**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

ý   **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended: June 30, 2004**

 

**OR**

** **

o   **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the transition period from               to**

 

**Commission File Number: 001-32213**

 

**MORTGAGEITHOLDINGS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Maryland**                                                                        | ** **   | **20-0404134**                        |
|-------------------------------------------------------------------------------------|--------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |         | (IRS Employer  Identification Number) |
|                                                                                | *** *** | *** ***                          |
| **33 Maiden Lane  New York, New York**                                              | *** *** | **10038**                             |
| (Address of principal executive offices)                                            |         | (Zip Code)                            |
|                                                                                |         |                                  |
| Registrant’s telephone number, including  area code: **(212) 651-7700**        |
|                                                                                |         |                                  |
| (Former name, former address and former  fiscal year, if changed since last report) |
| **Not applicable**                                                                  |

 

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

 

| Yes  o |   | No  ý |
|------------------|--------|----------------------|

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in rule 12b-2 of the Securities Exchange Act of 1934)

 

| Yes  o |   | No  ý |
|------------------|--------|----------------------|

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the lastpracticable date:

 

COMMON STOCK, $0.01 PAR VALUEPER SHARE: 19,405,473 SHARES OUTSTANDING AS OF SEPTEMBER 9, 2004.

 

 

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**TABLE OF CONTENTS**

 
| Cautionary Statements               | 3                                                                                           |
|-------------------------------------|---------------------------------------------------------------------------------------------|
|                                |                                                                                        |
| Part I.  Financial Information | 4                                                                                           |
|                                |                                                                                        |   |
| Item 1.                             | Financial Statements                                                                        | 4 |
|                                | Consolidated Balance Sheets                                                                 | 4 |
|                                |                                                                                        |   |
|                                | Consolidated  Statements of Operations  (Unaudited)                                    | 5 |
|                                |                                                                                        |   |
|                                | Consolidated  Statements of Cash Flows (Unaudited)                                          | 6 |
|                                |                                                                                        |   |
|                                | Notes to  Consolidated Financial Statements                                                 | 7 |
|                                |                                                                                        |   |
| Item  2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16 |
| Item  3.                            | Quantitative  and Qualitative Disclosures About Market Risk                                 | 28 |
| Item 4.                             | Controls And Procedures                                                                     | 31 |
| Part II.  Other Information    | 32                                                                                          |
|                                |                                                                                        |   |
| Item 1.                             | Legal Proceedings                                                                           | 32 |
| Item  2.                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 32 |
| Item 3.                             | Defaults Upon  Senior Securities                                                            | 32 |
| Item  4.                            | Submission  of Matters to a Vote of Security Holders                                        | 32 |
| Item 5.                             | Other Information                                                                           | 32 |
| Item 6.                             | Exhibits                                                                                    | 32 |
| Signatures                          | 34                                                                                          |

 

2

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**CAUTIONARY STATEMENTS**

 

Theinformation contained in this quarterly report on Form 10-Q is not a completedescription of our business or the risks associated with an investment in ourCompany. We urge you to carefully review and consider the various disclosuresmade by us in this report and in our other filings with the Securities andExchange Commission (“SEC”), including our registration statement on Form S-11declared effective on July 29, 2004, that discuss our business in greaterdetail.

 

This reportcontains certain “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statementsrelate to, among other things, the operating performance of our investments andfinancing needs. Forward-looking statements are generally identifiable by useof forward-looking terminology such as “may,” “will,” “should,” “potential,”“intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,”“overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,”“continue” or other similar words or expressions. Forward-looking statementsare based on certain assumptions, discuss future expectations, describe futureplans and strategies, contain projections of results of operations or offinancial condition or state other forward-looking information.  Our ability to predict results or the actualeffect of future plans or strategies is inherently uncertain. Although webelieve that the expectations reflected in such forward-looking statements arebased on reasonable assumptions, our actual results and performance coulddiffer materially from those set forth in the forward-looking statements. Theseforward-looking statements involve risks, uncertainties and other factors thatmay cause our actual results in future periods to differ materially fromforecasted results.  Factors which couldhave a material adverse effect on our operations and future prospects include,but are not limited to, changes in economic conditions generally and the realestate and bond markets specifically; our ability to originate a portfolio ofhigh quality prime adjustable-rate mortgage (“ARM”) and hybrid ARM loans;changes in interest rates and/or credit spreads, as well as the success of ourhedging strategy in relation to such changes; the quality and size of theinvestment pipeline and the rate at which we can invest our cash; changes inthe markets; legislative/regulatory changes; completion of pending investments;the availability and cost of capital for future investments; competition withinthe finance and real estate industries; and other risks detailed from time totime in our SEC reports. Readers are cautioned not to place undue reliance onany of these forward-looking statements, which reflect our management’s viewsas of the date of this report. The factors noted above could cause our actualresults to differ significantly from those contained in any forward-lookingstatement. For a discussion of our critical accounting policies see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations - Critical Accounting Policies and Estimates.”

 

Although webelieve that the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceor achievements. We are under no duty to update any of the forward-lookingstatements after the date of this report to conform these statements to actualresults.

 

3

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**PARTI.  FINANCIAL INFORMATION**

** **

**ITEM1.  FINANCIAL STATEMENTS**

 

**MortgageIT, Inc. and Subsidiaries**

 

**CONSOLIDATEDBALANCE SHEETS**

(**Dollars in thousands)**

 
| ** **                                                                                                | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                | ** ** | **(unaudited)**    | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                |       |               |       |                   |       |
| Cash and cash equivalents                                                                                 |       | $                  | 6,351      |                   | $          | 22,261 |   |
| Restricted cash                                                                                           |       | 1,293              |       | 1,517                  |       |
| Marketable securities held to maturity                                                                    |       | 1,419              |       | 1,419                  |       |
| Mortgage loans held for sale                                                                              |       | 1,074,887          |       | 322,012                |       |
| Receivables, net of allowance                                                                             |       | 18,593             |       | 10,301                 |       |
| Prepaids and other current assets                                                                         |       | 6,130              |       | 5,481                  |       |
| Goodwill — IPI                                                                                       |       | 11,639             |       | 11,665                 |       |
| Property and equipment, net                                                                               |       | 4,928              |       | 5,324                  |       |
| **Total assets**                                                                                          |       | $                  | 1,125,240  |                   | $          | 379,980 |   |
|                                                                                                      |       |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY  (DEFICIT)**                                                  |       |               |       |                   |       |
| Liabilities:                                                                                              |       |               |       |                   |       |
| Warehouse lines payable                                                                                   |       | $                  | 1,031,214  |                   | $          | 300,699 |   |
| Notes payable and other debt                                                                              |       | 15,000             |       | 1,125                  |       |
| Accounts payable                                                                                          |       | 857                |       | 1,938                  |       |
| Accrued expenses                                                                                          |       | 23,529             |       | 26,462                 |       |
| Other liabilities                                                                                         |       | 4,094              |       | 2,596                  |       |
| **Total liabilities**                                                                                     |       | 1,074,694          |       | 332,820                |       |
|                                                                                                      |       |               |       |                   |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                         |       |               |       |                   |       |
| Convertible redeemable preferred stock:  22,000,000 shares authorized:  15,082,973 issued and outstanding |       | 65,917             |       | 62,557                 |       |
|                                                                                                      |       |               |       |                   |       |
| **STOCKHOLDERS’ EQUITY (DEFICIT):**                                                                  |       |               |       |                   |       |
| Common stock: Class A, $0.01 par value;  1,895,000 shares authorized;  517,835 issued and outstanding(1)  |       | 5                  |       | 5                      |       |
| Additional paid-in capital(1)                                                                             |       | 3,955              |       | 3,955                  |       |
| Accumulated deficit                                                                                       |       | (19,331            | )          | (19,357                | )          |
| **Total stockholders’ equity (deficit)**                                                             |       | (15,371            | )          | (15,397                | )          |
| **Total liabilities and stockholders’ equity**                                                       |       | $                  | 1,125,240  |                   | $          | 379,980 |   |

 

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*(1) Reflects, on a retroactive basis, for allperiods presented, the exchange of approximately 12.80 shares of MortgageIT,Inc. common stock for each share of MortgageIT Holdings, Inc. common stock andthe retention and retirement of common shares pursuant to the reorganization ofMortgageIT, Inc.*

 

*The accompanying notes are an integral part of the consolidatedfinancial statements*

 

4

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**MortgageIT, Inc.and Subsidiaries**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited****)**

**(Dollarsand shares in thousands, except per share data)**

 
| ** **                                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                               | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues:**                                            |       |                            |       |                          |       |   |   |   |   |
| Gain on sale of mortgage loans                           |       | $                               | 21,904     |                          | $          | 25,396 |   | $ | 37,672 |   | $ | 42,258 |   |
| Brokerage revenues                                       |       | 11,844                          |       | 16,456                        |       | 20,589 |   | 30,805 |   |
| Interest income                                          |       | 6,291                           |       | 6,325                         |       | 11,593 |   | 12,072 |   |
| Interest expense                                         |       | 2,455                           |       | 3,729                         |       | 4,985 |   | 7,208 |   |
| Net interest income                                      |       | 3,836                           |       | 2,596                         |       | 6,608 |   | 4,864 |   |
| Other                                                    |       | 17                              |       | 49                            |       | 24 |   | 920 |   |
| **Total revenues**                                       |       | 37,601                          |       | 44,497                        |       | 64,893 |   | 78,847 |   |
| **Operating expenses:**                                  |       |                            |       |                          |       |   |   |   |   |
| Compensation and employee benefits                       |       | 19,899                          |       | 21,004                        |       | 36,431 |   | 38,284 |   |
| Processing expenses                                      |       | 6,341                           |       | 8,351                         |       | 9,787 |   | 13,996 |   |
| General and administrative expenses                      |       | 2,486                           |       | 2,807                         |       | 4,803 |   | 4,913 |   |
| Rent                                                     |       | 1,858                           |       | 1,604                         |       | 3,673 |   | 3,141 |   |
| Marketing, loan acquisition and business  development    |       | 1,175                           |       | 1,961                         |       | 2,225 |   | 3,389 |   |
| Professional fees                                        |       | 472                             |       | 790                           |       | 1,059 |   | 1,372 |   |
| Depreciation and amortization                            |       | 644                             |       | 555                           |       | 1,270 |   | 1,165 |   |
| **Total operating expenses**                             |       | 32,875                          |       | 37,072                        |       | 59,248 |   | 66,260 |   |
|                                                     |       |                            |       |                          |       |   |   |   |   |
| **Income before income taxes**                           |       | 4,726                           |       | 7,425                         |       | 5,645 |   | 12,587 |   |
| **Income taxes**                                         |       | 1,884                           |       | 1,847                         |       | 2,259 |   | 2,785 |   |
| **Net income**                                           |       | 2,842                           |       | 5,578                         |       | 3,386 |   | 9,802 |   |
| **Dividends on convertible redeemable  preferred stock** |       | 1,699                           |       | 1,552                         |       | 3,360 |   | 3,055 |   |
| **Net income attributable to common  stockholders**      |       | $                               | 1,143      |                          | $          | 4,026 |   | $ | 26 |   | $ | 6,747 |   |
| **Per share data:**                                      |       |                            |       |                          |       |   |   |   |   |
| Basic                                                    |       | $                               | 2.21       |                          | $          | 7.79 |   | $ | 0.05 |   | $ | 13.05 |   |
| Diluted                                                  |       | $                               | 0.58       |                          | $          | 1.22 |   | $ | 0.05 |   | $ | 2.17 |   |
| Weighted average number of shares —  basic(1)       |       | 518                             |       | 517                           |       | 518 |   | 517 |   |
| Weighted average number of shares —  diluted(1)     |       | 4,917                           |       | 4,559                         |       | 577 |   | 4,518 |   |

 

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*(1) Reflects, on a retroactive basis, for all periods presented, theexchange of approximately 12.80 shares of MortgageIT, Inc. common stock foreach share of MortgageIT Holdings, Inc. common stock and the retention andretirement of common shares pursuant to the reorganization of MortgageIT, Inc.*

 

*The accompanying notes are an integral partof the consolidated financial statements.*

 

5

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**MortgageIT, Inc.and Subsidiaries**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited****)**

**(Dollars in thousands)**

 
| ** **                                                                     | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                           | ** ** | **2003** | ** ** |
|                                                                           |       |                               |       |   |   |
| Cash flows from operating activities:                                          |       |                               |       |   |   |
| Net income                                                                     |       | $                                  | 3,386      |   | $ | 9,802 |   |
| Adjustments to reconcile net income to net  cash used in operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                  |       | 1,270                              |       | 1,165 |   |
| Amortization of the cost of restricted  stock                                  |       | —                             |       | (4 | ) |
| Changes in operating assets:                                                   |       |                               |       |   |   |
| Decrease in restricted cash                                                    |       | 224                                |       | 2,786 |   |
| Increase in mortgage loans held                                                |       | (752,875                           | )          | (90,341 | ) |
|                                                                           |       |                               |       |   |   |
| Increase in receivables                                                        |       | (8,292                             | )          | (5,372 | ) |
| Increase in prepaids and other assets                                          |       | (623                               | )          | (246 | ) |
| Changes in operating liabilities:                                              |       |                               |       |   |   |
| (Decrease) in accounts payable                                                 |       | (1,081                             | )          | (674 | ) |
| (Decrease) increase in accrued expenses                                        |       | (2,933                             | )          | 5,626 |   |
| Increase in other liabilities                                                  |       | 1,498                              |       | 1,810 |   |
| **Net cash used in operating activities**                                      |       | (759,426                           | )          | (75,448 | ) |
|                                                                           |       |                               |       |   |   |
| **Cash flows from investing activities:**                                      |       |                               |       |   |   |
| Purchases of property and equipment                                            |       | (874                               | )          | (1,875 | ) |
| Proceeds from maturities of marketable  securities                             |       | 4,260                              |       | 2,800 |   |
| Purchases of marketable securities                                             |       | (4,260                             | )          | (2,731 | ) |
| **Net cash used in investing activities**                                      |       | (874                               | )          | (1,806 | ) |
|                                                                           |       |                               |       |   |   |
| **Cash flows from financing activities:**                                      |       |                               |       |   |   |
| Proceeds from issuance of common stock                                         |       | —                             |       | 5 |   |
| Proceeds from notes payable and other debt                                     |       | 15,000                             |       | 10,000 |   |
| Repayment of notes payable and other debt                                      |       | (1,125                             | )          | (5,000 | ) |
| Net proceeds of warehouse lines payable                                        |       | 730,515                            |       | 93,318 |   |
| **Net cash provided by financing activities**                                  |       | 744,390                            |       | 98,323 |   |
|                                                                           |       |                               |       |   |   |
| **Net (decrease) increase in cash and cash  equivalents**                      |       | (15,910                            | )          | 21,069 |   |
| **Cash and cash equivalents at beginning of  period**                          |       | 22,261                             |       | 2,104 |   |
|                                                                           |       |                               |       |   |   |
| **Cash and cash equivalents at end of period**                                 |       | $                                  | 6,351      |   | $ | 23,173 |   |

 

*The accompanying notes are an integral partof the consolidated financial statements*

 

6

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE1-ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Basis ofPresentation**

 

As discussed further in Note 9,MortgageIT Holdings, Inc. (“Holdings”) is a residential mortgage lender thatwas formed in March 2004 to continue and expand the business ofMortgageIT, Inc. (“MortgageIT” or the “Company”).  Holdings is organized and conducts itsoperations to qualify as a REIT for federal income tax purposes.  MortgageIT was incorporated in New York onFebruary 1, 1999 and began marketing mortgage loan services on May 1,1999. MortgageIT originates, funds and brokers residential mortgage loans in 50states and the District of Columbia, and is an approved U.S. Department ofHousing and Urban Development (“HUD”) Title II Nonsupervised DelegatedMortgagee. The Company’s operations consist solely of this single segment.

