UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

Commission file number: 001-13417

Hanover Capital Mortgage Holdings, Inc.

(Exact name of registrant as specified in its charter)

379 Thornall Street, Edison, New Jersey 08837

(Address of principal executive offices) (Zip Code)

(732) 548-0101

(Registrant’s telephone number, including area code)

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

The registrant had 8,401,940 shares of common stock outstanding as of May 11, 2005.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

FORM 10-Q

For the Three Months Ended March 31, 2005

INDEX

PART I. FINANCIAL INFORMATION

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

See notes to consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

See notes to consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

See notes to consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

(Unaudited)

See notes to consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See notes to consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

      Hanover Capital Mortgage Holdings, Inc. (“Hanover”) is a real estate investment trust (“REIT”) formed to operate as a specialty finance company. Hanover has two primary subsidiaries: Hanover Capital Partners Ltd. (“HCP”) and HanoverTrade, Inc. (“HT”). When we refer to the “Company,” we mean Hanover together with its consolidated subsidiaries.

      The Company’s principal business is the REIT that generates net interest income on its portfolio of mortgage securities and mortgage loans on a leveraged basis. Secondarily, mortgage industry service and technology related income is earned through HCP and HT.

Interim Financial Reporting

      The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter ended March 31, 2005 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2005. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the Company’s annual report on Form 10-K for the year ended December 31, 2004.

Stock-Based Compensation

      Hanover accounts for stock-based awards under the recognition and measurement principles of the Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations (“APB25”). Under APB25 Hanover has not recognized as compensation expense the value of stock-based awards. Hanover did not issue stock awards during the three months ended March 31, 2005 and 2004.

      In December 2004 the Financial Accounting Standards Board (FASB) revised Statement of Financial Accounting Standards No. 123 “Accounting for Stock-based Compensation” (“SFAS 123”) that supercedes APB25 and requires the use of a fair value based methodology (similar to the original SFAS 123 methodology) to measure and record expenses and liabilities associated with stock-based compensation. The revised standard is required to be adopted by Hanover beginning January 1, 2006 and is applicable to any new awards and to all existing awards for which the requisite service to earn the award has not yet been rendered. The effect of adopting the revised standard is not expected to be material to Hanover’s earnings or financial condition.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Common Stock Issued and Outstanding

Earnings Per Share

(Dollars in thousands, except share and per share data)

      Mortgage loans classified as held for sale are carried at the lower of cost or market and consist of approximately $11,000 in fixed rate mortgages and $160,000 in adjustable rate mortgages as of March 31, 2005.

CMO Collateral

(Dollars in thousands)

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

CMO Collateral — Loan Loss Allowance Activity

(Dollars in thousands)

Mortgage Securities Pledged Under Repurchase Agreements

(Dollars in thousands)

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Mortgage Securities, Not Pledged

(Dollars in thousands)

All Mortgage Securities by Collateral Type

(Dollars in thousands)

      As of March 31, 2005, Hanover had approximately $583,000 of loans outstanding to four of its executive officers (the “Principals”). The notes mature in September 2007. The loans to the Principals, recorded as a deduction from stockholders’ equity of as of March 31, 2005, are secured solely by an aggregate of 38,889 shares of Hanover’s common stock, owned by the Principals, and are otherwise non-recourse to the Principals.

      The $583,000 of loans outstanding could be forgiven and 72,223 shares of the Company’s common stock could be earned by, and subsequently transferred to, the Principals as of any July 1 between 2005 and 2007 if the return on the Company’s common stock meets or exceeds predefined conditions.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

      Information pertaining to individual repurchase agreement lenders as of March 31, 2005 is as follows (dollars in thousands):

      As of March 31, 2005, the weighted-average borrowing rate on the Company’s repurchase agreements was 3.30%. The committed borrowing amount for Lender A, set to expire on April 25, 2005, has been extended until the lender can complete the renewal process. Management expects Lender A to renew the commitment for twelve months (see Note 12). All of the Company’s other repurchase borrowings are pursuant to uncommitted financing arrangements that are typically renewed monthly.

