** **

**U.S. Securities and Exchange Commission**

**Washington, D.C.  20549**

 

**Form 10-Q**

 

| **ý** |   | **Quarterly Report Pursuant To  Section 13 or 15 (d) of the Securities Exchange Act of 1934**  |   |   |
|------------|--------|------------------------------------------------------------------------------------------------|--------|--------|
|       |   |                                                                                           |   |   |
|       |   | **For the Quarter 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 1-31795**                                                             |   |   |

 

**The Washtenaw Group, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Michigan**                                                    |   | **20-0126218**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (IRS Employer  Identification No.) |
|                                                            |   |                               |
| **3767 Ranchero Drive  Ann Arbor, Michigan  48108**        |
| (Address of Principal Executive Offices)                        |
|                                                            |   |                               |
| **734-662-9733**                                                |
| (Registrant’s Telephone Number, Including Area Code)       |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. Yes       ý       Noo

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common equity, as of the latestpracticable date:

 

Common Stock Outstanding as ofApril 30, 2004

 
| Common  stock, $0.01 Par value | 4,488,351  Shares |
|--------------------------------|-------------------|

 

 

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Index

 
| Part I.  Financial Information |                                                                                                       |
|--------------------------------|------------------------------------------------------------------------------------------------------------|
|                           |                                                                                                       |   |   |
|                           | Item  1.  Financial Statements (unaudited)                                                       |   |
|                           |                                                                                                       |   |   |
|                           |                                                                                                       | Consolidated Balance Sheets as of March 31, 2004 and December 31,  2003 |   |
|                           |                                                                                                       |   |   |
|                           |                                                                                                       | Consolidated Statements of Income and  Comprehensive Income for the Three Months  Ended March 31, 2004 and 2003 |   |
|                           |                                                                                                       |   |   |
|                           |                                                                                                       | Consolidated Statements of Cash Flows for  the Three Months Ended  March 31, 2004 and 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 Shareholders                                             |   |
|                           |                                                                                                       |   |
|                           | Item 5.  Other Information                                                                            |   |
|                           |                                                                                                       |   |
|                           | Item 6.   Exhibits and Reports on Form 8-K                                                            |   |
|                                |                                                                                                            |  |  |  |

 

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**THE WASHTENAW GROUP,INC.**

ConsolidatedBalance Sheets

 
|                                                                                                                     |   | **March 31,  2004** |        | **December  31, 2003** |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-------------|------------------------|--------|
|                                                                                                                     |   | **(Unaudited)**     |        |                   |   |
| **ASSETS**                                                                                                               |   |                |        |                   |   |
| Cash and cash equivalents                                                                                                |   | $                   | 100,000     |                   | $      | 100,000 |   |
| Accounts receivable, net                                                                                                 |   | 5,319,392           |        | 5,340,932              |   |
| Loans held for sale                                                                                                      |   | 93,628,858          |        | 97,687,823             |   |
| Mortgage servicing rights, net                                                                                           |   | 21,591,740          |        | 24,614,381             |   |
| Other real estate owned                                                                                                  |   | 893,385             |        | 925,839                |   |
| Premises and equipment, net                                                                                              |   | 1,566,900           |        | 1,480,988              |   |
| Other assets                                                                                                             |   | 1,249,342           |        | 1,030,653              |   |
|                                                                                                                     |   |                |        |                   |   |
|                                                                                                                     |   | $                   | 124,349,617 |                   | $      | 131,180,616 |   |
|                                                                                                                     |   |                |        |                   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                            |   |                |        |                   |   |
| Liabilities                                                                                                              |   |                |        |                   |   |
| Due to bank                                                                                                              |   | 17,883,573          |        | 11,074,372             |   |
| Notes payable                                                                                                            |   | 40,007,318          |        | 33,211,685             |   |
| Repurchase agreements                                                                                                    |   | 32,158,921          |        | 43,926,901             |   |
| GNMA repurchase liability                                                                                                |   | 6,498,614           |        | 8,599,700              |   |
| Other liabilities                                                                                                        |   | 8,673,246           |        | 12,162,996             |   |
| Total liabilities                                                                                                        |   | 105,221,672         |        | 108,975,654            |   |
|                                                                                                                     |   |                |        |                   |   |
| Shareholders’ equity                                                                                                |   |                |        |                   |   |
| Preferred stock, $.01 par value 1,000,000  shares authorized; none outstanding                                           |   | —              |        | —                 |   |
| Common stock, $.01 par value 9,000,000  shares authorized 4,488,351 outstanding at March 31, 2004 and December 31,  2003 |   | 44,884              |        | 44,884                 |   |
| Additional paid in capital                                                                                               |   | 1,981,251           |        | 1,955,932              |   |
| Retained earnings                                                                                                        |   | 17,100,810          |        | 20,204,146             |   |
| Total shareholders’ equity                                                                                          |   | 19,126,945          |        | 22,204,962             |   |
|                                                                                                                     |   |                |        |                   |   |
|                                                                                                                     |   | $                   | 124,349,617 |                   | $      | 131,180,616 |   |