 

All shares of common stock andcommon stock equivalents have been retroactively restated, for all periodspresented, to reflect the exchange of approximately 12.80 shares of MortgageITcommon stock for each share of Holdings common stock and the retention andretirement of common stock pursuant to the reorganization of MortgageIT.

 

The consolidated financialstatements included herein relate exclusively to MortgageIT and its whollyowned subsidiaries, IPI Skyscraper Mortgage Corporation and Home Closer LLC.IPI provides residential mortgage banking and brokerage services in the NewYork, New Jersey and Connecticut Tri-state area. Home Closer providessettlement and other mortgage related services to the Company and itscustomers. All material intercompany account balances and transactions havebeen eliminated in consolidation.

 

**Use ofEstimates**

 

The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and the accompanying notes.Management bases its estimates on certain assumptions, which they believe arereasonable under the circumstances, and does not believe that any change inthose assumptions would have a significant effect on the financial position orresults of operations of the Company. Actual results could differ materiallyfrom those estimates.

 

**MortgageLoans Held for Sale**

 

Mortgage loans held for sale are carried atthe lower of the adjusted cost or market value. Adjusted cost is the principalamount outstanding net of deferred direct origination costs and fees, andincludes any premiums or discounts. For mortgage loans held for sale that arehedged with forward sale commitments, the carrying value is adjusted for thechange in market value during the time the hedge was deemed to be highlyeffective. The market value is determined by outstanding commitments frominvestors or current investor yield requirements calculated on an aggregatebasis. Determining market value requires management judgment in determining howthe market would value a particular mortgage loan based on characteristics ofthe loan and available market information.

 

**Derivative Financial Investmentsand Hedging Activities**

 

MortgageIT utilizes derivatives in connectionwith its interest rate risk management activities. In accordance with Statementof Financial Accounting Standards, or “SFAS,” No. 133, “Accounting forDerivative Investments and Hedging Activities,” all derivative instruments arerecorded at fair value. The derivatives used in conjunction with interest raterisk management activities with respect to mortgage loans held for sale qualifyfor hedge accounting under SFAS No. 133. To qualify for hedge accountingunder SFAS No. 133, MortgageIT must demonstrate, on an ongoing basis, thatits interest rate risk management activity is highly effective. MortgageITdetermines the effectiveness of its interest rate risk management activitiesusing standard statistical measures. If MortgageIT is unable to qualify certainof its interest rate risk management activities for hedge accounting, then thechange in fair value of the associated derivative financial instruments wouldbe reflected in current period earnings, but the change in fair value of therelated asset or liability may not, thus creating a possible earnings mismatch.

 

7

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**Risk Management of the MortgageLoan Pipeline**

 

In connection with its mortgage loanorigination activities, MortgageIT issues interest rate lock commitments, or“IRLCs,” to loan applicants and financial intermediaries. The IRLCs guaranteethe loan terms, subject to credit approval, for a specified period while theapplication is in process, typically between 15 and 30 days. MortgageIT’srisk management objective is to protect earnings from an unexpected change in thefair value of IRLCs. MortgageIT’s strategy is to utilize forward deliverycontracts as economic hedging derivatives to protect the value of itsIRLCs.  Both the forward deliverycontracts, and the above-described IRLCs, are derivative instruments as definedby SFAS No. 133 and, therefore, are required to be recorded at fair valuewith changes in fair value reflected in current period earnings. MortgageITestimates the fair value of an IRLC based on an estimate of the ultimate gainon sale of the underlying mortgage loan net of the estimated cost to originatethe loan, and given the probability that the loan will fund within the terms ofthe IRLC. At the time of issuance, the estimated fair value of an IRLC isnegligible. After issuance, the value of an IRLC can change and be eitherpositive or negative, depending on the change in value of the underlyingmortgage loan. The probability that the underlying loan will fund is driven bya number of factors, in particular, the change, if any, in mortgage rates afterthe lock date. In general, the probability of funding increases if mortgagerates rise and decreases if mortgage rates fall. The probability that a loanwill fund within the terms of the IRLC also is influenced by the source of theapplicant, age of the applicant, purpose for the loan (purchase or refinance)and the application approval rate. MortgageIT utilizes funding ratio estimatesusing its historical empirical data that take into account these variables, aswell as renegotiations of rate and point commitments that tend to occur whenmortgage rates fall.

 

**Risk Management of Mortgage LoansHeld for Sale**

 

MortgageIT’s risk management procedures alsoseek to protect earnings from an unexpected change in the fair value ofmortgage loans held for sale. MortgageIT’s strategy is to utilize forwarddelivery contracts as fair value hedging derivatives to protect the value ofmortgage loans held for sale. At inception of the hedge, MortgageIT formallydocuments the relationship between these derivatives and the mortgage loansheld for sale, as well as its objective and strategy for undertaking the hedgetransactions. The amount of the derivatives associated with mortgage loans heldfor sale is designed to substantially eliminate interest rate and price risk toMortgageIT. MortgageIT classifies and accounts for these forward deliverycontracts as fair value hedges. The derivatives are carried at fair value withthe changes in fair value recorded into current period earnings. When thehedges are deemed to be highly effective, the carrying value of the hedgedmortgage loans held for sale is also adjusted for changes in fair value duringthe hedge period.

 

**Termination of HedgingRelationships**

 

MortgageIT employs a number of riskmanagement monitoring procedures that are designed to ensure that its hedgingarrangements are demonstrating, and are expected to continue to demonstrate, ahigh level of effectiveness. Hedge accounting is discontinued on a prospectivebasis if it is determined that the hedging relationship is no longer highlyeffective or expected to be highly effective in offsetting changes in fairvalue of the hedged item. Additionally, MortgageIT may elect, pursuant to SFASNo. 133, to re-designate a hedge relationship during an interim period andre-designate upon the rebalancing of a hedge relationship. If hedge accountingis discontinued, the affected loans are carried at the lower of cost or market,and the corresponding derivative instruments continue to be carried at fairvalue with changes in their value recorded to current period earnings.

 

**Revenue Recognition**

 

Gains on sale of loans represent the difference between the net salesproceeds and the carrying values of the mortgage loans sold, and are recognizedat the time of sale. Loan origination fees, as well as discount points andcertain direct origination costs, are initially recorded as an adjustment ofthe cost of the loans held for sale and are recognized in earnings when theloans held for sale are sold.

 

Brokerage fees represent revenues earned for the brokering of mortgageloans to third party lenders and are earned and recognized at the time the loanis closed by the third party lender. Revenues are comprised of application feesand origination points paid to the Company by borrowers, as well as compensationpaid to the Company by third party lenders.

 

Interest income is accrued as earned. Interest on mortgage loans heldfor sale accrues on loans from the date of funding through the date of sale.Interest on loans is computed based on the contractual loan rate.

 

Generally, the Company is not exposed to significant credit risk on itsloans sold to investors. In the normal course of business, the Company isobligated to repurchase loans from investors consistent with the terms of itsinvestor contracts. At the time of loan sale, the Company records a repurchaseprovision. The liability for potential losses applicable to loans sold isincluded in accrued expenses.

 

**Stock Compensation**

 

As of June 30, 2004, the Company had one stock-based employeecompensation plan in effect, the 2001 Stock Option Plan

 

8

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(“2001 Plan”), which is described more fully in Note 6.  The Company accounts for all transactionsunder which employees receive shares of stock or other equity instruments inthe Company based on the price of its stock in accordance with the provisionsof Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees.” Pursuant to these accounting standards, the Companyrecords deferred compensation for stock awards at the date of grant based onthe estimated values of the shares on that date. No stock-based employeecompensation cost is reflected in net income for stock option plans, as alloptions granted had an exercise price equal to the market value of theunderlying common stock on the date of grant. The following table illustratesthe effect on net income if the Company had applied the fair value recognitionprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation-Transitionand Disclosure”(in thousands, except per share data):

 
| ** **                                                                                                    | ** ** | **(unaudited)**                  | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
| ** **                                                                                                    | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                          |       |                             |       |   |   |   |   |   |   |
| Net income attributable to common  stockholders                                                               |       | $                                | 1,143      |   | $ | 4,026 |   | $ | 26 |   | $ | 6,747 |   |
| Amortization of restricted stock, including  forfeitures                                                      |       | —                           |       | — |   | — |   | (4 | ) |
| Stock-based employee compensation expense  determined under the fair value method, net of related tax effects |       | (114                             | )          | (84 | ) | (229 | ) | (167 | ) |
| Pro forma net income (loss)                                                                                   |       | $                                | 1,029      |   | $ | 3,942 |   | $ | (203 | ) | $ | 6,576 |   |
|                                                                                                          |       |                             |       |   |   |   |   |   |   |
| Net income (loss) per share attributable to  common stock:                                                    |       |                             |       |   |   |   |   |   |   |
| Basic-As reported                                                                                             |       | $                                | 2.21       |   | $ | 7.79 |   | $ | 0.05 |   | $ | 13.05 |   |
| Basic-Pro forma                                                                                               |       | $                                | 1.99       |   | $ | 7.62 |   | $ | (0.39 | ) | $ | 12.72 |   |
|                                                                                                          |       |                             |       |   |   |   |   |   |   |
| Net income (loss) per share for diluted  earnings per share:                                                  |       |                             |       |   |   |   |   |   |   |
| Diluted-As reported                                                                                           |       | $                                | 0.58       |   | $ | 1.22 |   | $ | 0.05 |   | $ | 2.17 |   |
| Diluted-Pro forma                                                                                             |       | $                                | 0.55       |   | $ | 1.21 |   | $ | (0.35 | ) | $ | 2.13 |   |

 

The fair value for each option granted was estimated at the date ofgrant using the minimum value, option-pricing model, one of the allowablevaluation methods under SFAS No. 123 “Accounting For Stock-BasedCompensation,” with the following weighted average assumptions: risk-freeinterest rate of 4.25% for the first six months of 2004 and for 2003, expectedoption lives of eight years, and no dividends.

 

Stock awards granted to employees under the 2001 Plan are subject tocertain sale and transfer restrictions. Unvested awards are also subject toforfeiture if employment terminates prior to the end of the prescribedrestriction period. The value of restricted stock awards is expensed over thevesting period, generally three years.

 

**Income Taxes**

 

Income taxes are determined using the liability method under SFASNo. 109, “Accounting for Income Taxes.” Under this method, deferred incometaxes reflect the net tax effect of temporary differences between the carryingamounts of assets and liabilities for financial reporting purposes and theamounts reported for federal and state income tax purposes.

 

**Fair Valueof Financial Instruments**

 

Assets, including cash and cash equivalents and receivables, arecarried at fair value. Mortgage loans held for sale are carried at amounts thatapproximate fair value. Similarly, liabilities, including warehouse linespayable and notes payable and other debt, are carried at fair value orcontractual amounts approximating fair value based on market rates.

 

**NewAccounting Standards**

 

In 2004, the Securities and Exchange Commission issued Staff AccountingBulletin No. 105 (“SAB 105”). SAB 105

 

9

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contains guidance for valuing loan commitments accounted for asderivatives under SFAS 133. Under SAB 105, any expected future cashflows related to the customer relationship or loan servicing must be excludedfrom the estimation of fair value. SAB 105 is effective for loancommitments accounted for as derivatives entered into subsequent toMarch 31, 2004. The adoption SAB No. 105 did not have any effecton the Company’s consolidated financial condition or results of operations.

 

**NOTE2-MORTGAGE LOANS HELD FOR SALE**

** **

Mortgage loans held for sale consist of the following components (inthousands):

 
| ** **                   | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
|                         |       |              |       |                  |       |
| Mortgage loans held for sale |       | $                 | 1,072,031  |                  | $          | 320,829 |   |
| Deferred origination costs   |       | 2,856             |       | 1,183                 |       |
| Mortgage loans held for sale |       | $                 | 1,074,887  |                  | $          | 322,012 |   |

** **

Mortgage loans represent residential mortgages on properties locatedthroughout the United States having maturities of up to 30 years. Pursuantto the terms of the mortgage loans, the borrowers have pledged the underlyingreal estate as collateral for the loans. It is the Company’s practice to sellthese loans to third party investors shortly after they are funded, generallywithin 30 days.

 

As of June 30, 2004 and December 31, 2003, the Company had loanpurchase commitments from third party investors for approximately$135.1 million and $91.7 million, respectively. Substantially allloans held for sale at June 30, 2004 and December 31, 2003 weresubsequently sold to third party investors. All mortgage loans held for saleare pledged as collateral for warehouse lines payable (See Note 4.)