      HCP has a line of credit established with a major business finance organization for up to $2 million or 80% of HCP’s accounts receivable. The line is secured by the assets of HCP. The interest rate is applied daily to outstanding amounts based on the LIBOR rate plus 2.8%. At March 31, 2005, HCP’s borrowing rate was 5.66%.

      Hanover uses certain derivative instruments to manage the risk of changes in market conditions that could affect the value of certain portfolio securities or adverse changes in floating interest rates of its debt instruments. Hanover’s derivatives are classified as freestanding with income realized from settlements and changes in valuation of contracts included in income. Derivative instruments are included as a component of other assets and carried at fair value based on estimates using market prices.

      Hanover uses forward sales contracts to provide protection against adverse changes in the market value of its Agency mortgage-backed securities. Hanover also uses interest rate caps to provide protection against increases in floating interest rates on financing liabilities, primarily repurchase agreements, and to some extent CMOs.

      As of March 31, 2005, the fair value of Hanover’s interest rate caps was approximately $107,000 and the fair value of forward sales contracts was approximately $996,000.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Components of Income From Freestanding Derivatives

(Dollars in thousands)

      During March of 2005, Hanover Statutory Trust I (“the Trust”) sold, in a private placement, trust preferred securities for an aggregate amount of $20 million. Hanover owns all of the common stock of the Trust. The Trust used the proceeds to purchase Hanover junior subordinated notes due March 2035, which represent all of the Trust’s assets. The terms of the junior subordinated notes are substantially the same as the terms of the trust preferred securities. The trust preferred securities have a fixed interest rate of 8.51% per annum during the first five years, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 4.25% per annum.

      Under the provisions of the FASB issued revision to FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46(R)”), Hanover determined that the holders of the trust preferred securities were the primary beneficiaries of the Trust. As a result, Hanover cannot consolidate the Trust and has reflected the obligation to the Trust under the caption “liability to subsidiary trust issuing preferred securities” and will account for the investment in the common stock of the Trust on the equity method of accounting.

      Hanover may redeem the notes, in whole or in part, for cash, at par, after March 30, 2010. To the extent Hanover redeems notes the Trust is required to redeem a corresponding amount of trust preferred securities.

      The ability of the Trust to pay dividends depends on the receipt of interest payments on the notes. Hanover has the right, pursuant to certain qualifications and covenants, to defer payments of interest on the notes for up to four consecutive quarters. If payment of interest on the notes is deferred, the Trust will defer the quarterly distributions on the trust preferred securities for a corresponding period. Additional interest accrues on deferred payments at the annual rate payable on the notes, compounded quarterly.

Summary

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

      The Company’s three principal business segments are each conducted through its three primary operating companies, Hanover, HCP, and HT. Segment information is prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States. HCP and HT rely on Hanover for financing portions of their operations. Intercompany transactions are recorded on an arms-length basis. All significant intercompany accounts and transactions are eliminated in consolidation. However, interest on any intercompany notes from HCP and HT to Hanover is determined on an incremental cost basis that may be less than HCP and HT would pay to independent third parties.

      The principal business of Hanover is earning interest and income on leveraged investments in subordinated mortgage-backed securities and, to a lesser extent, mortgage-loans. The principal business of HCP is to generate income from services provided to the mortgage industry in the form of consulting, loan sale advisory services, loan file due diligence reviews, staffing solutions, and mortgage assignment and collateral rectification services. The principal business of HT is generating income from loan sale advisory services, traditional loan brokerage services, technology solutions, and valuation services. HT also brokers loan pools, mortgage-servicing rights, and other mortgage related assets through an Internet-based exchange. The Company’s businesses are all conducted within the United States.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

      On May 13, 2005, Hanover received notice from the lender of its $20 million committed borrowing that the term of such borrowing would be extended to May 15, 2006 (see Note 7).

