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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2005

OR

For the transition period from              to             

Commission File No. 001-32245

HomeBanc Corp.

(Exact name of registrant as specified in its charter)

(404) 459-7400

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  x    NO  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2):    YES  ¨    NO  x

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

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Index

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IMPORTANT INFORMATION ABOUT THIS REPORT

In this Quarterly Report on Form 10-Q, which we refer to as this “Report,” the words “Company,” “we,” “us” and “our” mean HomeBanc Corp., including its subsidiaries, as well as HomeBanc Corp.’s predecessors and their subsidiaries. “HBMC” refers to HomeBanc Mortgage Corporation, which became our wholly-owned subsidiary pursuant to a reorganization that we effected in connection with our initial public offering, which was completed on July 19, 2004. Prior to the reorganization, HBMC was wholly-owned by HBMC Holdings, LLC, which we refer to in this Report as “Holdings.” Except as otherwise indicated, we refer throughout this Report to the reorganization as having been completed prior to the period covered by this Report.

SPECIAL CAUTIONARY NOTICE

REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements made in this Report are “forward-looking statements” within the meaning, and subject to the protections, of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, or the “Exchange Act.”

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, many of which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by the forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “hope,” “project,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “could,” “intend,” “seek,” “outlook,” “target,” and other similar words and expressions of the future. Such forward-looking statements include, without limitation, statements regarding:

It is important to note that the description of our business, in general, and our mortgage-backed securities financings, in particular, is a statement about our operations as of a specific point in time. It is not meant to be construed as an investment policy, and the types of assets we hold, the amount of leverage we use, the liabilities we incur, and other characteristics of our assets and liabilities are subject to reevaluation and change without notice.

The forward-looking statements may not be realized due to a variety of factors, including, without limitation:

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All written or oral statements that are made by or are attributable to the Company are expressly qualified in their entirety by this cautionary notice. You should not place undue reliance on forward-looking statements, since the statements speak only as of the date that they are made. We have no obligation and do not undertake to publicly update, revise or correct any of the forward-looking statements after the date of this Report, or after the respective dates on which such statements otherwise are made, whether as a result of new information, future events or otherwise.

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PART I

Item 1. Financial Statements

HomeBanc Corp. and Subsidiaries

Condensed Consolidated Balance Sheet (Unaudited)

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

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HomeBanc Corp. and Subsidiaries

Condensed Consolidated Statement of Operations (Unaudited)

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

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HomeBanc Corp. and Subsidiaries

Condensed Consolidated Statement of Changes in Shareholders’ Equity (Unaudited)

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

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HomeBanc Corp. and Subsidiaries

Condensed Consolidated Statement of Cash Flows (Unaudited)

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

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HomeBanc Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1. Organization and Basis of Presentation

HomeBanc Corp. (“HomeBanc” or the “Company”) is a Georgia corporation engaged in the business of mortgage banking. The Company was formed on March 17, 2004 to, among other things, hold and service residential mortgage loans. The Company completed its initial public offering (the “Offering”) of 38,750,000 shares of common stock on July 19, 2004. The gross proceeds from the Offering were approximately $288.6 million, excluding the costs related to the Offering, principally $17.3 million in underwriting fees. As more fully discussed below, immediately prior to the Offering, the Company completed a corporate reorganization, through a merger with an affiliate, to meet the requirements for qualification as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). The Company has elected to be taxed as a REIT beginning with the tax year ending December 31, 2004.

In connection with the Company’s reorganization, the Company issued 6,751,107 shares of its common stock to HBMC Holdings, LLC (“Holdings”), a holding company for entities engaged in the business of mortgage banking. In return, the Company received all of the outstanding capital stock of Holdings’ wholly-owned subsidiary, Abetterwayhome Corp. Abetterwayhome Corp., in turn, owned Holdings’ principal operating entity, HomeBanc Mortgage Corporation (“HBMC”), an originator of residential mortgage loans. As a result of the reorganization, the Company temporarily became a wholly-owned subsidiary of Holdings and the owner of HBMC and all of Holdings’ other subsidiaries.

In July 2004, Holdings distributed, prior to the Offering, 6,101,677 shares of the HomeBanc Corp. common stock that it received in the reorganization to the holders of its preferred units. The total value of the distribution was equal to the aggregate value of, and in payment of, the capital accounts, including accumulated but unpaid distributions, of the preferred units as of the date of the closing of the Offering. This transaction has been accounted for in a manner similar to a pooling of interests, and the condensed consolidated financial statements of the Company include the combined entities from the earliest date presented.

The Company completed a second public equity offering on February 9, 2005 of 10,925,000 shares of its common stock priced at $9.10 per share, which included the exercise of the underwriters’ option to purchase 1,425,000 additional shares of common stock to cover over-allotments. The net proceeds to the Company, including proceeds from the exercise of the underwriters’ over-allotment option, was $93.0 million after deducting underwriting discounts, commissions and other related expenses.

The Company, through HBMC, originates residential mortgage loans through its 21 store locations and its 129 realtor store-in-store locations in the States of Georgia, Florida and North Carolina. HBMC’s mortgage product line includes conforming FNMA/FHLMC mortgage loans, FHA/VA government-insured mortgage loans, adjustable-rate mortgage loans, including construction-to-permanent and second-lien mortgage loans, nonconforming jumbo loans and a limited volume of sub-prime mortgage loans. The Company’s strategy emphasizes retail residential mortgage loan originations, primarily purchase money mortgages. The Company executes its strategy through the formation of strategic marketing alliances (“SMAs”) with residential realtors and home builders who have a significant presence in their markets. As of March 31, 2005, the Company had 230 SMAs, 88 of which were with residential realtors and 142 of which were with home builders.

