UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended June 30, 2004

OR

For the Transition Period from _____ to _____
Commission File Number 0-26960

ITLA CAPITAL CORPORATION

(858) 551-0511

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 þ No o.

Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes þ No o.

Number of shares of common stock of the registrant: 6,195,418 outstanding as of August 2, 2004.

ITLA CAPITAL CORPORATION
FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004

TABLE OF CONTENTS

Forward Looking Statements

     “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This Form 10-Q contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to, changes in economic conditions in our market areas, changes in policies by regulatory agencies, the impact of competitive loan products, loan demand risks, the quality or composition of our loan or investment portfolios, fluctuations in interest rates and changes in the relative differences between short and long-term interest rates, levels of nonperforming assets and operating results, the impact of terrorist actions on our loan portfolio and loan repayments, and other risks detailed from time to time in our filings with the Securities and Exchange Commission. We caution readers not to place undue reliance on forward-looking statements. We do not undertake and specifically disclaim any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for 2004 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of, us.

     As used throughout this report, the terms “we”, “our”, “ITLA Capital” or the “Company” refer to ITLA Capital Corporation and its consolidated subsidiaries.

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PART I — FINANCIAL INFORMATION

ITLA CAPITAL CORPORATION AND SUBSIDIARIES

See accompanying notes to the unaudited consolidated financial statements.

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ITLA CAPITAL CORPORATION AND SUBSIDIARIES

See accompanying notes to the unaudited consolidated financial statements.

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ITLA CAPITAL CORPORATION AND SUBSIDIARIES

See accompanying notes to the unaudited consolidated financial statements.

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ITLA CAPITAL CORPORATION AND SUBSIDIARIES

NOTE 1 – BASIS OF PRESENTATION

     The unaudited consolidated financial statements of ITLA Capital Corporation (the “Company”) included herein reflect all normal recurring adjustments which are, in the opinion of management, necessary to present fairly the results of operations and financial position of the Company, as of and for the interim periods indicated. The unaudited consolidated financial statements include the accounts of ITLA Capital Corporation and its wholly-owned subsidiaries, Imperial Capital Bank (the “Bank”), and Imperial Capital Real Estate Investment Trust (“Imperial Capital REIT”).

     On December 31, 2003, the Company adopted FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities, which addresses consolidation by business enterprises of variable interest entities having certain characteristics. In connection with the Company’s adoption of FIN 46, ITLA Capital Statutory Trust I (“Trust I”), ITLA Capital Statutory Trust II (“Trust II”), ITLA Capital Statutory Trust III (“Trust III”), ITLA Capital Statutory Trust IV (“Trust IV”), and ITLA Capital Statutory Trust V (“Trust V”), collectively referred to as the “Trusts”, were no longer consolidated as of December 31, 2003. The result of the deconsolidation was to recognize the Company’s investment in the Trusts in other assets, and to recognize the subordinated debentures issued by the Company to the Trusts as liabilities. Accordingly, effective January 1, 2004, the Company recognized interest expense on the subordinated debentures in the consolidated statements of income. Prior to FIN 46, the Company consolidated the Trusts and reported the trust preferred securities issued by the Trusts in the mezzanine section of the Company’s consolidated balance sheets and recognized the proportionate share of income attributable to the preferred shareholders as minority interest in income of subsidiary in the consolidated statements of income. The trust preferred securities currently qualify as Tier 1 capital for ITLA Capital under Federal Reserve Board guidelines. As a result of the issuance of FIN 46, the Federal Reserve Board proposed a rule on May 6, 2004 related to the qualification of the trust preferred securities as Tier 1 capital. Under the proposed rule, the Company’s trust preferred securities would still qualify as Tier 1 capital. As of June 30, 2004, the Company would meet all requirements to maintain its well capitalized designation under applicable regulatory guidelines regardless of the inclusion of the trust preferred securities in Tier 1 capital. Financial information prior to the adoption of FIN 46 has not been restated.

     All intercompany transactions and balances have been eliminated. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Certain amounts in prior periods have been reclassified to conform to the presentation in the current period. The results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of the results of operations for the remainder of the year.

