of the same factors, in particular thevolume of loans we originate or hold for investment, management believes thatit is helpful in understanding our operations to analyze the impact of interestincome and expense together within each segment of our operations.  For this reason, the discussion belowprovides information regarding the net interest income (interest income lessinterest expense) generated by each segment. Management believes that this is consistent with how financial analyststypically consider interest in analyzing mortgage banking operations.  This reasoning also applies in ourdiscussion of the Mortgage Banking Business expenses.  The explanation of expenses includes a discussion of our operatingexpenses, which excludes interest expense.

 

Becausecertain other expenses incurred by AmNet in the Mortgage Banking Business, suchas commissions and contract labor, also vary with the volume of AmNet’s loanoriginations, management also believes that it is important in understandingthis business to consider the variable and the fixed expenses separately.  Accordingly, we have included an estimatedbreakdown between variable and fixed amounts for each category of our operatingexpenses.  Management believes that thiswill enable a better understanding of the Company’s results and the likelyimpact in the future of changes in our origination volumes.

 

15

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**Results of Operations**

 

***Three Month Results***

 

MortgageBanking Business

 

Gainon the sale of loans for the three-month period ending September 30, 2003,amounted to $9.6 million. This represents a $9.2 million decrease from the sameperiod ending September 30, 2002 when our gain on the sale of loans was $18.8million. AmNet loan production volume increased from $1.3 billion for thequarter ending September 30, 2002 to $3.0 billion for the quarter endingSeptember 30, 2003.  However, interestrates were increasing during the quarter ending September 30, 2003 andtherefore loan value decreased during the period, whereas interest rates weredecreasing in the quarter ended September 30, 2002 and accordingly loan valuesincreased.  Gains on the sale of loanswere augmented by a gain of $15.1 million on the Company’s derivative financialinstruments and market adjustments for the quarter ending September 30, 2003while a loss was incurred of $15.2 million for the three month period endingSeptember 30, 2002.

 

Forthe three months ending September 30, 2003, AmNet’s gain on sale of loans of$9.6 million is a combination of various account categories.  Loan premiums of approximately$52.5 million represent the price at which AmNet sold the loans toinvestors in excess of the principal balance of loans sold. Fee income ofapproximately $8.5 million represents various charges to brokers forservices rendered, which are deferred and recognized as part of the gain on thesales of the loans. Gross gain and fee income are offset by capitalized(deferred) loan acquisition costs. The largest deferred cost associated withloan production is yield spread premiums paid to brokers totaling approximately$45.8 million. Other deferred costs include (i) true sale scheduleddiscount, which is recognized at the time of loan sale, of approximately$4.7 million; (ii) deferred origination costs, which are recognizedat the time of loan sale, of approximately $4.1 million and(iii) loan premiums repaid to investors (“premium recapture”) and loanloss reserve costs aggregating approximately $1.6 million. Premiumrecapture expenses represent repayment of a portion of certain loan salepremiums to investors on previously sold loans which subsequently payoff withinsix months of loan sale.  Gain on thesale of loans of $9.6 million for the three-month period ending September30, 2003 represents approximately 29 basis points (.29%) on loan sales of$3.2 billion but were augmented by hedging gains (see paragraphbelow).  For the same period endingSeptember 30, 2002, gain on the sale of loans was $18.8 million whichrepresented approximately 149 basis points (1.49%) on loan sales of $1.3billion but were offset by hedging losses. (See paragraph below.)

 

Duringthe third quarter of 2003, AmNet incurred net hedging gains on its derivativefinancial instruments and market adjustments on derivative financialinstruments totaling $15.1 million. For the same period ending September 30, 2002 net losses on derivativefinancial instruments and market adjustments totaled $15.2 million.  Derivative financial instruments arepurchased to try to offset any loss from market interest rate movement whichadversely affects gain on loan sales. During the third quarter of 2003, AmNetused forward commitments on mortgage-backed securities (TBA) and options to purchaseor sell mortgage-backed securities as its primary hedging vehicles. At the endof the second quarter interest rates began to increase which added value to ourhedging instruments and reduced the value of our loan pipeline.  Due to increases in yields on mortgagesduring most of the third quarter of 2003, AmNet recorded gains on hedginginstruments and market adjustments. These gains were offset by lower gains onthe sale of loans during the quarter. During the first six months of 2002, AmNet used treasury futures andoptions on treasury futures as prime hedging vehicles.  In the following periods through September30, 2003, forward commitments on mortgage-backed securities (TBA) and optionsto purchase or sell mortgage-backed securities are used as our primary hedgingvehicles.

 

AmNetrecorded interest income of $10.4 million for the three months endedSeptember 30, 2003 and $4.2 million for the same period ending September 30,2002.  AmNet earns interest on a loanfrom the date the loan is funded until it is sold. 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.  Volume of loans increased period over period ($1.3 billion forthe three months ending September 30, 2002 and $3.0 billion for the three monthperiod ending September 30, 2003). Holding time prior to sale remained relatively constant between periodswhile interest rates increased between periods.  Therefore, interest income increased primarily due to an increasein loan volume and to a lesser extent higher interest rates.  To the extent AmNet funds loans withborrowings under its warehouse facilities, it records interest expense based onthe same factors. Interest expense for the period was $4.5 million. Theresulting net interest income earned on loan inventories was $10.4 million,representing 34 basis points (0.34%) on loan production in the third quarter of$3.0 billion.  For the three monthsending September 30, 2002, interest expense was $2.4 million.  The resulting net interest income earned onloan inventories was $1.7 million, representing 14 basis points (0.14%) on loanproduction of $1.3 billion.

 

Totalexpenses incurred in the Mortgage Banking Business for the three month periodending September 30, 2003, were approximately $25.4 million. Operating expensewhich included all expenses except interest expense, was approximately $20.9million for the three month period ending September 30, 2003. For thecomparable period ending September 30, 2002, there were approximately $10.1million of total expenses of which $7.7 million were operatingexpenses.  The increase was due to theincreased overhead of AmNet’s mortgage banking operations, which are comprisedof regional loan production offices and headquarter operations. For the threemonths ended September 30, 2003, estimated variable expenses, predominatelycommissions and contract labor, were approximately $9.3 million which wereapproximately 31 basis points (0.31%) on $3.0 billion in funded loans.Operating Expenses that were not directly variable to the level of loanproduction were estimated at $11.6 million, or approximately 38 basispoints (0.38%) on $3.0 billion in funded loans for the third quarter of2003. 

 

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Thetable below provides the relationship between fixed, variable and totalexpenses for the three month period ending September 30, 2003. (dollars in000’s)

 
| **Mortgage Banking Expenses**                          |   | **Estimated   Variable   Expenses** |   | **Estimated   Fixed Expenses** |   | **Total  Expenses** |   |
|--------------------------------------------------------|--------|-------------------------------------|--------|--------------------------------|--------|---------------------|--------|
|                                                   |   |                                |   |                           |   |                |   |
| Employee compensation and benefits                     |   | $                                   | 7,128  |                           | $      | 6,765               |   | $ | 13,893 |   |
| Office and occupancy expense                           |   | —                              |   | 706                            |   | 706                 |   |
| Professional fees (contract labor, legal,  accounting) |   | 380                                 |   | 1,075                          |   | 1,455               |   |
| Other operating expense                                |   | 1,767                               |   | 3,019                          |   | 4,786               |   |
| **Total operating expenses**                           |   | 9,275                               |   | 11,565                         |   | 20,840              |   |
| Interest expense                                       |   | 4,535                               |   | —                         |   | 4,535               |   |
| **Total expenses**                                     |   | $                                   | 13,810 |                           | $      | 11,565              |   | $ | 25,375 |   |

 

Interestrates began to rise from historic lows during the third quarter of 2003.  Although interest rate movements aredifficult to predict, rates are expected to continue their upward movement forthe remainder of 2003.  We expect thatthe total number of home purchase and refinancing transactions to decline,causing a significant overall contraction of the loan origination market. Ourfinancial projections for the remainder of 2003 assume a significantcontraction in the size of the market and total funded loan volume ofapproximately $10.5 billion for 2003. During the third quarter of 2003, wegenerated an average monthly funded loan volume of $1.1 billion. For the sameperiod ending September 30, 2002 we generated an average monthly funded loanvolume of $421 million.  In formulatingour financial projections, we anticipate higher costs per loan and lower perloan revenues as a direct consequence of the expected market contraction. Weexpect continued quarterly profitability in our mortgage banking business. Weexpect interest rates to rise for the remainder of 2003 and during periods ofrising rates, we would expect to see an increase in the value of our hedges anda corresponding decrease in the value of our loan pipeline.

