**U.S. Securities and ExchangeCommission**

**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, 2005** |
|                                           |       |                                                                                                 |
| **Or**                                         |
|                                           |       |                                                                                                 |
| **o**                                          | ** ** | **Transition  Report Pursuant To Section 13 or 15 (d) of the  Securities Exchange Act of 1934** |

 

**Commissionfile number 1-31795**

 

**The Washtenaw Group, Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Michigan**                                                     |   | **20-0126218**                      |
|------------------------------------------------------------------|--------|-------------------------------------|
| (State or  Other Jurisdiction of  Incorporation or Organization) |   | (IRS  Employer  Identification No.) |

 

**3767Ranchero Drive**

**Ann Arbor,Michigan  48108**

(Address of Principal ExecutiveOffices)

 

**734-662-9733**

(Registrant’s Telephone Number,Including Area Code)

 

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 Actof 1934 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.   Yes ý   No o

 

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

 

Common Stock Outstanding as of April 30, 2005

 

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

 

 

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Index

 
| Part I. Financial Information |              |
|-------------------------------|-------------------|
|                          |              |   |   |
|                          | Item 1.           | Financial Statements (unaudited) |   |
|                          |              |   |   |
|                          |              | Consolidated Balance Sheets as of March 31, 2005 and December 31,  2004 |   |
|                          |              |   |   |
|                          |              | Consolidated Statements of Income and  Comprehensive Income for the Three Months Ended March 31, 2005 and 2004 |   |
|                          |              |   |   |
|                          |              | Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2005 and 2004 |   |
|                          |              |   |   |
|                          |              | 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.           | Unregistered Sales of Equity 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 |   |

 

2

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**THEWASHTENAW GROUP, INC.**

ConsolidatedBalance Sheets

 
| ** **                                                                                                                         | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                         | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                         |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                         |       | $                        | 100,000    |                        | $          | 100,000 |   |
| Accounts  receivable                                                                                                               |       | 4,503,750                |       | 7,107,462                   |       |
| Loans held  for sale                                                                                                               |       | 34,289,600               |       | 68,518,733                  |       |
| Securities  available for sale                                                                                                     |       | 5,528,870                |       | 22,234,244                  |       |
| Mortgage  servicing rights, net                                                                                                    |       | 17,363,477               |       | 17,240,953                  |       |
| Other real  estate owned                                                                                                           |       | 1,412,638                |       | 1,589,591                   |       |
| Premises and  equipment, net                                                                                                       |       | 1,542,608                |       | 1,678,252                   |       |
| Other assets                                                                                                                       |       | 1,360,772                |       | 835,787                     |       |
|                                                                                                                               |       | $                        | 66,101,715 |                        | $          | 119,305,022 |   |
|                                                                                                                               |       |                     |       |                        |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                     |       |                     |       |                        |       |
| Liabilities                                                                                                                        |       |                     |       |                        |       |
| Due to bank                                                                                                                        |       | $                        | 5,323,357  |                        | $          | 6,507,279 |   |
| Notes  payable                                                                                                                     |       | 33,845,866               |       | 59,952,788                  |       |
| GNMA  repurchase liability                                                                                                         |       | 1,274,388                |       | 6,465,538                   |       |
| Repurchase  agreements                                                                                                             |       | 5,159,000                |       | 22,390,336                  |       |
| Other  liabilities                                                                                                                 |       | 6,359,786                |       | 8,000,486                   |       |
| Total  liabilities                                                                                                                 |       | 51,962,397               |       | 103,316,427                 |       |
|                                                                                                                               |       |                     |       |                        |       |
| 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,  2005 and December 31, 2004 |       | 44,884                   |       | 44,884                      |       |
| Additional  paid in capital                                                                                                        |       | 2,006,816                |       | 2,006,816                   |       |
| Retained  earnings                                                                                                                 |       | 12,123,933               |       | 13,797,423                  |       |
| Accumulated  other comprehensive income/(loss)                                                                                     |       | (36,315                  | )          | 139,472                     |       |
| Total  shareholders’ equity                                                                                                   |       | 14,139,318               |       | 15,988,595                  |       |
|                                                                                                                               |       |                     |       |                        |       |
|                                                                                                                               |       | $                        | 66,101,715 |                        | $          | 119,305,022 |   |

 

See accompanying notes toconsolidated financial statements

 

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**THEWASHTENAW GROUP, INC.**