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     These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2003.

NOTE 2 – ACCOUNTING FOR STOCK-BASED COMPENSATION

     The Company has stock-based compensation plans. These plans are accounted for under APB Opinion No. 25, Accounting for Stock Issued to Employees, and accordingly, no compensation costs have been recognized in the accompanying unaudited consolidated statements of income. The Company applies Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, for disclosure purposes only. SFAS No. 123 disclosures include pro forma net income and earning per share as if compensation expense had been recognized using the fair value of the options at the date of grant. If compensation had been determined based on SFAS No. 123, the Company’s pro forma net income and pro forma per share data would be as follows:

     The fair value of each option grant was estimated on the date of grant using an option pricing model with the following weighted-average assumptions for option grants:

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NOTE 3 – EARNINGS PER SHARE

     Basic Earnings Per Share (“Basic EPS”) is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted Earnings Per Share (“Diluted EPS”) reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock which shared in the Company’s earnings.

     The following is a reconciliation of the calculation of Basic EPS and Diluted EPS:

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NOTE 4 – COMPREHENSIVE INCOME

     Comprehensive income, which encompasses net income and the net change in unrealized gains (losses) on investment securities available for sale, is presented below:

NOTE 5 – IMPAIRED LOANS RECEIVABLE

     As of June 30, 2004 and December 31, 2003, the recorded investment in impaired loans (including impaired real estate loans held in trust) was $18.5 million and $13.1 million, respectively. The average recorded investment in impaired loans was $18.8 million and $17.2 million, respectively, for the three and six months ended June 30, 2004 and $12.1 million and $14.6 million, respectively, for the same periods last year. Interest income recognized on impaired loans totaled $140,000 and $370,000 for the three and six months ended June 30, 2004 as compared to $116,000 and $257,000 for the same periods last year.

NOTE 6 – RESIDUAL INTEREST IN SECURITIZATION

     During the first quarter of 2002, the Company formed a limited liability company to issue $86.3 million of asset-backed notes in a securitization of substantially all of the Company’s residential loan portfolio. The Company recognized a gain of $3.7 million on the securitization of these loans, which was included in other non-interest income within the consolidated statement of income. Concurrent with recognizing such gain on sale, the Company recorded a residual interest, which represented the present value of future cash flows (spread and fees) that are estimated to be received over the life of the loans. The residual interest is recorded on the consolidated balance sheet in “Investment securities available for sale, at fair value”. The value of the residual interest is subject to substantial credit, prepayment, and interest rate risk on the sold residential loans. In accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the residual interest is classified as “available-for-sale” and, as such, recorded at fair value with the resultant changes in fair value recorded as accumulated unrealized gain or loss in a separate component of shareholders’ equity entitled “accumulated other comprehensive income or loss”, until realized. Fair value is estimated on a monthly basis based on a discounted cash flow analysis. These cash flows are estimated over the lives of the receivables using prepayment, default, and interest rate

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assumptions that management believes market participants would use for similar financial instruments.

     During the six months ended June 30, 2004 and 2003, the Company recognized an other than temporary impairment of $500,000 in connection with its residual interest. Impairments that are deemed to be other than temporary are charged to income as other expense. In evaluating impairments as other than temporary the Company considers credit risk, as well as the magnitude and trend of default rates and prepayment speeds of the underlying residential loans.

     At June 30, 2004 and December 31, 2003, key economic assumptions and the sensitivity of the current fair value of the residual interest based on projected cash flows to immediate adverse changes in those assumptions are as follows:

     These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in the fair value of the residual interest are based on a variation in assumptions and generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the above table, the effect of a variation in a particular assumption on the fair value of the residual interest is calculated without changing any other assumption; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments but increased credit losses), which might magnify or counteract the sensitivities, and depending on the severity of such changes, the results of operations may be materially affected.