 

Thereis a degree of seasonality to our business. Spring and summer seasons are typically stronger home buying months thanother parts of the year.  We may expectsomewhat lower loan volume in the remainder of 2003 as a result of thisseasonality.

 

Theincome tax expense recorded for the third quarter of 2003 was $3.5 million andour effective federal and state tax rate for this segment was estimated to be34.7%.  The Company also recorded a REITrelated tax benefit of $724 thousand for this period.

 

Mortgage Asset Portfolio Business

 

Forthe third quarters ended September 30, 2003 and 2002, we generated net incomeof approximately $832 thousand and a net loss of $1.2 millionrespectively.  Net income before incometax increased in 2003, even as revenue and expense categories declined as aresult of a decline of our mortgage asset portfolio from $294.4 million atSeptember 30, 2002 to $181.6 million at September 30, 2003. Our decision todiscontinue portfolio acquisitions beginning in 2000 and continuing to date hasresulted in a decline in the size of Bond Collateral Mortgage Loan portfolio.The Mortgage Asset Portfolio business derives income from the difference ininterest received on bond collateral and interest paid on bonds. A decline inour portfolio has resulted in a decrease in interest income from $3.0 millionfor the three month period ending September 30, 2002 to $2.7 million for thethree month period ending September 30, 2003 and a related decrease on interestexpense of $2.4 million to $1.1 million. For the same periods net interest income (interest income less interestexpense) increased from $0.6 million and $1.6 million.

 

Netinterest income is the primary source of revenue in this segment of ourbusiness. The weighted average interest rate we receive from our bondcollateral was 9.2% at September 30, 2003 and was 9.3% at September 30, 2002,while the weighted average interest rate we paid was 2.3% and 2.7% for the sameperiods, respectively.  Although thedifference between interest rate income and interest rate expense is relativelylarge, our net income for the three month period ending September 30, 2003 wasrelatively low at approximately $832 thousand, because of an increase incertain costs, including premium amortization and credit loss provisions.  As our portfolio balances continue to decline,we find that a key expense item continues to be premium amortization. andcredit losses. Our portfolio has been declining in size rapidly as a result ofborrowers refinancing their mortgages which necessitates writing off ourpremium at accelerated rates. Credit losses on collateral also remain as asignificant portion of total mortgage asset portfolio business expenses.

 

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Mostof the intermediate adjustable rate mortgages in the CMO/FASIT, 1999-1, 1999-A,1999-2 and 2000-2 segments of the Bond Collateral Mortgage Loans portfolio havereached their first contractual interest rate adjustment and prepayment penaltyclauses on the underlying pool of loans have expired or declined, resulting ina higher probability of refinancing (principal prepayments). There can be noassurance that prepayment rates will not increase. Our financial condition andresults of operations could be materially adversely affected if prepaymentlevels increase significantly.

 

Duringthe third quarter of 2003, other income increased approximately $291 thousandover the three month period ended September 30, 2002 from $243 thousand to $534thousand, primarily due to a distribution of approximately $363 thousand fromour investment in the 1998-1 REMIC.

 

Forthe three month period ended September 30, 2003, total expenses decreasedapproximately $2.4 million (from $4.4 million to $2.0 million)over the three month period ended September 30, 2002. During 2003, our Companyhad decreases in all of the major expense categories for this segment of ourbusiness mainly as a result of the decrease of $113 million in bond collateral.The primary decreases included the following: interest expense decreasedapproximately $1.3 million; provision for loan losses decreased byapproximately $728 thousand and professional fees decreased $532 thousand.  The professional fee decrease was a resultof litigation costs in 2002.

 

Asof September 30, 2003, this segment of our business had bond collateral (net ofreserves) which totaled $185.9 million. The table below indicates how this total is segregated by delinquencytype:

 
| **Description**       |   | **Total  (000’s)** |    | **% of Total** |   |
|-----------------------|--------|-------------------------|---------|----------------|--------|
|                  |   |                    |    |           |   |
| Regular               |   | $                       | 149,079 |           | 80.2   | % |
| Bankruptcy            |   | $                       | 15,579  |           | 8.4    | % |
| Foreclosure           |   | $                       | 14,447  |           | 7.8    | % |
| Unamortized Premium   |   | $                       | 4,648   |           | 2.5    | % |
| Credit Reserve        |   | $                       | (2,202  | )              | -1.2   | % |
| Subtotal              |   | $                       | 181,551 |           |   |   |
|                  |   |                    |    |           |   |
| REO                   |   | $                       | 6,763   |           | 3.6    | % |
| REO Reserve           |   | $                       | (2,383  | )              | -1.3   | % |
| REO Total             |   | $                       | 4,380   |           |   |   |
|                  |   |                    |    |           |   |
| Total Bond Collateral |   | $                       | 185,931 |           | 100    | % |

 

Theincome tax expense recorded for the Mortgage Asset Portfolio Business for thethird quarter of 2003 was $398 thousand and our effective tax rate for thissegment was 32.4%.

 

***Nine Month Results***

 

MortgageBanking Business 

 

Gainon the sale of loans for the nine month period ending September 30, 2003,amounted to $62.8 million. This represents a $37.6 million increase overthe same period ending September 30, 2002 when our gain on the sale of loanswas $25.3 million. AmNet’s increase in gains on the sale of loans is the resultof the increase in its loan production volume. Our gains over the first six months of this period were $53.2 million onloan production of $5.3 billion while gains slowed in the following three monthperiod ($9.6 million on loan production of $3 billion) as a result of risinginterest rates. For the nine month period ending September 30, 2003 andSeptember 30, 2002, AmNet recorded loan sales volume of $8.3 billion and $2.2billion respectively.  For the ninemonths period ending September 30, 2003 a gain of $3.7 million was recorded onthe Company’s derivative financial instruments and market adjustments.  Gains on the sale of loans were offset by aloss on the Company’s derivative financial instruments and market adjustmentsfor the nine month period ending September 30, 2002 totaling $23.6 million.

 

Forthe nine months ending September 30, 2003, AmNet’s gain on sale of loans of$62.8 million is a combination of various account categories.  Loan premiums of approximately$168.3 million represent the price at which AmNet sold the loans to investorsin excess of the principal balance of loans sold. Fee income of approximately$23.6 million represents various charges to brokers for services rendered,which are deferred and recognized as part of the gain on the sales of theloans. Gross gain and fee income are offset by capitalized (deferred) loanacquisition costs. The largest deferred cost associated with loan production isyield spread premiums paid to brokers totaling approximately$112.5 million. Other deferred costs include (i) true sale scheduleddiscount, which is recognized at the time of loan sale, of approximately $265thousand; (ii) deferred origination costs, which are recognized at thetime of loan sale, of approximately $9.8 million and (iii) loanpremiums repaid to investors (“premium recapture”) and loan loss reserve costsaggregating approximately $3.7 million. Premium recapture expensesrepresent repayment of a portion of certain loan sale premiums to investors onpreviously sold loans which subsequently payoff within six months of loansale.  Gain on the sale of loans of$62.8 million for the nine month period ending September 30, 2003represents approximately 74 basis points (.74%) on loan sales of$8.3 billion.  For the same periodending September 30, 2002, gain on the sale of loans was $25.3 millionwhich represented approximately 114 basis points (1.14%) on loan sales of $2.2billion.

 

Duringthe first nine months of 2003, AmNet incurred net gains on its hedginginstruments and market adjustments totaling $3.7 million.  For the same period ending September 30,2002 net losses on hedging instruments and market adjustments totaled $23.6million.  Derivative financialinstruments are purchased to attempt to offset losses from market interest ratemovement which adversely affects gain on loan sales. During the first ninemonths of 2003, AmNet used forward commitments on mortgage-backed securities(TBA) and options to purchase or sell mortgage-backed securities as its primaryhedging vehicles.  AmNet used treasuryfutures and options on treasury futures as prime hedging vehicles for the firstsix months of 2002 and then switched to forward commitments on mortgage backedsecurities (TBA) and options on TBA’s. Due to increases in yields on mortgages during first nine months of2003, AmNet recorded net gains on derivative financial instruments and marketadjustments. These gains were offset by lower gains on the sale of loans duringthe third quarter (due to rising interest rates).

 

AmNetrecorded interest income of $23.8 million for the nine months endedSeptember 30, 2003 and $8.1 million for the same period ending September 30,2002.  Holding time prior to saleremained relatively constant between periods while interest rates increasedbetween periods overall.  However,during the nine month period ending September 30, 2003 interest rates decreasedfor the first six months and then increased. Volume of loans increased period over period ($2.2 billion for the ninemonths ending September 30, 2002 and $8.3 billion for the nine month periodending September 30, 2003).  Thereforeloan volume was the key to increased interest income.  Interest expense for the period was $10.7 million. Theresulting net interest income earned on loan inventories was $13.1 million,representing 16 basis points (0.16%) on 2003 loan production of$8.3 billion.

