**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(MarkOne)**

**ý**          QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

** **

**Forthe quarterly period ended September 30, 2005**

** **

**or**

** **

**o**          TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

** **

**Forthe transition period from    to    **

** **

**CommissionFile Number: 000-50938**

** **

**Fieldstone Investment Corporation**

(Exact name of registrant as specified inits charter)

 
| **Maryland**                              | ** ** | **74-2874689**      |
|-------------------------------------------|------------|---------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer    |
| incorporation or  organization)           |       | Identification No.) |
|                                      |       |                |
| **11000  Broken Land Parkway**            | ** ** | ** **          |
| **Columbia,  MD**                         | ** ** | **21044**           |
| (Address of principal  executive offices) |       | (Zip Code)          |

 

**(410) 772-7200**

(Registrant’s telephonenumber, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.                                                                   ý  Yes o  No

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act)

o Yes ý No

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act)

o Yes ý No

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date. On November 1, 2005, the issuer had 48,820,876 shares of common stockoutstanding.

 

 

----

 

**Tableof Contents**

 
| **Part I**  | FINANCIAL INFORMATION                                                                       |   |
|------------------|---------------------------------------------------------------------------------------------|--------|
|             |                                                                                        |   |
| **Item 1.**      | Financial Statements                                                                        |   |
|             | Condensed  Consolidated Statements of Condition                                             |   |
|             | Condensed  Consolidated Statements of Operations                                            |   |
|             | Condensed  Consolidated Statements of Shareholders’ Equity                             |   |
|             | Condensed  Consolidated Statements of Cash Flows                                            |   |
|             | Notes  to Condensed Consolidated Financial Statements                                       |   |
| **Item 2.**      | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |   |
|             | Executive  Overview                                                                         |   |
|             | Key  Components of Financial Results of Operations                                          |   |
|             | Critical  Accounting Policies                                                               |   |
|             | Results of  Operations                                                                      |   |
|             | Consolidated  Statements of Condition                                                       |   |
|             | Business Segment  Results                                                                   |   |
|             | Liquidity and  Capital Resources                                                            |   |
|             | Commitments and  Contingencies                                                              |   |
|             | REIT  Taxable Income                                                                        |   |
|             | Other  Operational and Investment Portfolio Data                                            |   |
|             | Impact of New  Accounting Standards                                                         |   |
|             | Effect  of Inflation                                                                        |   |
| **Item 3**       | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
| **Item 4.**      | Controls  and Procedures                                                                    |   |
|             |                                                                                        |   |
| **Part II** | OTHER  INFORMATION                                                                          |   |
|             |                                                                                        |   |
| **Item 1.**      | Legal  Proceedings                                                                          |   |
| **Item 5.**      | Other  Information                                                                          |   |
| **Item 6.**      | Exhibits                                                                                    |   |

 

2

----

 

**PART I**

 

**ITEM1.**                    FINANCIALSTATEMENTS.

 

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIES**

 

**Condensed ConsolidatedStatements of Condition**

 

**September 30, 2005 andDecember 31, 2004**

 

**(In thousands, exceptshare data)**

 
| ** **                                                                                                                                                                               | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **(Unaudited)**             | ** ** | ** **                      | ** ** |
| **Assets**                                                                                                                                                                               |       |                        |       |                            |       |
| Cash                                                                                                                                                                                     |       | $                           | 34,549     |                            | 61,681     |   |
| Restricted cash                                                                                                                                                                          |       | 11,431                      |       | 4,022                           |       |
| Mortgage loans  held for sale, net                                                                                                                                                       |       | 528,870                     |       | 357,050                         |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Mortgage loans  held for investment                                                                                                                                                      |       | 5,311,889                   |       | 4,774,756                       |       |
| Allowance for  loan losses—loans held for investment                                                                                                                                |       | (39,329                     | )          | (22,648                         | )          |
| Mortgage loans  held for investment, net                                                                                                                                                 |       | 5,272,560                   |       | 4,752,108                       |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Accounts  receivable                                                                                                                                                                     |       | 9,587                       |       | 9,326                           |       |
| Accrued interest  receivable                                                                                                                                                             |       | 25,633                      |       | 22,420                          |       |
| Trustee  receivable                                                                                                                                                                      |       | 118,317                     |       | 91,082                          |       |
| Prepaid expenses  and other assets                                                                                                                                                       |       | 23,922                      |       | 20,172                          |       |
| Derivative  assets, net                                                                                                                                                                  |       | 40,079                      |       | 20,161                          |       |
| Deferred tax  asset, net                                                                                                                                                                 |       | 16,159                      |       | 15,880                          |       |
| Furniture and  equipment, net                                                                                                                                                            |       | 9,314                       |       | 9,815                           |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Total assets                                                                                                                                                                             |       | $                           | 6,090,421  |                            | 5,363,717  |   |
| **Liabilities and Shareholders’ Equity**                                                                                                                                            |       |                        |       |                            |       |
| ** **                                                                                                                                                                               |       |                        |       |                            |       |
| Warehouse  financing—loans held for sale                                                                                                                                            |       | $                           | 429,551    |                            | 188,496    |   |
| Warehouse  financing—loans held for investment                                                                                                                                      |       | 693,565                     |       | 521,506                         |       |
| Securitization  financing                                                                                                                                                                |       | 4,336,677                   |       | 4,050,786                       |       |
| Reserve for  losses—loans sold                                                                                                                                                      |       | 37,784                      |       | 33,302                          |       |
| Dividends  payable                                                                                                                                                                       |       | —                      |       | 21,501                          |       |
| Accounts payable  and accrued expenses                                                                                                                                                   |       | 24,426                      |       | 21,788                          |       |
| Total  liabilities                                                                                                                                                                       |       | 5,522,003                   |       | 4,837,379                       |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Commitments and  contingencies                                                                                                                                                           |       | —                      |       | —                          |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Shareholders’  equity:                                                                                                                                                              |       |                        |       |                            |       |
| Common stock  $0.01 par value; 90,000,000 shares authorized; 48,820,876 and 48,855,876  shares issued and outstanding as of September 30, 2005 and December 31,  2004, respectively |       | 488                         |       | 489                             |       |
| Paid-in capital                                                                                                                                                                          |       | 496,983                     |       | 497,147                         |       |
| Accumulated  earnings                                                                                                                                                                    |       | 75,919                      |       | 34,687                          |       |
| Unearned  compensation                                                                                                                                                                   |       | (4,972                      | )          | (5,985                          | )          |
| Total  shareholders’ equity                                                                                                                                                         |       | 568,418                     |       | 526,338                         |       |
|                                                                                                                                                                                     |       |                        |       |                            |       |
| Total  liabilities and shareholders’ equity                                                                                                                                         |       | $                           | 6,090,421  |                            | 5,363,717  |   |

 

See accompanying notes tothe condensed consolidated financial statements.

 

3

----

 

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIES**

 

**Condensed ConsolidatedStatements of Operations**

 

**Three and Nine MonthsEnded September 30, 2005 and 2004**

 

**(Unaudited; inthousands, except share and per share data)**

 
| ** **                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Interest income:                                          |       |                                  |       |                                 |       |   |   |   |   |
| Loans held for  investment                                |       | $                                     | 84,940     |                                 | 60,141     |   | 248,350 |   | 130,139 |   |
| Loans held for  sale                                      |       | 9,860                                 |       | 6,445                                |       | 29,458 |   | 19,036 |   |
| Total interest  income                                    |       | 94,800                                |       | 66,586                               |       | 277,808 |   | 149,175 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Interest  expense:                                        |       |                                  |       |                                 |       |   |   |   |   |
| Loans held for  investment                                |       | 54,361                                |       | 20,274                               |       | 134,742 |   | 38,705 |   |
| Loans held for  sale                                      |       | 5,166                                 |       | 1,543                                |       | 12,855 |   | 4,271 |   |
| Total interest  expense                                   |       | 59,527                                |       | 21,817                               |       | 147,597 |   | 42,976 |   |
| Net interest  income                                      |       | 35,273                                |       | 44,769                               |       | 130,211 |   | 106,199 |   |
| Provision for  loan losses—loans held for investment |       | 11,045                                |       | 5,921                                |       | 22,402 |   | 14,878 |   |
| Net interest  income after provision for loan losses      |       | 24,228                                |       | 38,848                               |       | 107,809 |   | 91,321 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Gains on sales  of mortgage loans, net                    |       | 20,147                                |       | 14,238                               |       | 57,070 |   | 41,356 |   |
| Other income  (expense)—portfolio derivatives        |       | 15,630                                |       | (15,032                              | )          | 26,540 |   | (4,488 | ) |
| Fees and other  income                                    |       | 661                                   |       | 1,067                                |       | 1,198 |   | 2,898 |   |
| Total revenues                                            |       | 60,666                                |       | 39,121                               |       | 192,617 |   | 131,087 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Expenses:                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Salaries and  employee benefits                           |       | 20,555                                |       | 20,690                               |       | 60,004 |   | 62,417 |   |
| Occupancy                                                 |       | 1,941                                 |       | 1,733                                |       | 5,711 |   | 4,800 |   |
| Depreciation and  amortization                            |       | 961                                   |       | 633                                  |       | 2,584 |   | 1,761 |   |
| Servicing fees                                            |       | 2,208                                 |       | 1,912                                |       | 6,555 |   | 3,838 |   |
| General and  administration                               |       | 8,578                                 |       | 8,666                                |       | 24,368 |   | 23,430 |   |
| Total expenses                                            |       | 34,243                                |       | 33,634                               |       | 99,222 |   | 96,246 |   |
| Income before  income taxes                               |       | 26,423                                |       | 5,487                                |       | 93,395 |   | 34,841 |   |
| Provision for  income tax expense                         |       | (2,999                                | )          | (1,536                               | )          | (4,792 | ) | (4,538 | ) |
| Net income                                                |       | $                                     | 23,424     |                                 | 3,951      |   | 88,603 |   | 30,303 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |   |
| Earnings per  share of common stock:                      |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                                     |       | $                                     | 0.48       |                                 | 0.08       |   | 1.82 |   | 0.62 |   |
| Diluted                                                   |       | $                                     | 0.48       |                                 | 0.08       |   | 1.82 |   | 0.62 |   |
|                                                      |       |                                  |       |                                 |       |   |   |   |   |   |
| Basic weighted  average common shares outstanding         |       | 48,462,126                            |       | 48,327,338                           |       | 48,462,080 |   | 48,326,356 |   |
| Diluted weighted  average common shares outstanding       |       | 48,479,152                            |       | 48,481,516                           |       | 48,478,654 |   | 48,527,501 |   |

 

See accompanying notes tothe condensed consolidated financial statements.

 

4

----

 

**FIELDSTONEINVESTMENT CORPORATION AND SUBSIDIARIES**

 

**CondensedConsolidated Statements of Shareholders’ Equity**

 

**NineMonths Ended September 30, 2005 and 2004**

 

**(Unaudited;in thousands)**

 
| ** **                                 | ** ** | **Common  shares  outstanding** | ** ** | **Common  stock** | ** ** | **Paid-in  capital** | ** ** | **Accumulated  earnings** | ** ** | **Unearned  compensation** | ** ** | **Total  shareholders’  equity** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|-------------------|------------|----------------------|------------|---------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| Balance at  January 1, 2004                |       | 48,836                          |       | $                 | 488        |                 | 498,230    |                      | 22,378     |                       | (7,542     | )                                     | 513,554    |   |
| Restricted stock  award                    |       | 30                              |       | —            |       | 537                  |       | —                    |       | (537                       | )          | —                                |       |
| Restricted stock  forfeited                |       | (15                             | )          | —            |       | (225                 | )          | —                    |       | 225                        |       | —                                |       |
| Restricted stock  compensation expense     |       | —                          |       | —            |       | —               |       | —                    |       | 1,416                      |       | 1,416                                 |       |
| Stock options  exercised                   |       | 1                               |       | —            |       | 24                   |       | —                    |       | —                     |       | 24                                    |       |
| Stock options  compensation expense        |       | —                          |       | —            |       | 211                  |       | —                    |       | —                     |       | 211                                   |       |
| Costs relating  to the equity registration |       | —                          |       | —            |       | (960                 | )          | —                    |       | —                     |       | (960                                  | )          |
| Dividends  declared                        |       | —                          |       | —            |       | —               |       | (15,143                   | )          | —                     |       | (15,143                               | )          |
| Net income                                 |       | —                          |       | —            |       | —               |       | 30,303                    |       | —                     |       | 30,303                                |       |
| Balance at  September 30, 2004             |       | 48,852                          |       | $                 | 488        |                 | 497,817    |                      | 37,538     |                       | (6,438     | )                                     | 529,405    |   |
|                                       |       |                            |       |              |       |                 |       |                      |       |                       |       |                                  |       |
| Balance at  January 1, 2005                |       | 48,856                          |       | $                 | 489        |                 | 497,147    |                      | 34,687     |                       | (5,985     | )                                     | 526,338    |   |
| Restricted stock  award                    |       | —                          |       | —            |       | 587                  |       | —                    |       | (587                       | )          | —                                |       |
| Restricted stock  forfeited                |       | (38                             | )          | (1                | )          | (562                 | )          | —                    |       | 563                        |       | —                                |       |
| Restricted stock  compensation expense     |       | —                          |       | —            |       | —               |       | —                    |       | 1,037                      |       | 1,037                                 |       |
| Stock options  exercised                   |       | 3                               |       | —            |       | 37                   |       | —                    |       | —                     |       | 37                                    |       |
| Stock options  compensation expense        |       | —                          |       | —            |       | 207                  |       | —                    |       | —                     |       | 207                                   |       |
| Costs relating  to the equity registration |       | —                          |       | —            |       | (433                 | )          | —                    |       | —                     |       | (433                                  | )          |
| Dividends  declared                        |       | —                          |       | —            |       | —               |       | (47,371                   | )          | —                     |       | (47,371                               | )          |
| Net income                                 |       | —                          |       | —            |       | —               |       | 88,603                    |       | —                     |       | 88,603                                |       |
| Balance at  September 30, 2005             |       | 48,821                          |       | $                 | 488        |                 | 496,983    |                      | 75,919     |                       | (4,972     | )                                     | 568,418    |   |

 

See accompanyingnotes to the condensed consolidated financial statements.

 

5

----

 

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIES**

 

**Condensed ConsolidatedStatements of Cash Flows**

 

**Nine Months Ended September30, 2005 and 2004**

 

**(Unaudited; inthousands)**

 
| ** **                                                                             | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                                 |       |                                 |       |   |   |
| Net income                                                                             |       | $                                    | 88,603     |   | 30,303 |   |
|                                                                                   |       |                                 |       |   |   |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:     |       |                                 |       |   |   |
| Depreciation and  amortization                                                         |       | 2,584                                |       | 1,761 |   |
| Amortization of  deferred origination costs—loans held for investment             |       | 19,618                               |       | 7,491 |   |
| Amortization of  securitization issuance costs                                         |       | 8,278                                |       | 2,723 |   |
| Amortization of  bond discount                                                         |       | 315                                  |       | 355 |   |
| Provision for  losses—loans sold                                                  |       | 6,313                                |       | 7,548 |   |
| Provision for  loan losses—loans held for investment                              |       | 22,402                               |       | 14,878 |   |
| Increase in  accounts receivable                                                       |       | (261                                 | )          | (4,438 | ) |
| Increase in  accrued interest receivable                                               |       | (3,213                               | )          | (18,000 | ) |
| Increase in  trustee receivable                                                        |       | (27,235                              | )          | (51,817 | ) |
| Funding of  mortgage loans held for sale                                               |       | (3,246,872                           | )          | (2,473,777 | ) |
| Proceeds from  sales of mortgage loans held for sale                                   |       | 3,603,977                            |       | 2,719,642 |   |
| Increase in  prepaid expenses and other assets                                         |       | (5,293                               | )          | (7,866 | ) |
| Increase in  deferred tax asset, net                                                   |       | (279                                 | )          | (1,359 | ) |
| Increase in  derivative assets, net                                                    |       | (19,918                              | )          | (2,588 | ) |
| Increase  (decrease) in accounts payable and accrued expenses                          |       | 2,638                                |       | (9,750 | ) |
| Stock  compensation expense                                                            |       | 1,244                                |       | 1,627 |   |
| Net cash  provided by operating activities                                             |       | 452,901                              |       | 216,733 |   |
|                                                                                   |       |                                 |       |   |   |
| Cash flows from  investing activities:                                                 |       |                                 |       |   |   |
| Funding of  mortgage loans held for investment                                         |       | (2,499,285                           | )          | (3,182,410 | ) |
| Payments of mortgage  loans held for investment                                        |       | 1,389,851                            |       | 355,560 |   |
| Increase in  restricted cash                                                           |       | (7,409                               | )          | (4,534 | ) |
| Purchase of  furniture and equipment, net                                              |       | (2,004                               | )          | (6,325 | ) |
| Proceeds from  sale of real estate owned                                               |       | 9,392                                |       | 1,619 |   |
| Net cash used in  investing activities                                                 |       | (1,109,455                           | )          | (2,836,090 | ) |
|                                                                                   |       |                                 |       |   |   |
| Cash flows from  financing activities:                                                 |       |                                 |       |   |   |
| Proceeds from  warehouse financing—loans held for sale                            |       | 3,322,271                            |       | 2,346,171 |   |
| Repayment of  warehouse financing—loans held for sale                             |       | (3,081,216                           | )          | (2,697,831 | ) |
| Proceeds from  warehouse financing—loans held for investment                      |       | 1,866,173                            |       | 3,957,040 |   |
| Repayment of  warehouse financing—loans held for investment                       |       | (1,694,114                           | )          | (3,253,146 | ) |
| Proceeds from  securitization financing                                                |       | 1,639,706                            |       | 2,445,864 |   |
| Repayment of  securitization financing                                                 |       | (1,354,130                           | )          | (288,664 | ) |
| Dividends paid                                                                         |       | (68,872                              | )          | (15,143 | ) |
| Costs relating  to the issuance of common stock                                        |       | (433                                 | )          | (960 | ) |
| Proceeds from  exercise of stock options                                               |       | 37                                   |       | 24 |   |
| Net cash  provided by financing activities                                             |       | 629,422                              |       | 2,493,355 |   |
| Net decrease in  cash                                                                  |       | (27,132                              | )          | (126,002 | ) |
| Cash at the  beginning of the period                                                   |       | 61,681                               |       | 158,254 |   |
| Cash at the end  of the period                                                         |       | $                                    | 34,549     |   | 32,252 |   |
|                                                                                   |       |                                 |       |   |   |   |
| Supplemental  disclosures:                                                             |       |                                 |       |   |   |
| Cash paid for  interest                                                                |       | $                                    | 145,031    |   | 49,217 |   |
| Cash paid (received)  for taxes                                                        |       | (105                                 | )          | 10,195 |   |
|                                                                                   |       |                                 |       |   |   |
| Noncash  investing and financing activities:                                           |       |                                 |       |   |   |
| Transfer from  mortgage loans held for sale to real estate owned                       |       | 405                                  |       | 931 |   |
| Transfer from  mortgage loans held for investment to real estate owned                 |       | 21,907                               |       | 2,069 |   |
| Transfer from  mortgage loans held for investment to mortgage loans held for sale, net |       | 530,830                              |       | — |   |

 

See accompanying notes tothe condensed consolidated financial statements.

 

6

----

 

**FIELDSTONE INVESTMENT CORPORATIONAND SUBSIDIARIES**

 

**Notes to Condensed ConsolidatedFinancial Statements**

 

**September 30, 2005 and2004**

 

**(Unaudited)**

 

**(1)**            Organization

 

***(a)***      Organization

 

Fieldstone Mortgage Company (FMC) was incorporatedin the State of Maryland on April 27, 1995 under the name FieldstoneManagement Company. Fieldstone Investment Corporation (FIC) was incorporated inthe State of Maryland on August 20, 2003, as a wholly owned subsidiary ofFieldstone Holdings Corp. (FHC). FHC was incorporated in the State of Delawarein February 1998. In July 1998, FHC purchased 100% of the shares ofFMC. Prior to 2003, FHC operated as a taxable C corporation. EffectiveJanuary 1, 2003, FHC elected to be taxed as an S Corporation.

 

In November 2003, FHC merged with and into FIC,with FIC as the surviving entity, in a transaction that was accounted for as amerger of entities under common control whereby the historical cost basis ofthe assets and liabilities was retained. Effective with the merger inNovember 2003, FIC elected to be taxed as a Real Estate Investment Trust(REIT) for federal income tax purposes, and FMC, its wholly owned subsidiary,elected to be taxed as a Taxable REIT Subsidiary (TRS).

 

On February 3, 2004, FIC formed two whollyowned subsidiaries, Fieldstone Mortgage Ownership Corp. (FMOC) and FieldstoneServicing Corp. (FSC), as Maryland corporations, which are treated as qualifiedREIT subsidiaries. FMOC holds securities and ownership interests in ownertrusts and other financing vehicles, including securities issued by FIC or onFIC’s behalf. FMOC holds the residual interest in FIC’s securitized pools ofmortgage loans, as well as any derivatives designated as economic interest ratehedges related to securitized debt. FSC holds the rights to direct theservicing of the mortgage loans held for investment.

 

During the second quarter of 2005, FIC formed twowholly owned, limited purpose financing subsidiaries, Fieldstone MortgageInvestment Corporation (FMIC), a Maryland corporation, and FieldstoneInvestment Funding LLC (FIF), a Delaware limited liability company, which aretreated as qualified REIT subsidiaries. FMIC was formed for the purpose of facilitating the financing and saleof mortgage loans and mortgage-related assets by issuing and selling securitiessecured primarily by, or evidencing interests in, mortgage loans andmortgage-related assets.  FIF was formedfor the purpose of facilitating the financing of mortgage loans through aconduit commercial paper facility.

 

FMC originates, purchases, and sells, non-conformingand conforming residential mortgage loans and engages in other activitiesrelated to mortgage banking. FMC originates residential mortgage loans throughover 4,700 independent mortgage brokers serviced by regional wholesaleoperations centers and a network of retail branch offices located throughoutthe country.

 

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of Fieldstone Investment Corporationand its subsidiaries (together, the Company) and have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (GAAP) for interim financial information and with the instructionsto Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they donot include all of the information and footnotes required by GAAP for completefinancial statements. All intercompany balances and transactions have beeneliminated in consolidation. Certain amounts in the prior period’s unaudited condensedconsolidated financial statements have been reclassified to conform to thecurrent period presentation. During the quarter ended September 30, 2005, theCompany reclassified the increase in restricted cash reported in the condensedconsolidated statements of cash flows as cash flows from investing activities,compared to its previous presentation as a component of cash provided byoperations*.*

 

7

----

 

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements contain all adjustments,consisting of normal recurring accruals, necessary for a fair presentation. Theresults of operations and other data for the three and nine months ended September30, 2005 are not necessarily indicative of the results that may be expected forthe fourth quarter of 2005 or the fiscal year ending December 31, 2005.The unaudited condensed consolidated financial statements presented hereinshould be read in conjunction with the audited consolidated financialstatements and related notes thereto in the Company’s Annual Report onForm 10-K, as amended, for the fiscal year ended December 31, 2004.

 

***(b)***      Use ofEstimates

 

The preparation of consolidated financial statementsin conformity with GAAP requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Critical estimates include (i) an estimate ofthe representation and warranty liabilities related to the sale of mortgageloans: (ii) an estimate of losses inherent in mortgage loans held forinvestment, which is used to determine the related allowance for loan losses andrealizable value of the Company’s accrued interest receivable; (iii) anestimate of the future loan prepayment rate of mortgage loans held forinvestment, which is used in the calculation of deferred origination and bondissuance cost amortization; (iv) the non-cash mark to market valuation of theinterest rate swaps which economically hedge the Company’s securitization debtand (v) the fair market value of equity compensation awards.  Actual results could differ from thoseestimates. Amounts on the consolidated statements of operations most affectedby the use of estimates are the reserve for losses—loans sold (which is acomponent of gains on sales of mortgage loans, net), provision for loanlosses—loans held for investment, interest income – loans held for investment,derivative valuations (which are a component of other income(expense)—portfolio derivatives), stock-based compensation (which is acomponent of salaries and employee benefits) and deferred origination andissuance costs (which are components of net interest income after provision forloan losses for loans held for investment and gains on sales of mortgage loans,net, for loans held for sale).

 

***(c)***       RecentAccounting Pronouncements

 

In May 2005, the FASBissued Statement of Financial Accounting Standards No. 154, *“Accounting Changes and Error Corrections,”*(Statement No.154).  This Statement replaces APBOpinion No. 20, *“Accounting Changes,”* (APB No.20)**and FASB Statement No. 3, *“Reporting Accounting Changes in Interim Financial Statements.” *Statement No. 154 carries forwardthe guidance contained in APB No. 20 for reporting the correction of an errorin previously issued financial statements and a change in accountingestimate.  However, Statement No. 154changes the requirements for the accounting for and reporting a change inaccounting principle and requires retrospective application to prior periods’financial statements, unless it is impracticable.  It also applies to changes required by anaccounting pronouncement in the unusual instance that the pronouncement doesnot include specific transition provisions. Statement No. 154 is effective for accounting changes and corrections oferrors made in fiscal years beginning after December 15, 2005, although earlierapplication is permitted for accounting changes and corrections of errors madein fiscal years beginning after June 1, 2005. The Statement does not change the transition provisions of any existingaccounting pronouncements, including those that are in a transition phase as ofthe effective date of this Statement. The Company will adopt Statement No. 154, as applicable, beginning infiscal year 2006.

 

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123R, “*ShareBased Payments*” (Statement No. 123R), requiring, among otherthings, that the compensation cost of stock options and other equity-basedcompensation issued to employees, which cost is based on the estimated fairvalue of the awards on the grant date, be reflected in the income statement overthe requisite service period. Statement No. 123R is effective for interimor annual reporting periods beginning after June 15, 2005. In March 2005,the SEC staff issued Staff Accounting Bulletin No. 107 (SAB No. 107).  SAB No. 107 expresses the views of the SECregarding Statement No. 123R and certain rules and regulations and provides theSEC’s view regarding the valuation of share-

 

8

----

 

based payment arrangementsfor public companies.  InApril 2005, the SEC amended the compliance dates for StatementNo. 123R to the beginning of the next fiscal year after June 15,2005.  We have adopted the fair valuemethod of accounting for our grants of stock options and restricted stock asprescribed by Statement of Financial Accounting Standards No. 148, “*Accounting for Stock-Based Compensation-Transition and Disclosure.”*  Under this method, compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as expense on a straight-line basis over the award’s vesting period.Management believes that the implementation of Statement No. 123R and SAB No.107 will not have a material effect on the Company’s results of operations orstatements of condition.

 

**(2)**            MortgageLoans Held for Sale and Reserve for Losses—Loans Sold

 

Mortgage loans that the Company acquires ororiginates with the intent to sell in the foreseeable future are initiallyrecorded at cost including any premium paid or discount received, adjusted forthe fair value change during the period in which the loan was an interest ratelock commitment. Loans held for sale are carried at the lower of cost or marketvalue calculated on an aggregate basis by type of loan. Mortgage loans held forsale, net, as of September 30, 2005 and December 31, 2004 are as follows(in thousands): 

 
| ** **                                   | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Mortgage loans  held for sale                |       | $                       | 526,016    |                   | 356,408    |   |
| Net deferred  origination costs              |       | 1,655                   |       | 1,031                  |       |
| Premium, net of  discount                    |       | 2,049                   |       | 1,505                  |       |
| Allowance for  lower of cost or market value |       | (850                    | )          | (1,894                 | )          |
| Total                                        |       | $                       | 528,870    |                   | 357,050    |   |

 

The Company maintains a reserve for itsrepresentation and warranty liabilities related to the sale of loans and forits contractual obligations to rebate a portion of any premium paid by aninvestor when a sold loan prepays within an agreed period. The reserve, whichis recorded as a liability on the consolidated statements of condition, isestablished when loans are sold, and is calculated as the fair value ofliabilities reasonably estimated to occur during the life of the related soldloans. The provision is recorded as a reduction of gains on sales of mortgageloans.  The adequacy of this reserve forlosses – loans sold is reviewed on a quarterly basis and adjusted, asnecessary, based on this review.