NOTE 7 – NEW ACCOUNTING PRONOUNCEMENTS

     On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued the Exposure Draft, Share-Based Payment, which is a proposed amendment to SFAS No. 123, Accounting For Stock-Based Compensation. In this draft, the FASB formally proposed to require companies to recognize the fair value of stock options and other stock-based compensation to employees for future reporting periods in the income statement based on their fair values. The

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final standard is expected in late 2004 and, as currently written, would be effective for public companies for recognition and disclosure purposes for fiscal years beginning after December 15, 2004. The Company is in the process of evaluating the impact that expensing stock options and other stock-based compensation will have on the results of operations and financial position.

     American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. SOP 03-3 addresses accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities acquired individually, in pools or as part of a business combination and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 does not allow the excess of contractual cash flows over cash flows expected to be collected to be recognized as an adjustment of yield, loss accrual or valuation allowance, such as the allowance for possible loan losses. SOP 03-3 requires that increases in expected cash flows subsequent to the initial investment be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. In the case of loans acquired in a business combination where the loans show signs of credit deterioration, SOP 03-3 represents a significant change from current purchase accounting practice whereby the acquiree’s allowance for loan losses is typically added to the acquirer’s allowance for loan losses. SOP 03-3 is effective for loans and debt securities acquired by the Company beginning January 1, 2005. The adoption of this new standard is not expected to have a material impact on the Company’s financial statements.

NOTE 8 – BUSINESS SEGMENT INFORMATION

     SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, requires disclosure of segment information in a manner consistent with the “management approach”. The management approach is based on the way the chief operating decision-maker organizes segments within a company for making operating decisions and assessing performance.

     The main factors used to identify operating segments were the specific product and business lines of the various operating segments of the Company. Operating segments are organized separately by product and service offered. We have identified one operating segment that meets the criteria of being a reportable segment in accordance with the provisions of SFAS No. 131. This reportable segment is the origination and purchase of loans, which by its legal form, is identified as operations of the Bank and Imperial Capital REIT. This segment derives the majority of its revenue by originating and purchasing loans. Other operating segments of the Company that did not meet the criteria of being a reportable segment in accordance with SFAS No. 131 have been aggregated and reported as “All Other”. Substantially all of the transactions from the Company’s operating segments occur in the United States.

     Transactions between the reportable segment of the Company and its other operating segments are made at terms which approximate arm’s-length transactions and in accordance with

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GAAP. There is no significant difference between the measurement of the reportable segment’s assets and profits and losses disclosed below and the measurement of assets and profits and losses in our consolidated balance sheets and statements of income. Accounting allocations are made in the same manner for all operating segments.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion and analysis is intended to identify the major factors that affected the financial condition and results of operations for the three and six months ended June 30, 2004.

Application of Critical Accounting Policies and Accounting Estimates

     The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States (“GAAP”) and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

     The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements. Accounting polices related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. The Company also considers accounting policies related to stock-based compensation to be critical due to the continuously evolving standards, changes to which could materially impact the way the Company accounts for stock options. Additionally, the Company considers its accounting policies in regards to its tax refund lending program and other real estate owned to be critical accounting policies.

     For additional information regarding critical accounting policies, refer to Note 1 – Organization and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements and the sections captioned “Application of Critical Accounting Policies and Accounting Estimates” and “Allowance for Possible Loan Losses and Nonperforming Assets” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Form 10-K for the year ended December 31, 2003. There have been no significant changes in the Company’s application of accounting policies since December 31, 2003.

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RESULTS OF OPERATIONS

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Executive Summary

     Consolidated net income was $5.6 million and $5.5 million for the three months ended June 30, 2004 and 2003, respectively. Diluted EPS was $0.86 for the three months ended June 30, 2004 compared to $0.85 for the same period last year. The increase in net income was primarily due to the increase in net interest income after provision for loan losses, partially offset by an increase in non-interest expense.

     Net interest income before provision for loan losses decreased from the prior year period primarily as a result of the increase in interest expense, which, pursuant to the adoption of FIN 46, required the inclusion of the interest payments on the junior subordinated debentures related to the Company’s trust preferred securities, and the decrease in net interest income earned by the REIT.