 

See accompanying notes to consolidated financial statements

 

3

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**THE WASHTENAW GROUP,INC.**

Consolidated Statements of Income (Unaudited)

 
|                                                                   |   | **Three  Months Ended  March 31,** |       |
|------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                   |   | **2004**                           |       | **2003** |   |
|                                                                   |   |                               |       |   |   |
| Interest income                                                        |   | $                                  | 1,208,841  |   | $ | 3,062,016 |   |
| Interest expense                                                       |   | 821,762                            |       | 1,539,577 |   |
| Net interest income                                                    |   | 387,079                            |       | 1,522,439 |   |
|                                                                   |   |                               |       |   |   |
| Noninterest income                                                     |   |                               |       |   |   |
| Servicing income                                                       |   | 2,388,877                          |       | 1,719,956 |   |
| Gain on sales of mortgage servicing rights  and loans, net             |   | 2,748,977                          |       | 11,437,201 |   |
| Other income                                                           |   | 285,544                            |       | 204,170 |   |
| Total noninterest income                                               |   | 5,423,398                          |       | 13,361,327 |   |
|                                                                   |   |                               |       |   |   |
| Noninterest expense                                                    |   |                               |       |   |   |
| Compensation and employee benefits                                     |   | 3,307,966                          |       | 5,301,144 |   |
| Occupancy and equipment                                                |   | 419,348                            |       | 395,303 |   |
| Telephone                                                              |   | 78,379                             |       | 129,200 |   |
| Postage                                                                |   | 148,681                            |       | 184,358 |   |
| Amortization of mortgage servicing rights                              |   | 1,953,227                          |       | 1,183,785 |   |
| Mortgage servicing rights valuation  adjustment                        |   | 2,902,314                          |       | 1,805,004 |   |
| Loss and provision for loss on loan  repurchases and other real estate |   | 616,834                            |       | 917,341 |   |
| Other noninterest expense                                              |   | 994,833                            |       | 932,788 |   |
| Total noninterest expense                                              |   | 10,421,582                         |       | 10,848,923 |   |
|                                                                   |   |                               |       |   |   |
| **Income (loss) before income taxes**                                  |   | (4,611,105                         | )          | 4,034,843 |   |
|                                                                   |   |                               |       |   |   |
| Provision for income taxes                                             |   | (1,507,768                         | )          | 1,375,819 |   |
|                                                                   |   |                               |       |   |   |
| **Net income (loss)**                                                  |   | $                                  | (3,103,337 | ) | $ | 2,659,024 |   |
|                                                                   |   |                               |       |   |   |
| Basic and diluted earnings (loss) per share                            |   | $                                  | (0.69      | ) | $ | 0.60 |   |

 

See accompanying notes to consolidated financial statements

 

4

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**THE WASHTENAW GROUP,INC.**

Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended March 31,

 
|                                              |   | **2004**    |       | **2003**    |       |
|---------------------------------------------------|--------|-------------|------------|-------------|------------|
| **Cash flows from operating activities**          |   |        | ** ** |        | ** ** |
| Net cash used by operating activities             |   | $           | (5,967,022 | )           | $          | (8,152,976 | ) |
|                                              |   |        |       |        |       |
| **Cash flows from investing activities**          |   |        | ** ** |        | ** ** |
| Proceeds from sales of mortgage servicing  rights |   | 4,313,377   |       | 5,242,923   |       |
| Other real estate owned, net                      |   | 32,454      |       | 140,001     |       |
| Property and equipment expenditures               |   | (216,663    | )          | (207,057    | )          |
| Net cash provided by investing activities         |   | 4,129,168   |       | 5,175,867   |       |
|                                              |   |        |       |        |       |
| **Cash flows from financing activities**          |   |        | ** ** |        | ** ** |
| Increase in due to bank                           |   | 6,809,201   |       | 15,017,873  |       |
| Cash dividends                                    |   | —      |       | (676,688    | )          |
| Increase in notes payable due on demand           |   | 6,795,633   |       | 12,839,446  |       |
| Decrease in repurchase agreements                 |   | (11,766,980 | )          | (24,203,522 | )          |
| Net cash provided by financing activities         |   | 1,837,854   |       | 2,977,109   |       |
|                                              |   |        |       |        |       |
| Net change in cash and cash equivalents           |   | —      |       | —      |       |
|                                              |   |        |       |        |       |
| Cash and cash equivalents at beginning of  period |   | 100,000     |       | 100,000     |       |
|                                              |   |        |       |        |       |
| **Cash and cash equivalents at end of period**    |   | $           | 100,000    |        | $          | 100,000 |   |

 

See accompanying notes to consolidated financial statements

 

5

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**THE WASHTENAW GROUP, INC.**

Notesto the Consolidated Financial Statements (Unaudited)

 

**NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES**

 

Principles ofConsolidation:

The unauditedconsolidated financial statements as of and for the three month period endedMarch 31, 2004 and 2003, include the accounts of The Washtenaw Group, Inc.(“The Washtenaw Group”) and its wholly owned subsidiary Washtenaw MortgageCompany  (“Washtenaw”) for allperiods.  All references herein to TheWashtenaw Group include the consolidated results of its subsidiary.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

Operating Segments:

Washtenaw’s operationsinclude one primary segment: mortgage banking.

 

StockCompensation:

Compensation expense understock options is reported using the intrinsic value method.  Stock-based compensation of $25,319 isreflected in net income for the three months ended March 31, 2004, as optionsgranted had an exercise price less than the market price of the underlyingcommon stock at date of grant.  Thefollowing table illustrates the effect on net income and earnings per share ifexpense was measured using the fair value recognition provisions of FASBStatement No. 123, *Accounting forStock-Based Compensation*.

 

|                                                                                           |   | **Three  Months Ended March 31,** |       |
|------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                           |   | **2004**                          |       | **2003** |   |
| Net income (loss) as reported                                                                  |   | $                                 | (3,103,337 | ) | $ | 2,659,024 |   |
| Deduct: Incremental stock-based  compensation expense determined under fair value based method |   | 1,210                             |       | — |   |
| Pro forma net income (loss)                                                                    |   | $                                 | (3,104,547 | ) | $ | 2,659,024 |   |
|                                                                                           |   |                              |       |   |   |
| Basic earnings (loss) per share as reported                                                    |   | $                                 | (0.69      | ) | $ | 0.60 |   |
| Pro forma basic earnings (loss) per share                                                      |   | (0.69                             | )          | 0.60 |   |
|                                                                                           |   |                              |       |   |   |
| Diluted earnings (loss) per share                                                              |   | $                                 | (0.69      | ) | $ | 0.60 |   |
| Pro forma diluted earnings (loss) per share                                                    |   | (0.69                             | )          | 0.60 |   |

 

Due tothe spin-off (see Note 3), options outstanding of Pelican Financial at December31, 2003 included 10,735 options that were held by employees of Washtenaw.  These options were cancelled during thefirst quarter of 2004 and replaced with 21,470 options on stock of TheWashtenaw Group at an exercise price of $3.25. These options were granted with an intrinsic value (market value pershare, less option exercise price) substantially equal to the intrinsic valueof the cancelled Pelican Financial options.