 

The reserve for losses—loans sold is summarized asfollows for the nine months ended September 30, 2004 and 2005 (in thousands):

 
| Balance at  December 31, 2003 |   | $      | 31,965 |   |
|------------------------------------|--------|--------|--------|--------|
| Provision                          |   | 7,548  |   |
| Realized losses                    |   | (8,025 | )      |
| Recoveries                         |   | 917    |   |
| Balance at  September 30, 2004     |   | $      | 32,405 |   |
|                               |   |   |   |
| Balance at  December 31, 2004 |   | $      | 33,302 |   |
| Provision                          |   | 6,313  |   |
| Realized losses                    |   | (1,958 | )      |
| Recoveries                         |   | 127    |   |
| Balance at  September 30, 2005     |   | $      | 37,784 |   |

 

Historically, theCompany has experienced substantially all of its representation and warrantylosses on loans sold during the first three years following the sale. Thereserve for losses—loans sold as of September 30, 2005 and

 

9

----

 

2004 relate to loansales primarily during the period of October 1, 2002 through September 30,2005 of approximately $14.7 billion, and sales during the period October 1,2001 through September 30, 2004 of approximately $13.2 billion, respectively.

 

**(3)**            MortgageLoans Held for Investment and Allowance for Loan Losses

 

The Company originates fixed-rate andadjustable-rate mortgage loans that have a contractual maturity of up to30 years. These mortgage loans are initially recorded at cost includingany premium or discount and deferred loan fees and costs. These mortgage loansare financed with warehouse debt until they are pledged as collateral forsecuritization financing. The Company is exposed to risk of loss from itsmortgage loan portfolio and establishes an allowance for loan losses takinginto account a variety of criteria, including the contractual delinquencystatus, market delinquency roll rates and market historical loss severities.The adequacy of this allowance for loan loss is reviewed on a quarterly basisand adjusted, as necessary, based on this review.

 

The following is a detail of the mortgage loans heldfor investment, net as of September 30, 2005 and December 31, 2004 (inthousands): 

 
| ** **                                                  | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Mortgage loans  held for investment—securitized        |       | $                       | 4,478,135  |                        | 4,156,790  |   |
| Mortgage loans  held for investment—warehouse financed |       | 794,344                 |       | 578,273                     |       |
| Net deferred  origination fees and costs                    |       | 39,410                  |       | 39,693                      |       |
| Mortgage loans  held for investment                         |       | 5,311,889               |       | 4,774,756                   |       |
| Allowance for  loan losses—loans held for investment   |       | (39,329                 | )          | (22,648                     | )          |
| Mortgage loans  held for investment, net                    |       | $                       | 5,272,560  |                        | 4,752,108  |   |

 

The allowance for loan losses—loans held forinvestment is summarized as follows for the nine months September 30, 2004 and2005 (in thousands):

 
| Balance at  December 31, 2003 |   | $      | 2,078  |   |
|------------------------------------|--------|--------|--------|--------|
| Provision                          |   | 14,878 |   |
| Charge—offs                   |   | (256   | )      |
| Recoveries                         |   | — |   |
| Balance at  September 30, 2004     |   | $      | 16,700 |   |
|                               |   |   |   |
| Balance at  December 31, 2004 |   | $      | 22,648 |   |
| Provision                          |   | 22,402 |   |
| Charge—offs                   |   | (6,357 | )      |
| Recoveries                         |   | 636    |   |
| Balance at  September 30, 2005     |   | $      | 39,329 |   |

 

Mortgage loans held for investment, which were onnon-accrual status for interest income recognition due to delinquencies greaterthan 90 days, were $76.7 million, $40.6 million and $29.3 million asof September 30, 2005, December 31, 2004 and September 30, 2004,respectively.

 

**(4)**            WarehouseFinancing, Loans Held for Sale and Loans Held for Investment

 

At September 30, 2005, the Company had a total of $2.3billion of warehouse lines of credit and repurchase facilities with six financialentities, of which $2.2 billion of the total funds available were committedfacilities and $50.0 million were uncommitted. At December 31, 2004, the Company had a total of $1.9 billion ofwarehouse lines of credit and repurchase facilities with six financialentities, of which $1.85 billion of the total funds available were

 

10

----

 

committed facilities and$50.0 million were uncommitted.  Thefacilities are accounted for as short-term liabilities, secured by mortgageloans held for investment to be securitized, mortgage loans held for sale, therelated investor commitments to purchase those loans held for sale, and allproceeds thereof.

 

Warehouse lines of credit and repurchase facilitiesconsist of the following at September 30, 2005 and December 31, 2004 (inmillions):

 
| **Agreements as of September 30, 2005**    | ** ** | **Amount  Outstanding as of** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                | ** ** | **Amount**                              | ** ** | **Maturity** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **Lender**                                                | ** ** | **Available**                           | ** ** | **Date** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Countrywide Warehouse  Lending                            |       | $                                       | 75.0       |   | August 2006 |   | $ | 63.8 |   | 21.5 |   |
| Countrywide  Early Purchase Program                       |       | 50.0                                    |       | Uncommitted |   | — |   | — |   |
| Credit Suisse  First Boston Mortgage Capital              |       | 500.0                                   |       | February 2006 |   | 340.2 |   | 291.1 |   |
| Credit Suisse,  New York Branch Commercial Paper Facility |       | 500.0                                   |       | July 2006 |   | 466.7 |   | — |   |
| Guaranty Bank                                             |       | 0.0                                     |       | Not Renewed | * | 0.0 |   | 25.6 |   |
| JP Morgan Chase  Bank                                     |       | 150.0                                   |       | April 2006 |   | 114.7 |   | 77.3 |   |
| Lehman Brothers  Bank                                     |       | 500.0                                   |       | December 2005 |   | 93.9 |   | 228.0 |   |
| Merrill Lynch  Bank USA                                   |       | 500.0                                   |       | November 2005 |   | 43.8 |   | 66.5 |   |
| Total                                                     |       | $                                       | 2,275.0    |   |   |   | $ | 1,123.1 |   | 710.0 |   |

 

----

*     Fieldstonedecided not to renew this warehouse line of credit on its scheduled maturity.

 

The interest rates paid by the Company under theselines are based on spreads to one month or overnight LIBOR, and are generallyreset daily or weekly. The Company also pays facility fees based on thecommitment amount and non-use fees. A summary of coupon interest expense andfacility fees, included in total interest expense in the consolidated statementsof operations, and the weighted average cost of funds of the warehouse lines ofcredit and repurchase facilities for the three and nine months ended September30, 2005 and 2004 is as follows (in thousands):

 
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **               | ** ** | **Amount**                           | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest  expense |       | $                                    | 10,366     |   | 4.1 | % | $ | 5,634 |   | 2.4 | % |
| Facilities fees          |       | 956                                  |       | 0.4 | % | 843 |   | 0.4 | % |
| Total                    |       | $                                    | 11,322     |   | 4.5 | % | $ | 6,477 |   | 2.8 | % |

 
| ** **              | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **              | ** ** | **Amount**                          | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest expense |       | $                                   | 23,708     |   | 3.8 | % | $ | 13,320 |   | 2.1 | % |
| Facilities fees         |       | 2,588                               |       | 0.4 | % | 2,706 |   | 0.4 | % |
| Total                   |       | $                                   | 26,296     |   | 4.2 | % | $ | 16,026 |   | 2.5 | % |

 

The average warehouse financing outstanding was $1.0billion and $0.9 billion for the three and nine months ended September 30, 2005,respectively, and $0.8 billion for the year ended December 31, 2004.

 

The warehouse lines and repurchase facilitiesgenerally have a term of 364 days or less. Management expects to renewthese lines of credit prior to their respective maturity dates.  The Merrill Lynch Bank USA facility has beenextended through December 9, 2005. Management expects to renew this line of credit for another year.  The credit facilities are secured bysubstantially all of the Company’s unsecuritized mortgage loans and containcustomary

 

11

----

 

financial and operatingcovenants that require the Company to maintain specified levels of liquidityand net worth, restrict indebtedness and investments, and require compliancewith applicable laws. The Company was in compliance with all of these covenantsat September 30, 2005 and December 31, 2004, respectively.

 

**(5)**            SecuritizationFinancing

 

During the nine months ended September 2005, theCompany issued $1.6 billion of mortgage-backed bonds throughsecuritization trusts to finance the Company’s portfolio of loans held forinvestment. Interest rates on these bonds reset monthly and are indexed toone-month LIBOR. The bonds pay interest monthly based upon a spread over LIBOR.The estimated average life of the bonds is approximately 19 months, and isbased on assumptions made by management. The actual period from inception tomaturity may differ from expectations. The bonds are repaid from the cash flowsreceived from the mortgage loans pledged to the trust.

 

The following is a summary of the securitizationseries issued during the nine months ended September 30, 2005 (in millions): 

 
| ** **                      | ** ** | **FMIT  2005-1** | ** ** | **FMIT  2005-2** | ** ** |
|---------------------------------|------------|------------------|------------|------------------|------------|
| Bonds issued                    |       | $                | 729        |             | $          | 911 |   |
| Loans pledged                   |       | $                | 750        |             | $          | 967 |   |
| Deferred bond issuance costs    |       | $                | 2.7        |             | $          | 3.3 |   |
| Financing costs—LIBOR plus |       | 0.12 - 2.00      | %          | 0.12 - 1.35      | %          |

 

The average securitization financing outstanding was$4.3 billion for the three and nine months ended September 30, 2005 and $2.3billion for the year ended December 31, 2004. The unamortized bondissuance costs at September 30, 2005 and December 31, 2004 were $10.2 millionand $12.5 million, respectively.

 

A summary of interest expense, amortization ofdeferred issuance costs and original issue discount, and the weighted averagecost of funds of the securitization financing for the three and nine monthsended September 30, 2005 and 2004 is as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **Amount**                           | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest  expense                              |       | $                                    | 43,867     |   | 4.0 | % | $ | 13,558 |   | 1.9 | % |
| Amortization of  deferred costs                       |       | 4,171                                |       | 0.4 | % | 1,657 |   | 0.3 | % |
| Amortization of  bond discount                        |       | 167                                  |       | 0.0 | % | 125 |   | 0.0 | % |
| Total interest  expense—securitization financing |       | $                                    | 48,205     |   | 4.4 | % | $ | 15,340 |   | 2.2 | % |

 
| ** **                                            | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **Amount**                          | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest  expense                              |       | $                                   | 112,708    |   | 3.5 | % | $ | 23,872 |   | 1.8 | % |
| Amortization of  deferred costs                       |       | 8,278                               |       | 0.3 | % | 2,723 |   | 0.2 | % |
| Amortization of  bond discount                        |       | 315                                 |       | 0.0 | % | 355 |   | 0.0 | % |
| Total interest  expense—securitization financing |       | $                                   | 121,301    |   | 3.8 | % | $ | 26,950 |   | 2.0 | % |

 

12

----

 

Thefollowing is a summary of the outstanding securitization bond financing byseries as of September 30, 2005 and December 31, 2004 (in thousands):

 
| ** **                      | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------|------------|------------------------|------------|---------------------------------|------------|
| FMIT  Series 2005-2        |       | $                      | 900,953    |                            | —     |   |
| FMIT  Series 2005-1        |       | 624,245                |       | —                          |       |
| FMIT  Series 2004-5        |       | 689,006                |       | 861,403                         |       |
| FMIT  Series 2004-4        |       | 602,054                |       | 816,527                         |       |
| FMIT  Series 2004-3        |       | 604,139                |       | 879,659                         |       |
| FMIT  Series 2004-2        |       | 425,717                |       | 692,854                         |       |
| FMIT  Series 2004-1        |       | 311,238                |       | 484,025                         |       |
| FMIC  Series 2003-1        |       | 179,509                |       | 316,817                         |       |
|                            |       | 4,336,861              |       | 4,051,285                       |       |
| Unamortized bond  discount      |       | (184                   | )          | (499                            | )          |
| Total  securitization financing |       | $                      | 4,336,677  |                            | 4,050,786  |   |

 

Thecurrent carrying amount of the mortgage loans pledged to the securitizationtrusts was $4.5 billion and $4.2 billion as of September 30, 2005 andDecember 31, 2004, respectively.

 

**(6)**            SegmentInformation

 

The information presented below with respect to theCompany’s reportable segments is consistent with the content of the businesssegment data provided to the Company’s management. This segment data uses acombination of business lines and channels to assess consolidated results. TheCompany has six reportable segments, which include four production segments,Non-Conforming Wholesale, Non-Conforming Retail, Conforming Wholesale,Conforming Retail, and two operating segments which include InvestmentPortfolio, and Corporate.

 

The Company originates loans through two channels: anon-conforming channel and a conforming channel, each of which operates bothwholesale and retail divisions. The Investment Portfolio segment primarilyincludes the net interest income earned by the loans held for investment. Inaddition, the Company has a Corporate segment that includes the timing andother differences between revenues and costs recognized for GAAP as compared toamounts allocated to the production segments. The Corporate segment alsoincludes the effects of the deferral and capitalization of net originationcosts as required by FASB Statement No. 91, “*Accounting for Nonrefundable Fees and Costs Associated with Originatingor Acquiring Loans and Initial Direct Costs of Leases.*” Financialinformation by segment is evaluated regularly by management and used indecision-making relating to the allocation of resources and the assessment of Companyperformance. The Company manages the business on a pre-tax basis and thereforeall income tax expense or benefit is allocated to the Corporate segment. Forthe purposes of segment information provided in the tables below, certain fees,origination costs, and other expenses recorded as a component of gains on saleof mortgage loans, net, have been reflected in total revenues or total expensesconsistent with intercompany allocations reported to the Company’s management.Also, gain on sale revenue is recognized at the time of funding by theproduction segments as if all loans will be sold, and adjusted in the Corporatesegment to reflect the actual gain on sale recognizable for GAAP revenuereporting on the loans that are sold. In addition, net interest income isrecognized on origination volume by the production segments and adjusted in theCorporate segment for the actual net interest income earned. The Corporatesegment includes reconciling amounts necessary for the segment totals to agreeto the consolidated financial statements.

 

13

----

 

The assets of the Company that are specificallyidentified to a segment include mortgage loans held for sale and investment,net, trustee receivable, derivative assets, net and furniture and equipment,net. All other assets are attributed to the Corporate segment. Total assets bysegment at September 30, 2005 and December 31, 2004 are summarized asfollows (in thousands): 

 
| ** **                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------|------------|-------------------------|------------|------------------------|------------|
| Non-Conforming—Wholesale |       | $                       | 373,854    |                   | 228,653    |   |
| Non-Conforming—Retail    |       | 92,927                  |       | 27,014                 |       |
| Conforming—Wholesale     |       | 57,300                  |       | 77,691                 |       |
| Conforming—Retail        |       | 9,672                   |       | 27,104                 |       |
| Investment  Portfolio         |       | 5,429,367               |       | 4,863,544              |       |
| Corporate                     |       | 127,301                 |       | 139,711                |       |
| Total                         |       | $                       | 6,090,421  |                   | 5,363,717  |   |

 

Operating results bybusiness segment for the three months ending September 30, 2005 are as follows(in thousands):

 
| ** **                                                | ** ** | **Non-Conforming** | ** ** | **Conforming** | ** ** | **Investment** | ** ** | ** ** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|----------------|------------|----------------|------------|------------|------------|---------------|------------|
| ** **                                                | ** ** | **Wholesale**      | ** ** | **Retail**     | ** ** | **Wholesale**  | ** ** | **Retail** | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                 |       |               |       |           |       |           |       |       |       |          |       |   |   |   |   |
| Interest income                                           |       | $                  | 9,973      |           | 1,130      |           | 1,217      |       | 517        |          | 84,940     |   | (2,977 | ) | 94,800 |   |
| Interest expense                                          |       | 5,916              |       | 622            |       | 915            |       | 377        |       | 54,361        |       | (2,664 | ) | 59,527 |   |
| Net interest  income                                      |       | 4,057              |       | 508            |       | 302            |       | 140        |       | 30,579        |       | (313 | ) | 35,273 |   |
| Provision for  loan losses—loans held for investment |       | —             |       | —         |       | —         |       | —     |       | (11,045       | )          | — |   | (11,045 | ) |
| Gains on sales  of mortgage loans, net                    |       | 35,586             |       | 9,143          |       | 1,789          |       | 2,263      |       | —        |       | (28,634 | ) | 20,147 |   |
| Other income  (expense)—portfolio derivatives        |       | —             |       | —         |       | —         |       | —     |       | 15,630        |       | — |   | 15,630 |   |
| Fees and other  income                                    |       | —             |       | 166            |       | —         |       | 570        |       | (155          | )          | 80 |   | 661 |   |
| Total revenues                                            |       | 39,643             |       | 9,817          |       | 2,091          |       | 2,973      |       | 35,009        |       | (28,867 | ) | 60,666 |   |
| Total expenses                                            |       | 28,592             |       | 9,205          |       | 2,255          |       | 3,961      |       | 2,603         |       | (12,373 | ) | 34,243 |   |
| Income (loss)  before income taxes                        |       | 11,051             |       | 612            |       | (164           | )          | (988       | )          | 32,406        |       | (16,494 | ) | 26,423 |   |
| Provision for  income tax expense                         |       | —             |       | —         |       | —         |       | —     |       | —        |       | (2,999 | ) | (2,999 | ) |
| Net income  (loss)                                        |       | $                  | 11,051     |           | 612        |           | (164       | )          | (988       | )             | 32,406     |   | (19,493 | ) | 23,424 |   |

 

14

----

 

Operating results bybusiness segment for the three months ending September 30, 2004 are as follows(in thousands):

 
| ** **                                                | ** ** | **Non-Conforming** | ** ** | **Conforming** | ** ** | **Investment** | ** ** | ** ** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|----------------|------------|----------------|------------|------------|------------|---------------|------------|
| ** **                                                | ** ** | **Wholesale**      | ** ** | **Retail**     | ** ** | **Wholesale**  | ** ** | **Retail** | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                 |       |               |       |           |       |           |       |       |       |          |       |   |   |   |   |
| Interest income                                           |       | $                  | 4,626      |           | 538        |           | 863        |       | 418        |          | 60,141     |   | — |   | 66,586 |   |
| Interest expense                                          |       | 892                |       | 112            |       | 373            |       | 166        |       | 20,274        |       | — |   | 21,817 |   |
| Net interest  income                                      |       | 3,734              |       | 426            |       | 490            |       | 252        |       | 39,867        |       | — |   | 44,769 |   |
| Provision for  loan losses—loans held for investment |       | —             |       | —         |       | —         |       | —     |       | (5,921        | )          | — |   | (5,921 | ) |
| Gains on sales  of mortgage loans, net                    |       | 37,469             |       | 9,511          |       | 1,152          |       | 2,860      |       | —        |       | (36,754 | ) | 14,238 |   |
| Other income  (expense)—portfolio derivatives        |       | —             |       | —         |       | —         |       | —     |       | (15,032       | )          | — |   | (15,032 | ) |
| Fees and other  income                                    |       | —             |       | 262            |       | —         |       | 716        |       | —        |       | 89 |   | 1,067 |   |
| Total revenues                                            |       | 41,203             |       | 10,199         |       | 1,642          |       | 3,828      |       | 18,914        |       | (36,665 | ) | 39,121 |   |
| Total expenses                                            |       | 30,759             |       | 10,782         |       | 2,824          |       | 3,584      |       | 2,432         |       | (16,747 | ) | 33,634 |   |
| Income (loss)  before income taxes                        |       | 10,444             |       | (583           | )          | (1,182         | )          | 244        |       | 16,482        |       | (19,918 | ) | 5,487 |   |
| Provision for  income tax expense                         |       | —             |       | —         |       | —         |       | —     |       | —        |       | (1,536 | ) | (1,536 | ) |
| Net income  (loss)                                        |       | $                  | 10,444     |           | (583       | )              | (1,182     | )          | 244        |          | 16,482     |   | (21,454 | ) | 3,951 |   |

 

Operating results bybusiness segment for the nine months ending September 30, 2005 are as follows(in thousands):

 
| ** **                                                | ** ** | **Non-Conforming** | ** ** | **Conforming** | ** ** | **Investment** | ** ** | ** ** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|----------------|------------|----------------|------------|------------|------------|---------------|------------|
| ** **                                                | ** ** | **Wholesale**      | ** ** | **Retail**     | ** ** | **Wholesale**  | ** ** | **Retail** | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                 |       |               |       |           |       |           |       |       |       |          |       |   |   |   |   |
| Interest income                                           |       | $                  | 24,919     |           | 2,998      |           | 3,368      |       | 1,294      |          | 248,350    |   | (3,121 | ) | 277,808 |   |
| Interest expense                                          |       | 13,979             |       | 1,565          |       | 2,682          |       | 932        |       | 134,742       |       | (6,303 | ) | 147,597 |   |
| Net interest  income                                      |       | 10,940             |       | 1,433          |       | 686            |       | 362        |       | 113,608       |       | 3,182 |   | 130,211 |   |
| Provision for  loan losses—loans held for investment |       | —             |       | —         |       | —         |       | —     |       | (22,402       | )          | — |   | (22,402 | ) |
| Gains on sales  of mortgage loans, net                    |       | 91,360             |       | 24,069         |       | 4,842          |       | 6,226      |       | —        |       | (69,427 | ) | 57,070 |   |
| Other income  (expense)—portfolio derivatives        |       | —             |       | —         |       | —         |       | —     |       | 26,540        |       | — |   | 26,540 |   |
| Fees and other  income                                    |       | —             |       | 516            |       | —         |       | 1,379      |       | (925          | )          | 228 |   | 1,198 |   |
| Total revenues                                            |       | 102,300            |       | 26,018         |       | 5,528          |       | 7,967      |       | 116,821       |       | (66,017 | ) | 192,617 |   |
| Total expenses                                            |       | 75,040             |       | 26,513         |       | 6,899          |       | 11,083     |       | 7,602         |       | (27,915 | ) | 99,222 |   |
| Income (loss)  before income taxes                        |       | 27,260             |       | (495           | )          | (1,371         | )          | (3,116     | )          | 109,219       |       | (38,102 | ) | 93,395 |   |
| Provision for  income tax expense                         |       | —             |       | —         |       | —         |       | —     |       | —        |       | (4,792 | ) | (4,792 | ) |
| Net income  (loss)                                        |       | $                  | 27,260     |           | (495       | )              | (1,371     | )          | (3,116     | )             | 109,219    |   | (42,894 | ) | 88,603 |   |

 

15

----

 

Operating results bybusiness segment for the nine months ending September 30, 2004 are as follows(in thousands):

 
| ** **                                                | ** ** | **Non-Conforming** | ** ** | **Conforming** | ** ** | **Investment** | ** ** | ** ** | ** ** | ** **    | ** ** |
|-----------------------------------------------------------|------------|--------------------|------------|----------------|------------|----------------|------------|------------|------------|---------------|------------|
| ** **                                                | ** ** | **Wholesale**      | ** ** | **Retail**     | ** ** | **Wholesale**  | ** ** | **Retail** | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                 |       |               |       |           |       |           |       |       |       |          |       |   |   |   |   |
| Interest income                                           |       | $                  | 12,857     |           | 1,786      |           | 2,973      |       | 1,420      |          | 130,139    |   | — |   | 149,175 |   |
| Interest expense                                          |       | 2,423              |       | 340            |       | 1,050          |       | 458        |       | 38,705        |       | — |   | 42,976 |   |
| Net interest  income                                      |       | 10,434             |       | 1,446          |       | 1,923          |       | 962        |       | 91,434        |       | — |   | 106,199 |   |
| Provision for  loan losses—loans held for investment |       | —             |       | —         |       | —         |       | —     |       | (14,878       | )          | — |   | (14,878 | ) |
| Gains on sales  of mortgage loans, net                    |       | 102,480            |       | 29,154         |       | 3,936          |       | 9,242      |       | —        |       | (103,456 | ) | 41,356 |   |
| Other income  (expense)—portfolio derivatives        |       | —             |       | —         |       | —         |       | —     |       | (4,488        | )          | — |   | (4,488 | ) |
| Fees and other  income                                    |       | —             |       | 617            |       | —         |       | 1,831      |       | —        |       | 450 |   | 2,898 |   |
| Total revenues                                            |       | 112,914            |       | 31,217         |       | 5,859          |       | 12,035     |       | 72,068        |       | (103,006 | ) | 131,087 |   |
| Total expenses                                            |       | 84,422             |       | 31,004         |       | 8,294          |       | 11,033     |       | 4,871         |       | (43,378 | ) | 96,246 |   |
| Income (loss)  before income taxes                        |       | 28,492             |       | 213            |       | (2,435         | )          | 1,002      |       | 67,197        |       | (59,628 | ) | 34,841 |   |
| Provision for  income tax expense                         |       | —             |       | —         |       | —         |       | —     |       | —        |       | (4,538 | ) | (4,538 | ) |
| Net income  (loss)                                        |       | $                  | 28,492     |           | 213        |           | (2,435     | )          | 1,002      |          | 67,197     |   | (64,166 | ) | 30,303 |   |

 

**(7)****            Stock-BasedCompensation**

 

The Company has adoptedthe fair value method of accounting for stock options and shares of restrictedstock as prescribed by Statement of Financial Accounting StandardsNo. 148, *“Accounting for Stock-Based Compensation-Transitionand Disclosure”*(StatementNo. 148) which amends Statement of Financial Standards No. 123, *“Accounting for Stock Based Compensation”*(Statement No. 123). Under this method, compensation cost is measured atthe grant date based on the fair value of the award and is recognized asexpense on a straight-line basis over the award’s vesting period. The fairvalue of awards of restricted stock is determined at the date of grant based onthe market price of our common stock on that date. For both the stock optionsand restricted stock, the amount of compensation cost is adjusted for estimatedannual forfeitures. The fair value of the stock options is determined using theBlack-Scholes option pricing model.

 

On May 6, 2005, theCompensation Committee of the Board of Directors, pursuant to the FieldstoneInvestment Corporation Equity Incentive Plan (the “Stock Plan”), granted tocertain of key officers and key employees, 138,400 non-qualified stock optionswith dividend equivalent rights (“Options with DERs”).  The exercise price was $12.70, which was theclosing price of the Company’s common stock on the date of grant.  One hundred percent of the options vest onMarch 31, 2009 with a term expiring on March 31, 2012.  While the option is unvested, dividendequivalents are earned based on the number of option shares held and are deemedinvested in phantom shares of the Company’s common stock at the closing priceof the stock on the dividend payment date. The phantom shares also will be credited with dividend equivalent rightsat the same time and in the same amount as cash dividends are paid on theCompany’s common stock.  The total valueof dividend equivalents, adjusted for the change in value of the phantom sharesfrom date of issuance through vest date, will be paid in cash at the time theoption vests.

 

In accordance with FASBStatement No. 123, *“Accounting forStock-Based Compensation,”* the Company expenses its stock-basedcompensation by applying the fair value method to stock-based compensation usingthe Black-Scholes option pricing model. Compensation cost of $33.0 thousand and $56.7 thousand, relating to theissuance of the grant of Options with DER’s, was recorded in salaries andemployee benefits for the three and nine months ending September 30, 2005,respectively.

 

16

----

 

The following tablesummarizes the weighted average fair value of the Options with DERs, determinedusing the Black-Scholes option pricing model, and the assumptions used in theirdetermination.

 
| Fair value, at  date of grant   |   | $    | 4.56   |   |
|---------------------------------|--------|------|--------|--------|
| Expected life in  years         |   | 5.5  |   |
| Annual risk-free  interest rate |   | 4.03 | %      |
| Expected  volatility            |   | 30   | %      |
| Expected  forfeitures           |   | 20   | %      |
| Expected  dividend yield        |   | 0.0  | %      |

 

On June 22, 2005, theCompensation Committee, pursuant to the Stock Plan, awarded a maximum of 65,040shares of restricted stock to certain of the Company’s senior officers subjectto a level of achievement of certain corporate performance objectives (the “performanceshares”).  The performance shares werevalued at $10.82 per share, with one hundred percent of the earned shares tovest on March 31, 2009.  The performanceshares are shares of restricted stock that are subject to vesting requirementsand can be earned based primarily on the Company’s achievement of certainreturn on equity targets for the period April 1, 2005 through December 31,2006.  Compensation cost of $31.7thousand and $38.3 thousand, relating to the issuance of the performance shares,was recorded in salaries and employee benefits for the three and nine monthsending September 30, 2005, respectively.

