**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:  June 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**                                                       |

 

| **AMERICAN  RESIDENTIAL 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) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct). Yes o No ý

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date.

 

| Common Stock ($0.01) |   | 7,864,749 as of July 16, 2003 |
|----------------------|--------|-------------------------------|

 

 

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| INDEX                                                                                                                                                                                            |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                             |
| PART I.  FINANCIAL INFORMATION                                                                                                                                                              |
|                                                                                                                                                                                             |
| Item 1.  Consolidated Financial Statements                                                                                                                                                       |
|                                                                                                                                                                                             |
| Consolidated Balance Sheets  at June 30, 2003 and June 30, 2002                                                                                                                                  |
|                                                                                                                                                                                             |
| Consolidated  Statements of Operations and Comprehensive Income (Loss) for the three months  ended June 30, 2003 and June 30, 2002 and for the six months ended June 30,  2003 and June 30, 2002 |
|                                                                                                                                                                                             |
| Consolidated  Statements of Cash Flows for the six months ended June 30, 2003 and June 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                                                                                                                                                        |

 

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PART I.  FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

 

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

ConsolidatedBalance Sheets

(in thousands, except share and per share data)

 
|                                                                                                                                                                                               |   | **(unaudited)**    |    |                   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|------------------------|--------|
|                                                                                                                                                                                               |   | **June 30,  2003** |    | **December  31, 2002** |   |
| ASSETS                                                                                                                                                                                             |   |               |    |                   |   |
| Cash  and cash equivalents                                                                                                                                                                         |   | $                  | 27,240  |                   | $      | 13,640 |   |
| Cash  and cash equivalents – restricted                                                                                                                                                       |   | 2,100              |    | 1,132                  |   |
| Mortgage  loans held for sale, net, pledged, (lower of cost or market)                                                                                                                             |   | 576,297            |    | 390,125                |   |
| Bond  collateral, mortgage loans, net                                                                                                                                                              |   | 203,656            |    | 259,851                |   |
| Bond  collateral, real estate owned                                                                                                                                                                |   | 5,328              |    | 9,527                  |   |
| Accounts  receivable – mortgage loans sold/funded                                                                                                                                             |   | 11,139             |    | 6,205                  |   |
| Derivative  financial instruments                                                                                                                                                                  |   | (927               | )       | (2,307                 | )      |
| Accrued  interest receivable                                                                                                                                                                       |   | 1,496              |    | 1,852                  |   |
| Deferred  tax asset                                                                                                                                                                                |   | 9,141              |    | —                 |   |
| Other  assets                                                                                                                                                                                      |   | 4,794              |    | 2,975                  |   |
|                                                                                                                                                                                               |   | $                  | 840,264 |                   | $      | 683,000 |   |
|                                                                                                                                                                                               |   |               |    |                   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                         |   |               |    |                   |   |
| Liabilities:                                                                                                                                                                                       |   |               |    |                   |   |
| Short-term  debt                                                                                                                                                                                   |   | $                  | 560,352 |                   | $      | 378,553 |   |
| Long-term  debt, net                                                                                                                                                                               |   | 176,977            |    | 237,456                |   |
| Accrued  interest payable                                                                                                                                                                          |   | 595                |    | 582                    |   |
| Accrued  expenses and other liabilities                                                                                                                                                            |   | 21,074             |    | 6,811                  |   |
| Total  liabilities                                                                                                                                                                                 |   | 758,998            |    | 623,402                |   |
|                                                                                                                                                                                               |   |               |    |                   |   |
| Commitments  and contingencies (Note 15)                                                                                                                                                           |   | —             |    | —                 |   |
|                                                                                                                                                                                               |   |               |    |                   |   |
| Minority  interest                                                                                                                                                                                 |   | 117                |    | 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; 7,863,437  shares issued and outstanding at June 30, 2003 and 7,862,490 shares issued  and outstanding at December 31, 2002 |   | 79                 |    | 79                     |   |
| Additional  paid-in-capital                                                                                                                                                                        |   | 108,762            |    | 108,760                |   |
| Accumulated  deficit                                                                                                                                                                               |   | (27,692            | )       | (49,354                | )      |
| Total  stockholders’ equity                                                                                                                                                                   |   | 81,149             |    | 59,485                 |   |
|                                                                                                                                                                                               |   | $                  | 840,264 |                   | $      | 683,000 |   |

 

See accompanying notes to consolidated financial statements.

 

3

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American Residential Investment Trust, Inc.and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income,unaudited

(in thousands, except per share data)

 
|                                                                    |   | **For the   Three Months Ended   June 30, 2003** |   | **For the   Three Months Ended   June 30, 2002** |   | **For the   Six Months Ended    June 30, 2003** |   | **For the   Six Months Ended   June 30, 2002** |   |
|-------------------------------------------------------------------------|--------|--------------------------------------------------|--------|--------------------------------------------------|--------|------------------------------------------------------|--------|------------------------------------------------|--------|
| **Revenues**                                                            |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Gain on sales of loans                                                  |   | $                                                | 32,971 |                                             | $      | 4,503                                                |   | $                                              | 53,180 |   | $ | 6,446 |   |
| Derivative  financial instruments and market adjustments                |   | (9,284                                           | )      | (8,315                                           | )      | (11,495                                              | )      | (8,402                                         | )      |
| Interest  on mortgage assets, net of premium amortization               |   | 10,393                                           |   | 7,494                                            |   | 19,639                                               |   | 14,415                                         |   |
| Litigation  settlement                                                  |   | —                                           |   | 10,281                                           |   | —                                               |   | 10,281                                         |   |
| Other  income                                                           |   | 247                                              |   | 366                                              |   | 462                                                  |   | 836                                            |   |
| Total  revenue, net of derivative financial instruments and adjustments |   | 34,327                                           |   | 14,329                                           |   | 61,786                                               |   | 23,576                                         |   |
|                                                                    |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| **Expenses**                                                            |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Employee  compensation and benefits                                     |   | 12,586                                           |   | 3,752                                            |   | 22,070                                               |   | 6,698                                          |   |
| Interest  expense                                                       |   | 4,598                                            |   | 4,072                                            |   | 8,811                                                |   | 7,899                                          |   |
| Office  and occupancy expense                                           |   | 621                                              |   | 326                                              |   | 1,188                                                |   | 689                                            |   |
| Provision  for loan losses                                              |   | 794                                              |   | 1,024                                            |   | 1,713                                                |   | 3,127                                          |   |
| (Gain)  loss on sale of real estate owned, net                          |   | (330                                             | )      | 347                                              |   | (515                                                 | )      | 432                                            |   |
| Professional  fees                                                      |   | 1,338                                            |   | 1,097                                            |   | 2,742                                                |   | 1,861                                          |   |
| Other  operating expenses                                               |   | 4,025                                            |   | 1,372                                            |   | 7,779                                                |   | 2,433                                          |   |
| Total  expenses                                                         |   | 23,632                                           |   | 11,990                                           |   | 43,788                                               |   | 23,139                                         |   |
|                                                                    |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Income  before income taxes                                             |   | 10,695                                           |   | 2,339                                            |   | 17,998                                               |   | 437                                            |   |
| Income  taxes                                                           |   | 3,652                                            |   | 2                                                |   | 5,478                                                |   | 7                                              |   |
| Income  tax benefit from utilization ofREIT net operating losses        |   | (2,462                                           | )      | —                                           |   | (9,141                                               | )      | —                                         |   |
| Net  income                                                             |   | 9,505                                            |   | 2,337                                            |   | 21,661                                               |   | 430                                            |   |
|                                                                    |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Other  comprehensive loss                                               |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Unrealized  loss on retained interest in securitization, net of tax     |   | —                                           |   | (415                                             | )      | —                                               |   | (417                                           | )      |
| Total  comprehensive income                                             |   | $                                                | 9,505  |                                             | $      | 1,922                                                |   | $                                              | 21,661 |   | $ | 13 |   |
|                                                                    |   |                                             |   |                                             |   |                                                 |   |                                           |   |
| Net  income per share of common stock – basic                      |   | $                                                | 1.21   |                                             | $      | 0.30                                                 |   | $                                              | 2.75   |   | $ | 0.05 |   |
| Net  income per share of common stock - diluted                         |   | $                                                | 1.12   |                                             | $      | 0.29                                                 |   | $                                              | 2.56   |   | $ | 0.05 |   |

 

See accompanying notes to consolidated financial statements

 

4

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American Residential Investment Trust, Inc. and Subsidiaries

ConsolidatedStatements of Cash Flows,unaudited

(in thousands)

 
|                                                                           |   | **For the****Six****Months Ended****   June 30****, 2003** |   | **For the  Six Months Ended****    June****30, 2002** |   |
|--------------------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|------------------------------------------------------------|--------|
|                                                                           |   |                                                            |   |                                                       |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                           |   |                                                            |   |                                                       |   |
| Net income                                                                     |   | $                                                               | 21,661 |                                                       | $      | 430 |   |
| Adjustments to reconcile net income to net cash used in operating  activities: |   |                                                            |   |                                                       |   |
| Amortization of mortgage assets premiums                                       |   | 1,838                                                           |   | 5,415                                                      |   |
| Amortization of CMO capitalized costs                                          |   | 189                                                             |   | 326                                                        |   |
| Provision for loan losses                                                      |   | 1,713                                                           |   | 3,127                                                      |   |
| Decrease on retained interest in securitization                                |   | —                                                          |   | 86                                                         |   |
| Loss (gain) on sale of real estate owned                                       |   | (515                                                            | )      | 432                                                        |   |
| Proceeds from sale of mortgage loans held for sale                             |   | 5,115,960                                                       |   | 786,732                                                    |   |
| Mortgage loan originations                                                     |   | (5,302,132                                                      | )      | (958,668                                                   | )      |
| Decrease (increase) in accounts receivable-mortgage loans sold/funded          |   | (4,934                                                          | )      | 256                                                        |   |
| Decrease (increase) in restricted cash                                         |   | (968                                                            | )      | 3                                                          |   |
| Increase in derivative financial instruments                                   |   | (1,380                                                          | )      | (2,775                                                     | )      |
| Decrease in accrued interest receivable                                        |   | 356                                                             |   | 407                                                        |   |
| Decrease in due from affiliate                                                 |   | —                                                          |   | 149                                                        |   |
| Increase in deferred tax asset                                                 |   | (9,141                                                          | )      | —                                                     |   |
| Increase in other assets                                                       |   | (1,819                                                          | )      | (759                                                       | )      |
| Increase in accrued interest payable                                           |   | 13                                                              |   | 65                                                         |   |
| Increase in accrued and other expenses                                         |   | 14,263                                                          |   | 294                                                        |   |
| Increase in minority interest                                                  |   | 4                                                               |   | 10                                                         |   |
| Net cash used in operating activities                                          |   | (164,892                                                        | )      | (164,468                                                   | )      |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                          |   |                                                            |   |                                                       |   |
| Principal payments on bond collateral, mortgage loans, net                     |   | 49,203                                                          |   | 97,431                                                     |   |
| Proceeds from sale of real estate owned                                        |   | 8,155                                                           |   | 6,798                                                      |   |
| Net cash provided by investing activities                                      |   | 57,358                                                          |   | 104,229                                                    |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                          |   |                                                            |   |                                                       |   |
| Payments on long-term debt                                                     |   | (60,668                                                         | )      | (109,750                                                   | )      |
| Increase in net borrowings from short-term debt                                |   | 181,799                                                         |   | 170,289                                                    |   |
| Stock options exercised                                                        |   | 3                                                               |   | —                                                     |   |
| Purchase treasury stock                                                        |   | —                                                          |   | (199                                                       | )      |
| Net cash provided by financing activities                                      |   | 121,134                                                         |   | 60,340                                                     |   |
| Net increase in cash and cash equivalents                                      |   | 13,600                                                          |   | 101                                                        |   |
| Cash and cash equivalents at beginning of period                               |   | 13,640                                                          |   | 10,726                                                     |   |
| Cash and cash equivalents at end of period                                     |   | $                                                               | 27,240 |                                                       | $      | 10,827 |   |
| Supplemental information-interest paid                                         |   | $                                                               | 8,795  |                                                       | $      | 7,828 |   |
|                                                                           |   |                                                            |   |                                                       |   |
| Non-cash transactions:                                                         |   |                                                            |   |                                                       |   |
| Transfers from bond collateral, mortgage loans, net to real estate  owned      |   | $                                                               | (3,441 | )                                                          | $      | 13,043 |   |

 

Seeaccompanying 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*

 

The interim financialstatements included herein have been prepared by American ResidentialInvestment Trust, Inc., (“AmRIT” or the “Company”) without audit, pursuant tothe 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 June 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.

 

The Company reports segmentsin accordance with SFAS No. 131, “Disclosures about Segments of an Enterpriseand Related Information”.  SFAS 131establishes standards for the way companies report information about operatingsegments in annual financial statements. Effective January 1, 2002, the Companybegan reporting in two segments: the Mortgage Banking Business and the MortgageAsset Portfolio Business.

 

During the first half of 1998, AmRIT formed American ResidentialHoldings Inc. (“Holdings”), through which a portion of the Company’snon-conforming adjustable-rate and fixed-rate, single-family whole loans(collectively, “Mortgage Loans”), acquisition and finance activities areconducted. AmRIT owns all of the preferred stock of Holdings and has anon-voting 95% economic interest in Holdings. Because AmRIT does not havevoting control of Holdings, its investment in Holdings was accounted for underthe equity method prior to January 1, 2003. Under the equity method, originalequity investments in Holdings were recorded at cost and adjusted by AmRIT’sshare of earnings or losses and decreased by dividends received. InJanuary 2003, the FASB issued FIN 46, “Consolidation of Variable InterestEntities—an interpretation of ARB No. 51. FIN 46 addresses consolidation by business enterprises of variableinterest entities, which have one or both of the following characteristics:1) the equity investment at risk is not sufficient to permit the entity tofinance its activities without additional subordinated financial support fromother parties, which is provided through other interests that will absorb someor all of the expected losses of the entity; and 2) the equity investorslack an essential characteristic of a controlling financial interest. TheCompany interprets FIN 46 to require the consolidation of Holdings rather thanaccounting for Holdings under the equity method.  Prior period financial statements have been restated to includeHoldings as a consolidated entity.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities,” (“SFAS 149”).  SFAS 149 amends and clarifies financialaccounting and reporting for derivative instruments and for hedging activitiesunder FAS 133, Accounting for Derivative Instruments and HedgingActivities.  In particular, SFAS 149 (1)clarifies under what circumstances a contract with an initial net investment meetsthe characteristic of a derivative discussed in paragraph 6(b) of Statement133, (2) clarifies when a derivative contains a financing component, (3) amendsthe definition of an "underlying" to conform it to language used inFASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others, and(4) amends certain other existing pronouncements.  Those changes will result in more consistent reporting ofcontracts as either derivatives or hybrid instruments.  SFAS 149 is effective for contracts enteredinto or modified after June 30, 2003, except for certain exceptions, and forhedging relationships designated after June 30, 2003.  The Company has determined that SFAS 149 will not have asignificant impact on its consolidated financial statements.

