BIMINI CAPITAL MANAGEMENT, INC. - Quarter Report: 2006 March (Form 10-Q)

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Mortgage Loans Held for Sale— Mortgage loans held for sale represent mortgage loans originated and held pending sale to investors. The mortgages are carried at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. Deferred net fees or costs are not amortized during the period the loans are held for sale, but are recognized when the loan is sold.

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Mortgage Servicing Rights— the estimated fair value of MSRs is determined by obtaining a market valuation from a specialist who brokers MSRs. To determine the market valuation, the broker uses a valuation model which incorporates assumptions relating to the estimate of the cost of servicing per loan, a discount rate, a float value, an inflation rate, ancillary income per loan, prepayment speeds, and default rates that market participants use for acquiring similar servicing rights.

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Interest Rate Lock Commitments—The fair value of interest rate lock commitments is estimated using the fees and rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter-parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

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Commitments to Deliver Mortgages—The fair value of these instruments is estimated using current market prices for dealer or investor commitments relative to the Company’s existing positions. These instruments contain an element of risk in the event that the counter-parties may be unable to meet the terms of such agreements. In the event a counter-party to a delivery commitment was unable to fulfill its obligation, the Company would not incur any material loss by replacing the position at market rates in effect at March 31, 2006. The Company minimizes its risk exposure by limiting the counter-parties to those major banks, investment bankers, and private investors who meet established credit and capital guidelines. Management does not expect any counter-party to default on its obligations and, therefore, does not expect to incur any loss due to counter-party default.

 

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

 

When used in this quarterly report, on Form 10-Q, in future filings with the Commission or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” and similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”), and, as such, may involve known and unknown risks, uncertainties and assumptions.

 

These forward-looking statements are subject to various risks and uncertainties, including, but not limited to, those relating to: changes in the prepayment rates on the mortgage loans securing Opteum’s mortgage backed securities (“MBS”); changes in interest rates and the market value of Opteum’s MBS, Opteum’s ability to use borrowings to finance its assets; changes in government regulations affecting Opteum’s business; Opteum’s ability to maintain its qualification as a Real Estate Investment Trust (“REIT”) for federal income tax purposes; and changes in business conditions and the general economy. These and other risks, uncertainties and factors, including those described in reports that Opteum files from time to time with the Commission, could cause Opteum’s actual results to differ materially from those projected in any forward-looking statements it makes. All forward-looking statements speak only as of the date they are made and Opteum does not undertake, and specifically disclaims, any obligation to update or revise any forward-looking statements to reflect events or circumstances occurring after the date of such statements.

The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.

Introduction and Overview

Opteum Inc., formerly Bimini Mortgage Management, Inc., was formed in September 2003 to invest primarily in but not limited to, residential mortgage related securities issued by the Federal National Mortgage Association (more commonly known as Fannie Mae), the Federal Home Loan Mortgage Corporation (more commonly known as Freddie Mac) and the Government National Mortgage Association (more commonly known as Ginnie Mae). Opteum earns returns on the spread between the yield on its assets and its costs, including the interest expense on the funds it borrows. It generally intends to borrow between eight and twelve times the amount of its equity capital to attempt to enhance its returns to stockholders. Our leverage may be adjusted above or below this range to the extent management or our board deems necessary. For purposes of this calculation, Opteum treats its trust preferred securities as an equity capital equivalent. Opteum is self-managed and self-advised.

In evaluating its assets and their performance, Opteum’s management team primarily evaluates these critical factors: asset performance in differing interest rate environments, duration of the security, yield to maturity, potential for prepayment of principal, and the market price of the investment.

On September 29, 2005, Opteum executed a definitive merger agreement with Opteum Financial Services, LLC (“OFS”), a privately held home mortgage lender headquartered in Paramus, New Jersey. OFS has approximately 1,000 associates operating out of 35 offices and lending in 46 states. The transaction, in which OFS became a wholly-owned taxable REIT subsidiary (“TRS”) of Opteum, closed on November 3, 2005. OFS acquires and originates mortgages that are either sold to third parties or securitized by a wholly-owned special purpose entity Opteum Mortgage Acceptance Corporation (“OPMAC”). OFS services the mortgages securitized by OPMAC.

Critical Accounting Policies

Opteum’s accounting policies are described in Note 1 to the Consolidated Financial Statements. Opteum has identified the following accounting policies that are critical to the presentation of our financial statements and that require critical accounting estimates by management.

Opteum’s financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These accounting principles require Opteum to make some complex and subjective decisions and assessments. Its most critical accounting policies involve decisions and assessments which could significantly affect its reported assets and liabilities, as well as its reported revenues and expenses. Opteum believes that all of the decisions and assessments upon which its financial statements are based were reasonable at the time made based upon information available to it at that time. Management has identified its most critical accounting policies to be the following:

Mortgage Backed Securities

Opteum’s investments in MBS are classified as available-for-sale securities. As a result, changes in fair value are recorded as a balance sheet adjustment to accumulated other comprehensive income (loss), which is a component of stockholders' equity, rather than through the statement of operations. If available-for-sale securities were classified as trading securities, there could be substantially greater volatility in earnings from period-to-period.

Valuations of Opteum’s MBS are carried on the balance sheet at fair value. Statement of Financial Accounting Standards (“SFAS”) No. 107, Disclosures about the Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. Opteum’s mortgage backed securities have fair values determined by management based on the average of third-party broker quotes received and/or by independent pricing sources when available. Because the price estimates may vary to some degree between sources, management must make certain judgments and assumptions about the appropriate price to use to calculate the fair values for financial reporting purposes. Different judgments and assumptions could affect the amounts Opteum could realize in a current market exchange.

When the fair value of an available-for-sale security is less than amortized cost, management considers whether there is an other-than-temporary impairment in the value of the security (for example, whether the security will be sold or repaid by the borrower prior to the recovery of fair value). If, in management's judgment, an other-than-temporary impairment exists, the cost basis of the security is written down to the then-current fair value, and this loss is realized and charged against earnings. The determination of other-than-temporary impairment is a subjective process, and different judgments and assumptions could affect the timing of loss realization.

The decline in fair value of investments held in the portfolio at March 31, 2006 is not considered to be other-than- temporary. Accordingly, the write down to fair value is recorded in other comprehensive loss as an unrealized loss (see Note 1 to the financial statements). The factors considered in making this determination included the expected cash flow from the investment and the magnitude and duration of the historical decline in market prices, as well as Opteum's capacity and intention to hold such securities owned.