      The Board of Directors declared a first quarter dividend of $0.30 per share on May 13, 2005, to be paid on June 6, 2005, to stockholders of record as of May 27, 2005.

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

      Certain statements in this report, including, without limitation, matters discussed under this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” should be read in conjunction with the financial statements, related notes, and other detailed information included elsewhere in this Quarterly Report on Form 10-Q. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,” “may,” “should,” “will,” or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties described in Items 1, 7 and 7A of our Annual Report on Form 10-K for the year ended December 31, 2004 and in our other securities filings with the Securities and Exchange Commission. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties. The forward-looking statements contained in this report are made only as of the date hereof. We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview

      We are a specialty finance company qualified as a real estate investment trust, which we refer to as a “REIT”. Accordingly, we generally distribute substantially all of our earnings to stockholders without paying Federal or state income tax at the corporate level on the distributed earnings. We seek to generate consistent income from our investments and business activities and provide steady dividends to our shareholders by investing primarily in the domestic residential mortgage market. We have three principal business segments that service the domestic residential mortgage market:

For the three months ended March 31, 2005, we reported net income of $1.4 million, or $0.16 diluted earnings per share, as compared to $2.5 million, or $0.31 diluted earnings per share, in the same period in 2004. Our earnings were driven largely by the income generated by our mortgage investment portfolio. The size of this portfolio increased to $207.7 million as of March 31, 2005 from $146.7 million as of March 31, 2004.

      Our principal business is to invest in Subordinate MBS and Mortgage Loans. We also maintain a portfolio of whole pool Agency MBS to satisfy certain Investment Company Act of 1940 requirements.

      The table below describes the principal assets of our investment portfolio as of March 31, 2005 (dollars in thousands):

      Our Subordinate MBS portfolio is comprised of non-investment grade securities that represent retained interests that are subordinate to other classes of the same series of mortgage-backed securities in the right to receive payments from the underlying mortgage loans. These securities are backed by prime quality domestic residential mortgage loans issued and serviced by large mortgage originators. Our Subordinate MBS portfolio is comprised of both adjustable- and fixed-rate securities. These securities are financed under agreements where we have sold securities with a commitment to repurchase these securities at a later date, commonly referred to as “Repurchase Agreements”. Our Repurchase Agreements are both committed and uncommitted and re-price monthly based on the one-month London Interbank Offered Rate Index, or “LIBOR” index. LIBOR is an average of the interest rates that major international banks charge each other to borrow U.S. dollars in the London money market.

      The investment objective for our Subordinate MBS portfolio is to generate interest income and, when appropriate, gain on sale through credit risk management combined with leverage, which incurs some interest rate risk. Credit risk management is accomplished by pre-purchase and ongoing collateral analysis coupled with a pro-active disposition strategy. As of March 31, 2005, our Subordinate MBS portfolio has financing of $38.7 million and net equity of $27.7 million for a debt to equity ratio of 1.40 to 1.00.

      The investment objective for our Mortgage Loan portfolio is to generate interest income through credit risk and interest rate risk management. As of March 31, 2005, our Mortgage Loan portfolio consists of mortgage loans that collateralize two debt securitizations. Both securitizations are financing transactions where we sold senior bonds and retained certain subordinate bonds. The Mortgage Loans are classified as assets in our Consolidated Balance Sheets and generate interest income. The senior bonds we sold are classified as liabilities in our Consolidated Balance Sheets as collateralized mortgage obligations (CMOs) and generate interest expense. The difference between this interest income and expense is the net interest income we earn on our Mortgage Loan portfolio.

      We maintain an Agency MBS portfolio to satisfy Investment Company Act of 1940 requirements. Our Agency MBS portfolio is comprised of whole pool fixed-rate Fannie Mae and Freddie Mac guaranteed mortgage-backed securities that we economically hedge via forward sales of like-coupon

Agency MBS. We finance most of our Agency MBS portfolio with Repurchase Agreements, which re-price monthly based on the one-month LIBOR index. To the extent that we increase our Mortgage Loan portfolio, we would anticipate our Agency MBS portfolio to decline as the Mortgage Loan portfolio fulfills the Investment Company Act of 1940 requirements currently met by the Agency MBS portfolio.