     The return on average assets was 1.30% for the three months ended June 30, 2004 compared to 1.38% for the same period last year. The return on average shareholders’ equity was 11.23% for the three months ended June 30, 2004, compared 12.68% for the same period last year.

     Total loan production was $258.1 million for the quarter ended June 30, 2004 compared to $144.0 million for the same period last year. Loan production during the current quarter consisted of originations of $156.0 million of commercial real estate loans, $55.8 million of Imperial Capital Express (“ICE”) small balance multi-family loans, $21.6 million of film finance loans and $24.7 million of franchise loans. Loan production for the same period last year consisted of originations of $93.0 million of commercial real estate loans, $31.4 million of ICE small balance multi-family loans, $9.1 million of film finance loans and $10.5 million of franchise loans.

     Substantially all refund anticipation loans (“RAL”) originated during the quarter were sold to Household International, Inc. (“Household”), a wholly-owned subsidiary of HSBC Holdings plc (“HSBC”). At June 30, 2004, and 2003 the Company held $1.7 million and $1.1 million, respectively, in RAL participation interests. Because the origination of loans under the RAL program results from the filing of individual income tax returns, transaction activity is concentrated most heavily during the tax season. This results in the Company earning most of its RAL program income in the first quarter of the year. We expect that our financial results for the remaining quarters of 2004 will not be significantly impacted by the RAL program due to the seasonal nature of the business. On June 24, 2004, the Company announced that it received final confirmation that Household and its affiliates would, effective this year, terminate their RAL and private label credit card programs with the Bank. Pursuant to the agreement, this termination comes without penalty to Household.

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Net Interest Income and Margin

     The following table presents, for the three months ended June 30, 2004 and 2003, our condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are computed using daily average balances. Nonaccrual loans are included in loans receivable.

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     The following table sets forth a summary of the changes in interest income and interest expense resulting from changes in average interest-earning asset and interest-bearing liability balances and changes in average interest rates. The change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of each.

     Total interest income increased $277,000 to $28.2 million in the second quarter of 2004 as compared to $27.9 million for the same period last year. The increase in interest income was primarily attributable to an increase of $134.0 million in average interest earning assets, partially offset by a decrease of 47 basis points in the average yield earned on interest earning assets due to lower market interest rates.

     The average balance of loans held by the Bank was $1.5 billion and $1.3 billion for the three months ended June 30, 2004 and 2003, respectively. Loans secured by income producing properties and construction loans had an average balance of $1.3 billion during the quarter ended June 30, 2004 compared to $1.1 billion during the same period last year. The average balance of franchise loans was $125.1 million and $55.3 million during the quarters ended June 30, 2004 and 2003, respectively. The average balance of film finance loans was $95.2 million and $107.7 million during the quarters ended June 30, 2004 and 2003, respectively.

     The average balance of real estate loans held in trust decreased to $53.1 million for the three months ended June 30, 2004 as compared to $107.1 million for the same period last year. This decrease was due to loan prepayments and principal amortization.

     The average balance of cash and investments decreased to $150.6 million in the second quarter of 2004 compared to $203.2 million during the same period last year. The decrease in

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average cash and investments was attributable to a decline in liquidity maintained in connection with the Bank’s RAL program during the quarter ended June 30, 2004. The increase in the average yield earned on cash and investments from 1.96% during the second quarter of 2003 to 2.58% during the second quarter of 2004 was primarily caused by the decline in the average daily cash and cash equivalents balance maintained. Cash and cash equivalents are typically invested in short-term or overnight investments, which yield relatively low rates of return.

     The average yield earned on total loans decreased to 7.02% in the quarter ended June 30, 2004 as compared to 7.86% in the same period last year. The decline in our yield was primarily caused by higher yielding loans being repaid and replaced by new loan production at lower current market interest rates. Our commercial real estate loan portfolio is primarily comprised of adjustable rate mortgages indexed to six month LIBOR. Approximately 95.9% of our real estate loans (including real estate loans held in trust) were adjustable rate mortgages at June 30, 2004. These adjustable rate mortgages generally reprice on a quarterly basis. At June 30, 2004, approximately $1.3 billion or 89.6% of our real estate loans contained interest rate floors, below which the loans’ contractual interest rate may not adjust. At June 30, 2004, the weighted average floor interest rate of these loans was 6.6%. At that date, approximately $1.2 billion or 87.8% of those loans were at the floor interest rate, approximately $162.0 million or 11.7% were within 50 basis points of their floor interest rate, and approximately $0.5 million or 0.1% were greater than 50 but less than 100 basis points from their floor interest rate.