 

 

 

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Totalexpenses incurred in the Mortgage Banking Business for the nine month periodending September 30, 2003, were approximately $63.9 million. Operating expenseswere approximately $12.1 million for the nine month period ending September 30,2003. For the comparable period ending September 30, 2002, there wereapproximately $3.6 million of operating expenses incurred. The increasewas due to the ongoing overhead of AmNet’s mortgage banking operations, whichare comprised of regional loan production offices and headquarter operations.For the nine months ended September 30, 2003, estimated variable expenses,predominately commissions and contract labor, were approximately$24.2 million which were approximately 29 basis points (0.29%) on$8.3 billion in funded loans. Operating Expenses that were not directlyvariable to the level of loan production totaled $29.1 million, orapproximately 35 basis points (0.35%) on $8.3 billion in funded loans forthe nine months ending September 30, 2003.

 

Thetable below provides the relationship between estimated fixed, variable andtotal expenses for the nine month period ending September 30, 2003. (dollars in000’s)

 
| **Mortgage Banking Expenses**                          |   | **Estimated   Variable   Expenses** |   | **Estimated   Fixed   Expenses** |   | **Total   Expenses** |   |
|--------------------------------------------------------|--------|-------------------------------------|--------|----------------------------------|--------|----------------------|--------|
|                                                   |   |                                |   |                             |   |                 |   |
| Employee compensation and benefits                     |   | $                                   | 18,671 |                             | $      | 16,816               |   | $ | 35,487 |   |
| Office and occupancy expense                           |   | —                              |   | 1,894                            |   | 1,894                |   |
| Professional fees (contract labor, accounting,  legal) |   | 927                                 |   | 2,800                            |   | 3,727                |   |
| Other operating expense                                |   | 4,559                               |   | 7,549                            |   | 12,108               |   |
| **Total operating expenses**                           |   | 24,157                              |   | 29,059                           |   | 53,216               |   |
| Interest expense                                       |   | 10,656                              |   | —                           |   | 10,656               |   |
| **Total expenses**                                     |   | $                                   | 34,813 |                             | $      | 29,059               |   | $ | 63,872 |   |

 

Duringthe first nine months of 2003, we generated an average monthly funded loanvolume of $924 million. For the same period ending September 30, 2002 wegenerated an average monthly funded loan volume of $246 million.

 

Theincome tax expense recorded for the nine month period ending September 30, 2003was $8.6 million and our effective federal and state tax rate for this segmentwas estimated to be 32.5%.  The Companyrecorded a REIT related tax benefit of $9.9 million for this period.

 

*Mortgage Asset Portfolio Business*

 

Forthe nine month period ended September 30, 2003 and 2002, we generated netincome of approximately $1.7 million and $9.4 million, respectively.  September 30, 2002 net income includes alitigation settlement of $10.3 million. Operational net income before income tax (net income less litigationsettlement we received in 2002) increased for 2003, although revenue andexpense categories declined as a result of a decline of our mortgage assetportfolio from $294.4 million at September 30, 2002 to $181.6 million atSeptember 30, 2003.  Although there wasan increase in net income for 2003, (excluding the 2002 litigation settlement)all revenue and expense categories declined as a result of a decline of ourmortgage asset portfolio.  A decline inour portfolio has a resulted in a decrease in interest income from $13.5million for the nine month period ending September 30, 2002 to $8.8 million forthe nine month period ending September 30, 2003 and a related decrease oninterest expense of $8.5 million to $3.8 million for the same periods and netinterest income (interest income less interest expense) of $5.0 million forboth periods, respectively.

 

Duringthe first nine months of 2003, other income decreased approximately $127thousand over the nine month period ended September 30, 2002 from $1.1 millionto $945 thousand, primarily due to a decrease of approximately $417 thousand inprepayment penalty income.

 

Forthe nine month period ended September 30, 2003, total expenses decreasedapproximately $8.2 million (from $15.5 million to $7.3 million)compared to the nine month period ended September 30, 2002. During 2003, ourCompany had decreases in all of the major expense categories for this segmentof our business as a result of the decrease of $112.8 million in bondcollateral. The primary decreases included the following: interest expensedecreased approximately $4.7 million; provision for loan losses decreasedby approximately $2.1 million and professional fees $958 thousand.  The professional fee decrease was a resultof litigation costs in 2002.

 

Theincome tax expense recorded for the nine month period ending September 30, 2003was $826 thousand and our effective federal and state tax rate for this segmentwas estimated to be 32.7%.

 

**Liquidity and Capital Resources**

 

*General*

 

Ourcurrent sources of liquidity primarily consist of the following:

 

•                                            borrowings under our warehouse and othercredit facilities;

 

•                                            revenues generated by our mortgage bankingoperating activities including interest, branch fees and loan sale proceeds;and

 

•                                            excess interest spread and overcollateralization “step down” payments related to the mortgage asset portfoliobusiness, net of repayments to servicers for past principal and interestadvances on completed real estate owned dispositions.

 

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Ourprimary cash requirements include:

 

•                                            funding our mortgage loan originations, loanrepurchases or credit losses;

 

•                                            interest expense or margin call under ourwarehouse facilities;

 

•                                            operating expenses, including commissions;

 

•                                            repayment of our borrowings; and

 

•                                            maintaining “restricted cash” accounts, whichinclude amounts required to be held by certain of our warehouse lenders thatmay not be used in our operations, as well as amounts held in escrow for thirdparties.

 

Asour mortgage banking operations have grown and our mortgage asset portfolio hasdeclined, our cash flow from mortgage asset portfolio investment activities hascontinued to decline in amounts and materiality.

 

*Cash required for leaseobligations and short-term debt repayment*

 

Leases- As of September 30, 2003, the minimum future lease payments undernon-cancelable operating leases were as follows (dollars in thousands)(unaudited):

 

| **Three Months Ending:** |   |   |   |
|--------------------------|--------|--------|--------|
| 2003                     |   | $      | 605    |   |
| **Years Ending:**        |   |   |   |
| 2004                     |   | 2,521  |   |
| 2005                     |   | 2,206  |   |
| 2006                     |   | 1,070  |   |
| 2007                     |   | 777    |   |
| 2008                     |   | 362    |   |
|                     |   |   |   |
| Total                    |   | $      | 7,541  |   |

 

Short-termdebt - includes warehouse lines and the Subordinated Loan Agreement.  Due dates for short term debt is as follows:

 

JPMorgan/Chase March 2004

CountrywideWarehouse Lending – October 2004

GMACResidential Funding Corporation – July 2004

UBSWarburg – uncommitted agreement – there is no due date

SubordinatedLoan Agreement – February 2004

 

*Cash Generated By and Used In Our Operations*

 

Duringthe nine month period ended September 30, 2003, on a consolidated basis wegenerated a net positive cash flow of $30.7 million. This net positivenumber can be better understood by explaining the major components:

 

***Mortgage Banking Business:***

 

Ourwarehouse line lending agreements allow us to borrow from 96% to 99% of par foreach mortgage loan.  These agreementscontain restrictive covenants.  As ofSeptember 30, 2003, we are in compliance with all covenants associated withthese agreements. We pay an additional 1% to 2% of the loan principal amount infees or yield spread premium to the mortgage brokers. Lastly, a small portionof our loan inventory is funded with equity capital. We typically have cashinvested totaling between 1% to 4% (including loan repurchases) of theprincipal amount of loans held for sale, which is recouped when the loans arepurchased by investors. Should we increase the amount of loan inventory, eitherby holding loans for longer periods, or due to increased loan funding volume,the cash reserves necessary to carry loan inventories will increase in directproportion to the inventory held. Our total warehouse line capacity as ofOctober 1, 2003 was $1.4 billion.

 

Cashreceipts in excess of cash expenditures in AmNet were approximately $28.7million for the nine months ended September 30, 2003. Cash receipts consist ofproceeds for loan sales and hedging gains, interest on loans held for sale, andfees charged on funded loans.  Cashexpenditures consist of payments on hedging losses, salary benefits,commissions and other operating expenses.

 

Capitalexpenditures totaled approximately $3.2 million during the nine months endedSeptember 30, 2003. Capital expenditures included approximately $1.2 million incomputer hardware, approximately $1.3 million for fixtures and equipment, andapproximately $732 thousand for computer software and other equipment.

 

Ourfinancial condition can be affected by turmoil in world markets, which coulddirectly impact domestic liquidity. We intend to renew existing financingfacilities and seek new financing sources as the need arises. There can be noassurance that we will be able to secure new short or long-term financing orthat financing will be available on favorable terms.