Interest income on mortgage related securities is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective yield method adjusted for the effects of estimated prepayments based on SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases; an amendment of Financial Accounting Standards Board (“FASB”) Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17. Adjustments are made using the retrospective method to the effective interest computation each reporting period based on the actual prepayment experiences to date and the present expectation of future prepayments of the underlying mortgages. To make assumptions as to future estimated rates of prepayments, Opteum currently uses actual market prepayment history for the securities it owns and for similar securities that Opteum does not own and current market conditions. If the estimate of prepayments is incorrect; Opteum is required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.

Mortgage Loans Held for Sale

Mortgage loans held for sale represent mortgage loans originated and held pending sale to investors. The mortgages are carried at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. OFS generally sells or securitizes loans with servicing rights retained. Gains or losses on such sales are recognized at the time legal title transfers to the investor based upon the difference between the sales proceeds from the final investor and the allocated basis of the loan sold, adjusted for net deferred loan fees and certain direct costs and selling costs. OFS defers net loan origination costs and fees as a component of the loan balance on the balance sheet. Such costs are not amortized and are recognized into income as a component of the gain or loss upon sale.

Valuation Allowance

A valuation allowance is maintained to adjust mortgage loans held for sale to the lower of cost or market.

Retained Interest, Trading

OFS uses warehouse loan arrangements to finance the origination and purchase of pools of principally fixed and adjustable-rate residential first mortgage loans (the “Mortgage Loans”). Subsequent to their origination or purchase, OFS either sells these loans to third party institutional investors through bulk sale arrangements or through securitization transactions. OFS generally makes several representations and warranties regarding the performance of the Mortgage Loans in connection with each sale or securitization. OFS accumulates the desired amount of Mortgage Loans and securitizes them in order to create marketable securities.

OFS, pursuant to a purchase and sale agreement, transfers the Mortgage Loans to OPMAC, a wholly-owned special purpose entity set-up for the execution of these securitizations.

 

OPMAC then sells the Mortgage Loans to an institutional third party to serve as Depositor, pursuant to a Mortgage Loan Purchase and Servicing Agreement (“P&S Agreement”). Under this P&S Agreement, OFS makes general representations and warranties for Mortgage Loans sold by OFS.

 

The Depositor then deposits the Mortgage Loans into the Real Estate Mortgage Investment Conduit trust (“REMIC”) where the rights to such Mortgage Loans are pooled and converted into marketable debt securities pursuant to the P&S Agreement. These securities, issued by the REMIC, are divided into different classes of certificates (the “Certificates”) with varying claims to payments received on the Mortgage Loans. These Certificates are transferred to the depositor in exchange for all of its rights in the Mortgage Loans deposited into the REMIC.

 

Certain Certificates are rated by Moody’s Investors Service, Inc. (“Moody’s”) and Standard & Poor’s (“S&P”). In all of the securitizations, all of the senior certificate classes were rated “AAA” by S&P and “Aaa” by Moody’s, respectively. In addition, most of the mezzanine classes of certificates, starting with Class M-1 through the lowest respective subordinate class for each offering, with each lower numerical class designation being subordinated to the previous designation, were each given investment grade ratings. The subordinate classes not given an investment grade rating were sold through a Private Placement Offering Memorandum. Certain of these Certificates are offered to the public (the “Public Certificates”) pursuant to a prospectus. These Public Certificates are sold to underwriters on the closing date pursuant to an underwriting agreement. The proceeds from the sale of the Public Certificates to the underwriters (less an underwriting discount) and the remaining non-publicly offered Certificates are transferred to OFS as consideration for the Mortgage Loans sold to the depositor pursuant to the P&S Agreement.

 

Finally, OFS transfers the proceeds from the sale of the Public Certificates and the non-publicly offered Certificates representing the residual interest in the REMIC to OPMAC pursuant to the Purchase and Sale Agreement. The additional non-publicly offered Certificates, representing prepayment penalties and overcollateralization fundings (the “Underlying Certificates”) are held by OPMAC in anticipation of a net interest margin (“NIM”) securitization. Subsequent to a securitization transaction as described above, OFS executes an additional securitization or “resecuritization” of the Underlying Certificates being held by OPMAC. This NIM securitization is typically transacted as follows:

 

OPMAC deposits the Underlying Certificates into a trust (the “NIM Trust”) pursuant to a deposit trust agreement. The NIM Trust is a Delaware statutory trust. The NIM trust, pursuant to an Indenture, issues (i) notes (the “NIM Notes”) representing interests in the Underlying Certificates and (ii) an owner Trust Certificate representing the residual interest in the NIM trust. The NIM Notes are sold to third parties via private placement transactions, and the Trust Certificate is transferred from OPMAC to OFS in consideration for the deposit of the Underlying Certificates.

 

Securities Held for Sale

Securities held for sale are recorded as of the date of purchase or sale at fair value. Changes in fair value subsequent to the purchase date are reflected in earnings as gains and losses from investments. Realized gains and losses are determined on a specific identified basis cost basis.

Mortgage Servicing Rights

OFS recognizes mortgage servicing rights (“MSR”) as assets when separated from the underlying mortgage loans, upon the sale of the loans. Upon sale of a loan, OFS measures the retained MSRs by allocating the total cost of originating a mortgage loan between the loan and the servicing right based on their relative fair values. Gains or losses on the sale of MSRs are recognized when title and all risks and rewards have irrevocably passed to the buyer and there are no significant unresolved contingencies.

 

In March 2006 the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets ("SFAS 156"). SFAS 156 amends SFAS 140 with respect to the accounting for separately-recognized servicing assets and liabilities. SFAS 156 requires all separately-recognized servicing assets and liabilities to be initially measured at fair value, and permits companies to elect, on a class-by-class basis, to account for servicing assets and liabilities on either a lower of cost or market value basis or a fair value measurement basis. Opteum elected to early adopt SFAS 156 as of January 1, 2006 and to measure all mortgage servicing assets at fair value (and as one class). Servicing assets and liabilities at December 31, 2005 were accounted for at the lower of amortized cost or market value basis. As a result of adopting SFAS 156, Opteum recognized a $2.6 million after-tax increase ($4.1 million pre-tax) to opening retained earnings as of January 1, 2006, representing the effect of re-measuring all servicing assets and liabilities that existed at December 31, 2005 from a lower of amortized cost or market basis to a fair value basis.

Prior to the election by OFS to adopt a new MSR valuation model, an independent third party was hired to perform the valuation. In conjunction with the early adoption of SFAS 156, the Company intends to actively hedge the MSR position. In order to hedge this position effectively, management believed utilizing the same model to value the MSRs and perform sensitivity analysis would ensure the best hedging results. Accordingly, management has elected to utilize an internal model for valuation purposes. The new model employs somewhat more conservative assumptions than that of the independent third party model, resulting in a downward fair value adjustment of approximately $1.1 million.