     Total interest expense increased by $946,000 to $8.8 million in the second quarter of 2004, compared to $7.9 million for the same period last year. This increase was attributable to the adoption of FIN 46, which required that beginning January 1, 2004, the Company recognize interest expense incurred on its junior subordinated debentures issued to the Trusts in the consolidated statements of income. For the three months ended June 30, 2004, the junior subordinated debentures had an average balance of $86.6 million and an average rate of 6.97%.

     Excluding the impact of the adoption of FIN 46, interest expense decreased by $555,000 as compared to the same period last year. This decrease was primarily caused by the lower average balance on our Collateralized Mortgage Obligations (“CMOs”) and Federal Home Loan Bank (“FHLB”) advances, as well as higher interest bearing FHLB advances maturing and being replaced with new advances at lower current market rates. The decline in interest expense was also affected by deposit accounts repricing to lower current market interest rates, partially offset by an increase in the average balance during the period.

     Our average cost of funds decreased to 2.47% during the three month period ended June 30, 2004, compared to 2.55% for the same period last year. This decrease in funding costs was due primarily to lower rates being paid on our deposit accounts as a result of the general decline in market interest rates, and FHLB advances maturing and being replaced with new advances at lower current market rates. The average rate paid on deposit accounts was 2.14% during the three months ended June 30, 2004 as compared to 2.49% for the same period last year. The average rate paid on FHLB advances was 2.58% during the three months ended June 30, 2004 compared to 3.07% for the same period last year. The average balance of deposit accounts increased $204.2 million to $1.2 billion for the three months ended June 30, 2004 as compared to $1.0 billion for the same period last year. The average balance of our CMOs was $1.4 million

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during the second quarter of 2004, compared to $56.0 million for the same period last year reflecting the decline in the related real estate loans held in trust due to loan prepayments and principal amortization. FHLB advances averaged $128.5 million in the current quarter, compared to $168.7 million for the same period last year.

     Net interest margin decreased to 4.55% for the three months ended June 30, 2004 as compared to 5.10% for the same period last year primarily due to increased interest expense resulting from the adoption of FIN 46 and higher yielding loans within the Bank’s loan portfolio being repaid and replaced by new loan production at lower current market rates.

Provision for Loan Losses

     Management periodically assesses the adequacy of the allowance for loan losses by reference to many factors, which may be weighted differently at various times depending on prevailing conditions. These factors include, among other elements:

•

general portfolio trends relative to asset and portfolio size;

•

asset categories;

•

credit and geographic concentrations;

•

delinquency trends and nonaccrual loan levels;

•

historical loss experience; and

•

risks associated with changes in economic, social and business conditions.

     Accordingly, the calculation of the adequacy of the allowance for loan losses is not based solely on the level of nonperforming assets. Management believes that the allowance for loan losses as of June 30, 2004 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of the Bank’s allowance for loan losses is subject to review by the Bank’s regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.

     The consolidated provision for loan losses totaled $1.0 million for the second quarter of 2004, compared to $1.9 million for the same period last year. The current period provision for loan losses was recorded based on an analysis of the factors referred to above. The provision for loan losses for the same period last year was also recorded based on an analysis of the factors referred to above and the declining valuation of certain non-performing loans and other loans of concern as of June 30, 2003. The allowance for loan losses was 2.25% of total loans and real estate loans held in trust at June 30, 2004 as compared to 2.17% at December 31, 2003. During the quarter ended June 30, 2004, we had net loan recoveries of $41,000 as compared to net loan charge-offs of $818,000 during the same period last year. See also – “Financial Condition – Credit Risk”.