 

**NOTE3-HEDGING OF MORTGAGE LOANS HELD FOR SALE AND COMMITTED PIPELINE**

** **

The Company is exposed to certain risks in conjunction with theorigination, funding and sale of mortgage loans including changes in bothinterest rates and estimated loan funding volume. The Company manages the riskof interest rate changes primarily through use of derivative financialinstruments designed to hedge potential changes in the value of both loans heldfor sale and the IRLC pipeline. Forward delivery contracts represent theprimary derivative instrument used for this purpose.

 

The Company is also exposed to the risk that actual new loan closings(also called “pull-through rate”) may deviate from the estimated pull-throughrate. Loan pull-through rates are variable and can be impacted by severalfactors including changes in interest rates, the composition of the committedpipeline and remaining commitment periods.

 

The Company’s risk management policy is to hedge 100% of loans held forsale, and 100% of the estimated pull-through volume from the IRLC pipeline.

 

At June 30, 2004 and December 31, 2003, the notional amount of theCompany’s committed pipeline (*i.e.,*IRLCs) wasapproximately $577.9 million and $294.3 million, respectively. Thefair value of the IRLCs at June 30, 2004 and December 31, 2003 wasapproximately a $3.7 million gain and a $1.2 million loss, respectively.

 

The fair value adjustment of the mortgage loans held for sale at June30, 2004 and December 31, 2003 was a gain of approximately $2.5 millionand $406,000, respectively.

 

At June 30, 2004 the combined amount of forward sale and Eurodollarcontracts outstanding was approximately $3.1 billion with a fair valueloss of approximately $4.3 million.   AtDecember 31, 2003, the notional amount of forward sale contractsoutstanding was approximately $504.9 million with a fair value loss ofapproximately $2.0 million.

 

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The fair value of the IRLCs, fair value adjustment of mortgage loansheld for sale, fair value of forward delivery contracts and fair value of loanpurchase commitments from investors are included in mortgage loans held forsale in the accompanying balance sheets. The related fair value adjustments areincluded in gain on sale of mortgage loans in the accompanying statements ofoperations.

 

The amount of hedge ineffectiveness for all periods presented was notsignificant and was recorded on the statements of operations in the respectiveperiods.

 

**NOTE4-WAREHOUSE LINES PAYABLE**

** **

The Company has various warehouse credit facilities with major lendersthat are used to fund mortgage loans.  Asof June 30, 2004, the first facility, with UBS Real Estate Securities, Inc.(“UBS”), had an uncommitted credit limit of $850 million, which includes awet/dry line and a mortgage loan sale conduit facility. This credit facilityhas no specific expiration date and may be terminated at the discretion of thelender. The facility provides for temporary increases in the line amount on anas-requested basis. Under the wet/dry line, outstanding advances arecollateralized by the specific mortgage loans funded, and bear interest at theLondon Interbank Offered Rate (“LIBOR”) plus a spread based on the types ofloans being funded. Interest is payable at the time the outstanding principalamount of the advance is due, generally within 30 days. All advances under thisagreement are evidenced by a note, which is collateralized by all of the loansfunded through this facility. As of June 30, 2004 and December 31, 2003,the Company had outstanding on the wet/dry line $629.6 million and $164.2million, respectively. Under the conduit facility, the Company sells mortgageloans to UBS at a price equal to the committed purchase price from a thirdparty investor, and records the transaction as a sale in accordance with SFASNo. 140. UBS, in turn, sells the loan to a third party investor. TheCompany facilitates the sale to the third party investor on behalf of UBS andreceives a performance fee that varies depending on the time required by UBS tocomplete the transfer of the loans to the third party investor. The Companyaccounts for the performance fee as brokerage revenues in the amounts of $4.0million, $5.6 million $2.7 million and $5.4 million for the three and sixmonths ended June 30, 2004 and 2003, respectively. Loans on the conduit line,which totaled approximately $264.3 million and $190.1 million at June 30, 2004and December 31, 2003, reduce availability under the facility until theyare transferred to the third party investor by UBS. The mortgage loans sold toUBS are subject to repurchase under certain limited conditions, primarily ifUBS determines that a mortgage loan was not properly underwritten.  This credit facility expires in August 2005.

 

The second facility, with Residential Funding Corporation (“RFC”), hasa committed credit limit of $100 million collateralized by the specificmortgage loans funded, and bears interest at LIBOR plus a spread based on thetypes of loans being funded. As of June 30, 2004 and December 31, 2003,the Company had outstanding approximately $100.1 million and $56.9 million,respectively, on this facility. This credit facility expires in January 2005.

 

The third facility, with Merrill Lynch Commercial Finance Corp.(“Merrill Lynch”), has a partially committed credit limit of $500 millioncollateralized by the specific mortgage loans funded, and bears interest atLIBOR plus a spread based on the types of loans being funded. As of June 30,2004 and December 31, 2003, the Company had $301.5 million and $79.6million outstanding on this facility. This credit facility expires in August 2005.

 

The weighted average effective rate of interest for the periods onborrowings under all warehouse lines of credit was approximately 2.7% at June30, 2004 and 3.0% at December 31, 2003.

 

All mortgage loans held for sale have been pledged as collateral underthe above warehouse credit facilities. In addition, two of the facilitiescontain various financial covenants and restrictions, including a requirementthat the Company maintain specified leverage ratios and net worth amounts, andone facility limits the payment of dividends to 50% of the Company’s net incomefor any one year. The Company was not in compliance with certain leverage ratiorestrictions as of June 30, 2004. However, waivers were obtained from the lenders for the period of non-compliance.  As of August 31, 2004, the Company was incompliance with these leverage ratio restrictions.

 

11

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**NOTE5-NOTES PAYABLE AND OTHER DEBT (in thousands):**

 
| ** **                     | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
|                           |       |              |       |                  |       |
| Unsecured Promissory Notes (a) |       | $                 | —     |                  | $          | 1,125 |   |
| Senior Secured Notes (b)       |       | 15,000            |       | —                |       |
|                           |       | $                 | 15,000     |                  | $          | 1,125 |   |

 

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(a)                                  Promissory noteissued in connection with the IPI acquisition, which was paid inJanuary 2004.

 

(b)                                 Senior Secured Notesdue 2007 with an aggregate principal amount of $15 million were issued inMarch 2004. The Notes bear interest at a rate of 10.0% per annum, payable inquarterly installments beginning June 30, 2004. The notes are secured by afirst priority security interest in all of the Company’s assets with theexception of the Company’s mortgage loans held for sale. The Notes containvarious restrictions and covenants. The Company was not in compliance withcertain leverage ratio restrictions at June 30, 2004.  However, the Company obtained waivers fromthe lenders for the period of non-compliance. As of August 31, 2004, the Company was in compliance with these leverageratio restrictions.

 

**NOTE6-CONVERTIBLE REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY**

** **

As of June 30, 2004, the Company was authorized to issue 22,000,000shares of convertible preferred stock, par value $.01 per share, of which6,250,000 have been designated and issued as Series A ConvertiblePreferred Stock, 7,000,000 have been designated and 4,401,170 issued asSeries B Convertible Preferred Stock, and 6,500,000 have been designatedand 4,431,803 issued as Series C Convertible Preferred Stock. TheCompany’s Board of Directors is authorized to fix the rights and preferences ofthe 2,250,000 shares of undesignated preferred stock as necessary withoutfurther stockholder approval.

 

The Series A Convertible Redeemable Preferred Stock is held byprivate investors and is convertible at the option of the holder into shares ofClass A Common Stock at a conversion rate of $1.00 per share, subject toadjustment. The holders of the Series A Convertible Preferred Stock havevoting rights equal to the number of shares of Class A Common Stock intowhich the Series A shares can be converted. Annual dividends on each shareare cumulative and payable quarterly at the discretion of the Company’s Boardof Directors at the rate of 8% per annum on the liquidation value of $1.00 pershare.  No dividend shall be declared orpaid with respect to the Series A Convertible Preferred Stock until allaccrued and unpaid dividends on the Series B and Series C PreferredStock for all prior dividend periods have been paid in full. No dividends weredeclared during 2003 or 2002. Cumulative undeclared and unpaid dividends on theSeries A Convertible Preferred Stock totaled approximately $3,116,000 and$2,753,000 at June 30, 2004 and December 31, 2003, respectively, and areincluded in Series A Convertible Redeemable Preferred Stock on the balancesheets. The Series A Convertible Preferred Stock may be redeemed at thediscretion of the Series A Preferred stockholders at any time afterApril 30, 2005 upon written request of at least a majority of the thenoutstanding Series A Convertible Preferred stockholders, subject to theprior approval of the Series B and Series C Convertible Preferredstockholders.

 

The Series B Convertible Redeemable Preferred Stock is held byprivate investors and is convertible at the option of the holder into shares ofClass A Common Stock at a conversion rate of $5.6821 per share. This pricereflects adjustments for the dilutive effect of the issuance of Series CConvertible Preferred stock during 2001. The holders of the Series BConvertible Preferred Stock have voting rights equal to the number of shares ofClass A Common Stock into which the Series B shares can be converted.Annual dividends on each share are cumulative and payable quarterly at thediscretion of the Company’s Board of Directors at the greater of 10% of theliquidation value of $6.4151 per share, compounded quarterly, or the amount ofdividends paid on each share of Common Stock. Cumulative undeclared and unpaiddividends on the Series B Convertible Preferred Stock totaledapproximately $14,204,000 and $12,165,000 at June 30, 2004 and December 31,2003, respectively, and are included in Series B Convertible RedeemablePreferred Stock on the balance sheets. The Series B Convertible PreferredStock may be redeemed at the discretion of the Series B PreferredStockholders at any time after April 30, 2005 upon written request of atleast 66 2/3%of the then outstanding Series B Convertible Preferred

 

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stockholders, subject to the prior approval of the Series CConvertible Preferred stockholders.

 

The Series C Convertible Preferred Stock is held by privateinvestors and is convertible at the option of the holder into shares ofClass A Common Stock at a conversion rate of $2.4246 per share. Theholders of the Series C Convertible Preferred Stock have voting rightsequal to the number of shares of Class A Common Stock into which theSeries C shares can be converted. Annual dividends on each share arecumulative and payable quarterly at the discretion of the Company’s Board ofDirectors at the greater of 10% of the original issue price of theSeries C Convertible Preferred stock of $2.4246 per share, compoundedquarterly, or the amount of dividends paid on each share of Common Stock.Cumulative undeclared and unpaid dividends on the Series C Convertible PreferredStock totaled approximately $3,800,000 and $3,101,000 at June 30, 2004 andDecember 31, 2003, respectively, and are included in Series CConvertible Redeemable Preferred Stock on the balance sheets. The Series CConvertible Preferred Stock may be redeemed at the discretion of theSeries C Preferred Stockholders at any time after April 30, 2005 uponwritten request of the holders of at least 50% of the then outstandingSeries C Preferred shares.

 

All three series of Convertible Preferred Stock have preemptive rightsentitling the holders to subscribe to certain future issuances of Companysecurities on a pro rata basis, as defined.

 

Costs incurred in connectionwith the issuance of the Series B and Series C convertible redeemablepreferred stock amounting to approximately $2,312,000 and $106,000,respectively, are being amortized using the effective interest method over theperiod to the earliest redemption date (April 30, 2005) as an increase tothe carrying amount of these series of preferred stock. The unamortized balanceof these costs at June 30, 2004 for the Series B and Series Cconvertible redeemable preferred stock is approximately $413,000 and $23,000,respectively.

 

In August 2004, as a result ofthe reorganization of MortgageIT and Holdings’ initial public offering, alloutstanding shares of Convertible Preferred Stock were exchanged for eithershares of Holdings common stock or cash. (See Note 9.)

 

**RestrictedStock Plan**

 

The Company has reserved116,000 shares of Class B Common Stock to issue to certain employees pursuantto the Company’s 1999 Equity Incentive Stock Compensation Plan (“1999 Plan”).As of June 30, 2004 and December 31, 2003 the Company has issued and outstanding under the plan 59,000 ofrestricted shares of Class B Common Stock (the “restricted stock”), net offorfeitures. Restricted stock awards to employees vest in equal installments,generally over a period of three years, and are subject to forfeiture undercertain circumstances. In 2003, the Company terminated the 1999 Plan and willmake no further awards under it. All outstanding share grants are fully vestedat June 30, 2004.

 

In August 2004, as a result ofthe reorganization of MortgageIT and Holdings’ initial public offering, alloutstanding shares of Class B Common Stock were exchanged for shares ofHoldings common stock.  In addition, inAugust 2004, the Company adopted the MortgageITHoldings, Inc. 2004 Long-Term Incentive Plan.  (See Note 9.)

 

**StockOptions**

 

In 2001, the Companyestablished the 2001 Stock Option Plan (“2001 Plan”). The 2001 Plan providesfor the granting of stock options to employees, directors and consultants ofthe Company to purchase up to 776,000 shares of Class B Common Stock. Theexercise price of the options shall not be less than the fair market value onthe date of grant with a maximum term of ten years, or in the case of 10%stockholders, at 110% of the fair market value on the date of grant with amaximum term of five years. The Company awarded option grants for 241,000shares for the six months ended June 30, 2004 and 256,000 shares for the yearended December 31, 2003, respectively, all of which have a ten-year life andvest at the rate of one-third each year on the first three anniversaries of therespective grant date. The 2001 Plan will terminate in 2012.

 

At June 30, 2004 andDecember 31, 2003, the Company had 636,000 and 404,000 of optionsoutstanding, respectively. Shares available for future grant under the plan atJune 30, 2004 and December 31, 2003 were 140,000 and 372,000, respectively.

 

In August 2004, options to purchase 45,000 shares of common stock wereexercised at an exercise price of $4.96 per share. Proceeds to the Companyapproximated $225,000. As a result of the reorganization of MortgageIT andHoldings'

 

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initial public offering, options to purchase 56,000 shares of commonstock were exchanged for approximately $390,000 and options to purchase 535,000shares were cancelled. In addition, in August 2004, theCompany adopted the MortgageIT Holdings, Inc. 2004 Long-Term IncentivePlan.  (See Note 9.)