Historically, HomeBanc sold a substantial number of the mortgage loans that it originated to third parties in whole loan and securitized form. As a result, the substantial majority of the Company’s revenue prior to January 1, 2004 was gain on sale of mortgage loans. During 2004, the Company began holding and servicing certain mortgage loans, primarily adjustable-rate mortgage loans with rates based on the London Interbank Offered Rate (“LIBOR”), for investment. HomeBanc expects to continue to hold and service these types of loans for investment in the future. These loans are financed by equity and debt, primarily through the issuance of adjustable-rate notes through securitization transactions treated as secured borrowings of HomeBanc in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. The entities used to complete the securitization transactions are not qualifying special purpose entities under SFAS No. 140 and are, therefore, consolidated. The Company has sold, and presently expects to continue selling, the majority of the fixed-rate mortgage loans that it originates. This change in the business model has resulted in a shift in revenue sources from gain on sale of mortgage loans to net interest income earned primarily on the adjustable-rate (including hybrid) mortgage loan portfolio held for investment.

At March 31, 2005, the Company had the following subsidiaries: HBMC; Abetterwayhome Corp.; HomeBanc Funding Corp.; HomeBanc Funding Corp. II; HMB Acceptance Corp.; Abetterwayhome Finance, LLC; Abetterwayhome Finance, LLC II; and HomeBanc Title Partners, LLC. All of these subsidiaries are wholly-owned by the Company, except for HomeBanc Title Partners, LLC, a joint venture in which Security First Title Affiliates, Inc., an agent offering title insurance to customers of the Company, owns a 15% equity interest. HBMC and Abetterwayhome Corp. have each made elections to be treated as a taxable REIT subsidiary. HomeBanc Funding Corp.; HomeBanc Funding Corp. II; and HMB Acceptance Corp. are treated as qualified REIT subsidiaries. Abetterwayhome Finance, LLC and Abetterwayhome Finance, LLC II are single-member limited liability companies disregarded for

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federal income tax purposes and treated for such purposes as branches of Abetterwayhome Corp. HomeBanc Mortgage Trust 2004-1; HomeBanc Mortgage Trust 2004-2; HomeBanc Mortgage Trust 2005-1; and HomeBanc Mortgage Trust 2005-2 are bankruptcy-remote Delaware statutory trusts used in connection with the Company’s securitization activities and are exempt from taxation. In accordance with accounting principles generally accepted in the United States (“GAAP”), these entities are consolidated. HomeBanc Title Partners, LLC is a limited partnership for federal income tax purposes. HomeBanc Funding Corp.; HomeBanc Funding Corp. II; HMB Acceptance Corp.; Abetterwayhome Finance, LLC; Abetterwayhome Finance, LLC II; HomeBanc Mortgage Trust 2004-1; HomeBanc Mortgage Trust 2004-2; HomeBanc Mortgage Trust 2005-1; and HomeBanc Mortgage Trust 2005-2 are all bankruptcy-remote special purpose entities utilized in the financing of the Company’s operations.

In the opinion of management, the condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring accruals, which are necessary for the fair presentation of the financial condition and results of operations for the interim periods presented. Certain information and disclosures normally included in notes to consolidated financial statements have been condensed or omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission (the “SEC”). Due to the cyclical and seasonal nature of the mortgage banking industry, the results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year or for any other periods.

All material intercompany transactions have been eliminated in consolidation. Certain balances in the prior period have been reclassified to conform to the current presentation.

Unless the context otherwise requires, for purposes of these notes to the condensed consolidated financial statements, the “Company” refers to HomeBanc and its subsidiaries.

Note 2. Summary of Significant Accounting Policies

Use of Estimates

The accounting and reporting policies of HomeBanc and its subsidiaries conform with GAAP and 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. Examples of estimates include the adequacy of the allowance for loan losses (the “Allowance”), estimates of contingency losses on repurchases of loans arising from representation and warranty claims, and estimates of fair value of financial instruments. Accordingly, actual results and future estimates could differ from the estimates presented.

The following is a summary of the more significant accounting policies of HomeBanc.

Transfers of Financial Assets

From time to time, the Company sells or securitizes mortgage loans. These transfers of financial assets are accounted for as sales for financial reporting purposes when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company; (2) the transferee obtains the right, free of conditions that constrain it from taking advantage of that right, to pledge or exchange the transferred assets; and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Transfers of financial assets not meeting these sale criteria are treated as secured borrowings. Tax treatment for transfers of financial assets is dependent upon the particular facts and circumstances but does not necessarily match the treatment applied for financial reporting purposes.

Mortgage Loans Held for Sale

Mortgage loans held for sale include mortgage loans and any related deferred origination fees and costs. Deferred net fees or costs are not amortized during the period the loans are held for sale, but are recognized when the loans are sold. Mortgage loans held for sale are carried at the lower of aggregate cost or estimated fair market value as determined by aggregate outstanding commitments from investors or current investor yield requirements. Any adjustment to the carrying amount of loans resulting from the application of SFAS No. 133, Accounting for Derivative Financial Instruments and Hedging Activities, is considered in the determination of lower of cost or estimated fair market value. Net unrealized losses are recognized in a valuation allowance by charges to income.

Gains and losses on the sale of loans are recognized at the settlement date and are determined by the difference between the selling price and the carrying value of the loans sold. These transactions are treated as sales in accordance with SFAS No. 140. At the time of sale, a reserve is established for estimated contingencies in the form of loss indemnification related to customary standard representations and warranties made in connection with the sale. Prior to 2004, the Company sold substantially all of the mortgage loans that it originated on a servicing-released basis to various investors. The Company currently sells, on a servicing-released basis, the majority of the fixed-rate mortgage loans it originates and retains for investment the majority of the adjustable-rate mortgage loans, as well as the related servicing rights.

The majority of the loans originated by the Company are in the states of Georgia, Florida and North Carolina. As a result, real estate values in these markets impact the credit risk of loans held for sale.

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Mortgage Loans Held for Investment

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are considered held for investment. Loans held for investment are recorded at their unpaid principal balance together with the net unamortized deferred loan origination costs and fees. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to income over the lives of the related loans. Unearned income is amortized into income over the estimated life of the loan using methods that approximate the interest method. Interest income is accrued based on the outstanding principal amount and contractual terms of each individual loan.

The majority of the loans originated by the Company are in the states of Georgia, Florida and North Carolina. As a result, real estate values in these markets impact the credit risk of loans held for investment.