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Non-Interest Income

     Non-interest income decreased to $1.0 million for the three months ended June 30, 2004, compared to $1.2 million for the same period last year. Substantially all of the non-interest income earned during the current and prior year period related to the RAL program. As a result of Household’s termination of its RAL program with the Bank discussed above (see “-Executive Summary”), the Company expects that its non-interest income will decrease significantly in future periods.

Non-Interest Expense

     Non-interest expense totaled $10.2 million for the three months ended June 30, 2004, compared to $9.0 million for the same period last year. The increase was primarily caused by our continued expansion of ICE, the Bank’s small balance real estate lending platform. During the year, nine ICE lending offices were opened throughout the East Coast. Our efficiency ratio (defined as recurring general and administrative expenses as a percentage of net revenue) was 51.4 percent in the second quarter of 2004 as compared to 41.9 percent for the same period in 2003.

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

Executive Summary

     Consolidated net income totaled $19.4 million for the six months ended June 30, 2004 compared to $18.5 million for the same period last year. The increase in net income was primarily due to increases in net interest income after provision for loan losses and non-interest income, partially offset by an increase in non-interest expense. Diluted EPS was $2.93 for the six months ended June 30, 2004, compared to $2.86 for the same period last year.

     Net interest income before provision for loan losses decreased from the prior year period primarily as a result of the increase in interest expense, which, pursuant to the adoption of FIN 46, required the inclusion of the interest payments on the junior subordinated debentures related to the Company’s trust preferred securities, and the decrease in net interest income earned by the REIT.

     The return on average assets was 1.79% for the six months ended June 30, 2004, compared to 1.83% for the same period last year. The return on average shareholders’ equity was 19.61% for the six months ended June 30, 2004, compared to 21.95% for the same period last year.

     Total loan production was $413.2 million for the six months ended June 30, 2004, compared to $245.7 million for the same period last year. During the current six-month period, the Bank originated $236.0 million of commercial real estate loans, $94.0 million of ICE small balance multi-family real estate loans, $42.0 million of film finance loan and $41.2 million of franchise loans. Loan production for the same period last year consisted of $150.7 million of commercial real estate loans, $58.3 million of ICE small balance multi-family real estate loans, $24.4 million of film finance loans and $12.3 million of franchise loans.

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Net Interest Income and Margin

     The following table presents, for the six months ended June 30, 2004 and 2003, our condensed average balance sheet information, together with interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities. Average balances are computed using daily average balances. Nonaccrual loans are included in loans receivable.

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     The following table sets forth a summary of the changes in interest income and interest expense resulting from changes in average interest-earning asset and interest-bearing liability balances and changes in average interest rates. The change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of the absolute dollar amounts of each.

     Total interest income decreased $1.2 million to $60.3 million in the six months ended June 30, 2004, as compared to $61.4 million for the same period last year. The decrease in interest income was primarily attributable to the decrease of 63 basis points in the average yield earned on interest earning assets reflecting lower market interest rates, partially offset by an increase of $161.6 million of interest earning assets.

     The average balance of loans held by the Bank was $1.5 billion and $1.3 billion for the six months ended June 30, 2004 and 2003, respectively. Loans secured by income producing properties and construction loans increased to $1.3 billion for the six month period ended June 30, 2004, from $1.1 billion during same period last year. The average balance of franchise loans was $115.4 million and $56.0 million during the six months ended June 30, 2004 and 2003, respectively. The average balance of film finance loans was $96.4 million and $111.3 million, respectively during the six months ended June 30, 2004 and 2003.

     The average balance of real estate loans held in trust decreased to $57.6 million for the six months ended June 30, 2004 as compared to $112.1 million for the same period last year. This decrease was due to loan prepayments and principal amortization.

     The average balance of our cash and investments increased to $530.3 million for the six months ended June 30, 2004 compared to $492.3 million during the same period last year. The increase in our average cash and investments was attributable to the increased liquidity maintained in connection with the RAL program. The decline in the average yield earned on

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cash and investments from 1.53% during the six months ended June 30, 2003 to 1.29% during the same period in 2004 was caused by lower yields earned on short-term and overnight investments as a result of a general decline in market interest rates during the year. A significant portion of the Company’s excess liquidity maintained during the six months ended June 30, 2004 was invested in overnight investments, which yielded lower returns during the current year as compared to the same period last year.

