10-Q 1 file1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2006

OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to    

Commission File Number: 001-32213

MORTGAGEIT HOLDINGS, INC.
(Exact name of registrant as specified in its charter)


Maryland 20-0947002
(State or other jurisdiction of
incorporation or organization)
(IRS EmployerIdentification 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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(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 such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]    No [ ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated and large accelerated filer’’ in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [ ]            Accelerated filer [X]            Non-accelerated filer [ ]

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   [ ]    No   [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

COMMON STOCK, $0.01 PAR VALUE PER SHARE: 29,185,984 SHARES OUTSTANDING AS OF OCTOBER 31, 2006.




TABLE OF CONTENTS


    PAGE
Forward-Looking 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 Comprehensive Income (Loss) (Unaudited) 6
  Consolidated Statements of Changes in Stockholders' Equity (Unaudited) 7
  Consolidated Statements of Cash Flows (Unaudited) 8
  Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk 57
Item 4. Controls And Procedures 62
Part II. Other Information 63
Item 1. Legal Proceedings 63
Item 1A. Risk Factors 64
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 64
Item 3. Defaults Upon Senior Securities 64
Item 4. Submission of Matters to a Vote of Security Holders 64
Item 5. Other Information 64
Item 6. Exhibits 64
  Signatures  

2




FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains certain ‘‘forward-looking statements,’’ which are based on management's current expectations. Such forward-looking statements include information concerning possible or assumed future results of operations, trends, financial results and business plans, including, among other things, the ability of MortgageIT Holdings, Inc. (the ‘‘Company’’) to fund a fully-leveraged, self-originated loan portfolio, its anticipated loan funding volume and its ability to pay dividends. For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements that relate to future events and are generally identifiable by use of 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 statements are based on the current economic environment and management's current expectations and beliefs, and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Forward-looking statements are inherently subject to significant economic, competitive, and other contingencies that are beyond the control of management. The Company can give no assurance that its expectations will be attained. Factors that could cause actual results to differ materially from the Company's expectations include, but are not limited to: its mortgage bank subsidiary’s continued ability to originate new loans, including loans that the Company deems suitable for its securitization portfolio; changes in the capital markets, including changes in interest rates and/or credit spreads; and the risk factors or other uncertainties described from time to time in the Company's filings with the Securities and Exchange Commission, including the Company’s annual report on Form 10-K and this quarterly report on Form 10-Q.

Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect management's views as of the date of this report. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance or achievements. The Company does not undertake, and specifically disclaims, any obligation to update or revise any of the forward-looking statements after the date of this quarterly report on Form 10-Q, to conform these forward-looking statements to actual results or to update the reasons why actual results could differ from those projected in the forward-looking statements.

3




PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

MortgageIT Holdings, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)


  September 30,
2006
December 31,
2005
  (Unaudited)  
ASSETS  
 
Cash and cash equivalents $ 43,860
$ 36,757
Restricted cash 2,641
712
Marketable securities held to maturity
3,675
Portfolio ARM Loans  
 
ARM loans collateralizing debt obligations, net 4,642,282
4,681,554
ARM loans held for securitization, net
282
Total Portfolio ARM Loans 4,642,282
4,681,836
Mortgage loans held for sale 3,499,918
3,378,197
Mortgage-backed securities – available for sale 20,982
23,357
Hedging instruments 46,639
54,472
Accounts receivable, net of allowance 140,936
146,043
Prepaids and other assets 44,373
31,262
Goodwill 11,639
11,639
Property and equipment, net 16,607
13,941
Total assets $ 8,469,877
$ 8,381,891
LIABILITIES AND STOCKHOLDERS' EQUITY  
 
Liabilities:  
 
Collateralized debt obligations $ 4,442,590
$ 4,485,197
Warehouse lines payable 3,318,868
3,177,990
Repurchase agreements 94,692
87,058
Hedging instruments 7,422
8,801
Junior subordinated debentures 128,871
77,324
Notes payable and other debt 15,000
15,000
Accounts payable, accrued expenses and other liabilities 130,767
176,619
Total liabilities 8,138,210
8,027,989
STOCKHOLDERS' EQUITY:  
 
Common stock, $.01 par value: 125,000,000 shares authorized; 29,276,384 issued and 29,185,984 outstanding in 2006; 28,889,540 issued and 28,799,140 outstanding in 2005 293
289
Treasury stock (1,178
)
(1,178
)
Additional paid-in capital 395,016
393,304
Unearned compensation – restricted stock (3,174
)
(5,889
)
Accumulated other comprehensive income (loss) 8,189
13,225
Accumulated deficit (67,479
)
(45,849
)
Total stockholders' equity 331,667
353,902
Total liabilities and stockholders' equity $ 8,469,877
$ 8,381,891

The accompanying notes are an integral part of the consolidated financial statements.

4




MortgageIT Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars and shares in thousands, except per share data)


  Three months ended
September 30,
Nine months ended
September 30,
  2006 2005 2006 2005
Revenues:  
 
 
 
Gain on sale of mortgage loans $ 71,119
$ 61,612
$ 185,744
$ 140,704
Brokerage revenues 4,301
7,506
16,549
20,179
Interest income 114,341
90,384
344,884
212,036
Interest expense (115,530
)
(75,741
)
(336,853
)
(156,482
)
Net interest (expense) income (1,189
)
14,643
8,031
55,554
Realized and unrealized (loss) gain on hedging instruments (1,727
)
1,706
9,742
Other 797
209
1,654
715
Total revenues 73,301
83,970
213,684
226,894
Operating expenses:  
 
 
 
Compensation and employee benefits 38,742
39,037
111,388
99,051
Processing expenses 16,515
16,014
63,301
40,064
General and administrative expenses 7,130
6,112
22,854
19,117
Rent 2,748
2,700
9,942
7,257
Marketing, loan acquisition and business development 1,320
1,206
3,864
3,126
Professional fees 4,437
2,411
10,879
7,238
Depreciation and amortization 1,699
984
4,888
2,621
Total operating expenses 72,591
68,464
227,116
178,474
Income (loss) before income taxes 710
15,506
(13,432
)
48,420
Income tax (benefit) expense (731
)
6,841
(15,989
)
15,607
Net income $ 1,441
$ 8,665
$ 2,557
$ 32,813
Per share data:  
 
 
 
Basic $ 0.05
$ 0.31
$ 0.09
$ 1.47
Diluted $ 0.05
$ 0.30
$ 0.09
$ 1.44
Weighted average number of shares – basic 28,491
28,077
28,409
22,381
Weighted average number of shares – diluted 28,805
28,427
28,626
22,788

The accompanying notes are an integral part of the consolidated financial statements.

5




MortgageIT Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(Dollars in thousands)


  Three months ended
September 30,
Nine months ended
September 30,
  2006 2005 2006 2005
Net income $ 1,441
$ 8,665
$ 2,557
$ 32,813
Other comprehensive income:  
 
 
 
Realized and unrealized (loss) gain on hedging instruments arising during the period (30,071
)
20,254
1,985
9,008
Unrealized (loss) gain on mortgage-backed securities – available for sale, net of amortization (367
)
317
Reclassification of (gain) loss included in net income (1,615
)
1,062
(7,338
)
1,935
Net realized and unrealized gain (loss) during the period (32,053
)
21,316
(5,036
)
10,943
Comprehensive (loss) income $ (30,612
)
$ 29,981
$ (2,479
)
$ 43,756

The accompanying notes are an integral part of the consolidated financial statements.