 

**NOTE 2 – BASIS OF PRESENTATION**

 

The accompanyingunaudited consolidated financial statements were prepared in accordance withinstructions for Form 10-Q and, therefore, do not include information orfootnotes necessary for a complete presentation of consolidated financialcondition, results of operations, and cash flows in conformity with accountingprinciples generally accepted in the United States of America.  However, all adjustments, consisting ofnormal recurring accruals, which, in the opinion of management, are necessaryfor fair presentation of the consolidated financial statements have beenincluded.  The results of operations forthe period ended March 31, 2004, are not necessarily indicative of the resultswhich may be expected for the entire fiscal year or for any other period.  For further information, refer to theconsolidated financial statements and footnotes thereto for the year endedDecember 31, 2003 included in The Washtenaw Group’s Form 10-K.

 

6

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**NOTE 3– SPIN-OFF**

 

On December 31, 2003,Pelican Financial, the former parent company of Washtenaw, distributed all ofthe outstanding shares of Washtenaw to the holders of Pelican Financial commonstock on a share for share basis based on Pelican Financial shareholders ofrecord on December 22, 2003.  Uponcompletion of the distribution on December 31, 2003, Washtenaw is no longer asubsidiary of Pelican Financial.  Duringthe periods presented in the financial statements, Pelican Financial did notincur any expenses on behalf of Washtenaw and no allocation of parent companyexpenses has been reflected in these financial statements.

 

Following thedistribution certain individuals continue to serve as officers of bothWashtenaw and Pelican Financial. Washtenaw pays their salaries and all other compensation, and PelicanFinancial reimburses Washtenaw, as part of the Transitional Services Agreement,for time spent on Pelican Financial matters. Prior to 2004, Pelican did not reimburse Washtenaw for theseservices.  Beginning in 2004, officersand other employees providing services to both companies maintain records oftheir time spent on the affairs of each company as a basis for determining thereimbursements.

 

**NOTE 4 - EARNINGS PER SHARE**

 

The following summarizesthe computation of basic and diluted earnings per share.

 
|                                                  |   | **Three  Months  ended  March 31,  2004** |       | **Three  Months  ended  March 31,  2003** |   |
|-------------------------------------------------------|--------|-------------------------------------------|------------|-------------------------------------------|--------|
| Basic earnings (loss) per share                       |   |                                      |       |                                      |   |
| Net income (loss)                                     |   | $                                         | (3,103,337 | )                                         | $      | 2,659,024 |   |
| Weighted average shares outstanding                   |   | 4,488,351                                 |       | 4,463,221                                 |   |
| Basic earnings (loss) per share                       |   | $                                         | (0.69      | )                                         | $      | 0.60 |   |
|                                                  |   |                                      |       |                                      |   |
| Diluted earnings (loss) per share                     |   |                                      |       |                                      |   |
| Net income (loss)                                     |   | $                                         | (3,103,337 | )                                         | $      | 2,659,024 |   |
| Weighted average shares outstanding                   |   | 4,488,351                                 |       | 4,463,221                                 |   |
| Dilutive effect of assumed exercise of  stock options |   | —                                    |       | —                                    |   |
| Diluted average shares outstanding                    |   | 4,488,351                                 |       | 4,463,221                                 |   |
| Diluted earnings (loss) per share                     |   | $                                         | (0.69      | )                                         | $      | 0.60 |   |

 

At March 31, 2004 therewere 21,470 stock options outstanding that were not considered dilutive. Therewere no options outstanding during 2003.