     The average yield earned on loans decreased 78 basis points to 7.38% for the six months ended June 30, 2004 as compared to 8.16% in the same period last year. The decrease in the yield on loans was primarily due to the origination and repricing of variable rate loans at lower interest rates resulting from the continuation of the relatively low interest rate environment. Our commercial real estate loan portfolio is primarily comprised of adjustable rate mortgages indexed to the six month LIBOR.

     Total interest expense increased by $1.7 million to $18.0 million for the six months ended June 30, 2004, compared to $16.3 million for the same period last year. This increase was attributable to the adoption of FIN 46, which required that beginning January 1, 2004, the Company recognize interest expense incurred on its junior subordinated debentures issued to the Trusts in the consolidated statements of income. For the six months ended June 30, 2004, the junior subordinated debentures had an average balance of $86.6 million and an average cost of funds of 6.94%.

     Excluding the impact of the adoption of FIN 46, interest expense decreased by $1.3 million as compared to the same period last year. This decrease was primarily caused by the lower average balance on our CMOs and FHLB advances, as well as higher interest bearing FHLB advances maturing and being replaced with new advances at lower current market rates. The decline in interest expense was also affected by deposit accounts repricing to lower current market interest rates, partially offset by an increase in the average balance during the period.

     Our average cost of funds decreased to 2.52% during the six months ended June 30, 2004, compared to 2.64% for the same period last year. This decrease in funding costs was due primarily to a general decline in market interest rates, resulting in lower rates being paid on our deposit accounts compared to the same period last year, as well as FHLB advances maturing and being replaced with new advances at lower current market rates. This decrease was partially offset by the average cost of funds of the junior subordinated debentures of 6.94%. The average rate paid on deposit accounts was 2.17% during the six months ended June 30, 2004 compared to 2.59% for the same period last year. The average rate paid on the FHLB advances was 2.77% during the six months ended June 30, 2004 compared to 2.99% for the same period last year. The average balance of deposit accounts increased $183.0 million to $1.2 billion for the six months ended June 30, 2004, compared to $1.0 billion for the same period last year. The average balance of our CMOs was $5.8 million during the six months ended June 30, 2004, compared to $57.9 million for the same period last year. FHLB advances averaged $138.1 million for the six months ended June 30, 2004, compared to $167.7 million for the same period last year.

     Net interest margin decreased to 4.09% for the six months ended June 30, 2004 as compared to 4.74% for the same period last year. This decrease was primarily due to the

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increased interest expense resulting from the adoption of FIN 46 and the 63 basis point decrease in the average yield earned on interest-earning assets as a result higher yielding loans being repaid and replaced with new loan production at lower current market rates.

Provision for Loan Losses

     The consolidated provision for loan losses totaled $2.4 million for the six months ended June 30, 2004, compared to $6.4 million for the same period last year. The current period provision for loan losses was recorded to provide for reserves based on an analysis of the factors referred to previously. The prior period provision for loan losses was recorded based on the same factors referred to previously, as well as the declining valuation of certain nonperforming loans and other loans of concern, and for specific charge-offs experienced through the six months ended June 30, 2003. During the six months ended June 30, 2004, the Company had net loan recoveries of $125,000, compared to net loan charge-offs of $5.8 million for the same period last year. The charge-offs during 2003 related primarily to one commercial real estate loan.

Non-interest Income

     Non-interest income totaled $14.4 million for the six months ended June 30, 2004, compared to $13.8 million for the same period last year. Substantially all of the non-interest income earned during the current and prior period was due to income earned in connection with the RAL program. As a result of Household’s termination of its RAL program with the Bank discussed above (see “-Executive Summary”), the Company expects that its non-interest income will decrease significantly in future periods.