 

**Stock Options**

 

The Company elected to apply APB Opinion No. 25 in accounting forits equity compensation plans: the 1997 Stock Incentive Plan, 1997 Stock OptionPlan, 1997 Employee Stock Purchase Plan and 1997 Outside Directors Stock OptionPlan and, accordingly, no compensation cost has been recognized in thefinancial statements. SFAS 123 requires pro forma disclosures of expensecomputed as if the fair value based method had been applied for in financialstatements of companies that continue to follow current practice in accountingfor such arrangements under Opinion No. 25.

 

In December 2002 the Financial Accounting Standards Board (“FASB”)issued SFAS 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 month periodending December 31, 2002. The Company will continue to account for itsstock based compensation according to the provisions of APB OpinionNo. 25.

 

6

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The Company does not recognize compensation cost of stock options, buthad compensation cost for the Company’s stock options been recognized basedupon the estimated fair value on the grant date under the fair valuemethodology prescribed by SFAS No. 123 as amended by SFAS No. 148,the Company’s net income and earnings per share would have been as follows (inthousands except earnings per share):

 
| **Six Months  Ended (unaudited) (in thousands except share data)**                                          |   | **June 30, 2003** |   | **June 30, 2002** |   |
|-------------------------------------------------------------------------------------------------------------|--------|-------------------|--------|-------------------|--------|
|                                                                                                        |   |              |   |              |   |
| Net earnings as reported                                                                                    |   | $                 | 21,661 |              | $      | 430 |   |
| Deduct: Total stock-based compensation expense determined under fair  value based method net of tax effects |   | (1,023            | )      | (406              | )      |
|                                                                                                        |   |              |   |              |   |
| Pro forma net earnings                                                                                      |   | $                 | 20,638 |              | $      | 24 |   |
| Earnings per share                                                                                          |   |              |   |              |   |
| Basic as reported                                                                                           |   | $                 | 2.75   |              | $      | 0.05 |   |
| Basic pro forma                                                                                             |   | $                 | 2.62   |              | $      | 0.00 |   |
| Diluted as reported                                                                                         |   | $                 | 2.56   |              | $      | 0.05 |   |
| Diluted pro forma                                                                                           |   | $                 | 2.44   |              | $      | 0.00 |   |

 

The assumptions used to calculate the fair value of options granted areevaluated and revised as necessary to reflect market conditions and theCompany’s experience.

 

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

 

Historically,the Company has sold a most of the mortgage loans it originates to CountrywideHome Loans, Inc. The Company’s primary consideration in deciding where to sellloans is price.  The Company alsoconsiders speed of execution and loan product guidelines.  The Company believes that the majority ofloans it sells currently could be sold to a number of investors with littleprice or execution degradation.

 

**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  June 30, 2003** |   | **For the   Three months ended  June 30, 2002** |   | **For the   Six months ended  June 30, 2003** |   | **For the   Six months ended  June 30, 2002** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                                              |   | **(in thousands, except share data)**           |   |
|                                                                                                              |   | **(unaudited)**                                 |   |
| Numerator:                                                                                                        |   |                                            |   |                                            |   |                                          |   |                                          |   |
| Numerator  for basic income per share                                                                             |   | $                                               | 9,505  |                                            | $      | 2,337                                         |   | $                                             | 21,661 |   | $ | 430 |   |
| Denominator:                                                                                                      |   |                                            |   |                                            |   |                                          |   |                                          |   |
| Denominator  for basic income per share - weighted average number of common shares  outstanding during the period |   | 7,863,437                                       |   | 7,880,090                                       |   | 7,863,154                                     |   | 7,899,340                                     |   |
| Denominator  for diluted income pershare                                                                          |   | 8,470,633                                       |   | 7,955,090                                       |   | 8,470,350                                     |   | 7,974,340                                     |   |
|                                                                                                              |   |                                            |   |                                            |   |                                          |   |                                          |   |
| Income  per share - basic                                                                                         |   | $                                               | 1.21   |                                            | $      | 0.30                                          |   | $                                             | 2.75   |   | $ | 0.05 |   |
| Income  per share - diluted                                                                                       |   | $                                               | 1.12   |                                            | $      | 0.29                                          |   | $                                             | 2.56   |   | $ | 0.05 |   |

 

Forthe six months ended June 30, 2003 and 2002 there were 1,131,904 and 1,239,100options, respectively, that were antidilutive and, therefore, not included inthe calculations above.

 

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

 

AmRIT’s subsidiary, AmericanMortgage Network, Inc. (“AmNet”) has pledged loans held for sale totalingapproximately $568.6 million to secure credit lines (warehouse facilities) fromthree financial institutions. See Note 8, “Short-Term Debt.” Mortgage loansheld for sale at June 30, 2003 consist of loans which have been committed forsale of approximately $217.8 million and loans available for sale atapproximately $350.7 million, all of which are carried at the lower of cost ormarket.

 

7

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

 

AmRIT has pledged mortgageloans as collateral in order to secure long-term-debt.  Mortgage loan bond collateral consistsprimarily ofadjustable-rate, conventional, 30-year mortgage loans secured by first liens onone to four-family residential properties. All such mortgage loan bond collateral is pledged to secure repayment ofthe related long-term debt obligation. All principal and interest (less servicing and related fees) on thisbond collateral is remitted to a trustee and is available for payment on thelong-term-debt obligation.  Theobligation under the long-term debt is payable solely from the bond collateraland are otherwise non-recourse to AmRIT. The components of this bond collateralat June 30, 2003 and December 31, 2002 are summarized as follows (dollars inthousands) (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 June 30, 2003**                                |   |                                   | ** ** |                                   | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Mortgage loans                                      |   | $                                      | 11,093     |                                   | $          | 49,901                          |       | $                               | 75,098     |                                  | $          | 36,559                     |       | $ | 27,888 |   | $ | 200,539 |   |
| Unamortized premium                                 |   | 528                                    |       | 1,146                                  |       | 2,546                           |       | 1,043                           |       | 210                                   |       | 5,473                      |       |
| Allowance for loan losses                           |   | (177                                   | )          | (569                                   | )          | (1,003                          | )          | (294                            | )          | (313                                  | )          | (2,356                     | )          |
|                                                |   | $                                      | 11,444     |                                   | $          | 50,478                          |       | $                               | 76,641     |                                  | $          | 37,308                     |       | $ | 27,785 |   | $ | 203,656 |   |
|                                                |   |                                   | ** ** |                                   | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Weighted average net coupon                         |   | 9.15                                   | %          | 9.48                                   | %          | 8.99                            | %          | 8.84                            | %          | 9.48                                  | %          | 9.17                       | %          |
| Unamortized premiums as a percent of mortgage loans |   | 4.76                                   | %          | 2.30                                   | %          | 3.39                            | %          | 2.85                            | %          | 0.75                                  | %          | 2.73                       | %          |
|                                                |   |                                   | ** ** |                                   | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| **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                       | %          |

 

The Company maintains an allowance for losseson mortgage loan bond collateral at an amount which it believes is sufficientto provide adequate protection against losses in the mortgage loan portfolio.

 

**Note 6.  Derivative Financial Instruments**

 

The following is a summary ofAmNet’s forward sales of mortgage backed securities (MBS) and options on mortgagebacked securities (dollars in thousands) (unaudited):

 
| **Security**               |   | **Notional  Amount** |    | **Derivative** |   | **Short   Long** |   | **Expiration** |                                     |
|----------------------------|--------|----------------------|---------|----------------|--------|------------------|--------|----------------|------------------------------------------|
| FNMA 15 – Year MBS    |   | $                    | 345,000 |           | TBA    |             | Short  |           | July  17, 2003 – September 18, 2003 |   |
| FNMA 30 – Year MBS    |   | $                    | 866,000 |           | TBA    |             | Short  |           | July  14, 2003 – October 15, 2003   |   |
| GNMA 15 – Year MBS    |   | $                    | 3,000   |           | TBA    |             | Short  |           | August  18, 2003                         |   |
| GNMA 30 – Year MBS    |   | $                    | 126,500 |           | TBA    |             | Short  |           | July  22, 2003 – September 22, 2003 |   |
| GNMA II 30 – Year MBS |   | $                    | 6,000   |           | TBA    |             | Short  |           | August  20, 2003                         |   |
| FNMA 30 – Options     |   | $                    | 240,000 |           | Puts   |             | Long   |           | July  7, 2003 – September 8, 2003   |   |
| GNMA 30 – Options     |   | $                    | 40,000  |           | Puts   |             | Long   |           | August  13, 2003                         |   |

 

These derivatives are accounted for as tradingsecurities in the accompanying consolidated financial statements. The decreasein fair market value of derivative financial instruments is included in theConsolidated Statements of Operations and Comprehensive Income.

 

The short and long positionsnoted in the schedule above represent forward loan sale commitments (TBA’s) (agreements to sell mortgage loans at a futuredate at a specified rate, a specified price and by a specified time deadline) or options to purchase or sell the underlyingsecurity.  Generally, long put positionsgain in value as market interest rates increase and short TBA positions lose invalue as market interest rates decrease.

 

The value of the mortgageloans that AmNet originates is at risk due to fluctuations in interest ratesduring two time periods: (1) the period beginning when AmNet has committed tofunding the loan and ending when the loan closes, or funds; and (2) the timeperiod beginning when the loan closes and ending when AmNet commits to sell orsells the loans to third-party purchasers. These loans are collectivelyreferred to as the loan pipeline. AmNet uses TBA's and options, or “hedges” tomitigate the adverse impact interest rate fluctuations can have on the value ofthe loan pipeline. AmNet's hedges aredesigned to protect profit margins on locked loans and closed loans before theyare committed for sale. The hedges used are forward commitments on mortgage backed securities (“TBA”) and options topurchase or sell mortgage backed securities. The transactions are recorded asderivative financial instruments. Changes in the price of 

 

8

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thesederivative instruments closely relate to changes in the value of the loanpipeline. The Company cannot assure however, that AmNet’s use ofderivative securities will fuly offset the risk of changes in interest rates.See Management’s Discussion and Analysis of Financial Condition and Results ofOperations – Business Risks Factors

 

At June 30,2003, AmNet had committed for sale to specific investors approximately $217.8million in mortgage loans, $350.7 million in funded loans that had not yet beencommitted for sale or sold and $1.8 billion in rate lock commitments toborrowers.  These mortgage loans are forsingle-family residences collateralized by first trust deeds.

 

Derivativefinancial instruments have several components which total the amount shown onthe Consolidated Balance Sheets.  Thetable below shows these components. (000's)

 
| **Derivative  Financial**

**Instruments  Components** |   | **(unaudited)**

**June 30,  2003** |   | **December  31, 2002** |   |
|--------------------------------------------------------|--------|-------------------------------------|--------|------------------------|--------|
| TBA's                                                  |   | $                                   | 2,943  |                   | $      | (5,424 | ) |
| Options                                                |   | 1,580                               |   | 151                    |   |
| Fair value of rate lock commitments                    |   | (5,450                              | )      | 2,966                  |   |
| Total                                                  |   | $                                   | (927   | )                      | $      | (2,307 | ) |

 

 

In the Company’s mortgage banking business, determinations of fairmarket value (“FMV”) are made for hedging instruments (derivatives), the lockedloan pipeline, and loans which are closed but uncommitted for sale. FMVdecisions are made based on consistently applied methods accepted within thefinancial industry in which the Company operates. Hedging instruments aremarked to market according to similar or identical financial instrumentsavailable in the market place at the time of the mark. The loan pipeline markis determined by recording market prices available for loan sales and derivinga value for those loans, less a factor for loans which will not close (loanfallout) based on Company’s history of loan fallout. By accounting rules, theCompany does not recognize any revenue from loan sales until a true sale hastaken place. However, if these loans are stated at a value less than could beobtained by sale in the marketplace, the lower value is used. The Companyadheres to this method of book valuation.

 

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

 

The Company owned 94properties and 148 properties as of June 30, 2003 and December 31, 2002, respectively.  Upon transfer of  loans to real estate owned (as a result of default orforeclosure), the Company records a corresponding charge against the allowancefor loan losses to write-down the real estate owned to fair value lessestimated cost of disposal.  As of June30, 2003 and December 31, 2002, real estate owned totaled approximately $5.3million and $9.5 million, respectively (including loss reserves).

 

**Note 8.  Short-Term Debt**

 

As of June 30, 2003, short-term debt consisted of revolving credit lines(warehouse facilities) used to fund the Company’s lending activities. As ofJune 30, 2003, mortgage loans held for sale were pledged as collateral for thewarehouse facilities. The warehouse facilities of $557.4 million withfinancial institutions provide for a maximum amount of borrowing capacity of$1.3 billion as of June 30, 2003, with outstanding amounts maturing onvarious dates within one year secured by mortgage loans held for sale. Thetable below shows the age of funded loans as of June 30, 2003.

 
| **Aging Range**     |   | **Number of Loans** |       | **Warehouse line usage****(000’s)** |        | **% of Total** |      |
|---------------------|--------|---------------------|------------|------------------------------------------|-------------|----------------|-----------|
| Less than 30  days  |   | 2,982               |       | $                                        | 539,170     |           | 96.8      | % |
| 30 to 60 days       |   | 122                 |       | 14,122                                   |        | 2.5            | %         |
| 61 days to 90  days |   | 15                  |       | 4,060                                    |        | 0.7            | %         |
| **TOTAL**           |   | **3,119**           | ** ** | **$**                                    | **557,352** | ** **     | **100.0** | **%** |

 

Of  the $557.4 million of warehouse line usageat June 30, 2003, $204.1 million was funded through uncommitted warehousefacilities.

 

Warehousefacilities generally bear interest at LIBOR plus spread (2.57% per annumaverage at June 30, 2003). The weighted-average interest rate was 2.69% perannum for the first six months of 2003 and the facility fee was 0.25% per annumon the aggregate committed amount of the warehouse facilities. The warehousefacilities are repaid as principal payments on mortgage loans are received, or asthe mortgage loans are sold. The agreements governing these facilities containa number of covenants, including covenants based on tangible net worth, cashflows, net income, and liquidity of the Company. The Company is in compliancewith these covenants at June 30, 2003.

 

In 2001, the Company also entered into a $5 million seniorsubordinated secured revolving loan agreement (Subordinated Loan Agreement).The Subordinated 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 June 30,2003. As of June 30, 2003, there was $3 million in borrowings on theSubordinated Loan Agreement.