Allowance for Loan Losses

The Company began to maintain an Allowance as it began to accumulate mortgage loans for investment in the first quarter of 2004. Additions to the Allowance are based on assessments of certain factors, including historical loan loss experience of similar types of loans, the Company’s loan loss experience, the amount of past due and nonperforming loans, specific known risks, the value of collateral securing the loans, and current and anticipated economic and interest rate conditions. Evaluation of these factors requires that the Company’s management make subjective estimates and judgments that may change or prove to be incorrect. Additions to the Allowance are provided through a charge to earnings. Subsequent recoveries, if any, are credited to the Allowance.

Nonperforming Loans and Impaired Loans

The accrual of interest on loans is discontinued at the time the loan is 90 days past due, unless the credit is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Loans are generally charged off in the period in which an event occurs that confirms the existence of a loss. In all cases, loans are treated as non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans past due 90 days or more totaled $4.0 million and $3.9 million at March 31, 2005 and December 31, 2004, respectively. There were no loans past due 90 days or more still accruing interest at March 31, 2005 or December 31, 2004.

All current period interest accrued but not collected for loans that are treated as non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Under SFAS No. 114, Accounting by Creditors for Impairment of a Loan, a loan is considered impaired when, based on current information, the Company believes it is probable that the Company will not receive all amounts due in accordance with the contractual terms of the underlying loan agreement. The fair value of the loan is then compared with the recorded investment in the loan to determine whether or not a specific reserve is necessary. Due to the fact that all of the Company’s loans held for investment are collateral-dependent, a loan’s fair value is determined using the fair value of the underlying collateral. In accordance with SFAS No. 114, the Company reviews its loans for impairment collectively because they represent a large group of homogenous loans.

Mortgage Servicing Rights and Servicing Income

Mortgage servicing rights (“MSRs”) are recognized when a mortgage loan is sold, on a servicing-retained basis, to a third party. In connection with the sale of mortgage loans, a portion of the cost of originating each loan is allocated to the MSRs based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service the loan, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The expense related to capitalized MSRs is amortized into other revenue in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage loans.

MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to their amortized cost. Impairment is determined by stratifying the MSRs into tranches based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.

Servicing fee income is recognized monthly on an accrual basis, based upon the terms of the underlying agreement. Generally, such agreements provide for fees based upon a percentage of the outstanding balance of the related loans. Servicing activities include the monthly collection of principal, interest and escrow payments, and the performance of certain accounting and reporting functions on behalf of mortgage investors. Ancillary fees, including late fees, are recognized as collected.

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Commencing in December 2003, the Company began retaining the servicing rights for those loans that it found economically attractive to service, namely a portion of the nonconforming mortgage loans and a limited number of loans sold to Fannie Mae. The Company also services construction-to-permanent loans during the construction phase of these mortgage loans. In addition, the Company generally has serviced loans that are the subject of sale transactions for up to 30 days after the loans are sold.

Goodwill and Intangibles

Goodwill relates to the excess of purchase price over net assets acquired in business combinations. Prior to 2002, the Company amortized goodwill over 20 years utilizing the straight-line method. Effective January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which resulted in the cessation of the amortization of goodwill. Accumulated amortization was $3.6 million at both March 31, 2005 and 2004. Under SFAS No. 142, goodwill and intangible assets are deemed to have indefinite lives and are not amortized but are subjected to impairment testing.

The carrying value of goodwill for the Company is subject to at least an annual assessment for impairment by applying a fair value-based test. If the carrying value exceeds the fair value, goodwill is impaired. The Company regularly evaluates whether events and circumstances have occurred that indicate the value of goodwill may not be recoverable. In evaluating whether impairment exists, the Company uses a discounted cash flow analysis. The calculation of cash flows begins with an estimation of net earnings in several trend scenarios, taking into account anticipated effective tax rates, over the next 10 years, including forecasted, high performance, low performance and worst-case trends. A terminal value based on an estimated earnings multiple is added to each scenario at the end of 10 years to determine total cash flows. A discount factor, approximating HomeBanc’s cost of capital, is then applied to each cash flow scenario to determine the present value. The present value of each scenario is then weighted based on the probability of occurrence as assessed by management. The resulting weighted-average present value is compared to the recorded equity. As long as the weighted-average present value is greater, goodwill is not considered to be impaired. HomeBanc performed its annual test for impairment of goodwill as of the designated testing date during the fourth quarter of 2004 and determined that, at that time, there was no impairment. Subsequent to the annual test, there have been no events or circumstances indicating the value of goodwill may not be recoverable.

Stock-Based Compensation

The Company has elected to adopt the recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, which requires a fair-value-based method of accounting for stock options and similar equity awards. The fair value of equity incentives granted is estimated on the date of grant using a Black-Scholes option-pricing model or other fair value estimation methods, as appropriate. Forfeitures are appropriately recognized as they occur. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), Share-Based Payment, which requires that forfeitures be estimated at grant date and factored into the associated compensation expense calculation. SFAS 123(R) required adoption for interim periods beginning after June 15, 2005. The Company previously planned to adopt this standard as of January 1, 2005; however, on April 14, 2005, the SEC approved Release No. 33-8568 (the “SEC release”) delaying the effective date of SFAS No. 123(R) making it effective for public companies for annual, rather than interim, periods that begin after June 15, 2005. As a result of the issuance of the SEC Release, the Company will adopt this standard on January 1, 2006 and is still in the process of quantifying the impact that implementation will have upon the Company’s financial condition, results of operations and cash flows.

Income Taxes

As long as it maintains its election and qualification as a REIT, HomeBanc, as a stand-alone entity for income tax purposes, will not be subject to taxation. HomeBanc’s taxable REIT subsidiaries are subject to taxation. For those entities, HomeBanc accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, which requires an asset and liability approach for accounting and reporting of income taxes. The provision for income taxes is comprised of taxes that are currently payable and deferred taxes that relate to temporary differences between the book basis and tax basis of assets and liabilities that will result in deductible or taxable amounts in future years when such assets and liabilities are recovered or settled. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be realized or settled. Recognition of certain deferred tax assets is based upon management’s belief that, based upon historical earnings and anticipated future earnings, normal operations or available tax planning strategies will generate sufficient future taxable income to realize these benefits. When, in the opinion of management, it is “more likely than not” that the asset will be realized, no valuation allowance is established for deferred tax assets.