Non-interest Expense

     Non-interest expense totaled $22.6 million for the six months ended June 30, 2004, compared to $19.2 million for the same period last year. General and administrative expenses totaled $21.8 million during the six months ended June 30, 2004, compared to $19.0 million for the same period last year. The increase in general and administrative expenses was primarily due to the costs incurred in connection with the expansion of our ICE lending platform. During the current year, the Bank’s opened nine ICE lending offices located throughout the East Coast. The Company’s efficiency ratio (defined as recurring general and administrative expenses as percentage of net revenue) was 38.49 percent for the six months ended June 30, 2004, compared to 32.32 percent for the same period in 2003.

FINANCIAL CONDITION

     Total assets increased to $1.9 billion at June 30, 2004 as compared to $1.8 billion at December 31, 2003. At June 30, 2004, loans, net totaled $1.6 billion, including approximately $1.3 billion of commercial real estate loans, $132.0 million of franchise loans and $100.7 million of film finance loans. During the six months ended June 30, 2004, the Bank’s loan portfolio increased $73.6 million and the REIT’s portfolio decreased $19.0 million. The decrease in the REIT’s loan portfolio reflects loan prepayments and principal amortization experienced during the six months ended June 30, 2004. Additionally, cash and cash equivalents increased $17.0 million primarily as a result of increased liquidity caused by the RAL program. Total deposit accounts increased to $1.2 billion at June 30, 2004 from $1.1 billion at December 31, 2003.

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FHLB advances increased $20.4 million to $382.5 million at June 30, 2004, compared to $362.1 million at December 31, 2003. Management believes that a significant portion of deposits will remain with us upon maturity based on our historical experience regarding retention of deposits. CMOs decreased from $15.9 million at December 31, 2003 to none at June 30, 2004 reflecting the decline in real estate loans held in trust. Accounts payable and other liabilities increased $17.5 million primarily as a result of outstanding checks and other liabilities related to the RAL program.

Residual Interest

     In the first quarter of 2002, we formed a limited liability company to issue $86.3 million of asset-backed notes in a securitization of substantially all of our residential loan portfolio. These notes were rated AAA by Standard & Poor’s, Aaa by Moody’s, and are insured by Financial Security Assurance. In the securitization, residential loans were sold to the limited liability company for a cash purchase price and an interest in the loans securitized in the form of the excess spread. The cash purchase price was raised through an offering of asset-backed notes issued by the limited liability company. Note holders are entitled to receive the principal collected on the loans and the stated interest rate on the notes. We are entitled to receive the excess spread. The excess spread generally represents, over the estimated life of the loans, the excess of the weighted average coupon on the loans sold over the sum of the note interest rate less other expenses including a trustee fee and an insurance fee. Valuation of the excess spread includes an estimate of annual future credit losses related to the loans securitized. These estimated cash flows are discounted when computing the value of the residual interest.

     We recognized a gain on the sale of these loans, although cash (representing the excess spread and servicing fees) is received by us over the lives of the loans. Concurrent with recognizing such gain on sale, we recorded the excess spread as a residual interest, which is included in our consolidated balance sheets as “Investment securities available for sale, at fair value.” The value of the residual interest is subject to substantial credit, prepayment and interest rate risk on the sold residential loans.

     In accordance with the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, we classified our residual interest as an “available-for-sale” asset and, as such, they are recorded at fair value with the resultant changes in fair value recorded as accumulated unrealized gain or loss in a separate component of shareholders equity entitled “accumulated other comprehensive income or loss”, until realized. We estimate fair value on a monthly basis based on a discounted cash flow analysis. These cash flows are estimated over the lives of the receivables using prepayment, default, and interest rate assumptions that we believe market participants would use for similar financial instruments.

     During each of the six months ended June 30, 2004 and 2003, we recognized an other than temporary impairment of $500,000 in connection with our residual interest. Impairments that are deemed to be other than temporary are charged to income, as other expense. In evaluating impairments as other than temporary we consider credit risk, as well as the magnitude and trend of default rates and prepayment speeds of the underlying residential loans.

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     At June 30, 2004 and December 31, 2003, key economic assumptions and the sensitivity of the current fair value of the residual interest based on projected cash flows to immediate adverse changes in those assumptions is as follows: