**+**

**UNITED STATES SECURITIES ANDEXCHANGE 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,  2002** |
|--------|----------------------------------------------------|

 

**OR**

 
|   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
|--------|--------------------------------------------------------------------------------------------------|

 
|   | **Commission File Number:  1-13485** |
|--------|-------------------------------------------|

 

**AMERICAN RESIDENTIAL INVESTMENTTRUST, 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 mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

ý    YES                   o    NO

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| Common Stock ($0.01) | 7,880,090 as  of July 16, 2002 |
|----------------------|--------------------------------|

 

 

----

 
| INDEX                                                                                                                                                                                                          |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                           |   |
| PART I.  FINANCIAL INFORMATION                                                                                                                                                                            |   |
|                                                                                                                                                                                                           |   |
| Item 1. Consolidated Financial Statements                                                                                                                                                                      |
|                                                                                                                                                                                                           |   |
| Consolidated Balance Sheets at June 30,  2002 and December 31, 2001                                                                                                                                            |
|                                                                                                                                                                                                           |   |
| Consolidated Statements of Operations and  Comprehensive Income (Loss) for the three months ended June 30, 2002 and June  30, 2001 and for the six months ended June 30, 2002 and June 30, 2001  respectively. |
|                                                                                                                                                                                                           |   |
| Consolidated Statements of Cash Flows for  the six months ended June 30, 2002 and June 30, 2001.                                                                                                               |
|                                                                                                                                                                                                           |   |
| 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                                                                                                                                            |
|                                                                                                                                                                                                           |   |
| 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                                                                                                                                                                       |

 

 

2

----

 

PART I.  FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements

 

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

Consolidated Balance Sheets, Unaudited

(in thousands, except share and per sharedata)

 
|                                                                                                                                                                                               |   | **June 30, 2002** |    | **December 31, 2001** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|-----------------------|--------|
| ASSETS                                                                                                                                                                                             |   |              |    |                  |   |
| Cash and  cash equivalents                                                                                                                                                                         |   | $                 | 12,348  |                  | $      | 10,945 |   |
| Mortgage  loans held for sale, net, pledged, (lower of cost or market)                                                                                                                             |   | 210,031           |    | 38,095                |   |
| Bond  collateral, mortgage loans, net                                                                                                                                                              |   | 337,153           |    | 452,152               |   |
| Bond  collateral, real estate owned                                                                                                                                                                |   | 11,022            |    | 9,226                 |   |
| Retained  interests in securitization                                                                                                                                                              |   | 1,079             |    | 1,582                 |   |
| Derivative  financial instruments                                                                                                                                                                  |   | 3,701             |    | 926                   |   |
| Accrued  interest receivable                                                                                                                                                                       |   | 2,641             |    | 3,048                 |   |
| Due from  affiliate                                                                                                                                                                                |   | —            |    | 159                   |   |
| Investment  in American Residential Holdings, Inc.                                                                                                                                                 |   | 1,991             |    | 1,789                 |   |
| Other assets                                                                                                                                                                                       |   | 2,342             |    | 1,802                 |   |
|                                                                                                                                                                                               |   | $                 | 582,308 |                  | $      | 519,724 |   |
|                                                                                                                                                                                               |   |              |    |                  |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                          |   |              |    |                  |   |
| Liabilities:                                                                                                                                                                                       |   |              |    |                  |   |
| Short-term  debt                                                                                                                                                                                   |   | $                 | 205,554 |                  | $      | 35,265 |   |
| Long-term  debt, net                                                                                                                                                                               |   | 312,925           |    | 422,349               |   |
| Accrued  interest payable                                                                                                                                                                          |   | 150               |    | 85                    |   |
| Due to  affiliate                                                                                                                                                                                  |   | 1,964             |    | 1,786                 |   |
| Accrued  expenses and other liabilities                                                                                                                                                            |   | 3,274             |    | 1,612                 |   |
| Total  liabilities                                                                                                                                                                                 |   | 523,867           |    | 461,097               |   |
|                                                                                                                                                                                               |   |              |    |                  |   |
| 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; 7,880,090  shares issued and outstanding at June 30, 2002 and 7,959,900 shares issued  and outstanding at December 31, 2001 |   | 79                |    | 80                    |   |
| Additional  paid-in-capital                                                                                                                                                                        |   | 108,797           |    | 108,995               |   |
| Accumulated  other comprehensive income                                                                                                                                                            |   | 31                |    | 448                   |   |
| Accumulated  deficit                                                                                                                                                                               |   | (50,466           | )       | (50,896               | )      |
| Total  stockholders’ equity                                                                                                                                                                   |   | 58,441            |    | 58,627                |   |
|                                                                                                                                                                                               |   | $                 | 582,308 |                  | $      | 519,724 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

3

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AmericanResidential Investment Trust, Inc. and Subsidiaries

Consolidated Statements of Operations, unaudited

(inthousands, except per share data)

 
|                                                                  |   | **For the  Three Months Ended  June 30, 2002** |   | **For the  Three Months Ended  June 30, 2001** |   | **For the  Six Months Ended  June 30, 2002** |   | **For the  Six Months Ended  June 30, 2001** |   |
|-----------------------------------------------------------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| Interest income:                                                      |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Mortgage assets                                                       |   | $                                              | 10,021 |                                           | $      | 13,983                                       |   | $                                            | 20,042 |   | $ | 32,059 |   |
| Cash and investments                                                  |   | 37                                             |   | 168                                            |   | 66                                           |   | 356                                          |   |
| Interest rate cap and floor agreement expense                         |   |                                           |   | —                                         |   |                                         |   | (9                                           | )      |
| Total interest income                                                 |   | 10,058                                         |   | 14,151                                         |   | 20,108                                       |   | 32,406                                       |   |
| Interest expense                                                      |   | 4,072                                          |   | 8,990                                          |   | 7,899                                        |   | 23,239                                       |   |
| Net interest spread                                                   |   | 5,986                                          |   | 5,161                                          |   | 12,209                                       |   | 9,167                                        |   |
| Premium amortization                                                  |   | 2,526                                          |   | 2,960                                          |   | 5,628                                        |   | 5,436                                        |   |
| Net interest income                                                   |   | 3,460                                          |   | 2,201                                          |   | 6,581                                        |   | 3,731                                        |   |
| Provision for loan losses                                             |   | 1,024                                          |   | 779                                            |   | 3,127                                        |   | 2,420                                        |   |
| Net interest income after provision for loan losses                   |   | 2,436                                          |   | 1,422                                          |   | 3,454                                        |   | 1,311                                        |   |
| Other operating income:                                               |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Gain on sale of mortgage loans                                        |   | 4,952                                          |   | —                                         |   | 6,504                                        |   | —                                       |   |
| Management fee income                                                 |   | 31                                             |   | 45                                             |   | 59                                           |   | 96                                           |   |
| Equity in income of American Residential Holdings, Inc.               |   | 128                                            |   | 46                                             |   | 202                                          |   | 157                                          |   |
| Prepayment penalty income                                             |   | 170                                            |   | 853                                            |   | 510                                          |   | 1,674                                        |   |
| Total other operating income                                          |   | 5,281                                          |   | 944                                            |   | 7,275                                        |   | 1,927                                        |   |
| Net operating income                                                  |   | 7,717                                          |   | 2,366                                          |   | 10,729                                       |   | 3,238                                        |   |
| Other income:                                                         |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Litigation settlement                                                 |   | 10,281                                         |   | —                                         |   | 10,281                                       |   | —                                       |   |
| Total other income                                                    |   | 10,281                                         |   | —                                         |   | 10,281                                       |   | —                                       |   |
| Other expenses:                                                       |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Loss (gain) on sale of real estate owned, net                         |   | 347                                            |   | (98                                            | )      | 432                                          |   | 154                                          |   |
| Loss (gain) on derivative financial instruments                       |   | 8,765                                          |   | —                                         |   | 8,459                                        |   | —                                       |   |
| Underwriting costs on loan orginations                                |   | 66                                             |   | —                                         |   | 109                                          |   | —                                       |   |
| Management fees                                                       |   | —                                         |   | 674                                            |   | —                                       |   | 1,440                                        |   |
| Professional fees                                                     |   | 1,097                                          |   | 222                                            |   | 1,861                                        |   | 481                                          |   |
| General and administrative expenses                                   |   | 5,386                                          |   | 243                                            |   | 9,719                                        |   | 433                                          |   |
| Write-off of acquisition due diligence costs                          |   | —                                         |   | 514                                            |   | —                                       |   | 514                                          |   |
| Total other expenses                                                  |   | 15,661                                         |   | 1,555                                          |   | 20,580                                       |   | 3,022                                        |   |
| Income before cumulative effect of a change in accounting principle   |   | 2,337                                          |   | 811                                            |   | 430                                          |   | 216                                          |   |
| Adoption of SFAS 133 Accounting Change:                               |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Reduce Cap Agreement cost to market                                   |   | —                                         |   | —                                         |   | —                                       |   | (1,106                                       | )      |
| Net income (loss)                                                     |   | 2,337                                          |   | 811                                            |   | 430                                          |   | (890                                         | )      |
| Other comprehensive income (loss)                                     |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Unrealized gains (losses) on retained interest in securitization      |   | (415                                           | )      | 184                                            |   | (417                                         | )      | 217                                          |   |
| Unrealized holding gains (losses) arising during the period           |   | (415                                           | )      | 184                                            |   | (417                                         | )      | 217                                          |   |
| Comprehensive income (loss)                                           |   | 1,922                                          |   | 995                                            |   | 13                                           |   | (673                                         | )      |
|                                                                  |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Income (loss) per share before cumulative effect of accounting change |   | $                                              | 0.30   |                                           | $      | 0.10                                         |   | $                                            | 0.05   |   | $ | 0.03 |   |
| Net income (loss) per share of common stock-basic and diluted         |   | $                                              | 0.29   |                                           | $      | 0.10                                         |   | $                                            | 0.05   |   | $ | (0.11 | ) |
| Dividends per share of common stock for the related period            |   | $                                              | — |                                           | $      | —                                       |   | $                                            | — |   | $ | — |   |

 

Seeaccompanying notes to consolidated financial statements

 

4

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AmericanResidential Investment Trust, Inc. and Subsidiaries

Consolidated Statements of Cash Flows, unaudited

(inthousands)

 
|                                                                                                     |   | **For the  Six Months Ended  June 30, 2002** |   | **For the  Six Months Ended  June 30, 2001** |   |
|----------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES                                                                     |   |                                         |   |                                         |   |
| Net income (loss)                                                                                        |   | $                                            | 430    |                                         | $      | (890 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities: |   |                                         |   |                                         |   |
| Amortization of mortgage assets premiums                                                                 |   | 5,415                                        |   | 5,436                                        |   |
| Cumulative effect of change in accounting principle                                                      |   | —                                       |   | 1,115                                        |   |
| Amortization of interest rate cap agreements                                                             |   | —                                       |   | 9                                            |   |
| Amortization of CMO capitalized costs                                                                    |   | 326                                          |   | 568                                          |   |
| Amortization of CMO premium                                                                              |   | —                                       |   | (82                                          | )      |
| Provision for loan losses                                                                                |   | 3,127                                        |   | 2,420                                        |   |
| Equity in undistributed income of American Residential Holdings, Inc.                                    |   | (202                                         | )      | (157                                         | )      |
| Decrease in deposits to retained interest in securitization                                              |   | 1                                            |   | 168                                          |   |
| Decrease in retained interest in securitization                                                          |   | 85                                           |   | 4                                            |   |
| Loss on sale of real estate owned                                                                        |   | 1,681                                        |   | 154                                          |   |
| Proceeds from sale of mortgage loans held for sale                                                       |   | 786,732                                      |   | —                                       |   |
| Mortgage loan originations                                                                               |   | (958,668                                     | )      | —                                       |   |
| Increase in derivative financial instruments                                                             |   | (2,775                                       | )      | —                                       |   |
| Decrease in accrued interest receivable                                                                  |   | 891                                          |   | 3,697                                        |   |
| Increase (decrease) in due from affiliate                                                                |   | 159                                          |   | (58                                          | )      |
| (Increase) decrease in other assets                                                                      |   | (1,024                                       | )      | 12                                           |   |
| Increase (decrease) in accrued interest payable                                                          |   | 65                                           |   | (166                                         | )      |
| Increase in due to affiliate                                                                             |   | 178                                          |   | 239                                          |   |
| Increase in accrued expenses and other liabilities                                                       |   | 1,662                                        |   | 378                                          |   |
| Net cash (used in) provided by operating activities                                                      |   | (161,917                                     | )      | 12,847                                       |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    |   |                                         |   |                                         |   |
| Principal payments on bond collateral, mortgage loans, net                                               |   | 97,431                                       |   | 187,484                                      |   |
| Proceeds from sale of real estate owned                                                                  |   | 5,549                                        |   | 6,308                                        |   |
| Net cash provided by investing activities                                                                |   | 102,980                                      |   | 193,792                                      |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    |   |                                         |   |                                         |   |
| Increase (decrease) in net borrowings from short-term debt                                               |   | 170,289                                      |   | (2,871                                       | )      |
| Dividends paid                                                                                           |   | —                                       |   | (1,606                                       | )      |
| Payments on long-term debt                                                                               |   | (109,750                                     | )      | (196,895                                     | )      |
| Purchase of Treasury Stock                                                                               |   | (199                                         | )      | (196                                         | )      |
| Net cash provided by (used in) financing activities                                                      |   | 60,340                                       |   | (201,568                                     | )      |
| Net increase in cash and cash equivalents                                                                |   | 1,403                                        |   | 5,071                                        |   |
| Cash and cash equivalents at beginning of period                                                         |   | 10,945                                       |   | 14,688                                       |   |
| Cash and cash equivalents at end of period                                                               |   | $                                            | 12,348 |                                         | $      | 19,759 |   |
| Supplemental information – interest paid                                                            |   | $                                            | 7,828  |                                         | $      | 23,163 |   |
| Non-cash transactions:                                                                                   |   |                                         |   |                                         |   |
| Transfers from bond collateral to real estate owned                                                      |   | $                                            | 13,043 |                                         | $      | 6,859 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

5

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AMERICAN RESIDENTIAL INVESTMENTTRUST, INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

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

 

*Basis of Financial Statement Presentation*

 

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, 2002, have been included. Certain reclassifications may have been made to prior interim periodamounts to conform to the current presentation.  The results of operations for interim periods are not necessarilyindicative of results for the full year.