Consolidated Statements of Income (Unaudited)

 
| ** **                                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                            |       |                                   |       |   |   |   |
| Interest  income                                                |       | $                                      | 1,184,357  |   | $ | 208,841 |   |
| Interest  expense                                               |       | 469,617                                |       | 821,762 |   |
| Net interest  income                                            |       | 714,740                                |       | 387,079 |   |
|                                                            |       |                                   |       |   |   |
| Noninterest  income                                             |       |                                   |       |   |   |
| Servicing  income                                               |       | 1,318,164                              |       | 2,388,877 |   |
| Gain on  sales of mortgage servicing rights and loans, net      |       | 484,935                                |       | 2,748,977 |   |
| Gain on  sales of securities, net                               |       | 122,108                                |       | — |   |
| Other income                                                    |       | 187,590                                |       | 285,544 |   |
| Total  noninterest income                                       |       | 2,112,797                              |       | 5,423,398 |   |
|                                                            |       |                                   |       |   |   |
| Noninterest  expense                                            |       |                                   |       |   |   |
| Compensation  and employee benefits                             |       | 2,120,685                              |       | 3,307,966 |   |
| Occupancy  and equipment                                        |       | 449,227                                |       | 419,348 |   |
| Telephone                                                       |       | 41,340                                 |       | 78,379 |   |
| Postage                                                         |       | 90,681                                 |       | 148,681 |   |
| Amortization  of mortgage servicing rights                      |       | 870,209                                |       | 1,953,227 |   |
| Mortgage  servicing rights valuation adjustment                 |       | (51,541                                | )          | 2,902,314 |   |
| Loss and  provision for loss on loan repurchases and other real |       | 804,092                                |       | 616,834 |   |
| Other  noninterest expense                                      |       | 1,034,668                              |       | 994,833 |   |
| Total  noninterest expense                                      |       | 5,359,361                              |       | 10,421,582 |   |
| Loss before  income taxes                                       |       | (2,531,824                             | )          | (4,611,105 | ) |
| Provision  for income taxes                                     |       | (858,334                               | )          | (1,507,768 | ) |
| Net Loss                                                        |       | $                                      | (1,673,490 | ) | $ | (3,103,337 | ) |
| Basic and  diluted loss per share                               |       | $                                      | (0.37      | ) | $ | (0.69 | ) |
| Comprehensive  loss                                             |       | $                                      | (1,849,277 | ) | $ | (3,103,337 | ) |

 

Seeaccompanying notes to consolidated financial statements

 

4

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**THEWASHTENAW GROUP, INC.**

Consolidated Statements of Cash Flows (Unaudited)

Three Months Ended March 31,

 
| ** **                                                           | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **Cash  flows from operating activities**                            |       |        |       |        |       |
| Net cash  provided (used) by operating activities                    |       | $           | 25,183,171 |        | $          | (5,967,022 | ) |
|                                                                 |       |        |       |        |       |
| **Cash  flows from investing activities**                            |       |        |       |        |       |
| Proceeds  from sales of securities available for sale                |       | 15,889,356  |       | —      |       |
| Proceeds  from principal repayments of securities available for sale |       | 816,018     |       | —      |       |
| Proceeds  from sales of mortgage servicing rights                    |       | 2,497,678   |       | 4,313,377   |       |
| Other real  estate owned, net                                        |       | 176,953     |       | 32,454      |       |
| Property and  equipment expenditures                                 |       | (40,996     | )          | (216,663    | )          |
| Net cash  provided by investing activities                           |       | 19,339,009  |       | 4,129,168   |       |
|                                                                 |       |        |       |        |       |
| **Cash flows  from financing activities**                            |       |        |       |        |       |
| Increase  (Decrease) in due to bank                                  |       | (1,183,922  | )          | 6,809,201   |       |
| Increase  (Decrease) in notes payable due on demand                  |       | (26,106,922 | )          | 6,795,633   |       |
| Decrease in  repurchase agreements                                   |       | (17,231,336 | )          | (11,766,980 | )          |
| Net cash  provided (used) by financing activities                    |       | (44,522,180 | )          | 1,837,854   |       |
|                                                                 |       |        |       |        |       |
| 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 toconsolidated financial statements

 

5

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**THEWASHTENAW GROUP, INC.**

Notesto the Consolidated Financial Statements (Unaudited)

 

**NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES**

 

Principlesof Consolidation:

Theunaudited consolidated financial statements as of and for the three monthperiod ended March 31, 2005 and 2004, include the accounts of TheWashtenaw Group, Inc. (“The Washtenaw Group”) and its wholly owned subsidiaryWashtenaw Mortgage Company  (“Washtenaw”)for all periods.  All references hereinto The Washtenaw Group include the consolidated results of its subsidiary.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

OperatingSegments:

Washtenaw’soperations include one primary segment: mortgage banking.