      Generally we invest in securities that are the first to absorb credit losses. Our income will be affected both by the change in fair value of our securities and by credit losses. Changes in both the fair value and the credit losses are caused by increased delinquency and foreclosure rates in the residential mortgage market and reductions in housing values. In general, delinquency and foreclosure rates are correlated with local area employment rates and loss severities are associated with regional housing price trends.

      The future direction of unemployment, home prices and interest rates is uncertain and is expected to have a material affect on the performance of our investment portfolio. Historically each of these macroeconomic factors has been cyclical. Unemployment has been relatively low, which has led to relatively low delinquencies and defaults on mortgage loans. A decline of economic growth or a return to recession could result in increased delinquencies and defaults. In addition, home prices have increased over the past five years at a rate above the historical long-term trend. Declining home prices could lead to increased loss severity on defaulted mortgage loans. Moreover, short-term interest rates declined to recent low levels in 2004 and began to increase thereafter. Further increases in short-term interest rates will increase our cost of funds and reduce the net interest income on our portfolio.

      Our exposure to adverse macroeconomic trends is mitigated by our active credit risk management and our strategy of targeting (a) high credit score borrowers, who are less likely to default in an economic downturn, and (b) loans with low loan-to-value ratios, which are less likely to suffer losses due to declining home prices. In addition, our shift to adjustable-rate Subordinate MBS and our purchase of interest rate caps reduce the risk of declining net interest income caused by rising interest rates.

      Opportunities for HDMF-I LLC to acquire loans at attractive prices and yields could arise should the number of defaulted mortgage loans increase and home prices decline.

      Through our COS operations we provide services to commercial banks, mortgage banks, government agencies, credit unions and insurance companies. Our services include: conduit support services including loan due diligence (credit and compliance) on a full range of mortgage products; quality control reviews of newly originated mortgage loans; operational reviews of loan origination and servicing operations; mortgage assignment services; loan collateral reviews; loan document rectification; and temporary staffing services.

      Our COS revenue is driven by our ability to generate opportunities from new clients and by continuing to provide existing clients with needed services. Our business objective is to work closely with a specifically targeted group of clients so that we may tailor our services to meet their specific outsourcing and consulting needs. To that end, we have created an on-site fulfillment center in order to provide our clients with regularly scheduled pre-and post-closing loan services. Those clients that have utilized our fulfillment center have provided us with longer-term revenue streams. The market for COS services is affected by industry trends such as the volume of loan originations and the pace of consolidation in the mortgage industry.

      Our LSA operations earn fees by providing brokerage, asset valuation and consulting services. Our brokerage service integrates varying degrees of traditional voice brokerage conducted primarily by telephone, web-enhanced brokerage and on-line auction hosting. We also perform market price valuations for a variety of loan products and offer consulting advice on loan product pricing and business strategies.

      We earn licensing and related professional fees by licensing our proprietary software applications to the financial industry. We market web-based technology solutions to meet specific needs of the mortgage industry in the secure transmission, analysis, valuation, tracking and stratification of loan portfolios. The

software technology is licensed to government agencies and financial institutions that originate and/or trade financial assets. We also use the applications to provide servicing rights valuations to clients who do not license our software.

      The market for LSA and technology solutions is affected by industry trends such as the volume of loan originations and the pace of consolidation in the mortgage industry.

