** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

----

**FORM 10-Q**

**(Mark One)**
| **x**                                                                                                                                                                            | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                       | ** ** | ** **                                                                                              |
| **For the  quarterly period ended March 31, 2006**                                                                                                                          |
| ** **                                                                                                                                                                       | ** ** | ** **                                                                                              |
| **o**                                                                                                                                                                            | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                       | ** ** | ** **                                                                                              |
| **For the  transition period  from          to             ** |

** **

**CommissionFile Number: 000-50938**

**Fieldstone Investment Corporation**

(Exact name of registrant as specified in its charter)

 

| **Maryland**                                                    | **74-2874689**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |

 

| **11000 Broken Land Parkway  Columbia, MD** | **21044**  | **410-772-7200**                      |
|---------------------------------------------|------------|---------------------------------------|
| (Address of principal executive offices)    | (Zip Code) | (Telephone No.,  including area code) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes x Noo

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  o        AcceleratedFiler  o        Non-acceleratedFiler  x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act).  Yes  o   No  x

Number of shares ofCommon Stock outstanding as of May 1, 2006:  48,536,485

 

----

**Table of Contents**
|                  | ** ** | ** **                                                                                       | ** ** | **Page** | ** ** |
|------------------|------------|--------------------------------------------------------------------------------------------------|------------|----------|------------|
| **Part I**  |       | FINANCIAL  INFORMATION                                                                           |       |     | 1          |   |   |
| **Item  1.**     |       | Financial  Statements                                                                            |       |     | 1          |   |   |
| ** **       |       | Condensed Consolidated Statements of Condition                                                   |       |     | 1          |   |   |
| ** **       |       | Condensed Consolidated Statements of Operations                                                  |       |     | 2          |   |   |
| ** **       |       | Condensed Consolidated Statements of Shareholders’  Equity                                  |       |     | 3          |   |   |
| ** **       |       | Condensed Consolidated Statements of Cash Flows                                                  |       |     | 4          |   |   |
| ** **       |       | Notes to Condensed Consolidated Financial Statements                                             |       |     | 5          |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 2.**      |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |       |     | 26         |   |   |
|             |       | Executive Overview                                                                               |       |     | 26         |   |   |
|             |       | Key Components of Financial Results of Operations                                                |       |     | 28         |   |   |
|             |       | Critical  Accounting Policies                                                                    |       |     | 29         |   |   |
|             |       | Results of Operations                                                                            |       |     | 33         |   |   |
|             |       | Consolidated Statements of Condition                                                             |       |     | 39         |   |   |
|             |       | Business Segment Results                                                                         |       |     | 45         |   |   |
|             |       | Liquidity and Capital Resources                                                                  |       |     | 49         |   |   |
|             |       | Commitments  and Contingencies                                                                   |       |     | 53         |   |   |
|             |       | Other Operational and Investment Portfolio Data                                                  |       |     | 54         |   |   |
|             |       | Core Financial Measures                                                                          |       |     | 58         |   |   |
|             |       | Recent Accounting Pronouncements                                                                 |       |     | 62         |   |   |
|             |       | Off-Balance  Sheet Arrangements                                                                  |       |     | 63         |   |   |
|             |       | Effect of Inflation                                                                              |       |     | 63         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 3.**      |       | Quantitative and Qualitative Disclosures About Market  Risk                                      |       |     | 63         |   |   |
|             |       |                                                                                             |       |     |       |   |   |
| **Item 4.**      |       | Controls and Procedures                                                                          |       |     | 64         |   |   |
|             |       |                                                                                             |       |     |       |   |   |
| **Part II** |       | OTHER  INFORMATION                                                                               |       |     | 66         |   |   |
| **Item  1.**     |       | Legal  Proceedings                                                                               |       |     | 66         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item  1A.**    |       | Risk  Factors                                                                                    |       |     | 67         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 2.**      |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                     |       |     | 67         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 3.**      |       | Defaults Upon Senior Securities                                                                  |       |     | 67         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 4.**      |       | Submission of Matters to a Vote of Security Holders                                              |       |     | 67         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item  5.**     |       | Other  Information                                                                               |       |     | 67         |   |   |
| ** **       |       |                                                                                             |       |     |       |   |   |
| **Item 6.**      |       | Exhibits                                                                                         |       |     | 67         |   |   |
| ** **       |       | Signatures                                                                                       |       |     | 68         |   |   |
| ** **       |       | Exhibit Index                                                                               |       |     | 69         |   |   |

 

i

----

**PART I**

**ITEM1.**                    FINANCIALSTATEMENTS.

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIESCondensed Consolidated Statements of ConditionMarch 31, 2006 and December 31, 2005(Unaudited; in thousands, except share data)**
| ** **                                                                                                                                                               | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                               | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| **Assets**                                                                                                                                                               | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| Cash                                                                                                                                                                     |       | $                            | 31,020     |                            | 33,536     |   |
| Restricted cash                                                                                                                                                          |       | 255,305                      |       | 7,888                           |       |
| Mortgage loans  held for sale, net                                                                                                                                       |       | 312,836                      |       | 594,269                         |       |
| Mortgage loans  held for investment                                                                                                                                      |       | 5,532,481                    |       | 5,570,415                       |       |
| Allowance for  loan losses—loans held for investment                                                                                                                |       | (45,744                      | )          | (44,122                         | )          |
| Mortgage loans held for investment, net                                                                                                                                  |       | 5,486,737                    |       | 5,526,293                       |       |
|                                                                                                                                                                     |       |                         |       |                            |       |
| Accounts  receivable                                                                                                                                                     |       | 13,062                       |       | 7,201                           |       |
| Accrued interest  receivable                                                                                                                                             |       | 29,043                       |       | 29,940                          |       |
| Trustee  receivable                                                                                                                                                      |       | 119,771                      |       | 130,237                         |       |
| Prepaid expenses  and other assets                                                                                                                                       |       | 38,227                       |       | 31,197                          |       |
| Derivative  assets                                                                                                                                                       |       | 37,410                       |       | 35,223                          |       |
| Deferred tax  asset                                                                                                                                                      |       | 16,855                       |       | 17,679                          |       |
| Furniture and  equipment, net                                                                                                                                            |       | 9,479                        |       | 10,151                          |       |
| Total assets                                                                                                                                                             |       | $                            | 6,349,745  |                            | 6,423,614  |   |
| ** **                                                                                                                                                               |       |                         |       |                            |       |
| **Liabilities  and Shareholders’ Equity**                                                                                                                           |       |                         |       |                            |       |
| Warehouse  financing—loans held for sale                                                                                                                            |       | $                            | 252,814    |                            | 434,061    |   |
| Warehouse  financing—loans held for investment                                                                                                                      |       | 259,513                      |       | 378,707                         |       |
| Securitization  financing                                                                                                                                                |       | 5,241,266                    |       | 4,998,620                       |       |
| Reserve for  losses—loans sold                                                                                                                                      |       | 33,497                       |       | 35,082                          |       |
| Dividends  payable                                                                                                                                                       |       | 23,298                       |       | 26,689                          |       |
| Accounts  payable, accrued expenses and other liabilities                                                                                                                |       | 22,499                       |       | 23,812                          |       |
| Total liabilities                                                                                                                                                        |       | 5,832,887                    |       | 5,896,971                       |       |
|                                                                                                                                                                     |       |                         |       |                            |       |
| Commitments and  contingencies (Note 11)                                                                                                                                 |       |                         |       |                            |       |
|                                                                                                                                                                     |       |                         |       |                            |       |
| Shareholders’ equity:                                                                                                                                               |       |                         |       |                            |       |
| Common stock $0.01 par value; 90,000,000 shares  authorized; 48,536,485 and 48,513,985 shares issued as of March 31, 2006  and December 31, 2005, respectively |       | 485                          |       | 485                             |       |
| Paid-in capital                                                                                                                                                          |       | 489,602                      |       | 493,603                         |       |
| Accumulated earnings                                                                                                                                                     |       | 26,771                       |       | 37,093                          |       |
| Unearned compensation                                                                                                                                                    |       | —                       |       | (4,538                          | )          |
| Total shareholders’ equity                                                                                                                                          |       | 516,858                      |       | 526,643                         |       |
| Total  liabilities and shareholders’ equity                                                                                                                         |       | $                            | 6,349,745  |                            | 6,423,614  |   |

 

 

See accompanying notes tocondensed consolidated financial statements.

1

----

 

**FIELDSTONEINVESTMENT CORPORATION AND SUBSIDIARIESCondensed Consolidated Statements of OperationsThree Months Ended March 31, 2006 and 2005(Unaudited; in thousands, except share data)**
| ** **                                                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                                             | ** ** | **2005  (As restated-  see Note 1 (g))** | ** ** |
| Revenues:                                                                                                   |       |                                                 |       |   |   |
| Interest income:                                                                                            |       |                                                 |       |   |   |
| Loans held for investment                                                                                   |       | $                                                    | 95,113     |   | 82,836 |   |
| Loans held for sale                                                                                         |       | 6,601                                                |       | 4,287 |   |
| Total interest income                                                                                       |       | 101,714                                              |       | 87,123 |   |
| Interest  expense:                                                                                          |       |                                                 |       |   |   |
| Loans held for investment                                                                                   |       | 68,916                                               |       | 38,608 |   |
| Loans held for sale                                                                                         |       | 2,605                                                |       | 992 |   |
| Total interest expense                                                                                      |       | 71,521                                               |       | 39,600 |   |
| Net interest income                                                                                         |       | 30,193                                               |       | 47,523 |   |
| Provision for  loan losses—loans held for investment                                                   |       | 5,393                                                |       | 4,494 |   |
| Net interest income after provision for loan losses                                                         |       | 24,800                                               |       | 43,029 |   |
| Gains on sales  of mortgage loans, net                                                                      |       | 10,295                                               |       | 8,469 |   |
| Other income  (expense)—portfolio derivatives                                                          |       | 12,158                                               |       | 20,342 |   |
| Fees and other  income                                                                                      |       | 350                                                  |       | 286 |   |
| Total revenues                                                                                              |       | 47,603                                               |       | 72,126 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Expenses:                                                                                                   |       |                                                 |       |   |   |
| Salaries and employee benefits                                                                              |       | 20,869                                               |       | 17,704 |   |
| Occupancy                                                                                                   |       | 1,823                                                |       | 1,499 |   |
| Depreciation and amortization                                                                               |       | 935                                                  |       | 760 |   |
| Servicing fees                                                                                              |       | 2,569                                                |       | 2,604 |   |
| General and administration                                                                                  |       | 7,563                                                |       | 7,321 |   |
| Total expenses                                                                                              |       | 33,759                                               |       | 29,888 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Income from continuing operations before income  taxes                                                      |       | 13,844                                               |       | 42,238 |   |
| Income tax  benefit                                                                                         |       | 729                                                  |       | 157 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Income from continuing operations                                                                           |       | 14,573                                               |       | 42,395 |   |
| Discontinued  operations, net of income tax (including loss on disposal of $0.5 million;  see Note 7)  |       | (1,645                                               | )          | (641 | ) |
|                                                                                                        |       |                                                 |       |   |   |
| Net income                                                                                                  |       | $                                                    | 12,928     |   | 41,754 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Earnings per share of  common stock:                                                                        |       |                                                 |       |   |   |
| Basic:                                                                                                      |       |                                                 |       |   |   |
| Continuing operations                                                                                       |       | $                                                    | 0.30       |   | 0.87 |   |
| Discontinued operations                                                                                     |       | (0.03                                                | )          | (0.01 | ) |
| Total                                                                                                       |       | $                                                    | 0.27       |   | 0.86 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Diluted:                                                                                                    |       |                                                 |       |   |   |
| Continuing operations                                                                                       |       | $                                                    | 0.30       |   | 0.87 |   |
| Discontinued operations                                                                                     |       | (0.03                                                | )          | (0.01 | ) |
| Total                                                                                                       |       | $                                                    | 0.27       |   | 0.86 |   |
|                                                                                                        |       |                                                 |       |   |   |
| Basic weighted  average common shares outstanding                                                           |       | 48,273,985                                           |       | 48,461,987 |   |
| Diluted weighted  average common shares outstanding                                                         |       | 48,273,985                                           |       | 48,519,518 |   |

 

See accompanying notes tocondensed consolidated financial statements.

2

----

 

**FIELDSTONEINVESTMENT CORPORATION AND SUBSIDIARIESCondensed Consolidated Statements of Shareholders’ Equity**Three Months Ended March 31, 2006 and 2005(Unaudited; in thousands)

 
| ** **                                                                                      | ** ** | **Common  shares  outstanding** | ** ** | **Common  stock** | ** ** | **Paid-in  capital** | ** ** | **Accumulated  earnings** | ** ** | **Unearned  compensation** | ** ** | **Total  shareholders’  equity** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------|------------|----------------------|------------|---------------------------|------------|----------------------------|------------|---------------------------------------|------------|
| Balance at  January 1, 2006                                                                |       | 48,514                          |       | $                 | 485        |                 | $          | 493,603                   |       | $                          | 37,093     |                                  | $          | (4,538 | ) | $ | 526,643 |   |
| Restricted stock  issued                                                                        |       | 45                              |       | —            |       | —               |       | —                    |       | —                     |       | —                                |       |
| Restricted stock  forfeited                                                                     |       | (23                             | )          | —            |       | —               |       | —                    |       | —                     |       | —                                |       |
| Restricted stock  compensation expense                                                          |       | —                          |       | —            |       | 422                  |       | —                    |       | —                     |       | 422                                   |       |
| Stock options  compensation expense                                                        |       | —                          |       | —            |       | 115                  |       | —                    |       | —                     |       | 115                                   |       |
| Reclass unearned  compensation to paid-in capital upon adoption of FASB Statement No. 123R |       | —                          |       | —            |       | (4,538               | )          | —                    |       | 4,538                      |       | —                                |       |
| Dividends  declared.                                                                            |       |                            |       |              |       | —               |       | (23,250                   | )          | —                     |       | (23,250                               | )          |
| Net income                                                                                      |       | —                          |       | —            |       | —               |       | 12,928                    |       | —                     |       | 12,928                                |       |
| Balance at  March 31, 2006                                                                 |       | 48,536                          |       | $                 | 485        |                 | $          | 489,602                   |       | $                          | 26,771     |                                  | $          | — |   | $ | 516,858 |   |
|                                                                                            |       |                            |       |              |       |                 |       |                      |       |                       |       |                                  |       |
| Balance at  January 1, 2005                                                                |       | 48,856                          |       | $                 | 489        |                 | $          | 497,147                   |       | $                          | 36,430     |                                  | $          | (5,985 | ) | $ | 528,081 |   |
| Restricted stock  forfeited                                                                     |       | (23                             | )          | (1                | )          | (337                 | )          | —                    |       | 338                        |       | —                                |       |
| Restricted stock  compensation expense                                                          |       | —                          |       | —            |       | —               |       | —                    |       | 450                        |       | 450                                   |       |
| Stock options  compensation expense                                                        |       | —                          |       | —            |       | 72                   |       | —                    |       | —                     |       | 72                                    |       |
| Stock options  exercised                                                                        |       | 3                               |       | —            |       | 38                   |       | —                    |       | —                     |       | 38                                    |       |
| Costs relating  to the equity registration                                                      |       | —                          |       | —            |       | (386                 | )          | —                    |       | —                     |       | (386                                  | )          |
| Net income (as  restated-see Note 1 (g))                                                        |       | —                          |       | —            |       | —               |       | 41,754                    |       | —                     |       | 41,754                                |       |
| Balance at  March 31, 2005 (as restated-see Note 1(g))                                     |       | 48,836                          |       | $                 | 488        |                 | $          | 496,534                   |       | $                          | 78,184     |                                  | $          | (5,197 | ) | $ | 570,009 |   |

** **

See accompanying notes tocondensed consolidated financial statements.

3

----

** **

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIESCondensed Consolidated Statements of Cash FlowsThree Months Ended March 31, 2006 and 2005(Unaudited; in thousands)**
| ** **                                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                             | ** ** | **2005  (As restated-  see Note 1 (g))** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                 |       |   |   |
| Net income                                                                         |       | $                                                    | 12,928     |   | 41,754 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                      |       | 935                                                  |       | 760 |   |
| Amortization of deferred origination costs—loans  held for investment         |       | 6,871                                                |       | 5,504 |   |
| Amortization of securitization issuance costs                                      |       | 2,685                                                |       | 1,998 |   |
| Amortization of bond discount                                                      |       | 32                                                   |       | 63 |   |
| Provision for losses—loans sold                                               |       | 2,329                                                |       | 2,538 |   |
| Provision for loan losses—loans held for investment                           |       | 5,393                                                |       | 4,494 |   |
| Loss on disposal of discontinued operations                                        |       | 904                                                  |       | — |   |
| Loss from discontinued operations                                                  |       | 741                                                  |       | 641 |   |
| Increase in accounts receivable                                                    |       | (5,861                                               | )          | (1,928 | ) |
| (Increase) decrease in accrued interest receivable                                 |       | 897                                                  |       | (814 | ) |
| (Increase) decrease in trustee receivable                                          |       | 10,466                                               |       | (8,085 | ) |
| Funding of mortgage loans held for sale                                            |       | (480,522                                             | )          | (416,664 | ) |
| Proceeds from sales and payments of mortgage loans  held for sale                  |       | 658,823                                              |       | 532,997 |   |
| Increase in prepaid expenses and other assets                                      |       | (2,478                                               | )          | (2,386 | ) |
| Decrease in deferred tax asset, net                                                |       | 824                                                  |       | 346 |   |
| Increase in fair market value of derivative  instruments                           |       | (2,824                                               | )          | (19,697 | ) |
| Decrease in accounts payable, accrued expenses and  other liabilities              |       | (526                                                 | )          | (3,062 | ) |
| Stock compensation expense                                                         |       | 585                                                  |       | 522 |   |
| Net cash provided by operating activities from  continuing operations              |       | 212,202                                              |       | 138,981 |   |
| Net cash provided by (used in) operating activities  from discontinued operations  |       | 97,368                                               |       | (33,602 | ) |
| Net cash provided by operating activities                                          |       | 309,570                                              |       | 105,379 |   |
| Cash flows from  investing activities:                                             |       |                                                 |       |   |   |
| Funding of mortgage loans held for investment                                      |       | (531,782                                             | )          | (737,568 | ) |
| Payments of mortgage loans held for investment                                     |       | 543,453                                              |       | 370,031 |   |
| Increase in restricted cash                                                        |       | (247,417                                             | )          | (1,925 | ) |
| Purchase of furniture and equipment, net                                           |       | (549                                                 | )          | (370 | ) |
| Proceeds from sale of real estate owned                                            |       | 8,624                                                |       | 2,092 |   |
| Net cash used in investing activities from  continuing operations                  |       | (227,671                                             | )          | (367,740 | ) |
| Net cash provided by (used in) investing activities  from discontinued operations  |       | 101                                                  |       | (43 | ) |
| Net cash used in investing activities                                              |       | (227,570                                             | )          | (367,783 | ) |
| Cash flows from  financing activities:                                             |       |                                                 |       |   |   |
| Proceeds from warehouse financing—loans held for  sale                        |       | 317,060                                              |       | 377,382 |   |
| Repayment of warehouse financing—loans held for sale                          |       | (422,441                                             | )          | (438,918 | ) |
| Proceeds from warehouse financing—loans held for investment                   |       | 537,953                                              |       | 607,867 |   |
| Repayment of warehouse financing—loans held for  investment                   |       | (657,147                                             | )          | (707,686 | ) |
| Proceeds from securitization financing                                             |       | 904,078                                              |       | 728,625 |   |
| Repayment of securitization financing                                              |       | (661,464                                             | )          | (357,009 | ) |
| Dividends paid                                                                     |       | (26,689                                              | )          | (21,501 | ) |
| Costs relating to the equity registration                                          |       | —                                               |       | (386 | ) |
| Proceeds from exercise of stock options                                            |       | —                                               |       | 38 |   |
| Net cash provided by (used in) financing activities  from continuing operations    |       | (8,650                                               | )          | 188,412 |   |
| Net cash provided by (used in) financing activities  from discontinued operations  |       | (75,866                                              | )          | 47,121 |   |
| Net cash provided by (used in) financing activities                                |       | (84,516                                              | )          | 235,533 |   |
| Net decrease in cash                                                               |       | (2,516                                               | )          | (26,871 | ) |
| Cash at the  beginning of the period                                               |       | 33,536                                               |       | 61,681 |   |
| Cash at the end  of the period                                                     |       | $                                                    | 31,020     |   | 34,810 |   |
| Supplemental  disclosures:                                                         |       |                                                 |       |   |   |
| Cash paid for interest                                                             |       | $                                                    | 71,859     |   | 38,970 |   |
| Cash paid (received) for taxes                                                     |       | 89                                                   |       | (115 | ) |
| Non-cash operating and  investing activities:                                      |       |                                                 |       |   |   |
| Transfer from mortgage loans held for sale to real  estate owned                   |       | 468                                                  |       | 204 |   |
| Transfer from  mortgage loans held for investment to real estate owned             |       | 19,463                                               |       | 4,642 |   |

 

 

See accompanying notes tocondensed consolidated financial statements.

4

----

**FIELDSTONE INVESTMENTCORPORATION AND SUBSIDIARIESNotes to Condensed Consolidated Financial StatementsMarch 31, 2006 and 2005(Unaudited)**

**(1)**            Organization andSummary of Significant Accounting Policies

***(a)   Organization***

Fieldstone Investment Corporation (FIC) wasincorporated in the State of Maryland on August 20, 2003, as a whollyowned subsidiary of Fieldstone Holdings Corp. (FHC). FHC was incorporated inthe State of Delaware in February 1998 as a C Corporation. In July 1998,FHC purchased 100% of the shares of Fieldstone Mortgage Company (FMC), aMaryland corporation formed in 1995. Prior to 2003, FHC operated as a taxable Ccorporation. Effective January 1, 2003, FHC elected to be taxed as an SCorporation, and FMC was treated as a qualified sub-chapter S subsidiary.

In November 2003,FIC executed a reverse merger with FHC, with FIC as the surviving entity, in atransaction that was accounted for as a merger of entities under common controlwhereby the historical cost basis of the assets and liabilities was retained. Inconnection with the merger in November 2003, FIC elected to be taxed as aReal Estate Investment Trust (REIT), and FMC, its wholly owned subsidiary,elected to be taxed as a Taxable REIT Subsidiary (TRS).

In February of 2004, FIC formed two wholly ownedsubsidiaries, 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, aswell as any derivatives designated as economic interest rate hedges related tosecuritized debt. FSC holds the rights to direct the servicing of the mortgageloans held for investment.

In May of 2005, FIC formed a wholly owned,limited purpose financing subsidiary, Fieldstone Mortgage InvestmentCorporation (FMIC), a Maryland corporation, which is treated as a qualifiedREIT subsidiary. FMIC was formed for the purpose of facilitating the financingand sale of mortgage loans and mortgage-related assets by issuing and sellingsecurities secured primarily by, or evidencing interests in, mortgage loans andmortgage-related assets.

FMC originates, purchases and sells non-conforming andconforming residential mortgage loans and engages in other activities relatedto mortgage banking. FMC originates mortgage loans through wholesale and retailbusiness channels through its network of over 4,300 independent mortgagebrokers serviced by regional wholesale operations centers and a network ofretail branch offices located throughout the country.

The non-conforming loans that are originated areunderwritten in accordance with FMC’s underwriting guidelines, which aredesigned to evaluate a borrower’s credit history, capacity, willingness andability to repay the loan, and the value and adequacy of the collateral. Theconforming loans that are originated are loans that meet the underwritingcriteria required for a mortgage loan to be saleable to a Government SponsoredEntity (GSE), such as Fannie Mae or Freddie Mac, or institutional investors.

A substantial portion of the non-conforming loansoriginated by FMC are closed by FMC using funds advanced by FIC, with asimultaneous assignment of the loans to FIC. These loans are held forinvestment and financed by warehouse debt and by issuing mortgage-backedsecurities secured by these loans. FMC sells the portion of the non-conformingloans not held for investment and all of the conforming loans that itoriginates on a whole-loan, servicing-released basis. FMC provides interimservicing on the loans held for sale from the time of funding until the timethe loans are transferred to the permanent servicer, which is generally between30 and 45 days after funding of the loan. With regard to the loans held forinvestment, the servicing rights are transferred to FSC. Pursuant to anagreement, JPMorgan Chase Bank, National Association acts as sub-

5

----

servicer of the non-conforming loans held forinvestment. The sub-servicer has primary responsibility for performing theservicing functions with respect to the loans, including all collection,advancing and loan level reporting obligations, maintenance of custodial andescrow accounts, maintenance of insurance and enforcement of foreclosureproceedings.

FMC is licensed or exemptfrom licensing requirements to originate residential mortgages in 49 states andthe District of Columbia. FIC is licensed or exempt from licensing requirementsto fund residential mortgage loans and acquire closed residential mortgageloans in all states in which it operates.

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 States ofAmerica (GAAP) for interim financial information and with the instructions to Form 10-Qand Rule 10-01 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by GAAP for complete financialstatements. All intercompany balances and transactions have been eliminated inconsolidation.

In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments, consisting of normal recurring accruals,necessary for a fair presentation. The results of operations and other data forthe three months ended March 31, 2006 are not necessarily indicative ofthe results that may be expected for the fiscal year ending December 31,2006. The unaudited condensed consolidated financial statements presentedherein should be read in conjunction with the audited consolidated financialstatements and related notes thereto in the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2005.

***(b)    Discontinued Operations***

On January 13,2006, the Company’s Board of Directors approved a plan of disposal to sell,close or otherwise dispose of the assets of its conforming retail andconforming wholesale segments. In February 2006 the assets pertaining tothe conforming division’s headquarters office, all wholesale offices andcertain of its retail offices were sold to third parties. The remaining assetsof the conforming division, which include retail offices in Maryland andVirginia, have been combined with the Company’s non-conforming retail offices,which will offer a range of non-conforming and conforming loan products.

The provisions ofStatement of Financial Accounting Standards No. 144, *“Accountingfor the Impairment or Disposal of Long-Lived Assets”*(Statement No. 144),require the results of operations associated with the disposal of theseconforming wholesale and conforming retail offices to be classified asdiscontinued operations, net of income tax and segregated from the Company’scontinuing results of operations for all periods presented.

***(c)   Use of Estimates***

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. Criticalestimates include (i) an estimate of the representation and warrantyliabilities related to the sale of mortgage loans; (ii) an estimate oflosses inherent in mortgage loans held for investment, which is used todetermine the related allowance for loan losses and realizable value of theCompany’s accrued interest receivable; (iii) an estimate of the futureloan prepayment rate of mortgage loans held for investment, which is used in thecalculation of deferred origination and bond issuance cost amortization; (iv) thenon-cash mark to market valuation of the interest rate swaps which economicallyhedge the Company’s securitization debt and (v) the fair market value ofequity compensation awards. Actual results could differ from those estimates.Amounts on the consolidated statements of operations most affected by the useof estimates are the reserve for losses—loans sold (which is a component ofgains on sales of mortgage loans, net), provision for loan losses—loans heldfor investment, interest income — loans held for investment, derivativevaluations (which are a component of other income (expense)—portfolioderivatives), stock-based 

6

----

compensation (which is a component of salaries and employeebenefits) and deferred origination and bond issuance costs (which arecomponents of net interest income after provision for loan losses for loansheld for investment and gains on sales of mortgage loans, net, for loans heldfor sale).