 

Stock Compensation:

Compensation expense under stock options is reported using theintrinsic value method.  Stock-basedcompensation of zero and $25,319 is reflected in net income for the threemonths ended March 31, 2005 and 2004, respectively as options granted hadan exercise price less than the market price of the underlying common stock atdate of grant.  The following tableillustrates the effect on net income and earnings per share if expense wasmeasured using the fair value recognition provisions of FASB Statement No. 123,*Accounting for Stock-Based Compensation*.

 
| ** **                                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                      | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Net loss as  reported                                                                           |       | $                                     | (1,673,490 | ) | $ | (3,103,337 | ) |
| Deduct:  Incremental stock-based compensation expense determined under fair value  based method |       | —                                |       | 1,210 |   |
| Pro forma  net loss                                                                             |       | $                                     | (1,673,490 | ) | $ | (3,104,547 | ) |
|                                                                                            |       |                                  |       |   |   |
| Basic loss  per share as reported                                                               |       | $                                     | (0.37      | ) | $ | (0.69 | ) |
| Pro forma  basic loss per share                                                                 |       | (0.37                                 | )          | (0.69 | ) |
|                                                                                            |       |                                  |       |   |   |
| Diluted loss  per share                                                                         |       | $                                     | (0.37      | ) | $ | (0.69 | ) |
| Pro forma  diluted loss per share                                                               |       | (0.37                                 | )          | (0.69 | ) |

 

Due to the spin-off (see Note 3), optionsoutstanding of Pelican Financial, Inc. (“Pelican Financial”) the former parentcompany, at December 31, 2003 included 10,735 options that were held byemployees of Washtenaw.  These optionswere cancelled during the first quarter of 2004 and replaced with 21,470options on stock of The Washtenaw Group at an exercise price of $3.25.  These options were granted with an intrinsicvalue (market value per share, less option exercise price) substantially equalto the intrinsic value of the cancelled Pelican Financial options.

 

**NOTE 2 – BASIS OF PRESENTATION**

 

Theaccompanying unaudited consolidated financial statements were prepared inaccordance with instructions for Form 10-Q and, therefore, do not includeinformation or footnotes necessary for a complete presentation of consolidatedfinancial condition, results of operations, and cash flows in conformity withaccounting principles 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, 2005 are not necessarily indicative of theresults which may be expected for the entire fiscal year or for any otherperiod.  For further information, referto the consolidated financial statements and footnotes thereto for the yearended December 31, 2004 included in The Washtenaw Group’s Form 10-K.

 

6

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**NOTE 3 – SPIN-OFF**

 

OnDecember 31, 2003, Pelican Financial, the former parent company of TheWashtenaw Group and Washtenaw, distributed all of the outstanding shares of TheWashtenaw Group to the holders of Pelican Financial common stock on a share forshare basis based on Pelican Financial shareholders of record on December 22,2003.  Upon completion of thedistribution on December 31, 2003, The Washtenaw Group and Washtenaw areno longer a subsidiary of Pelican Financial. During the periods presented in the financial statements, PelicanFinancial did not incur any expenses on behalf of The Washtenaw Group andWashtenaw and no allocation of parent company expenses has been reflected inthese financial statements.

 

Followingthe distribution certain individuals continue to serve as officers of both TheWashtenaw Group, Washtenaw and Pelican Financial.  The Washtenaw Group pays their salaries andall other compensation, and Pelican Financial reimburses The Washtenaw Group,as part of the Transitional Services Agreement, for time spent on PelicanFinancial matters.  Prior to 2004,Pelican did not reimburse The Washtenaw Group for these services.  Beginning in 2004, officers and otheremployees providing services to both companies maintain records of their timespent on the affairs of each company as a basis for determining thereimbursements.

 

**NOTE 4 - EARNINGS PER SHARE**

 

Thefollowing summarizes the computation of basic and diluted earnings per share.

 
| ** **                                            | ** ** | **Three Months  ended  March 31,  2005** | ** ** | **Three Months  ended  March 31,  2004** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| Basic loss  per share                                 |       |                                          |       |                                          |       |
| Net loss                                              |       | $                                             | (1,673,490 | )                                             | $          | (3,103,337 | ) |
| Weighted  average shares outstanding                  |       | 4,488,351                                     |       | 4,488,351                                     |       |
| Basic loss  per share                                 |       | $                                             | (0.37      | )                                             | $          | (0.69 | ) |
|                                                  |       |                                          |       |                                          |       |   |   |
| Diluted loss  per share                               |       |                                          |       |                                          |       |
| Net loss                                              |       | $                                             | (1,673,490 | )                                             | $          | (3,103,337 | ) |
| Weighted  average shares outstanding                  |       | 4,488,351                                     |       | 4,488,351                                     |       |
| Dilutive  effect of assumed exercise of stock options |       | —                                        |       | —                                        |       |
| Diluted  average shares outstanding                   |       | 4,488,351                                     |       | 4,488,351                                     |       |
| Diluted loss  per share                               |       | $                                             | (0.37      | )                                             | $          | (0.69 | ) |

 

AtMarch 31, 2005 and 2004 there were 16,830 and 21,470 stock options outstandingthat were not considered dilutive.

 

7

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Item 2: Management’s Discussion and Analysis of Financial Condition andResults of Operations

 

FORWARD LOOKING STATMENTS

 

Certain information in this Form 10-Q may constitute forward-lookinginformation that involves risks and uncertainties that could cause actualresults to differ materially from those estimated.  Persons are cautioned that suchforward-looking statements are not guarantees of future performance and aresubject to various factors that could cause actual results to differ materiallyfrom those estimated.  These factorsinclude, 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.

 

### **OVERVIEW**

 

The Washtenaw Group, serves as the holding company of Washtenaw.  The Washtenaw Group’s operations involvecorrespondent, wholesale and retail mortgage banking.  The operation involves the origination andpurchase of single-family residential mortgage loans in approximately 40states, the sale of these loans, usually on a pooled and securitized basis, inthe secondary market, and the servicing of mortgage loans for investors.

 

The Washtenaw Group’s earnings are primarily dependent upon threesources: net interest income, which is the difference between interest earnedon interest-earning assets and interest paid on interest-bearing liabilities;fee income from servicing mortgages held by investors; and gains realized onsales of mortgage loans and Mortgage Servicing Rights (“MSRs”).  These revenues are in turn significantlyaffected by factors such as changes in prevailing interest rates and in theyield curve (that is, the difference between prevailing short-term andlong-term interest rates), as well as changes in the volume of mortgageoriginations nationwide and prepayments of outstanding mortgages.

 

To address the deterioration in operating performance, management hasinitiated plans to: (a) consolidate departments and cross train employeesto further reduce employee headcount; (b) rationalize and reduce capitalexpenditures to more closely align capital spending with expected incrementalloan production volume; (c) consider alternative loan sale mechanisms toimprove profit margin per loan; (d) implement technological tools and providefurther training to its loan underwriters to reduce future loan repurchases;(e) expand the loan products offered to it customers to increase loanproduction; and (f) implement a number of other cost reduction initiatives.

 

If The Washtenaw Group is not successful, and possibly even if it issuccessful, in implementing these actions, it may continue to experienceoperating losses, which would hinder its ability to pay down existingindebtedness, fund future growth and provide returns to stockholders.

 

**CRITICAL ACCOUNTING POLICIES**

 

## **Theaccounting policies that have the greatest impact on The Washtenaw Group’sfinancial condition and results of operations and that requires the mostjudgment relate to its mortgage activities. The Washtenaw Group’s accounting policy for gain on sale of loans, MSRs,interest rate risk management activities, litigation and claims and estimate oflosses on future loan repurchases have not changed since December 31, 2004and the accounting policies are described more fully in the annual report onForm 10-K for the year ended December 31, 2004.**

 

## **EARNINGS PERFORMANCE**

 

The Washtenaw Group reported a net loss of $1.7 million for the quarterended March 31, 2005 compared to a net loss of $3.1 million for thequarter ended March 31, 2004.  Basicand diluted earnings per share was a loss of $0.37 per share compared to a lossof  $0.69 per share for the three monthsended March 31, 2005 and 2004, respectively.

 

8

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## **RESULTS OF OPERATIONS**

 

Loan Production

The volume of loans produced for the three months ended March 31,2005 totaled $169 million as compared to $394 million for the three monthsended March 31, 2004, a decrease of $224 million or 57%.  The decrease was the result of risinginterest rates during the fourth quarter of 2004 and the beginning of thequarter ended March 31, 2005.

 

Noninterest Income

Total noninterest income for the three months ended March 31, 2005was $2.1 million, compared to $5.4 million for the three months ended March 31,2004, a decrease of $3.3 million or 61%. This decrease was primarily due to a82% decrease in the gain on sales of MSRs. The decrease in gain on sale of MSRs and loans was primarily due to adecrease in the overall new loan origination volume in the first three monthsof 2005.  In addition, the gains on saleof MSRs and loans was affected by reduced profit margins on each new loanorigination as a result of the current interest rate environment.

 

Loan Servicing

At March 31, 2005, Washtenaw serviced $1.8 billion of loanscompared to $2.9 billion at March 31, 2004, a 38% decrease.  This is the result of bulk servicing salestotaling $936 million in the twelve months ended December 31, 2004 and anadditional bulk sale totaling $93 million in the three months ended March 31,2005.  The remainder of the loanservicing rights created are retained in the mortgage loan servicing portfolio.