 

**(8)**            Earnings PerShare

 

Information relating tothe calculations of earnings per share (EPS) of common stock for the three and ninemonths ended September 30, 2005 and 2004 is summarized as follows (inthousands, except per share data):

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Basic earnings  per share:                             |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                             |       | $                                     | 23,424     |                                 | 3,951      |   | 88,603 |   | 30,303 |   |
| Dividends on  unvested restricted stock                |       | (187                                  | )          | (125                                 | )          | (363 | ) | (162 | ) |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Adjusted net  income used in EPS computation           |       | $                                     | 23,237     |                                 | 3,826      |   | 88,240 |   | 30,141 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding                   |       | 48,462                                |       | 48,327                               |       | 48,462 |   | 48,326 |   |
| Earnings per share                                     |       | $                                     | 0.48       |                                 | 0.08       |   | 1.82 |   | 0.62 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |   |
| Diluted earnings  per share:                           |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                             |       | $                                     | 23,424     |                                 | 3,951      |   | 88,603 |   | 30,303 |   |
| Dividends on  unvested restricted stock                |       | (187                                  | )          | (125                                 | )          | (363 | ) | (162 | ) |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Adjusted net  income used in EPS computation           |       | $                                     | 23,237     |                                 | 3,826      |   | 88,240 |   | 30,141 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding                   |       | 48,462                                |       | 48,327                               |       | 48,462 |   | 48,326 |   |
| Dilutive effect  of stock options and restricted stock |       | 17                                    |       | 155                                  |       | 17 |   | 202 |   |
|                                                   |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding, diluted          |       | 48,479                                |       | 48,482                               |       | 48,479 |   | 48,528 |   |
| Diluted earnings  per share                            |       | $                                     | 0.48       |                                 | 0.08       |   | 1.82 |   | 0.62 |   |

 

Effects of potentially dilutive securities arepresented only in periods in which they are dilutive. For the three and ninemonths ended September 30, 2005, 834,000 stock options and 358,750 shares ofunvested restricted stock granted in 2003 through 2005 were excluded from thecalculation of diluted earnings per share. For the three and nine months ended September30, 2004, 782,400 and 46,000, respectively, of stock options granted wereexcluded from the calculation of diluted earnings per share.  These stock compensation awards would have anantidilutive effect on earnings per share.

 

17

----

 

**(9)**            Commitmentsand Contingencies

 

***(a)***      LoanCommitments

 

At September 30, 2005and December 31, 2004, the Company had origination commitments outstandingto fund approximately $642.8 million and $421.8 million in mortgageloans, respectively. Fixed rate and hybrid ARM mortgages which are fixed forthe initial two to three year term of the loan comprised 97.6% and 96.9%,respectively, of the outstanding origination commitments at September 30, 2005and December 31, 2004. The Company had forward delivery commitments to sellapproximately $1.9 billion and $0.4 billion of loans at September 30, 2005and December 31, 2004, respectively, of which $129.0 million and$63.1 million, respectively, were mandatory sales of mortgage backedsecurities and investor whole loan trades. At September 30, 2005 andDecember 31, 2004, the Company had a commitment to sell $460.0 millionand $40.0 million, respectively, of treasury note forward contracts, usedto economically hedge the interest rate risk of its non-conforming loans.

 

***(b)***      Legal Matters

 

On October 28,2005, in the Company’s defense of the suit filed by its former shareholders, theCompany served a cross claim against KPMG LLP (“KPMG”) in the matter of *820 Management Trust et al. v. Fieldstone Investment Corporation (FIC),Fieldstone Mortgage Company (FMC) and KPMG LLP* (the “820 ManagementTrust Lawsuit”).  The cross claim wasfiled in the District Court of Tarrant County, Texas, where the 820 ManagementTrust Lawsuit is pending.   The 820Management Trust Lawsuit is an action filed by certain of FIC’s formershareholders, alleging that the shareholders whose shares were redeemed out ofthe proceeds of the 144A Offering are entitled to an additional post-closingredemption price payment of approximately $19.0 million, plus interest andattorney fees. The former shareholders were paid $188.1 million for theirshares on November 14, 2003 and the Redemption Agreement between theshareholders and the Company required an adjustment to the redemption price be paidto the shareholders based on the Company’s November 13, 2003 balancesheet, as audited by KPMG, the Company’s former auditors, pursuant to which theCompany paid an additional $1.8 million to the former shareholders on February18, 2004.  Following notification by theredeemed shareholders of their objection to the Company’s November 13,2003 balance sheet, KPMG, on April 20, 2004, advised the Company that its auditof the November 13, 2003 balance sheet should no longer be relied upon.   The Company’s cross claim asserts, amongother claims, that KPMG’s withdrawal of its audit report on the November 13,2003 balance sheet was improper and that due to this improper withdrawal theCompany suffered damages.   In addition, thecross claim asserts that in the event the former shareholders prevail in the820 Management Trust Lawsuit, KPMG negligently advised FIC regarding theNovember 13, 2003 balance sheet giving rise to this dispute.  The cross claim seeks a judgment against KPMGin an unspecified amount in excess of approximately $1 million, plusprejudgment interest for the attorneys fees and cost incurred in the abovereferenced matter.  See Part 1 Item 3 of theCompany’s Annual Report on Form 10-K for the fiscal year ending on December 31,2004 filed with the SEC on March 25, 2005 for a description of the 820Management Trust Lawsuit.

 

*Arredondo, et al. v. FieldstoneInvestment, et al.**,*isan action filed on August 3, 2004 in the United States District Court for theDistrict of Arizona by nine former employees of Fieldstone Mortgage Companyalleging that that their supervisors and co-workers created a hostile workenvironment resulting from gender discrimination, racial discrimination andretaliation in the workplace pursuant to Title VII of the Civil Rights Act of1964, 42 U.S.C. §2000e, and the Civil Rights Act of 1866, 42 U.S.C. §1981, asamended by the Civil Rights Act of 1991, 42 U.S.C. §1981(a). Plaintiffs claimthat they are entitled to money damages in the form of back pay and front payand nominal, compensatory and punitive damages, costs and attorney fees andequitable relief.  The Company filed itsanswer denying all relevant claims on August 25, 2004.  In addition, theCompany filed a variety of motions seeking to have some of the plaintiffsdismissed from the lawsuit for failure to exhaust their administrativeremedies, to dismiss other claims as not being permitted under the statute, andfinally to sever the plaintiffs for trial purposes.  Plaintiffs filed aresponse to the Company’s motion to dismiss, sever or in the alternative,bifurcate, and on April 18, 2005, the Company’s motion to dismiss wasdenied.  The parties are currently in theprocess of discovery and no trial date has yet been set; however, motions forsummary judgment are due no later than June 21, 2006. Due to the uncertainnature of the litigation at this time, the Company is unable to estimate theprobable outcome of this matter.  Theplaintiffs in this matter have not specified damages sought and the Company istherefore unable to estimate potential exposure. While the Company intends tovigorously defend this matter, there can be no assurance that an adverseoutcome would not have a material effect on the Company’s results ofoperations.

 

18

----

 

The Company issubject to various legal proceedings in the ordinary course of its businessrelated to foreclosures, bankruptcies, condemnation and quiet title actions andalleged statutory and regulatory violations. The Company’s management believesthat any liability with respect to these legal actions, individually or in theaggregate, will not have a material adverse effect on the Company’s business,results of operations or financial position.

 

**(10)**     SubsequentEvents

 

***On October 11, 2005, FMOC entered into amaster repurchase agreement with Liquid Funding, Ltd. (Liquid Funding), anaffiliate of Bear Stearns Bank plc.  Underthe repurchase facility FMOC may borrow up to an aggregate amount of $200million from Liquid Funding by pledging a portfolio of non-prime mortgage-backedsecurities (Retained Securities).  The facilityis scheduled to remain open until October 13, 2006 and bears interest at anannual rate of LIBOR plus an additional percentage.  The specific pricing terms and compositionand amount of Retained Securities pledged in each transaction will bedetermined by the parties on a transaction by transaction basis.  As of November 11, 2005, Retained Securitieshaving a market value of $80.8 million have been pledged to Liquid Funding ascollateral for $57.1 million of borrowings under the agreement.***

 

***On October 21, 2005, FMOC entered into amaster repurchase agreement with Lehman Brothers Inc. and Lehman BrothersCommercial Paper Inc. (together Lehman Brothers).  Under the repurchase facility FMOC may borrowup to an aggregate amount of $200 million from Lehman Brothers by pledging aportfolio of non-prime mortgage-backed securities (Retained Securities).  The facility is scheduled to remain openindefinitely, but may be terminated by either party at any time, and bearsinterest at an annual rate of LIBOR plus an additional percentage.  The specific pricing terms and compositionand amount of Retained Securities pledged in each transaction will bedetermined by the parties on a transaction by transaction basis.  As of November 11, 2005, Retained Securitieshaving a market value of $88.5 million have been pledged to Lehman Brothers ascollateral for $68.1 million of borrowings under the agreement.***

 

19

----

 

**ITEM2.**       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis of our resultsof operations, financial condition and liquidity and capital resources shouldbe read in conjunction with our unaudited condensed consolidated financialstatements and related notes contained in this Quarterly Report onForm 10-Q, as well as the audited consolidated financial statements andrelated notes for the fiscal year ended December 31, 2004 and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”contained in our Annual Report on Form 10-K, as amended, for the yearended December 31, 2004.

 

**Safe Harbor for Forward-Looking Statements**

 

The Private Securities Litigation Reform Act of 1995provides a safe harbor for forward-looking statements; as such term is definedunder Section 21E of the Securities Exchange Act of 1934, as amended. Anywritten or oral statement, made by or on our behalf, using words such as “believes,”“expects,” “intends,” “estimates,” “projects,” “predicts,” “assumes,” “anticipates,”“plans,” “seeks,” and comparable terms, is a forward-looking statement.Forward-looking statements are not statements of historical fact, but ratherare based on our views and assumptions regarding future events and performance,taking into account all information currently available to us. Because we havea limited operating history, many statements relating to us and our business,including statements relating to our competitive strengths and businessstrategies, may be forward-looking statements.

 

All forward-looking statements (none of which isintended as a guarantee of performance) are subject to certain risks anduncertainties, known and unknown, that could cause our actual results to differmaterially from the expected results expressed by the forward-lookingstatements. We believe that the factors that may affect future performance andthe accuracy of forward-looking statements contained in this Form 10-Qinclude, but are not limited to, the following:

 

•                  our limited operating history with buildingand managing an investment portfolio, which limits your ability to evaluate akey component of our business strategy and our growth prospects and increasesyour investment risk;

•                  our ability to estimate future loanperformance on our loans held for investment;

•                  changes in the prepayment speeds of our loansheld for investment;

•                  fluctuations in interest rates, particularlyin an environment where increases in short-term rates, which effect our borrowingcosts, may exceed increases in the longer term mortgage rates from which wederive a significant portion of our income;

•                  the availability, terms and deployment ofcapital;

•                  the success of our portfolio-based model ofsecuritizations, which is subject to the effects of interest rate fluctuations,margin calls and credit enhancement levels;

•                  our ability to execute successfully a hedgingstrategy to mitigate our risks associated with changes in interest rates;

•                  our ability to qualify or remain qualified asa REIT in any taxable year;

•                  general volatility of the capital markets;

•                  the degree and nature of our competition;

•                  changes in government regulations that affectour ability to originate and securitize mortgage loans; and

•                  certain other factors set forth in ourfilings, from time to time, with the SEC, including our Annual Report onForm 10-K as amended for the fiscal year ended December 31, 2004.

 

Allforward-looking statements should be read in conjunction with the othercautionary statements that are included in this Quarterly Report onForm 10-Q. You are cautioned not to place undue reliance on theforward-looking statements contained in this Quarterly Report onForm 10-Q, which speak only as of the date it is filed with the SEC. Weundertake no obligation to update publicly any forward-looking statement,whether as a result of new information, future events or otherwise.

 

20

----

 

**ExecutiveOverview**

 

We are a mortgage REIT that invests in non-conformingloans originated by our wholly owned subsidiary, Fieldstone Mortgage Company (FMC),which are financed with mortgage-backed securities. FMC originates loansthrough both wholesale and retail origination channels. Through FMC, weoriginate, service and sell both non-conforming and conforming single familyresidential mortgage loans.

 

Currently, our primary sources of income are the netinterest income on our loans held for investment and the gains on sales ofmortgage loans held for sale which are sold servicing-released. Our currentstrategy is to retain a portion of our non-conforming loans in our REITinvestment portfolio, to finance our portfolio of loans with mortgage-backedsecurities collateralized by those loans, and to continue to sell our conformingloans and the remainder of our non-conforming loans. The non-conforming loansthat we retain meet our specific cash flow, credit and projected returnrequirements.

 

During the three months ended September 30, 2005,our net income was $23.4 million and we funded $1.8 billion of non-conformingloans, a record quarterly funding of non-conforming loans. Our earnings duringthe third quarter reflected a decrease in our net interest margin as marketinterest rates continued to rise, and the spread narrowed between the interest ratesof our new loans compared to our current financing costs. The effect of thisspread narrowing was more pronounced because of a faster rate of prepayments onthe older loans in our portfolio, loans we had invested in previously at widermargins. Our sales of non-conforming loans in the third quarter were $896.6million at an average gross price of 2.7%, net of hedge gains.  The quarter’s results include a $7.6 millionnon-cash mark to market valuation gain on the interest rate swap and capagreements used as economic hedges of the variable rate debt financing ourloans held for investment.

 

Our portfolio of loans held for investment, net, was$5.3 billion at September 30, 2005 and $4.8 billion at December 31,2004. At September 30, 2005, our financing debt on the loans held in ourportfolio was 8.8 times our equity. Based on the current size of our portfolioand management’s estimates and assumptions regarding expected futureorigination levels and market factors, in February 2005 we increased our targetdebt to equity ratio on our portfolio to 13 times our equity from 11 times ourequity. We intend to continue to build our portfolio by retaining the majorityof our non-conforming fundings; however, the percentage of loans we retain forthe portfolio in any given period is likely to vary based upon the size of theportfolio we hold, prepayments and the availability of loans which meet ourcash flow, credit and projected return criteria.

 

We use interest rate swaps and caps to economicallyhedge the variable rate financing costs for the fixed rate period of our twoand three year hybrid mortgage loans held for investment. Because thesederivatives are not designated as cash flow hedges under Statement ofAccounting Standards No. 133, “*Accountingfor Derivative Instruments and Hedging Activities,*” changes in thefair market value of the swaps and caps are recognized in current periodearnings and reported in our consolidated statement of operations in “Otherincome (expense)—portfolio derivatives.” For example, in the second quarter of2005, we recognized a $12.1 million mark to market valuation loss as interestrates decreased slightly during the quarter; however, as interest rates increasedduring the third quarter of 2005, we recognized a $7.6 million mark to market gain.We cannot predict the future path of interest rates, nor can we predict themagnitude by which these changes in the fair market value of our swaps and capcould cause our total revenue and net income to increase or decreasesignificantly during periods of interest rate volatility.

 

**Key Components of Financial Results of Operations**

 

**Revenues**

 

The principal factors that affect our revenues are thespread between the interest income we receive on our mortgage loans and ourcost of funds to finance those loans, interest rate changes, originationvolumes, sale margins on our loans held for sale, prepayment rates of ourmortgage loans held for investment, home price appreciation, trends in consumercredit, and provision for loan losses on our investment portfolio. Risinginterest rates may result in an increase in the mortgage rates we charge on ourloan originations, but also will increase our costs of borrowing to

 

21

----

 

finance the loans. Rising interest rates may lead to decreases in loanprepayments of our hybrid adjustable rate mortgages during the initial loanperiod in which our borrowers pay a fixed interest rate, generally during thefirst two years of the loan.  Rising interestrates may also lead to an increase in prepayments at or near the reset date ofthe loan, when the coupon resets to a margin over six-month LIBOR. After thereset date of the loans, our margins are subject to less volatility because theloans and the related debt will be adjusting based on the same interestindex.  In addition, rising interestrates generally will increase the fair value on the swaps and caps economicallyhedging our portfolio financing costs.

 

**Expenses**

 

The principal factors which lead to changes in ourexpenses are the current period funding volumes, the number of originationoffices we operate, our staffing required to support our origination business,the balance of our investment portfolio incurring third-party servicing feeexpenses and the corporate overhead required to support a publicly-tradedcompany. As loan volumes increase, we generally would expect salaries, benefitsand variable operating expenses to increase, net of deferred direct originationcosts, including commissions. We also have incurred incremental expenses in2005 due to costs related to enhanced portfolio analytic tools, higher auditand legal fees, and increased amortization expense as our new loan originationsoftware becomes fully operational.

 

**Critical Accounting Policies**

 

We consider the policies discussed below to becritical to an understanding of our financial statements because theirapplication places the most significant demands on the judgment of ourmanagement, with financial reporting results relying on estimates andassumptions about the effects of matters that are inherently uncertain.Specific risks for these critical accounting policies are described in thefollowing paragraphs. While we believe that the estimates and assumptionsmanagement utilizes in preparing our financial statements are reasonable, suchestimates and assumptions routinely require periodic adjustment. Actual resultscould differ from our estimates, and these differences could be significant.

 

***Securitizations***

 

We must comply with the provisions of Statement ofFinancial Accounting Standards No. 140 “*Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*” (Statement No. 140) and Financial InterpretationNumber 46R, “*Consolidation of Variable InterestEntities,*” (FIN 46R) relating to each securitization. Depending onthe structure of the securitization, it will either be treated as a sale orsecured financing for financial statement purposes. We account for oursecuritizations of mortgage loans as secured financings, and accordingly, weinclude the securitized mortgage loans on our books as mortgage loans held forinvestment. The loans are sold to a trust which is a wholly-owned specialpurpose entity for purposes of credit ratings; however, because thesecuritizations are designed as secured financings, they are designed not tomeet the qualifying special purpose entity criteria of Statement No. 140.

 

***Allowance for Loan Losses—Loans Held forInvestment***

 

Because we maintain our loans held for investment onthe statements of condition for the life of the loans, we maintain an allowancefor loan principal losses, based on our estimates of the losses inherent in theportfolio. This is a critical accounting policy because of the subjectivenature of the estimates required and potential for imprecision. Two criticalassumptions used in estimating the loss reserve are an assumed rate at whichthe loans go into foreclosure subsequent to initial default and an assumed lossseverity rate, which represents the expected rate of realized loss upondisposition of the properties that have been foreclosed. Because we havelimited historical loss data on our past originations, all of which were soldservicing-released, we currently utilize industry loss assumptions for loanssimilar in credit, loan size and product type. These assumptions result in anestimate that approximately 26% of loans that are delinquent 30+ daysultimately will default and experience an average principal balance loss of35%. These underlying assumptions and estimates are continually evaluated andupdated to reflect management’s current assessment of the value of theunderlying collateral, our limited actual historical loss experience from thethird quarter

 

22

----

 

of 2003 through the currentperiod, and other relevant factors impacting portfolio credit quality andinherent losses.  Provision for losses ischarged to our consolidated statements of operations as a reduction in netinterest income.  Losses incurred onmortgage loans held for investment are charged to the allowance at the time ofliquidation or at the time the loan is transferred to real estate owned.  Subsequent decreases in net realizable valueand losses at property disposal are recorded to gain (loss) on disposal of realestate owned, which is a component of “Fee and other income” on ourconsolidated statements of operation.

 

We define the beginning of the loss emergence periodfor a mortgage loan to be the occurrence of a contractual delinquency greaterthan 30 days. On a monthly basis, loans meeting this criterion areincluded in a determination of the allowance for loan losses, which utilizesindustry roll rate experience to assess the likelihood and severity ofportfolio losses. We do not assess loans individually for impairment due to thehomogeneous nature of the loans, which are collectively evaluated forimpairment. If actual results differ from our estimates, we may be required toadjust our provision accordingly. The use of different estimates or assumptionscould produce different provisions for loan losses.

 

We place individual loans on non-accrual status whenthey are past-due 90 days or when, in the opinion of management, thecollection of principal and interest is in doubt. At the time an individualloan is placed on non-accrual status, all previously accrued but uncollectibleinterest is reversed against current period interest income. In addition, wereserve for interest income accrued on our pool of homogeneous 30 and 60 daydelinquent loans on the basis of the same industry loss roll rate assumptions,by estimating the interest due on our pool of homogeneous loans which willmigrate to non-accrual status in the future.

 

***Amortization of Deferred Loan OriginationCosts and Deferred Debt Issuance Costs***

 

Interest income on our mortgage loan portfolio is acombination of the accrual of interest based on the outstanding balance andcontractual terms of the mortgage loans, adjusted by the amortization of netdeferred origination costs related to originations in our investment portfolio,in accordance with Statement of Financial Accounting Standards No. 91, “*Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct Costs ofLeases*” (Statement No. 91). Our net deferred origination costsconsist primarily of premiums, discounts and other net fees or costs directlyassociated with originating our mortgage loans, including commissions paid onclosed loans. For our loans held for investment, these net deferred costs areamortized as adjustments to interest income over the estimated lives of theloans using the interest method. Because we hold a large number of similarloans for which prepayments are probable and for which we can reasonablyestimate the timing of such prepayments, we use prepayment estimates indetermining periodic amortization based on a model that considers actualprepayment experience to-date as well as forecasted prepayments based on thecontractual interest rate on the loans, loan age, loan type, prepayment feecoverage and a variety of other factors. Mortgage prepayment forecasts are alsoaffected by the terms and credit grades of the loans, conditions in the housingand financial markets, relative levels of interest rates, and general economicconditions. Prepayment assumptions are reviewed regularly to ensure that actualCompany experience as well as industry data are supportive of prepaymentassumptions used in our model. Updates that are required to be made to theseestimates are applied as if the revised estimates had been in place since theorigination of the loans and may result in adjustments to the current periodamortization recorded to interest income.

 

Interest expense on our warehouse and securitizationfinancing is a combination of the accrual of interest based on the contractualterms of the financing arrangements and the amortization of bond original issuediscounts and issuance costs. The amortization of bond original issue discountsand issuance costs also considers estimated prepayments and is calculated usingthe interest method. The principal balance of the securitization financing isrepaid as the related collateral principal balance amortizes, either throughreceipt of monthly mortgage payments or any loan prepayment. The deferredissuance costs and original issue discounts are amortized through interestexpense over the estimated life of the outstanding balance of thesecuritization financing, utilizing the prepayment assumptions referenced aboveto estimate the average life of the related debt. Updates that are required tobe made to these estimates are applied as if the revised estimates had been inplace since the issuance of the related debt and result in adjustments to theperiod amortization recorded to interest expense.

 

23

----

 

We have sought to partially offset the impact to ournet interest income of faster than anticipated prepayment rates by originatingmortgage loans with prepayment fees. These fees typically expire two yearsafter origination of a loan. As of September 30, 2005, approximately 86% of ourmortgage loan portfolio had prepayment fee features. We anticipate thatprepayment rates on our portfolio will increase as these predominately adjustablerate loans reach their initial adjustments, typically 24 months after fundingthe loans, starting in 2005. The varying prepayment rate, referred to on anannualized basis as the constant prepayment rate, or CPR, will be reforecasteach quarter to project cash flows based upon historical industry data forsimilar loan products in the context of the current markets and our actualhistory to date. The forward-looking expected CPR used in our currentassumptions averages 32 CPR during the first 12 months, averages 45 CPRthrough month 21, and increases to an average of 74 CPR during the months onand around the reset date, declining to an average 46 CPR thereafter. Ifprepayment speeds increase, our net interest margin would decrease due to theadditional cost amortization, which may be partially offset by an increase inprepayment fee income.

 

***Economic Hedges***

 

The economic hedging of our interest rate riskrelated to our loans held for sale is a critical aspect of our business becauseof its interest rate sensitivity and the difficulty in estimating whichinterest rate locks will convert to closed loans as interest rates fluctuate.We use various financial instruments to hedge our exposure to changes ininterest rates. The financial instruments typically include mandatory deliveryforward sale contracts of mortgage-backed securities, mandatory and bestefforts whole-loan sale agreements and treasury note forward sales contracts.These financial instruments are intended to mitigate the interest rate risk inherentin providing interest rate lock commitments to prospective borrowers to financeone-to-four family homes and to hedge the value of our loans held for saleprior to entering fixed price sale contracts.

 

The interest rate locks for conforming loans and themandatory forward sales, which are typically used to hedge the interest raterisk associated with these locks, are undesignated derivatives and are markedto market through earnings. For interest rate lock commitments related toconforming loans, mark to market adjustments are recorded from inception of theinterest rate lock through the funding date of the underlying loan. The fundedloans have not been designated by us as a qualifying hedged asset in accordancewith Statement of Financial Accounting Standards No. 133, “*Accounting for Derivative Instruments and HedgingActivities*” (Statement No. 133). We record the funded loans onthe consolidated statements of condition at the lower of cost or market value.The mandatory forward sales, which generally serve as an effective economichedge from the inception of the interest rate lock through the time of the saleof the loans, remain subject to mark to market adjustments beyond the time theloan funds, and our reported earnings may reflect some non-economic volatilityas a result of this differing treatment. The non-cash mark to market valuationsof both our interest rate lock commitments and derivative instruments isreported as a component of gains on sales of mortgage loans, net.

 

The interest rate lock commitments associated withnon-conforming loans held for sale and the treasury note forward salescontracts typically used to hedge the interest rate risk associated with theselocks are also derivatives and are marked to market through earnings. Similarto the conforming loans, the funded non-conforming loans have not beendesignated as a qualifying hedged asset in accordance with Statement No. 133,and, accordingly, we record them at the lower of cost or market value on theconsolidated statements of condition. The treasury note forward salescontracts, which do serve as an effective economic hedge prior to the sale ofsome of our non-conforming loans, remain subject to mark to market adjustmentsbeyond the time the loans fund, and our reported earnings may reflect somenon-economic volatility as a result of this differing treatment.

 

Relative to our loans held for investment, we economicallyhedge the effect of interest rate changes on our cash flows as a result ofchanges in the benchmark interest rate, in this case, LIBOR, on which ourinterest payments on warehouse financing and securitization financing arebased. These derivatives are not classified as cash flow hedges under StatementNo. 133. We enter into interest rate swap agreements to hedge the financing onmortgage loans held for investment. The change in fair value of the derivativeduring the hedge period is reported as a component of “Other income(expense)—portfolio derivatives.” The periodic net cash settlements and anygain or loss on terminated swaps are also reported as a component of “Otherincome (expense)—portfolio derivatives.” We also entered into an interest ratecap agreement to hedge interest rate changes relative to our firstsecuritization in the fourth quarter of 2003. The

 

24

----

 

cap was not designated as acash flow hedge instrument, and as such, realized and unrealized changes in itsfair value are recognized as a component of “Other income (expense)-portfolioderivatives” during the period in which the changes occur.

 

Changes in interest rates during a reporting periodwill affect the mark to market valuations on our undesignated derivatives.Increases in short-term interest rates will result in a non-cash credit beingrecognized in our consolidated statements of operations, while decreases inshort-term rates will result in a non-cash charge being recognized in our consolidatedstatements of operations.

 

***Stock-Based Compensation***

 

We have adopted the fair value method of accountingfor stock options and shares of restricted stock as prescribed by Statement ofFinancial Accounting Standards No. 148, *“Accountingfor Stock-Based Compensation-Transition and Disclosure”*(Statement No. 148) which amends Statementof Financial Standards No. 123, *“Accountingfor Stock Based Compensation”* (Statement No. 123). Underthis method, compensation cost is measured at the grant date based on the fairvalue of the award and is recognized as expense on a straight-line basis overthe award’s vesting period. The fair value of awards of restricted stock isdetermined at the date of grant based on the market price of our common stockon that date. For both the stock options and restricted stock, the amount ofcompensation cost is adjusted for estimated annual forfeitures. The fair valueof the stock options is determined using the Black-Scholes option pricingmodel. Due to the subjective nature and estimates required under StatementNo. 123, we consider this a critical accounting policy.

 

***Reserve for Losses—Loans Sold***

 

We maintain a reserve for our representation andwarranty liabilities related to the sale of loans and for our contractualobligation to rebate a portion of any premium paid by a purchaser when aborrower prepays a sold loan within an agreed period. The representations andwarranties generally relate to the accuracy and completeness of informationrelated to the loans sold and to the collectibility of the initial paymentsfollowing the sale of the loan. The reserve, which is recorded as a liabilityon our consolidated statements of condition, is established when loans are soldand is calculated as the fair value of losses estimated to occur over the lifeof the loan. The reserve for losses is established through a provision forlosses, which is reflected as a reduction of the gain on the loans sold at thetime of sale. We forecast future losses on current sales based on our analysisof our actual historical losses, stratified by type of loss, type of loan, lienposition, collateral location, and year of sale. This analysis takes intoconsideration historical information regarding frequency and severity oflosses, and compares economic and real estate market trends which may haveaffected historical losses, and the potential impact of these trends to losseson current loans sold. We estimate losses due to premium recaptures on earlyloan prepayments by reviewing loan product and rate, borrower prepayment fee,if any, and estimates of future interest rate volatility. If the actual losstrend on loans sold varies compared to the loss provision previously forecast,an adjustment to the provision expense will be recorded as a change inestimate.