 

Fair value is estimated based on expected cash flows considering market prepayment estimates, historical prepayment rates, portfolio characteristics, interest rates, and other economic factors.

 

Derivative Assets and Derivative Liabilities

OFS’s mortgage committed 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. Effective with the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, OFS classifies and accounts for the IRLCs as freestanding derivatives. Accordingly, IRLCs are recorded at their fair value with changes in fair value recorded to current earnings. OFS uses other derivative instruments to economically hedge the IRLCs, which are also classified and accounted for as freestanding derivatives.

 

OFS’s risk management objective for its mortgage loans held for sale includes use of mortgage forward delivery contracts designed as fair value derivative instruments to protect earnings from an unexpected change due to a decline in value. Effective with the adoption of SFAS No. 133, OFS’s mortgage forward delivery contracts are recorded at their fair value with changes in fair value recorded to current earnings.

 

IRLCs and derivative assets or liabilities arising from OFS’s derivative activities are included in either receivables or accounts payable and accrued liabilities in the accompanying consolidated financial statements. OFS also evaluates its contractual arrangements, assets and liabilities for the existence of embedded derivatives.

Income Recognition

Interest income and interest expense are recognized as earned. Loans are placed on a nonaccrual status when concern exists as to the ultimate collectibility of principal or interest. Loans return to accrual status when principal and interest become current and are anticipated to be fully collectible.

 

Gains on Sales of Mortgage Assets

OFS recognizes gain (or loss) on the sale of loans.  Gains or losses on such sales are recognized at the time legal title transfers to the investor based upon the difference between the sales proceeds from the final investor and the allocated basis of the loan sold, adjusted for net deferred loan fees and certain direct costs and selling costs. OFS defers net loan origination costs and fees as a component of the loan balance on the balance sheet. Such costs are not amortized and are recognized into income as a component of the gain or loss upon sale.

 

Servicing Fee Income

Servicing fee income is generally a fee based on a percentage of the outstanding principal balances of the mortgage loans serviced by OFS (or by a subservicer where OFS is the master servicer) and is recorded as income as the installment payments on the mortgages are received by OFS or the subservicer. 

Loan Origination Fees and Costs

 

Loan fees, discount points, and certain direct origination costs are recorded as an adjustment of the cost of the loan and are included in gain on sales of loans when the loan is sold. Accordingly, salaries, commissions, benefits and other operating expenses have been reduced by $16.0 million during the period ended March 31, 2006, due to direct loan origination costs, including commission costs. Loan fees related to the origination and funding of mortgage loans held for sale were $1.6 million during the period ended March 31, 2006.

 

Accounting for Stock-Based Compensation

Stock-based compensation is accounted for using the fair value based method prescribed by SFAS No. 123(R), Share-Based Payments. For stock and stock-based awards issued to employees, a compensation charge is recorded against earnings based on the fair value of the award. For transactions with non-employees in which services are performed in exchange for Opteum's common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date of issuance.

Income Taxes

Opteum has elected to be taxed as a REIT under the Code. As further described below, the Company’s TRS is a taxpaying entity for income tax purposes, and is taxed separately from Opteum. Opteum will generally not be subject to federal income tax on its net taxable income to the extent that Opteum distributes its net taxable income to its stockholders and satisfies the ongoing REIT requirements including meeting certain asset, income and stock ownership tests. A REIT must generally distribute at least 90% of its net taxable income to its stockholders of which 85% must be distributed within the taxable year in order to avoid the imposition of an excise tax. The remaining balance may be distributed up to the timely filing date of the REIT’s tax return in the subsequent taxable year, provided the rEIT elects to treat such amount as a prior year distribution and meets certain other requirements.

OFS is the Company’s TRS, and its activities are subject to corporate income taxes, and the applicable provisions of SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Financial Condition

All of Opteum’s assets at March 31, 2006 were acquired with the proceeds of private placements and public offerings of Class A Common Stock, private placements of junior subordinated debt (trust preferred securities) and the use of leverage. Opteum received net proceeds after offering costs of approximately $141.7 million in the private placements, which closed on December 19, 2003, January 30, 2004 and February 17, 2004. Opteum received net proceeds of approximately $66.1 million in the initial public offering, which closed on September 21, 2004. On September 24, 2004 Opteum received an additional $9.8 million of net proceeds pursuant to the underwriters' exercise of their over-allotment option. Opteum received net proceeds of approximately $66.7 million (including the underwriters’ exercise of their over-allotment option) in a secondary public offering of Class A Common Stock which closed on December 21, 2004. Opteum received total net proceeds of approximately $48.5 million from the privately placed issuance of trust preferred securities of Bimini Capital Trust I on May 17, 2005. Opteum received total net proceeds of approximately $48.5 million from the privately placed issuance of trust preferred securities of Bimini Capital Trust II in October 2005, the proceeds of which were used to fund the loan to OFS.

 

Mortgage Related Securities

At March 31, 2006, Opteum held $3.5 billion of agency or government mortgage related securities at fair value in Opteum’s portfolio. Opteum’s portfolio of mortgage related securities will typically be comprised of adjustable-rate mortgage backed securities, fixed-rate mortgage backed securities, hybrid adjustable-rate mortgage backed securities and balloon maturity mortgage backed securities. Opteum seeks to acquire low duration assets that offer high levels of protection from mortgage prepayments. Although the duration of an individual asset can change as a result of changes in interest rates, Opteum plans to maintain a portfolio with an effective duration of less than 2.0. The stated contractual final maturity of the mortgage loans underlying Opteum’s portfolio of mortgage related securities generally ranges up to 30 years. However, the effect of prepayments of the underlying mortgage loans tends to shorten the resulting cash flows from Opteum’s investments substantially. Prepayments occur for various reasons, including refinancings of underlying mortgages and payoffs associated with sales of the underlying homes as people move. At March 31, 2006, Opteum’s TRS, OFS, owned $721.6 million of mortgage loans which were classified as mortgage loans held for sale. In addition, OFS owned approximately $105.2 million of residual interests in asset backed securities and $93.3 million of originated mortgage servicing rights. On going, it will be the intention of OFS to either sell the loans held for sale to a third party investor or issue asset backed securities with the mortgages on the OPMAC shelf. The period of time between issuing securities on the OPMAC shelf will typically be one full quarter, although market conditions may cause management to vary its issuance timing. In addition to general market conditions, prepayments, delinquencies, or defaults on these mortgage loans held for sale may affect the value of these loans in the future.

