**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

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

 
|   | **For the quarterly period ended:  March 31, 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 INVESTMENT TRUST, INC.**

(Exact name of registrantas specified in its charter)

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

ý   YES                   o    NO

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| Common Stock ($0.01) |   | 7,880,090 as of April 20, 2002 |
|----------------------|--------|--------------------------------|

 

 

----

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

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PART I. FINANCIAL INFORMATION

Item1.  Consolidated Financial Statements

 

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

Consolidated Balance Sheets,Unaudited

(in thousands,except share and per share data)

 
| ASSETS                                                                                                                                                                                             |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                               |   | **March 31,  2002** |   | **December  31, 2001** |   |
|                                                                                                                                                                                               |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                          |   | $ | 8,647 |   | $ | 10,945 |   |
| Mortgage loans held for sale, net, pledged                                                                                                                                                         |   | 120,991 |   | 38,095 |   |
| Bond collateral, mortgage loans, net                                                                                                                                                               |   | 397,061 |   | 452,152 |   |
| Bond collateral, real estate owned                                                                                                                                                                 |   | 9,795 |   | 9,226 |   |
| Retained interests in securitization                                                                                                                                                               |   | 1,495 |   | 1,582 |   |
| Derivative financial instruments                                                                                                                                                                   |   | 5,459 |   | 926 |   |
| Accrued interest receivable                                                                                                                                                                        |   | 2,609 |   | 3,048 |   |
| Due from affiliate                                                                                                                                                                                 |   | — |   | 159 |   |
| Investment in American Residential Holdings, Inc.                                                                                                                                                  |   | 1,863 |   | 1,789 |   |
| Other assets                                                                                                                                                                                       |   | 2,375 |   | 1,802 |   |
|                                                                                                                                                                                               |   | $ | 550,295 |   | $ | 519,724 |   |
|                                                                                                                                                                                               |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                          |   |
| Liabilities:                                                                                                                                                                                       |   |   |   |   |   |
| Short-term debt                                                                                                                                                                                    |   | $ | 120,544 |   | $ | 35,265 |   |
| Long-term debt, net                                                                                                                                                                                |   | 369,101 |   | 422,349 |   |
| Accrued interest payable                                                                                                                                                                           |   | 93 |   | 85 |   |
| Due to affiliate                                                                                                                                                                                   |   | 1,871 |   | 1,786 |   |
| Accrued expenses and other liabilities                                                                                                                                                             |   | 2,167 |   | 1,612 |   |
| Total liabilities                                                                                                                                                                                  |   | 493,776 |   | 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 March 31, 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                                                                                                                                                             |   | 446 |   | 448 |   |
| Accumulated deficit                                                                                                                                                                                |   | (52,803 | ) | (50,896 | ) |
| Total stockholders’ equity                                                                                                                                                                    |   | 56,519 |   | 58,627 |   |
|                                                                                                                                                                                               |   | $ | 550,295 |   | $ | 519,724 |   |

 

See accompanyingnotes to consolidated financial statements.

 

3

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**American Residential InvestmentTrust, Inc. and Subsidiaries**

ConsolidatedStatements of Operations and Comprehensive Loss, unaudited

(in thousands, except pershare data)

 
|                                                               |   | **For the  Three Months Ended  March 31, 2002** |   | **For the  Three Months Ended  March 31, 2001** |   |
|--------------------------------------------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|--------|
|                                                               |   |                                            |   |
| Interest income:                                                   |   |                                            |   |                                            |   |
| Mortgage assets                                                    |   | $                                               | 10,021 |                                            | $      | 18,077 |   |
| Cash and investments                                               |   | 30                                              |   | 188                                             |   |
| Total interest income                                              |   | 10,051                                          |   | 18,265                                          |   |
| Interest expense                                                   |   | 3,828                                           |   | 14,249                                          |   |
| Net interest spread                                                |   | 6,223                                           |   | 4,016                                           |   |
| Premium amortization                                               |   | 3,100                                           |   | 2,476                                           |   |
| Net interest income                                                |   | 3,123                                           |   | 1,540                                           |   |
| Provision for loan losses                                          |   | 2,103                                           |   | 1,641                                           |   |
| Net interest income after provision for loan losses                |   | 1,020                                           |   | (101                                            | )      |
| Other operating income:                                            |   |                                            |   |                                            |   |
| Gain on sale of mortgage loans                                     |   | 1,552                                           |   | —                                          |   |
| Management fee income                                              |   | 28                                              |   | 51                                              |   |
| Equity in income of American Residential Holdings,  Inc.           |   | 74                                              |   | 111                                             |   |
| Prepayment penalty income                                          |   | 340                                             |   | 821                                             |   |
| Unrealized losses on interest rate cap agreements                  |   | —                                          |   | (9                                              | )      |
| Total other operating income                                       |   | 1,994                                           |   | 974                                             |   |
| Net operating income                                               |   | 3,014                                           |   | 873                                             |   |
| Other expenses:                                                    |   |                                            |   |                                            |   |
| Loss on sale of real estate owned, net                             |   | 85                                              |   | 252                                             |   |
| (Gain) on derivative financial instruments                         |   | (304                                            | )      | —                                          |   |
| Underwriting costs on loan orginations                             |   | 44                                              |   | —                                          |   |
| Management fees                                                    |   | —                                          |   | 766                                             |   |
| Professional fees                                                  |   | 764                                             |   | 258                                             |   |
| General and administrative expenses                                |   | 4,332                                           |   | 191                                             |   |
| Total other expenses                                               |   | 4,921                                           |   | 1,467                                           |   |
| Loss before cummulative effect of a change in  accounting princple |   | (1,907                                          | )      | (594                                            | )      |
| Adoption of SFAS 133 Accounting Change:                            |   |                                            |   |                                            |   |
| Reduce cap agreement cost to market                                |   | —                                          |   | (1,106                                          | )      |
| Net loss                                                           |   | (1,907                                          | )      | (1,700                                          | )      |
| Other comprehensive (loss) income                                  |   |                                            |   |                                            |   |
| Unrealized (losses) gains on retained interests in  securitization |   | (2                                              | )      | 33                                              |   |
|                                                               |   | $                                               | (1,909 | )                                               | $      | (1,667 | ) |
|                                                               |   |                                            |   |                                            |   |
| Loss per share before cumulative effect of  accounting change      |   | $                                               | (0.24  | )                                               | $      | (0.07 | ) |
| Loss per share of common stock-basic and diluted                   |   | (0.24                                           | )      | (0.21                                           | )      |

 

See accompanyingnotes to consolidated financial statements.

 

4

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**American Residential InvestmentTrust, Inc. and Subsidiaries**

Consolidated Statements of Cash Flows, unaudited

(in thousands)

 
|                                                                                       |   | **For the  Three Months Ended  March 31, 2002** |   | **For the  Three Months Ended  March 31, 2001** |
|--------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|-------------------------------------------------|
|                                                                                       |   |                                            |
|                                                                                       |   |                                            |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                       |   |                                            |   |                                            |   |
| Net loss                                                                                   |   | $                                               | (1,907 | )                                               | $ | (1,700 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |   |                                            |   |                                            |   |
| Amortization of mortgage assets premiums                                                   |   | 3,100                                           |   | 2,481                                           |   |
| Amortization of CMO capitalized costs                                                      |   | 158                                             |   | 225                                             |   |
| Cumulative effect of change in accounting principle                                        |   | —                                          |   | 1,106                                           |   |
| Amortization of interest rate cap agreements                                               |   | —                                          |   | 9                                               |   |
| Amortization of CMO premium                                                                |   | —                                          |   | (39                                             | ) |
| Provision for loan losses                                                                  |   | 2,103                                           |   | 1,641                                           |   |
| Equity in undistributed income of American  Residential Holdings, Inc.                     |   | (74                                             | )      | (111                                            | ) |
| Decrease in deposits to retained interest in  securitzation                                |   | —                                          |   | 8                                               |   |
| Decrease on retained interest in securitization                                            |   | 85                                              |   | 4                                               |   |
| Loss on sale of real estate owned                                                          |   | 851                                             |   | 252                                             |   |
| Mortgage loans held for sale, market adjustment                                            |   | 449                                             |   | —                                          |   |
| Proceeds from sale of mortgage loans held for sale                                         |   | 287,204                                         |   | —                                          |   |
| Mortgage loan originations                                                                 |   | (370,549                                        | )      | —                                          |   |
| Decrease (increase) in accrued interest receivable                                         |   | 439                                             |   | 1,258                                           |   |
| Decrease (increase) in other assets                                                        |   | (573                                            | )      | (121                                            | ) |
| Decrease (increase) in due from affiliate                                                  |   | 159                                             |   | (180                                            | ) |
| Increase (decrease) in accrued interest payable                                            |   | 8                                               |   | (52                                             | ) |
| Increase (decrease) in accrued expenses and other  liabilities                             |   | 555                                             |   | 404                                             |   |
| Increase (decrease) in due to affiliate                                                    |   | 85                                              |   | 146                                             |   |
| Derivative financial instruments                                                           |   | (4,533                                          | )      | —                                          |   |
| Net cash (used in) provided by operating activities                                        |   | (82,440                                         | )      | 5,331                                           |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                      |   |                                            |   |                                            |   |
| Principal payments on bond collateral, mortgage  loans, net                                |   | 45,258                                          |   | 65,368                                          |   |
| Proceeds from sale of real estate owned                                                    |   | 3,210                                           |   | 3,180                                           |   |
| Net cash provided by investing activities                                                  |   | 48,468                                          |   | 68,548                                          |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                      |   |                                            |   |                                            |   |
| Increase (decrease) in net borrowings from  short-term debt                                |   | 85,279                                          |   | (1,095                                          | ) |
| Dividends paid                                                                             |   | —                                          |   | (1,606                                          | ) |
| Payments on long-term debt                                                                 |   | (53,406                                         | )      | (72,538                                         | ) |
| Purchase of treasury stock                                                                 |   | (199                                            | )      | (196                                            | ) |
| Net cash provided by (used in) financing activities                                        |   | 31,674                                          |   | (75,435                                         | ) |
| Net (decrease) increase in cash and cash equivalents                                       |   | (2,298                                          | )      | (1,556                                          | ) |
| Cash and cash equivalents at beginning of period                                           |   | 10,945                                          |   | 14,688                                          |   |
| Cash and cash equivalents at end of period                                                 |   | $                                               | 8,647  |                                            | $ | 13,132 |   |
| Supplemental information — interest paid                                              |   | $                                               | 3,820  |                                            | $ | 14,012 |   |
| Non-cash transactions:                                                                     |   |                                            |   |                                            |   |
| Transfers from bond collateral to real estate owned                                        |   | $                                               | 856    |                                            | $ | 2,074 |   |