 

Weanticipate our liquidity will be predominantly impacted by our Mortgage BankingBusiness. Specifically, we expect to continue to originate approximately$650 million to $1.5 billion per month of new mortgage loans and fundthese originations with equity capital and warehouse facility borrowings. Wealso expect to continue to engage in hedging transactions that may require cashinvestment to maintain or adjust hedged positions. Furthermore, we anticipategreater general and administrative costs associated with the operations of ourMortgage Banking Business. We intend to use cash reserves, borrowings under thewarehouse facilities and the Subordinated Loan Agreement and cash flowgenerated by the mortgage asset portfolio, as well as cash flow generated fromthe origination and sale of mortgage loans, to fund our operations. We aretherefore dependent on significant levels of warehouse financing to helpexecute our mortgage banking strategy. Furthermore, we must originate a certainminimum level of loans to remain profitable. See Business Risk Factors.

 

***Mortgage AssetPortfolio Business:***

 

Net cash flow from our mortgage asset portfolio was positive atapproximately $2.0 million for the first nine months of 2003.  The Mortgage Asset Portfolio businessgenerates cash from interest and principal received from bond collateral andproceeds from the sale of real estate owned bond collateral. The bond trustees(master servicer) offset this cash by paying interest and

 

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principalto bondholders, paying servicer and trustee fees, bond insurance premiums andreimbursing servicers for any advances made on real estate owned dispositions.Any excess cash flow is remitted to us from the bond trustees on a monthlybasis. There are various factors that affect this flow, such as market interestrate changes. Additionally, our bond agreement provisions specify therequirements for over collateralization accounts. If over collateralizationaccounts are deficient, this can restrict our receipt of excess cash flow andbe used instead by the bond trustee to pay down long-term debt.

 

Cashflow from the mortgage asset portfolio is expected to decline in 2003 due to adecline in the size of the portfolio and potential increases in over collateralizationaccounts.

 

Administrativeexpenditures for our Mortgage Asset Portfolio Business aggregated approximately$1.4 million for the nine month period ending September 30, 2003.  Administrative expenses allocated to ourMortgage Asset Portfolio Business included portfolio management payrollallocations of approximately $613 thousand, general legal expenses ofapproximately $197 thousand, professional and consulting fees ofapproximately $250 thousand, director fees of $94 thousand, stock exchange feesof $65 thousand and liability insurance of approximately $216 thousand.Stock exchange fees relate to our change from the New York Stock Exchange tothe American Stock Exchange. We expect director fees and general legal andprofessional expenses to increase due to the implementation of various newcorporate governance measures required by the Sarbanes-Oxley Act of 2002.

 

**BusinessRisk Factors**

 

**Risks Associated with Changing OurBusiness Strategy**

 

*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 began originatingand selling mortgages (mortgage banking). As a result, comparisons betweenfinancial performance in current quarters and past quarters may not be helpfulin evaluating our current performance or our future prospects.  We must originate increasing amounts ofmortgages in the future to grow our business. While our executive officers haveextensive mortgage origination and mortgage banking experience, and have hiredexperienced personnel in our mortgage banking subsidiary, there are asignificant number of risks and uncertainties inherent in the mortgageorigination industry, especially in light of our limited relevant operatinghistory relative to our mortgage banking activities.

 

*We Expect Our Operating Expenses to Increase, which MayAdversely Affect Our Results of Operations*

 

Wehad net income of approximately $29.0 million for the nine month periodending September 30, 2003 which included an income tax benefit of $9.9 million.We expect to incur additional costs and expenses related to the expansion ofour sales force and the opening of new regional underwriting centers, as wellas the expansion of our management team and establishment of the internalinfrastructure necessary to support the growth of our mortgage bankingbusiness. If these expansion initiatives do not generate adequate revenues, ourfinancial performance will suffer. In addition, these expenses will require theuse of cash, which may not be offset by additional revenues. See “RisksAssociated with Our Mortgage Banking Business — Overhead Expenses May Not BeCovered by Sufficient Revenues to Sustain Profitable Operations.”

 

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

 

Recently,we have experienced rapid growth. In the beginning of 2001, we hadapproximately 20 employees. As of September 30, 2003, we had over 650employees. Many of these employees have very limited experience with us and alimited understanding of our systems. Many of our financial, operational and managerial systems were designedfor a small business and have only recently been adapted or replaced to supportlarger scale operations. At the same time, we will need to continue to upgradeand expand our financial, technological, operational and managerial systems andpolicies and procedures. If we fail to manage our growth effectively, ourexpenses could increase and management’s time and attention could be diverted.If we do not succeed in these efforts, we will be unable to effectively growand manage the business, and our financial results could be negativelyaffected.

 

**Risks Associated with Our Mortgage Banking Business**

 

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

 

Asof October 1, 2003 we had warehouse borrowing facilities in place totaling $1.4billion.  In order to continue toincrease loan origination volumes, we must obtain additional warehouse lines ofcredit, or reduce the time loans are held for sale (warehoused). There are anumber of financial institutions which specialize in lending to mortgagebanking companies and these types of secured

 

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borrowings.We expect to expand our current warehouse facilities with JP Morgan/Chase, UBSWarburg and Countrywide Warehouse Lending; however, there can be no assurancesthat we will expand our current warehouse facilities or obtain additionalwarehouse facilities. Failure to obtain additional facilities would limit ourpotential for growth and may adversely affect our financial results. Among thefactors that will affect our ability to expand our warehouse line borrowingsare financial market conditions and the value and performance of our companyprior to the time of such financing. There can be no assurance that any suchfinancing can be successfully completed at advantageous rates or at all. Ourwarehouse credit facilities contain extensive restrictions and covenants that,among other things, require us to satisfy specified financial, asset qualityand loan performance tests. If we fail to meet or satisfy any of thesecovenants, we would be in default under these agreements and our lenders couldelect to declare all amounts outstanding under the agreements to be immediatelydue and payable, enforce their interests against collateral pledged under suchagreements and restrict our ability to make additional borrowings. Theseagreements also contain cross-default provisions, so that if a default occursunder one agreement, the lenders under our other agreements could also declarea default. Any default under our credit facilities would have an adverse effecton our financial results.

 

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 Company’s financialcondition, liquidity and results of operations. As of the date of filing thisreport, we are in compliance with all restrictions and covenants contained inour warehouse borrowing facilities.

 

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

 

Ourprimary source of revenue is gains on sales of loans, offset by gains or losseson derivative financial instruments. We set rates and pay broker premiums forloans we fund based on a pricing process designed to create a targeted profitmargin on each loan. Appropriately pricing these loans can be complex, and wemay not always successfully price our loans with adequate margin to compensateus for the risk of interest rate volatility.

 

Thevalue of the mortgage loans that we originate is at risk due to fluctuations ininterest rates during two time periods: (1) the period beginning when wehave committed to funding the loan and ending when the loan closes, or funds;and (2) the time period beginning when the loan closes and ending when wecommit to sell or sell the loans to third-party purchasers. These loans arecollectively referred to as our loan pipeline. To manage the interest rate riskof our pipeline, we continuously project the percentage of the pipeline loanswe expect to close. Because projecting a percentage of pipeline loans that willclose is especially difficult during periods of volatile interest rates, wecannot assure that our projections will be accurate. On the basis of suchprojections, we use forward sale of mortgage loan securities (TBA-MBS) andoptions on TBA’s, which are classified as derivative instruments. These“hedges” are designed to mitigate the adverse impact of interest ratefluctuations on the value of the loan pipeline. Our use of hedges is driven byour estimates as to the percentage of loans that will close, and therefore wecannot provide assurance that our use of derivative securities will offset therisk of changes in interest rates.

 

Ifinterest rates change unexpectedly, the actual percentage of pipeline loansthat close may differ from the projected percentage. A sudden increase ininterest rates can cause a higher percentage of pipeline loans to close thanprojected. We may not have made forward sales commitments to sell theseadditional loans and consequently may incur significant losses upon their saleat current market prices, which may not be offset by gains in the value ofderivative securities, adversely affecting results of operations. Likewise, ifa lower percentage of pipeline loans closes than was projected, due to a suddendecrease in interest rates or otherwise; we have and may in the future adjusthedge positions or mandatory sales commitments at a significant cost, adverselyaffecting our results of operations. This risk is greater during times ofvolatile interest rates.

 

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*Contracting Mortgage Origination Market may Adversely ImpactOur Business*

 

According to the Mortgage Bankers Association, 2003will be a record $3.3 trillion in mortgage loan origination, however 2004 willbe $1.6 trillion.  We have assumed acontraction in the level of mortgage originations in the remainder of 2003 and2004 due to generally higher mortgage interest rates and a decline in the levelof loan refinancings.  We anticipatehigher costs per loan and lower per loan revenue as a direct consequence of theexpected market contraction.  Increasedmarket share in existing markets and planned expansion into new markets may beinsufficient to prevent an overall decline in results of operations.  The growth of our business may also beadversely impacted due to general market contraction.

