UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended March 31, 2007

OR

o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from            to

Commission File Number: 000-31828

LUMINENT MORTGAGE CAPITAL, INC.

(Exact name of registrant as specified in its charter)

Maryland		06-1694835
(State or other jurisdiction of incorporation or		(I.R.S. Employer
organization)		Identification No.)

101 California Street, Suite 1350, San Francisco, California		94111
(Address of principal executive offices)		(Zip Code)

(415) 217-4500
(Registrant’s Telephone Number, Including Area Code)

N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

     Indicate by check mark whether 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 registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definition of “accelerated filer and large accelerated filer” as defined in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer o       Accelerated filer þ       Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act ).
Yes o. No þ.

     The number of shares of common stock outstanding on April 30, 2007 was 46,822,244.

 

 

INDEX

		PAGE
PART I
ITEM 1. FINANCIAL STATEMENTS			1
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			51
ITEM 4. CONTROLS AND PROCEDURES			54
PART II
ITEM 1. LEGAL PROCEEDINGS			56
ITEM 1A. RISK FACTORS			56
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			56
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			56
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			56
ITEM 5. OTHER INFORMATION			56
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K			56
SIGNATURES			57
EXHIBIT INDEX			58
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

 i

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

     This Form 10-Q contains certain forward-looking statements under the Private Securities litigation Reform Act of 1995. Forward-looking statements convey our current expectations or forecasts of future events. All statements contained in this Form 10-Q other than statements of historical fact are forward-looking statements. Forward-looking statements include statements regarding our financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. The words “may continue”, “estimate”, “intend”, “project”, “believe”, “expect”, “plan”, “anticipate” and similar terms may identify forward-looking statements, but the absence of such words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include, among other things, statements about:

•

our ability to purchase sufficient mortgages for our securitization business;

•

the flattening of, or other changes in the yield curve, on our investment strategies;

•

changes in interest rates and mortgage prepayment rates;

•

our ability to obtain or renew sufficient funding to maintain our leverage strategies;

•

continued creditworthiness of the holders of mortgages underlying our mortgage-related assets;

•

the possible effect of negative amortization of mortgages on our financial condition and REIT qualification;

•

potential impacts of our leveraging policies on our net income and cash available for distribution;

•

the power of our board of directors to change our operating policies and strategies without stockholder approval;

•

the effects of interest rate caps on our adjustable-rate and hybrid adjustable-rate loans and mortgage-backed securities;

•

the degree to which our hedging strategies may or may not protect us from interest rate volatility;

•

our ability to invest up to 10% of our investment portfolio in residuals, leveraged mortgage derivative securities and shares of other REITs as well as other investments;

•

volatility in the timing and amount of our cash distributions; and

     Any or all of our forward-looking statements in this Form 10-Q may turn out to be inaccurate and actual results could differ materially from those anticipated or implied by our forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and future trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties.

     You should not rely unduly on those forward-looking statements, which speak only as of the date of this Form 10-Q. Unless required by the federal securities laws, we undertake no obligation to update publicly or revise any forward-looking statements to reflect new information or future events.

     This Form 10-Q contains market data, industry statistics and other data that have been obtained from, or compiled from, information made available by third parties. We have not independently verified any third party data.

 ii

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

INDEX TO FINANCIAL STATEMENTS

     Condensed Consolidated Financial Statements of Luminent Mortgage Capital, Inc.:

Condensed Consolidated Balance Sheets (unaudited) at March 31, 2007 and December 31, 2006			2
Condensed Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2007 and March 31, 2006			3
Condensed Consolidated Statement of Stockholders’ Equity (unaudited) for the three months ended March 31, 2007			4
Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2007 and March 31, 2006			5
Notes to the Condensed Consolidated Financial Statements (unaudited)			7

LUMINENT MORTGAGE CAPITAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

		March 31,				December 31,
(in thousands, except share and per share amounts)		2007				2006
Assets:
Cash and cash equivalents		$	60,343			$	5,902
Restricted cash			57,445				7,498
Loans held-for-investment, net of allowance for loan losses of $8,262 at March 31, 2007 and $5,020 at December 31, 2006			5,569,169				5,591,717
Mortgage-backed securities (including $65,880 of trading securities at March 31, 2007) at fair value			200,918				141,556
Mortgage-backed securities pledged as collateral (including $70,609 of trading securities at March 31, 2007) at fair value			3,052,451				2,789,382
Debt securities, at fair value			1,263				—
Equity securities, at fair value			925				1,098
Interest receivable			38,117				36,736
Principal receivable			1,462				1,029
Derivatives, fair value			19,401				13,021
Other assets			52,072				25,856
Total assets		$	9,053,566			$	8,613,795
Liabilities:
Mortgage-backed notes		$	4,273,596			$	3,917,677
Repurchase agreements			2,880,678				2,707,915
Commercial paper			619,022				637,677
Collateralized debt obligations			270,013				—
Warehouse lending facilities			403,232				752,777
Junior subordinated notes			92,788				92,788
Unsettled security purchases			2,271				—
Cash distributions payable			14,418				14,343
Accrued interest expense			9,340				12,094
Accounts payable and accrued expenses			14,885				6,969
Total liabilities			8,580,243				8,142,240
Stockholders’ Equity:
Preferred stock, par value $0.001:
10,000,000 shares authorized; no shares issued and outstanding at March 31, 2007 and December 31, 2006			—				—
Common stock, par value $0.001:
100,000,000 shares authorized; 47,958,510 and 47,808,510 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively			48				48
Additional paid-in capital			584,204				583,492
Accumulated other comprehensive income			4,929				3,842
Accumulated distributions in excess of accumulated earnings			(115,858	)			(115,827	)
Total stockholders’ equity			473,323				471,555
Total liabilities and stockholders’ equity		$	9,053,566			$	8,613,795

See notes to condensed consolidated financial statements

LUMINENT MORTGAGE CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Three months ended March 31,
(in thousands, except share and per share amounts)		2007				2006
Revenues:
Interest income:
Mortgage loan and securitization portfolio		$	98,690			$	22,611
Spread portfolio			30,376				30,965
Credit sensitive bond portfolio			16,500				8,016
Total interest income			145,566				61,592
Interest expense			115,204				46,072
Net interest income			30,362				15,520
Other Income (Expense):
Gains on derivatives, net			15,264				8,694
Impairment losses on mortgage-backed securities			(4	)			(1,717	)
Gains (losses) on sales of mortgage-backed securities			(15,453	)			2,063
Other expense			(80	)			(477	)
Total other income (expense)			(273	)			8,563
Expenses:
Salaries and benefits			3,084				2,423
Servicing expense			5,986				1,482
Provision for loan losses			3,543				—
Due diligence expense			254				83
Professional services			844				622
Board of directors expense			80				113
Insurance expense			162				141
Custody expense			151				112
Management compensation expense to related party			—				712
Incentive compensation expense to related parties			—				98
Other general and administrative expenses			1,138				507
Total expenses			15,242				6,293
Income before income taxes			14,847				17,790
Income tax expense			460				11
Net income		$	14,387			$	17,779
Net income per share — basic		$	0.30			$	0.45
Net income per share — diluted		$	0.30			$	0.45
Weighted-average number of shares outstanding — basic			47,316,058				39,491,786
Weighted-average number of shares outstanding — diluted			47,427,502				39,718,552
Dividend declared per share		$	0.30			$	0.05