 

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

 

The components of thelong-term debt at June 30, 2003 and December 31, 2002, along with selectedother information are summarized below (dollars in thousands) (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 June 30, 2003**                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                      | ** ** |
| Long-term debt                      |   | $                                     | 10,782     |                                  | $          | 42,965                          |       | $                               | 69,689     |                                  | $          | 26,935                    |       | $ | 27,234 |   | $ | 177,605 |   |
| Capitalized costs on long-term debt |   | (45                                   | )          | —                                |       | (349                            | )          | (234                            | )          | —                                |       | (628                      | )          |
| Total long-term debt                |   | $                                     | 10,737     |                                  | $          | 42,965                          |       | $                               | 69,340     |                                  | $          | 26,701                    |       | $ | 27,234 |   | $ | 176,977 |   |
|                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                      | ** ** |
| Weighted average financing rates    |   | 2.20                                  | %          | 1.48                                  | %          | 3.08                            | %          | 2.02                            | %          | 2.37                                  | %          | 2.37                      | %          |
|                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                      | ** ** |
| **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**

 

As of June 30, 2003, shares of common stock were reserved for issuanceunder the 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                          |   | 1,244,300                     |   | —                                    |   | 210,000                                               |   | 1,739,100 |   |
| Options Reserved for Issuance        |   | 30,400                           |   | 230,500                       |   | 20,000                                    |   | —                                                |   | 280,900   |   |

 

Stock option activity during the periodspresented is as follows (unaudited):

 
|                         |   | **Number of********Options** |   | **Weighted-Average  Exercise Price** |   |
|------------------------------|--------|------------------------------|--------|--------------------------------------|--------|
|                         |   |                         |   |                                 |   |
| Balance at December 31, 2002 |   | 1,244,600                    |   | $                                    | 9.01   |   |
| Granted                      |   | 518,000                      |   | 4.56                                 |   |
| Forfeited                    |   | (23,500                      | )      | (3.17                                | )      |
|                         |   |                         |   |                                 |   |
| Balance at June 30, 2003     |   | 1,739,100                    |   | $                                    | 7.85   |   |

 

At June 30, 2003, the range of exercise prices for outstanding optionswas $1.75 to $15.00 and the weighted-average remaining contractual life ofoutstanding options was 6.86 years. The weighted average exercise price ofexercisable outstanding options was $7.85. At June 30, 2003, 1,158,721 of the outstanding options were exercisable.

 

The per share weighted-average fair value of stock options grantedbetween April 1, 2003 and June 30, 2003 was $5.03; and between January 1 andMarch 31, 2003 was $1.33 on the dates of grant using the Black-Scholesoption-pricing model, applied through Equity Edge program software using thefollowing weighted-average assumptions (unaudited):

 

10

----

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

 

**Note11.  Commitments and Contingencies**

 

TheCompany has used, and will continue to use, TBA's to help mitigate the loan pipelineexposure ($1.8 billion in locked loans at June 30, 2003) to market interestrate fluctuations (See Management’s Discussion and Analysis of FinancialCondition and Results of Operations – MortgageBanking Business).  Thesecommitments provide that the Company agrees to sell an established volume ofmortgage 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.

 

**Note 12.  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.  Thesemortgage loans are subsequently sold tofinancial institutions. The Mortgage Asset Portfolio Business segment manages aportfolio of mortgage loans pledged as collateral 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 second quarter statement of operations activity bysegment.

 

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

 
|                                                                |   | **For the  Three Months ended  June 30, 2003********Mortgage  Banking** |   | **For the   Three Months Ended  June 30, 2003  Mortgage Asset  Portfolio** |   | **For the  Three Months Ended   June 30, 2003  Combined Segments** |   | **For the  Six Months Ended  June 30, 2003  Mortgage Banking** |   | **For the  Six Months Ended********June 30,  2003********Mortgage  Asset   Portfolio** |   | **For the  Six Months Ended   June 30, 2003   Combined Segments** |   |
|---------------------------------------------------------------------|--------|-------------------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------------------------------------------------------------------|--------|----------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------|--------|
| **Revenues**                                                        |   |                                                                    |   |                                                                       |   |                                                               |   |                                                           |   |                                                                                   |   |                                                              |   |
| Gain  on sales of loans                                             |   | $                                                                       | 32,971 |                                                                       | $      | —                                                             |   | $                                                              | 32,971 |                                                                                   | $      | 53,180                                                            |   | $ | — |   | $ | 53,180 |   |
| Derivative  financial instruments and market adjustments            |   |                                                                    |   |                                                                       |   |                                                               |   |                                                           |   |                                                                                   |   |                                                              |   |
| Derivative  financial instruments - forward commitments and options |   | (3,027                                                                  | )      | —                                                                     |   | (3,027                                                             | )      | (3,080                                                         | )      | —                                                                                 |   | (3,080                                                            | )      |
| Market  adjustment on interest rate lock commitments                |   | (6,257                                                                  | )      | —                                                                     |   | (6,257                                                             | )      | (8,415                                                         | )      | —                                                                                 |   | (8,415                                                            | )      |
| Total  derivative financial instruments and market adjustments      |   | (9,284                                                                  | )      | —                                                                     |   | (9,284                                                             | )      | (11,495                                                        | )      | —                                                                                 |   | (11,495                                                           | )      |
| Interest  on mortgage assets, net of premium amortization           |   | 7,561                                                                   |   | 2,832                                                                      |   | 10,393                                                             |   | 13,462                                                         |   | 6,177                                                                                  |   | 19,639                                                            |   |
| Other  income                                                       |   | 34                                                                      |   | 213                                                                        |   | 247                                                                |   | 51                                                             |   | 411                                                                                    |   | 462                                                               |   |
| Total  revenue                                                      |   | 31,282                                                                  |   | 3,045                                                                      |   | 34,327                                                             |   | 55,198                                                         |   | 6,588                                                                                  |   | 61,786                                                            |   |
|                                                                |   |                                                                    |   |                                                                       |   |                                                               |   |                                                           |   |                                                                                   |   |                                                              |   |
| **Expenses**                                                        |   |                                                                    |   |                                                                       |   |                                                               |   |                                                           |   |                                                                                   |   |                                                              |   |
| Employee  compensation and benefits                                 |   | 12,449                                                                  |   | 137                                                                        |   | 12,586                                                             |   | 21,594                                                         |   | 476                                                                                    |   | 22,070                                                            |   |
| Interest  expense                                                   |   | 3,447                                                                   |   | 1,151                                                                      |   | 4,598                                                              |   | 6,122                                                          |   | 2,689                                                                                  |   | 8,811                                                             |   |
| Office  and occupancy expense                                       |   | 621                                                                     |   | —                                                                     |   | 621                                                                |   | 1,188                                                          |   | —                                                                                 |   | 1,188                                                             |   |
| Provision  for loan losses                                          |   | —                                                                  |   | 794                                                                        |   | 794                                                                |   | —                                                         |   | 1,713                                                                                  |   | 1,713                                                             |   |
| Loss  on sale of real estate owned, net                             |   | —                                                                  |   | (330                                                                       | )      | (330                                                               | )      | —                                                         |   | (515                                                                                   | )      | (515                                                              | )      |
| Professional  fees                                                  |   | 1,183                                                                   |   | 155                                                                        |   | 1,338                                                              |   | 2,272                                                          |   | 470                                                                                    |   | 2,742                                                             |   |
| Other  operating expenses                                           |   | 3,826                                                                   |   | 199                                                                        |   | 4,025                                                              |   | 7,321                                                          |   | 458                                                                                    |   | 7,779                                                             |   |
| Total  expenses                                                     |   | 21,526                                                                  |   | 2,106                                                                      |   | 23,632                                                             |   | 38,497                                                         |   | 5,291                                                                                  |   | 43,788                                                            |   |
|                                                                |   |                                                                    |   |                                                                       |   |                                                               |   |                                                           |   |                                                                                   |   |                                                              |   |
| Income  before income taxes                                         |   | 9,756                                                                   |   | 939                                                                        |   | 10,695                                                             |   | 16,701                                                         |   | 1,297                                                                                  |   | 17,998                                                            |   |
| Income  taxes                                                       |   | 3,224                                                                   |   | 428                                                                        |   | 3,652                                                              |   | 5,050                                                          |   | 428                                                                                    |   | 5,478                                                             |   |
| Income  tax benefit from utilization of REIT net operating losses   |   | (2,462                                                                  | )      | —                                                                     |   | (2,462                                                             | )      | (9,141                                                         | )      | —                                                                                 |   | (9,141                                                            | )      |
| Net  income                                                         |   | $                                                                       | 8,994  |                                                                       | $      | 511                                                                |   | $                                                              | 9,505  |                                                                                   | $      | 20,792                                                            |   | $ | 869 |   | $ | 21,661 |   |

 

An income tax benefit fromutilization of REIT net operating losses is expected for 2003 due to thetaxable income generated by the mortgage banking business, and accordingly thisbenefit is attributable to the mortgage banking segment.

 

11

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|                                                                |   | **For the  Three  Months ended  June 30, 2002********Mortgage  Banking** |   | **For the  Three Months Ended  June 30, 2002   Mortgage Asset Portfolio** |   | **For the  Three Months Ended  June 30, 2002  Combined Segments** |   | **For the  Six  Months ended  June 30, 2002********Mortgage  Banking** |   | **For the  Six Months Ended  June 30, 2002  Mortgage Asset   Portfolio** |   | **For the  Six Months Ended  June 30, 2002  Combined Segments** |   |
|---------------------------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|-------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|
| **Revenues**                                                        |   |                                                                          |   |                                                                      |   |                                                              |   |                                                                        |   |                                                                     |   |                                                            |   |
| Gain  on sales of loans                                             |   | $                                                                             | 4,503  |                                                                      | $      | —                                                            |   | $                                                                           | 4,503  |                                                                     | $      | 6,446                                                           |   | $ | — |   | $ | 6,446 |   |
| Derivative  financial instruments and market adjustments            |   |                                                                          |   |                                                                      |   |                                                              |   |                                                                        |   |                                                                     |   |                                                            |   |
| Derivative  financial instruments - Treasury futures                |   | (10,771                                                                       | )      | —                                                                    |   | (10,771                                                           | )      | (10,123                                                                     | )      | —                                                                   |   | (10,123                                                         | )      |
| Derivative  financial instruments - forward commitments and options |   | (123                                                                          | )      | —                                                                    |   | (123                                                              | )      | (123                                                                        | )      | —                                                                   |   | (123                                                            | )      |
| Market  adjustment on interest rate lock commitments                |   | 2,579                                                                         |   | —                                                                    |   | 2,579                                                             |   | 1,844                                                                       |   | —                                                                   |   | 1,844                                                           |   |
| Total  derivative financial instruments and market adjustments      |   | (8,315                                                                        | )      | —                                                                    |   | (8,315                                                            | )      | (8,402                                                                      | )      | —                                                                   |   | (8,402                                                          | )      |
| Interest  on mortgage assets, net of premium amortization           |   | 2,432                                                                         |   | 5,062                                                                     |   | 7,494                                                             |   | 3,893                                                                       |   | 10,522                                                                   |   | 14,415                                                          |   |
| Litigation  settlement                                              |   | —                                                                        |   | 10,281                                                                    |   | 10,281                                                            |   | —                                                                      |   | 10,281                                                                   |   | 10,281                                                          |   |
| Other  income                                                       |   | 3                                                                             |   | 363                                                                       |   | 366                                                               |   | 7                                                                           |   | 829                                                                      |   | 836                                                             |   |
| Total  revenue                                                      |   | (1,377                                                                        | )      | 15,706                                                                    |   | 14,329                                                            |   | 1,944                                                                       |   | 21,632                                                                   |   | 23,576                                                          |   |
|                                                                |   |                                                                          |   |                                                                      |   |                                                              |   |                                                                        |   |                                                                     |   |                                                            |   |
| **Expenses**                                                        |   |                                                                          |   |                                                                      |   |                                                              |   |                                                                        |   |                                                                     |   |                                                            |   |
| Employee  compensation and benefits                                 |   | 3,615                                                                         |   | 137                                                                       |   | 3,752                                                             |   | 6,544                                                                       |   | 154                                                                      |   | 6,698                                                           |   |
| Interest  expense                                                   |   | 1,130                                                                         |   | 2,942                                                                     |   | 4,072                                                             |   | 1,824                                                                       |   | 6,075                                                                    |   | 7,899                                                           |   |
| Office  and occupancy expense                                       |   | 326                                                                           |   | —                                                                    |   | 326                                                               |   | 689                                                                         |   | —                                                                   |   | 689                                                             |   |
| Provision  for loan losses                                          |   | —                                                                        |   | 1,024                                                                     |   | 1,024                                                             |   | —                                                                      |   | 3,127                                                                    |   | 3,127                                                           |   |
| Loss  on sale of real estate owned, net                             |   | —                                                                        |   | 347                                                                       |   | 347                                                               |   | —                                                                      |   | 432                                                                      |   | 432                                                             |   |
| Professional  fees                                                  |   | 517                                                                           |   | 580                                                                       |   | 1,097                                                             |   | 965                                                                         |   | 896                                                                      |   | 1,861                                                           |   |
| Other  operating expenses                                           |   | 1,179                                                                         |   | 193                                                                       |   | 1,372                                                             |   | 2,046                                                                       |   | 387                                                                      |   | 2,433                                                           |   |
| Total  expenses                                                     |   | 6,767                                                                         |   | 5,223                                                                     |   | 11,990                                                            |   | 12,068                                                                      |   | 11,071                                                                   |   | 23,139                                                          |   |
|                                                                |   |                                                                          |   |                                                                      |   |                                                              |   |                                                                        |   |                                                                     |   |                                                            |   |
| Income  before income taxes                                         |   | (8,144                                                                        | )      | 10,483                                                                    |   | 2,339                                                             |   | (10,124                                                                     | )      | 10,561                                                                   |   | 437                                                             |   |
| Income  taxes                                                       |   | 1                                                                             |   | 1                                                                         |   | 2                                                                 |   | 1                                                                           |   | 6                                                                        |   | 7                                                               |   |
| Net  income (loss)                                                  |   | $                                                                             | (8,145 | )                                                                         | $      | 10,482                                                            |   | $                                                                           | 2,337  |                                                                     | $      | (10,125                                                         | )      | $ | 10,555 |   | $ | 430 |   |

 

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 $39.4 million for the three month period ending June 30, 2003.

 

**Note 13.  Subsequent Events**

 

Subsequent to the periodending June 30, 2003, the company secured additional warehouse line capacity of$50 million from JP Morgan Chase Bank until September 8, 2003.

 

**Note 14.  Income Taxes**

 

During 1997,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. As a result of the conversion to fully taxable status, an income taxbenefit and related deferred tax asset of $9.1 million after valuationallowance was recorded through June 30, 2003. The deferred tax asset will be reduced by realization of income taxprovisions over time.  Accordingly, theincome tax expense recorded for the six months ended June 30, 2003 was $5.5million and the Company’s effective tax rate was 31%.

 

**Note 15.  Commitments and Contingencies**

 

In the normal course of business, there arevarious outstanding commitments and contingent liabilities that have not beenreflected in the consolidated financial statements.  In addition, in the normal course of business, there are variousother outstanding legal and administrative proceedings.  In the opinion of management, afterconsultation with legal counsel, the financial position and results of operationsof the Company will not be affected materially as a result of such commitmentsand contingent liabilities or by the outcome of such legal or administrative proceedings.