 

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

 

Weuse forward sale of mortgage loan securities (TBA-MBS) and options on TBA’s,which are classified as derivative financial instruments, to provide a level ofprotection against interest rate risks. We may, if the need arises, use other hedging instruments if we feelsuch instruments more effectively mitigate interest rate risk.  When rates change we expect to record a gainor loss on derivatives which would be offset by an inverse change in the valueof our pipeline of rate lock commitments and loans not yet committed for sale.We cannot provide assurance however, that our use of derivatives will offsetall of our risk related to changes in interest rates. There have been periods,and it is likely that there will be periods in the future, during which we willincur losses after accounting for our derivative financial instruments. Thederivative financial instruments we select may not have the desired effect ofreducing our interest rate risk. In addition, the nature and timing of hedgingtransactions may influence the effectiveness of these strategies. If we poorlydesign strategies or improperly execute transactions we could actually increaseour exposure to interest rate risk and potential losses. In addition, hedgingstrategies involve transaction and other costs. We cannot provide assurancethat our hedging strategy and the derivatives that we use will adequatelyoffset the risk of interest rate volatility or that our hedging transactionswill not result in losses.

 

*Overhead Expenses May Not Be Covered By Sufficient RevenuesTo Sustain Profitable Operations*

 

Wemade a number of fixed overhead commitments to establish the operational andadministrative infrastructure necessary to support the loan originationbusiness. At September 30, 2003, lease commitments for headquarters andregional offices totaled approximately 122,750 square feet. There were over 650salaried, commissioned and hourly employees. In order to achieve profitability,our monthly originations must be in the $500 million to $750 millionrange, such that the expected revenues associated with this loan productionexceed fixed and variable overhead costs. Since our revenues are tied directlyto the level of loan production, it is imperative that we achieve a profitablelevel of originations, and the level of future profitability from mortgagebanking will be in direct correlation to the level of loan origination volume.There can be no assurances that we will be able to maintain loan originationvolumes sufficient to cover our fixed overhead costs, and should we incursignificant operating losses, our capital base and cash reserves could bematerially adversely impacted, precluding us from fully implementing ourmortgage banking strategies.

 

*Non-saleable or Repurchased 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 originate a loan that does not meet investor underwritingcriteria or has some other defect, requiring us to sell the loan at asignificant discount. We have hired experienced personnel at all levels andhave established significant controls to ensure that all loans are originatedto our underwriting standards, and are maintained in compliance with all of therepresentations made by us in connection with our loan sale agreements.However, there can be no assurances that mistakes will not be made or thatcertain employees will not deliberately violate our lending policies and,accordingly, we are subject to repurchase risk and losses on unsaleable loans.Typically, with respect to any loan that might be repurchased or unsaleable, wewould correct the flaws if possible and re-sell the loan in the market. We havecreated repurchase reserves to provide for this contingency on our financialstatements, but there can be no assurances that loan losses associated withrepurchased or unsaleable loans will not adversely impact results of operationsor the financial condition of our Company.

 

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

 

Ourmortgage banking activities require a significant level of cash reserves andcapital to support loan inventories and overhead expense coverage.Additionally, while we utilize warehouse credit facilities to fund our loanorigination activity, we must invest cash in our loan inventories approximating1% to 4% of the cost basis for these loans. We also maintain derivativefinancial instruments, potentially requiring cash payments as those instrumentsmature. While we believe our capital base, cash reserves and cash revenues fromour mortgage asset portfolio business and mortgage banking revenues will besufficient to cover overhead expenses, 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.

 

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*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 enactlaws that restrict loan origination activities in those cities and counties.The laws and regulations of each of these jurisdictions are different, complexand, in some cases, in direct conflict with each other. As our operationscontinue to grow, it may be more difficult to comprehensively identify,accurately interpret and properly program our technology systems andeffectively train our personnel with respect to all of these laws andregulations, thereby potentially increasing our exposure to the risks ofnoncompliance with these laws 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 within certainstates;

 

•                                            demands for indemnification or loanrepurchases from purchasers of our loans;

 

•                                            class action lawsuits;

 

•                                            assignee liability, which may make our loansunsaleable; 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 Cost ofDoing 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 numberof these laws, rules and regulations seek to impose liability for violations onpurchases of loans, regardless of whether a purchaser knew of or participatedin the violation.

 

OurCompany does not engage in predatory lending practices and therefore we avoidoriginating loans that exceed the APR or “points and fees” thresholds asprescribed in predatory lending laws, rules and regulations. In addition, thecompanies that buy our loans and/or provide financing for our loan originationoperations generally do not want to buy or finance such loans. The continuedenactment of these laws, rules and regulations may prevent us from makingcertain loans and may cause us to reduce the APR or the points and fees onloans that we do make. In addition, the difficulty of managing the riskspresented by these laws, rules and regulations may decrease the availability ofwarehouse financing and the overall demand for loans, making it difficult tofund, sell or securitize any of our loans. If we decide to relax our restrictionson loans subject to these laws, rules and regulations because the companieswhich buy our loans and/or provide financing for our loan originationoperations relax their restrictions, we will be subject to greater risks foractual or perceived non-compliance with such laws, rules and regulations,including demands for indemnification or loan repurchases from our lenders andloan purchasers, class action lawsuits, increased defenses to foreclosure ofindividual loans in default, individual claims for significant monetary damagesand administrative enforcement actions. The growing number of these laws, rulesand regulations will likely increase our cost of doing business as we arerequired to develop systems and procedures to ensure that we do not violate anyaspect of these new requirements. Any of the foregoing could materially andadversely affect our business, financial condition, liquidity and results ofoperations.

 

*Competition In The Mortgage Banking Industry and Demand forMortgages May Hinder Our Ability to Achieve or Sustain Profitable OriginationLevels*

 

Oursuccess in the mortgage banking strategy will depend, in large part, on ourability to originate quality loans in sufficient quantity such that the gain onsales of loans after hedge costs are in excess of both fixed and variableoverhead costs. There can be no assurance that we will be able to originatesufficient levels of mortgages to achieve and sustain profitability. Inoriginating and selling quality loans, we will compete with investment bankingfirms, savings and loan associations, banks, mortgage bankers and otherentities originating “A” paper for residential 1-4 unit mortgages, many ofwhich have greater financial resources than us. We will also face competitionfrom companies already established in these markets. In addition to the levelof home purchase activity, the origination market is directly tied to thegeneral level of interest rates and refinance activity. The origination market,per the Mortgage Bankers Association, is expected to be a record $3.2 trillionin 2003, however, 2004 mortgage originations are expected to be $1.5 trillion.

 

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Theoverall market size will contract, thereby increasing competitiveness in themortgage markets and putting pressure on the market competitors to reduce netrevenues to sustain origination volumes and market share. We believe that thevariety and competitiveness of our loan products and customer service levelswill allow us to gain market share over the next several years, even if theoverall demand for mortgages declines; however, there can be no assurance thatwe will be able to successfully compete.

 

*We Must Attract and Retain Qualified Account Executives toProduce Our Desired Level of Revenues*

 

Werely on commissioned account executives to generate loan referrals fromprofessional mortgage brokers. These account executives typically haveestablished relationships with our broker clients. Our overall loan fundingsare in direct proportion to the number of account executives, and as such, oursustained loan production and market share growth are dependent on thesuccessful retention and recruitment of our sales force. Due to this verycompetitive labor market, there can be no assurances we will be able to retainand recruit account executives.

 

*We Are Subject To Losses Due To Fraudulent Acts On The PartOf Loan Applicants, Employees or Mortgage Brokers*

 

Mortgagebrokers who assist loan applicants in obtaining mortgage loans refer all of themortgage loans originated by us. As such, the loan application, propertyappraisal, credit report and other supporting documentation are furnished bythe mortgage broker and used by our underwriters to make approval or denialdecisions. There could be the potential of collusion between the broker and anemployee to produce a fraudulent loan. Our employees have limited contact withapplicants, and rely on the mortgage broker to obtain and furnish all of thedocumentation supporting the mortgage loan application. Mortgage brokers maymake mistakes in completing the documentation for a loan, leading to anincreased risk of our holding a non-saleable loan.

 

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 loan.

 

Shouldmaterial fraud be detected on a mortgage loan prior to sale to an investor, themortgage loans 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 loans deemed to be fraudulentlyobtained, we could incur significant losses on these fraudulent mortgage loansif principal or interest is not fully recovered through the foreclosure and dispositionof 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. Regular quality control auditsare done on representative samples of mortgage loans and all mortgage loanssubmitted by brokers who come under suspicion in the normal course 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 brokers and/or borrowers do not submit fraudulent or inaccuratedocumentation that is not detected by our personnel or by electronic fraudchecks utilized by us. Should we originate significant numbers of fraudulentloans or loans based on inaccurate documentation, our results of operations andfinancial condition could be materially adversely affected.

 

*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 an “agent” of the lender, and the FTC imposed a fine on the lender inpart 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.

 

*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 hedging transactions which involve optionpurchases and sales.

 

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Wehave 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 correspondentlending.  However, there can be noassurances that counterparties will perform. If counterparties do not perform,our results of operations may be adversely affected.

 

*We Sell a Substantial Portion of Loans We Originate to aCompetitor*

 

Wehave warehouse line facilities with Countrywide Home Loans, Inc.(Countrywide). In the nine months ended September 30, 2003 we sold 78% of ourloans to Countrywide and expect to continue to sell a substantial majority ofour loans to Countrywide. We may have to find other investors for loan sales orbe forced to find other sources of warehouse line lending if Countrywidechanges its policies and procedures. Either of these results may have anadverse effect on our results of operations.

 

*Mortgage Banking Revenues Can Fluctuate From Period toPeriod Based on a Number 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, pipeline loans or positions in derivative securities.Accordingly, the consolidated net income of our Company may fluctuate fromperiod to period.

 

*Dependency on Correspondent Investors, Secondary Markets*

 

Ourability to generate gains on the sale of mortgages is largely dependent uponthe continuation of correspondent lending programs offered by large correspondentlenders, as well as our continued eligibility to participate in such programs.Although we are in good standing with a number of large correspondent lendersand are not aware of any proposed discontinuation of, or significant reductionin, the operation of such programs, any such changes could have a materialadverse effect on our operations. We anticipate that we will continue to remaineligible to participate in such programs, but any significant impairment ofsuch eligibility would materially adversely affect our operations.

 

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

 

Alarge proportion of loans (31.0% of all loans closed for the nine month periodending September 30, 2003) we fund are concentrated in California. Although weare expanding our operations on the East Coast of the United States in 2003, asignificant portion of our loan origination volume is likely to be based inCalifornia for the foreseeable future. Consequently, our results of operationsand financial condition are dependent upon general trends in the Californiaeconomy and its residential real estate market. Residential real estate marketdeclines may adversely affect the levels of new mortgages in California or thevalue paid by correspondent lenders for loans in California, potentiallyadversely affecting our results of operations and financial condition.

 

Duringthe week of October 27, 2003, extensive wild fires occurred in SouthernCalifornia.  One of our investorsordered re-inspections of properties in affected postal zip code areas forloans funded but not sold.  We hadapproximately 84 properties which were subject to re-inspection.  Although the effect of the wild fires wasnegligible on our operations, potentially adverse affects could occur as aresult of future wildfires and our substantial presence in the Californiamarketplace.

 

*A Housing and Urban Development Department (“HUD”) ProposedRule to Reform Real Estate Settlement Procedures (“RESPA”) May Adversely Affectthe Way We Conduct Business with Mortgage Brokers*

 

HUDis proposing to improve the manner in which yield spread premiums paid tobrokers are disclosed by requiring that yield spread premiums (and othermortgage broker compensation) be reported as payments from the lender. Thepurpose of this would be to have the mortgage broker only receive directcompensation from borrowers and attempt to eliminate disputes regardingimproper broker payments. This proposed rule may adversely affect our businessby requiring changes in systems and procedures which may cause delays andre-work to meet regulatory requirements.

 

*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 our mainloan origination system, and this software is not fully documented and we havea limited number of employees who are knowledgeable about this program. Wecannot provide assurance that systems failure or interruptions will not occur,or if they do occur that they will be adequately addressed by us or the thirdparties on 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 and Implement 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 closings. The origination processis becoming more dependent upon technological advancement, such as the abilityto process applications over the Internet, accept electronic signatures, and

 

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provideprocess status updates instantly and other customer-expected conveniences thatare cost-efficient to our process. Implementing this new technology andachieving proficiency with it may also require significant capitalexpenditures. As these requirements increase in the future, we will have tofully develop these technological capabilities to remain competitive or ourbusiness will be significantly harmed.

 

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

 

Allof our loan originations of mortgage loans come from independent brokers. Ourbrokers are not contractually obligated to do business with us. Further, ourcompetitors also have relationships with our brokers and actively compete withus in our efforts to expand our broker networks. Accordingly, we cannot provideassurance that we will be successful in maintaining our existing relationshipsor expanding our broker networks, the failure of which would significantly harmour business, financial condition, liquidity and results of operations.

 

*Our Financial Results Fluctuate As a Result of Seasonalityand Other Timing Factors, Which Makes It Difficult To Predict Our FuturePerformance and May Affect the Price of Our Common Stock*

 

Ourbusiness is generally subject to seasonal trends. These trends reflect thegeneral pattern of housing sales, which typically peak during the spring andsummer seasons. Our quarterly operating results have fluctuated in the past andare expected to fluctuate in the future, reflecting the seasonality of theindustry. Further, if the closing of a sale of loans is postponed, therecognition of gain from the sale is also postponed. If such a delay causes usto recognize income in the next quarter, our results of operations for the previousquarter could be significantly depressed. If our results of operations do notmeet the expectations of our stockholders, the price of our common stock maydecrease.

 

**Risks Associated with Our Mortgage Asset Portfolio Business**

 

*High Levels of Bond Collateral Mortgage Loan Prepayments MayReduce Operating Income*

 

Thelevel of prepayments of Bond Collateral Mortgage Loans we purchased at apremium directly impacts the level of amortization of capitalized premiums. Weuse a calculation for determining the premium amortization which is based onthe interest method. If prepayment levels exceed projections used for thepremium amortization calculation, the potential exists for impairmentwrite-downs as a result of under-amortized premiums.  Therefore premium amortization cost would be incurred soonerrather pro-rated over a longer time period.

 

BondCollateral Mortgage Loans prepayment rates generally increase when marketinterest rates fall below the current interest rates on mortgage loans.Prepayment experience also may be affected by the expiration of prepaymentpenalty clauses, the ability of the borrower to obtain a more favorablemortgage loan, geographic location of the property securing the adjustable-ratemortgage loans, the assumability of a mortgage loan, conditions in the housingand financial markets and general economic conditions. The level of prepaymentsis also subject to the same seasonal influences as the residential real estateindustry with prepayment rates generally being highest in the summer months andlowest in the winter months. We have experienced high levels of prepaymentsduring 1999 through 2000 on the CMO/FASIT segment of our Bond CollateralMortgage Loan portfolio, due principally to the fact that the underlyingadjustable rate loans were subject to their first initial interest rateadjustment (after being fixed for the first two years), prepayment penaltyclauses expired and borrowers were able to secure more favorable rates byrefinancing. In 2001, the same trend occurred in the 99-A and 1999-2 segmentsof our portfolio, as the loans in these portfolios reached the end of their2-year fixed rate periods and prepayment penalty clauses expired. The overallrate of prepayments declined slightly for the nine month period ending September30, 2003 (34.75%) decreased from the same period ending September 30, 2002(39.68%). We anticipate that overall prepayment rates are likely to remain inthe 30% to 45% range in 2003. There can be no assurance that prepayment rateswill not be higher or that prepayment penalty income will offset premiumamortization expense. Accordingly, our financial condition and results ofoperations could be materially adversely affected.

 

Asof September 30, 2003 approximately 14.6% of our Company’s Bond Collateral MortgageLoan portfolio had prepayment penalty clauses, with a weighted average ofthirteen months remaining before prepayment penalties expire.

 

*Borrower Credit Defaults, Special Hazard Losses and NationalRecessions May Decrease Value Of Bond Collateral Mortgage Assets Held By OurCompany*

 

Duringthe time we hold bond collateral mortgage assets or retained interests insecuritizations, we are subject to credit risks, including risks of borrowerdefaults, bankruptcies and special hazard losses that are not covered bystandard hazard insurance (such as those occurring from earthquakes or floods).In the event of a default on any mortgage loan we hold or mortgages underlyingbond collateral, we will bear the risk of loss of principal to the extent ofany deficiency between the value of the secured property and the amount owingon the mortgage loan, less any payments from an insurer or guarantor. Althoughwe have established an allowance for loan losses, there can be no assurancethat any allowance for loan losses which is established will be sufficient tooffset losses on mortgage loans in the future.

