**UNITED STATESSECURITIES 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,  2004**                                             |
| ** ** | ** ** | ** **                                                                                      |
| **OR**     |
| ** ** | ** ** | ** **                                                                                      |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT  TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
| ** ** | ** ** | ** **                                                                                      |
| ** ** | ** ** | **Commission File Number:  1-13485**                                                       |

 

**AMNETMORTGAGE, INC.**

(Exact name of registrant as specified in itscharter)

 
| **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:   **American Residential Investment Trust, Inc.**                 |
| (Former name, former address and former  fiscal year, if changed since last report) |

 

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

 

ý  YES    o  NO

 

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

 

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

 
| Common Stock ($0.01) |   | 7,855,547 as of April 30, 2004 |
|----------------------|--------|--------------------------------|

 

 

----

 
| INDEX                                                                                                                                |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                 |   |
| PART I.  FINANCIAL INFORMATION                                                                                                  |   |
|                                                                                                                                 |   |
| Item 1.  Consolidated Financial Statements                                                                                           |   |
|                                                                                                                                 |   |
| Consolidated Balance Sheets  at March 31, 2004 and March 31, 2003                                                                    |   |
|                                                                                                                                 |   |
| Consolidated  Statements of Operations and Comprehensive Income (Loss) for the three months  ended March 31, 2004 and March 31, 2003 |   |
|                                                                                                                                 |   |
| Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and March  31, 2003.                                |   |
|                                                                                                                                 |   |
| Notes to  Consolidated Financial Statements                                                                                          |   |
|                                                                                                                                 |   |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                                 |   |
|                                                                                                                                 |   |
| Item  3. Quantitative and Qualitative Disclosures about Market Risk                                                                  |   |
|                                                                                                                                 |   |
| Item 4 Controls and  Procedures                                                                                                      |   |
|                                                                                                                                 |   |
| PART II.  OTHER INFORMATION                                                                                                     |   |
|                                                                                                                                 |   |
| Item 1.  Legal Proceedings                                                                                                           |   |
|                                                                                                                                 |   |
| Item 2.  Changes in Securities and Use of Proceeds                                                                                   |   |
|                                                                                                                                 |   |
| Item 3. Defaults Upon  Senior Securities                                                                                             |   |
|                                                                                                                                 |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                                         |   |
|                                                                                                                                 |   |
| Item  5. Other Information                                                                                                           |   |
|                                                                                                                                 |   |
| Item 6. Exhibits  and Reports on Form 8-K                                                                                            |   |

 

2

----

 

PARTI.  FINANCIAL INFORMATION

Item 1.  Consolidated FinancialStatements

 

AmNet Mortgage,Inc. and Subsidiaries

ConsolidatedBalance Sheets

(in thousands, except share and per sharedata) (unaudited)

 
| ** **                                                                                                                                                                    | ** ** | **March 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------------|------------|
|                                                                                                                                                                          |       |               |       |                       |       |
| **ASSETS**                                                                                                                                                                    |       |               |       |                       |       |
| Cash and  cash equivalents                                                                                                                                                    |       | $                  | 27,647     |                       | $          | 44,400 |   |
| Cash and  cash equivalents—restricted                                                                                                                                    |       | 2,100              |       | 2,100                      |       |
| Mortgage  loans held for sale, net, pledged (lower of cost or market)                                                                                                         |       | 510,524            |       | 276,781                    |       |
| Bond  collateral, mortgage loans, net, held for sale (lower of cost or market)                                                                                                |       | 116,226            |       | —                     |       |
| Bond  collateral, mortgage loans, net                                                                                                                                         |       | 20,592             |       | 157,872                    |       |
| Bond  collateral, real estate owned                                                                                                                                           |       | 623                |       | 3,380                      |       |
| Accounts  receivable—mortgage loans sold/funded                                                                                                                          |       | 3,182              |       | 3,856                      |       |
| Accrued  interest receivable                                                                                                                                                  |       | 2,196              |       | 2,593                      |       |
| Deferred  taxes                                                                                                                                                               |       | 7,747              |       | 5,694                      |       |
| Other  assets                                                                                                                                                                 |       | 6,223              |       | 5,520                      |       |
|                                                                                                                                                                          |       | $                  | 697,060    |                       | $          | 502,196 |   |
|                                                                                                                                                                          |       |               |       |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                 |       |               |       |                       |       |
| Liabilities:                                                                                                                                                                  |       |               |       |                       |       |
| Short-term  debt                                                                                                                                                              |       | $                  | 495,292    |                       | $          | 268,619 |   |
| Short-term  debt related to bond collateral held for sale                                                                                                                     |       | 90,097             |       | —                     |       |
| Long-term  debt, net                                                                                                                                                          |       | 20,078             |       | 130,295                    |       |
| Derivative  financial instruments                                                                                                                                             |       | 205                |       | 1,224                      |       |
| Accrued  interest payable                                                                                                                                                     |       | 487                |       | 494                        |       |
| Accrued  expenses and other liabilities                                                                                                                                       |       | 7,947              |       | 12,950                     |       |
| Total  liabilities                                                                                                                                                            |       | 614,106            |       | 413,582                    |       |
| Commitments  and contingencies (Note 13)                                                                                                                                 |       |               |       |                       |       |
| Minority  Interest                                                                                                                                                            |       | 137                |       | 129                        |       |
| Stockholders’  Equity:                                                                                                                                                   |       |               |       |                       |       |
| Preferred  stock, par value $.01 per share; 100,000 shares authorized; no shares issued  and outstanding                                                                      |       | —             |       | —                     |       |
| Common  stock, par value $.01 per share; 24,900,000 shares authorized; 7,875,634  shares issued and outstanding in 2004, and 7,873,714 shares issued and  outstanding in 2003 |       | 79                 |       | 79                         |       |
| Additional  paid-in-capital                                                                                                                                                   |       | 108,723            |       | 108,719                    |       |
| Accumulated  deficit                                                                                                                                                          |       | (25,985            | )          | (20,313                    | )          |
| Total  stockholders’ equity                                                                                                                                              |       | 82,817             |       | 88,485                     |       |
|                                                                                                                                                                          |       | $                  | 697,060    |                       | $          | 502,196 |   |

 

See accompanying notes to consolidatedfinancial statements

 

3

----

 

AmNet Mortgage, Inc. and Subsidiaries

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

(in thousands, except per share data)

 
| ** **                                                                                                                         | ** ** | **For the Three Months  Ended March 31, 2004** | ** ** | **For the Three Months  Ended March 31, 2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                                                                                                               |       |                                                |       |                                                |       |
| **Revenues**                                                                                                                       |       |                                                |       |                                                |       |
| Gain on  sales of loans                                                                                                            |       | $                                                   | 15,515     |                                                | $          | 20,209 |   |
| Derivative  financial instruments and market adjustments                                                                           |       |                                                |       |                                                |       |
| Derivative  financial instruments—forward sales of mortgage backed securities and options  to sell mortgage backed securities |       | (5,487                                              | )          | (52                                                 | )          |
| Market  adjustment on interest rate lock commitments                                                                               |       | (1,157                                              | )          | (2,159                                              | )          |
| Total  derivative financial instruments and market adjustments                                                                     |       | (6,644                                              | )          | (2,211                                              | )          |
| Interest on  mortgage assets                                                                                                       |       | 6,641                                               |       | 9,246                                               |       |
| Other  income                                                                                                                      |       | 296                                                 |       | 215                                                 |       |
| Total  revenue, net of derivative financial instruments and adjustments                                                            |       | 15,808                                              |       | 27,459                                              |       |
| **Expenses**                                                                                                                       |       |                                                |       |                                                |       |
| Employee  compensation and benefits                                                                                                |       | 11,842                                              |       | 9,484                                               |       |
| Interest  expense                                                                                                                  |       | 3,241                                               |       | 4,213                                               |       |
| Office and  occupancy expense                                                                                                      |       | 836                                                 |       | 566                                                 |       |
| Provision  for loan losses                                                                                                         |       | —                                              |       | 919                                                 |       |
| Gain on  sale of real estate owned, net                                                                                            |       | (259                                                | )          | (184                                                | )          |
| Valuation  adjustment-bond collateral held for sale                                                                                |       | 4,428                                               |       | —                                              |       |
| Professional  fees                                                                                                                 |       | 1,035                                               |       | 1,405                                               |       |
| Other  operating expenses                                                                                                          |       | 4,253                                               |       | 3,753                                               |       |
| Total  expenses                                                                                                                    |       | 25,376                                              |       | 20,156                                              |       |
| (Loss)  income  before income taxes                                                                                           |       | (9,568                                              | )          | 7,303                                               |       |
| Income tax  benefit                                                                                                                |       | (3,896                                              | )          | (4,853                                              | )          |
| Net (loss)  income                                                                                                                 |       | $                                                   | (5,672     | )                                                   | $          | 12,156 |   |
|                                                                                                                               |       |                                                |       |                                                |       |
| Basic  weighted average shares outstanding                                                                                         |       | 7,874,347                                           |       | 7,862,869                                           |       |
| Diluted  weighted average shares outstanding                                                                                       |       | 7,874,347                                           |       | 7,945,795                                           |       |
|                                                                                                                               |       |                                                |       |                                                |       |
| Net income  (loss) per share basic                                                                                                 |       | $                                                   | (0.72      | )                                                   | $          | 1.55 |   |
|                                                                                                                               |       |                                                |       |                                                |       |
| Net income  (loss) per share diluted                                                                                               |       | $                                                   | (0.72      | )                                                   | $          | 1.53 |   |

 

See accompanying notes to consolidatedfinancial statements

 

4

----

 

AmNet Mortgage, Inc. and Subsidiaries

Consolidated Statements of Cash Flows, unaudited

(in thousands)

 
| ** **                                                                            | ** ** | **For the Three Months  Ended March 31, 2004** | ** ** | **For the Three Months  Ended March 31, 2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------------------------------|------------|
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                |       |                                                |       |                                           |       |
| Net (loss)  income                                                                    |       | $                                                   | (5,672     | )                                              | $          | 12,156 |   |
| Adjustments  to reconcile net (loss) income to net cash used in operating activities: |       |                                                |       |                                           |       |
| Valuation  adjustment-bond collateral held for sale                                   |       | 4,428                                               |       | —                                         |       |
| Amortization  of mortgage assets premiums                                             |       | 762                                                 |       | 994                                            |       |
| Amortization  of CMO capitalized costs                                                |       | 70                                                  |       | 99                                             |       |
| Changes in  provision for loan losses                                                 |       | —                                              |       | 919                                            |       |
| Change in  real estate owned provision                                                |       | 245                                                 |       | 725                                            |       |
| Gain on  sale of real estate owned                                                    |       | (259                                                | )          | (184                                           | )          |
| Proceeds  from sale of mortgage loans held for sale                                   |       | 1,641,555                                           |       | 1,982,410                                      |       |
| Mortgage  loan originations                                                           |       | (1,875,298                                          | )          | (2,080,293                                     | )          |
| Decrease in  accounts receivable—mortgage loans sold/funded                      |       | 674                                                 |       | 1,251                                          |       |
| Increase in  restricted cash                                                          |       | —                                              |       | (625                                           | )          |
| Decrease in  accrued interest receivable                                              |       | 397                                                 |       | 550                                            |       |
| Increase in  deferred taxes                                                           |       | (2,053                                              | )          | (6,679                                         | )          |
| Increase in  other assets                                                             |       | (702                                                | )          | (778                                           | )          |
| Decrease in  derivative financial instruments                                         |       | (1,019                                              | )          | (1,181                                         | )          |
| Decrease in  accrued interest payable                                                 |       | (7                                                  | )          | (94                                            | )          |
| (Decrease)/increase  in accrued expenses and other liabilities                        |       | (5,003                                              | )          | 4,551                                          |       |
| Increase in  minority interest                                                        |       | 8                                                   |       | 3                                              |       |
| Principal  payments on bond collateral, mortgage loans, net, held for sale            |       | 15,615                                              |       | —                                         |       |
| Net cash  used in operating activities                                                |       | (226,259                                            | )          | (86,176                                        | )          |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                |       |                                                |       |                                           |       |
| Principal  payments on bond collateral, mortgage loans, net                           |       | 1,731                                               |       | 24,888                                         |       |
| Proceeds  from sale of real estate owned                                              |       | 1,289                                               |       | 2,989                                          |       |
| Net cash  provided by investing activities                                            |       | 3,020                                               |       | 27,877                                         |       |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                |       |                                                |       |                                           |       |
| Payments on  long-term debt                                                           |       | (2,151                                              | )          | (31,456                                        | )          |
| Increase in  net borrowings from short-term debt                                      |       | 208,634                                             |       | 98,892                                         |       |
| Stock  options exercised                                                              |       | 3                                                   |       | 2                                              |       |
| Net cash  provided by financing activities                                            |       | 206,486                                             |       | 67,438                                         |       |
| Net  (decrease)/increase in cash and cash equivalents                                 |       | (16,753                                             | )          | 9,139                                          |       |
| Cash and  cash equivalents at beginning of year                                       |       | 44,400                                              |       | 13,647                                         |       |
| Cash and  cash equivalents at end of period                                           |       | $                                                   | 27,647     |                                           | $          | 22,786 |   |
| Supplemental  information                                                             |       |                                                |       |                                           |       |
| Interest  paid                                                                        |       | $                                                   | 3,248      |                                           | $          | 4,202 |   |
| Taxes paid                                                                            |       | $                                                   | 2,720      |                                           | —     |   |
| Transfers  from bond collateral, mortgage loans, net to real estate owned             |       | $                                                   | 823        |                                           | $          | 2,245 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

5

----

 

**AMNET MORTGAGE, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1. Subsequent Events**

 

In May 2004, American ResidentialTrust, Inc. changed its name to AmNet Mortgage, Inc. (“AmNet Parent”). 

 

Due to favorable market conditions,approximately $113.9 in mortgage loan bond collateral and approximately $2.3million in REO bond collateral, which together represent the vast majority ofAmNet Parent’s remaining mortgage asset portfolio, were put up for sale inMarch, 2004.   Several offers forpurchase were received and buyers were selected for majority of the assets inthe 1999-1, 1999-2, and 1999-A structures. Additionally, AmNet Parent accepteda bid from another firm for all of the bond collateral in its 2000-2 structure.Accordingly, as of March 31, 2004, wereclassified certain mortgage portfolio assets as held for sale. Prior to thattime, these assets were classified as held for investment. The reclassifiedmortgage assets were loans and REO representing the bond collateral forCMO/REMIC 1999-A, CMO 1999-1, CMO 1999-2, and CMO/REMIC 2000-2.  As a result of the reclassification from heldfor investment to held for sale, it was necessary for us to value these assetsat the lower of cost or market. It was determined that the market value of theassets was lower than the carrying value and a valuation impairment of $4.4million was recorded at March 31, 2004. Upon expected completion of the sale inMay of 2004, there will be additional losses of up to $400 thousand of debtissuance cost which will be recorded in the second quarter of 2004.  The portfolio sales are expected toclose in May, and AmNet Parent will be required to simultaneously redeem andextinguish related CMO bond liabilities totaling approximately $90.1million.  Net cash proceeds, after debtextinguishment, are anticipated to be approximately $25 million.  The exact sales price and related expensesare subject to due diligence being completed by the buyers of these portfolioassets.

 
| **Period**                      | ** ** | **Total Number of Shares (or Units) Purchased** | ** ** | **Average Price Paid per Share (or Unit)** | ** ** | **Total Numbers of Shares (or Units) Purchased as Part of Publicly  Announced Plans or Programs** | ** ** | **Maximum Number (or Approximate Dollar Value) of Shares (or Units)  that May Yet Be Purchased Under the Plan or Programs** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
|                            |       |                                            |       |                                       |       |                                                                                              |       |                                                                                                                        |       |
| April 30, 2004   Board Approved |       |                                            |       |                                       |       |                                                                                              |       | $                                                                                                                           | 3,668,000  |   |
|                                 |            |                                                 |            |                                            |            |                                                                                                   |            |                                                                                                                             |            |  |

 

 

Contingent upon the successfulcompletion of the above-mentioned portfolio sales, the Board of Directorsauthorized the repurchase of up to 400,000 shares of the Company’s commonstock.  The timing of repurchases willdepend on market conditions and corporate requirements. There is no expiration date for the share repurchase plan. However,shares must be purchased at a 15% discount to book value.

 

In April 2004, AmNet Parent paidoff its $3 million outstanding debt under a Subordinated Loan Agreement (SeeNote 8 below).