Reserve for Contingencies

The Company maintains a reserve for contingencies that represents estimated losses on repurchases arising from representation and warranty claims and probable obligations related to disputes with investors on contractual obligations with respect to loans sold. The reserve is included in other liabilities in the condensed consolidated balance sheet. Further discussion on the reserve for contingencies is included in Note 8, “Commitments and Contingencies.”

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Derivative Financial Instruments

In accordance with SFAS No. 133, the Company records all derivative financial instruments in the condensed consolidated balance sheet at their fair value in other assets or other liabilities. Changes in fair value are recorded each period in current earnings (other revenue or other operating expense) or other comprehensive income depending upon the purpose for using the derivative and its qualification, designation and effectiveness as a hedging instrument. Under SFAS No. 133, the Company may designate a derivative as a hedging instrument in either a cash flow hedge or a fair value hedge.

Derivatives designated in a hedging relationship to mitigate exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. To the extent that a hedging instrument is proven effective in mitigating exposure to the risk being hedged, changes in fair value of the hedged item may be recorded within current earnings as an offset to amounts recorded with respect to fair value changes of the derivative.

Derivatives that are designated to hedge the variability in expected future cash flows or forecasted transactions are considered cash flow hedges. The effective portion of the change in fair value of the derivative is recorded in other comprehensive income and reclassified into earnings within the related revenue/expense line item during the period in which the hedged transaction occurs. Ineffectiveness is recorded in current period earnings in other revenue or other operating expense as appropriate.

The Company must perform a prospective assessment at the inception of each hedging relationship and at least quarterly thereafter to determine whether the derivative is expected to be highly effective in hedging the designated risk. If the derivative is no longer expected to be highly effective in the hedging relationship, hedge accounting must be discontinued prospectively. Retrospective testing must also be performed quarterly when financial statements are produced to determine whether the derivative has been highly effective in achieving risk management objectives. When a hedging relationship fails retrospective testing, hedge accounting is discontinued at the date when the hedge was last demonstrated as effective.

Hedge accounting is discontinued prospectively in existing hedging relationships when: (1) any qualification criteria can no longer be met; (2) the hedging instrument has expired, been sold, terminated or exercised; (3) the hedged item has been sold, matured or terminated; (4) it is no longer deemed probable that a hedged forecasted transaction will occur; or (5) management determines that a hedge is no longer deemed appropriate and de-designates the hedging instrument.

In the case of fair value hedges, when: (1) hedging criteria are no longer met; (2) management de-designates the hedging instrument; or (3) the hedging instrument has expired, been sold, terminated or exercised, the Company will discontinue recording changes in fair value of the hedged item and will amortize the existing basis adjustment to earnings over its remaining expected life. For fair value hedges where the hedged item been sold, matured or terminated, the difference between the carrying value of the hedged item and its fair value is recorded into current earnings.

For cash flow hedges, when: (1) hedging criteria are no longer met; (2) management de-designates the hedging relationship; or (3) the hedging instrument has expired, been sold, terminated or exercised, changes in the value of the derivative will be recorded to current earnings while the net gain or loss previously recorded in other comprehensive income will continue to be reported there until the hedged forecasted transaction impacts earnings. When it is no longer deemed probable that a hedged forecasted transaction will occur, the amounts recorded in other comprehensive income are immediately released into current earnings.

Derivative financial instruments and hedging activities—business perspective. The Company has developed risk management programs and processes designed to manage market risk associated with the Company’s business activities. Interest rate risk is a predominant risk that further influences a number of other business risks such as pricing risk, prepayment risk, valuation risk, balance sheet management and funding risk. As part of its risk management program, the Company utilizes derivative financial instruments, including interest rate swaps, interest rate basis swaps, forward contracts, interest rate caps and options on forward contracts to manage interest rate risks associated with its balance sheet activities. The Company’s derivative financial instrument positions currently include cash flow hedges and other freestanding derivative financial instruments.

Loan production activities include the origination of mortgage loans, the warehousing of those loans in inventory and the resale of those loans to investors in the secondary market. The Company utilizes derivative financial instruments to protect against and manage interest rate risk and pricing risk associated with its loans held for sale and its mortgage pipeline. SFAS No. 133 also defines interest rate lock commitments relating to future mortgage loans held for sale as a derivative financial instrument, which is marked-to-market through earnings. Similar to mortgage loans held for sale, the fair value of interest rate lock commitments is determined by examining outstanding commitments from investors or current investor yield requirements. The fair value of derivative financial instruments associated with loans held for sale and the mortgage pipeline are reported on a gross basis and included within other assets or other liabilities, as appropriate.

Variable Interest Entities

The Company owns contractual interests in segregated accounts of two captive private mortgage reinsurance companies controlled and managed by unaffiliated insurance companies. These arrangements provide the Company with income based upon the amount of

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capital required to support these policies and the claims experience of the private mortgage insurance sold by these entities to customers of HBMC, and in which the Company bears the second 5% of losses in an amount up to its capital contributions. The Company began its participation in these ventures in 2003. The Company consolidates its interests in the two captive private mortgage reinsurance companies consistent with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51.

Note 3. Mortgage Servicing Rights

The following tables present a reconciliation of the changes in MSRs and the associated valuation allowance for the three months ended March 31, 2005 (dollars in thousands):

During the three months ended March 31, 2005, the Company recorded a valuation allowance related to its MSRs of $0.2 million, which reduced the carrying value of the MSRs. No servicing valuation provision was required during the three months ended March 31, 2004.

Note 4. Borrowings

Warehouse and Aggregation Facilities

The Bear Stearns master repurchase agreement, used to finance a portion of the mortgage loans that the Company originates, was amended on January 24, 2005, effective as of December 31, 2004, since the Company would not have met the GAAP net income covenant applicable at that date. The amendment requires the Company to have a consolidated GAAP net loss of no greater than $15 million for the quarter ending March 31, 2005, a consolidated GAAP net loss of no greater than $10 million for the quarter ending June 30, 2005, a consolidated GAAP net loss of no greater than $5 million for the quarter ending September 30, 2005, consolidated GAAP net income of no less than $1.00 for the quarter ending December 31, 2005 and consolidated GAAP net income of at least $2.00 for every two consecutive quarters thereafter.

Collateralized Debt Obligations

On February 23, 2005, the Company completed an offering to the public, through HomeBanc Mortgage Trust 2005-1 (the “2005-1 Trust”), of approximately $1.1 billion of notes (the “2005-1 Notes”) backed by adjustable-rate, residential first mortgage loans. The Company has accounted for the securitization as a secured borrowing for both financial reporting and tax purposes. The approximate amount of each class of the 2005-1 Notes sold to the public, together with the interest rate and the initial credit ratings for each class assigned by Moody’s and S&P, respectively, are set forth below:

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In connection with the issuance of the 2005-1 Notes, the Company incurred costs of $3.1 million, which were deducted from the proceeds of the securitization and are being amortized monthly in proportion to the outstanding balance of the 2005-1 Notes.

On March 31, 2005, the Company completed its fourth loan securitization, through an offering by HomeBanc Mortgage Trust 2005-2 (the “2005-2 Trust”), of approximately $170.9 million of notes (the “2005-2 Notes”) backed by adjustable-rate, residential second-lien mortgage loans. The Company has accounted for the securitization as a secured borrowing for both financial reporting and tax purposes. The approximate amount of each class of the 2005-2 Notes, together with the interest rate and the initial credit ratings for each class assigned by Moody’s and Fitch, respectively, are set forth below:

All classes of the notes listed above were sold to the public except for the B-2, B-3 and B-4 classes, which were retained by the Company.

In connection with the issuance of the 2005-2 Notes, the Company incurred costs of $0.5 million, which were deducted from the proceeds of the securitization and are being amortized monthly in proportion to the outstanding balance of the 2005-2 Notes.

Note 5. Earnings per Share

Basic earnings per share represents income available to holders of shares of common stock divided by the weighted-average number of shares of common stock outstanding during the period. Diluted shares of common stock outstanding include the weighted-average number of shares of common stock outstanding during the period, together with additional shares of common stock that would have been outstanding if all dilutive potential shares of common stock had been issued, as well as any adjustment to income that would result from the assumed issuance.

Earnings per share of common stock have been computed based on the following (dollars in thousands, except per share amounts):

Excluded from the computation of diluted shares for the three-month period ended March 31, 2005 were 1,236,025 stock appreciation rights (“SARs”) and 764,242 restricted stock units (“RSUs”) because the effect would be antidilutive due to the Company’s loss applicable to common stock.

Note 6. Stock-Based Compensation

Stock Appreciation Rights

A SAR entitles the grantee to a payment equal to the appreciation in value of the underlying common stock over a specified time. SARs granted under the Amended and Restated 2004 Long-Term Incentive Plan (the “LTIP”) will be settled in common stock, subject to the satisfaction of vesting requirements. The base price of a SAR is equal to the fair market value of one share of common stock on the grant date. The grantee is entitled to a payment upon exercise of the SAR equal to the excess, if any, of the fair market value of the common stock at the exercise date over the base price (the “spread”), multiplied by the number of SARs being exercised. That payment is made in the form of common stock having a value equal to the aggregate spread on the SARs.

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SARs granted in 2004 included tandem dividend equivalent rights in the form of restricted stock units that are converted to shares when the SAR is exercised. SARs granted in 2005 do not include tandem dividend rights, except for those issued to members of the board of directors.

The following assumptions were used for grants of SARs during the first quarter of 2005: expected dividend yield of 7.19%; expected volatility of 20.0%; risk-free interest rate of 4.11%; and an expected life of 6.5 years.

During the three months ended March 31, 2005, the Company recognized $0.2 million in expense related to SARs.

Restricted Stock Units

RSUs represent the right to receive shares of common stock in the future, subject to the satisfaction of vesting requirements. Until the RSUs are settled on each applicable vesting date and stock is delivered, the grantee does not own actual shares of stock and, therefore, does not have voting rights or receive dividends. RSUs granted in 2004 included tandem dividend equivalent rights, according to which the dollar amount of any dividends paid on the Company’s common stock is converted to additional RSUs based on the stock price at the dividend payment date and credited to the account of the grantee. Such additional RSUs are subject to the same forfeiture and transfer restrictions and payment terms as apply to the RSUs with respect to which they relate. RSUs granted to HomeBanc associates in 2005 also include dividend equivalent rights paid in the form of cash as opposed to additional RSUs. Dividend equivalent rights associated with RSUs granted to non-employee members of the board of directors during 2005 will continue to be paid in the form of additional RSUs.

The total amount expensed for RSUs during the first quarter of 2005 was $0.4 million.

Note 7. Income Taxes

Applicable income taxes for the three months ended March 31, 2005 were a net benefit of $3.5 million, compared to a net benefit of $6.8 million for the three months ended March 31, 2004. At March 31, 2005, the Company had a net deferred tax asset of $15.5 million, compared to a net deferred tax asset of $12.0 million at December 31, 2004. The results for the three months ended March 31, 2005 include a gross benefit of $8.0 million and a valuation allowance of $4.5 million, which is further discussed below. The Company did not have a valuation allowance for any period prior to March 31, 2005.

As a result of HomeBanc Corp.’s election to be taxed as a REIT, it does not pay any taxes as long as it continues to meet the criteria to be a REIT. The Company’s primary operating subsidiary, HBMC, as a separate income tax filer and a taxable REIT subsidiary of HomeBanc Corp., must record tax expense or benefit based on its stand-alone earnings or losses. From time to time, HBMC sells and transfers mortgage loans to HomeBanc. For GAAP purposes, no gain on sale is recognized on mortgage loans sold and transferred to HomeBanc’s investment portfolio. However, for tax purposes, mortgage loans sold and transferred to HomeBanc are transferred at their fair values resulting in a taxable gain on sale at HBMC.