For the three months ended March 31, 2006, Opteum had consolidated interest income of $60.7 million and consolidated interest expense of $56.2 million. As of March 31, 2006, Opteum’s portfolio of MBS had a weighted average yield on assets of 4.44% and a net weighted average borrowing cost of 4.54%. Prepayments on the loans underlying Opteum’s mortgage related securities can alter the timing of the cash flows from the underlying loans to the Company. As a result, Opteum gauges the interest rate sensitivity of Opteum’s assets by measuring their effective duration. While modified duration measures the price sensitivity of a bond to movements in interest rates, effective duration captures both the movement in interest rates and the fact that cash flows to a mortgage related security are altered when interest rates move. Accordingly, when the contract interest rate on a mortgage loan is substantially above prevailing interest rates in the market, the effective duration of securities collateralized by such loans can be quite low because of expected prepayments. Although some of the fixed-rate mortgage backed securities in Opteum’s portfolio are collateralized by loans with a lower propensity to prepay when the contract rate is above prevailing rates, their price movements track securities with like contract rates and therefore exhibit similar effective duration. The value of Opteum’s portfolio will change as interest rates rise or fall. See "Qualitative and Quantitative Disclosures about Market Risk—Interest Rate Risk—Effect on Fair Value."

The following tables summarize Opteum’s agency and government mortgage related securities as of March 31, 2006:

Asset Category		Market Value	Percentage of Entire Portfolio	Weighted Average Coupon	Weighted Average Maturity in Months	Longest Maturity	Weighted Average Coupon Reset in Months	Weighted Average Lifetime Cap	Weighted Average Periodic Cap
Adjustable-Rate Mortgage backed securities	$	2,005,867,897	56.7%	4.70%	331	1-Apr-44	3.92	10.43%	1.79%
Fixed-Rate Mortgage backed securities	$	715,618,090	20.2%	6.91%	277	1-Apr-36	n/a	n/a	n/a
Hybrid Adjustable-Rate Mortgage backed securities	$	770,860,599	21.8%	4.33%	336	1-Nov-35	17.43	9.89%	1.75%
Balloon Maturity Mortgage backed securities	$	46,207,624	1.3%	4.05%	45	1-Feb-11	n/a	n/a	n/a
Total Portfolio	$	3,538,554,210	100.0%	4.96%	312	1-Apr-44	7.67	10.28%	1.78%

Agency		Market Value	Percentage of Entire Portfolio
Fannie Mae	$	2,285,690,961	64.59%
Freddie Mac		676,176,953	19.11%
Ginnie Mae		576,686,296	16.30%
Total Portfolio	$	3,538,554,210	100.00%

Entire Portfolio
Effective Duration (1)		1.59
Weighted Average Purchase Price	$	102.49
Weighted Average Current Price	$	100.67

(1) Effective duration of 1.59 indicates that an interest rate increase of 1% would be expected to cause a 1.59% decline in the value of the securities in the portfolio.

As of March 31, 2006, approximately 49.5% of the portfolio of 15 year fixed-rate coupon mortgage securities, and 44.0% of the 30 year fixed-rate coupon mortgage securities, contain only loans with principal balances of $85,000 or less. Because of the low loan balance on these mortgages, Opteum believes borrowers have a lower economic incentive to refinance and have historically prepaid more slowly than comparable securities.

OFS held residual interests in twelve securitizations which contain loans originated or purchased by OFS prior to securitization. The total fair market value of these interests was approximately $105.2 million as of March 31, 2006. Prior to the acquisition of OFS, Opteum owned no residual interests in mortgage securitizations. It is expected that OFS will continue to hold residual interests in securitizations in the future.

OFS held originated mortgage servicing rights on approximately $8.4 billion in mortgages with a fair market value as of March 31, 2006 of approximately $93.3 million. Prior to the acquisition of OFS, Opteum owned no mortgage servicing rights. It is expected that OFS will continue to hold mortgage servicing rights in the future.

The table below shows the principal balance of Opteum’s investment securities, the net un-amortized premium, amortized cost of securities held, average cost expressed as a price, the fair market value of investments and the fair market value expressed as a price for the current quarter and each of the previous eight quarters for the portfolio of MBS securities only.  The data in the table below does not include information pertaining to OFS.

 

Quarter Ended		Principal Balance of Investment Securities Held		Unamortized Premium (Net)		Amortized Cost of Securities Held	Amortized Cost/Principal Balance Held		Fair Market Value of Investment Securities Held	Fair Market Value/Principal Balance Held
At March 31,2006	$	3,515,112,798	$	111,754,082	$	3,626,866,880	103.179	$	3,538,554,210	100.667
At December 31, 2005	$	3,457,891,363	$	112,635,825	$	3,570,527,188	103.257	$	3,494,029,359	101.045
At September 30, 2005	$	3,797,400,645	$	113,392,661	$	3,910,793,306	102.986	$	3,858,319,701	101.604
At June 30, 2005	$	3,784,668,467	$	114,672,670	$	3,899,341,137	103.030	$	3,876,205,996	102.419
At March 31, 2005	$	3,212,516,823	$	109,389,703	$	3,321,906,527	103.405	$	3,299,051,561	102.694
At December 31, 2004	$	2,876,319,085	$	97,753,097	$	2,974,072,182	103.399	$	2,973,232,897	103.369
At September 30, 2004	$	1,589,828,988	$	48,498,955	$	1,638,327,943	103.051	$	1,638,264,065	103.047
At June 30, 2004	$	1,479,500,209	$	38,033,673	$	1,517,533,882	102.571	$	1,508,421,270	101.955
At March 31, 2004	$	1,473,583,661	$	39,535,014	$	1,513,118,676	102.683	$	1,516,539,744	102.915

The Company had approximately $90.9 million of cash and cash equivalents as of March 31, 2006.

Liabilities

In May 2005, Opteum issued $51.5 million of trust preferred securities of Bimini Capital Trust I (“BCTI”). The interest rate on the BCTI trust preferred securities is fixed for the first five years at 7.61% and then floats at a spread of 3.30% over three-month LIBOR for the remaining 25 years. However, the trust preferred securities are redeemable at Opteum’s option at the end of the first five year period and at any subsequent date that Opteum chooses. In addition, in October 2005, Opteum issued an additional $51.5 million of trust preferred securities of Bimini Capital Trust II (“BCTII”). The interest rate on the BCTII trust preferred securities is fixed for the first five years at 7.8575% and then floats at a spread of 3.50% over three-month LIBOR for the remaining 25 years. However, the trust preferred securities are redeemable at Opteum’s option at the end of the first five year period and at any subsequent date that Opteum chooses. Opteum believes that the income generated from available investment opportunities, when the use of leverage is employed for the purchase of assets, will exceed the cost of the debt. However, the issuance of debt at a fixed rate for any long-term period, considering the use of leverage, could create an interest rate mismatch if Opteum is not able to invest at yields that exceed the cost of the trust preferred securities.