 

At March 31, 2005 and 2004, with the exception of servicingrelated to loans held for sale in Washtenaw’s loan portfolio and servicing soldbut not yet delivered, all loan servicing was serviced for others.  Service fee income, net of amortization was$600,000 and $436,000 for the three months ended March 31, 2005 and 2004,respectively.  Servicing income net ofamortization increased however, gross servicing income decreased $1.1 millionor 45% due to the decrease in the servicing portfolio and the sale ofservicing.  The decrease in amortizationis related to the effect of the rising interest rate environment, which hasdecreased actual and expected prepayment rates used to determine amortizationrates.

 

Noninterest Expense

Total noninterest expense for the three months ended March 31,2005 was $5.4 million, compared to $10.4 million for the same period in 2004, adecrease of $5.0 million or 49%. This decrease was primarily due to thedecrease in employee compensation and benefits expenses of approximately $1.2million, a decrease in the amortization of MSRs of $1.0 million and a decreasein the mortgage servicing rights valuation adjustment of approximately $3.0million.  The decrease in employeecompensation and benefits was the result of a decrease in operations staff dueto attrition and layoffs, a reduction in overtime expense, and a reduction incommission compensation paid to the sales staff.   The MSRs valuation adjustment was due to anincrease in mortgage interest rates during the period, resulting in decreasesin expected 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 amortization of MSRs is theresult of the sale of mortgage loan servicing and the decreased speed in whichthe asset is being amortized due to the lower prepayment speeds.

 

**BALANCE SHEET ANALYSIS**

 

The following is a discussion of the consolidated balance sheet of TheWashtenaw Group.

 

## **ASSETS**

At March 31, 2005, total assets of The Washtenaw Group equaled$66.1 million as compared to $119.3 million at December 31, 2004, adecrease of $53.2 million or 45%. The decrease is primarily due to the decreasein loans held for sale and securities available for sale.

 

AccountsReceivable

Accountsreceivable were $4.5 million at March 31, 2005 compared to $7.1 million atDecember 31, 2004.  This decrease of$2.6 million or 37% is primarily due to the receipt of $1.9 million from thebulk-servicing sale recorded in December 2004.  Additionally, escrow advances decreased$892,000, or 49% from $1.8 million at December 31,

 

9

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2004compared to $926,000 at March 31, 2005. This is primarily due to funds being received from customers on negativeescrow balances and the overall decrease in the servicing portfolio.

 

LoansHeld for Sale

Loansheld for sale were $34.3 million at March 31, 2005 compared to $68.5million at December 31, 2004.  Thisdecrease of $34.2 million or 50% was the result of a decrease in mortgage loanproduction.

 

SecuritiesAvailable for Sale

Securities available for sale were $5.5 million at March 31, 2005compared to $22.2 million at December 31, 2004  This decrease of $16.7 million or 75% is dueto the sale of the securities available for sale.  During the fourth quarter in 2004, Washtenawinitiated a strategy to hold or buy in the open market variable ratemortgage-backed securities.  Thesecurities were primarily obtained in a securitization of loans held for sale inexchange for 100% of the beneficial interests in the form of mortgage backedsecurities.  The securities are pledgedas collateral for repurchase agreements used to fund the mortgage-backedsecurities.  Management uses variousderivative instruments to hedge the interest rate risks that exists.  The risk is due to the duration of therepurchase agreements being different than the related time until theunderlying loans in the mortgage-backed securities reach their adjustment date.  Due to the increase in the borrowing costs,it is no longer beneficial to continue holding securities available for sale.

 

Mortgage Servicing Rights

Total MSRs were $17.4 million at March 31, 2005, a slight increaseof $123,000, or less than one percent from $17.2 million at December 31,2004.   This is primarily due to thepositive MSRs valuation adjustment for the three months ended March 31,2005.  The MSRs valuation adjustment wasdue to an increase in mortgage interest rates during the period, resulting indecreases 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.

 

In April 2004, Washtenaw began hedging a portion of its mortgageloan servicing portfolio.  Management hasused ten-year treasury futures contracts and ten-year treasury put and calloptions to hedge against the reduction in the value of the MSRs due to adecline in mortgage interest rates.  Thederivative instruments were purchased to protect between 20% and 25% of theservicing rights that can be hedged against declining interest rates.  All fixed rate loan servicing may be hedged,while arms and balloons are not.  The MSRvaluation adjustment for the three months ended March 31, 2005, included afavorable MSRs valuation adjustment of $312,000.  During the same period, Washtenaw recognizeda $260,000 unfavorable adjustment on MSRs hedging activity.