In accordance with GAAP, management must make an assessment, at the end of each reporting period, of the likelihood that the recorded net deferred tax asset will be realized. The net deferred tax asset must be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or all of the net deferred tax asset will not be realized within a relatively short period, generally no more than three years. The available evidence includes consideration of:

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The Company’s net deferred tax asset at March 31, 2005 includes an asset of $28.8 million arising from net operating losses of HBMC. These net operating losses will expire in 20 years for tax return purposes, currently ranging from 2024 – 2025. After consideration of management’s expectations about future taxable income and tax planning strategies that could be invoked to generate taxable income, management has concluded that $4.5 million of the net deferred tax asset at March 31, 2005 is unlikely to be realized within a three-year period. Accordingly, the net deferred tax asset at March 31, 2005 includes a valuation allowance of $4.5 million.

Note 8. Commitments and Contingencies

The Company maintains a reserve for contingencies arising in connection with loan sales to third parties. The reserve for contingency losses anticipated in association with investor repurchase and indemnification requests was $3.1 million and $3.2 million as of March 31, 2005 and December 31, 2004, respectively. Total reserves, including valuation allowances, if any, related to individual mortgage loans held for sale, were $4.7 million and $4.5 million at March 31, 2005 and December 31, 2004, respectively.

The nature of the Company’s business requires compliance with various state and federal lending laws and exposes the Company to a variety of legal proceedings and matters in the ordinary course of business, primarily related to its loan servicing activities, foreclosures, real estate settlements, bankruptcies, condemnation and quiet title actions, and alleged statutory and regulatory violations. The Company also is subject to legal proceedings from time to time, which generally have related to employee and employment issues. The Company presently believes that all of the proceedings to which it is presently subject, taken as a whole, will not have a material adverse impact on its financial condition or results of operations.

Note 9. Derivative Financial Instruments

During the first quarter of 2005, the Company de-designated certain interest rate swaps representing $675.0 million in notional value previously designated in cash flow hedging relationships of forecasted interest payments on collateralized debt obligations. These swaps were subsequently re-designated in new cash flow hedging relationships of anticipated interest payments on collateralized debt obligations. In accordance with the requirements of SFAS No. 133, the associated market value recorded in accumulated other comprehensive income of $2.5 million will be reclassified into earnings when the forecasted interest payments impact earnings.

A summary of the Company’s position with respect to its derivative financial instruments by hedging category and designated hedged item, where appropriate, follows:

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

General

We are a Georgia corporation formed in March 2004 to own, continue and expand the business of HBMC, a residential mortgage banking company. HBMC and its predecessors have been in the residential mortgage loan origination business for over 20 years. We focus our mortgage origination activities primarily on prime one-to-four family residential purchase money mortgage loans rather than mortgage refinancings. While the definition of “prime” loans varies from company to company, we consider “prime” loans to be loans that satisfy our prescribed investment criteria, namely loan product type, credit scores and loan-to-value ratios. We presently focus on select markets within the states of Georgia, Florida and North Carolina. Our goal is to focus on markets where we believe the demographics, including population growth, new one-to-four family building permits, and sales of new and existing homes, provide opportunities to originate purchase money mortgage loans in sufficient volume to support our offices and growth objectives.

Historically, HBMC sold substantially all of the mortgage loans that it originates to third parties in whole loan and securitized form and financed its operations through warehouse and repurchase lines of credit. In addition, HBMC historically did not service any loans, other than construction-to-permanent loans during the construction phase.

In July 2004, we completed our initial public offering and related reorganization, which resulted in our ownership of 100% of the outstanding stock of HBMC. We elected to be taxed as a REIT for the year ended December 31, 2004, and HBMC is one of our taxable REIT subsidiaries. Our revenues and results of operations for periods after July 19, 2004, including the year ended December 31, 2004, reflect the changes in strategy implemented by us in anticipation of our initial public offering and the reorganization, which are further described below.

Adjustable-Rate Mortgage Loan Retention Strategy. In February 2004, we began to hold for investment a majority of the prime adjustable-rate mortgage loans we originate, while continuing to sell a majority of our fixed-rate mortgages loan originations. As a result, our revenues and losses for the quarter ended March 31, 2005 reflect changes in the business strategy during which we, through our affiliates, continued to retain and aggregate a significant amount of our total loan origination volume, rather than selling those loans to generate gains on sale.

We presently expect to continue selling the majority of the fixed-rate mortgage loans that we originate. We believe that, due to the complexity of some interest-only, adjustable-rate mortgage products, the secondary whole loan mortgage market does not always accurately reflect their true economic value. The majority of mortgage loans retained by us in the first quarter of 2005 were, and in our future operations will continue to be, adjustable-rate mortgage loans with rates based on the London Interbank Offered Rate or “LIBOR.”

As a result of the initiation of our loan retention strategy, we anticipate that our historical financial results, including those periods presented herein, will not be entirely indicative of our future financial performance for any corresponding periods. Following our change in business strategy, our income from gain on sales declined predominantly as a result of holding mortgage loans for investment. During the first six months of 2004, we used short-term warehouse and repurchase agreement facilities to fund our long-term holdings. We began in the third quarter to securitize adjustable-rate mortgage loans held for investment by offering long-term adjustable-rate debt, which we expect will be lower in cost than our warehouse and repurchase facilities. We expect to incur greater interest expense to carry loans in our portfolio and to generate higher interest and fee revenues from these retained loans.

Securitization Strategy. We finance the mortgage loans retained by us through debt and equity offerings, primarily securitization transactions treated as debt for financial reporting and tax purposes, which provide substantially matched-funded, long-term financing with lower interest rates than short-term debt facilities. During the first quarter of 2005, we continued to execute our securitization strategy by completing two additional securitization transactions. On February 23, 2005, we completed our third loan securitization, through an offering by HomeBanc Mortgage Trust 2005-1, of approximately $1.1 billion of notes backed by adjustable-rate, residential first mortgage loans. On March 31, 2005, we completed our fourth loan securitization, through an offering by HomeBanc Mortgage Trust 2005-2, of approximately $170.9 million of notes backed by adjustable-rate, residential second-lien mortgage loans. See “Liquidity and Capital Resources- Loan Securitizations,” for further discussion.