 

**Note 2. Summary of Significant Accounting Policies and Practices**

 

*Basis of Financial Statement Presentation*

 

The consolidated financial statements includethe accounts of AmNet Parent, a Maryland corporation, American MortgageNetwork, Inc. (“AmNet Sub”), a Delaware corporation and wholly-ownedsubsidiary of AmNet Parent, American Residential Eagle, Inc., (“Eagle”), aDelaware special purpose corporation and wholly-owned subsidiary of AmNetParent and American Residential Eagle 2, Inc. (“Eagle 2”), aDelaware limited purpose corporation and wholly-owned subsidiary of Eagle (collectively“AmNet Parent”). Substantially all of the assets of Eagle and Eagle 2 arepledged or subordinated to support short or long-term debt in the form ofcollateralized mortgage bonds and are not available for the satisfaction of generalclaims of AmNet Parent. American Residential Holdings, Inc. (“Holdings”),is an affiliate of AmNet Parent that is consolidated in accordance with FASBInterpretation No. 46R “Consolidation of Variable Interest Entities.”AmNet Parent and Holdings are together referred to as the “Company.” TheCompany’s exposure to loss on the assets pledged as collateral is limited toits net investment, as the collateralized mortgage bonds are non-recourse tothe Company. All significant intercompany balances and transactions with AmNet,Eagle, Eagle 2, and Holdings have been eliminated in the consolidation ofAmNet Parent. Certain reclassifications may have been made to prior internalperiod amounts to conform to the current presentation.

 

In management’s opinion, all adjustmentsnecessary for a fair statement are reflected in the interim period presented.

 

Subsidiaries of AmNet Parent, Eagle andEagle 2 hold bond collateral assets of approximately $100.5 million and$36.9 million, respectively, at March 31, 2004.

 

Sales of mortgage loans are accounted forunder Statement of Financial Accounting Standards (SFAS) No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities.” Mortgage loans are sold with the mortgage servicing rights released.Gains or losses on sales of mortgage loans are recognized based on thedifference between the selling prices and the carrying value of the relatedmortgage loans sold. Deferred origination fees and expenses are recognized atthe time of sale.

 

In March 2004, the SEC released StaffAccounting Bulletin (SAB) No. 105, “Application of Accounting Principles toLoan Commitments.” The Company accounts for its commitments to extend credit asderivatives and records changes in fair value of the commitments in thestatement of operations. The adoption of SAB No. 105 is not expected to have asignificant effect on the Company’s financial statements.

 

Please refer to the Company’s Form 10-K forthe year ending December 31, 2003, for a detailed discussion of these policies.

 

6

----

 

*Stock Options*

 

The Company elected to apply APB OpinionNo. 25, “Accounting for Stock Issued to Employees,” in accounting for itsplans: the 1997 Stock Incentive Plan, 1997 Stock Option Plan, 1997 EmployeeStock Purchase Plan and 1997 Outside Directors Stock Option Plan. Accordingly,no compensation cost has been recognized in the financial statements.SFAS 123 “Accounting for Stock Based Compensation” requires pro formadisclosures of expense computed as if the fair value based method had beenapplied in the financial statements of companies that continue to account forsuch arrangements under Opinion No. 25.

 

In December 2002, the Financial AccountingStandards Board (“FASB”) issued SFAS 148, “Accounting For Stock BasedCompensation Transition and Disclosure,” which amends SFAS No. 123. SFASNo. 148 requires more prominent and frequent disclosures about the effectsof stock-based compensation, which the Company elected to early adopt for thetwelve-month period ending December 31, 2002. The Company will continue toaccount for its stock based compensation according to the provisions of APBOpinion No. 25.

 

The FASB is currently considering amendingSFAS 123, “Accounting for Stock-Based Compensation,” and APB Opinion No. 25,“Accounting for Stock Issued to Employees.” The proposed standard will requirethe Company to record compensation expense for all share-based compensationplans. If adopted, this proposed standard would have a negative impact on ourearnings in future periods.

 

Had compensation cost for the Company’s stockoptions been recognized based upon the estimated fair value on the grant dateunder the fair value methodology prescribed by SFAS No. 123, as amended bySFAS No. 148, the Company’s net income (loss) and earnings per share wouldhave been as follows (in thousands except earnings per share) (unaudited):

 

| ** **                                                                                                                  | ** ** | **Three months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                  | ** ** | **March 31, 2004**     | ** ** | **March 31, 2003** | ** ** |
|                                                                                                                        |       |                   |       |   |   |
| Net (loss)  earnings as reported                                                                                            |       | $                      | (5,672     | ) | $ | 12,156 |   |
| Deduct:  Total stock-based compensation expense determined under fair value-based  method, net of tax effects (See Note 10) |       | (283                   | )          | (518 | ) |
| Pro forma  net (loss) earnings                                                                                              |       | $                      | (5,955     | ) | $ | 11,638 |   |
| (Loss)  earnings per share:                                                                                                 |       |                   |       |   |   |
| Basic as  reported                                                                                                          |       | $                      | (0.72      | ) | $ | 1.55 |   |
| Basic pro  forma                                                                                                            |       | $                      | (0.76      | ) | $ | 1.48 |   |
| Diluted as  reported                                                                                                        |       | $                      | (0.72      | ) | $ | 1.53 |   |
| Diluted pro  forma                                                                                                          |       | $                      | (0.76      | ) | $ | 1.46 |   |

 

The assumptions used to calculate the fairvalue of options granted are evaluated and revised as necessary to reflectmarket conditions and the Company’s experience.

 

**Note 3. Concentration of Mortgage Loan Sales**

 

For the three months ending March 31, 2004, the Company sold a majorityof the mortgage loans it originated to two of it's competitors, CountrywideHome Loans, Inc (68%) and Wells Fargo (16%). The Company’s considerations indeciding where to sell loans are price and operational efficiency.  The Company also considers speed of executionand loan product guidelines.  The Companybelieves that all of the loans it sells currently could be sold to a number ofother investors. A Countrywide entity, Countrywide Warehouse Lending, is also awarehouse lender to the Company (see Note 8 Short-Term Debt).

 

7

----

 

**Note 4. Income Per Share**

 

The following table illustrates the computation of basic and dilutedincome per share (in thousands, except share and per share data) (unaudited):

 
| ** **                                                                                                               | ** ** | **For the three  months ended  March 31, 2004** | ** ** | **For the three  months ended  March 31, 2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| Numerator:                                                                                                               |       |                                            |       |                                            |       |
| Numerator  for basic (loss) income per share                                                                             |       | $                                               | (5,672     | )                                               | $          | 12,156 |   |
| Denominator:                                                                                                             |       |                                            |       |                                            |       |
| Denominator  for basic (loss) income per share - weighted average number of common shares  outstanding during the period |       | 7,874,347                                       |       | 7,862,869                                       |       |
| Denominator  for diluted (loss) income per share                                                                         |       | 7,874,347                                       |       | 7,945,795                                       |       |
|                                                                                                                     |       |                                            |       |                                            |       |
| (Loss)  income per share - basic                                                                                         |       | $                                               | (0.72      | )                                               | $          | 1.55 |   |
| (Loss)  income per share - diluted                                                                                       |       | $                                               | (0.72      | )                                               | $          | 1.53 |   |

 

For the three months ended March 31, 2004 and 2003 there were 1,411,917and 1,526,227 options, respectively, that were antidilutive and, therefore, notincluded in the calculations above.

 

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

 

AmNet Sub has pledged loans held for sale totaling approximately $510.5million to secure credit lines (warehouse facilities) from four financialinstitutions. See Note 8, “Short-Term Debt.” Mortgage loans held for sale atMarch 31, 2004 consist of loans which have been committed for sale ofapproximately $196.7 million and loans available for sale at approximately$313.8 million, all of which are carried at the lower of cost or market value.

 

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

 

AmNet Parent has pledged collateral in orderto secure the long-term debt issued in the form of CMOs. Bond Collateral MortgageLoans consist primarily of adjustable-rate, conventional, 30-year mortgageloans secured by first liens on one-to-four family residential properties. Asof March 31, 2004 and 2003, 17.17% and 17.82%, respectively, of the bondcollateral mortgage loans were fixed rate loans. The balance of the bondcollateral mortgage loans are adjustable-rate mortgages. All Bond CollateralMortgage Loans are pledged to secure repayment of the related long-term debtobligation. All principal and interest (less servicing and related fees) on thebond collateral is remitted to a trustee and is available for payment of thelong-term debt obligation. The obligations under the long-term debt are payablesolely from the bond collateral and are otherwise non-recourse to AmNet Parent.

 

As of March 31, 2004, AmNet Parentreclassified at the lower of cost or market, certain mortgage assets heretoforecarried as held for investment to held for sale as a result of a pending saleof approximately $116 million of bond collateral. AmNet Parent intends to use aportion of the proceeds to redeem the underlying collateralized debt. Thereclassified mortgage assets were loans representing the bond collateral forCMO/REMIC 1999-A, CMO 1999-1, CMO 1999-2, and CMO/REMIC 2000-2.  AmNet Parent recorded a valuation adjustmentof $4.4 million at March 31, 2004 to reflect the loss on sale of the bondcollateral.

8

----

 

The components of the Bond Collateral Mortgage Loans held for sale orinvestment at March 31, 2004 and 2003, are summarized as follows (dollarsin thousands) (unaudited):

 
| ** **                                           | ** ** | **Pending Sale  CMO/REMIC  2000-2  Securitization** | ** ** | **Pending Sale  CMO/REMIC  1999-A  Securitization** | ** ** | **Pending Sale  CMO  1999-2  Securitization** | ** ** | **Pending Sale  CMO  1999-1  Securitization** | ** ** | **Total  Pending  Sale** | ** ** | **Held for  Investment  CMO/FASIT  1998-1  Securitization** | ** ** | **TOTAL  Bond  Collateral  Mortgage  Loans** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|--------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------|------------|
|                                                 |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| **At March  31, 2004**                               |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| Mortgage  loans                                      |       | $                                                   | 5,959      |                                                | $          | 36,847                                        |       | $                                             | 51,136     |                     | $          | 22,649                                                      |       | $                                            | 116,591    |   | $ | 20,862 |   | $ | 137,453 |   |
| Unamortized  premium                                 |       | 238                                                 |       | 665                                                 |       | 1,400                                         |       | 627                                           |       | 2,930                    |       | 78                                                          |       | 3,008                                        |       |
| Allowance  for loan losses                           |       | (143                                                | )          | (337                                                | )          | (473                                          | )          | (219                                          | )          | (1,172                   | )          | (348                                                        | )          | (1,520                                       | )          |
|                                                 |       | $                                                   | 6,054      |                                                | $          | 37,175                                        |       | $                                             | 52,063     |                     | $          | 23,057                                                      |       | $                                            | 118,349    |   | $ | 20,592 |   | $ | 138,941 |   |
| Valuation adjustment                                 |       | (27                                                 | )          | (1,277                                              | )          | (2,011                                        | )          | (1,113                                        | )          | (4,428                   | )          | —                                                      |       | (4,428                                       | )          |
|                                                 |       | $                                                   | 6,027      |                                                | $          | 35,898                                        |       | $                                             | 50,052     |                     | $          | 21,944                                                      |       | $                                            | 113,921    |   | $ | 20,592 |   | $ | 134,513 |   |
|                                                 |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| Weighted  average net coupon                         |       | 9.30                                                | %          | 9.48                                                | %          | 8.99                                          | %          | 8.90                                          | %          | 9.14                     | %          | 9.42                                                        | %          | 9.19                                         | %          |
| Unamortized  premiums as a percent of Mortgage Loans |       | 4.00                                                | %          | 1.80                                                | %          | 2.74                                          | %          | 2.77                                          | %          | 2.51                     | %          | 0.37                                                        | %          | 2.19                                         | %          |
|                                                 |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| **At March  31, 2003**                               |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| Mortgage  loans                                      |       | $                                                   | 13,027     |                                                | $          | 56,985                                        |       | $                                             | 85,974     |                     | $          | 41,382                                                      |       | $                                            | 197,368    |   | $ | 29,974 |   | $ | 227,342 |   |
| Unamortized  premium                                 |       | 546                                                 |       | 1,297                                               |       | 3,010                                         |       | 1,171                                         |       | 6,024                    |       | 291                                                         |       | 6,315                                        |       |
| Allowance  for loan losses                           |       | (138                                                | )          | (891                                                | )          | (872                                          | )          | (474                                          | )          | (2,375                   | )          | (478                                                        | )          | (2,853                                       | )          |
|                                                 |       | $                                                   | 13,435     |                                                | $          | 57,391                                        |       | $                                             | 88,112     |                     | $          | 42,079                                                      |       | $                                            | 201,017    |   | $ | 29,787 |   | $ | 230,804 |   |
|                                                 |       |                                                |       |                                                |       |                                          |       |                                          |       |                     |       |                                                        |       |                                         |       |
| Weighted  average net coupon                         |       | 9.17                                                | %          | 9.46                                                | %          | 8.97                                          | %          | 8.86                                          | %          | 9.11                     | %          | 9.52                                                        | %          | 9.16                                         | %          |
| Unamortized  premiums as a percent of Mortgage Loans |       | 4.19                                                | %          | 2.28                                                | %          | 3.50                                          | %          | 2.83                                          | %          | 3.05                     | %          | 0.97                                                        | %          | 2.78                                         | %          |

 

**Note 7.  Derivative Financial Instruments**

 

In the ordinary course of business AmNet Submakes commitments to fund mortgages at set interest rates, which we refer toindividually as rate lock commitments, and has funded loans not committed forsale.  Collectively, this is our pipeline.  The value of the rate lock commitments anduncommitted loans will vary depending on changes in market interest ratesbetween the time that a rate lock commitment is made and the time that the loanfunds and is committed for sale to an investor.

 

AmNet Sub attempts to estimate the number of ratelock commitments in the pipeline that will not close in order to calculate itsinterest rate exposure on a daily basis. AmNet Sub then purchases hedginginstruments in order to try to protect profit margins on (i) locked loans inthe pipeline and (ii) closed loans before they are committed for sale.  The hedging instruments used are forwardsales of mortgage-backed securities (“TBA”) and options on forwards sales ofmortgage-backed securities. Changes in the price of these instruments closelyrelate to changes in the value (price) of loans in the pipeline and closedloans not yet committed for sale.

 

At March 31, 2004 and March 31, 2003 AmNetSub had the following pipeline, closed loans not yet committed for sale toinvestors, and offsetting hedge coverage as follows (dollars in thousands)(unaudited):

 
| ** **                                                                                | ** ** | **3/31/04** | ** ** | **3/31/03** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Interest  rate exposure:                                                                  |       |        |       |        |       |
| Commitments  to originate loans at set interest rates (pipeline) (after applying fallout) |       | $           | 883,957    |        | $          | 746,413 |   |
|                                                                                      |       |        |       |        |       |
| Closed  loans not yet committed for sale to investors                                     |       | 313,852     |       | 225,716     |       |
| Hedge  coverage:                                                                          |       |        |       |        |       |
| Forward  sales of mortgage-backed securities (TBA)(notional amount)                       |       | 1,067,500   |       | 856,500     |       |
|                                                                                      |       |        |       |        |       |
| Options on  forward sales of mortgage-backed securities (notional amount)                 |       | 185,000     |       | 150,000     |       |
|                                                                                           |            |             |            |             |            |  |  |

 

9

----

 

The fair value of forward sales ofmortgage-backed securities and options on forward sales of mortgage-backedsecurities are based on quoted market prices for these instruments. Themortgage loan pipeline is also considered a derivative instrument and isassigned a fair value based on the change in the quoted market value of theunderlying loans due to market movements, less an estimated factor for loansthat will not close (fallout ratio). The fallout ratio is affected by theCompany’s recent fallout history, interest rate changes and pipelinecharacteristics.