***(d)******         Concentration of CreditRisk***

The non-conforming mortgage loans that the Companyoriginates primarily consist of adjustable-rate mortgage (ARM) loans, thepayments on which are adjustable from time to time as interest rates change,generally after an initial two-year period during which the loans’ interestrates are fixed and do not change. After the initial fixed rate period, theborrowers’ payments on their ARM loans adjust once every six months to apre-determined margin over a measure of market interest rates, generally theLondon InterBank Offered Rate (LIBOR) for one-month deposits. For the threemonths ended March 31, 2006 and 2005, 42% and 55%, respectively, ofnon-conforming mortgage loan originations are ARM’s and also have an “interestonly” feature for the first five years of the loan, so that the borrowers donot begin to repay the principal balance of the loans until after the fifthyear of the loans. After the fifth year, the borrowers’ payments increase toamortize the entire principal balance owed over the remaining years of theloan.

These features willlikely result in the borrowers’ payments increasing in the future. The interestadjustment feature generally will result in an increased payment after thesecond year of the loan and the interest only feature will result in anincreased payment after the fifth year of the loan. Since these features willincrease the debt service requirements of the borrowers, it may increase therisk of default on the Company’s investment portfolio of non-conforming loansfor loans that remain in the Company’s portfolio for at least two years(relative to the ARM feature) or for five years (relative to the interest onlyfeature).

For the three monthsended March 31, 2006 and 2005, 55% and 51%, respectively, of non-conformingloan originations, were underwritten with little or no supporting documentationof the borrowers’ income, under the Company’s “stated income” loan programs and“bank statement” programs. The Company mitigates its risk on “stated income”loans by establishing minimum credit score standards and evaluating otherwisethe borrower’s income and cash flow. Based on its experiences with similarloans in the past, and on industry performance data, the Company believes itsstrict underwriting guidelines relating to non-conforming loans that areoriginated help the Company to evaluate a borrower’s credit history,willingness and ability to repay the loans, as well as the value and adequacyof the borrower’s collateral. The Company’s underwriting guidelines are designedto balance the credit risk of the borrower with the loan-to-value (LTV) andinterest rate of the loan.

In addition, for the three months ended March 31,2006 and 2005, 34% and 40%, respectively, of the non-conforming loanoriginations included loans secured by properties located in California. Anoverall decline in the economy or the residential real estate market, or theoccurrence of a natural disaster in California could adversely affect the valueof the mortgaged properties in that state and increase the risk of delinquency,foreclosure, bankruptcy or loss on the non-conforming mortgage loans in theCompany’s investment portfolio. The Company’s non-conforming loan originationsare concentrated heavily in California because it is the largest mortgagemarket in the U.S. and the Company believes that its underwriting, productdesign and pricing philosophies address the characteristics of Californiaborrowers, which the Company believes to be non-standard credit profiles,interest in low downpayment products, payment-focused mortgages and higher homevalues.

***(e)   Recent Accounting Pronouncements***

In March 2006,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 156, *“Accounting For Servicingof Financial Assets-an amendment of FASB Statement No. 140,”*(StatementNo. 156). Statement No. 156 amends Statement of Financial AccountingStandards No. 140, *“Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,”* (Statement No. 140),with respect to the accounting for separately recognized servicing rights. StatementNo. 156 requires an entity to initially recognize, at fair value, aservicing asset or servicing liability each time it undertakes an 

7

----

obligation to service a financial asset by enteringinto a servicing contract in certain situations. In addition, Statement No. 156permits the subsequent measurement of servicing assets and servicingliabilities using the fair value method or the amortization method asprescribed under Statement No. 140. Statement No. 156 is effective asof the beginning of an entity’s first fiscal year that begins after September 15,2006. The Company will adopt Statement No. 156, as applicable, beginningin fiscal year 2007. Management believes that the implementation of Statement No. 156will not have a material effect on its results of operations, statements ofcondition or cash flows.

In February 2006,the FASB issued Statement of Financial Accounting Standards No. 155, *“Accounting For Certain Hybrid Financial Instruments-an amendment ofFASB Statements No. 133 and 140,”*(Statement No. 155). StatementNo. 155 amends Statement No. 133, to permit fair value remeasurementfor any hybrid financial instrument with an embedded derivative that otherwisewould require bifurcation, provided that the whole instrument is accounted foron a fair value basis. Statement No. 155 amends Statement No. 140 toallow a qualifying special-purpose entity to hold a derivative financialinstrument that pertains to a beneficial interest other than another derivativefinancial instrument. Statement No. 155 is effective for all financialinstruments acquired, issued or subject to a remeasurement (new basis) eventoccurring after the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The Company will adopt Statement No. 155,as applicable, beginning in fiscal year 2007. Management believes that theimplementation of Statement No. 155 will not have a material effect on itsresults of operations, statements of condition or cash flows.

In December 2005,the FASB issued Staff Position 94-6-1*, “Terms ofLoan Products That May Give Rise to a Concentration of Credit Risk,”*(FSP 94-6-1). FSP 94-6-1 clarifies that loan productsthat expose an originator, holder, investor, guarantor or servicer to anincreased risk of non-payment or not realizing the full value of the loan, suchas non-traditional loan products, may result in a concentration of credit riskas defined in Statement of Financial Accounting Standards No. 107, *“Disclosures about Fair Value of Financial Instruments,”*(Statement No. 107). FSP 94-6-1 also emphasizes therequirement to assess the adequacy of disclosures for all lending products(including both secured and unsecured loans) and the effect of changes inmarket or economic conditions on the adequacy of those disclosures. Theguidance under FSP 94-6-1 is effective for interim and annualreporting periods ending on or after December 19, 2005 and for loanproducts that are determined to represent a concentration of credit risk,disclosure requirements of Statement No. 107 should be provided for allperiods presented. The adoption of FSP 94-6-1 has not had asignificant impact on the Company’s consolidated financial statements.

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. In March 2005, the SEC staff issuedStaff Accounting Bulletin No. 107 (SAB No. 107). SAB No. 107expresses the views of the SEC regarding Statement No. 123R and certain rules andregulations and provides the SEC’s view regarding the valuation of share-basedpayment arrangements for public companies. In April 2005, the SEC amendedthe compliance dates for Statement No. 123R to the beginning of the nextfiscal year after June 15, 2005. In November 2003, the Companyadopted the fair value method of accounting for grants of stock options andrestricted stock as prescribed by Statement of Financial Accounting Standards No. 148,“*Accounting for Stock-Based Compensation-Transitionand Disclosure.”*  Under thismethod, compensation cost is measured at the grant date based on the fair valueof the award and is recognized as expense on a straight-line basis over theaward’s vesting period. The Company adopted Statement No. 123R and SAB No. 107as of January 1, 2006, which resulted in a change in the accounting forunearned compensation whereby the balance of unearned compensation as of December 31,2005, and all subsequent unearned compensation transactions were recorded toadditional paid-in capital on the consolidated statements of condition. Theimplementation of Statement No. 123R and SAB No. 107 has not had amaterial effect on the Company’s results of operations, statements of conditionor cash flows.

8

----

***(f)   Reclassifications***

Certain prior period amounts have been reclassified toconform to the current period presentation. In accordance with Statement No. 144,the Company has reclassified the operating results of the conforming wholesaleand retail offices that were disposed of in the first quarter of 2006 asdiscontinued operations in the condensed consolidated statements of operationsfor the three months ended March 31, 2005. Also included in thesereclassifications is the reclassification of changes in restricted cash fromcash flows from operating activities to cash flows from investing activities inthe amounts of $1.9 million for the three months ended March 31, 2005.

***(g)   Restatement***

In preparing theCompany’s 2005 consolidated financial statements, the Company’s management identifiederrors in the accounting for income taxes related to the sale of loans by FMC,the Company’s TRS, to FIC, which operates as a REIT, in the fourth quarter of2003 and the second quarter of 2005. In each of these periods, the Company hadpreviously recognized the entire income tax expense related to the gain on saleearned by FMC on these sales of non-conforming loans to FIC for inclusion inits investment portfolio. However, the Company determined that it should havedeferred the portion of the income tax expense related to the intercompany saleof those loans that remained on the Company’s consolidated statements ofcondition at each period end. Such deferred tax asset should have beenrecognized as expense over the life of the loans. As a result, the Company hasrestated the accompanying first quarter of 2005 condensed consolidatedfinancial statements.

A summary of thesignificant effects of the restatement on the accompanying first quarter of2005 condensed consolidated financial statements is as follows (in thousands,except per share data):

CondensedConsolidated Statement of Condition:

|                         | ** ** | **March 31, 2005**          | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **Total  Shareholder’s  Equity** | ** ** |
| As previously  reported |       | $                                     | 568,616    |   |
| Income tax  adjustment  |       | 1,393                                 |       |
| As restated             |       | $                                     | 570,009    |   |

 

Condensed ConsolidatedStatements of Operations:

|                        | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|------------------------|------------|------------------------------------------------------------|------------|
| ** **             | ** ** | **Income Tax  (Expense)  Benefit**                    | ** ** | **Net  Income** | ** ** | **Earnings  Per Share  (Basic and  Diluted)** | ** ** |
| As previously reported |       | $                                                          | 941        |   | 42,104 |   | 0.87 |   |
| Income tax adjustment  |       | (350                                                       | )          | (350 | ) | (0.01 | ) |
| As restated            |       | $                                                          | 591        |   | 41,754 |   | 0.86 |   |
|                   |       |                                                       |       |   |   |   |   |

 

9

----

**(2)**            Mortgage Loans Heldfor Sale and Reserve for Losses—Sold Loans

Mortgage loansthat the Company acquires or originates with the intent to sell in theforeseeable future are initially recorded at cost including any premium paid ordiscount received, adjusted for the fair value change during the period inwhich the loan was an interest rate lock commitment. Loans held for sale arecarried on the books at the lower of cost or market value calculated on anaggregate basis by type of loan. Mortgage loans held for sale, net, as of March 31,2006 and December 31, 2005 are as follows (in thousands):

|                                              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Mortgage loans  held for sale                |       | $                        | 314,147    |                        | 591,840    |   |
| Net deferred  origination costs              |       | 880                      |       | 1,547                       |       |
| Premium, net of  discount                    |       | 589                      |       | 1,987                       |       |
| Allowance for  lower of cost or market value |       | (2,780                   | )          | (1,105                      | )          |
| Total                                        |       | $                        | 312,836    |                        | 594,269    |   |

 

The Company maintains a reserve for its representationand warranty liabilities related to the sale of loans and for its contractualobligations to rebate a portion of any premium paid by an investor when a soldloan prepays within an agreed period. The reserve, which is recorded as a liabilityon the consolidated statements of condition, is established when loans aresold, and is calculated as the fair value of liabilities reasonably estimatedto occur during the life of the related sold loans. The provision is recordedas a reduction of gain on sale of loans. At March 31, 2006 and December 31,2005, mortgage loans held for sale included approximately $2.9 million and $1.7million, respectively, of loans repurchased pursuant to the provisionsdescribed in the preceding sentence, net of valuation allowance. Net realizedlosses on sold loans, primarily related to early payment defaults, premiumrecaptures on early payoffs and representation and warranty liability totaled$3.9 million and $0.7 million, or 0.44% and 0.09% of total loan sales in thethree months ended March 31, 2006 and 2005, respectively.

At March 31, 2006, the Company had $19.2 millionof loans deemed to be unsaleable at standard sale premiums compared to $5.2million at December 31, 2005. The Company recorded a valuation allowanceof $2.8 million and $1.1 million, as of March 31, 2006 and December 31,2005, respectively, for these loans unsaleable at standard sale premiums.

The reserve forlosses—loans sold is summarized as follows for the three months ended March 31,2005 and 2006 (in thousands):

| Balance at December 31,  2004 |   | $33,302 |   |
|------------------------------------|--------|---------|--------|
| Provision.                         |   | 2,538   |   |
| Realized losses                    |   | (762    | )      |
| Recoveries                         |   | 21      |   |
| Balance at  March 31, 2005    |   | $35,099 |   |
|                               |   |    |   |
| Balance at  December 31, 2005 |   | $35,082 |   |
| Provision                          |   | 2,329   |   |
| Realized losses                    |   | (3,963  | )      |
| Recoveries                         |   | 49      |   |
| Balance at  March 31, 2006    |   | $33,497 |   |

 

Historically, theCompany has experienced substantially all of its representation and warrantylosses on loans sold during the first three years following the sale. The reservefor losses—loans sold as of March 31, 

10

----

2006 and 2005 relate to loan sales primarily duringthe period of April 1, 2003 through March 31, 2006 of approximately$13.4 billion, and sales during the period April 1, 2002 through March 31,2005 of approximately $13.4 billion, respectively.

**(3)**            Mortgage Loans Heldfor Investment and Allowance for Loan Losses

The Company originates fixed-rate and adjustable-ratemortgage loans that have a contractual maturity of up to 40 years. Thesemortgage loans are initially recorded at cost including any premium ordiscount. These mortgage loans are financed with warehouse debt until they arepledged as collateral for securitization financing. The Company is exposed torisk of loss from its mortgage loan portfolio and establishes an allowance forloan losses taking into account a variety of criteria including the contractualdelinquency status, market delinquency roll rates, and market historical lossseverities. The adequacy of this allowance for loan loss is periodicallyevaluated and adjusted based on this review.

The following is adetail of the mortgage loans held for investment, net as of March 31, 2006and December 31, 2005 (in thousands):

|                                                             | ** ** | **March 31,   2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| Securitized  mortgage loans held for investment             |       | $                              | 5,186,624  |                        | 5,043,762  |   |
| Mortgage loans  held for investment—warehouse financed |       | 309,081                        |       | 486,454                     |       |
| Net deferred  origination fees and costs                    |       | 36,776                         |       | 40,199                      |       |
| Mortgage loans  held for investment                         |       | 5,532,481                      |       | 5,570,415                   |       |
| Allowance for  loan losses—loans held for investment   |       | (45,744                        | )          | (44,122                     | )          |
| Mortgage loans held for  investment, net                    |       | $                              | 5,486,737  |                        | 5,526,293  |   |

 

The allowance forloan losses—loans held for investment is summarized as follows for the threemonths ended March 31, 2005 and 2006 (in thousands):

| Balance at December 31,  2004 |   | $22,648 |   |
|------------------------------------|--------|---------|--------|
| Provision                          |   | 4,494   |   |
| Charge—offs                   |   | (827    | )      |
| Recoveries                         |   | 64      |   |
| Balance at  March 31, 2005    |   | $26,379 |   |
|                               |   |    |   |
| Balance at  December 31, 2005 |   | $44,122 |   |
| Provision                          |   | 5,393   |   |
| Charge—offs                   |   | (3,771  | )      |
| Recoveries                         |   | —  |   |
| Balance at  March 31, 2006    |   | $45,744 |   |

 

Mortgage loans held for investment, which were onnon-accrual status for interest income recognition due to delinquencies greaterthan ninety days, were $169.5 million and $61.7 million as of March 31,2006 and 2005, respectively, and $150.3 million as of December 31, 2005,and averaged $168.7 million and $57.1 million for the three months ended March 31,2006 and 2005, respectively, and $91.4 million during the year ended December 31,2005. During the three months ended March 31, 2006 and 2005, the Companyreversed previously accrued interest income relating to non-performing anddelinquent loans, which would ordinarily have been recognized per contractualloan terms, of $2.2 million and $1.9 million, respectively.

11

----

At March 31,2006 and December 31, 2005, approximately 39.8% and 41.3%, respectively,of mortgage loans held for investment were collateralized by properties locatedin the state of California.

**(4)**            Warehouse Financing,Loans Held for Sale and Loans Held for Investment

At March 31, 2006 and December 31, 2005, theCompany had a total of $1.875 billion of warehouse lines of credit andrepurchase facilities with six financial entities. Committed facilities comprise$1.825 billion of the total available, with uncommitted facilitiestotaling $0.050 billion. The facilities are short-term liabilities,secured by mortgage loans held for investment to be securitized, mortgage loansheld for sale, the related investor commitments to purchase those loans heldfor sale, and all proceeds thereof.

Warehouse lines ofcredit and repurchase facilities consist of the following at March 31,2006 and December 31, 2005 (dollars in millions):
| **Agreements as of March 31, 2006** | ** ** | **Amount  Outstanding as of** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------|------------|
| **Lender**                                                   | ** ** | ** **                              | ** ** | **Amount  Available** | ** ** | **Maturity  Date** | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| Countrywide  Warehouse Lending                               |       | $                                       | 75.0       |   | August 2006 |   | $ | 2.2 |   | 34.3 |   |
| Countrywide  Early Purchase Program                          |       | 50.0                                    |       | Uncommitted |   | — |   | — |   |
| Credit Suisse  First Boston Mortgage Capital*                |       | 400.0                                   |       | April 2006 |   | 238.9 |   | 195.2 |   |
| Credit Suisse,  New York Branch Commercial Paper Facility    |       | 600.0                                   |       | July 2006 |   | 147.4 |   | 415.8 |   |
| JPMorgan Chase  Bank                                         |       | 150.0                                   |       | June 2006 |   | 60.2 |   | 53.9 |   |
| Lehman Brothers  Bank                                        |       | 300.0                                   |       | December 2006 |   | 25.9 |   | 51.7 |   |
| Merrill Lynch  Bank USA                                      |       | 300.0                                   |       | November 2006 |   | 37.7 |   | 61.9 |   |
| Total                                                        |       | $                                       | 1,875.0    |   |   |   | $ | 512.3 |   | 812.8 |   |

----

*    The CreditSuisse First Boston Mortgage Capital facility has been renewed through April 2007.

The average outstanding amounts under these agreementswere $769.6 million and $658.5 million for the three months ended March 31,2006 and 2005, respectively, and $876.2 million for the year ended December 31,2005. The maximum amount outstanding under these agreements at any month-endduring the three months ended March 31, 2006 and 2005 was $912.1 millionand $843.7 million, respectively and $1.3 billion for the year ended December 31,2005. The weighted average interest rate on March 31, 2006, December 31,2005 and March 31, 2005 was 5.3%, 4.7% and 3.7%, respectively. Theinterest rates are based on spreads to one month or overnight LIBOR, and aregenerally reset daily or weekly. The Company also pays facility fees based onthe commitment amount and non-use fees.

12

----

The averageoutstanding amounts under these agreements relating to continuing operationswere $723.0 million and $617.1 million for the three months ended March 31,2006 and 2005, respectively. A summary of coupon interest expense andfacilities fees, included in total interest expense in the condensed consolidatedstatements of operations, and the weighted average cost of funds of thewarehouse lines of credit and repurchase facilities for the three months ended March 31,2006 and 2005 is as follows (in thousands):

|                                | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **Amount**                                           | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest  expense  |       | $                                                    | 8,360      |   | 4.6 | % | 5,062 |   | 3.3 | % |
| Facilities fees                |       | 609                                                  |       | 0.4 | % | 833 |   | 0.5 | % |
| Total                          |       | $                                                    | 8,969      |   | 5.0 | % | 5,895 |   | 3.8 | % |

 

The warehouse linesand repurchase facilities generally have a term of 364 days or less. Managementexpects to renew these lines of credit prior to their respective maturitydates. The credit facilities are secured by substantially all of the Company’smortgage loans and contain customary financial and operating covenants thatrequire the Company to maintain specified levels of liquidity and net worth,maintain specified levels of profitability, restrict indebtedness andinvestments and require compliance with applicable laws. The Company was incompliance with all of these covenants at March 31, 2006 and December 31,2005.

**(5)**            SecuritizationFinancing

During the three months ended March 31, 2006, theCompany issued $0.9 billion of mortgage-backed bonds through a securitizationtrust to finance the Company’s portfolio of loans held for investment. Interestrates reset monthly and are indexed to one-month LIBOR. The bonds pay interestmonthly based upon a weighted average spread over LIBOR. The estimated averagelife of the bonds is approximately 20 months, and is based on estimates andassumptions made by management. The actual period from inception to maturitymay differ from management’s expectations. The Company retains the option torepay the bonds when the remaining unpaid principal balance of the underlyingmortgages loans for each pool falls below 20% of the original principal balancewith the exception of FMIC Series 2003-1 which may be repaid when theprincipal balance falls below 10% of the original collateral amount. Thesecuritization financings include a step up stipulation which provides that thebond margin over LIBOR will increase 1.5 to 2.0 times the original margin ifthe option to repay the bonds is not exercised, per the contractual provisions.The bonds are repaid from the cash flows derived from the mortgage loanspledged to the trust.

The following is asummary of the securitization issued by series during the three months ended March 31,2006 (dollars in millions):

|                                     | ** ** | **FMIT  2006-1** | ** ** |
|-------------------------------------|------------|------------------|------------|
| Bonds issued                        |       | $                | 904        |   |
| Loans pledged                       |       | $                | 933        |   |
| Deferred bond  issuance costs       |       | $                | 3.1        |   |
| Weighted average  spread over LIBOR |       | 0.32             | %          |
| Financing costs—LIBOR  plus    |       | 0.08% -2.30      | %          |

 

During the first quarterof 2006, the FMIT Series 2006-1 securitization included a pre-fundingwhereby a portion of the collateral pledged to the trust was delivered in April 2006,subsequent to the March 2006 bond closing 

13

----

date. The $233.0 million of bond proceeds, which werenot collateralized at closing, were held in escrow by the trustee. The Companyreported the pre-funding proceeds as a component of restricted cash in thecondensed consolidated statements of condition as of March 31, 2006.

The averagesecuritization financing outstanding was $4.8 billion and $4.2 billion for thethree months ended March 31, 2006 and 2005, respectively and $4.4 billionfor the year ended December 31, 2005. The unamortized bond issuance costsat March 31, 2006 and December 31, 2005 were $12.1 million and $11.6million, respectively.

A summary of couponinterest expense, amortization of deferred issuance costs and original issuediscount, included in total interest expense in the consolidated statements ofoperations, and the weighted average cost of funds of the securitizationfinancing for the three months ended March 31, 2006 and 2005 is as follows(in thousands):

 

|                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Amount**                                           | ** ** | **Weighted  Average  Cost** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost** | ** ** |
| Coupon interest  expense        |       | $                                                    | 59,835     |   | 5.0 | % | 31,644 |   | 3.0 | % |
| Amortization of  deferred costs |       | 2,685                                                |       | 0.2 | % | 1,998 |   | 0.2 | % |
| Amortization of  bond discount  |       | 32                                                   |       | 0.0 | % | 63 |   | 0.0 | % |
| Total                           |       | $                                                    | 62,552     |   | 5.2 | % | 33,705 |   | 3.2 | % |

 

TheCompany also has the ability to finance the securities it retains in itssecuritizations (retained securities) through two repurchase facilities, eachwith an uncommitted amount of $200 million. The first facility is with LiquidFunding, Ltd., an affiliate of Bear Stearns Bank plc. The second facility iswith Lehman Brothers, Inc. and Lehman Brothers Commercial Paper Inc. Eachfacility bears interest at an annual rate of LIBOR plus an additionalpercentage.

Thefollowing is a summary of the outstanding securitization bond financing andweighted average interest rate by series as of March 31, 2006 and December 31,2005 (in thousands):
| ** **                             | ** ** | **March 31, 2006** | ** ** | **December 31, 2005**   | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **Amount  Outstanding**      | ** ** | **Weighted  Avg  Interest  Rate** | ** ** | **Amount  Outstanding** | ** ** | **Weighted  Avg  Interest  Rate** | ** ** |
| FMIT  Series 2006-1               |       | $                            | 904,078    |                              | 5.0        | % | $ | — |   | — | % |
| FMIT  Series 2005-3               |       | 1,059,345                    |       | 5.1                               | %          | 1,089,820 |   | 4.7 | % |
| FMIT  Series 2005-2               |       | 827,101                      |       | 5.1                               | %          | 872,455 |   | 4.7 | % |
| FMIT  Series 2005-1               |       | 490,093                      |       | 5.2                               | %          | 555,650 |   | 4.7 | % |
| FMIT  Series 2004-5               |       | 528,439                      |       | 5.3                               | %          | 595,481 |   | 4.9 | % |
| FMIT  Series 2004-4               |       | 466,142                      |       | 5.3                               | %          | 518,283 |   | 4.9 | % |
| FMIT  Series 2004-3               |       | 482,777                      |       | 5.3                               | %          | 523,296 |   | 4.9 | % |
| FMIT  Series 2004-2               |       | 276,494                      |       | 5.5                               | %          | 377,500 |   | 4.9 | % |
| FMIT  Series 2004-1 (*)           |       | 100,400                      |       | 5.8                               | %          | 233,977 |   | 5.0 | % |
| FMIC  Series 2003-1               |       | 61,285                       |       | 6.9                               | %          | 83,308 |   | 6.1 | % |
|                                   |       | 5,196,154                    |       | 5.2                               | %          | 4,849,770 |   | 4.8 | % |
| Unamortized bond  discount             |       | (42                          | )          |                              |       | (74 | ) |   |   |
| Subtotal securitization bond financing |       | 5,196,112                    |       |                              |       | 4,849,696 |   |   |   |
| Liquid Funding  repurchase facility    |       | 45,154                       |       |                              |       | 86,079 |   |   |   |
| Lehman Brothers  repurchase facility   |       | —                       |       |                              |       | 62,845 |   |   |   |
| Total  securitization financing        |       | $                            | 5,241,266  |                              |       |   | $ | 4,998,620 |   |   |   |

----

(*) FMITSeries 2004-1 was called and paid in full in April 2006. SeeNote 12.

14

----

The current carrying amount of the mortgage loanspledged to the trusts was $5.2 billion and $5.0 billion as of March 31,2006 and December 31, 2005, respectively.

**(6)**            Derivatives andHedging Activities

In conjunction with the financing of its portfolio ofloans held for investment, the Company entered into interest rate swapsdesigned to be economic hedges of the floating rate debt of the warehouse andsecuritization debt. At March 31, 2006, the fair value of 30 interest rateswaps with positive fair values was $36.9 million. At December 31, 2005,the fair value of 26 interest rate swaps with positive fair values was $35.2million and the fair value of three swaps with negative fair values was $(0.2)million, for a net fair value of $35.0 million. The swaps are not classified ascash flow hedges under Statement No. 133, and therefore, the mark tomarket valuation increase of $1.9 million and $20.6 million has been included incurrent period earnings during the three months ended March 31, 2006 and2005, respectively.

In conjunction with the Company’s FMIT Series 2003-1securitization, the Company purchased an interest rate cap agreement by payinga premium of $3.0 million, determined to be an economic hedge of thefloating rate debt of the security. The mark to market valuation increase of$70.0 thousand has been included in current period earnings during the threemonths ended March 31, 2005. During the fourth quarter of 2005, theinterest rate cap expired.