 

Washtenaw intends to sell approximately $300 million to $700 million inMSRs during the quarter ended June 30, 2005.  Management anticipates this will reduce theMSRs asset by approximately $3.0 million to $7.0 million at the sale date.  At the time of the sale, management willreduce its hedge position accordingly in an effort to hedge the same overallpercentage of the MSRs.

 

## **LIABILITIES**

At March 31, 2005, the total liabilities of The Washtenaw Groupwere $52.0 million as compared to $103.3 million at December 31, 2004, adecrease of $51.4 million or 50%. This decrease was primarily due to decreasesin notes payable, repurchase agreements, and GNMA repurchase liability.

 

Due to Bank

Due to bank was $5.3 million at March 31, 2005 compared to $6.5 atDecember 31, 2004.  The decrease of$1.2 million or 18% was due to changes in mortgage loan production.  Due to bank represents the drafts provided tofund the loans purchased by Washtenaw that have not yet been presented to andcleared by the bank.

 

Notes Payable

Notes payable was $33.8 million at March 31, 2005 compared to$60.0 million at December 31, 2004. This decrease of $26.1 million or 44% was primarily caused by thedecrease in loan originations during the quarter ended March 31,2005.  The notes payable represent thewarehouse line of credit that Washtenaw uses to fund its loan production untilsuch time that the loans are sold to the secondary market.

 

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GNMA repurchase liability

GNMA repurchase liability was $1.3 million at March 31, 2005compared to $6.5 million at December 31, 2004.  This decrease of $5.2 million or 80% wasprimarily caused by the sale of approximately 80% of the GNMA mortgageservicing portfolio during the quarter ended March 31, 2005.  The GNMA repurchase liability representsWashtenaw’s right, but not an obligation, to repurchase eligible GNMA loansfrom the securities that Washtenaw services.

 

Repurchase Agreements

Washtenaw used repurchase agreements to fund its securities availablefor sale.  Repurchase agreements were$5.2 million at March 31, 2005 compared to $22.4 million at December 31,2004.  This decrease of $17.2 million or77%, in the repurchase agreements was primarily the result of the sale ofsecurities available for sale.  Therepurchase agreements have various maturity dates all within 30 days of theperiod end.

 

Other Liabilities

Other liabilities also decreased from $8.0 million at December 31,2004 to $6.4 million or 21% as of March 31, 2005.  This decrease was primarily due to a decreasein fees on loans due FNMA and reserve for repurchases.  The fees on loans due to FNMA decreased$786,000 as a result of the decrease in loan production.  FNMA charges Washtenaw various fees at theloan level for certain type of loans based on the risk characteristics of theparticular loan.  The reserve forrepurchases decreased $748,000 as a result of fewer repurchase requests frominvestors and the payment of existing obligations.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity Management

The objective of liquidity management is to ensure the availability ofsufficient resources to meet all financial commitments and to capitalize onopportunities for business expansion. Liquidity management addresses the ability to meet deposit withdrawalseither on demand or by contractual maturity, to repay other borrowings as theymature and to make new loans and investments as opportunities arise.

 

To date The Washtenaw Group has conducted no business other thanmanaging its investments in Washtenaw. The Washtenaw Group’s source of funds is dividends paid by Washtenaw.Washtenaw’s sources of funds include cash from gains on sales of mortgage loansand servicing, net interest income, servicing fees and borrowings. Washtenawsells its mortgage loans generally on a monthly basis to generate cash foroperations. Washtenaw’s uses of cash in the short-term include the funding ofmortgage loan purchases and originations and purchases of MSRs, payment ofinterest, repayment of amounts borrowed pursuant to warehouse lines of credit,operating and administrative 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 business through the use of a warehouse line ofcredit and the use of agreements to repurchase. The agreements to repurchase typically have terms of less than 90 daysand are treated as a source of financing. The warehouse line of credit has a limit of $80 million, of which $10million represents a sublimit for servicing under contract for sale.  Effective May 1, 2005, these limits willdecrease to $70 million and $9.0 million, respectively. Borrowing pursuant tothe warehouse line of credit totaled $33.8 million at March 31, 2005 and$60.0 million at December 31, 2004, which included advances on the servicingsublimit of $7.8 million and $8.3 million for the aforementioned periods,respectively.  The interest rate on thewarehouse line of credit is the Federal Funds Rate plus 1.50% resulting in aneffective rate of 4.25% and 3.75% at March 31, 2005 and December 31,2004, respectively.  The effectiveinterest rate paid on the warehouse line is reduced by compensating balancesrelated to Washtenaw’s loan servicing portfolio.  The warehouse line of credit is payable ondemand.  The terms of the warehouse lineof credit impose certain limitations on the operations of Washtenaw.  Pursuant to the warehouse line of credit,Washtenaw must maintain a minimum servicing portfolio of $1.0 billion, aminimum net worth of $12.0 million plus 50% of net income, calculated inaccordance with U.S. generally accepted accounting principles, and a minimumadjusted tangible net worth of $14.0 million plus 50% of net income.  Washtenaw must also maintain a ratio of totalindebtedness to adjusted tangible net worth of no more than ten to one andmaintain a ratio of adjusted total indebtedness to adjusted tangible net worthof no more than one to one.  For purposesof the warehouse line of credit, adjusted tangible net worth is defined as theexcess of total assets over total liabilities, with certain additions andsubtractions as specified in the warehouse line of credit agreement, primarilyrelated to MSRs and deferred taxes.  As