 

**Results of Operations**

 

**Three and Nine Months Ended September 30, 2005Compared to Three and Nine Months Ended September 30, 2004**

 

**Net Income**

 

Net income increased $19.4 million, to $23.4 million,for the three months ended September 30, 2005, from $4.0 million for the threemonths ended September 30, 2004.  This increasewas primarily the result of the $30.7 million increase in “Other income (loss) –portfolio derivatives” in the third quarter of 2005, which includes a $19.7million increase in the non-cash mark to market valuation gain on interest rateswap and cap agreements and a $10.9 million increase in the net cash settlementon these related swaps. The valuation of the swaps and cap resulted from a risein the two year swap rate at the end of the quarter due to a higher forwardyield curve during the third quarter of 2005, as

 

25

----

 

compared to a flattening forwardcurve during the comparable period in 2004. Our interest rate swaps and cap arenot designated as cash flow hedges under Statement No. 133 and, therefore, thechange in the periodic mark to market of the future value of the interest rateswaps and cap is reported in current period earnings. Gains on sales ofmortgage loans increased $5.9 million in the third quarter of 2005 from thecomparable period in 2004, primarily due to a 44% increase in sales volumeduring the current period. The gain on sale increase was partially offset by adecrease in net interest income on our loans held for investment as theseasoned loans in our portfolio which prepaid during the period were replacedwith new loans originated with the current market’s narrower spreads.

 

Net income increased $58.3 million, to $88.6million, for the nine months ended September 30, 2005 from $30.3 million forthe nine months ended September 30, 2004, primarily due to the increase in thenon-cash mark to market gain on our portfolio derivatives combined with highernet interest income on our growing portfolio of loans held for investment. Ouraverage balance of loans held for investment was $4.8 billion for the ninemonths ended September 30, 2005 as compared to $2.6 billion for the ninemonths ended September 30, 2004. Gains on sales of mortgage loans, net, throughSeptember 30, 2005 also exceeded gains on sales through September 30, 2004,because we sold 32.1% more loans year to date in 2005 as compared to the sameperiod in 2004.

 

**Revenues**

 

***Net Interest Income after Provision forLoan Losses***

 

The following are the components of net interestincome after provision for loan losses for the three and nine months ended September30, 2005 and 2004 (in thousands): 

 
| ** **                                                | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                | ** ** | **2005**                               | ** ** | **2004**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest income:                                          |       |                                   |       |                                  |       |   |   |   |   |
| Coupon interest  income on loans held for investment      |       | $                                      | 84,621     |                                  | 60,692     |   | 243,297 |   | 132,256 |   |
| Coupon interest  income on loans held for sale            |       | 9,860                                  |       | 6,445                                 |       | 29,458 |   | 19,036 |   |
| Amortization of  deferred origination costs               |       | (8,832                                 | )          | (3,984                                | )          | (19,618 | ) | (7,491 | ) |
| Prepayment fees                                           |       | 9,151                                  |       | 3,433                                 |       | 24,671 |   | 5,374 |   |
| Total interest  income                                    |       | 94,800                                 |       | 66,586                                |       | 277,808 |   | 149,175 |   |
| Interest  expense:                                        |       |                                   |       |                                  |       |   |   |   |   |
| Financing  interest expense on loans held for investment  |       | 50,023                                 |       | 18,492                                |       | 126,149 |   | 35,627 |   |
| Financing  interest expense on loans held for sale        |       | 5,166                                  |       | 1,543                                 |       | 12,855 |   | 4,271 |   |
| Amortization of  deferred bond issuance costs             |       | 4,338                                  |       | 1,782                                 |       | 8,593 |   | 3,078 |   |
| Total interest  expense                                   |       | 59,527                                 |       | 21,817                                |       | 147,597 |   | 42,976 |   |
| Net interest  income                                      |       | 35,273                                 |       | 44,769                                |       | 130,211 |   | 106,199 |   |
| Provision for  loan losses—loans held for investment |       | 11,045                                 |       | 5,921                                 |       | 22,402 |   | 14,878 |   |
| Net interest  income after provision for loan losses      |       | $                                      | 24,228     |                                  | 38,848     |   | 107,809 |   | 91,321 |   |

 

26

----

 

The following table presents the average balancesfor our loans held for investment and loans held for sale and our warehouse andsecuritization financing, with the corresponding annualized yields for thethree and nine months ended September 30, 2005 and 2004 (in thousands). 

 
| ** **                                                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Average  balances:                                                                                                    |       |                                  |       |                                 |       |   |   |   |   |
| Mortgage loans  held for investment                                                                                   |       | $                                     | 4,986,748  |                                 | 3,602,695  |   | 4,820,949 |   | 2,608,641 |   |
| Securitization  financing—loans held for investment                                                              |       | 4,339,839                             |       | 2,762,324                            |       | 4,257,215 |   | 1,786,848 |   |
| Warehouse  financing—loans held for investment                                                                   |       | 552,965                               |       | 697,437                              |       | 431,853 |   | 606,881 |   |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Yield  analysis—loans held for investment:                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Coupon interest  income on loans held for investment                                                                  |       | 6.7                                   | %          | 6.6                                  | %          | 6.6 | % | 6.7 | % |
| Amortization of  deferred origination costs                                                                           |       | (0.7                                  | )%         | (0.5                                 | )%         | (0.5 | )% | (0.4 | )% |
| Prepayment fees                                                                                                       |       | 0.7                                   | %          | 0.4                                  | %          | 0.7 | % | 0.3 | % |
| Yield on loans  held for investment (1)                                                                               |       | 6.7                                   | %          | 6.5                                  | %          | 6.8 | % | 6.6 | % |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Interest expense  securitization financing – loans held for investment                                           |       | 4.0                                   | %          | 1.9                                  | %          | 3.5 | % | 1.8 | % |
| Interest expense  warehouse financing – loans held for investment                                                |       | 4.4                                   | %          | 2.8                                  | %          | 4.1 | % | 2.5 | % |
| Amortization—deferred  bond issuance costs and issue discount                                                    |       | 0.4                                   | %          | 0.3                                  | %          | 0.3 | % | 0.2 | % |
| Cost of  financing for loans held for investment (2)                                                                  |       | 4.3                                   | %          | 2.3                                  | %          | 3.8 | % | 2.1 | % |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Net yield on  loans held for investment (3)                                                                           |       | 2.4                                   | %          | 4.3                                  | %          | 3.1 | % | 4.6 | % |
| Provision for  loan losses                                                                                            |       | (0.9                                  | )%         | (0.6                                 | )%         | (0.6 | )% | (0.7 | )% |
| Net yield on  loans held for investment after provision for loan losses                                               |       | 1.5                                   | %          | 3.7                                  | %          | 2.5 | % | 3.9 | % |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Average  balances:                                                                                                    |       |                                  |       |                                 |       |   |   |   |   |
| Mortgage loans  held for sale                                                                                         |       | $                                     | 592,456    |                                 | 340,087    |   | 570,552 |   | 348,677 |   |
| Warehouse  financing—loans held for sale                                                                         |       | 445,504                               |       | 222,459                              |       | 396,750 |   | 224,010 |   |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Yield  analysis—loans held for sale:                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Yield on loans  held for sale (1)                                                                                     |       | 6.5                                   | %          | 7.4                                  | %          | 6.8 | % | 7.2 | % |
| Cost of  financing for loans held for sale (2)                                                                        |       | 4.5                                   | %          | 2.7                                  | %          | 4.3 | % | 2.5 | % |
| Net yield on  loans held for sale (3)                                                                                 |       | 3.1                                   | %          | 5.6                                  | %          | 3.8 | % | 5.6 | % |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Yield analysis –  loans held for investment and loans held for sale:                                             |       |                                  |       |                                 |       |   |   |   |   |
|                                                                                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Yield—net  interest income on loans held for sale and loans held for investment after  provision for loan losses |       | 1.7                                   | %          | 3.9                                  | %          | 2.6 | % | 4.1 | % |

 

----

(1)           Calculated as the annualized interest incomedivided by the average daily balance of the mortgage loans.

 

(2)           Calculatedas the annualized interest expense divided by the average daily balance of thedebt related to mortgage loans.

 

(3)           Calculatedas the annualized net interest income divided by the average daily balance ofmortgage loans. The net yield on loans will not equal the difference betweenthe yield on loans and the cost of financing due to the difference in thedenominators of the two calculations.

 

The increase in our net interest income afterprovision for loan losses in the nine months ended September 30, 2005 comparedto the same period in 2004 was attributable primarily to the increase in ourportfolio of loans held for investment, partially offset by the increase ininterest expense on the securitization debt financing the portfolio during aperiod of rising interest rates. Our net interest income decreased in the thirdquarter of 2005 compared to the third

 

27

----

 

quarter of 2004 due to a 200basis point increase in financing costs, partially offset by a higher averageportfolio balance. We expect net interest income on our loans held forinvestment to remain flat for the remainder of 2005, as loans which wereoriginated during 2003 and 2004 with wider net interest spreads continue toprepay, while new originations with thinner margins are added to the portfolio.The amortization of deferred origination and bond issuance costs is expected toincrease through the remainder of 2005 based upon faster estimates of theprepayment speed of our 2/28 hybrid mortgage loans during the period in whichthe prepayment fee obligation expires and the loan note rate resets from fixedto adjustable.  A 2/28 hybrid mortgageloan is a loan whose interest rate is fixed for the first two years andsubsequently adjusts to a six month ARM indexed to LIBOR.  Prepayment fee income collected in 2005 has partiallyoffset this expense to date.

 

We anticipate that interest expense related to bothwarehouse and securitization financing will continue to increase in 2005 as wecontinue to finance our investment portfolio growth with mortgage-backedsecurities indexed to a LIBOR-based rate. Interest expense will also increaseboth notionally and as a percentage cost of financing due to the prepayment ofolder loans financed with lower-rate debt, compared to new mortgage fundingsfinanced with higher cost debt.

 

The following table recaps the 2 Year Swap rate asof the following quarter end dates:

 
| ** **       | ** ** | **2004**   | ** ** | **2005**    | ** ** |
|------------------|------------|------------|------------|-------------|------------|
| ** **       | ** ** | **Mar 31** | ** ** | **June 30** | ** ** | **Sept 30** | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** | **June 30** | ** ** | **Sept 30** | ** ** |
| 2 Year Swap Rate |       | 1.88       | %          | 3.09        | %          | 2.94 | % | 3.45 | % | 4.19 | % | 3.98 | % | 4.57 | % |

 

Source:  Bloomberg L.P.

 

Provision for loan losses increased in the three andnine months ended September 2005 compared to the same period in 2004,consistent with expectations, due to the increase in delinquent loans in ourportfolio as the portfolio continues to season.

 

Net interest income after provision for loan lossesexcludes the net cash settlements received/(paid) of $8.0 million and ($2.9) million,in the three months ending September 30, 2005 and September 30, 2004,respectively, and the net cash settlements received/(paid) of $10.4 million and($8.3) million in the nine months ended September 30, 2005 and 2004,respectively, under the terms of the swap and cap agreements used toeconomically hedge the financing costs of our investment portfolio. The regularmonthly swap and cap settlement amounts, plus any cash paid or received attermination of the agreements prior to maturity, are included in theconsolidated statements of operations in the line item “Other income(expense)—portfolio derivatives.”

 

28

----

 

***Gains on Sales of Mortgage Loans, net***

 

***Total Loan Sales***

 

The components of the gains on sales of mortgageloans, net, are illustrated in the following table for the three and ninemonths ended September 30, 2005 and 2004 (in millions)*:

 
| ** **                                                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                             | ** ** | **% of  Sales  Volume**             | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** | **2005** | ** ** | **% of  Sales  Volume** | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** |
| Gross premiums -  whole loan sales, net of hedging gains or losses |       | $                                    | 30.0       |                                | 2.4        | % | $ | 20.1 |   | 2.3 | % | $ | 95.4 |   | 2.7 | % | $ | 69.9 |   | 2.6 | % |
| Loan fees  collected(1)                                            |       | 5.9                                  |       | 0.5                                 | %          | 5.1 |   | 0.5 | % | 19.3 |   | 0.5 | % | 16.7 |   | 0.6 | % |
| Premiums paid(2)                                                   |       | (7.5                                 | )          | (0.6                                | )%         | (5.4 | ) | (0.6 | )% | (27.8 | ) | (0.8 | )% | (19.0 | ) | (0.7 | )% |
| Subtotal                                                           |       | 28.4                                 |       | 2.3                                 | %          | 19.8 |   | 2.2 | % | 86.9 |   | 2.4 | % | 67.6 |   | 2.5 | % |
| Provision for  losses—loans sold                              |       | (0.2                                 | )          | 0.0                                 | %          | (0.2 | ) | 0.0 | % | (6.3 | ) | (0.2 | )% | (7.5 | ) | (0.3 | )% |
| Direct  origination costs(3)                                       |       | (8.0                                 | )          | (0.7                                | )%         | (5.4 | ) | (0.6 | )% | (23.5 | ) | (0.6 | )% | (18.8 | ) | (0.7 | )% |
|                                                               |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gains on sales  of mortgage loans, net                             |       | $                                    | 20.2       |                                | 1.6        | % | $ | 14.2 |   | 1.6 | % | $ | 57.1 |   | 1.6 | % | $ | 41.3 |   | 1.5 | % |
| Loan sales  volume                                                 |       | $                                    | 1,247.5    |                                |       |   | $ | 868.9 |   |   |   | $ | 3,587.0 |   |   |   | $ | 2,716.2 |   |   |   |

 

----

*                                         Loanfees collected, premiums paid and direct origination costs are deferred atfunding and recognized on settlement of the loan sale.

 

(1)                                  Loanfees collected represent points and fees collected from borrowers.

 

(2)                                  Premiumspaid represent fees paid to brokers for wholesale loan originations.

 

(3)                                  Directorigination costs primarily are commissions and direct salary costs.

 

The increase in gains on sales of mortgage loans,net, for the three and nine months ended September 30, 2005 compared to thesame periods in 2004, is due primarily to the increase in the volume ofnon-conforming loans sold in 2005.  Seethe discussions below for factors specific to the gain generated bynon-conforming loan sales versus conforming loan sales.

 

***NonConforming Loan Sales***

 

The components of the total gains on sales ofmortgage loans, net, related to non-conforming loan sales are illustrated inthe following table for the three and nine months ended September 30, 2005 and2004 (in millions):

 
| ** **                                                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                             | ** ** | **% of  Sales  Volume**             | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** | **2005** | ** ** | **% of  Sales  Volume** | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** |
| Gross premiums -  whole loan sales, net of hedging gains or losses |       | $                                    | 24.5       |                                | 2.7        | % | $ | 14.7 |   | 2.5 | % | $ | 75.4 |   | 3.0 | % | $ | 51.1 |   | 2.9 | % |
| Loan fees collected                                                |       | 4.6                                  |       | 0.5                                 | %          | 3.8 |   | 0.7 | % | 15.5 |   | 0.6 | % | 11.9 |   | 0.7 | % |
| Premiums paid                                                      |       | (3.9                                 | )          | (0.4                                | )%         | (2.9 | ) | (0.5 | )% | (14.6 | ) | (0.6 | )% | (9.3 | ) | (0.5 | )% |
| Subtotal                                                           |       | 25.2                                 |       | 2.8                                 | %          | 15.6 |   | 2.7 | % | 76.3 |   | 3.0 | % | 53.7 |   | 3.1 | % |
| Provision for  losses—loans sold                              |       | 0.2                                  |       | 0.0                                 | %          | 0.1 |   | 0.0 | % | (5.0 | ) | (0.2 | )% | (6.6 | ) | (0.4 | )% |
| Direct  origination costs                                          |       | (6.3                                 | )          | (0.7                                | )%         | (3.6 | ) | (0.6 | )% | (18.7 | ) | (0.7 | )% | (13.3 | ) | (0.8 | )% |
|                                                               |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gains on sales  of mortgage loans, net                             |       | $                                    | 19.1       |                                | 2.1        | % | $ | 12.1 |   | 2.1 | % | $ | 52.6 |   | 2.1 | % | $ | 33.8 |   | 1.9 | % |
| Loan sales  volume                                                 |       | $                                    | 896.6      |                                |       |   | $ | 583.1 |   |   |   | $ | 2,543.5 |   |   |   | $ | 1,744.2 |   |   |   |

 

The increase in gains on sales of non-conforming mortgageloans, net, for the three and nine months ended September 30, 2005 compared tothe same periods in 2004, is due to the increase in 2005 sales volume combinedwith higher gross premiums on sales, net of hedging results. Period-over-periodgross premiums on whole loan sales were relatively flat, and are expected toremain at third quarter 2005 levels during the remainder of 2005 due to forwardsales entered into in the third quarter of 2005 that have delivery datesthrough January 2006, on terms comparable to the third quarter sales’ terms,adjusted for market interest rate changes.

 

29

----

 

Provision for losses—loans sold for the three monthsended September 30, 2005 and 2004 reflects a credit in 2005 to the provisionfor a change in the loss forecast estimate for prior year’s loan sales. Ourperiodic review of historical loss trends determined that the actual lossexperience to date on 2002 through 2004 loan sales was lower than our previousestimates due primarily to the lower rate of foreclosures and losses as aresult of those years’ significant home value appreciation, as high as 75% inCalifornia which represents almost one-half of our sold loans, combined withmore rapid prepayment speeds in the non-conforming ARM marketplace. We expectthe provision through the remainder of 2005 will more closely reflect the yearto date expense.

 

***ConformingLoan Sales***

 

The components of the total gains on sales ofmortgage loans, net, related to conforming loan sales are illustrated in thefollowing table for the three and nine months ended September 30, 2005 and 2004(in millions):

 
| ** **                                                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                             | ** ** | **% of  Sales  Volume**             | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** | **2005** | ** ** | **% of  Sales  Volume** | ** ** | **2004** | ** ** | **% of  Sales  Volume** | ** ** |
| Gross premiums -  whole loan sales, net of hedging gains or losses |       | $                                    | 5.5        |                                | 1.6        | % | $ | 5.4 |   | 1.9 | % | $ | 20.0 |   | 1.9 | % | $ | 18.8 |   | 1.9 | % |
| Loan fees  collected                                               |       | 1.3                                  |       | 0.3                                 | %          | 1.3 |   | 0.5 | % | 3.8 |   | 0.4 | % | 4.8 |   | 0.5 | % |
| Premiums paid                                                      |       | (3.6                                 | )          | (1.0                                | )%         | (2.5 | ) | (0.9 | )% | (13.2 | ) | (1.3 | )% | (9.7 | ) | (1.0 | )% |
| Subtotal                                                           |       | 3.2                                  |       | 0.9                                 | %          | 4.2 |   | 1.5 | % | 10.6 |   | 1.0 | % | 13.9 |   | 1.4 | % |
| Provision for  losses—loans sold                              |       | (0.4                                 | )          | (0.1                                | )%         | (0.3 | ) | (0.1 | )% | (1.3 | ) | (0.1 | )% | (0.9 | ) | (0.1 | )% |
| Direct  origination costs                                          |       | (1.7                                 | )          | (0.5                                | )%         | (1.8 | ) | (0.6 | )% | (4.8 | ) | (0.5 | )% | (5.5 | ) | (0.5 | )% |
|                                                               |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gains on sales  of mortgage loans, net                             |       | $                                    | 1.1        |                                | 0.3        | % | $ | 2.1 |   | 0.8 | % | $ | 4.5 |   | 0.4 | % | $ | 7.5 |   | 0.8 | % |
| Loan sales  volume                                                 |       | $                                    | 351.0      |                                |       |   | $ | 285.8 |   |   |   | $ | 1,043.4 |   |   |   | $ | 972.0 |   |   |   |

 

Conforming gains on sales of mortgage loans, net,decreased for the three and nine months ended September 30, 2005 compared tothe same periods in 2004, despite an increase in sales volume. The decreasereflects lower premiums received and a higher basis in the loans due to adecrease in loan fees collected and an increase in premiums paid to brokers dueto a shrinking refinance market and increased competition overall.

 

30

----

 

***Other Income (Expense)—PortfolioDerivatives***

 

We use interest rate swap and cap agreements toeconomically hedge the variable rate debt financing of our portfolio ofnon-conforming mortgage loans held for investment. Changes in the fair value ofthese agreements, which reflect the potential future cash settlements over theremaining lives of the agreements according to the market’s changingprojections of interest rates, are recognized in the line item “Other income(expense)—portfolio derivatives” in the consolidated statements of operations.This single line item includes both the actual cash settlements related to theagreements that occurred during the period and recognition of the non-cashchanges in the fair value of the agreements over the period. The cashsettlements include regular monthly payments or receipts under the terms of theswap agreements and cash paid or received to terminate the agreements prior tomaturity. The amounts of cash settlements and non-cash changes in value thatwere included in “Other income (expense)—portfolio derivatives” are as followsfor the three and nine months ended September 30, 2005 and 2004 (in thousands):

 
| ** **                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                             | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Non-cash changes  in fair value                                                        |       | $                                     | 7,630      |                                 | (12,119    | ) | 16,171 |   | 3,777 |   |
| Net cash  settlements received (paid) on existing derivatives                          |       | 6,035                                 |       | (2,913                               | )          | 7,893 |   | (7,281 | ) |
| Net cash  settlements received (paid) to terminate derivatives prior to final maturity |       | 1,965                                 |       | —                               |       | 2,476 |   | (984 | ) |
| Other income  (expense)—portfolio derivatives                                     |       | $                                     | 15,630     |                                 | (15,032    | ) | 26,540 |   | (4,488 | ) |

 

Our portfolio derivatives allow us to stabilize theexpected financing costs of our investment portfolio over a future contractualtime period. At September 30, 2005 and September 30, 2004, the notionalbalance of our interest rate swaps and cap agreements was $4.7 billion and $3.2 billion,respectively.

 

The following table summarizes the average notionalbalance and the future weighted average fixed payment interest rate of ourinterest rate swaps in effect as of September 30, 2005, for the three andtwelve months ending December 31, 2005 and 2006, respectively (inthousands): 

 
| ** **           | ** ** | **Three Months Ended**         | ** ** | **Twelve Months Ended**              | ** ** |
|----------------------|------------|--------------------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **December 31, 2005**          | ** ** | **December 31, 2006**                | ** ** |
| ** **           | ** ** | **Average  Notional  Balance** | ** ** | **Weighted  Average  Pay Rate** | ** ** | **Average  Notional  Balance** | ** ** | **Weighted  Average  Pay Rate** | ** ** |
| Interest rate  swaps |       | $                              | 4,388,018  |                                 | 3.16       | % | $ | 2,674,911 |   | 3.59 | % |
|                      |            |                                |            |                                      |            |  |  |  |  |  |  |

 

Other income (expense)—portfolio derivatives willvary as the market’s expectation of future changes to the LIBOR interest ratevary throughout the period. Generally, rising interest rates will increase thefair value of our derivatives and our net cash settlements on existing derivatives.We cannot predict the net effect of interest rate volatility in future periodsto our other income (expense)—portfolio derivatives.

 

**Expenses**

 

The following is a summary of total expenses and thepercentage change from the prior period, for the three and nine months ended September30, 2005 and 2004 (in thousands): 

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                           | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Salaries and  employee benefits      |       | $                                     | 20,555     |                                 | 20,690     |   | 60,004 |   | 62,417 |   |
| Occupancy                            |       | 1,941                                 |       | 1,733                                |       | 5,711 |   | 4,800 |   |
| Depreciation and  amortization       |       | 961                                   |       | 633                                  |       | 2,584 |   | 1,761 |   |
| Servicing fees                       |       | 2,208                                 |       | 1,912                                |       | 6,555 |   | 3,838 |   |
| General and  administration          |       | 8,578                                 |       | 8,666                                |       | 24,368 |   | 23,430 |   |
| Total expenses*                      |       | $                                     | 34,243     |                                 | 33,634     |   | 99,222 |   | 96,246 |   |
| Percentage  change from prior period |       | 1.8                                   | %          | N/A                                  |       | 3.1 | % | N/A |   |

 

----

* Does not include direct origination costs whichare required by Statement No. 91 to be capitalized as deferred originationcosts.

 

***Total Expenses.***  Totalexpenses increased during the three months ended September 30, 2005 compared tothe three months ended September 30, 2004 primarily reflecting increasedservicing expense attributable to our growing portfolio of loans held forinvestment, increased amortization of the portion of our new loan origination softwareput into service in 2005, offset by decreased salaries and benefit expense. Theincrease in total expenses during the nine months ended September 30, 2005 ascompared to the nine months ended September 30, 2004 is also primarily due to

 

31

----

 

the increased servicing feesoffset by lower salaries and employee benefits, including the cost savings as aresult of our self-insurance health plan, implemented in the third quarter of2004. We expect total expenses to be relatively flat for the remainder of 2005while increasing in 2006 primarily due to the addition of personnel to support growthof loan originations in a competitive market as well as personnel to support initiativesrelated to IT improvements and expansion of portfolio analytic capabilities.

 

We are currently replacing our two separate loanorigination software systems with a single, integrated system to support bothconforming and non-conforming originations and fundings. The project involvespurchasing, developing, installing, training and supporting the new system.Additionally, we have upgraded “Fieldscore,” our pre-approval and creditgathering engine. The initial “Fieldscore” upgrade and conforming retail originationcomponent was complete as of September 30, 2005, and we anticipate the non-conformingorigination component, currently in the test phase, will be in productionbefore the end of 2005 and will be implemented fully by the end of firstquarter of 2006.

 

***Salaries andEmployee Benefits.***Salaries and employee benefits decreased from the three and nine months ended September30, 2004 to the three and nine months ended September 30, 2005 primarily due toa $0.2 million and $1.7 million decrease, respectively, in employeebenefit expense related to our self-insurance plan, combined with originationprocess improvement initiatives which reduced staffing levels in the productionsupport area.  We expect salaries andemployee benefits, net of deferred direct origination costs, to increase slightlythroughout the remainder of 2005 primarily due to the additional personnelrequired to support a higher level of loan originations, and additionalinformation technology personnel to support planned enhancements in access andsecurity controls.

 

***Servicing Fees.*** Servicing fees for the loans in ourportfolio increased for the three and nine months ended September 30, 2005compared to the three and nine months ended September 30, 2004 due to thegrowth of the investment portfolio. Currently, all of our loans held forinvestment are serviced by a third-party servicer effective with the firstmortgage payment due after loan funding. Servicing fees for the nine monthsended September 30, 2005 have been reduced by approximately $1.4 millionrelated to compensatory interest, related to prepayments, received from thesub-servicer.

 

***General andAdministration Expenses.*** General and administration expenses were down slightly in the threemonths ended September 30, 2005 from the three months ended September 30, 2004primarily due to a reduction in marketing costs in the non-conforming retaildivision, as the division has restructured its sales initiatives. General andadministration expenses increased in the nine months ended September 30, 2005from the same period in 2004 due to increased costs associated with qualitycontrol and due diligence programs, audit, legal and insurance fees related tooperation as a public company, and maintenance and equipment costs associatedwith the development of a new loan origination system. We expect general andadministrative expenses to remain relatively flat in the fourth quarter of 2005.

 

***Provision forIncome Tax Expense.***We elected to be taxed as a REIT, effective in the fourth quarter of 2003, andwe elected to treat our loan origination and sale subsidiary, FieldstoneMortgage Company (FMC), as a taxable REIT subsidiary (TRS).  The provision for income tax expense reflectsthe following effective tax rates:

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| FMC pre-tax net income in millions |       | $                                     | 8.0        |                                 | 4.8        |   | 13.3 |   | 12.2 |   |
| Effective tax rate                 |       | 37                                    | %          | 32                                   | %          | 36 | % | 37 | % |
|                                    |            |                                       |            |                                      |            |  |  |  |  |  |

 

The lower effective tax rate in the third quarter of2004 included a credit to the provision related to the carrying value of thedeferred tax asset, net as of September 30, 2004.  Provision for the remainder of 2005 isexpected to approximate 36%.

 

On April 21, 2005, FMC committed to sell a pool ofnon-conforming mortgage loans at a price of 103.5%, which includedapproximately $640 million of loans purchased on April 20, 2005 from FieldstoneInvestment Corporation

 

32

----

 

(the “REIT”) at a price of102.7%, which was determined to be the fair value of the inter-company soldloans as of April 20, 2005. FMC has included in year to date taxable income, andrecorded a tax provision on, the difference between the purchase price of the$640 million of loans from the REIT and the subsequent sale to the third-partypurchaser, which resulted in approximately $5.0 million of taxable income tothe TRS.