The amounts ofcash settlements and non-cash changes in value that were included in “Otherincome (expense)—portfolio derivatives” is as follows for the three monthsended March 31, 2006 and 2005 (in thousands):

|                                                                                        | ** ** | **Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Non-cash changes  in fair value                                                        |       | $                                                | 1,894      |   | 20,628 |   |
| Net cash  settlements on existing derivatives                                          |       | 10,264                                           |       | (1,295 | ) |
| Net cash  settlements received (paid) to terminate derivatives prior to final maturity |       | —                                           |       | 1,009 |   |
| Other income  (expense)—portfolio derivatives                                     |       | $                                                | 12,158     |   | 20,342 |   |

 

**(7)**            DiscontinuedOperations

On January 13,2006, the Company’s Board of Directors approved a plan of disposal to sell,close or otherwise dispose of the assets of its conforming retail andconforming wholesale segments. In February 2006, the assets pertaining tothe conforming division’s headquarters office, all wholesale offices andcertain of its retail offices were sold to third parties. The remaining assetsof the conforming segment, which include retail offices in Maryland andVirginia, have been combined with the Company’s non-conforming retail offices,which will offer a range of non-conforming and conforming loan products. Thepre-tax loss on disposal was $0.9 million and is included in discontinuedoperations, net of income tax, in the condensed consolidated statements ofoperations.

The provisions ofStatement No. 144 require the results of operations associated with theconforming wholesale and conforming retail offices that were disposed to beclassified as discontinued operations, net of income tax and segregated fromthe Company’s continuing results of operations for all periods presented.

15

----

Operating resultsof discontinued operations, net of income tax included in the condensedconsolidated statements of operations are summarized as follows for the threemonths ended March 31, 2006 and 2005 (in thousands):

|                                             | ** ** | **Three Months Ended**         | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|
| ** **                                  | ** ** | **March 31,  2006**                 | ** ** | **March 31,  2005** | ** ** |
| Revenues:                                   |       |                                     |       |   |   |
| Interest income                             |       | $      839 |       | 1,085 |   |
| Interest expense                            |       | 657                                      |       | 421 |   |
| Net interest income                         |       | 182                                      |       | 664 |   |
| Gains on sales  of mortgage loans, net      |       | (188                                     | )          | 1,200 |   |
| Fees and other  income                      |       | 41                                       |       | 107 |   |
| Total revenues                              |       | 35                                       |       | 1,971 |   |
|                                        |       |                                     |       |   |   |
| Expenses:                                   |       |                                     |       |   |   |
| Salaries and employee benefits              |       | 1,692                                    |       | 2,038 |   |
| Occupancy                                   |       | 272                                      |       | 296 |   |
| Depreciation and amortization               |       | 104                                      |       | 35 |   |
| General and administration                  |       | 727                                      |       | 677 |   |
| Total expenses                              |       | 2,795                                    |       | 3,046 |   |
| Discontinued operations before income taxes |       | (2,760                                   | )          | (1,075 | ) |
| Income tax  benefit                         |       | 1,115                                    |       | 434 |   |
| Discontinued  operations, net of income tax |       | $  (1,645                      | )          | (641 | ) |

 

The impact ofdiscontinued operations on cash flows from operating, cash flows from investingand cash flows from financing activities are separately presented in thecondensed consolidated statements of cash flows for the three months ended March 31,2006 and 2005.

**(8)**            Segment Information

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 four reportable segments, which include two production segments,Wholesale and Retail, and two operating segments, which include InvestmentPortfolio, and Corporate. Prior to the first quarter of 2006, the Companyreported two additional production segments referred to as its ConformingWholesale and Conforming Retail segments. In the first quarter of 2006, theCompany’s Board of Directors approved a plan of disposal to sell, close orotherwise dispose of the assets of the Conforming Wholesale and ConformingRetail segments due to the decline in profitability of these segments. In February 2006,the Company sold the assets pertaining to its conforming division’sheadquarters, wholesale offices, and certain retail offices to third parties.The remaining assets of the conforming segment, which included retail officesin Maryland and Virginia, have been combined with our non-conforming retailoffices and will be reported as a component of the Company’s Retail segment.The following discussion of results reflects the Company’s continuing Wholesaleand Retail segments only, 

16

----

while the results of its former Conforming Wholesaleand Conforming Retail segments are reported herein as discontinued operations.

The Company originates loans through two productionsegments:  a wholesale segment whichoriginates non-conforming loans and a retail segment, which originatesnon-conforming and conforming loans. The Investment Portfolio segment primarilyincludes the net interest income earned by the loans held for investment andthe direct costs, including third-party servicing fees, incurred to manage theportfolio. In addition, the Company has a Corporate segment that includes thetiming and other differences between actual revenues and costs and amountsallocated to the production segments. The Corporate segment also includes theeffects of the deferral and capitalization of net origination costs as requiredby Statement of Financial Accounting Standards No. 91, *“Accounting for Non-refundable Fees and CostsAssociated with Originating or Acquiring Loans and Initial Direct Costs ofLeases.”* Financial information by segment is evaluated regularly bymanagement and used in decision-making relating to the allocation ofresources and the assessment of Company performance. For the purposes ofsegment information provided in the tables below, certain fees, originationcosts, and other expenses recorded as a component of gains on sale of mortgageloans, net, have been reflected in total revenues or total expenses consistentwith intercompany allocations reported to the Company’s management. Also,origination fees and gain on sale revenue are recognized at the time of fundingby the production segments, and adjusted in the corporate segment to reflectthe actual fees and gain on sale recognizable for GAAP revenue reporting, whenthe loans are sold. The Corporate segment includes reconciling amountsnecessary for the segment totals to agree to the condensed consolidatedfinancial statements.

Theassets of the Company that are specifically identified to a segment includemortgage loans held for sale and investment, net, trustee receivable,derivative assets and furniture and equipment, net. All other assets areattributed to the Corporate segment. Total assets by segment at March 31,2006 and December 31, 2005 are summarized as follows (in thousands):

|                              | ** ** | **March 31,  2006**         | ** ** | **December 31,  2005** | ** ** |
|------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| Production —  Wholesale |       | $    274,081 |       | 526,914                     |       |
| Production —  Retail    |       | 42,161                           |       | 70,632                      |       |
| Investment  Portfolio        |       | 5,643,455                        |       | 5,691,744                   |       |
| Corporate                    |       | 390,048                          |       | 134,324                     |       |
| Total                        |       | $ 6,349,745                 |       | 6,423,614                   |       |

 

17

----

 

Operatingresults by business segment for the three months ended March 31, 2006 areas follows (in thousands):
| ** **                                                    | ** ** | **Production**                                         | ** ** | **Investment** | ** ** | ** **    | ** ** | ** **    | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------|------------|---------------|------------|---------------|------------|
| ** **                                                    | ** ** | **Wholesale**                                          | ** ** | **Retail**     | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                     |       |                                                   |       |           |       |          |       |          |       |   |   |
| Interest income                                               |       | $        6,064 |       | 1,018          |       | 95,113        |       | (481          | )          | $    101,714 |   |
| Interest expense                                              |       | 3,265                                                  |       | 565            |       | 68,916        |       | (1,225        | )          | 71,521 |   |
| Net interest income                                           |       | 2,799                                                  |       | 453            |       | 26,197        |       | 744           |       | 30,193 |   |
| Provision for  loan losses—loans held for investment     |       | —                                                 |       | —         |       | (5,393        | )          | —        |       | (5,393 | ) |
| Gains on sales  of mortgage loans, net                        |       | 17,170                                                 |       | 6,755          |       | —        |       | (13,630       | )          | 10,295 |   |
| Other income  (expense)—portfolio derivatives            |       | —                                                 |       | —         |       | 12,158        |       | —        |       | 12,158 |   |
| Fee and other  income                                         |       | —                                                 |       | 449            |       | (238          | )          | 139           |       | 350 |   |
| Total revenues                                                |       | 19,969                                                 |       | 7,657          |       | 32,724        |       | (12,747       | )          | 47,603 |   |
|                                                          |       |                                                   |       |           |       |          |       |          |       |   |   |
| Direct expenses                                               |       | 17,755                                                 |       | 8,912          |       | 2,899         |       | 4,193         |       | 33,759 |   |
| Corporate  overhead allocation                                |       | 4,200                                                  |       | 728            |       | —        |       | (4,928        | )          | — |   |
| Total expenses                                                |       | 21,955                                                 |       | 9,640          |       | 2,899         |       | (735          | )          | 33,759 |   |
| Income (loss) from continuing operations before  income taxes |       | (1,986                                                 | )          | (1,983         | )          | 29,825        |       | (12,012       | )          | 13,844 |   |
| Income tax  benefit                                           |       | N/A                                                    |       | N/A            |       | N/A           |       | 729           |       | 729 |   |
| Income (loss) from continuing operations                      |       | $       (1,986      | )          | (1,983         | )          | 29,825        |       | (11,283       | )          | 14,573 |   |
| Discontinued  operations, net of income tax                   |       |                                                   |       |           |       |          |       |          |       | (1,645 | ) |
| Net income                                                    |       |                                                   |       |           |       |          |       |          |       | $      12,928 |   |

 

18

----

 

Operatingresults by business segment for the three months ended March 31, 2005 areas follows (in thousands):
| ** **                                                      | ** ** | **Production**                                         | ** ** | **Investment** | ** ** | ** **    | ** ** | ** **    | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------|------------|---------------|------------|---------------|------------|
| ** **                                                      | ** ** | **Wholesale**                                          | ** ** | **Retail**     | ** ** | **Portfolio** | ** ** | **Corporate** | ** ** | **Consolidated** | ** ** |
| Revenues:                                                       |       |                                                   |       |           |       |          |       |          |       |   |   |
| Interest income                                                 |       | $        6,018 |       | 1,011          |       | 82,836        |       | (2,742        | )          | $      87,123 |   |
| Interest expense                                                |       | 3,075                                                  |       | 533            |       | 38,608        |       | (2,616        | )          | 39,600 |   |
| Net interest income                                             |       | 2,943                                                  |       | 478            |       | 44,228        |       | (126          | )          | 47,523 |   |
| Provision for  loan losses—loans held for investment  |       | —                                                 |       | —         |       | (4,494        | )          | —        |       | (4,494 | ) |
| Gains on sales  of mortgage loans, net                          |       | 21,983                                                 |       | 7,513          |       | —        |       | (21,027       | )          | 8,469 |   |
| Other income  (expense)—portfolio derivatives              |       | —                                                 |       | —         |       | 20,342        |       | —        |       | 20,342 |   |
| Fee and other  income                                           |       | —                                                 |       | 435            |       | (201          | )          | 52            |       | 286 |   |
| Total revenues                                                  |       | 24,926                                                 |       | 8,426          |       | 59,875        |       | (21,101       | )          | 72,126 |   |
| Direct expenses                                                 |       | 16,827                                                 |       | 9,143          |       | 2,985         |       | 933           |       | 29,888 |   |
| Corporate  overhead allocation                                  |       | 4,322                                                  |       | 809            |       | —        |       | (5,131        | )          | — |   |
| Total expenses                                                  |       | 21,149                                                 |       | 9,952          |       | 2,985         |       | (4,198        | )          | 29,888 |   |
| Income (loss) from continuing operations before  income taxes   |       | 3,777                                                  |       | (1,526         | )          | 56,890        |       | (16,903       | )          | 42,238 |   |
| Income tax  benefit                                             |       | N/A                                                    |       | N/A            |       | N/A           |       | 157           |       | 157 |   |
| Income (loss) from continuing operations                        |       | $        3,777 |       | (1,526         | )          | 56,890        |       | (16,746       | )          | 42,395 |   |
| Discontinued  operations, net of income tax                     |       |                                                   |       |           |       |          |       |          |       | (641 | ) |
| Net income                                                      |       |                                                   |       |           |       |          |       |          |       | $      41,754 |   |

 

19

----

 

**(9)**            Earnings Per Share

Informationrelating to the calculations of earnings per share (EPS) of common stock forthe three months ended March 31, 2006 and 2005 is summarized as follows(in thousands, except per share data):
| ** **                                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| *Basic earnings per share:*                                         |       |                                             |       |   |   |
| Income from continuing operations                                   |       | $  14,573                              |       | 42,395 |   |
| Dividends on unvested restricted stock                              |       | (78                                              | )          | — |   |
| Income from continuing operations available to  common shareholders |       | 14,495                                           |       | 42,395 |   |
| Discontinued operations, net of income tax                          |       | (1,645                                           | )          | (641 | ) |
| Net income available to common shareholders                         |       | $  12,850                              |       | 41,754 |   |
| Weighted average shares outstanding                                 |       | 48,274                                           |       | 48,462 |   |
| Basic earnings  per share:                                          |       |                                             |       |   |   |
| Continuing operations                                               |       | $      0.30        |       | 0.87 |   |
| Discontinued operations                                             |       | (0.03                                            | )          | (0.01 | ) |
| Total                                                               |       | $      0.27        |       | 0.86 |   |
| * *                                                            |       |                                             |       |   |   |
| *Diluted earnings per share:*                                       |       |                                             |       |   |   |
| Income from continuing operations                                   |       | $  14,573                              |       | 42,395 |   |
| Dividends on unvested restricted stock                              |       | (78                                              | )          | — |   |
| Income from continuing operations available to  common shareholders |       | 14,495                                           |       | 42,395 |   |
| Discontinued operations, net of income tax                          |       | (1,645                                           | )          | (641 | ) |
| Net income available to common shareholders                         |       | $  12,850                              |       | 41,754 |   |
| Weighted average shares outstanding                                 |       | 48,274                                           |       | 48,462 |   |
| Dilutive effect of options and restricted stock                     |       | —                                           |       | 58 |   |
| Weighted average shares outstanding, diluted                        |       | 48,274                                           |       | 48,520 |   |
| Diluted earnings  per share:                                        |       |                                             |       |   |   |
| Continuing operations                                               |       | $      0.30        |       | 0.87 |   |
| Discontinued operations                                             |       | (0.03                                            | )          | (0.01 | ) |
| Total                                                               |       | $      0.27        |       | 0.86 |   |

 

20

----

Effects of potentiallydilutive securities are presented only in periods in which they are dilutive.For the three months ended March 31, 2006, all stock options, at a strikeprice range of $11.60 to $19.25, and all shares of unvested restricted stockwere excluded from the calculation of diluted earnings per share. For the threemonths ended March 31, 2005, all stock options, at a strike price range of$15.00 to $19.25 were excluded from the calculation of diluted earnings pershare. These stock options and restricted stock would have an antidilutiveeffect on earnings per share.

**(10)**     Stock-Based Compensation

Under the Company’s Equity Incentive Plan (the “StockPlan”) approved by the Board of Directors and shareholders in November 2003,an aggregate of 2.7 million of share options or shares of the Company’s stockmay be awarded to employees, outside directors and consultants and to any otherindividual whose participation in the plan is determined to be in the bestinterests of the Company by the Compensation Committee of FIC’s Board ofDirectors. Awards of common stock will be made with currently authorized butnot issued common stock.

As of January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),*“Share-Based Payment,”*(Statement No. 123R).In accordance with Statement No. 123R, the Company expenses itsstock-based compensation by applying the fair value method to stock-basedcompensation. Prior to the adoption of Statement No. 123R, the Companyelected to expense its stock-based compensation by applying the fair valuemethod to stock-based compensation in accordance with Financial AccountingStandards No. 123, *“Accounting forStock-Based Compensation”*(Statement No. 123). The adoption ofStatement No. 123R did not have a material effect on the Company’sconsolidated statements of operations or cash flows. In accordance withStatement No. 123R, the balance of unearned compensation as of January 1,2006, included in the Company’s consolidated statements of condition, has beenreclassified as a reduction to paid-in capital.

***(a) Stock Options***

Under the Stock Plan, the exercise price of each stockoption may not be less than 100% of the fair market value of the common stockon the date of grant. Stock options typically vest ratably over a four-yearperiod with a term fixed by the compensation committee not to exceedten years from the date of grant. Stock options with accompanying dividendequivalent rights (“Options with DERs”) typically cliff vest approximately fouryears from the date of grant with a term fixed by the compensation committeenot to exceed seven years from the date of grant. The fair value of each optionaward is estimated on the date of grant using the Black-Scholes option 

21

----

pricing model, which takes into account as of thegrant date the exercise price and expected life of the option, its expectedvolatility, expected dividends on the stock and the risk-free interest rate forthe expected term of the option.

On February 16 and 21, 2006, the CompensationCommittee of the Board of Directors, pursuant to the Stock Plan, granted to certainkey officers and employees 162,000 non-qualified stock options withaccompanying dividend equivalent rights. The exercise price was $11.60, whichwas the closing price of the Company’s common stock on the date of grant. Onehundred percent of the options vest on March 31, 2010 with a term expiringon March 31, 2013. While the option is unvested, dividend equivalents areearned based on the number of option shares held and are deemed invested inphantom shares of the Company’s common stock at the closing price of the stockon the dividend payment date. The phantom shares also will be credited withdividend equivalent rights at the same time and in the same amount as cashdividends are paid on the Company’s common stock. The total value of dividendequivalents, adjusted for the change in value of the phantom shares from dateof issuance through vest date, will be paid in cash at the time the optionvests.

The followingtable summarizes the weighted average fair value of the Options with DERsgranted in the three months ended March 31, 2006, determined using theBlack-Scholes option pricing model.

| Fair value, at date of grant    |   | $ 4.71 |   |
|---------------------------------|--------|-------------|--------|
| Expected life in  years         |   | 5.5         |   |
| Annual risk-free  interest rate |   | 4.6         | %      |
| Expected  volatility            |   | 35          | %      |
| Expected forfeitures            |   | 20          | %      |

 

The followingtable summarizes stock option activity for the three months ended March 31,2006:

| Options                                   | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price**                                                       | ** ** | **Weighted  Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value**                                                                                                 | ** ** |
|-------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| Outstanding at  January 1, 2006      |       | 826,500    |       | $               14.86 |       | 8.0                                                     |       |                                                                                                                            |       |
| Granted                                   |       | 162,000    |       | 11.60                                                                                            |       | 10.0                                                    |       |                                                                                                                            |       |
| Exercised                                 |       | —     |       | —                                                                                           |       | —                                                  |       |                                                                                                                            |       |
| Forfeited or  expired                     |       | (29,500    | )          | 14.81                                                                                            |       | 7.9                                                     |       |                                                                                                                            |       |
| Outstanding at  March 31, 2006       |       | 959,000    |       | 14.31                                                                                            |       | 8.4                                                     |       | $             32,400                                           |       |
| Exercisable at  March 31, 2006  |       | 382,850    |       | 15.26                                                                                            |       | 7.7                                                     |       | $                    — |       |

 

The weighted average grant date fair value of optionsgranted during the three months ended March 31, 2006 was $4.71. No optionswere granted in the first quarter of 2005. Total compensation expense relatingto stock option issuance of $0.1 million was recorded in salaries and employeebenefits expense for each of the three months ended March 31, 2006 and2005. As of March 31, 2006, there was $1.5 million of total unrecognizedcompensation cost related to nonvested options granted under the Stock Plan,which is expected to be recognized over a period of four years.

*** (b) Restricted Stock***

On February 16,2006, the Compensation Committee of the Board of Directors, pursuant to theStock Plan, granted 45,000 shares of restricted stock to the Company’s newlyappointed chief financial officer, valued at $11.90 per share. The restrictedstock vests ratably over a four-year period beginning December 31, 2006.

On February 21,2006, the Compensation Committee of the Board of Directors, pursuant to theStock Plan, awarded a maximum of 83,400 shares of restricted stock to certainof the Company’s senior officers subject to a level of achievement of certaincorporate performance objectives (the “performance shares”). The 

22

----

performance shares were valued at $8.35 per share,with one hundred percent of any earned performance shares to vest on March 31,2010. The performance shares are shares of restricted stock that are subject tovesting requirements and can be earned based primarily on the Company’sachievement of certain return on equity targets for the period January 1,2006 through December 31, 2007.

The followingtable summarizes restricted stock activity for the three months ended March 31,2006:

| Restricted Stock                | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
| Outstanding at  January 1, 2006 |       | 467,225    |       | $     15.18                    |       |
| Granted                              |       | 45,000     |       | 11.90                                                   |       |
| Forfeited                            |       | (22,500    | )          | (15.00                                                  | )          |
| Outstanding at  March 31, 2006  |       | 489,725    |       | $     14.89                    |       |

** **

**All ofthe restricted stock awards are expensed on a straight-line method over thescheduled vesting period. Total compensation expense relating to the issuanceof shares of restricted stock of $0.4 million and $0.4 million was recorded insalaries and employee benefits expense for the three months ended March 31,2006 and 2005, respectively. As of March 31, 2006, there was $4.5 millionof total unrecognized compensation cost related to nonvested restricted stockgranted under the Stock Plan, which is expected to be recognized over a periodof four years.**

A summary of the status of the Company’s nonvestedrestricted stock as of March 31, 2006 and changes during the three monthsended March 31, 2006 is presented below:      

| Nonvested Restricted Stock | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
| Nonvested at  January 1, 2006   |       | 240,000    |       | $     15.18                    |       |
| Granted                              |       | 45,000     |       | 11.90                                                   |       |
| Vested                               |       | —     |       | —                                                  |       |
| Forfeited                            |       | (22,500    | )          | 15.00                                                   |       |
| Nonvested at March 31, 2006     |       | 262,500    |       | $     14.64                    |       |

** **

**(11)**     Commitments and Contingencies

***(a)   Loan Commitments***

At March 31, 2006 and December 31, 2005, theCompany had origination commitments outstanding to fund approximately $451million and $422 million in mortgage loans, respectively. Fixed rate andhybrid ARM mortgages which are fixed for the initial two to three year term ofthe loan, comprised 97.5% and 97.0%, respectively, of the outstandingorigination commitments. The Company had forward delivery commitments to sellapproximately $0.5 billion and $1.3 billion of loans at March 31,2006 and December 31, 2005, respectively, of which $67.5 million and$745.9 million, respectively, were mandatory sales of mortgage-backedsecurities and investor whole loan trades. At March 31, 2006 and December 31,2005, the Company had a commitment to sell $415 million and $580 million,respectively, of treasury note forward contracts, used to economically hedgethe interest rate risk of its non-conforming loans.

***(b)   LegalMatters***

Because the nature of theCompany’s business involves the collection of numerous accounts, the validityof liens and compliance with various state and federal lending and consumerprotection laws, the Company is subject to various legal proceedings in theordinary course of business related to foreclosures, bankruptcies, 

23

----

condemnation and quiet title actions and allegedstatutory and regulatory violations. The Company is also subject to other legalproceedings in the ordinary course of business related to employee matters. Allof these ordinary course proceedings, individually or taken as a whole, are notexpected to have a material adverse effect on the Company’s business, financialcondition or results of operations.

***Arredondo**Litigation*:**

*Arredondo, et al. v. FieldstoneInvestment, et al.**,*is an actionfiled on August 3, 2004 in the United States District Court for theDistrict of Arizona by nine former employees of Fieldstone Mortgage Companyalleging  that their supervisors andco-workers created a hostile work environment resulting from genderdiscrimination, racial discrimination and retaliation in the workplace.Plaintiffs claim that they are entitled to money damages in the form of backpay and front pay and nominal, compensatory and punitive damages, costs andattorney fees and equitable relief.

The Company filedits answer denying all relevant claims on August 25, 2004. In addition,the Company 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 a responseto the Company’s motion to dismiss, sever or in the alternative, bifurcate, andon April 18, 2005, the Company’s motion to dismiss was denied. Thediscovery process continues and is currently required to be completed by theend of May 2006. On December 27, 2005, the named Plaintiff, BerindaArredondo, requested to be, and was, dismissed from the litigation.

Due to the uncertain nature of the litigation atthis time, the Company is unable to estimate the probable outcome of thismatter. The plaintiffs in this matter have not specified damages sought andtherefore the Company is unable to estimate potential exposure.

***Bass Litigation:***

On May 24,2004, all of the Company’s former shareholders whose shares were redeemedfollowing the closing of the 144A Offering (the “Former Shareholders”), filedan action in the District Court of Tarrant County, Texas, against FieldstoneInvestment Corporation, Fieldstone Mortgage and KPMG LLP (KPMG), alleging thatthe Former Shareholders whose shares were redeemed for approximately$188.1 million, are entitled to an additional post-closing redemptionprice payment of approximately $19.0 million. On September 9, 2004, KPMGserved its response to plaintiffs’ request for disclosure, stating, among otherthings, that KPMG has determined that the deferred tax asset, which isreflected in the Company’s December 31, 2003 audited financial statements,should have been reflected in the Company’s financial statements as of November 13,2003, the day immediately prior to the closing of the 144A Offering. At thepresent time, the ultimate outcome of this claim and the amount of liability,if any, that may result is not determinable, and no amounts have been accruedin the Company’s financial statements with respect to this claim. On October 28,2005, the Company served a cross claim against KPMG. The cross claim asserts,among other 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 theevent the Former Shareholders prevail in their suit, KPMG negligently advisedthe Company regarding the November 13, 2003 balance sheet giving rise tothis dispute. The cross claim seeks a judgment against KPMG in an amount inexcess of $1 million, plus prejudgment interest for the attorneys fees andcosts incurred in this lawsuit. A tria1 date has been scheduled for October 9,2006.

The Companyintends to vigorously defend against the claim made by the Former Shareholdersdescribed above. If the Company ultimately is unsuccessful in defending thismatter, the Company could be required to make a cash payment of up to$19.0 million to the Former Shareholders, plus potential interest andthird-party costs associated with the litigation. Excluding interest orthird-party costs, which may be payable as part of a settlement, the potentialpayment will be an increase in the redemption price of their shares andrecorded as a reduction of the Company’s paid-in capital in the period in whichthe dispute is resolved and will be paid out of the Company’s working capitaland will not be reflected in the Company’s income statement.

24

----

***Rhodes Litigation:***

On January 9,2006, a class action lawsuit was filed naming Fieldstone Mortgage in theNorthern District of Illinois (Eastern Division) alleging violations of theFair Credit Reporting Act (“FCRA”). The class action is entitled Rhodes v.Fieldstone Mortgage Company. Plaintiff alleges that Fieldstone Mortgageviolated the firm offer of credit guidelines encapsulated in 15 U.S.C.§1681 et seq. during its mail marketing campaign in or around April 2005.Specifically, Plaintiff alleges that Fieldstone Mortgage did not comply withthe statutory guidelines in providing a firm offer of credit to the potentialconsumer. Pursuant to 15 U.S.C. §1681 et seq., statutory damages can rangefrom $100 to $1,000 per mailing in the event that the violation is deemedwillful. No motion for class certification has yet been filed in this case.Fieldstone Mortgage filed a motion to dismiss/motion to strike pursuant toFederal Rule 12(b)(6) for the injunctive relief portion of thecompliant. This action is in the initial stage of discovery.

