In years passed a borrower would visit their local savings and loan to
obtain a mortgage. The Loan Officer at the bank would approve the
mortgage and fund it with cash reserves from the vault. This system
worked well until the bank ran out of money to lend. Borrowers came to
the S&L looking for a loan and were told to come back when a current
mortgage paid off. What the bank needed was a way to sell the loans they
made freeing up the capital to lend to new borrowers. This way they could
lend the "same" money over and over, earning an income from servicing the
loans and assisting the community by offering a near limitless pool of
money.

To address this issue, FNMA and GNMA were established. The goal was to
provide cheap mortgage money to prospective homeowners and a high quality
bond for the investment community. The bond or Mortgage Backed Security
(MBS) takes mortgages with similar risk characteristics and pools them
together. Investors in the MBS's know ahead of time the return they are
going to receive, much like a Certificate of Deposit. To ensure the
performance of the bond, each mortgage is underwritten to specific
guidelines. By ensuring the borrower is both capable (VOE), willing to
repay (credit report) the debt, has the cash to close (VOD), and the value
is in the property (appraisal), the loans and thus the bond will perform
as expected.

During the recent real estate boom underwriting guidelines were relaxed
giving way to a whole new menu of products such as the 100% NOO with
credit scores below 600. In addition, to streamline the influx of
applications, income and asset verification took a back seat to a borrower
with strong credit. With housing prices rising rapidly, the basis for the
mortgage, the property, could be sold to cover the note and foreclosure
costs if this occurred. This cycle worked well until the price of houses
moderated in 2006.

Once the housing market began to cool and prices moderated, foreclosed
homes were being sold for less than the note. To add insult to injury,
the loans underwritten to the looser guidelines are not performing as
hoped. With the value of the collateral in question (falling home prices)
and the future performance of the borrowers unknown, investors' appetites
for this risk has waned. To attract investors in this environment, rates
had to increase substantially.

Loans sold to GNMA or FNMA remain largely untouched in the recent credit
rout because the investment qualities of the loans are well known. The
foreclosure and delinquency rates are well within acceptable standards
lending support to these products as their interest rates have fallen in
the recent weeks.

The recent rapid rise in rates not directly tied to FNMA/GNMA is an
example of the pendulum swinging too wide. The fact remains that a
qualified borrower is a good investment from a bondholder perspective. In
a typical interest rate market, jumbo loans (loans in excess of the
conforming limit) with proper documentation carry a yield about 1/4 higher
than similar conforming products. Sanity will eventually return to the
markets and non-conforming pricing will come in line with their risk
characteristics. The depth and breadth of the current subprime issue will
determine when that change occurs.

Our hearts go out to everybody touched by this unfortunate issue.
Investors have closed, companies have closed, and borrowers have been left
with un-funded loans. Unfortunately the damage is widespread. The fact
remains this is the best industry in the world and we diligently press
forward as we work harder through these difficult times

Chinese Proverb

There is a Chinese proverb that states, "May you live in interesting
times." It is often argued that the word interesting is meant to be a
synonym for turbulent or dangerous. This phrase hits the bull's-eye given
the current state of the financial markets.

While stocks and bonds are swinging around wildly there is good news.
Interest rates for conforming and FHA/VA loans are still in the 6's,
historically low by many standards and the funds are widely available. In
addition, the National Association of Realtors has projected home sales
will move in a narrow range and improve throughout the year.