 

See accompanyingnotes to consolidated financial statements.

 

5

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AMERICAN RESIDENTIALINVESTMENT TRUST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

**Note1.  Summary of Significant AccountingPolicies and Practices**

 

*Basisof Financial Statement Presentation*

 

The interim financial statementsincluded herein have been prepared by American Residential Investment Trust,Inc., (“AmRIT” or the “Company”) without audit, pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnotedisclosures, normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of America(“GAAP”), have been condensed or omitted pursuant to such SEC rules andregulations.  These financial statementsshould be read in conjunction with the audited financial statements and notesthereto 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 March 31, 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 about Segmentsof an Enterprise and Related Information. SFAS 131 establishes standards forthe way companies report information about operating segments in annualfinancial statements. It also establishes standards for related disclosuresabout products and services, geographic areas and major customers. EffectiveJanuary 1, 2002, the Company was reorganized into two segments: the MortgageAsset Portfolio Investments—Spread Lending Business and the Mortgage BankingBusiness.

 

*New AccountingStandards*

 

SFAS 142 requires thatgoodwill and intangible assets with indefinite useful lives no longer beamortized, but instead tested for impairment at least annually in accordancewith the provisions of SFAS 142. SFAS 142 also requires that intangible assetswith definite useful lives be amortized over their respective estimated usefullives to their estimated residual values, and reviewed for impairment. Aspermitted by SFAS 142, the Company adopted the new standard in the firstquarter of the fiscal year 2002. Intangible assets are less than $1,000 andtherefore adoption of SAS 142 has no material affect on the consolidatedfinancial statements.

 

SFAS144 provides guidance on how a long-lived asset that is used as a part of agroup should be evaluated for impairment, establishes criteria for when along-lived asset 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.  Loss PerShare**

 

The following tableillustrates the computation of basic and diluted loss per share (in thousands,except share and per share data):

 

6

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|                                                                                                                  |   | **Quarter ended  March 31, 2002**         |   | **Quarter ended  March 31, 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                                  |   | **(in thousands, except per share data)** |   |
|                                                                                                                  |   | **(unaudited)**                           |   |
| Numerator:                                                                                                            |   |                                      |   |                              |   |
| Numerator for loss per share before cumulative  effect of accounting change                                           |   | $                                         | (1,907 | )                                 | $      | (594 | ) |
| Numerator for basic loss per share net earnings                                                                       |   | (1,907                                    | )      | (1,700                            | )      |
| Denominator:                                                                                                          |   |                                      |   |                              |   |
| Denominator for basic income per share — weighted  average number of common shares outstanding during the period |   | 7,918,805                                 |   | 7,970,133                         |   |
| Incremental common shares attributable to exercise  of outstanding options                                            |   | —                                    |   | —                            |   |
| Denominator for diluted income per share                                                                              |   | 7,918,805                                 |   | 7,970,133                         |   |
|                                                                                                                  |   |                                      |   |                              |   |
| Loss per share before cumulative effect of  accounting change                                                         |   | $                                         | (0.24  | )                                 | $      | (0.07 | ) |
| Basic and diluted loss per share                                                                                      |   | (0.24                                     | )      | (0.21                             | )      |

 

For the three monthsended March 31, 2002 and 2001 there were 1,134,475 and 1,218,100 options,respectively, that were antidilutive and, therefore, not included in thecalculations above.

 

**Note 3.  Mortgageloans held for sale, net pledged**

 

The AmRIT subsidiary,American Mortgage Network, Inc. (“AmNet”) has pledged loans held for sale tosecure credit lines (warehouse facilities) from two financial institutions. SeeNote 7 Short-Term Debt.

 

**Note 4.  BondCollateral, Mortgage Loans, net**

 

AmRIT has pledgedmortgage loans and real estate owned, net, as collateral in order to securelong-term-debt.  Bond collateralconsists primarily of adjustable-rate, conventional, 30-year mortgage loanssecured by first 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 March 31, 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  March 31, 2002**                              |   |                                  |       |                                  |       |                            |       |                            |       |                                  |       |                       |       |
| Mortgage loans                                      |   | $                                     | 24,762     |                                  | $          | 99,859                          |       | $                               | 153,414    |                                  | $          | 64,227                     |       | $ | 46,545 |   | $ | 388,807 |   |
| Unamoritized premium                                |   | 923                                   |       | 3,066                                 |       | 6,020                           |       | 2,219                           |       | 1,001                                 |       | 13,229                     |       |
| Allowance for loan losses                           |   | (273                                  | )          | (1,325                                | )          | (1,422                          | )          | (804                            | )          | (1,151                                | )          | (4,975                     | )          |
|                                                |   | $                                     | 25,412     |                                  | $          | 101,600                         |       | $                               | 158,012    |                                  | $          | 65,642                     |       | $ | 46,395 |   | $ | 397,061 |   |
|                                                |   |                                  |       |                                  |       |                            |       |                            |       |                                  |       |                       |       |
| Weighted average net coupon                         |   | 9.29                                  | %          | 9.81                                  | %          | 9.14                            | %          | 8.98                            | %          | 10.56                                 | %          | 9.47                       | %          |
| Unamortized premiums as a percent of Mortgage loans |   | 3.73                                  | %          | 3.07                                  | %          | 3.92                            | %          | 3.45                            | %          | 2.15                                  | %          | 3.40                       | %          |
|                                                |   |                                  | ** ** |                                  | ** ** |                            | ** ** |                            | ** ** |                                  | ** ** |                       | ** ** |
| **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 collateral,mortgage loans at an amount which it believes is sufficient to provide adequateprotection against losses in the mortgage loan portfolio.

 

**Note 5.  Derivative Financial Instruments**

 

The following is asummary of AmNet’s derivative instruments (dollars in thousands)(unaudited):

 
| **Security**         |   | **Notional Amount** |       | **Strike** |   | **Puts  Calls  Futures** |   | **Short  Long** |   | **Expires** |         |
|----------------------|--------|---------------------|------------|------------|--------|--------------------------|--------|-----------------|--------|-------------|--------------|
|                 |   |                |       |       |   |
|                 |   |                |       |       |   |
| Ten Year Treasuries  |   | $                   | 450,000.00 |       | 105    |                     | Calls  |            | Short  |        | May 25, 2002 |   |
| Ten Year Treasuries  |   | $                   | 400,000.00 |       | 100    |                     | Puts   |            | Short  |        | May 25, 2002 |   |
| Five year Treasuries |   | $                   | 150,000.00 |       | 1025   |                     | Puts   |            | Short  |        | May 25, 2002 |   |
| Five year Treasuries |   | $                   | 500,000.00 |       | 1055   |                     | Calls  |            | Short  |        | May 25, 2002 |   |
| Five year Treasuries |   | $                   | 800,000.00 |       | 1150   |                     | Calls  |            | Long   |        | May 25, 2002 |   |

 

These derivatives do notqualify for hedge accounting under SFAS 133 and, accordingly, have beenaccounted for as trading securities in the accompanying consolidated financialstatements. The increase in 

 

8

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fair market value ofderivative financial instruments is included in the Consolidated Statements ofOperations and Comprehensive Loss.

 

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

 

The Company owned 141properties and 148 properties as of March 31, 2002 and December 31, 2001,respectively.  Upon transfer of theloans to real estate owned, the Company recorded a corresponding charge againstthe allowance for loan losses to write-down the real estate owned to fair valueless estimated cost of disposal.  At March31, 2002 and December 31, 2001 real estate owned totaled approximately $9.8million and $9.2 million, respectively.