 

**Warrants**

 

In connection with a bridge loan financing in 2000, the Company issuedto private investors warrants to purchase 233,823 shares of Series BConvertible Preferred Stock having an aggregate purchase price of $1,500,000,or $6.4151 per share. At December 31, 2003, warrants to purchase 155,882shares were outstanding. These warrants were cancelled in April 2004.

 

**NOTE7-EARNINGS PER SHARE**

** **

Basic and diluted income per share are calculated in accordance withSFAS No. 128, “Earnings Per Share.” The basic and diluted income percommon share for all periods presented were computed based on theweighted-average number of common shares outstanding, as follows (in thousands,except per share data):

 
| ** **                                                                   | ** ** | **(unaudited)**                  | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
| ** **                                                                   | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                         |       |                             |       |   |   |   |   |   |   |
| Net income (loss)                                                            |       | $                                | 2,842      |   | $ | 5,578 |   | $ | 3,386 |   | $ | 9,802 |   |
| Dividends on convertible redeemable  preferred stock:                        |       |                             |       |   |   |   |   |   |   |
| Series A                                                                     |       | 183                              |       | 169 |   | 363 |   | 333 |   |
| Series B                                                                     |       | 1,032                            |       | 935 |   | 2,039 |   | 1,837 |   |
| Series C                                                                     |       | 354                              |       | 320 |   | 699 |   | 630 |   |
| Accretion of discount on preferred stock                                     |       | 130                              |       | 128 |   | 259 |   | 255 |   |
| Total dividends on preferred stock                                           |       | 1,699                            |       | 1,552 |   | 3,360 |   | 3,055 |   |
| Net income attributable to common  stockholders                              |       | $                                | 1,143      |   | $ | 4,026 |   | $ | 26 |   | $ | 6,747 |   |
|                                                                         |       |                             |       |   |   |   |   |   |   |
| Basic earnings per share:                                                    |       |                             |       |   |   |   |   |   |   |
| Net income attributable to common  stockholders                              |       | $                                | 1,143      |   | $ | 4,026 |   | $ | 26 |   | $ | 6,747 |   |
| Weighted average common stock outstanding  for basic earnings per share(1)   |       | 518                              |       | 517 |   | 518 |   | 517 |   |
| Basic earnings per share                                                     |       | $                                | 2.21       |   | $ | 7.79 |   | $ | 0.05 |   | $ | 13.05 |   |
|                                                                         |       |                             |       |   |   |   |   |   |   |
| Diluted earnings per share:                                                  |       |                             |       |   |   |   |   |   |   |
| Net income attributable to common  stockholders                              |       | $                                | 1,143      |   | $ | 4,026 |   | $ | 26 |   | $ | 6,747 |   |
|                                                                         |       |                             |       |   |   |   |   |   |   |
| Add preferred stock dividends                                                |       | 1,699                            |       | 1,552 |   | — |   | 3,055 |   |
| Net income for diluted earnings per share                                    |       | $                                | 2,842      |   | $ | 5,578 |   | $ | 26 |   | $ | 9,802 |   |
| Common stock outstanding for basic earnings  per share computation           |       | 518                              |       | 517 |   | 518 |   | 517 |   |
| Assumed conversion of dilutive:                                              |       |                             |       |   |   |   |   |   |   |
| Convertible preferred stock                                                  |       | 4,340                            |       | 3,983 |   | — |   | 3,942 |   |
|                                                                         |       |                             |       |   |   |   |   |   |   |
| Stock options                                                                |       | 59                               |       | 59 |   | 59 |   | 59 |   |
| Weighted average common stock outstanding  for diluted earnings per share(1) |       | 4,917                            |       | 4,559 |   | 577 |   | 4,518 |   |
| Diluted earnings per share                                                   |       | $                                | 0.58       |   | $ | 1.22 |   | $ | 0.05 |   | $ | 2.17 |   |

 

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*(1) Reflects, on a retroactive basis, for allperiods presented, the exchange of approximately 12.80 shares of MortgageITcommon stock for each share of Holdings common stock and the retention andretirement of common shares pursuant to the reorganization of MortgageIT.*

 

14

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Options and warrants aggregating approximately 535,000, 661,000,420,000 and 420,000 were excluded from the computation for the three and sixmonths ended June 30, 2004 and 2003, respectively, as their effect would havebeen anti-dilutive. Potentially dilutive shares amounting to approximately 4.3million relating to the conversion of Series A, Series B and Series CPreferred Stock were excluded from the computation for the six months endedJune 30, 2004, as their effect would have been anti-dilutive.

 

**NOTE8-STATEMENT OF CASH FLOWS**

** **

**Supplemental disclosure of cash flow information (in thousands):**

 
| ** **                     | ** ** | **(unaudited)**               | ** ** |
|--------------------------------|------------|-------------------------------|------------|
| ** **                     | ** ** | **Six months ended June 30,** | ** ** |
| ** **                     | ** ** | **2004**                      | ** ** | **2003** | ** ** |
|                           |       |                          |       |   |   |
| Cash paid during the year for: |       |                          |       |   |   |
| Interest                       |       | $                             | 3,141      |   | $ | 7,280 |   |
| Income taxes                   |       | 3,996                         |       | 350 |   |
|                                |            |                               |            |  |  |  |  |

 

**NOTE9-SUBSEQUENT EVENT**

** **

On August 4, 2004, we consummated the reorganization ofMortgageIT.  In the reorganization,MortgageIT became a wholly owned subsidiary of its holding company parent,Holdings, which is organized and conducts its operations to qualify as a realestate investment trust (“REIT”) for U.S. federal income tax purposes.  Concurrently with the reorganization,Holdings made an initial public offering of its common stock, whereby it issued14.6 million shares at a price to the public of $12.00 per share. Net proceedsof the offering, after deducting the underwriting discount and estimated offeringexpenses, approximated $163.8 million. Concurrently with the closing of theinitial public offering, on August 4, 2004, holders of 6,764,338 shares ofcommon stock and 14,859,659 shares of preferred stock of MortgageIT exchangedtheir shares for 4,804,473 shares of common stock of Holdings. In additionholders of 160,241 shares of common stock and 223,314 shares of preferred stockof MortgageIT, who either did not submit a vote in connection with thereorganization or who did not certify that they were accredited investorspursuant to applicable securities laws, exchanged their shares for cashpayments totaling $2,179,843.

 

In addition, in August 2004,Holdings adopted the MortgageIT Holdings, Inc. 2004 Long-Term Incentive Plan(the “2004 Plan”).  A total of 1,725,000shares of common stock have been reserved for issuance under the 2004 Plan,which terminates in 2014. The 2004 Plan provides for the grant of incentivestock options, non-qualified stock options, stock appreciation rights andrestricted stock. In connection with the initial public offering, Holdingsgranted options to purchase 1,050,875 shares of common stock at an exerciseprice of $12.00 per share and an aggregate of 216,578 shares of restrictedstock. The options and restricted stock will vest over a three year period.

 

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**ITEM2.   MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*** ***

*The following should be read in conjunction with our consolidated financialstatements and notes thereto contained in Part I., Item 1. of this report onForm 10-Q.*

 

**GENERAL**

 

We are a residential mortgage lender that was formed in March 2004to continue and expand the business of MortgageIT.  MortgageIT is a full-service residentialmortgage banking company that is licensed to originate loans throughout theUnited States. MortgageIT originates single-family mortgage loans of all types,with a particular focus on prime ARM and fixed-rate, first lien residentialmortgage loans.  MortgageIT focuses onborrowers with strong credit profiles as evidenced by the weighted averagemiddle FICO credit score (which consists generally of obtaining three differentcredit scores and using the middle of the three) of its borrowers, which was 718(out of a high score of 850) in 2003. Historically, MortgageIT has sold all of the loans it originates throughboth its retail and wholesale operations to third party mortgage lenders.Moreover,  MortgageIT did not service anyloans, except for loans which were held in MortgageIT’s portfolio pending sale,which MortgageIT serviced in-house for a limited period of time. On August 4,2004, we closed our initial public offering and sold 14.6 million shares of ourcommon stock at a price to the public of $12.00 per share, for net proceeds ofapproximately $163.8 million after deducting the underwriters’ discount andother offering-related expenses.

 

Since the completion of our initial public offering, the primary focusof our business is to build a leveraged portfolio of single-family residentialmortgage loans comprised largely of prime ARM loans and hybrid ARM loans, whichare loans that have an initial fixed-rate period followed by an adjustable-rateperiod. Our portfolio of mortgage loans will primarily consist of loanspurchased from and originated by the retail and wholesale operations of oursubsidiaries. As of September 10, 2004, we have transferred to our investmentportfolio approximately $500 million of single-family residential prime ARMloans and hybrid ARM loans originated by MortgageIT.

 

The loans that we retain in our portfolio will be serviced through asubservicing arrangement. Generally, we expect to continue to sell the fixedrate loans originated through MortgageIT to third parties as well as any ARM orhybrid ARM loans MortgageIT originates that do not meet our investment criteriaor portfolio requirements. We may also include in our mortgage loan portfolioloans acquired in bulk pools from other originators and securities dealers.

 

MortgageIT’s operations essentially consist of:

 

•                  retailoperations, including both brokered loans and funded loans held for sale, thatare originated by MortgageIT through its wholly owned subsidiary, IPISkyscraper Mortgage Corporation, and through MortgageIT’s Internet Division;

 

•                  wholesaleoperations, whereby loans are originated through other retail loan brokers andcorrespondents and funded by MortgageIT through its MIT Lending Division;

 

•                  subprimeoperations, including both retail loans originated through MortgageIT’sPrimetime Division, and wholesale loans originated through MortgageIT’s NewBeginnings Division; and

 

•                  mortgage loansettlement services and ancillary products through MortgageIT’s subsidiaries,Home Closer LLC and Unified Settlement Services.

 

MortgageIT commenced retail and wholesale operations in subprime loansin mid-to-late 2003.

 

MortgageIT originates both mortgage loans to finance home purchases,referred to as purchase mortgage loans, and loans to refinance existingmortgage loans. For the three and six months ended June 30, 2004, MortgageIT’spurchase loan originations represented approximately 44.6% and 42.1%,respectively, of MortgageIT’s total residential mortgage loan originationsmeasured by principal balance, compared to an industry average of approximately34.0%, according to the February 17, 2004 report of the Mortgage BankersAssociation of America. MortgageIT’s average volume of purchase mortgage loansrelative to total originations was 28.3% for the year ended December 31, 2003.

 

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We are organized and conduct our operations to qualify, and will electto be taxed, as a REIT for federal income tax purposes, commencing with ourshort taxable year beginning on July 30, 2004 and ending December 31,2004. MortgageIT and its subsidiaries will, together with us, elect forMortgageIT and its subsidiaries to be treated as taxable REITsubsidiaries.  We are currently exploringforming a new subsidiary, which would originate ARM and hybrid ARM loans forretention in our portfolio and would be treated as a “qualified REITsubsidiary” for federal income tax purposes. A “qualified REIT subsidiary” isnot subject to the same types of limitations nor is it a fully taxablecorporation as MortgageIT is as a “taxable REIT subsidiary.” Consequently, theutilization of a “qualified REIT subsidiary” in order to originate ARM andhybrid ARM loans for retention in our portfolio would result in certain taxsavings for us on a consolidated basis.

 

**Information Regarding MortgageIT’s Historical, and Changes to Our,Accounting Policies and Financial Statements**

 

MortgageIT has historically generated revenues through the originationand subsequent sale of mortgage loans and the brokering of mortgage loans sourcedthrough both its retail and wholesale loan operations. These revenues areprimarily made up of loan brokerage revenues, gain on sale of mortgage loansand net interest income. Brokerage revenues consist of fees and commissionsearned by brokering mortgage loans to third party lenders. Gain on sale ofmortgage loans consists of the gain on the sale of mortgage loans, which aresold to investors generally within 30 to 45 days of funding. This gain isrecognized based on the difference between the net sales proceeds and thecarrying value of the mortgage loans sold and is recognized at the time ofsale. The carrying value of the mortgage loans sold includes certainloan-related fees collected from the borrowers, and certain direct originationcosts. Interest on mortgage loans held for sale accrues on loans from the dateof funding through the date of sale.

 

MortgageIT’s operating expenses to date have consisted primarily of:

 

•                  compensation andemployee benefits;

 

•                  mortgage loanprocessing expenses;

 

•                  general andadministrative expenses;

 

•                  marketing, loanacquisitions and business development;

 

•                  rent expense;

 

•                  professionalfees; and

 

•                  depreciation andamortization expense.

 

A substantial portion of MortgageIT’s expenses are variable in nature.Loan origination commissions are paid only upon the origination of the mortgageloan, making them 100% variable. Administrative and corporate salaries,benefits and other related payroll costs may fluctuate based upon management’sassessment of current and predicted future levels of mortgage loan originationvolume.

 

As a result of the reorganization of MortgageIT and our initial publicoffering, combined with our REIT election, there will be significant changes tocertain of our accounting policies and to our consolidated financial statementsas compared to MortgageIT’s historical accounting policies and consolidatedfinancial statements, which changes are discussed below under the captions “—Critical Accounting Estimates” and “—Forward Looking Financial StatementEffects.”  Because of these changes,MortgageIT’s historic financial results, as discussed in this section, are notnecessarily indicative of our future performance, as the financial results ofMortgageIT will represent only part of our future financial performance. Theprimary change to our consolidated financial statements will be the inclusionof loans held for investment and, to a lesser extent, mortgage-backed and othersecurities held for investment. MortgageIT has historically generated revenues consistingof gain on sale of mortgage loans, loan brokerage revenues and, to a lesserextent, interest income (consisting of interest earned during the shortduration (30 to 60 days) that the loans are held for sale).  In future periods, a substantial portion ofour consolidated revenues will consist of interest income, since our businesswill consist primarily of holding loans in our portfolio. MortgageIT willcontinue to generate gains on sale of mortgage loans and loan brokeragerevenues. Because in future periods we will hold loans for investment in ourinvestment loan portfolio, such revenues will comprise

 

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a smaller percentage of our total revenues.  In future periods, we expect that ourinterest expense will increase as a result of the funding utilized to acquiremortgage assets that we will retain in our portfolio.