Due to theuncertain nature of the litigation at this time, the Company is unable toestimate the probable outcome of this matter. While the Company intends tocontinue to vigorously defend this claim and believes the Company hasmeritorious defenses available, there can be no assurance the Company willprevail and that an adverse outcome would not have a material effect on theCompany’s results of operations.

For information onother legal proceedings, see the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2005.

** (12) Subsequent Event**

During March 2006,the unpaid principal balance of the loans collateralizing FMIT Series 2004-1fell below 20% of the original principal cut-off balance of the collateral,permitting Fieldstone Servicing Corp. to exercise its right of optionaltermination of the financing. Management reviewed the performance of mortgageloans in the financing trust and related cost of financing and subsequentlydelivered notice in April 2006 to the FMIT Series 2004-1trustee and bondholders of the exercise of the Company’s option to purchase themortgage loans, REO property, and any other property remaining in the trust atthe next payment date. The Company paid $100.4 million to third-partybondholders on April 25, 2006. The underlying collateral will remain onthe consolidated statement of condition as unsecuritized loans held forinvestment.

25

----

** **

** **

**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 on Form 10-Q,as well as the audited consolidated financial statements and related notes forthe fiscal year ended December 31, 2005 and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” each contained inour Annual Report on Form 10-K for the fiscal year ended December 31,2005.

**SafeHarbor for Forward-Looking Statements**

Statements contained in this Form 10-Qwhich are not historical facts may be forward-looking statements within themeaning of Section 21E of the Securities Exchange Act of 1934, as amended(the “Exchange Act”). We intend such forward-looking statements to be coveredby the safe harbor provisions for forward-looking statements contained inSection 21E of the Exchange Act. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datethis Form 10-Q is filed with the SEC.

The forward-lookingstatements are based on our beliefs, assumptions and expectations of our futureperformance, taking into account all information currently available to us.These beliefs, assumptions and expectations can change as a result of manypossible events or factors, not all of which are known to us or are within ourcontrol. If a change occurs, our business, financial condition and results ofoperations may vary materially from those expressed in our forward-lookingstatements. These statements (none of which is intended as a guarantee ofperformance) are subject to certain risks and uncertainties which could causeour actual future results, achievements or transactions to differ materiallyfrom those projected or anticipated. Some of the important factors that couldcause our actual results, performance or financial condition to differmaterially from expectations are:

·       our ability to successfullyimplement or change aspects of our portfolio strategy;

·       interest rate volatilityand the level of interest rates generally;

·       the sustainability of loanorigination volumes and levels of origination costs;

·       continued availability ofcredit facilities for the origination of mortgage loans;

·       the ability to sell orsecuritize mortgage loans on favorable economic terms;

·       deterioration in the creditquality of our loan portfolio;

·       the nature and amount ofcompetition;

·       the impact of changes tothe fair value of our interest rate swaps on our net income, which will varybased upon changes in interest rates and could cause net income to varysignificantly from quarter to quarter; and

·       the other factors set forthin our filings, from time to time, with the SEC, including our Annual Report onForm 10-K for the fiscal year ended December 31, 2005.

**Executive Overview**

We are a mortgage real estate investment trust (REIT)that invests in non-conforming loans originated by our wholly owned subsidiary,Fieldstone Mortgage Company (FMC), which we finance by issuing mortgage-backedsecurities. Through FMC, we originate, service and sell non-conformingsingle-family residential mortgage loans through our wholesale originationchannel and both non-conforming and conforming single-family residentialmortgage loans through our retail origination channel.

26

----

Our primary sources of income are the interest incomeon our loans held for investment net of the interest expense of financing thoseloans, the cash gains on sales of mortgage loans that we choose not to hold forinvestment  which include originationsfees collected at funding, and the net interest income on loans held for saleduring the period from origination to date of sale.

During the three months ended March 31, 2006, ournet income was $12.9 million as compared to $41.8 million in the three monthsended March 31, 2005, down primarily due to a $18.7 million decrease inthe mark to market valuation change in the derivatives we use to economicallyhedge the financing costs of our loans held for investment, and a $7.5 milliondecrease in the revenue related to our investment portfolio of non-conformingmortgages. The net cash settlements on our interest swaps and cap used toeconomically hedge our securitization financing costs, which are reported as acomponent of other income (expense) portfolio derivatives, plus the netinterest income before loss provision on loans held for investment, decreasedto $36.4 million in the three months ended March 31, 2006 from $43.9million in the same period in 2005, primarily due to a decrease in our averagefirst quarter 2006 net interest income margin, partially offset by a higherportfolio balance. Net interest margin plus the net cash received on our swaps,declined to 2.6% in the first quarter of 2006 from 3.6% in the comparableperiod last year, while our older, lower rate swaps expired and new swaps wereadded to the portfolio at higher rates. The margins available on new loansnarrowed, as intense market competition for new loans did not permit coupons onnew originations to increase at the same rate as the increase in financingcosts.

Our portfolio of loansheld for investment, net, remained at $5.5 billion at March 31, 2006 asthe amount of new loans added to the portfolio during the quarter was offset byloan prepayments. We intend to continue to build our portfolio by retaining themajority of our non-conforming fundings. The percentage of loans we retain forthe portfolio in any given period will vary based upon the size of theportfolio we hold, prepayments during the quarter and the availability of loanswhich meet our cash flow, credit and projected return criteria. As of March 31,2006, our financing debt on the loans held in our portfolio was 10.6 times ourequity. Based on the current size of our portfolio and management’s estimatesand assumptions regarding expected future origination levels and marketfactors, we believe we can achieve by year end our target portfolio debt toequity ratio on our portfolio of at least 13 times our equity, adjusted for thenon-cash mark to market of our portfolio derivatives.

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 ARM mortgage loans held for investment. Because thesederivatives are not designated as cash flow hedges under Statement of FinancialAccounting Standards No. 133, “*Accountingfor Derivative Instruments and Hedging Activities,”*(Statement No. 133) changes inthe fair 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.” We cannot predict the future path of interest rates, nor can we predictthe magnitude by which these changes in the fair market value of our swaps andcap could cause our total revenue and net income to increase or decreasesignificantly during periods of interest rate volatility.

In the firstquarter of 2006, we disposed of the majority of the assets of our conformingretail and conforming wholesale segments, based upon the declining trend in thesegments’ profitability in 2005 and 2004, as increased competition anddepressed margins due to rising interest rates reduced the funding volumes andincome contribution of those segments. In February 2006, we sold theassets pertaining to our conforming division’s headquarters office, all of itswholesale offices and certain of its retail offices to third parties. Theremaining conforming retail offices in Maryland and Virginia have been combinedwith our non-conforming retail offices, which will offer a range ofnon-conforming and conforming loan products. The pre-tax loss on disposal was$0.9 million.

Our continuing operations originated $1.0 billion ofmortgage loans during the three months ended March 31, 2006, a 12%reduction from the $1.1 billion originated by our continuing operations duringthe same period in 2005. Our origination volumes declined in 2006 as a resultof continued competition for new loan originations during the quarter. TheMortgage Bankers Association of America forecasted that total mortgage 

27

----

originations in the first quarter of 2006 would beapproximately 12% lower than the first quarter of 2005. We added offices andpersonnel to our mortgage origination franchise during 2005 to offset theeffect of competition and a declining market on originations.

Our continuing operations reported a net cost toproduce of 3.52% in the three months ended March 31 2006, an increase fromthe 3.07% in the three months ended March 31, 2005. The cost to produce inthe first quarter of 2006 included 0.38% additional expenses related toproduction sales force increases, and 0.25% of additional home office expenseprimarily related to incremental legal and accounting costs. These costincreases were partially offset by a 0.19% decrease in the net premiums paid onnew originations during the quarter.

**Restatement of Condensed ConsolidatedFinancial Statements**

We have restatedour condensed consolidated financial statements for the three months ended March 31,2005 to correct an error in the accounting for income taxes related to the saleof loans by FMC, our taxable REIT subsidiary, to FIC, which operates as a REIT,in the fourth quarter of 2003 and the second quarter of 2005. In each of theseperiods, we had previously recognized the entire income tax expense related tothe gain on sale earned by FMC on these sales to FIC for inclusion in itsinvestment portfolio. However, we determined that we should have deferred theportion of the income tax expense related to the intercompany sale, because theloans remained on our consolidated statements of condition at period end. Thedeferred tax asset should have been recognized as expense over the life of theloans. See Note 1(g) “Restatement” to the condensed consolidated financialstatements, which is included in Part I, Item 1 of this report. Thecorrection of these errors resulted in a cumulative increase to accumulatedearnings and shareholders’ equity of $1.4 million as of March 31, 2005. Asof March 31, 2006, and 2005, the balance of the deferred tax asset relatedto the intercompany loan sales was $1.2 million and $1.4 million, respectively.

This restatementof our income tax expense has no effect on our REIT taxable income, which isthe basis for determining the dividends we pay to our stockholders. In addition,the entry to correct the accounting error did not result in (i) a changeto our cash position, (ii) a default under any of our credit facilities, (iii) achange to our reported non-GAAP financial measures relating to cost to produceand core net interest income and margin, or (iv) a change to our federalor state tax liability for any of the periods restated. For tax accountingpurposes, the gain on sale was reported correctly as taxable income on the taxreturn of FMC. The following discussion contained in “Management’s Discussionand Analysis of Financial Condition and Results of Operations” gives effect tothe restatement discussed in Note 1(g) to the condensed consolidatedfinancial statements included in this report.

**Key Components ofFinancial Results of Operations**

**Revenues**

Our revenues are basedprimarily on the spread between the interest income we receive from the loanswe fund for investment and the interest expense on the debt financing theseloans, sale margins on our loans held for sale, the rate of prepayment of ourmortgage loans held for investment, credit losses on our investment portfolio,and origination volumes. During periods of rising interest rates, we wouldgenerally increase the mortgage interest rates we charge on our loan originations,but we will also experience an increase in our costs of borrowing to financethe loans. If the rise in borrowing costs is greater than the coupon on neworiginations of loans held for investment, net interest income spread will belower on new loans which replace older loans originated and financed at highernet interest income spreads in the portfolio that have prepaid. Rising interestrates may lead to decreases in loan prepayments of our hybrid adjustable-ratemortgages during the initial loan period in which our borrowers pay a fixedinterest rate, generally during the first two to three years of the loan, 

28

----

but increase prepayments at or near the reset date ofthe loan, when the coupon resets to a six-month LIBOR-based ARM reflecting thehigher market rates. Decreases in prepayment speeds result in lower prepaymentfee income, but offer other potential expense reductions in the form ofdecreases to the rate of amortization of deferred origination costs and bondissuance costs, which are recorded as a reduction in yield.

**Expenses**

The principal factors which lead to changes in ourexpenses are funding volumes, the number of production facilities we operate,our staffing required to support our origination platform, the balance of ourinvestment portfolio incurring third-party servicing fee expense and thecorporate overhead required to support a public company. As loan volumesincrease, we generally would expect salaries and employee benefit expenses toincrease as well as variable loan related expenses. There are also increasedcosts related to compliance with the Sarbanes-Oxley Act of 2002, SEC andinvestor reporting and accounting and legal fees. We also expect expenses toincrease as the final development phase of our new loan origination softwaresystem is completed, which is expected in the second and third quarters of2006, and thereafter, as the capitalized development costs for the final phasebegin to be amortized.

**Critical Accounting Policies**

We consider the policies discussed below to be criticalto an understanding of our financial statements because their applicationplaces the most significant demands on the judgment of our management, withfinancial reporting results relying on estimates and assumptions about theeffects of matters that are inherently uncertain. Specific risks for thesecritical accounting policies are described in the following paragraphs. Whilewe believe that the estimates and assumptions management utilizes in preparingour financial statements are reasonable, such estimates and assumptionsroutinely require periodic adjustment. Actual results could differ from ourestimates, and these differences could be significant.

***Securitizations***

We must comply with the provisions of Statement ofFinancial Accounting Standards No. 140, *“Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities,”* (Statement No. 140)relating to each securitization. Depending on the structure of thesecuritization, it will either be treated as a sale or secured financing forfinancial statement purposes. We account for our securitizations of mortgageloans as secured financings, and accordingly, we include the securitizedmortgage loans on our books as mortgage loans held for investment. The loansare sold to a trust which is a wholly-owned special purpose entity for purposesof credit ratings; however, because the securitizations are designed as securedfinancings, they are designed not to meet the qualifying special purpose entitycriteria of Statement No. 140.

***Allowance for LoanLosses—Loans Held for Investment***

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 critical assumptions used in estimatingthe loss reserve are an assumed rate at which the loans go into foreclosuresubsequent to initial default and an assumed loss severity rate, whichrepresents the expected rate of realized loss upon disposition of theproperties that have been foreclosed. Because we have limited historical lossdata on our past originations, all of which were sold servicing-released priorto October 2003, we currently utilize industry loss assumptions for loanssimilar in credit, loan size and product type. These assumptions result in anestimate that approximately 21% 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 

29

----

of the value of the underlying collateral, our limitedactual historical loss experience from the third quarter of 2003 through thecurrent period, and other relevant factors impacting portfolio credit qualityand inherent losses. Provision for losses is charged to our consolidated statementsof operations as a reduction in net interest income. Losses incurred onmortgage loans held for investment are charged to the allowance at the earlierof the time of liquidation or at the time the loan is transferred to realestate owned. Subsequent gains or losses at property disposal are recorded togain (loss) on disposal of real estate owned, which is a component of “Fees andother income” on our consolidated 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, the collectionof principal and interest is in doubt. At the time an individual loan is placedon non-accrual status, all previously accrued but uncollectible interest isreversed against current period interest income. In addition, we reserve forinterest income accrued on our pool of homogeneous 30 and 60 day delinquentloans on the basis of the same industry loss roll rate assumptions, byestimating the interest due on our pool of homogeneous loans which will migrateto non-accrual status in the future.

***Amortization ofDeferred Loan Origination Costs 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 

30

----

debt. Updates that are required to be made to theseestimates are applied as if the revised estimates had been in place since theissuance of the related debt and result in adjustments to the current periodamortization recorded to interest expense.

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 March 31, 2006 and December 31,2005, approximately 85.9% and 86.0%, respectively, of our mortgage loanportfolio had prepayment fee features. We anticipate that prepayment rates onour portfolio will increase as these predominately adjustable-rate loans reachtheir initial adjustments, typically 24 months after funding the loans, whichbegan in 2005. The varying prepayment rate, referred to on an annualized basisas the constant prepayment rate, or CPR, will be reforecast each quarter toproject cash flows based upon historical industry data for similar loanproducts in the context of the current markets and our actual history to date.The forward-looking expected CPR used in our current assumptions averages 20CPR during the first 12 months, averages 30 CPR through month 21, andincreases to an average of 70 CPR during the months on and around the resetdate, declining to an average 38 CPR thereafter. If prepayment speeds increase,our net interest margin would decrease due to the additional cost amortization,which may be partially offset by an increase in prepayment fee income.

***Derivatives***

The economic hedging of our interest rate risk relatedto our loans held for sale is a critical aspect of our business because of itsinterest rate sensitivity and the difficulty in estimating which interest ratelocks will convert to closed loans as interest rates fluctuate. We use variousfinancial instruments to economically hedge our exposure to changes in interestrates. The financial instruments typically include mandatory delivery forwardsale contracts of mortgage-backed securities, mandatory and best effortswhole-loan sale agreements and treasury note forward sales contracts. Thesefinancial 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 economically hedge the value of our loans heldfor sale prior to entering fixed price sale contracts.

The interest rate locks for conforming loans and themandatory forward sales, which are typically used to economically hedge theinterest rate risk associated with these locks, are undesignated derivativesand are marked to market through earnings. For interest rate lock commitmentsrelated to conforming loans, mark to market adjustments are recorded frominception of the interest rate lock through the funding date of the underlyingloan. The funded loans have not been designated by us as a qualifying hedgedasset in accordance with Statement of Financial Accounting Standards No. 133,“*Accounting for Derivative Instruments andHedging Activities*” (Statement No. 133). We record thefunded loans on the consolidated statements of condition at the lower of costor market value. The mandatory forward sales, which generally serve as aneffective economic hedge from the inception of the interest rate lock throughthe time of the sale of the loans, remain subject to mark to market adjustmentsbeyond the time the loan funds, and our reported earnings may reflect somenon-economic volatility as a result of this differing treatment. The non-cashmark to market valuations of both our interest rate lock commitments andderivative instruments is reported as a component of gains on sales of mortgageloans, net.

The interest rate lock commitments associated withnon-conforming loans held for sale and the treasury note forward salescontracts typically used to economically hedge the interest rate risk associatedwith these locks are also derivatives and are marked to market throughearnings. Similar to the conforming loans, the funded non-conforming loans havenot been designated 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 adjustments 

31

----

beyond the time the loans fund, and our reportedearnings may reflect some non-economic volatility as a result of this differingtreatment.

Relative to our loans held for investment, weeconomically hedge the effect of interest rate changes on our cash flows as aresult of changes in the benchmark interest rate, in this case, LIBOR, on whichour interest 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 economically hedgethe financing on mortgage loans held for investment. The change in fair valueof the derivative during the hedge period is reported as a component of “Otherincome (expense)—portfolio derivatives.” The periodic net cash settlements andany gain 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 economically hedge interest rate changes relative to our firstsecuritization in the fourth quarter of 2003. The 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 ourconsolidated statements of operations.

***Stock-Based Compensation***

We  have adoptedthe fair value method of accounting for stock options and shares of restrictedstock as prescribed by Statement of Financial Accounting Standards No. 123R,*“Share-Based Payments”*(Statement No. 123R). UnderStatement No. 123R, compensation cost is measured at the grant date basedon the fair value of the award and is recognized as expense on a straight-linebasis over the award’s vesting period. The fair value of awards of restrictedstock is determined at the date of grant based on the market price of ourcommon stock on that date. For both the stock options and restricted stock, theamount of compensation cost is adjusted for estimated annual forfeitures. Thefair value of the stock options is determined using the Black-Scholes optionpricing model. Due to the subjective nature and estimates required underStatement No. 123R, we consider this a critical accounting policy.

***Reserve forLosses—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 of lossesand compares economic and real estate market trends which may have affectedhistorical losses and the potential impact of these trends to losses on currentloans sold. We estimate losses due to premium recaptures on early loan prepaymentsby reviewing loan product and rate, borrower prepayment fee, if any, andestimates of future interest rate volatility. If the actual loss trend on loanssold varies compared to the loss provision previously forecast, an adjustmentto the provision expense will be recorded as a change in estimate.

32

----

**Results of Operations**

**Three Months Ended March 31, 2006 Compared toThree Months Ended March 31, 2005**

**Net Income**

Net income decreased69.0%, or $28.9 million, to $12.9 million, for the three months ended March 31,2006, from $41.8 million for the three months ended March 31, 2005.The decrease includes an $18.7 million decrease in the non-cash mark to marketvaluation gain on interest rate swaps and caps in effect during the firstquarter of 2006. Our interest rate swaps and cap are not designated as cashflow hedges under Statement No. 133 and, therefore, the change in theperiodic mark to market of the future value of the interest rate swaps and capis reported in current period earnings. The decline in net income also reflectsa $7.5 million decrease in the revenue from our mortgage loan portfolio, whichincludes the net interest income before loss provision on loans held forinvestment plus the net cash settlements on our interest swaps and cap used toeconomically hedge our securitization financing costs. The decline in 2006portfolio margin is due to the prepayment of older, higher rate loans that haveadjusted, or are about to adjust, from their initial fixed rate to an adjustingrate, combined with new loans added to the portfolio at lower margins. Thefirst quarter of 2006 net income also includes the recognition of a $0.9million pre-tax loss on disposal related to the discontinuation of theconforming division.

**Revenues**

***Net InterestIncome After Provision for Loan Losses***

The following arethe components of net interest income after provision for loan losses for thethree months ended March 31, 2006 and 2005 (in thousands):

|                                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Interest income:                                                 |       |                                             |       |   |   |
| Coupon interest income on loans held for investment              |       | $                                                | 96,433     |   | 81,551 |   |
| Coupon interest income on loans held for sale                    |       | 6,601                                            |       | 4,287 |   |
| Amortization of deferred origination costs                       |       | (6,871                                           | )          | (5,504 | ) |
| Prepayment fees                                                  |       | 5,551                                            |       | 6,789 |   |
| Total interest income                                            |       | 101,714                                          |       | 87,123 |   |
|                                                             |       |                                             |       |   |   |
| Interest  expense:                                               |       |                                             |       |   |   |
| Financing interest expense on loans held for  investment*        |       | 66,199                                           |       | 36,547 |   |
| Financing interest expense on loans held for sale                |       | 2,605                                            |       | 992 |   |
| Amortization of deferred bond issuance costs and  issue discount |       | 2,717                                            |       | 2,061 |   |
| Total interest expense                                           |       | 71,521                                           |       | 39,600 |   |
| Net interest income                                              |       | 30,193                                           |       | 47,523 |   |
| Provision for  loan losses—loans held for investment        |       | 5,393                                            |       | 4,494 |   |
| Net interest  income after provision for loan losses             |       | $                                                | 24,800     |   | 43,029 |   |

----

*  Does notinclude the effect of the interest rate swap and cap agreements whicheconomically hedge our portfolio of financing costs.

33

----

 

The followingtable presents the average balances for our loans held for investment and loansheld for sale and our warehouse and securitization financing, with thecorresponding annualized yields for the three months ended March 31, 2006and 2005 (in thousands). 
| ** **                                                                                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Average balances:                                                                                                      |       |                                             |       |   |   |
| Mortgage loans held for investment                                                                                     |       | $                                                | 5,453,923  |   | 4,884,311 |   |
| Securitization financing—loans held for investment                                                                |       | 4,825,196                                        |       | 4,187,989 |   |
| Warehouse financing—loans held for investment                                                                     |       | 510,867                                          |       | 518,852 |   |
|                                                                                                                   |       |                                             |       |   |   |
| Yield analysis—loans  held for investment:                                                                        |       |                                             |       |   |   |
| Coupon interest income on loans held for investment                                                                    |       | 7.07                                             | %          | 6.68 | % |
| Amortization of deferred origination costs                                                                             |       | (0.50                                            | )%         | (0.46 | )% |
| Prepayment fees                                                                                                        |       | 0.41                                             | %          | 0.56 | % |
| Yield on loans held for investment (1)                                                                                 |       | 6.98                                             | %          | 6.78 | % |
|                                                                                                                   |       |                                             |       |   |   |
| Interest expense securitization financing                                                                              |       | 4.96                                             | %          | 3.02 | % |
| Interest expense warehouse financing                                                                                   |       | 4.98                                             | %          | 3.78 | % |
| Amortization—deferred bond issuance costs and issue  discount                                                     |       | 0.23                                             | %          | 0.20 | % |
| Cost of financing for loans held for investment (2)                                                                    |       | 5.17                                             | %          | 3.28 | % |
| Net yield on loans held for investment (3)                                                                             |       | 1.92                                             | %          | 3.62 | % |
| Provision for loan losses as % of average loan  balance                                                                |       | (0.40                                            | )%         | (0.37 | )% |
| Net yield on loans held for investment after  provision for loan losses                                                |       | 1.52                                             | %          | 3.25 | % |
|                                                                                                                   |       |                                             |       |   |   |
|                                                                                                                   |       |                                             |       |   |   |
| Average balances:                                                                                                      |       |                                             |       |   |   |
| Mortgage loans held for sale                                                                                           |       | $                                                | 330,044    |   | 216,783 |   |
| Warehouse financing—loans held for sale                                                                           |       | 212,156                                          |       | 98,213 |   |
|                                                                                                                   |       |                                             |       |   |   |
| Yield analysis—loans  held for sale:                                                                              |       |                                             |       |   |   |
| Yield on loans held for sale (1)                                                                                       |       | 8.00                                             | %          | 7.91 | % |
| Cost of financing for loans held for sale (2)                                                                          |       | 4.91                                             | %          | 4.04 | % |
| Net yield on loans held for sale (3)                                                                                   |       | 4.84                                             | %          | 6.08 | % |
|                                                                                                                   |       |                                             |       |   |   |
| Combined yield—net  interest income after provision for loan losses, loans held for investment  and held for sale |       | 1.72                                             | %          | 3.37 | % |

----

(1)             Calculatedas the annualized interest income divided by the average daily balance of themortgage 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.

***Net Interest Income AfterProvision for Loan Losses Earned on Loans Held for Investment***

In the three months ended March 31, 2006, the$12.3 million increase in interest income on loans held for investment earnedby the $0.6 billion higher average portfolio balance in 2006 compared to thesame period in 2005, was largely offset by a $30.3 million increase in interestexpense on loans held for investment, as the one-month LIBOR interest rateindex used to determine our portfolio debt financing costs, rose to an averageof 4.68% in three months ended March 31, 2006 compared to an average of2.71% in the same period in 2005. 

34

----

 

Interest expense related to both warehouse andsecuritization financing rose in the three months ended March 31, 2006 ascompared to the same period in 2005 and is expected to continue to increase in2006 both notionally and as a percentage cost of financing due to theanticipated prepayment of older loans financed with lower-rate debt, comparedto new mortgage fundings financed with higher cost debt. We expect net interestincome before loan loss provision in the remainder of 2006 to continue todecline from 2005, as incremental net interest income earned on the forecastedincrease in the average portfolio loan balance in 2006 is offset by thenarrower margins on new originations, compared to the wider spreads on the 2003and 2004 loans expected to prepay in 2006. Margins available on new loans areexpected to continue to be narrower in 2006, as forecasted financing rateincreases are not expected to be wholly offset by mortgage coupon rateincreases of the same magnitude due to market competition for new originations.

 The $30.2million net interest income before provision for loan losses earned in thethree months ended March 31, 2006 does not include the $10.3 million ofnet cash settlements received in 2006 under the terms of the swap agreementsused to economically hedge the financing costs of our loans held forinvestment. The regular monthly swap settlement amounts, plus any cash paid orreceived at termination of the agreements prior to maturity, are included inthe line item “Other income (expense)—portfolio derivatives.”

The increase in theinterest income yield on loans held for investment to 6.98% in the three monthsended March 31, 2006 from 6.78% in the same period in 2005 reflects theincrease in coupons on our 2/28 hybrid mortgages which reached their noteresets from fixed to adjustable during the period combined with higher yieldson new loans added to the portfolio.

Provision for loan losses increased in the threemonths ended March 31, 2006 compared to the same period in 2005, due tothe increase in delinquent loans as the portfolio continued to mature. Theincrease in the provision for loan losses was lower than our previousexpectations due to fewer delinquent loans and lower realized losses. Ourdelinquent loans were lower than historical levels due to faster portfolioprepayment speeds and our charge-offs were lower than historical levels due tostrong home price appreciation from 2003 through 2005. We expect the provisionfor loan losses to continue to rise in 2006, due to (i) higher amounts ofdelinquent loans due to slower prepayment speeds, (ii) more normalizedlosses on foreclosure due to flattening home price appreciation and (iii) higherlevels of delinquencies due to the increases in borrowers’ payment onapproximately 28% of our loans as they reach their initial rate reset periodfrom fixed to adjustable in 2006.