 

**Note7.  Short-Term Debt**

 

As of March 31, 2002,short-term debt consists of a revolving credit line (warehouse facility) usedto fund the Company’s lending activities. As of March 31, 2002, mortgage loansheld for sale were pledged as collateral for the warehouse facility. Thefacility consists of borrowings of $120.5 million with two financialinstitutions for a maximum amount of $260 million, secured by mortgage loansheld for sale, generally bearing interest at LIBOR plus spread (3.41% at March31, 2002). The weighted–average interest rate was 3.22% in 2002 and thefacility fee is 0.25% on the aggregate committed amount of the warehouse facilitywhich matures on November 25, 2002. The facility is repaid as principalpayments on mortgage loans are received, or as the mortgage loans are sold. Theagreement governing the facility contains a number of covenants, includingcovenants based on tangible net worth, cash flows, net income, and liquidity ofthe Company.

 

In 2001, the Companyentered into a $5 million senior subordinated secured revolving loan agreement(Subordinated Loan Agreement). The Subordinated Loan Agreement bears interestat 12% and matures in December 2002, with provisions for extension of twoadditional one–year periods at the Company’s option. The SubordinatedLoan Agreement contains a number of covenants, including covenants based ontangible net worth, cash flows, net income and liquidity of the Company. As ofMarch 31, 2002, the Company has $3.0 million in borrowings on the SubordinatedLoan Agreement.

 

**Note8.  Long-Term Debt, Net**

 

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

 
|                                 |   | **CMO/REMIC  2000-2****Securitization** |       | **CMO/REMIC  1999-A****Securitization** |       | **CMO  1999-2****Securitization** |       | **CMO  1999-1****Securitization** |       | **CMO/FASIT****1998-1****Securitization** |       | **TOTAL  Long-Term Debt** |       |
|--------------------------------------|--------|-----------------------------------------|------------|-----------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|-------------------------------------------|------------|---------------------------|------------|
|                                 |   |                                    |       |                                    |       |                              |       |
|                                 |   |                                    |       |                                    |       |                              |       |
| **At March 31, 2002**                |   |                                    |       |                                    |       |                              |       |                              |       |                                      |       |                      |       |
| Long-term debt                       |   | $                                       | 24,359     |                                    | $          | 94,055                            |       | $                                 | 147,077    |                                      | $          | 57,535                    |       | $ | 47,290 |   | $ | 370,316 |   |
| Capitalized costs on  long-term debt |   | (93                                     | )          | (9                                      | )          | (683                              | )          | (430                              | )          | —                                    |       | (1,215                    | )          |
| Total long-term debt                 |   | $                                       | 24,266     |                                    | $          | 94,046                            |       | $                                 | 146,394    |                                      | $          | 57,105                    |       | $ | 47,290 |   | $ | 369,101 |   |
|                                 |   |                                    |       |                                    |       |                              |       |                              |       |                                      |       |                      |       |
| Weighted average financing  rates    |   | 2.37                                    | %          | 2.02                                    | %          | 3.27                              | %          | 2.20                              | %          | 2.97                                      | %          | 2.69                      | %          |
|                                 |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                      | ** ** |                      | ** ** |
| **At December 31, 2001**             |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                      | ** ** |                      | ** ** |
| Long-term debt                       |   | $                                       | 31,809     |                                    | $          | 107,574                           |       | $                                 | 167,200    |                                      | $          | 65,546                    |       | $ | 51,592 |   | $ | 423,721 |   |
| CMO premium, net                     |   | —                                  |       | —                                  |       | —                            |       | —                            |       | —                                    |       | —                    |       |
| 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                      | %          |

 

9

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**Note 9.   Business Segments**

 

The Company wasreorganized into two segments: the Mortgage Asset Portfolio Investments—SpreadLending Business and the Mortgage Banking Business.  The Mortgage Asset Portfolio Investments—Spread Lending segmentmanages a portfolio of mortgage assets pledged as collateral for long-termdebt. The Mortgage Banking Business originates home mortgage loans through anetwork of mortgage loan brokers.  Thesemortgage loans are subsequently sold to financial institutions.

 

The accounting policiesof the segments are the same as described in Note 1 “Summary of SignificantAccounting Policies and Practices.” The Company evaluates the performance ofits business segments based on income before income taxes. Expenses under thedirect control of each business segment and the expense of premises andequipment incurred to support business operations are allocated accordingly, bysegment.

 

The table below reflectsthe first quarter activity by segment.

 
|                                                |   | **Quarter Ended March 31, 2002  (000’s) (unaudited)** |    |
|-----------------------------------------------------|--------|------------------------------------------------------------|---------|
|                                                |   |                                                       |
|                                                |   | **Spread  Lending**                                        |    | **Mortgage  Banking** |   | **Consolidated  Totals** |   |
|                                                |   |                                                       |    |   |
| Net interest income after provision for loan losses |   | $                                                          | (840    | ) | $ | 1,860 |   | $ | 1,020 |   |
| Net gain on sale of loans                           |   | —                                                     |    | 1,552 |   | 1,552 |   |
| Segment income (loss) before taxes                  |   | (1,019                                                     | )       | (888 | ) | (1,907 | ) |
| Total assets                                        |   | $                                                          | 419,228 |   | $ | 131,067 |   | $ | 550,295 |   |

 

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 liabilitieseliminated for consolidation purposes were $7.5 million for the three monthperiod ending March 31, 2002.

 

**Note 10.   Subsequent Events**

 

The Company settledlitigation on mutually agreeable terms for $6.1 million (net of certain legalfees) which was paid to the Company in early April of 2002.  Additionally, binding arbitration with LongBeach Mortgage Company was concluded May 8, 2002.  The Company was awarded $5 million by the arbitrator as fullcompensation and settlement of claims made in connection with the Company'spurchase of loans between December 1997 and March 1998.  Income related to these events will berecognized in the second quarter of 2002.

 

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ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL

CONDITION AND RESULTS OFOPERATIONS.

 

*The statements contained in thisForm 10-Q that are not purely historical are forward looking statements,including statements regarding our expectations, hopes, beliefs, intentions, orstrategies regarding the future. 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 and operating performance ofchanges in interest rates*

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

*•**                                           ouranticipated lack of dividends in 2002*

*•**                                           ourbelief regarding future prepayment rates, future borrowing costs andappropriate premium amortization levels*

*•**                                           recoveryof loan losses through arbitration*

*•**                                           recoveryof damages through litigation*

*•**                                           thesufficiency of our cash reserves*

 

*In addition, we have included anumber of statements regarding the development of our new mortgage loanorigination capabilities, which are forward looking. These statements includestatements regarding:*

 

*•**                                           ourcreation of operational capabilities to originate and sell “A” quality mortgageloans*

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

*•**                                           projectedloan origination volumes*

*•**                                           expensesassociated with AmNet*

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

*•**                                           ourability to resell our loans on the secondary market*

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

*•**                                           theeffectiveness of our hedge instruments*

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

*•**                                           achievingprofitability at the AmNet level*

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

 

*These forward looking statements arebased on information available to the Company on the date hereof, and theCompany assumes no obligation to update any such forward looking statement. Itis important to note that the Company’s actual results and timing of certain eventscould differ materially from those in such forward looking statements due to anumber of factors, including but not limited to, general economic conditions,overall interest rates, the shape of the yield curve, reductions in the valueof retained interests in securitizations, the Company’s ability to successfullygrow its origination subsidiary and the Company’s ability to obtain thefinancing necessary to fund its origination business. Other risk factors thatcould cause actual results to differ materially are set forth in this itemunder 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. In 2001, the Companyformed an operating subsidiary, American Mortgage Network, Inc. (“AmNet”), awholly owned taxable REIT subsidiary, for the purpose of engaging in mortgagebanking activities. Through a network of regional offices in the United States,

 

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AmNet originates loansthrough mortgage brokers and then sells them to institutional purchasers. Allservicing rights are also sold along with the mortgage loans. Effective January1, 2002, the Company was reorganized into two segments: The Mortgage AssetPortfolio Investments—Spread Lending Business, and the Mortgage BankingBusiness. The Mortgage Banking Business was not significant in 2001.

 

**Mortgage Asset Portfolio Investments---Spread Lending Business**

 

Currently, the Company’sspread lending revenue primarily consists of 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 investment balances(collectively, “earning assets”), prepayment penalty income, income generatedby equity in income of American Residential Holdings, Inc. and management fees.