 

7

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Item 2:Management’s Discussion and Analysis of Financial Condition and Results ofOperations

 

Forward Looking Statements

 

Certain information in thisForm 10-Q may constitute forward-looking information that involves risks anduncertainties that could cause actual results to differ materially from thoseestimated.  Persons are cautioned thatsuch forward-looking statements are not guarantees of future performance andare subject to various factors that could cause actual results to differmaterially from those estimated.  Thesefactors include, but are not limited to, changes in general economic and marketconditions, legislative and regulatory changes, monetary and fiscal policies ofthe federal government, demand for loan and deposit products and thedevelopment of an interest rate environment that adversely affects the interestrate spread or other income from The Washtenaw Group’s investments andoperations.

 

**CRITICALACCOUNTING POLICIES**

 

## **The accounting policies that have the greatestimpact on the Washtenaw Group’s financial condition and results of operationsand that requires the most judgment relate to its mortgage activities.  The Washtenaw Group’s accounting policy forgain on sale of loans, mortgage servicing rights, interest rate risk managementactivities and litigation and claims have not changed since December 31, 2003and the accounting policies are described more fully in the annual report onForm 10-K for the year ended December 31, 2003.**

 

## **EARNINGSPERFORMANCE**

 

The Washtenaw Group reportednet loss of $3.1 million for the quarter ended March 31, 2004 compared to netincome of $2.7 million for the quarter ended March 31, 2003.  Basic and diluted earnings per share was aloss of $0.69 per share compared to earnings of  $0.60 per share for the three months ended March 31, 2004 and2003 respectively.

## ** **

## **RESULTS OFOPERATIONS**

 

Loan Production

The volume of loans producedfor the three months ended March 31, 2004 totaled $394 million as compared to$897 million for the three months ended March 31, 2003, a decrease of $503million or 56%.  The decrease was theresult of rising interest rates during the fourth quarter of 2003 and beginningof the quarter ended March 31, 2004.

 

Noninterest Income

Total noninterest income forthe three months ended March 31, 2004 was $5.4 million, compared to $13.4million for the three months ended March 31, 2003, a decrease of $8.0 millionor 59%. This decrease was primarily due to a 76% decrease in the gain on salesof mortgage servicing rights.  Thedecrease in gain on sale of mortgage servicing rights and loans was primarilydue to a decrease in the overall new loan origination volume in the first threemonths of 2004.  In addition, the gainson sale of mortgage servicing rights and loans was affected by reduced profitmargins on each new loan origination as a result of the current interest rateenvironment.

 

Loan Servicing

At March 31, 2004, Washtenaw serviced$2.9 billion of loans compared to $2.5 billion at March 31, 2003, a 16%increase.  During the three months endedMarch 31, 2004, Washtenaw was selling approximately 49% of its mortgageservicing rights under this agreement. Washtenaw has an agreement to sell the servicing rights related tomortgage loan production on a monthly basis. The remainder of the loan servicing rights created are retained in themortgage loan servicing portfolio.

 

At March 31, 2004 and 2003,with the exception of servicing related to loans held for sale in Washtenaw’sloan portfolio and servicing sold but not yet delivered, all loan servicing wasserviced for others.  Service feeincome, net of amortization was $436,000 and $536,000 for the three monthsended March 31, 2004 and 2003 respectively. Servicing income increased $669,000 or 39% due to the increase in theservicing portfolio; however, the increase in amortization of mortgageservicing rights more than offset the increase in income.  The increase in amortization is related tothe effect of the low interest rate environment, which has increased actual andexpected prepayment rates used to determine amortization rates.

 

8

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Noninterest Expense

Total noninterest expense forthe three months ended March 31, 2004 was $10.4 million, compared to $10.8million for the same period in 2003, a decrease of $400,000 or 4%. Thisdecrease was primarily due to the decrease in employee compensation andbenefits expenses of approximately $2.0 million and a decrease in loss andprovision for loss on loan repurchases and other real estate of $301,000,offset by an increase in the amortization of mortgage servicing rights of$769,000 and an increase in the mortgage servicing rights valuation adjustmentof approximately $1.1 million.  Themortgage servicing rights valuation adjustment was due to a decrease inmortgage interest rates during the end of the period, resulting in increases inexpected prepayment speeds, which project the expected runoff of the mortgageloan servicing portfolio based on comparing the interest rates of the loans inthe portfolio against current market interest rates.  The decrease in employee compensation and benefits was the resultof a decrease in operations staff due to attrition, a reduction in overtimeexpense, a reduction in commission compensation paid to the sales staff and thereduction in management bonus compensation. The increase in amortization ofmortgage servicing rights is the result of the increase in mortgage loanservicing portfolio and the increased speed in which the asset is beingamortized due to the higher prepayment speeds. The decrease in the loss and provision for loss on loan repurchases andother real estate was due to the successful rebuttals of an additional $600,000in repurchase requests as compared to the prior year and the decrease inmortgage loan production. Washtenaw establishes a reserve for repurchases basedon mortgage loan production.  Thereserve is established based on historical repurchase experience and currentrepurchase requests.

 

**BALANCE SHEET ANALYSIS**

 

The following is a discussionof the consolidated balance sheet of The Washtenaw Group.

 

## **ASSETS**

At March 31, 2004, total assetsof The Washtenaw Group equaled $124.4 million as compared to $131.2 million atDecember 31, 2003, a decrease of $6.8 million or 5%. The decrease is primarilydue to the decrease in loans held for sale and mortgage servicing rights.

 

Loans Held for Sale

Loans held for sale were $93.6 million at March 31,2004 compared to $97.7 million at December 31, 2003.  This decrease of $4.1 million or 4% was the result of a decreasein mortgage loan production.

 

Mortgage Servicing Rights

Total mortgage servicing rightswere $21.6 million at March 31, 2004, a decrease of $3.0 million or 12% from$24.6 million at December 31, 2003. Washtenaw has retained the servicing rights on a portion of currentmortgage loan production.             Theseadditions were offset by $4.9 million of amortization and impairment valuationadjustments on the servicing rights for the three months ended March 31,2004.  The impairment valuationadjustments were due to a decrease in mortgage interest rates resulting inincreases in expected prepayment speeds, which project the expected runoff ofthe mortgage loan servicing portfolio based on comparing the interest rates ofthe loans in the portfolio against current market interest rates

 

Washtenaw did not use anyhedges on its mortgage loan servicing portfolio, in the quarter ended March 31,2004.  In general, servicing rightvalues tend to decline in a falling interest rate environment and increase in arising interest rate environment. Management cannot predict future market interest rate levels or themagnitude of future servicing valuation adjustments; however, the potential forfurther impairment charges exist depending on the mortgage interest rateenvironment.  In April 2004, Washtenawbegan hedging a portion of its mortgage loan servicing portfolio.

 

## **LIABILITIES**

At March 31, 2004, the totalliabilities of The Washtenaw Group were $105.2 million as compared to $109.0million at December 31, 2003, a decrease of $3.8 million or 3%. This decreasewas primarily due to decreases in repurchase agreements, GNMA repurchaseliability and other liabilities and was partially offset by an increase in dueto bank and notes payable.

 

9

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Due to Bank

Due to bank was $17.9 millionat March 31, 2004 compared to $11.1 at December 31, 2003.  The increase of $6.8 million or 61% was dueto the increase of mortgage loan production at Washtenaw at the end of thequarter.  Loan production increased inthe last week of the quarter ended March 31, 2004 compared to the year endedDecember 31, 2003.  Due to Bankrepresents the drafts provided to fund the loans purchased by Washtenaw thathave not yet been presented and cleared by the bank.