Servicing Strategy. We service the mortgage loans that we originate and hold for investment. While we are an experienced mortgage loan originator, we historically have only serviced, for brief periods of generally not more than three months, the mortgage loans we originated. Prior to December 2003, we routinely transferred the servicing responsibilities on mortgage loans that we originated, other than construction-to-permanent loans during the construction phase, to third-party servicers shortly after our origination of the loans. Beginning in December 2003, we retained the servicing responsibilities for those loans that we found economically attractive to service, namely a portion of the nonconforming mortgage loans and a limited number of Fannie Mae mortgage loans, and continued to service the construction-to-permanent loans during the construction phase of these mortgage loans. In addition, HBMC generally has serviced loans that are the subject of securitization transactions for up to 30 days after the loans are securitized. In 2004, we began to service, and in the future will continue to service, the loans we hold for investment. Although we do not presently intend to actively invest in loans or mortgage-backed securities collateralized by assets that we do not originate, we may do so from time to time in the future.

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The form of our reorganization results in accounting treatment similar to a pooling of interests, and the condensed consolidated financial statements of HomeBanc Corp. include the results of HomeBanc Corp.’s predecessor companies prior to HomeBanc Corp.’s initial public offering on July 19, 2004.

Industry Outlook

According to the Mortgage Bankers Association (“MBA”) projections as of April 14, 2005, total mortgage originations are expected to decline by 6% during 2005 compared with 2004. The MBA projects that this decline will largely be driven by a decrease in refinance mortgage originations. This suggests that the competition for purchase money mortgage originations will continue to intensify, which is what we observed during the three months ended March 31, 2005. We will continue to operate in select markets within the states of Georgia, Florida and North Carolina. Our focus remains on utilizing traditional retail mortgage loan origination channels and developing and expanding our strategic marketing alliances with residential realtors and homebuilders.

Critical Accounting Policies

There have been no material changes in the critical accounting policies disclosed within the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Financial Condition Discussion

The following discussion should be read in conjunction with the table above:

Cash

Cash increased from December 31, 2004 to March 31, 2005 because the increase in our borrowings and the net proceeds received from our second equity offering exceeded the cash requirements for growth in mortgage loans held for investment and our operating activities. Details regarding changes in cash balances are provided in HomeBanc Corp.’s condensed consolidated statement of cash flows.

Mortgage Loans Held for Sale, Net

Mortgage loans that we have originated, but do not intend to hold for the foreseeable future, are classified as “mortgage loans held for sale.” Mortgage loans held for sale represent mortgage loans originated and held pending sale to permanent investors and are carried at the lower of cost or fair value on an aggregate basis. Fluctuations in mortgage loans held for sale are dependent upon loan production seasonality, cyclical trends and our investors’ ability to purchase mortgage loans on a timely basis.

Mortgage Loans Held for Investment

Mortgage loans originated by HBMC and transferred to HomeBanc Corp. are classified as “mortgage loans held for investment.” Mortgage loans held for investment represent mortgage loans that we intend to hold for the foreseeable future and are carried at cost, less an allowance for loan losses reflecting losses inherent in the portfolio. The substantial majority of the mortgage loans held for investment balance represents either loans serving as collateral for collateralized debt obligations resulting from securitization transactions accounted for as securitized borrowings, or loans being aggregated for future securitization transactions. Fluctuations in mortgage loans held for investment are dependent upon loan production seasonality and our ability to transfer loans and securitize mortgage loans at HomeBanc Corp. Mortgage loans held for investment exhibited continued growth from December 31, 2004 to March 31, 2005 as we continued to execute our business strategy of retaining for investment a majority of the adjustable-rate loans that we originate.

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Mortgage Servicing Rights, Net

The increase in the balance of mortgage servicing rights was due to the fact that the capitalization of mortgage servicing rights related to loans sold on a servicing-retained basis during the first quarter of 2005 of $1.2 million exceeded the related amortization expense of $0.6 million and a valuation allowance for impairment of $0.2 million, which resulted primarily from the rising interest rate environment that caused an increase in both current and anticipated prepayment speeds.

Accounts Receivable

Accounts receivable represents amounts due from the custodians of the trust entities organized to facilitate securitization activity. The increased balance was the result of the two securitizations completed during the first quarter of 2005 as well as an increase in the level of borrower payoff activity leading up to March 31, 2005.

Other Assets

The increase was primarily the result of a $24.7 million increase in the value of derivative financial instruments designated in cash flow hedging relationships, including $5.1 million in premiums paid during the first quarter of 2005, in addition to $3.6 million in deferred financing fees incurred in connection with the two securitization transactions completed during the first quarter of 2005, offset by other less significant changes.

Other Liabilities

The decrease from year-end was due primarily to the payment to shareholders during the first quarter of 2005 of $7.7 million in accrued dividends declared and recorded prior to year-end and $3.7 million in cash payments made to associates for bonus accruals also recorded prior to December 31, 2004.

Borrowings

Warehouse lines of credit are used to finance mortgage loans held for sale and, therefore, increase or decrease based upon loan production seasonality, cyclical trends and our investors’ ability to purchase mortgage loans on a timely basis. The total borrowings balance has continued to grow as a result of financing requirements associated with the adjustable-rate mortgage loan retention strategy. We use aggregation credit facilities to finance our mortgage loans held for investment until such time as we are able to securitize these loans. The aggregation credit facilities decreased and collateralized debt obligations increased from December 31, 2004 to March 31, 2005 as a result of the two securitizations, representing $1.3 billion in new borrowings, during the first quarter of 2005. The securitization transactions were accounted for as secured borrowings with debt instruments issued to third party investors.