***Net Interest Income Earned onLoans Held for Sale***

Net interest incomeearned on loans held for sale includes the net interest spread on all of ourconforming loan originations that are all held for sale, and the portion of ournon-conforming originations that are not held for investment. This amountincreased $0.7 million in the first three months in 2006 compared to the sameperiod in 2005, as the increase in the 2006 average balance of loans held forsale was substantially offset by the decline in net interest income yield from6.08% in the first three months of 2005 to 4.84% in the first three months of2006. The decline in yield reflects the rise in financing costs tied to LIBOR—basedindices, while coupon rates on new originations declined, due to borrowerschoosing lower rate ARM mortgages during this period of rising market rates. In2006, we expect a decline in net interest income on loans held for sale due tothe disposal in the first quarter 2006 of our conforming retail and wholesalesegments, which will result in a lower average balance of earning assets heldfor sale in 2006.

35

----

***Gains on Sales ofMortgage Loans, net***

***Loan Sales from Continuing Operations***

The components of the gains on sale of mortgage loansfrom continuing operations, net are illustrated in the following table for thethree months ended March 31, 2006 and 2005 (in millions)*:******

|                                                                            | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                             | ** ** | **% of  Sales  Volume** | ** ** | **2005** | ** ** | **% of  Sales  Volume** | ** ** |
| Gross premiums -  whole loan sales, net of derivative gains or losses |       | $                                                    | 15.6       |   | 2.37 | % | $ | 13.7 |   | 2.58 | % |
| Loan fees  collected(1)                                                    |       | 4.0                                                  |       | 0.61 | % | 3.4 |   | 0.65 | % |
| Premiums paid(2)                                                           |       | (2.8                                                 | )          | (0.42 | )% | (2.1 | ) | (0.40 | )% |
| Subtotal                                                                   |       | 16.8                                                 |       | 2.56 | % | 15.0 |   | 2.83 | % |
| Provision for  losses—loans sold                                      |       | (2.0                                                 | )          | (0.31 | )% | (2.2 | ) | (0.42 | )% |
| Direct  origination costs(3)                                               |       | (4.5                                                 | )          | (0.68 | )% | (4.3 | ) | (0.81 | )% |
| Gains on sales of mortgage loans, net                                      |       | $                                                    | 10.3       |   | 1.57 | % | $ | 8.5 |   | 1.60 | % |
| Loan sales  volume                                                         |       | $                                                    | 654.6      |   |   |   | $ | 529.6 |   |   |   |

----

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

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

(2)      Premiums paid represent fees paid to brokers for wholesale loanoriginations.

(3)      Direct origination costs primarily are commissions and direct salarycosts.

The gains on sales of mortgage loans, net, increasedfor the three months ended March 31, 2006 compared to the same period in2005, due to a 24% increase in sales volume, as forward sale contracts enteredinto in the fourth quarter of 2005 settled in January 2006. Period-over-period,gross whole loan sales premiums, net of derivative gains or losses, declined asnarrower interest spreads compressed sale margins, combined with declines inthe sales premiums paid on second lien mortgages which comprise approximately19.5% of our originations of loans held for sale. We expect gross sale premiumsto continue at lower levels than 2005 as the industry responds to increasedcompetition in a shrinking mortgage market by offering coupon rates on neworiginations which are not increasing at the same rate as the increase in thecost of financing the loans.

We maintained a $2.8million valuation allowance on $19.2 million of unsaleable loans withdocumentation deficiencies or delinquency histories as of March 31, 2006.

***Other Income(Expense)—Portfolio Derivatives***

We use interest rate swapand cap agreements to create economic hedges of the variable rate debtfinancing of our portfolio of non-conforming mortgages held for investment.Changes in the fair value of these agreements, which reflect the potential futurecash settlements over the remaining lives of the agreements 

36

----

accordingto the market’s changing projections of interest rates, are recognized in theline item “Other income (expense)—portfolio derivatives” in the condensedconsolidated statements of operations. This single line item includes both theactual cash settlements related to the agreements that occurred during theperiod and recognition of the non-cash changes in the fair value of theagreements over the period. The cash settlements include regular monthlypayments or receipts under the terms of the swap agreements and cash paid orreceived to terminate the agreements prior to maturity. The amount of cashsettlements and non-cash changes in value that were included in “Other income(expense)—portfolio derivatives” is as follows for the three months ended March 31,2006 and 2005 (in thousands):

|                                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Non-cash changes in  fair value                                                        |       | $                                                    | 1,894      |   | 20,628 |   |
| Net cash settlements on  existing derivatives                                          |       | 10,264                                               |       | (1,295 | ) |
| Net cash settlements  received (paid) to terminate derivatives prior to final maturity |       | —                                               |       | 1,009 |   |
| Other income (expense)—portfolio derivatives                                      |       | $                                                    | 12,158     |   | 20,342 |   |

 

Our portfolio derivatives allow us to “lock-in” theexpected financing costs of our investment portfolio over a future contractualtime period. At March 31, 2006 and 2005, the notional balance of ourinterest rate swaps was $4.4 billion and $4.5 billion, respectively.

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

|                  | ** ** | **2005**        | ** ** | **2006**        | ** ** |
|------------------|------------|-----------------|------------|-----------------|------------|
| ** **       | ** ** | **Mar 31** | ** ** | **Jun 30** | ** ** | **Sep 30** | ** ** | **Dec 31** | ** ** | **Mar 31** | ** ** |
| 2 Year Swap Rate |       | 4.19            | %          | 3.98            | %          | 4.57 | % | 4.85 | % | 5.28 | % |

 

Source:  Bloomberg L.P.

Thefollowing table summarizes the average notional balance and the future weightedaverage fixed payment interest rate of our interest rate swaps in effect as of March 31,2006, for the nine months ending December 31, 2006 and the year ending December 31,2007 (in thousands):
| ** **           | ** ** | **Period Ending December 31,** | ** ** |
|----------------------|------------|-----------------------------------------------|------------|
| ** **           | ** ** | **2006**                                      | ** ** | **2007** | ** ** |
| ** **           | ** ** | **Average  Notional  Balance**                | ** ** | **Weighted  Average  Pay Rate** | ** ** | **Average  Notional  Balance** | ** ** | **Weighted  Average  Pay Rate** | ** ** |
| Interest rate  swaps |       | $                                             | 3,238,656  |   | 4.02% |   | $ | 1,251,559 |   | 4.55% |   |
|                      |            |                                               |            |  |  |  |  |  |  |  |  |

 

Other income(expense)—portfolio derivatives will vary as movements in the LIBOR interestrate occur throughout the period. Generally, rising interest rates willincrease the fair value of our derivatives and our net cash settlements onexisting derivatives. We cannot predict the net effect of interest rate volatilityin future periods to our other income (expense)—portfolio derivatives.

37

----

**Expenses**

The following is asummary of total expenses and the percentage change from the prior period, andthe provisions for income tax benefit for the three months ended March 31,2006 and 2005 (in thousands):

|                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Salaries and  employee benefits      |       | $                                                    | 20,869     |   | 17,704 |   |
| Occupancy                            |       | 1,823                                                |       | 1,499 |   |
| Depreciation and  amortization       |       | 935                                                  |       | 760 |   |
| Servicing fees                       |       | 2,569                                                |       | 2,604 |   |
| General and  administration          |       | 7,563                                                |       | 7,321 |   |
| Total expenses                       |       | $                                                    | 33,759     |   | 29,888 |   |
| Percentage  change from prior period |       | 13.0                                                 | %          | N/A |   |
| Income tax benefit                   |       | $                                                    | 729        |   | 157 |   |

*** ***

***Total Expenses*.**Total expenses increased during the three months ended March 31, 2006 comparedto the same period in 2005 primarily due to higher salary and benefit expensesand occupancy costs related to the growth of our business since March 31,2005. We expect total expenses to increase in 2006, compared to 2005, primarilydue to the addition of sales personnel to maintain our market share of loanoriginations in light of industry expectations of a reduction in over-allmortgage originations in 2006, as well as additional personnel and costs tosupport initiatives related to information technology improvements.

We have partially replacedour two non-integrated conforming and non-conforming origination softwaresystems with a single, integrated system to serve as both the conforming andnon-conforming origination and funding support system, and upgraded “Fieldscore,”our pre-approval and credit gathering engine. The project involves purchasing,developing, installing, training and supporting the new system. The “Fieldscore”upgrade was complete as of December 31, 2004, the conforming component wasplaced in use in the third quarter of 2005, and we anticipate thenon-conforming component will be fully implemented in the second and thirdquarters of 2006. We have capitalized $5.5 million to date for hardware andsoftware development, and expensed approximately $0.3 million and $0.3 millionfor the three months ended March 31, 2006 and 2005, respectively, inmaintenance contracts and depreciation for the hardware and in-use portion ofthe internally-developed software. We expect maintenance and depreciationexpense to increase in 2006 as we complete development of the software andplace the system fully into service.

***Salaries andEmployee Benefits.*** The increase in salaries and employee benefitsin the three months ended March 31, 2006 compared to the same period in2005 is due to the additional sales personnel hired during 2005 to maintain ourloan origination volume in a declining mortgage market, home office staffadditions to manage the growth of our REIT portfolio, the legal and financerequirements of operating as a public company including Sarbanes – Oxleycompliance, and additional information technology personnel to support plannedenhancements in access and security controls, combined with a $0.8 millionincrease in employee benefit expense related to our self-insurance plan.

We expect salaries andemployee benefits, net of deferred direct origination costs, to increase in2006, compared to 2005, primarily due to the additional account executives andloan officers required to support loan funding volume, and additionalinformation technology personnel to support the complete implementation of ournew loan origination system.

***Servicing Fees*.**   Servicing fees paid to our third-partyservicer of the loans in our portfolio decreased slightly for the three monthsended March 31, 2006 compared to the same period in the prior year, due to

38

----

lower servicing ratesnegotiated with our third-party servicer on recently issued securitizationdeals, partially offset by an increase in the average balance of our portfolio.Currently, all of our loans held for investment are serviced by a third-partyservicer effective with the first mortgage payment due after loan funding.

***General and Administration.****  * General andadministration expenses rose slightly in the three months ended March 31,2006 compared to the same period in 2005 primarily due to increased audit feesrelated to our re-audit of financial results for the years 2003 and 2004,completed in the first quarter of 2006. We do not expect general andadministration expenses during the remainder of 2006 to change significantlyfrom first quarter 2006 levels, as planned cost reductions in office expenses,telecom, and credit reporting efficiencies are expected to substantially offsetvariable loan related costs, which we anticipate may rise as origination volumeincreases throughout the remainder of 2006.

***IncomeTax Benefit.****  *Wequalified to be taxed as a REIT, effective in the fourth quarter of 2003, andwe elected to treat our loan origination and sale subsidiary, FMC, as a taxableREIT subsidiary (TRS). A TRS is a corporation that is permitted to engage innon-qualifying REIT activities. Taxable income of our TRS is subject tofederal, state, and local income taxes. Income tax expense reflects thefollowing effective tax rates:

|                                   | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| FMC pre-tax net  loss in millions |       | $                                                      | (5.3       | ) | $ | (2.5 | ) |
| Effective tax benefit  rate       |       | 35                                                     | %          | 24 | % |
|                                   |            |                                                        |            |  |  |  |  |

 

The lower effective tax benefit rate in the firstquarter of 2005 includes a higher amortization of a deferred tax asset relatedto prior year inter-company loan sales during that quarter, which decreased theeffective tax benefit rate.

**Consolidated Statements of Condition at March 31,2006 and December 31, 2005**

***Mortgage LoansHeld for Investment***

The followingtable summarizes the principal balance of our investment portfolio for the threemonths ended March 31, 2006 and the year ended December 31, 2005 (inthousands):
| ** **                                     | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Beginning  principal balance                   |       | $                                                          | 5,530,216  |                                             | 4,735,063  |   |
| Loan fundings                                  |       | 528,334                                                    |       | 3,341,911                                        |       |
| Payoffs and principal reductions               |       | (543,382                                                   | )          | (1,981,866                                       | )          |
| Transfers to mortgage loans held for sale, net |       | —                                                     |       | (530,830                                         | )          |
| Transfers to real estate owned                 |       | (19,463                                                    | )          | (34,062                                          | )          |
| Ending principal  balance                      |       | 5,495,705                                                  |       | 5,530,216                                        |       |
| Net deferred loan origination (fees)/costs     |       | 36,776                                                     |       | 40,199                                           |       |
| Ending balance  loans held for investment      |       | 5,532,481                                                  |       | 5,570,415                                        |       |
| Allowance for loan losses                      |       | (45,744                                                    | )          | (44,122                                          | )          |
| Ending balance loans  held for investment, net |       | $                                                          | 5,486,737  |                                             | 5,526,293  |   |

 

During the three months ended March 31, 2006, weoriginated $528 million in loans for the portfolio, which generated$26.2 million of net interest income before provision for loan losses. Aprovision for loan losses of $5.4 million was recorded and $3.8 million ofnet charge-offs were incurred, resulting in an allowance for loan losses of$45.7 million as of March 31, 2006.

The decrease in portfolio balance is the result ofpayoffs exceeding fundings during the first quarter, consistent with seasonalfluctuations.  Because we sold all of ourloans prior to the third quarter of 2003, we do not have

39

----

comprehensiveperformance data on our loans sold to investors relative to credit losses andprepayments. We estimate prepayment speeds based upon historical industry datafor similar loan products and actual history to date, which are adjusted forcurrent market assumptions regarding future economic conditions such as homeprice appreciation and interest rate forecasts. These assumptions forprepayment speeds indicate an average loan life of approximately 23 months.There can be no assurance that this industry data will be reflective of ouractual results. Management will continue to monitor prepayment speeds of loansin our securitizations upon reaching the expiration period of prepayment feeobligation and adjustment to an adjustable-rate mortgage.

In the second quarter of 2005, we transferred loansheld by the REIT to our TRS, FMC. The transfer of loans held for investment tomortgage loans held for sale, net in the second quarter of 2005 reflectsmanagement’s determination at that time that the projected return on assets andreturn on equity to be generated by approximately $640 million of loans held bythe REIT and yet to be securitized had declined to levels below our targetedinvestment return. Later in the second quarter, management determined thatapproximately $110 million of loans originated by FMC and held-for-sale met thecompany’s revised return-on-asset criteria for the REIT and were subsequentlysold in an arms-length transaction from FMC to the REIT.

***Allowance for LoanLosses—Loans Held for Investment***

The followingtable summarizes the allowance for loan loss activity of our investmentportfolio for the three months ended March 31, 2006 and the year ended December 31,2005 (in thousands):
| ** **                                                    | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Beginning  balance allowance for loan losses                  |       | $                                                          | 44,122     |                                             | 22,648     |   |
| Provision                                                     |       | 5,393                                                      |       | 30,065                                           |       |
| Charge-offs                                                   |       | (3,771                                                     | )          | (8,591                                           | )          |
| Ending balance  allowance for loan losses                     |       | $                                                          | 45,744     |                                             | 44,122     |   |
| Ending principal  balance, mortgage loans held for investment |       | $                                                          | 5,495,705  |                                             | 5,530,216  |   |
| Ending allowance  balance as % of ending principal balance    |       | 0.8                                                        | %          | 0.8                                              | %          |

 

The delinquencystatus of our loans held for investment as of March 31, 2006 and December 31,2005 was as follows (in thousands):
| ** **                                                                                                               | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                               | ** ** | **Principal  Balance**       | ** ** | **Percentage  of Total**   | ** ** | **Principal  Balance** | ** ** | **Percentage  of Total** | ** ** |
| Current                                                                                                                  |       | $                            | 4,897,817  |                            | 89.1       | % | $ | 4,925,656 |   | 89.1 | % |
| 30 days past due                                                                                                         |       | 331,656                      |       | 6.1                             | %          | 359,074 |   | 6.5 | % |
| 60 days past due                                                                                                         |       | 94,519                       |       | 1.7                             | %          | 93,663 |   | 1.7 | % |
| 90+ days past  due                                                                                                       |       | 59,063                       |       | 1.1                             | %          | 65,810 |   | 1.2 | % |
| In process of  foreclosure                                                                                               |       | 112,650                      |       | 2.0                             | %          | 86,013 |   | 1.5 | % |
| Total                                                                                                                    |       | $                            | 5,495,705  |                            | 100.0      | % | $ | 5,530,216 |   | 100.0 | % |
| Allowance for loan losses                                                                                                |       | $                            | 45,744     |                            |       |   | $ | 44,122 |   |   |   |
| Allowance for  loan losses as a % of total delinquent loans (30+ days past due and loans in  the process of foreclosure) |       | 7.7                          | %          |                            |       | 7.3 | % |   |   |

 

40

----

Delinquency, lifeto date loss experience and weighted average coupon of our loans held forinvestment by securitization pool as of March 31, 2006 and December 31,2005 were as follows (in thousands):
| ** **                                   | ** ** | **As of March 31, 2006** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | **Current  Principal  Balance**              | ** ** | **Current  Balance as  Factor of  Original  Principal** | ** ** | **% of  Principal  Balance  Seriously  Delinquent(1)** | ** ** | **% of   Cumulative  Realized  Losses(2)** | ** ** | **Weighted   Avg. Coupon** | ** ** | **Avg. Age  of Loans  from  Funding  (months)** | ** ** |
| Loans held for  investment-securitized:      |       |                                         |       |   |   |   |   |   |   |   |   |   |   |
| FMIC Series 2003-1                      |       | $                                            | 68,297     |   | 14% |   | 19.6% |   | 0.35% |   | 9.17% |   | 32 |   |
| FMIT Series 2004-1 (3)                  |       | 115,364                                      |       | 17% |   | 14.9% |   | 0.28% |   | 9.35% |   | 28 |   |
| FMIT Series 2004-2                      |       | 273,494                                      |       | 31% |   | 8.9% |   | 0.34% |   | 8.41% |   | 25 |   |
| FMIT Series 2004-3                      |       | 517,735                                      |       | 52% |   | 6.2% |   | 0.27% |   | 6.49% |   | 23 |   |
| FMIT Series 2004-4                      |       | 485,227                                      |       | 55% |   | 8.8% |   | 0.23% |   | 6.95% |   | 20 |   |
| FMIT Series 2004-5                      |       | 545,245                                      |       | 61% |   | 6.8% |   | 0.18% |   | 6.78% |   | 18 |   |
| FMIT Series 2005-1                      |       | 494,175                                      |       | 66% |   | 6.1% |   | 0.20% |   | 6.90% |   | 16 |   |
| FMIT Series 2005-2                      |       | 867,977                                      |       | 90% |   | 4.3% |   | 0.03% |   | 7.13% |   | 10 |   |
| FMIT Series 2005-3                      |       | 1,121,285                                    |       | 96% |   | 2.3% |   | 0.00% |   | 7.32% |   | 6 |   |
| FMIT Series 2006-1                      |       | 697,825                                      |       | 100% |   | 0.9% |   | 0.00% | ** ** | 7.92% |   | 3 |   |
| Total                                        |       | 5,186,624                                    |       | 62% |   | 5.1% |   | 0.18% |   |   |   | 13 |   |
| Loans held for  investment-to be securitized |       | 309,081                                      |       | 100% |   | 0.1% |   | 0.00% |   |   |   | 1 |   |
| Total loans held for  investment             |       | $                                            | 5,495,705  |   | 63% |   | 4.8% |   | 0.17% | ** ** | 7.32% |   | 13 |   |

 
| ** **                                   | ** ** | **As of December 31, 2005** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                   | ** ** | **Current  Principal  Balance**                 | ** ** | **Current  Balance as  Factor of  Original  Principal** | ** ** | **% of  Principal  Balance  Seriously  Delinquent(1)** | ** ** | **% of  Cumulative  Realized  Losses(2)** | ** ** | **Weighted   Avg. Coupon** | ** ** | **Avg. Age  of Loans  from  Funding  (months)** | ** ** |
| Loans held for  investment-securitized:      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| FMIC Series 2003-1                      |       | $                                               | 83,201     |   | 17% |   | 17.1% |   | 0.31% |   | 8.79% |   | 29 |   |
| FMIT Series 2004-1 (3)                  |       | 221,352                                         |       | 33% |   | 9.1% |   | 0.22% |   | 8.48% |   | 25 |   |
| FMIT Series 2004-2                      |       | 398,754                                         |       | 45% |   | 7.0% |   | 0.30% |   | 6.83% |   | 22 |   |
| FMIT Series 2004-3                      |       | 556,056                                         |       | 56% |   | 6.9% |   | 0.18% |   | 6.46% |   | 20 |   |
| FMIT Series 2004-4                      |       | 535,681                                         |       | 61% |   | 7.5% |   | 0.20% |   | 6.97% |   | 17 |   |
| FMIT Series 2004-5                      |       | 610,985                                         |       | 68% |   | 6.7% |   | 0.07% |   | 6.80% |   | 15 |   |
| FMIT Series 2005-1                      |       | 562,331                                         |       | 75% |   | 4.9% |   | 0.11% |   | 6.92% |   | 13 |   |
| FMIT Series 2005-2                      |       | 918,831                                         |       | 95% |   | 3.0% |   | 0.00% |   | 7.14% |   | 7 |   |
| FMIT Series 2005-3                      |       | 1,156,571                                       |       | 99% |   | 0.7% |   | 0.00% |   | 7.34% |   | 3 |   |
| Total                                        |       | 5,043,762                                       |       | 65% |   | 4.9% |   | 0.14% |   |   |   | 13 |   |
| Loans held for  investment-to be securitized |       | 486,454                                         |       | 100% |   | 0.1% |   | 0.00% |   |   |   | 1 |   |
| Total loans held for  investment             |       | $                                               | 5,530,216  |   | 67% |   | 4.4% |   | 0.13% |   | 7.13% |   | 12 |   |

----

(1)  Seriously delinquent is defined as a mortgage loan that is 60 + dayspast due or in the process of foreclosure.

(2)          Realized losses includecharge-offs to the allowance for loan losses—loans held for investment relatedto loan principal balances and do not include previously accrued but uncollectedinterest, which is reversed against current period interest income.

(3)          Series 2004-1was called and paid in full in April 2006.

41

----

The increase in allowance for loan losses from $44.1million as of December 31, 2005, to $45.7 million as of March 31,2006 reflects the portfolio growth and seasoning of the underlying loans. Dueto the short time span from our initial securitization through March 31,2006, we have limited actual loss experience on our investment portfolio. Wecurrently estimate an average loss severity of 35%, not including past dueinterest which is reversed against current period interest income when the loanis placed on non-accrual status or deemed otherwise uncollectible.

During the three months ended March 31, 2006, wesold 83 real estate owned properties previously collateralizing loans held forinvestment with an average aggregate principal net charge-off of 24%, whichincludes the initial charge-off at transfer to real estate owned and subsequentdecrease in net realizable value, if any, and the final gain or loss ondisposal of the property. At this time, we believe our 35% estimated averageloss severity is supported by our limited disposal history from the portfolio,combined with the risk that loss severity may increase as the loans continue toseason and economic factors may slow the increases in property values. We willcontinue to review our loss assumptions and update our estimates as required.

At March 31, 2006, $266.2 million, or 4.8%, ofloans held for investment were seriously delinquent (60+ days past due andloans in the process of foreclosure), compared to $245.5 million, or 4.4%, at December 31,2005. This is consistent with industry trends and expectations, as theportfolio grows and loans further season. According to Moody’s Investor ServiceSpecial Report dated April 26, 2006, the industry 60+ days delinquency onloan products with similar credit characteristics to our portfolio and aweighted average seasoning of 16.2 months was 7.05% in November 2004. Managementanticipates that delinquencies will increase, but is unable to predict at thistime whether the delinquencies will be higher or lower than this industryaverage.

***Real Estate Owned***

Real estate owned is reported at its estimated netrealizable value through “Prepaid expenses and other assets” on the condensed consolidatedstatements of condition. At the time a loan held for investment isforeclosed and the underlying collateral is transferred to real estate owned,any reduction in value from the loan’s previous carrying balance is charged tothe allowance for loan losses — loans held for investment. We record gains andlosses at disposal of the property to gain (loss) on disposal of real estateowned, a component of “Fees and other income” on the condensed consolidatedstatements of operations. The following is a summary of real estate owned as ofMarch 31, 2006 and December 31, 2005 (in thousands):
| ** **                                               | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Beginning  balance real estate owned                     |       | $                                                          | 14,997     |                                             | 4,374      |   |
| Plus: Transfers  from mortgage loans held for sale       |       | 468                                                        |       | 867                                              |       |
|  Transfers from mortgage loans  held for investment |       | 19,463                                                     |       | 34,062                                           |       |
| Less:  Charge-offs                                       |       | (3,782                                                     | )          | (7,634                                           | )          |
|  Real estate sold                                   |       | (8,842                                                     | )          | (16,672                                          | )          |
| Ending balance real  estate owned*                       |       | $                                                          | 22,304     |                                             | 14,997     |   |

----

*       Includes properties previously securing loansheld for sale of $0.7 million and $0.5 million as of March 31, 2006 and December 31,2005, respectively.

42

----

***Mortgage Loans Held for Sale and Related WarehouseFinancing—Loans Held for Sale***

The followingtable provides a summary of the mortgage loans held for sale, net and warehousefinancing—loans held for sale as of March 31, 2006 and December 31,2005 (in thousands):
| ** **                                             | ** ** | **March 31   2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| Total mortgage  loans held for sale, net               |       | $                             | 312,836    |                        | 594,269    |   |
| Warehouse  financing—mortgage loans held for sale |       | $                             | 252,814    |                        | 434,061    |   |
| Percentage  financed—mortgage loans held for sale |       | 81                            | %          | 73                          | %          |

 

The decrease in mortgage loans held for sale, net, at March 31,2006 compared to December 31, 2005 primarily reflects the decrease inconforming loan origination volumes in the two months ended March 31, 2006compared to the two months ended December 31, 2005, reflecting the sale ofthe assets of our conforming division in February 2006. We typicallyretain loans held for sale for approximately 60 days prior to investorpurchase.

At March 31, 2006, we had $19.2 million of loansdeemed to be unsaleable at standard sale premiums compared to $5.2 million at December 31,2005. We recorded a valuation allowance of $2.8 million and $1.1 million, as ofMarch 31, 2006 and December 31, 2005, respectively, for these loansunsaleable at standard sale premiums.

Warehouse financing—loans held for sale decreased asof March 31, 2006 compared to December 31, 2005 reflecting ourdecreased level of mortgage loans held for sale at March 31, 2006.

***Trustee Receivable***

Trustee receivable decreased to$119.8 million at March 31, 2006 from $130.2 million at December 31,2005. The decrease reflects lower principal payments and prepaid loanpayments received after the cut-off date for the current month bond paymentsfrom our ten securitized mortgage pools outstanding as of March 31, 2006,compared to securitized mortgage pools at December 31, 2005. Trusteereceivable includes principal and interest prepayments received after the 15th day of the period end month from loanssecuritized in pools FMIT Series 2004-1 through  FMIT Series 2006-1, andprepayments received after the last day of the month prior to the period endmonth from loans in pool FMIC Series 2003-1. The trustee retainsthese funds until the following month’s disbursement date.