 

Notes Payable

Notes payable was $40.0 millionat March 31, 2004 compared to $33.2 million at December 31, 2003.  This increase of $6.8 million or 20% wasprimarily caused by the significant increase in loan originations at the end ofthe quarter as described above.  Thenotes payable represent the warehouse line of credit that Washtenaw uses tofund its loan production until such time that the loans are sold to thesecondary market.  Since such a highpercentage of loans closed at the end of the quarter, Washtenaw was not able tosell all these loans to the secondary market or transfer the loans to repurchaseagreements prior to the end of the quarter. Also, Washtenaw is selling more loans to alternative investors that donot allow the transfer to repurchase agreements.

 

Repurchase Agreements

Repurchase agreements were$32.2 million at March 31, 2004 compared to $43.9 million at December 31, 2003.  This decrease of $11.7 million or 27% wasprimarily the result of increased loan originations at the end of the quarteras described above.  Washtenaw is unableto use repurchase agreements to fund loans until the note collateralizing theloan is received from the closing agent. This process usually takes two to five days.  Therefore, when a large percentage of loans close at the end of aquarter, Washtenaw uses its warehouse line as an interim source of funds untilthe note is received.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity Management

The objective of liquiditymanagement is to ensure the availability of sufficient resources to meet allfinancial commitments and to capitalize on opportunities for businessexpansion.  Liquidity managementaddresses the ability to meet deposit withdrawals either on demand or bycontractual maturity, to repay other borrowings as they mature and to make newloans and investments as opportunities arise.

 

To date The Washtenaw Group hasconducted no business other than managing its investments in Washtenaw.  The Washtenaw Group’s source of funds isdividends paid by Washtenaw. Washtenaw’s sources of funds include cash fromgains on sales of mortgage loans and servicing, net interest income, servicingfees and borrowings. Washtenaw sells its mortgage loans generally on a monthlybasis to generate cash for operations. Washtenaw’s uses of cash in theshort-term include the funding of mortgage loan purchases and originations andpurchases of mortgage servicing rights, payment of interest, repayment ofamounts borrowed pursuant to warehouse lines of credit, operating andadministrative expenses, income taxes and capital expenditures.  Long-term uses of cash may also include thefunding of securitization activities or portfolios of loan or servicing assets.

 

Washtenaw funds its businessthrough the use of a warehouse line of credit and the use of agreements torepurchase.  The agreements torepurchase typically have terms of less than 90 days and are treated as asource of financing.  The warehouse lineof credit has a limit of $90 million, of which $11.1 million represents asublimit for servicing under contract for sale, and $6.0 million represents aworking capital sublimit.  Borrowingpursuant to the warehouse line of credit totaled $40.0 million at March 31,2004 and $33.2 million at December 31, 2003. The interest rate on the warehouse line of credit is the Federal FundsRate plus 1.50% resulting in an effective rate of 2.50% at March 31, 2004 andDecember 31, 2003.  The effectiveinterest rate on the agreements to repurchase was 1.90% at March 31, 2004 andDecember 31, 2003.

 

Washtenaw purchases its loanseither by wiring funds to the closing agent or sending a draft.  The decision is based on the requirements ofthe state where the loan is being purchased. When a draft is used, Washtenaw begins earning interest on the day thedraft is issued but does not incur any cost of funds until the draft ispresented to bank.  When the draftclears the bank, Washtenaw will either borrow money on its warehouse line ofcredit or through its agreements to repurchase depending on the type ofloan.  Outstanding drafts totaled $17.9million at March 31, 2004

 

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and $11.1 million at December31, 2003.  The increase is the result ofthe surge in mortgage lending activity at the end of the quarter.

 

The Washtenaw Group’s abilityto continue to purchase loans and mortgage servicing rights and to originatenew loans is dependent in large part upon its ability to sell the mortgageloans at par or for a premium or to sell the mortgage servicing rights in thesecondary market in order to generate cash proceeds to repay borrowingspursuant to the warehouse facility, thereby creating borrowing capacity to fundnew purchases and originations.  Thevalue of and market for The Washtenaw Group’s loans and mortgage servicingrights are dependent upon a number of factors, including the borrower creditrisk classification, loan-to-value ratios and interest rates, general economicconditions, warehouse facility interest rates and governmental regulations.