See notes to condensed consolidated financial statements

LUMINENT MORTGAGE CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

																		Accumulated
														Accumulated				Distributions
		Common Stock								Additional				Other				in Excess of
						Par				Paid-in				Comprehensive				Accumulated				Comprehensive
(in thousands)		Shares				Value				Capital				Income/(Loss)				Earnings				Income/(Loss)				Total
Balance, January 1, 2007			47,809			$	48			$	583,492			$	3,842			$	(115,827	)						$	471,555
Net income																			14,387			$	14,387				14,387
Securities available-for-sale, fair value adjustment															1,531								1,531				1,531
Amortization of derivative gains															(444	)							(444	)			(444	)
Comprehensive income																						$	15,474
Distributions to stockholders																			(14,418	)							(14,418	)
Issuance and amortization of restricted common stock			150								712																712
Balance, March 31, 2007			47,959			$	48			$	584,204			$	4,929			$	(115,858	)						$	473,323

See notes to condensed consolidated financial statements

LUMINENT MORTGAGE CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Three months ended March 31,
(in thousands)		2007				2006
Cash flows from operating activities:
Net income		$	14,387			$	17,779
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of premium/(discount) on loans held-for-investment and mortgage-backed securities and depreciation			4,442				(1,733	)
Impairment losses on mortgage-backed securities			4				1,717
Provision for loan losses			3,543				—
Negative amortization of loans held-for-investment			(35,466	)			(3,428	)
Share-based compensation			712				1,199
Net realized and unrealized gains on derivative instruments			(4,550	)			(5,209	)
Net gain (losses) on sales of mortgage-backed-securities available-for-sale			15,453				(2,063	)
Changes in operating assets and liabilities:
(Increase) decrease in interest receivable, net of purchased interest			(1,251	)			6,106
(Increase) in other assets			(18,492	)			(245	)
Increase (decrease) in accounts payable and other liabilities			7,485				(361	)
Decrease in accrued interest expense			(2,754	)			(14,774	)
Increase in management compensation payable, incentive compensation payable and other related-party payable			—				221
Net cash used in operating activities			(16,485	)			(791	)
Cash flows from investing activities:
Purchases of mortgage-backed securities			(461,640	)			(1,079,321	)
Proceeds from sales of mortgage-backed securities			14,887				3,151,447
Principal payments of mortgage-backed securities			115,838				201,647
Purchases of loans held-for-investment, net			(414,262	)			(1,671,093	)
Principal payments of loans held-for-investment			460,433				21,744
Purchases of derivative instruments			(8,880	)			(77	)
Proceeds from derivative instruments			6,701				—
Net change in restricted cash			(49,947	)			777
Other			(136	)			—
Net cash provided by (used in) investing activities			(337,006	)			625,124
Cash flows from financing activities:
Repurchases of common stock			—				(9,008	)
Capitalized financing costs			(4,414	)			(3,902	)
Borrowings under repurchase agreements			11,312,497				12,975,841
Principal payments on repurchase agreements			(11,139,734	)			(14,946,878	)
Borrowings under warehouse lending facilities			834,153				1,634,658
Paydown of warehouse lending facilities			(1,183,515	)			(1,375,181	)
Borrowings under commercial paper facility			1,840,410				—
Paydown of commercial paper facility			(1,859,065	)			—
Distributions to stockholders			(14,343	)			(1,218	)
Proceeds from issuance of mortgage-backed notes			718,451				1,283,630
Principal payments on mortgage-backed notes			(362,535	)			(26,060	)
Proceeds from issuance of collateralized debt obligations			266,027				—
Principal payments on margin debt			—				(3,548	)
Net cash provided by (used in) financing activities			407,932				(470,856	)
Net increase in cash and cash equivalents			54,441				153,477
Cash and cash equivalents, beginning of the period			5,902				11,466
Cash and cash equivalents, end of the period		$	60,343			$	164,943

LUMINENT MORTGAGE CAPITAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

		Three months ended March 31,
(in thousands)		2007				2006
Supplemental disclosure of cash flow information:
Interest paid		$	122,217			$	48,795
Taxes paid			56				—
Non-cash investing and financing activities:
Increase in unsettled security purchases		$	2,271			$	179,773
(Increase) decrease in principal receivable			(433	)			9,215
Transfer of loans held-for-investment to real estate owned			2,879				—
Acquisition of mortgage-backed securities available-for-sale through collateralized debt obligations			(3,986	)			—
Principal payments of mortgage-backed securities available-for-sale			183				—
Paydown of warehouse lending facilities			(183	)			—
Increase in cash distributions payable to stockholders			75				766

See notes to condensed consolidated financial statements

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

          Luminent Mortgage Capital, Inc., or the Company, was organized as a Maryland corporation on April 25, 2003. The Company commenced its operations on June 11, 2003 upon completion of a private placement offering. On December 18, 2003, the Company completed the initial public offering of its shares of common stock and began trading on the New York Stock Exchange, or NYSE, under the trading symbol LUM on December 19, 2003. On March 29, 2004 and October 12, 2006, the Company completed follow-on public offerings of its common stock.

          The Company is a real estate investment trust, or REIT, which, together with its subsidiaries, invests in two core mortgage investment strategies. Under its Residential Mortgage Credit strategy, the Company invests in mortgage loans purchased from selected high-quality providers within certain established criteria as well as subordinated mortgage-backed securities and other asset-backed securities that have credit ratings below AAA. Under its Spread strategy, the Company invests primarily in U.S. agency and other highly-rated single-family, adjustable-rate and hybrid adjustable-rate mortgage-backed securities. The Company operates as only one reportable segment as defined in Statement of Financial Accounting Standards, or SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.

          The information furnished in these unaudited condensed consolidated interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with the Company’s 2006 Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 16, 2007.

          Descriptions of the significant accounting policies of the Company are included in Note 2 to the consolidated financial statements in the Company’s 2006 Form 10-K. There have been no significant changes to these policies during 2007 with the exception of the required adoption of SFAS No. 155 Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statement No. 133 and 140. See the description of recent accounting pronouncements below.