Dividend Policy

      Hanover operates as a REIT and is required to pay dividends equal to at least 90% of its REIT taxable income. The current policy of our Board of Directors is to annually pay four quarterly dividends based on management’s estimate of Hanover’s GAAP income and REIT taxable income in order to pay the greater of GAAP income or 90% of REIT taxable income. Hanover’s REIT taxable income is primarily generated by its leveraged investment portfolio of Subordinate MBS and CMOs. Hanover’s per share dividend rate is determined in the first quarter of each taxable year and, in general, would be the amount expected to be paid for each of the four quarters of the taxable year. To the extent that our GAAP income exceed this rate, a special dividend would be considered after the close of the taxable year. In all cases, the required 90% of REIT taxable income would be paid under our current policy.

Critical Accounting Policies

      Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and judgments that can affect the reported amounts of assets, liabilities (including contingencies), revenues and expenses as well as related disclosures. These estimates are based on available internal and market information and appropriate valuation methodologies believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the expected useful lives and carrying values of assets and liabilities which can materially affect the determination of net income and book value per common share. Actual results may differ from these estimates.

      Management believes the following are critical accounting policies in the preparation of our consolidated financial statements that involve the use of estimates requiring considerable judgment.

      Mortgage Securities — Our mortgage securities are designated as available for sale, trading, or held to maturity.

      Hanover’s assets are not generally traded on a national securities exchange or national automated quotation system and as a result prices may not be readily ascertainable. To overcome this void Hanover uses complex cash flow modeling in determining estimated fair value. Considerable judgment is required when interpreting market data to develop estimated fair values, particularly in circumstances of deteriorating credit quality and market liquidity. Several of the assumptions used by management are confirmed by independent third parties on at least a quarterly basis. In determining fair value, future cash

flows are based on estimates of prepayments, the impact of interest rate movements on yields, delinquency of the underlying loans and estimated probable losses based on historical experience and estimates of expected future performance. Assumptions are reviewed in light of market expectations adjusted by Hanover’s experience. To the extent that management’s assumptions do not reflect market expectations, the value of the portfolio may be adversely impacted.

      Revenue Recognition — Revenue from services performed under due diligence contracts in progress and long-term technology consulting contracts is recognized on an as-earned basis. To calculate the percentage of a contract earned, management must make estimates. As the majority of these revenues relate to services performed, such estimates may include the amount of time spent by individuals in relation to the aggregate amount of time required to complete the contract, the evaluation of both quantitative and qualitative criteria as agreed to and maintained in the contract and possibly regulations set forth in the contract if such contract is with an agency of the Federal government.

      We recognize revenue from loan brokering and advisory services when transactions fund which is the time fees are earned.

Results of Operations

      The following table presents our unaudited consolidated results of operations for the three months ended March 31, 2005 and 2004 (dollars in thousands, except per share data):

      We recorded net income for the three months ended March 31, 2005 of $1.4 million, or $0.16 per share, based on 8,408,335 diluted weighted-average common shares outstanding compared to net income of

$2.5 million, or $0.31 per share, based on 8,287,045 diluted weighted-average common shares outstanding for the same period in 2004. Net income for the three months ended March 31, 2005 decreased $1.1 million from the same period in 2004 primarily due to an increase in total of expenses of $0.9 million for the three months ended March 31, 2005 as compared to the same period in 2004. This increase in legal and professional, technology and other (including insurance and financing expenses) is more fully described under the section entitled “Operating Expenses” below. Total revenues for the three months ended March 31, 2005 were $7.8 million compared to $7.9 million previously reported for the same period in 2004.

      The Board of Directors declared a first quarter dividend of $0.30 per share on May 13, 2005 to be paid on June 6, 2005 to stockholders of record as of May 27, 2005.

      The following table provides details of net interest income for interest earning assets (dollars in thousands):

      The investment portfolio’s net interest income remained constant at $2.3 million for each of the three months ended March 31, 2005 and March 31, 2004. The increase in the net interest income in the Agency MBS portfolio to $0.7 million for the three months ended March 31, 2005 from $0.3 million for the same period in 2004 primarily resulted from an increase in the size of the portfolio. The increase in the size of the Agency MBS portfolio was intended to satisfy certain REIT related asset requirements. Net interest income in the Mortgage Loan portfolio declined $0.2 million during the three months ended March 31, 2005 as compared to the same period in 2004 as a result of scheduled and unscheduled principal payments that reduced the underlying mortgage loan balances. Net interest income in the Subordinate MBS portfolio declined $0.2 million during the three months ended March 31, 2005 as compared to the same period in 2004 primarily as a result of increased financing costs.