 

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

 

*The statements contained in thisQuarterly Report on Form 10-Q that are not purely historical are forwardlooking statements.  Such forwardlooking statements 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:*

 

*•**                                         **ourexpectations surrounding the total size of the loan origination market, ourability to maintain average monthly loan fundings in a potentially decliningmarket and our loan origination volume;*

 

*•**                                         **ourexpectation of maintaining quarter-over-quarter profitability inthe Mortgage Banking Business;*

 

*•**                                         **ourexpectations surrounding our cash requirements, expenses, cash flow fromoperations, the sufficiency of our capital base, the sufficiency of our cashreserves and our sources of liquidity, including our intention to increase thesize of our warehouse lending facilities and the factors we expect to affectour ability to do so;*

 

*•**                                         **theexpected adequacy of our various reserves;*

 

*•**                                         **AmNet’sintention to expand operations in 2003 and the expected costs of doing so;*

 

*•**                                         **AmNet’sintention to continue to try and hedge against market fluctuations in interestrates, the instruments AmNet intends to use and the expected inverserelationship of gains on hedging to margins on loan sales;*

 

*•**                                         **ourexpectation of selling loans on a service-released basis withinapproximately 30 days from origination;*

 

*•**                                         **theexpected correlation of our success to loan origination volume;*

* *

•*                                         **theanticipated impact from the Company’s adoption of SFAS 149*

* *

*•**                                         **management’sexpectations of what outstanding commitments and contingent liabilities andlegal and administrative proceedings will not materially affect the Company’sfinancial position or results of operations.*

 

*•**                                         **AmNet’sbelief it will continue to qualify for correspondent lending programs and itsability to find alternative buyers for loans it originates;*

 

*•**                                         **theexpected concentration of AmNet’s loans in California;*

 

*•**                                         **ourexpectation interest rates may rise and the anticipated effect on variousaspects of our business from changes in interest rates, including increased perloan costs of loan generation and changes in the value of our loans and ourderivatives;*

 

*•**                                         **ourbeliefs regarding future prepayment rates and their effect and anticipatedprepayment penalties;*

 

*•**                                         **our expectationrevenues and cash flow from our Mortgage Asset Portfolio Business will continueto decline;*

 

*•**                                         **ourexpected effective tax rates, the impact of our deferred tax asset and thereduction of that asset over time;*

 

*•**                                         **who weanticipate will be our competitors;*

 

*•**                                         **anexpected increase in the level of our general and administrative expenses,including directors’ and professional fees;*

 

*•**                                         **theanticipated impact of changes in laws;*

 

*•**                                         **theexpected affect of seasonality on our business;*

 

*•**                                         **ourintent to hold mortgage loan bond collateral to maturity; and*

 

•                                          *ourexpected increasing reliance on information technology systems and thenecessity of developing and upgrading such systems.*

 

*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 retained interestsin securitizations, our ability to successfully grow AmNet, the ability toobtain the financing necessary to fund AmNet, changes in accounting rules ortheir application, changes in the margins for gains on sale of originatedloans, changes in the demand of mortgage brokers for AmNet’s loan products andservices or of loan purchasers for originated loans, the availability ofcapital and our ability to qualify for such capital, increases in prepaymentrates and default rates, the effect of terminating our status as a REIT,changes in the requirements of correspondent loan programs or our ability tomeet such requirements and changes in AmNet’s and our anticipated cashrequirements. 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**

 

Our Company was founded in 1997 as anexternally managed Real Estate Investment Trust. Until 2001, substantially allof our operations consisted of the acquisition of residential mortgages forinvestment purposes. In mid-2001, our Board of Directors and managementdetermined that it was in the best interest of the stockholders tofundamentally shift the strategic direction of the Company to mortgage banking.We began implementation in 2001 by forming American Mortgage Network, Inc.(“AmNet”), a wholly owned subsidiary, to engage in mortgage banking activities.AmNet originates mortgage loans to prime credit quality borrowers secured byfirst trust deeds through a network of independent mortgage brokers. Aconcentration of our business is in California (33.3% of loans originated inthe first six months of 2003). We sell the loans that we originate toinstitutional purchasers on a servicing-released basis.

 

We generate revenue in our Mortgage BankingBusiness segment two principal ways:

 

•                                          *Interest income*. From the time we originate a loan until the timewe sell the loan, we earn interest on the loan, which is paid by the borrower.The interest that we earn is partially offset by the interest we pay under ourwarehouse credit facilities used to finance our mortgage originations.

 

•                                          *Gain on loan sales net ofhedging gains or losses*. Wecurrently sell the loans that we originate to institutional purchasers, on aservicing-released basis for cash. We record the difference between the saleprice of loans that we have sold and our cost to originate the sold loans asgain on loan sales revenue. We recognize revenue at the time that we completethe loan sale, which is generally when we receive loan sale proceeds from thepurchaser.  Gain on loan sales alsoincludes fees we charge for loan origination such as, underwriting fees, loandocument preparation fees and wiring fees. Hedging instruments are used to helpmitigate exposure to inerest rate fluctuation. The cost of this activityrelates to revenue derived from loan sales and therefore hedging gains orlosses are included in the gain on loan sales.

 

We continue to generate revenue from our Mortgage Asset PortfolioBusiness, although we expect that revenues from this segment of our businesswill continue 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.

 

Our mortgage banking operations have grownsignificantly in 2002 and 2003 and represented 44.3% of our 2002 revenue and89.3% of the first six months 2003 revenue. Also during the first six months,five branch offices were opened and the number of employees increased from over300 to over 500 employees. At the same time, the Mortgage Asset PortfolioBusiness has significantly declined as mortgage loans in our portfolio haveprepaid over time and have not been replenished.

 

As a result of the change in focus of ourCompany’s strategic direction and the decision to emphasize taxable operatingactivities and retain earnings for growth, our shareholders, based upon arecommendation from our Board of Directors, approved two proposals thatpermited us to amend our charter documents to terminate our status as a REIT.In February of 2003 we notified the Internal Revenue Service of our decision tode-REIT, effective for the tax year beginning January 1, 2003.  As a REIT, we generally did not pay federaltaxes at the corporate level on income we distributed to stockholders. We havenot distributed income to our stockholders since January of 2001.

 

Effective January 1, 2003, we became anincome tax paying entity, and as such we must recognize deferred tax assetsthat are largely a result of previous net operating losses and that provide areduction in our effective income tax rate for 2003.  Our effective income tax rate for 2003 will be approximately 30%.

 

Upon termination of our REIT status, we wereno longer eligible for listing on the New York Stock Exchange. As ofJanuary 31, 2003, we moved from the New York Stock Exchange to theAmerican Stock Exchange. Our ticker symbol, INV, remains the same.

 

**MortgageBanking Business**

 

*Summary*

 

AmNet originates mortgage loans referred byindependent mortgage brokers for subsequent sale on a servicing-released basisto large investors.

 

AmNet utilizes a dedicated sales force tooffer loan products to approved wholesale mortgage brokers, who refer theirclient’s loans to us for underwriting and funding. Loans meeting ourunderwriting criteria are approved and funded at our regional underwriting loancenters. Our headquarters office performs various functions through multipledepartments including establishment of policy, risk management, secondarymarketing, finance, accounting, administration, human resources, andinformation technology.

 

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We funded $5.3 billion in home loans during the six month periodending June 30, 2003. For the twelve month period ending December 31,2002, we funded $4.2 billion in home loans. As of June 30, 2003, we hadover 500 loan production and loan operations employees. As of June 30, 2003, weoperated fifteen regional centers and seven satellite centers around thecontinental United States of America.

 

We borrow funds under our credit facilitiesto fund and accumulate loans prior to sale to correspondent investors on aservicing-released basis. As of August 8, 2003 we have three warehousefacilities that enable us to borrow up to an aggregate of $1.3 billion. Weare allowed to borrow from 98% to 99% of the loan balance (par) and must complywith various lender covenants restricting, among other things, the absolutelevel of leverage and minimum levels of cash reserves. We expect to increaseour warehouse borrowing facilities to enable increased loan production.

 

We currently sell all loans we fund on a servicing-released basis,usually within 30 days of funding. The table below shows the age of fundedloans as of June 30, 2003.

 
| **Aging Range**     |   | **Number of  Loans** |       | **Warehouse line usage  (000’s)** |        | **% of Total** |      |
|---------------------|--------|----------------------|------------|----------------------------------------|-------------|----------------|-----------|
| Less than 30  days  |   | 2,982                |       | $                                      | 539,170     |           | 96.8      | % |
| 30 to 60 days       |   | 122                  |       | 14,122                                 |        | 2.5            | %         |
| 61 days to 90  days |   | 15                   |       | 4,060                                  |        | 0.7            | %         |
| **TOTAL**           |   | **3,119**            | ** ** | **$**                                  | **557,352** | ** **     | **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 have beenprepared in accordance with accounting principles generally accepted in theUnited 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 six month period ending June 30, 2003:

 

•  Provision for loan losses

•  Derivative financial instruments

•  Premium amortization on bond collateral,mortgage loans

•  Gainon sale of loans

•  Income taxes

 

Pleaserefer to the Company Form 10-K for the one-year period ending December 31,2002, for a detailed discussion of these procedures except income taxes, whichis discussed in this report (below).

 

During 1997,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 theconversion 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. As a result of the conversion to fully taxable status, an income taxbenefit and related deferred tax asset of $9.1 million after valuationallowance was recorded through June 30, 2003. The deferred tax asset will be reduced by realization of income taxprovisions over time.  Accordingly, theincome tax expense recorded for the six months ended June 30, 2003 was $5.5million and the Company’s effective tax rate was 31%.

 

**Management’sFinancial Analysis**

 

We earninterest income and incur interest expense in both segments of our  operations. In the Mortgage Banking Business, AmNet earns interest on a loan fromthe date the loan is funded until final disposition of the loan sale.  Accordingly, interest income is a functionof the volume of loans funded, the interest rate on the loans and the length oftime the loans are held prior to sale. To the extent AmNet funds loans with borrowings under its warehousefacilities, it records interest expense based on the same factors.   Similarly, in the Mortgage Asset PortfolioBusiness, we generate revenue on the interest we receive on the mortgage loanswe hold for investment and we incur interest expense on the borrowings used tofund our loan portfolio.

 

Because theinterest 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.  For the same reasons,  in our discussion of the Mortgage BankingBusiness, the discussion of  expensesincludes a discussion of our operating expenses, which excludes interestexpense. 

 

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 estimated breakdown betweenvariable and fixed amounts for each category of our operating expenses.  Management believes that this will enable abetter understanding of the Company’s results and the likely impact in thefuture of changes in our origination volumes.

 

15

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**Results of Operations**

 

***Three Month Results***

 

MortgageBanking Business

 

Gain on the sale of loans for the three-month period ending June 30,2003, amounted to $33.0 million. This represents a $28.5 million increaseover the same period ending June 30, 2002 when our gain on the sale of loanswas $4.5 million. AmNet’s increase in gain on the sale of loans is the result of the increase in its loanproduction volume. For the three month period ending June 30, 2003 and June 30,2002, AmNet recorded loan sales volume of $2.9 billion and $499.5 millionrespectively. Gains on the sale of loans were offset by a loss on the Company’sderivative financial instruments and market adjustments totaling$9.3 million and $8.3 million for the same periods, respectively.

 

For the three months ending June 30, 2003, AmNet’s gain on sale ofloans of $33.0 million is a combination of various accountcategories.  Loan premiums ofapproximately $70.1 million represent the price at which AmNet sold theloans to investors in excess of the principal balance of loans sold. Fee incomeof approximately $9.4 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$46.3 million. Other deferred costs include (i) true sale scheduleddiscount, which is recognized at the time of loan sale, of approximately$3.9 million; (ii) deferred origination costs, which are recognizedat the time of loan sale, of approximately $3.2 million and(iii) loan premiums repaid to investors (“premium recapture”) and loanloss reserve costs aggregating approximately $1.7 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 $33.0 million for the three-month period ending June 30,2003 represents approximately 106 basis points (1.06%) on loan sales of $3.1 billion.  For the same period ending June 30, 2002,gain on the sale of loans was $4.5 million which represented approximately90 basis points (0.90%) on loan sales of $500 million.

 

During the second quarter of 2003, AmNet incurred net losses on its derivativefinancial instruments and market adjustments totaling $9.3 million.  For the same period ending June 30, 2002 netlosses on derivative financial instruments and market adjustments totaled $8.3million.  Derivative financialinstruments are purchased to offset any loss from market interest rate movementwhich adversely affects gain on loan sales. During the second quarter of 2003,AmNet used forward commitments on mortgage backed securities (TBA) and optionsto purchase or sell mortgage backed securities as its primary hedging vehicles.At the end of the second quarter interest began to increase which added valueto our derivative financial instruments and reduced the value of our lockedloans and loans which were booked (closed) but not sold.  Due to declines in yields on mortgagesduring most of the second quarter of 2003, AmNet recorded net losses onderivative financial instruments and market adjustments. These losses wereoffset by higher gains on the sale of loans during the quarter and in July of2003.  During 2002, AmNet used treasuryfutures and options on treasury futures as prime hedging vehicles.

 

AmNet recorded interest income of $7.6 million for the threemonths ended June 30, 2003 and $2.4 million for the same period ending June 30,2002 due principally to an increase in mortgage loans held for sale. AmNetearns interest on a loan from the date the loan is funded until finaldisposition. 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 prior to sale. To the extent AmNet funds loans with borrowings under itswarehouse facilities, it records interest expense based on the same factors.Interest expense for the period was $3.4 million. The resulting netinterest income earned on loan inventories was $4.2 million, representing 13basis points (0.13%) on loan production in the second quarter of $3.2 billion.

 

Total expenses incurred in the Mortgage Banking Business for the threemonth period ending June 30, 2003, was approximately $21.5 million. Operatingexpenses which included all expenses except interest expense, was approximately$18.1 million for the three month period ending June 30, 2003. For thecomparable period ending June 30, 2002, there was approximately $6.8 million oftotal expenses of which $5.6 million were operating expenses incurred. Theincrease was due to the ongoing overhead of AmNet’s mortgage bankingoperations, which are comprised of regional loan production offices and headquarteroperations. For the three months ended June 30, 2003, estimated variableexpenses, predominately commissions and contract labor, were approximately$8.8 million which were approximately 28 basis points (0.28%) on$3.2 billion in funded loans. Operating Expenses that were not directlyvariable were estimated at $9.3 million, or approximately 29 basis points(0.29%) on $3.2 billion in funded loans for the second quarter of 2003.The table below provides the relationship between fixed, variable and total expensesfor the three month period ending June 30, 2003. (dollars in 000’s)

 

16

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| **Mortgage Banking Expenses**      |   | **Estimated  Variable Expenses** |   | **Estimated  Fixed Expenses** |   | **Total  Expenses** |   |
|------------------------------------|--------|----------------------------------|--------|-------------------------------|--------|---------------------|--------|
|                               |   |                             |   |                          |   |                |   |
| Employee compensation and benefits |   | $                                | 7,069  |                          | $      | 5,380               |   | $ | 12,449 |   |
| Office and occupancy expense       |   | —                           |   | 621                           |   | 621                 |   |
| Professional fees                  |   | 293                              |   | 890                           |   | 1,183               |   |
| Other operating expense            |   | 1,468                            |   | 2,358                         |   | 3,826               |   |
| **Total operating expenses**       |   | 8,830                            |   | 9,249                         |   | 18,079              |   |
| Interest expense                   |   | 3,447                            |   | —                        |   | 3,447               |   |
| **Total expenses**                 |   | $                                | 12,277 |                          | $      | 9,249               |   | $ | 21,526 |   |

 

Interest rate movements are difficult to predict but it is recognizedthat interest rates on residential mortgages were continuing from 2002 to behistorically low throughout the second quarter of 2003. While rates havecontinued to remain at historical lows in 2003, rates are expected to increasein the second half of 2003 and we expect that the total number of home purchaseand refinancing transactions to decline, causing a significant overallcontraction of the loan origination market. Our financial projections for 2003assume a significant contraction in the size of the market by the fourthquarter of 2003, and total funded loan volume of $11 to $12 billion. During thesecond quarter of 2003, we generated an average monthly funded loan volume of$1.1 billion. For the same period ending June 30, 2002 wegenerated an average monthly funded loan volume of $195 million. Despite an assumed mortgage market contraction, wedo not expect our monthly loan fundings to decline at a rate greater than thetotal market in 2003 due to initiatives to increase sales coverage and brokerpenetration in existing markets and planned expansion into new markets.However, in formulating our financial projections and above noted funded loanvolume forecast, we do anticipate higher costs per loan and lower per loanrevenues as a direct consequence of the expected market contraction. We expectcontinued quarterly profitability in our mortgage banking business. We expectinterest rates to rise in the second half of 2003 and during periods of risingrates, we would expect to see an increase in the value of our hedges and acorresponding decrease in the value of our loan pipeline.