 

The following is a summary of the carryingvalue of AmNet Sub’s derivative instruments as of March 31, 2004 and March 31,2003 (dollars in thousands) (unaudited):

 
| **March 31,  2004**                                   | ** ** | **Range of  Coupon Rate** | ** ** | **Range of  Notional Amount** | ** **   | **Fair Value** | ** ** | **Range of  Expiration Dates** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|--------------|----------------|------------|--------------------------------|------------|
| ***Forward  sales of mortgage-backed securities (TBAs):*** |       |                      |       |                          |         |           |       |                           |       |
| Fifteen  year Fannie Mae                                   |       | 4.0-5.5 MBS               |       | $                             | 4,000-20,000 |           | $          | (347                           | )          | Apr 20-June 17, 2004 |   |
| Thirty year  Fannie Mae                                    |       | 4.5-5.5 MBS               |       | 500-30,000                    |         | (295           | )          | Apr 15-June 14, 2004           |       |
| Thirty year  Ginnie Mae                                    |       | 4.5-5.5 MBS               |       | 1,500-10,000                  |         | (194           | )          | Apr 22-June 22, 2004           |       |
| Thirty year  Ginnie Mae II                                 |       | 5.0 MBS                   |       | 6,500                         |         | 46             |       | Apr 22, 2004                   |       |
| ***Options  on TBAs:***                                    |       |                      |       |                          |         |           |       |                           |       |
| Thirty year  Fannie Mae                                    |       | 5.0-5.5 Puts              |       | 15,000-50,000                 |         | 880            |       | Apr 15-May 13, 2004            |       |
| ***Rate  Lock Commitments (loan pipeline)***               |       |                      |       |                          |         | (295           | )          |                           |       |
| ***Total  derivative financial instruments***              |       |                      |       |                          |         | $              | (205       | )                              |       |   |
|                                                            |            |                           |            |                               |              |                |            |                                |            |  |  |

 
| **March 31, 2003**                                    | ** ** | **Range of  Coupon Rate** | ** ** | **Range of  Notional Amount** | ** **   | **Fair Value** | ** ** | **Range of  Expiration Dates** | ** ** |
|------------------------------------------------------------|------------|---------------------------|------------|-------------------------------|--------------|----------------|------------|--------------------------------|------------|
| ***Forward  sales of mortgage-backed securities (TBAs):*** |       |                      |       |                          |         |           |       |                           |       |
| Fifteen  year Fannie Mae                                   |       | 4.5-5.5 MBS               |       | $                             | 4,000-20,000 |           | $          | (1,615                         | )          | May 19-June 17, 2003 |   |
| Thirty year  Fannie Mae                                    |       | 5.0-6.0 MBS               |       | 500-45,000                    |         | (1,005         | )          | Apr-June 12, 2003              |       |
| Thirty year  Ginnie Mae                                    |       | 5.0-6.0 MBS               |       | 1,500-10,000                  |         | (127           | )          | May 21-June 19, 2003           |       |
| ***Options  on TBAs:***                                    |       |                      |       |                          |         |           |       |                           |       |
| Thirty year  Fannie Mae                                    |       | 5.5 Puts                  |       | 10,000-25,000                 |         | 812            |       | Apr 14-June 12, 2003           |       |
| Thirty year  Ginnie Mae                                    |       | 5.5 Puts                  |       | 15,000                        |         | 2              |       | Apr 23, 2003                   |       |
| ***Rate  Lock Commitments (loan pipeline)***               |       |                      |       |                          |         | 807            |       |                           |       |
| ***Total  derivative financial instruments***              |       |                      |       |                          |         | $              | (1,126     | )                              |       |   |
|                                                            |            |                           |            |                               |              |                |            |                                |            |  |  |

 

**Note 8. Short-Term Debt**

 

As of March 31, 2004, mortgage loansheld for sale totaling $510.5 million were pledged as collateral forwarehouse facility borrowings of $492.3 million with four financialinstitutions. At March 31, 2004, the Company's maximum borrowing capacitycombined from these four financial institutions was $1.4 billion.  The table below shows the age of pledgedmortgage loans as of March 31, 2004. (unaudited):

 
| **Aging Range**     | ** ** | **Number of Loans** | ** ** | **Warehouse line usage** | ** ** | **% of Total** | ** ** |
|---------------------|------------|---------------------|------------|--------------------------|------------|----------------|------------|
| ** **          | ** ** | ** **          | ** ** | **(in thousands)**       | ** ** | ** **     | ** ** |
| Less than  30 days  |       | 2,685               |       | $                        | 477,610    |           | 97.0       | % |
| 30 to 60  days      |       | 66                  |       | 13,016                   |       | 2.6            | %          |
| 61 days to  90 days |       | 15                  |       | 1,666                    |       | 0.4            | %          |
| TOTAL               |       | 2,766               |       | $                        | 492,292    |           | 100.0      | % |

 

Of the $492.3 million of warehouse line usage at March 31, 2004, $108.3million was funded through uncommitted warehouse facilities.

 

Warehouse facilities mature on various dateswithin one year, generally bearing interest at one-month LIBOR plus spread. Theweighted average borrowing rates were 2.48% at March 31, 2004 and 2.75% atMarch 31, 2003. The weighted-average borrowing rate was 2.43% for the threemonths ending March 31, 2004 (2.73% for the three months ending March 31, 2003)and the weighted average facility fee is 0.42% and 0.25%, respectively for thesame periods on the aggregate committed amount of the warehouse facilities. Thewarehouse facilities are repaid as principal payments on mortgage loans arereceived, or as the mortgage loans are sold. The agreements governing thesefacilities contain a number of covenants, including covenants based on tangiblenet worth, net income, and liquidity of the Company.

 

Asa direct result of the Company’s expected first quarter net loss, at March 31,2004, the Company was out of compliance with certain of its warehouse lendingagreements. The Company was out of compliance with earnings

 

10

----

 

covenants in its JPMorgan Chase Bank and CountrywideWarehouse Lending agreements, and with a net worth covenant in its ResidentialFunding Corporation agreement. Prior to the non-compliance, the warehouseproviders each waived the covenants for which the Company was out ofcompliance.

 

In 2001, the Company also entered into a$5 million senior subordinated secured revolving loan agreement(“Subordinated Loan Agreement”). The Subordinated Loan Agreement bore aninterest rate of 12%, and as of March 31, 2004, there was $3 million inborrowings under the Subordinated Loan Agreement. The loan was paid off inApril 2004.

 

In April of 2004, the Companyentered into agreements to sell 85% of the bond collateral and notified thedebt holders of its intention to redeem underlying CMO debt. Accordingly, $90million of CMO bond liabilities have been reclassified to short-term debt.

 

**Note 9. Debt Related to Securitizations, net**

 

The components of the long-term debt at March 31, 2004 and December 31,2003, along with selected other information are summarized below (dollars inthousands) (unaudited):

 

 
| ** **                           | ** ** | **Pending Redemption**                | ** **  | ** **                            | ** ** | ** **                      | ** ** | ** **                      | ** **   |
|--------------------------------------|------------|---------------------------------------|-------------|---------------------------------------|------------|---------------------------------|------------|---------------------------------|--------------|
| ** **                           | ** ** | **CMO/REMIC  2000-2  Securitization** | ** **  | **CMO/REMIC  1999-A  Securitization** | ** ** | **CMO  1999-2  Securitization** | ** ** | **CMO  1999-1  Securitization** | ** **   | **Total  Pending  Sale** | ** ** | **CMO/FASIT  1998-1  Securitization** | ** ** | **Total Debt  Related to  Securitizations, Net** | ** ** |
| **At March 31, 2004**                |       |                                  |        |                                  |       |                            |       |                            |         |   |   |   |   |   |   |
| Debt related to securitization       |       | $                                     |  6,154 |                                  | $          |  29,215                    |       | $                               |  43,067 |   | $ |  12,066 |   | $ | 90,502 |   | $ |  20,078 |   | $ |  110,580 |   |
| Capitalized costs on  long-term debt |       | (26                                   | )           | (1                                    | )          | (232                            | )          | (146                            | )            | (405 | ) | — |   | (405 | ) |
| Total long-term debt                 |       | $                                     |  6,128 |                                  | $          |  29,214                    |       | $                               |  42,835 |   | $ |  11,920 |   | $ | 90,097 |   | $ |  20,078 |   | $ |  110,175 |   |
|                                 |       |                                  |        |                                  |       |                            |       |                            |         |   |   |   |   |   |   |
| Weighted average financing  rates    |       | 2.17                                  | %      | 1.14                                  | %     | 3.32                            | %     | 1.73                            | %       | 2.34 | % | 2.04 | % | 2.29 | % |
|                                 |       |                                  |        |                                  |       |                            |       |                            |         |   |   |   |   |   |   |
| **At December 31, 2003**             |       |                                  |        |                                  |       |                            |       |                            |         |   |   |   |   |   |   |
| Debt related to securitization       |       | $                                     |  7,182 |                                  | $          |  33,012                    |       | $                               |  51,594 |   | $ |  16,753 |   | $ | 108,541 |   | $ |  22,229 |   | $ |  130,770 |   |
| Capitalized costs on  long-term debt |       | (30                                   | )           | (1                                    | )          | (267                            | )          | (177                            | )            | (475 | ) | — |   | (475 | ) |
| Total long-term debt                 |       | $                                     |  7,152 |                                  | $          |  33,011                    |       | $                               |  51,327 |   | $ |  16,576 |   | $ | 108,065 |   | $ |  22,229 |   | $ |  130,295 |   |
|                                 |       |                                  |        |                                  |       |                            |       |                            |         |   |   |   |   |   |   |
| Weighted average financing  rates    |       | 2.24                                  | %           | 1.29                                  | %          | 3.33                            | %          | 1.82                            | %            | 2.43 | % | 2.14 | % | 2.37 | % |

 

**Note 10.Stock Option Plans**

 

As of March 31, 2004, shares of common stock were reserved for issuanceunder the Company’s option plans as follows (unaudited):

 
| ** **                            | ** ** | **1997 Stock Incentive Plan** | ** ** | **1997 Stock Option Plan** | ** ** | **1997 Employee Stock Purchase Plan** | ** ** | **1997 Outside Director Stock Option Plan** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|----------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|-----------|------------|
|                                  |       |                          |       |                       |       |                                  |       |                                        |       |      |       |
| Total  Options Authorized at 1/1/2004 |       | 315,200                       |       | 1,474,800                  |       | 20,000                                |       | 210,000                                     |       | 2,020,000 |       |
| Total  Options Issued                 |       | 284,800                       |       | 1,380,925                  |       | —                                |       | 210,000                                     |       | 1,875,725 |       |
| Options  Reserved for Issuance        |       | 30,400                        |       | 93,875                     |       | 20,000                                |       | —                                      |       | 144,275   |       |

 

Stock option activity during the quarter ending March 31, 2004 was asfollows (unaudited):

 
| ** **                    | ** ** | **Number of  Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|-------------------------------|------------|------------------------|------------|--------------------------------------|------------|
|                          |       |                   |       |                                 |       |
| Balance at  December 31, 2003 |       | 1,768,100              |       | $                                    | 7.96       |   |
| Granted                       |       | 96,609                 |       | 8.32                                 |       |
| Forfeited                     |       | (20,208                | )          | 5.17                                 |       |
| Exercised                     |       | (6,920                 | )          | 4.70                                 |       |
| Balance at  March 31, 2004    |       | 1,837,581              |       | $                                    | 8.03       |   |

 

11

----

 

At March 31, 2004, the range of exercise prices for outstanding optionswas $1.75 to $15.00 and the weighted-average remaining contractual life ofoutstanding options was 6.84 years. The weighted average exercise price ofexercisable outstanding options was $7.36. The table below shows options and prices for all outstanding options atMarch 31, 2004 (unaudited):

 
| **Option  Exercise Price Range** | ** ** | **Vested** | ** ** | **Unvested** | ** ** | **Number of Options** | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|-----------------------|------------|
|                             |       |       |       |         |       |                  |       |
| $1.75 to $3.00                   |       | 109,143    |       | 85,357       |       | 194,500               |       |
| $3.01 to $5.00                   |       | 212,590    |       | 298,035      |       | 510,625               |       |
| $5.01 to $7.50                   |       | 313,700    |       | 48,000       |       | 361,700               |       |
| $7.51 to $10.00                  |       | 101,800    |       | 154,200      |       | 256,000               |       |
| $10.01 to $12.50                 |       | 286,675    |       | 2,625        |       | 289,300               |       |
| $12.51 to $15.00                 |       | 263,600    |       | —       |       | 263,600               |       |
|                             |       | 1,287,508  |       | 588,217      |       | 1,875,725             |       |

 

The per share weighted-average fair value of stock options grantedbetween January 1, 2004 and March 31, 2004 was $2.48 (see Note 2) on the datesof grant using the Black-Scholes option-pricing model, applied using thefollowing weighted-average assumptions (unaudited):

 
| ** **               | ** ** | **March 31, 2004** | ** ** |
|--------------------------|------------|--------------------|------------|
| Expected  dividend yield |       | 0.00               | %          |
| Risk-free  interest rate |       | 2.80               | %          |
| Expected  volatility     |       | 27.78              | %          |
| Expected  life (years)   |       | 5                  |       |

 

**Note 11. Business Segments**

 

The Company reports its financial results intwo segments: the Mortgage Banking Business and the Mortgage Asset PortfolioBusiness. The Mortgage Banking Business originates home mortgage loans througha network of mortgage loan brokers. These mortgage loans are subsequently soldto financial institutions. The Mortgage Asset Portfolio Business segmentmanages a portfolio of mortgage loans pledged as collateral for CMO debt.

 

The accounting policies of the segments arethe same as described in Note 2, “Summary of Significant AccountingPolicies and Practices.” The Company evaluates the performance of its businesssegments based on income before income taxes. Expenses under the direct controlof each business segment and the expense of premises and equipment incurred tosupport business operations are allocated accordingly, by segment.

 

The table below reflects the total assets atMarch 31, 2004 and 2003, and the capital expenditures for three-monthperiods ending March 31, 2004 and 2003 (in thousands) (unaudited):

 
| ** **                                                             | ** ** | **Mortgage  Banking** | ** ** | **Mortgage Asset  Portfolio** | ** ** | **Combined  Segments** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------------|------------|------------------------|------------|
|                                                                   |       |                  |       |                          |       |                   |       |
| Total  assets as of March 31, 2004                                     |       | $                     | 541,579    |                          | $          | 155,481                |       | $ | 697,060 |   |
| Total  capital expenditures for the three months ending March 31, 2004 |       | $                     | 485        |                          | —     |                   | $          | 485 |   |
|                                                                   |       |                  |       |                          |       |                   |       |
| Total  assets as of March 31, 2003                                     |       | $                     | 512,313    |                          | $          | 255,966                |       | $ | 768,279 |   |
| Total  capital expenditures for the three months ending March 31, 2003 |       | $                     | 526        |                          | —     |                   | $          | 526 |   |
|                                                                   |       |                  |       |                          |       |                   |       |

 

12

----

 

The tables below reflect the year-to-dateincome statement activity by segment for the three-month periods ending March31, 2004 and March 31, 2003:

 

AmNet Mortgage, Inc. and SubsidiariesConsolidated Statements of Operations by Business Segment, (unaudited)

(in thousands)

 
| ** **                                                                     | ** ** | **For the Three Months  Ended March 31, 2004** | ** ** | **For the Three Months  Ended March 31, 2004** | ** ** | **For the Three Months  Ended March 31, 2004** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Mortgage  Banking**                          | ** ** | **Mortgage Asset  Portfolio**                  | ** ** | **Combined  Segments**                         | ** ** |
|                                                                           |       |                                           |       |                                           |       |                                           |       |
| **Revenues**                                                                   |       |                                           |       |                                           |       |                                           |       |
| Gain on  sales of loans                                                        |       | $                                              | 15,515     |                                           | $          | —                                         |       | $ | 15,515 |   |
| Derivative  financial instruments and market adjustments                       |       |                                           |       |                                           |       |                                           |       |
| Derivative  financial instruments—forward commitments and options         |       | (5,487                                         | )          | —                                         |       | (5,487                                         | )          |
| Market  adjustment on interest rate lock commitments                           |       | (1,157                                         | )          | —                                         |       | (1,157                                         | )          |
| Total  derivative financial instruments and market adjustments                 |       | (6,644                                         | )          | —                                         |       | (6,644                                         | )          |
| Interest on  mortgage assets                                                   |       | 5,013                                          |       | 1,628                                          |       | 6,641                                          |       |
| Other income                                                                   |       | 80                                             |       | 216                                            |       | 296                                            |       |
| Total  revenue, net of derivative financial instruments and market adjustments |       | 13,964                                         |       | 1,844                                          |       | 15,808                                         |       |
| **Expenses**                                                                   |       |                                           |       |                                           |       |                                           |       |
| Employee  compensation and benefits                                            |       | 11,700                                         |       | 142                                            |       | 11,842                                         |       |
| Interest  expense                                                              |       | 2,346                                          |       | 895                                            |       | 3,241                                          |       |
| Office and  occupancy expense                                                  |       | 836                                            |       | —                                         |       | 836                                            |       |
| Gain on  sale of real estate owned, net                                        |       | —                                         |       | (259                                           | )          | (259                                           | )          |
| Valuation  adjustment-bond collateral                                          |       | —                                         |       | 4,428                                          |       | 4,428                                          |       |
| Professional  fees                                                             |       | 912                                            |       | 123                                            |       | 1,035                                          |       |
| Other  operating expenses                                                      |       | 4,088                                          |       | 165                                            |       | 4,253                                          |       |
| Total  expenses                                                                |       | 19,882                                         |       | 5,494                                          |       | 25,376                                         |       |
| Loss before  income taxes                                                      |       | (5,918                                         | )          | (3,650                                         | )          | (9,568                                         | )          |
| Income tax  benefit                                                            |       | (2,378                                         | )          | (1,518                                         | )          | (3,896                                         | )          |
| Net loss                                                                       |       | $                                              | (3,540     | )                                              | $          | (2,132                                         | )          | $ | (5,672 | ) |

 