 

In May 2005, FMC sold approximately $110 million ofnon-conforming mortgage loans to the REIT, at a price of 103.6%, and recognizedin gain on sale the difference between the book basis in the loans, and thegross sales price received from the REIT, which resulted in approximately $2.7million of taxable income to FMC.

 

**Consolidated Statements of Condition at September 30, 2005and December 31, 2004**

 

***Mortgage Loans Held for Investment***

 

The following table summarizes the principal balanceof our investment portfolio for the nine months ended September 30, 2005 andfor the year ended December 31, 2004 (in thousands): 

 
| ** **                                              | ** ** | **Nine Months  Ended  September 30,** | ** ** | **Year Ended  December 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2004**                     | ** ** |
| Beginning  principal balance                            |       | $                                     | 4,735,063  |                         | 1,319,123  |   |
| Loan fundings                                           |       | 2,479,950                             |       | 4,112,190                    |       |
| Payoffs and  principal reductions                       |       | (1,389,797                            | )          | (690,037                     | )          |
| Transfers to  mortgage loans held for sale, net         |       | (530,830                              | )          | —                       |       |
| Transfers to  real estate owned                         |       | (21,907                               | )          | (6,213                       | )          |
| Ending principal  balance                               |       | 5,272,479                             |       | 4,735,063                    |       |
| Net deferred  loan origination (fees)/costs             |       | 39,410                                |       | 39,693                       |       |
| Ending balance  mortgage loans held for investment      |       | 5,311,889                             |       | 4,774,756                    |       |
| Allowance for  loan losses                              |       | (39,329                               | )          | (22,648                      | )          |
| Ending balance  mortgage loans held for investment, net |       | $                                     | 5,272,560  |                         | 4,752,108  |   |

 

Payoffs and principal reductions continue toincrease consistent with expectations as our portfolio seasons. Because we soldall of the loans originated prior to the third quarter of 2003, we do not havecomprehensive performance data on our loans sold to investors relative toeither prepayments or credit losses. We estimate prepayment rates and creditlosses based on the limited actual history to date of our portfolio combinedwith historical industry data for similar loan products, which we adjust forcurrent market assumptions regarding future economic conditions including homeprice appreciation and interest rate trend forecasts. These assumptions forprepayment curves indicate an average loan life of approximately 22 months.There can be no assurance that our prepayment and loss forecasts will bereflective of our actual results.  Duringthe third quarter of 2005, the 2/28 hybrid ARMs in our first securitization,FMIC Series 2003-1, reached the expiration period of their prepayment feeobligation, and at the same time adjusted from a fixed note rate to anadjustable note rate indexed to six month LIBOR. Prepayment speeds for 2003-1 duringthe third quarter of 2005 averaged 87 CPR, a 23% increase over the forecasted resetperiod average CPR of 71. Related to the higher than estimated increase in CPRrate, management has revised its estimate of prepayment speeds during the resetperiod for the remainder of the portfolio, and recorded an adjustment duringthe third quarter of 2005 to net deferred loan origination (fees)/costs toreflect revised level yield amortization based upon actual and projected fasterpay downs.

 

The transfer of loans held for investment to mortgageloans held for sale, net, illustrated in the above table reflects management’sdetermination at the beginning of the second quarter of 2005 that the projectedreturn on assets and return on equity to be generated by approximately $640million of loans held by the REIT and yet to be securitized, including $557million of non-securitized loans held for investment as of March 31, 2005, haddeclined to levels below our targeted investment return. The projected declinein net interest margin was the result of an increase in the cost of financing atthe beginning of the second quarter, which was not offset by an increase in thecoupon rate

 

33

----

 

on new loans required byoriginators.  Due to the projectedreturns, management decided to transfer the loans from held for investment toloans held for sale.  The non-securitizedportfolio was not examined at loan level in any attempt to select only the mostattractive returning assets, but the entire non-securitized portion of theportfolio was transferred to held for sale, with the exception of delinquentloans.

 

The transfer and subsequent sale of these loans wasdue primarily to an unforeseen and significant business need in circumstanceswhere market conditions were evolving, is not expected to be a recurring event,and, therefore, the transfer and subsequent sale should not be treated as a “prohibitedtransaction” for purposes of Section 857(b)(6)(A) of the Internal RevenueCode.  In May 2005, managementimplemented additional policies and procedures to ensure that, prior to thedesignation of loans as held for investment, the loans funded by the REIT willachieve our minimum portfolio rate of return threshold.

 

***Allowance for Loan Losses—Loans Held forInvestment***

 

The following table summarizes the allowance forloan loss activity of our investment portfolio for the nine months ended September30, 2005 and the year ended December 31, 2004 (in thousands):

 
| ** **                                                    | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** | **Year Ended  December 31,  2004** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|
| Beginning  balance allowance for loan losses                  |       | $                                           | 22,648     |                               | 2,078      |   |
| Provision                                                     |       | 22,402                                      |       | 21,556                             |       |
| Charge-offs                                                   |       | (6,357                                      | )          | (986                               | )          |
| Recoveries                                                    |       | 636                                         |       | —                             |       |
| Ending balance  allowance for loan losses                     |       | $                                           | 39,329     |                               | 22,648     |   |
| Ending principal  balance, mortgage loans held for investment |       | $                                           | 5,272,479  |                               | $          | 4,735,063 |   |
| Ending allowance  balance as % of ending principal balance    |       | 0.7                                         | %          | 0.5                                | %          |
|                                                               |            |                                             |            |                                    |            |  |  |

 

The delinquency status of our loans held forinvestment as of September 30, 2005 and December 31, 2004 was as follows(in thousands):

 
| ** **                                                                                                               | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| ** **                                                                                                               | ** ** | **Principal  Balance** | ** ** | **Percentage  of Total**   | ** ** | **Principal  Balance** | ** ** | **Percentage  of Total** | ** ** |
| Current                                                                                                                  |       | $                      | 4,835,343  |                            | 91.7       | % | $ | 4,424,418 |   | 93.4 | % |
| 30 days past due                                                                                                         |       | 258,807                |       | 4.9                             | %          | 230,787 |   | 4.9 | % |
| 60 days past due                                                                                                         |       | 64,461                 |       | 1.2                             | %          | 38,713 |   | 0.8 | % |
| 90+ days past  due                                                                                                       |       | 37,707                 |       | 0.7                             | %          | 15,487 |   | 0.3 | % |
| In process of  foreclosure                                                                                               |       | 76,161                 |       | 1.5                             | %          | 25,658 |   | 0.6 | % |
| Total                                                                                                                    |       | $                      | 5,272,479  |                            | 100.0      | % | $ | 4,735,063 |   | 100.0 | % |
|                                                                                                                     |       |                   |       |                            |       |   |   |   |   |
| Allowance for  loan losses                                                                                               |       | $                      | 39,329     |                            |       |   | $ | 22,648 |   |   |   |
|                                                                                                                     |       |                   |       |                            |       |   |   |   |   |
| Allowance for  loan losses as a % of total delinquent loans (30+ days past due and loans in  the process of foreclosure) |       | $                      | 437,136    |                            | 9.0        | % | $ | 310,645 |   | 7.3 | % |

 

34

----

 

Delinquency and life to date loss status of ourloans held for investment by securitization pool as of September 30, 2005 andDecember 31, 2004 was as follows (in thousands):

 
| ** **                                   | ** ** | **As of September 30, 2005** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|
| ** **                                   | ** ** | **Current  Principal  Balance**        | ** ** | **% of  Principal  Balance  Seriously  Delinquent (1)** | ** ** | **Original  Principal  Pledged** | ** ** | **% of  Realized  Losses(2)** | ** ** | **Avg. Age  of Loans  from  Funding  (months)** | ** ** |
| Loans held for  investment-securitized:      |       |                                   |       |   |   |   |   |   |   |   |   |
| FMIT  Series 2005-2                     |       | $                                      | 953,426    |   | 0.5 | % | $ | 966,667 |   | 0.00 | % | 4 |   |
| FMIT  Series 2005-1                     |       | 634,301                                |       | 3.6 | % | 749,999 |   | 0.04 | % | 10 |   |
| FMIT  Series 2004-5                     |       | 708,794                                |       | 4.1 | % | 900,000 |   | 0.03 | % | 12 |   |
| FMIT  Series 2004-4                     |       | 619,546                                |       | 5.7 | % | 879,604 |   | 0.12 | % | 14 |   |
| FMIT  Series 2004-3                     |       | 636,463                                |       | 4.4 | % | 999,865 |   | 0.13 | % | 17 |   |
| FMIT  Series 2004-2                     |       | 447,224                                |       | 5.9 | % | 879,325 |   | 0.23 | % | 19 |   |
| FMIT  Series 2004-1                     |       | 329,736                                |       | 5.7 | % | 680,858 |   | 0.19 | % | 22 |   |
| FMIC  Series 2003-1                     |       | 148,645                                |       | 9.0 | % | 498,844 |   | 0.25 | % | 26 |   |
| Total                                        |       | 4,478,135                              |       | 4.0 | % | 6,555,162 |   | 0.11 | % | 13 |   |
| Loans held for  investment-to be securitized |       | 794,344                                |       | 0.0 | % | 794,436 |   | 0.00 | % | 2 |   |
| Total loans held  for investment             |       | $                                      | 5,272,479  |   | 3.4 | % | $ | 7,349,598 |   | 0.10 | % | 11 |   |

 
| ** **                                   | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | **Current  Principal  Balance**                 | ** ** | **% of  Principal  Balance  Seriously  Delinquent (1)** | ** ** | **Original  Principal  Pledged** | ** ** | **% of  Realized  Losses (2)** | ** ** | **Avg. Age  of Loans  from  Funding  (months)** | ** ** |
| Loans held for  investment-securitized:      |       |                                            |       |   |   |   |   |   |   |   |   |
| FMIT  Series 2004-5                     |       | $                                               | 892,488    |   | 0.5 | % | $ | 900,000 |   | 0.00 | % | 3 |   |
| FMIT  Series 2004-4                     |       | 842,340                                         |       | 1.3 | % | 879,604 |   | 0.00 | % | 5 |   |
| FMIT  Series 2004-3                     |       | 913,253                                         |       | 1.6 | % | 999,865 |   | 0.00 | % | 8 |   |
| FMIT  Series 2004-2                     |       | 709,909                                         |       | 3.3 | % | 879,325 |   | 0.04 | % | 10 |   |
| FMIT  Series 2004-1                     |       | 490,043                                         |       | 3.2 | % | 680,858 |   | 0.04 | % | 13 |   |
| FMIC  Series 2003-1                     |       | 892,488                                         |       | 3.4 | % | 498,844 |   | 0.07 | % | 17 |   |
| Total                                        |       | 4,156,791                                       |       | 1.9 | % | 4,838,496 |   | 0.02 | % |   |   |
| Loans held for  investment-to be securitized |       | 578,272                                         |       | 0.2 | % | 578,312 |   | 0.00 | % | 1 |   |
| Total loans held  for investment             |       | $                                               | 4,735,063  |   | 1.7 | % | $ | 5,416,808 |   | 0.02 | % | 7 |   |

 

----

(1)             Seriously delinquentis defined as a mortgage loan that is 60 plus days past due or in the processof foreclosure.

 

(2)             Realized lossesinclude charge-offs to the allowance for loan losses—loans held for investmentrelated to loan principal balances and do not include previously accrued butuncollected interest, which is reversed against current period interest income.

 

The increase in allowance for loan losses as of September30, 2005 and December 31, 2004 reflects our estimate of losses inherent inthe loan portfolio, and is based upon loss assumptions which take into accountthe contractual delinquency status, market delinquency roll rates and markethistorical loss severities. We currently estimate an average loss severity of35%, not including past due interest which is reversed against current periodinterest income when the loan is placed on non-accrual status or deemedotherwise uncollectible. Due to the short time span from our initialsecuritization through September 30, 2005, we have only limited actual lossexperience from our investment portfolio.

 

We anticipate that delinquent loans will continue toincrease in principal balance and as a percentage of the portfolio, consistentwith industry expectations, as the portfolio grows and the loans continue toseason.

 

35

----

 

***Real Estate Owned***

 

Real estate owned is a component of “Prepaidexpenses and other assets” on the consolidated statements of condition and isreported at its estimated net realizable value. At the time a loan isforeclosed and transferred to real estate owned, any reduction in value fromits previous carrying balance is charged to the allowance for loan losses —loans held for investment.  Subsequentdecreases in net realizable value, and losses at disposal of the property, arerecorded to gain (loss) on disposal of real estate owned, which is a componentof “Fee and other income” on the consolidated statements of operations.Recoveries of amounts previously charged off at the date of foreclosure arerecorded as an increase to the allowance for loan losses. The following is asummary of real estate owned as of September 30, 2005 and December 31,2004 (in thousands): 

 
| ** **                                         | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** | **Year Ended  December 31,  2004** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|
| Beginning  balance real estate owned               |       | $                                           | 4,374      |                               | 1,805      |   |
| Plus: Transfers  from mortgage loans held for sale |       | 405                                         |       | 998                                |       |
| Transfers from  mortgage loans held for investment |       | 21,907                                      |       | 6,213                              |       |
| Less:  Charge-offs                                 |       | (5,173                                      | )          | (1,438                             | )          |
| Real estate sold                                   |       | (10,325                                     | )          | (3,204                             | )          |
| Ending balance  real estate owned *                |       | $                                           | 11,188     |                               | 4,374      |   |

 

----

*                    Includesproperties previously securing loans held for sale of $0.3 million, as of September30, 2005 and December 31, 2004.

 

During the nine months ended September 30, 2005, wesold 101 real estate owned properties formerly collateralizing loans held forinvestment with an average aggregate principal net charge-off of 27%, whichincludes both the initial charge-off at transfer to real estate owned, if any,and the final gain or loss on disposal of the property. At this time, webelieve our higher estimated average loss severity is supported by our limiteddisposal history from the portfolio, combined with the risk that loss severitymay increase as the loans continue to season and as the increases in propertyvalues may slow in the future. As we dispose of sufficient properties todetermine a loss severity trend in our portfolio, we will review our lossassumptions and update our estimates as required.

 

***Mortgage Loans Held for Sale and RelatedWarehouse Financing—Loans Held for Sale***

 

The following table provides a summary of themortgage loans held for sale, net and warehouse financing—loans held for saleas of September 30, 2005 and December 31, 2004 (in thousands):

 
| ** **                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Mortgage loans  held for sale, net:                    |       |                    |       |                   |       |
| Non-Conforming                                         |       | $                       | 462,650    |                   | 252,620    |   |
| Conforming                                             |       | 66,220                  |       | 104,430                |       |
| Total mortgage  loans held for sale, net               |       | $                       | 528,870    |                   | 357,050    |   |
| Warehouse  financing—mortgage loans held for sale |       | $                       | 429,551    |                   | 188,496    |   |
| Percentage  financed—mortgage loans held for sale |       | 81                      | %          | 53                     | %          |

 

The increase in mortgage loans held for sale, net,at September 30, 2005 compared to December 31, 2004 primarily reflects theincrease in non-conforming loan origination volumes in the two months endedSeptember 30, 2005 compared to the two months ended December 31, 2004.  We typically retain loans held for sale forapproximately 60 days prior to investor purchase. We had $2.7 million and$6.6 million of loans deemed to be unsaleable at standard sale premiums asof September 30, 2005 and December 31, 2004, respectively, for which wehad recorded a valuation allowance of $0.9 million and $1.9 million,respectively.

 

36

----

 

Warehouse financing—loans held for sale increased asof September 30, 2005 compared to December 31, 2004 reflecting theincreased level of mortgage loans held for sale as of the end of the thirdquarter of 2005, combined with an increase in the percentage financed due tothe use of equity offering proceeds to support the portfolio during 2005, whichwere otherwise used to pay down warehouse financing as of December 31, 2004.

 

***Trustee Receivable***

 

Trustee receivable increased to $118.3 millionat September 30, 2005, from $91.1 million at December 31, 2004. Theincrease reflects higher principal payments and prepaid loan payments receivedafter the cut-off date for the current month bond payments from our eightsecuritized mortgage pools outstanding as of September 30, 2005, compared tosix securitized pools outstanding as of December 31, 2004.  Trustee receivable includes principal andinterest prepayments received after the 15th day prior to the end ofthe reporting period from loans securitized in pools FMIT Series 2004-1 throughpools FMIT Series 2005-2, and prepayments received by the trustee afterthe last day of the month prior to the end of the reporting period from loansin pool FMIC Series 2003-1. The funds are retained by the trustee untilthe following month’s disbursement date.

 

***Derivative Assets, Net***

 

Derivative assets, net increased to $40.1 millionat September 30, 2005, from $20.2 million at December 31, 2004. Theincrease primarily relates to the $16.2 million increase in the fair value ofthe interest rate swap and cap agreements over the period, reflecting an increasein the two year swap rate of 112 basis points as of September 30, 2005 comparedto December 31, 2004.

 

***Securitization Financing***

 

The following is a summary of the outstandingsecuritization bond financing by series as of September 30, 2005 andDecember 31, 2004 (in thousands): 

 
| ** **                      | ** ** | ** **        | ** ** | **Balance as of**       | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **Bonds  Issued** | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| FMIT  Series 2005-2        |       | $                 | 911,081    |                    | 900,953    |   | — |   |
| FMIT  Series 2005-1        |       | 728,625           |       | 624,245                 |       | — |   |
| FMIT  Series 2004-5        |       | 863,550           |       | 689,006                 |       | 861,403 |   |
| FMIT  Series 2004-4        |       | 845,283           |       | 602,054                 |       | 816,527 |   |
| FMIT  Series 2004-3        |       | 949,000           |       | 604,139                 |       | 879,659 |   |
| FMIT  Series 2004-2        |       | 843,920           |       | 425,717                 |       | 692,854 |   |
| FMIT  Series 2004-1        |       | 652,944           |       | 311,238                 |       | 484,025 |   |
| FMIC  Series 2003-1        |       | 488,923           |       | 179,509                 |       | 316,817 |   |
|                            |       | 6,283,326         |       | 4,336,861               |       | 4,051,285 |   |
| Unamortized bond  discount      |       | (1,130            | )          | (184                    | )          | (499 | ) |
| Total  securitization financing |       | $                 | 6,282,196  |                    | 4,336,677  |   | 4,050,786 |   |

 

During the nine months ended September 30, 2005 andthe year ended December 31, 2004, we issued $1.6 billion and$4.2 billion, respectively, of mortgage-backed bonds throughsecuritization trusts to finance the Company’s portfolio of loans held forinvestment. Interest rates reset monthly and are indexed to one-month LIBOR.The bonds pay interest monthly based upon a spread over LIBOR. The estimatedaverage months to maturity is based on estimates and assumptions made bymanagement. The actual maturity may differ from expectations. We retain theoption to repay the bonds when the remaining unpaid principal balance of theunderlying mortgages loans for the pool falls below 20% of the originalprincipal balance, with the exception of FMIC Series 2003-1, which may berepaid when the principal balance falls below 10% of the originalcollateralized amount. The repayment of the bonds is secured by pledgingmortgage loans to the trust.

 

37

----

 

During the third quarter of 2005, the 2/28 hybridARMs in our first securitization, FMIC Series 2003-1, reached the expirationperiod of their prepayment fee obligation, and adjusted from a fixed note rateto an adjustable rate indexed to six month LIBOR. Prepayment speeds for 2003-1during the third quarter of 2005 exceeded our previously forecasted rates,which supported a revision in the estimate of prepayment speeds during thereset period for the remainder of the portfolio. We recorded an increasedeferred bond issuance costs in the third quarter of 2005 to reflect revisedlevel yield amortization based upon faster pay downs of the bonds financing theportfolio.

 

As of September 30, 2005 and December 31, 2004,the outstanding bonds were over-collateralized by $270.7 million and$194.8 million, respectively. The collateral includes mortgage loans andtrustee receivables. We enter into interest rate swap or cap agreements tohedge the bond costs and protect against rising interest rates.

 

***Total Shareholders’ Equity***

 

Our total shareholders’ equity increased to $568.4 millionat September 30, 2005, from $526.3 million at December 31, 2004. Thechange in shareholders’ equity primarily reflects an increase in accumulatedearnings of $88.6 million from net income for the nine months ended September30, 2005, partially offset by the $47.4 million in dividends paid year to datein 2005.

 

**Business Segment Results**

 

We have a total of six reportable business segments,which include four production segments and two operating segments. We originateloans through our production segments, which include the Non-ConformingWholesale, Non-Conforming Retail, Conforming Wholesale, and Conforming Retailsegments. The results of operations of our production segments primarilyinclude a net interest income allocation for funded loans, direct expenses andan allocation of corporate overhead expenses. In addition, revenues include anallocation method whereby the production segments are credited with a pro formavalue for net gain on sale of loan production as if all fundings were soldservicing-released, concurrent with funding, at standard investor premiummargins.

 

The operating segments include the InvestmentPortfolio and Corporate segments. The results of operations of the Investment Portfoliosegment primarily include the net interest income after provision for loanlosses for the loans held in our investment portfolio, changes in the fairvalue and actual cash settlements relating to our portfolio derivatives, anddirect expenses, including third-party servicing fees paid related to our loansheld for investment. The results of operations of the Corporate segmentprimarily include direct expenses of the corporate home office, income taxexpense related to the TRS operating results, and the elimination of thecorporate overhead allocated to the production segments. The Corporate segmentalso includes amounts recorded to reconcile the internal revenue and expensesallocated to the production segments with the revenue and expense recognitionin our consolidated statement of operations which complies with GAAP reportingunder Statement No. 91.

 

The results of operations reported per segmentdiffer materially from consolidated results due to timing differences in netgain on sale recognition at time of cash settlement of the sale compared toloan funding, the actual sale prices compared to the pro forma values, theactual net interest margin earned on loans, and the holding for investment of asubstantial portion of our non-conforming loans for which actual revenue willconsist of net interest income rather than net gain on sale.

 

38

----

 

The following is a summary of net income byproduction segments and operating segments for the three and nine months ended September30, 2005 and 2004 (in thousands): 

 
| ** **                                   | ** ** | **Production  Segments** | ** ** | **Operating  Segments** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|-------------------------|------------|-----------|------------|
| ***Three  Months Ended September 30, 2005*** |       |                     |       |                    |       |      |       |
| Total revenues                               |       | $                        | 54,524     |                    | 6,142      |      | 60,666     |   |
| Total expenses                               |       | 44,013                   |       | (9,770                  | )          | 34,243    |       |
| Income before  income taxes                  |       | 10,511                   |       | 15,912                  |       | 26,423    |       |
| Provision for  income tax expense            |       | —                   |       | (2,999                  | )          | (2,999    | )          |
| Net income                                   |       | $                        | 10,511     |                    | 12,913     |      | 23,424     |   |
| *** ***                                 |       |                     |       |                    |       |      |       |
| ***Three  Months Ended September 30, 2004*** |       |                     |       |                    |       |      |       |
| Total revenues                               |       | $                        | 56,872     |                    | (17,751    | )         | 39,121     |   |
| Total expenses                               |       | 47,949                   |       | (14,315                 | )          | 33,634    |       |
| Income (loss)  before income taxes           |       | 8,923                    |       | (3,436                  | )          | 5,487     |       |
| Provision for  income tax expense            |       | —                   |       | (1,536                  | )          | (1,536    | )          |
| Net income  (loss)                           |       | $                        | 8,923      |                    | (4,972     | )         | 3,951      |   |
|                                         |       |                     |       |                    |       |      |       |
| ***Nine  Months Ended September 30, 2005***  |       |                     |       |                    |       |      |       |
| Total revenues                               |       | $                        | 141,813    |                    | 50,804     |      | 192,617    |   |
| Total expenses                               |       | 119,535                  |       | (20,313                 | )          | 99,222    |       |
| Income before  income taxes                  |       | 22,278                   |       | 71,117                  |       | 93,395    |       |
| Provision for  income tax expense            |       | —                   |       | (4,792                  | )          | (4,792    | )          |
| Net income                                   |       | $                        | 22,278     |                    | 66,325     |      | 88,603     |   |
| *** ***                                 |       |                     |       |                    |       |      |       |
| ***Nine  Months Ended September 30, 2004***  |       |                     |       |                    |       |      |       |
| Total revenues                               |       | $                        | 162,025    |                    | (30,938    | )         | 131,087    |   |
| Total expenses                               |       | 134,753                  |       | (38,507                 | )          | 96,246    |       |
| Income before  income taxes                  |       | 27,272                   |       | 7,569                   |       | 34,841    |       |
| Provision for  income tax expense            |       | —                   |       | (4,538                  | )          | (4,538    | )          |
| Net income                                   |       | $                        | 27,272     |                    | 3,031      |      | 30,303     |   |

 

39

----

 

***Production Segment Results***

 

The following tables summarize our productionsegment results for the three and nine months ended September 30, 2005 and 2004(in thousands): 

 
| ** **                                   | ** ** | **Non-Conforming** | ** ** | **Conforming** | ** ** | **Total**     | ** ** |
|----------------------------------------------|------------|--------------------|------------|----------------|------------|---------------|------------|
| ** **                                   | ** ** | **Wholesale**      | ** ** | **Retail**     | ** ** | **Wholesale** | ** ** | **Retail** | ** ** | **Production** | ** ** |
| ***Three  Months Ended September 30, 2005*** |       |               |       |           |       |          |       |   |   |   |   |
| Revenues                                     |       | $                  | 39,643     |           | 9,817      |          | 2,091      |   | 2,973 |   | 54,524 |   |
| Direct expenses                              |       | 21,973             |       | 8,186          |       | 1,837         |       | 3,714 |   | 35,710 |   |
| Segment  contribution                        |       | 17,670             |       | 1,631          |       | 254           |       | (741 | ) | 18,814 |   |
| Corporate  overhead allocation               |       | 6,619              |       | 1,019          |       | 418           |       | 247 |   | 8,303 |   |
| Net income  (loss)                           |       | $                  | 11,051     |           | 612        |          | (164       | ) | (988 | ) | 10,511 |   |
| Funding volume                               |       | $                  | 1,642,987  |           | 177,804    |          | 318,746    |   | 115,258 |   | 2,254,795 |   |
| Segment  contribution as a % of volume       |       | 1.08               | %          | 0.92           | %          | 0.08          | %          | (0.64 | )% | 0.83 | % |
|                                         |       |               |       |           |       |          |       |   |   |   |   |
| ***Three  Months Ended September 30, 2004*** |       |               |       |           |       |          |       |   |   |   |   |
| Revenues                                     |       | $                  | 41,203     |           | 10,199     |          | 1,642      |   | 3,828 |   | 56,872 |   |
| Direct expenses                              |       | 21,989             |       | 9,621          |       | 2,552         |       | 3,487 |   | 37,649 |   |
| Segment  contribution                        |       | 19,214             |       | 578            |       | (910          | )          | 341 |   | 19,223 |   |
| Corporate  overhead allocation               |       | 8,770              |       | 1,161          |       | 272           |       | 97 |   | 10,300 |   |
| Net income  (loss)                           |       | $                  | 10,444     |           | (583       | )             | (1,182     | ) | 244 |   | 8,923 |   |
| Funding volume                               |       | $                  | 1,520,157  |           | 167,413    |          | 207,981    |   | 93,288 |   | 1,988,839 |   |
| Segment  contribution as a % of volume       |       | 1.26               | %          | 0.35           | %          | (0.44         | )%         | 0.37 | % | 0.97 | % |
|                                         |       |               |       |           |       |          |       |   |   |   |   |
| ***Nine  Months Ended September 30, 2005***  |       |               |       |           |       |          |       |   |   |   |   |
| Revenues                                     |       | $                  | 102,300    |           | 26,018     |          | 5,528      |   | 7,967 |   | 141,813 |   |
| Direct expenses                              |       | 58,003             |       | 23,780         |       | 5,851         |       | 10,498 |   | 98,132 |   |
| Segment  contribution                        |       | 44,297             |       | 2,238          |       | (323          | )          | (2,531 | ) | 43,681 |   |
| Corporate  overhead allocation               |       | 17,037             |       | 2,733          |       | 1,048         |       | 585 |   | 21,403 |   |
| Net income  (loss)                           |       | $                  | 27,260     |           | (495       | )             | (1,371     | ) | (3,116 | ) | 22,278 |   |
| Funding volume                               |       | $                  | 4,087,199  |           | 470,886    |          | 879,724    |   | 287,845 |   | 5,725,654 |   |
| Segment  contribution as a % of volume       |       | 1.08               | %          | 0.48           | %          | (0.04         | )%         | (0.88 | )% | 0.76 | % |
|                                         |       |               |       |           |       |          |       |   |   |   |   |
| ***Nine  Months Ended September 30, 2004***  |       |               |       |           |       |          |       |   |   |   |   |
| Revenues                                     |       | $                  | 112,914    |           | 31,217     |          | 5,859      |   | 12,035 |   | 162,025 |   |
| Direct expenses                              |       | 61,440             |       | 27,742         |       | 7,594         |       | 10,745 |   | 107,521 |   |
| Segment  contribution                        |       | 51,474             |       | 3,475          |       | (1,735        | )          | 1,290 |   | 54,504 |   |
| Corporate  overhead allocation               |       | 22,982             |       | 3,262          |       | 700           |       | 288 |   | 27,232 |   |
| Net income  (loss)                           |       | $                  | 28,492     |           | 213        |          | (2,435     | ) | 1,002 |   | 27,272 |   |
| Funding volume                               |       | $                  | 4,148,379  |           | 500,154    |          | 680,166    |   | 296,398 |   | 5,625,097 |   |
| Segment  contribution as a % of volume       |       | 1.24               | %          | 0.69           | %          | (0.26         | )%         | 0.44 | % | 0.97 | % |

 

Production segment net income increased during thethree months ended September 30, 2005 compared to the same period in 2004,primarily due to lower corporate overhead expense allocated based upon an 11%increase in the average funded loan principal balance period over period. Theproduction segments are charged corporate overhead on a per loan basis ascompared to an allocation per loan dollar; therefore, an increase in averageloan balance will generate a reduced corporate overhead allocation as a percentof volume.