 

For that portion of theCompany’s earning assets funded with borrowings (“spread lending”), theresulting net interest income is a function of the volume of spread lending andthe difference between the Company’s average yield on earning assets and thecost of borrowed funds.   The tablebelow illustrates interest rates on mortgage assets (net coupon) and interestrates on long-term debt (financing rates)(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 March 31, 2002**             |   |                                    |       |                                    |       |                              |       |                              |       |                                      |       |      |       |
| Weighted average net coupon       |   | 9.29                                    | %          | 9.81                                    | %          | 9.14                              | %          | 8.98                              | %          | 10.56                                     | %          | 9.47      | %          |
| Weighted average financing  rates |   | 2.37                                    | %          | 2.02                                    | %          | 3.27                              | %          | 2.20                              | %          | 2.97                                      | %          | 2.69      | %          |
|                              |   |                                    | ** ** |                                    | ** ** |                              | ** ** |                              | ** ** |                                      | ** ** |      | ** ** |
| **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.  Yields onadjustable rate loans generally adjust based on a short term interest rateindex, and the majority of the Company’s earning assets are adjustable rate loansthat adjust periodically every six months. Gross income from spread lending will generally increase following afall in short term interest rates due to decreases in borrowing costs and a lagand/or ‘floor’ in downward adjustments to the earning asset yields.

 

The Company’s primaryexpenses, beside its borrowing costs, are amortization of loan purchasepremiums, provision for loan losses and losses on sale of real estate owned(“REO”). Provision for loan losses represent the Company’s best estimate ofexpenses related to loan defaults. Gains or losses on the sale of REO represent a differences between saleproceeds and the net carrying amount of the property. The carrying valueincludes a reduction (credit provision) to reflect an estimate of net proceedsat time of sale.  Premiums are amortizedusing the interest method over their estimated lives.

 

During the pasttwenty-seven months the Company’s asset base has declined due to the Company’sdecision to avoid loan acquisitions if market conditions did not meet itsinvestment criteria and to reserve capital for the pursuit of direct loanorigination strategies. Revenues have declined in direct proportion to thedecline in mortgage assets from approximately $1,292 million at December 31,1999 to $858 million at December 31, 2000; $452 million at December 31, 2001;and $397 million at March 31, 2002. Simultaneously, premium amortization and credit provision expense haveincreased 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 Assets in the Company’s portfolio.

 

**Mortgage Banking Business**

 

One of the Company’sprimary objectives continues to be to augment and eventually diversify itsrevenue base and earnings. The Company intends to deploy capital to augmentdeclining revenues from its current, declining bond collateral mortgage loanswhich have not been replenished due to unfavorable pricing on bulk purchases ofmortgage loans. The primary strategy in diversifying the Company’s incomestream has been to establish a direct loan origination business, and to sellthe loans on a servicing released basis to large correspondent lenders for aprofit.

 

As of March 15, 2002,AmNet has hired 148 experienced loan production and loan operations employeesand will continue to expand AmNet in 2002. Two regional production centerslocated in Oregon and Northern California began originating loans in November 2001.Three centers in California, Connecticut and Georgia were opened in the firstquarter of 2002, and additional centers will open in 2002. AmNet utilizes adedicated sales force to offer AmNet’s loan products to approved wholesalemortgage brokers, who refer their client’s loans to AmNet for underwriting andfunding. Loans meeting AmNet’s underwriting criteria are approved and funded atAmNet’s regional underwriting loan centers. AmNet’s headquarters officeperforms various functions through multiple departments including establishmentof policy, risk management, secondary marketing, finance, accounting,administration, and information technology. The Company completed a relocationto its new corporate headquarters in February 2002 in order to accommodate thespace requirements of the Company and AmNet.

 

All loans produced areexpected to be sold on a servicing–released basis to large secondarymarket correspondent investors, typically within 30 days of origination. InNovember 2001, the Company obtained an initial warehouse facility for $75million to fund and accumulate loans prior to sale to its correspondentinvestors. In March 2002 the warehouse facility was increased to $160 million.Additionally, a second facility was obtained in late March 2002 for $150million. By prior agreement, upon securing the second facility, the originalfacility was decreased to $110 million. AmNet is required to maintain an equityinvestment in its loan inventory ranging from 1% to 4%, and must comply withvarious lender covenants restricting the absolute level of leverage and minimumlevels of cash reserves. The Company expects to increase its warehouseborrowing facilities to enable it to increase loan production. There can be noassurances that credit lines will be obtained in time to enable continuedgrowth and expansion of AmNet’s loan origination.

 

**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 Statesof America (“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 procedures listed below have not changed in thethree-month period ending March 31, 2002:

 

• Allowance for loanlosses

• Amortization ofpremiums on bond collateral, mortgage loans

• Derivative and hedgingactivities

 

Please refer to theCompany Form 10-K for the one-year period ending December 31, 2001, for adetailed discussion of these procedures.

 

**Results of Operations**

 

***Three Month Results***

 

For the three monthsended March 31, 2002, the Company generated a net loss of approximately $1.9million and a net loss per share of $(0.24) compared to the three months endedMarch 31, 2001 when the Company generated a net loss of approximately $1.7million and a net loss per share of $(0.21).

 

Mortgage asset interestincome decreased approximately $8.2 million to approximately $10.1 million forthe three months ended March 31, 2002 from approximately $18.3 million for thethree months ended March 31, 2001.  Thisdecrease was primarily due to lower average mortgage assets.  Mortgage assets were approximately $397.1million at March 31, 2002 and approximately $774.2 million at March 31, 2001which represents approximately a 48.71% decline. The Mortgage asset 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 expensedecreased by approximately $10.4 million to approximately $3.8 million for thethree months ended March 31, 2002 from approximately $14.2 million for thethree months ended March 31, 2001. This decrease is attributable to lowerborrowings outstanding as well as lower borrowing rates. A majority of theCompany’s borrowing rates are based upon a spread over the one-month LondonInterBank Offered Rate (“LIBOR”). One month LIBOR rates decreased fromapproximately 5.08% at March 31, 2001 to approximately 1.88% at March 31, 2002.

 

Net interest income forthe three months ended March 31, 2002 and March 31, 2001 was approximately $3.1 million and $1.5 millionrespectively. The increase of approximately $1.6 million was due to an increasein net interest spread (discussed in the two preceding paragraphs) and despitean increase in premium amortization. The premium amortization rate for thethree months ended March 31, 2002 increased approximately $624 thousand fromthe same period ended March 31, 2001 due to the use of a level yieldamortization method and the fact that prepayments increased on the two largestcomponents of the portfolio, the 1999-2 and 1999-A segments.  Premium amortization expense represents theamortization of purchase premiums paid for mortgage loans acquired in excess ofthe par value of the loans.  Premiumamortization expense including adjustments, was approximately $3.1 million forthe three months ended March 31, 2002 and approximately $2.5 million for thethree months ended March 31, 2001.

 

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The following chartrepresents constant prepayment rates (“CPRs”):

 
|             |   | **As of March 31, 2002** |   | **As of March 31, 2001** |   |
|------------------|--------|--------------------------|--------|--------------------------|--------|
|             |   | **Three****Months**      |   | **Six****Months**        |   | **Life-   Time** |   | **Three****Months** |   | **Six****Months** |   | **Life-   Time** |   |
| Bond collateral: |   |                     |   |                     |   |   |   |   |   |   |   |   |   |
| CMO/FASIT 1998-1 |   | 27.8                     | %      | 28.4                     | %      | 42.9 | % | 51.3 | % | 47.6 | % | 44.8 | % |
| CMO 1999-1       |   | 34.4                     | %      | 36.6                     | %      | 35.1 | % | 37.0 | % | 36.2 | % | 33.6 | % |
| CMO 1999-2       |   | 35.4                     | %      | 41.3                     | %      | 32.0 | % | 19.6 | % | 20.9 | % | 17.5 | % |
| CMO/REMIC 1999-A |   | 38.5                     | %      | 41.0                     | %      | 36.2 | % | 30.4 | % | 24.8 | % | 21.5 | % |
| CMO 2000-2       |   | 39.3                     | %      | 35.9                     | %      | 34.9 | % | 47.7 | % | 43.1 | % | 20.0 | % |

 

Net interest income,after provision for loan losses, increased $1.1 million from a loss ofapproximately $101 thousand for the three months ended March 31, 2001, toincome of approximately $1.0 million for the three months ended March 31, 2002.This increase was due primarily to the increase in net interest spreaddiscussed above. Loan loss provision increased $462 thousand from approximately$1.6 million for the three months ended March 31, 2001 to approximately $2.1million for the three months ended March 31, 2002.  The provision for loan losses as a percentage of total interestincome has been steadily increasing. For the three month period ending March31, 2001 the percentage of the provision for loan losses to total interestincome was approximately 9.0% and for the three month period ending March 31,2002 the percentage has increased to approximately 20.9%. The increases arerelated to seasoning of the sub-prime mortgage portfolio and expected increasesin the number of loans in foreclosure which are likely to result in a loss tothe Company.

 

During the three monthsended March 31, 2002, other operating income increased $1.0 million as comparedto the three months ended March 31, 2001, primarily due to AmNet’s gain on saleof mortgage loans from it’s origination business which was not in existence inthe prior period. This increase is offset by decreases for the period inmanagement fee income (approximately $23 thousand); equity in income ofAmerican Residential Holdings, Inc. (approximately $37 thousand); andprepayment penalty income (approximately $481 thousand).