      The following table provides details of total gains (losses) as follows (dollars in thousands):

      Gain on sale of mortgage assets decreased $1.2 million for the three months ended March 31, 2005 as compared to the same period in 2004 primarily due to an increase in interest rates and an increase in the average cost basis of the assets sold.

      Losses on mark to market of mortgage assets increased $1.6 million for the three months ended March 31, 2005 as compared to the same period in 2004 primarily as a result of a decline in the carrying value of the Agency MBS portfolio.

      Gain on freestanding derivatives (which primarily relates to the economic hedge on the Agency MBS portfolio) increased $1.8 million for the three months ended March 31, 2005 as compared to the same period in 2004 primarily as a result of decreased expenses associated with economically hedging the Agency MBS portfolio.

      The following table provides details of the net interest income generated on the Mortgage Loan portfolio (dollars in thousands):

      Our Mortgage Loan portfolio net interest income declined to $0.1 million for the three months ended March 31, 2005 from $0.3 million for the same period in 2004. This decline in net interest income is due to the declining principal balance of our Mortgage Loan portfolio due to scheduled and unscheduled principal payments which reduced the underlying mortgage loan balances and, to a lesser extent, due to the rise in the interest expense related to one-month LIBOR indexed securities sold in our 1999-B securitization.

      The following table provides details of the net interest income generated on the Subordinate MBS portfolio (dollars in thousands):

      The Subordinate MBS portfolio’s net interest income decreased to $1.4 million for the three months ended March 31, 2005 from $1.6 million for the same period in 2004. This decrease in revenues was primarily attributable to the increase in financing costs.

      The following table provides details of the net interest income generated on the Agency MBS portfolio (dollars in thousands):

      The Agency MBS portfolio’s net interest income increased to $0.7 million for the three months ended March 31, 2005 from $0.3 million for the same period in 2004. The increase is primarily due to the increase in the size of the Agency MBS portfolio.

      We attempt to fully economically hedge our Agency MBS portfolio to potentially offset any gains or losses in our portfolio with losses or gains from our forward sales of like-kind Agency MBS.

      Earnings on our Agency MBS portfolio consist of net interest income and gains or losses on mark to market of the Agency MBS. However, these earnings are substantially economically offset by gains or losses from forward sales of like-coupon Agency MBS.

      The table below reflects the net economic impact of our Agency MBS portfolio for the three months ended March 31, 2005 (dollars in thousands):

      We believe that the net economic impact of our Agency MBS portfolio provides useful information to investors because it provides information not readily apparent from our Consolidated Statements of Income.

      For the three months ended March 31, 2005, each of due diligence fees and assignment fees increased from the same period in 2004. Due diligence fees increased to $2.0 million for the three months ended March 31, 2005 from $1.4 million for the same period in 2004 and assignment fees decreased to $0.5 million for the three months ended March 31, 2005 from $0.6 million for the same period in 2004.

      The increase in due diligence fees for the three months ended March 31, 2005 is attributed mainly to increased revenues from our conduit support services, which includes loan due diligence.

      For the three months ended March 31, 2005 revenues generated by technology services were $0.6 million as compared to $0.4 million for the same period in 2004. The increase in technology services for the three months ended March 31, 2005 is attributed mainly to an increase in license fees from deployment of our technology to a large mortgage banker.

      For the three months ended March 31, 2005, revenues generated from loan brokering and advisory services remained unchanged from the same period in 2004 at $0.5 million.

      The following table sets forth the increase (decrease) in operating expenses for the three months ended March 31, 2005 as compared to the same period in March 31, 2004 (dollars in thousands):