 

Production segment net income decreased during the ninemonths ended September 30, 2005 compared to the same period in 2004 due tolower revenue partially offset by a decrease in direct expenses. As interestrates increased during 2005, the industry-wide margin compression on new loanoriginations resulted in a decrease in revenues per loan in all productionsegments. We expect margins to remain at these compressed levels in thenear-term future as

 

40

----

 

the industry adjusts rateson new loan originations to mirror changes in the yield curve. To address themarket revenue compression and increase segment contribution from each of ourproduction segments we have hired additional account executives and loanofficers to increase origination volume, and are continuing to implement costefficiency measures, including our new loan origination system.

 

***Non-ConformingWholesale Segment.***  Ournon-conforming wholesale segment continued to report positive net income aftercorporate allocation in the three and nine months ended September 30, 2005,although the contribution was reduced through nine months ended September 30,2005 from levels in the same period in 2004, primarily due to lower interestand sale margins as interest rates increased throughout 2004 and the first ninemonths of 2005. The decrease in direct expenses in three and nine months ended September30, 2005 compared to the three and nine months ended September 30, 2004reflects lower variable loan costs including commissions, as we adjustedcompensation structures for the thinner margin in the current lendingenvironment.

 

***Non-ConformingRetail Segment.***  Theincrease in our non-conforming retail segment contribution in the three monthsended September 30, 2005 from the three months ended September 30, 2004reflects an increase in origination volume combined with a decrease in directorigination expenses quarter over quarter, as new divisional managementrestructured personnel costs and marketing initiatives. The decrease in segmentcontribution in the nine months ended September 30, 2005 compared to the sameperiod in 2004 reflects a reduction in origination volume and revenue per loanyear over year, due primarily to increased pricing competition and a higherpercentage in 2005 of second lien originations, which generate lower feeincome. The appointment of new management in 2005 and a more focused marketingstrategy has increased volume, reduced costs and contributed to a positivesegment contribution, expected to continue throughout the remainder of 2005.

 

***ConformingWholesale Segment.***  Theconforming wholesale segment reported a positive segment contribution in the thirdquarter of 2005, and an improved contribution level for the nine months endedSeptember 30, 2005 as compared to the same period in 2004. The quarter overquarter improvement reflects a 53% increase in volume combined with a decreasein direct production costs as we closed unprofitable production operations. Inthe second half of 2004, we evaluated each conforming wholesale branch forprofitability and closed those branches with negative contributions. Managementis continuing its review of the long-term profitability of the conformingwholesale segment, and expects to finalize its evaluation of all optionsrelating to the future viability of this operation.

 

***Conforming RetailSegment.***  Thedecrease in our conforming retail segment contribution in the three and ninemonths ended September 30, 2005 from the three and nine months ended September30, 2004 reflects a decrease in revenue period over period, combined with additionalsalaries and office expenses incurred to expand our offices in the Coloradoregion. As we focus on the profitability of the conforming wholesale segment,we are also reviewing our retail branches to determine the most prudent use ofresources in view of the increased competition and depressed margins affectingthe profitability of this segment.

 

41

----

 

***Operating Segment Results***

 

The following tablesummarizes our operating segment results for the three and nine months endedSeptember 30, 2005 and 2004 (in thousands): 

 
| ** **                                   | ** ** | ** **                | ** ** | **Corporate**        | ** ** | ** **                        | ** ** |
|----------------------------------------------|------------|---------------------------|------------|----------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **Investment  Portfolio** | ** ** | **Segment  Results** | ** ** | **Reconciliations  to GAAP** | ** ** | **Total  Corporate** | ** ** | **Total  Operating** | ** ** |
| ***Three  Months Ended September 30, 2005*** |       |                      |       |                 |       |                              |       |   |   |   |   |
| Revenues                                     |       | $                         | 35,009     |                 | 71         |                              | (28,938    | ) | (28,867 | ) | 6,142 |   |
| Direct expenses                              |       | 2,603                     |       | 10,326               |       | (14,396                           | )          | (4,070 | ) | (1,467 | ) |
| Segment  contribution                        |       | 32,406                    |       | (10,255              | )          | (14,542                           | )          | (24,797 | ) | 7,609 |   |
| Corporate  overhead allocation               |       | —                    |       | (8,303               | )          | —                            |       | (8,303 | ) | (8,303 | ) |
| Income (loss)  before income taxes           |       | 32,406                    |       | (1,952               | )          | (14,542                           | )          | (16,494 | ) | 15,912 |   |
| Provision for  income tax expense            |       | —                    |       | (2,999               | )          | —                            |       | (2,999 | ) | (2,999 | ) |
| Net income  (loss)                           |       | $                         | 32,406     |                 | (4,951     | )                                 | (14,542    | ) | (19,493 | ) | 12,913 |   |
| *** ***                                 |       |                      |       |                 |       |                              |       |   |   |   |   |
| ***Three  Months Ended September 30, 2004*** |       |                      |       |                 |       |                              |       |   |   |   |   |
| Revenues                                     |       | $                         | 18,914     |                 | 51         |                              | (36,716    | ) | (36,665 | ) | (17,751 | ) |
| Direct expenses                              |       | 2,432                     |       | 7,990                |       | (14,436                           | )          | (6,446 | ) | (4,014 | ) |
| Segment  contribution                        |       | 16,482                    |       | (7,939               | )          | (22,280                           | )          | (30,219 | ) | (13,737 | ) |
| Corporate  overhead allocation               |       | —                    |       | (10,301              | )          | —                            |       | (10,301 | ) | (10,301 | ) |
| Income (loss)  before income taxes           |       | 16,482                    |       | 2,362                |       | (22,280                           | )          | (19,918 | ) | (3,436 | ) |
| Provision for  income tax expense            |       | —                    |       | (1,536               | )          | —                            |       | (1,536 | ) | (1,536 | ) |
| Net income  (loss)                           |       | $                         | 16,482     |                 | 826        |                              | (22,280    | ) | (21,454 | ) | (4,972 | ) |
|                                         |       |                      |       |                 |       |                              |       |   |   |   |   |
| ***Nine  Months Ended September 30, 2005***  |       |                      |       |                 |       |                              |       |   |   |   |   |
| Revenues                                     |       | $                         | 116,821    |                 | 189        |                              | (66,206    | ) | (66,017 | ) | 50,804 |   |
| Direct expenses                              |       | 7,602                     |       | 29,566               |       | (36,078                           | )          | (6,512 | ) | 1,090 |   |
| Segment  contribution                        |       | 109,219                   |       | (29,377              | )          | (30,128                           | )          | (59,505 | ) | 49,714 |   |
| Corporate  overhead allocation               |       | —                    |       | (21,403              | )          | —                            |       | (21,403 | ) | (21,403 | ) |
| Income (loss)  before income taxes           |       | 109,219                   |       | (7,974               | )          | (30,128                           | )          | (38,102 | ) | 71,117 |   |
| Provision for  income tax expense            |       | —                    |       | (4,792               | )          | —                            |       | (4,792 | ) | (4,792 | ) |
| Net income  (loss)                           |       | $                         | 109,219    |                 | (12,766    | )                                 | (30,128    | ) | (42,894 | ) | 66,325 |   |
| *** ***                                 |       |                      |       |                 |       |                              |       |   |   |   |   |
| ***Nine  Months Ended September 30, 2004***  |       |                      |       |                 |       |                              |       |   |   |   |   |
| Revenues                                     |       | $                         | 72,068     |                 | 373        |                              | (103,379   | ) | (103,006 | ) | (30,938 | ) |
| Direct expenses                              |       | 4,871                     |       | 23,660               |       | (39,805                           | )          | (16,145 | ) | (11,274 | ) |
| Segment  contribution                        |       | 67,197                    |       | (23,287              | )          | (63,574                           | )          | (86,861 | ) | (19,664 | ) |
| Corporate  overhead allocation               |       | —                    |       | (27,233              | )          | —                            |       | (27,233 | ) | (27,233 | ) |
| Income (loss)  before income taxes           |       | 67,197                    |       | 3,946                |       | (63,574                           | )          | (59,628 | ) | 7,569 |   |
| Provision for  income tax expense            |       | —                    |       | (4,538               | )          | —                            |       | (4,538 | ) | (4,538 | ) |
| Net income  (loss)                           |       | $                         | 67,197     |                 | (592       | )                                 | (63,574    | ) | (64,166 | ) | 3,031 |   |

 

***InvestmentPortfolio.***  Segmentcontribution increased $15.9 million in the three months ended September30, 2005 as compared to the three months ended September 30, 2004 primarily dueto the $7.6 million non-cash mark to market valuation gain on interest rateswap and cap agreements in the third quarter of 2005 compared to the ($12.1)million non-cash mark to market valuation loss in the third quarter of 2004.The increase in the ending valuation of the swaps and caps as of September 30,2005  resulted from a heightening of theforward yield curve during the third quarter of 2005 as compared to a decliningcurve during the comparable period in 2004. Our interest rate swaps and cap arenot designated as cash flow hedges and, therefore, the change in the periodicmark to market of the future value of the interest rate swaps and cap isreported in current period earnings. The non-cash valuation increase waspartially offset by decreased net interest income on our loans held forinvestment as the average financing costs of our portfolio grew to 4.3% in thethird quarter of 2005 from 2.3% during the third quarter of 2004.

 

Segment contribution increased $42.0 million inthe nine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004 primarily due to the increase in net interest income afterprovision for loan loss, as a result of the growth of our portfolio of loansheld for investment.  During the ninemonths ended September 30, 2005, our average portfolio of loans held forinvestment increased to $4.8 billion from $2.6 billion for the ninemonths ended September 30, 2004.  Inaddition, we recognized a $31.0 million increase in the non-cash mark to marketand net cash received from our interest rate swaps hedging our securitizationfinancing in the nine months

 

42

----

 

ended September 30, 2005versus the nine months ended September 30, 2004.  The $2.7 million increase in direct expensesfor the nine months ended September 30, 2005 compared to the same period in2004 primarily reflects an increase in third-party servicing expense relatingto our loan portfolio.  We anticipateinvestment segment contribution for the final quarter of 2005 to approximatethe third quarter of 2005 results, with slightly higher net income in 2006,primarily due to the planned growth of our held for investment portfoliopartially offset by thinner net interest margins on the loans to be originatedin 2006 compared to the loans currently in our portfolio which are expected toprepay in 2006.

 

***Corporate.***    Direct expensesincreased from the three and nine months ended September 30, 2004 to September30, 2005 due to staffing increases in the second half of 2004 primarily tosupport our legal, accounting and information technology departments. Theincrease in 2005 direct expenses also includes increases in professional costsrelated to operating as a public company. We expect direct expenses to increaseslightly in the final quarter of 2005, and increase additionally in 2006,reflecting incremental costs to be incurred for additional technology staffing,amortization, and maintenance expenses related to placing our new loanorigination software system fully into service and the implementation ofSarbanes-Oxley Act compliance measures.

 

**Liquidity and Capital Resources**

 

As a mortgage lending company, we borrow substantialcash to fund the mortgage loans we originate. After funding, our primaryoperating subsidiary, Fieldstone Mortgage Company, holds all of the conformingloans and some of the non-conforming loans that it originates in inventory(warehouse) prior to sale. We hold the remainder of the non-conforming loansfor investment in our portfolio. Our primary cash requirements include:

 

•             fundingmortgages;

 

•             premiumspaid in connection with loans originated in the wholesale channel;

 

•             interestexpense on our warehouse lines, repurchase facilities and securitizationfinancings;

 

•             ongoinggeneral and administrative expenses;

 

•             hedgetransactions; and

 

•             REITstockholder distributions – as a REIT, we are required to distribute at least90% of our REIT taxable income to our stockholders.

 

Our primary cash sources include:

 

•             borrowingsfrom our warehouse lines and repurchase facilities secured by mortgage loansheld in inventory;

 

•             proceedsfrom the issuance of securities collateralized by the loans in our portfolio;

 

•             proceedsof whole loan sales;

 

•             principaland interest collections relative to the mortgage loans held in inventory; and

 

•             pointsand fees collected from the origination of retail and wholesale loans.

 

We rely on our securitizations as a primary sourceof liquidity. As of September 30, 2005, we have completed eightsecuritizations, issuing an aggregate $6.3 billion of mortgage-backedsecurities.

 

43

----

 

The following is a summary of the securitizations weissued by series, as of the date of issuance, during the year endedDecember 31, 2004 and the nine months ended September 30, 2005 (inmillions):

 
| ** **                                 | ** ** | **Year Ended**        | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **December 31, 2004** | ** ** | **September 30, 2005** | ** ** |
| ** **                                 | ** ** | **FMIT  2004-1**      | ** ** | **FMIT  2004-2**       | ** ** | **FMIT  2004-3** | ** ** | **FMIT  2004-4** | ** ** | **FMIT  2004-5** | ** ** | **FMIT  2005-1** | ** ** | **FMIT  2005-2** | ** ** |
| Issue date                                 |       | Feb 2004              |       | Apr 2004               |       | Jul 2004 |   | Oct 2004 |   | Nov 2004 |   | Feb 2005 |   | Aug 2005 |   |
| Bonds issued                               |       | $                     | 652        |                   | 844        |   | 949 |   | 845 |   | 864 |   | 729 |   | 911 |   |
| Loans pledged                              |       | $                     | 681        |                   | 880        |   | 1,000 |   | 879 |   | 900 |   | 750 |   | 967 |   |
| Bond ratings—Standard and Poor’s |       | AAA–BBB          |       | AAA–BBB           |       | AAA–BBB |   | AAA–A+ |   | AAA–BBB+ |   | AAA–BBB- |   | AAA–A+ |   |
| Bond ratings—Moody’s             |       | Aaa–Baa2         |       | Aaa–Baa2          |       | Aaa–Baa2 |   | Aaa–Baa2 |   | Aaa–Baa2 |   | Aaa–Baa3 |   | Aaa–Baa2 |   |
| Financing costs—LIBOR plus            |       | 0.29 – 1.8       | %          | 0.24 – 2.15       | %          | 0.27 – 2.15 | % | 0.33 – 1.80 | % | 0.24 – 1.85 | % | 0.12-2.0 | % | 0.12-1.35 | % |
| Weighted average spread over LIBOR         |       | 0.55                  | %          | 0.47                   | %          | 0.48 | % | 0.51 | % | 0.53 | % | 0.40 | % | 0.38 | % |
| Transaction fees                           |       | 0.36                  | %          | 0.32                   | %          | 0.34 | % | 0.35 | % | 0.32 | % | 0.36 | % | 0.33 | % |

 

We use our various warehouse lines and repurchasefacilities to fund substantially all of our loan originations. FieldstoneMortgage sells the mortgage loans it holds within three months of originationand pays down these facilities with the sale proceeds. We issue mortgage-backedsecurities to pay down the portion of those facilities financing our loans heldfor investment.

 

The material terms and features of these securedwarehouse lines and repurchase facilities as of September 30, 2005 are asfollows (in millions): 

 
| **Lender**                                                | ** ** | **Committed** | ** ** | **Uncommitted** | ** ** | **Maturity  Date** | ** **  | **Range of  Allowable  Advances** | ** ** | **Minimum  Consolidated  Tangible  Net  Worth** | ** ** | **Maximum Ratio of  Indebtedness  To Adjusted  Tangible  Net  Worth** | ** ** | **Minimum  Liquidity** | ** ** |
|-----------------------------------------------------------|------------|---------------|------------|-----------------|------------|--------------------|-------------|----------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|------------------------|------------|
| Countrywide Warehouse Lending                             |       | $             | 75.0       |            | —     |               | August 2006 |                                   | 95%-99.5   | %                                               | $          | 250.0                                                                           |       | 17:1                   |       | N/A |   |
| Countrywide Early Purchase Program                        |       | —        |       | 50.0            |       | Uncommitted        |        | N/A                                    |       | N/A                                             |       | N/A                                                                             |       | N/A                    |       |
| Credit Suisse First Boston Mortgage Capital               |       | 500.0         |       | —          |       | February 2006      |        | 95%-99                                 | %          | 400.0                                           |       | 16:1                                                                            |       | 15.0                   |       |
| Credit Suisse,  New York Branch Commercial Paper Facility |       | 500.0         |       | —          |       | July 2006          |        | 92.5                                   | %          | 250.0                                           |       | 16:1                                                                            |       | 15.0                   |       |
| JP Morgan Chase Bank                                      |       | 150.0         |       | —          |       | April 2006         |        | 95%-97                                 | %          | 400.0                                           |       | 16:1                                                                            |       | 20.0                   |       |
| Lehman Brothers Bank                                 |       | 500.0         |       | —          |       | December 2005      |        | 95.5%-98.5                             | %          | 250.0                                           |       | 16:1                                                                            |       | 15.0                   |       |
| Merrill Lynch Bank USA*                                   |       | 500.0         |       | —          |       | November 2005      |        | 93%-98                                 | %          | 250.0                                           |       | 17:1                                                                            |       | N/A                    |       |
| Total                                                     |       | $             | 2,225.0    |            | 50.0       |               |        |                                   |       |                                            |       |                                                                            |       |                   |       |   |
|                                                           |            |               |            |                 |            |                    |             |                                        |            |                                                 |            |                                                                                 |            |                        |            |  |  |

 

----

* During the fourth quarter of 2005, the MerrillLynch Bank USA facility was extended through December 9, 2005.  We expect to renew this warehouse line ofcredit for another year.

 

Under our warehouse lines and repurchase facilities,interest is payable monthly in arrears and outstanding principal is payableupon receipt of loan sale proceeds or transfer of a loan into a securitizationtrust. Outstanding principal is also repayable upon the occurrence of certaindisqualifying events, which include a mortgage loan in default for a period oftime, a repaid mortgage loan, a mortgage loan obtained with fraudulentinformation or the failure to cure a defect in mortgage loan documentation.Outstanding principal also is repayable if the mortgage loan does not close,but had been pledged and funds were advanced. Our warehouse lines andrepurchase facilities contain terms mandating principal repayment if a loanremains on the line after a contractual time period from date of funding, or onthe maturity date of the facility.

 

A primary component of our liquidity strategy is tofinance our mortgage loans held for sale and our loans held for investment(prior to issuing securities collateralized by those loans) through a diversegroup of lending

 

44

----

 

counterparties and toschedule frequent sales or securitizations of loans so that the average holdingperiod of our inventory of loans generally does not exceed 60 days.

 

We use our excess cash from operations and ourcapital to reduce the advances on our warehouse lines or repurchase facilities.This process reduces our debt outstanding and the corresponding interestexpense incurred and results in excess mortgage collateral available to secureborrowings in an amount required to meet our working capital needs. This poolof available collateral totaled approximately $145 million and$190 million as of September 30, 2005 and December 31, 2004,respectively. We plan to deploy a portion of this working capital to financethe continued growth of our investment portfolio.

 

Our Board of Directors may consider authorizing usto repurchase a limited amount of our common stock, depending upon theprojected incremental returns available through new loan originations and ourstock price.  Any repurchase of ourcommon stock could decrease our capital base, but could increase our overallreturn on remaining equity. If we did decrease our capital base, we wouldadjust our target portfolio balance to maintain our current 13:1 leveragetarget.

 

The warehouse lines and repurchase facilities aresecured by substantially all of our non-securitized mortgage loans and containcustomary financial and operating covenants that, among other things, requireus to maintain specified levels of liquidity and net worth, restrictindebtedness other than in the ordinary course of business, restrictinvestments in other entities except in certain limited circumstances, restrictour ability to engage in mergers, consolidations or substantially change thenature or character of our business and require compliance with applicablelaws. We were in compliance with all of these covenants at September 30, 2005and December 31, 2004.

 

For our warehouse lines and repurchase facilities,advances bear interest at annual rates that vary depending upon the type ofmortgage loans securing the advance of LIBOR plus an additional percentagewhich ranges from 0.23% to 3.25%. We are required to pay facilities feesranging from 0.02% to 0.15% of the committed amount of the facility. We arealso required to pay non-use fees on some of the warehouse lines and repurchasefacilities of 0.125% on unused amounts which exceed certain thresholds relatingto the average outstanding balance of the facility.

 

***On October 11, 2005, FMOC entered into amaster repurchase agreement with Liquid Funding, Ltd. (Liquid Funding), anaffiliate of Bear Stearns Bank plc. Under the repurchase facility FMOC may borrow up to an aggregate amountof $200 million from Liquid Funding by pledging a portfolio of non-primemortgage-backed securities (Retained Securities).  The facility is scheduled to remain openuntil October 13, 2006 and bears interest at an annual rate of LIBOR plus anadditional percentage.  The specificpricing terms and composition and amount of Retained Securities pledged in eachtransaction will be determined by the parties on a transaction by transactionbasis.  As of November 11, 2005, RetainedSecurities having a market value of $80.8 million have been pledged to LiquidFunding as collateral for $57.1 million of borrowings under the agreement.***

*** ***

***On October 21, 2005, FMOC entered into amaster repurchase agreement with Lehman Brothers Inc. and Lehman BrothersCommercial Paper Inc. (together Lehman Brothers).  Under the repurchase facility FMOC may borrowup to an aggregate amount of $200 million from Lehman Brothers by pledging aportfolio of non-prime mortgage-backed securities (Retained Securities).  The facility is scheduled to remain openindefinitely, but may be terminated by either party at any time, and bearsinterest at an annual rate of LIBOR plus an additional percentage.  The specific pricing terms and compositionand amount of Retained Securities pledged in each transaction will bedetermined by the parties on a transaction by transaction basis.  As of November 11, 2005, Retained Securitieshaving a market value of $88.5 million have been pledged to Lehman Brothers ascollateral for $68.1 million of borrowings under the agreement.***

 

**Cash Flows**

 

For the nine months ended September 30, 2005, ourcash flow from operations was $452.9 million as compared to operating cashflows of $216.7 million for the nine months ended September 30, 2004. Thisincrease in operating cash flows is primarily due to increased proceeds fromthe higher volume of mortgage loan sales in the first nine months of 2005compared to the first nine months of 2004.

 

45

----

 

Our cash used in investing activities was ($1.1)billion and ($2.8) billion for the nine months ended September 30, 2005 and2004, respectively. The decrease in investing activities primarily relates tothe lower funding volume of loans to be held for investment, as thinnerinterest margins during 2005 resulted in a lower portion of non-conforming loanoriginations which met our minimum return on asset threshold for loans to beadded to our investment portfolio. Higher principal repayments in 2005 of ourloans held for investment due to the continued seasoning of our portfolio ofloans held for investment, also contributed to the decrease in investingactivity. Our investing cash flows are negative as presented in ourconsolidated statements of cash flows, because they exclude the net proceedsfrom mortgage warehouse financing and securitization financing used to supportthe increase in our investment in mortgage loans. We are required to presentthe net proceeds from, or repayments of, mortgage financing in our consolidatedstatements of cash flows as cash flow from financing activities and not asinvesting cash flow. Our cash flows from financing activities were $0.6 billionand $2.5 billion for the nine months ended September 30, 2005 and 2004,respectively.

 

**Commitments and Contingencies**

 

We had commitments to fund approximately$642.8 million and $421.8 million of mortgage loans at September 30,2005 and December 31, 2004, respectively. Interest rate lock commitmentsare considered derivatives under Statement No. 133, and as such, have beenrecorded at fair value in the consolidated statements of condition as acomponent of derivative assets, net. This does not necessarily represent futurecash requirements, as some of the commitments are likely to expire withoutbeing drawn upon or may be subsequently declined for credit or other reasons.

 

We had forward delivery commitments to sellapproximately $1.9 billion and $0.4 billion of loans at September 30,2005 and December 31, 2004, respectively, of which $129.0 million and$63.1 million, respectively, were mandatory sales of mortgage-backedsecurities and investor whole loan trades, and $460.0 million and$40.0 million, respectively, were treasury note forward contracts, whichwe used to economically hedge the interest rate risk of our non-conformingloans.

 

Because the nature of our business involves thecollection of numerous accounts, the validity of liens and compliance withvarious state and federal lending and consumer protection laws, we are subjectto various legal proceedings in the ordinary course of our business related to foreclosures,bankruptcies, condemnation and quiet title actions and alleged statutory andregulatory violations. We are also subject to other legal proceedings in theordinary course of business related to employee matters. All of these ordinarycourse proceedings, taken as a whole, are not expected to have a materialadverse effect on our business, financial condition or results of operations.

 

On October 28,2005, in the Company’s defense of the suit filed by its former shareholders, theCompany served a cross claim against KPMG LLP (“KPMG”) in the matter of *820 Management Trust et al. v. Fieldstone Investment Corporation (FIC),Fieldstone Mortgage Company (FMC) and KPMG LLP* (the “820 ManagementTrust Lawsuit”).  The cross claim wasfiled in the District Court of Tarrant County, Texas, where the 820 ManagementTrust Lawsuit is pending.  The 820Management Trust Lawsuit is an action filed by certain of FIC’s formershareholders, alleging that the shareholders whose shares were redeemed out ofthe proceeds of the 144A Offering are entitled to an additional post-closingredemption price payment of approximately $19.0 million, plus interest andattorney fees. The former shareholders were paid $188.1 million for theirshares on November 14, 2003 and the Redemption Agreement between theshareholders and the Company required an adjustment to the redemption price bepaid to the shareholders based on the Company’s November 13, 2003 balancesheet, as audited by KPMG, the Company’s former auditors, pursuant to which theCompany paid an additional $1.8 million to the former shareholders on February18, 2004.  Following notification by theredeemed shareholders of their objection to the Company’s November 13,2003 balance sheet, KPMG, on April 20, 2004, advised the Company that its auditof the November 13, 2003 balance sheet should no longer be relied upon.  The Company’s cross claim asserts, amongother claims, that KPMG’s withdrawal of its audit report on the November 13,2003 balance sheet was improper and that due to this improper withdrawal theCompany suffered damages.  In addition,the cross claim asserts that in the event the former shareholders prevail inthe 820 Management Trust Lawsuit, KPMG negligently advised FIC regarding theNovember 13, 2003 balance sheet giving rise to this dispute.  The cross claim seeks a judgment against KPMGin an unspecified amount in excess of approximately $1 million, plusprejudgment interest for the attorneys fees and cost incurred in the abovereferenced matter.  See Part 1 Item 3 of

 

46

----

 

the Company’s Annual Report on Form 10-K for the fiscal year ending onDecember 31, 2004 filed with the SEC on March 25, 2005 for a description of the820 Management Trust Lawsuit.