 

For the three monthsended March 31, 2002, other expenses increased $3.5 million as compared to thethree months ended March 31, 2001. This increase was mainly the result of anincrease in general and administrative costs related to the ramp-up of AmNetloan origination activity. Additionally, legal fees related to the Company’slitigation against Lehman increased. General and administrative costs wereapproximately $4.3 million for the period ending March 31, 2002. Thisrepresents an increase of approximately $4.1 million over the period endingMarch 31, 2001 when the balance for general and administrative cost was $191thousand. The increase in general and administrative expenses was offset by a$766 thousand decline in management fees as a result of the buyout of the HAMCOmanagement contract in December of 2001.

 

**Liquidity and Capital Resources**

 

During the three monthsended March 31, 2002, net cash used in operating activities was approximately$82.4 million.  The difference betweennet use of cash provided by operating activities and the net loss ofapproximately $1.9 million was primarily the result of using $370.5 million inmortgage loan originations. This use was partially offset by $287.2 million inproceeds from sale of mortgage loans held for sale. The other major use of cashduring the period was $4.5 million for investments in derivative financialinstruments. Mortgage loans held for sale, net, pledged at March 31, 2002 wasapproximately $121.0 million of which approximately $60.7 million was committedfor sale.

 

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Net cash provided byinvesting activities for the three months ended March 31, 2002 wasapproximately $48.5 million. Cash flows from investing activities for the threemonths ended March 31, 2002 came from principal payments on bond collateral ofapproximately $45.3 million and proceeds from the sale of real estate owned ofapproximately $3.2 million.

 

For the three monthsended March 31, 2002, net cash provided by financing activities wasapproximately $31.7 million, primarily due to the increase in short-term debtof approximately $85.3 million.  Theincrease in cash was partially offset by payments on long-term debt ofapproximately $53.4 million and the purchase of outstanding common stockpursuant to the share repurchase program of approximately $199 thousand.Available short-term credit increased approximately $185 million during theperiod from approximately $75 million to approximately $260 million byincreases in loan limits from an existing warehouse loan facility and theaddition of a short-term borrowing facility. (See Note 7 to the financial statements). The Company’s mortgage bankingstrategy requires that the Company increase its loan origination levels to aprofitable level and continue to increase loan production volumes for sustainedand increased profitability. In order to continue to increase loan originationvolumes, the Company must obtain additional warehouse lines of credit, orreduce the time loans are held for sale (warehoused). There are a number offinancial institutions which specialize in lending to mortgage bankingcompanies and these types of secured borrowings. AmNet expects to expand itscurrent however, there can be no assurances that AmNet will be successful inobtaining additional warehouse facilities.

 

The Company’s mortgagebanking activities will require a significant level of cash reserves andcapital 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 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 notexpect to pay dividends in 2002.  As aREIT, it has been the Company's policy to distribute at least 90% of taxableincome to its 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 $10.2 million in the 2nd quarter of 2002, will be incomefor GAAP purposes but only partially recorded as income for tax purposes.

 

During the three monthsended March 31, 2001, net cash provided by operating activities wasapproximately $5.3 million.  The differencebetween net cash provided by operating activities and the net loss ofapproximately $1.7 million was primarily the result of amortization of mortgageasset premiums, reduction of interest rate cap agreements to market value,provision for loan losses, and a decrease in accrued interest receivable.Accrued interest receivable increased cash flow during the first three monthsof 2001 due to the mortgage asset portfolio decreasing approximately $73.7million from December 31, 2000 to March 31, 2001.

 

Net cash provided byinvesting activities for the three months ended March 31, 2001 wasapproximately $68.5 million.  Net cashused for the three months ended March 31, 2001 was positively affected byprincipal payments of approximately $65.4 million and proceeds from the sale ofreal estate owned of approximately $3.2 million.

 

For the three monthsended March 31, 2001, net cash used in financing activities was approximately$75.4 million, primarily due to payments on long-term debt of approximately$72.5 million and payments on short-term debt of approximately $1.1million.  Net cash used in financing wasfurther increased by the payment of dividends of approximately $1.6 million andthe purchase of outstanding common stock pursuant to the share repurchase programof approximately $196,000.

 

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**Business Risks—Mortgage AssetPortfolio Investments—Spread Lending Business**

 

*High Levels of Bond CollateralMortgage Loans Prepayments May Reduce Operating Income*

 

The level of prepaymentsof bond collateral mortgage loans purchased at a premium by the Companydirectly impacts the level of amortization of capitalized premiums. The Companyuses a calculation for determining the premium amortization which is based onthe interest method. If prepayment levels exceed projections used for thepremium amortization calculation, the potential exists for impairment write–downsas a result of under–amortized premiums.

 

Bond collateral mortgageloans prepayment rates generally increase when market interest rates fall belowthe current interest rates on mortgage loans. Prepayment experience also may beaffected by the expiration of prepayment penalty clauses, the ability of theborrower to obtain a more favorable mortgage loan, geographic location of theproperty securing the adjustable-rate mortgage loans, the assumability of amortgage loan, conditions in the housing and financial markets and generaleconomic conditions. The level of prepayments is also subject to the sameseasonal influences as the residential real estate industry with prepaymentrates generally being highest in the summer months and lowest in the wintermonths. The Company experienced high levels of prepayments during 1999 through2000 on its CMO/FASIT segment of its bond collateral mortgage loan portfoliodue principally to the fact that the underlying adjustable rate loans weresubject to their first initial interest rate adjustment (after being fixed forthe first two years), prepayment penalty clauses expired and borrowers wereable to secure more favorable rates by refinancing. In 2001 and 2002, the samephenomenon occurred in the 99-A and 1999-2 segments of the portfolio, as theloans in these portfolios reached the end of their 2 year fixed rate periodsand prepayment penalty clauses expired. The overall rate of prepayments hasdecreased over the past several months averaging 36.6% in the first quarter of2002, 41.66% in the fourth quarter of 2001, down from 52.15% in the thirdquarter and 49.60% in the second quarter. The Company anticipates that overallprepayment rates are likely to remain in the 40% to 50% range in 2002. Therecan be no assurance that prepayment rates will not be higher or that prepaymentpenalty income will offset premium amortization expense. Accordingly, theCompany’s financial condition and results of operations could be materiallyadversely affected.

 

As of March 31, 2002approximately 39.4% of the Company’s Bond Collateral Mortgage Loan portfoliohad prepayment penalty clauses, with a weighted average of nine monthsremaining before prepayment penalties expire. Prepayment penalty clauses serveas a deterrent to early prepayments and the penalties collected help to offsetthe premium amortization expense. However, prepayment penalty fees may be in anamount which is less than the figure which would fully compensate the Companyfor its remaining capitalized premiums, and prepayment penalty provisions mayexpire before the prepayment occurs.

 

*Borrower Credit Defaults, SpecialHazard Losses and National Recessions May Decrease Value Of Bond CollateralMortgage Assets Held By The Company*

 

During the time theCompany 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 loan in the future.

 

Credit risks associatedwith non-conforming mortgage loans, especially sub-prime mortgage loans will begreater than those associated with mortgage loans that conform to FNMA andFHLMC guidelines. The principal difference between sub-prime mortgage loan andconforming mortgage loans is that sub-prime mortgage loans typically includeone or more of the following: worse credit and income histories of themortgagors, higher loan-to-value ratios, reduced or alternative documentationrequired for approval of the mortgagors, different types of properties securingthe mortgage loans, higher loan sizes and the mortgagor’s non-owner occupancystatus with respect to the mortgaged property. As a result of these and

 

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other factors, theinterest rates charged on non-conforming mortgage loans are often higher thanthose charged for conforming mortgage loans. The combination of differentunderwriting criteria and higher rates of interest may lead to higherdelinquency rates and/or credit losses for non-conforming as compared toconforming mortgage loans and thus require high loan loss allowances. All ofthe Company’s Bond Collateral Mortgage Loans at March 31, 2002 were originatedas sub-prime mortgage loans.

 

A down turn in thenational 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 may beinadequate should economic conditions worsen significantly causing higher thanexpected defaults and property value decreases. Management believes theallowances for loan losses are adequate as of March 31, 2002.

 

Even assuming thatproperties secured by the mortgage loans held by the Company provide adequatesecurity for such mortgage loans, substantial delays could be encountered inconnection with the foreclosure of defaulted mortgage loans, with correspondingdelays in the receipt of related proceeds by the Company. State and localstatutes and rules may delay or prevent the Company’s foreclosure on or sale ofthe mortgaged property and typically prevent the Company from receiving netproceeds sufficient to repay all amounts due on the related mortgage loan.