 

Because in future periods we will hold loans for investment in ourinvestment loan portfolio, we expect that we will incur incremental operatingexpenses related to these activities. These expenses will primarily consist ofcompensation expense relating to portfolio management and outsourced servicingexpense.

 

At June 30, 2004, MortgageIT had approximately $1.125 billion of totalassets.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

*** ***

Management’s discussion and analysis of MortgageIT’s financialcondition and results of operations is based on the amounts reported inMortgageIT’s historical consolidated financial statements included in Part I.,Item 1, of this report on Form 10-Q. These consolidated financial statementshave been prepared in conformity with accounting principles generally acceptedin the United States of America, or GAAP, many of which require the use ofestimates, judgments and assumptions that affect reported amounts. Changes inthe estimates and assumptions could have a material effect on theseconsolidated financial statements. In accordance with recent Securities andExchange Commission guidance, those material accounting policies that webelieve are the most critical to an investor’s understanding of MortgageIT’sfinancial results and condition and require complex management judgment havebeen described below. We will continue to apply these accounting policiesexcept where otherwise noted in this section or below under the caption“—Forward-Looking Financial Statements Effects.”

 

**Derivative Financial Investments and Hedging Activities**

 

MortgageIT utilizes derivatives in connection with its interest raterisk management activities. In accordance with SFAS No. 133, “Accountingfor Derivative Investments and Hedging Activities,” all derivative instrumentsare recorded at fair value. The derivatives used in conjunction with interestrate risk management for mortgage loans held for sale qualify for hedgeaccounting under SFAS No. 133. To qualify for hedge accounting under SFASNo. 133, MortgageIT must demonstrate, on an ongoing basis, that itsinterest rate risk management activity is highly effective. MortgageIT determinesthe effectiveness of its interest rate risk management activities usingstandard statistical measures. If MortgageIT is unable to qualify certain ofits interest rate risk management activities for hedge accounting, then thechange in fair value of the associated derivative financial instruments wouldbe reflected in current period earnings, but the change in fair value of therelated asset or liability may not, thus creating a possible earnings mismatch.

 

**Risk Management of the Mortgage Loan Pipeline**

 

In connection with its mortgageloan origination activities, MortgageIT issues interest rate lock commitments,or “IRLCs,” to loan applicants and financial intermediaries. The IRLCsguarantee the loan terms, subject to credit approval, for a specified periodwhile the application is in process, typically between 15 and 30 days.MortgageIT’s risk management objective is to protect earnings from anunexpected change in the fair value of IRLCs. MortgageIT’s strategy is toutilize forward delivery contracts as economic hedging derivatives to protectthe value of its IRLCs.  Both the forwarddelivery contracts, and the above-described IRLCs, are derivative instrumentsas defined by SFAS No. 133 and, therefore, are required to be recorded atfair value with changes in fair value reflected in current period earnings.MortgageIT estimates the fair value of an IRLC based on an estimate of theultimate gain on sale of the underlying mortgage loan net of the estimated costto originate the loan, and given the probability that the loan will fund withinthe terms of the IRLC. At the time of issuance, the estimated fair value of anIRLC is negligible. After issuance, the value of an IRLC can change and beeither positive or negative, depending on the change in value of the underlyingmortgage loan. The probability that the underlying loan will fund is driven bya number of factors, in particular, the change, if any, in mortgage rates afterthe lock date. In general, the probability of funding increases if mortgagerates rise and decreases if mortgage rates fall. The probability that a loanwill fund within the terms of the IRLC also is influenced by the source of theapplicant, age of the applicant, purpose for the loans (purchase or refinance)and the application approval rate. MortgageIT utilizes funding ratio estimatesusing its historical empirical data that take into account these variables, aswell as renegotiations of rate and point commitments that tend to occur whenmortgage rates fall.

 

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**RiskManagement of Mortgage Loans Held for Sale**

 

MortgageIT’s risk management objective is to protect earnings from anunexpected change in the fair value of mortgage loans held for sale.MortgageIT’s strategy is to utilize forward delivery contracts as fair valuehedging derivatives to protect the value of mortgage loans held for sale. Atinception of the hedge, MortgageIT formally documents the relationship betweenthese derivatives and the mortgage loans held for sale, as well as its objectiveand strategy for undertaking the hedge transactions. The notional amount of thederivatives associated with mortgage loans held for sale are equivalent to theunpaid principal amount of the mortgage loans being hedged; hence, thesederivatives effectively fix the forward sales price and thereby substantiallyeliminate interest rate and price risk to MortgageIT. MortgageIT classifies andaccounts for these forward delivery contracts as fair value hedges. Thederivatives are carried at fair value with the changes in fair value recordedinto current period earnings. When the hedges are deemed to be highlyeffective, the carrying value of the hedged mortgage loans held for sale isalso adjusted for changes in fair value during the hedge period.

 

**Terminationof Hedging Relationships**

 

MortgageIT employs a number ofrisk management monitoring procedures that are designed to ensure that itshedging arrangements are demonstrating, and are expected to continue todemonstrate, a high level of effectiveness. Hedge accounting is discontinued ona prospective basis if it is determined that the hedging relationship is nolonger highly effective or expected to be highly effective in offsettingchanges in fair value of the hedged item. Additionally, MortgageIT may elect, pursuantto SFAS No. 133, to re-designate a hedge relationship during an interimperiod and re-designate upon the rebalancing of a hedge relationship. If hedgeaccounting is discontinued, the affected loans are carried at the lower of costor market., and the corresponding derivative instruments continue to be carriedat fair value with changes in their value recorded to current period earnings.

 

**Goodwill**

 

Goodwill represents the excess purchase price over the fair value ofnet assets attributable to business acquisitions. In accordance with theprovisions of SFAS No. 142, “*Goodwill and OtherIntangible Assets*,” effective January 1, 2002, MortgageIT nolonger amortizes goodwill, but instead tests for impairment at least annually.MortgageIT will test for impairment more frequently if events or circumstancesindicate that an asset may be impaired. In accordance with SFAS No. 142,MortgageIT tests for impairment by comparing the fair value of goodwill, asdetermined by using a discounted cash flow method, with its carrying value. Anyexcess of carrying value over the fair value of the goodwill would berecognized as an impairment loss in continuing operations. The discounted cashflow calculation includes a forecast of the expected future loan originationsand the related revenues and expense associated with business acquisitions.These cash flows are discounted using an appropriate interest rate that isconsistent with management’s required return on invested capital. At June 30,2004, there was no impairment of goodwill.

 

**FORWARD-LOOKINGFINANCIAL STATEMENTS EFFECTS**

 

As a result of the changes in the way we conduct our business since thecompletion of our initial public offering on August 4, 2004, we believe it isimportant to describe the differences that an investor would expect to see inour future consolidated financial statements.

 

We expect to retain in our portfolio substantially all of the ARM loansand hybrid ARM loans that MortgageIT originates and that meet our investmentcriteria and portfolio requirements. Consistent with the Internal RevenueCode’s REIT requirements, we will purchase loans from MortgageIT at marketvalue. MortgageIT will determine market value by using the median of threecompetitive price indications from independent parties in determining theconsideration to be paid by us to MortgageIT. MortgageIT has not historicallyserviced loans except for a limited period of time between the time a loan isoriginated and eventually sold. We are beginning to service loans thatMortgageIT originates for us through a subservicer. Servicing primarilyconsists of collecting monthly payments from mortgage borrowers, and disbursingthose funds to the appropriate loan investors.

 

We may also include in our portfolio loans acquired in bulk pools fromother originators and securities dealers. Mortgage loans held for investmentwill be recorded net of deferred loan origination fees and associated directcosts. Mortgage loan origination fees and associated direct mortgage loanorigination costs on mortgage loans held-in-portfolio will be deferred

 

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and amortized over the estimated life of the loans as an adjustment toyield using the level yield method. The estimated life of the loans willreflect our estimated rate of future mortgage loan prepayments.

 

Interest will be recognized as revenue when earned according to theterms of the mortgage loans and when, in the opinion of our management, it iscollectible. The accrual of interest on loans will be discontinued when, inmanagement’s opinion, the interest is not collectible in the normal course ofbusiness, but in no case will interest be accrued beyond when payment on a loanbecomes 90 days delinquent.

 

MortgageIT’s historical operations had an insignificant amount of loanlosses due to default or non-performance on the loans primarily becausemortgage loans were sold soon after being originated. When we hold loans forinvestment, we will record an allowance for loan losses reflecting our estimateof future loan default losses. Our portfolio of mortgage loans held forinvestment will be collectively evaluated for impairment as the loans will behomogeneous in nature. The allowance will be based upon management’s assessmentof the various risk factors affecting our mortgage loan portfolio, includingcurrent economic conditions, the makeup of the portfolio based on credit grade,loan-to-value ratios, delinquency status, historical credit losses, purchasedmortgage insurance and other factors deemed to warrant consideration. Theallowance will be maintained through ongoing loss provisions charged tooperating income and will be reduced by loans that are charged off. Determiningthe allowance for loan losses is subjective in nature due to the estimatesrequired and the potential for imprecision. This will be a critical accountingpolicy and our management intends to create methodologies to assist in theperiodic and reasonable calculation of the allowance.

 

As we build our portfolio of loans held for investment, we will alsomake certain changes to our balance sheet. As of June 30, 2004, MortgageITreported “Mortgage loans held for sale” consisting of fixed-rate andadjustable-rate loans, at fair value. Since we intend to continue to sell allof MortgageIT’s fixed-rate loans, we will continue to record them as “Mortgageloans held for sale” which will also include any adjustable-rate loans thatMortgageIT intends to sell. We will report adjustable-rate loans that we retainin our portfolio as “Mortgage loans held for securitization,” “Mortgage loansheld for investment” or “Mortgage loans collateralizing debt obligations,”depending on the corresponding disposition of individual loans as of thereporting date.

 

**NEWACCOUNTING POLICIES**

 

As we implement our business plan of retaining a significant percentageof the mortgages originated by MortgageIT and securitizing our portfolio, weexpect to apply the following critical accounting policies, in addition tothose discussed above.

 

**Accounting for transfers and servicing of financial assets**

 

We may regularly securitize mortgage loans by transferring mortgageloans to independent trusts that issue securities collateralized by themortgage loans transferred into these independent trusts. We will generallyretain interests in all or some of the securities issued by the trusts. Certainof the securitization agreements may require us to repurchase loans that arefound to have legal deficiencies, after the date of transfer. The accountingtreatment for transfers of assets upon securitization depends on whether or notwe have retained control over the transferred assets. We will service, througha subservicer, loans that MortgageIT originates for us for retention in ourportfolio.

 

As we begin to generate and retain a portfolio of loans forsecuritization, we will comply with the provisions of SFAS No. 140, “*Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities*,” or SFAS No. 140, related toeach securitization. Depending on the structure of the securitization, it willeither be treated as a sale or secured financing for financial statementpurposes. We anticipate that our securitizations will be treated as securedfinancings under SFAS No. 140. Our strategy of retaining ownership ofcertain mortgage loans held for investment and included in our securitizationpools will reduce the number of loans MortgageIT sells to third party investorsand, therefore, our total gains on sales of mortgage loans for financialaccounting purposes may be lower than MortgageIT has historically recognized.

 

**Managing interest rate risk**

 

We may hedge the aggregate risk of interest rate fluctuations withrespect to our hybrid ARM loans. Some or all of the following financialinstruments may be used for hedging interest rate risk: interest rate swaps andEurodollar contracts, interest rate caps and other instruments that may bedetermined to be advantageous and are permitted under the hedging

 

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policy that was adopted by our board of directors and is described inPart I., Item 3., “Quantitative and Qualitative Disclosures About MarketRisk—Risk Management.”

 

To qualify for cash flow hedge accounting, interest rate swaps,Eurodollar contracts, interest rate caps and other derivative instruments mustmeet certain criteria, including:

 

•                  that the itemsto be hedged are exposed to interest rate risk; and

•                  that thederivative instruments are highly effective in reducing our exposure tointerest rate risk.

 

Correlation and effectiveness of these hedging instruments areperiodically assessed based upon a comparison of the relative changes in thefair values or cash flows of the interest rate swaps and caps and the itemsbeing hedged.

 

For derivative instruments that are designated and qualify as a cashflow hedge (meaning hedging the exposure to variability in expected future cashflows that is attributable to a particular risk), the effective portion of thegain or loss, and net payments received or made, on the derivative instrumentwill be reported as a component of other comprehensive income and reclassifiedinto earnings in the same period or periods during which the hedged transactionaffects earnings. The remaining gain or loss on the derivative instrument inexcess of the cumulative change in the present value of future cash flows ofthe hedged item, if any, will be recognized in current earnings during theperiod of change.

 

With respect to hedging instruments that have not been designated ashedges, any net payments under, or fluctuations in the fair value of, theseinstruments will be recognized as current income or loss.

 

Derivative financial instruments contain credit risk to the extent thatthe institutional counterparties may be unable to meet the terms of theagreements. We expect to minimize this risk by using multiple counterpartiesand limiting our counterparties to major financial institutions with goodcredit ratings. In addition, we plan to regularly monitor the potential risk ofloss with any one party resulting from this type of credit risk. Accordingly,we do not expect any material losses as a result of default by other parties.

 

**REITCompliance**

 

We intend to qualify, and will elect to be taxed as a REIT for federalincome tax purposes. MortgageIT will continue as a mortgage originationsubsidiary and we will make an election, together with MortgageIT, to treatMortgageIT and its corporate subsidiaries as taxable REIT subsidiaries. Inorder to meet certain of the requirements for us to qualify as a REIT, we intendto continue to conduct all of our loan sales and loan brokerage activities, aswell as certain origination functions, through MortgageIT and its subsidiaries.Loans held for investment will be funded by us or by a qualified REITsubsidiary and accounted for at amortized cost for financial accountingpurposes. Interest income generated from our retained portfolio will berecognized as income.