     Recent Accounting Pronouncements

          The FASB has placed an item on its SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, project agenda relating to the treatment of transactions where mortgage-backed securities purchased from a particular counterparty are financed via a repurchase agreement with the same counterparty. Currently, the Company records such assets and the related financing gross on its consolidated balance sheet, and the corresponding interest income and interest expense gross on its consolidated statement of operations. Any change in fair value of the security is reported through other comprehensive income or current period income, depending on its classification under SFAS No. 115.

          However, in a transaction where the mortgage-backed securities are acquired from and financed under a repurchase agreement with the same counterparty, the acquisition may not qualify as a sale from the seller’s perspective under the provisions of SFAS No. 140. In such cases, the seller may be required to continue to consolidate the assets sold to the Company, based on the seller’s continuing involvement with such investments. Depending on the ultimate outcome of the FASB deliberations, the Company may be precluded from presenting the assets gross on its balance sheet and may instead be required to treat its net investment in such assets as a derivative.

          This potential change in accounting treatment does not affect the economics of the transactions but does affect how the transactions would be reported in the Company’s consolidated financial statements. The Company’s cash flows, liquidity and ability to pay a dividend would be unchanged, and it is expected that its REIT taxable income and its qualification as a REIT would not be affected. Also, net equity would not be materially affected.

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

     In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140. This Statement provides entities with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract in accordance with SFAS No. 133. The Statement allows an entity to make an irrevocable election to measure such a hybrid financial instrument at fair value in its entirety, with changes in fair value recognized in earnings. The election may be made on an instrument-by-instrument basis and can be made only when a hybrid financial instrument is initially recognized or when certain events occur that constitute a remeasurement (i.e., new basis) event for a previously recognized hybrid financial instrument. An entity must document its election to measure a hybrid financial instrument at fair value, either concurrently or via a pre-existing policy for automatic election. Once the fair value election has been made, that hybrid financial instrument may not be designated as a hedging instrument pursuant to SFAS No. 133. The Statement is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. In January 2007, the FASB released Statement 133 Implementation Issue No. B40, Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets (B40). B40 provides a narrow scope exception for certain securitized interests from the tests required under paragraph 13(b) of SFAS No. 133. Those tests are commonly referred to in practice as the “double-double” test. B40 represents the culmination of the FASB staff’s consideration of the need for further guidance for securitized interests, following the issuance in February 2006 of SFAS No. 155. B40 is applicable to securitized interests issued after June 30, 2007. The Company reviewed all securities that were purchased from January 1, 2007 to March 31, 2007. The adoption of this statement as of January 1, 2007 did not have a material effect on the Company’s financial statements; however, this review is required to be performed on an ongoing basis. From January 1, 2007 to March 31, 2007, the Company purchased certain hybrid securities which require bifurcation. The Company has elected to carry these securities at fair value as trading securities, although these securities were not acquired for resale. See Note 2 for further discussion. Changes in fair value of these securities will be recognized in other income.

     In June 2006, the FASB issued Interpretation, or FIN, No. 48, Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company’s adoption of this interpretation did not have a material impact on its financial statements.

     In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This Statement allows entities to make an election to record financial assets and liabilities, with limited exceptions, at fair value on the balance sheet, with changes in fair value recorded in earnings. SFAS No. 159 is effective for fiscal years beginning after November 17, 2007. Early adoption of SFAS No. 159 was permitted as of the beginning of the fiscal year ending after November 17, 2007. The Company elected not to early adopt the Statement and is still evaluating the impact of this Statement on its consolidated financial statements.

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

NOTE 2—SECURITIES

     Mortgage-backed securities

          The following table summarizes the Company’s mortgage-backed securities including securities classified as available-for-sale and hybrid securities classified as trading at March 31, 2007 and December 31, 2006, which are carried at fair value (in thousands):

		March 31,				December 31,
		2007				2006
Amortized cost		$	3,251,597			$	2,930,878
Unrealized gains			10,051				7,549
Unrealized losses			(8,279	)			(7,489	)
Fair value		$	3,253,369			$	2,930,938

          At March 31, 2007 and December 31, 2006, mortgage-backed securities had a weighted-average amortized cost, excluding residual interests, of 99.1% and 99.0% of face amount, respectively.

          The Company purchased securities in the three months ended March 31, 2007 with an amortized cost basis of $136.4 million at March 31, 2007, which are hybrid securities under the definition of SFAS No. 155. The Company elected to account for these securities as trading securities for which changes in fair value will be recognized in income. The change in fair value for the three months ended March 31, 2007 was $59 thousand.

          Actual maturities of mortgage-backed securities are generally shorter than stated contractual maturities. Actual maturities of the Company’s mortgage-backed securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal.

          The following table summarizes the Company’s mortgage-backed securities at March 31, 2007, according to their estimated weighted-average life classifications (dollars in thousands):

										Weighted-
						Amortized				Average
Weighted-Average Life		Fair Value				Cost				Coupon
Less than one year		$	297,025			$	296,494				5.77	%
Greater than one year and less than five years			2,905,998				2,900,655				5.88
Greater than five years			50,346				54,448				6.93
Total		$	3,253,369			$	3,251,597				5.88	%

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

     The following table summarizes the Company’s mortgage-backed securities at December 31, 2006, according to their estimated weighted-average life classifications (dollars in thousands):

										Weighted-
										Average
Weighted-Average Life		Fair Value				Amortized Cost				Coupon
Less than one year		$	235,186			$	234,932				5.52	%
Greater than one year and less than five years			2,612,020				2,608,627				5.89
Greater than five years			83,732				87,319				6.46
Total		$	2,930,938			$	2,930,878				5.88	%

     The weighted-average lives of the mortgage-backed securities at March 31, 2007 and December 31, 2006 in the tables above are based upon data provided through subscription-based financial information services, assuming constant prepayment rates to the balloon or reset date for each security. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rates of the outstanding loans, loan age, margin and volatility.

     The actual weighted-average lives of the mortgage-backed securities could be longer or shorter than the estimates in the table above depending on the actual prepayment rates experienced over the lives of the applicable securities and are sensitive to changes in both prepayment rates and interest rates.