 

*Prepayments, Credit Losses andIncreases in Short Term Interest Rates May Adversely Affect the Value ofRetained Interest in Securitization*

 

In 1998, the Companycompleted a sale of residential mortgage loans through the securitization ofsuch loans through “REMIC.” The REMIC consisted of pooled, first-lien mortgagesand was issued by American Residential Holdings, Inc (“Holdings”) to the publicthrough a registration statement of an underwriter. The interest-only strip referredto as the Class “X” Certificate was created in the process of thesecuritization and was transferred from Holdings to American Residential Eagle,Inc., a wholly owned REIT subsidiary of the Company. The value of thisinvestment is impacted by the level of future prepayments, credit loss and netinterest spread on the underlying mortgages. There were no impairment chargesduring the quarter ending March 31, 2002. However, during the year endingDecember 31, 2000, the Company incurred a $5.1 million impairment chargerelated to its retained interest in a REMIC securitization (the “Residual”).Accounting principles generally accepted in the United States of Americarequire that any decline in residual asset value that is other than temporarybe reflected through the Company’s current period statement of operations.There are no other retained interests in securitizations 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 connection withsecuring 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 Pledgedto Secure Long-Term Debt, the Company may not be Able to Sell Such Assets andTherefore the Company’s Liquidity and Capital Resources may be AdverselyAffected*

 

All of the Company’s bondcollateral mortgage assets at March 31, 2002 were pledged as bond collateral tosecure Long-Term Debt. These assets are subject to the terms of the Long-TermDebt agreements and may not be separately sold or exchanged. While the Companymay sell its interests in the bond collateral subject to the liens and otherrestrictions of the Long-Term Debt agreements, there is not a liquid market forsuch encumbered interests and a significant liquidity discount would beapplied. As such, the Company would expect to receive less than its book valueshould it sell its interests in the bond collateral.

 

*Increases In Short Term InterestRates May Increase the Cost of Borrowings by the Company Which May ReduceIncome From Operations*

 

The majority of theCompany’s Bond Collateral Mortgage Loans have a repricing frequency of sixmonths 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 MayResult in Increased Delinquency Rates and Credit Losses which May AdverselyAffect the Company’s Results of Operations and Financial Condition*

 

All of the Company’s BondCollateral Mortgage Loans are serviced by sub-servicers. The Companycontinually monitors the performance of the sub-servicers through performancereviews, comparable statistics for delinquencies and on-site visits. TheCompany has on occasion determined that sub-servicers have not followedstandard collection and servicing practices related to the Company’s BondCollateral Mortgage Loans which the Company believes has lead 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 thesesub-servicers will service the Company’s mortgage loans in such a way as tominimize delinquency rates and/or credit losses and not cause an adverse effecton the Company’s results of operations.

 

**Risks Associated with Changing theCompany’s Business Strategy**

 

*The Stockholders of the*Company*May notApprove the Termination of the Company’s Status as a REIT which Would Limit theCompany from Pursuing its Mortgage Origination Business and May MateriallyAdversely Affect the Company’s Revenues*

 

At the Annual Meeting ofStockholders scheduled for on or about July 19, 2002, the stockholders of theCompany will be asked to approve certain amendments to the Company’s charterdocuments that will effectively terminate the Company’s status as a REIT as ofJanuary 1, 2003. Should the stockholders not approve the termination of theCompany’s status as a REIT, the Company will not be able to transition entirelyto a mortgage origination business. In addition, the Company will be unable tofully utilize AmNet and the operations already put in place to support themortgage origination business, hence those assets may be wasted. The Companybelieves that this will result in a material adverse effect on the Company’sresults of operations, financial condition and growth.

 

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*The Company has a Limited OperatingHistory in the Mortgage Origination Industry, which Makes it Difficult toEvaluate the Company’s Current Business Performance and Future Prospects*

 

The Company was formed in1997 and operated as a mortgage REIT (mortgage portfolio investment) until thefourth quarter of 2001, at which time the Company began originating and sellingmortgages (mortgage banking). The Company must originate increasing amounts ofmortgages in the future to grow its business. While the Company’s executiveofficers have extensive mortgage origination and mortgage banking experience,and have hired experienced personnel in its mortgage banking subsidiary, thereare a significant number of risks and uncertainties inherent in the mortgageorigination industry, especially in light of the Company’s limited relevantoperating history and experience originating mortgages.

 

*The Company Expects OperatingExpenses to Increase Significantly which May Adversely Affect its Results of Operations*

 

The Company incurred anet loss of approximately $1.9 million in the first quarter of 2002. TheCompany expects its operating expenses to increase significantly, which mayrender it unable to generate sufficient revenues to be profitable in the future.In particular, the Company expects to incur additional costs and expensesrelated to the expansion of the sales force and regional underwriting centersas well as the expansion of its management team and internal infrastructurenecessary to support the growth of the mortgage banking business.

 

Unprofitable operationsmay have an adverse effect on the price of the Company’s common stock andconsequently your investment in the Company.

 

*The Company May not be Successful ifit Loses the Services of its Existing Key Employees*

 

The Company expects thatthe services of the following key employees will be important to its futureoperations:

 

•              John M. Robbins, Chairman of the Board and ChiefExecutive Officer;

 

•              Jay M. Fuller, President and Chief Operating Officer;

 

•              Judith A. Berry, Executive Vice President and ChiefFinancial Officer;

 

•              Lisa S. Faulk, Executive Vice President, Operations;

 

•              Scott Day, Senior Vice President, Capital Markets;

 

•              Clayton W. Strittmatter, Senior Vice President,Finance; and

 

•              Randall Myres, Senior Vice President, Technology.

 

Any of the Company’s keypersonnel may terminate his or her employment relationship with the Company onshort notice. The Company does not maintain any “key person” life insurancepolicies. If the Company is unable to maintain an effective executive team, itmay not be able to achieve its short or long-term objectives or create ormaintain stockholder value.

 

*The Company May Not Be Able toEffectively Manage the Growth of its Business*

 

Recently, the Company hasexperienced rapid growth. In the beginning of 2001, the Company hadapproximately 20 employees. As of March 31, 2002, it had approximately 174employees. 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 toattract and hire additional sales and management personnel in an intenselycompetitive hiring environment. At the same time, the Company will need tocontinue to upgrade and expand its financial, operational and managerialsystems and controls. If the Company fails to manage its growth effectively,the Company’s expenses could increase and the management’s time and attentioncould be diverted. If the Company does not succeed in these efforts, it will beunable to effectively grow and manage the business, and its financial resultscould be negatively affected.

 

**Mortgage Banking Business—BusinessRisks**

 

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

 

The Company’s mortgagebanking strategy requires that the Company increase its loan origination levelsto a profitable level and continue to increase loan production volumes forsustained and increased profitability. The Company currently has warehouseborrowing facilities in place totaling $260 million, which are scheduled todecrease to $235 million on May 26, 2002. In order to continue to increase loanorigination volumes, the Company must obtain additional warehouse lines ofcredit, or reduce the time loans are held for sale (warehoused). There are anumber of financial institutions which specialize in lending to mortgagebanking companies and these types of secured 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 the factors thatwill affect AmNet’s ability to expand its warehouse line borrowings arefinancial market conditions and the value and performance of AmNet prior to thetime of such financing. There can be no assurance that any such financing canbe successfully completed at advantageous rates or at all. Additionally, theCompany’s warehouse borrowing facilities contain various financial covenantsincluding maximum leverage and cash reserve (liquidity) requirements. Failureto comply with these covenants would accelerate these debt agreements and ifwaivers or modifications could not be obtained, the Company could have aninterruption in its ability to fund its mortgage loan originations, which couldmaterially adversely impact the Company’s results of operations and financialcondition.

 

*Overhead Expenses May Not Be CoveredBy Sufficient Revenues To Achieve Or Sustain Profitable Operations.*

 

The Company made a numberof fixed overhead commitments to establish the operational and administrativeinfrastructure necessary to support the loan origination business. At March 31,2002, lease commitments for headquarter and regional offices totaledapproximately 35,000 square feet. There were 174 salaried employees. In orderto achieve profitability, AmNet’s originations must be in the $250 million to$400 million range, such that the revenues associated with this loan productionexceed fixed and variable overhead costs. Since AmNet’s revenues are tieddirectly to the level of loan production, it is imperative that AmNet achievesa profitable level of originations, and the level of future profitability frommortgage banking will be in direct correlation to the level of loan originationvolume. There can be no assurances that AmNet will increase its loanorigination volumes sufficiently to cover its fixed overhead costs, and shouldit incur significant operating losses during its start-up phase, the capitalbase and cash reserves could be materially adversely impacted, precluding theCompany from fully implementing its mortgage banking strategies.

 

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

 

In connection with thesale 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 underwritingcriteria or has some other defect, requiring AmNet to sell the loan at asignificant discount. AmNet has hired experienced personnel at all levels andhas established 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’s primary source ofrevenues is expected to be gains from the sale of loans, net of gains or losseson hedging transactions. AmNet sets rates and pays broker premiums based on apricing process designed to create a targeted profit margin on each loan. AmNethedges its exposure to changes in interest rates between the time it makes arate lock commitment and the time each loan is closed and/or sold to investors.