***Derivative Assets and DerivativeLiabilities***

Derivative assets increased to $37.4 million at March 31,2006 from $35.2 million at December 31, 2005. Derivative liabilities,included in “Accounts payable, accrued expenses and other liabilities” in the condensedconsolidated statements of condition, decreased to $0.1 million at March 31,2006 from $0.9 million at December 31, 2005. The changes in derivativeassets and liabilities primarily relate to the $1.9 million increase in thefair value of the interest rate swap and cap agreements over the period,reflecting an increase in the two year swap rate of 43 basis points as of March 31,2006 compared to December 31, 2005.  Derivative assets as of March 31, 2006and December 31, 2005 also included $5.7 million paid in 2005 to buy-downthe fixed rate of the swaps contributed to the FMIT series 2005-2 and 2005-3securitization trusts.

43

----

***Securitization Financing***

Thefollowing is a summary of the outstanding securitization financing by series asof March 31, 2006 and December 31, 2005 (in thousands):
| ** **                              | ** ** | ** **        | ** ** | **Balance as of** | ** ** |
|-----------------------------------------|------------|-------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **Bonds  Issued** | ** ** | **March 31,  2006**    | ** ** | **December 31,  2005** | ** ** |
| FMIT  Series 2006-1                |       | $                 | 904,078    |                        | 904,078    |   | — |   |
| FMIT  Series 2005-3                |       | 1,094,246         |       | 1,059,345                   |       | 1,089,820 |   |
| FMIT Series 2005-2                 |       | 911,081           |       | 827,101                     |       | 872,455 |   |
| FMIT Series 2005-1                 |       | 728,625           |       | 490,093                     |       | 555,650 |   |
| FMIT Series 2004-5                 |       | 863,550           |       | 528,439                     |       | 595,481 |   |
| FMIT Series 2004-4                 |       | 845,283           |       | 466,142                     |       | 518,283 |   |
| FMIT Series 2004-3                 |       | 949,000           |       | 482,777                     |       | 523,296 |   |
| FMIT Series 2004-2                 |       | 843,920           |       | 276,494                     |       | 377,500 |   |
| FMIT Series 2004-1  (*)            |       | 652,944           |       | 100,400                     |       | 233,977 |   |
| FMIC Series 2003-1                 |       | 488,923           |       | 61,285                      |       | 83,308 |   |
|                                    |       | 8,281,650         |       | 5,196,154                   |       | 4,849,770 |   |
| Unamortized bond  discount              |       | (1,130            | )          | (42                         | )          | (74 | ) |
| Subtotal  securitization bond financing |       | 8,280,520         |       | 5,196,112                   |       | 4,849,696 |   |
| Liquid Funding  repurchase facility     |       | —            |       | 45,154                      |       | 86,079 |   |
| Lehman Brothers  repurchase facility    |       | —            |       | —                      |       | 62,845 |   |
| Total securitization  financing         |       | $                 | 8,280,520  |                        | 5,241,266  |   | 4,998,620 |   |

----

(*) Series 2004-1was called and paid in full in April 2006.

During the threemonths ended March 31, 2006 and the year ended December 31, 2005, weissued $0.9 billion and $2.7 billion, respectively, of mortgage-backed bonds throughsecuritization trusts to finance our portfolio of loans held for investment.Interest rates reset monthly and are indexed to one-month LIBOR. The bonds payinterest monthly based upon a spread over LIBOR. We retain the option to repaythe bonds when the remaining unpaid principal balance of the underlyingmortgage loans for each pool falls below 20% of the original principal balance,with the exception of FMIC Series 2003-1, which may be repaid whenthe principal balance falls below 10% of the original collateralized amount.

During March 2006, the current principal balanceas a percentage of original principal balance of the underlying mortgage loanscollateralizing FMIT Series 2004-1 fell below 20%, permitting the Companyto call on its option to repay the relating bonds. Management reviewed theeconomic factors relating to this potential call, and subsequently deliverednotice in April 2006 to FMIT Series 2004-1 bondholders to repaythe bonds at the next payment date. At March 31, 2006, approximately 14%of the original principal balance of underlying mortgage loans collateralizingFMIC Series 2003-1 remained. The repayment of the bonds is securedby pledging mortgage loans to the trust.

As of March 31, 2006and December 31, 2005, the outstanding bonds were over-collateralized by$319.7 million and $189.8 million, respectively. The collateral includesmortgage loans, trustee receivables, real estate owned and proceeds from bondpre-fundings which are designated as restricted cash until the mortgage loancollateral is delivered to the trust. Weenter into interest rate swap or cap agreements to economically hedge the bondcosts and protect against rising interest rates.

***Total Shareholders’ Equity***

Total shareholders’ equity decreased to $516.9 millionat March 31, 2006, from $526.6 million at December 31, 2005. Thechange in shareholders’ equity primarily reflects the three months ended March 31,2006 net income of $12.9 million offset by $23.3 million in dividendsdeclared in the first quarter of 2006, net of dividends paid on unvestedrestricted stock that are recorded to compensation expense.

44

----

Dividends werepaid from our operating cash flows. The following is a summary of the dividendsdeclared per share for the three months ended March 31, 2006:

| Declaration Date | ** ** | **Record Date** | ** ** | **Payment Date** | ** ** | **Dividend** | ** ** |
|-----------------------|------------|----------------------|------------|-----------------------|------------|--------------|------------|
| March 17,  2006  |       | March 31, 2006  |       | April 28, 2006   |       | $0.48        |       |

** **

**Business Segment Results**

Effective thefirst quarter of 2006, we are reporting a total of four business segments,which include two production segments and two operating segments. Ourproduction segments currently include our Wholesale segment, previouslydesignated as Non-conforming Wholesale, and our Retail segment, previouslydesignated as Non-conforming Retail. Our Wholesale segment originatesnon-conforming loans, while our Retail segment originates both conforming andnon-conforming mortgages, in order to provide a complete range of mortgageoptions to our retail borrowers. Prior to the first quarter of 2006, wereported two additional production segments referred to as our ConformingWholesale and Conforming Retail segments. In the first quarter of 2006 ourBoard of Directors approved a plan of disposal to sell, close or otherwisedispose of the assets of the Conforming Wholesale and Conforming Retailsegments due to the decline in profitability of these segments. In February 2006,we sold the assets pertaining to our conforming division’s headquarters,wholesale offices, and certain retail offices to third parties. The remainingassets of the conforming segment, which include retail offices in Maryland andVirginia, have been combined with our non-conforming retail offices and will bereported as a component of our Retail segment. The following discussion ofresults reflects our continuing Wholesale and Retail segments only, while theresults of our former Conforming Wholesale and Conforming Retail segments arereported herein as discontinued operations.

 The results ofoperations of our production segments primarily include a net interest incomeallocation for funded loans, direct expenses and a corporate overhead expenseallocation. In addition, segment revenues include an allocation which creditsthe production segments with the pro forma current value of the net gain onsale of loan production as if all of the segments’ fundings were sold servicing-released,concurrent with funding, even though a significant portion of the loansoriginated will be held for investment, and generate revenue over the life ofloan, which currently averages two years.

***OperatingSegments***

Our operating segments include the Investment Portfolioand Corporate segments. The results of operations of the Investment Portfoliosegment primarily include the net interest income after provision for loanlosses for our portfolio of loans held for investment, 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, the eliminationof the corporate overhead allocated to the production segments, and the incometax provision related to the net income (loss) of FMC, our taxable REITsubsidiary. The Corporate segment also includes various reconciling amountsnecessary to adjust for the retention of a substantial portion of ournon-conforming loans to be held for investment, and to convert the productionsegments’ allocated revenue and expenses to comply with GAAP reporting underStatement No. 91.

The results of operations reported per segment differmaterially from consolidated results due to timing differences in net gain onsale recognition at the time of cash settlement of the sale compared to therevenue allocation which each segment receives at the time of loan funding, theactual whole loan sale prices compared to the pro forma values, the actual netinterest margin earned on loans prior to their sale, and the holding forinvestment of a substantial portion of our non-conforming loans for which actualrevenue will consist of net interest income generated over the life of the loanrather than net gain on sale recognized one-time as of the sale date.

45

----

The following is asummary of net income (loss) by production segments and operating segments forthe three months ended March 31, 2006 and 2005 (in thousands):

|                                                               | ** **   | **Production  Segments** | ** **   | **Operating  Segments** | ** **   | **Total**    | ** **   |
|---------------------------------------------------------------|--------------|--------------------------|--------------|-------------------------|--------------|--------------|--------------|
| ***Three  Months Ended March 31, 2006***                 | *** *** | *** ***             | *** *** | *** ***            | *** *** | *** *** | *** *** |
| Total revenues                                                |         | $                        | 27,626       |                    | 19,977       |         | 47,603       |   |
| Total expenses                                                |         | 31,595                   |         | 2,164                   |         | 33,759       |         |
| Income (loss) from continuing operations before  income taxes |         | (3,969                   | )            | 17,813                  |         | 13,844       |         |
| Income tax  benefit                                           |         | —                   |         | 729                     |         | 729          |         |
| Income (loss) from continuing operations                      |         | (3,969                   | )            | 18,542                  |         | 14,573       |         |
| Discontinued  operations, net of income tax                   |         | (1,645                   | )            | —                  |         | (1,645       | )            |
| Net income (loss)                                             |         | $                        | (5,614       | )                       | 18,542       |         | 12,928       |   |
| *** ***                                                  | *** *** | *** ***             | *** *** | *** ***            | *** *** | *** *** | *** *** |
| ***Three  Months Ended March 31, 2005***                 | *** *** | *** ***             | *** *** | *** ***            | *** *** | *** *** | *** *** |
| Total revenues                                                |         | $                        | 33,352       |                    | 38,774       |         | 72,126       |   |
| Total expenses                                                |         | 31,101                   |         | (1,213                  | )            | 29,888       |         |
| Income from continuing operations before income  taxes        |         | 2,251                    |         | 39,987                  |         | 42,238       |         |
| Income tax  benefit                                           |         | —                   |         | 157                     |         | 157          |         |
| Income (loss) from continuing operations                      |         | 2,251                    |         | 40,144                  |         | 42,395       |         |
| Discontinued  operations, net of income tax                   |         | (641                     | )            | —                  |         | (641         | )            |
| Net income (loss)                                             |         | $                        | 1,610        |                    | 40,144       |         | 41,754       |   |

*** ***

46

----

***Production Segment Results***

The followingtable summarizes our production segment results for the three months ended March 31,2006 and 2005 (in thousands), and includes the results of our continuingproduction segments only:

|                                               | ** **   | ** **    | ** **   | ** **   | ** **   | **Total**      | ** **   |
|-----------------------------------------------|--------------|---------------|--------------|--------------|--------------|----------------|--------------|
| ** **                                    | ** **   | **Wholesale** | ** **   | **Retail**   | ** **   | **Production** | ** **   |
| ***Three  Months Ended March 31, 2006*** | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***   | *** *** |
| Revenues                                      |         | $             | 19,969       |         | 7,657        |           | 27,626       |   |
| Direct expenses                               |         | 17,755        |         | 8,912        |         | 26,667         |         |
| Segment contribution                          |         | 2,214         |         | (1,255       | )            | 959            |         |
| Corporate  overhead allocation                |         | 4,200         |         | 728          |         | 4,928          |         |
| Loss from  continuing operations              |         | $             | (1,986       | )            | (1,983       | )              | (3,969       | ) |
| Funding volume                                |         | $             | 860,523      |         | 150,795      |           | 1,011,318    |   |
| Segment  contribution as % of volume          |         | 0.26          | %            | (0.83        | )%           | 0.09           | %            |
| *** ***                                  | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***   | *** *** |
| ***Three  Months Ended March 31, 2005*** | *** *** | *** ***  | *** *** | *** *** | *** *** | *** ***   | *** *** |
| Revenues                                      |         | $             | 24,926       |         | 8,426        |           | 33,352       |   |
| Direct expenses                               |         | 16,827        |         | 9,143        |         | 25,970         |         |
| Segment contribution                          |         | 8,099         |         | (717         | )            | 7,382          |         |
| Corporate  overhead allocation                |         | 4,322         |         | 809          |         | 5,131          |         |
| Income (loss) from  continuing operations     |         | $             | 3,777        |         | (1,526       | )              | 2,251        |   |
| Funding volume                                |         | $             | 975,905      |         | 171,956      |           | 1,147,861    |   |
| Segment contribution as  % of volume          |         | 0.83          | %            | (0.42        | )%           | 0.64           | %            |

 

Production segment net income decreased in the threemonths ended March 31, 2006 compared to the same period in 2005, primarilydue to a 12% decrease in loan originations and a reduction in the gain on salerevenue allocation per funding dollar, as narrowing interest margins in 2006contributed to reduced sale premiums. As interest rates increased during 2005,the industry-wide margin compression on new loan originations resulted in adecrease in revenues per loan in our production segments. We expect margins toremain at these compressed levels in the near-term future as the industryadjusts rates on new loan originations to mirror changes in the yield curve. In2006, we expect our production segments to originate a total of approximately$5.0 to $6.2 billion, which represents 85% to 100% of 2005 volume level, thelower range of which reflects industry forecasts of 20% fewer mortgageoriginations. To address the market revenue compression and increase segmentcontribution, we have hired additional account executives and loan officers toincrease origination volume, and are continuing to implement cost efficiencymeasures, including our new loan origination system.

***Wholesale Segment.  ***Ourwholesale segment continued to report a positive segment contribution beforecorporate allocation in the three months ended March 31, 2006, althoughlower than 2005, due to reduced sale margins in 2006. In 2005, the industryresponded to competitive pressures in an increasing interest rate environmentby originating loans with narrower net interest income spreads, which generallyreduced sale premiums. Direct expenses rose in the three months ended March 31,2006 to 2.1% of origination volume, compared to 1.7% in the same period in2005, and reflect higher salary costs related to additional account executiveshired to sustain funding volumes in a reduced overall mortgage marketplace.Higher base salary expenses are partially offset by lower variable loan costsincluding commissions, as our commission plan was restructured to reducecompensation for narrower margins in the current lending environment.

47

----

***Retail Segment.  ***Segmentcontribution in the three months ended March 31, 2006 was lower than thesame period in 2005 reflecting a 12% reduction in origination volume whilerevenue as a percent of volume rose to 5.1% in the first three months of 2006from 4.9% in the same period in 2005, due to a lower component of second lienoriginations, which typically earn lower sale premiums, and higher fee incomefrom loans brokered to third-parties. Our retail direct expensesdecreased 2.5% in the three months ended March 31, 2006 compared to thesame period in 2005, as we streamlined our marketing initiatives in 2005 andappointed new management to support our initiatives to improve costefficiencies within the production centers.

***Operating SegmentResults***

The followingtable summarizes our operating segment results for the three months ended March 31,2006 and 2005 (in thousands):
| ** **                                                    | ** **   | ** **                | ** **   | **Corporate**        | ** **   | ** **                        | ** **   |
|---------------------------------------------------------------|--------------|---------------------------|--------------|----------------------|--------------|-----------------------------------|--------------|
| ** **                                                    | ** **   | **Investment  Portfolio** | ** **   | **Segment  Results** | ** **   | **Reconciliations  to GAAP** | ** **   | **Total  Corporate** | ** ** | **Total  Operating** | ** ** |
| ***Three  Months Ended March 31, 2006***                 | *** *** | *** ***              | *** *** | *** ***         | *** *** | *** ***                      | *** *** | *** *** | *** *** | *** *** | *** *** |
| Revenues                                                      |         | $                         | 32,724       |                 | 143          |                              | (12,890      | ) | (12,747 | ) | 19,977 |   |
| Direct expenses                                               |         | 2,899                     |         | 10,787               |         | (6,594                            | )            | 4,193 |   | 7,092 |   |
| Segment contribution                                          |         | 29,825                    |         | (10,644              | )            | (6,296                            | )            | (16,940 | ) | 12,885 |   |
| Corporate  overhead allocation                                |         | —                    |         | (5,068               | )            | 140                               |         | (4,928 | ) | (4,928 | ) |
| Income (loss)  from continuing operations before income taxes |         | $                         | 29,825       |                 | (5,576       | )                                 | (6,436       | ) | (12,012 | ) | 17,813 |   |
|                                                          |         |                      |         |                 |         |                              |         |   |   |   |   |
| ***Three  Months Ended March 31, 2005***                 | *** *** | *** ***              | *** *** | *** ***         | *** *** | *** ***                      | *** *** | *** *** | *** *** | *** *** | *** *** |
| Revenues                                                      |         | $                         | 59,875       |                 | 36           |                              | (21,137      | ) | (21,101 | ) | 38,774 |   |
| Direct expenses                                               |         | 2,985                     |         | 9,185                |         | (8,252                            | )            | 933 |   | 3,918 |   |
| Segment  contribution                                         |         | 56,890                    |         | (9,149               | )            | (12,885                           | )            | (22,034 | ) | 34,856 |   |
| Corporate  overhead allocation                                |         | —                    |         | (5,479               | )            | 348                               |         | (5,131 | ) | (5,131 | ) |
| Income (loss) from  continuing operations before income taxes |         | $                         | 56,890       |                 | (3,670       | )                                 | (13,233      | ) | (16,903 | ) | 39,987 |   |

 

***Investment Portfolio***.   TheInvestment Portfolio contribution decrease in the three months ended March 31,2006 compared to the same period in 2005 reflects the decrease in net interestincome after provision for losses earned by our portfolio of loans held forinvestment. The decline is primarily due to a decrease in our average 2006 netinterest income margin, partially offset by a higher portfolio balance. Netinterest margin plus the net cash received on our swaps declined to 2.6% in thefirst quarter of 2006 from 3.6% in the comparable period last year, as ourolder, higher margin loans prepaid and new loans were added to the portfolio atlower margins. The margins available on new loans narrowed, as intense marketcompetition for new loans did not permit coupons on new originations toincrease at the same rate as the increase in financing costs for these loans,which are indexed to rising market interest rates.

 Direct expenses primarily include the third partyservicing expense relating to our portfolio of loans held for investment andthe salaries incurred for portfolio management personnel. We anticipateinvestment segment contribution for the remainder of 2006 to be lower than thecomparable periods in 2005, primarily due to narrower net interest margins onthe loans to be originated in 2006 compared to the loans currently in ourportfolio which are expected to prepay in 2006, partially offset by the plannedgrowth of our held for investment portfolio to approximately $6.0 billion bythe end of 2006.

***Corporate***.   Thedirect expenses reported under segment results rose 17% in the three monthsended March 31, 2006 to $10.8 million compared to $9.2 million in the sameperiod in 2005, and include additional audit fees, additional technology, legaland accounting personnel costs, and incremental amortization expense forin-service components of our new loan origination system. We expect directexpenses to increase in 2006 reflecting costs to be incurred for theimplementation of Sarbanes-Oxley Act compliance measures and additionaltechnology salaries, depreciation and maintenance expenses related to placingour new loan origination software system fully into service.

48

----

**Liquidity and Capital Resources**

As a mortgagelending company, we borrow substantial sums of money to fund the mortgage loanswe originate. After funding, our primary operating subsidiary, FMC, holds allof the conforming loans and some of the non-conforming loans that it originatesin inventory (warehouse) prior to sale. We hold the remainder of the non-conformingloans for investment in our portfolio. Our primary cash requirements include:

·       funding mortgages;

·       premiums paid in connectionwith loans originated in the wholesale channel;

·       interest expense on ourcredit facilities and securitization financings;

·       ongoing general andadministration expenses;

·       derivative transactions;and

·       REIT stockholderdistributions — as a REIT, we are required to distribute at least 90% of ourREIT taxable income to our shareholders.

Our primary cashsources include:

·       borrowings from our creditfacilities secured by mortgage loans held in inventory and the securities weretain from our securitizations;

·       proceeds from the issuanceof securities collateralized by the loans in our portfolio;

·       proceeds of whole loansales;

·       principal and interestcollections relative to the mortgage loans held in inventory; and

·       points andfees collected from the origination of retail and wholesale loans.

We rely on our securitizations as a primary source ofliquidity. As of March 31, 2006, we have completed ten securitizations,issuing an aggregate of $8.3 billion of mortgage-backed securities.

The following is asummary of the securitizations issued by series during the year ended December 31,2005 and the three months ended March 31, 2006 (in millions):
| ** **                                  | ** ** | **FMIT  2005-1** | ** ** | **FMIT  2005-2** | ** ** | **FMIT  2005-3** | ** ** | **FMIT  2006-1** | ** ** |
|---------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Issue date                                  |       | Feb 2005         |       | Aug 2005         |       | Nov 2005         |       | Mar 2006         |       |
| Bonds issued                                |       | $729             |       | 911              |       | 1,094            |       | 904              |       |
| Loans pledged                               |       | $750             |       | 967              |       | 1,165            |       | 933              |       |
| Bond  ratings—Standard and Poor’s |       | AAA–BBB-    |       | AAA–A+      |       | AAA–A+      |       | AAA–BBB     |       |
| Bond  ratings—Moody’s             |       | Aaa–Baa3    |       | Aaa–Baa2    |       | Aaa–Baa2    |       | Aaa–Baa3    |       |
| Financing  costs—LIBOR plus            |       | 0.12% - 2.00%    |       | 0.12% - 1.35%    |       | 0.12% -1.45%     |       | 0.08% -2.30%     |       |
| Weighted average  spread over LIBOR         |       | 0.40%            |       | 0.38%            |       | 0.37%            |       | 0.32%            |       |
| Transaction fees                            |       | 0.36%            |       | 0.33%            |       | 0.30%            |       | 0.32%            |       |

 

49

----

We use our various credit facilities to fundsubstantially all of our loan originations. Fieldstone Mortgage sells themortgage loans it holds within two or three months of origination and pays downthese facilities with the proceeds. We issue mortgage-backed securitiesto pay down those facilities financing our loans held for investment.

The material terms andfeatures of these credit facilities as of March 31, 2006 (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(1)       |       | 400.0         |       | —          |       | April 2006    |             | 91%-96%                                |       | 400.0                                           |       | 16:1                                                                             |       | 15.0                   |       |
| Credit Suisse, New York Branch Commercial Paper  Facility |       | 600.0         |       | —          |       | July 2006     |             | 92.5%                                  |       | 400.0                                           |       | 16:1                                                                             |       | 15.0                   |       |
| JPMorgan Chase Bank                                  |       | 150.0         |       | —          |       | June 2006     |             | 95%-97%                                |       | 400.0                                           |       | 16:1                                                                             |       | 20.0                   |       |
| Lehman Brothers Bank                                 |       | 300.0         |       | —          |       | December 2006 |             | 91.5%-94.5%                            |       | 250.0                                           |       | 16:1                                                                             |       | 15.0                   |       |
| Merrill Lynch Bank USA                                    |       | 300.0         |       | —          |       | November 2006 |             | 91%-96%                                |       | 250.0                                           |       | 17:1                                                                             |       | N/A                    |       |
| Subtotal                                                  |       | 1,825.0       |       | 50.0            |       |               |             |                                   |       |                                            |       |                                                                             |       |                   |       |
| Liquid Funding (Bear Stearns)(2)                          |       | —        |       | 200.0           |       | Uncommitted        |             | N/A                                    |       | N/A                                             |       | N/A                                                                              |       | N/A                    |       |
| Lehman Brothers(2)                                        |       | —        |       | 200.0           |       | Uncommitted        |             | N/A                                    |       | N/A                                             |       | N/A                                                                              |       | N/A                    |       |
| Total                                                     |       | $             | 1,825.0    |            | 450.0      |               |             |                                   |       |                                            |       |                                                                             |       |                   |       |   |
|                                                           |            |               |            |                 |            |                    |                  |                                        |            |                                                 |            |                                                                                  |            |                        |            |  |  |  |

----

(1) The Credit Suisse First Boston Mortgage Capital facility has been renewedthrough April 2007.

(2) Facilities remain open indefinitely, but may be terminated by either party atany time.

50

----

Under ourwarehouse lines and repurchase facilities, interest is payable monthly inarrears and outstanding principal is payable upon receipt of loan sale proceedsor transfer of a loan into a securitization trust. Outstanding principal isalso repayable upon the occurrence of certain disqualifying events, whichinclude a mortgage loan in default for a period of time, a repaid mortgageloan, a mortgage loan obtained with fraudulent information or the failure tocure a defect in a mortgage loan’s documentation. Outstanding principal also isrepayable if the mortgage loan does not close, but had been pledged and fundswere advanced. Our warehouse lines and repurchase facilities contain termsmandating principal repayment if a loan remains on the line after a contractualtime period from date of funding, or on the maturity date of the facility.

***In addition to our traditional warehouse lines and creditfacilities, in October 2005 one of our wholly owned subsidiaries, FMOC,which holds the securities we retain in our securitizations (RetainedSecurities), entered into two repurchase facilities, each with the uncommittedamount of $200 million and each secured by FMOC’s pledge of the RetainedSecurities. The first facility is with Liquid Funding, Ltd. (Liquid Funding),an affiliate of Bear Stearns Bank plc, and remains open indefinitely, but maybe terminated by either party at any time, and bears interest at an annual rateof LIBOR plus an additional percentage. As of March 31, 2006 and December 31,2005, $45.2 million and $86.1 million, respectively, of borrowings wereoutstanding under this agreement.***

The second facility is with Lehman Brothers Inc. andLehman Commercial Paper Inc. (together, Lehman Brothers), and is scheduled toremain open indefinitely, but may be terminated by either party at any time,and bears interest at an annual rate of LIBOR plus an additional percentage. Asof March 31, 2006, no borrowings were outstanding under this agreement. Asof December 31, 2005, $62.8 million of borrowings were outstanding underthis agreement.

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 counterparties and to schedule frequent sales orsecuritizations of loans so that the average holding period of our inventory ofloans generally does not exceed 60 days.

We use our excess cash from operations to reduce theadvances on our warehouse lines or repurchase facilities. This process reducesour debt outstanding and the corresponding interest expense incurred andresults in a pool of highly liquid mortgage collateral available to secureborrowings to meet our working capital needs. This pool of available collateraltotaled approximately $180 million and $199 million as of March 31,2006 and December 31, 2005, respectively. We expect to continue to investour working capital in our portfolio of loans held for investment.

The warehouse lines and repurchase facilities aresecured by substantially all of our mortgage loans (prior to issuing securitiescollateralized by these loans) and contain customary financial and operatingcovenants that, among other things, require us to maintain specified levels ofliquidity and net worth, restrict indebtedness other than in the ordinarycourse of business, restrict investments in other entities except in certainlimited circumstances, restrict our ability to engage in mergers,consolidations or substantially change the nature or character of our businessand require compliance with applicable laws. We were in compliance with all ofthese covenants at March 31, 2006.

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 percentage whichranges from 0.23% to 1.35%. We are required to pay facilities fees ranging from0.10% to 0.15% of the committed amount of the facility. We are also required topay non-use fees of 0.125% on unused amounts which exceed certain thresholdsrelating to the average outstanding balance of the facility.