13

----

 
| ** **                                                                     | ** ** | **For the Three Months  Ended March 31, 2003** | ** ** | **For the Three Months  Ended March 31, 2003** | ** ** | **For the Three Months  Ended March 31, 2003** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                     | ** ** | **Mortgage  Banking**                          | ** ** | **Mortgage Asset  Portfolio**                  | ** ** | **Combined  Segments**                         | ** ** |
|                                                                           |       |                                           |       |                                           |       |                                           |       |
| **Revenues**                                                                   |       |                                           |       |                                           |       |                                           |       |
| Gain on  sales of loans                                                        |       | $                                              | 20,209     |                                           | $          | —                                         |       | $ | 20,209 |   |
| Derivative  financial instruments and market adjustments                       |       |                                           |       |                                           |       |                                           |       |
| Derivative  financial instruments—forward commitments and options         |       | (52                                            | )          | —                                         |       | (52                                            | )          |
| Market  adjustment on interest rate lock commitments                           |       | (2,159                                         | )          | —                                         |       | (2,159                                         | )          |
| Total  derivative financial instruments and market adjustments                 |       | (2,211                                         | )          | —                                         |       | (2,211                                         | )          |
| Interest on  mortgage assets                                                   |       | 5,902                                          |       | 3,344                                          |       | 9,246                                          |       |
| Other  income                                                                  |       | 17                                             |       | 198                                            |       | 215                                            |       |
| Total  revenue, net of derivative financial instruments and market adjustments |       | 23,917                                         |       | 3,542                                          |       | 27,459                                         |       |
| **Expenses**                                                                   |       |                                           |       |                                           |       |                                           |       |
| Employee  compensation and benefits                                            |       | 9,145                                          |       | 339                                            |       | 9,484                                          |       |
| Interest  expense                                                              |       | 2,674                                          |       | 1,539                                          |       | 4,213                                          |       |
| Office and  occupancy expense                                                  |       | 566                                            |       | —                                         |       | 566                                            |       |
| Provision  for loan losses                                                     |       | —                                         |       | 919                                            |       | 919                                            |       |
| Gain on  sale of real estate owned, net                                        |       | —                                         |       | (184                                           | )          | (184                                           | )          |
| Professional  fees                                                             |       | 1,090                                          |       | 315                                            |       | 1,405                                          |       |
| Other  operating expenses                                                      |       | 3,495                                          |       | 258                                            |       | 3,753                                          |       |
| Total  expenses                                                                |       | 16,970                                         |       | 3,186                                          |       | 20,156                                         |       |
| Income  before income taxes                                                    |       | 6,947                                          |       | 356                                            |       | 7,303                                          |       |
| Income tax  (benefit)                                                          |       | 1,826                                          |       | (6,679                                         | )          | (4,853                                         | )          |
| Net income                                                                     |       | $                                              | 5,121      |                                           | $          | 7,035                                          |       | $ | 12,156 |   |

 

**Note 12. Income Taxes**

 

During 1997, the Company elected tobe taxed as a real estate investment trust (“REIT”) under the Internal RevenueCode of 1986, as amended. As a result of this election, the Company was not, withcertain exceptions, taxed at the corporate level on the net income distributedto the Company’s shareholders. On July 19, 2002, the shareholders of theCompany approved two proposals that allowed for the conversion of the Companyfrom a REIT to a fully taxable entity. On February 7, 2003, the Company filed anotice with the Internal Revenue Service of its decision to de-REIT, effectivebeginning January 1, 2003.

 

As a result of the conversion tofully taxable status, an income tax benefit and related deferred tax asset of$6.7 million, after valuation allowance, was recorded in 2003.  The deferred tax asset has been and willcontinue to be reduced by realization of income tax provisions over time.  In addition, the Company recorded an assumedincome tax benefit for the three months ended March 31, 2004 of $3.9 million asa result of a pretax loss of $9.6 million. This benefit was calculated based on an assumed income tax rate of 41%for 2004.

 

**Note 13. Commitments and Contingencies**

 

*Lease Commitments*

 

The Company rents certain premises andequipment under non-cancelable operating leases expiring at various datesthrough the year 2008. Rental expense under such leases is included in officeand occupancy expense, and other operating expenses. Lease costs totaled$913 thousand in the quarter ending March 31, 2004 and $615 thousandin the quarter ending March 31, 2003. Future minimum lease payments under theseleases as of March 31, 2004, are as follows (dollars in thousands)(unaudited):

 

| **Year ending  March 31:** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|
| 2005                            |       | $          | 3,533      |   |
| 2006                            |       | 2,594      |       |
| 2007                            |       | 1,150      |       |
| 2008                            |       | 703        |       |
| 2009 and  thereafter            |       | 381        |       |
|                            |       | $          | 8,361      |   |

 

14

----

 

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

 

*The statements contained in this Form 10-Q that are not purelyhistorical are forward looking statements, including statements regarding ourexpectations, hopes, beliefs, intentions, or strategies regarding the future.Such statements use the words “expect,” “will,” “may,” “anticipate,” “goal,”“intend,” “seek,” “believe,” “plan,” “strategy” and derivatives of such words.Forward looking statements in this report include those statements regarding:*

 

•                                          *the percentage of interest rate lockcommitments that will likely result in mortgage loan fundings;*

 

*•**                                         **our expectation of being able to renew,increase and syndicate our warehouse borrowing facilities;*

 

*•**                                         **the expectation that AmNet Sub’s primarysource of revenues will be interest income, gains on sales of loans, net ofgains or losses on derivative financial instruments;*

 

*•**                                         **our belief that the quality of our loanproducts and services will permit us to gain market share even if demand formortgages declines;*

 

*•**                                         **our expectations surrounding the total sizeof the loan origination market, our ability to originate loans, expand marketshare and be profitable in a potentially declining market, our loan originationvolume and our expectations regarding higher loan costs and our target profitmargins on each loan;*

 

*•**                                         **our expectations surrounding our cashrequirements, expenses, cash flow from operations, the sufficiency of ourcapital base, the sufficiency of our cash reserves and our sources ofliquidity, including our ability to maintain our warehouse lending facilitiesand the factors we expect to affect our ability to do so;*

 

*•**                                         **the expected adequacy of our variousreserves;*

 

*•**                                         **our intention to expand operations in 2004and the expected costs of doing so;*

 

*•**                                         **our intention to continue to try and hedgeagainst market fluctuations in interest rates and protect profit margins on ourloan pipeline and loans, the instruments we intend to use and the expectedinverse relationship of gains on hedging to margins on loan sales;*

 

*•**                                         **the expected correlation of our profitabilityto loan origination volume;*

 

*•**                                         **the anticipated impact from the adoption ofSAB 105;*

 

*•**                                         **management’s expectations regarding an appealby Loan City of a verdict in favor of the Company;*

 

*•**                                         **our belief that we will continue to qualifyfor correspondent lending programs and its ability to find alternative buyersfor loans it originates;*

 

*•**                                         **the expected concentration of our loans inCalifornia;*

 

*•**                                         **the expected maturity dates for our long-termdebt;*

 

*•**                                         **the sub-prime loans we plan to offer, ourexpectations regarding our future levels of sub-prime originations and theoperations and risks related to such originations;*

 

*•**                                         **our expectation that interest rates may riseand the anticipated effect on various aspects of our business from changes ininterest rates, including increased loan generation cost per loan and changesin the value of our loans and our derivatives;*

 

*•**                                         **our expectations regarding the sale of asubstantial portion of our mortgage asset portfolio, our uses of cash therefrom, and the impact on our operations;*

 

*•**                                         **our expectations regarding a return toprofitability;*

 

15

----

 

*•**                                         **our expectation that revenues and cash flowfrom our Mortgage Asset Portfolio Business will continue to decline;*

 

*•**                                         **our expected effective tax rates, the impactof our deferred tax assets and the reduction of those assets over time;*

 

*•**                                         **who we anticipate will be our competitors;*

 

*•**                                         **the anticipated impact of changes in laws;*

 

*•**                                         **our expectation that the purchase loanbusiness will become a greater portion of our originations and the relatedimpact of seasonality; and*

 

*•**                                         **our expected increasing reliance oninformation technology systems and the necessity of developing and upgradingsuch systems.*

 

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

 

•                  *We are expanding our business operations andincreasing our fixed expenses in a contracting market.  Our strategy requires us to capture anincreasing percentage of the market in a highly competitive environment whichwill put pressure on our gross margins. If we are not able to do this, we would likely experience losses due toour increased level of expenses.*

 

•                  *We sell a substantial portion of our loans totwo of our competitors.  If ourcompetitors stop purchasing our loans on favorable terms, we could be requiredto find alternate purchasers and/or accept unfavorable terms.  In either case, this could reduce ourrevenues and earnings.*

 

•                  *We are dependent on our warehouse lendingfacilities to operate our business.  Wemust maintain, renew or replace our warehouse lines of credit in order tocontinue to fund loans.  Although we arecurrently out of compliance with three of our lenders, and we believe we are ingood standing with our warehouse lenders and have obtained waivers. We do notexpect any negative impact from our non-compliance, however, any futurereductions or restrictions in our warehouse capacity would reduce the volume ofloans that we could fund and would therefore reduce our revenues and earnings.*

 

•                  *A large portion of the loans we fund areconcentrated in California and therefore our results are subject to adverseeconomic conditions in California.*

 

•                  *Our hedging strategies may not be successfulin mitigating our risks associated with interest rate changes.  In particular, for new loan products withshorter terms and loan products with adjustable rates, hedging strategies maynot be effective at certain times.*

 

•                  *In anticipation of the sale of a substantialportion of our existing mortgage asset portfolio, we have notified bond holdersof our intent to redeem related bonds. If we do not complete this sale, a disruption may occur in our plannedretirement of bond debt while we arrange alternative short-term financing andour costs of carrying these assets could increase significantly.*

 

*Other factors that may impact our results,include but are not limited to, general economic conditions, the worldpolitical climate, unexpected expense increases, overall interest rates,volatility in interest rates, the shape of the yield curve,  changes in accounting rules or theirapplication, changes in the margins for gains on sale of originated loans,changes in the demand of mortgage brokers for our loan products and services orof loan purchasers for originated loans, increases in prepayment rates anddefault rates, changes in the requirements of correspondent loan programs or ourability to meet such requirements and changes in our anticipated cashrequirements. These and other risk factors that could cause actual results todiffer materially are set forth in more detail in this item under the heading“Business Risk Factors.”*

 

16

----

 

**Introduction**

 

Our Company was founded in 1997 as an externally managed Real EstateInvestment Trust. Until 2001, substantially all of our operations consisted ofthe acquisition of residential mortgages for investment purposes. In mid-2001,our Board of Directors and management determined that it was in the bestinterest of the stockholders to fundamentally shift our strategic direction tomortgage banking. We began implementation in 2001 by forming AmNet Sub toengage in mortgage banking activities. In order to more closely align our namewith our activities, we changed our name from American Residential InvestmentTrust, Inc. to AmNet Mortgage, Inc., as of May 5, 2004. Effective January 1,2002 we began reporting our financial results in two segments the MortgageBanking Business and the Mortgage Asset Portfolio Business.

 

Our mortgage banking segment originates mortgage loans predominately toprime quality borrowers secured by first trust deeds through a network ofindependent mortgage brokers. A concentration of our business is in California(27.6% of loans originated in the first three months of 2004); however, we dobusiness on a nationwide basis. We sell the loans that we originate toinstitutional purchasers on a servicing-released basis.

 

We use a dedicated sales force to offer ourloan products to approved wholesale mortgage brokers, who refer their clients’loans to us for underwriting and funding. Loans meeting our underwritingcriteria are generally approved and funded at our regional underwriting loancenters. Our headquarters office performs various functions through multipledepartments including establishment of policy, risk management, secondarymarketing, and loan delivery to investors, finance, accounting, administration,marketing, human resources, and information technology.

 

Our mortgage banking operations represented88.3% of our revenue for the three months ended March 31, 2004. During thefirst three months of 2004, two branch offices and two regional offices wereopened for a total of twenty-six. As of March 31, 2004, we operatedtwenty-six loan offices around the continental United States of America. Thenumber of employees company-wide decreased from 648 to 646 employees during thequarter.

 

We borrow funds under our warehouse creditfacilities to fund and accumulate loans prior to sale to correspondentinvestors on a servicing-released basis. Currently we have four warehousefacilities that enable us to borrow up to an aggregate of $1.4 billion. Weare generally allowed to borrow from 96% to 99% of the lesser of par or marketvalue of the loan, and must comply with various lender covenants restricting,among other things, the absolute level of leverage and minimum levels of cash reserves.

 

We generate revenue in our Mortgage Banking Business segment threeprincipal ways:

 

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

 

•                                          *Gain on loan sales*. Loan rates, fees and discount points areset based on our targeted gain on sale. This is referred to as our pricingmargin. We currently sell the loans that we originate to institutionalpurchasers, on a servicing-released basis, for cash. We record the differencebetween the sale price of loans that we have sold and our cost to originate thesold loans as gain on loan sales revenue. We recognize revenue at the time thatwe complete the loan sale, which is generally when we receive loan saleproceeds from the purchaser.  Gain onloan sales also includes fees we charge for loan origination such asunderwriting fees, loan document preparation fees and wiring fees.

 

•                                          *Hedging.*Hedging instruments are used to help mitigateexposure to interest rate fluctuation. The gains or losses from this activitywill correspond to revenue derived from loan sales. Typically higher thanexpected gains from the sale of loans will be offset by hedging losses, whilelower than expected gains from the sale of loans will be offset by hedginggains. Hedging gains or losses are included in the consolidated statements ofoperation and comprehensive income as derivative financial instruments andmarket adjustments.

 

The expenses in our Mortgage Banking segmentinclude directly variable costs such as commissions, loan expenses, contractlabor, and fixed overhead expenses such as personnel, rent, supplies andutilities.

 

We have continued to generate revenues and expenses from our MortgageAsset Portfolio Business. However, we expect that revenues and expenses fromthis segment of our business will decline in the second quarter of 2004 due tothe anticipated sale of the majority of the portfolio assets in May, 2004.

 

17

----

 

***Our 1st Quarter 2004 Highlights (Executive Overview)***

 

Our operating results for the first quarterof 2004 were dominated by the following:

 

•                  Basedon a decision to liquidate the majority of its remaining portfolio, we enteredinto a purchase and sale contract to sell mortgage assets, and intend to use aportion of the proceeds to redeem all of the related collateralized long-termdebt. Accordingly, as of March 31, 2004, we reclassified certain mortgageportfolio assets as held for sale. Prior to that time, these assets wereclassified as held for investment. The reclassified mortgage assets were loansand REO representing the bond collateral for CMO/REMIC 1999-A, CMO 1999-1, CMO1999-2, and CMO/REMIC 2000-2.  As aresult of the reclassification from held for investment to held for sale, itwas necessary for us to value these assets at the lower of cost or market. Itwas determined that the market value of the assets was lower than the carryingvalue and a valuation impairment of $4.4 million was recorded at March 31,2004. Consequently, the Mortgage Asset Portfolio segment reported a pretax lossof approximately $3.7 million for the three months ended March 31, 2004. Uponexpected completion of the sale in May of 2004, there will be additional lossesof up to $400 thousand of debt issuance cost which will be recorded in thesecond quarter of 2004. The exact sales price and related expenses are subjectto due diligence being completed by the buyers of these portfolio assets.

 

•                  OurMortgage Banking segment funded approximately $1.9 billion in loan volumefor the period while funding for the same period in 2003 was $2.1 billion.  This represents a decline of approximately10% from the first quarter of 2003 production. Interest rates declined duringthe first quarter of 2004 from 5.85% to 5.40% per Freddie Mac rates for thirtyyear fixed rate mortgages. Generally, demand for loans increased beginning inmid-February due to both lower interest rates and increased purchase activity.The graph below indicates monthly loan production comparison between the firstquarters of 2004 and 2003.

 

 

•                                         Loan sales volume totaled $1.6 billion, withrevenues of $14.0 million. This revenue was not sufficient to cover variableand fixed expenses totaling $19.9 million for the mortgage banking segment.

 

•                                          Our tax benefit reduced our first quarteroperating loss by 41%.  As we anticipatea return to profitability in the remainder of 2004, we expect to utilize thistax benefit related to the pretax loss of $9.6 million.

 

•                                          Cash and cash equivalents decreased by $16.8million during the first quarter of 2004. Key factors in this decline include;operating losses totaling $3.9 million; a reduction of accrued taxes andbonuses; increases in other assets; and an increase in total cash investment inmortgage loan inventories totaling $6.5 million.