 

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of March 31, 2005, Washtenaw’s servicing portfolio totaled $1.8billion, net worth calculated in accordance with U.S. generally acceptedaccounting principles was $14.4 million and adjusted tangible net worth was$16.4 million.  Washtenaw’s ratio oftotal indebtedness to adjusted tangible net worth was 2.79 and adjusted totalindebtedness to adjusted tangible net worth was 0.40.  Washtenaw met all of these covenants duringall time periods reported.  The maturitydate of the warehouse line agreement is August 1, 2005.

 

Washtenaw continues to consider other alternatives permitted by thecredit agreement to improve liquidity. These actions include, but are notlimited to, factoring of accounts receivable and establishing a line of creditcollateralized by its outstanding real estate owned.

 

Washtenaw is also attempting to manage its liquidity requirementsthrough the prudent use of its cash resources, effective management of workingcapital and capital expenditures and periodic sales of MSRs.

 

Washtenaw also enters into sales of mortgage loans pursuant to agreementsto repurchase.  These agreementstypically have terms of less than 90 days and are treated as a source offinancing.  The weighted average interestrate on these agreements to repurchase was 3.65% at March 31, 2005, and3.15% at December 31, 2004.  At March 31,2005, Washtenaw was not using these as a source of funds.

 

Washtenaw’s ability to continue to purchase loans and MSRs and tooriginate new loans is dependent in large part upon its ability to sell themortgage loans at par or for a premium or to sell the MSRs in the secondarymarket in order to generate cash proceeds to repay borrowings pursuant to thewarehouse facility, thereby creating borrowing capacity to fund new purchasesand originations.  The value of andmarket for The Washtenaw Group’s loans and MSRs are dependent upon a number offactors, including the borrower credit risk classification, loan-to-valueratios and interest rates, general economic conditions, warehouse facilityinterest rates, and governmental regulations. A significant amount of Washtenaw’s loan production in any month isfunded during the last several business days of that month.

 

Washtenaw generally grants commitments to fund mortgage loans for up to60 days at a specified term and interest rate. The commitments are commonly known as rate-lock commitments.  At March 31, 2005 and December 31,2004, Washtenaw had outstanding rate-lock commitments to lend of $56.5 millionand $52.7 million, respectively for mortgage loans.  Because these commitments may expire withoutbeing drawn upon, they do not necessarily represent future cashcommitments.  Also, as of March 31,2005 and December 31, 2004, Washtenaw had outstanding commitments to sell$59.4 million and $64.9 million of mortgage loans, respectively.  These commitments will be funded within 90days.

 

Washtenaw purchases its loans either by wiring funds to the closingagent or sending a draft.  The decisionis based on the requirements of the state where the loan is beingpurchased.  When a draft is used,Washtenaw begins earning interest on the day the draft is issued but does notincur any cost of funds until the draft is presented to bank.  When the draft clears the bank, Washtenawwill either borrow money on its warehouse line of credit or through itsagreements to repurchase depending on the type of loan.  Outstanding drafts totaled $5.3 million at March 31,2005 and $6.5 million at December 31, 2004.

 

Item 3:  Quantitative andQualitative Disclosure About Market Risk

 

For a discussion of The Washtenaw Group’s asset/liability managementpolicies as well as the potential impact of interest rate changes upon themarket value of The Washtenaw Group’s portfolio, see The Washtenaw Group’sAnnual Report to Shareholders and Form 10-K for the fiscal year ended December 31,2004.  Management believes that there hasbeen no material change in The Washtenaw Group’s asset/liability position orthe market value of The Washtenaw Group’s portfolio since December 31,2004.

 

Item 4:  Controls and Procedures

 

Washtenaw, under the supervision and with the participation of itsmanagement, including its principal executive officer and principal financialofficer, evaluated the effectiveness of the design and operation of itsdisclosure controls and procedures as of the end of the period covered by thisreport.  Based on this evaluation, theprincipal executive officer and principal financial officer concluded thatWashtenaw’s disclosure controls and procedures are effective in reaching areasonable level of assurance that information required to be disclosed byWashtenaw in the reports that it

 

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files or submits under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time period specified in theSecurities and Exchange Commission’s rules and forms.