     The following table shows the Company’s mortgage-backed securities’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2007 (in thousands):

		Less than 12 Months								12 Months or More								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
Agency-backed mortgage-backed securities		$	5,986			$	(29	)		$	1,210			$	(17	)		$	7,196			$	(46	)
Non-agency-backed mortgage-backed securities			1,109,960				(3,321	)			180,997				(4,912	)			1,290,957				(8,233	)
Total temporarily impaired mortgage-backed securities		$	1,115,946			$	(3,350	)		$	182,207			$	(4,929	)		$	1,298,153			$	(8,279	)

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

     The following table shows the Company’s mortgage-backed securities’ fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2006 (in thousands):

		Less than 12 Months								12 Months or More								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
Agency-backed mortgage-backed securities		$	8,850			$	(66	)		$	—			$	—			$	8,850			$	(66	)
Non-agency-backed mortgage-backed securities			971,034				(3,058	)			138,210				(4,365	)			1,109,244				(7,423	)
Total temporarily impaired mortgage-backed securities		$	979,884			$	(3,124	)		$	138,210			$	(4,365	)		$	1,118,094			$	(7,489	)

     At March 31, 2007, the Company held $3.3 billion of mortgage-backed securities at fair value, comprised of $2.3 billion in the Spread portfolio and $1.0 billion in the Residential Mortgage Credit portfolio, net of unrealized gains of $7.7 million and unrealized losses of $7.4 million. At December 31, 2006, the Company held approximately $2.9 billion of mortgage-backed securities at fair value, comprised of approximately $2.1 billion in the Spread portfolio and $0.8 billion in the Residential Mortgage Credit portfolio, net of unrealized gains of $7.5 million and unrealized losses of $7.5 million.

     During the three months ended March 31, 2006, the Company recognized total impairment losses on mortgage-backed securities in the Spread portfolio of $1.7 million. The impairment loss recognized in the three months ended March 31, 2006 was due to the Company’s decision to reposition the Spread portfolio. The Company did not intend to hold certain mortgage-backed securities in the Spread portfolio that were at unrealized loss positions for a period of time sufficient to allow for recovery in fair value. The Company determined that the unrealized losses on these mortgage-backed securities reflected at March 31, 2006 were other-than-temporary impairments as defined in SFAS No. 115, and therefore the Company recognized impairment losses in its consolidated statement of operations. No impairment losses were recognized in mortgage-backed securities in the Spread portfolio during the three months ended March 31, 2007

     At March 31, 2007 and December 31, 2006, the Spread portfolio contained mortgage-backed securities with unrealized losses of $0.8 million and $0.4 million, respectively. The Company intends to hold the mortgage-backed securities in the Spread portfolio for a period of time, to maturity if necessary, sufficient to allow for the anticipated recovery in fair value of the securities held. The temporary impairment of these mortgage-backed securities results from the fair value of the mortgage-backed securities falling below their amortized cost basis and is solely attributable to changes in interest rates. At March 31, 2007 and December 31, 2006, none of the securities held had been downgraded by a credit rating agency since their purchase and all of the securities were AAA-rated non-agency-backed or agency-backed mortgage-backed securities. As such, the Company does not believe any of these securities are other-than-temporarily impaired at March 31, 2007 and December 31, 2006.

     Certain of the mortgage-backed securities in the Company’s Residential Mortgage Credit portfolio are accounted for in accordance with the Emerging Issues Task Force, or EITF 99-20, Recognition of interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,. Under EITF 99-20, the Company evaluates whether there is other-than-temporary impairment by discounting projected cash flows using credit, prepayment and other assumptions compared to prior period projections. If the discounted projected cash flows have decreased due to a change in the credit, prepayment and other assumptions, then the mortgage-backed security must be written down to market value if the market value is below the amortized cost basis. If there have been no changes to the Company’s assumptions and the change in value is solely due to interest rate changes, the Company does not recognize an impairment of a mortgage-backed security in its consolidated statement of

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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operations. It is difficult to predict the timing or magnitude of these other-than-temporary impairments and impairment losses could be substantial. During the three months ended March 31, 2007, the Company recorded losses due to other-than-temporary impairments of $4 thousand in the Residential Mortgage Credit portfolio due to changes in loss assumptions on certain Residential Mortgage Credit securities.

          At March 31, 2007 and December 31, 2006, the Residential Mortgage Portfolio contained mortgage-backed securities with unrealized losses of $7.4 million and $7.1 million in mortgage-backed securities held in the Company’s Residential Mortgage Credit portfolio. The Company has the intent to hold these mortgage-backed securities for a period of time, to maturity if necessary, sufficient to allow for the anticipated recovery in fair value. The temporary impairment of these mortgage-backed securities results from the fair value of the mortgage-backed securities falling below their amortized cost basis and is solely attributable to changes in interest rates. At March 31, 2007 and December 31, 2006, none of the securities held had been downgraded by a credit rating agency since their purchase. As such, the Company does not believe any of these securities are other-than-temporarily impaired at March 31, 2007 and December 31, 2006.

          During the three months ended March 31, 2007, the Company had realized losses of $15.5 million on the sale of securities in its Residential Mortgage credit portfolio. These securities were selected for sale due to their rising level of delinquencies in the underlying loan collateral which was noted in the first quarter of 2007, as well as to reduce the Company’s exposure to certain mortgage-backed asset issuers. During the three months ended March 31, 2006, the Company had realized gains of $9.6 million and realized losses of $7.6 million on the sale of mortgage backed securities. Securities were sold during the first quarter of 2006 in order to reposition the portfolio.

     Other securities

          The following table summarizes the Company’s other securities classified as available-for-sale at March 31, 2007 and December 31, 2006, which are carried at fair value (in thousands):

		March 31, 2007												December 31, 2006
		Equity				Debt								Equity				Debt
		Securities				Securities				Total				Securities				Securities				Total
Amortized cost		$	1,050			$	1,271			$	2,321			$	1,050			$	—			$	1,050
Unrealized gains							—				—				—				48				48
Unrealized losses			(125	)			(8	)			(133	)			—				—				—
Fair value		$	925			$	1,263			$	2,188			$	1,098			$	—			$	1,098

NOTE 3—LOANS HELD-FOR-INVESTMENT

     The following table summarizes the Company’s residential mortgage loans classified as held-for-investment at March 31, 2007 and December 31, 2006, which are carried at amortized cost, net of allowance for loan losses (in thousands):

		March 31,				December 31,
		2007				2006
Principal		$	5,452,591			$	5,472,325
Unamortized premium			124,840				124,412
Amortized cost			5,577,431				5,596,737
Allowance for loan losses			(8,262	)			(5,020	)
Total residential loans, net of allowance for loan losses		$	5,569,169			$	5,591,717

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

     At March 31, 2007 and December 31, 2006, residential mortgage loans had a weighted-average amortized cost of 102.3% and 102.3% of face amount, respectively.