 

**Critical Accounting Policies**

 

The following analysis of financial condition and results of operationsare based upon our consolidated financial statements and the notes thereto,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America (“GAAP”). The preparation of theseconsolidated financial statements requires us to make a number of estimates andassumptions that affect the reported amounts and disclosures in theconsolidated financial statements. On an ongoing basis, we evaluate ourestimates and assumptions based upon historical experience and various otherfactors and circumstances. We believe that our estimates and assumptions arereasonable in the circumstances; however, actual results may differsignificantly from these estimates and assumptions, which could have a materialimpact on the carrying value of assets and liabilities at the balance sheetdates

 

18

----

 

and our results of operations for the reporting periods.

 

We believe that estimates andassumptions are important factors in the portrayal of our financial conditionand results of operations. Our critical accounting policies that requiremanagement’s most subjective judgments include the following:

 

• Derivativehedging activities/determination of fair values

• Incometaxes and benefits

•Allowance for loan losses – bond collateral mortgage loans

•Amortization of premiums on bond collateral loans

•Loan loss reserves – mortgage loans held for sale

 

Please refer to theCompany’s Form 10-K for the year ending December 31, 2003, for a detaileddiscussion of these policies.

 

**Management’s Financial Analysis**

 

A registrant, or a person acting on its behalf, shall not make public anon-GAAP financial measure that, taken together with the informationaccompanying that measure, contains an untrue statement of a material fact oromits to state a material fact necessary in order to make the presentation ofthe non-GAAP financial measure, in light of the circumstances under which it ispresented, not misleading.

 

*GrossMargins -*The Mortgage Banking segment generates gain on the sale ofloans.  These gains are a function of thevolume of loans sold in the period, and the value of the loans at the timethese loans are committed for sale to an investor.  We also generate gains and losses on thederivative financial instruments that we acquire to hedge our gain on sale ofloans.  We consider our gross margin tobe the sum of our (i) gain on sale of loans and (ii) total derivative financialinstruments and market adjustments.  Thissum expressed as a percentage of our loan sales volume is our gross marginpercentage.

 

When we develop the pricing of ourloans, we incorporate a target gross margin percentage that we expect toobtain.  We then provide rate lockcommitments to borrowers based on that pricing and the related target grossmargin percentage.  However, if interestrates increase between the time we make a rate lock commitment and commit aloan for sale, then the market value of the loan would be reduced and we wouldnot achieve our target margin percentage. Accordingly, we acquire derivative financial instruments to hedge orprotect our target margins from interest rate movements.  We hedge our loans from the time of a ratelock commitment to the time the loan is committed for sale to an investor.

 

If our hedging is effective, as thevalue of our pipeline and our loans goes down and we record a lower gain onsale, our hedge instruments go up in value to offset the reduced gain.  Alternatively, as the value of our pipelineand our loans goes up, we record a higher gain on sale but the higher gain isoffset by a loss on our hedges. Accordingly, if we successfully hedge our pipeline and our loans, thegross margin percentage that we ultimately earn will be close to our target grossmargin percentage and we will not be significantly impacted by interest ratechanges.  In order to evaluate theeffectiveness of our hedging program, management believes that it is importantto evaluate our gross margins and then compare our actual gross marginpercentage against our target gross margin percentage.

 

*Net Interest Income* - We earn interest income and incur interestexpense in both segments of our operations. In the Mortgage Banking Business,we earn interest on a loan from the date the loan is funded until finaldisposition of the loan sale. Accordingly, interest income is a function of thevolume of loans funded, the interest rate on the loans and the length of timethe loans are held. To the extent we fund loans with borrowings under our warehousefacilities, we record interest expense based on the same factors. Similarly, inthe Mortgage Asset Portfolio Business, we generate revenue from the interest wereceive on the mortgage loans we hold for investment and we incur interestexpense on the borrowings used to fund our loan portfolio.

 

Because the interest income and interestexpense in each segment of our business are closely related and dependant onmany of the same factors, in particular the volume of loans we originate orhold for investment, management believes that it is helpful in understandingour operations to analyze the impact of interest income and expense togetherwithin each segment of our operations. For this reason, the discussion belowprovides information regarding the net interest income (interest income lessinterest expense) generated by each segment. Management believes that this isconsistent with how financial analysts typically consider interest in analyzingmortgage banking operations.

 

*Fixedand Variable Operating Expenses*–  For the same reasons describedabove the explanation of expenses includes a discussion of our operatingexpenses, which excludes interest expense. Because certain other expenses weincur in the Mortgage Banking Business, such as commissions and contract labor,also vary with the volume of AmNet Sub’s loan originations, management believesthat it is important in understanding this business to consider the variableand the fixed expenses separately. Accordingly, we have included an estimatedbreakdown between variable and fixed amounts for each category of our operatingexpenses. Management believes that this will enable a better understanding ofour results and the likely impact in the future of changes in our originationvolumes.

 

19

----

**Results of Operations**

 

***Three Month Results***

 

MortgageBanking Business

 

OurMortgage Banking Business recorded an after tax loss of $3.5 million forthe three-month period ending March 31, 2004 as compared to an after taxgain of $11.8 million in 2003 for the same period. These results were duein large part to (i) a 17% decrease in loan sales volume reflecting acontracted overall mortgage loan origination marketplace from 2003; (ii)decreased margin on loan sales; (iii) increased expenses as we continue toexpand regional and branch offices; and (iv) significant tax benefits realizedin 2003.

 
|                                                                                                                   |   | **Three  Months Ended  March 31, 2004** |       | **Three  Months Ended  March 31, 2003** |      | **2004  Increase (Decrease)** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|------------|----------------------------------------------|-----------|-------------------------------|--------|
|                                                                                                                   |   | **Amount  Income  (Expense)**                |       | **Basis  Points**                            |      | **Amount  Income  (Expense)** |   | **Basis  Points** |   | **Amount** |   | **Basis  Points** |   |
|                                                                                                                   |   | **($ amounts  in 000’s) (unaudited):**  |       |
| Loans Sold, Net                                                                                                        |   | $                                            | 1,641,555  |                                         | —    |                          | $      | 1,982,410 |   | — |   | $ | (340,855 | ) | — |   |
|                                                                                                                   |   |                                         |       |                                         |      |                          |   |   |   |   |   |   |   |
| Revenues:                                                                                                              |   |                                         |       |                                         |      |                          |   |   |   |   |   |   |   |
| Premiums                                                                                                               |   | 38,742                                       |       | 236.01                                       |      | 43,400                        |   | 218.92 |   | (4,658 | ) | (17.09 | ) |
| Broker Fees                                                                                                            |   | 4,182                                        |       | 25.48                                        |      | 5,703                         |   | 28.77 |   | (1,521 | ) | (3.29 | ) |
| Mortgage Broker Premiums                                                                                               |   | (23,653                                      | )          | (144.09                                      | )         | (24,958                       | )      | (125.90 | ) | 1,305 |   | (18.19 | ) |
| Premium Recapture and Loan Loss Provisions                                                                             |   | (1,325                                       | )          | (8.07                                        | )         | (1,468                        | )      | (7.41 | ) | 143 |   | (0.66 | ) |
| Deferred Origination Costs                                                                                             |   | (2,431                                       | )          | (14.81                                       | )         | (2,468                        | )      | (12.45 | ) | 37 |   | (2.36 | ) |
| **Gain on sales of  loans**                                                                                            |   | **$**                                        | **15,515** | ** **                                   | **94.52** | ** **                    | **$**  | **20,209** | ** ** | **101.95** | ** ** | **$** | **(4,694** | **)** | **(7.43** | **)** |
| Less: Derivative financial instruments and  market adjustments                                                         |   | (6,644                                       | )          | (40.47                                       | )         | (2,211                        | )      | (11.15 | ) | (4,433 | ) | (29.32 | ) |
| **Gain on Sale of  loans, after derivative financial instruments and market adjustments (“gross  margins”)** |   | **$**                                        | **8,871**  | ** **                                   | **54.04** | ** **                    | **$**  | **17,998** | ** ** | **90.79** | ** ** | **$** | **(9,127** | **)** | **(36.75** | **)** |
| Interest on mortgage assets                                                                                            |   | 5,013                                        |       | 30.54                                        |      | 5,902                         |   | 29.77 |   | (889 | ) | 0.77 |   |
| Other income                                                                                                           |   | 80                                           |       | 0.49                                         |      | 17                            |   | 0.09 |   | 63 |   | 0.40 |   |
| **Total revenue  (Mortgage Banking segment)**                                                                          |   | **$**                                        | **13,964** | ** **                                   | **85.07** | ** **                    | **$**  | **23,917** | ** ** | **120.65** | ** ** | **$** | **(9,953** | **)** | **(35.58** | **)** |

 

Gainon the sales of loans decreased for the quarter ended March 31, 2004,primarily due to our decrease in volume of loan sales and narrower margins. Forthe first quarter of 2004 loan sales were $1.6 billion, while firstquarter of 2003 loan sales were $2.0 billion. Our gain on the sale ofloans was made up of a combination of various account categories which aresummarized in the chart above, and quantified in basis points to loan salesvolume. Premiums represent the price at which we sell the loans to investors inexcess of the principal balance of loans sold. Broker fees represent variouscharges to brokers for services rendered which are deferred and recognized aspart of the gain on the sales of the loans. Premiums and borrower fees areoffset by capitalized (deferred) loan origination costs. The largest deferredcost associated with loan production is broker premiums, or yield spreadpremiums. Other offsets to gain on sale include (i) loan premiums repaidto investors (“premium recapture”) and loan loss provisions and(ii) deferred origination costs, which are recognized at the time of loansale. Premium recapture expenses represent repayment of a portion of certainloan sale premiums to investors on previously sold loans which subsequentlypayoff within six months of loan sale. We sell a substantial portion of ourloans to two of our competitors.  If ourcompetitors stop purchasing our loans on favorable terms, we could be requiredto find alternate purchasers and/or accept unfavorable terms.  In either case, this could reduce ourrevenues and earnings.

 

Theuse of derivative financial instruments is a key to protecting our profitmargins between the time a loan is locked and when the loan is sold to aninvestor. We use forward sales of mortgage backed securities (TBA) andoptions on forward sales of mortgage-backed securities as our primary hedginginstruments. Due to declines in mortgage interest rates during the firstquarters of 2004 and 2003, we recorded net losses on derivative financialinstruments of $6.6 million and $2.2 million, respectively, but hadoffsetting, higher than expected gains on sales of loans. During the firstquarter of 2004, we continued with the same strategy of using forward sales ofmortgage-backed securities and options on mortgage-backed securities.

 

20

----

 

Our gross margins were $8.9 million for the three months endedMarch 31, 2004, a decline of $9.1 million from $18.0 for the comparableperiod in 2003.  Loan sales volumedeclined $341 million. This decline was a major contributor in our reduction ingross margins. The remaining decline was due to the lower overall gross marginsthat resulted from lower pricing due to competitive pressures.  Premium recapture and loss provisions arecomparable between quarters.

 

Comparison between first quarter of 2004 and first quarter of 2003shows a decline in our margin rate from 91 basis points to 54 basispoints.  While the market conditionswere extremely favorable in the first quarter of 2003, the competition forbroker referrals was more difficult in the later part of 2003 and first quarterof 2004, causing us to substantially reduce our target gross margin percentagesin January and February in order to remain competitive. Thecompetitive pricing pressures subsided in late February allowing us toincrease our target margin percentages for the remainder of the quarter. Ouractual gross margin percentages in each quarter were close to our target marginpercentages and accordingly, we believe that our hedging program was successfulin protecting profit margins on our loan originations in both quarters.  However, our hedging strategies may not besuccessful in mitigating our risks associated with interest rate changes infuture periods. In particular, for new loan products with short terms, and loanproducts with adjustable rates, hedging products may not be effective atcertain times.

 

Werecorded interest income of $5.0 million for the three months endedMarch 31, 2004. We earn interest on a loan from the date the loan isfunded until final disposition. Accordingly, interest income is a function ofthe volume of loans funded, the interest rate on the loans and the length oftime the loans are held prior to sale. To the extent we fund loans withborrowings under our warehouse facilities, we record interest expense based onthe same factors. Interest expense for the period was $2.3 million. Theresulting net interest income earned on loan inventories was $2.7 million,representing 14 basis points on first quarter 2004 loan production of$1.9 billion. For the comparable period ended March 31, 2003 interestincome was $5.9 million and interest expense was $2.7 million. Thisresulted in net interest earned of $3.2 million, representing 16 basispoints on first quarter 2003 loan production of $2.1 billion.

 

Totalexpenses incurred in the Mortgage Banking Business for the three months endedMarch 31, 2004 were approximately $19.9 million. Operating expenses,which included all expenses except interest expense (employee compensation andbenefits, office and occupancy expense and other operating expenses), wereapproximately $17.6 million for the three months ended March 31,2004. For the comparable period ended March 31, 2003, there wereapproximately $17.0 million of total expenses of which approximately$14.3 million were operating expenses. The increase in operating expensesin 2004 was due to the ongoing expansion of our mortgage banking operations,which are comprised of regional loan production offices and headquartersoperations. For the three months ended March 31, 2004, expenses includedapproximately $3.3 million in sales commissions, which vary in directproportion with the volume of funded loans, or approximately 18 basis points(.18%) on $1.9 billion in funded loans. Operating expenses that were notdirectly variable totaled $12.2 million, or approximately 65 basis points(.65%), on $1.9 billion in funded loans in the first quarter of 2004.Total variable and fixed basis point operating expenses (which is a measurementof the cost per loan) increased for the three months ended 2004 (from 69 basispoints in 2003 to 94 basis points in 2004). The operating cost per loanincreased from $1,222 in 2003 to $1,649 per loan in the first quarter of 2004.The increased cost per loan in 2004 compared to the cost in the first quarterof 2003 shows that the reduced loan production in the first quarter of 2004also reduced efficiency due to a larger branching system (over capacity in somebranches) and higher headquarter overhead.

 

Thetable below provides the relationship between estimated fixed, variable andtotal expenses for the three months ended March 31, 2004 and 2003 (dollarsin thousands) (unaudited):

 
| **2004  Mortgage Banking Expenses** |   | **Estimated  Variable  Expenses** |       | **Estimated  Fixed  Expenses** |       | **Total  Expenses** |       |
|-------------------------------------|--------|-----------------------------------|------------|--------------------------------|------------|---------------------|------------|
|                                |   |                              |       |                           |       |                |       |
| Employee compensation and benefits  |   | $                                 | 3,827      |                           | $          | 7,873               |       | $ | 11,700 |   |
| Office and occupancy expense        |   | —                            |       | 836                            |       | 836                 |       |
| Professional fees                   |   | 150                               |       | 762                            |       | 912                 |       |
| Other operating expense             |   | 1,342                             |       | 2,746                          |       | 4,088               |       |
| **Total Operating  Expenses**       |   | **5,319**                         | ** ** | **12,217**                     | ** ** | **17,536**          | ** ** |
| Interest Expense                    |   | 2,346                             |       | —                         |       | 2,346               |       |
| **Total Expenses**                  |   | **$**                             | **7,665**  | ** **                     | **$**      | **12,217**          | ** ** | **$** | **19,882** | ** ** |

 

21

----

 
| **2003  Mortgage Banking Expenses** |   | **Estimated  Variable  Expenses** |       | **Estimated  Fixed  Expenses** |       | **Total  Expenses** |       |
|-------------------------------------|--------|-----------------------------------|------------|--------------------------------|------------|---------------------|------------|
|                                |   |                              |       |                           |       |                |       |
| Employee compensation and benefits  |   | $                                 | 4,343      |                           | $          | 4,802               |       | $ | 9,145 |   |
| Office and occupancy expense        |   | —                            |       | 566                            |       | 566                 |       |
| Professional fees                   |   | 254                               |       | 836                            |       | 1,090               |       |
| Other operating expense             |   | 1,333                             |       | 2,162                          |       | 3,495               |       |
| **Total Operating  Expenses**       |   | **5,930**                         | ** ** | **8,366**                      | ** ** | **14,296**          | ** ** |
| Interest Expense                    |   | 2,674                             |       | —                         |       | 2,674               |       |
| **Total Expenses**                  |   | **$**                             | **8,604**  | ** **                     | **$**      | **8,366**           | ** ** | **$** | **16,970** | ** ** |

 

Asa result of a pretax loss of approximately $5.9 million in the first quarter of2004, we recorded a tax benefit of $2.4 million. The effective federal and state tax rate for thissegment was estimated to be 41%. This income tax expense is expected to berealized in 2004 with a return to profitability and therefore the effective taxrate is anticipated to be approximately 41%. In 2003, we had a combined federal and state effective tax rate ofapproximately 30% due to the realization of our operating loss carryforwardsassociated with our start-up operating losses.