6




MortgageIT Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
Nine months ended September 30, 2006 (Dollars and shares in thousands)


      
    
Common Stock
Treasury
Stock
Additional
Paid-In
Capital
Accumulated
Deficit
Unamortized
Cost of
Restricted
Stock
Accumulated
Other
Comprehensive
Loss
Total
Stockholders'
Equity
(Deficit)
  Shares Amount
Balance at December 31, 2005 28,799
$ 289
$ (1,178
)
$ 393,304
$ (45,849
)
$ (5,889
)
$ 13,225
$ 353,902
Issuance of common stock in connection with restricted stock grants 317
3
559
562
Issuance of common stock in connection with exercise of stock options 104
1
 
1,246
 
 
 
1,247
Restricted stock forfeitures (34
)
(315
)
315
Amortization of the cost of restricted stock
2,400
2,400
Stock based compensation
222
222
Other comprehensive (loss) income
(5,036
)
(5,036
)
Dividends declared on common stock – $.85 per share
(24,187
)
(24,187
)
Net income
2,557
2,557
Balance at September 30, 2006 29,186
$ 293
$ (1,178
)
$ 395,016
$ (67,479
)
$ (3,174
)
$ 8,189
$ 331,667

The accompanying notes are an integral part of the consolidated financial statements.

7




MortgageIT Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)


  Nine months ended
September 30,
  2006 2005
Cash flows from operating activities:  
 
Net income $ 2,557
$ 32,813
Adjustments to reconcile net income to net cash used in operating activities:  
 
Depreciation and amortization 7,985
7,957
Stock based compensation 3,184
2,483
Unrealized gain on hedging instruments (945
)
(7,635
)
Net amortization of mortgage-backed securities 2,710
Impairment of mortgage-backed securities 95
Impairment of mortgage servicing rights 85
Changes in operating assets:  
 
Increase in restricted cash (1,929
)
(12
)
Increase in mortgage loans held for sale (121,721
)
(2,509,137
)
Decrease (increase) in accounts receivable 5,107
(85,785
)
Increase in prepaids and other assets (13,859
)
(6,168
)
Changes in operating liabilities:  
 
(Decrease) increase in accounts payable, accrued expenses and other liabilities (40,839
)
61,012
Net cash used in operating activities (157,570
)
(2,504,472
)
Cash flows from investing activities:  
 
Decrease (increase) in ARM loans 39,554
(2,071,726
)
Purchases of property and equipment (7,554
)
(5,544
)
Proceeds from maturities of marketable securities 15,500
19,322
Purchases of marketable securities (11,825
)
(15,460
)
Net cash provided by (used in) investing activities 35,675
(2,073,408
)
Cash flows from financing activities:  
 
Net proceeds from issuance of junior subordinated debentures 48,451
72,618
Proceeds from collateralized debt obligations 733,093
3,057,367
Payments made on collateralized debt instruments (775,700
)
(490,116
)
Net borrowings from repurchase agreements 7,634
8,223
Net proceeds (payments) on hedging instruments 2,597
(10,035
)
Distributions paid (29,202
)
(27,166
)
Proceeds from notes payable 15,000
Repayment of notes payable (15,000
)
Proceeds from issuance of common stock
150,086
Proceeds from the exercise of stock options 1,247
1,698
Net proceeds of warehouse lines payable 140,878
1,803,980
Net cash provided by financing activities 128,998
4,566,655
Net increase (decrease) in cash and cash equivalents 7,103
(11,225
)
Cash and cash equivalents at beginning of period 36,757
70,224
Cash and cash equivalents at end of period $ 43,860
$ 58,999

The accompanying notes are an integral part of the consolidated financial statements.

8




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information.

In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. The operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The interim financial information should be read in conjunction with MortgageIT Holdings, Inc.'s 2005 Annual Report on Form 10-K.

Basis of Presentation

MortgageIT Holdings, Inc. (‘‘Holdings’’ or the ‘‘Company’’) is a residential mortgage lender that was formed in March 2004 to continue and expand the business of MortgageIT, Inc. (‘‘MortgageIT’’ or the ‘‘TRS’’). Holdings is organized and conducts its operations to qualify as a real estate investment trust (‘‘REIT’’) for federal income tax purposes and is focused on earning net interest income from mortgage loans originated by MortgageIT, Holdings' taxable REIT subsidiary. MortgageIT was incorporated in New York on February 1, 1999 and began marketing mortgage loan services on May 4, 1999. MortgageIT originates, sells and brokers residential mortgage loans in 50 states and the District of Columbia, and is an approved U.S. Department of Housing and Urban Development (‘‘HUD’’) Title II Nonsupervised Delegated Mortgagee.

As discussed further in Note 11, the Company operates its business in two primary segments, mortgage investment operations and mortgage banking operations. Mortgage investment operations are driven by the net interest income generated on its investment loan portfolio. Mortgage banking operations include loan origination, underwriting, funding, secondary marketing and loan brokerage, title and insurance activities.

The consolidated financial statements included herein contain results for Holdings, Holdings' wholly owned subsidiaries, MHL Funding Corp., Next at Bat Lending, Inc., MHL Reinsurance Ltd. and MortgageIT, and MortgageIT's wholly owned subsidiary Home Closer LLC (‘‘Home Closer’’). Home Closer provides title, settlement and other mortgage related services to the Company and its customers. All material intercompany account balances and transactions have been eliminated in consolidation.

Reclassification

Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Management bases its estimates on certain assumptions, which it believes are reasonable under the circumstances, and does not believe that any change in those assumptions would have a significant effect on the financial position or results of operations of the Company. Actual results could differ materially from those estimates.

Adjustable Rate Mortgage (‘‘ARM’’) Loan Investment Portfolio

The Company's ARM loan investment portfolio is comprised of ARM loans collateralizing debt obligations and ARM loans held for securitization (collectively referred to as ‘‘Portfolio ARM Loans’’ or ‘‘ARM Loans’’). All of the Company's Portfolio ARM Loans are traditional ARM Loans, meaning they have interest rates that reprice in one year or less (‘‘Traditional ARMs’’ or ‘‘Traditional ARM

9




loans’’), hybrid ARM Loans that have a fixed interest rate for an initial period of not more than five years and then convert to Traditional ARMs for their remaining terms to maturity (‘‘Hybrid ARMs’’ or ‘‘Hybrid ARM loans’’), or pay option ARM Loans (‘‘POAs’’) that have a low introductory rate for the first 30-90 days and, thereafter, reprice monthly on the basis of an index, such as the 12-month Treasury average.

Portfolio ARM Loans are designated as held to maturity because the Company has the intent and ability to hold them until maturity or payoff. Portfolio ARM Loans are carried at cost, which includes unpaid principal balances, unamortized loan origination costs and fees, and the allowance for loan losses.

ARM loans collateralizing debt obligations are mortgage loans the Company has securitized into rated classes with the lower rated classes providing credit support for higher rated certificates issued to third party investors or retained by the Company in structured financing arrangements.