 

However, unexpected gainsor losses on sales of mortgage loans may result from changes in interest ratesfrom the time the interest rate on a customer’s mortgage loan application isestablished to the time AmNet sells the loan. At any given time, AmNet hascommitted to sell substantially all of its mortgage loans that are closed(closed loan inventory) and a percentage of the mortgage loans that are not yetclosed but for which the interest rate has been established (pipeline loans).To manage the interest rate risk of AmNet’s pipeline loans, AmNet continuouslyprojects the percentage of the pipeline loans it expects to close. On the basisof such projections, AmNet employs a variety of techniques, currentlyconsisting of a combination of mandatory forward sales commitments and put andcall option contracts on treasuries to mitigate interest rate risk.

 

If interest rates make anunanticipated change, the actual percentage of pipeline loans that close maydiffer from the projected percentage. A sudden increase in interest rates cancause a higher percentage of pipeline loans to close than projected. AmNet maynot have made forward sales commitments to sell these additional loans andconsequently may incur significant losses upon their sale at current marketprices, which may not be offset by gains in the value of hedge positions,adversely affecting results of operations. Likewise, if a lower percentage ofpipeline loans closes than was projected, due to a sudden decrease in interestrates or otherwise, AmNet may have to adjust is hedge positions or mandatorysales commitments at a significant cost, adversely affecting results ofoperations. This risk is greater during times of volatility of interest rates.

 

*Changes in Interest Rates Could Adversely Impact Results ofOperations*

 

The profitability ofAmNet is likely to be adversely affected during any period of unexpected orrapid increases in interest rates. Such interest rate increases could have theeffect of reducing the value of loans held for sale with such decline not fullyoffset by gains from hedging activities. Higher mortgage rates could also causea decline in the overall market for new loans, adversely impacting AmNet’sorigination levels. Furthermore, while the Company currently enjoys a positivenet interest spread on its loans held for sale, inverse or flattened interestyield curves (the relationship between long term rates and short term rates)could have an adverse impact on AmNet’s warehouse interest spread incomebecause AmNet generally has loans in inventory based on the 30–year fixedrate while the warehouse line of credit facility bears a short-term interestrate.

 

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*Capital Shortages Could Impede the Company’s Ability toExecute Its Mortgage Banking Strategy*

 

The Company’s mortgagebanking activities will require a significant level of cash reserves andcapital 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 Rules And RegulationsMay Adversely Impact AmNet’s Ability to Originate and Sell Loans*

 

In connection with theorigination and sale of residential 1-4 unit mortgages, AmNet and the Companyare subject to various state licensing requirements, and various state andfederal rules and regulations of the department of Housing and UrbanDevelopment, the Federal Housing Administration and the Veterans Administration.Failure to comply with state and federal laws and requirements could impact theAmNet’s ability to originate and/or sell loans, and thus could have an adverseimpact on the Company’s results of operation and financial condition. WhileAmNet has controls and processes to ensure compliance with laws andregulations, there can be no assurances that it fully complies with allregulatory requirements.

 

A number of legislativeinitiatives are underway in several local and state jurisdictions as well as onthe federal level that would define and potentially restrict or prohibit‘predatory’ lending.  While the Companydoes not consider its lending practices to be predatory, there can be noassurances 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 and Demand forMortgages May Hinder The Company’s Ability to Achieve or Sustain ProfitableOrigination Levels.*

 

The Company’s success inits mortgage banking strategy will depend, in large part, on AmNet’s ability tooriginate “A” paper loans in sufficient quantity such that gains on the sale ofthese mortgages combined with broker fees and interest spread are in excess ofboth fixed and variable overhead costs. There can be no assurance that AmNetwill be able to originate sufficient levels or mortgages to achieve and sustainprofitability. In originating and selling A paper loans, AmNet will competewith investment banking firms, savings and loan associations, banks, mortgagebankers and other entities originating A paper residential 1-4 unit mortgages,many of which have greater financial resources than AmNet. The Company willface competition from companies already established in these markets. Inaddition to the level of home purchase activity, the origination market isdirectly tied to the general level of interest rates and refinance activity.The origination market exceeded $1.2 trillion in 2000 and $2 trillion 2001, dueto both strong home sales and low interest rates. While it is expected that theloan origination market will continue to be in the trillion-plus level in 2002and beyond, the overall market size could contract, increasing competitivenessin the mortgage markets, and putting pressure on the market competitors toreduce revenues to sustain origination volumes and market share. The Companybelieves that it has identified a market niche that will allow it to gainmarket share over the next several years, even if the overall demand formortgages declines, however there can be no assurance that the Company will beable to successfully compete.

 

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

 

Mortgage brokers, whoassist loan applicants in obtaining mortgage loans, refer all of the mortgageloans originated by AmNet. As such, the loan application, property appraisal,credit report and other supporting documentation are furnished by the mortgagebroker and used by AmNet’s underwriters to make approval or denial decisions.AmNet employees have virtually no contact with applicants, and rely on themortgage broker to obtain and furnish all of the documentation supporting themortgage loan application.

 

Further, in rare cases,the mortgage broker may knowingly or unknowingly submit an application whereinmultiple parties to the transaction (borrower, appraiser, seller, or title insurer)work in collusion to inflate the property value and/or falsify otherdocumentation in order to obtain a mortgage loan. These 

 

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types of fraudulent mortgage loans will have ahigh risk of default, and will likely not be fully recoverable throughdisposition of the underlying property securing the mortgage loan.

 

Should material fraud bedetected on a mortgage loan prior to sale to an investor, the mortgage loansmay have to be sold at a significant discount or may not be saleable. Shouldmaterial fraud be detected after a mortgage loan is sold to a correspondentinvestor, AmNet may be required to repurchase the loan or indemnify theinvestor. While the investor and/or AmNet can initiate foreclosure proceedingson any loans deemed to be fraudulently obtained, AmNet could incur significantlosses on these fraudulent mortgage loans if principal or interest is not fullyrecovered through the foreclosure and disposition of the underlying propertysecuring the mortgage loan.

 

AmNet has establishedrisk management and quality control committees to set policy and manageexposure to credit losses due to fraud, compliance errors or non-compliancewith AmNet’s underwriting standards. Regular quality control audits are done onrepresentative samples of mortgage loans and all mortgage loans submitted bybrokers who come under suspicion in the normal course. Additionally, AmNet hasnumerous controls and processes to ensure that all of the mortgage loanapplications submitted through mortgage brokers are not based on fraudulent orintentionally misrepresented documentation. However there can be no assurancesthat the broker and/or borrowers do not submit fraudulent or inaccuratedocumentation that is not detected by AmNet personnel, or by electronic fraudchecks utilized by AmNet. Should AmNet originate significant numbers offraudulent loans, the Company’s results of operations and financial conditioncould be materially adversely affected.

 

*AmNet is Subject to Counterparty Risks on Loan SalesCommitments and Hedging Transactions*

 

In connection with itsmortgage loan sales, which involve the sale of mortgage loans and mortgage–backedsecurities on a forward or other deferred delivery and payment basis, AmNetalso enters into treasury option purchases and sales in connection with itshedging 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.

 

*Mortgage Banking Revenues Can Fluctuate From Period toPeriod Based on a Number of Factors*

 

AmNet’s operating resultscould fluctuate from period to period as a result of a number of factors,including the volume of loan production, interest rates and the level ofunrealized gains/losses in unsold loans, pipeline loans or hedge positions.Accordingly, the consolidated net income of the Company may fluctuate fromperiod to period.

 

*Dependency on Correspondent Investors, Secondary Markets*

 

AmNet’s ability togenerate gains on the sale of mortgages is largely dependent upon thecontinuation of correspondent lending programs offered by large correspondentlenders, as well as AmNet’s continued eligibility to participate in suchprograms. 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 In California, Makingthe Company’s Results Subject to Adverse Economic Conditions In California.*

 

A large proportion ofloans expected to be originated by AmNet will be concentrated in California.Although AmNet is expanding its operations to the East Coast of the UnitedStates in 2002, a significant portion of its loan origination volume is likelyto be based in California for the foreseeable future. Consequently, AmNet’sresults of operations and financial conditions are dependent upon generaltrends in the California economy and its residential real estate market. Residentialreal estate market declines may adversely affect the levels of new mortgages inCalifornia or the value paid by correspondent lenders for loans in California,potentially adversely affecting the Company’s results of operations andfinancial condition.

 

*A Recent Federal Circuit Decision Regarding the Legality ofYield Spread Premiums Could Increase Litigation Against Us and Other MortgageLenders*

 

A recent federal circuitcourt decision regarding the legality of yield spread premiums could increaselitigation against other mortgage lenders and us. In June 2001, the EleventhCircuit 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 valueratio, and credit grade, and the amount of the lender’s baseline or par pricedthat the lender offers to pay for loans with certain baseline or parcharacteristics. For example, if a broker produces a $100,000 loan meeting therequirements that lender has specified in order to pay 101% (1% above thelender’s par price) then the lender will pay that broker a yield spread premiumof $1,000 ($100,000 times 1%). In 1999, the Department of Housing and UrbanDevelopment issued a policy statement taking the position that lender paymentsto mortgage brokers, including yield spread premiums, are not *per se*illegal, and it reiterated this basic position in a statement issued in October2001. The *Culpepper*decision is inconsistent with the position taken by the Department of Housingand Urban Development; 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.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

A primary market riskfacing the Company is interest rate risk. The Company attempts to manage thisrisk by striving to balance its mortgage loan origination *and* mortgage loan salebusiness. To a lesser degree the Company also manages the interest rate risk onit portfolio business between interest earned on bond collateral mortgageassets and interest paid on long term debt collaterized by mortgage assets.