 

Interestrate movements are difficult to predict, but it is recognized that interestrates on residential mortgages were historically low, and refinance demand wasvery strong during the later part of the first quarter of 2004. Revisedprojections by the Mortgage Bankers Association (April 2004) for mortgageloan originations for the remainder of 2004 indicate an increase in interestrates and a reduction of refinance demand over the next 3 quarters. Ourfinancial projections for 2004 assume an increase in loan production over firstquarter 2004 levels, principally due to an expectation of a larger sales forceand continued market share penetration. Increased loan production levels and management of overhead expenses arethe keys to achieving profitability for the remainder of 2004. We arecontinuing our strategy of regional office expansion in metropolitan serviceareas we do not already serve and an increased number of account executives tocapture market share in areas we do serve. In summary, we are expanding our business operations and increasing ourfixed expenses in a contracting market. Our strategy requires us to capture an increasing percentage of themarket in a highly competitive environment which will put pressure on our grossmargins.  If we are not able to do this,we would likely experience losses due to our increased level of expenses.

 

Mortgage Asset Portfolio Business 

 

Weheld mortgage assets of approximately $137 million as of March 31,2004, compared to $237 million as of March 31, 2003. This reductionis a result of prepayments due to favorable refinance rates and our decisionnot to replenish these assets.  For thethree months ended March 31, 2004 the mortgage asset portfolio businessgenerated a net loss of approximately $2.1 million as compared to a netincome of approximately $7.0 million for the three months ended March 31,2003.  The net loss in the three monthsended March 31, 2004 was mainly due to the valuation adjustment on thebond collateral totaling $4.4 million in 2004 compared to no valuationadjustment in 2003. In 2003, we also realized significant one-time tax benefitsdue to recording an income tax benefit of $6.7 million.

 

Basedon a decision to liquidate the majority of its remaining portfolio, we enteredinto purchase and sale contracts to sell mortgage assets, and intend to use aportion of the proceeds to redeem all of the related collateralized long-termdebt. Accordingly, the assets pending sale have been reclassified as held forsale as compared to their previous classification as held for investment.  As a result of the reclassification it wasnecessary for us to value these assets at the lower of cost or market. It wasdetermined that the market value of the assets was lower than the carryingvalue and a valuation impairment of $4.4 million was recorded at March 31,2004. In anticipation of the sale of a substantial portion of our existingmortgage asset portfolio, we have notified bond holders of our intent to redeemrelated bonds. If we do not complete this sale, a disruption may occur in ourplanned retirement of bond debt while we arrange alternative short-termfinancing. Upon completion of the sale in May of 2004, there will be additionalcosts of up to $400 thousand of debt issuance cost which would be recorded inthe second quarter of 2004.  The exactsales price and related expenses are subject to due diligence being completedby the buyers of these portfolio assets.

 

Forthe three months ended March 31, 2004, interest revenue was $1.6 millionas compared to $3.3 million for the same period in 2003. The decline was due tothe expected decline in the mortgage asset portfolio.

 

Forthe three months ended March 31, 2004, total expenses were $5.5 million. Forthe same period ending March 31, 2003, total expenses were $3.2 million.  The March 31, 2004 expense balance includesa valuation allowance of $4.4 million. Excluding the valuation allowance, thebalance of $1.1 million represents a decrease from March 31, 2003.  The primary decreases included thefollowing: interest expense decreased approximately $643 thousand as aresult of the decrease of $96 million in outstanding debt; provision forloan losses decreased by approximately $919 thousand; and other operatingexpenses decreased approximately $94 thousand.

 

Inthe first quarter of 2003, AmNet Parent realized approximately $6.7 million inone-time tax benefits associated with its election to no longer be a tax-exemptREIT, and accordingly, net income for this segment is not comparable to thefirst quarter of 2004.

 

22

----

 

***Liquidityand Capital Resources***

 

*General*

 

Our sources of liquidity during the three months ended March 31,2004 primarily consist of the following:

 

•                                          borrowingsunder our warehouse and other credit facilities;

 

•                                          revenuesgenerated by our mortgage banking operating activities including interest,broker fees, loan sale proceeds and hedge proceeds;

 

•                                          excessinterest spread in the Mortgage Asset Portfolio Business, net of repayments toservicers for past principal and interest advances on completed real estateowned dispositions.

 

Our primary cash requirements include:

 

•                                          fundingour mortgage loan originations;

 

•                                          hedginglosses;

 

•                                          interestexpense under our warehouse facilities;

 

•                                          operatingexpenses, including commissions;

 

•                                          repaymentof our borrowings; and

 

•                                          maintaininga “restricted cash” account, which includes amounts required to be held by certainwarehouse line providers that may not be used in our operations or as equityfor other warehouse lines of credit.

 

As our mortgage banking operations have grown and our mortgage assetportfolio has declined, our cash flow from investment activities has continuedto decline in amounts and materiality.

 

*Cash Generated By and Used In Our Operations*

 

During the three months ended March 31, 2004, on a consolidatedbasis we had net negative cash flow of $16.8 million. The principal factorsimpacting our negative cash flow are:

 

•                  Net increases inour cash investment in loan inventories totaled approximately $6.5million.  Our warehouse line lendingagreements allow us to borrow from 96% to 99% of the lesser of par or marketvalue for each mortgage loan. We pay an additional 1% to 2% of the loanprincipal amount in fees or yield spread premium to the mortgage brokers.Lastly, a small portion of our loan inventory is funded with equity capital. Wetypically have total cash invested totaling between 2% to 4% of the principalamount of loans held for sale, which is recouped when the loans are purchasedby investors. Should we increase the amount of loan inventory, either byholding loans for longer periods, or due to increased loan funding volume, thecash reserves necessary to carry loan inventories will increase in directproportion to the inventory held.

 

•                  Payments forconsolidated cash expenses exceeded consolidated cash revenues collected byapproximately $3.2 million.

 

In addition, we prepaid warehouse line facility fees and workerscompensation premiums totaling $1.1 million, paid state taxes totaling $2.7million (approximately  $2.5 millionwill be applied against future California corporate income taxes), had capitalexpenditures that totaled approximately $485 thousand, and paid 2003 accruedbonuses and incentives that totaled approximately $2.8 million.

 

We expect to generate a significant amount of cash in the secondquarter from the sale of a majority of our mortgage asset portfolio;thereafter, we anticipate that our future liquidity will be predominantlyimpacted by the mortgage banking activity. In 2004 we will continue to expandour regional office presence in various metropolitan service areas.  New offices are expected to have a cashnegative effect for a period of six to twelve months and our planned expansionwill slow cash accumulation. We expect to originate $500 million to$1.5 billion per month of new mortgage loans and fund these originationswith equity capital and warehouse facility borrowings. We expect our loaninventories to grow in proportion to growth in funding volume, and consequentlyexpect to make additional cash investments in loan

 

23

----

 

inventories.  We also expect tocontinue to engage in hedging transactions that may require cash investment tomaintain or adjust hedged positions. Furthermore, we anticipate greater generaland administrative costs associated with the operations of our Mortgage BankingBusiness.  We also intend to fund anewly authorized common stock share repurchase program approved by our Board ofDirectors. Share repurchase will be contingent on the completion of our pendingmortgage asset portfolio sale. We are authorized to purchase up to 400,000shares of our common stock which is approximately 5% of our shares currentlyoutstanding. We intend to use cash reserves, borrowings under the warehousefacilities and approximately $25 million in cash flow generated by the sale ofthe majority of the mortgage asset portfolio, as well as cash flow generatedfrom the origination and sale of mortgage loans, to fund our operations. We aretherefore dependent on significant levels of warehouse financing to helpexecute our mortgage banking strategy. Furthermore, we must originate minimumlevels of loans to be profitable. See Business Risk Factors in Item 1.Management believes that our company has sufficient sources of liquidity atMarch 31, 2004 to meet anticipated business requirements for theforeseeable future.

 

*Short-Term Debt*

 

As of March 31, 2004, short-term debt consists of: $492 million ofrevolving credit lines (warehouse facilities) used to fund our lendingactivities, $3 million of senior subordinated secured revolving loan debt, and$90 million in bond debt reclassified from long-term debt to short-term debt asa result of the pending sale of bond collateral. As of March 31, 2004,mortgage loans held for sale totaling $511 million were pledged ascollateral for the warehouse facilities. We are dependent on our warehouselending facilities to operate our business. We must maintain, renew or replace our warehouse lines of credit inorder to continue to fund loans.  Ourwarehouse facilities consist of borrowings of $492 million with fourfinancial institutions. At March 31, 2004, our maximum availableborrowings combined, from these four financial institutions is$1.4 billion. These facilities typically advance 96% to 99% of the lesserof par or market value of the loans pledged as collateral. Such financing iscurrently provided primarily under (i) a 364-day secured mortgagewarehousing revolving credit agreement, dated as of November 26, 2001,(the “Bank Credit Agreement”) and entered into by AmNet Sub, AmNet Parent andJPMorgan/Chase; (ii) a 364-day secured mortgage warehousing revolvingcredit agreement, dated as of March 28, 2002, (the “UBS WarburgAgreement”) and entered into by AmNet Sub and UBS Warburg Real EstateSecurities Inc.; (iii) a 364-day secured mortgage warehousingrevolving credit agreement, dated as of October 11, 2002, (the“Countrywide Agreement”) and entered into by AmNet Sub, AmNet Parent andCountrywide; and (iv) a 364-day secured mortgage warehousing revolvingcredit agreement, dated as of September 15, 2003, (the “GMAC Agreement”) andentered into by us, AmNet Sub and GMAC. These warehouse facilities are repaidas principal payments on mortgage loans are received, or as the mortgage loansare sold. The agreements governing these facilities contain a number ofcovenants, including covenants based on tangible net worth, cash flows, netincome, and liquidity of our Company. As a direct result of the Company'sexpected first quarter net loss, at March 31, 2004, the Company was out of compliance withcertain of its warehouse lending agreements. The Company was out of compliancewith earnings covenants in its JPMorgan Chase Bank and Countrywide WarehouseLending agreements and with a net worth covenant in its Residential FundingCorporation agreement. The warehouse providers each waived the covenants for whichthe Company was out of compliance. The Company believes it is in good standingwith its warehouse providers and is in the process of renegotiating warehouselending covenants and increasing warehouse loan limits. Although we do notexpect any negative impact from our non-compliance. However, any futurereductions or restrictions in our warehouse capacity would reduce the volume ofloans that we could fund and would therefore reduce our revenues and earnings.

 

In2001, the Company also entered into a $5 million senior subordinatedsecured revolving loan agreement (Subordinated Loan Agreement). TheSubordinated Loan Agreement bore an interest at 12% and as of March 31,2004, there was $3 million in borrowings outstanding. The loan was paid off inApril 2004 and the Subordinated Loan Agreement was cancelled.

 

In April of 2004, the Company entered into agreements to sell 85%of the mortgage portfolio assets. Although the transactions are not expected tobe completed until May of 2004, we have reclassified approximately $90 millionof our long-term debt to short-term debt as a result of a pending sale. TheCompany intends to extinguish all of reclassified short-term debt during thesecond quarter of 2004, using proceeds from its expected sale of the mortgage loanand real estate owned bond collateral. The Company has notified the bond trustees of its rights and intentionsto call these debt obligations.  Shouldthe bond collateral not be sold, the Company intends to obtain short-termfinancing to redeem the bonds.

 

*Long-Term Debt—Non Recourse Mortgage BackedNotes*

 

Our long-term debt consists of CMO/FASIT 1998-1 mortgage-backed notes,which are collateralized by Bond Collateral Mortgage loans and bond collateralreal estate owned. Obligations under the mortgage-backed notes are payablesolely from the proceeds from the bond collateral and are otherwisenon-recourse to our Company.

 

*Rate Lock Commitments to Borrowers andCommitments to Sell Loans*

 

In the ordinary course of business, we make rate lock commitments toborrowers which obligate us to fund mortgages at set interest rates. The valuesof the underlying loans, and thus our expected gain on the subsequent fundingand sale of these loans, may be

 

24

----

 

impacted by subsequent changes in market interest rates. Accordingly,we attempt to protect (or hedge) our pricing margins by utilizing forward salesof mortgage-backed securities (“TBAs”) and options on TBAs. The hedgestypically increase or decrease in value in correlation to offsetting decreaseor increases in the value of the loans. As loans fund, we sell or assign ourhedges and enter into mandatory loan sale commitments with our correspondentinvestors.

 

The following table summarizes our rate lock commitments and ourcommitments to sell mortgage-backed securities and mortgage loans (dollars inthousands) (unaudited):

 
|                                                                   |   | **3/31/04** |      | **3/31/03** |   |
|------------------------------------------------------------------------|--------|-------------|-----------|-------------|--------|
| Commitments to originate loans at set  interest rate                   |   | $           | 1,593,112 |        | $      | 1,204,749 |   |
| Forward sales of mortgage-backed securities  (TBA and options on TBAs) |   | 1,252,500   |      | 1,006,500   |   |
| Mandatory commitments to sell mortgage  loans held for sale            |   | 196,672     |      | 262,291     |   |
|                                                                        |        |             |           |             |        |  |  |

 

For the purposes of hedging our interest rate exposure on our pipeline,we make various assumptions to estimate the rate lock commitments which willnot close (fallout ratio). The fallout ratio is applied to the total pipelineto arrive at the net exposure to interest rate changes in the market. Thepipeline, after applying the fallout ratio, amounted to $884 million and $746.4million at March 31, 2004 and 2003, respectively. The loans expected toclose and loans not committed for sale are hedged utilizing forward sales ofmortgage-backed securities and options. Some of these commitments willultimately be denied by our Company or declined by the borrower, and therefore,the commitment amounts do not necessarily represent future cash requirements.

 

*Lease and Long-Term Debt Commitments*

 

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

 
|                                                   |   | **Payments  Due by Period**             |       |
|--------------------------------------------------------|--------|-----------------------------------------|------------|
| **Contractual Obligations as of  March 31, 2004** |   | **Total**                               |       | **Less than  1  Year** |   | **1-3  Years** |   | **3-5  Years** |   | **More Than  5  Years** |   |
|                                                   |   | **(dollars  in thousands) (unaudited)** | ** ** |
|                                                   |   |                                    |       |   |   |   |   |   |   |   |   |
| Long-Term Debt                                         |   | $                                       | 20,078     |   | $ | 9,683 |   | $ | 5,592 |   | $ | 2,093 |   | $ | 2,710 |   |
| Operating Leases                                       |   | 8,361                                   |       | 3,533 |   | 3,744 |   | 1,084 |   | — |   |
| Total                                                  |   | $                                       | 28,439     |   | $ | 13,216 |   | $ | 9,336 |   | $ | 3,177 |   | $ | 2,710 |   |

 

Long-term debt is in theform of bonds which are directly tied to bond collateral (assets) and are inthe form of mortgage loans. As a result of the sale of approximately 85% of ourportfolio, we project payment of the sale portion of our long-term debt to bepaid within one year.

 

**Business RiskFactors**

 

**Risks Associated with Our MortgageBanking Business**

 

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

 

OurCompany was formed in 1997 and operated as a mortgage REIT (mortgage portfolioinvestment) until the fourth quarter of 2001, at which time we beganoriginating and selling residential mortgages (mortgage banking). As a result,comparisons between financial performance in current quarters and past quartersmay not be helpful in evaluating our current performance or our futureprospects. The market for mortgage originations have been dominated byrefinances during 2002 and 2003. While our executive officers have extensivemortgage origination and mortgage banking experience, and have hiredexperienced personnel in our mortgage banking subsidiary, there are asignificant number of risks and uncertainties inherent in the mortgageorigination industry, primarily due to the limited operating history of theCompany’s mortgage banking activities.

 

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

 

Ourmortgage banking business had a net loss of approximately $3.5 million (afterincome tax benefits) for the three month period ended March 31, 2004.These losses were primarily attributable to a decline in loan funding volumesand revenues and higher overhead expenses as compared to the same period in2003. We expect to incur additional costs and expenses related to the expansionof our branching system and the opening of new regional underwriting centers.If this expansion does not result in adequate revenues, our financialperformance will suffer. We must generate approximately $700 million to$900 million in sales volume per month, depending

 

25

----

 

onpricing margins achieved, to meet our expense obligations. We are expanding ourbusiness operations and increasing our fixed expenses in a contractingmarket.  Our strategy requires us tocapture an increasing percentage of the market in a highly competitiveenvironment which will put pressure on our gross margins.  If we are not able to do this, we wouldlikely experience losses due to our increased level of expenses.  See “Overhead Expenses May Not Be Covered bySufficient Revenues to Sustain Profitable Operations.”

 

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

 

Overthe past three years, we have experienced rapid growth. In the beginning of2001, we had approximately 20 employees. As of March 31, 2004, we hadapproximately 646 employees. Many of these employees have very limitedexperience with us and a limited understanding of our systems. Many of ourfinancial, operational and managerial systems were designed for a smallbusiness and have only recently been upgraded or replaced to support largerscale operations. If we fail to manage our growth effectively, our expensescould increase, negatively affecting our financial results.