 

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**MORTGAGEIT’SRESULTS OF OPERATIONS**

 

The following table sets forth MortgageIT’s financial data as apercentage of total revenues for the three months ended June 30, 2004 and 2003and the six months ended June 30, 2004 and 2003.

 
| ** **                                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **2004**                              | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                             |       |                                  |       |                           |       |   |   |   |   |
| Gains on sale of mortgage loans                       |       | 58.3                                  | %          | 57.1                           | %          | 58.1 | % | 53.6 | % |
| Brokerage revenues                                    |       | 31.5                                  | %          | 37.0                           | %          | 31.7 | % | 39.1 | % |
| Net interest income                                   |       | 10.2                                  | %          | 5.8                            | %          | 10.2 | % | 6.1 | % |
| Other                                                 |       | —                                |       | 0.1                            | %          | — |   | 1.2 | % |
| Total revenues                                        |       | 100.0                                 | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
|                                                  |       |                                  |       |                           |       |   |   |   |   |
| Operating expenses:                                   |       |                                  |       |                           |       |   |   |   |   |
| Compensation and employee benefits                    |       | 52.9                                  | %          | 47.2                           | %          | 56.1 | % | 48.5 | % |
| Processing expenses                                   |       | 16.9                                  | %          | 18.8                           | %          | 15.1 | % | 17.8 | % |
| General and administrative expenses                   |       | 6.6                                   | %          | 6.3                            | %          | 7.4 | % | 6.2 | % |
| Marketing, loan acquisition and business  development |       | 3.1                                   | %          | 4.4                            | %          | 3.4 | % | 4.3 | % |
| Rent                                                  |       | 4.9                                   | %          | 3.6                            | %          | 5.7 | % | 4.0 | % |
| Professional fees                                     |       | 1.3                                   | %          | 1.8                            | %          | 1.6 | % | 1.7 | % |
| Depreciation and amortization                         |       | 1.7                                   | %          | 1.2                            | %          | 2.0 | % | 1.5 | % |
| Total operating expenses                              |       | 87.4                                  | %          | 83.3                           | %          | 91.3 | % | 84.0 | % |
| Income before income taxes                            |       | 12.6                                  | %          | 16.7                           | %          | 8.7 | % | 16.0 | % |
| Income taxes                                          |       | 5.1                                   | %          | 4.2                            | %          | 3.5 | % | 3.6 | % |
| Net income                                            |       | 7.5                                   | %          | 12.5                           | %          | 5.2 | % | 12.4 | % |

 

**Three months ended June 30, 2004 compared to three months ended June30, 2003**

 

*Net Income*

 

Net income decreased approximately 49.0% to $2.8 million for thequarter ended June 30, 2004 from $5.6 million for the quarter ended June30, 2003. The decrease in net income during the second quarter in 2004 wasprimarily the result of a 7.8% decrease in loan production as well as more than$750 million of loans that MortgageIT did not sell as of June 30, 2004 inanticipation of the formation of the REIT. During the three months ended June30, 2004, MortgageIT originated $3.4 billion of loans, as compared to$3.7 billion of loan originations during the three months ended June 30,2003. The decrease in loan originations reflected a decline in refinanceactivity due to an increase in market rates of interest.  This decrease was partially offset by anincrease in the volume of purchase mortgage loans.

 

*Revenues*

 

**Gains on sales of mortgage loans.** Gain onsales of mortgage loans decreased approximately 13.8% to $21.9 million forthe quarter ended June 30, 2004 from $25.4 million for the comparableperiod in 2003. The decrease in gain on sales of mortgage loans was due todecreased loan sales volume that was primarily the result of a decline inoverall volume and the accumulation of loans in anticipation of formation ofthe REIT.  By accumulating these loans,the Company was not able to recognize the gain since the loans were not sold bythe end of the quarter.

 

**Brokerage revenue.** Brokerage revenue decreasedapproximately 28.0% to $11.8 million for the quarter ended June 30, 2004from $16.5 million for the comparable period in 2003. The decline isattributable to a decrease in loans brokered to other institutions, due to areduction in refinance activity as well as a greater emphasis on banking retailoriginations as opposed to brokering such originations to other institutions.

 

**Net interest income.** Net interest incomeincreased approximately 47.8% to $3.8 million for the quarter ended June30, 2004 from $2.6 million for the comparable period in 2003. The increaseis attributable to an increase of the loans held for

 

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sale and the corresponding interest income from the weighted averagecoupon rate of the loans held versus the interest expense on MortgageIT’swarehouse lines.

 

*Expenses*

 

**Compensation and employee benefits.**Compensation and employee benefits expenses decreased approximately 5.3% to$19.9 million for the quarter ended June 30, 2004 from $21.0 millionfor the comparable period in 2003. The decrease was due to decreasedcommissions paid as a result of a declining volume of loans, which was partiallyoffset by the staff additions resulting from the addition of several branchesand in connection with the Company’s then pending initial public offering. Theaverage number of employees decreased slightly to 1,285 during the quarterended June 30, 2004 from 1,290 during the quarter ended June 30, 2003.

 

**Processing expenses.** Mortgage loan processingexpenses decreased approximately 24.1% to $6.3 million for the quarterended June 30, 2004 from $8.4 million in the comparable period in 2003.The decrease was due to an overall decline in the number of loans processedduring the quarter ended June 30, 2004, as well as a decrease in lossesassociated with the repurchase of loans from investors.

 

**General and administrative expenses.** Generaland administrative expenses decreased approximately 11.4% to $2.5 millionfor the quarter ended June 30, 2004 from $2.8 million for the comparableperiod in 2003. The decrease was primarily due to a $400,000 accrual made inthe quarter ended June 30, 2003 for a potential liability the Company believedwas probable.  The Company reversed thisaccrual in the third quarter of 2003 because the matter was resolved with noliability to the Company.

 

**Marketing, loan acquisition and business development expenses.**Marketing, loan acquisition and business development expenses decreasedapproximately 40.1% to $1.2 million for the quarter ended June 30, 2004from $2.0 million for the comparable period in 2003. The decrease was dueto the reduction in retail loan volume and a decline in the use of Internetleads by retail loan officers.

 

**Rent expense.** Rent expense increasedapproximately 15.8% to $1.9 million for the quarter ended June 30, 2004from $1.6 million for the comparable period in 2003. The increase wasprimarily due to the addition of five branch locations in the six months endedJune 30, 2004.

 

**Professional fees.** Professional fees decreasedapproximately 40.3% to $472,000 for the quarter ended June 30, 2004 from$790,000 for the comparable period in 2003. The decrease was primarily due tolower legal fees as compared to the comparable period in 2003.

 

**Depreciation and amortization.** Depreciationand amortization increased approximately 16.0% to $644,000 million for thequarter ended June 30, 2004 from $555,000 for the comparable period in 2003. Theincrease was primarily due to the general capital expenditures as well as theaddition of five branch locations in the six months ended June 30, 2004.

 

**Six months ended June 30, 2004 compared to six months ended June 30,2003**

 

*Net income*

 

Net income decreased approximately 65.5% to $3.4 million for thesix months ended June 30, 2004 from $9.8 million for the six months endedJune 30, 2003. The decrease in net income in 2004 was primarily the result ofan 11.6% decrease in loan origination production resulting in decreased loansales volume and brokerage revenue. Total revenues decreased approximately 17.7% with a corresponding 10.6%decrease in total expenses during the six months ended June 30, 2004, ascompared to the six months ended June 30, 2003.

 

*Revenues*

 

**Gains on sales of mortgage loans.** Gain onsales of mortgage loans decreased approximately 10.9% to $37.7 million forthe six months ended June 30, 2004 from $42.3 million for the six monthsended June 30, 2003. The decrease in gain on

 

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sales of mortgage loans was due to decreased loan sales volume in 2004and the accumulation of loans in anticipation of formation of the REIT.  By accumulating these loans, the Company wasnot able to recognize the gain since the loans were not sold by the end of June2004.

 

**Brokerage Revenue.** Brokerage revenue decreasedapproximately 33.2% to $20.6 million for the six months ended June 30,2004 from $30.8 million for the six months ended June 30, 2003.  The decrease was directly attributable to a36.6% decrease in the volume of loans brokered due to the general decline inloan production during the six months ended June 30, 2004.

 

**Net interest income.** Net interest incomeincreased approximately 35.9% to $6.6 million for the six months endedJune 30, 2004 from $4.9 million for the six months ended June 30, 2003.The increase is attributable to a 37.0% increase of the loans held for salesand the corresponding interest income from the weighted average coupon rate ofthe loans held versus the interest expense on MortageIT’s warehouse lines.

 

*Expenses*

 

**Compensation and employee benefits.**Compensation and employee benefits expenses decreased approximately 4.8% to$36.4 million for the six months ended June 30, 2004 from $38.3 millionfor the six months ended June 30, 2003. The decrease was due to decreasedcommissions paid as a result of a declining volume of loans, which waspartially offset by the staff additions resulting from the addition of severalbranches and in connection with the Company’s then pending initial publicoffering.  The average number ofemployees increased from 1,228 to 1,248 for the six months ended June 30, 2003,as compared to the six months ended June 30, 2004.

 

**Processing expenses.** Mortgage loan processingexpenses decreased approximately 30.1% to $9.8 million for the six monthsended June 30, 2004, a $4.2 million decrease as compared to the six monthsended June 30, 2003. The decrease was due to an overall decline in the numberof loans processed during the quarter ended June 30, 2004 as well as a $2.5million decrease in losses associated with the repurchase of loans frominvestors.

 

**General and administrative expenses.** Generaland administrative expenses decreased by 2.2% to $4.8 million for the sixmonths ended June 30, 2004 from $4.9 million for the six months ended June30, 2003 primarily due to a $400,000 accrual made in the quarter ended June 30,2003 as described above.  The decreasewas partially offset by an increase in general and administrative expenses thatresulted from the addition of five new branches during the six months endedJune 30, 2004.

 

**Marketing, loan acquisition and business development expenses.**Marketing, loan acquisition and business development expenses decreased approximately34.3% to $2.2 million for the six months ended June 30, 2004 from$3.4 million for the six months ended June 30, 2003. The decrease was dueto the reduction in retail loan volume and a decline in the use of Internetleads by retail loan officers.

 

**Rent expense.** Rent expense increasedapproximately 16.9% to $3.7 million for the six months ended June 30, 2004from $3.1 million for the six months ended June 30, 2003. This increasewas primarily due to the addition of five new branch locations during the sixmonths ended June 30, 2004.

 

**Professional fees.** Professional fees decreasedapproximately 22.8% to $1.1 million for the six months ended June 30, 2004from $1.4 million for the six months ended June 30, 2003. This decreasewas primarily due to increased legal expenses in 2003 relating to a lawsuitagainst MortgageIT that was subsequently dismissed.

 

**Depreciation and amortization expenses.**Depreciation and amortization increased 9.0% to $1.3 million for the sixmonths ended June 30, 2004 from $1.2 million for the six months ended June30, 2003. This increase was primarily due to an increase in depreciable assetsas a result of the branches opened during the past year and general capitalexpenditures.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

Liquidity is a measure of our ability to meet potential cashrequirements, including ongoing commitments to repay borrowings, fund andmaintain investments, pay dividends to our shareholders and other generalbusiness needs. It is our policy to have adequate liquidity available at alltimes. We believe our existing cash balances, funds available under our creditfacilities and cash flows from operations are sufficient to fund our liquidityrequirements for at least the next 12 months. Availability of financing under our credit facilities is generally basedupon the market value of our assets and will vary accordingly. After we havebuilt our investment portfolio and are fully leveraged, our investments willgenerate liquidity on an ongoing basis through mortgage principal and interestpayments and pre-payments. Should our future liquidity needs exceed the sourcesof liquidity discussed above, we believe that we could raise additional cash byselling certain of our loans held for investment. We do, however, expect tocontinue the expansion that MortgageIT has undertaken and may have to arrangefor additional sources of capital through the issuance of debt or equity oradditional bank borrowings to fund that expansion. We currently have nocommitments for any additional financings, and we cannot ensure that we will beable to obtain any additional financing at the times required and on terms andconditions acceptable to us. If we fail to obtain needed additional financing,the pace of our growth could be adversely affected.

 

To originate a mortgage loan, MortgageIT may draw against a $1.150billion warehouse facility with UBS, a $500.0 million warehouse facilitywith Merrill Lynch and a $100.0 million warehouse facility with RFC. Thesefacilities are secured by the mortgage loans owned by MortgageIT and by certainof its other assets including cash deposited in an interest-bearing collateralaccount. Advances drawn under these facilities bear interest at rates that varydepending on the type of mortgage loans securing the advances. The averageannual interest rates for the quarter ended June 30, 2004, for the UBS, MerrillLynch and RFC facilities were 2.70%, 2.46% and 2.70%, respectively. Thesefacilities are subject to sub-limits, advance rates and terms that varydepending on the type of mortgage loans securing these financings and the ratioof MortgageIT’s liabilities to its tangible net worth. These facilitiesgenerally require MortgageIT to maintain a minimum tangible net worth andrestrict the amount by which its tangible net worth may decrease during a twoyear period. Also, MortgageIT is required to maintain a minimum ratio ofindebtedness to tangible net worth and minimum amounts of cash and cashequivalents. As of June 30, 2004, the aggregate maximum amount available foradditional borrowings under these warehouse facilities was approximately $1.75billion. The agreement with UBS is not a committed facility and may beterminated in the discretion of UBS. The agreement with Merrill Lynch is apartially committed facility and has a term of one year expiring in August2005. In addition, the Merrill Lynch agreement may be terminated by MerrillLynch upon the happening of certain events including a rating below the fourhighest generic grades by a nationally recognized statistical ratingorganization of the senior debt obligations or short-term debt obligations ofMerrill Lynch & Co., Inc. Upon termination for such an event,Merrill Lynch could require MortgageIT to repurchase, within 60 days ofthe date of such request, any mortgage loans purchased by Merrill Lynch. Theagreement with RFC is a committed facility with a term of one year expiring inSeptember 2004, and is renewable annually.

 

The documents governing MortgageIT’s warehouse facilities contain anumber of compensating balance requirements and restrictive financial and othercovenants that, among other things, require it to maintain a minimum ratio oftotal liabilities to tangible net worth, minimum levels of tangible net worth,liquidity and stockholders’ equity and maximum leverage ratios, as well as tocomply with applicable regulatory and investor requirements. At June 30, 2004,MortgageIT was not in compliance with leverage ratio restrictions contained incertain of its credit facilities.  Thisresulted from MortgageIT’s accumulation of mortgage loans for retention inHoldings’ investment loan portfolio. MortgageIT obtained waivers from the lenders for the period ofnon-compliance.  As of August 31, 2004,we were in compliance with these leverage ratio restrictions.  The agreements also contain covenantslimiting MortgageIT’s ability to:

 

•                  consolidate,merge or enter into similar transactions;

•                  transfer or sellassets;

•                  create liens onthe collateral; or

•                  change thenature of its business, without obtaining the prior consent of the lenders,which consent may not be unreasonably withheld.

 

25

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These limits may in turn restrict our ability to pay cash or stockdividends on Holdings’ common stock. In addition, under the warehousefacilities, MortgageIT cannot continue to finance a mortgage loan thatMortgageIT holds through the warehouse facility if:

 

•                  the loan isrejected as “unsatisfactory for purchase” by the ultimate investor and hasexceeded its permissible warehouse period which varies by facility;

•                  MortgageIT failsto deliver the applicable note, mortgage or other documents evidencing the loanwithin the requisite time period;

•                  the underlyingproperty that secures the loan has sustained a casualty loss in excess of 5% ofits appraised value; or

•                  the loan ceasesto be an eligible loan (as determined pursuant to the warehouse facilityagreement).

 

As of June 30, 2004, MortgageIT’s aggregate warehouse facility borrowingsamounted to $1.031 billion, compared to $300.7 million of such borrowings as ofDecember 31, 2003. These borrowings are short-term facilities secured by theunderlying residential mortgage loans held for sale. At June 30, 2004,MortgageIT’s mortgage loans held for sale were $1.075 billion, compared to$322.0 million at December 31, 2003.

 

In addition to the UBS, Merrill Lynch and RFC warehousefacilities, MortgageIT has entered into a mortgage loan purchase agreement withUBS which we refer to as a conduit facility. Under this agreement, UBSpurchases a loan from MortgageIT which enables MortgageIT to accelerate sale ofthe loan. MortgageIT recognizes the gain on sale upon the sale of the loan toUBS. Upon the sale, MortgageIT removes both the loans and the correspondingliability incurred by MortgageIT under the UBS warehouse facility from itsbalance sheet. A third party subsequently purchases the loan directly from UBS.MortgageIT facilitates the final settlement of the loan sale between UBS andthe third party, and receives a performance fee for these services from UBS.MortgageIT accounts for the performance fee as brokerage revenues.  The capacity available under the conduitfacility is included in the $1.150 billion warehouse facility with UBS, meaningthat the overall facility capacity is reduced by the balance of loansoutstanding under the warehouse facility plus the amount of loans sold to UBSunder the conduit facility. This agreement is not a committed facility and maybe terminated at the discretion of UBS.

 

In addition to the UBS, Merrill Lynch and RFC warehouse facilities andthe UBS conduit facility, MortgageIT has entered into a $15,000,000 NotePurchase Agreement with Technology Investment Capital Corp., or TICC, wherebyMortgageIT sold $15,000,000 of senior secured promissory notes (the “Notes”) toTICC. The proceeds from the sale of the Notes provide for the working capitalneeds of MortgageIT. The Notes have an interest rate of ten percent perannum payable quarterly in arrears, and provide for a single payment of theentire amount of the unpaid principal and any unpaid and accrued interest onthe Notes on March 29, 2007.

 

MortgageIT makes certain representations and warranties, and is subjectto various affirmative and negative financial and other covenants, under boththe terms of the warehouse credit facilities and the terms of the investor loansale agreements regarding, among other things, the loans’ compliance with lawsand regulations, their conformity with the investor’s underwriting standardsand the accuracy of information. In the event of a breach of theserepresentations, warranties or covenants or in the event of an early paymentdefault, these loans may become ineligible collateral for the warehouse creditfacilities or may become ineligible for sale to an investor, and MortgageIT maybe required to repurchase the loans from the warehouse lender or the investor.MortgageIT has implemented strict procedures to ensure quality control andconformity to underwriting standards and minimize the risk of being required torepurchase loans. MortgageIT has been required to repurchase loans it has soldfrom time to time; however, these repurchases have not had a material impact onthe results of operations of MortgageIT. The Company was not in compliance with certain credit facility leverageratio restrictions as of June 30, 2004. However, waivers were obtained from the lenders for the period ofnon-compliance.  As of August 31, 2004,we were in compliance with these leverage ratio restrictions.

 

MortgageIT intends to utilize repurchase agreements as a source offinancing for its investment portfolio. These arrangements, some of which arecurrently being negotiated, will vary in size among multiple providers. Inparticular, repurchase agreements will have terms that will vary in size,advance rates, interest spreads, duration and other characteristics dependingon the nature of the underlying collateral in the program. These financingarrangements are short-duration facilities secured by our underlying investmentin both whole loans and residential mortgage-backed

 

26

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securities, the value of which may move inversely with changes ininterest rates. A decline in the market value of our investments may limit ourability to borrow or result in lenders requiring additional collateral. As aresult, we could be required to sell some of our investments under adversemarket conditions in order to maintain liquidity. If such sales are made atprices lower than the amortized costs of such investments, we will incurlosses.

 

MortgageIT’s ability to originate and fund loans has historicallydepended in large part on its ability to sell the mortgage loans it originatesat a premium in the secondary market so that it may generate cash proceeds torepay borrowings under its warehouse facilities. As we implement our new loaninvestment strategy, which is less dependent upon gains on sale, we will berelying on our cash flow from operations, securitizations and the proceeds ofsecurities offerings to enable us to repay our borrowings and fund our growth.The value of our loans will still be relevant to determining the overall amountof borrowings that will be available to us under our financing facilities. Thevalue of our loans depends on a number of factors, including:

 

•                  interest rateson our loans compared to market interest rates;

•                  the borrowercredit risk classification;

•                  loan-to-valueratios, loan terms, underwriting and documentation; and

•                  general economicconditions.

 

We intend to make distributions to our stockholders to comply with thevarious requirements to maintain our REIT status and to avoid corporate incometax and the nondeductible excise tax. However, differences in timing betweenthe recognition of REIT taxable income and the actual receipt of cash couldrequire us to sell assets or to borrow funds on a short-term basis to meet theREIT distribution requirements and to avoid corporate income tax and thenondeductible excise tax.

 

Certain of our assets may generate substantial mismatches between REITtaxable income and available cash. Such assets could include mortgage-backedsecurities we hold that have been issued at a discount and require the accrualof taxable income in advance of the receipt of cash. As a result, our taxableincome may exceed our cash available for distribution and the requirement todistribute a substantial portion of our net taxable income could cause us to:(1) sell assets under adverse market conditions, (2) borrow on unfavorableterms or (3) distribute amounts that would otherwise be invested in futureacquisitions, capital expenditures or repayment of debt in order to comply withthe REIT distribution requirements.

 

MortgageIT’s cash and cash equivalents decreased to $6.4 million atJune 30, 2004 from $22.3 million at December 31, 2003 primarily due to anincrease in mortgage loans held for sale. MortgageIT’s primary sources of cashand cash equivalents during the six months ended June 30, 2004 were as follows:

 

•                  a $730.5 millionincrease in warehouse lines payable; and

•                  a $13.9 millionincrease in notes payable and other debt.

 

MortgageIT’s primary uses of cash and cash equivalents during the sixmonths ended June 30, 2004 were as follows:

 

•                  a $752.9 millionincrease in mortgage loans held for sale;

•                  a $8.3 millionincrease in accounts receivable; and a

•                  $1.1 millionrepayment of notes payable and other debt.

 

**INFLATION**

 

For the periods presented herein, inflation has been relatively low andwe believe that inflation has not had a material effect on MortgageIT’s resultsof operations. To the extent inflation increases in the future, interest rateswill also likely rise, which would likely reduce the number of mortgage loanswe originate. A reduction in the number of loans we originate resulting fromincreased inflation would adversely affect our future results of operations.

 

27

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**CONTRACTUALOBLIGATIONS**

 

MortgageIT had the following commitments (excluding derivative financialinstruments) at June 30, 2004 (in thousands):

 
| ** **              | ** ** | **Payments due by Period** | ** ** |
|-------------------------|------------|----------------------------|------------|
| ** **              | ** ** | **(in thousands)**         | ** ** |
| ** **              | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Warehouse lines payable |       | $                          | 1,031,214  |   | $ | 1,031,214 |   | $ | — |   | $ | — |   | $ | — |   |
| Operating leases(1)     |       | 31,673                     |       | 8,088 |   | 11,991 |   | 8,542 |   | 3,052 |   |
| Notes payable           |       | 15,000                     |       | — |   | 15,000 |   | — |   | — |   |
|                         |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*(1)          Net of subleases.*

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

*** ***

Market risk is the exposure to loss resulting from changes in interestrates, credit spreads, foreign currency exchange rates, commodity prices andequity prices. As we are invested solely in U.S. dollar-denominatedinstruments, primarily single-family residential mortgage instruments, and ourborrowings are also domestic and U.S. dollar denominated, we are not subject toforeign currency exchange, or commodity and equity price risk. The primarymarket risk that we are exposed to is interest rate risk and its relatedancillary risks. Interest rate risk is highly sensitive to many factors,including governmental monetary and tax policies, domestic and internationaleconomic and political considerations and other factors beyond our control. Allof our market risk sensitive assets, liabilities and related derivative positionsare for non-trading purposes only.

 

The following table presents information as to the notional amount,carrying amount and estimated fair value of certain of MortgageIT’s assets andliabilities at June 30, 2004 and December 31, 2003:

 
| ** **                        | ** ** | **Notional  Amount** | ** ** | **June 30, 2004  Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
|-----------------------------------|------------|----------------------|------------|-------------------------------------|------------|---------------------------|------------|
| ** **                        | ** ** | **(In thousands)**   | ** ** |
| Assets:                           |       |                 |       |                                |       |                      |       |
|                              |       |                 |       |                                |       |                      |       |
| Mortgage loans held for sale      |       | $                    | 1,066,404  |                                | $          | 1,075,467                 |       | $ | 1,075,467 |   |
| Interest rate lock commitments    |       | 577,943              |       | 3,684                               |       | 3,684                     |       |
| Forward delivery commitments      |       | 3,068,463            |       | (4,264                              | )          | (4,264                    | )          |
| Mortgage loans held for sale, net |       |                 |       | $                                   | 1,074,887  |                      | $          | 1,074,887 |   |
| Liabilities:                      |       |                 |       |                                |       |                      |       |
| Warehouse lines payable           |       | $                    | 1,031,214  |                                | $          | 1,031,214                 |       | $ | 1,031,214 |   |

 
| ** **                        | ** ** | **Notional  Amount** | ** ** | **December 31, 2003  Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------------------------------|------------|---------------------------|------------|
| ** **                        | ** ** | **(In thousands)**   | ** ** |
| Assets:                           |       |                 |       |                                    |       |                      |       |
| Mortgage loans held for sale      |       | $                    | 323,625    |                                    | $          | 325,214                   |       | $ | 325,214 |   |
| Interest rate lock commitments    |       | 294,307              |       | (1,236                                  | )          | (1,236                    | )          |
| Forward delivery commitments      |       | 504,895              |       | (1,966                                  | )          | (1,966                    | )          |
| Mortgage loans held for sale, net |       |                 |       | $                                       | 322,012    |                      | $          | 322,012 |   |
| Liabilities:                      |       |                 |       |                                    |       |                      |       |
| Warehouse lines payable           |       | $                    | 300,699    |                                    | $          | 300,699                   |       | $ | 300,699 |   |

 

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**INTERESTRATE RISK**

 

**Historical operations**

 

Movements in interest rates can pose a major risk to us in either arising or declining interest rate environment. MortgageIT utilizes asubstantial amount of borrowings in order to conduct its business.  These borrowings are all at variable interestrate terms that will increase as short term interest rates rise. Additionally,when interest rates rise, mortgage loans held for sale and any applications inprocess with IRLCs decrease in value.

 

When interest rates decline, loan pull-through may decline as a resultof loan applicants withdrawing their open applications on which we have issuedan IRLC. In those instances, MortgageIT may be required to purchase loans atcurrent market prices to fulfill existing forward sale loan commitments,thereby incurring losses upon sale. MortgageIT monitors its mortgage loanpipeline closely and on occasion may choose to renegotiate locked loan termswith a borrower to prevent withdrawal of open applications and mitigate theassociated losses.

 

MortgageIT utilizes a variety of derivative instruments in order tohedge its interest rate risk. MortgageIT’s hedging transactions usingderivative instruments involve certain risks such as counterparty credit risk,the enforceability of hedging contracts and the risk that unanticipated andsignificant changes in interest rates will cause a significant loss of basis inthe contract. The counterparties to its derivative arrangements are majorfinancial institutions and securities dealers that are well capitalized withhigh credit ratings and with which we may also have other financialrelationships. While MortgageIT does not anticipate nonperformance by anycounterparty, MortgageIT is exposed to potential credit losses in the event thecounterparty fails to perform. MortgageIT’s exposure to credit risk in theevent of default by a counterparty is the difference between the value of thecontract and the current market price. There can be no assurance thatMortgageIT will be able to adequately protect against the foregoing risks andwill ultimately realize an economic benefit that exceeds the related expensesincurred in connection with engaging in such hedging strategies.

 

**Forward-looking interest rate risk**

 

In addition to MortgageIT’s interest rate risk described above, we aresubject to interest rate exposure relating to the portfolio of ARM loans,hybrid ARM loans and mortgage-backed securities we expect to hold. Changes ininterest rates will impact our future earnings in various ways. While we willinvest primarily in ARM loans, rising short-term interest rates may temporarilynegatively affect our earnings, and, conversely, falling short-term interestrates may temporarily increase our earnings. This impact can occur for severalreasons and may be mitigated by portfolio prepayment activity as discussed below.First, our borrowings may react to changes in interest rates sooner than ourARM loans because the weighted average next repricing dates of the borrowingsare likely to be shorter time periods than that of the ARM loans. Second,interest rates on non-hybrid ARM loans may be capped per adjustment period(commonly referred to as the periodic cap), and our borrowings may not havesimilar limitations. Third, ARM loans typically lag changes in the applicableinterest rate indices, due to the notice period provided to ARM loan borrowerswhen the interest rates on their loans are scheduled to change.

 

Interest rates can also affect our net return on hybrid ARM loans.During a declining interest rate environment, the prepayment of hybrid ARMloans may accelerate, causing the amount of fixed-rate financing to increaserelative to the amount of hybrid ARM loans, possibly resulting in a decline inour net return on hybrid ARM loans, as replacement hybrid ARM loans may have alower yield than the ones paying off. In contrast, during an increasinginterest rate environment, hybrid ARM loans may prepay slower than expected,requiring us to finance a higher amount of hybrid ARM loans than originallyanticipated at a time when interest rates may be higher, resulting in a declinein our net return on hybrid ARM loans.

 

The rate of prepayment on mortgage loans may increase if interest ratesdecline or if the difference between long term and short term interest ratesdiminishes. Increased prepayments would cause us to amortize the premiums paidfor our mortgage loans faster, resulting in a reduced yield on our mortgageloans. Additionally, to the extent proceeds of prepayments cannot be reinvestedat a rate of interest at least equal to the rate previously earned on such mortgageloans, our earnings would be adversely affected.

 

Conversely, the rate of prepayment on mortgage loans may decrease ifinterest rates rise or if the difference between long term and short terminterest rates increases. Decreased prepayments would cause us to amortize thepremiums paid for our ARM loans over a longer time period, resulting in anincreased yield on our mortgage loans. Therefore, in rising interest

 

29

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rate environments where prepayments are declining, not only would theinterest rate on our ARM loans portfolio increase in order to re-establish aspread over the higher interest rates, but the yield also would rise due toslower prepayments. The combined effect could significantly mitigate othernegative effects that rising short-term interest rates might have on earningsover a longer time period, resulting in an increased yield on our mortgageloans.

 

While we have not experiencedany significant credit losses, in the event of a significant rising interestrate environment and/or economic downturn, mortgage loan defaults may increaseand result in credit losses that would adversely affect our liquidity andoperating results.

 

**RISKMANAGEMENT**

 

**Historical operations risk management**

 

MortgageIT has developed risk management practices and programsdesigned to manage market risk associated with its normal investment andbusiness activities. We continue to apply these practices and programsfollowing completion of our initial public offering except where otherwisenoted in this section or under the caption “—Forward-Looking FinancialStatements Effects.”

 

MortgageIT enters into derivative transactions solely for the purposeof minimizing the risks associated with the loan origination business, while maximizinggain on sale of mortgage loans. The primary risk associated with the loanorigination business is the risk of fluctuating interest rates. The interestrate risk is a direct result of timing delays (1) from the fixing of themortgage loan interest rate with borrowers to the funding of the loan and(2) from the funding of the loan to the setting of terms for sale of loansto secondary market investors.

 

In the normal course of its mortgage loan origination business,MortgageIT enters into IRLCs to extend credit to finance residential mortgages.These commitments, which contain fixed expiration dates, become effective wheneligible borrowers lock-in a specified interest rate within time framesestablished by MortgageIT’s origination, credit and underwriting practices.Interest rate risk arises if interest rates change between the time of thelock-in of the rate by the borrower and the sale of the loan. The IRLCs areconsidered free-standing derivatives. Accordingly, IRLCs are recorded at fairvalue with changes in fair value recorded to current period earnings.

 

To mitigate the effect of the interest rate risk inherent in issuing anIRLC from the lock-in date to the funding date of a loan, MortgageIT usesvarious derivative instruments, including forward sale loan commitments andforward sales and purchases of mortgage-backed securities and options on suchsecurities in the forward delivery “to be announced,” or TBA, market toeconomically hedge the IRLCs, which are also classified and accounted for as free-standingderivatives and thus are recorded at fair value with the changes in fair valuerecorded to current period earnings.

 

If MortgageIT does not deliver into forward sale loan or TBAcommitments, such instruments can be settled on a net basis. Net settlemententails paying or receiving cash based upon the change in market value of theexisting instrument. All forward sale loan commitments and forward sales andpurchases of TBA commitments are typically settled within 90 days of thecontract date.

 

MortgageIT also hedges the economic value of funded loans that are heldfor sale but not yet allocated to an investor sale commitment. Once a loan hasbeen funded, MortgageIT’s risk management objective for its mortgage loans heldfor sale is to protect earnings from an unexpected charge due to a decline invalue of its mortgage loans. MortgageIT’s strategy is to engage in a riskmanagement program involving forward sale loan commitments and/or the sale andpurchase of mortgage-backed securities and options on such securities in theforward delivery “to be announced” market to hedge its mortgage loans held forsale. At the inception of the hedge, MortgageIT formally documents therelationship between the derivative contract (*i.e.*,the forward delivery contracts or the mortgage-backed securities or options tobe sold or purchased) and the mortgage inventory, as well as its objective andstrategy for undertaking the hedge transaction. The notional amount of thederivative contracts, along with the underlying rate and terms of suchcontracts, are equivalent to the unpaid principal amount of the mortgageinventory being hedged; hence, the derivative contracts effectively fix theforward sales price and thereby substantially eliminate interest rate and pricerisk to MortgageIT. MortgageIT classifies and accounts for these derivativecontracts as fair value hedges. The derivatives are carried at fair value withthe changes in fair value recorded to current period earnings. When the hedgesare deemed to be highly effective, the book value of the hedged loans held forsale is adjusted for its change in fair value during the hedge period.

 

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**Forward-looking risk management**

 

As we are building the investment portfolio of mortgage loans, our riskmanagement is focused on protecting against possible “compression” in the netinterest margin with respect to the investment portfolio. The “yield curve”creates this risk because of different repricing durations for instruments withdifferent maturities. In substance, the hedging objective is to protect the netinterest margin by matching repricing durations for the ARM and hybrid ARM loanportfolio and the corresponding funding sources. As discussed below, hybrid ARMloans will be the primary loans requiring hedges. For accounting purposes,these hedges are called cash flow hedges**,** and theaccounting is different than for fair value hedges.

 

Traditional ARM loans have shorter repricing durations (1 year orless). Therefore it is unlikely that we will need to hedge these loans becausethey can be match funded. The interest rate on traditional ARM loans will resetmonthly, semi-annually or annually based on a margin over a U.S. Treasury indexor a LIBOR index. The corresponding funding liabilities will similarly haveshorter duration repricing that can be closely matched to these loans. Thus, aproperly matched funding strategy will enable us to protect our net interestmargin for this segment of our investment portfolio.

 

Hybrid ARM loans have longer repricing durations and we may not be ableto obtain matched repricing durations for the corresponding funding sourcessince borrowings generally have a shorter repricing duration than most hybridARM loans where the initial rate is fixed for 3 to 10 years. We intend tohedge these loans with interest rate swap agreements, Eurodollar futurescontracts and cap agreements in order to match the repricing durations of theloans and our funding sources.

 

**FAIRVALUES**

 

The following describes the methods and assumptions we use inestimating fair values of the financial instruments:

 

•                  Fair valueestimates are made as of a specific point in time based on estimates usingpresent value or other valuation techniques. These techniques may involveuncertainties and are significantly affected by the assumptions used and thejudgments made regarding risk characteristics of various financial instruments,discount rates, estimates of future cash flows, future expected loss experienceand other factors. Changes in assumptions could significantly affect theseestimates and the resulting fair values.

 

•                  The fair valueof commitments to fund with agreed upon rates are estimated using the fees andrates currently charged to enter into similar agreements, taking into accountthe remaining terms of the agreements and the present creditworthiness of thecounterparties. For fixed rate loan commitments, fair value also considers thedifference between current market interest rates and the existing committedrates.

 

•                  The fair valueof commitments to deliver mortgages is estimated using current market pricesfor dealer or investor commitments relative to our existing positions.

 

**ITEM4.  CONTROLS AND PROCEDURES**

*** ***

**(a)Evaluation of disclosure controls and procedures**

 

We carried out an evaluation,with the participation of management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of our disclosure controls andprocedures (pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934)as of the end of the period covered by this report. Based upon that evaluation,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to our company (including its consolidatedsubsidiaries) required to be included in our periodic SEC filings.

 

**(b)Internal control over financial reporting**

 

There have been no changes inour internal control over financial reporting (as such term is defined in Rule13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June30, 2004 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PARTII.  OTHER INFORMATION**

** **

**Item 1. Legal Proceedings**

*** ***

Because the nature of ourbusiness involves the collection of numerous accounts, the validity of liensand compliance with various state and federal lending laws, we are subject tovarious legal proceedings in the ordinary course of our business related toforeclosures, bankruptcies, condemnation and quiet title actions, and allegedstatutory and regulatory violations. We are also subject to legal proceedingsin the ordinary course of business related to employment matters. We believeall of these proceedings, taken as a whole, will not have a material adverseeffect on our business, financial position or our results of operations.

 

**Item2.  Unregistered Sales of Equity Securitiesand Use of Proceeds**

*** ***

None.

 

**Item3.  Defaults Upon Senior Securities**

*** ***

None.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

*** ***

None.

 

**Item 5. Other Information**

*** ***

None.

 

**Item 6. Exhibits**

*** ***

Exhibits filed with this Form 10-Q:

 
| **No.** | ** ** | **Description**                                                                                                                     |
|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------|
| 10.14   |       | Employment Agreement between John R. Cuti and  MortgageIT Holdings, Inc. and MortgageIT, Inc.                                       |
|    |       |                                                                                                                                |
| 10.15   |       | Employment Agreement between Donald Epstein and  MortgageIT Holdings, Inc. and MortgageIT, Inc.                                     |
|    |       |                                                                                                                                |
| 10.16   |       | Employment Agreement between Greg Lattanzio and  MortgageIT Holdings, Inc. and MortgageIT, Inc.                                     |
|    |       |                                                                                                                                |
| 10.17   |       | Employment Agreement between Joseph Blalock and  MortgageIT Holdings, Inc. and MortgageIT, Inc.                                     |
|    |       |                                                                                                                                |
| 10.18   |       | TRS  Servicing Agreement, dated as of August 4, 2004, among UBS Real Estate  Securities Inc., MortgageIT SPV I and MortgageIT, Inc. |
|    |       |                                                                                                                                |
| 10.19   |       | Loan Sale Agreement, dated as of August 4, 2004, between MortgageIT,  Inc., MortgageIT Holdings, Inc., and MortgageIT SPV I.        |
|    |       |                                                                                                                                |

 

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| 10.20  |   | Custodial Agreement, dated as of the date set  forth on the cover page hereof, among UBS Real Estate Securities Inc.,  JPMorgan Chase Bank, MortgageIT SPV I, MortgageIT, Inc. and MortgageIT  Holdings, Inc.                                                                                                                                                                                                                                                                                                                                    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.21  |   | Administration Agreement, dated as of August 4,  2004, between MortgageIT SPV I and MortgageIT, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.22  |   | Trust Agreement, dated as of August 4, 2004, by  and among MortgageIT, Inc., MortgageIT Holdings, Inc. and Wilmington Trust  Company.                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.23  |   | Side Letter Servicing Agreement, dated August 4,  2004, by and among GMAC Mortgage Corporation, UBS Real Estate Securities  Inc., MortgageIT SPV I and MortgageIT Holdings, Inc.                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.24  |   | REIT Servicing Agreement, dated as of August 4,  2004, among UBS Real Estate Securities Inc., MortgageIT SPV I and MortgageIT  Holdings, Inc.                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.25* |   | Amended and Restated Master Purchase Agreement,  dated as of August 4, 2004, among MortgageIT, Inc., MortgageIT Holdings, Inc.  and Merrill Lynch Mortgage Capital Inc.                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 10.26  |   | Amended and Restated Custodial Agreement, dated as  of August 4, 2004, among Merrill Lynch Mortgage Capital Inc., MortgageIT,  Inc., MortgageIT Holdings, Inc. and Deutsche Bank National Trust Company.                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.1   |   | Certification of Chief Executive Officer pursuant  to Rule 13a - 14(a)/15d-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2   |   | Certification of Chief Financial Officer pursuant  to Rule 13a - 14(a)/15d-14(a) of the Securities Exchange Act of 1934, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1   |   | Certification of Chief Executive Officer pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed “filed” for  purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or  otherwise subject to the liability of that section. Further, this exhibit  shall not be deemed to be incorporated by reference into any filing under the  Securities Act of 1933, as amended, or the Securities Exchange Act of 1934,  as amended.). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.2   |   | Certification of Chief Financial Officer pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (This exhibit shall not be deemed “filed” for  purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or  otherwise subject to the liability of that section. Further, this exhibit  shall not be deemed to be incorporated by reference into any filing under the  Securities Act of 1933, as amended, or the Securities Exchange Act of 1934,  as amended.). |

 

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* An application has beensubmitted to the Securities and Exchange Commission for confidential treatment,pursuant to Rule 24b-2 under the Exchange Act, of certain portions of thisexhibit. These portions of the exhibit have been redacted from the exhibitfiled with this report.

 

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Pursuant tothe requirements of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized:

 

 
|       | **MORTGAGEIT  HOLDINGS, INC.** |
|------------|--------------------------------|
|       |                           |   |   |
|       |                           |   |   |
|       | **By:**                        |    /s/  DOUG W. NAIDUS |
| ** ** | ** **                     | **Name:** | Doug W.  Naidus |
| ** ** | ** **                     | **Title:** | Chairman and** **Chief Executive Officer |
| ** ** | ** **                     | **Date:** | September 13,  2004 |
|       |                           |   |   |
|       |                           |   |   |
|       | **By:**                        |    /s/  DONALD EPSTEIN |
| ** ** | ** **                     | **Name:** | Donald  Epstein |
| ** ** | ** **                     | **Title:** | Chief  Financial Officer |
| ** ** | ** **                     | **Date:** | September 13,  2004 |

 

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