 

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Creditrisks associated with non-conforming mortgage loans, especially sub-primemortgage loans, will be greater than those associated with mortgage loans thatconform to FNMA and FHLMC guidelines. The principal difference betweensub-prime mortgage loans and conforming mortgage loans is that sub-primemortgage loans typically include one or more of the following: worse credit andincome histories of the mortgagors, higher loan-to-value ratios, reduced oralternative documentation required for approval of the mortgagors, differenttypes of properties securing the mortgage loans, higher loan sizes and themortgagor’s non-owner occupancy status with respect to the mortgaged property.As a result of these and other factors, the interest rates charged onnon-conforming mortgage loans are often higher than those charged forconforming mortgage loans. The combination of different underwriting criteriaand higher rates of interest may lead to higher delinquency rates and/or creditlosses for non-conforming as compared to conforming mortgage loans and thusrequire higher loan loss allowances. All of our Bond Collateral Mortgage Loansat September 30, 2003, were originated as sub-prime mortgage loans.

 

Adown-turn in the national economy and the resultant adverse impact onemployment rates could adversely affect mortgage loan defaults. Additionalcredit could become scarce in such an environment and therefore risk of lossthrough loan default and decreased property value could increase. Ourallowances may be deemed inadequate should economic conditions declinesignificantly, causing higher than expected defaults and property valuedecreases. We believe the allowances for loan losses are adequate as ofSeptember 30, 2003.

 

Evenassuming that properties secured by the mortgage loans we hold provide adequatesecurity for such mortgage loans, substantial delays could be encountered inconnection with the foreclosure of defaulted mortgage loans, with correspondingdelays in the receipt of related proceeds. State and local statutes and rulesmay delay or prevent our foreclosure on or sale of the mortgaged property andtypically prevent us from receiving net proceeds sufficient to repay allamounts due on the related mortgage loan.

 

*Requirements to Maintain Over-collateralization Accounts MayReduce Our Cash Flow and Inhibit Plans for Expansion of the Mortgage BankingBusiness*

 

Inconnection with securing long-term debt, all of our Bond Collateral MortgageLoans have been pledged as collateral to secure long-term debt. Certain overcollateralization accounts have been established representing the excessprincipal amount of these mortgages over the associated bond obligations.Various indenture agreements associated with these securitizations call for theover collateralization levels to be maintained on an ongoing basis depending onthe amount of remaining bond obligations as well as the status of delinquencyof the underlying bond collateral or the loan loss performance of bondcollateral. Although long-term financing agreements are non-recourse, netinterest income from some segments of our Bond Collateral Mortgage Loans has inthe past, and could in the future, be “trapped” to pay down debt in order forus to achieve our over-collateralization requirements. While we believe that wehave sufficient cash reserves and other liquidity to support our plannedmortgage banking activities, there can be no assurance that we will not berequired to reduce or cease our planned mortgage banking activities should webe required to divert cash flow to maintain over collateralizationrequirements.

 

*Because Mortgage Assets Are Pledged to Secure Long-Term Debt,We May Not Be Able to Sell Such Assets and Therefore Our Liquidity and CapitalResources May Be Adversely Affected*

 

Allof our Company’s bond collateral mortgage assets at September 30, 2003 werepledged as bond collateral to secure long-term debt. These assets are subjectto the terms of the long-term debt agreements and may not be separately sold orexchanged. While we may sell our interests in the bond collateral subject tothe liens and other restrictions of the long-term debt agreements, there is nota liquid market for such encumbered interests and a significant liquiditydiscount would be applied. As such, we would expect to receive less than ourbook value should we sell our interest in the bond collateral.

 

*Increases In Short-Term Interest Rates May Increase Our Costof Borrowings, Which May Reduce Income From Operations*

 

Themajority of our Bond Collateral Mortgage Loans have a repricing frequency ofsix months or less, while substantially all of our borrowings have a repricingfrequency of one month or less. Accordingly, the interest rates on theseborrowings may be based on interest rate indices which are different from, andadjust more rapidly than, the interest rate indices of our related mortgageloans. Consequently, increases in short-term interest rates may significantlyinfluence our net interest income. While increases in short-term interest rateswill increase the yields on a portion of our adjustable-rate Bond CollateralMortgage Loans, rising short-term rates will also increase our cost ofborrowings. To the extent such costs rise more than the yields on such BondCollateral Mortgage Loans, our net interest income will be reduced or a netinterest loss may result. We may mitigate this “gap” risk by purchasinginterest rate hedges (referred to as “caps”); however potential income fromthese hedges may only partially offset the adverse impact of rising borrowingcosts.

 

*Loans Serviced by Third Parties May Result in IncreasedDelinquency Rates and Credit Losses, which May Adversely Affect Our Results ofOperations and Financial Condition*

 

Allof our Bond Collateral Mortgage Loans are serviced by sub-servicers. Wecontinually monitor the performance of the sub-servicers through performancereviews, comparable statistics for delinquencies and on-site visits. We have onoccasion determined that

 

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sub-servicershave not followed standard collection and servicing practices related to ourBond Collateral Mortgage Loans, which we believe have led to increaseddelinquencies and higher loan losses on selected segments. We continue tomonitor these servicers, have put these entities on notice of suchdeficiencies, and have instituted other mitigating processes. We have arrangedfor servicing with entities that have particular expertise in non-conformingmortgage loans. Although we have established these relationships andprocedures, there can be no assurance that these sub-servicers will service ourmortgage loans in such a way as to minimize delinquency rates and/or creditlosses and not cause an adverse effect on our results of operations.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT 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 in our MortgageBanking and Mortgage Asset Portfolio businesses.

 

**Mortgage Banking Business**

 

*Interest Rate Risk*

 

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

 

**Mortgage Asset Portfolio Business**

 

*Interest Rate Risk*

 

Ouroperating results for this business segment will depend in large part ondifferences between the income earned from our assets (net of credit losses)and our borrowing costs. All of this business segment’s mortgage assets arepledged as collateral for long-term debt (securitizations). In most cases, theincome from assets will respond more slowly to interest rate fluctuations thanthe cost of borrowings, which creates a mismatch between asset yields andborrowing rates.  Consequently, changesin interest rates, particularly short-term interest rates, may influence theMortgage Asset Portfolio Business net income. Long-term debt interest rates aretied to LIBOR.  Increases in these rateswill tend to decrease net income. A significant increase in short-term interestrates, where the one month LIBOR exceeded 12%, could result in interest expenseexceeding interest income and would result in operating losses. In the past, wehave attempted to mitigate interest rate gap risk through hedging instrumentscalled Interest Rate Caps. The majority of mortgages held in the portfolio areadjustable rate mortgages (ARM’s) which adjust every six months. Consequentlyour gap risk is limited and at the present time we do not believe that the costof hedging our gap risk is justified. Currently we do not have any Interest Rate Caps in place.

 

*Other Risks*

 

Thevalue of Mortgage Portfolio assets may be affected by prepayment rates on bondcollateral mortgage loans.  Prepaymentrates are influenced by changes in current interest rates and a variety ofeconomic, geographic and other factors beyond our control. Partial protectioncomes in the form of prepayment penalties, but since our portfolio is becomingmore mature, most of the prepayment penalty clauses have expired.

 

Increasesin delinquency rates and defaults by borrowers on their mortgages can alsonegatively impact the financial results of the Mortgage Asset PortfolioBusiness. We monitor delinquencies and defaults and adjust the loan lossprovision and interest reserves accordingly.

 

**Sensitivity Analyses**

 

Wehave performed various sensitivity analyses that quantify the net financialimpact of changes in interest rates on our interest rate-sensitive assets,liabilities and commitments. These analyses presume an instantaneous parallelshift of the yield curve. Various techniques are employed to value theunderlying financial instruments, and these techniques rely upon a number ofcritical assumptions. The scenarios presented are illustrative. Actualexperience may differ materially from the estimated amounts presented for eachscenario. To the extent that yield curve shifts are non-parallel, and to theextent that actual variations in significant assumptions differ from thoseapplied for purposes of the valuations, the resultant valuations can also beexpected to vary. Such variances may prove material.