Opteum has entered into repurchase agreements to finance acquisitions of primarily agency and government mortgage related securities. None of the counter-parties to these agreements are affiliates of Opteum. These agreements are secured by the mortgage related securities and bear interest rates that are based on a spread to LIBOR. As of March 31, 2006, Opteum had 19 master repurchase agreements with various investment banking firms and other lenders and had outstanding balances under 15 of these agreements.

At March 31, 2006, Opteum had approximately $3.4 billion outstanding under repurchase agreements with a net weighted average borrowing cost of 4.54%, $1,644.3 million of which matures between two and 30 days, $1,142.5 million of which matures between 31 and 90 days, and $627.1 million of which matures in more than 90 days. It is Opteum’s present intention to seek to renew these repurchase agreements as they mature under the then-applicable borrowing terms of the counter-parties to our repurchase agreements. At March 31, 2006, the repurchase agreements were secured by mortgage related securities with an estimated fair value of $3.5 billion and a weighted average maturity of 312 months.

At March 31, 2006, Opteum’s repurchase agreements had the following counter-parties, amounts outstanding, amounts at risk and weighted average remaining maturities:

Repurchase Agreement Counter-parties		Amount Outstanding ($000)		Amount at Risk(1) ($000)	Weighted Average Maturity of Repurchase Agreements in Days	Percent of Total Amount Outstanding
Deutsche Bank Securities, Inc.	$	963,877	$	11,941	66	28.23	%
Nomura Securities International, Inc.		430,521		16,862	85	12.61
Washington Mutual		410,994		12,625	9	12.04
Bear Stearns & Co. Inc.		299,764		7,788	44	8.78
UBS Investment Bank, LLC		246,670		8,448	54	7.23
Cantor Fitzgerald		209,148		10,256	24	6.13
Goldman Sachs		170,567		4,645	50	5.00
Morgan Stanley		165,555		5,053	41	4.85
JP Morgan Securities		149,603		4,665	78	4.38
Merrill Lynch		112,255		4,129	55	3.29
RBS Greenwich Capital		94,053		2,631	55	2.75
BNP Paribas		67,430		1,993	8	1.98
Lehman Brothers		56,782		1,499	89	1.66
Daiwa Securities America Inc.		19,732		884	98	0.57
Countrywide Securities Corp		17,004		491	24	0.50
Total	$	3,413,955	$	93,910		100.00	%

(1) Equal to the fair value of securities sold, plus accrued interest income, minus the sum of repurchase agreement liabilities, plus accrued interest expense.

As of March 31, 2006, OFS had warehouse lines and aggregation lines of credit, used for the origination or purchase of mortgage loans, outstanding of approximately $679.2 million. At any given point in time, the dollar amount of loans held by OFS can be a high multiple of the amount of equity allocated to OFS. The warehouse lines and aggregation lines of credit enable OFS to originate or purchase loans and finance loans until they are sold in a timely and capital efficient manner. These borrowings leverage the equity capital at OFS. Functionally, OFS issues drafts or wires at loan settlement in order to facilitate the closing of mortgage loans held for sale. Drafts payable represent mortgage loans on which a closing has occurred prior to quarter end but the related drafts have not cleared the respective bank. Upon clearing the bank, the drafts are funded by the appropriate warehouse line of credit. Warehouse and aggregation lines of credit and loans sale agreements accounted for as financing consisted of the following at March 31, 2006:

 

Warehouse and aggregation lines of credit:		March 31, 2006
A committed warehouse line of credit for $100.0 million between the Company and Residential Funding Corporation ("RFC").	$	7,095,775
A committed warehouse line of credit for $284.5 million between the Company and Colonial Bank.		199,050,231
A committed warehouse line of credit for $150.0 million between the Company and JP Morgan Chase.		90,881,688
An Aggregation facility for $1.0 billion between the Company and Citigroup Global Markets Realty Inc. to aggregate loans pending securitization.		273,213,144
A $750.0 million purchase and security agreement among OFS and UBS Warburg Real Estate Securities, Inc. (“UBS Warburg”)		108,955,338
	$	679,196,176

 

OFS had other secured borrowings totaling $105.5 million that were collateralized by residual interests in securitizations and originated mortgage servicing rights. These borrowings are short-term and mature within 364 days. The outstanding balances on these lines of credit were as follows as of March 31, 2006:

   

		March 31, 2006
A committed working capital line of credit for $82.5 million between OFS and Colonial Bank	$	63,355,607
A committed warehouse line of credit for $150.0 million between OFS and JP Morgan Chase		7,710,000
Citigroup Global Realty Inc., working capital line of credit secured by the retained interests in securitizations through OPMAC 2005-4		34,386,512
	$	105,452,119

Opteum has lent to OFS $65.0 million (long term) and $8.8 million (short term) for a total of $73.8 million to use for general operating purposes. OFS pays Opteum interest at an annual rate of 11.0%, payable semi-annually, on the long term loan, which matures on November 1, 2015 and 11.0% on the short term loans. The amounts under this arrangement were eliminated in preparation of the consolidated financial statements.

Equity

 

Accumulated other comprehensive loss, as reflected in stockholders’ equity, increased approximately $11.8 million from December 31, 2005 to March 31, 2006.  This is reflective of an overall decline in the fair value of Opteum’s portfolio as compared to the original aggregate purchase price of the investments.  Changes in interest rates over time are the primary market factor for this value decline; generally, as interest rates rise, the value of long-term interest rate sensitive securities decline. The value of the majority of Opteum’s assets is driven by movements in short-term rates—rates typically inside two years and these rates increased substantially over the period. Additionally, as longer term rates decreased, prepayment expectations increased resulting in a widening in the spreads at which Opteum’s assets are priced.

 

The Company has negative retained earnings (titled “accumulated deficit” in the stockholders’ equity section) at March 31, 2006 partially because of the consequences of Opteum’s tax qualification as a REIT. The negative retained earnings was entirely a result of Opteum’s REIT qualification as of December 31, 2004 and 2003. As is more fully described in the section titled “Future Taxable Income Distributions,” Opteum’s dividends are based on its net taxable income, as determined for federal income tax purposes, and not on its net income computed in accordance with GAAP (as reported in the accompanying financial statements).  Therefore, to the extent that Opteum’s cumulative net taxable income is greater than cumulative financial statement income and Opteum continues to pay out as dividends all of its net taxable income, the Company will report negative retained earnings on its balance sheet.