 

TheCompany reports segments in accordance with SFAS 131, Disclosures aboutSegments of an Enterprise and Related Information. SFAS 131 establishesstandards for the way companies report information about operating segments inannual financial statements. It also establishes standards for relateddisclosures about products and services, geographic areas and major customers.Effective January 1, 2002, the Company was reorganized into two segments: theMortgage Asset Portfolio Investments—Spread Lending Business and the MortgageBanking Business.

 

*New Accounting Standards*

 

In June 2002, the FASB issuedSFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities(SFAS 146), which addresses financial accounting and reporting for costsassociated with exit or disposal activities and nullifies Emerging Issues TaskForce (EITF) Issue No. 94-3 “Liability Recognition for Certain EmployeeTerminations Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit ordisposal activity be recognized when the liability is incurred as opposed tothe date of an entity’s commitment to an exit plan as required under EITF IssueNo. 94-3.  SFAS 146 also requires thatmeasurement of the liability associated with exit or disposal activities be atfair value.  SFAS 146 is effective forthe Company for exit or disposal activities that are initiated after December31, 2002.  The implementation of SFAS146 is not expected to have a material impact on the Company’s financialstatements.

 

SFAS 142 requires that goodwilland intangible assets with indefinite useful lives no longer be amortized, butinstead tested for impairment at least annually in accordance with theprovisions of SFAS 142. SFAS 142 also requires that intangible assets withdefinite useful lives be amortized over their respective estimated useful livesto their estimated residual values, and reviewed for impairment. As permitted bySFAS 142, the Company adopted the new standard in the first quarter of thefiscal year 2002. Intangible assets are less than $1,000 and therefore adoptionof SAS 142 has no material effect on the consolidated financial statements.

 

SFAS 144provides guidance on how a long-lived asset that is used as a part of a groupshould be evaluated for impairment, establishes criteria for when a long-livedasset is held for sale, andprescribes the accounting for a long-lived asset that will be disposed of otherthan by sale. The Company adopted SFAS 144 beginning January 1, 2002.  The Company does not expect the adoption ofSFAS 144 for long-lived assets held for use to have a material impact on theCompany’s consolidated financial statements.

 

**Note 2. Income (Loss) Per Share**

 

The following table illustratesthe computation of basic and diluted income (loss) per share (in thousands,except share and per share data):

 

6

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|                                                                                                             |   | **For the  Three months ended  June 30, 2002** |   | **For the  Three months ended  June 30, 2001** |   | **For the  Six Months Ended  June 30, 2002** |   | **For the  Six Months Ended  June 30, 2001** |   |
|------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                             |   | **(in  thousands, except share data)**         |   |
|                                                                                                             |   | **(unaudited)**                                |   |
| Numerator:                                                                                                       |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Numerator for basic income (loss) per share net earnings                                                         |   | $                                              | 2,337  |                                           | $      | 811                                          |   | $                                            | 430    |   | $ | (890 | ) |
| Denominator:                                                                                                     |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Denominator for basic income per share - weighted average number of  common shares outstanding during the period |   | 7,880,090                                      |   | 7,959,900                                      |   | 7,899,340                                    |   | 7,965,000                                    |   |
| Incremental common shares attributable to exercise of outstanding  options                                       |   | 75,000                                         |   | —                                         |   | 75,000                                       |   | —                                       |   |
| Denominator for diluted income per share                                                                         |   | 7,955,090                                      |   | 7,959,900                                      |   | 7,974,340                                    |   | 7,965,000                                    |   |
|                                                                                                             |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Income (loss) per share before cumulative effect of accounting change                                            |   | $                                              | 0.30   |                                           | $      | 0.10                                         |   | $                                            | 0.05   |   | $ | 0.03 |   |
| Basic income (loss) per share                                                                                    |   | 0.30                                           |   | 0.10                                           |   | 0.05                                         |   | (0.11                                        | )      |
| Diluted income (loss) per share                                                                                  |   | 0.29                                           |   | 0.10                                           |   | 0.05                                         |   | (0.11                                        | )      |

 

For the six months ended June30, 2002 and 2001 there were 1,199,100 and 1,218,100 options, respectively,that were antidilutive and, therefore, not included in the calculations above.

 

**Note 3. Mortgage loans held for sale, net pledged**

 

The AmRIT subsidiary, AmericanMortgage Network, Inc. (“AmNet”) has pledged loans held for sale to securecredit lines (warehouse facilities) from two financial institutions. See Note 7Short-Term Debt. Mortgage loans held for sale at June 30, 2002, consist ofloans which have been committed for sale of approximately $127.3 million andloans available for sale at approximately $80.7 million, both of which arecarried at the lower of cost or market.

 

**Note 4. Bond Collateral, Mortgage Loans, net**

 

AmRIT has pledged mortgageloans and real estate owned, net, as collateral in order to securelong-term-debt.  Bond collateral consistsprimarily of adjustable-rate, conventional, 30-year mortgage loans secured byfirst liens on one to four-family residential properties.  All bond collateral is pledged to securerepayment of the related long-term-debt obligation.  All principal and interest (less servicing and related fees) onthe bond collateral is remitted to a trustee and is available for payment onthe long-term-debt obligation.  Theobligations under the long-term-debt are payable solely from the bondcollateral and are otherwise non-recourse to AmRIT. The components of the bondcollateral at June 30, 2002 and December 31, 2001 are summarized as follows(dollars in thousands)(unaudited):

 

7

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|                                                |   | **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, 2002**                               |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Mortgage loans                                      |   | $                                     | 22,090     |                                  | $          | 83,917                          |       | $                               | 126,174    |                                  | $          | 57,802                     |       | $ | 40,386 |   | $ | 330,369 |   |
| Unamoritized premium                                |   | 754                                   |       | 2,403                                 |       | 5,172                           |       | 1,884                           |       | 702                                   |       | 10,915                     |       |
| Allowance for loan losses                           |   | (270                                  | )          | (1,019                                | )          | (1,435                          | )          | (955                            | )          | (452                                  | )          | (4,131                     | )          |
|                                                |   | $                                     | 22,574     |                                  | $          | 85,301                          |       | $                               | 129,911    |                                  | $          | 58,731                     |       | $ | 40,636 | ** ** | $ | 337,153 | ** ** |
|                                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Weighted average net coupon                         |   | 9.25                                  | %          | 9.77                                  | %          | 9.11                            | %          | 9.00                            | %          | 10.62                                 | %          | 9.45                       | %          |
| Unamortized premiums as a percent of Mortgage loans |   | 3.41                                  | %          | 2.86                                  | %          | 4.10                            | %          | 3.26                            | %          | 1.74                                  | %          | 3.30                       | %          |
|                                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| **At  December 31, 2001**                           |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Mortgage loans                                      |   | $                                     | 32,340     |                                  | $          | 112,770                         |       | $                               | 173,118    |                                  | $          | 71,732                     |       | $ | 50,719 |   | $ | 440,679 |   |
| Unamoritized premium                                |   | 1,127                                 |       | 3,978                                 |       | 7,233                           |       | 2,623                           |       | 1,369                                 |       | 16,330                     |       |
| Allowance for loan losses                           |   | (246                                  | )          | (1,582                                | )          | (1,137                          | )          | (761                            | )          | (1,131                                | )          | (4,857                     | )          |
|                                                |   | $                                     | 33,221     |                                  | $          | 115,166                         |       | $                               | 179,214    |                                  | $          | 73,594                     |       | $ | 50,957 | ** ** | $ | 452,152 | ** ** |
|                                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| Weighted average net coupon                         |   | 9.23                                  | %          | 9.99                                  | %          | 9.31                            | %          | 9.29                            | %          | 10.84                                 | %          | 9.65                       | %          |
| Unamortized premiums as a percent of Mortgage loans |   | 3.48                                  | %          | 3.53                                  | %          | 4.18                            | %          | 3.66                            | %          | 2.70                                  | %          | 3.71                       | %          |

 

The Company maintains anallowance for losses on mortgage loans held-for-investment and bond collateralat an amount which it believes is sufficient to provide adequate protectionagainst losses in the mortgage loan portfolio.

 

**Note 5. Derivative Financial Instruments**

 

The following is a summary ofAmNet’s derivative instruments (dollars in thousands)(unaudited):

 
| **Security**        |   | **Notional Amount** |    | **Strike** |    | **Derivative** |   | **Short  Long** |   | **Expiration** |                |
|---------------------|--------|---------------------|---------|------------|---------|----------------|--------|-----------------|--------|----------------|---------------------|
| Treasury Bond       |   | $                   | 300,000 |       | 108     |           | Calls  |            | Long   |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 500,000 |       | 107     |           | Calls  |            | Short  |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 550,000 |       | 110     |           | Calls  |            | Long   |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 200,000 |       | 116     |           | Calls  |            | Long   |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 200,000 |       | 92      |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 200,000 |       | 97      |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Treasury Bond       |   | $                   | 300,000 |       | 98      |           | Puts   |            | Short  |           | September  19, 2002 |   |
|                |   |                |    |       |    |           |   |            |   |           |                |
| Ten Year Treasuries |   | $                   | 300,000 |       | 110     |           | Calls  |            | Short  |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 200,000 |       | 112     |           | Calls  |            | Long   |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 100,000 |       | 112     |           | Calls  |            | Long   |           | December  19, 2002  |   |
| Ten Year Treasuries |   | $                   | 200,000 |       | 98      |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 200,000 |       | 100     |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 250,000 |       | 103     |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 500,000 |       | 104     |           | Puts   |            | Short  |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 100,000 |       | 106     |           | Puts   |            | Long   |           | September  19, 2002 |   |
| Ten Year Treasuries |   | $                   | 100,000 |       | 102     |           | Puts   |            | Short  |           | December  19, 2002  |   |
|                |   |                |    |       |    |           |   |            |   |           |                |
| FNMA 30 -Year MBS   |   | $                   | 100,000 |       | 101.125 |           | TBA    |            | Short  |           | August  14, 2002    |   |
| GNMA 30-Year MBS    |   | $                   | 75,000  |       | 101.16  |           | TBA    |            | Short  |           | August  21, 2002    |   |

 

These derivatives are accountedfor as trading securities in the accompanying consolidated financialstatements. The decrease in

 

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fair market value of derivativefinancial instruments is included in the Consolidated Statements of Operationsand Comprehensive Loss.

 

The short and long positionsnoted in the schedule above represent options to purchase or sell theunderlying security.  Long positionsgain in value as market interest rates increase and short positions gain in valueas market interest rates decrease.

 

Hedges are put in place to helpmitigate market interest rate fluctuations, which may adversely impact thelocked mortgage loan pipeline and mortgage loans closed which are unsold. AtJune 30, 2002, the locked pipeline was approximately $368.3 million and closedloans which were unsold were approximately $80.7 million.  The locked pipeline (potential loans) andclosed loans are for single family residences collateralized by first trustdeeds.  For the purposes of valuing thelocked loan pipeline an assumption is made as to the estimated percentage ofthese loans that will eventually be funded. Prior to the period ending June 30, 2002, the estimated percentage wascalculated using industry standards, because the Company had little loanorigination history available.  As theCompany continues to build a loan origination history, the estimated percentagewill be based on this history and the constant reassessment of market interestrates.

 

**Note 6. Bond Collateral, Real Estate Owned**

 

The Company owned 159 propertiesand 148 properties as of June 30, 2002 and December 31, 2001,respectively.  Upon transfer of theloans to real estate owned (as a result of default or foreclosure), the Companyrecorded a corresponding charge against the allowance for loan losses to write-downthe real estate owned to fair value less estimated cost of disposal.  As of June 30, 2002 and December 31, 2001,real estate owned totaled approximately $11.0 million and $9.2 million,respectively.

 

**Note 7. Short-Term Debt**

 

As of June 30, 2002, short-termdebt consists of a revolving credit line (warehouse facility) used to fund theCompany’s lending activities. As of June 30, 2002, mortgage loans held for salewere pledged as collateral for the warehouse facility. The facility consists ofborrowings of $202.5 million with two financial institutions for a maximumamount of $260 million, secured by mortgage loans held for sale, generallybearing interest at LIBOR plus spread (3.23% at June 30, 2002). The weighted–averageinterest rate was 3.30% in 2002 and the facility fee is 0.25% on the aggregatecommitted amount of the warehouse facility which matures on November 25, 2002.The facility is repaid as principal payments on mortgage loans are received, oras the mortgage loans are sold. The agreement governing the facility contains anumber of covenants, including covenants based on tangible net worth, cashflows, net income, and liquidity of the Company.  As of June 30, 2002 the Company was out of compliance with a networth covenant. The non-compliance was waived by the financial institution.