 

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|                                                                    |   |                    |    |                       |   | **If  Interest Rates Were To**              |   |
|-------------------------------------------------------------------------|--------|-------------------------|---------|----------------------------|--------|---------------------------------------------|--------|
|                                                                    |   | **September  30, 2003** |    | **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                                               |   | $                       | 44,357  |                       | $      | 44,357                                      |   | $ | 44,357 |   | $ | 44,357 |   | $ | 44,357 |   | $ | 44,357 |   |
| Mortgage loans held for sale, net, pledged, (lower  of cost or market)) |   | 367,013                 |    | 372,197                    |   | 369,147                                     |   | 373,980 |   | 366,034 |   | 375,742 |   |
| Bond collateral and real estate owned (net)                             |   | 185,931                 |    | 188,981                    |   | 188,779                                     |   | 189,197 |   | 188,603 |   | 189,427 |   |
| Derivatives                                                             |   | (3,826                  | )       | (3,826                     | )      | (1,115                                      | )      | (5,936 | ) | 1,170 |   | (8,222 | ) |
| Total interest-earning assets                                           |   | $                       | 593,475 |                       | $      | 601,709                                     |   | 601,168 |   | 601,598 |   | 600,164 |   | 601,304 |   |
|                                                                    |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                           |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Short-term debt                                                         |   | $                       | 352,777 |                       | $      | 352,777                                     |   | $ | 352,777 |   | $ | 352,777 |   | $ | 352,777 |   | $ | 352,777 |   |
| Long-term debt, net                                                     |   | 153,284                 |    | 153,284                    |   | 153,284                                     |   | 153,284 |   | 153,284 |   | 153,284 |   |
| Total interest-bearing liabilities                                      |   | $                       | 506,061 |                       | $      | 506,061                                     |   | $ | 506,061 |   | $ | 506,061 |   | $ | 506,061 |   | $ | 506,061 |   |
|                                                                    |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Resulting effect on equity                                              |   | $                       | 87,414  |                       | $      | 95,648                                      |   | $ | 95,107 |   | $ | 95,537 |   | $ | 94,103 |   | $ | 95,243 |   |

 
|                                                                   |   |                    |    |                       |   | **If  Interest Rates Were To**              |   |
|------------------------------------------------------------------------|--------|-------------------------|---------|----------------------------|--------|---------------------------------------------|--------|
|                                                                   |   | **September  30, 2002** |    | **Increase**               |   | **Decrease**                                |   | **Increase** |   | **Increase** |   |
|                                                                   |   | **Carrying   Amount**   |    | **Estimated   Fair Value** |   | **50 Basis  Points   Estimated Fair Value** |   | **100 Basis  Points   Estimated Fair Value** |   |
| Interest-earning assets:                                               |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |   | $                       | 11,428  |                       | $      | 11,428                                      |   | $ | 11,428 |   | $ | 11,428 |   | $ | 11,428 |   | $ | 11,428 |   |
| Mortgage loans held for sale, net, pledged, (lower  of cost or market) |   | 243,929                 |    | 243,929                    |   | 243,463                                     |   | 244,384 |   | 242,082 |   | 244,717 |   |
| Bond collateral and real estate owned (net)                            |   | 305,682                 |    | 315,924                    |   | 315,052                                     |   | 316,801 |   | 314,313 |   | 317,685 |   |
| Derivatives                                                            |   | 2,097                   |    | 2,097                      |   | 2,762                                       |   | 1,540 |   | 3,495 |   | 642 |   |
| Total interest-earning assets                                          |   | $                       | 563,136 |                       | $      | 573,378                                     |   | $ | 572,705 |   | $ | 574,153 |   | $ | 571,318 |   | $ | 574,472 |   |
|                                                                   |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                          |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Short-term debt                                                        |   | $                       | 255,890 |                       | $      | 255,890                                     |   | $ | 255,890 |   | $ | 255,890 |   | $ | 255,890 |   | $ | 255,890 |   |
| Long-term debt, net                                                    |   | 273,016                 |    | 273,016                    |   | 273,016                                     |   | 273,016 |   | 273,016 |   | 273,016 |   |
| Total interest-bearing liabilities                                     |   | $                       | 528,906 |                       | $      | 528,906                                     |   | $ | 528,906 |   | $ | 528,906 |   | $ | 528,906 |   | $ | 528,906 |   |
|                                                                   |   |                    |    |                       |   |                                        |   |   |   |   |   |   |   |
| Resulting effect on equity                                             |   | $                       | 34,230  |                       | $      | 44,472                                      |   | $ | 43,799 |   | $ | 45,247 |   | $ | 42,412 |   | $ | 45,566 |   |

 

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

 

*Cash and Cash Equivalents*

 

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

 

*Mortgage Loans 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 due to subsequent changes in interest rates.

 

*Bond Collateral and Real EstateOwned*

 

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

 

31

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financingcosts. However, due to the fact that our Bond Collateral is pledged to securelong-term debt, there is not a liquid market for such encumbered interests. Assuch, a significant liquidity discount would be applied.  Since we intend to hold the bond collateralmortgage loans to maturity, such a liquidity discount has not been reflected infair value.

 

*Retained Interest inSecuritization*

 

Thissecurity is classified as available-for-sale and as such is carried at fairvalue.

 

*Derivatives*

 

Fairvalues of forward sales of mortgage-backedsecurities and options onmortgage-backedsecurities are based on quoted market prices for theseinstruments. Fair values of our commitments to originate loans in the quotedmarket prices for the loans expected to close vary due to differences betweencurrent levels of interest rates and committed rates.

 

*Short-Term Debt*

 

Thefair value of the warehouse line debt approximates the carrying amounts becauseof the short-term nature of the debt and interest on the debt fluctuates withmarket interest rates.

 

*Long-Term Debt*

 

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

 

ITEM 4.  CONTROLS AND PROCEDURES

 

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

 

(b)There has been no change in our internal control over financial reporting identifiedin connection with the evaluation required by paragraph (d) of Exchange ActRule 13a-15 that occurred during the period covered by this quarterly reportthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

PART II.  OTHER INFORMATION

 
| ITEM  1. | LEGAL  PROCEEDINGS                                   |
|----------|------------------------------------------------------|
|     | None                                                 |
|     |                                                 |
| ITEM  2. | CHANGES  IN SECURITIES AND USE OF PROCEEDS           |
|     | None                                                 |
|     |                                                 |
| ITEM  3. | DEFAULTS  UPON SENIOR SECURITIES                     |
|     | Not  applicable.                                     |
|     |                                                 |
| ITEM  4. | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS |
|     | None                                                 |

 

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| ITEM  5. | OTHER  INFORMATION           |
|----------|------------------------------|
|     | None                         |
|     |                         |
| ITEM  6. | EXHIBITS  AND REPORTS ON 8-K |

 
| (a)    | Exhibits             |                                                                                                             |                                                                                                                                      |
|--------|----------------------|------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|   |                 |                                                                                                             |                                                                                                                                      |
| *      | 3.1                  |                                                                                                             | Second  Articles of Amendment and Restatement of the Registrant                                                                           |
| **     | 3.2                  |                                                                                                             | Second  Amended and Restated Bylaws of the Registrant                                                                                     |
| ***    | 4.1                  |                                                                                                             | Rights  Plan dated February 2, 1999 by and between the Company and American Stock  Transfer Company as Rights Agent                       |
|   | 31.1                 |                                                                                                             | Section  302 CEO Certification                                                                                                            |
|   | 31.2                 |                                                                                                             | Section  302 CFO Certification                                                                                                            |
|   | 32.1                 |                                                                                                             | Section  906 CEO Certification                                                                                                            |
|   | 32.2                 |                                                                                                             | Section  906 CFO Certification                                                                                                            |
|   |                 |                                                                                                             |                                                                                                                                      |
|        |
| *      |                 |                                                                                                             | Incorporated by reference to our annual report on  Form 10-K for the fiscal year ended December 31, 2002 filed March 31, 2003.            |
| **     |                 |                                                                                                             | Incorporated by reference to our quarterly report  on Form 10-Q for the fiscal quarter ended September 30, 2002 filed on August  14, 2002 |
| ***    |                 |                                                                                                             | Incorporated  by reference to Form 8-K filed on February 17, 1999.                                                                        |
|   | (File No. 001-13485) |                                                                                                             |                                                                                                                                      |   |
|   |                 |                                                                                                             |                                                                                                                                      |   |
| (b)    |                 | Reports  on Form 8-K – The Company filed or furnished the following reports on form  8-K during the quarter |
|   |                 |                                                                                                             |                                                                                                                                      |   |
|   |                 | **Date**                                                                                                         |                                                                                                                                      | **Items** |
|   |                 | 7/17/2003                                                                                                        |                                                                                                                                      | Item  7 Exhibits (press releases furnished) |
|   |                 |                                                                                                             |                                                                                                                                      | Item  9 Reg. FD Disclosure (information furnished under Item 12) |
|   |                 | 7/29/2003                                                                                                        |                                                                                                                                      | Item  7 Exhibits (press release furnished) |
|   |                 |                                                                                                             |                                                                                                                                      | Item  12 results of operations and financial conditions |
|        |                      |                                                                                                                  |                                                                                                                                           |  |  |  |

 

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.

 
| AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. |
|---------------------------------------------|
|                                        |   |   |
| Dated:  November 13, 2003              | By: | /s/ Judith A. Berry |   |
|                                        |   |   | Judith  A. Berry, |
|                                        |   |   | Executive  Vice President |
|                                        |   |   | Chief  Financial Officer |
|                                             |  |  |  |  |

 

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