ARM loans held for securitization are mortgage loans the Company has originated and intends to securitize and retain.

Mortgage Loans Held for Sale

Unallocated Mortgage Loans Held For Sale

Unallocated mortgage loans held for sale represent loans that have not yet been allocated to a forward sales commitment. At September 30, 2006 and December 31, 2005, unallocated mortgage loans held for sale are carried at the lower of adjusted cost or market value. Determining market value requires judgment by management in determining how the market would value a particular mortgage loan based on characteristics of the loan and available market information.

Allocated Mortgage Loans Held For Sale

Allocated mortgage loans held for sale represent loans that have been allocated to a forward sales commitment. For the nine months ended September 30, 2006 and the year ended December 31, 2005, the Company qualified and elected to apply Statement of Financial Accounting Standards (‘‘SFAS’’) No. 133 ‘‘Accounting for Derivative Instruments and Hedging Activities’’ (‘‘SFAS No. 133’’) fair value hedge accounting for allocated loans held for sale. Allocated mortgage loans held for sale are carried at the lower of adjusted cost or market value. Determining market value requires judgment by management in determining how the market would value a particular mortgage loan based on characteristics of the loan and available market information. Adjusted cost includes the loan principal amount outstanding, deferred direct origination costs and fees, and any adjustment to the carrying amount of loans resulting from the application of hedge accounting.

Mortgage-Backed Securities – Available for Sale

Mortgage-backed securities – available for sale represent beneficial interests the Company purchased in the MortgageIT real estate mortgage investment conduit (‘‘REMIC’’) securitization.

Mortgage-backed securities classified as available for sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) (‘‘OCI’’). 

Mortgage-backed securities represent the retained interests in certain components of the cash flows of the underlying mortgage loans or mortgage securities transferred to securitization trusts. As payments are received, the payments are applied to the cost basis of the mortgage related security. Each period, the accretable yield for each mortgage security is evaluated and, to the extent there has been a change in the estimated cash flows, it is adjusted and applied prospectively. The estimated cash flows change as assumptions for credit losses, borrower prepayments and interest rates are updated. The accretable yield is recorded as interest income with a corresponding increase to the cost basis of the mortgage security.

10




At each reporting period subsequent to the initial valuation of the purchased securities, the fair value of mortgage securities is estimated based on different methods, including independent valuations from broker dealers. Management’s best estimate of key assumptions, including credit losses, prepayment speeds, the market discount rates and forward yield curves commensurate with the risks involved, are used in estimating future cash flows. To the extent that the cost basis of mortgage securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in OCI is reclassified to earnings as a realized loss.

Loan Securitizations

The Company securitizes mortgage loans by transferring them to independent trusts that issue securities collateralized by the transferred mortgage loans. The Company generally retains interests in all or some of the securities issued by the trusts. Certain of the securitization agreements may require the Company to repurchase loans that are found to have legal deficiencies after the date of transfer. The accounting treatment for transfers of assets upon securitization depends on whether or not the Company has retained control over the transferred assets. The Company's accounting policy for ARM loan securitizations complies with the provisions of SFAS No. 140 ‘‘Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities’’ (‘‘SFAS No. 140’’). Depending on the structure of the securitization, the accounting for securitizations is treated as either a sale or secured financing for financial statement purposes. The securitization transactions in the Company's mortgage investment operations segment are treated as secured financings under SFAS No. 140 as the Company has retained control over the transferred assets. The MortgageIT REMIC securitization completed in February 2006 was treated as a financing under SFAS No. 140. The MortgageIT REMIC securitization completed in November 2005 was treated as a sale under SFAS No. 140.

Mortgage Servicing Rights

Mortgage servicing rights retained in the REMIC securitization are recorded at allocated cost based upon the relative fair values of the transferred loans and the servicing rights. Mortgage servicing rights are amortized in proportion to and over the projected net servicing revenues. Periodically, the Company evaluates the carrying value of mortgage servicing rights based on their estimated fair value. If the estimated fair value is less than the carrying amount of the mortgage servicing rights, the mortgage servicing rights are written down to the amount of the estimated fair value. For purposes of evaluating and measuring impairment of mortgage servicing rights the Company stratifies the mortgage servicing rights based on their predominant risk characteristics.

Mortgage servicing rights are recorded in other assets in the consolidated balance sheets. The servicing fee income associated with the mortgage servicing rights is reported in other income in the consolidated statements of operations.

Derivative Instruments and Hedging Activities

The Company manages its interest rate risk exposure through the use of derivatives, including interest rate swaps, Eurodollar futures, forward delivery contracts on mortgage-backed securities (‘‘TBA Securities’’), options on TBA Securities, forward sale commitments and interest rate caps. In accordance with SFAS No. 133, all derivative instruments are recorded on the balance sheets at fair value.

If certain conditions are met, the Company may designate a derivative as a fair value hedge (the hedge of the exposure to changes in the fair value of a recognized asset, liability or commitment), or a cash flow hedge (a hedge of the exposure to variability in the cash flows related to a forecasted or recognized liability).

Certain derivatives used in conjunction with interest rate risk management activities qualify for hedge accounting under SFAS No. 133. For derivative hedging activities to qualify for hedge accounting, the Company formally documents, at the inception of each hedge, the hedging relationship and its risk management objective and strategy for undertaking the hedge, the hedging instrument, the item or,

11




the nature of the risk being hedged, how the hedging instrument's effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring ineffectiveness. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

The Company's fair value hedges are primarily for mortgage loans held for sale. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair value hedge, along with the change in fair value attributable to the hedged risk, are recorded in earnings. Derivatives that are utilized as fair value hedges and that qualify for hedge accounting are carried at fair value with changes in value included in gain on sale of mortgage loans in the accompanying consolidated statements of operations.

The Company's cash flow hedges, which are used for LIBOR based borrowings, have the effect of fixing the interest rate on LIBOR based liabilities in the event that LIBOR based funding costs change. Gains and losses on a derivative that is highly effective and that is designated and qualifies as a cash flow hedge are recorded in OCI to the extent that the derivative is effective as a hedge, until earnings are affected by the variability in cash flows of the designated hedged item.

The ineffective portion of the change in fair value of a derivative instrument that qualifies as either a fair value hedge or a cash flow hedge was approximately $2.5 million for the nine months ended September 30, 2006. The change in value of a derivative instrument that does not qualify for hedge accounting, is reported in earnings under the caption realized and unrealized gain (loss) on hedging instruments.

The Company employs a number of risk management monitoring procedures that are designed to ensure that its hedging arrangements are demonstrating, and are expected to continue to demonstrate, a high level of effectiveness. Hedge accounting is discontinued on a prospective basis if it is determined that the hedging relationship is no longer highly effective or expected to be highly effective in offsetting changes in fair value or cash flows of the hedged item. Additionally, the Company may elect, pursuant to SFAS No. 133, to re-designate a hedge relationship during an interim period and re-designate upon the rebalancing of a hedge relationship.

The Company's committed mortgage pipeline includes interest rate lock commitments (‘‘IRLCs’’) that have been extended to borrowers who have applied for loan funding and meet certain defined credit and underwriting criteria. The Company classifies and accounts for the IRLCs associated with loans expected to be sold as free-standing derivatives. The Company does not assign fair value to IRLCs at inception of the loan commitment, but does record subsequent changes in fair value in gain on sale of mortgage loans on the consolidated statements of operations.

Repurchase Agreements

Repurchase agreements represent legal sales of the Company's mortgage assets and an agreement to repurchase the assets at a future date. Repurchase agreements are accounted for as collateralized financing transactions since the Company still has control of the transferred assets and is both entitled and obligated to repurchase the transferred assets. They are carried at the amount at which the assets will be repurchased, including accrued interest.

12




Other Comprehensive Income

SFAS No. 130, ‘‘Reporting Comprehensive Income,’’ divides comprehensive income into net income and other comprehensive income (loss), which consists of unrealized gains and losses on derivative financial instruments that qualify for cash flow hedge accounting under SFAS No. 133, and mortgage-backed securities — available for sale. Accumulated OCI is comprised of the following:


  Net Unrealized Loss
on Mortgage-Backed
Securities –
Available for Sale
Net Realized and
Unrealized Gain
(Loss) on Derivative
Financial
Instruments
Accumulated
Other
Comprehensive
Income (Loss)
Balance at December 31, 2004 $    — (387 )  (387 ) 
Net change (948 )  14,560   13,612  
Balance at December 31, 2005 $ (948 )  $ 14,173   $ 13,225  
Balance at January 1, 2006 (948 )  14,173   13,225  
Net change 316   (5,352 )  (5,036 ) 
Balance at September 30, 2006 (unaudited)     $ (632 )  $ 8,821   $ 8,189  

Revenue Recognition

Mortgage Investment Operations

Interest income is accrued based on the outstanding principal amount and contractual terms of the loans. Direct loan origination costs and fees associated with the loans are amortized into interest income over the lives of the loans using the effective yield method, adjusted for the effects of estimated prepayments. Estimating prepayments and estimating the remaining lives of the loans requires judgment by management, which involves consideration of possible future interest rate environments. The actual lives could be more or less than the amount estimated by management.

Mortgage Banking Operations

Gain on sale of loans represents the difference between the net sales proceeds and the carrying values of the mortgage loans sold, and is recognized at the time of sale. Direct loan origination costs and fees associated with the loans are initially recorded as an adjustment of the cost of the loans held for sale and are recognized in earnings when the loans are sold.

Brokerage fees represent revenues earned for the brokering of mortgage loans to third party lenders and are earned and recognized at the time the loan is closed by the third party lender. Revenues are primarily comprised of borrower application and/or administrative fees and brokerage fees paid to the Company by third party lenders.

Interest income is accrued as earned. Interest on mortgage loans held for sale accrues on loans from the date of funding through the date of sale. Interest on loans is computed based on the contractual loan note rate. Once a loan is 90 days or more delinquent or a borrower declares bankruptcy, the Company adjusts the value of its accrued interest receivable to what it believes to be collectible and stops accruing interest on that loan.

Generally, the Company is not exposed to significant credit risk on its loans sold to investors. In the normal course of business, the Company is obligated to repurchase loans from investors consistent with the terms of its investor contracts. In connection with the sale of loans, the Company records a repurchase reserve for potential future losses applicable to loans sold. The repurchase reserve is included in accrued expenses on the Company's balance sheets.

Loan Loss Reserves

The Company maintains an allowance for loan losses based on management's estimate of credit losses inherent in the Company's Portfolio ARM Loans. The estimation of the allowance is based on a variety of factors including, but not limited to, industry statistics, current economic conditions, loan

13




portfolio composition, delinquency trends, credit losses to date on underlying loans and remaining credit protection. If the credit performance of the Company's Portfolio ARM Loans is different than expected, the Company adjusts the allowance for loan losses to a level deemed appropriate by management to provide for estimated losses inherent in the Company's ARM loan portfolio. Two critical assumptions used in estimating the loan loss reserves are an assumed rate of default, which is the expected rate at which loans go into foreclosure over the life of the loans, and an assumed rate of loss severity, which represents the expected rate of realized loss upon disposition of the properties that have gone into foreclosure. The Company’s estimated loan loss reserves are comprised of baseline expected credit losses for the next four to six quarters and a stress component which considers the effects of alternative economic scenarios. The Company will charge off losses against the credit loss reserve at the time of loan disposition. The following table summarizes changes in the reserve:


  Nine months
ended
September 30,
2006
Year ended
December 31,
2005
  (unaudited)  
Loan loss reserve, beginning of period $ 4,123   $ 674  
Loan loss provision 964   3,449  
Write offs (1,087 )   
Loan loss reserve, end of period $ 4,000   $ 4,123  

Stock Compensation

As of September 30, 2006, the Company had in effect the 2004 Long-Term Incentive Plan (the ‘‘2004 Plan’’) and the Amended Long-Term Incentive Plan (the ‘‘Amended Plan’’), which are described more fully in Note 8.

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), ‘‘Share-Based Payment’’ (SFAS No. 123R), requiring that compensation cost relating to share-based payment transactions be recognized in the financial statements. The cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity award). We adopted SFAS No. 123R using the modified prospective method and, accordingly, financial statement amounts for prior periods presented in this Form 10-Q have not been restated to reflect the fair value method of recognizing compensation cost relating to stock options.          

There was approximately $74,000 and $222,000 of before tax compensation cost related to stock options recognized in operating results during the three and nine months ended September 30, 2006, respectively. The associated future income tax benefit recognized was approximately $30,000 and $90,000 during the three and nine months ended September 30, 2006, respectively.

At September 30, 2006, there was approximately $250,000 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 0.8 years.

Through December 31, 2005, the Company accounted for all transactions under which employees received shares of stock or other equity instruments in the Company based on the price of its stock in accordance with the provisions of Accounting Principles Board Opinion No. 25, ‘‘Accounting for Stock Issued to Employees.’’ Pursuant to these accounting standards, the Company recorded deferred compensation for stock awards at the date of grant based on the estimated values of the shares on that date. There was no stock option-based employee compensation cost reflected in net income because all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income if the Company had applied the fair value recognition provisions of SFAS No. 123, ‘‘Accounting for Stock-Based Compensation – Transition and Disclosure’’ (‘‘SFAS No. 123’’) for the three and nine months ended September 30, 2005. (Dollars in thousands, except per share data):

14





  Three months
ended
September 30,
2005
Nine months
ended
September 30,
2005
  (unaudited) (unaudited)
Net income attributable to common stockholders $ 8,665   $ 32,813  
Amortization of restricted stock, including forfeitures, net of tax effects 559   1,708  
Stock-based employee compensation expense determined under the fair value method, net of related tax effects (622 )  (1,881 ) 
Pro forma net income $ 8,602   $ 32,640  
Net income per share attributable to common stock:        
Basic – As reported $ 0.31   $ 1.47  
Basic – Pro forma $ 0.31   $ 1.46  
Net income per share for diluted earnings per share:        
Diluted – As reported $ 0.30   $ 1.44  
Diluted – Pro forma $ 0.30   $ 1.43  

Under the 2004 Plan, the fair value for each option granted was estimated at the date of grant using the Black-Scholes option-pricing model, with the following assumptions: risk-free interest rate of 3.75%, expected option lives of five years, 26% volatility and 9% dividend rate.

The weighted average fair value of options issued under the 2004 Plan, for the nine months ended September 30, 2005, under the Black-Scholes option-pricing model, was $1.01 per option.

No stock options have been granted under the Amended Plan.

Restricted stock awards granted to employees under the 2004 Plan and the Amended Plan are subject to certain sale and transfer restrictions. Unvested awards are also subject to forfeiture if employment terminates prior to the end of the prescribed restriction period. The value of restricted stock awards is expensed over the vesting period, generally three years.

Income Taxes

Income taxes are determined using the liability method under SFAS No. 109, ‘‘Accounting for Income Taxes.’’ Under this method, deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts reported for federal and state income tax purposes.

The Company has elected to be taxed as a REIT and believes it complies with the provisions of the Internal Revenue Code of 1986, as amended (the ‘‘Code’’), with respect thereto. Accordingly, the Company is not subject to federal income tax on that portion of its income that is distributed to stockholders, as long as certain asset, income and stock ownership tests are met. To maintain its REIT status, the Company is required to distribute a minimum of 90% of its annual taxable income to its stockholders.

MortgageIT made the election to be treated as a taxable REIT subsidiary and, therefore, is subject to both federal and state corporate income taxes. Accordingly, the Company records a tax provision based primarily on the taxable income of the TRS.

Fair Value of Financial Instruments

Cash and cash equivalents, marketable securities and accounts receivable are carried at amounts approximating fair value. Unallocated and allocated mortgage loans held for sale are carried at the lower of adjusted cost or market value, or at market value.

Mortgage-backed securities – available for sale are carried at fair value.

Derivative instruments related to the hedging of the Company's financing costs, including interest rate swap agreements, Eurodollar futures contracts and interest rate cap agreements (collectively ‘‘Portfolio Hedging Instruments’’) are carried at fair value and are classified as hedging instruments on the balance sheets.

15




Derivative instruments, including IRLCs and those related to the hedging of the Company's locked pipeline loans and mortgage loans held for sale, including TBA Securities, options on TBA Securities, forward sale commitments and Eurodollar futures contracts, are carried at fair value and are classified as hedging instruments on the balance sheets.

Liabilities, including warehouse lines payable, collateralized debt obligations, notes payable and other debt, are carried at their contractual notional amounts which approximate fair value. Portfolio ARM Loans are carried at cost, as more fully described in Note 2.

The following table presents information as to the carrying amount and estimated fair value of certain of the Company's market risk sensitive assets, liabilities and hedging instruments at September 30, 2006 and December 31, 2005:


  September 30, 2006
  Carrying
Amount
Estimated
Fair Value
  (Dollars in thousands)
(unaudited)
Assets:        
Mortgage loans held for sale $ 3,499,918   $ 3,521,076  
ARM loans collateralizing debt obligations, net 4,642,282   4,598,891  
Mortgage-backed securities – available for sale 20,982   20,982  
Hedging instruments 46,639   46,639  
Liabilities:        
Warehouse lines payable $ 3,318,868   $ 3,318,868  
Collateralized debt obligations 4,442,590   4,452,057  
Repurchase agreements 94,692   94,692  
Junior subordinated debentures 128,871   128,871  
Hedging instruments 7,422   7,422  

  December 31, 2005
  Carrying
Amount
Estimated
Fair Value
  (Dollars in thousands)
Assets:        
Mortgage loans held for sale $ 3,378,197   $ 3,383,752  
ARM loans held for securitization, net 282   277  
ARM loans collateralizing debt obligations, net 4,681,554   4,624,237  
Mortgage-backed securities – available for sale 23,357   23,357  
Hedging instruments 54,472   54,472  
Liabilities:        
Warehouse lines payable $ 3,177,990   $ 3,177,990  
Collateralized debt obligations 4,485,197   4,485,197  
Repurchase agreements 87,058   87,058  
Junior subordinated debentures 77,324   77,324  
Hedging instruments 8,801   8,801  

RECENTLY ISSUED ACCOUNTING STANDARDS

In February 2006, FASB issued SFAS No. 155, ‘‘Accounting for Certain Hybrid Financial Instruments’’, which addresses issues on the evaluation of beneficial interests issued in securitization transactions under SFAS No. 133. The statement also amends SFAS No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement shall be effective for all financial instruments acquired, issued, or subject to a remeasurement event occurring after December 31, 2006. The Company will adopt this statement when effective and is currently evaluating its impact.

16




In March 2006, the FASB issued SFAS No. 156, ‘‘Accounting for Servicing of Financial Assets’’, an amendment of SFAS No. 140 (‘‘SFAS 156’’). This statement requires that an entity separately recognize a servicing asset or a servicing liability when it undertakes an obligation to service a financial asset under a servicing contract in certain situations. Such servicing assets or servicing liabilities are required to be initially measured at fair value, if practicable. SFAS 156 also allows an entity to choose one of two methods when subsequently measuring its servicing assets and servicing liabilities: (1) the amortization method or (2) the fair value measurement method. The amortization method existed under SFAS 140 and remains unchanged in (1) allowing entities to amortize their servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and (2) requiring the assessment of those servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date. The fair value measurement method allows entities to measure their servicing assets or servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period the change occurs. SFAS 156 introduces the notion of classes and allows companies to make a separate subsequent measurement election for each class of its servicing rights. In addition, SFAS 156 requires certain comprehensive roll−forward disclosures that must be presented for each class. The Statement is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, so long as the entity has not yet issued financial statements, including financial statements for any interim period, for that fiscal year. The Company will adopt this statement when effective and is currently evaluating its impact.

In July 2006, the FASB issued Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes’’ (‘‘FIN 48’’). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. The provisions of this interpretation apply to fiscal years beginning after December 15, 2006. Management is currently evaluating FIN 48, but does not currently expect it to have a material impact on the Company’s financial statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin (‘‘SAB’’) 108 ‘‘Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements’’ (SAB 108). SAB 108 requires that public companies utilize a ‘‘dual−approach’’ to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Company is currently evaluating the impact of adopting SAB 108 but does not expect that it will have a material effect on our consolidated financial position or results of operations.

In September 2006, the FASB issued SFAS No. 157, ‘‘Fair Value Measurements’’ (‘‘SFAS No. 157’’). This Statement defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements and accordingly, does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS No. 157 but does not expect that it will have a material effect on our consolidated financial position or results of operations.

17




NOTE 2 — PORTFOLIO ARM LOANS

The following table presents the Company's Portfolio ARM Loans as of September 30, 2006 and December 31, 2005 (Dollars in thousands):


September 30, 2006 (unaudited) ARM loans
collateralizing
debt obligations
ARM loans
held for
securitization
Total
Principal balance outstanding $ 4,597,856   $   $ 4,597,856  
Unamortized loan origination costs and fees 48,426     48,426  
Loan loss reserves (4,000 )    (4,000 ) 
Amortized cost, net 4,642,282     4,642,282  
Gross unrealized loss (43,391 )    (43,391 ) 
Estimated fair value $ 4,598,891   $   $ 4,598,891  
Carrying value $ 4,642,282   $   $ 4,642,282  

December 31, 2005 ARM loans
collateralizing
debt obligations
ARM loans
held for
securitization
Total
Principal balance outstanding $ 4,641,588   $ 278   $ 4,641,866  
Unamortized loan origination costs and fees 44,089   4   44,093  
Loan loss reserves (4,123 )    (4,123 ) 
Amortized cost, net 4,681,554   282   4,681,836  
Gross unrealized loss (57,317 )  (5 )  (57,322 ) 
Estimated fair value $ 4,624,237   $ 277   $ 4,624,514  
Carrying value $ 4,681,554   $ 282   $ 4,681,836  

The loans that the Company retains in its portfolio are serviced through a subservicing arrangement. The TRS sells all of its fixed rate loan production to third parties, as well as any ARM loans that the Company does not retain in its portfolio.

The Company does not account for mortgage-backed securities created in connection with the securitization of Portfolio ARM Loans and placed with third party investors as sales and, therefore, does not record any gain or loss in connection with these securitization transactions. Instead, the Company accounts for the securities it issues as a long-term collateralized financing. As of September 30, 2006, the Company held approximately $4.6 billion of ARM loans that collateralize the securities resulting from its securitization activities, and are classified on its balance sheet as ARM loans collateralizing debt obligations, net.

The Company has credit exposure on its ARM Loan investment portfolio. During the nine months ended September 30, 2006, the Company recorded loan loss provisions totaling $964,000 to reserve for estimated future credit losses on Portfolio ARM Loans, and charged $1,087,000 against the allowance for losses during the period.

The following table summarizes Portfolio ARM Loan delinquency information as of September 30, 2006 and December 31, 2005 (Dollars in thousands):

18




September 30, 2006 (unaudited)


Delinquency Status Loan Count Loan Balance Percent of
Portfolio ARM
Loans
Percent of
Total Assets
60 to 89 days 35   $ 9,620   0.21 %  0.11 % 
90 days or more 36   9,935   0.21   0.12  
In bankruptcy and foreclosure 72   19,610   0.42   0.23  
  143   $ 39,165   0.84 %  0.46 % 

December 31, 2005


Delinquency Status Loan Count Loan Balance Percent of
Portfolio ARM
Loans
Percent of
Total Assets
60 to 89 days 48   $ 12,189   0.26 %  0.15 % 
90 days or more 19   5,627   0.12   0.07  
In bankruptcy and foreclosure 18   4,461   0.10   0.05  
  85   $ 22,277   0.48 %  0.27 % 

NOTE 3 — MORTGAGE LOANS HELD FOR SALE

Mortgage loans held for sale consist of the following components (Dollars in thousands):


  September 30,
2006
December 31,
2005
  (unaudited)  
Mortgage loans held for sale $ 3,451,582   $ 3,331,966  
Deferred origination costs and fees 48,336   46,231  
Carrying amount of mortgage loans held for sale $ 3,499,918   $ 3,378,197  

Mortgage loans are residential mortgages on properties located throughout the United States having maturities of up to 40 years, and include ARM loans that are not Portfolio ARM Loans. Pursuant to the terms of the mortgage loans, the borrowers have pledged the underlying real estate as collateral for the loans. It is the Company's practice to sell to third party investors any loans that do not constitute Portfolio ARM Loans shortly after they are funded, generally within 30 to 60 days.

The Company had loan purchase commitments from third party investors for approximately $2.1 billion and $2.3 billion, as of September 30, 2006 and December 31, 2005, respectively. Substantially all loans held for sale at September 30, 2006 and December 31, 2005 were subsequently sold to third party investors. Substantially all mortgage loans held for sale are pledged as collateral for warehouse lines payable (See Note 6).

As of September 30, 2006 and December 31, 2005, the Company had aggregate locked pipeline commitments to fund mortgage loans held for sale of $2.6 billion and $2.3 billion, respectively.

NOTE 4 — DERIVATIVES AND HEDGING ACTIVITIES

The Company is exposed to interest rate risk in conjunction with the origination, funding, sale and investment in mortgage loan assets. The Company manages the risk of interest rate changes primarily through the use of derivative instruments as follows:

•  Fair value hedges, which are intended to manage the risks associated with potential changes in the fair value of loans held for sale; and
•  Cash flow hedges, which are intended to manage the risks associated with potential changes in the Company's financing costs.

In connection with its mortgage loan origination activities, MortgageIT issues IRLCs to loan applicants and financial intermediaries. The IRLCs guarantee the loan terms, subject to credit

19




approval, for a specified period while the application is in process, typically between 15 and 60 days. MortgageIT's risk management objective is to protect earnings from an unexpected change in the fair value of IRLCs by economically hedging the estimated closed loan volume from the IRLC pipeline. MortgageIT's pipeline hedging strategy primarily utilizes TBA Securities to protect the value of its IRLCs. The TBA Securities, options on TBA Securities, forward sales commitments and IRLCs relating to mortgage loans held for sale, are derivative instruments and have been classified as such by the Company. Accordingly, these derivatives have been recorded at fair value with changes in fair value reflected in gain on sale of loans.

At September 30, 2006 and December 31, 2005, the notional amount of the Company's IRLCs relating to mortgage loans held for sale, was approximately $1.65 billion and $1.59 billion, respectively. The fair value of the IRLCs at September 30, 2006 and December 31, 2005 reflected a gain of approximately $8.4 million and $5.8 million, respectively.

At September 30, 2006 and December 31, 2005, the notional amount of TBA Securities and options on TBA Securities outstanding was approximately $1.30 billion and $1.03 billion, respectively, with a fair value loss of approximately $1.6 million and approximately $2.9 million, respectively.

At September 30, 2006 and December 31, 2005, the notional amount of the Company's forward sales commitments with third party investors was approximately $2.4 billion and $1.8 billion, respectively, with a fair value loss of approximately $3.1 million and approximately $4.6 million, respectively.

Fair Value Hedges

The Company is exposed to interest rate risk in conjunction with the sale of mortgage loans. The Company manages the risk of interest rate changes associated with its loans held for sale through use of TBA Securities, options on TBA Securities, forward sale commitments and Eurodollar futures contracts. These derivative instruments are designed to hedge potential changes in the fair value of loans held for sale.

The fair value adjustments for IRLCs, TBA Securities, options, forward sales commitments and Eurodollar futures contracts are included in gain on sale of mortgage loans.

Cash Flow Hedges

The Company primarily utilizes Eurodollar futures contracts, interest rate cap agreements (‘‘Cap Agreements’’) and interest rate swap agreements (‘‘Swap Agreements’’) in order to manage potential changes in future LIBOR-based financing costs. The Company generally borrows funds based on short-term LIBOR-based interest rates to finance its Portfolio ARM Loans. However, its Portfolio ARM Loans have an initial fixed interest rate period up to five years. As a result, the Company's existing and forecasted borrowings reprice to a new rate more frequently than its Portfolio ARM Loans. Therefore, the purpose of these hedges is to better match the average repricing of the variable rate debt with the average repricing of the Portfolio ARM Loans.

All changes in the fair value of derivatives designated as cash flow hedges, (Cap Agreements, Swap Agreements and the effective portion of the Eurodollar futures contracts), are recorded in OCI on the consolidated balance sheets and will be recognized as net interest income when the forecasted financing transactions occur. If it becomes probable that the forecasted transaction, which is the future interest payments on the Company's collateralized debt obligations, will not occur as specified at the inception of the hedging relationship, then the related gain or loss in OCI would be reclassified out of OCI and recognized in interest expense. The carrying value of these derivative instruments is included in hedging instruments on the accompanying consolidated balance sheets.

The Company purchases Cap Agreements by incurring a one-time fee or premium. Pursuant to the terms of the Cap Agreements, the Company will receive cash payments if the interest rate index specified in the Cap Agreements increases above contractually specified levels. Therefore, such Cap Agreements have the effect of capping the interest rate on a portion of the Company's borrowings at a level specified by the Cap Agreement. The notional balances of the caps generally decline over the life of these instruments approximating the declining balance of the Company's collateralized debt obligations.

20




Under the Company's existing Cap Agreements, the Company will receive cash payments should one-month LIBOR increase above the contract rates of the caps, which range from 3.00% to 6.02%. The Cap Agreements had an average maturity of 4.87 years as of September 30, 2006 and will expire between August 2007 and June 2014.

The Company enters into Swap Agreements to fix the interest rate on a portion of the Company's borrowings as specified in the Swap Agreement. When the Company enters into a Swap Agreement, it agrees to pay a fixed interest rate as specified in the agreement, typically based on LIBOR. Swap Agreements have the effect of converting the Company's variable-rate debt into fixed-rate debt over the life of the Swap Agreements.

Both Cap and Swap Agreements represent a means to lengthen the average repricing period of the Company's variable-rate collateralized debt obligations such that the average repricing duration of the borrowings more closely matches the average repricing duration of the Company's Portfolio ARM Loans.

The Company uses Eurodollar futures contracts to hedge both forecasted and recognized LIBOR-based borrowings. When LIBOR-based interest rates change, the change in the value of Eurodollar futures contracts can be expected to approximately offset the change in LIBOR-based funding costs.

The following table presents notional amount, carrying amount and realized and unrealized gains and (losses) recorded in OCI for the Company's cash flow hedges at September 30, 2006 and December 31, 2005. The carrying amount of the cash flow derivative instruments is included in hedging instruments in the accompanying balance sheets.


  September 30, 2006 (unaudited)
  Notional
Amount
Carrying
Amount
Net Gain
(Loss)
  (Dollars in thousands)
Eurodollar futures contracts $ 1,200,000   $ (602 )  $ 522  
Cap agreements 4,203,632   29,366   (402 ) 
Swap agreements 503,747   8,836   8,701  
Total cash flow hedges $ 5,907,379   $ 37,600   $ 8,821  

  December 31, 2005
  Notional
Amount
Carrying
Amount
Net Gain
(Loss)
  (Dollars in thousands)
Eurodollar futures contracts $ 4,141,000   $ 469   $ (3,627 ) 
Cap agreements 3,971,027   31,524   6,801  
Swap agreements 596,463   11,264   10,999  
Total cash flow hedges $ 8,708,490   $ 43,257   $ 14,173  

As of September 30, 2006, the net gain in OCI was approximately $8.8 million. The Company estimates that, over the next twelve months, approximately $2.2 million of this net gain will be reclassified from OCI to net interest income.

NOTE 5 — REMIC SECURITIZATION

In November 2005, MortgageIT completed its first REMIC securitization, whereby a pool of ARM loans totaling approximately $388 million was securitized and sold to the public. The Company retained the mortgage servicing rights and retained approximately $24.3 million in mortgage-backed securities created in the transaction.

The available for sale mortgage-backed securities consist of the Company’s investment in the interest-only, prepayment penalty and other subordinated securities that the trust issued. The unrealized losses and estimated fair value of the available for sale mortgage-backed securities as of

21




September 30, 2006 and December 31, 2005, are approximately $632,000 and $21.0 million, and $948,000 and $23.4 million, respectively.

MortgageIT records mortgage servicing rights arising from the sale of loans in the REMIC securitization. The carrying value of mortgage servicing rights and the estimated fair value of the servicing rights as of September 30, 2006 and December 31, 2005, are approximately $2.5 million and $2.9 million, and $2.5 million and $2.6 million, respectively.

In February 2006, MortgageIT completed its second REMIC transaction, which was structured to qualify as a financing and, as such, is included in collateralized debt obligations, discussed below.

NOTE 6 — BORROWINGS

Collateralized Debt Obligations

In the February 2006 REMIC securitization, the Company issued, through a trust, AAA and AA-rated floating-rate pass-through certificates totaling $723.0 million and A-rated subordinated floating-rate securities totaling $10.1 million to third party investors, and retained $33.3 million of subordinated certificates, which provide credit support to the higher-rated certificates.

In addition, through December 31, 2005, the Company had issued AAA/AA-rated floating-rate pass-through certificates totaling $5.25 billion and A+/BBB+ subordinated floating-rate securities totaling $55.1 million to third party investors and retained $112.2 million of subordinated certificates, which provide credit support to the higher-rated certificates that were placed with third party investors. The interest rates on the floating-rate pass-through certificates reset monthly and are indexed to one-month LIBOR.

In connection with the issuance of these mortgage-backed securities, which are also referred to as collateralized debt obligations, the Company incurred costs of $17.7 million through September 30, 2006. These costs are being amortized over the expected life of the securities using the level yield method. These transactions were accounted for as financings of loans and represent permanent financing that is not subject to margin calls. The Company's collateralized debt obligations are issued by trusts and are secured by ARM loans deposited into the trust. For financial reporting and tax purposes, the trusts' ARM loans held as collateral are recorded as assets of the Company and the issued mortgage-backed securities are recorded as collateralized debt obligations.

The mortgage-backed securities were collateralized by ARM loans with a principal balance of $4.6 billion, as of both September 30, 2006 and December 31, 2005. The debt matures between 2033 and 2036 and is callable by the Company at par anytime after the total balance of the loans collateralizing the debt is amortized down to 20%, or 10% for the February 2006 REMIC securitization, of the original unpaid balance. The balance of this debt is reduced as the underlying loan collateral is paid down by borrowers and is expected to have an average life of approximately 2.5 years.

Repurchase Agreements

The Company had $94.7 million and $87.1 million outstanding under repurchase agreements with a weighted average borrowing rate of approximately 5.5% and 3.5% and a weighted average remaining maturity of 25 days and 26 days as of September 30, 2006 and December 31, 2005, respectively.

Junior Subordinated Debentures

During March 2006, MortgageIT issued approximately $51.5 million of junior subordinated debentures (the ‘‘2006 Debentures’’). The 2006 Debentures were issued to a trust subsidiary of MortgageIT in order to fund such trust's obligations with respect to an aggregate of $50 million of trust preferred securities which were issued by such trust subsidiary. The 2006 Debentures are floating-rate and bear a variable interest rate of 360 basis points above 3-month LIBOR, paid quarterly, and mature in 2036. They are redeemable, by MortgageIT, at par, after five years and at a premium to par in certain

22




limited circumstances over the first five years. In connection with the issuance of the 2006 Debentures, the Company incurred costs of $1.5 million. These costs are being amortized over the expected life of the 2006 Debentures using the interest method.

During April and May 2005, MortgageIT issued an aggregate of approximately $77.3 million of junior subordinated debentures (the ‘‘2005 Debentures’’). The 2005 Debentures were issued to trust subsidiaries of MortgageIT in order to fund such trust's obligations with respect to an aggregate of $75 million of trust preferred securities which were issued by such trust subsidiary. The 2005 Debentures are floating-rate and bear a variable interest rate of 375 basis points above 3-month LIBOR, paid quarterly, and mature in 2035. They are redeemable, by MortgageIT, at par, after five years and at a premium to par in certain limited circumstances over the first five years. In connection with the issuance of the 2005 Debentures, the Company incurred costs of $2.5 million. These costs are being amortized over the expected life of the 2005 Debentures using the interest method.

As of September 30, 2006, the Company did not include in its consolidated financial statements the assets, liabilities and operations of the trust subsidiaries pursuant to FASB Interpretation No. 46 (revised December 2003), ‘‘Consolidation of Variable Interest Entities’’ (‘‘FIN 46R’’). As of September 30, 2006 and December 31, 2005, the Company recorded its investment in the trust subsidiaries, of approximately $3.8 and $2.3 million, respectively, in prepaids and other assets in the accompanying consolidated balance sheets.

Warehouse Lines Payable

As of September 30, 2006, the Company had eight warehouse credit facilities with major lenders that it used to fund mortgage loans. During October 2006, the Company’s warehouse credit facilities with JPMorgan Chase Bank, National Association, Greenwich Capital Financial Products Inc. and Residential Funding Corporation expired according to their terms.

In May 2006, the Company entered into a warehouse credit facility with Bank of America, N.A., for a noncommitted credit limit of $1.0 billion. Under the line, outstanding advances are secured by the specific mortgage loans funded, and bear interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006, there were no outstanding borrowings on the line. This credit facility expires in May 2007.

In July 2006, the Company entered into a warehouse credit facility with DB Structured Products, Inc., an indirect subsidiary of Deutsche Bank AG, (‘‘DB Structured Products’’) for a committed credit limit of $5.0 billion. Under the line, outstanding advances are secured by the specific mortgage loans funded, and bear interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006, the Company had approximately $3.0 billion outstanding on this facility. This credit facility expires in July 2007. On July 11, 2006, the Company entered into a definitive agreement to be acquired by DB Structured Products, which is described more fully in Note 13.

The Company maintains a warehouse credit facility with Credit Suisse First Boston Mortgage Capital LLC for an uncommitted credit limit of $750 million. Under the line, outstanding advances are secured by the specific mortgage loans funded, and bear interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006 and December 31, 2005, the Company had outstanding approximately $147.9 million and $384.1 million, respectively, on this facility. This credit facility expires in December 2006.

The Company maintains a warehouse credit facility with Merrill Lynch Bank USA, which has a partially committed credit limit of $1.25 billion. Under the line, outstanding advances are secured by the specific mortgage loans funded, and bear interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006 and December 31, 2005, the Company had outstanding approximately $107.0 million and $1.1 billion, respectively, on this facility. This credit facility expires in December 2006.

The Company maintains a credit facility (the ‘‘UBS Warehouse Facility’’) with UBS Real Estate Securities, Inc. (‘‘UBS’’), for an uncommitted credit limit of $2.0 billion, which includes a mortgage loan sale conduit facility. The Company has no outstanding borrowing on this line and does not expect

23




to have any additional borrowings on this line, and expects to terminate it in November 2006. The facility provides for temporary increases in the line amount on an as-requested basis. Under the UBS Warehouse Facility, outstanding advances are secured by the specific mortgage loans funded and bear interest at LIBOR plus a spread based on the types of loans being funded. Interest is payable at the time the outstanding principal amount of the advance is due, generally within 30 to 60 days. As of September 30, 2006, there were no outstanding borrowings on the line. As of December 31, 2005, the Company had outstanding approximately $589.0 million on this facility. Under the conduit facility, the Company sells mortgage loans to UBS at a price equal to the committed purchase price from a third party investor, and records the transaction as a sale in accordance with SFAS No. 140. UBS, in turn, sells the loan to a third party investor. The Company facilitates the sale to the third party investor on behalf of UBS and receives a performance fee that varies depending on the time required by UBS to complete the transfer of the loans to the third party investor. The performance fee of $43,000, $2.3 million, $1.6 million and $3.7 million for the three and nine months ended September 30, 2006 and 2005, respectively, is included in brokerage revenue on the statement of operations. As of September 30, 2006, there were no loans on the conduit line. Loans on the conduit line, which totaled approximately $1.1 billion at December 31, 2005, reduced availability under the facility until they were transferred to the third party investor by UBS. The mortgage loans sold to UBS are subject to repurchase under certain limited conditions, primarily if UBS determines that a mortgage loan was not properly underwritten.

The Company maintained a warehouse credit facility with JPMorgan Chase Bank, National Association, which expired in October 2006, for a noncommitted credit limit of $500 million. Under the line, outstanding advances were secured by the specific mortgage loans funded, and bore interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006, there were no outstanding borrowings on the line. As of December 31, 2005, the Company had outstanding approximately $153.4 million on this facility.

The Company maintained a warehouse credit facility with Greenwich Capital Financial Products Inc., which expired in October 2006, for an uncommitted credit limit of $750 million. Under the line, outstanding advances were secured by the specific mortgage loans funded, and bore interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006, there were no outstanding borrowings on the line. As of December 31, 2005, the Company had outstanding approximately $485.6 million on this facility.

The Company maintained a credit facility with Residential Funding Corporation, which expired in October 2006, for a committed credit limit of $54 million, collateralized by the specific mortgage loans funded, and bore interest at LIBOR plus a spread based on the types of loans being funded. As of September 30, 2006 and December 31, 2005, the Company had outstanding approximately $21.3 million and $510.1 million, respectively, on this facility.

The weighted average effective rate of interest for borrowings under all warehouse lines of credit was approximately 5.9% and 4.3% for the nine months ended September 30, 2006 and the year ended December 31, 2005, respectively.

Substantially all mortgage loans held for sale have been pledged as collateral under the warehouse credit facilities described above. In addition, the facilities contain various financial covenants and restrictions, including a requirement that the Company maintain specified leverage ratios and net worth amounts. The Company was not in compliance with a covenant contained in one of its warehouse credit facilities as of July 31, 2006 and August 31, 2006, for which waivers have been obtained. No assurance can be made that the Company's lenders will waive future covenant violations, if violations occur.

24




Maturities of borrowings are as follows at September 30, 2006 (Dollars in thousands):


  Payments due by Period
  (unaudited)
  Total Less than
1 year
1-3 years 3-5 years More than
5 years
Collateralized debt obligations(1) $ 4,442,590   $ 953,440   $ 1,854,135   $ 1,555,977   $ 79,038  
Warehouse lines payable 3,318,868   3,318,868        
Repurchase agreements 94,692