          The following table summarizes the changes in the allowance for loan losses for the Company’s residential mortgage loan portfolio during the three months ended March 31, 2007 (in thousands):

		For the Three
		Months Ended
		March 31,
		2007
Balance, beginning of period		$	5,020
Provision for loan losses			3,543
Usage of allowance			(301	)
Balance, end of period		$	8,262

          On a quarterly basis, the Company evaluates the adequacy of its allowance for loan losses. Based on this analysis, the Company recorded a provision for loan losses of $3.5 million for the three months ended March 31, 2007 on the residential mortgage loan portfolio. At March 31, 2006, the Company had not recorded an allowance for loan losses because none of the loans held in the portfolio were considered impaired. At March 31, 2007 and December 31, 2006, $51.8 million and $33.9 million, respectively, of residential mortgage loans were 90 days or more past due all of which were on non-accrual status. Net of delinquent loans which are 90 days or more past due which we believe will be repurchased, our allowance for loan losses represent 21.6% of our loans 90 days or more past due.

NOTE 4—BORROWINGS

     The Company leverages its portfolio of mortgage-backed securities and loans held-for-investment through the use of various financing arrangements.

     The following table presents summarized information with respect to the Company’s borrowings at March 31, 2007 and December 31, 2006 (dollars in thousands):

		March 31, 2007												December 31, 2006
						Weighted-												Weighted-
		Borrowings				Average				Fair Value of				Borrowings				Average				Fair Value of
		Outstanding(1)				Interest Rate				Collateral(2)				Outstanding(1)				Interest Rate				Collateral(2)
Mortgage-backed notes			4,270,888				5.56	%		$	4,270,739			$	3,914,932				5.60	%		$	3,919,354
Repurchase agreements			2,880,678				5.42				3,046,210				2,707,915				5.45				2,909,895
Commercial paper facility			619,022				5.36				625,041				637,677				5.36				643,823
Collateralized debt obligations			271,000				6.44				268,390				—				—				—
Warehouse lending facilities			403,232				5.82				420,925				752,777				5.80				794,420
Junior subordinated notes			92,788				8.58			none					92,788				8.58			none
Total		$	8,537,608				5.57	%		$	8,631,305			$	8,104,089				5.58	%		$	8,267,492

     Mortgage-backed Notes

          At March 31, 2007 and December 31, 2006, the Company had mortgage-backed notes with an outstanding balance of $4.3 billion and $3.9 billion, respectively, and with a weighted-average borrowing rate of 5.56% and

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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5.60%, respectively, per annum. The borrowing rates of the mortgage-backed notes reset monthly based on LIBOR except for $0.2 billion of the notes which, like the underlying loan collateral, are fixed for a period of three to five years then become variable based on the average rates of the underlying loans which will adjust based on LIBOR. Unpaid interest on the mortgage-backed notes was $5.0 million and $4.5 million at March 31, 2007 and December 31, 2006, respectively. The stated maturities of the mortgage-backed notes at March 31, 2007 were between 2035 and 2047. The stated maturities of the mortgage-backed notes at December 31, 2006 were between 2035 and 2046. At March 31, 2007 and December 31, 2006, residential mortgage loans with an estimated fair value of $4.3 billion and $3.9 billion were pledged as collateral for mortgage-backed notes issued.

          Each series of mortgage-backed notes issued by the Company consists of various classes of securities which bear interest at varying spreads to the underlying interest rate index. The maturity of each class of securities is directly affected by the rate of principal repayments on the associated residential mortgage loan collateral. As a result, the actual maturity of each series of mortgage-backed notes may be shorter than the stated maturity.

          The following table presents the outstanding balance and weighted-average interest rate of each series of mortgage-backed notes issued by the Company at March 31, 2007 and December 31, 2006 (dollars in thousands):

		March 31, 2007								December 31, 2006
						Weighted-								Weighted-
		Borrowings				Average				Borrowings				Average
		Outstanding(1)				Interest Rate				Outstanding(1)				Interest Rate
LUM 2005-1		$	343,966				5.60	%		$	368,203				5.63	%
LUM 2006-1			421,909				5.61				495,453				5.64
LUM 2006-2			581,403				5.55				668,049				5.58
LUM 2006-3			548,254				5.67				588,999				5.69
LUM 2006-4			292,568				5.52				324,819				5.55
LUM 2006-6			664,131				5.55				712,959				5.58
LUM 2006-7			752,061				5.53				756,450				5.55
LUM 2007-1			666,596				5.49				—				—
Total		$	4,270,888				5.56	%		$	3,914,932				5.60	%

     Repurchase Agreements

          The Company has entered into repurchase agreements with third-party financial institutions to finance the purchase of most of its mortgage-backed securities. The repurchase agreements are short-term borrowings that bear interest rates that have historically moved in close relationship to the three-month London Interbank Offered Rate, or LIBOR. At March 31, 2007 and December 31, 2006, the Company had repurchase agreements with an outstanding balance of $2.9 billion and $2.7 billion, respectively, and with weighted-average interest rates of 5.42% and 5.45%, respectively. At March 31, 2007 and December 31, 2006, mortgage-backed securities and loans held-for-investment pledged as collateral for repurchase agreements had estimated fair values of $3.0 billion and $2.9 billion, respectively.

          At March 31, 2007, repurchase agreements had the following remaining maturities (in thousands):

Overnight 1 day or less		$	—
Between 2 and 30 days			2,377,123
Between 31 and 90 days			60,800
Between 91 and 1,094 days			442,755
Total			2,880,678

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

          At December 31, 2006, repurchase agreements had the following remaining maturities (in thousands):

Overnight 1 day or less		$	—
Between 2 and 30 days			2,070,939
Between 31 and 90 days			201,976
Between 91 and 636 days			435,000
Total		$	2,707,915

     Commercial Paper Facility

          In August 2006, the Company established a $1.0 billion commercial paper facility, Luminent Star Funding I, to fund its mortgage-backed security portfolio. Luminent Star Funding I is a single-seller commercial paper program that provides a financing alternative to repurchase agreement financing by issuing asset-backed secured liquidity notes that are rated by the rating agencies Standard & Poor’s and Moody’s. At March 31, 2007 and December 31, 2006, the outstanding balance on the commercial paper facility was $619.0 million and $637.7 million, respectively. The weighted-average interest rate was 5.36% at March 31, 2007 and December 31, 2007, respectively.