 

There is adegree of seasonality to our business. Spring and summer seasons are typically stronger home buying months thanother parts of the year.  We may expectgreater loan volume as a result of this seasonality.

 

On February 7,2003, the Company filed a notice with the Internal Revenue Service of ourdecision to de-REIT, effective  January1, 2003.  As a result of the conversionto fully taxable status, an income tax benefit and related deferred tax assetof $6.7 million was recorded in January 2003 and an additional $2.4 million wasrecorded in June 2003.  Based uponexpected utilization of net operating loss carry forwards generated by AmNet in2001 and 2002 and expected profitability in 2003, the income tax expenserecorded for the second quarter of 2003 was $3.2 million and our effective taxrate was 33%.

 

*Mortgage AssetPortfolio Business*

 

For the second quarters ended June 30, 2003 and 2002, we generated netincome of approximately $511 thousand and $10.6 million, respectively.  June 30, 2002 net income includes alitigation settlement of $10.3 million. Management believes thatbecause the litigation settlement is a one time event and because it is solarge in comparison to the net income otherwise generated by this businesssegment, the Company’s results are better understood if the litigationsettlement is excluded in discussing the Company’s operating results. Excluding the litigation settlement, theCompany’s operational net income from Mortgage Asset Portfolio operations was$300 thousand. Operational net income before income tax increased in 2003,although revenue and expense categories declined as a result of a decline ofour mortgage asset portfolio from $337.2 million at June 30, 2002 to $203.7million at June 30, 2003. Our decision to discontinue portfolio acquisitions beginningin 2000 and continuing to date has resulted in a decline in the size of BondCollateral Mortgage Loan portfolio. The Mortgage Asset Portfolio businessderives income from the difference in interest received on bond collateral andinterest paid on bonds. A decline in our portfolio has resulted in a decreasein net interest income from $5.1 million for the three month period ending June30, 2002 to $2.8 million for the three month period ending June 30, 2003 anda related decrease on interest expense of $2.9 million to $1.2 million for thesame periods and net interest income (interest income less interest expense) of$2.2 million and $1.6 million for the same periods.

 

Net interest income is the primary source of revenue in this segment ofour business. The weighted average interest rate we receive from our bondcollateral was 9.2% at June 30, 2003 and was 9.6% at June 30, 2002, while theweighted average interest rate we paid was 2.4% and 2.7% for the same periods,respectively.  Although the differencebetween interest rate income and interest rate expense is relatively large ournet income for the  six month periodending June 30, 2003 was relatively low at approximately $869 thousand, certaincosts, including premium amortization and credit loss provisions have causedthe low profit margin. Loss severity (amount of loss incurredwhen real estate owned is sold) has not been a factor in the reduced profitmargin by remaining relatively  constantas a percentage of original loan amount during the six month period ending June30, 2003. As our portfolio balances continueto decline, we find that a key expense item continues to be premiumamortization. and credit losses. Our portfolio has been declining in sizerapidly as a result of borrowers refinancing their mortgages which necessitateswriting off our premium at accelerated rates. Credit losses on collateralremain as a significant portion of total mortgage asset portfolio businessexpenses.

 

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Most of the intermediate adjustable rate mortgages in the CMO/FASIT,1999-1, 1999-A, 1999-2 and 2000-2 segments of the Bond Collateral MortgageLoans portfolio have reached their first contractual interest rate adjustmentand prepayment penalties clauses on the underlying pool of loans have expiredor declined, resulting in a higher probability of refinancing (principalprepayments). There can be no assurance that prepayment rates will notincrease. Our financial condition and results of operations could be materiallyadversely affected if prepayment levels increase significantly.

 

During the second quarter of 2003, other income decreased approximately$150 thousand over the three month period ended June 30, 2002 from $363thousand to $213 thousand, primarily due to a decrease of approximately $104thousand in equity income from our subsidiary, American Residential Holdings,Inc.

 

For the three month period ended June 30, 2003, total expensesdecreased approximately $3.1 million (from $5.2 million to$2.1 million) over the three month period ended June 30, 2002. During2003, our Company had decreases in all of the major expense categories for thissegment of our business as a result of the decrease of $133 million in bondcollateral. The primary decreases included the following: interest expensedecreased approximately $1.8 million; provision for loan losses decreasedby approximately $230 thousand and loss on real estate owned decreased $677thousand.

 

On February 7, 2003, the Company filed a notice with the Internal RevenueService of our decision to de-REIT, effective January 1, 2003. Based uponexpected utilization of net operating loss carry forwards generated by AmNet in2001 and 2002 and expected profitability in 2003, the income tax expenserecorded for the Mortgage Asset Portfolio Business for the second quarter of2003 was $428 thousand and our effective tax rate was 45%.

 

***Six Month Results***

 

MortgageBanking Business 

 

Gain on the sale of loans for the six-monthperiod ending June 30, 2003, amounted to $53.2 million. This represents a$46.8 million increase over the same period ending June 30, 2000 when our gainon the sale of loans was $6.4 million. AmNet’s increase in gains on the sale ofloans is the result of the increase in its loan production volume. For the sixmonth period ending June 30, 2003 and June 30, 2002, AmNet recorded loan salesvolume of $5.1 billion and $954 million respectively. Gains on the sale ofloans were offset by a loss on the Company’s derivative financial instrumentsand market adjustments totaling $11.5 million and $8.4 million for thesame periods, respectively.

 

For the six months ending June 30, 2003,AmNet’s gain on sale of loans of $53.2 million is a combination of variousaccount categories.  Loan premiums ofapproximately $115.8 million represent the price at which AmNet sold theloans to investors in excess of the principal balance of loans sold. Fee incomeof approximately $15.1 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$71.2 million. Other deferred costs include (i) true sale scheduleddiscount, which is recognized at the time of loan sale, of approximately$4.5 million; (ii) deferred origination costs, which are recognizedat the time of loan sale, of approximately $5.7 million and(iii) loan premiums repaid to investors (“premium recapture”) and loanloss reserve costs aggregating approximately $3.1 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 $53.2 million for the six-month period ending June 30,2003 represents approximately 105 basis points (1.05%) on loan sales of$5.1 billion.  For the same periodending June 30, 2002, gain on the sale of loans was $6.5 million whichrepresented approximately 82 basis points (0.82%) on loan sales of$787 million.

 

During the first six months of 2003, AmNetincurred net losses on its derivative financial instruments and marketadjustments totaling $11.5 million. For the same period ending June 30, 2002 net losses on derivativefinancial instruments and market adjustments totaled $8.4 million.  Derivative financial instruments arepurchased to offset any loss from market interest rate movement which adverselyaffects gain on loan sales. During the first six months of 2003, AmNet usedforward commitments on mortgage backed securities (TBA) and options to purchaseor sell mortgage backed securities as its primary hedging vehicles.  During 2002, AmNet used treasury futures andoptions on treasury futures as prime hedging vehicles.  Due to declines in yields on mortgagesduring first six months of 2003, AmNet recorded net losses on derivativefinancial instruments and market adjustments. These losses were offset byhigher gains on the sale of loans during the quarter and in July of 2003.

 

AmNet recorded interest income of$13.5 million for the six months ended June 30, 2003 and $3.9 million forthe same period ending June 30, 2002. Interest expense for the period was$6.1 million. The resulting net interest income earned on loan inventorieswas $7.4 million, representing 14 basis points (0.14%) on 2003 loan productionof $5.3 billion.

 

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Total expenses incurred in the Mortgage Banking Business for the sixmonth period ending June 30, 2003, was approximately $38.9 million. Operatingexpenses were approximately $32.3 million for the six month period ending June30, 2003. For the comparable period ending June 30, 2002, there wasapproximately $10.2 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 six months ended June 30, 2003, estimated variable expenses,predominately commissions and contract labor, were approximately$14.7 million which were approximately 28 basis points (0.28%) on$5.3 billion in funded loans. Operating Expenses that were not directlyvariable totaled $17.7 million, or approximately 33 basis points (0.33%)on $5.3 billion in funded loans for the second quarter of 2003. The tablebelow provides the relationship between fixed, variable and total expenses forthe six month period ending June 30, 2003. (dollars in 000’s)

 
| **Mortgage Banking Expenses**      |   | **Estimated  Variable Expenses** |   | **Estimated  Fixed Expenses** |   | **Total  Expenses** |   |
|------------------------------------|--------|----------------------------------|--------|-------------------------------|--------|---------------------|--------|
|                               |   |                             |   |                          |   |                |   |
| Employee compensation and benefits |   | $                                | 11,341 |                          | $      | 10,253              |   | $ | 21,594 |   |
| Office and occupancy expense       |   | —                           |   | 1,188                         |   | 1,188               |   |
| Professional fees                  |   | 547                              |   | 1,725                         |   | 2,272               |   |
| Other operating expense            |   | 2,801                            |   | 4,520                         |   | 7,321               |   |
| **Total operating expenses**       |   | 14,689                           |   | 17,686                        |   | 32,375              |   |
| Interest expense                   |   | 6,122                            |   | —                        |   | 6,122               |   |
| **Total expenses**                 |   | $                                | 20,811 |                          | $      | 17,686              |   | $ | 38,497 |   |

 

During the first six months of 2003, wegenerated an average monthly funded loan volume of $882 million. For thesame period ending June 30, 2002 we generated an average monthlyfunded loan volume of $159 million.

 

*Mortgage AssetPortfolio Business*

 

For the six month period ended June 30, 2003and 2002, we generated net income of approximately $869 thousand and $10.7million, respectively.  June 30, 2002net income includes a litigation settlement of $10.3 million.  Operational net income before income tax(net income less litigation settlement we received in 2002) increased for 2003,although revenue and expense categories declined as a result of a decline ofour mortgage asset portfolio from $337.2 million at June 30, 2002 to $203.7million at June 30, 2003. Excluding the litigation settlement our MortgageAsset Portfolio operations had revenues matching expenses resulting in no netincome for the period. Although there was an increase in net income for 2003,all revenue and expense categories declined as a result of a decline of ourmortgage asset portfolio from $337.2 million at June 30, 2002 to $203.7 millionat June 30, 2003.  A decline in ourportfolio has a resulted in a decrease in net interest income from $10.5 millionfor the six month period ending June 30, 2002 to $6.2 million for the six monthperiod ending June 30, 2003 and a related decrease on interest expense of $6.1million to $2.7 million for the same periods and net interest income (interestincome less interest expense) of $4.4 million and $3.5 million for the sameperiods.

 

During the first six months of 2003, otherincome decreased approximately $418 thousand over the six month period endedJune 30, 2002 from $829 thousand to $411 thousand, primarily due to a decreaseof approximately $342 thousand in prepayment penalty income.

 

For the six month period ended June 30, 2003,total expenses decreased approximately $5.8 million (from$11.1 million to $5.3 million) over the six month period ended June30, 2002. During 2003, our Company had decreases in all of the major expensecategories for this segment of our business as a result of the decrease of$133.5 million in bond collateral. The primary decreases included thefollowing: interest expense decreased approximately $3.4 million;provision for loan losses decreased by approximately $1.4 million and (gain)loss on sale of real estate owned decreased $947 thousand.

 

 **Liquidity and Capital Resources**

 

*General*

 

Our current sources of liquidity primarilyconsist of the following:

 

•                                          borrowings under our warehouse and other creditfacilities;

 

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

 

•                                          excess interest spread and over collateralization“step down” payments related to the mortgage asset portfolio business, net ofrepayments to servicers for past principal and interest advances on completedreal estate owned dispositions.

 

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Our primary 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.

 

As our mortgage banking operations have grown and our mortgage assetportfolio has declined, our cash flow from mortgage asset portfolio investmentactivities has continued to decline in amounts and materiality.

 

*Cash GeneratedBy and Used In Our Operations*

 

During the six month period  ended June 30, 2003, on a consolidated basiswe generated a net positive cash flow of $13.6 million. This net positivenumber can be better understood by explaining the major components:

 

***MortgageBanking Business:***

 

•                                          Cash reserves utilized to fund loan inventoriesand maintain cash collateral accounts in our Mortgage Banking Business wereapproximately $15.8 million for the first six months of 2003.

 

Our warehouse line lending agreements allowus to borrow from 98% to 99% of par for each mortgage loan.  These agreements contain restrictivecovenants.  As of June 30, 2003, we arein compliance with all covenants associated with these agreements. We pay anadditional 1% to 2% of the loan principal amount in fees or yield spreadpremium to the mortgage brokers. Lastly, a small portion of our loan inventoryis funded with equity capital. We typically have cash invested totaling between2% to 4% (including loan repurchases) of the principal amount of loans held forsale, which is recouped when the loans are purchased by investors. Should weincrease the amount of loan inventory, either by holding loans for longerperiods, or due to increased loan funding volume, the cash reserves necessaryto carry loan inventories will increase in direct proportion to the inventory held.Our total warehouse line capacity as of August 8, 2003 was $1.3 billion.

 

•                                          Cash receipts in excess of cash expenditures inAmNet were approximately $12.7 million for the six months ended June 30, 2003.

 

Cash receipts consist of proceeds for loansales and hedging gains, interest on loans held for sale, and fees charged onfunded loans. Cash expenditures consist of payments on hedging losses, salarybenefits, commissions and other operating expenses.

 

•                                          Capital expenditures totaled approximately $1.6 millionduring the six months ended June 30, 2003.

 

Capital expenditures included approximately$609 thousand in computer hardware, approximately $623 thousand for fixturesand equipment, and approximately $356 thousand for computer software and otherequipment.

 

Our financial condition can be affected byturmoil in world markets, which could directly impact domestic liquidity. Weintend to renew existing financing facilities and seek new financing sources asthe need arises. There can be no assurance that we will be able to secure newshort or long-term financing or that financing will be available on favorableterms.