 

*ExpandingOur Market Presence and Market Share in the Face of a Contracting Market MayNot Be Successful*

 

The origination market was $3.8 trillion in 2003 dueto low interest rates which were spurred by both strong home sales and refinancedemand. In 2004, the origination market is expected to contract to $2.6trillion. Competitiveness will increase in this shrinking mortgage market,putting pressure on the market competitors to reduce revenues to sustainorigination volumes and market share. We are embarking on a business strategywhich will increase our present number of regional and satellite offices fromtwenty-six at March 31, 2004 to thirty offices (or more) by the end of2004, and we hope to increase our sales force in order to increase our share ofthe overall market. There can be no assurance that this strategy will besuccessful in the face of stiffening competition amid a contractingmarketplace.

 

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

 

Oursuccess in the mortgage banking strategy depends, in large part, on our abilityto originate loans in sufficient quantity such that the gain on sales of loansnet of hedge costs are in excess of both fixed and variable overhead costs.There can be no assurance that we will be able to originate sufficient levelsof mortgages to achieve and sustain profitability. In originating and sellingloans, we compete with investment banking firms, savings and loan associations,banks, mortgage bankers and other entities originating residential 1-4 unitmortgages, many of which have greater financial resources than us. We also facecompetition from companies already established in these markets. In addition tothe level of home purchase activity, the origination market is directly tied tothe general level of interest rates and refinance activity. The originationmarket was $3.8 trillion in 2003 due to strong home sales, low interest ratesand strong refinance demand. In 2004 the origination market is expected tocontract to $2.6 trillion. Competitiveness will increase in this shrinkingmortgage market, putting pressure on the market competitors to reduce revenuesto sustain origination volumes and market share. We believe that variety andthe competitiveness of our loan products and customer service levels will allowus to gain market share over the next several years, even as overall market formortgages declines; however, there can be no assurance that we will be able tosuccessfully and profitably compete.

 

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

 

Wehave made a number of fixed overhead commitments to establish the operationaland administrative infrastructure necessary to support our loan originationbusiness. At March 31, 2004, lease commitments for headquarter andregional offices totaled approximately 144,800 square feet. There were 646employees. In order to achieve profitability, our monthly loan sales volumemust be approximately $700 to $900 million, such that the expectedrevenues associated with this loan production exceed fixed and variableoverhead costs. Since our revenues are tied directly to the level of loanproduction and subsequent sale, it is imperative that we achieve a profitablelevel of originations, and the level of future profitability from mortgagebanking will be in direct correlation to the level of loan origination volume.During the first quarter of 2004, interest rates fell, and loan originationsincreased to the point of profitability in March, although the entirequarter was unprofitable. Interest rate movements are not easily projected andmay adversely affect financial results in the future. There can be no assurancesthat we will be able to maintain loan origination volumes sufficient to coverour fixed overhead costs, and should we incur significant operating losses, ourcapital base and cash reserves could be materially adversely impacted.

 

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

 

Ouroperating results have and may in the future fluctuate significantly fromperiod to period as a result of a number of factors, including the volume ofloan origination, interest rates and the level of unrealized gains/losses inunsold loans, pipeline loans or positions in derivative securities.Accordingly, the consolidated net income of our Company may fluctuate fromperiod to period.

 

26

----

 

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

 

Althoughthe refinance portion of our mortgage broker business is not seasonal, ourpurchase business is generally subject to seasonal trends. During 2003, ourrefinance business grew to 90% of our activity. In 2004, as we return to normalmarkets and purchase and refinance activity become more equal, seasonality willagain become a significant factor in our business. Seasonality trends reflectthe general pattern of housing sales, which typically peak during the springand summer seasons. Our quarterly operating results have fluctuated in the pastand are expected to fluctuate in the future, reflecting the seasonality of theindustry.

 

Further,if the closing of a sale of loans is postponed, the recognition of gain fromthe sale is also postponed. If such a delay causes us to recognize income inthe next quarter, our results of operations for the previous quarter could besignificantly depressed. If our results of operations do not meet theexpectations of our stockholders and potential stockholders, the price of ourcommon stock may decrease.

 

*Contracting Mortgage Origination Market May Adversely ImpactOur Business*

 

Accordingto the Mortgage Bankers Association, 2003 was a record year with $3.8 trillionin mortgage loan originations; however, 2004 is currently projected to be $2.6trillion. This expected contraction is due to generally higher mortgageinterest rates and a decline in the level of loan refinancings. We anticipatehigher costs per loan and lower per loan revenue as a direct consequence of theexpected market contraction and increased competition. Increased market sharein existing markets and planned expansion into new markets may be insufficientto prevent an overall decline in results of operations. The growth of ourbusiness may also be adversely impacted due to general market contraction. Weare expanding our business operations and increasing our fixed expenses in acontracting market.  Our strategyrequires us to capture an increasing percentage of the market in a highlycompetitive environment which will put pressure on our gross margins.  If we are not able to do this, we wouldlikely experience losses due to our increased level of expenses.

 

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

 

Weuse forward sales of mortgage loan securities (TBA) and options onmortage-backed securities ("MBS") which are classified as derivativefinancial instruments, to provide a level of protection against interest raterisks. When rates change we expect to record a gain or loss on derivativeswhich would be offset by an inverse change in the value of our pipeline of ratelock commitments and loans not yet committed for sale. We cannot assure you,however, that our use of derivatives will offset all of our risk related tochanges in interest rates. There have been periods, and it is possible thatthere will be periods in the future, during which we will incur losses afteraccounting for our derivative financial instruments. The derivative financialinstruments we select may not have the desired effect of reducing our interestrate risk. In addition, the nature and timing of hedging transactions mayinfluence the effectiveness of these strategies. If we poorly design strategiesor improperly execute transactions we could actually increase our exposure tointerest rate risk and potential losses. In addition, hedging strategiesinvolve transaction and other costs. We cannot assure you that our hedgingstrategy and the derivatives that we use will adequately offset the risk ofinterest rate volatility or that our hedging transactions will not result inlosses.

 

Weoffer loan programs of many terms, from thirty year fixed interest rate loansto one year adjustable loans. The hedging instruments used, on balance,correlate satisfactorily with the thirty and fifteen year loan programs. Thehedging instruments used for our shorter term loan programs and adjustableinterest rate loans have a somewhat lower correlation to changes in marketinterest rates than do thirty year term programs. Consequently, the design ofour hedge strategy may not be effective at certain times and this occurrencecould be amplified for these shorter term loan programs.

 

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

 

Ourprimary source of revenue is from gains on sales of loans, net of gains orlosses on derivative financial instruments. We set rates and pay brokerpremiums for loans we fund based on a pricing process designed to create atargeted profit margin on each loan. Appropriately pricing these loans can becomplex, and we may not always successfully price our loans with adequatemargin to compensate us for the risk of interest rate volatility.

 

Thevalue of the mortgage loans that we originate is at risk due to fluctuations ininterest rates during two time periods: (1) the period beginning when wehave committed to funding the loan (rate lock commitments) and ending when theloan closes, or funds; and (2) the time period beginning when the loancloses and ending when we commit to sell, or sell the loans to third-partypurchasers (uncommitted loans). These rate lock commitments and uncommittedloans are collectively referred to as our pipeline. To manage the interest raterisk of our pipeline, we continuously project the percentage of the pipelineloans we expect to close. Because projecting a percentage of pipeline loansthat will close is especially difficult during periods of volatile interestrates, we cannot assure that our projections will be accurate. On the basis ofsuch projections, we use forward sales of mortgage-backed securities (TBA) andoptions on

 

27

----

 

MBS,which are classified as derivative instruments. These “hedges” are designed tomitigate the adverse impact interest rate fluctuations have on the value of thepipeline. Our use of hedges is driven by our estimates as to the percentage ofloans that will close, and therefore we cannot assure you that our use ofderivative securities will offset the risk of changes in interest rates.

 

Ifinterest rates change, the actual percentage of pipeline loans that close maydiffer from the projected percentage. A sudden significant increase in interestrates can cause a higher percentage of pipeline loans to close than projected.We may not have made forward sales commitments to sell these additional loansand consequently may incur significant losses upon their sale at current marketprices, which may not be offset by gains in the value of derivative securities,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, we have and may in the future adjust our hedge positions ormandatory sales commitments at a significant cost, adversely affecting ourresults of operations. This risk is greater during times of volatile interestrates.

 

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

 

Inconnection with our mortgage loan sales, which involve the sale of mortgageloans and mortgage-backed securities on a forward or other deferred deliveryand payment basis, we may enter into forward sale of mortgage-backed securities(TBA) and options on MBS in connection with our hedging activities. We have creditrisk exposure to the extent purchasers/sellers are unable to meet the terms oftheir forward purchase/sale contracts. As is customary in the marketplace, noneof the forward payment obligations of any of our counterparties is currentlysecured or subject to margin requirements. We attempt to limit our creditexposure on forward sales arrangements on mortgage loans and mortgage-backedsecurities by entering into forward contracts only with institutions that webelieve are acceptable credit risks, and which have substantial capital and anestablished track record in correspondent lending.  If counterparties do not perform, our results of operations maybe adversely affected.

 

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

 

We currently have revolvingwarehouse borrowing facilities in place totaling $1.4 billion. Thesefacilities enable AmNet Sub to fund up to approximately $1.6 billion on amonthly basis. In order to continue our operations, we must maintain, renew orreplace warehouse lines of credit. There are a number of financial institutionswhich specialize in lending to mortgage banking companies and these types ofsecured borrowings. We expect to renew our current warehouse facilities with JPMorgan/Chase, UBS Warburg, Countrywide Warehouse Lending and RFC. Failure torenew facilities would limit our potential to fund loans and may adverselyaffect our financial results. Among the factors that will affect our ability torenew and expand our warehouse line borrowings are financial market conditionsand the value and performance of our Company prior to the time of suchfinancing. There can be no assurance that any such financing can besuccessfully completed at advantageous rates or at all. Our warehouse creditfacilities contain extensive restrictions and covenants that, among otherthings, require us to satisfy specified financial, asset quality and loanperformance tests. If we fail to meet or satisfy any of these covenants, wewould be in default under these agreements and our lenders could elect todeclare all amounts outstanding under the agreements to be immediately due andpayable, enforce their interests against collateral pledged under suchagreements and restrict our ability to make additional borrowings. Theseagreements also contain cross-default provisions, so that if a default occurs,under one agreement, the lenders under our other agreements could also declarea default. Any default under our credit facilities would have an adverse effecton our financial results.

 

Asa direct result of the Company’s expected first quarter net loss, the Companywas out of compliance with certain warehouse line covenants. Prior to thenon-compliance, the warehouse providers each waived the covenants for which theCompany was out of compliance, and management believes we are in good standingwith these lenders. However, there can be no assurances that such waivers willbe obtained in the event of ongoing losses, which would have a material adverseeffect on our financial results.

 

Thecovenants and restrictions in our warehouse credit facilities may restrict ourability to, among other things:

 

•                                          incur additional debt by virtue of havingwarehouse loan covenants;

 

•                                          make certain investments or acquisitions;

 

•                                          repurchase or redeem capital stock;

 

•                                          engage in mergers or consolidations;

 

•                                          finance loans with certain attributes;

 

•                                          reduce liquidity below certain levels; and

 

28

----

 

•                                          hold loans for longer than established timeperiods.

 

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

 

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

 

Wehave warehouse line facilities with Countrywide. We also sell a portion of ourloans to two of our competitors, Countrywide Home Loans, Inc., 68% in the firstthree months of 2004, and 16% were sold to Wells Fargo for the same timeperiod. In addition, if either Countrywide or Wells Fargo changes itscorrespondent lending strategy or procedures, or stops purchasing our loans onfavorable terms, we could be required to find alternate purchasers and/oraccept unfavorable terms. We could also be forced to find other sources ofwarehouse line lending. Any of these results may have an adverse effect on ourresults of operations.

 

*Dependency on Correspondent Investors, Secondary Markets*

 

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

 

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

 

Alarge proportion of loans (27.6% of all loans closed for the three month periodended March 31, 2004) we fund are concentrated in California. Although wehave expanded our operations on the East Coast of the United States, a significantportion of our loan origination volume is likely to be based in California forthe foreseeable future. Consequently, our results of operations and financialcondition are dependent upon general trends in the California economy and itsresidential real estate market. Residential real estate market declines mayadversely affect the levels of new mortgages in California or the value paid bycorrespondent lenders for loans in California, potentially adversely affectingour results of operations and financial condition.

 

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

 

Inconnection with the sale of loans to correspondent investors, we make a varietyof representations and warranties regarding the loans, including those that arecustomary in the industry relating to, among other things, compliance withlaws, regulations and investor program standards and the accuracy ofinformation on the loan documents and in the loan file. In the event that aninvestor finds that a loan or group of loans violates our representations, theinvestor may require us to repurchase the loan or loan group and bear anypotential related loss on the disposition of the loans, or provide anindemnification for any losses sustained by the investor on the loans.Additionally, we may originate a loan that does not meet investor underwritingcriteria or has some other defect, requiring us to sell the loan at asignificant discount. We have hired experienced personnel at all levels and haveestablished significant controls to ensure that all loans are originated to ourunderwriting standards, and are maintained in compliance with all of therepresentations made by us in connection with our loan sale agreements.However, there can be no assurances that mistakes will not be made or thatcertain employees will not deliberately violate our lending policies and,accordingly, we are subject to repurchase risk and losses on unsaleable loans.Typically, with respect to any loan that might be repurchased or unsaleable, wewould correct the flaws if possible and re-sell the loan in the market. We havecreated repurchase reserves to provide for this contingency on our financialstatements, but there can be no assurances that loan losses associated withrepurchased or unsaleable loans will not adversely impact results of operationsor the financial condition of our Company.

 

*The Company is Beginning to Lend to Sub-prime Borrowerswhich May Adversely Affect Earnings*

 

Beginningin March of 2004, the Company began lending to sub-prime borrowers. Creditrisks associated with sub-prime mortgage loans will be greater than thoseassociated with mortgage loans that conform to FNMA and FHLMC guidelines. Theprincipal difference between sub-prime mortgage loans and conforming mortgageloans is that sub-prime mortgage loans typically include one or more of thefollowing: worse credit and income histories of the mortgagors, higherloan-to-value ratios, reduced or alternative documentation required forapproval of the mortgagors, different types of properties securing the mortgageloans, higher loan sizes and the mortgagor’s non-owner occupancy status withrespect to the mortgaged property. We intend to add personnel in a centralizedsub-prime underwriting and funding center to help mitigate the risks associatedwith these loans, however there can be no assurance that all sub-prime loanswill be able to be sold to investors at a profit. If we are not successful,higher overhead incurred to produce these loans may not be covered by theincome derived from sub-prime lending.

 

29

----

 

*Our Estimate of Recourse Reserve is Difficult to EstimateGiven Our Limited History in the Mortgage Banking Business*

 

Webegan our Mortgage Banking segment in November of 2001. Mortgage loans wesell to investors provide for repurchase of loans which become delinquentwithin varying timeframes. Our limited history makes it difficult to assess theamount of recourse reserves which should be provided given these buy backarrangements. Therefore there is no assurance that our recourse reserves areadequate.

 

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

 

Weoriginate mortgage loans in many states. We must comply with the laws andregulations, as well as judicial and administrative decisions, of all of thesejurisdictions, as well as an extensive body of federal laws and regulations.The volume of new or modified laws and regulations has increased in recentyears, and, in addition, individual cities and counties have begun to enactlaws that restrict loan origination activities in those cities and counties.The laws and regulations of each of these jurisdictions are different, complexand, in some cases, in direct conflict with each other. As our operationscontinue to grow, it may be more difficult to comprehensively identify, toaccurately interpret and to properly program our technology systems andeffectively train our personnel with respect to all of these laws andregulations, thereby potentially increasing our exposure to the risks ofnoncompliance with these laws and regulations.

 

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

 

•                                          civil and criminal liability;

 

•                                          loss of approved status;

 

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

 

•                                          class action lawsuits;

 

•                                          assignee liability, which may make our loansunsaleable; and

 

•                                          administrative enforcement actions.

 

*The Increasing Number of State and Local “Anti-predatoryLending” Laws May Restrict Our Ability to Originate or Increase Our Risk ofLiability With Respect To Certain Mortgage Loans and Could Increase Our Costsof Doing Business*

 

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

 

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

 

30

----

 

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

 

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

 

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

 

Ourmortgage loan origination business is currently dependent upon our ability toeffectively interface with our brokers, borrowers and other third parties andto efficiently process loan applications and closings. The origination processis becoming more dependent upon technological advancement, such as the abilityto process applications over the Internet, accept electronic signatures, andprovide process status updates instantly and other customer-expectedconveniences that are cost-efficient to our process. Implementing this newtechnology and becoming proficient with it may also require significant capitalexpenditures. As these requirements increase in the future, we will have tofully develop these technological capabilities to remain competitive or ourbusiness will be significantly harmed.