     Collateralized Debt Obligations

          In March 2007, the Company issued $400.0 million of collateralized debt obligations, or CDOs, from Charles Fort CDO I, Ltd., a qualified REIT subsidiary of the Company. The CDOs were in the form of floating-rate pass-through certificates collateralized by $289.1 million of the Company’s mortgage-backed securities and $59.1 million of mortgage-backed securities that the Company retained from prior whole loan securitizations. Of the $400.0 million of CDOs issued, $271.0 million were purchased by third party investors and the Company retained $129.0 million of certificates including subordinated certificates, which provide credit support to the certificates issued to third party investors. The interest rates on the floating-rate pass-through certificates reset quarterly and are indexed to three-month LIBOR. The entity has an uninvested cash balance at March 31, 2007 of $51.4 million which will be used to purchase additional mortgage-backed securities as collateral for the CDOs. This securitization transaction was accounted for as a financing of the mortgage-backed securities. At March 31, 2007, the Company’s CDOs had a balance of $271.0 million, the weighted-average interest rate was 6.44%. See Note 11, Subsequent Events for further detail of CDOs.

     Warehouse Lending Facilities

          Mortgage Loan Financing. The Company has established warehouse lending facilities which are structured as repurchase agreements. These facilities are the Company’s primary source of funding for acquiring mortgage loans. These warehouse lending facilities are short-term borrowings that are secured by the loans and bear interest based on LIBOR. In general, the warehouse lending facilities provide financing for loans for a maximum of 120 days.

          The Company acquires residential mortgage loans with the intention of securitizing them and retaining the securitized mortgage loans in the Company’s portfolio to match the income earned on mortgage assets with the cost of the related liabilities, also referred to as match-funding the balance sheet. In order to facilitate the securitization or financing of its loans, the Company generally creates subordinate certificates, providing a specified amount of credit enhancement, which the Company intends to retain in its investment portfolio. Proceeds from securitizations are used to pay down the outstanding balance of warehouse lending facilities.

          Asset-backed Securities Financing. During the year ended December 31, 2006, the Company established a $500 million warehouse lending facility with Greenwich Capital Financial Products, Inc. The facility was used to

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

purchase mortgage-backed securities rated below AAA until the Company financed the securities permanently through CDOs. This warehouse lending facility was a short-term borrowing arrangement that was secured by asset-backed securities, bearing interest based on LIBOR. The facility was terminated in March 2007 concurrently with the permanent financing of the asset-backed securities by the CDOs.

          The total borrowing capacity under the Company’s warehouse lending facilities was $2.5 billion and $3.0 billion at March 31, 2007 and December 31, 2006, respectively. At March 31, 2007 and December 31, 2006, $0.4 billion and $0.8 billion, respectively, were outstanding under the Company’s warehouse lending facilities.

          At March 31, 2007 and December 31, 2006, the Company’s warehouse lending facilities included the following (in millions):

		At March 31, 2007												At December 31, 2006
										Weighted-												Weighted-
		Borrowing				Borrowings				Average				Borrowing				Borrowings				Average
Counterparty		Capacity				Outstanding				Interest Rate				Capacity				Outstanding				Interest Rate
Mortgage loan financing:
Greenwich Capital Financial Products, Inc.		$	1,000.0			$	403.2				5.82	%		$	1,000.0			$	455.2				5.80	%
Barclays Bank plc			1,000.0				—				—				1,000.0				290.1				5.78
Bear Stearns Mortgage Capital Corp.			500.0				—				—				500.0				7.5				5.77
Asset-backed securities financing:
Greenwich Capital Financial Products, Inc.			—				—				—				500.0				—				—
Total		$	2,500.0			$	403.2				5.82	%		$	3,000.0			$	752.8				5.80	%

          At March 31, 2007, the Company was in compliance with all of its debt covenants for all borrowing arrangements and credit facilities.

     Junior Subordinated Notes

          Junior subordinated notes consist of 30-year notes issued in March and December 2005 to Diana Statutory Trust I, or DST I, and Diana Statutory Trust II, or DST II, respectively, unconsolidated affiliates of the Company formed to issue $2.8 million of the trusts’ common securities to the Company and to place $90.0 million of preferred securities privately with unrelated third-party investors. The note balances and related weighted-average interest rates listed by trust were as follows at March 31, 2007 and December 31, 2006 (dollars in thousands):

		March 31, 2007								December 31, 2006
		Borrowings				Interest				Borrowings				Interest
		Outstanding				Rate				Outstanding				Rate
Junior subordinated notes:
DST I		$	51,550				8.16	%		$	51,550				8.16	%
DST II			41,238				9.10				41,238				9.11
Total		$	92,788				8.58	%		$	92,788				8.58	%

          The Company pays interest to the trusts quarterly. The DST I notes bear interest at a fixed rate of 8.16% per annum through March 30, 2010 and, thereafter, at a variable rate equal to three-month LIBOR plus 3.75% per annum through maturity. The DST II notes bear interest at a variable rate equal to three-month LIBOR plus 3.75% per annum through maturity. The trusts remit dividends pro rata to the common and preferred trust securities based on the same terms as the junior subordinated notes. The DST I notes and trust securities mature in March 2035 and are redeemable on any interest payment date at the option of the Company in whole, but not in part, on or after March 30, 2010 at the redemption rate of 100% plus accrued and unpaid interest. Prior to March 30, 2010, upon the occurrence of a special event relating to certain federal income tax or investment company events, the Company

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

may redeem the DST I notes in whole, but not in part, at the redemption rate of 107.5% plus accrued and unpaid interest. The DST II notes and trust securities mature in December 2035 are redeemable on any interest payment date at the option of the Company in whole, but not in part at the redemption rate of 100% plus accrued and unpaid interest.

     Margin Lending Facility

          The Company has a margin lending facility with its primary custodian from which the Company may borrow money in connection with the purchase or sale of securities. The terms of the borrowings, including the rate of interest payable, are agreed to with the custodian for each amount borrowed. Borrowings are repayable immediately upon demand by the custodian. No borrowings were outstanding under the margin lending facility at March 31, 2007 and December 31, 2006.

     Capitalized Financing Costs

          At March 31, 2007 and December 31, 2006, the Company had unamortized capitalized financing costs of $20.7 million and $15.9 million, respectively, related to the Company’s borrowings, which were deferred at the issuance date of the related borrowing and are being amortized using the effective yield method over the estimated life of the borrowing.

NOTE 5—CAPITAL STOCK AND EARNINGS PER SHARE

          At March 31, 2007 and December 31, 2006, the Company’s charter authorized the issuance of 100,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred stock, par value $0.001 per share. At March 31, 2007 and December 31, 2006, 47,958,510 and 47,808,510 shares of common stock, respectively, were outstanding and no shares of preferred stock were outstanding.

          On November 7, 2005, the Company announced that its board of directors had authorized a share repurchase program that permits the Company to repurchase up to 2,000,000 shares of its common stock at prevailing prices through open market transactions subject to the provisions of SEC Rule 10b-18 and in privately negotiated transactions. On February 9, 2006, the Company announced the initiation of an additional share repurchase program to acquire an incremental 3,000,000 shares. Through March 31, 2007, the Company had repurchased 2,594,285 shares at a weighted-average price of $8.00 and was authorized to acquire up to 2,405,715 more common shares.