**Cash Flows**

For the threemonths ended March 31, 2006, our cash flow provided by operations was$309.6 million compared to $105.4 million for the three months ended March 31,2005. The increase in operating cash flows in 2006 as compared to 2005 isprimarily due to the increase in loans sold in the first quarter of 2006compared to

51

----

the first quarter of 2005.Our cash used in investing activities was $227.6 million and $367.8 million forthe three months ended March 31, 2006 and 2005, respectively. The decreasein cash used in investing activities in 2006 compared to 2005 primarily relatesto the lower volume of loans funded for investment in the first quarter of2006. As a result of the “coupon filter” that we use to allocate loans to heldfor investment versus held for sale, the compressed net interest margins onloans originated in the quarter ended March 31, 2006 resulted in more ofthe loans being funded as loans held for sale rather than as loans held forinvestment. Investing cash flows, as presented in our condensed consolidatedstatements of cash flows, will typically be negative because they exclude thenet proceeds from mortgage warehouse financing and securitization financingused to support the increase in our investment in mortgage loans. We arerequired to show the net proceeds from, or repayments of, mortgage financing inour condensed consolidated statements of cash flows as cash flow from financingactivities and not as investing cash flow. Our cash flows (used in) provided byfinancing activities were $(84.5) million and $235.5 million for the threemonths ended March 31, 2006 and 2005, respectively. A lower level of cashwas provided by financing activities because of the lower origination volumes, andhigher sales and portfolio loan prepayments in the first quarter of 2006.

**REIT Taxable Income**

To maintain ourstatus as a REIT, we are required to distribute at least 90% of our REITtaxable income each year to our shareholders. Federal tax rules calculateREIT taxable income in a manner that, in certain respects, differs from thecalculation of consolidated net income pursuant to GAAP. Our consolidated GAAPnet income will differ from our REIT taxable income primarily for the followingreasons:

·       the provision for loan lossexpense recognized for GAAP purposes is based upon our estimate of probableloan losses inherent in our current portfolio of loans held for investment, forwhich we have not yet recorded a charge-off (tax accounting rules allow adeduction for loan losses only in the period when a charge-off occurs);

·       the mark to marketvaluation changes to our interest rate swap derivatives recognized for GAAPpurposes are not recognized for tax accounting;

·       the differences betweenGAAP and tax methodologies for capitalization of origination expenses; and

·       income of a TRS is includedin the REIT’s earnings for consolidated GAAP purposes; tax rules for REITtaxable income do not provide for a REIT to recognize income of the TRS until aTRS pays a dividend 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 SEC. Management believesthat the presentation of REIT taxable income provides useful information toinvestors regarding the estimated annual distributions to our investors. Thepresentation of REIT taxable income is not meant to be considered in isolationor as a substitute for financial results prepared in accordance with GAAP.

52

----

The followingtable is a reconciliation of GAAP net income to REIT taxable net income for thethree months ended March 31, 2006 and the year ended December 31,2005 (in thousands):
| ** **                                                 | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Year Ended  December 31, 2005** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| Consolidated  GAAP pre-tax net income                      |       | $                                                          | 11.1       |                                             | 102.9      |   |
| Plus:                                                      |       |                                                       |       |                                             |       |
| Provision for  loan losses in excess of actual charge-offs |       | 1.2                                                        |       | 21.5                                             |       |
| Variance in  recognition of net origination expenses       |       | (0.2                                                       | )          | 6.4                                              |       |
| Less:                                                      |       |                                                       |       |                                             |       |
| Taxable REIT  subsidiary pre-tax net (income) loss         |       | 5.3                                                        |       | (9.6                                             | )          |
| Mark to market  valuation changes on derivatives           |       | (1.9                                                       | )          | (9.0                                             | )          |
| Miscellaneous  other                                       |       | (0.2                                                       | )          | (7.2                                             | )          |
| REIT taxable income                                        |       | $                                                          | 15.3       |                                             | 105.0      |   |

 

REIT taxable income for thethree months ended March 31, 2006 and the year ended December 31,2005 is subject to change until we file our REIT federal tax return.

**Commitments and Contingencies**

***(a)***      Loan Commitments

At March 31, 2006 and December 31, 2005, wehad origination commitments outstanding to fund approximately $451 million and$422 million in mortgage loans, respectively. Fixed rate and hybrid ARMmortgages which are fixed for the initial two to three year term of the loan,comprised 97.54% and 97.0%, respectively, of the outstanding originationcommitments. We had forward delivery commitments to sell approximately $0.5billion and $1.3 billion of loans at March 31, 2006 and December 31,2005, respectively, of which $67.5 million and $745.9 million,respectively, were mandatory sales of mortgage-backed securities and investorwhole loan trades. At March 31, 2006 and December 31, 2005, we had acommitment to sell $415 million and $580 million, respectively, of treasurynote forward contracts, used to economically hedge the interest rate risk ofits non-conforming loans.

*** (b)***   Legal Matters

See a description of ourmaterial legal proceedings contained in Part I, Item 1, Note 11 (b) ofthis Quarterly Report on Form 10-Q. Because the nature of ourbusiness involves the collection of numerous accounts, the validity of liensand compliance with various state and federal lending and consumer protectionlaws, we are subject to various legal proceedings in the ordinary course of ourbusiness related to foreclosures, bankruptcies, condemnation and quiet titleactions and alleged statutory and regulatory violations. We are also subject toother legal proceedings in the ordinary course of business related to employeematters. All of these ordinary course proceedings, individually and taken as awhole, are not expected to have a material adverse effect on our business,financial condition or results of operations.

53

----

**Other Operational and Investment Portfolio Data**

***Loan Fundings***

The followingtable indicates our total loan fundings of loans held for investment and loansheld for sale for the three months ended March 31, 2006 and 2005 (inthousands):

|                         | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **              | ** ** | **Fundings**                                         | ** ** | **% of  Total** | ** ** | **Fundings** | ** ** | **% of  Total** | ** ** |
| Mortgage Loan Fundings: |       |                                                 |       |   |   |   |   |   |   |
| Wholesale               |       | $                                                    | 860,523    |   | 76% |   | 975,905 |   | 67% |   |
| Retail                  |       | 150,795                                              |       | 13% |   | 171,956 |   | 12% |   |
| Discontinued operations |       | 127,797                                              |       | 11% |   | 307,991 |   | 21% |   |
| Total fundings          |       | $                                                    | 1,139,115  |   | 100% |   | 1,455,852 |   | 100% |   |

 

Loan fundings decreased to $1.1 billion in the threemonths ended March 31, 2006 compared to $1.5 billion in the same period in2005. The decrease in loan fundings in the three months ended March 31,2006 compared to the same period in 2005 was due primarily to a rising interestrate environment and mortgage originator price competition. In 2006, we expectnon-conforming fundings to be approximately $5.0 to $6.2 billion, whichrepresents 85% to 110% of 2005 volume level, the lower range of which reflectsindustry forecasts of 20% fewer mortgage originations in 2006 than 2005.

***OriginatedNon-Conforming Loan Characteristics***

The following tables provide a summary of thecharacteristics of our total non-conforming loan originations for the threemonths ended March 31, 2006 (in thousands):

*Income Documentation*
| ** **                   | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent  of  Originations** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** |
|------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| Full  Documentation          |       | $                                 | 424,736    |                          | 43.3%      |                          | 8.3%       |                                 | 621        |                            | $          | 114                        |       | 84.7%                       |       | 93.7% |   |
| Stated Income  Wage Earner   |       | 264,687                           |       | 27.0%                         |       | 8.7%                          |       | 680                                  |       | 170                             |       | 85.0%                      |       | 96.1%                       |       |
| Stated Income  Self Employed |       | 182,362                           |       | 18.6%                         |       | 8.7%                          |       | 663                                  |       | 186                             |       | 84.0%                      |       | 94.4%                       |       |
| 24 Month Bank  Statements    |       | 21,706                            |       | 2.2%                          |       | 8.2%                          |       | 629                                  |       | 182                             |       | 85.4%                      |       | 93.1%                       |       |
| 12 Month Bank  Statements    |       | 84,039                            |       | 8.6%                          |       | 8.5%                          |       | 636                                  |       | 178                             |       | 84.3%                      |       | 94.7%                       |       |
| Limited  Documentation       |       | 2,477                             |       | 0.3%                          |       | 8.5%                          |       | 644                                  |       | 130                             |       | 85.4%                      |       | 93.0%                       |       |
| Total                        |       | $                                 | 980,007    |                          | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |   |
| Weighted  Average/Average    |       |                              |       |                          |       | 8.5%                          |       | 646                                  |       | 142                             |       | 84.6%                      |       | 94.5%                       |       |
|                              |            |                                   |            |                               |            |                               |            |                                      |            |                                 |            |                            |            |                             |            |  |  |

 

54

----

*Credit Score*
| ** **                | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent  of  Originations** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent Full  Documentation** | ** ** |
|---------------------------|------------|-----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|--------------------------------------|------------|
| 500 – 549            |       | $                                 | 22,823     |                          | 2.3%       |                          | 9.9%       |                                 | 535        |                            | 131        |                       | 79.0%      |                        | 81.0%      |                                 | 80.8%      |   |
| 550 – 599            |       | 159,568                           |       | 16.3%                         |       | 8.7%                          |       | 581                                  |       | 122                             |       | 83.7%                      |       | 90.9%                       |       | 77.0%                                |       |
| 600 – 649            |       | 355,178                           |       | 36.2%                         |       | 8.4%                          |       | 626                                  |       | 129                             |       | 84.3%                      |       | 94.8%                       |       | 54.8%                                |       |
| 650 – 699            |       | 294,064                           |       | 30.0%                         |       | 8.4%                          |       | 671                                  |       | 161                             |       | 85.1%                      |       | 96.2%                       |       | 21.3%                                |       |
| 700 or greater            |       | 148,374                           |       | 15.2%                         |       | 8.3%                          |       | 729                                  |       | 180                             |       | 86.2%                      |       | 96.7%                       |       | 17.7%                                |       |
| Total                     |       | $                                 | 980,007    |                          | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |                                 |       |   |
| Weighted  Average/Average |       |                              |       |                          |       | 8.5%                          |       | 646                                  |       | 142                             |       | 84.6%                      |       | 94.5%                       |       | 43.3%                                |       |

 

*Product Type*
| ** **                 | ** ** | **Aggregate  Principal  Balance** | ** ** | **Percent  of  Originations** | ** ** | **Weighted  Average  Coupon** | ** ** | **Weighted  Average  Credit  Score** | ** ** | **Average  Principal  Balance** | ** ** | **Weighted  Average  LTV** | ** ** | **Weighted  Average  CLTV** | ** ** | **Percent Full  Documentation** | ** ** |
|----------------------------|------------|-----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|-----------------------------|------------|--------------------------------------|------------|
| 2/28 LIBOR ARM             |       | $                                 | 334,590    |                          | 34.1%      |                          | 8.5%       |                                 | 618        |                            | 151        |                       | 82.8%      |                        | 92.4%      |                                 | 55.6%      |   |
| 2/28 LIBOR ARM IO          |       | 340,059                           |       | 34.7%                         |       | 8.0%                          |       | 666                                  |       | 291                             |       | 82.7%                      |       | 96.0%                       |       | 26.5%                                |       |
| 3/27 LIBOR ARM             |       | 22,017                            |       | 2.3%                          |       | 7.8%                          |       | 642                                  |       | 163                             |       | 81.6%                      |       | 93.1%                       |       | 66.5%                                |       |
| 3/27 LIBOR ARM IO          |       | 63,088                            |       | 6.4%                          |       | 7.6%                          |       | 672                                  |       | 293                             |       | 83.7%                      |       | 97.2%                       |       | 39.9%                                |       |
| 5/25 Treasury ARM          |       | 1,863                             |       | 0.2%                          |       | 8.2%                          |       | 636                                  |       | 169                             |       | 78.8%                      |       | 85.0%                       |       | 74.9%                                |       |
| 5/25 Treasury ARM IO  |       | 3,596                             |       | 0.4%                          |       | 7.5%                          |       | 674                                  |       | 327                             |       | 82.5%                      |       | 90.0%                       |       | 48.1%                                |       |
| Fixed Rate                 |       | 67,719                            |       | 6.9%                          |       | 7.9%                          |       | 645                                  |       | 132                             |       | 80.4%                      |       | 87.7%                       |       | 69.6%                                |       |
| Fixed Rate IO              |       | 3,346                             |       | 0.3%                          |       | 8.0%                          |       | 681                                  |       | 223                             |       | 83.9%                      |       | 95.5%                       |       | 64.3%                                |       |
| 6 month LIBOR ARM          |       | 628                               |       | 0.1%                          |       | 8.4%                          |       | 672                                  |       | 157                             |       | 80.0%                      |       | 88.9%                       |       | 30.1%                                |       |
| 6 month LIBOR ARM IO       |       | 1,055                             |       | 0.1%                          |       | 8.0%                          |       | 678                                  |       | 352                             |       | 80.3%                      |       | 99.8%                       |       | 0.0%                                 |       |
| 2nd Liens                  |       | 118,074                           |       | 12.0%                         |       | 10.8%                         |       | 654                                  |       | 47                              |       | 99.1%                      |       | 99.1%                       |       | 39.1%                                |       |
| 2/38 LIBOR ARM             |       | 22,283                            |       | 2.3%                          |       | 8.1%                          |       | 647                                  |       | 225                             |       | 84.4%                      |       | 95.2%                       |       | 39.4%                                |       |
| 3/37 LIBOR ARM             |       | 1,689                             |       | 0.2%                          |       | 7.8%                          |       | 645                                  |       | 241                             |       | 82.7%                      |       | 95.4%                       |       | 61.1%                                |       |
| Total                      |       | $                                 | 980,007    |                          | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |                                 |       |   |
| Weighted  Average/Average  |       |                              |       |                          |       | 8.5%                          |       | 646                                  |       | 142                             |       | 84.6%                      |       | 94.5%                       |       | 43.3%                                |       |

** **

***Cost to Produce***

Cost to produce is a non-GAAP financial measure withinthe meaning of Regulation G promulgated by the SEC. Management believes thatthe presentation of cost to produce provides useful information to investorsregarding financial performance because this measure includes additional coststo originate mortgage loans, both recognized when incurred and deferred costs,which are not included in total expenses under GAAP. In addition, theproduction segments’ cost to produce includes the allocation of the directexpenses of the operating segments, which include corporate home office costsand investment portfolio management costs. The presentation of cost to produceis not meant to be considered in isolation or as a substitute for financialresults prepared in accordance with GAAP. The following discussion includes thecost to produce from our Wholesale, Retail, Corporate and Investment Portfolio segments,and excludes the results of our discontinued conforming Portfolio segments.

55

----

As required byRegulation G, a reconciliation of cost to produce to the most directlycomparable measure under GAAP, which is total expenses, is provided below forthe three months ended March 31, 2006 and 2005 (in thousands):

|                                                          | ** ** | **Three Months Ended   March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Total expenses                                           |       | $                                                      | 33,759     |   | 29,888 |   |
| Deferred origination costs                               |       | 6,506                                                  |       | 8,061 |   |
| Servicing costs—internal and external               |       | (3,255                                                 | )          | (3,319 | ) |
| Total operating costs                                    |       | 37,010                                                 |       | 34,630 |   |
| Premiums paid, net of fees collected                     |       | (1,398                                                 | )          | 592 |   |
| Cost to produce*                                         |       | $                                                      | 35,612     |   | 35,222 |   |
| Mortgage loan fundings:                                  |       |                                                   |       |   |   |
| Wholesale                                                |       | $                                                      | 860,523    |   | 975,905 |   |
| Retail                                                   |       | 150,795                                                |       | 171,956 |   |
| Mortgage loan fundings*                                  |       | $                                                      | 1,011,318  |   | 1,147,861 |   |
|                                                     |       |                                                   |       |   |   |
| Cost to produce  as % of mortgage loan fundings          |       | 3.52                                                   | %          | 3.07 | % |
| Total operating  costs as % of mortgage loan fundings    |       | 3.66                                                   | %          | 3.02 | % |
|                                                     |       |                                                   |       |   |   |
| Cost to produce as % of  mortgage loan fundings:         |       |                                                   |       |   |   |
| Total expenses                                           |       | 3.34                                                   | %          | 2.60 | % |
| Deferred  origination costs                              |       | 0.64                                                   | %          | 0.70 | % |
| Servicing  costs—internal and external              |       | (0.32                                                  | )%         | (0.28 | )% |
| Total general  and administrative costs                  |       | 3.66                                                   | %          | 3.02 | % |
| Premiums paid,  net of fees collected                    |       | (0.14                                                  | )%         | 0.05 | % |
| Cost to produce  as % of mortgage loan fundings          |       | 3.52                                                   | %          | 3.07 | % |
| Segment cost to produce  as % of mortgage loan fundings: |       |                                                   |       |   |   |
| Wholesale                                                |       | 3.34                                                   | %          | 2.90 | % |
| Retail                                                   |       | 4.61                                                   | %          | 4.14 | % |

----

* Excludes cost to produce and mortgage loan fundingsrelating to discontinued operations.

Our cost to produce increased in the three monthsended March 31, 2006 from the same period in the prior year due primarilyto (i) a rising level of fixed costs supporting lower funding volumes, (ii) anincrease in home office costs as a percent of volume due to the disposal of theconforming division in the first quarter of 2006 and related reduction in 2006total loan volume, (iii) increased salaries related to additional accountexecutives and loan officers hired to maintain market share and non-conformingloan origination volume in a flat origination environment, and (iv) thecost of implementing our new loan origination software system.

 These increaseswere partially offset by a lower commission structure in the wholesale segmentas a response to narrower market interest spreads, combined with reductions inmarketing costs incurred by our retail segment. We expect our cost to produceto decrease throughout the remainder of 2006 due primarily to a higher loanorigination volume expectation, and cost reduction initiatives in process inthe areas of variable loan costs, telecom and office expenses.

***Wholesale Segment.  ***Ourwholesale segment net cost to produce increased in the three months ended March 31,2006 from the same period in 2005, primarily due to increased salaries andbenefits related to additional sales personnel, and the incremental occupancyand general and administrative costs related to expansion offices in the westand northwestern region of the country during the period subsequent to March 31,2005.

56

----

***Retail Segment.  ***The increase inour retail segment cost to produce in the three months ended March 31, 2006compared to the same period in 2005 reflects higher salary and benefit costsdue to a 37% increase in loan officers in 2006, partially offset by a reductionin marketing costs as we streamlined our marketing initiatives throughout 2005.

***Investment Portfolio***

The following tables provide a summary of thecharacteristics of the principal balance of our portfolio of loans held forinvestment as of March 31, 2006 (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             |       | $                                 | 2,501,052  |                                | 45.5%      |                          | 7.3%       |                                 | 619        |                            | $          | 160                        |       | 82.0%                       |       | 91.4% |   |
| Stated Income  Wage Earner      |       | 1,511,929                         |       | 27.5%                               |       | 7.3%                          |       | 688                                  |       | 212                             |       | 78.8%                      |       | 95.1%                       |       |
| Stated Income  Self Employed    |       | 945,345                           |       | 17.2%                               |       | 7.4%                          |       | 671                                  |       | 234                             |       | 79.1%                      |       | 93.1%                       |       |
| 24 Month Bank  Statements       |       | 186,569                           |       | 3.4%                                |       | 7.2%                          |       | 626                                  |       | 231                             |       | 83.3%                      |       | 91.4%                       |       |
| 12 Month Bank  Statements       |       | 326,387                           |       | 5.9%                                |       | 7.4%                          |       | 635                                  |       | 224                             |       | 82.4%                      |       | 92.4%                       |       |
| Limited  Documentation          |       | 24,423                            |       | 0.5%                                |       | 7.3%                          |       | 639                                  |       | 207                             |       | 79.2%                      |       | 93.4%                       |       |
| Total                           |       | $                                 | 5,495,705  |                                | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |   |
| Weighted  Average/Average  |       |                              |       |                                |       | 7.3%                          |       | 648                                  |       | $                               | 188        |                       | 80.7%      |                        | 92.7%      |   |

 

*Credit Score*
| ** **                | ** ** | **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            |       | $                                 | 280,778    |                                | 5.1%       |                          | 8.5%       |                                 | 532        |                            | $          | 133                        |       | 79.2%                       |       | 81.2%                            |       | 82.4% |   |
| 550 – 599            |       | 864,047                           |       | 15.7%                               |       | 7.8%                          |       | 578                                  |       | 157                             |       | 81.7%                      |       | 86.7%                       |       | 75.4%                            |       |
| 600 – 649            |       | 1,546,470                         |       | 28.2%                               |       | 7.3%                          |       | 626                                  |       | 188                             |       | 81.8%                      |       | 91.8%                       |       | 63.4%                            |       |
| 650 – 699            |       | 1,796,118                         |       | 32.7%                               |       | 7.1%                          |       | 673                                  |       | 214                             |       | 80.7%                      |       | 95.8%                       |       | 25.2%                            |       |
| 700 or greater            |       | 1,008,292                         |       | 18.3%                               |       | 7.0%                          |       | 732                                  |       | 202                             |       | 78.3%                      |       | 97.1%                       |       | 18.4%                            |       |
| Total                     |       | $                                 | 5,495,705  |                                | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted  Average/Average |       |                              |       |                                |       | 7.3%                          |       | 648                                  |       | $                               | 188        |                       | 80.7%      |                        | 92.7%      |                             | 45.5%      |   |

 

57

----

*Product Type*
| ** **                 | ** ** | **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             |       | $                                 | 1,766,123  |                                | 32.1%      |                          | 7.8%       |                                 | 620        |                            | $          | 142                        |       | 81.1%                       |       | 90.7%                            |       | 55.8% |   |
| 2/28 LIBOR ARM IO          |       | 2,794,444                         |       | 50.9%                               |       | 7.0%                          |       | 664                                  |       | 260                             |       | 82.1%                      |       | 94.5%                       |       | 36.5%                            |       |
| 3/27 LIBOR ARM             |       | 204,149                           |       | 3.7%                                |       | 7.4%                          |       | 623                                  |       | 144                             |       | 81.7%                      |       | 90.2%                       |       | 63.8%                            |       |
| 3/27 LIBOR ARM IO          |       | 324,865                           |       | 5.9%                                |       | 6.9%                          |       | 662                                  |       | 255                             |       | 81.7%                      |       | 92.3%                       |       | 45.5%                            |       |
| 5/25 Treasury ARM          |       | 23,043                            |       | 0.4%                                |       | 6.5%                          |       | 655                                  |       | 176                             |       | 76.9%                      |       | 85.4%                       |       | 67.4%                            |       |
| 5/25 Treasury ARM IO  |       | 65,393                            |       | 1.2%                                |       | 6.4%                          |       | 672                                  |       | 277                             |       | 80.8%                      |       | 89.5%                       |       | 64.0%                            |       |
| Fixed Rate                 |       | 186,056                           |       | 3.4%                                |       | 7.6%                          |       | 641                                  |       | 141                             |       | 79.3%                      |       | 88.2%                       |       | 68.2%                            |       |
| Fixed Rate IO              |       | 29,910                            |       | 0.5%                                |       | 7.1%                          |       | 666                                  |       | 234                             |       | 80.4%                      |       | 91.3%                       |       | 55.6%                            |       |
| 6 Month LIBOR ARM          |       | 710                               |       | 0.0%                                |       | 8.2%                          |       | 679                                  |       | 177                             |       | 79.9%                      |       | 90.2%                       |       | 26.6%                            |       |
| 6 Month LIBOR ARM IO       |       | 3,820                             |       | 0.1%                                |       | 7.5%                          |       | 682                                  |       | 212                             |       | 80.9%                      |       | 94.1%                       |       | 16.0%                            |       |
| 2nd Liens                  |       | 81,146                            |       | 1.5%                                |       | 10.2%                         |       | 717                                  |       | 57                              |       | 18.9%                      |       | 99.5%                       |       | 11.3%                            |       |
| 2/38 LIBOR ARM             |       | 14,045                            |       | 0.3%                                |       | 8.2%                          |       | 647                                  |       | 223                             |       | 83.4%                      |       | 94.1%                       |       | 34.7%                            |       |
| 3/37 LIBOR ARM             |       | 545                               |       | 0.0%                                |       | 7.7%                          |       | 679                                  |       | 273                             |       | 85.9%                      |       | 91.6%                       |       | 61.8%                            |       |
| 40 Year Fixed              |       | 1,456                             |       | 0.0%                                |       | 8.1%                          |       | 611                                  |       | 208                             |       | 80.2%                      |       | 83.8%                       |       | 69.9%                            |       |
| Total                      |       | $                                 | 5,495,705  |                                | 100.0%     |                          |       |                                 |       |                            |       |                       |       |                        |       |                             |       |   |
| Weighted  Average/Average  |       |                              |       |                                |       | 7.3%                          |       | 648                                  |       | $                               | 188        |                       | 80.7%      |                        | 92.7%      |                             | 45.5%      |   |

** **

**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 of Regulation Gpromulgated by the SEC. Management believes that the presentation of core netincome and core earnings per share (diluted) provides useful information toinvestors regarding financial performance because this measure excludes thenon-cash mark to market gains or losses on interest rate swap and capagreements. The presentation of core net income and core earnings per share(diluted) is not meant to be considered in isolation or as a substitute forfinancial results prepared in accordance with GAAP.

As required by Regulation G, a reconciliation ofnet income and earnings per share (diluted) in the condensed consolidatedstatements of operations, presented in accordance with GAAP, to core net incomeand core earnings per share (diluted) is provided below for the three monthsended March 31, 2006 and 2005 (in thousands):

58

----

 

|                                                                                                                                         | ** **   | **Three Months Ended  March 31,** | ** **   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------------|--------------------------------------------------|--------------|
| ** **                                                                                                                              | ** **   | **2006**                                         | ** **   | **2005** | ** ** |
| ***Core  net income:***                                                                                                                 | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| Net income                                                                                                                              |         | $                                                | 12,928       |   | 41,754 |   |
| Less: Mark to market  (gain) loss on portfolio derivatives included in “Other income (expense) —  portfolio derivatives” |         |                                             |         |   |   |
| Mark to market interest rate swaps                                                                                                      |         | (1,894                                           | )            | (20,558 | ) |
| Mark to market interest rate cap                                                                                                        |         | —                                           |         | (70 | ) |
| Total mark to market on portfolio derivatives                                                                                           |         | (1,894                                           | )            | (20,628 | ) |
| Less:  Amortization of interest rate swap buydown payments                                                                              |         | (867                                             | )            | — |   |
| Core net income                                                                                                                         |         | $                                                | 10,167       |   | 21,126 |   |
|                                                                                                                                    |         |                                             |         |   |   |
| ***Core  earnings per share (diluted):***                                                                                               |         |                                             |         |   |   |
| Net income                                                                                                                              |         | $                                                | 12,928       |   | 41,754 |   |
| Unvested  restricted stock dividends                                                                                                    |         | (78                                              | )            | — |   |
| Net income  available to common shareholders                                                                                            |         | 12,850                                           |         | 41,754 |   |
| Less: Mark to  market (gain) loss on portfolio derivatives                                                                              |         | (1,894                                           | )            | (20,628 | ) |
| Amortization of interest rate swap buydown payments                                                                                     |         | (867                                             | )            | — |   |
| Core net income available to common shareholders                                                                                        |         | $                                                | 10,089       |   | 21,126 |   |
|                                                                                                                                    |         |                                             |         |   |   |
| Earnings per  share — diluted                                                                                                      |         | $                                                | 0.27         |   | 0.86 |   |
| Core earnings  per share — diluted                                                                                                 |         | $                                                | 0.21         |   | 0.44 |   |
|                                                                                                                                    |         |                                             |         |   |   |
| Diluted weighted average  common shares outstanding                                                                                     |         | 48,273,985                                       |         | 48,519,518 |   |

 

The decrease in core net income during the threemonths ended March 31, 2006 compared to the same period in 2005, wasprimarily due to a $9.2 million, or 23.4%, decrease in core net interest incomeon loans held for investment after provision for loan losses as our older,higher margin portfolio loans prepaid and new loans were added to the portfolioat lower margins. The margins available on new loans narrowed, as intensemarket competition for new loans did not permit coupons on new originations toincrease at the same rate as the increase in financing costs, which are indexedto rising market interest rates. The decline in margin was partially offset byan increase in our average portfolio balance to $5.5 billion in the firstquarter of 2006, from $4.9 billion in the comparable period last year.