 

Werely on processing information electronically. We have no disaster recoveryplan in the event of a disaster which impairs or eliminates our electroniccapabilities, and it is not clear how the necessary systems and informationwould be recovered to allow for renewal of operations.

 

*We Must Attract and Retain Qualified Account Executives andQualified Personnel to Produce Our Desired Level of Revenues*

 

TheCompany relies on commissioned account executives to generate loan referralsfrom professional mortgage brokers. These account executives typically haveestablished relationships with broker clients. The Company’s overall loanfundings are in direct proportion to the number of account executives, and as such,sustained loan production and market share growth are dependent on thesuccessful retention and recruitment of the sales force. Similarly, the Companyrelies on the expertise of its employees in other facets of operations,including underwriting, capital markets, risk management, and finance andaccounting. Given the dependency on the job market for qualified employees, tocontinue our growth poses the potential risk that the Company will not be ableto attract and retain qualified employees.

 

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

 

Ourmortgage banking activities require a significant level of cash reserves andcapital to support loan inventories and overhead exposure. Additionally, whilewe utilize warehouse credit facilities to fund our loan origination activity,we must invest cash equity in our loan inventories approximating 1% to 4% ofthe cost basis of these loans. While we believe our capital base, cash reservesand cash flow from the pending sale of a majority of our mortgage assetportfolio business and mortgage banking revenues will be sufficient to enableus to execute our mortgage banking strategy, there can be no assurances thatcapital shortages will not occur, requiring us to raise additional debt orequity capital or decrease or cease our origination activities

 

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

 

Mortgagebrokers who assist loan applicants in obtaining mortgage loans refer all of themortgage loans originated by us. As such, the loan application, propertyappraisal, credit report and other supporting documentation are furnished bythe mortgage broker and used by our underwriters to make approval or denialdecisions. There could also be the potential of collusion between the brokerand an employee to produce a fraudulent loan. Our employees usually have littlecontact with applicants, and rely on the mortgage broker to obtain and furnishall of the documentation supporting the mortgage loan application. Mortgagebrokers may make mistakes in completing the documentation for a loan leading toan increased risk of our holding a non-saleable loan or of indemnifying orrepurchasing loans from investors.

 

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

 

31

----

 

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

 

Wehave established risk management and quality control committees to set policyand manage exposure to credit losses due to fraud, compliance errors ornon-compliance with our underwriting standards. Regular quality control auditsare done on representative samples of mortgage loans and all mortgage loanssubmitted by brokers who come under suspicion in the normal course business.Additionally, we have numerous controls and processes to ensure that all of themortgage loan applications submitted through mortgage brokers are not based onfraudulent or intentionally misrepresented documentation. However, there can beno assurances that the broker and/or borrowers do not submit fraudulent orinaccurate documentation that is not detected by our personnel or by electronicfraud checks utilized by us. Should we originate significant numbers offraudulent loans or loans based on inaccurate documentation, our results ofoperations and financial condition could be materially adversely affected.

 

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

 

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

 

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

 

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

 

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

 

HUDis proposing to improve the manner in which mortgage broker fees are disclosedby requiring that yield spread premiums (“YSP”) (and other mortgage brokercompensation) be reported as payments from the lender. The purpose of thiswould be to have the mortgage broker only receive direct compensation fromborrowers and attempt to eliminate disputes regarding improper broker payments.This proposed rule may adversely affect our business by requiring changes insystems and procedures which may cause delays and re-work to meet regulatoryrequirements.

 

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

 

InApril 2004, we entered into contracts to sell the majority of our bondcollateral mortgage loans and bond collateral real estate owned. The sales areexpected to close in May 2004, at which time we expect to redeem the vastmajority of our long-term debt. As such, the Mortgage Asset Portfolio Businessis not expected to have a material impact on the Company’s financial statementsgoing forward. The risks associated with our mortgage asset portfolio businessare outlined in our 2003 10K filed with the SEC on March 30, 2004. Theserisks will be substantially less material to the Company subsequent to theabove mentioned portfolio sale and debt extinguishment.

 

*If the Sale of the Majority of thePortfolio is not Completed, We will be Required to Obtain New Financing andMake New, Less Attractive, Sub-Servicing Arrangements*

 

Allof our issuances of CMO debt have provisions permitting us to redeem the debtwhen the remaining collateral has been paid down to various percentages of itsinitial amount. In certain of these issuances, the master servicer or trusteemay elect to redeem the debt if we do not. Based on a contract for sale of themajority of our remaining bond collateral, we have formally notified the masterservicers or

 

32

----

 

trusteesthat we intend to exercise our call rights and redeem the bonds. We expect theportfolio sales to be completed in May of 2004, with simultaneousextinguishment of the bond liabilities. In the event that the portfolio sale isnot consummated, in order to redeem the CMO bonds, we will be required toobtain new short-term financing and negotiate new sub-servicing arrangements.In such an event, our costs of carrying the assets could increasesignificantly.

 

*If the Purchasers of thePortfolios Fail to Purchase all of the Bond Collateral, We May be Required toSell it to Another Purchaser or Attempt to Enforce Remedies underRepresentations and Warranties Obtained from the Original Seller/ServicersWhich May No Longer be Enforceable*

 

Inconnection with their due diligence, the firms purchasing the majority of theremaining bond collateral may reject certain loans due to non-compliance withregulatory requirements in place at the time the loans were originated. If thisis the case, we have protections under the representation and warrantiesprovided by the original seller/servicers from which we purchased the loans,and we would expect to exercise these remedies.

 

However,to the extent any remaining collateral is so rejected by the firms purchasingthe portfolio assets, the protections afforded by the representations andwarranties obtained from the original seller/servicer may no longer beenforceable. Certain sellers/servicers may no longer be in existence or thepassage of time may have rendered the claim for a breach uncertain. In thisevent, we would need to re-sell or refinance the collateral and potentiallyincur cost or losses in the disposition of these assets and potentially utilizecash recourses to carry these assets in the meantime.  Accordingly, while we expect net proceeds of the sale, after debtextinguishment, to be approximately $25 million in the second quarter of 2004,some delays may be incurred in receipt of the entire $25 million.

 

33

----

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

Aprimary market risk facing our Company is interest rate risk, which is highlysensitive to many factors, including governmental monetary and tax policies,domestic and international economic and political considerations and otherfactors beyond our control. We attempt to manage this risk in our MortgageBanking and Mortgage Asset Portfolio businesses.

 

**Mortgage Banking Business**

 

*Interest Rate Risk*

 

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

 

**Mortgage Asset Portfolio Business**

 

*Interest Rate Risk*

 

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

 

*Other Risks*

 

Weare selling approximately 85% of our portfolio and retiring related debt. Thesales are expected to be completed in May of 2004. If the buyers’ review ofportfolio assets reveals inconsistencies, these sales could be changed orcancelled prior to completion. If we do not complete these sales, a disruptionmay occur in our planned retirement of bond debt while we arrange alternativeshort-term financing and our costs of carrying these assets could increasesignificantly. Our estimates of net proceeds and expenses could also beaffected by these changes.

 

**Sensitivity Analysis**

 

Themethods we have used in our sensitivity analysis have not changed significantlysince December 31, 2003. However, because our Mortgage Asset Portfolio isno longer subject to interest rate risk, as described above, the impact fromchanges in interest rates on our bond collateral is significantly reduced.

 

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

 

34

----

 
|                                                                   |   |                     |    |                      |   | **If  Interest Rates Were To**             |   |
|------------------------------------------------------------------------|--------|--------------------------|---------|---------------------------|--------|--------------------------------------------|--------|
|                                                                   |   | **March 31,  2004** |    | **Increase**              |   | **Decrease**                               |   | **Increase** |   | **Decrease** |   |
|                                                                   |   | **Carrying  Amount**     |    | **Estimated  Fair Value** |   | **50 Basis  Points  Estimated Fair Value** |   | **100 Basis  Points  Estimated Fair Value** |   |
| Interest-earning assets:                                               |   |                     |    |                      |   |                                       |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |   | $                        | 27,647  |                      | $      | 27,647                                     |   | $ | 27,647 |   | $ | 27,647 |   | $ | 27,647 |   | $ | 27,647 |   |
| Mortgage loans held for sale, net, pledged,  (lower of cost or market) |   | 510,524                  |    | 514,631                   |   | 508,055                                    |   | 518,844 |   | 501,291 |   | 522,968 |   |
| Bond collateral and real estate owned (net,  held for sale)            |   | 116,226                  |    | 116,226                   |   | 116,226                                    |   | 116,226 |   | 116,226 |   | 116,226 |   |
| Bond collateral and real estate owned (net)                            |   | 21,215                   |    | 21,374                    |   | 21,364                                     |   | 21,388 |   | 21,354 |   | 21,401 |   |
| Total interest-earning assets                                          |   | $                        | 675,612 |                      | $      | 679,878                                    |   | $ | 673,292 |   | $ | 684,105 |   | $ | 666,518 |   | $ | 688,242 |   |
|                                                                   |   |                     |    |                      |   |                                       |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                                          |   |                     |    |                      |   |                                       |   |   |   |   |   |   |   |
| Short-term debt                                                        |   | $                        | 495,292 |                      | $      | 495,292                                    |   | $ | 495,292 |   | $ | 495,292 |   | $ | 495,292 |   | $ | 495,292 |   |
| Short-term debt related to bond collateral  held for sale              |   |                     | 90,097  |                      |   | 90,097                                     |   |   | 90,097 |   |   | 90,097 |   |   | 90,097 |   |   | 90,097 |   |
| Long-term debt, net                                                    |   | 20,078                   |    | 20,078                    |   | 20,078                                     |   | 20,078 |   | 20,078 |   | 20,078 |   |
| Derivative financial instruments                                       |   | 205                      |    | 205                       |   | (6,179                                     | )      | 5,061 |   | (10,950 | ) | 11,213 |   |
| Total interest-bearing liabilities                                     |   | $                        | 605,672 |                      | $      | 605,672                                    |   | $ | 599,288 |   | $ | 610,528 |   | $ | 594,517 |   | $ | 616,680 |   |

 

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

 

*Cash and Cash Equivalents*

 

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

 

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

 

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

 

*Bond Collateral, Mortgage Loansand Real Estate Owned*

 

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

 

Thebond collateral held for sale is subject to contracts for sale which areexpected to close in May 2004. Consequently, this asset is not revalued forsubsequent changes in interest rates.

 

*Derivatives*

 

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

 

*Short-Term Debt*

 

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

 

*Long-Term Debt*

 

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

 

ITEM 4.  CONTROLS AND PROCEDURES

 

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

 

35

----

 

by this quarterly report.

 

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

 

PART II.  OTHER INFORMATION

 
| ITEM  1. |   | LEGAL PROCEEDINGS                                                                                                                                                                                                                                                                                                   |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                |
|     |   | The  Company filed a lawsuit in 2003 for breach of contract, unfair competition  and misappropriation of trade secrets against LoanCity.com. On March 10,  2004, the Company was awarded $3.4 million in compensatory and punitive  damages. It is anticipated that LoanCity.com will appeal the verdict. |
|     |   |                                                                                                                                                                                                                                                                                                                |
| ITEM  2. |   | CHANGES IN SECURITIES AND  USE OF PROCEEDS                                                                                                                                                                                                                                                                          |
|     |   | None                                                                                                                                                                                                                                                                                                                |
|     |   |                                                                                                                                                                                                                                                                                                                |
| ITEM  3. |   | DEFAULTS UPON SENIOR  SECURITIES                                                                                                                                                                                                                                                                                    |
|     |   | Not  applicable.                                                                                                                                                                                                                                                                                                    |
|     |   |                                                                                                                                                                                                                                                                                                                |
| ITEM  4. |   | SUBMISSION OF MATTERS TO A  VOTE OF SECURITY HOLDERS                                                                                                                                                                                                                                                                |
|     |   | None                                                                                                                                                                                                                                                                                                                |

 

36

----

 

ITEM5.                        OTHER INFORMATION

 

(a)                        Our Board of Directors has set the date ofour Annual Meeting of stockholders for August 12, 2004.  Accordingly, we anticipate that the date ofour proxy statement for that meeting will be approximately June 28th.  To be included in this year’s proxystatement for our Annual Meeting, stockholder proposals must be received by usby May 28, 2004 and must satisfy the conditions established by the Securitiesand Exchange Commission, specifically, Rule 14(a)-8 of the Securities ExchangeAct of 1934 as amended.

 

(b)                       In January 2004 our Board approved aDirector Nominations Policy.  Under thispolicy, the Corporate Governance and Nominating Committee will evaluate anyrecommendation for director nominee proposed by a stockholder who hascontinuously held at least 1% of the outstanding shares of our Company’s commonstock entitled to vote at the meeting for at least one year by the date thestockholder makes the recommendation and who undertakes to continue to hold thecommon stock through the date of the meeting. In order to be evaluated in connection with our established proceduresfor evaluating potential director nominees, any recommendation for directornominee submitted by a qualifying stockholder must be received by us 120 daysprior to the anniversary of the date proxy statements were mailed tostockholders in connection with the prior year’s annual meeting of stockholders.  Any stockholder recommendation for directornominee must be submitted to the Company’s Chairman of the Corporate Governanceand Nominating Committee in writing at 10421 Wateridge Circle, Suite 250 SanDiego, California 92121 and must contain the following information:

 

• a statement by the stockholder that he/sheis the holder of 1% of the Company’s common stock and that the stock has beenheld for at least a year prior to the date of the submission and that thestockholder will continue to hold the shares through the date of the meeting;

• the candidate’s name, age, contactinformation and present principal occupation or employment;

• a description of the candidate’squalifications in business and other experience during, at a minimum, the lastfive years, including his/her principal occupation and employment and the nameand principal business of any corporation or other organization in which thecandidate was employed;

• the candidate’s resume; and

• 3 references.

 

Thecommittee will evaluate recommendations for director nominees submitted bydirectors, management and qualifying stockholders using the same criteria forall candidates.

 

Alldirectors and director nominees will submit a completed form of directors’ andofficers’ questionnaire as part of the nominating process.  The process may also include interviews andadditional background and reference checks for non-incumbent nominees, at thediscretion of the committee.

 

ITEM6.                        EXHIBITS AND REPORTS ON 8-K

 
| (a)    |   | Exhibits |   |                                                                                                                                                                                    |
|--------|--------|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |     |   |                                                                                                                                                                                    |
|   | *      | 3.1      |   | Second  Articles of Amendment and Restatement of the Registrant                                                                                                                         |
|   |   | 3.1  A   |   | Articles  of Amendment (regarding name change)                                                                                                                                          |
|   | **     | 3.2      |   | Fourth  Amended and Restated Bylaws of the Registrant                                                                                                                                   |
|   | ***    | 4.1      |   | Registration  Rights Agreement dated February 11, 1997                                                                                                                             |
|   | **     | 4.3      |   | First  Amended and Restated Rights Agreement between the Company and American Stock  Transfer and Trust Company dated as of February 2, 1999 and amended as  of March 4, 2004 |
|   |   | 31.1     |   | Section 302  CEO Certification                                                                                                                                                     |
|   |   | 31.2     |   | Section 302  CFO Certification                                                                                                                                                     |
|   |   | 32.1     |   | Section 906  CEO Certification                                                                                                                                                     |
|   |   | 32.2     |   | Section 906  CFO Certification                                                                                                                                                     |

 

----

|   | *   |   |   | Incorporated by reference to our annual report on  Form 10-K for the fiscal year ended December 31, 2002 filed  March 31, 2003    |
|--------|-----|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   | **  |   |   | Incorporated by reference to our annual report on  Form 10-K for the fiscal year ended December 31, 2003 filed on  March 30, 2004 |
|   | *** |   |   | Incorporated by reference to our registration  statement on Form S-11 filed September 25, 1997                                         |

 

37

----

 
| (b)    |   |      |   | Reports  on Form 8-K – The Company filed or furnished the following reports on form  8-K during the quarter |
|--------|--------|-----------|--------|------------------------------------------------------------------------------------------------------------------|
|   |   |      |   |                                                                                                             |
|   |   | **Date**  |   | **Items**                                                                                                        |
|   |   | 2/12/2004 |   | Item  7 Exhibits (press release furnished)                                                                       |
|   |   |      |   | Item  12 results of operations and financial conditions                                                          |

 

38

----

 

SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                      | AMNET  MORTGAGE, INC. |
|---------------------------|-----------------------|
|                      |                  |   |   |
| Dated:  May 17, 2004 | By:                   | /s/ Judith A. Berry |   |
|                      |                  |   | Judith  A. Berry, |
|                      |                  |   | Executive  Vice President |
|                      |                  |   | Chief  Financial Officer |
|                           |                       |  |  |  |  |

 

39

----