 

*Arredondo, et al. v. FieldstoneInvestment, et al.**,*isan action filed on August 3, 2004 in the United States District Court for theDistrict of Arizona by nine former employees of Fieldstone Mortgage Companyalleging that that their supervisors and co-workers created a hostile workenvironment resulting from gender discrimination, racial discrimination andretaliation in the workplace pursuant to Title VII of the Civil Rights Act of1964, 42 U.S.C. §2000e, and the Civil Rights Act of 1866, 42 U.S.C. §1981, asamended by the Civil Rights Act of 1991, 42 U.S.C. §1981(a). Plaintiffs claimthat they are entitled to money damages in the form of back pay and front payand nominal, compensatory and punitive damages, costs and attorney fees andequitable relief.  The Company filed itsanswer denying all relevant claims on August 25, 2004.  In addition, theCompany filed a variety of motions seeking to have some of the plaintiffsdismissed from the lawsuit for failure to exhaust their administrativeremedies, to dismiss other claims as not being permitted under the statute, andfinally to sever the plaintiffs for trial purposes.  Plaintiffs filed aresponse to the Company’s motion to dismiss, sever or in the alternative,bifurcate, and on April 18, 2005, the Company’s motion to dismiss wasdenied.  The parties are currently in theprocess of discovery and no trial date has yet been set; however, motions forsummary judgment are due no later than June 21, 2006. Due to the uncertainnature of the litigation at this time, the Company is unable to estimate theprobable outcome of this matter.  Theplaintiffs in this matter have not specified damages sought and the Company istherefore unable to estimate potential exposure. While the Company intends tovigorously defend this matter, there can be no assurance that an adverseoutcome would not have a material effect on the Company’s results ofoperations.

 

The Company issubject to various legal proceedings in the ordinary course of its businessrelated to foreclosures, bankruptcies, condemnation and quiet title actions andalleged statutory and regulatory violations. The Company’s management believesthat any liability with respect to these legal actions, individually or in theaggregate, will not have a material adverse effect on the Company’s business,results of operations or financial position.

 

**REITTaxable Income**

 

To maintain our status as a REIT, we are required todistribute at least 90% of our REIT taxable income each year to ourshareholders. Federal tax rules calculate REIT taxable income in a manner that,in certain respects, differs from the calculation of consolidated net incomepursuant to GAAP. Our consolidated GAAP net income will differ from our REITtaxable income primarily for the following reasons:

 

•             theprovision for loan loss expense recognized for GAAP purposes is based upon ourestimate of probable loan losses inherent in our current portfolio of loansheld for investment, for which we have not yet recorded a charge-off (taxaccounting rules allow a deduction for loan losses only in the period when acharge-off occurs);

 

•             themark-to-market valuation changes to our interest rate swap and cap derivativesrecognized for GAAP purposes are not recognized for tax accounting;

 

•             thereare differences between GAAP and tax methodologies for capitalization oforigination expenses; and

 

•             incomeof the TRS is included in the REIT’s earnings for consolidated GAAP purposes,but is not recognized in REIT taxable income unless and until a dividend isdeclared from the TRS to the REIT.

 

Our REIT taxable income will continue to differ fromour GAAP consolidated income, particularly during the period in which we buildour investment portfolio.

 

REIT taxable income is a non-GAAP financial measurewithin the meaning of Regulation G promulgated by the Securities andExchange Commission (SEC). Management believes that the presentation of REITtaxable income provides useful information to investors regarding the estimatedannual distributions to our investors. The

 

47

----

 

presentation of REIT taxableincome is not meant to be considered in isolation or as a substitute forfinancial results prepared in accordance with GAAP.

 

The following table is a reconciliation of GAAP netincome to estimated REIT taxable net income for the nine months ended September30, 2005 and the year ended December 31, 2004 (in thousands): 

 
| ** **                                                 | ** ** | **Nine Months Ended  September 30,  2005** | ** ** | **Year  Ended  December 31, 2004** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|
| Consolidated GAAP pre-tax net income                       |       | $                                          | 93,395     |                               | 69,530     |   |
| Plus:                                                      |       |                                       |       |                               |       |
| Provision for loan losses in excess of actual  charge-offs |       | 19,064                                     |       | 21,056                             |       |
| Variance in recognition of net origination expenses        |       | 13,342                                     |       | 9,922                              |       |
| Less:                                                      |       |                                       |       |                               |       |
| Taxable REIT subsidiary pre-tax net income                 |       | (13,311                                    | )          | (10,091                            | )          |
| Mark-to-market valuation changes on derivatives            |       | (16,171                                    | )          | (22,079                            | )          |
| Miscellaneous other                                        |       | (6,443                                     | )          | (5,143                             | )          |
| Estimated REIT taxable income                              |       | $                                          | 89,876     |                               | 63,195     |   |

 

Our REIT taxable income for the nine months endedSeptember 30, 2005 is an estimate only, and is subject to change until we fileour 2005 REIT federal tax returns.

 

On October 5, 2005, we declared a quarterly cashdividend of $0.51 per share for the third quarter of 2005. The dividend waspaid on October 28, 2005 to stockholders of record at the close of business onOctober 19, 2005. We declared dividends totaling $1.48 per share year to datethrough November 14, 2005.

 

We currently intend to distribute approximately 85%of our 2005 REIT taxable income in 2005, together with the portion of the 2004REIT taxable income that was not distributed in 2004.

 

**Other Operational and Investment Portfolio Data**

 

***Loan Fundings***

 

The following table indicates our total fundings ofloans held for investment and loans held for sale for the three and nine monthsended September 30, 2005 and 2004 (in thousands)*: 

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                 | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **Fundings**                         | ** ** | **% of  Total**                | ** ** | **Fundings** | ** ** | **% of  Total** | ** ** | **Fundings** | ** ** | **% of  Total** | ** ** | **Fundings** | ** ** | **% of  Total** | ** ** |
| Non-Conforming:            |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  investment |       | $                                    | 1,019,811  |                                | 56         | % | $ | 1,210,648 |   | 72 | % | $ | 1,949,120 |   | 43 | % | $ | 3,149,689 |   | 68 | % |
| Loans held for  sale       |       | 800,980                              |       | 44                                  | %          | 476,922 |   | 28 | % | 2,608,965 |   | 57 | % | 1,498,844 |   | 32 | % |
| Total Non-Conforming       |       | 1,820,791                            |       | 100                                 | %          | 1,687,570 |   | 100 | % | 4,558,085 |   | 100 | % | 4,648,533 |   | 100 | % |
|                       |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Conforming:                |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale       |       | 434,004                              |       | 100                                 | %          | 301,269 |   | 100 | % | 1,167,569 |   | 100 | % | 976,564 |   | 100 | % |
| Total Fundings             |       | $                                    | 2,254,795  |                                |       |   | $ | 1,988,839 |   |   |   | $ | 5,725,654 |   |   |   | $ | 5,625,097 |   |   |   |

 

----

*Datafor the nine months ended September 30, 2005 reflects the second quarter of2005 net transfer of mortgage loans held for investment to mortgage loans heldfor sale.

 

The increase in loan fundings in the three and ninemonths ended September 30, 2005 compared to the same periods in 2004 reflectsincreased production from our conforming wholesale operations throughout all of2005, and

 

48

----

 

an increase in ournon-conforming fundings quarter over quarter. Non-conforming originations have grown as a result of additional accountexecutives and loan officers, combined with increased production from neweroffices in the North western and Mid-Atlantic regions. We expect originationvolumes in the fourth quarter of 2005 to approximate 85 - 90% of third quarter2005 volume, down due primarily to market competition, rising interest ratesand seasonal trends.

 

The following tables provide a summary of thecharacteristics of our total non-conforming loan originations for the threemonths ended September 30, 2005 (in thousands):

 

*Income Documentation*

 
| ** **                  | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| Full Documentation          |       | $                                 | 798,164    |                                | 43.9       | %                             | 7.2        | %                                    | 632        |                            | $          | 138                        |       | 83.9                        | %          | 92.1 | % |
| Stated Income Wage Earner   |       | 535,270                           |       | 29.4                                | %          | 7.5                           | %          | 683                                  |       | 176                             |       | 84.2                       | %          | 95.5                        | %          |
| Stated Income Self Employed |       | 299,513                           |       | 16.4                                | %          | 7.5                           | %          | 676                                  |       | 198                             |       | 83.5                       | %          | 93.5                        | %          |
| 24 Month Bank Statements    |       | 53,209                            |       | 2.9                                 | %          | 7.1                           | %          | 639                                  |       | 214                             |       | 83.7                       | %          | 91.9                        | %          |
| 12 Month Bank Statements    |       | 128,785                           |       | 7.1                                 | %          | 7.2                           | %          | 644                                  |       | 194                             |       | 83.9                       | %          | 93.2                        | %          |
| Limited Documentation       |       | 5,850                             |       | 0.3                                 | %          | 7.3                           | %          | 655                                  |       | 177                             |       | 80.2                       | %          | 89.9                        | %          |
| Total                       |       | $                                 | 1,820,791  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |   |
| Weighted Average            |       |                              |       |                                |       | 7.3                           | %          | 655                                  |       | $                               | 161        |                       | 83.9       | %                           | 93.4       | % |

 

*CreditScore*

 
| ** **       | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent  Full  Documentation** | ** ** |
|------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| 500 – 549   |       | $                                 | 39,915     |                                | 2.2        | %                             | 8.6        | %                                    | 535        |                            | $          | 160                        |       | 77.4                        | %          | 78.4                             | %          | 77.3 | % |
| 550 – 599   |       | 223,033                           |       | 12.3                                | %          | 7.7                           | %          | 579                                  |       | 141                             |       | 81.6                       | %          | 86.6                        | %          | 76.1                             | %          |
| 600 – 649   |       | 565,034                           |       | 31.0                                | %          | 7.3                           | %          | 627                                  |       | 151                             |       | 84.0                       | %          | 93.1                        | %          | 59.7                             | %          |
| 650 – 699   |       | 635,337                           |       | 34.9                                | %          | 7.3                           | %          | 672                                  |       | 170                             |       | 84.7                       | %          | 95.7                        | %          | 29.0                             | %          |
| 700 or greater   |       | 357,472                           |       | 19.6                                | %          | 7.1                           | %          | 731                                  |       | 180                             |       | 84.7                       | %          | 95.6                        | %          | 21.6                             | %          |
| Total            |       | $                                 | 1,820,791  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted Average |       |                              |       |                                |       | 7.3                           | %          | 655                                  |       | $                               | 161        |                       | 83.9       | %                           | 93.4       | %                                | 43.9       | % |

 

49

----

 

*ProductType*

 
| ** **           | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent  Full  Documentation** | ** ** |
|----------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| 2/28 LIBOR ARM       |       | $                                 | 347,020    |                                | 19.1       | %                             | 7.4        | %                                    | 629        |                            | $          | 157                        |       | 82.9                        | %          | 92.2                             | %          | 53.6 | % |
| 2/28 LIBOR ARM IO    |       | 810,478                           |       | 44.5                                | %          | 6.8                           | %          | 665                                  |       | 287                             |       | 82.0                       | %          | 94.3                        | %          | 33.9                             | %          |
| 3/27 LIBOR ARM       |       | 104,214                           |       | 5.7                                 | %          | 7.3                           | %          | 631                                  |       | 160                             |       | 83.1                       | %          | 91.6                        | %          | 64.4                             | %          |
| 3/27 LIBOR ARM IO    |       | 206,292                           |       | 11.3                                | %          | 6.7                           | %          | 663                                  |       | 277                             |       | 81.6                       | %          | 92.4                        | %          | 47.0                             | %          |
| 5/25 Treasury ARM    |       | 4,780                             |       | 0.3                                 | %          | 6.6                           | %          | 658                                  |       | 266                             |       | 76.4                       | %          | 81.8                        | %          | 91.2                             | %          |
| 5/25 Treasury ARM IO |       | 18,229                            |       | 1.0                                 | %          | 6.6                           | %          | 670                                  |       | 331                             |       | 79.0                       | %          | 88.4                        | %          | 52.6                             | %          |
| Fixed Rate           |       | 105,559                           |       | 5.8                                 | %          | 7.1                           | %          | 655                                  |       | 151                             |       | 79.0                       | %          | 85.3                        | %          | 69.9                             | %          |
| Fixed Rate IO        |       | 13,864                            |       | 0.8                                 | %          | 7.1                           | %          | 654                                  |       | 262                             |       | 81.1                       | %          | 90.6                        | %          | 58.7                             | %          |
| 6 Month ARM          |       | 550                               |       | 0.0                                 | %          | 7.7                           | %          | 688                                  |       | 550                             |       | 90.0                       | %          | 95.0                        | %          | 0.0                              | %          |
| 6 Month ARM IO       |       | 1,503                             |       | 0.1                                 | %          | 7.2                           | %          | 672                                  |       | 250                             |       | 81.2                       | %          | 93.0                        | %          | 0.0                              | %          |
| 2nd Liens            |       | 208,302                           |       | 11.4                                | %          | 10.0                          | %          | 667                                  |       | 52                              |       | 99.0                       | %          | 99.0                        | %          | 37.7                             | %          |
| Total                |       | $                                 | 1,820,791  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted Average     |       |                              |       |                                |       | 7.3                           | %          | 655                                  |       | $                               | 161        |                       | 83.9       | %                           | 93.4       | %                                | 43.9       | % |

 

***Cost to Produce***

 

Cost to produce is a non-GAAP financial measurewithin the meaning of Regulation G promulgated by the SEC. Managementbelieves that the presentation of cost to produce provides useful informationto investors regarding financial performance because this measure includesadditional costs to originate mortgage loans, both recognized when incurred anddeferred costs, which are not all included in total expenses under GAAP. Inaddition, the production segments’ cost to produce includes the allocation ofthe direct expenses of the operating segments, which include corporate homeoffice costs and investment portfolio management costs. The presentation ofcost to produce is not meant to be considered in isolation or as a substitutefor financial results prepared in accordance with GAAP.

 

50

----

 

As required by Regulation G, a reconciliationof cost to produce to the most directly comparable measure under GAAP, which istotal expenses, is provided below for the three and nine months ended September30, 2005 and 2004 (in thousands): 

 
| ** **                                                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total expenses                                                               |       | $                                     | 34,243     |                                 | 33,634     |   | 99,222 |   | 96,246 |   |
| Deferred  origination costs                                                  |       | 14,397                                |       | 14,435                               |       | 36,078 |   | 39,806 |   |
| Servicing  costs—internal and external                                  |       | (2,743                                | )          | (2,689                               | )          | (8,566 | ) | (6,085 | ) |
| Total general  and administrative costs                                      |       | 45,897                                |       | 45,380                               |       | 126,734 |   | 129,967 |   |
| Premiums paid,  net of fees collected                                        |       | 4,751                                 |       | (3,270                               | )          | 14,884 |   | 9,791 |   |
| Cost to produce                                                              |       | $                                     | 50,648     |                                 | 48,650     |   | 141,618 |   | 139,758 |   |
|                                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Fundings:                                                                    |       |                                  |       |                                 |       |   |   |   |   |
| Non-Conforming wholesale                                                     |       | $                                     | 1,642,987  |                                 | 1,520,157  |   | 4,087,199 |   | 4,148,379 |   |
| Non-Conforming  retail                                                       |       | 177,804                               |       | 167,413                              |       | 470,886 |   | 500,154 |   |
| Conforming  wholesale                                                        |       | 318,746                               |       | 207,981                              |       | 879,724 |   | 680,166 |   |
| Conforming  retail                                                           |       | 115,258                               |       | 93,288                               |       | 287,845 |   | 296,398 |   |
| Total mortgage  fundings                                                     |       | $                                     | 2,254,795  |                                 | 1,988,839  |   | 5,725,654 |   | 5,625,097 |   |
|                                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Cost to produce  as % of total mortgage loan fundings                        |       | 2.25                                  | %          | 2.45                                 | %          | 2.47 | % | 2.48 | % |
| Total general  and administrative costs as % of total mortgage loan fundings |       | 2.04                                  | %          | 2.28                                 | %          | 2.21 | % | 2.31 | % |
|                                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Segment cost to  produce as % of mortgage loan fundings:                     |       |                                  |       |                                 |       |   |   |   |   |
| Non-Conforming  wholesale                                                    |       | 2.25                                  | %          | 2.28                                 | %          | 2.40 | % | 2.38 | % |
| Non-Conforming  retail                                                       |       | 3.19                                  | %          | 3.98                                 | %          | 3.69 | % | 3.74 | % |
| Total  non-conforming                                                        |       | 2.35                                  | %          | 2.45                                 | %          | 2.53 | % | 2.52 | % |
|                                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Conforming  wholesale                                                        |       | 1.74                                  | %          | 2.48                                 | %          | 2.16 | % | 2.33 | % |
| Conforming  retail                                                           |       | 2.07                                  | %          | 2.25                                 | %          | 2.54 | % | 2.24 | % |
| Total conforming                                                             |       | 1.83                                  | %          | 2.41                                 | %          | 2.25 | % | 2.30 | % |

 

Our cost to produce decreased in the three and ninemonths ended September 30, 2005 compared to the prior year same periods,primarily due to a decrease in direct costs and an increase in loan fundings inthe conforming segments.  We expect ourcost to produce as a percentage of total mortgage loan fundings to increaseslightly throughout the remainder of 2005 based upon our forecast of 10% to 15%lower funding volumes during the fourth quarter.

 

***Non-ConformingWholesale Segment. ***Our non-conforming wholesale segment net costto produce remained relatively flat in both the three and nine months endedSeptember 30, 2005, compared to the same periods in 2004.

 

***Non-ConformingRetail Segment. ***The decrease in our non-conforming retailsegment cost to produce both quarter and year to date 2005 over the prior yearsame periods reflects a reduction in marketing expenses combined with anincrease in net revenue generated by our relationship-based andaffinity-lending programs.

 

***ConformingWholesale Segment. ***Our conforming wholesale segment cost toproduce decreased in the three and nine months ended September 30, 2005 fromthe three and nine months ended September 30, 2004, primarily due to a decreasein fixed expenses in 2005 combined with a 53.3% increase in loan fundings inthe third quarter of 2005 and a 29.3% increase in loan fundings in the ninemonths ended September 30, 2005 as compared to the same periods in 2004. In thefirst nine months of 2004, we evaluated each conforming wholesale branch forprofitability and closed those branches with negative contributions.

 

***Conforming RetailSegment.***  Thedecrease in the cost to produce of our conforming retail segment in the threemonths ended September 30, 2005, primarily reflects a 6.5% increase in directcosts supporting a 23.6% increase in loan fundings. Net cost to produce roseduring the nine months ended September 30, 2005 compared to the same

 

51

----

 

period in 2004 primarily dueto a decrease in fee revenue due to market price competition and a decrease inrevenue from loans brokered to other mortgage companies.  Cost to produce also increased in the ninemonths ended September 30, 2005 due to higher costs associated with expandedoperations in Colorado during this period.

 

***I******nvestmentPortfolio***

 

The following tables provide a summary of thecharacteristics of the principal balance of our portfolio of loans held forinvestment as of September 30, 2005 (in thousands):

 

*IncomeDocumentation*

 
| ** **                  | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| Full Documentation          |       | $                                 | 2,390,498  |                                | 45.3       | %                             | 6.9        | %                                    | 621        |                            | $          | 165                        |       | 83.0                        | %          | 91.0 | % |
| Stated Income Wage Earner   |       | 1,511,451                         |       | 28.7                                | %          | 6.9                           | %          | 689                                  |       | 212                             |       | 81.4                       | %          | 95.0                        | %          |
| Stated Income Self Employed |       | 866,206                           |       | 16.4                                | %          | 7.0                           | %          | 672                                  |       | 226                             |       | 80.8                       | %          | 93.4                        | %          |
| 24 Month Bank Statements    |       | 197,814                           |       | 3.8                                 | %          | 6.9                           | %          | 626                                  |       | 230                             |       | 83.7                       | %          | 91.1                        | %          |
| 12 Month Bank Statements    |       | 278,024                           |       | 5.3                                 | %          | 7.0                           | %          | 638                                  |       | 221                             |       | 83.0                       | %          | 91.9                        | %          |
| Limited Documentation       |       | 28,486                            |       | 0.5                                 | %          | 7.0                           | %          | 634                                  |       | 209                             |       | 80.5                       | %          | 92.4                        | %          |
| Total                       |       | $                                 | 5,272,479  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |   |
| Weighted Average            |       |                              |       |                                |       | 6.9                           | %          | 650                                  |       | $                               | 190        |                       | 82.2       | %                           | 92.6       | % |

 

*CreditScore*

 
| ** **       | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent  Full  Documentation** | ** ** |
|------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| 500 – 549   |       | $                                 | 311,110    |                                | 5.9        | %                             | 8.0        | %                                    | 531        |                            | $          | 137                        |       | 80.1                        | %          | 81.4                             | %          | 81.8 | % |
| 550 – 599   |       | 787,572                           |       | 15.0                                | %          | 7.5                           | %          | 576                                  |       | 160                             |       | 82.2                       | %          | 85.7                        | %          | 75.2                             | %          |
| 600 – 649   |       | 1,366,716                         |       | 25.9                                | %          | 6.9                           | %          | 627                                  |       | 191                             |       | 82.4                       | %          | 91.4                        | %          | 63.5                             | %          |
| 650 – 699   |       | 1,788,059                         |       | 33.9                                | %          | 6.7                           | %          | 674                                  |       | 210                             |       | 82.2                       | %          | 95.9                        | %          | 26.4                             | %          |
| 700 or greater   |       | 1,019,022                         |       | 19.3                                | %          | 6.6                           | %          | 733                                  |       | 209                             |       | 82.7                       | %          | 97.1                        | %          | 20.0                             | %          |
| Total            |       | $                                 | 5,272,479  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted Average |       |                              |       |                                |       | 6.9                           | %          | 650                                  |       | $                               | 190        |                       | 82.2       | %                           | 92.6       | %                                | 45.3       | % |

 

52

----

 

*ProductType*

 
| ** **           | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent of  Mortgage  Pool** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent  Full  Documentation** | ** ** |
|----------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| 2/28 LIBOR ARM       |       | $                                 | 1,629,526  |                                | 30.9       | %                             | 7.3        | %                                    | 624        |                            | $          | 141                        |       | 82.2                        | %          | 90.8                             | %          | 54.4 | % |
| 2/28 LIBOR ARM IO    |       | 2,800,252                         |       | 53.1                                | %          | 6.7                           | %          | 664                                  |       | 253                             |       | 82.2                       | %          | 94.3                        | %          | 37.9                             | %          |
| 3/27 LIBOR ARM       |       | 217,971                           |       | 4.1                                 | %          | 7.4                           | %          | 622                                  |       | 147                             |       | 82.0                       | %          | 89.9                        | %          | 62.9                             | %          |
| 3/27 LIBOR ARM IO    |       | 328,587                           |       | 6.3                                 | %          | 6.8                           | %          | 660                                  |       | 253                             |       | 81.3                       | %          | 91.4                        | %          | 45.3                             | %          |
| 5/25 Treasury ARM    |       | 25,293                            |       | 0.5                                 | %          | 6.5                           | %          | 656                                  |       | 174                             |       | 78.5                       | %          | 85.4                        | %          | 65.3                             | %          |
| 5/25 Treasury ARM IO |       | 69,186                            |       | 1.3                                 | %          | 6.3                           | %          | 671                                  |       | 271                             |       | 81.0                       | %          | 89.8                        | %          | 63.5                             | %          |
| Fixed Rate           |       | 115,890                           |       | 2.2                                 | %          | 7.4                           | %          | 649                                  |       | 151                             |       | 78.8                       | %          | 86.4                        | %          | 66.0                             | %          |
| Fixed Rate IO        |       | 22,731                            |       | 0.4                                 | %          | 6.9                           | %          | 668                                  |       | 237                             |       | 80.3                       | %          | 90.8                        | %          | 54.0                             | %          |
| 6 Month ARM IO       |       | 4,795                             |       | 0.1                                 | %          | 6.5                           | %          | 681                                  |       | 208                             |       | 80.7                       | %          | 92.7                        | %          | 25.3                             | %          |
| 2nd Liens            |       | 58,248                            |       | 1.1                                 | %          | 10.0                          | %          | 713                                  |       | 55                              |       | 99.5                       | %          | 99.5                        | %          | 11.8                             | %          |
| Total                |       | $                                 | 5,272,479  |                                | 100.0      | %                             |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted Average     |       |                              |       |                                |       | 6.9                           | %          | 650                                  |       | $                               | 190        |                       | 82.2       | %                           | 92.6       | %                                | 45.3       | % |

 

***Core Financial Measures***

 

***Core Net Income and Core Earnings Per Share(Diluted)***

 

Core net income and core earnings per share(diluted) are non-GAAP financial measures within the meaning ofRegulation G promulgated by the SEC. Management believes that thepresentation of core net income and core earnings per share (diluted) providesuseful information to investors regarding financial performance because thismeasure excludes the non-cash mark to market gains or losses on interest rateswap and cap agreements. The presentation of core net income and core earningsper share (diluted) is not meant to be considered in isolation or as a substitutefor financial results prepared in accordance with GAAP.

 

As required by Regulation G, a reconciliationof net income and earnings per share (diluted) in the consolidated statementsof operations, presented in accordance with GAAP, to core net income and coreearnings per share (diluted) is provided below for the three and nine monthsended September 30, 2005 and 2004 (in thousands):

 
| ** **                                                                                                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ***Core  net income:***                                                                                                           |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                                                                                                        |       | $                                     | 23,424     |                                 | 3,951      |   | 88,603 |   | 30,303 |   |
| Less: Mark to  market (gain) loss on portfolio derivatives included in “Other income  (expense) – portfolio derivatives |       |                                  |       |                                 |       |   |   |   |   |
| Mark to market  interest rate swaps                                                                                               |       | (7,858                                | )          | 11,023                               |       | (16,628 | ) | (5,296 | ) |
| Mark to market  interest rate cap                                                                                                 |       | 228                                   |       | 1,096                                |       | 457 |   | 1,519 |   |
| Total mark to  market on portfolio derivatives                                                                                    |       | (7,630                                | )          | 12,119                               |       | (16,171 | ) | (3,777 | ) |
| Less:  Amortization of interest rate swap buydown payments                                                                        |       | (224                                  | )          | —                               |       | (224 | ) | — |   |
| Core net income                                                                                                                   |       | $                                     | 15,570     |                                 | 16,070     |   | 72,208 |   | 26,526 |   |
|                                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| ***Core  earnings per share (diluted):***                                                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Net income  available to common shareholders                                                                                      |       | $                                     | 23,424     |                                 | 3,951      |   | 88,603 |   | 30,303 |   |
| Less: Mark to  market (gain) loss on portfolio derivatives                                                                        |       | (7,630                                | )          | 12,119                               |       | (16,171 | ) | (3,777 | ) |
| Amortization of  interest rate swap buydown payments                                                                              |       | (224                                  | )          | —                               |       | (224 | ) | — |   |
| Unvested  restricted stock dividends                                                                                              |       | (187                                  | )          | (125                                 | )          | (363 | ) | (162 | ) |
| Core net income  available to common shareholders                                                                                 |       | $                                     | 15,383     |                                 | 15,945     |   | 71,845 |   | 26,364 |   |
|                                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Earnings per  share – diluted                                                                                                |       | $                                     | 0.48       |                                 | 0.08       |   | 1.82 |   | 0.62 |   |
| Core earnings  per share – diluted                                                                                           |       | $                                     | 0.32       |                                 | 0.33       |   | 1.48 |   | 0.54 |   |
|                                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Diluted weighted  average common shares outstanding                                                                               |       | 48,479,152                            |       | 48,481,516                           |       | 48,478,654 |   | 48,527,501 |   |

 

53

----

 

Core net income for the three months ended September30, 2005 was $15.6 million, or $0.32 per share (diluted), a decrease of$0.5 million from the $16.1 million core net income, or $0.33 pershare (diluted) for the third quarter of 2004. This decrease was due primarilyto a 1.0% reduction in core net yield on loans held for investment coupled withan increase in the provision for loan losses – loans held for investmentreflecting higher portfolio delinquencies as expected with a more seasoned loanportfolio.

 

Core net income for the nine months ended September30, 2005 was $72.2 million, or core earnings per share (diluted) of $1.48,an increase of $45.7 million from the $26.5 million core net income,or core earnings per share (diluted) of $0.54 for the nine months endedSeptember 30, 2004.  Core net income inthe nine months ended September 30, 2005 was higher than the nine months endedSeptember 30, 2004 due to the growth of the investment portfolio to an averagebalance of $4.8 billion during 2005 compared to an average balance of $2.6billion during the nine months ended September 30, 2004.

 

***Core Net Interest Income and Margin***

 

Core net interest income after provision for loanlosses is a non-GAAP financial measure within the meaning of Regulation Gpromulgated by the SEC. Management believes that the presentation of core netinterest income after provision for loan losses provides useful information toinvestors because this measure includes the effect of the net cash settlementson the existing interest rate swap and cap agreements economically hedging thevariable rate debt financing the portfolio of mortgage loans and the net cashsettlements incurred or paid to terminate those derivatives prior to maturity.Core net interest income after provision for loan losses does not include thenet cash settlements incurred or paid to terminate swaps or caps related toloans ultimately sold. The presentation of core net interest income afterprovision for loan losses is not meant to be considered in isolation or as asubstitute for financial results prepared in accordance with GAAP.