***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 net

59

----

interestincome after provision for loan losses provides useful information to investorsbecause this measure includes the effect of the net cash settlements on theexisting 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 reconciliation ofnet interest income after provision for loan losses in the condensed consolidatedstatements of operations, presented in accordance with GAAP, to core netinterest income after provision for loan losses is provided below for the threemonths ended March 31, 2006 and 2005 (in thousands): 

|                                                                                                                                             | ** **   | **Three Months Ended  March 31,** | ** **   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------------|--------------------------------------------------|--------------|
| ** **                                                                                                                                  | ** **   | **2006**                                         | ** **   | **2005** | ** ** |
| ***Core  net interest income after provision for loan losses:***                                                                            | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| Net interest income  after provision for loan losses                                                                                        |         | $                                                | 24,800       |   | 43,029 |   |
| Plus: Net cash  settlements received (paid) on portfolio derivatives included in “Other  income (expense) — portfolio derivatives |         | 10,264                                           |         | (286 | ) |
| Less:  Amortization of interest rate swap buydown payments                                                                                  |         | (867                                             | )            | — |   |
| Core net  interest income after provision for loan losses                                                                                   |         | $                                                | 34,197       |   | 42,743 |   |
|                                                                                                                                        |         |                                             |         |   |   |
| Interest income  loans held for investment                                                                                                  |         | $                                                | 95,113       |   | 82,836 |   |
|                                                                                                                                        |         |                                             |         |   |   |
| Interest expense  loans held for investment                                                                                                 |         | 68,916                                           |         | 38,608 |   |
| Plus: Net cash  settlements received (paid) on portfolio derivatives                                                                        |         | (10,264                                          | )            | 286 |   |
| Plus:  Amortization of interest rate swap buydown payments                                                                                  |         | 867                                              |         | — |   |
| Core interest  expense — loans held for investment                                                                                     |         | 59,519                                           |         | 38,894 |   |
| Core net  interest income loans held for investment                                                                                         |         | 35,594                                           |         | 43,942 |   |
| Provision for  loan losses loans held for investment                                                                                        |         | 5,393                                            |         | 4,494 |   |
| Core net  interest income loans held for investment after provision for loan losses                                                    |         | 30,201                                           |         | 39,448 |   |
|                                                                                                                                        |         |                                             |         |   |   |
| Net interest  income loans held for sale                                                                                                    |         | 3,996                                            |         | 3,295 |   |
| Core net  interest income after provision for loan losses                                                                                   |         | $                                                | 34,197       |   | 42,743 |   |
| *** ***                                                                                                                                | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| ***Core  yield analysis:***                                                                                                                 | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| ***Core  yield analysis — loans held for investment:***                                                                                | *** *** | *** ***                                     | *** *** | *** *** | *** *** |
| Coupon interest  income on loans held for investment                                                                                        |         | 7.07                                             | %            | 6.68 | % |
| Amortization of  deferred origination costs.                                                                                                |         | (0.50                                            | )%           | (0.46 | )% |
| Prepayment fees                                                                                                                             |         | 0.41                                             | %            | 0.56 | % |
| Yield on loans  held for investment                                                                                                         |         | 6.98                                             | %            | 6.78 | % |
|                                                                                                                                        |         |                                             |         |   |   |
| Cost of  financing for loans held for investment                                                                                            |         | 5.17                                             | %            | 3.28 | % |
| Net cash  settlements (received) paid on portfolio derivatives                                                                              |         | (0.77                                            | )%           | 0.03 | % |
| Amortization of  interest rate swap buydown payments                                                                                        |         | 0.06                                             | %            | 0.00 | % |
| Core cost of financing  for loans held for investment                                                                                       |         | 4.46                                             | %            | 3.31 | % |

 

60

----

 

| Net yield on loans held for  investment                                                                                           |         | 1.92         | %            | 3.62         | %            |
|-----------------------------------------------------------------------------------------------------------------------------------|--------------|--------------|--------------|--------------|--------------|
| Net cash  settlements received (paid) on portfolio derivatives                                                                    |         | 0.75         | %            | (0.02        | )%           |
| Amortization of  interest rate swap buydown payments                                                                              |         | (0.06        | )%           | 0.00         | %            |
| Core net yield  on loans held for investment                                                                                      |         | 2.61         | %            | 3.60         | %            |
| Provision for  loan losses — loans held for investment                                                                       |         | (0.40        | )%           | (0.37        | )%           |
| Core yield on  loans held for investment after provision for loan losses                                                          |         | 2.21         | %            | 3.23         | %            |
| *** ***                                                                                                                      | *** *** | *** *** | *** *** | *** *** | *** *** |
| ***Core  yield analysis — loans held for sale:***                                                                            | *** *** | *** *** | *** *** | *** *** | *** *** |
| Yield on loans  held for sale                                                                                                     |         | 8.00         | %            | 7.91         | %            |
| Cost of  financing for loans held for sale                                                                                        |         | 4.91         | %            | 4.04         | %            |
| Net yield on  loans held for sale                                                                                                 |         | 4.84         | %            | 6.08         | %            |
|                                                                                                                              |         |         |         |         |         |
| ***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 |         | 1.72         | %            | 3.37         | %            |
| Net cash  settlements received (paid) on portfolio derivatives                                                                    |         | 0.71         | %            | (0.02        | )%           |
| Amortization of  interest rate swap buydown payments                                                                              |         | (0.06        | )%           | 0.00         | %            |
| Core yield — net  interest income on loans held for sale and loans held for investment after  provision for loan losses      |         | 2.37         | %            | 3.35         | %            |

*** ***

***Core net interest margin in the three months ended March 31,2006 was lower than the same period in 2005 due to the lower net interestmargins available on new loans added to the portfolio throughout the twelvemonths ended March 31, 2006, as older loans financed with lower rate debtand swaps prepaid and were replaced with new loans with coupons that did notrise to the same extent as the increase in financing costs on the debt andswaps indexed to the rising LIBOR interest rate.***

***Core Equity and Core Portfolio Leverage***

Core equity and core portfolio leverage are non-GAAPfinancial measures within the meaning of Regulation G promulgated by theSEC. Management believes that the presentation of core equity and coreportfolio leverage provide useful information to investors because thesemeasures exclude the cumulative non-cash mark to market gains or losses oninterest rate swap and cap agreements economically hedging the variable ratedebt financing the portfolio of mortgage loans and include the cumulativeamortization of interest rate swap buydown payments. The presentation of coreequity and core portfolio leverage are not meant to be considered in isolationor as a substitute for financial results prepared in accordance with GAAP.

As required by Regulation G, a reconciliation ofequity and portfolio leverage, presented in accordance with GAAP, to coreequity and core portfolio leverage are provided below as of March 31, 2006and December 31, 2005 (in thousands):

61

----

 
| ** **                                                                                                                                         | ** **   | **March 31,  2006** | ** **   | **December 31,  2005** | ** **   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------------|--------------------------|--------------|-----------------------------|--------------|
| ***Core  equity:***                                                                                                                                | *** *** | *** ***             | *** *** | *** ***                | *** *** |
| Equity balance  at period end                                                                                                                      |         | $                        | 516,858      |                        | 526,643      |   |
| Less: Cumulative  mark to market (gain) loss on portfolio derivatives included in “Other income  (expense) — portfolio derivatives” |         | (28,007                  | )            | (26,113                     | )            |
| Less: Cumulative  amortization of interest rate swap buydown payments                                                                              |         | (1,622                   | )            | (755                        | )            |
| Core equity  balance at period end                                                                                                                 |         | $                        | 487,229      |                        | 499,775      |   |
|                                                                                                                                               |         |                     |         |                        |         |
| Portfolio debt  (warehouse financing —loans held for investment and securitization financing)                                                 |         | $                        | 5,500,779    |                        | 5,377,327    |   |
| Portfolio  leverage (portfolio debt to equity)                                                                                                     |         | 10.6:1                   |         | 10.2:1                      |         |
| Core portfolio leverage  (portfolio debt to core equity)                                                                                           |         | 11.3:1                   |         | 10.8:1                      |         |

 

**Recent Accounting Pronouncements**

In March 2006,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 156, “*Accounting For Servicingof Financial Assets-an amendment of FASB Statement No. 140*,”**(Statement No. 156). Statement No. 156 amends theStatement of Financial Accounting Standards No. 140, “*Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilitie*s,” (Statement No. 140), with respect to the accounting forseparately recognized servicing rights. Statement No. 156 requires anentity to initially recognize, at fair value, a servicing asset or servicingliability each time it undertakes an obligation to service a financial asset byentering into a servicing contract in certain situations. In addition,Statement No. 156 permits the subsequent measurement of servicing assetsand servicing liabilities using the fair value method or the amortizationmethod as prescribed under Statement No. 140. Statement No. 156 iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006. The Company will adopt Statement No. 156,as applicable, beginning in fiscal year 2007. Management believes that theimplementation of Statement No. 156 will not have a material effect on ourresults of operations, statements of condition or cash flows.

In February 2006,the FASB issued Statement of Financial Accounting Standards No. 155, “*Accounting For Certain Hybrid Financial Instruments-an amendment ofFASB Statements No. 133 and 140*,”**(StatementNo. 155). Statement No. 155 amends Statement No. 133, to permitfair value remeasurement for any hybrid financial instrument with an embeddedderivative that otherwise would require bifurcation, provided that the wholeinstrument is accounted for on a fair value basis. Statement No. 155amends Statement No. 140 to allow a qualifying special-purpose entity tohold a derivative financial instrument that pertains to a beneficial interestother than another derivative financial instrument. Statement No. 155 iseffective for all financial instruments acquired, issued or subject to aremeasurement (new basis) event occurring after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006. The Company willadopt Statement No. 155, as applicable, beginning in fiscal year 2007. Managementbelieves that the implementation of Statement No. 155 will not have amaterial effect on our results of operations, statements of condition or cashflows.

62

----

In December 2005,the FASB issued Staff Position 94-6-1*,*“*Terms of Loan Products That May Give Rise to a Concentration ofCredit Risk*,” (FSP 94-6-1). FSP 94-6-1clarifies that loan products that expose an originator, holder, investor,guarantor or servicer to an increased risk of non-payment or not realizing thefull value of the loan, such as non-traditional loan products, may result in aconcentration of credit risk as defined in Statement of Financial AccountingStandards No. 107, “*Disclosures about FairValue of Financial Instruments*,” (Statement No. 107). FSP 94-6-1also emphasizes the requirement to assess the adequacy of disclosures for alllending products (including both secured and unsecured loans) and the effect ofchanges in market or economic conditions on the adequacy of those disclosures.The guidance under FSP 94-6-1 is effective for interim and annualreporting periods ending December 19, 2005 and for loan products that aredetermined to represent a concentration of credit risk, disclosure requirementsof Statement No. 107 should be provided for all periods presented. Theadoption of FSP 94-6-1 has not had a significant impact on theCompany’s consolidated financial statements.

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. In March 2005, the SEC staff issuedStaff Accounting Bulletin No. 107 (SAB No. 107). SAB No. 107expresses the views of the SEC regarding Statement No. 123R and certain rules andregulations and provides the SEC’s view regarding the valuation of share-basedpayment arrangements for public companies. In April 2005, the SEC amendedthe compliance dates for Statement No. 123R to the beginning of the nextfiscal year after June 15, 2005. In November 2003, the Companyadopted the fair value method of accounting for grants of stock options andrestricted stock as prescribed by Statement of Financial Accounting Standards No. 148,“*Accounting for Stock-Based Compensation-Transitionand Disclosure*.”  Under thismethod, compensation cost is measured at the grant date based on the fair valueof the award and is recognized as expense on a straight-line basis over theaward’s vesting period.  Theimplementation of Statement No. 123R and SAB No. 107 has not had amaterial effect on the Company’s results of operations, statements of conditionor cash flows.

**Off-BalanceSheet Arrangements**

As of March 31,2006, we were not a party to any off-balance sheet arrangements.

**Effect of Inflation**

Inflation affects us mostsignificantly in the effect it has on interest rates and real estate values.Our level of loan originations is affected by the level and trends of interestrates. Interest rates normally increase during periods of high inflation (or inperiods when the Federal Reserve Bank raises short-term interest rates in anattempt to prevent inflation) and decrease during periods of low inflation. Inaddition, inflation of real estate values increases the equity homeowners havein their homes and increases the volume of refinancing loans we can originateas borrowers 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***

The market risk discussions and timing of re-pricingof our interest rate sensitive assets and liabilities are forward-lookingstatements that assume that certain market conditions occur. Actual results maydiffer materially from these forecasts due to changes in our held for saleportfolio and borrowings mix and due to developments in the finance and realestate markets, including the likelihood of changing interest rates and theimpact of these changes on our net interest margin, cost of funds and cashflows. The methods we utilize to assess and mitigate these market risks shouldnot be considered projections of future events or operating performance.

63

----

We carry interest-sensitive assets on ourbalance sheet that are financed by interest-sensitive liabilities. We aresubject to interest rate risk because the interval for re-pricing of the assetsand liabilities is not matched. An increase or decrease in interest rates wouldaffect our net interest income and the fair value of our mortgage loans heldfor investment and held for sale as well as the related financing. We employhedging strategies to manage the interest-rate risk inherent in our assets andliabilities. These strategies are designed to create gains when movements ininterest rates would cause our cash flows or the value of our assets to declineand to result in losses when movements in interest rates cause our cash flowsand/or the value of our assets to increase.

The interest rates on our hybrid ARM loans held forinvestment are fixed for the first two to three years of the loan, after whichthe interest rates reset every six months to the then-current market rate. Theinterest rates on the bonds financing these loans reset to current market rateseach month during the entire term of the loan. During the period we arereceiving fixed rate payments on our loans, we use interest rate swaps to payfixed rate payments to the swap counter-party, and receive variable interestrate payments which match the interest rates on our financing interest costs.The swap of “variable for fixed” rates allows us to match fund our loans duringthe fixed period of the loans.

***Effects of Interest Rate Volatility***

Changes in interest rates impact our earnings and cashflows in several ways. Interest rate changes can affect our net interest incomeon our hybrid mortgages held for investment (net of the cost of financing theseassets). We estimate the duration of our hybrid loans in our investment portfolioand our policy is to economically hedge the financing of the loans during theperiod in which the loans are paying a fixed coupon, while being financed withfloating rate debt indexed to LIBOR. During an increasing interest rateenvironment, our assets may prepay more slowly than expected, requiring us tofinance a higher amount of fixed assets with floating rate debt than originallyanticipated, at a time when interest rates may be higher, resulting in adecline in our net return. In order to manage our exposure to changes in theprepayment speed of our hybrid loan assets, we regularly monitor the portfoliobalance, revise the amounts anticipated to be outstanding in future periods andadjust the notional balance of our hedging derivatives to mitigate this risk.

During a rising interest rate environment, there maybe lower total loan origination and refinance activity. At the same time, arising interest rate environment may result in a larger percentage of ARMproducts being originated, mitigating the impact of lower overall loanorigination and refinance activity. Conversely, during a declining interestrate environment, consumers, in general, may favor fixed-rate mortgage productsover ARM and hybrid products. A flat or inverted yield curve may shift borrowerpreference from an ARM mortgage loan to a fixed mortgage loan.

If interest rates decline, the rate of prepayment onour mortgage assets may increase during the two to three year initial life ofour loans held for investment. Increased prepayments would cause us to amortizethe deferred origination costs of our mortgage assets faster, resulting in areduced yield on our mortgage assets. Additionally, to the extent proceeds ofprepayments cannot be reinvested at a rate of interest at least equal to the ratepreviously earned on such mortgage assets, our earnings may be adverselyaffected.

Conversely, if interest rates rise, the rate ofprepayment on our mortgage assets during the initial fixed pay period of theassets’ life may decrease. Decreased prepayments would cause us to amortize thedeferred origination costs of our ARM assets over a longer time period,resulting in an increased yield on our mortgage assets.

**ITEM 4.**                   CONTROLS ANDPROCEDURES.

**Disclosure Controls and Procedures**

Under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness as of March 31, 2006 of our disclosure

64

----

controls and procedures,as such term is defined under Rule 13(a)-15(e) under theSecurities Exchange Act of 1934, as amended. Based on this evaluation, ourprincipal executive officer and principal financial officer have concluded thatour system of disclosure controls and procedures were effective as of March 31,2006.

**Changes in Internal Control overFinancial Reporting**

Except as setforth below, there were no changes to our system of internal control overfinancial reporting during the first quarter of 2006 that had a material effector could materially affect the internal control over financial reporting. Duringthe first quarter of 2006, we took steps to address the material weaknessrelated to our controls over the process for determining the application ofaccounting principles to individual transactions discussed in detail in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2005. These steps included an update to our tax accounting policies andprocedures to address and remediate this material weakness.

65

----

**PART II — OTHER INFORMAITON**

**ITEM1.**                    LEGALPROCEEDINGS.

In addition to theproceedings discussed below, we are subject to various legal proceedings in theordinary course of our business related to foreclosures, bankruptcies,condemnation and quiet title actions and alleged statutory and regulatoryviolations. Our management believes that any liability with respect these legalactions, individually or in the aggregate, will not have a material adverseeffect on the Company’s business, results of operations or financial position.

***Bass Litigation:***

On May 24,2004, all of our former shareholders whose shares were redeemed following theclosing of the 144A Offering (the “Former Shareholders”), filed an action inthe District Court of Tarrant County, Texas, against us, Fieldstone Mortgageand KPMG LLP (KPMG), alleging that the Former Shareholders whose shares wereredeemed for approximately $188.1 million, are entitled to an additional post-closingredemption price payment of approximately $19.0 million. On September 9,2004, KPMG served its response to plaintiffs’ request for disclosure, stating,among other things, that KPMG has determined that the deferred tax asset, whichis reflected in our December 31, 2003 audited financial statements, shouldhave been reflected in our financial statements as of November 13, 2003,the day immediately prior to the closing of the 144A Offering. At the presenttime, the ultimate outcome of this claim and the amount of liability, if any,that may result is not determinable, and no amounts have been accrued in ourfinancial statements with respect to this claim. On October 28, 2005, weserved a cross claim against KPMG. Our cross claim asserts, among other claims,that KPMG’s withdrawal of its audit report on the November 13, 2003balance sheet was improper and that due to this improper withdrawal we suffereddamages. In addition, the cross claim asserts that in the event the FormerShareholders prevail in their suit, KPMG negligently advised us regarding the November 13,2003 balance sheet giving rise to this dispute. The cross claim seeks ajudgment against KPMG in an amount in excess of $1 million, plus prejudgmentinterest for the attorneys fees and costs incurred in this lawsuit. A trial datehas been scheduled for October 9, 2006.

We intend tovigorously defend against the claim made by the Former Shareholders describedabove. If we ultimately are unsuccessful in defending this matter, we could berequired to make a cash payment of up to $19.0 million to the FormerShareholders, plus potential interest and third-party costs associated with thelitigation. Excluding interest or third-party costs, which may be payable aspart of a settlement, the potential payment will be an increase in theredemption price of their shares and recorded as a reduction of our paid-incapital in the period in 

66

----

which the dispute isresolved and will be paid out of our working capital and will not be reflectedin our income statement.

***Rhodes Litigation:***

On January 9,2006, a class action lawsuit was filed naming Fieldstone Mortgage in theNorthern District of Illinois (Eastern Division) alleging violations of theFair Credit Reporting Act (“FCRA”). The class action is entitled Rhodes v.Fieldstone Mortgage Company. Plaintiff alleges that Fieldstone Mortgageviolated the firm offer of credit guidelines encapsulated in 15 U.S.C.§1681 et seq. during its mail marketing campaign in or around April 2005.Specifically, Plaintiff alleges that Fieldstone Mortgage did not comply withthe statutory guidelines in providing a firm offer of credit to the potentialconsumer. Pursuant to 15 U.S.C. §1681 et seq., statutory damages can rangefrom $100 to $1,000 per mailing in the event that the violation is deemedwillful. No motion for class certification has yet been filed in this case.Fieldstone Mortgage filed a motion to dismiss/motion to strike pursuant toFederal Rule 12(b)(6) for the injunctive relief portion of thecompliant. This action is in the initial stage of discovery.

Due to theuncertain nature of the litigation at this time, we are unable to estimate theprobable outcome of this matter. While we intend to continue to vigorouslydefend this claim and believe we have meritorious defenses available to us,there can be no assurance we will prevail and that an adverse outcome would nothave a material effect on our results of operations.

For information onour other material legal proceedings, see our Annual Report on Form 10-K,as amended, for the fiscal year ended December 31, 2005.

**ITEM1A.**            RISKFACTORS.

There have been nomaterial changes to the risk factors previously disclosed in our Annual Reporton Form 10-K for the fiscal year ended December 31, 2005.

**ITEM2.**                    UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

***Not applicable.***

**ITEM 3.**                   DEFAULTS UPONSENIOR SECURITIES.

Not applicable.

**ITEM 4.**                   SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

**ITEM5.**                    OTHERINFORMATION.

Not applicable.

**ITEM6.**                    EXHIBITS.

See the Exhibit Indexfor list of exhibits filed with this report.

67

----

**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, as amended, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized.
|                         |   | Fieldstone Investment  Corporation |
|-------------------------|--------|------------------------------------|
|                    |   | (registrant)                       |
|                    |   |                               |   |   |
| Dated May 15, 2006 |   | By:                                |   | /s/ Michael J. Sonnenfeld |
|                    |   |                               |   | Michael J. Sonnenfeld |
|                    |   |                               |   | *President and Chief Executive Officer* |
|                    |   |                               |   |   |
| Dated May 15, 2006 |   | By:                                |   | /s/ Nayan V. Kisnadwala |
|                    |   |                               |   | Nayan V. Kisnadwala |
|                    |   |                               |   | *Executive Vice President and Chief Financial  Officer* |

 

68

----

**EXHIBITINDEX**
| Exhibit  Number    | ** ** | **Description**                                                                                                                                                                                                              |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   2.1(1) |       | Asset Purchase Agreement, dated as of January 13,  2006, by and between Fieldstone Mortgage Company and Wausau Mortgage  Corporation.                                                                                   |
|               |       |                                                                                                                                                                                                                         |
| 10.1†         |       | Employment Agreement dated as of September 1,  2003 by and between Fieldstone Mortgage Company and James T. Hagan. (Filed  herewith)                                                                                    |
|               |       |                                                                                                                                                                                                                         |
| 10.2†         |       | Extended Severance Benefit Agreement by and between  Fieldstone Investment Corporation and Cynthia L. Harkness dated  February 27, 2006. (Filed herewith)                                                               |
|               |       |                                                                                                                                                                                                                         |
| 10.3(4)†      |       | Form of Nonqualified Stock Option Agreement for  Senior Executives.                                                                                                                                                     |
|               |       |                                                                                                                                                                                                                         |
| 10.4(3)†      |       | Amended and Restated Parameters of Awards of Stock  Options and Restricted Shares.                                                                                                                                           |
|               |       |                                                                                                                                                                                                                         |
| 10.5(3)†      |       | Form of Dividend Equivalent Rights Award  Agreement.                                                                                                                                                                    |
|               |       |                                                                                                                                                                                                                         |
| 10.6(2)†      |       | Employment Offer Letter, dated February 14,  2006, by and between Nayan V. Kisnadwala and Fieldstone Investment Corporation.                                                                                            |
|               |       |                                                                                                                                                                                                                         |
| 10.7(4)†      |       | Summary of Board of Directors’ Compensation.                                                                                                                                                                            |
|               |       |                                                                                                                                                                                                                         |
| 10.8(4)†      |       | Summary of Named Executive Officers’ 2005 Bonuses  and 2006 Annual Base Salaries.                                                                                                                                       |
|               |       |                                                                                                                                                                                                                         |
| 10.9(3)            |       | Amendment No. 2 to Second Master Repurchase  Agreement, dated as of February 22, 2006, among Credit Suisse First  Boston Mortgage Capital LLC, Fieldstone Mortgage Company and Fieldstone  Investment Corporation. |

 

69

----

 
| 10.10(a)(4) |   | Amendment No. 1 to Master Repurchase Agreement,  dated as of March 21, 2006, among Credit Suisse, New York Branch,  Fieldstone Mortgage Company and Fieldstone Investment Corporation.                                                                             |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                         |
| 10.10(b)(4) |   | Amendment No. 1 to Pricing Side Letter, dated  as of January 23, 2006, among Credit Suisse, New York Branch, Fieldstone  Mortgage Company and Fieldstone Investment Corporation.                                                                                   |
|        |   |                                                                                                                                                                                                                                                                         |
| 10.10(c)(4) |   | Amendment No. 2 to Pricing Side Letter, dated  as of March 21, 2006, among Credit Suisse, New York Branch, Fieldstone  Mortgage Company and Fieldstone Investment Corporation and the several  Conduit Buyers and Committed Buyers Party hereto from time to time. |
|        |   |                                                                                                                                                                                                                                                                         |
| 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 Chief 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 Chief  Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. (Furnished herewith)                                                               |

----

(1)  Incorporated by reference to the registrant’sForm 8-K filed with the SEC on January 18, 2006.

(2)  Incorporated by reference to the registrant’sForm 8-K filed with the SEC on February 16, 2006.

(3)  Incorporated by reference to the registrant’sForm 8-K filed with the SEC on February 27, 2006.

(4)          Incorporated byreference to the registrant’s Annual Report of Form 10-K for thefiscal year ended December 31, 2005 filed with the SEC on April 14,2006.

†              Denotesa management contract or compensatory plan.

70

----