The table below shows Opteum’s average investments held, total interest income, yield on average earning assets, average repurchase balances outstanding, interest expense, average cost of funds, net interest income and net interest spread for the quarter ended March 31, 2006 and the eight previous quarters for Opteum’s portfolio of MBS securities only.  The data in the table below does not include information pertaining to OFS’s results of operations. Opteum commenced operations on December 19, 2003 and quarterly results for the period ended December 31, 2003 are not meaningful.

RATIOS FOR THE QUARTERS HAVE BEEN ANNUALIZED

Quarter Ended		Average Investment Securities Held		Total Interest Income	Yield on Average Interest Earning Assets		Average Balance of Repurchase Agreements Outstanding		Interest Expense	Average Cost of Funds		Net Interest Income	Net Interest Spread
March 31, 2006	$	3,516,291,784	$	42,219,327	4.803%	$	3,375,776,594	$	37,660,857	4.462%	$	4,558,470	0.340%
December 31, 2005	$	3,676,174,530	$	43,139,911	4.694 %	$	3,533,486,002	$	35,912,966	4.065 %	$	7,226,945	0.629 %
September 30, 2005	$	3,867,262,849	$	43,574,308	4.507 %	$	3,723,603,116	$	33,101,847	3.556 %	$	10,472,461	0.951 %
June 30, 2005	$	3,587,628,779	$	36,748,640	4.097 %	$	3,449,743,973	$	26,703,422	3.096 %	$	10,045,218	1.001 %
March 31, 2005	$	3,136,142,229	$	31,069,934	3.963 %	$	2,976,409,157	$	19,841,710	2.667 %	$	11,228,224	1.296 %
December 31, 2004	$	2,305,748,481	$	20,463,071	3.550 %	$	2,159,890,886	$	10,824,164	2.005 %	$	9,638,907	1.545 %
September 30, 2004	$	1,573,342,668	$	11,017,346	2.801 %	$	1,504,919,407	$	4,253,337	1.131 %	$	6,764,009	1.670 %
June 30, 2004	$	1,512,480,507	$	10,959,098	2.898 %	$	1,452,004,000	$	4,344,012	1.197 %	$	6,615,086	1.702 %
March 31, 2004	$	871,140,453	$	7,194,033	3.303 %	$	815,814,500	$	2,736,434	1.342 %	$	4,457,599	1.962 %

Actions by the Federal Reserve and the resulting impact on various market interest rates have adversely impacted the net interest spread earned on Opteum’s portfolio of MBS securities over Opteum’s repurchase agreement funding.  Management has taken steps to mitigate the continued impact of further interest rate movements initiated by the Federal Reserve. Opteum’s portfolio of MBS securities has been adjusted and now contains a greater proportion of adjustable rate securities whose coupons reset in 12 months or less.  However, while the coupons on these securities reset frequently and their coupons are tied to the same market interest rates impacted by Federal Reserve actions; they do so with a lag and there is no assurance that net interest spread will not be compressed further.

Results of Operations

The quarter ended March 31, 2006 as compared with the quarter ended March 31, 2005 differed substantially because Opteum’s asset base changed significantly during the year and because Opteum acquired OFS. Other factors making the first quarter of 2006 difficult to compare with prior periods include the following: Opteum had limited operations in 2003, the Company concluded four separate equity raises during 2004, and the Company issued $103.1 million of junior subordinated debt during 2005. During the first quarter of 2006, the Company issued no shares of any class of its stock other than for Board or employee compensation. In addition, the Company purchased 527,300 shares of its Class A Common Stock in the open market place during the first quarter of 2006 for an aggregate of $4.5 million, at an average price of $8.38. The Company issued no junior subordinated debt in the first quarter of 2006.

Consolidated net loss for the quarter ended March 31, 2006 was ($5.1) million, compared to $10.9 million of net income for the quarter ended March 31, 2005. Consolidated net loss per diluted Class A Common Share was ($0.21) in the quarter ended March 31, 2006 compared to $0.52 of per share income for the same period in 2005.

Opteum expected the acquisition of OFS in the fourth quarter of 2005 to result in the addition of substantial ongoing operating expenses for the Company because the mortgage origination business is very labor intensive. For the quarter ended March 31, 2006 consolidated general and administrative costs at the Company were $20.1 million. Operating expenses, which incorporate trading costs, commissions and other direct costs, were $ 0.3 million for the quarter. OFS had approximately 1,000 employees as of March 31, 2006.

The Company earned $4.5 million of consolidated net interest income for the quarter ended March 31, 2006, and $11.2 million of net interest income for the quarter ended March 31, 2005. As measured against invested assets during each period, these net interest earnings represented an annualized net yield of approximately 0.13% for the quarter ended March 31, 2006 and 1.29% for the quarter ended March 31, 2005. These earnings are not representative of what can be expected for future periods, as Opteum only began to acquire investments in late December 2003, and the funds received during the year ended December 2004 from the private placements and public offerings were not fully invested for the entire twelve-month period. Borrowing rates increased during 2005 and during the first quarter of 2006 faster than the yields on Opteum’s current portfolio. The substantial decrease in the spread between the yields on assets and the costs to finance those assets will inevitably cause a decrease in net interest spread and net earnings. In 2005, Opteum issued $103.1 million of trust preferred securities, approximately half of which were used by Opteum to purchase mortgage related securities. The addition of these notes will make comparing Opteum’s first quarter 2006 results to past periods more difficult. The acquisition of OFS will create potential opportunities for earnings but will also add substantial expenses making the comparison of Opteum’s results to past reporting periods difficult.

During the three months ended March 31, 2006, the Company, through its TRS, sold approximately $1.4 billion of originated and purchased mortgage loans held for sale. OFS serviced approximately $8.2 billion of originated mortgage servicing rights as of March 31, 2006. It is OFS’s intention to continue to hold originated mortgage servicing rights. Opteum did not sell any mortgage related securities from the investment portfolio during the quarter ended March 31, 2006. Although Opteum generally intends to hold its portfolio investment securities to maturity, Opteum may determine at some time before they mature that it is in its interest to sell them and purchase securities with other characteristics. In that event, Opteum’s earnings will be affected by realized gains or losses.

For the quarters ended March 31, 2006 and 2005 comprehensive income (loss) was ($16.9) million including the net unrealized loss on the available for sale securities of ($11.8) million and $(13.8) million including the net unrealized loss on available for sale securities of ($22.7) million respectively. The factors resulting in the unrealized loss on available for sale securities are described above.