          The Company calculates basic net income per share by dividing net income for the period by the weighted-average shares of its common stock outstanding for that period. Diluted net income per share takes into account the effect of dilutive instruments, such as stock options and unvested restricted common stock, but uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted-average number of shares outstanding.

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

          The following table presents a reconciliation of basic and diluted net income per share for the three months ended March 31, 2007 and 2006:

		Three Months Ended March 31,
		2007								2006
		Basic				Diluted				Basic				Diluted
Net income (in thousands)		$	14,387			$	14,387			$	17,779			$	17,779
Weighted-average number of common shares outstanding			47,316,058				47,316,058				39,491,786				39,491,786
Additional shares due to assumed conversion of dilutive instruments			—				111,444				—				226,766
Adjusted weighted-average number of common shares outstanding			47,316,058				47,427,502				39,491,786				39,718,552
Net income per share		$	0.30			$	0.30			$	0.45			$	0.45

NOTE 6—2003 STOCK INCENTIVE PLANS

          The Company adopted a 2003 Stock Incentive Plan, effective June 4, 2003, and a 2003 Outside Advisors Stock Incentive Plan, effective June 4, 2003, pursuant to which up to 1,000,000 shares of the Company’s common stock are authorized to be awarded at the discretion of the compensation committee of the board of directors. On May 25, 2005, these plans were amended to increase the total number of shares reserved for issuance from 1,000,000 shares to 2,000,000 shares and to set the share limits at 1,850,000 shares for the 2003 Stock Incentive Plan and 150,000 shares for the 2003 Outside Advisors Stock Incentive Plan. The plans provide for the grant of a variety of long-term incentive awards to employees and officers of the Company or individual consultants or advisors who render or have rendered bona fide services as an additional means to attract, motivate, retain and reward eligible persons. These plans provide for the grant of awards that meet the requirements of Section 422 of the Internal Revenue Code, or the Code, of non-qualified stock options, stock appreciation rights, restricted stock, stock units and other stock-based awards and dividend equivalent rights. The maximum term of each grant is determined on the grant date by the compensation committee and may not exceed 10 years. The exercise price and the vesting requirement of each grant are determined on the grant date by the compensation committee. The Company uses historical data to estimate stock option exercises and employee termination in its calculations of stock-based employee compensation expense and expected terms.

          The following table illustrates the common stock available for grant at March 31, 2007:

						2003 Outside
		2003 Stock				Advisors Stock
		Incentive Plan				Incentive Plan				Total
Shares reserved for issuance			1,850,000				150,000				2,000,000
Granted			931,166				—				931,166
Forfeited			—				—				—
Expired			—				—				—
Total available for grant			918,834				150,000				1,068,834

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NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

		2007
						Weighted-
		Number				Average
		of				Exercise
		Options				Price
Outstanding, beginning of period			55,000			$	14.82
Granted			—				—
Exercised			—				—
Forfeited			—				—
Outstanding, end of period			55,000			$	14.82

          The following table summarizes certain information about stock options outstanding at March 31, 2007:

		Outstanding												Exercisable
						Weighted-												Weighted-
						Average												Average
Range of						Remaining				Weighted-								Remaining				Weighted-
Exercise		Number of				Life				Average				Number of				Life				Average
Prices		Options				(in years)				Exercise Price				Options				(in years)				Exercise Price
$13.00-$14.00			5,000				6.6			$	13.00				5,000				6.6			$	13.00
$14.01-$15.00			50,000				6.3				15.00				50,000				6.3				15.00
$13.00-$15.00			55,000							$	14.82				55,000							$	14.82

          The aggregate intrinsic value of outstanding stock options and exercisable stock options at March 31, 2007 was zero. All outstanding stock options were fully vested at March 31, 2007.

          The following table illustrates the changes in common stock awards during the three months ended March 31, 2007:

		Number of				Weighted-Average
		Common Shares				Issue Price
Outstanding, beginning of period			721,329			$	9.13
Issued			150,000				9.71
Repurchased			—				—
Outstanding, end of period			871,329			$	9.23

          The fair value of common stock awards is determined on the grant date using the closing stock price on the NYSE that day.

          The following table illustrates the changes in nonvested common stock awards during the three months ended March 31, 2007:

						Weighted-
						Average
		Number of				Grant-Date Fair
		Common Shares				Value
Nonvested, beginning of the period			555,923			$	9.20
Granted			150,000				9.71
Vested			(133,316		)		8.68
Repurchased			—				—
Nonvested, end of the period			572,607			$	9.46

          Total stock-based employee compensation expense related to common stock awards for the three months ended March 31, 2007 and 2006 was $0.7 million and $1.1 million, respectively. At March 31, 2007, stock-based

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

employee compensation expense of $4.7 million related to nonvested common stock awards is expected to be recognized over a weighted-average period of 1.3 years.

NOTE 7—FAIR VALUE OF FINANCIAL INSTRUMENTS

          SFAS No. 107, Disclosure About Fair Value of Financial Instruments, requires disclosure of the fair value of financial instruments for which it is practicable to estimate that value. The fair value of securities is equal to their carrying value presented in the consolidated balance sheet. The fair value of cash and cash equivalents, restricted cash, interest receivable, principal receivable, repurchase agreements, commercial paper, warehouse lending facilities, unsettled securities purchases and accrued interest expense approximates cost at March 31, 2007 and December 31, 2006 due to the short-term nature of these instruments. The carrying value and fair value of the Company’s junior subordinated notes was $92.8 million and $91.5 million, respectively, at March 31, 2007. The carrying value and fair value of the Company’s junior subordinated notes was $92.8 million and $91.3 million, respectively, at December 31, 2006. The carrying value and fair value of the Company’s loans held-for-investment was $5.6 billion and $5.5 billion, respectively, at March 31, 2007. The carrying value and fair value of the Company’s loans held-for-investment was $5.6 billion at December 31, 2006. The carrying value and fair value of the Company’s mortgage-backed notes was $4.3 billion at March 31, 2007 and $3.9 billion December 31, 2006. The carrying value and fair value of the Company’s CDOs was $270.0 million at March 31, 2007. No CDOs were outstanding at December 31, 2006.