Shareholders’ Equity

We completed our second public equity offering during the first quarter of 2005 of 10,925,000 shares of HomeBanc common stock. The net proceeds received by us increased equity by $93.0 million. The net loss recognized during the three-month period ended March 31, 2005 of $7.6 million served to decrease equity, offset by a $19.6 million increase in accumulated other comprehensive income resulting from an increase in the fair value of derivative financial instruments designated in cash flow hedging relationships and a $0.6 million increase resulting from stock-based compensation.

Results of Operations

The following discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto. Results for the periods presented may not be completely comparable or indicative of future results due to factors including our reorganization on July 12, 2004 and the recapitalization of our business effective upon the completion of our initial public offering on July 19, 2004.

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

Overview

When compared with the first quarter of 2004, our results of operations for the three months ended March 31, 2005 were significantly affected by (1) our decision to change our business model from one of selling substantially all of the mortgage loans that we originate to one of retaining for investment a majority of the adjustable-rate mortgage loans that we originate; (2) our reorganization and conversion to a REIT; and (3) the two public offerings of our common stock.

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Industry data obtained from the MBA as of April 14, 2005 estimates a drop of 5% in total mortgage originations in the first quarter 2005 when compared to the same period in 2004. Our total loan volume in the first quarter of 2005, when compared to the same period in 2004, increased 10%, which compares favorably to the MBA data cited above. We originated $1.39 billion of total mortgage loans in the first quarter of 2005, including approximately $1.04 billion in purchase money mortgage loan originations and $0.35 billion in refinancing originations, compared to $1.25 billion of total mortgage loans, including $0.93 billion and $0.32 billion, respectively, of purchase money and refinancing originations in the first quarter of 2004. Purchase money mortgage loan originations, which represented 75% of our total originations for the first quarter of 2005, increased 11% compared to the same period in 2004. Refinancing originations, which represented 25% of our total originations during the first quarter of 2005, have increased 8% when compared to the same period in 2004. We originated approximately $1.09 billion of adjustable-rate mortgage loans and $0.30 billion of fixed-rate mortgage loans during the first quarter of 2005, compared to $0.96 billion and $0.29 billion, respectively, of such loans in the first quarter of 2004. In the first quarter of 2005, 78% of our total mortgage loan originations were adjustable-rate loans, compared to 76% during the first quarter of 2004. The increase in our loan originations in the face of an overall decrease in the market was largely the result of continued success in developing our strategic marketing alliances and maintaining our focus on the purchase money mortgage market which historically exhibits more stability than the refinance market. Similarly, loan application volume of $1.95 billion during the first quarter of 2005 exceeded the first quarter of 2004 by approximately $0.20 billion.

Net Loss

The decreasing net loss was generated by an increase in net interest income resulting from growth in the held for investment loan portfolio in addition to a decrease in facility costs as a result of a one-time, non-cash charge incurred in relocating the corporate headquarters during 2004. The impact of these factors was somewhat diminished by increasing compensation costs and strategic marketing alliance expenditures along with a decreasing gain on sale of mortgage loans.

For GAAP purposes, no gain on sale is recognized on loans transferred to the REIT investment portfolio. However, for tax purposes, loans sold to the REIT investment portfolio are transferred at fair value resulting in a taxable gain on sale at HBMC, a taxable REIT subsidiary or “TRS”. As a REIT, HomeBanc Corp. is not consolidated with its taxable REIT subsidiaries for federal income tax purposes, and, generally, HomeBanc Corp. separately pays no federal income tax.

The following is the reconciliation of REIT taxable income to consolidated GAAP net loss for the three months ended March 31, 2005 (dollars in thousands):

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Revenues

The overall increase in revenues during the first quarter of 2005 compared with the first quarter of 2004 was directly attributable to substantial growth in net interest income resulting from the accumulation of mortgage loans held for investment in accordance with the adjustable-rate mortgage loan retention strategy implemented during the first quarter of 2004. Net interest income will continue to increase in the future as the Company experiences growth in mortgage loans held for investment. A significant increase in net interest income was slightly offset by a decrease in net gain on sale of mortgage loans.

Net Gain on Sale of Mortgage Loans

The decrease in gain on sale of mortgage loans was the direct result of a decrease in sales volume from $727.0 million during the first quarter of 2004 to $481.7 million during the first quarter of 2005. We implemented our adjustable-rate mortgage loan retention strategy during February 2004. As a result, gains were recognized during the first quarter of 2004 on the sale of certain loans taking place during the month of January that would have been retained as held for investment had the strategy been implemented at the inception of 2004. Gain on sale is presented net of the provision for contingent loss reserves of $0.7 million and $0.4 million for the first quarter of 2005 and 2004, respectively.

Net Interest Income

Net interest income for the three months ended March 31, 2005 increased substantially from the first quarter of 2004 due to growth in the loan portfolio as a direct result of the adjustable-rate mortgage loan retention strategy initiated during 2004. The following tables summarize the changes in our net interest income, prior to provision for loan losses, for the three months ended March 31, 2005 and 2004 (dollars in thousands):

Yields Earned on Mortgages Loans and Rates on Borrowings to Finance Mortgage Loans

As discussed above, as a result of the change in the Company’s business strategy, the GAAP results of operations, including net interest income on loans held for investment, reflect the difference in treatment under GAAP accounting and tax accounting. For the three months ended March 31, 2005, REIT taxable net interest income was $13.6 million. The following table provides a reconciliation of REIT taxable net interest income to consolidated GAAP net interest income (dollars in thousands):

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Provision for Loan Losses

The provision for loan losses has grown as the underlying portfolio of loans held for investment has grown. The Company only began retaining loans for investment during the first quarter of 2004 and, therefore, has not yet seen any significant charge-off activity or noticeable deterioration in credit quality. Loans 90 days past due increased only slightly during the first quarter of 2005 from $3.9 million at December 31, 2004 to $4.0 million at March 31, 2005. Management periodically evaluates the factors affecting the risk of loss in the portfolio and records additional provision for loan losses as necessary to maintain the adequacy of the allowance for loan losses.

Expenses