Gains on Sales of Mortgage Assets and Losses on Derivative Instruments

(in thousands)

		For the Period Ending March 31, 2006	For the Period Ending March 31, 2005
Fair Value adjustment of residuals interests, trading	$	(4,226)	N/A
Gain on Sales		20,829	N/A
Fees on brokered loans		1,549	N/A
Gain on derivatives		3,402	N/A
Direct loan origination expenses, deferred		1,238	N/A
Fees earned, brokering servicing		771	N/A
Write off purchased pipeline(Purchase Accounting Adjustment)		(534)	N/A
		23,029	N/A
Direct loan origination expenses, reclassified		(15,952)	N/A
Net gain on sale of mortgage loans	$	7,077	N/A

Taxable Net Income

Taxable net income, as generated by Opteum’s qualifying REIT activities, is computed differently from Opteum’s financial statement net income from REIT activities as computed in accordance with GAAP. Depending on the number and size of the various items or transactions being accounted for differently, the differences between Opteum’s taxable net income and Opteum’s financial statement net income from REIT activities can be substantial, and each item can affect several years. Opteum's most significant items and transactions currently being accounted for differently from REIT activities include restricted stock awards, depreciation of property and equipment, and the accounting for debt issuance costs.

For the three months ended March 31, 2006, Opteum's taxable net income was approximately $0.4 million greater than Opteum's financial statement net income from REIT activities. Substantially all of this amount is attributable to the phantom stock awards, and the future deduction of this amount against taxable net income is uncertain both as to the year (as the timing of the tax impact of each restricted stock award is up to each employee who has received a grant) and as to the amount (the amount of the tax impact is measured at the fair value of the shares as of a future date, and this amount may be greater than or less than the financial statement deduction already taken by Opteum). Since inception through March 31, 2006, Opteum's net taxable income is approximately $3.3 million greater than Opteum's financial statement net income from REIT activities as reported in its financial statements.

Future Taxable Income Distributions

In future periods, Opteum’s net taxable income may grow to be even greater than consolidated GAAP net income as the interest on the $65.0 million loan Opteum made to OFS could generate annual net taxable income of $7.2 million. This interest is not reported on the Company’s consolidated financial statements as it is eliminated in consolidation.

In order to maintain Opteum’s qualification as a REIT, Opteum is required (among other provisions) to distribute dividends to stockholders in an amount at least equal to, generally, 90% of its net taxable income. Net taxable income is a term that describes operating results following taxation rules and regulations governed by various provisions of the Code. Net taxable income is computed differently from net income as computed in accordance with GAAP ("GAAP net income"), which is included in the Company’s consolidated financial statements. Depending on the number and size of the various items or transactions being accounted for differently, the differences between net taxable income and GAAP net income can be substantial and each item can affect several reporting periods. Generally, these items are timing or temporary differences between years; for example, an item that may be a deduction for GAAP net income in the current year is not a deduction for net taxable income until a later year. As a REIT, Opteum may be subject to a federal excise tax. An excise tax is incurred if Opteum distributes less than 85 percent of its net taxable income by the end of the calendar year. Opteum's most significant item currently being accounted for differently are the restricted stock awards.

OFS is treated as a TRS of Opteum. OFS is subject to corporate income taxes and files stand-alone federal and state income tax returns. OFS had IRLCs along with other instruments that are hedges for both these IRLCs and mortgage loans held for sale and both are considered freestanding derivatives. The changes to the fair value of these freestanding derivatives from inception to the period end are recorded at their fair value with the resulting gain or loss reflected in current period earnings. The result of the changes in the fair value of these freestanding derivatives was a gain of approximately $3.5 million as of March 31, 2006. OFS can recognize a gain in the value of mortgages held for sale only when the loans are sold.

Liquidity and Capital Resources

Opteum’s primary source of funds as of March 31, 2006 consisted of repurchase agreements totaling $3.4 billion, with a net weighted average borrowing cost of 4.54%. Opteum expects to continue to borrow funds in the form of repurchase agreements. At March 31, 2006, Opteum had master repurchase agreements in place with 19 counter-parties and had outstanding balances under 15 of these agreements. These master repurchase agreements have no stated expiration but can be terminated at any time at Opteum’s option or at the option of the counter-party. However, once a definitive repurchase agreement under a master repurchase agreement has been entered into, it generally may not be terminated by either party. As of March 31, 2006, all of the existing repurchase agreements matured in less than one year. Increases in short-term interest rates could negatively impact the valuation of Opteum’s mortgage related securities, which could limit Opteum’s borrowing ability or cause Opteum’s lenders to initiate margin calls.

During 2005, Opteum entered into contracts and paid commitment fees to three lenders providing for an aggregate of $1.85 billion in committed repurchase lines at pre-determined borrowing rates and haircuts for a 364 day period following the commencement date of each contract. Opteum has no obligation to utilize these repurchase lines. Each one of these lines will be eligible for renewal at some point during 2006. It is the Company’s intention to renew these lines. However, market conditions could change making the renewal of these contractual arrangements more expensive or unattainable.

In addition, in order to facilitate the origination of mortgage loans, OFS had warehouse lines and aggregation lines of credit outstanding of approximately $697.9 million at March 31, 2006. OFS also had approximately $105.5 million outstanding on other lines of credit that are secured by the residual interests and the originated mortgage servicing rights with various lenders. The rates on these borrowings generally are based on a spread to LIBOR.

For liquidity, Opteum will also rely on cash flow from operations, primarily monthly principal and interest payments to be received on the mortgage related securities, as well as any primary securities offerings authorized by the Company’s Board of Directors. OFS may generate cash flow from residual interest in mortgage securitizations as well as receive funds from originated mortgage servicing rights and originated loan fees.

Opteum believes that equity and junior subordinated debt capital, combined with the cash flow from operations and the utilization of borrowings, will be sufficient to enable Opteum to meet anticipated liquidity requirements. Various changes in market conditions could adversely affect liquidity, including increases in interest rates, increases in prepayment rates substantially above expectations, or the reduction of fee income generated through mortgage originations at OFS. If cash resources are at any time insufficient to satisfy the liquidity requirements, Opteum may be required to pledge additional assets to meet margin calls, liquidate mortgage related securities or sell debt or additional equity securities. If required, the sale of mortgage related securities or originated mortgage loans held for sale (by OFS) at prices lower than the carrying value of such assets would result in losses and reduced income.