 

The principal executive officer and principal financial officer alsoconducted an evaluation of internal control over financial reporting (“InternalControl”) to determine whether any changes in Internal Control occurred duringthe fiscal quarter that have materially affected or which are reasonably likelyto materially affect Internal Control. Based on that evaluation, there has been no such change during thequarter covered by this report.

 

A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met.  Further, thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts.  Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within Washtenaw have been detected. Because of the inherent limitations in a cost-effective control system,misstatements due to error or fraud may occur and not be detected.  Washtenaw conducts periodic evaluations toenhance, where necessary, its procedures and controls.

 

Part II. Other Information

 

Item 1.   Legal Proceedings

 

*Washtenaw Mortgage Co. v Chase ManhattanMortgage Corp.*, Civil Action No. 04-73451, UnitedStates District Court for the Eastern District of Michigan (SouthernDivision).  Chase and Washtenaw areinvolved in a dispute involving approximately $400,000.  The dispute was the subject of a federalcourt declaratory judgment lawsuit filed by Washtenaw in 2004, which the courtdismissed without prejudice in early 2005. Chase has also asserted the claim in pleadings filed in late 2004 aspart of the Webb litigation, described above, pending in state court inWest Virginia.

 

At issue is the extent of Washtenaw’s obligation to reimburse Chase forfees and expenses which the latter has incurred in connection with the Webblawsuit referred to above.  Chase assertsthat, pursuant to the indemnification provisions of a sale-of-servicingagreement entered into between Washtenaw and Chase, Washtenaw must indemnifyChase for all monies paid out by Chase to defend and settle thoselawsuits.  Washtenaw disagrees with Chase’sposition.  As a practical matter,Washtenaw will not be able to determine the amount of its ultimate liability toChase, if any exists, until such time as the Webb lawsuit is resolved,at least insofar as Chase is concerned.

 

At this time, Washtenaw has reached an agreement to settle this disputeand the expected expense has been recorded.

 

There have been no other material changes to the pending legalproceedings to which The Washtenaw Group is a party since the filing of theregistrant’s Form 10-K for the fiscal year ended December 31, 2004, norhave there been any material legal proceedings to which The Washtenaw Group isa party instituted since that date.

 

Item 2.  Changes in Securitiesand Use of Proceeds

 

Not Applicable.

 

Item 3.   Defaults Upon SeniorSecurities

 

Not Applicable.

 

Item 4.   Submission of Mattersto a Vote of Security Holders

 

None.

 

Item 5.   Other Information

 

None.

 

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Item 6.   Exhibits

 

(a)          Exhibits

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                      |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                           |
| 2.1                 |       | Plan of Distribution                                                                                                                 |
|                |       |                                                                                                                                 |
| 3.1                 |       | Certificate of Incorporation of The  Washtenaw Group, Inc. (1)                                                                       |
|                |       |                                                                                                                                 |
| 3.2                 |       | Bylaws of The Washtenaw Group, Inc. (1)                                                                                              |
|                |       |                                                                                                                                 |
| 4                   |       | Form of Common Stock Certificate of The  Washtenaw Group, Inc. (1)                                                                   |
|                |       |                                                                                                                                 |
| 10.1                |       | Master Agreement between Federal National  Mortgage Association and Washtenaw Mortgage Corporation dated December 21,  1998 (1) |
|                |       |                                                                                                                                 |
| 10.2                |       | Transitional Services Agreement between  Pelican Financial, Inc. and The Washtenaw Group, Inc. (1)                                   |
|                |       |                                                                                                                                 |
| 10.3                |       | The Washtenaw Group, Inc. Stock Option and  Incentive Plan (1)                                                                       |
|                |       |                                                                                                                                 |
| 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     |

 

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(1)          Incorporated byreference to Exhibit bearing the same number in The Washtenaw Group, Inc.’sRegistration Statement on Form 10, filed on September 11, 2004, as amended(Reg. No. 001-31795).

 

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The Washtenaw Group, Inc. andSubsidiary

Signatures

 

Under the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this Report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
| Date: May 13, 2005 | /s/ Charles C. Huffman                        |   |
|--------------------|-----------------------------------------------|--------|
|               | Charles C. Huffman                            |
|               | President  and Chief Executive Officer        |
|               |                                          |
|               |                                          |
|               |                                          |
| Date: May 13, 2005 | /s/ Howard M. Nathan                          |   |
|               | Howard M. Nathan                              |
|               | Vice President and Chief Financial Officer    |
|               | (Principal Financial and Accounting  Officer) |
|                    |                                               |        |  |

 

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