 

The Company has performedvarious sensitivity analyses that quantify the net financial impact of changesin interest rates on its interest rate-sensitive assets, liabilities andcommitments. These analyses presume an instantaneous parallel shift of theyield curve. Various techniques are employed to value the underlying financialinstruments and rely upon a number of critical assumptions. The scenariospresented are illustrative. Actual experience may differ materially from theestimated amounts presented for each scenario. To the extent that yield curveshifts are non-parallel and to the extent that actual variations in significantassumptions differ from those applied for purposes of the valuations, theresultant valuations can also be expected to vary. Such variances may provematerial.

 

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|                                         |   | **March 31, 2002**   |         | **If Interest Rates Were To** |         |
|----------------------------------------------|--------|----------------------|--------------|-------------------------------|--------------|
|                                         |   |                 | **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                    |   | $                    | 8,647        |                          | $            | 8,647 |   | $ | 8,647 |   | $ | 8,647 |   | $ | 8,647 |   | $ | 8,647 |   |
| Mortgage loans held for sale, net1      |   | 120,991              |         | 120,991                       |         | 120,728 |   | 121,254 |   | 120,344 |   | 121,644 |   |
| Bond collateral, mortgage loans and REO, net |   | 406,856              |         | 420,538                       |         | 419,350 |   | 422,118 |   | 418,489 |   | 423,808 |   |
| Derivative financial instruments1       |   | 5,459                |         | 5,459                         |         | 5,979 |   | 6,607 |   | 5,650 |   | 5,024 |   |
| Retained interest in securitization          |   | 1,495                |         | 1,495                         |         | 1,495 |   | 1,495 |   | 1,495 |   | 1,495 |   |
| Total interest-earning assets                |   | $                    | 543,448      |                          | $            | 557,130 |   | $ | 556,199 |   | $ | 560,121 |   | $ | 554,625 |   | $ | 560,618 |   |
|                                         |   |                 |         |                          |         |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                |   |                 |         |                          |         |   |   |   |   |   |   |   |   |
| Short-term debt                              |   | $                    | 120,544      |                          | $            | 120,544 |   | $ | 120,544 |   | $ | 120,544 |   | $ | 120,544 |   | $ | 120,544 |   |
| Long-term debt, net                          |   | 369,101              |         | 369,101                       |         | 369,101 |   | 369,101 |   | 369,101 |   | 369,101 |   |
| Due to affiliate                             |   | 1,871                |         | 1,871                         |         | 1,871 |   | 1,871 |   | 1,871 |   | 1,871 |   |
| Total interest-bearing liabilities           |   | $                    | 491,516      |                          | $            | 491,516 |   | $ | 491,516 |   | $ | 491,516 |   | $ | 491,516 |   | $ | 491,516 |   |
|                                         |   |                 |         |                          |         |   |   |   |   |   |   |   |   |
| Effect on equity                             |   | $                    | 51,932       |                          | $            | 65,614 |   | $ | 64,683 |   | $ | 68,605 |   | $ | 63,109 |   | $ | 69,102 |   |

 
|                                         |   |                  |    |                      |   | **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 |   |
| Mortgage loans held for sale, net1      |   | 38,095                |    | 38,161                    |   | 37,954                                    |   | 38,120 |   | 37,872 |   | 38,203 |   |
| Bond collateral, mortgage loans and REO, net |   | 461,378               |    | 475,292                   |   | 473,883                                   |   | 477,127 |   | 471,294 |   | 479,192 |   |
| Derivative financial instruments1       |   | 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 for sale and derivative financial instruments areextremely sensitive to short term interest rate movements.  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 estimated basedon quoted market prices from institutional investors for similar types ofmortgage loans. The portion of mortgage loans held for sale which werecommitted for sale under mandatory sale arrangements and as such would notchange in value due to subsequent changes in interest rates.

 

*BondCollateral, Mortgage Loans, Net*

 

The fair value of Bond CollateralMortgage Loans is estimated based on quoted market prices from dealers andbrokers for similar types of mortgage loans, in the bulk mortgage market.Market prices reflect various assumptions as to prepayment rates, loan lossesand 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 aliquidity discount has not been reflected in fair value.

 

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*RetainedInterest in Securitization*

 

This security is classified asavailable-for-sale and as such is carried at fair value. See “Notes to theConsolidated Financial Statements—Note 5. Retained Interest in Securitization”for a description of the valuation methodology.

 

*DerivativeFinancial Instruments*

 

Fair values of treasury futuresand options on treasury futures are based on quoted market prices for theseinstruments. Fair values of the Company’s commitments to originate loansconsider the difference between current levels of interest rates and committedrates. Fair values of forward commitments to sell loans are determined usingquoted market prices.

 

*Due fromAffiliate*

 

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

 

*Short-Term Debt*

 

The fair value of the warehouse linedebt approximates the carrying amounts because of the short-term nature of thedebt 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 toAffiliate*

 

Thefair value of due to affiliate approximates the carrying amount because of theshort-term nature of the liability.

 

These analyses arelimited by the fact that they are performed at a particular point in time anddo not incorporate other factors that would impact the Company’s financialperformance in each such scenario. Consequently, the preceding estimates shouldnot be viewed as a forecast.

 

 

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PART II.  OTHERINFORMATION

 

Item. 1.  Legal Proceedings

On January 3, 2001, theCompany filed a lawsuit against Lehman Capital, a Division of Lehman BrothersHoldings, Inc., and Long Beach Mortgage Company, Inc., in the CaliforniaSuperior Court in San Diego seeking to recover damages arising from itspurchase of a pool of residential mortgage loans from Lehman Capital in late1997 and early 1998.  The complaintseeks damages for losses arising out of the Company's agreement to purchaseloans from Lehman Capital, which had acquired the loans from Long BeachMortgage Co.  Lehman Capital hadassigned the loans, and its loan purchase agreement with Long Beach MortgageCo., to the Company.  In April 2002, theCompany settled the litigation with Lehman Capital on mutually agreeable terms.

 

Binding arbitration withLong Beach 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.

 

Income related to theseevents will be recorded in the second quarter of 2002.

 

Item 2.   Changesin Securities and Use of Proceeds

None.

 

Item 3.Defaults Upon Senior Securities

Not applicable.

 

Item 4.Submission of Matters to a Vote ofSecurity Holders

 None

 

Item 5.Other Information

The date of this yearsAnnual Meeting of Stockholders is July 19, 2002.  This date has changed by more than 30 days from last yearsmeeting date.  Therefore, the deadlinefor submitting stockholder proposals to be considered at the meeting is May 20,2002.

 

American Residential hasan advanced notice provision in its bylaws for stockholder business to bepresented at meetings of stockholders. This provision states that in order for stockholder business to beproperly brought before a meeting by a stockholder, such stockholder must havegiven timely notice in writing to American Residential's Secretary.  In order to be timely, a stockholderproposal for next year's Annual Meeting of Stockholders must be received atAmerican Residential's offices at 10421 Wateridge Circle, Suite 250, San Diego,California 92121 between April 20, 2003 and May 20, 2003.  Any proposals received before April 20, 2003or after May 20, 2003 will be considered untimely and will not be presented atthe meeting.  If presented at themeeting, the persons named in the proxy for such meeting may exercise theirdiscretionary power with respect to such proposals. 

 

Stockholder proposals tobe included in American Residential's Proxy Statement for next year's AnnualMeeting of Stockholders must be received by American Residential by February17, 2003, and satisfy the conditions established by the Securities and ExchangeCommission, specifically, Rule 14a - 8 of the Exchange Act.

 

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

 

(a)           Exhibits

 

*3.1 Articles ofAmendment and Restatement of the Registrant

*3.2 Amended and RestatedBylaws of the Registrant

3.3 Amendment to Amendedand Restated Bylaws of the Registrant

**4.1 Rights Agreementdated February 2, 1999 by and between the Company and

American Stock TransferCompany as Rights Agent

*              Incorporated by reference to Registration Statement onForm S-11

(File No. 333-33679)

**             Incorporated by reference to Form 8-K filed on February17, 1999

(File No. 001-13485)

 

(b)           Reports on Form 8-K

Current Report on Form8-K (file number 001-13485) filed on January 9, 2002.

Current Report on Form8-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 of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized

 
| AMERICAN RESIDENTIAL  INVESTMENT TRUST, INC. |
|----------------------------------------------|
|                                         |   |   |   |
| Dated:    May  15, 2002       |   | By: |   | /s/ | Judith A. Berry |   |
|                                         |   |   |   | Judith A. Berry, |
|                                         |   |   |   | Executive Vice President |
|                                         |   |   |   | Chief Financial Officer |
|                                              |  |  |  |  |  |  |

 

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