Opteum may in the future increase capital resources by making additional offerings of equity and debt securities, including classes of preferred stock, common stock, commercial paper, medium-term notes, collateralized mortgage obligations and senior or subordinated notes. All debt securities, other borrowings, and classes of preferred stock will be senior to the Class A Common Stock in a liquidation of the company. Additional equity offerings may be dilutive to stockholders' equity or reduce the market price of the Class A Common Stock, or both. Opteum is unable to estimate the amount, timing or nature of any additional offerings as they will depend upon market conditions and other factors.

Off-Balance Sheet Arrangements

As discussed previously, OFS pools the loans they originate and purchase and securitizes them to obtain long-term financing for the assets. The loans are transferred to a trust where they serve as collateral for asset-backed bonds, which the trust issues to the public. During the first quarter of 2006 OFS executed one securitization collateralized by $934.4 million of loans. In addition, OFS held approximately $105.2 million of retained interests from securitizations as of March 31, 2006. OFS’s ability to use the securitization capital market is critical to the operations and overall profitability of the business.

External factors that are reasonably likely to affect OFS’s ability to continue to use these markets would be those factors that could disrupt the securitization capital market. A disruption in the market could prevent OFS from being able to sell the securities at a favorable price, or at all. Factors that could disrupt the securitization market include an international liquidity crisis such as occurred in the fall of 1998, a terrorist attack, outbreak of war or other significant event risk, or market specific events such as a default of a comparable type of securitization. If OFS were unable to access the securitization market, OFS may still be able to finance the mortgage operations by selling the loans to investors in the whole loan market but at lower than anticipated margins.

Specific items that may affect OFS’s ability to use the securitizations to finance their loans relate primarily to the performance of the loans that have been securitized. Extremely poor loan performance may lead to poor bond performance and investor unwillingness to buy bonds supported by OFS’s collateral. OFS’s financial condition could also have an adverse impact on their ability to access the securitization market if there was the perception that their financial condition had deteriorated to the point where investors would question OFS’s ability to stand behind their representations and warranties made in connection with their securitizations (Opteum has guaranteed the performance of OFS’s representation and warranties). The financial performance and condition of the past securitizations of OFS are too early to evaluate the impact of the underlying collateral’s performance. Additionally, past economic conditions that may have contributed to a favorable performance may not be an indication of future performance should economic conditions change unfavorably.

 

OFS has commitments to borrowers to fund residential mortgage loans as well as commitments to purchase and sell mortgage loans to third parties. As of March 31, 2006, OFS had outstanding commitments to originate loans of approximately $368.2 million. As of March 31, 2006, OFS had outstanding commitments to sell loans of approximately $213.0 million. The commitments to originate and purchase loans do not necessarily represent future cash requirements, as some portion of the commitments are likely to expire without being drawn upon or may be subsequently declined for credit or other reasons.

Inflation

Virtually all of the Company’s assets and liabilities are financial in nature. As a result, interest rates and other factors influence the Company’s performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Company’s financial statements are prepared in accordance with GAAP and the Company’s distributions are determined by the Company’s Board of Directors based primarily on the Company’s net taxable income as calculated for federal income tax purposes; in each case, the Company’s activities and balance sheet are measured with reference to historical cost and or fair market value without considering inflation.

Credit Risk

At March 31, 2006, Opteum had limited its exposure to credit losses on its portfolio of securities by purchasing primarily securities from federal agencies or federally chartered entities, such as, but not limited to, Fannie Mae, Freddie Mac, and Ginnie Mae. The portfolio is diversified to avoid undue loan origination, geographic and other types of concentrations. Opteum manages the risk of prepayments of the underlying mortgages by creating a diversified portfolio with a variety of prepayment characteristics.

Opteum is engaged in various trading and brokerage activities in which counter-parties primarily include broker-dealers, banks, and other financial institutions. In the event counter-parties do not fulfill their obligations, Opteum may be exposed to risk of loss. The risk of default depends on the creditworthiness of the counter-party and/or issuer of the instrument. It is Opteum’s policy to review, as necessary, the credit standing for each counter-party.

OFS has credit exposure to representation and warranties with respect to loans OFS sells to the whole loan market and loans OFS sells to securitization entities. When OFS sells loans to the whole loan market, OFS has exposure for loans that default within certain timeframes. In these cases, OFS may be obligated to repurchase the loans.  In addition, the credit performance of the loans originated or acquired by OFS will ultimately impact the performance of their retained interests in securitizations or the value of the originated mortgage servicing rights.  The valuation of both retained interests in securitizations and mortgage servicing rights is a function of both the credit performance of the underlying loans as well as the prepayment speeds realized.

§	civil and criminal liability;

§	loss of licensure;

§	damage to reputation in the industry;

§	inability to sell or securitize loans;

§	demands for indemnification or loan repurchases from purchasers of OFS’s loans;

§	fines and penalties and litigation, including class action lawsuits; or

§	administrative enforcement actions.

§	a substantial or sustained increase in interest rates could harm OFS’s ability to originate or acquire mortgage loans in expected volumes, which could result in a decrease in OFS’s cash flow and in OFS’s ability to support OFS’s fixed overhead expense levels;

§	interest rate fluctuations may harm OFS’s earnings as a result of potential changes in the spread between the interest rates on OFS’s borrowings and the interest rates on OFS’s mortgage assets;

§	mortgage prepayment rates vary depending on such factors as mortgage interest rates and market conditions, and changes in anticipated prepayment rates may harm OFS’s earnings; and

§	when OFS securitizes loans, the value of the residual interests OFS retains and the income OFS receives from them are based primarily on LIBOR, and an increase in LIBOR reduces the net income OFS receives from, and the value of, these residual interests.

§	interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;

§

hedging instruments involve risk because they often are not traded on regulated exchanges, guaranteed by an exchange or its clearing house, or regulated by any U.S. or foreign governmental authorities; consequently, there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions, and the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory, commodity and other regulatory requirements;

§	available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;

§	the duration of the hedge may not match the duration of the related liability or asset;

§	the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs OFS’s ability to sell or assign OFS’s side of the hedging transaction;

§	the party owing money in the hedging transaction may default on its obligation to pay, and a default by a party with whom OFS enters into a hedging transaction may result in the loss of unrealized profits; and

§	OFS may not be able to dispose of or close out a hedging position without the consent of the hedging counter-party, and OFS may not be able to enter into an offsetting contract in order to cover OFS’s risks.

·	The intention to acquire shares of its Class A common stock in the open market was authorized by the Company’s Board of Directors and announced October 7, 2005.

·	The share by-back program authorizes management to acquire up to 1,800,000 shares of the Company’s Class A Common Stock and will be in effect for a period of one year.