 

Washtenaw generally grantscommitments to fund mortgage loans for up to 30 days at a specified term andinterest rate.  The commitments arecommonly known as rate-lock commitments. At March 31, 2004, Washtenaw had outstanding rate-lock commitments tolend $214.5 million for mortgage loans. Because these commitments may expire without being drawn upon, they donot necessarily represent future cash commitments.  Also, as of March 31, 2004, Washtenaw had outstanding commitmentsto sell $186.8 million of mortgage loans. These commitments usually are funded within 90 days.

 

Item 3:  Quantitative and Qualitative DisclosureAbout Market Risk

 

For a discussion of The WashtenawGroup’s asset/liability management policies as well as the potential impact ofinterest rate changes upon the market value of The Washtenaw Group’s portfolio,see The Washtenaw Group’s Annual Report to Shareholders and Form 10-K.  Management believes that there has been nomaterial change in The Washtenaw Group’s asset/liability position or the marketvalue of The Washtenaw Group’s portfolio since December 31, 2003.

 

Item 4:  Controls and Procedures

 

Washtenaw, under thesupervision and with the participation of its management, including itsprincipal executive officer and principal financial officer, evaluated theeffectiveness of the design and operation of its disclosure controls andprocedures as of the end of the period covered by this report.  Based on this evaluation, the principalexecutive officer and principal financial officer concluded that Washtenaw’sdisclosure controls and procedures are effective in reaching a reasonable levelof assurance that information required to be disclosed by Washtenaw in thereports that it files or submits under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time period specifiedin the Securities and Exchange Commission’s rules and forms.

 

The principal executive officerand principal financial officer also conducted an evaluation of internalcontrol over financial reporting (“Internal Control”) to determine whether anychanges in Internal Control occurred during the fiscal quarter that havematerially affected or which are reasonably likely to materially affectInternal Control.  Based on thatevaluation, there has been no such change during the quarter covered by thisreport.

 

A control system, no matter howwell conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs.  Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within Washtenaw have been detected.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.  Washtenaw conductsperiodic evaluations to enhance, where necessary, its procedures and controls.

 

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Part II. Other Information

 

Item 1.    LegalProceedings

 

There have been no materialchanges to the pending legal proceedings to which The Washtenaw Group is aparty since the filing of the registrant’s Form 10-K, nor have there been anymaterial legal proceedings to which The Washtenaw Group is a party institutedsince that date.

 

Item 2.    Changes in Securities and Use of Proceeds

 

(a) NotApplicable

(b) NotApplicable

(c) NotApplicable

(d) NotApplicable

(e) NotApplicable

 

Item 3.    Defaults Upon Senior Securities

 

Not Applicable.

 

Item 4.    Submission of Matters to a Vote ofShareholders

 

None

 

Item 5.    OtherInformation

 

Item 6.    Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 
|   | 31.1   |   | Certification  of Principal Executive Officer                                                                           |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                    |
|   | 31.2   |   | Certification  of Principal Financial Officer                                                                           |
|   |   |   |                                                                                                                    |
|   | 32     |   | Certification  Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

(b)   Reportson Form 8-K

 

February 27, 2004 toannounce financial results of quarter and year ended December 31, 2003

 

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The Washtenaw Group, Inc. and Subsidiary

Signatures

 

Under the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this Report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
| Date: May  13, 2004 | /s/ Charles  C. Huffman                       |   |
|---------------------|-----------------------------------------------|--------|
|                | Charles C. Huffman                            |
|                | President  and Chief Executive Officer        |
|                |                                          |
|                |                                          |
| Date: May  13, 2004 | /s/ Howard  M. Nathan                         |   |
|                | Howard M.  Nathan                             |
|                | Vice  President and Chief Financial Officer   |
|                | (Principal  Financial and Accounting Officer) |
|                     |                                               |        |  |

 

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