 

We anticipate our liquidity will bepredominantly impacted by our Mortgage Banking Business. Specifically, weexpect to continue to originate approximately $1 billion to $1.5 billionper month of new mortgage loans and fund these originations with equity capitaland warehouse facility borrowings. We also expect to continue to engage inhedging transactions that may require cash investment to maintain or adjusthedged positions. Furthermore, we anticipate greater general and administrativecosts associated with the operations of our Mortgage Banking Business. Weintend to use cash reserves, borrowings under the warehouse facilities and theSubordinated Loan Agreement and cash flow generated by the mortgage assetportfolio, as well as cash flow generated from the origination and sale ofmortgage loans, to fund our operations. We are therefore dependent onsignificant and increasing levels of warehouse financing to help execute ourmortgage banking strategy. Furthermore, we must originate a certain minimumlevel of loans to remain profitable. See Business Risk Factors.

 

***Mortgage Asset Portfolio Business:***

 

•                                          Net cash flow from our mortgage asset portfoliowas positive at approximately $949 thousand for the first six 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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principal to bondholders, paying servicer andtrustee fees, bond insurance premiums and reimbursing servicers for any advancesmade on real estate owned dispositions. Any excess cash flow is remitted to usfrom the bond trustees on a monthly basis. There  are various factors that affect this flow, such as marketinterest rate changes. Additionally, our bond agreement provisions specify therequirements for over collateralization accounts. If overcollateralizationaccounts are deficient, this can restrict our receipt of excess cash flow andbe used instead by the bond trustee to pay down long-term debt.

 

Cash flow from the mortgage asset portfoliois expected to decline in 2003 due to a decline in the size of the portfolioand potential increases in overcollateralization accounts.

 

•                                          Administrative expenditures for our Mortgage AssetPortfolio Business aggregated approximately $1.9 million.

 

Administrative expenses allocated to ourMortgage Asset Portfolio Business included portfolio management payrollallocations of approximately $477 thousand, general legal expenses ofapproximately $337 thousand, professional and consulting fees ofapproximately $133 thousand, director fees of $61 thousand, stock exchange feesof $65 thousand and liability insurance of approximately $149 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.

 

**Business Risk Factors**

 

**Risks Associated with Changing OurBusiness Strategy**

 

*We Have aLimited Operating History in the Mortgage Origination Industry, Which Makes itDifficult to Evaluate Our Current Business Performance and Future Prospects*

 

Our Company was formed in 1997 and operatedas a mortgage REIT (mortgage portfolio investment) until the fourth quarter of2001, at which time we began originating and selling mortgages (mortgagebanking). As a result, comparisons between financial performance in currentquarters and past quarters may not be helpful in evaluating our currentperformance or our future prospects.  Wemust originate increasing amounts of mortgages in the future to grow ourbusiness. While our executive officers have extensive mortgage origination andmortgage banking experience, and have hired experienced personnel in ourmortgage banking subsidiary, there are a significant number of risks anduncertainties inherent in the mortgage origination industry, especially inlight of our limited relevant operating history relative to our mortgage bankingactivities.

 

*We Expect OurOperating Expenses to Increase, which May Adversely Affect Our Results ofOperations*

 

We had net income of approximately$21.7 million for the six month period ending June 30, 2003 which includedan income tax benefit of $9.1 million. We expect to incur additional costs andexpenses related to the expansion of our sales force and the opening of newregional underwriting centers, as well as the expansion of our management teamand establishment of the internal infrastructure necessary to support thegrowth of our mortgage banking business. If these expenses do not generateadequate revenues, our financial performance will suffer. In addition, theseexpenses will require the use of cash, which will reduce our ability to fund loansuntil such time as we generate additional revenues. See “Risks Associated withOur Mortgage Banking Business — Overhead Expenses May Not Be Covered bySufficient Revenues to Sustain Profitable Operations.”

 

*We May Not BeAble to Effectively Manage the Growth of Our Business*

 

Recently, we have experienced rapid growth.In the beginning of 2001, we had approximately 20 employees. As of June 30,2003, we had over 500 employees. Many of these employees have very limitedexperience with us and a limited understanding of our systems. Many of ourfinancial, operational and managerial systems were designed for a smallbusiness and have only recently been adopted or replaced to support largerscale operations. At the same time, we will need to continue to upgrade andexpand 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.

 

**RisksAssociated with Our Mortgage Banking Business**

 

*Failure toRenew and Obtain Adequate Financing May Adversely Affect Results Of Operations*

 

As of June 30, 2003 we had warehouseborrowing facilities in place totaling $1.3 billion.  In order to continue to increase loan origination volumes, wemust obtain additional warehouse lines of credit, or reduce the time loans areheld for sale (warehoused). There are a number of financial institutions whichspecialize in lending to mortgage banking 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 assurances that wewill expand our current warehouse facilities or obtain additional warehousefacilities. Failure to obtain additional facilities would limit our potentialfor growth and may adversely affect our financial results. Among the factorsthat will affect our ability to expand our warehouse line borrowings arefinancial market conditions and the value and performance of our company priorto 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.

 

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

 

•                                          incur additional debt by virtue of havingwarehouse loan covenants;

 

•                                          make certain investments or acquisitions;

 

•                                          repurchase or redeem capital stock;

 

•                                          engage in mergers or consolidations;

 

•                                          finance loans with certain attributes;

 

•                                          reduce liquidity below certain levels; and

 

•                                          hold loans for longer than established timeperiods.

 

These restrictions may interfere with ourability to obtain financing or to engage in other business activities, whichmay significantly harm our business financial condition, liquidity and resultsof operations. As of the date of filing this report, we are in compliance withall restrictions and covenants contained in our warehouse borrowing facilities.

 

*Volatility inInterest Rates May Adversely Affect Our Results of Operations and Our FinancialPosition*

 

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

 

The value of the mortgage loans that weoriginate is at risk due to fluctuations in interest rates during two timeperiods: (1) the period beginning when we have committed to funding theloan and ending when the loan closes, or funds; and (2) the time periodbeginning when the loan closes and ending when we commit to sell or sell theloans to third-party purchasers. These loans are collectively referred to asour loan pipeline. To manage the interest rate risk of our pipeline, wecontinuously project the percentage of the pipeline loans we expect to close.Because projecting a percentage of pipeline loans that will close is especiallydifficult during periods of volatile interest rates, we cannot assure that ourprojections will be accurate. On the basis of such projections, we use forwardsale of mortgage loan securities (TBA-MBS), which are classified as derivativeinstruments. These “hedges” are designed to mitigate the adverse impactinterest rate fluctuations on the value of the loan pipeline. Our use of hedgesis driven by our estimates as to the percentage of loans that will close, andtherefore we cannot provide assurance that our use of derivative securitieswill offset the risk of changes in interest rates.

 

If interest rates change unexpectedly, theactual percentage of pipeline loans that close may differ from the projectedpercentage. A sudden increase in interest rates can cause a higher percentageof pipeline loans to close than projected. We may not have made forward salescommitments to sell these additional loans and consequently may incursignificant losses upon their sale at current market prices, which may not beoffset by gains in the value of derivative securities, adversely affectingresults of operations. Likewise, if a lower percentage of pipeline loans closesthan was projected, due to a sudden decrease in interest rates or otherwise, wehave and may in the future adjust hedge positions or mandatory salescommitments at a significant cost, adversely affecting our results of operations.This risk is greater during times of volatile interest rates.

 

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*ContractingMortgage Origination Market may Adversely Impact Our Business*

 

We have assumed a contraction in the level ofmortgage originations in the remainder of 2003 and 2004 due to generally highermortgage interest rates and a decline in the level of loan refinancings.  We anticipate higher costs per loan andlower per loan revenue as a direct consequence of the expected market contraction.  Increased market share in existing marketsand planned expansion into new markets may be insufficient to prevent anoverall decline in results of operations. The growth of our business may also be adversely impacted due to generalmarket contraction.

 

*Our HedgingStrategies May Not Be Successful in Mitigating Our Risks Associated WithInterest Rate Changes*

 

We use forward sale of mortgage loansecurities (TBA-MBS), which are classified as derivative financial instruments,to provide a level of protection against interest rate risks. When rates changewe expect to record a gain or loss on derivatives which would be offset by aninverse change in the value of our pipeline of rate lock commitments and loansnot yet committed for sale. We cannot provide assurance however, that our useof derivatives will offset all of our risk related to changes in interestrates. There have been periods, and it is likely that there will be periods inthe future, during which we will incur losses after accounting for ourderivative financial instruments. The derivative financial instruments weselect may not have the desired effect of reducing our interest rate risk. Inaddition, the nature and timing of hedging transactions may influence theeffectiveness of these strategies. If we poorly design strategies or improperlyexecute transactions we could actually increase our exposure to interest raterisk and potential losses. In addition, hedging strategies involve transactionand other costs. We cannot provide assurance that our hedging strategy and thederivatives that we use will adequately offset the risk of interest ratevolatility or that our hedging transactions will not result in losses.

 

*OverheadExpenses May Not Be Covered By Sufficient Revenues To Sustain ProfitableOperations*

 

We made a number of fixed overheadcommitments to establish the operational and administrative infrastructurenecessary to support the loan origination business. At June 30, 2003, leasecommitments for headquarters and regional offices totaled approximately 119,300square feet. There were over 500 salaried, commissioned and hourly employees.In order to achieve profitability, our monthly originations must be in the$500 million to $750 million range, such that the expected revenuesassociated with this loan production exceed fixed and variable overhead costs.Since our revenues are tied directly to the level of loan production, it isimperative that we achieve a profitable level of originations, and the level offuture profitability from mortgage banking will be in direct correlation to thelevel of loan origination volume. There can be no assurances that we will beable to maintain loan origination volumes sufficient to cover our fixedoverhead costs, and should we incur significant operating losses, our capitalbase and cash reserves could be materially adversely impacted, precluding usfrom fully implementing our mortgage banking strategies.

 

*Non-saleableor Repurchased Loans May Adversely Impact Results of Operations and OurFinancial Position*

 

In connection with the sale of loans tocorrespondent investors, we make a variety of representations and warrantiesregarding the loans, including those that are customary in the industryrelating to, among other things, compliance with laws, regulations and investorprogram standards and the accuracy of information on the loan documents andloan file. In the event that an investor finds that a loan or group of loansviolates our representations, the investor may require us to repurchase theloan or loan group and bear any potential related loss on the disposition ofthe loans, or provide an indemnification for any losses sustained by theinvestor on the loans. Additionally, we may originate a loan that does not meetinvestor underwriting criteria or has some other defect, requiring us to sellthe loan at a significant discount. We have hired experienced personnel at alllevels and have established significant controls to ensure that all loans areoriginated to our underwriting standards, and are maintained in compliance withall of the representations made by us in connection with our loan saleagreements. However, there can be no assurances that mistakes will not be madeor that certain employees will not deliberately violate our lending 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 allowances 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 our results ofoperations or our financial condition of our Company.

 

*CapitalShortages Could Impede the Ability to Execute Our Mortgage Banking Strategy*

 

Our mortgage banking activities require asignificant level of cash reserves and capital to support loan inventories andoverhead expense coverage. Additionally, while we utilize warehouse creditfacilities to fund our loan origination activity, we must invest cash in ourloan inventories approximating 1% to 4% of the cost basis for these loans. Wealso maintain derivative financial instruments, potentially requiring cashpayments as those instruments mature. While we believe our capital base, cashreserves and cash revenues from our mortgage asset portfolio business andmortgage banking revenues will be sufficient to cover overhead expenses, therecan be no assurances that capital shortages will not occur, requiring us toraise additional debt or equity capital or decrease or cease our originationactivities.

 

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*The NationwideScope of Our Operations Exposes Us to Risks of Noncompliance with an Increasingand Inconsistent Body of Complex Laws and Regulations at the Federal, State andLocal Levels*

 

We originate mortgage loans in many states. We must comply with thelaws and regulations, as well as judicial and administrative decisions, of allof these jurisdictions, as well as an extensive body of federal laws andregulations. The volume of new or modified laws and regulations has increasedin recent years, and, in addition, individual cities and counties have begun toenact laws that restrict loan origination activities in those cities andcounties. The laws and regulations of each of these jurisdictions aredifferent, complex and, in some cases, in direct conflict with each other. Asour operations continue to grow, it may be more difficult to comprehensivelyidentify, 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.

 

Our failure to comply with these laws canlead to the following consequences, any of which could have an adverse effecton our ability to operate our business and our financial results:

 

•                                          civil and criminal liability;

 

•                                          loss of approved status within certain states;

 

•                                          demands for indemnification or loan repurchasesfrom purchasers of our loans;

 

•                                          class action lawsuits;

 

•                                          assignee liability, which may make our loansunsaleable; and

 

•                                          administrative enforcement actions.

 

*The IncreasingNumber of State and Local “Anti-predatory Lending” Laws May Restrict OurAbility to Originate or Increase Our Risk of Liability With Respect To CertainMortgage Loans and Could Increase Our Cost of Doing Business*

 

In recent years, several federal, state andlocal laws, rules and regulations have been adopted, or are underconsideration, that are intended to eliminate so-called “predatory” lendingpractices. These laws, rules and regulations impose certain restrictions onloans on which certain points and fees or the annual percentage rate (“APR”)exceeds specified thresholds. Some of these restrictions expose a lender torisks of litigation and regulatory sanction no matter how carefully a loan isunderwritten. In addition, an increasing number of these laws, rules andregulations seek to impose liability for violations on purchases of loans,regardless of whether a purchaser knew of or participated in the violation.

 

Our Company does not engage in  predatory lending practices and therefore weavoid originating loans that exceed the APR or “points and fees” thresholds asprescribed in predatory lending  laws,rules and regulations. In addition, the companies that buy our loans and/orprovide financing for our loan origination operations generally do not want tobuy or finance such loans. The continued enactment of these laws, rules andregulations may prevent us from making certain loans and may cause us to reducethe APR or the points and fees on loans that we do make. In addition, thedifficulty of managing the risks presented by these laws, rules and regulationsmay decrease the availability of warehouse financing and the overall demand forloans, making it difficult to fund, sell or securitize any of our loans. If wedecide to relax our restrictions on loans subject to these laws, rules andregulations because the companies which buy our loans and/or provide financingfor our loan origination operations relax their restrictions, we will besubject to greater risks for actual or perceived non-compliance with such laws,rules and regulations, including demands for indemnification or loanrepurchases from our lenders and loan purchasers, class action lawsuits,increased defenses to foreclosure of individual loans in default, individualclaims for significant monetary damages and administrative enforcement actions.The growing number of these laws, rules and regulations will likely increaseour cost of doing business as we are required to develop systems and proceduresto ensure that we do not violate any aspect of these new requirements. Any ofthe foregoing could materially and adversely affect our business, financialcondition, liquidity and results of operations.

 

*Competition InThe Mortgage Banking Industry and Demand for Mortgages May Hinder Our Abilityto Achieve or Sustain Profitable Origination Levels*

 

Our success in the mortgage banking strategywill depend, in large part, on our ability to originate quality loans insufficient quantity such that the gain on sales of loans net of hedge costs arein excess of both fixed and variable overhead costs. There can be no assurancethat we will be able to originate sufficient levels of mortgages to achieve andsustain profitability. In originating and selling quality loans, we willcompete with investment banking firms, savings and loan associations, banks,mortgage bankers and other entities originating A paper for residential 1-4unit mortgages, many of which have greater financial resources than us. We willalso face competition from companies already established in these markets. Inaddition to the level of home purchase activity, the origination market isdirectly tied to the general level of interest rates and refinance activity.The origination market exceeded $1.2 trillion in 2000

 

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and $2 trillion in 2001, due to both stronghome sales and low interest rates. The loan origination market was over a twotrillion dollars in 2002 and is projected to be over two trillion dollars in2003, the overall market size could contract if interest rates rise, increasingcompetitiveness in the mortgage markets and putting pressure on the marketcompetitors to reduce net revenues to sustain origination volumes and marketshare. We believe that the variety and competitiveness of our loan products andcustomer service levels will allow us to gain market share over the nextseveral years, even if the overall demand for mortgages declines; however,there can be no assurance that we will be able to successfully compete.

 

*We MustAttract and Retain Qualified Account Executives to Produce Our Desired Level ofRevenues*

 

We rely on commissioned account executives togenerate loan referrals from professional mortgage brokers. These accountexecutives typically have established relationships with our broker clients.Our overall loan fundings are in direct proportion to the number of accountexecutives, and as such, our sustained loan production and market share growthare dependent on the successful retention and recruitment of our sales force.Due to this very competitive labor market, there can be no assurances we willbe able to retain and recruit account executives.

 

*We Are SubjectTo Losses Due To Fraudulent Acts On The Part Of Loan Applicants, Employees orMortgage Brokers*

 

Mortgage brokers who assist loan applicantsin obtaining mortgage loans refer all of the mortgage loans originated by us.As such, the loan application, property appraisal, credit report and othersupporting documentation are furnished by the mortgage broker and used by ourunderwriters to make approval or denial decisions. There could be the potentialof collusion between the broker and an employee to produce a fraudulent loan.Our employees have limited contact with applicants, and rely on the mortgagebroker to obtain and furnish all of the documentation supporting the mortgageloan application. Mortgage brokers may make mistakes in completing thedocumentation for a loan, leading to an increased risk of our holding a non-saleableloan.

 

Further, in rare cases, the mortgage brokermay knowingly or unknowingly submit an application wherein multiple parties tothe transaction (borrower, appraiser, seller, or title insurer) work incollusion to inflate the property value and/or falsify other documentation inorder to obtain a mortgage loan. These types of fraudulent mortgage loans willhave a high risk of default, and will likely not be fully recoverable throughdisposition of the underlying property securing the mortgage loan.

 

Should material fraud be detected on amortgage loan prior to sale to an investor, the mortgage loans may have to besold

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 anddisposition of the underlying property securing the mortgage loan.

 

We have established risk management andquality control committees to set policy and manage exposure to credit lossesdue to fraud, compliance errors or non-compliance with our underwritingstandards. Regular quality control audits are done on representative samples ofmortgage loans and all mortgage loans submitted by brokers who come undersuspicion in the normal course business. Additionally, we have numerouscontrols and processes to ensure that all of the mortgage loan applicationssubmitted through mortgage brokers are not based on fraudulent or intentionallymisrepresented documentation. However, there can be no assurances that thebroker and/or borrowers do not submit fraudulent or inaccurate documentationthat is not detected by our personnel or by electronic fraud checks utilized byus. Should we originate significant numbers of fraudulent loans or loans basedon inaccurate documentation, our results of operations and financial conditioncould be materially adversely affected.

 

*We May beSubject to Fines or Other Penalties Based Upon the Conduct of Our IndependentBrokers*

 

The mortgage brokers from which we obtainloans have legal obligations to which they are subject. While these laws maynot explicitly hold the originating lenders responsible for the legalviolations of mortgage brokers, increasingly federal and state agencies havesought to impose such assignee liability. Recently, for example, the UnitedStates Federal Trade Commission (“FTC”) entered into a settlement agreementwith a mortgage lender in which the FTC characterized a broker that had placedall of its loan production with a single lender as the “agent” of the lender,and the FTC imposed a fine on the lender in part because, as “principal,” thelender was legally responsible for the mortgage broker’s unfair and deceptiveacts and practices. The United States Justice Department in the past has soughtto hold a mortgage lender responsible for the pricing practices of its mortgagebrokers, alleging that the mortgage lender was directly responsible for thetotal fees and charges paid by the borrower under the Fair Housing Act even ifthe lender neither dictated what the mortgage broker could charge nor kept themoney for its own account. Accordingly, we may be subject to fines or otherpenalties based upon the conduct of our independent mortgage brokers.

 

*We Are Subjectto Counterparty Risks on Loan Sale Commitments and Hedging Transactions*

 

In connection with our mortgage loan sales,which involve the sale of mortgage loans and mortgage-backed securities on aforward or other deferred delivery and payment basis, we may enter into hedgingtransactions which involve option purchases and sales.

 

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We havecredit risk exposure to the extent purchasers/sellers are unable to meet theterms of their forward purchase/sale contracts. As is customary in themarketplace, none of the forward payment obligations of any of ourcounterparties is currently secured or subject to margin requirements. Weattempt to limit our credit exposure on forward sales arrangements on mortgageloans and mortgage-backed securities by entering into forward contracts onlywith institutions that we believe are acceptable credit risks, and which havesubstantial capital and an established track record in correspondent lending.However, there can be no assurances that counterparties will perform. Ifcounterparties do not perform, our results of operations may be adverselyaffected.

 

*We Sell aSubstantial Portion of Loans We Originate to a Competitor*

 

We have warehouse line facilities withCountrywide Home Loans, Inc. (Countrywide). We also sell most of our loansto Countrywide. We may have to find other investors for loan sales or be forcedto find other sources of warehouse line lending if Countrywide changes itspolicies and procedures. Either of these results may have an adverse effect onour results of operations.

 

*MortgageBanking Revenues Can Fluctuate From Period to Period Based on a Number ofFactors*

 

Our operating results have and may in thefuture fluctuate significantly from period to period as a result of a number offactors, including the volume of loan origination, interest rates and the levelof unrealized gains/losses in unsold loans, pipeline loans or positions inderivative securities. Accordingly, the consolidated net income of our Companymay fluctuate from period to period.

 

*Dependency onCorrespondent Investors, Secondary Markets*

 

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

adversely affect our operations.

 

*OurOrigination Activity Is Concentrated In California, Making Our Results Subjectto Adverse Economic Conditions In California.*

 

A large proportion of loans (33.3% of allloans closed for the six month period ending June 30, 2003) we fund areconcentrated in California. Although we are expanding our operations on theEast Coast of the United States in 2003, a significant portion of our loanorigination volume is likely to be based in California for the foreseeablefuture. Consequently, our results of operations and financial condition aredependent upon general trends in the California economy and its residentialreal estate market. Residential real estate market declines may adverselyaffect the levels of new mortgages in California or the value paid bycorrespondent lenders for loans in California, potentially adversely affectingour results of operations and financial condition.

 

*A Housing andUrban Development Department (“HUD”) Proposed Rule to Reform Real EstateSettlement Procedures (“RESPA”) May Adversely Affect the Way We ConductBusiness with Mortgage Brokers*

 

HUD is proposing to improve the manner inwhich yield spread premiums paid to brokers are disclosed by requiring thatyield spread premiums (and other mortgage broker compensation) be reported aspayments from the lender. The purpose of this would be to have the mortgagebroker only receive direct compensation from borrowers and attempt to eliminatedisputes regarding improper broker payments. This proposed rule may adverselyaffect our business by requiring changes in systems and procedures which maycause delays and re-work to meet regulatory requirements.

 

*AnInterruption In or Breach of Our Information Systems May Result In LostBusiness*

 

We rely heavily upon communications andinformation systems to conduct our business. As we implement our growthstrategy and increase our volume of loan production, that reliance willincrease. Any failure or interruption or breach in security of our informationsystems or the third-party information systems on which we rely could causeunderwriting or other delays and could result in fewer loan applications beingreceived, slower processing of applications and reduced efficiency in loanservicing. We utilize proprietary software for our main loan originationsystem, and this software is not fully documented and we have a limited numberof employees who are knowledgeable about this program. We cannot provideassurance you that systems failure or interruptions will not occur, or if theydo occur that they will be adequately addressed by us or the third parties onwhich we rely. The occurrence of any failures or interruptions couldsignificantly harm our business.

 

*The Successand Growth of Our Business Will Depend Upon Our Ability to Adapt to andImplement Technological Changes*

 

Our mortgage loan origination business iscurrently dependent upon our ability to effectively interface with our brokers,borrowers and other third parties and to efficiently process loan applicationsand closings. The origination process is becoming more dependent upontechnological advancement, such as the ability to process applications over theInternet, 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 AreUnable to Maintain and Expand Our Network of Independent Brokers, Our LoanOrigination Business Will Decrease*

 

All of our loan originations of mortgageloans come from independent brokers. Our brokers are not contractuallyobligated to do business with us. Further, our competitors also haverelationships with our brokers and actively compete with us in our efforts toexpand our broker networks. Accordingly, we cannot provide assurance that wewill be successful in maintaining our existing relationships or expanding ourbroker networks, the failure of which would significantly harm our business,financial condition, liquidity and results of operations.

 

*Our FinancialResults Fluctuate As a Result of Seasonality and Other Timing Factors, WhichMakes It Difficult To Predict Our Future Performance and May Affect the Priceof Our Common Stock*

 

Our business is generally subject to seasonaltrends. These trends reflect the general pattern of housing sales, whichtypically peak during the spring and summer seasons. Our quarterly operatingresults have fluctuated in the past and are expected to fluctuate in thefuture, reflecting the seasonality of the industry. Further, if the closing ofa sale of loans is postponed, the recognition of gain from the sale is alsopostponed. If such a delay causes us to recognize income in the next quarter,our results of operations for the previous quarter could be significantlydepressed. If our results of operations do not meet the expectations of ourstockholders, the price of our common stock may decrease.

 

**RisksAssociated with Our Mortgage Asset Portfolio Business**

 

*High Levels ofBond Collateral Mortgage Loan Prepayments May Reduce Operating Income*

 

The level of prepayments of Bond CollateralMortgage Loans we purchased at a premium directly impacts the level ofamortization of capitalized premiums. We use a calculation for determining thepremium amortization which is based on the interest method. If prepaymentlevels exceed projections used for the premium amortization calculation, thepotential exists for impairment write-downs as a result of under-amortizedpremiums.

 

Bond Collateral Mortgage Loans prepaymentrates generally increase when market interest rates fall below the currentinterest rates on mortgage loans. Prepayment experience also may be affected bythe expiration of prepayment penalty clauses, the ability of the borrower toobtain a more favorable mortgage loan, geographic location of the propertysecuring the adjustable-rate mortgage loans, the assumability of a mortgageloan, conditions in the housing and financial markets and general economicconditions. The level of prepayments is also subject to the same seasonalinfluences as the residential real estate industry with prepayment ratesgenerally being highest in the summer months and lowest in the winter months.We have experienced high levels of prepayments during 1999 through 2000 on theCMO/FASIT segment of our Bond Collateral Mortgage Loan portfolio, dueprincipally to the fact that the underlying adjustable rate loans were subjectto their first initial interest rate adjustment (after being fixed for thefirst two years), prepayment penalty clauses expired and borrowers were able tosecure more favorable rates by refinancing. In 2001, the same trend occurred inthe 99-A and 1999-2 segments of our portfolio, as the loans in these portfoliosreached the end of their 2-year fixed rate periods and prepayment penaltyclauses expired. The overall rate of prepayments declined slightly for thethree month period ending June 30, 2003 (40.4%) decreased from the same periodending June 30, 2002 (44.23%). We anticipate that overall prepayment rates arelikely to remain in the 30% to 45% range in 2003. There can be no assurancethat prepayment rates will not be higher or that prepayment penalty income willoffset premium amortization expense. Accordingly, our financial condition andresults of operations could be materially adversely affected.

 

As of June 30, 2003 approximately 16.3% ofour Company’s Bond Collateral Mortgage Loan portfolio had prepayment penaltyclauses, with a weighted average of thirteen months remaining before prepaymentpenalties expire.

 

*BorrowerCredit Defaults, Special Hazard Losses and National Recessions May DecreaseValue Of Bond Collateral Mortgage Assets Held By Our Company*

 

During the time we hold bond collateralmortgage assets or retained interests in securitizations, we are subject tocredit risks, including risks of borrower defaults, bankruptcies and specialhazard losses that are not covered by standard hazard insurance (such as thoseoccurring from earthquakes or floods). In the event of a default on anymortgage loan we hold or mortgages underlying bond collateral, we will bear therisk of loss of principal to the extent of any deficiency between the value ofthe secured property and the amount owing on the mortgage loan, less any paymentsfrom an insurer or guarantor. Although we have established an allowance forloan losses, there can be no assurance that any allowance for loan losses whichis established will be sufficient to offset losses on mortgage loans in thefuture.

 

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Credit risks associated with non-conformingmortgage loans, especially sub-prime mortgage loans, will be greater than thoseassociated with mortgage loans that conform to FNMA and FHLMC guidelines. Theprincipal difference between sub-prime mortgage loans and conforming mortgageloans is that sub-prime mortgage loans typically include one or more of thefollowing: worse credit and income histories of the mortgagors, higherloan-to-value ratios, reduced or alternative documentation required forapproval of the mortgagors, different types of properties securing the mortgageloans, higher loan sizes and the mortgagor’s non-owner occupancy status withrespect to the mortgaged property. As a result of these and other factors, theinterest rates charged on non-conforming mortgage loans are often higher thanthose charged for conforming mortgage loans. The combination of differentunderwriting criteria and higher rates of interest may lead to higherdelinquency rates and/or credit losses for non-conforming as compared toconforming mortgage loans and thus require high loan loss allowances. All ofour Bond Collateral Mortgage Loans at June 30, 2003, were originated assub-prime mortgage loans.

 

A down-turn in the national economy and theresultant adverse impact on employment rates could adversely affect mortgageloan defaults. Additional credit could become scarce in such an environment andtherefore risk of loss through loan default and decreased property value couldincrease. Our allowances may be deemed inadequate should economic conditionsdecline significantly, causing higher than expected defaults and property valuedecreases. We believe the allowances for loan losses are adequate as of June30, 2003.

 

Even assuming that properties secured by themortgage loans we hold provide adequate security for such mortgage loans,substantial delays could be encountered in connection with the foreclosure ofdefaulted mortgage loans, with corresponding delays in the receipt of related proceeds.State and local statutes and rules may delay or prevent our foreclosure on orsale of the mortgaged property and typically prevent us from receiving netproceeds sufficient to repay all amounts due on the related mortgage loan.

 

*Requirementsto Maintain Over-collateralization Accounts May Reduce Our Cash Flow andInhibit Plans for Expansion of the Mortgage Banking Business*

 

In connection with securing long-term debt,virtually all of our Bond Collateral Mortgage Loans have been pledged ascollateral to secure long-term debt. Certain over collateralization accountshave been established representing the excess principal amount of thesemortgages over the associated bond obligations. Various indenture agreementsassociated with these securitizations call for the over collateralizationlevels to be maintained on an ongoing basis depending on the amount ofremaining bond obligations as well as the status of delinquency of theunderlying bond collateral or the loan loss performance of bond collateral. Althoughlong-term financing agreements are non-recourse, net interest income from somesegments of our Bond Collateral Mortgage Loans has in the past, and could inthe future, be “trapped” to pay down debt in order for us to achieve ourover-collateralization requirements. While we believe that we have sufficientcash reserves and other liquidity to support our planned mortgage bankingactivities, there can be no assurance that we will not be required to reduce orcease our planned mortgage banking activities should we be required to divertcash flow to maintain over collateralization requirements.