 

In 2001, the Company enteredinto a $5 million senior subordinated revolving loan agreement (SubordinatedLoan Agreement). Borrowings related to the Subordinated Loan Agreement aresecured by an interest in a securitization held by the Company. TheSubordinated Loan Agreement bears interest at 12% and matures in December 2002,with provisions for extension of two additional one–year periods at theCompany’s option. The Subordinated Loan Agreement contains a number ofcovenants, including covenants based on tangible net worth, cash flows, netincome and liquidity of the Company. As of June 30, 2002, the Company has $3.0million in borrowings on the Subordinated Loan Agreement.

 

**Note 8. Long-Term Debt, Net**

 

The components of thelong-term-debt at June 30, 2002 and December 31, 2001, along with selectedother information are summarized below (dollars in thousands)(unaudited):

 

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|                                |   | **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, 2002**               |   |                                    |       |                                    |       |                              |       |                              |       |                                    |       |                      |       |
| Long-term debt                      |   | $                                       | 22,097     |                                    | $          | 78,976                            |       | $                                 | 121,100    |                                    | $          | 50,534                    |       | $ | 41,264 |   | $ | 313,971 |   |
| Capitalized costs on long-term debt |   | (84                                     | )          | (7                                      | )          | (566                              | )          | (389                              | )          | —                                  |       | (1,046                    | )          |
| Total long-term debt                |   | $                                       | 22,013     |                                    | $          | 78,969                            |       | $                                 | 120,534    |                                    | $          | 50,145                    |       | $ | 41,264 |   | $ | 312,925 |   |
|                                |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                    | ** ** |                      | ** ** |
| Weighted average financing rates    |   | 2.06                                    | %          | 2.03                                    | %          | 3.28                              | %          | 2.21                              | %          | 2.98                                    | %          | 2.68                      | %          |
|                                |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                    | ** ** |                      | ** ** |
| **At  December 31, 2001**           |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                    | ** ** |                      | ** ** |
| Long-term debt                      |   | $                                       | 31,809     |                                    | $          | 107,574                           |       | $                                 | 167,200    |                                    | $          | 65,546                    |       | $ | 51,592 |   | $ | 423,721 |   |
| Capitalized costs on long-term debt |   | (122                                    | )          | (10                                     | )          | (761                              | )          | (479                              | )          | —                                  |       | (1,372                    | )          |
| Total long-term debt                |   | $                                       | 31,687     |                                    | $          | 107,564                           |       | $                                 | 166,439    |                                    | $          | 65,067                    |       | $ | 51,592 |   | $ | 422,349 |   |
|                                |   |                                    | ** ** |                                    |       |                              |       |                              | ** ** |                                    | ** ** |                      | ** ** |
| Weighted average financing rates    |   | 2.56                                    | %          | 2.25                                    | %          | 3.45                              | %          | 2.45                              | %          | 3.27                                    | %          | 2.90                      | %          |

 

**Note 9.  Commitments and Contingencies**

 

The Company has used, and willcontinue to use, Forward Loan Sale Commitments to help mitigate the lockedpipeline’s exposure to market interest rate fluctuations (See section – **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 10.  Related Party Transactions**

 

During the month of June theCompany made first trust deed loans on the personal residences of John Robbins,Chairman of the Board and Chief Executive Officer; and  Jay Fuller, President and Chief OperatingOfficer for $950,000 and $550,000 respectively.  The loans were immediately sold thru the normal channels tofinancial institutions. There were no discounts or special incentives regardingthese loans.

 

**Note 11. Business Segments**

 

The Company was reorganizedinto two segments: the Mortgage Asset Portfolio Investments—Spread LendingBusiness and the Mortgage Banking Business. The Mortgage Asset Portfolio Investments—Spread Lending segment managesa portfolio of mortgage loans pledged as collateral for long-term debt. The MortgageBanking Business originates home mortgage loans through a network of mortgageloan brokers.  These mortgage loans aresubsequently sold to financial institutions.

 

The accounting policies of thesegments are the same as described in Note 1 “Summary of Significant AccountingPolicies and Practices.” The Company evaluates the performance of its businesssegments based on income before income taxes. Expenses under the direct controlof each business segment and the expense of premises and equipment incurred tosupport business operations are allocated accordingly, by segment.

 

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The table below reflects thesecond quarter and year to date income statement activity by segment.

 

AmericanResidential Investment Trust, Inc. and Subsidiaries

Consolidated Statements of Operations by Business Segment, unaudited

(inthousands)

 
|                                                |   | **For the  Three Months Ended  June 30, 2002** |   | **For the  Three Months Ended  June 30, 2002** |   | **For the  Six Months Ended  June 30, 2002** |   | **For the  Six Months Ended  June 30, 2002** |   |
|-----------------------------------------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|----------------------------------------------|--------|----------------------------------------------|--------|
|                                                |   | **Spread Lending**                             |   | **Mortgage  Banking**                          |   | **Spread  Lending**                          |   | **Mortgage  Banking**                        |   |
| Interest  income:                                   |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Mortgage assets                                     |   | $                                              | 8,679  |                                           | $      | 1,342                                        |   | $                                            | 16,149 |   | $ | 3,893 |   |
| Cash and investments                                |   | 34                                             |   | 3                                              |   | 59                                           |   | 7                                            |   |
| Total interest income                               |   | 8,713                                          |   | 1,345                                          |   | 16,208                                       |   | 3,900                                        |   |
| Interest expense                                    |   | 2,942                                          |   | 1,130                                          |   | 6,075                                        |   | 1,824                                        |   |
| Net interest spread                                 |   | 5,771                                          |   | 215                                            |   | 10,133                                       |   | 2,076                                        |   |
| Premium amortization                                |   | 2,526                                          |   | —                                         |   | 5,628                                        |   | —                                       |   |
| Net interest income                                 |   | 3,245                                          |   | 215                                            |   | 4,505                                        |   | 2,076                                        |   |
| Provision for loan losses                           |   | 1,024                                          |   | —                                         |   | 3,127                                        |   | —                                       |   |
| Net interest income after provision for loan losses |   | 2,221                                          |   | 215                                            |   | 1,378                                        |   | 2,076                                        |   |
| Other operating income:                             |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Gain on sale of mortgage loans                      |   | —                                         |   | 4,952                                          |   | —                                       |   | 6,504                                        |   |
| Management fee income                               |   | 31                                             |   | —                                         |   | 59                                           |   | —                                       |   |
| Equity in income of American Residential            |   | —                                         |   | —                                         |   |                                         |   |                                         |   |
| Holdings, Inc.                                      |   | 128                                            |   | —                                         |   | 202                                          |   | —                                       |   |
| Prepayment penalty income                           |   | 170                                            |   | —                                         |   | 510                                          |   | —                                       |   |
| Total other operating income                        |   | 329                                            |   | 4,952                                          |   | 771                                          |   | 6,504                                        |   |
| Net operating income                                |   | 2,550                                          |   | 5,167                                          |   | 2,149                                        |   | 8,580                                        |   |
| Other income:                                       |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Litigation settlement                               |   | 10,281                                         |   | —                                         |   | 10,281                                       |   | —                                       |   |
| Total other income                                  |   | 10,281                                         |   | —                                         |   | 10,281                                       |   | —                                       |   |
| Other expenses:                                     |   |                                           |   |                                           |   |                                         |   |                                         |   |
| Loss on sale of real estate owned, net              |   | 347                                            |   | —                                         |   | 432                                          |   | —                                       |   |
| Loss on derivative financial instruments            |   | —                                         |   | 8,765                                          |   | —                                       |   | 8,459                                        |   |
| Underwriting costs on loan orginations              |   | —                                         |   | 66                                             |   | —                                       |   | 109                                          |   |
| Professional fees                                   |   | 580                                            |   | 517                                            |   | 897                                          |   | 964                                          |   |
| General and administrative expenses                 |   | 330                                            |   | 5,056                                          |   | 547                                          |   | 9,172                                        |   |
| Total other expenses                                |   | 1,257                                          |   | 14,404                                         |   | 1,876                                        |   | 18,704                                       |   |
| Net income (loss)                                   |   | $                                              | 11,574 |                                           | $      | (9,237                                       | )      | $                                            | 10,554 |   | $ | (10,124 | ) |

 

For the purpose of internalmanagement reporting, the Company records inter-segment funds transfers andeliminates these transfers on a consolidated basis for GAAP reporting.  Inter-segment assets and liabilities eliminatedfor consolidation purposes were $29.2 million for the six month period endingJune 30, 2002.

 

**Note 12.  Subsequent Events**

 

The Company held their annualmeeting on July 19, 2002, at which time voting took place with respect tocertain proposals.  This meeting wasadjourned to August 2, 2002 to permit additional voting with respect toinitiatives to eliminate certain restrictions in the Company’s charterrequiring it to remain a Real Estate Investment Trust (“REIT”). Subsequently, afinal vote count indicates the Company’s shareholders have voted in favor ofthe de-REIT proposals.  The Companyestimates the elimination of REIT status will begin January 1, 2003.

 

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

 

*The statements contained in this Form 10-Qthat are not purely historical are forward looking statements, includingstatements regarding our expectations, hopes, beliefs, intentions, orstrategies regarding the future. Statements that use the words “expects”,“will”, “may”, “anticipates”, “goal”, “intends”, “seeks”, “strategy” andderivatives of such words are forward looking statements. These forward lookingstatements include statements regarding:*

 

*•**                                          theeffect on our interest income, interest expense, gains on loan sales, gain/losson derivative financial instruments and operating performance from changes ininterest rates*

*•**                                          diversifyingand re-building our revenue streams*

*•**                                          ouranticipated lack of dividends in 2002*

*•**                                          ourbelief regarding future prepayment rates, anticipated prepayment penalties,future borrowing costs and appropriate premium amortization levels*

*•**                                          thesufficiency of our cash reserves*

*•**                                          theanticipated timing of eliminating our REIT status*

*•**                                          theimpact of new accounting standards*

*•**                                          ourintent to hold bond collateral to maturity*

 

 

*In addition, we have included a number ofstatements regarding the development of our new mortgage loan originationcapabilities, which are forward looking. These statements include statementsregarding:*

 

*•**                                          ourcreation of operational capabilities to originate and sell “A” quality mortgageloans including our expectation of deriving our revenues primarily from salesof loans net of hedging*

*•**                                          growthand profit potential from American Mortgage Network, Inc. (“AmNet”)*

*•**                                          projectedloan origination volumes, including the anticipated effect of fluctuations ininterest rates, the estimated size of the loan origination market and ourmarket share*

*•**                                          expensesassociated with AmNet*

*•**                                          ourability to obtain and expand debt facilities to fund AmNet loan originations*

*•**                                          ourability to resell our loans on the secondary market and the timing of thesere-sales*

*•**                                          thelevels of investment that we will need to make in our loan inventory*

*•**                                          theeffectiveness of our hedge instruments and our expectation of recouping in partpast hedging losses with increased loan sale revenues*

*•**                                          ourability to hedge against market fluctuations in interest rates*

*•**                                          achievingprofitability at the AmNet level, and the correlation of loan originationvolume and profitability and our expected loss for tax purposes for fiscal 2002*

*•**                                          sourcesof revenue that may be generated by our loan origination operations*

*•**                                          theadequacy of our allowances for losses on sale of mortgage loans, and our intentto set aside reserves for non-saleable loans*

 

*These forward looking statements are based oninformation available to the Company on the date hereof, and the Companyassumes no obligation to update any such forward looking statements. It isimportant to note that the Company’s actual results and timing of certainevents could differ materially from those in such forward looking statementsdue to a number of factors, including but not limited to, general economicconditions, overall interest rates, the shape of the yield curve, reductions inthe value of retained interests in securitizations, the Company’s ability tosuccessfully grow its origination subsidiary and the Company’s ability toobtain the financing necessary to fund its origination business. Other riskfactors that could cause actual results to differ materially are set forth inthis item under the heading “Business Risk Factors.”*

 

**Introduction**

 

The Company is currentlystructured as a REIT, thereby generally eliminating federal taxes at thecorporate level on income it distributes to stockholders. The proxy for the2002 Annual Stockholders Meeting included two proposals that would eliminaterestrictions on the Company’s charter documents to permit the Company toeliminate its REIT status. These proposals were passed as required of theshareholders.  The Company plans tode-REIT as of January 2003.

 

In 2001, the Company formed anoperating subsidiary, American Mortgage Network, Inc. (“AmNet”), a wholly ownedtaxable REIT subsidiary, for the purpose of engaging in mortgage bankingactivities. Through a network of regional offices in the United States,

 

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AmNet originates loans throughmortgage brokers and then sells them to institutional purchasers. All servicingrights are also sold along with the mortgage loans. Effective January 1, 2002,the Company was reorganized into two segments: The Mortgage Asset PortfolioInvestments—Spread Lending Business and the Mortgage Banking Business. The MortgageBanking Business was not significant in 2001.

 

**Mortgage Asset Portfolio Investments—SpreadLending Business**

 

Currently, the Company’s spreadlending revenue primarily consists of net interest income generated from itsbond collateral mortgage loans (consisting mainly of A- and B sub-primemortgage loans secured by residential properties) and its cash and investmentbalances (collectively, “earning assets”), prepayment penalty income and incomegenerated by equity in income of American Residential Holdings, Inc.

 

For that portion of theCompany’s earning assets funded with borrowings (“spread lending”), theresulting net interest income is the difference between the Company’s averageyield on earning assets and the cost of borrowed funds.   The table below illustrates interest rateson mortgage loans (net coupon) and interest rates on long-term debt (financingrates)(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** |       |
|-----------------------------------|--------|---------------------------------------|------------|---------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|-----------|------------|
| **At June 30, 2002**              |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |      | ** ** |
| Weighted  average net coupon      |   | 9.25                                  | %          | 9.77                                  | %          | 9.11                            | %          | 9.00                            | %          | 10.62                                 | %          | 9.45      | %          |
| Weighted  average financing rates |   | 2.06                                  | %          | 2.03                                  | %          | 3.28                            | %          | 2.21                            | %          | 2.98                                  | %          | 2.68      | %          |
|                              |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |      | ** ** |
| **At December 31, 2001**          |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |      | ** ** |
| Weighted  average net coupon      |   | 9.23                                  | %          | 9.99                                  | %          | 9.31                            | %          | 9.29                            | %          | 10.84                                 | %          | 9.65      | %          |
| Weighted  average financing rates |   | 2.56                                  | %          | 2.25                                  | %          | 3.45                            | %          | 2.45                            | %          | 3.27                                  | %          | 2.90      | %          |

 

Gross income from spreadlending will generally decrease following an increase in short term interestrates due to increases in borrowing costs but a lag in adjustments to theearning asset yields.  The majority ofthe Company’s earning assets are adjustable rate loans that adjust periodicallyevery six months based on a margin over the six-month LIBOR index.  Gross income from spread lending willgenerally increase following a fall in short term interest rates due todecreases in borrowing costs and a lag and/or ‘floor’ in downward adjustmentsto the earning asset yields.

 

The Company’s primary expenses,besides its borrowing costs, are amortization of loan purchase premiums,provision for loan losses and losses on sale of real estate owned (“REO”).Provision for loan losses represent the Company’s best estimate of expensesrelated to loan defaults.  Gains orlosses on the sale of REO represent differences between sale proceeds and thenet carrying amount of the property. The carrying value includes a reduction(credit provision) to reflect an estimate of net proceeds at time of sale.  Premiums are amortized using the interestmethod over their estimated lives.

 

During the past twenty-sevenmonths the Company’s asset base has declined due to the Company’s decision toavoid loan acquisitions if market conditions did not meet its investmentcriteria and to reserve capital for the pursuit of direct loan originationstrategies. Revenues from the Spread Lending Business have declined in directproportion to the decline in earning assets. The mortgage loan portfolio wasapproximately $1,292 million at December 31, 1999 to $858 million at December31, 2000; $452 million at December 31, 2001; and $337 million at June 30,2002.  Simultaneously, premiumamortization and credit provision expense have increased as a percentage of

 

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gross revenue, reflectingincreases in prepayments and delinquencies tied to a favorable refinance marketand normal seasoning of the mortgage loans in the Copany’s portfolio. SeeBusiness Risks — Mortgage Asset Portfolio Investments—Spread Lending Business.

 

**Mortgage Banking Business**

 

One of the Company’s primaryobjectives continues to be to augment and eventually diversify its revenue baseand earnings. The Company intends to deploy capital to augment declining revenuesfrom its current, declining mortgage loans which have not been replenished dueto unfavorable pricing on bulk purchases of mortgage loans. The primarystrategy in diversifying the Company’s income stream has been to establish aloan origination business, and to sell the loans on a servicing released basisto loan purchasers for a profit.

 

As of June 30, 2002, AmNet hashired 214 loan production and loan operations employees and will continue toexpand AmNet in 2002. Two regional production centers located in Oregon andNorthern California began originating loans in November 2001. Three centers inCalifornia, Connecticut and Georgia were opened in the first quarter of 2002,and an additional center was opened in Florida during the second quarter of2002. AmNet utilizes a dedicated sales force to offer AmNet’s loan products toapproved wholesale mortgage brokers, who refer their client’s loans to AmNetfor underwriting and funding. Loans meeting AmNet’s underwriting criteria areapproved and funded at AmNet’s regional underwriting loan centers. AmNet’sheadquarters office performs various functions through multiple departmentsincluding establishment of policy, risk management, secondary marketing,finance, accounting, administration, and information technology. The Companycompleted a relocation to new corporate headquarters in February 2002 in orderto accommodate the space requirements of the Company and AmNet.

 

All loans produced are expectedto be sold on a servicing-released basis to loan purchasers, typically within30 days of origination. In November 2001, the Company obtained an initialwarehouse facility for $75 million to fund and accumulate loans prior to saleto its loan purchasers. In March 2002 the warehouse facility was increased to$160 million. Additionally, a second facility was obtained in late March 2002for $150 million. By prior agreement, upon securing the second facility, theoriginal facility was decreased to $110 million. AmNet is required to maintainan equity investment in its loan inventory ranging from 1% to 4%, and mustcomply with various lender covenants restricting the absolute level of leverageand minimum levels of cash reserves. The Company expects to increase itswarehouse borrowing facilities to enable it to increase loan production. Therecan be no assurances that credit lines will be obtained in time to enablecontinued growth and expansion of AmNet’s loan origination.

 

AmNet’s primary sources ofrevenue are gains on the sale of mortgages, fees charged to borrowers and netinterest income earned on its loan inventory and net of gains or losses onhedging transactions.  Its primaryexpenses are commissions, salaries and occupancy costs associated with itsnetwork of regional loan origination offices, and headquarter payroll andoccupancy costs and other related general and administrative expenses.  Other expenses include potential costs andlosses associated with hedging activities (i.e., losses on derivative financialinstruments and losses on loan sales subject to certain forward loan salecontracts).

 

As is customary in the mortgagebanking industry, AmNet routinely provides rate lock commitments to borrowersfor up to 30 days prior to funding, with such loans ‘priced’ to reflect theCompany’s targeted gain on sale margin.  The Company has exposure to interest rate changes on its rate lockcommitments (loan pipeline) because a large majority of rate locks will ‘close’if interest market rates subsequently increase, and conversely, rate locks may‘fall out’ if market interest rates decline significantly. The gain on sale ofloans (loan sale margin) will generally decline if rates have risen, since theloans which were ‘priced’ when rates were lower carry lower-than-current-marketinterest rates.  Accordingly, AmNetattempts to hedge (or protect) its loan sale margin in its pipeline and closedloan inventory by utilizing certain derivative financial instruments, ForwardLoan Sale Commitments and similar agreements. Hedges are typically designed to protect against rising interestrates.  AmNet has generally adjusted itshedge coverage on a daily basis based on changes in the composition of thepipeline, market conditions and market volatility while seeking to meet theseobjectives.  For a variety of reasons,however, the Company does not believe its hedging strategy was entirelyeffective in the second quarter.

 

Since hedges are generallydesigned to protect against rising rates, should rates drop unexpectedly andsignificantly over a short time period prompting the Company to reduce itshedge coverage,  hedges losses mayoccur, and may not always be offset by higher loan sale margins due to pipelinefallout.

 

See Results of Operations – SixMonth Results and Mortgage Banking Business – Business Risks

 

**Critical Accounting Policies**

 

The following analysis offinancial condition and results of operations are based upon our consolidatedfinancial statements, and the notes thereto, which have been prepared inaccordance with accounting principles generally accepted in the United States ofAmerica (“GAAP”). The preparation of these consolidated financial statementsrequires us to make a number of estimates and assumptions that affect thereported amounts and disclosures in the consolidated financial statements. Onan ongoing basis, we evaluate our estimates and assumptions based uponhistorical experience and various other factors and circumstances. We believethat our estimates and assumptions are reasonable in the circumstances;however, actual results may differ significantly from these estimates andassumptions which could have a material impact on the carrying value of assetsand liabilities at the balance sheet dates and our results of operations forthe reporting periods.

 

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Our accounting policiesrelating to the basic procures listed below have not changed in the six-monthperiod ending June 30, 2002:

 

• Allowance for loan losses

• Amortization of premiums on bondcollateral, mortgage loans

• Derivative and hedging activities

 

Please refer to the CompanyForm 10-K for the one-year period ending December 31, 2001, for a detaileddiscussion of these procedures.

 

**Results of Operations**

 

***SixMonth Results***

 

For the six months ended June30, 2002, the Company generated net income of approximately $430 thousand andnet income per share of $0.05 compared to the six months ended June 30, 2001when the Company generated net income of approximately $216 thousand and netincome per share of $0.03.

 

Net interest income decreasedapproximately $12.0 million to approximately $20.0 million for the six monthsended June 30, 2002 from approximately $32.1 million for the six months endedJune 30, 2001.  This decrease wasprimarily due to a decrease in the value of mortgage loans.  Mortgage loans were approximately $337.1million at June 30, 2002 and approximately $643.6 million at June 30, 2001which represents approximately a 47.61% decline. The mortgage loan decline wasthe result of high prepayment activity and no portfolio replenishment.  Due to a favorable refinance market, theadjustable rate mortgage re-set rates are generally higher than rates availablein the market place.  Furthermore, inmany cases, prepayment penalties have expired, or have not served as adeterrent to refinances.

 

Interest expense decreased byapproximately $15.3 million to approximately $7.9 million for the six monthsended June 30, 2002 from approximately $23.2 million for the six months endedJune 30, 2001. This decrease is attributable to lower borrowings outstanding aswell as lower borrowing rates. A majority of the Company’s borrowing rates arebased upon a spread over the one-month London InterBank Offered Rate (“LIBOR”).One month LIBOR rates decreased from approximately 3.86% at June 30, 2001 toapproximately 1.84% at June 30, 2002.

 

Net interest income for the sixmonths ended June 30, 2002  and June 30,2001 was approximately $6.6 million and $3.7 million, respectively. Theincrease of approximately $2.9 million was due to an increase in net interestspread (discussed in the two preceding paragraphs) and despite an increase inpremium amortization. The premium amortization rate for the six months endedJune 30, 2002 increased approximately $192 thousand from the same period endedJune 30, 2001 due to the use of a level yield amortization method and the factthat prepayments increased on the two largest components of the portfolio, the1999-2 and 1999-A segments.  Premiumamortization expense represents the amortization of purchase premiums paid formortgage loans acquired in excess of the par value of the loans.  Premium amortization expense includingadjustments, was approximately $5.6 million for the six months ended June 30,2002 and approximately $5.4 million for the six months ended June 30, 2001.

 

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The following chart repesentsconstant prepayment rates (“CPRs”):

 
|             |   | **As of June  30, 2002** |   | **As of June  30, 2001** |   |
|------------------|--------|--------------------------|--------|--------------------------|--------|
|             |   | **Three****Months**      |   | **Six****Months**        |   | **Life-  Time** |   | **Three****Months** |   | **Six****Months** |   | **Life-  Time** |   |
| Bond collateral: |   |                     |   |                     |   |   |   |   |   |   |   |   |   |
| CMO/FASIT 1998-1 |   | 39.0                     | %      | 38.5                     | %      | 43.0 | % | 50.8 | % | 51.0 | % | 45.3 | % |
| CMO 1999-1       |   | 32.5                     | %      | 33.4                     | %      | 34.9 | % | 38.2 | % | 37.6 | % | 34.2 | % |
| CMO 1999-2       |   | 52.0                     | %      | 44.1                     | %      | 32.3 | % | 46.0 | % | 33.7 | % | 21.6 | % |
| CMO/REMIC 1999-A |   | 46.4                     | %      | 42.6                     | %      | 37.2 | % | 66.5 | % | 51.7 | % | 30.1 | % |
| CMO 2000-2       |   | 61.6                     | %      | 49.3                     | %      | 36.0 | % | 35.8 | % | 29.7 | % | 21.8 | % |

 

Net interest income, afterprovision for loan losses, increased $2.1 million from income of approximately$1.3 million for the six months ended June 30, 2001, to income of approximately$3.4 million for the six months ended June 30, 2002. This increase was dueprimarily to the increase in net interest spread discussed above. Loan lossprovision increased $707 thousand from approximately $2.4 million for the sixmonths ended June 30, 2001 to approximately $3.1 million for the six monthsended June 30, 2002.  The provision forloan losses as a percentage of total interest income has been steadilyincreasing due to normal aging of the mortgage asset portfolio (bondcollateral). For the six month period ending June 30, 2001 the percentage ofthe provision for loan losses to total interest income was approximately 7.5%and for the six month period ending June 30, 2002 the percentage has increasedto approximately 15.6%. The increases are related to seasoning of the sub-primemortgage portfolio and expected increases in the number of loans in foreclosurewhich are likely to result in a loss to the Company.

 

During the six months endedJune 30, 2002, other operating income increased $5.3 million as compared to thesix months ended June 30, 2001, primarily due to AmNet’s gain on sale ofmortgage loans from its mortgage banking business which was not in existence inthe prior period. A gain over the prior period was also experienced in theequity in income of American Residential Holdings, Inc. of approximately $45thousand. This increase is offset by decreases for the period in management feeincome (approximately $37 thousand) and prepayment penalty income(approximately $1.2 million) caused by the expiration of a high percentage ofprepayment penalty clauses on loans in the mortgage asset portfolio.

 

For the six months ended June30, 2002, other income increased approximately $10.3 million as a resultof  legal settlements. See Part II.OTHER INFORMATION for further description of these matters. There was no otherincome for the period ending June 30, 2001.

 

For the six months ended June30, 2002, other expenses increased $17.6 million as compared to the six monthsended June 30, 2001. This increase was mainly the result of an increase ingeneral and administrative costs of approximately $9.2 million related to theincrease in AmNet loan origination activity; the loss on derivative financialinstruments of $8.5 million; the increase in professional fees of approximately$1.4 million related to litigation costs and multi-state business licenseauthorizations and loss increases of approximately $278 thousand related to thesale of real estate owned. These other expense increases were partially offsetby decreases in management fee expense of approximately $1.4 million andacquisition cost write-off’s of approximately $514 thousand.

 

During the second quarter of2002 there were significant declines and uncertainties in the equity marketswhich contributed to unprecedented volatility in the bond markets as a ‘flightto quality’ occurred.  This significantvolatility in the bond markets was characterized by large and/or sudden upwardand downward changes in interest rates, or yields.  The volatility in the bond market yields caused significantchanges in value of AmNet’s mortgage pipeline and derivative financialinstrument positions, and required the Company to purchase and sell derivativefinancial instruments in order to attempt to offset this volatility on severaloccasions, incurring significantly higher transaction costs.   Additionally, the Company incurred losseson its derivative financial instruments which were partially offset by gains onthe sale of mortgages during the quarter ended June 30, 2002.  The Company expects a portion of the loss onderivative financial instruments will be partially offset by gains on the saleof mortgages in the third quarter of 2002.

 

While the intent of our hedgingstrategy is primarily to stabilize the value of the loans we are originatingagainst possible interest rate fluctuations, the strategy we employed in thesecond quarter was not effective for several reasons. Keeping hedge positionsaligned with our loan originations can be complex, and involves choosing fromamong a variety hedge instruments in the futures markets and delivery contractswith large buyers of loans.  Ideally, ifinterest rates rise, the value of the mortgage loans in our pipeline decreases,but the derivative financial instruments used to hedge against this risk wouldcreate an offsetting profit. Conversely, if we execute our hedging strategy well, we would expectthat if interest rates fall, the value of the mortgage loans in our pipelinewould increase, but the hedge position would create an acceptable offsettingloss.  For a variety of reasons, ourstrategy did not perform in accordance with this objective.  First, we elected to use primarily shortoption positions, which were only capable of offsetting interest rate moves ofapproximately 20 basis points. Second, the interest rate volatility of thesecond quarter was well in excess of historical norms, and on many days was inexcess of 50 basis points. Third, the nature of our short option positions wassuch that once interest rates dropped below the range protected by the optionpremium proceeds we collected, those same short positions actually accentuatedour losses, and those losses overtook the amount of the gains in ourloans.  Fourth, in order to createadditional option premiums, we periodically had a larger notional amount ofcoverage than the face amount of loans actually in the pipeline, thusexacerbating the divergence between the value of the assets we sought toprotect and our loss on the options. Fifth, because the decline in rates was so dramatic, we did not enjoysome of our hoped for profits in the loans we were originating because many ofour borrowers elected not to close those loans in favor of seeking alternativeloan approvals at lower rates. Subsequent to the second quarter and considering the recent volatilityin interest rates, we have elected to dramatically reduce the use of shortoption positions, and instead are using alternative approaches, such asmandatory delivery contracts and similar techniques.

 

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***ThreeMonth Results***

 

For the three months ended June30, 2002, the Company generated net income of approximately $2.3 million andnet income per share of $0.30 compared to the three months ended June 30, 2001when the Company generated net income of approximately $811 thousand and netincome per share of $0.10.

 

Mortgage asset interest incomedecreased approximately $4.0 million to approximately $10.0 million for thethree months ended June 30, 2002 from approximately $14.0 million for the threemonths ended June 30, 2001.  Thisdecrease was primarily due to lower average mortgage assets.  Mortgage assets were approximately $337.1million at June 30, 2002 and approximately $643.6 million at June 30, 2001,which represents a 47.61% decline. The Mortgage asset decline was the result ofhigh prepayment activity and no portfolio replenishment.  Due to a favorable refinance market, theadjustable rate mortgage re-set rates are generally higher than rates availablein the market place.  Furthermore, inmany cases, prepayment penalties have expired, or have not served as adeterrent to refinances.

 

Interest expense decreased byapproximately $4.9 million to approximately $4.1 million for the three monthsended June 30, 2002 from approximately $9.0 million for the three months endedJune 30, 2001. This decrease is attributable to lower borrowings outstanding aswell as lower borrowing rates. A majority of the Company’s borrowing rates arebased upon a spread over the one-month London InterBank Offered Rate (“LIBOR”).One month LIBOR rates decreased from approximately 3.86% at June 30, 2001 toapproximately 1.84% at June 30, 2002.

 

Net interest income for thethree months ended June 30, 2002  andJune 30, 2001 was approximately $3.5 million and $2.2 million respectively. Theincrease of approximately $1.3 million was due to an increase in net interestspread (discussed in the two preceding paragraphs) and a decrease in premiumamortization. The premium amortization rate for the three months ended June 30,2002 decreased approximately $434 thousand from the same period ended June 30,2001. Although for the six month period premium amortization increased over theprior period (see explanation above - ***Six Month Results***),******the three month period decreased. The decrease for thethree month period reflects the gradual decrease in level yield amortization asportfolio balances continue to decline. Premium amortization expense includingadjustments, was approximately $2.5 million for the three months ended June 30,2002 and approximately $3.0 million for the three months ended June 30, 2001.

 

Net interest income, afterprovision for loan losses, increased $1.0 million from income of approximately$1.4 million for the three months ended June 30, 2001, to income ofapproximately $2.4 million for the three months ended June 30, 2002. Thisincrease was due primarily to the increase in net interest spread discussedabove. Loan loss provision increased $245 thousand from approximately $779thousand for the three months ended June 30, 2001 to approximately $1.0 millionfor the three months ended June 30, 2002. The provision for loan losses as a percentage of total interest incomehas been steadily increasing. For the three month period ending June 30, 2001the percentage of the provision for loan losses to total interest income wasapproximately 5.5% and for the three month period ending June 30, 2002 thepercentage has increased to approximately 10.2%. The increases are related toseasoning of the sub-prime mortgage portfolio and expected increases in thenumber of loans in foreclosure which are likely to result in a loss to theCompany.

 

During the three months endedJune 30, 2002, other operating income increased $4.3 million as compared to thethree months ended June 30, 2001, primarily due to AmNet’s gain on sale ofmortgage loans from its origination business of approximately $5.0 million.This activity was not in existence in the prior period. In addition the equityin income from American Residential Holdings, Inc. increased approximately $82thousand. These increases were offset by decreases for the period in managementfee income (approximately $14 thousand) and prepayment penalty income(approximately $683 thousand).

 

For the three months ended June30, 2002, other income increased approximately $10.3 million as a resultof  lawsuit and arbitration proceedingssettlements. See Part II. OTHER INFORMATION for further description of thesematters. There was no other income for the period ending June 30, 2001.

 

For the three months ended June30, 2002, other expenses increased $14.1 million as compared to the threemonths ended June 30, 2001. This increase was mainly the result of a loss onderivative financial instruments of $8.8 million and an increase in general andadministrative costs related to the increase in AmNet loan origination activityof approximately $5.1 million. Additionally, legal fees related to theCompany’s litigation increased professional fees approximately $875 thousand.Other increases included losses on sale of real estate owned by approximately$445 thousand and underwriting costs on loan originations of approximately $66thousand. These other expense increases were partially offset by decreases inmanagement fee expense of approximately $674 thousand and acquisition costwrite-offs of approximately $514 thousand.

 

During the second quarter of2002 there were significant declines and uncertainties in the equity marketswhich contributed to unprecedented volatility in the bond markets as a ‘flightto quality’ occurred.  This significantvolatility in the bond markets was characterized by large and/or sudden upwardand downward changes in interest rates, or yields.  The volatility in the bond market yields caused significantchanges in value of AmNet’s mortgage pipeline and treasury positions, andrequired the Company to adjust its hedge positions on several occasions,incurring significantly higher transaction costs.   Additionally, the Company incurred losses on its derivativefinancial instruments which were partially offset by gains on the sale ofmortgages during the quarter ended June 30, 2002.  The Company expects a portion of the loss on derivative financialinstruments will be partially offset by gains on the sale of mortgages in thethird quarter of 2002.  See also SixMonth Results above.

 

**Liquidity and Capital Resources**

 

During the six months endedJune 30, 2002, net cash used in operating activities was approximately $161.9million.  The difference between net useof cash provided by operating activities and the net income of approximately$553 thousand was primarily the result of using $958.7 million to fund mortgageloan originations. This use was partially offset by $786.7 million in proceedsfrom loan sales. The other primary use of cash during the period was $2.8million for investments in derivative financial instruments. Mortgage loansheld for sale, net, pledged at June 30, 2002 was approximately $210.0 millionof which approximately $129.3 million was committed for sale.

 

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Net cash provided by investingactivities for the six months ended June 30, 2002 was approximately $103.0million. Cash flows from investing activities for the six months ended March31, 2002 came from principal payments on bond collateral of approximately $97.4million and proceeds from the sale of real estate owned of approximately $5.5million.

 

For the six months ended June30, 2002, net cash provided by financing activities was approximately $60.3million, primarily due to the increase in short-term debt of approximately$170.3 million.  The increase in cashwas partially offset by payments on long-term debt of approximately $110.0million and the purchase of outstanding common stock pursuant to the sharerepurchase program of approximately $199 thousand. Available short-term creditincreased approximately $185 million during the period from approximately $75million to approximately $260 million by increases in loan limits from anexisting warehouse loan facility and the addition of a short-term borrowingfacility.  (See Note 7 to the financialstatements). The Company’s mortgage banking strategy requires that the Companyincrease its loan origination levels to a profitable level and continue toincrease loan production volumes for sustained and increased profitability. Inorder to continue to increase loan origination volumes, the Company must obtainadditional warehouse lines of credit, or reduce the time loans are held forsale (warehoused). There are a number of financial institutions whichspecialize in lending to mortgage banking companies and these types of securedborrowings. AmNet expects to expand its current warehouse lines of credithowever, there can be no assurances that AmNet will be successful in obtainingadditional warehouse facilities.

 

The Company’s mortgage bankingactivities will require a significant level of cash reserves and capital tosupport start-up operating losses, loan inventories and hedge positions.Specifically, the Company expects its operations from mortgage banking to becash flow negative for several months. Additionally, while AmNet utilizeswarehouse credit facilities to fund its loan origination activity, AmNet mustinvest cash equity in its loan inventories approximating 1% to 4% of the costbasis for these loans. The Company also maintains interest rate hedges,requiring margin accounts set by the Chicago Board of Trade. While the Companybelieves its capital base, cash reserves and cash revenues from its spreadlending business and mortgage banking revenues will be sufficient to enable theCompany to execute its mortgage banking strategy, there can be no assurancesthat capital shortages will not occur, requiring the Company to raiseadditional debt or equity capital or decrease or cease its originationactivities.

 

The Company does not expect topay dividends in 2002.  As a REIT, ithas been the Company’s policy to distribute at least 90% of taxable income toits shareholders in the form of dividends. While the Company expects to report profits in 2002 for financialreporting (GAAP) purposes, it expects to have a loss in 2002 for taxpurposes.  This is because 1. theCompany has certain loss carryforwards from previous years, and 2. certainexpenses and charges taken for GAAP purposes in previous years, primarilyrelated to loan premium amortization and credit provisions, will be expensedfor tax purposes in 2002 and 2003. Furthermore, the proceeds received from the settlement of legal claimstotaling $10.3 million in the second quarter of 2002, is income for GAAPpurposes but only partially recorded as income for tax purposes.

 

During the six months endedJune 30, 2001, net cash provided by operating activities was approximately$12.8 million.  The difference betweennet cash provided by operating activities and the net loss of approximately$890 thousand was primarily the result of amortization of Mortgage Assetpremiums, reduction of interest rate cap agreements to market value, provisionfor loan losses, and a decrease in accrued interest receivable. Accruedinterest receivable increased cash flow during the first six months of 2001 dueto the Mortgage Asset portfolio decreasing approximately $203.7 million fromDecember 31, 2000 to June 30, 2001.  Theprimary uses of cash that lowered amounts available to fund operationsincluded: an increase in equity income of American Residential Holdings, Inc.;a decrease in accrued interest payable; and, payments which increase amountsdue from affiliates.

 

Net cash provided by investingactivities for the six months ended June 30, 2001 was approximately $193.8million. Cash flows from investing activities for the six months ended June 30,2001 came from principal payments on bond collateral of approximately $187.5million and proceeds from the sale of real estate owned of approximately $6.3million.

 

For the six months ended June30, 2001, net cash used in financing activities was approximately $201.6million, primarily due to payments on long-term debt of approximately $196.9million and payments on short-term debt of approximately $2.9 million.  Net cash used in financing was furtherincreased by the payment of dividends of approximately $1.6 million and thepurchase of outstanding common stock pursuant to the share repurchase programof approximately $196 thousand.

 

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**Business Risks—Mortgage Asset PortfolioInvestments—Spread Lending Business**

 

*High Levels of Bond Collateral Mortgage LoanPrepayments May Reduce Operating Income*

 

The level ofprepayments of bond collateral mortgage loans purchased at a premium by theCompany directly impacts the level of amortization of capitalized premiums. TheCompany uses a calculation for determining the premium amortization which isbased on the interest method. If prepayment levels exceed projections used forthe premium amortization calculation, the potential exists for impairmentwrite-downs as a result of under-amortized premiums.

 

Bondcollateral mortgage loan prepayment rates generally increase when marketinterest rates fall below the current interest rates on mortgage loans.Prepayment experience also may be affected by the expiration of prepaymentpenalty clauses, the ability of the borrower to obtain a more favorablemortgage loan, geographic location of the property securing the adjustable-ratemortgage loans, the assumability of a mortgage loan, conditions in the housingand financial markets and general economic conditions. The level of prepaymentsis also subject to the same seasonal influences as the residential real estateindustry with prepayment rates generally being highest in the summer months andlowest in the winter months. The Company experienced high levels of prepaymentsduring 1999 through 2000 on its CMO/FASIT segment of its bond collateralmortgage loan portfolio due principally to the fact that the underlyingadjustable rate loans were subject to their first initial interest rateadjustment (after being fixed for the first two years), prepayment penaltyclauses expired and borrowers were able to secure more favorable rates byrefinancing. In 2001 and 2002, the same phenomenon occurred in the 99-A and1999-2 segments of the portfolio, as the loans in these portfolios reached theend of their 2 year fixed rate periods and prepayment penalty clauses expired.The overall rate of prepayments has decreased over the past several months averaging40.15% in the first six months of 2002, 41.66% in the fourth quarter of 2001,down from 52.15% in the third quarter and 49.60% in the second quarter. TheCompany anticipates that overall prepayment rates are likely to remain in the40% to 50% range in 2002. There can be no assurance that prepayment rates willnot be higher or that prepayment penalty income will offset premiumamortization expense. Accordingly, the Company’s financial condition andresults of operations could be materially adversely affected.

 

As of June 30,2002 approximately 23.1% of the Company’s Bond Collateral Mortgage Loanportfolio had prepayment penalty clauses, with a weighted average of fifteenmonths remaining before prepayment penalties expire. Prepayment penalty clausesserve as a deterrent to early prepayments and the penalties collected help tooffset the premium amortization expense. However, prepayment penalty fees maybe in an amount which is less than the figure which would fully compensate theCompany for its remaining capitalized premiums, and prepayment penaltyprovisions may expire before the prepayment occurs.

 

*Borrower Credit Defaults, Special HazardLosses and National Recessions May Decrease Value and Cash Flow from theCompany Bond Collateral Mortgage Assets*

 

During thetime the Company holds bond collateral mortgage assets or retained interest insecuritizations, it is subject to credit risks, including risks of borrowerdefaults, bankruptcies and special hazard losses that are not covered bystandard hazard insurance (such as those occurring from earthquakes or floods).In the event of a default on any mortgage loan held by the Company or mortgagesunderlying bond collateral or retained interest in securitization, the Companywill bear the risk of loss of principal to the extent of any deficiency betweenthe value of the secured property and the amount owing on the mortgage loan,less any payments from an insurer or guarantor. Although the Company hasestablished an allowance for loan losses, there can be no assurance that anyallowance for loan losses which is established will be sufficient to offsetlosses on mortgage loans in the future.

 

Credit risksassociated with non-conforming mortgage loans, especially sub-prime mortgageloans, will be greater than those associated with mortgage loans that conformto FNMA and FHLMC guidelines. The principal difference between sub-primemortgage loan and conforming mortgage loans is that sub-prime mortgage loanstypically include one or more of the following: worse credit and incomehistories of the mortgagors, higher loan-to-value ratios, reduced oralternative documentation required for approval of the mortgagors, differenttypes of properties securing the mortgage loans, higher loan sizes and themortgagor’s non-owner occupancy status with respect to the mortgaged property.As a result of these and

 

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other factors, the interestrates charged on non-conforming mortgage loans are often higher than thosecharged 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 ofthe Company’s Bond Collateral Mortgage Loans at June 30, 2002 were originatedas sub-prime mortgage loans.

 

A downturn inthe national economy and the resultant adverse impact on employment rates couldadversely affect mortgage loan defaults. Additional credit could become scarcein such an environment and therefore risk of loss through loan default anddecreased property value could increase. The Company’s allowances for loanlosses may be inadequate should economic conditions worsen significantlycausing higher than expected defaults and property value decreases. Managementbelieves the allowances for loan losses are adequate as of June 30, 2002.

 

Even assumingthat properties secured by the mortgage loans held by the Company provideadequate security for such mortgage loans, substantial delays could beencountered in connection with the foreclosure of defaulted mortgage loans,with corresponding delays in the receipt of related proceeds by the Company.State and local statutes and rules may delay or prevent the Company’sforeclosure on or sale of the mortgaged property and typically prevent theCompany from receiving net proceeds sufficient to repay all amounts due on therelated mortgage loan.

 

*Prepayments, Credit Losses and Increases inShort Term Interest Rates May Adversely Affect the Value of Retained Interestin Securitization*

 

In 1998, theCompany completed a sale of residential mortgage loans through thesecuritization of such loans through a “REMIC.” The REMIC consisted of pooled,first-lien mortgages and was issued by American Residential Holdings, Inc(“Holdings”) to the public through a registration statement of an underwriter.The interest-only strip referred to as the Class “X” Certificate was created inthe process of the securitization and was transferred from Holdings to AmericanResidential Eagle, Inc., a wholly owned REIT subsidiary of the Company. Thevalue of this investment is impacted by the level of future prepayments, creditloss and net interest spread on the underlying mortgages. There were noimpairment charges during the six months ending June 30, 2002. However, duringthe year ending December 31, 2000, the Company incurred a $5.1 millionimpairment charge related to its retained interest in a REMIC securitization(the “Residual”). GAAP requires that any decline in residual asset value thatis other than temporary be reflected through the Company’s current periodstatement of operations. There are no other retained interests insecuritizations owned by the Company.

 

*Requirements to MaintainOver-collateralization Accounts May Reduce the Company’s Cash Flow and InhibitPlans for Expansion of the Mortgage Banking Business*

 

In connectionwith securing long term debt, virtually all of the Company’s Bond CollateralMortgage Loans have been pledged as collateral to secure long term debt.Certain overcollateralization accounts have been established representing theexcess principal amount of these mortgages over the associate bond obligations.Various indenture agreements associated with these financings call for theovercollateralization levels to be maintained on an ongoing basis depending onthe amount of remaining bond obligations as well as the status of delinquencyof the underlying bond collateral or the loan loss performance of bondcollateral. Although its long-term financing agreements are non-recourse, netinterest income from some segments of the Company’s Bond Collateral MortgageLoans has in the past, and could in the future, be “trapped” to pay down debtin order for the Company to achieve its over-collateralization requirements.While the Company believes that it has sufficient cash reserves and otherliquidity to support its planned mortgage banking activities, there can be noassurances that the Company will not be required to reduce or cease its plannedmortgage banking activities should it be required to divert cash flow tomaintain overcollateralization requirements.

 

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*Because Mortgage Assets Are Pledged to SecureLong-Term Debt, the Company may not be Able to Sell Such Assets and Thereforethe Company’s Liquidity and Capital Resources may be Adversely Affected*

 

All of theCompany’s bond collateral mortgage assets at June 30, 2002 were pledged as bondcollateral to secure Long-Term Debt. These assets are subject to the terms ofthe Long-Term Debt agreements and may not be separately sold or exchanged.While the Company may sell its interests in the bond collateral subject to theliens and other restrictions of the Long-Term Debt agreements, there is not aliquid market for such encumbered interests and a significant liquiditydiscount would be applied. As such, the Company would expect to receive lessthan its book value should it sell its interests in the bond collateral.

 

*Increases In Short Term Interest Rates MayIncrease the Cost of Borrowings by the Company Which May Reduce Income FromOperations*

 

The majorityof the Company’s Bond Collateral Mortgage Loans have a repricing frequency ofsix months or less, while substantially all of the Company’s borrowings have arepricing frequency of one month or less. Accordingly, the interest rates onthe Company’s borrowings may be based on interest rate indices which aredifferent from, and adjust more rapidly than, the interest rate indices of itsrelated mortgage loans. Consequently, increases in (short-term) interest ratesmay significantly influence the Company’s net interest income. While increasesin short-term interest rates will increase the yields on a portion of theCompany’s adjustable-rate Bond Collateral Mortgage Loans, rising short termrates will also increase the cost of borrowings by the Company. To the extentsuch costs rise more than the yields on such Bond Collateral Mortgage Loans theCompany’s net interest income will be reduced or a net interest loss mayresult. The Company may mitigate its “gap’ risk by purchasing interest ratehedges (referred to as “caps’), however potential income from these hedges mayonly partially offset the adverse impact of rising borrowing costs.

 

*Loans Serviced by Third Parties May Result inIncreased Delinquency Rates and Credit Losses which May Adversely Affect theCompany’s Results of Operations and Financial Condition*

 

All of theCompany’s Bond Collateral Mortgage Loans are serviced by sub-servicers. TheCompany continually monitors the performance of the sub-servicers throughperformance reviews, comparable statistics for delinquencies and on-sitevisits. The Company has on occasion determined that sub-servicers have notfollowed standard collection and servicing practices related to the Company’sBond Collateral Mortgage Loans which the Company believes has led to increaseddelinquencies and higher loan losses on selected segments. The Companycontinues to monitor these servicers, has put these entities on notice of suchdeficiencies, and has instituted other mitigating processes. The Company hasarranged for servicing with entities that have particular expertise innon-conforming mortgage loans. Although the Company has established theserelationships and procedures, there can be no assurance that these sub-servicerswill service the Company’s mortgage loans in such a way as to minimizedelinquency rates and/or credit losses and not cause an adverse effect on theCompany’s results of operations.

 

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**Risks Associated with Changing the Company’sBusiness Strategy**

 

*The Company has a Limited Operating Historyin the Mortgage Origination Industry, which Makes it Difficult to Evaluate theCompany’s Current Business Performance and Future Prospects*

 

The Companywas formed in 1997 and operated as a mortgage REIT (mortgage portfolioinvestment) until the fourth quarter of 2001, at which time the Company beganoriginating and selling mortgages (mortgage banking). The Company mustoriginate increasing amounts of mortgages in the future to grow its business.While the Company’s executive officers have extensive mortgage origination andmortgage banking experience, and have hired experienced personnel in itsmortgage banking subsidiary, there are a significant number of risks anduncertainties inherent in the mortgage origination industry, especially inlight of the Company’s limited relevant operating history and experienceoriginating mortgages.

 

*The Company Expects Operating Expenses toIncrease Significantly which May Adversely Affect its Results of Operations*

 

Although theCompany earned a net profit of approximately $430 thousand for the six monthperiod ending June 31, 2002, this profit was entirely due to lawsuit andarbitration settlements totaling $10.3 million. Without these settlements theCompany would have incurred a net loss of approximately $9.9 million for thefirst six months of 2002. The Company expects operating losses to continue,which may render it unable to generate sufficient revenues to be profitable inthe future. In particular, the Company expects to incur additional costs andexpenses related to the expansion of the sales force and regional underwritingcenters as well as the expansion of its management team and internalinfrastructure necessary to support the growth of the mortgage banking business.

 

Unprofitableoperations may have an adverse effect on the price of the Company’s commonstock.

 

*The Company May Not Be Able to EffectivelyManage the Growth of its Business*

 

Recently, theCompany has experienced rapid growth. In the beginning of 2001, the Company hadapproximately 20 employees. As of June 30, 2002, it had approximately 214employees. Many of these employees have very limited experience with theCompany and a limited understanding of its systems and controls. Many of theCompany’s financial, operational and managerial systems and controls weredesigned for a small business and have only recently been adopted or replacedto support larger scale operations. The

 

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Company will need to attractand hire additional sales and management personnel in an intensely competitivehiring environment. At the same time, the Company will need to continue toupgrade and expand its financial, operational and managerial systems andcontrols and policies and procedures. If the Company fails to manage its growth effectively, the Company’sexpenses could increase and the management’s time and attention could bediverted. If the Company does not succeed in these efforts, it will be unableto effectively grow and manage the business, and its financial results could benegatively affected.

 

**Mortgage Banking Business—Business Risks**

 

*Failure to Renew and Obtain AdequateFinancing May Adversely Affect Results Of Operations*

 

The Company’smortgage banking strategy requires that the Company increase its loan originationlevels to a profitable level and continue to increase loan production volumesfor sustained and increased profitability. The Company currently has warehouseborrowing facilities in place totaling $260 million. In order to continue toincrease loan origination volumes, the Company must obtain additional warehouselines of credit, or reduce the time loans are held for sale (warehoused). Thereare a number of financial institutions which specialize in lending to mortgagebanking companies and these types of secured borrowings. AmNet expects toexpand its current warehouse facilities with JP Morgan/Chase and UBS Warburg;however, there can be no assurances that AmNet will expand its currentwarehouse facility or obtain additional warehouse facilities.

 

Among thefactors that will affect AmNet’s ability to expand its warehouse lineborrowings are financial market conditions and the value and performance ofAmNet prior to the time of such financing. There can be no assurance that anysuch financing can be successfully completed at advantageous rates or at all.Additionally, the Company’s warehouse borrowing facilities contain variousfinancial covenants including maximum leverage and cash reserve (liquidity)requirements. Failure to comply with these covenants would accelerate thesedebt agreements and if waivers or modifications could not be obtained, theCompany could have an interruption in its ability to fund its mortgage loanoriginations, which could materially adversely impact the Company’s results ofoperations and financial condition.

 

*Overhead Expenses May Not Be Covered BySufficient Revenues To Achieve Or Sustain Profitable Operations.*

 

The Companymade a number of fixed overhead commitments to establish the operational andadministrative infrastructure necessary to support the loan originationbusiness. At June 30, 2002, lease commitments for headquarter and regionaloffices totaled approximately 35,000 square feet. There were 214 salariedemployees. In order to achieve profitability, AmNet’s monthly originations mustbe in the $350 million to $400 million range, such that the revenues associatedwith this loan production exceed fixed and variable overhead costs. SinceAmNet’s revenues are tied directly to the level of loan production, it isimperative that AmNet achieves a profitable level of originations, and thelevel of future profitability from mortgage banking will be in directcorrelation to the level of loan origination volume. There can be no assurancesthat AmNet will increase its loan origination volumes sufficiently to cover itsfixed overhead costs, and should it incur significant operating losses duringits start-up phase, the capital base and cash reserves could be materiallyadversely impacted, precluding the Company from fully implementing its mortgagebanking strategies.

 

*Non-saleable or Repurchased Loans MayAdversely Impact Results of Operations and The Company’s Financial Position*

 

In connectionwith the sale of loans to correspondent investors, AmNet makes a variety ofrepresentations and warranties on the loans including those that are customaryin the industry relating to, among other things, compliance with laws,regulations and investor program standards and as to the accuracy ofinformation on the loan documents and loan file. In the event that an investorfinds that a loan or group of loans violates AmNet’s representations, theinvestor may require AmNet to repurchase the loan and bear any potentialrelated loss on the disposition of the loan, or provide an indemnification forany losses sustained by the investor on the loan. Additionally, AmNet mayoriginate a loan that does not meet

 

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investor underwriting criteriaor has some other defect, requiring AmNet to sell the loan at a significantdiscount. AmNet has hired experienced personnel at all levels and hasestablished significant controls to ensure that all loans are originated toAmNet’s underwriting standards, and are maintained in compliance with all ofthe representations made by AmNet in connection with its loan sale agreements.However there can be no assurances that mistakes will not be made or thatcertain employees will not deliberately violate AmNet’s lending policies, andaccordingly AmNet is subject to repurchase risk and losses on unsaleable loans.Typically, with respect to any loan that might be repurchased or unsaleable,AmNet would correct the flaws if possible and re-sell the loan in the market.AmNet intends to create repurchase allowances to provide for this contingencyon its financial statements, but there can be no assurances that loan lossesassociated with repurchased or unsaleable loans will not adversely impactresults of operations or the financial condition of the Company.

 

*Volatility in Interest Rates*

 

AmNet’sprimary source of revenues is expected to be gains from the sale of loans, netof gains or losses on hedging transactions. AmNet sets rates and pays broker premiums based on a pricing processdesigned to create a targeted profit margin on each loan.  Appropriately pricing these loans can becomplex, and AmNet may not always successfully price its loans with adequatemargin to compensate it for the risk of interest rate volatility.  In addition, AmNet uses derivative financialinstruments in an effort to limit its exposure to changes in interest ratesbetween the time it makes a rate lock commitment and the time each loan isclosed and/or sold to investors.

 

Unexpectedgains or losses on sales of mortgage loans have resulted from and may in thefuture result from changes in interest rates from the time the interest rate ona customer’s mortgage loan application is established to the time AmNet sellsthe loan. At any given time, AmNet has committed to sell substantially all ofits mortgage loans that are closed (closed loan inventory) and a percentage ofthe mortgage loans that are not yet closed but for which the interest rate hasbeen established (pipeline loans). To manage the interest rate risk of AmNet’spipeline loans, AmNet continuously projects the percentage of the pipelineloans it expects to close.  Projecting apercentage of pipeline loans which will close is especially difficult duringperiods of volatile interest rates.  Onthe basis of such projections, AmNet employs a variety of techniques, currentlyconsisting of a combination of mandatory forward sales commitments and put andcall option contracts on United States Treasury obligations to partiallymitigate market interest rate risk.  TheCompany cannot assure however, that AmNet’s use of derivative securities willoffset the risk of changed in interest rates. In certain instances it may even increase this risk. See Management’sDiscussion and Analysis of Financial Condition and Results of Operations ---Six Month Results.

 

If interestrates make an unanticipated change, the actual percentage of pipeline loansthat close may differ from the projected percentage. A sudden increase ininterest rates can cause a higher percentage of pipeline loans to close thanprojected. AmNet may not have made forward sales commitments to sell these additionalloans and consequently may incur significant losses upon their sale at currentmarket prices, which may not be offset by gains in the value of derivativesecurities, adversely affecting results of operations. Likewise, if a lowerpercentage of pipeline loans closes than was projected, due to a suddendecrease in interest rates or otherwise, AmNet has had to and may in the futureadjust its hedge positions or mandatory sales commitments at a significantcost, adversely affecting results of operations. This risk is greater duringtimes of volatility of interest rates.

 

*Changes in Interest Rates Could AdverselyImpact Results of Operations*

 

Theprofitability of AmNet is likely to be adversely affected during any period ofunexpected or rapid increases in interest rates. Such interest rate increasescould have the effect of reducing the value of loans held for sale with suchdecline not fully offset by gains from hedging activities. Higher mortgagerates could also cause a decline in the overall market for new loans, adverselyimpacting AmNet’s origination levels. Furthermore, while the Company currentlyenjoys a positive net interest spread on its loans held for sale, inverse orflattened interest yield curves (the relationship between long term rates andshort term rates) could have an adverse impact on AmNet’s warehouse interestspread income because AmNet generally has loans in inventory based on the30-year fixed rate while the warehouse line of credit facility bears ashort-term interest rate.

 

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*Capital Shortages Could Impede the Company’sAbility to Execute Its Mortgage Banking Strategy*

 

The Company’smortgage banking activities will require a significant level of cash reservesand capital to support start-up operating losses, loan inventories and hedgepositions. Specifically, the Company expects its operations from mortgagebanking to be cash flow negative for several months. Additionally, while AmNetutilizes warehouse credit facilities to fund its loan origination activity,AmNet must invest cash equity in its loan inventories approximating 1% to 4% ofthe cost basis for these loans. The Company also maintains interest ratehedges, requiring margin accounts set by the Chicago Board of Trade. While theCompany believes its capital base, cash reserves and cash revenues from itsspread lending business and mortgage banking revenues will be sufficient toenable the Company to execute its mortgage banking strategy, there can be noassurances that capital shortages will not occur, requiring the Company toraise additional debt or equity capital or decrease or cease its originationactivities.

 

*Non-Compliance With State or Federal RulesAnd Regulations May Adversely Impact AmNet’s Ability to Originate and SellLoans*

 

In connectionwith the origination and sale of residential 1-4 unit mortgages, AmNet and theCompany are subject to various state licensing requirements, and various stateand federal rules and regulations of the department of Housing and UrbanDevelopment, the Federal Housing Administration and the VeteransAdministration. Failure to comply with state and federal laws and requirementscould impact the AmNet’s ability to originate and/or sell loans, and thus couldhave an adverse impact on the Company’s results of operation and financial condition.While AmNet has controls and processes to ensure compliance with laws andregulations, there can be no assurances that it fully complies with allregulatory requirements.

 

A number oflegislative initiatives are underway in several local and state jurisdictionsas well as on the federal level that would define and potentially restrict orprohibit ‘predatory’ lending.  While theCompany does not consider its lending practices to be predatory, there can beno assurances that practices or disclosure requirements used by the company tooriginate mortgages (while widely used throughout the A paper mortgageindustry) could be required to change pursuant to new legislation.  Restrictions, prohibitions and more onerousdisclosure or reporting requirements, particularly those that would be directedto lenders who originate mortgages through independent mortgage brokers, couldadversely impact loan origination volume or increase the cost of originatingmortgages.

 

*Competition In The Mortgage Banking Industry andDemand for Mortgages May Hinder The Company’s Ability to Achieve or SustainProfitable Origination Levels.*

 

The Company’ssuccess in its mortgage banking strategy will depend, in large part, on AmNet’sability to originate “A” paper loans in sufficient quantity such that gains onthe sale of these mortgages combined with broker fees and interest spread arein excess of both fixed and variable overhead costs. There can be no assurancethat AmNet will be able to originate sufficient levels or mortgages to achieveand sustain profitability. In originating and selling A paper loans, AmNet willcompete with investment banking firms, savings and loan associations, banks,mortgage bankers and other entities originating A paper residential 1-4 unitmortgages, many of which have greater financial resources than AmNet. TheCompany will face competition from companies already established in thesemarkets. In addition to the level of home purchase activity, the originationmarket is directly tied to the general level of interest rates and refinanceactivity. The origination market exceeded $1.2 trillion in 2000 and $2 trillionin 2001, due to both strong home sales and low interest rates. While it isexpected that the loan origination market will continue to be in thetrillion-plus level in 2002 and beyond, the overall market size could contract,increasing competitiveness in the mortgage markets, and putting pressure on themarket competitors to reduce revenues to sustain origination volumes and marketshare. The Company believes that it has identified a market niche that willallow it to gain market share over the next several years, even if the overalldemand for mortgages declines, however there can be no assurance that theCompany will be able to successfully compete.

 

*AmNet Is Subject To Losses Due To FraudulentActs On The Part Of Loan Applicants or Mortgage Brokers*

 

Mortgagebrokers, who assist loan applicants in obtaining mortgage loans, refer all ofthe mortgage loans originated by AmNet. As such, the loan application, propertyappraisal, credit report and other supporting documentation are furnished bythe mortgage broker and used by AmNet’s underwriters to make approval or denialdecisions. AmNet employees have virtually no contact with applicants, and rely onthe mortgage broker to obtain and furnish all of the documentation supportingthe mortgage loan application.

 

Further, inrare cases, the mortgage broker may knowingly or unknowingly submit anapplication wherein multiple parties to the transaction (borrower, appraiser,seller, or title insurer) work in collusion to inflate the property valueand/or falsify other documentation in order to obtain a mortgage loan. These

 

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types of fraudulent mortgageloans will have a high risk of default, and will likely not be fullyrecoverable through disposition of the underlying property securing themortgage loan.

 

Shouldmaterial fraud be detected on a mortgage loan prior to sale to an investor, themortgage loans may have to be sold at a significant discount or may not besaleable. Should material fraud be detected after a mortgage loan is sold to acorrespondent investor, AmNet may be required to repurchase the loan orindemnify the investor. While the investor and/or AmNet can initiateforeclosure proceedings on any loans deemed to be fraudulently obtained, AmNetcould incur significant losses on these fraudulent mortgage loans if principalor interest is not fully recovered through the foreclosure and disposition ofthe underlying property securing the mortgage loan.

 

AmNet hasestablished risk management and quality control committees to set policy andmanage exposure to credit losses due to fraud, compliance errors ornon-compliance with AmNet’s underwriting standards. Regular quality controlaudits are done on representative samples of mortgage loans and all mortgageloans submitted by brokers who come under suspicion in the normal course.Additionally, AmNet has numerous controls and processes to ensure that all ofthe mortgage loan applications submitted through mortgage brokers are not basedon fraudulent or intentionally misrepresented documentation. However there canbe no assurances that the broker and/or borrowers do not submit fraudulent orinaccurate documentation that is not detected by AmNet personnel, or byelectronic fraud checks utilized by AmNet. Should AmNet originate significantnumbers of fraudulent loans, the Company’s results of operations and financialcondition could be materially adversely affected.

 

*AmNet is Subject to Counterparty Risks onLoan Sales Commitments and Hedging Transactions*

 

In connectionwith its mortgage loan sales, which involve the sale of mortgage loans andmortgage-backed securities on a forward or other deferred delivery and paymentbasis, AmNet also enters into treasury option purchases and sales in connectionwith its hedging activities. AmNet has credit risk exposure to the extentpurchasers/sellers are unable to meet the terms of their forward purchase/salecontracts. As is customary in the marketplace, none of the forward paymentobligations of any of AmNet’s counterparties is currently secured or subject tomargin requirements. AmNet attempts to limit its credit exposure on forwardsales arrangements on mortgage loans and mortgage–backed securities byentering into forward contracts only with institutions that AmNet believes areacceptable credit risks, and which have substantial capital and an establishedtrack record in correspondent lending. In its treasuries futures transactions,AmNet enters into transactions with the Chicago Board of Trade through anapproved dealer to minimize potential trade risk however there can be noassurances that counterparties will perform. If counterparties do not perform,AmNet’s results of  operations mayadversely  affected.

 

*Mortgage Banking Revenues Can Fluctuate FromPeriod to Period Based on a Number of Factors*

 

AmNet’soperating results have and may in the future fluctuate significantly fromperiod to period as a result of a number of factors, including the volume ofloan production, interest rates and the level of unrealized gains/losses inunsold loans, pipeline loans or hedge positions. Accordingly, the consolidatednet income of the Company may fluctuate from period to period.

 

*Dependency on Correspondent Investors,Secondary Markets*

 

AmNet’sability to generate gains on the sale of mortgages is largely dependent uponthe continuation of correspondent lending programs offered by largecorrespondent lenders, as well as AmNet’s continued eligibility to participatein such programs. Although AmNet is in good standing with a number of largecorrespondent lenders and is not aware of any proposed discontinuation of, orsignificant reduction in, the operation of such programs, any such changescould have a material adverse effect on AmNet’s operations. AmNet anticipatesthat it will continue to remain eligible to participate in such programs, butany significant impairment of such eligibility would materially adverselyaffect its operations.

 

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*Origination Activity Is Concentrated InCalifornia, Making the Company’s Results Subject to Adverse Economic ConditionsIn California.*

 

A largeproportion of loans expected to be originated by AmNet will be concentrated inCalifornia. Although AmNet is expanding its operations to the East Coast of theUnited States in 2002, a significant portion of its loan origination volume islikely to be based in California for the foreseeable future. Consequently,AmNet’s results of operations and financial conditions are dependent upongeneral trends in the California economy and its residential real estatemarket. Residential real estate market declines may adversely affect the levelsof new mortgages in California or the value paid by correspondent lenders forloans in California, potentially adversely affecting the Company’s results ofoperations and financial condition.

 

*A Recent Federal Circuit Decision Regardingthe Legality of Yield Spread Premiums Could Increase Litigation Against Us andOther Mortgage Lenders*

 

A recentfederal circuit court decision regarding the legality of yield spread premiumscould increase litigation against other mortgage lenders and us. In June 2001,the Eleventh Circuit Court of Appeals issued a decision in *Culpepper v. Irwin Mortgage Corp*.in which the court revisited the legality of certain payments that lenderscommonly make to mortgage brokers, often referred to as yield spread premiums,under the federal Real Estate Settlement Procedures Act. A “yield spreadpremium” is an amount paid by a mortgage lender to a mortgage broker for theorigination of a loan, typically measured by the difference, or spread, betweenthe amount the lender is willing to pay with respect to a given loan based onthe loan’s specific characteristics, such as interest rate, loan to value ratio,and credit grade, and the amount of the lender’s baseline or par price that thelender offers to pay for loans with certain baseline or par characteristics.For example, if a broker produces a $100,000 loan meeting the requirements thatlender has specified in order to pay 101% (1% above the lender’s par price)then the lender will pay that broker a yield spread premium of $1,000 ($100,000times 1%). In 1999, the Department of Housing and Urban Development issued apolicy statement taking the position that lender payments to mortgage brokers,including yield spread premiums, are not *per se* illegal, and it reiterated thisbasic position in a statement issued in October 2001. The *Culpepper* decision isinconsistent with the position taken by the Department of Housing and UrbanDevelopment; however, the Department of Housing and Urban Developmentstatements do not have the binding effect of a statue or regulation. Othermortgage lenders and we now face inconsistent judicial decision about suchpayments. If the *Culpepper* decision is not overturned or otherwise supersededby law or regulation, there could be a substantial increase in litigationregarding lender payments to brokers and potential costs defending these typesof claims and in paying any judgments that might result. The Real EstateSettlement Procedures Act imposes severe penalties, including damages equal tothree times the amount of the illegal payments in the event such payments weredetermined to have violated the law, in addition to exposing the violatingparty to substantial amounts of attorney’s fees.  The Company is abiding by industry standards while this issue isbeing resolved through the legal system.

 

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

A primarymarket risk facing the Company is interest rate risk. The Company attempts tomanage this risk by striving to balance its mortgage loan origination andmortgage loan sale business. To a lesser degree the Company also manages theinterest rate risk on it portfolio business between interest earned on bondcollateral mortgage assets and interest paid on long term debt collaterized bymortgage assets.

 

The Companyhas performed various sensitivity analyses that quantify the net financialimpact of changes in interest rates on its interest rate-sensitive assets,liabilities and commitments. These analyses presume an instantaneous parallelshift of the yield curve. Various techniques are employed to value theunderlying financial instruments and rely upon a number of critical assumptions.The scenarios presented are illustrative. Actual experience may differmaterially from the estimated amounts presented for each scenario. To theextent that yield curve shifts are non-parallel and to the extent that actualvariations in significant assumptions differ from those applied for purposes ofthe valuations, the resultant valuations can also be expected to vary. Suchvariances may prove material.

 

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|                                         |   |                 |    |                      |   | **If  Interest Rates Were To**             |   |
|----------------------------------------------|--------|----------------------|---------|---------------------------|--------|--------------------------------------------|--------|
|                                         |   | **June 30,  2002**   |    | **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                    |   | $                    | 12,348  |                      | $      | 12,348                                     |   | $ | 12,348 |   | $ | 12,348 |   | $ | 12,348 |   | $ | 12,348 |   |
| Accounts receivable mortgage originations(1) |   | 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(1)                               |   | 3,630                |    | 3,630                     |   | 4,706                                      |   | 2,229 |   | 5,547 |   | — |   |
| Retained interest in securitization          |   | 1,079                |    | 1,079                     |   | 1,079                                      |   | 1,079 |   | 1,079 |   | 1,079 |   |
| Total interest-earning assets                |   | $                    | 575,263 |                      | $      | 584,453                                    |   | $ | 584,210 |   | $ | 584,578 |   | $ | 583,899 |   | $ | 584,166 |   |
|                                         |   |                 |    |                      |   |                                       |   |   |   |   |   |   |   |
| 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                             |   | $                    | 54,820  |                      | $      | 64,010                                     |   | $ | 63,767 |   | $ | 64,135 |   | $ | 63,456 |   | $ | 63,723 |   |
|                                              |        |                      |         |                           |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                         |   |                  |    |                      |   | **If Interest Rates Were To**             |   |
|----------------------------------------------|--------|-----------------------|---------|---------------------------|--------|-------------------------------------------|--------|
|                                         |   | **December 31, 2001** |    | **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                    |   | $                     | 10,945  |                      | $      | 10,945                                    |   | $ | 10,945 |   | $ | 10,945 |   | $ | 10,945 |   | $ | 10,945 |   |
| Accounts receivable mortgage originations(1) |   | 38,095                |    | 38,161                    |   | 37,954                                    |   | 38,120 |   | 37,872 |   | 38,203 |   |
| Bond collateral and real estate owned (net)  |   | 461,378               |    | 475,292                   |   | 473,883                                   |   | 477,127 |   | 471,294 |   | 479,192 |   |
| Derivatives(1)                               |   | 926                   |    | 926                       |   | 1,060                                     |   | 1,080 |   | 1,079 |   | 759 |   |
| Retained interest in securitization          |   | 1,582                 |    | 1,582                     |   | 1,582                                     |   | 1,582 |   | 1,582 |   | 1,582 |   |
| Due from affiliate                           |   | 159                   |    | 159                       |   | 159                                       |   | 159 |   | 159 |   | 159 |   |
| Total interest-earning assets                |   | $                     | 513,085 |                      | $      | 527,065                                   |   | $ | 525,583 |   | $ | 529,013 |   | $ | 522,931 |   | $ | 530,840 |   |
|                                         |   |                  |    |                      |   |                                      |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                |   |                  |    |                      |   |                                      |   |   |   |   |   |   |   |
| Short-term debt                              |   | $                     | 35,265  |                      | $      | 35,265                                    |   | $ | 35,265 |   | $ | 35,265 |   | $ | 35,265 |   | $ | 35,265 |   |
| Long-term debt, net                          |   | 422,349               |    | 422,349                   |   | 422,349                                   |   | 422,349 |   | 422,349 |   | 422,349 |   |
| Due to affiliate                             |   | 1,786                 |    | 1,786                     |   | 1,786                                     |   | 1,786 |   | 1,786 |   | 1,786 |   |
| Total interest-bearing liabilities           |   | $                     | 459,400 |                      | $      | 459,400                                   |   | $ | 459,400 |   | $ | 459,400 |   | $ | 459,400 |   | $ | 459,400 |   |
|                                         |   |                  |    |                      |   |                                      |   |   |   |   |   |   |   |
| Effect on equity                             |   | $                     | 53,685  |                      | $      | 67,665                                    |   | $ | 66,183 |   | $ | 69,613 |   | $ | 63,531 |   | $ | 71,440 |   |

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(1) Mortgage loans held forsale and derivative financial instruments are extremely sensitive to short terminterest rate movements.  Forward salesof mortgage backed securities, options on treasury futures (i.e. puts andcalls) and treasury futures are utilized to mitigate potential declines in thevalue of loans subject to rate lock commitments and uncommitted loans held forsale (collectively the loan pipeline) caused by increases in interestrates.  Typically, interest rateexposure on any given rate lock or mortgage loan is less than 30 days.  Evaluating these assets on a scale tolonger-term assets does not provide relevant value.  Therefore, mortgage loans held for sale and derivative financialinstruments are shown at 10 and 25 basis point shifts (increase and decrease)to provide relevant potential fair value changes.

 

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

 

*Cash and Cash Equivalents*

 

The carrying amount for cash andcash equivalents approximates fair value because these instruments are demanddeposits and money market mutual funds and do not present unanticipatedinterest rate or credit concerns.

 

*Mortgage Loans Held for Sale, Net*

 

The fair value is estimatedbased on quoted market prices from institutional investors for similar types ofmortgage loans. A portion of mortgage loans held for sale are committed forsale under mandatory sale arrangements and as such are not re-valued due tosubsequent changes in interest rates.

 

*Bond Collateral, Mortgage Loans, Net*

 

The fair value of BondCollateral Mortgage Loans is estimated based on quoted market prices fromdealers and brokers for similar types of mortgage loans, in the bulk mortgagemarket. Market prices reflect various assumptions as to prepayment rates, loanlosses and financing costs. However, due to the fact that the company’s BondCollateral Mortgage Loans are pledged to secure long term debt, there is not aliquid market for such encumbered interests. As such, a significant liquiditydiscount would be applied.  Since thecompany intends to hold the bond collateral mortgage loans to maturity, such a liquiditydiscount has not been reflected in fair value.

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*Retained Interest in Securitization*

 

This security is classified asavailable-for-sale and as such is carried at fair value.

 

*Derivatives*

 

Fair values of forward sales ofmortgage backed securities, treasury futures and options on treasury futuresare based on quoted market prices for these instruments. Fair values of theCompany’s commitments to originate loans in the quoted market prices for theloans expected to close vary due to differences between current levels ofinterest rates and committed rates.

 

*Short-Term Debt*

 

The fair value of the warehouseline debt approximates the carrying amounts because of the short-term nature ofthe debt and interest on the debt fluctuates with market interest rates.

 

*Long-Term Debt*

 

The fair value of long-term debtis estimated based upon all long-term debt being at variable rates andtherefore cost approximates fair market value.

 

*Due to Affiliate*

 

The fair value of due toaffiliate approximates the carrying amount because of the short-term nature ofthe liability.

 

These analyses are limited bythe fact that they are performed at a particular point in time and do notincorporate other factors that would impact the Company’s financial performancein each such scenario. Consequently, the preceding estimates should not beviewed as a forecast.

 

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PART II. OTHER INFORMATION

 

Item. 1. Legal Proceedings

On January 3, 2001, the Companyfiled a lawsuit against Lehman Capital, a Division of Lehman Brothers Holdings,Inc., and Long Beach Mortgage Company, Inc., in the California Superior Courtin San Diego seeking to recover damages arising from its purchase of a pool ofresidential mortgage loans from Lehman Capital in late 1997 and early1998.  The complaint sought damages forlosses arising out of the Company’s agreement to purchase loans from LehmanCapital, which had acquired the loans from Long Beach Mortgage Co.  Lehman Capital had assigned the loans, andits loan purchase agreement with Long Beach Mortgage Co., to the Company.  In April 2002, the Company settled thelitigation with Lehman Capital on mutually agreeable terms.

 

Binding arbitration with LongBeach Mortgage Company concluded on May 8, 2002.  In that arbitration, the Company was awarded $5 million ascompensation and full settlement of its claims for damages resulting frombreaches of representations and warranties made in connection with the purchaseof loans in late 1997 and early 1998.

 

Item 2.  Changes in Securities and Use of Proceeds

None.

 

Item 3.  Defaults Upon Senior Securities

Notapplicable.

 

Item 4.  Submission of Matters to a Vote of SecurityHolders

None.

 

Item 5. Other Information

During the month of June theCompany made first trust deed loans on the personal residences of John Robbins,Chairman of the Board and Chief Executive Officer; and  Jay Fuller, President and Chief OperatingOfficer for $950,000 and $550,000 respectively.  The loans were immediately sold through the normal channels to financialinstitutions. There were no discounts or special incentives regarding theseloans.

 

Item 6.Exhibits and Reports on Form 8-K:

 

                

 
| (a)                   | Exhibits             |                                                                                                                     |
|-----------------------|----------------------|--------------------------------------------------------------------------------------------------------------------------|
|                  |                 |                                                                                                                     |
| *                     | 3.1                  | Articles of  Amendment and Restatement of the Registrant                                                                 |
|                  | 3.2                  | Second  Amended and Restated Bylaws of the Registrant                                                                    |
| **                    | 4.1                  | Rights  Agreement dated February 2, 1999 by and between the Company and American  Stock Transfer Company as Rights Agent |
|                  | 99.1                 | Certification  of Chief Executive Officer                                                                                |
|                  | 99.2                 | Certification  of Chief Financial Officer                                                                                |
| *                     |                 | Incorporated by reference to Registration  Statement on Form S-11 (File No. 333-33679)                                   |
| **                    |                 | Incorporated by reference to Form 8-K filed  on February 17, 1999                                                        |
| (File No.  001-13485) |
|                  |                 |                                                                                                                     |
| (b)                   | Reports on  Form 8-K |
|                  |                 | Current  Report on Form 8-K (file number 001-13485) filed on January 9, 2002.                                            |
|                  |                 | Current  Report on Form 8-K (file number 001-13485) filed on April 22, 2002 as amended  on April 23, 2002.               |
|                       |                      |                                                                                                                          |  |

 

 

 

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SIGNATURES

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized

 
| AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. |
|---------------------------------------------|
|                                        |   |   |   |   |
| Dated:  August 14, 2002                     | By: |   | /s/ Judith  A. Berry |   |
|                                        |   |   | Judith A.  Berry, |
|                                        |   |   | Executive  Vice President |
|                                        |   |   | Chief  Financial Officer |
|                                             |  |  |  |  |  |  |  |

 

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