NOTE 8—ACCUMULATED OTHER COMPREHENSIVE INCOME

          The following is a summary of the components of accumulated other comprehensive income at March 31, 2007 and December 31, 2006 (in thousands):

		March 31,				December 31,
		2007				2006
Unrealized holding losses on mortgage-backed securities available-for-sale		$	(13,685	)		$	(5,957	)
Reclassification adjustment for net losses (gains) on mortgage-backed securities available-for-sale included in net income			15,453				(993	)
Impairment losses on mortgage-backed securities			4				7,010
Net unrealized gain on mortgage-backed securities available-for-sale			1,772				60
Net deferred realized and unrealized gains on cash flow hedges			3,290				3,734
Net unrealized losses (gains) on equity securities available-for-sale			(125	)			48
Net unrealized losses on debt securities available-for-sale			(8	)			—
Accumulated other comprehensive income		$	4,929			$	3,842

NOTE 9—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

          The Company seeks to manage its interest rate risk and credit exposure and protect the Company’s liabilities against the effects of major interest rate changes. Such interest rate risk may arise from: (1) the issuance and forecasted rollover and repricing of short-term liabilities with fixed rate cash flows or from liabilities with a contractual variable rate based on LIBOR; (2) the issuance of long-term fixed rate or floating rate debt through securitization activities or other borrowings or (3) the change in value of loan purchase commitments. The Company also seeks to manage its credit risk exposure which may arise from the creditworthiness of the holders of the mortgages underlying its mortgage-related assets. Among other strategies, the Company may use Eurodollar futures contracts, swaption contracts, interest rate swap contracts, credit default swaps, nterest rate cap contracts forward sales of To-be-Announced, or TBA, mortgage-backed securities and other risk-sharing arrangements to manage these risks.

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

          The following table is a summary of derivative contracts held at March 31, 2007 and December 31, 2006 (in thousands):

		Estimated Fair Value
		March 31,				December 31,
		2007				2006
Eurodollar futures contracts sold short		$	740			$	149
Interest rate swap contracts			1,469				4,383
Interest rate cap contracts			1,782				1,531
Credit default swaps			15,852				6,958
Forward sales of TBA mortgage-backed securities			105				—

     Free Standing Derivatives

          Free standing derivative contracts are carried on the consolidated balance sheet at fair value. Net unrealized gains of $4.7 million and $9.6 million were recognized in other income due to the change in fair value of these contracts during the three months ended March 31, 2007 and 2006, respectively.

          The Company realized net gains on free standing derivative contracts of $11.0 million and zero in other income during the three months ended March 31, 2007 and 2006, respectively. Realized net gains include realized gains and losses on derivative contracts and other income and expense on free standing derivatives.

     Cash Flow Hedging Strategies

          Prior to January 1, 2006, the Company entered into derivative contracts that were accounted for under hedge accounting as prescribed by SFAS No. 133. Effective January 1, 2006, the Company discontinued the use of hedge accounting. Under hedge accounting, prior to the end of the specified hedge time period, the effective portion of all contract gains and losses, whether realized or unrealized, was recorded in other comprehensive income or loss. Hedge effectiveness gains included in accumulated other comprehensive income at December 31, 2005 will be amortized during the specified hedge time period. Under hedge accounting, realized gains and losses were reclassified into earnings as an adjustment to interest expense during the specified hedge time period. Realized gains and losses included in accumulated other comprehensive income at December 31, 2005 will be amortized during the specified hedge time period. All changes in value of derivative instruments that had previously been accounted for under hedge accounting are recognized in other income or expense.

          During the three months ended March 31, 2007 and 2006, interest expense decreased by $0.1 million and $1.5 million, respectively, due to the amortization of net realized gains on Eurodollar futures contracts.

          During the three months ended March 31, 2007 and 2006, interest expense decreased by $0.4 million and $1.6 million due to the amortization of effectiveness gains on Eurodollar futures contracts and interest rate swap contracts.

     Purchase Commitment Derivatives

          The Company may enter into commitments to purchase mortgage loans, or purchase commitments, from the Company’s network of originators. Each purchase commitment is evaluated in accordance with SFAS No. 133 to determine whether the purchase commitment meets the definition of a derivative instrument. At March 31, 2007, outstanding purchase commitments with a net unrealized loss of $0.5 million were recorded on the Company’s consolidated statement of operations. There were no outstanding purchase commitments at December 31, 2006.

LUMINENT MORTGAGE CAPITAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

          During the three months ended March 31, 2007 and 2006, net losses of $0.6 million and $1.0 million related to purchase commitment derivatives were recorded in other expense on the Company’s consolidated statement of operations.

NOTE 10—INCOME TAXES

          The Company has elected to be taxed as a REIT under the Code. As such, the Company routinely distributes substantially all of the income generated from operations to its stockholders. As long as the Company retains its REIT status, it generally will not be subject to U.S. federal or state corporate taxes on its income to the extent that it distributes its REIT taxable net income to its stockholders.

          The Company has a taxable REIT subsidiary that receives management fees in exchange for various advisory services provided in conjunction with the Company’s investment strategies. In the first quarter of 2007, this taxable REIT subsidiary is subject to corporate income taxes on its taxable income at a combined federal and state effective tax rate. The same taxable REIT subsidiary was subject to the Pennsylvania Capital Stock and Franchise Tax as well as Philadelphia Gross Receipts Tax and Philadelphia Net Income Tax. The Company also has a taxable REIT subsidiary that purchases mortgage loans and creates securitization entities as a means of securing long-term collateralized financing.

          Distributions declared per share were $0.30 and $0.05 for the quarters ended March 31, 2007 and 2006, respectively. All distributions were classified as ordinary income to stockholders for income tax purposes.

NOTE 11—SUBSEQUENT EVENTS

          In May 2007, a securitization entity sponsored by the Company issued $657.0 million of mortgage-backed securities through Luminent Mortgage Trust 2007-2 which are collateralized by $662.1 of mortgage loans. The Company retained $3.9 million of the securities and sold $653.1 million to third parties. The securitization has been accounted for as financings under SFAS No. 140.

          Subsequent to March 31, 2007, the Company sold $25.0 million of CDOs which were originally retained at the closing of the CDO issuance. Additionally, $37.3 million of the uninvested cash balance at the closing of the transaction has been invested in mortgage-backed securities which will collateralize the CDO’s leaving a remaining uninvested cash balance of $11.6 million as of May 9, 2007.

          On April 11, 2007, the Company announced the adoption of a stock repurchase plan in accordance with the guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934. Rule 10b5-1 allows a public company to adopt a written, prearranged stock repurchase plan when it does not have material, non-public information in its possession. The adoption of this stock repurchase plan will allow the Company to repurchase shares during periods when it might otherwise be prevented from doing so under insider trading laws or because of self-imposed trading blackout periods. The Company repurchased a total of 2.2 million shares under repurchase programs through May 9, 2007.

          On May 7, 2007, Luminent’s board of directors approved an authorization to repurchase an additional five million shares of common stock. As of May 9, 2007 the Company is authorized to acquire up to 5.2 million shares of common stock.