 

*BecauseMortgage Assets Are Pledged to Secure Long-Term Debt, We May Not Be Able toSell Such Assets and Therefore Our Liquidity and Capital Resources May Be AdverselyAffected*

 

All of our Company’s bond collateral mortgageassets at June 30, 2003 were pledged as bond collateral to secure long-termdebt. These assets are subject to the terms of the long-term debt agreementsand may not be separately sold or exchanged. While we may sell our interests inthe bond collateral subject to the liens and other restrictions of thelong-term debt agreements, there is not a liquid market for such encumberedinterests and a significant liquidity discount would be applied. As such, wewould expect to receive less than our book value should we sell our interest inthe bond collateral.

 

*Increases InShort- Term Interest Rates May Increase Our Cost of Borrowings, Which MayReduce Income From Operations*

 

The majority of our Bond Collateral MortgageLoans have a repricing frequency of six months or less, while substantially allof our borrowings have a repricing frequency of one month or less. Accordingly,the interest rates on these borrowings may be based on interest rate indices whichare different from, and adjust more rapidly than, the interest rate indices ofour related mortgage loans. Consequently, increases in short-term interestrates may significantly influence our net interest income. While increases inshort-term interest rates will increase the yields on a portion of ouradjustable-rate Bond Collateral Mortgage Loans, rising short-term rates willalso increase our cost of borrowings. To the extent such costs rise more thanthe yields on such Bond Collateral Mortgage Loans, our net interest income willbe reduced or a net interest loss may result. We may mitigate this “gap” riskby purchasing interest rate hedges (referred to as “caps”), however potentialincome from these hedges may only partially offset the adverse impact of risingborrowing costs.

 

*Loans Servicedby Third Parties May Result in Increased Delinquency Rates and Credit Losses,which May Adversely Affect Our Results of Operations and Financial Condition*

 

All of our Bond Collateral Mortgage Loans areserviced by sub-servicers. We continually monitor the performance of thesub-servicers through performance reviews, comparable statistics fordelinquencies and on-site visits. We have on occasion 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

 

A primary market risk facing our Company isinterest rate risk, which is highly sensitive to many factors, includinggovernmental monetary and tax policies, domestic and international economic andpolitical considerations and other factors beyond our control. We attempt tomanage this risk in our Mortgage Banking and Mortgage Asset Portfoliobusinesses.

 

**MortgageBanking Business**

 

*Interest RateRisk*

 

Rate lock commitments and mortgage loans heldfor sale (collectively, loan pipeline) are subject to market price fluctuationuntil committed for sale. These fluctuations are primarily tied to changes inmarket interest rates and the relationship of short-term rates to long-termrates. In order to mitigate this risk, a variety of financial derivativeinstruments (including forward mandatory mortgage security sales (TBA-MBS) andoptions on TBA-MBS sales) are utilized to hedge or mitigate market pricefluctuations. These instruments are classified as derivative financialinstruments on our financial statements. Our hedge positions are continuallyadjusted based on routine and ongoing quantification of our risk, but hedgesmay or may not be fully successful in complete risk mitigation. In particular,our capital markets personnel must make estimates of the percentage of ratelock commitments expected to close under different interest rate changes.Losses on the sale of mortgage loans not offset by corresponding gains on hedgepositions, or hedging activity not offset by corresponding gains on the sale ofmortgages, could adversely impact results of operations and our financialposition.

 

**Mortgage AssetPortfolio Business**

 

*Interest RateRisk*

 

Our operating results for this businesssegment will depend in large part on differences between the income earned fromour assets (net of credit losses) and our borrowing costs. All of this businesssegment’s mortgage assets are pledged as collateral for long-term debt (securitizations).In most cases, the income from assets will respond more slowly to interest ratefluctuations than the cost of borrowings, which creates a mismatch betweenasset yields and borrowing rates. Consequently, changes in interest rates, particularly short-terminterest rates, may influence the Mortgage Asset Portfolio Business net income.Long-term debt interest rates are tied to LIBOR.  Increases in these rates will tend to decrease net income. Asignificant increase in short-term interest rates, where the one month LIBORexceeded 12%, could result in interest expense exceeding interest income andwould result in operating losses. In the past, we have attempted to mitigateinterest rate gap risk through hedging instruments called Interest Rate Caps. Themajority of mortgages held in the portfolio are adjustable rate mortgages(ARM’s) which adjust every six months. Consequently our gap risk is limited andat the present time we do not believe that the cost of hedging our gap risk isjustified.  Currently we do not have anyInterest Rate Caps in place.

 

*Other Risks*

 

The value of Mortgage Portfolio assets may beaffected by prepayment rates on bond collateral mortgage loans.  Prepayment rates are influenced by changesin current interest rates and a variety of economic, geographic and otherfactors beyond our control. Partial protection comes in the form of prepaymentpenalties, but since our portfolio is becoming more mature, most of theprepayment penalty clauses have expired.

 

Increases in delinquency rates and defaultsby borrowers on their mortgages can also negatively impact the financialresults of the Mortgage Asset Portfolio Business. We monitor delinquencies anddefaults and adjust the loan loss provision and interest reserves accordingly.

 

**SensitivityAnalyses**

 

We have performed various sensitivityanalyses that quantify the net financial impact of changes in interest rates onour interest rate-sensitive assets, liabilities and commitments. These analysespresume an instantaneous parallel shift of the yield curve. Various techniquesare employed to value the underlying financial instruments, and thesetechniques rely upon a number of critical assumptions. The scenarios presentedare illustrative. Actual experience may differ materially from the estimatedamounts presented for each scenario. To the extent that yield curve shifts arenon-parallel, and to the extent that actual variations in significantassumptions differ from those applied for purposes of the valuations, theresultant valuations can also be expected to vary. Such variances may provematerial.

 

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|                                                                    |   |                 |    |                      |   | **If  Interest Rates Were To**             |       |
|-------------------------------------------------------------------------|--------|----------------------|---------|---------------------------|--------|--------------------------------------------|------------|
|                                                                    |   | **June 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                                               |   | $                    | 27,240  |                      | $      | 27,240                                     |       | $ | 27,240 |   | $ | 27,240 |   | $ | 27,240 |   | $ | 27,240 |   |
| Mortgage loans held for sale, net, pledged, (lower  of cost or market)) |   | 576,297              |    | 579,116                   |   | 572,074                                    |       | 584,241 |   | 564,925 |   | 589,315 |   |
| Bond collateral and real estate owned (net)                             |   | 208,984              |    | 214,716                   |   | 214,203                                    |       | 215,266 |   | 213,695 |   | 215,844 |   |
| Derivatives                                                             |   | (927                 | )       | (927                      | )      | 7,151                                      |       | (6,303 | ) | 15,680 |   | (12,503 | ) |
| Total interest-earning assets                                           |   | $                    | 811,594 |                      | $      | 820,145                                    |       | $ | 820,668 |   | $ | 820,444 |   | $ | 821,540 |   | $ | 819,896 |   |
|                                                                    |   |                 |    |                      |   |                                       |       |   |   |   |   |   |   |
| Interest-bearing liabilities:                                           |   |                 |    |                      |   |                                       |       |   |   |   |   |   |   |
| Short-term debt                                                         |   | $                    | 560,352 |                      | $      | 560,351                                    |       | $ | 560,351 |   | $ | 560,351 |   | $ | 560,351 |   | $ | 560,351 |   |
| Long-term debt, net                                                     |   | 176,977              |    | 176,978                   |   | 176,978                                    |       | 176,978 |   | 176,978 |   | 176,978 |   |
| Total interest-bearing liabilities                                      |   | $                    | 737,329 |                      | $      | 737,329                                    |       | $ | 737,329 |   | $ | 737,329 |   | $ | 737,329 |   | $ | 737,329 |   |
|                                                                    |   |                 |    |                      |   |                                       |       |   |   |   |   |   |   |
| Effect on equity                                                        |   | $                    | 74,265  |                      | $      | 82,816                                     |       | $ | 83,339 |   | $ | 83,115 |   | $ | 84,211 |   | $ | 82,567 |   |

 
|                                                                   |   |                 |    |                      |   | **If  Interest Rates Were To**             |   |
|------------------------------------------------------------------------|--------|----------------------|---------|---------------------------|--------|--------------------------------------------|--------|
|                                                                   |   | **June 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                                              |   | $                    | 12,348  |                      | $      | 12,348                                     |   | $ | 12,348 |   | $ | 12,348 |   | $ | 12,348 |   | $ | 12,348 |   |
| Mortgage loans held for sale, net, pledged, (lower  of cost or market) |   | 210,031              |    | 210,031                   |   | 209,676                                    |   | 210,384 |   | 209,139 |   | 210,911 |   |
| Bond collateral and real estate owned (net)                            |   | 348,175              |    | 357,365                   |   | 356,401                                    |   | 358,538 |   | 355,786 |   | 359,828 |   |
| Derivatives                                                            |   | 3,630                |    | 3,630                     |   | 4,706                                      |   | 2,229 |   | 5,547 |   | — |   |
| Total interest-earning assets                                          |   | $                    | 574,184 |                      | $      | 583,374                                    |   | $ | 583,131 |   | $ | 583,499 |   | $ | 582,820 |   | $ | 583,087 |   |
|                                                                   |   |                 |    |                      |   |                                       |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                          |   |                 |    |                      |   |                                       |   |   |   |   |   |   |   |
| Short-term debt                                                        |   | $                    | 205,554 |                      | $      | 205,554                                    |   | $ | 205,554 |   | $ | 205,554 |   | $ | 205,554 |   | $ | 205,554 |   |
| Long-term debt, net                                                    |   | 312,925              |    | 312,925                   |   | 312,925                                    |   | 312,925 |   | 312,925 |   | 312,925 |   |
| Due to affiliate                                                       |   | 1,964                |    | 1,964                     |   | 1,964                                      |   | 1,964 |   | 1,964 |   | 1,964 |   |
| Total interest-bearing liabilities                                     |   | $                    | 520,443 |                      | $      | 520,443                                    |   | $ | 520,443 |   | $ | 520,443 |   | $ | 520,443 |   | $ | 520,443 |   |
|                                                                   |   |                 |    |                      |   |                                       |   |   |   |   |   |   |   |
| Effect on equity                                                       |   | $                    | 53,741  |                      | $      | 62,931                                     |   | $ | 62,688 |   | $ | 63,056 |   | $ | 62,377 |   | $ | 62,644 |   |

 

The following describes themethods and assumptions used by the Company in estimating fair values.

 

*Cash andCash Equivalents*

 

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

 

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

 

The fair value is estimated based on quoted market pricesfrom institutional investors for similar types of mortgage loans. A portion ofmortgage loans held for sale are committed for sale under mandatory salearrangements and as such are not re-valued due to subsequent changes ininterest rates.

 

*Bond Collateraland Real Estate Owned*

 

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

 

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financing costs. However, due to the fact thatour Bond Collateral are pledged to secure long-term debt, there is not a liquidmarket for such encumbered interests. As such, a significant liquidity discountwould be applied.  Since we intend tohold the bond collateral mortgage loans to maturity, such a liquidity discounthas not been reflected in fair value.

 

*RetainedInterest in Securitization*

 

This security is classified as available-for-sale andas such is carried at fair value.

 

*Derivatives*

 

Fair values of forward sales of mortgage backedsecurities and options on treasury futures are based on quoted market pricesfor these instruments. Fair values of our commitments to originate loans in thequoted market prices for the loans expected to close vary due to differencesbetween current levels of interest rates and committed rates.

 

*Short-TermDebt*

 

The fair value of the warehouse line debtapproximates the carrying amounts because of the short-term nature of the debtand interest on the debt fluctuates with market interest rates.

 

*Long-TermDebt*

 

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

 

*Due toAffiliate*

 

The fair value of due to affiliate approximates thecarrying amount because of the short-term nature of the liability.

These analyses are limited by the fact thatthey are performed at a particular point in time and do not incorporate otherfactors that would impact our financial performance in each such scenario.Consequently, the preceding estimates should not be viewed as a forecast.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

(a) Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we evaluated theeffectiveness of our disclosure controls and procedures, as such term isdefined under Rule 13a-15(e) promulgated under the Securities Exchange Act of1934, as amended. Based on this evaluation, our principal executive officer andprincipal financial officer concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this quarterlyreport.

 

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

 

PART II.  OTHER INFORMATION

 
|  ITEM 1. | LEGAL  PROCEEDINGS                                   |
|---------------|------------------------------------------------------|
|          | None                                                 |
|          |                                                 |
| ITEM 2.       | 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 |

 

The Company distributed its Definitive Proxy Statement, Proxy andAnnual Report to Stockholders on or about May 9, 2003 to each stockholder ofrecord as of April 25, 2003, for its Annual Meeting of Stockholders held June19, 2003.  At the Company’s AnnualMeeting, the stockholders were asked to consider one proposal.

 

The proposal considered by the stockholders at the Annual Meetinginvolved the election of two Class III directors. The existing Board ofDirectors selected two nominees, both of whom ran unopposed and each of whomwas then serving as a Class III director. Jay M. Fuller was a director and decided not to run for re-election tothe Board. The nominees of the Board, and the voting results

 

32

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with respect thereto, were:

 
| **Name**        |   | **Votes For** |   | **Withheld** |   |
|-----------------|--------|---------------|--------|--------------|--------|
| John M. Robbins |   | 7,791,388     |   | 28,155       |   |
| Mark J. Riedy   |   | 7,681,548     |   | 137,995      |   |

 

The following directors’ terms of office continued after the AnnualMeeting:  H. James Brown, Ray W.McKewon, John C. Rocchio, Keith Johnson and Richard T. Pratt.

 
| 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 |

 

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|   |                 | *      |                                                                                                |   | 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 June 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 the following reports on form 8-K during the  quarter |
|   |                 |   |                                                                                                |
|   |                 |   | **Date**                                                                                            |   | **Items**                                                                                                                            |
|   |                 |   | 4/19/2003                                                                                           |   | Item  7 Exhibits (press releases)                                                                                                    |
|   |                 |   |                                                                                                |   | Item  9 Reg. FD Disclosure (information furnished under Item 12)                                                                     |
|   |                 |   | 5/7/2003                                                                                            |   | Item  7 (Exhibits (press release)                                                                                                    |
|   |                 |   |                                                                                                |   | Item  9 Reg. FD Disclosure (information furnished under Item 12)                                                                     |

 

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:  August 14, 2003                | By: |   | /s/  Judith A. Berry |   |
|                                        |   |   | Judith  A. Berry, |   |
|                                        |   |   | Executive  Vice President |   |
|                                        |   |   | Chief  Financial Officer |   |
|                                             |  |  |  |  |  |

 

33

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