 

As required by Regulation G, a reconciliationof net interest income after provision for loan losses in the consolidated statementsof operations, presented in accordance with GAAP, to core net interest incomeafter provision for loan losses is provided below for the three and nine monthsended September 30, 2005 and 2004 (in thousands): 

 
| ** **                                                                                                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ***Core  net interest income after provision for loan losses:***                                                                            |       |                                  |       |                                 |       |   |   |   |   |
| Net interest  income after provision for loan losses                                                                                        |       | $                                     | 24,228     |                                 | 38,848     |   | 107,809 |   | 91,321 |   |
| Plus: Net cash  settlements received (paid) on portfolio derivatives included in “Other  income (expense) – portfolio derivatives |       | 8,000                                 |       | (2,913                               | )          | 10,369 |   | (8,265 | ) |
| Less:  Amortization of interest rate swap buydown payments                                                                                  |       | (224                                  | )          | —                               |       | (224 | ) | — |   |
| Core net  interest income after provision for loan losses                                                                                   |       | $                                     | 32,004     |                                 | 35,935     |   | 117,954 |   | 83,056 |   |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Interest income  loans held for investment                                                                                                  |       | $                                     | 84,940     |                                 | 60,141     |   | 248,350 |   | 130,139 |   |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Interest expense  loans held for investment                                                                                                 |       | 54,361                                |       | 20,274                               |       | 134,742 |   | 38,705 |   |
| Plus: Net cash  settlements received (paid) on portfolio derivatives                                                                        |       | (8,000                                | )          | 2,913                                |       | (10,369 | ) | 8,265 |   |
| Plus:  Amortization of interest rate swap buydown payments                                                                                  |       | 224                                   |       | —                               |       | 224 |   | — |   |
| Core interest  expense – loans held for investment                                                                                     |       | 46,585                                |       | 23,187                               |       | 124,597 |   | 46,970 |   |
| Core net  interest income loans held for investment                                                                                         |       | 38,355                                |       | 36,954                               |       | 123,753 |   | 83,169 |   |
| Provision for  loan losses loans held for investment                                                                                        |       | 11,045                                |       | 5,921                                |       | 22,402 |   | 14,878 |   |
| Core net  interest income loans held for investment after provision for loan losses                                                         |       | 27,310                                |       | 31,033                               |       | 101,351 |   | 68,291 |   |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Net interest  income loans held for sale                                                                                                    |       | 4,694                                 |       | 4,902                                |       | 16,603 |   | 14,765 |   |
| Core net  interest income after provision for loan losses                                                                                   |       | $                                     | 32,004     |                                 | 35,935     |   | 117,954 |   | 83,056 |   |
| ***Core  yield analysis:***                                                                                                                 |       |                                  |       |                                 |       |   |   |   |   |
| ***Core  yield analysis – loans held for investment:***                                                                                |       |                                  |       |                                 |       |   |   |   |   |
| Yield on loans  held for investment                                                                                                         |       | 6.7                                   | %          | 6.5                                  | %          | 6.8 | % | 6.6 | % |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Cost of  financing for loans held for investment                                                                                            |       | 4.3                                   | %          | 2.3                                  | %          | 3.8 | % | 2.1 | % |
| Net cash settlements  (received) paid on portfolio derivatives                                                                              |       | (0.6                                  | )%         | 0.3                                  | %          | (0.3 | )% | 0.5 | % |
| Amortization of  interest rate swap buydown payments                                                                                        |       | 0.0                                   | %          | 0.0                                  | %          | 0.0 | % | 0.0 | % |
| Core cost of  financing for loans held for investment                                                                                       |       | 3.7                                   | %          | 2.6                                  | %          | 3.5 | % | 2.6 | % |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Net yield on  loans held for investment                                                                                                     |       | 2.4                                   | %          | 4.3                                  | %          | 3.1 | % | 4.6 | % |
| Net cash  settlements received (paid) on portfolio derivatives                                                                              |       | 0.6                                   | %          | (0.3                                 | )%         | 0.3 | % | (0.4 | )% |
| Amortization of  interest rate swap buydown payments                                                                                        |       | 0.0                                   | %          | 0.0                                  | %          | 0.0 | % | 0.0 | % |
| Core net yield  on loans held for investment                                                                                                |       | 3.0                                   | %          | 4.0                                  | %          | 3.4 | % | 4.2 | % |
| Provision for  loan losses – loans held for investment                                                                                 |       | (0.9                                  | )%         | (0.6                                 | )%         | (0.6 | )% | (0.8 | )% |
| Core yield on  loans held for investment after provision for loan losses                                                                    |       | 2.1                                   | %          | 3.4                                  | %          | 2.8 | % | 3.4 | % |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| ***Core  yield analysis – loans held for sale:***                                                                                      |       |                                  |       |                                 |       |   |   |   |   |
| Yield on loans  held for sale                                                                                                               |       | 6.5                                   | %          | 7.4                                  | %          | 6.8 | % | 7.2 | % |
| Cost of  financing for loans held for sale                                                                                                  |       | 4.5                                   | %          | 2.7                                  | %          | 4.3 | % | 2.5 | % |
| Net yield on  loans held for sale                                                                                                           |       | 3.1                                   | %          | 5.6                                  | %          | 3.8 | % | 5.6 | % |
|                                                                                                                                        |       |                                  |       |                                 |       |   |   |   |   |
| ***Core  yield analysis – loans held for investment and loans held for sale:***                                                        |       |                                  |       |                                 |       |   |   |   |   |
| Yield- net  interest income on loans held for sale and loans held for investment after  provision for loan losses                           |       | 1.7                                   | %          | 3.9                                  | %          | 2.6 | % | 4.1 | % |
| Net cash  settlements received (paid) on portfolio derivatives                                                                              |       | 0.6                                   | %          | (0.3                                 | )%         | 0.3 | % | (0.4 | )% |
| Amortization of  interest rate swap buydown payments                                                                                        |       | 0.0                                   | %          | 0.0                                  | %          | 0.0 | % | 0.0 | % |
| Core yield – net  interest income on loans held for sale and loans held for investment after  provision for loan losses                |       | 2.3                                   | %          | 3.6                                  | %          | 2.9 | % | 3.7 | % |

 

54

----

 

Core net interest income after provision for loanlosses was $32.0 million for the three months ended September 30, 2005, a2.3% core net interest margin, a decrease of $3.9 million compared to$35.9 million for the three months ended September 30, 2004, a 3.6% corenet interest margin. Core net interest income after provision for loan losseswas $118.0 million for the nine months ended September 30, 2005, a 2.9%core net interest margin, an increase of $34.9 million compared to $83.1million for the nine months ended September 30, 2004, a 3.7% core net interestmargin.  Core net interest margin in thethree and nine months ended September 30, 2005 was lower than the same periodsin 2004 due to the generally lower net interest margins available on new loansadded to the portfolio as older loans financed with lower rate debt and swapswere replaced with loans with about the same interest rates that are financedby higher rate debt and swaps indexed to the rising LIBOR interest rate.

 

**Impact of New Accounting Standards**

 

In May 2005, the FASBissued Statement of Financial Accounting Standards No. 154, *“Accounting Changes and Error Corrections,”*(Statement No.154).  This Statement replaces APB OpinionNo. 20, *“Accounting Changes,”* (APB No. 20)**and FASB Statement No. 3, *“ReportingAccounting Changes in Interim Financial Statements.” *Statement No. 154 carries forwardthe guidance contained in APB No. 20 for reporting the correction of an errorin previously issued financial statements and a change in accountingestimate.  However, Statement No. 154changes the requirements for the accounting for and reporting a change inaccounting principle and requires retrospective application to prior periods’financial statements, unless it is impracticable.  It also applies to changes required by anaccounting pronouncement in the unusual instance that the pronouncement doesnot include specific transition provisions. Statement No. 154 is effective for accounting changes and corrections oferrors made in fiscal years

 

55

----

 

beginning after December 15, 2005, although earlier application ispermitted for accounting changes and corrections of errors made in fiscal yearsbeginning after June 1, 2005.  TheStatement does not change the transition provisions of any existing accountingpronouncements, including those that are in a transition phase as of theeffective date of this Statement.  TheCompany will adopt Statement No. 154, as applicable, beginning in fiscal year2006. Management does not believe that the implementation of Statement No. 154will have a material effect on our results of operations at the time of initialadoption.

 

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123R, “*ShareBased Payments*” (Statement No. 123R), requiring, among otherthings, that the compensation cost of stock options and other equity-basedcompensation issued to employees, which cost is based on the estimated fairvalue of the awards on the grant date, be reflected in the income statementover the requisite service period. Statement No. 123R is effective forinterim or annual reporting periods beginning after June 15, 2005. InMarch 2005, the SEC staff issued Staff Accounting Bulletin No. 107 (SAB No.107).  SAB No. 107 expresses the views ofthe SEC regarding Statement No. 123R and certain rules and regulations andprovides the SEC’s view regarding the valuation of share-based paymentarrangements for public companies.  InApril 2005, the SEC amended the compliance dates for StatementNo. 123R to the beginning of the next fiscal year after June 15,2005.  We have adopted the fair valuemethod of accounting for our grants of stock options and restricted stock asprescribed by Statement of Financial Accounting Standards No. 148, “*Accounting for Stock-Based Compensation-Transition and Disclosure.”*  Under this method, compensation cost ismeasured at the grant date based on the fair value of the award and is recognizedas expense on a straight-line basis over the award’s vesting period. Managementbelieves that the implementation of Statement No. 123R and SAB No. 107 will nothave a material effect on our results of operations or statements of condition.

 

**Effect ofInflation**

 

Inflation affects us most significantly in theeffect it has on interest rates and real estate values. Our level of loanoriginations is affected by the level and trends of interest rates. Interestrates normally increase during periods of high inflation (or in periods whenthe Federal Reserve Bank raises short-term interest rates in an attempt toprevent inflation) and decrease during periods of low inflation. In addition,inflation of real estate values increases the equity homeowners have in theirhomes and increases the volume of refinancing loans we can originate asborrowers draw down on the increased equity in their homes. We believe thatreal estate inflation will improve the performance of the loans originated byus in the past, reducing delinquencies and defaults, as borrowers protect orborrow against the equity in their homes.

 

**ITEM3.**                    QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

**General**

 

We carryinterest-sensitive assets on our balance sheet that are financed by interest-sensitiveliabilities. We are subject to interest rate risk because the interval forre-pricing of the assets and liabilities is not matched. An increase ordecrease in interest rates would affect our net interest income and the fairvalue of our mortgage loans held for investment and held for sale as well asthe related financing. We employ hedging strategies to manage the interest-raterisk inherent in our assets and liabilities. These strategies are designed tocreate gains when movements in interest rates would cause our cash flows or thevalue of our assets to decline and to result in losses when movements ininterest rates cause our cash flows or the value of our assets to increase.

 

The interest rates on ourhybrid ARM loans held for investment are fixed for the first two to five yearsof the loan, after which the interest rates reset every six months to thethen-current market rate. The interest rates on the bonds financing these loansreset to current market rates each month during the entire term of the loan.During the period we are receiving fixed rate payments on our loans, we useinterest rate swaps to pay fixed interest rate payments to the swapcounter-party, and receive variable interest rate payments which match theinterest rates on our financing interest costs. The swap of “variable forfixed” rates allows us to match fund our loans during the fixed rate period ofthe hybrid loans.

 

56

----

 

There have not been anysignificant changes in our interest rate risk profile and our strategies tomanage interest rate risk from December 31, 2004 to September 30, 2005.For further information on our interest rate risk profile, refer to Item 7A,“Quantitative and Qualitative Disclosures about Market Risk” contained in our2004 Form 10-K.

 

**Effects of interest ratevolatility**

 

Changes in interest ratesimpact our earnings and cash flows in several ways. Interest rate changes canaffect our net interest income on our hybrid mortgages held for investment (netof the cost of financing these assets). We estimate the duration of our hybridloans in our investment portfolio and our policy is to hedge the financing ofthe loans during the period in which the loans are paying a fixed coupon, whilebeing financed with floating rate debt indexed to LIBOR. During an increasinginterest rate environment, our assets may prepay slower than expected,requiring us to finance a higher amount of fixed assets with floating rate debtthan originally anticipated, at a time when interest rates may be higher,resulting in a decline in our net return. In order to manage our exposure tochanges in the prepayment speed of our hybrid loan assets, we regularly monitorthe portfolio balance, revise the amounts anticipated to be outstanding infuture periods and adjust the notional balance of our hedging derivatives tomitigate this risk.

 

During a rising interestrate environment, there may be less total loan origination and refinanceactivity. At the same time, a rising interest rate environment may result in alarger percentage of ARM products being originated, mitigating the impact oflower overall loan origination and refinance activity. Conversely, during adeclining interest rate environment, consumers, in general, may favor fixedrate mortgage products over ARM and hybrid products.

 

If interest ratesdecline, the rate of prepayment on our mortgage assets may increase during thetwo to three year initial life of our loans held for investment. Increasedprepayments would cause us to amortize the deferred origination costs of ourmortgage assets faster, resulting in a reduced yield on our mortgage assets.Additionally, to the extent proceeds of prepayments cannot be reinvested at arate of interest at least equal to the rate previously earned on such mortgageassets, our earnings may be adversely affected. Conversely, if interest ratesrise, the rate of prepayment on our mortgage assets during the initial fixedpay period of the assets’ life may decrease. Decreased prepayments would causeus to amortize the deferred origination costs of our ARM assets over a longertime period, resulting in an increased yield on our mortgage assets.

 

**ITEM 4.**                   CONTROLS ANDPROCEDURES.

 

**Evaluationof Disclosure Controls and Procedures**

 

Our principal executiveofficer, Michael J. Sonnenfeld, and our principal financial officer andprincipal accounting officer, Teresa McDermott, evaluated as of September 30,2005, the effectiveness of the design and operation of our disclosure controlsand procedures that are designed to ensure that information required to bedisclosed by us in the reports that we file with or submit to the SEC under theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andregulations.  As a result of thisevaluation, these executive officers have concluded that, as of such date, thedesign and operation of our disclosure controls and procedures were effective.

 

**Changesin Internal Controls**

 

In connection with theevaluation described above, our principal executive officer and principalfinancial and accounting officer identified no change in our internal controlover financial reporting that occurred during the three months ended September30, 2005, and that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

57

----

 

**PART II**

 

**ITEM1.**                    LEGALPROCEEDINGS.

 

On October 28,2005, in the Company’s defense of the suit filed by its former shareholders, theCompany served a cross claim against KPMG LLP (“KPMG”) in the matter of *820 Management Trust et al. v. Fieldstone Investment Corporation (FIC),Fieldstone Mortgage Company (FMC) and KPMG LLP* (the “820 ManagementTrust Lawsuit”).  The cross claim wasfiled in the District Court of Tarrant County, Texas, where the 820 ManagementTrust Lawsuit is pending.  The 820Management Trust Lawsuit is an action filed by certain of FIC’s formershareholders, alleging that the shareholders whose shares were redeemed out ofthe proceeds of the 144A Offering are entitled to an additional post-closingredemption price payment of approximately $19.0 million, plus interest andattorney fees. The former shareholders were paid $188.1 million for theirshares on November 14, 2003 and the Redemption Agreement between theshareholders and the Company required an adjustment to the redemption price bepaid to the shareholders based on the Company’s November 13, 2003 balancesheet, as audited by KPMG, the Company’s former auditors, pursuant to which theCompany paid an additional $1.8 million to the former shareholders on February18, 2004.  Following notification by theredeemed shareholders of their objection to the Company’s November 13,2003 balance sheet, KPMG, on April 20, 2004 advised the Company that its auditof the November 13, 2003 balance sheet should no longer be relied upon.  The Company’s cross claim asserts, among otherclaims, that KPMG’s withdrawal of its audit report on the November 13, 2003balance sheet was improper and that due to this improper withdrawal the Companysuffered damages.  In addition, the crossclaim asserts that in the event the former shareholders prevail in the 820Management Trust Lawsuit, KPMG negligently advised FIC regarding the November13, 2003 balance sheet giving rise to this dispute.  The cross claim seeks a judgment against KPMGin an unspecified amount in excess of approximately $1 million, plusprejudgment interest for the attorneys fees and cost incurred in the abovereferenced matter.  See Part 1 Item 3 ofthe Company’s Annual Report on Form 10-K for the fiscal year ending on December31, 2004 filed with the SEC on March 25, 2005 for a description of the 820Management Trust Lawsuit.

 

*Arredondo, et al. v. FieldstoneInvestment, et al.**,*isan action filed on August 3, 2004 in the United States District Court for theDistrict of Arizona by nine former employees of Fieldstone Mortgage Companyalleging that that their supervisors and co-workers created a hostile workenvironment resulting from gender discrimination, racial discrimination andretaliation in the workplace pursuant to Title VII of the Civil Rights Act of1964, 42 U.S.C. §2000e, and the Civil Rights Act of 1866, 42 U.S.C. §1981, asamended by the Civil Rights Act of 1991, 42 U.S.C. §1981(a). Plaintiffs claimthat they are entitled to money damages in the form of back pay and front payand nominal, compensatory and punitive damages, costs and attorney fees andequitable relief.  The Company filed itsanswer denying all relevant claims on August 25, 2004.  In addition, theCompany filed a variety of motions seeking to have some of the plaintiffsdismissed from the lawsuit for failure to exhaust their administrativeremedies, to dismiss other claims as not being permitted under the statute, andfinally to sever the plaintiffs for trial purposes.  Plaintiffs filed aresponse to the Company’s motion to dismiss, sever or in the alternative,bifurcate, and on April 18, 2005, the Company’s motion to dismiss wasdenied.  The parties are currently in theprocess of discovery and no trial date has yet been set; however, motions forsummary judgment are due no later than June 21, 2006. Due to the uncertainnature of the litigation at this time, the Company is unable to estimate theprobable outcome of this matter.  Theplaintiffs in this matter have not specified damages sought and the Company istherefore unable to estimate potential exposure. While the Company intends tovigorously defend this matter, there can be no assurance that an adverseoutcome would not have a material effect on the Company’s results ofoperations.

 

The Company issubject to various legal proceedings in the ordinary course of its businessrelated to foreclosures, bankruptcies, condemnation and quiet title actions andalleged statutory and regulatory violations. The Company’s management believesthat any liability with respect these legal actions, individually or in theaggregate, will not have a material adverse effect on the Company’s business,results of operations or financial position.

 

For information on othermaterial legal proceedings, see our Annual Report on Form 10-K, as amended, forthe fiscal year ended December 31, 2004.

 

58

----

 

**ITEM 5.   OTHER INFORMATION.**

 

**Amendment to Merrill Lynch MasterRepurchase Agreement**

 

On November 9, 2005, Fieldstone InvestmentCorporation and Fieldstone Mortgage Company entered into a fourth amendment(the “Fourth Amendment”) to that certain Master Repurchase Agreement dated asof November 12, 2004, as amended, with Merrill Lynch Bank USA (the “ML RepurchaseAgreement”).  The Fourth Amendmentextends the termination date from November 11, 2005 to December 9, 2005.  The Amendment did not change any othermaterial terms of the ML Repurchase Agreement and did not affect the amountoutstanding under the ML Repurchase Agreement.

 

**Repurchase Agreement with CreditSuisse, New York Branch**

 

On November 8,2005, Fieldstone Investment Corporation and Fieldstone Mortgage Company (collectivelythe “Sellers”), entered into (a) a Master Repurchase Agreement (the “RepurchaseAgreement”) by and among the Sellers and Credit Suisse, New York Branch(“CSFB”), as Administrative Agent for the benefit of the several Conduit Buyersand Committed Buyers party thereto from time to time (the “RepurchaseAgreement”).  Simultaneously with such execution, Fieldstone InvestmentFunding, LLC (“Fieldstone Funding”), a direct wholly owned subsidiary ofFieldstone Investment Corporation, and Fieldstone Investment Corporation terminatedthe Funding Agreement by and among Fieldstone Funding, Fieldstone Investment Corporationand CSFB, as Facility Agent for the benefit of the Group Agents and Lenders,and the several Conduit Lenders, Committed Lenders and Group Lenders a partythereto from time to time, dated as of July 27, 2005 (as amended, the “FundingAgreement”) and the ancillary transaction documents related thereto.  The Repurchase Agreement replaces the FundingAgreement, which is filed as Exhibit 10.1 to this report.

 

The RepurchaseAgreement sets forth the terms for a repurchase facility (the “Facility”) underwhich the Sellers may sell and CSFB must purchase, mortgage loans which meetthe eligibility criteria set forth thereunder (the “Mortgage Loans”), up to amaximum outstanding aggregate amount of $600,000,000.00, and the terms pursuantto which the Sellers must repurchase such Mortgage Loans from CSFB. Terms forthe purchase of the Mortgage Loans consist of an advance rate of 92.5% of themarket value of the Mortgage Loans, and an interest rate of one month LIBOR +0.23% (or, with respect to wet-ink Mortgage Loans, one month LIBOR + 0.43%),with a monthly administrative fee equal to (i) 0.02% per annum multiplied by(ii) the weighted average daily Facility outstanding principal for suchcalendar month. The Facility is scheduled to remain open until July 26,2006 and is subject to other customary terms and conditions relating tointerest rates, facility fees, limits on recourse obligations, and othercovenants, including maintenance of certain financial covenants, including,among other things: (a) the Sellers’ (x) combined ratio of consolidatedindebtedness to Consolidated Adjusted Tangible Net Worth (as defined under theRepurchase Agreement) must not exceed 16:1 and (y) combined ratio ofconsolidated indebtedness (net of non-recourse indebtedness) to ConsolidatedAdjusted Tangible Net Worth must not exceed 10:1, (b) the Sellers must maintaincash, cash equivalents and unencumbered Mortgage Loans held for sale orsecuritization of at least $15 million and (c) the Sellers must maintain aConsolidated Adjusted Tangible Net Worth of at least $400 million.

 

The RepurchaseAgreement also includes customary events of default including, among otherthings, (a) the Sellers’ failure to make any payment due and owing to CSFBthereunder; (b) the Sellers’ failure to cure any margin deficit arising as aresult of a decrease in the value of the Mortgage Loans, (c) an act of insolvencyoccurs with respect to either Sellers, (d) any of the Sellers’ representationsand warranties set forth in the Repurchase Agreement are found to be incorrector untrue in any material respect; (e) the Sellers’ failure to maintain thefinancial covenants set forth thereunder, or (f) the failure of FieldstoneInvestment to at any time continue to be qualified as a real estate investmenttrust as defined in Section 856 of the Code.

 

In the event of anevent of default by the Sellers, CSFB has the right to accelerate therepurchase date under the Facility, to cause all income generated by theMortgage Loans to be applied to the unpaid repurchase price of the MortgageLoans, and to direct the applicable servicers of the Mortgage Loans to remitpayment directly to CSFB.  In addition,the Sellers shall be liable to CSFB for (i) all reasonable legal fees incurredby CSFB incurred in connection with the event of default, (ii) all costs ofentering into replacement transactions and entering into or terminating hedge

 

59

----

 

transactions in connection with or as a result of the event of default,and (iii) any other damages, losses, costs or expenses directly arising orresulting from the occurrence of the event of default.

 

**Termination of Guaranty BankFacility**

 

Effective November9, 2005, Fieldstone Mortgage Company entered into a Termination Letter (the“Termination Letter”) with Guaranty Bank (“Guaranty”).  The parties previously entered into theMortgage Loan Purchase and Sale Agreement dated as of July 23, 2003 (the“Purchase Agreement”), which provided for an uncommitted amount of allowableborrowing not to exceed $50,000,000.  ThePurchase Agreement contained no stated maturity date and Fieldstone Mortgage Companyhas never borrowed under the Purchase Agreement.  The Termination Letter terminated thePurchase Agreement effective as of November 9, 2005.

 

**Extended Severance Benefit**

 

On November 11,2005, Fieldstone Investment Corporation entered into a severance agreement withMr. John Kendall, its Senior Vice President – Investment Portfolio, pursuant towhich, after a change in control, Mr. Kendall would be entitled to a lump sumpayment equal to 24 months’ salary if, within 12 months following theconsummation of the change in control, he were to be terminated for a reasonother than cause or if he terminated his employment for good reason.

 

**Increase in Audit CommitteeChairperson Annual Retainer**

 

On November 2,2005, upon the recommendation of the Compensation Committee, the Board ofDirectors approved an increase in the Audit Committee Chairman’s annualretainer from $5,000 to $10,000.  Theincrease in the Audit Committee Chairman’s annual retainer will be effectiveJanuary 1, 2006.

 

**ITEM6.**                    EXHIBITS.

 

Theexhibits required by this Item are set forth on the Exhibit Index attachedhereto.

 

60

----

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                    | Fieldstone  Investment Corporation |
|-------------------------|------------------------------------|
|                    | (registrant)                       |
|                    |                               |
|                    |                               |
| Date: November 14, 2005 | By:                                | /s/ Michael  J. Sonnenfeld |   |
|                    |                               | Michael J. Sonnenfeld*President and Chief Executive Officer* |
|                    |                               |   |
| Date: November 14, 2005 | By:                                | /s/ Teresa  McDermott |   |
|                    |                               | Teresa McDermott*Principal Financial Officer and Principal  Accounting Officer* |

 

61

----

 

**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                          |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1(1)             |       | Funding  Agreement, dated July 27, 2005, among Fieldstone Investment Corporation,  Fieldstone Investment Funding, LLC and Credit Suisse, New York Branch as  facility agent, the several conduit lenders, committed lenders and group  agents a party thereto from time to time. (Filed herewith)                        |
| 10.1(2)             |       | Fieldstone  Investment Funding, LLC Fee Letter, dated July 27, 2005, by and between  Fieldstone Investment Funding, LLC and Credit Suisse, New York Branch. (Filed  herewith)                                                                                                                                            |
| 10.1(3)             |       | Funding  Agreement Termination Letter dated November 8, 2005 by and between Credit  Suisse, New York Branch, Fieldstone Investment Funding, LLC, Fieldstone  Investment Corporation and Alpine Securitization Corp. (Filed herewith)                                                                                     |
| 10.2(1)             |       | Master  Repurchase Agreement by and among Credit Suisse, New York Branch, as administrative  agent, Fieldstone Investment Corporation, as seller, Fieldstone Mortgage  Company, as seller, and the several conduit buyers and committed buyers party  thereto from time to time dated November 8, 2005. (Filed herewith) |
| 10.2(2)             |       | Pricing  Letter, dated November 8, 2005, by and among Credit Suisse, New York Branch,  as administrative agent, Fieldstone Mortgage Company, as seller, and  Fieldstone Investment Corporation, as seller. (Filed herewith)                                                                                              |
| 10.3(1)             |       | First  Amendment to Master Repurchase Agreement, dated as of May 10, 2005,  among Merrill Lynch Bank USA, Fieldstone Mortgage Company and Fieldstone  Investment Corporation. (Filed herewith)                                                                                                                      |
| 10.3(2)             |       | Second  Amendment to Master Repurchase Agreement, dated as of June 1, 2005,  among Merrill Lynch Bank USA, Fieldstone Mortgage Company and Fieldstone  Investment Corporation. (Filed herewith)                                                                                                                     |
| 10.3(3)             |       | Third  Amendment to Master Repurchase Agreement, dated as of July 11, 2005,  among Merrill Lynch Bank USA, Fieldstone Mortgage Company and Fieldstone  Investment Corporation. (Filed herewith)                                                                                                                     |
| 10.3(4)             |       | Fourth  Amendment to Master Repurchase Agreement, dated as of November 9, 2005,  among Merrill Lynch Bank USA, Fieldstone Mortgage Company and Fieldstone  Investment Corporation. (Filed herewith)                                                                                                                 |
| 10.4                |       | Extended  Severance Benefit Agreement by and between Fieldstone Investment Corporation  and John Kendall dated November 11, 2005. (Filed herewith)                                                                                                                                                                       |
| 10.5                |       | Audit  Committee Chairperson Compensation, effective January 1, 2006. (Filed  herewith)                                                                                                                                                                                                                                  |
| 31.1                |       | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934 as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. (Filed herewith)                                                                                                   |
| 31.2                |       | Certification  of Principal Financial Officer pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934 as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. (Filed herewith)                                                                                               |
| 32.1                |       | Certification  of Chief Executive Officer and Principal Financial Officer pursuant to 18  U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. (Filed herewith)                                                                                                          |

 

62

----