**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





**(Mark One)**


**[x]**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**For
                the quarterly period endedMarch
                31, 2006





**or**




**[
                ]**
            **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:** **1-12109**







**DELTA
      FINANCIAL CORPORATION**





(Exact
      name of registrant as specified in its charter)





**Delaware**
            **11-3336165**(State
                or other jurisdiction of
            (I.R.S.
                Employerincorporation
                or organization)
            Identification
                No.)





**1000
      Woodbury Road, Suite 200, Woodbury, New York 11797**





(Address
      of principal executive offices)





**(516)
      364 - 8500**





(Registrant’s
      telephone number, including area code)





**No
      Change**





(Former
      name, former address and former fiscal year, if changed since last
      report)




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 a large accelerated filer,
      an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
      accelerated filer [ ]   Accelerated
      filer [ x ]   Non-accelerated
      filer [ ]





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).




Yes
      [
      ]   No
      [ x
      ]





As
      of
      April 28, 2006, 23,107,586 shares of the registrant’s common stock, par value
      $0.01 per share, were outstanding.







**INDEX
      TO FORM 10-Q**








**Page
                No.****PART
                I - FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheets as of March 31, 2006 and
                December 31, 2005 (unaudited)
            1Consolidated
                Statements of Operations for the Three
                Months Ended March
                31, 2006 and 2005 (unaudited)
            2Consolidated
                Statement of Changes in Stockholders’
                Equity for the Three Months Ended
                March 31, 2006 (unaudited)
            3Consolidated
                Statements of Cash Flows for the Three
                Months Ended March
                31, 2006 and 2005 (unaudited)
            4Notes
                to Consolidated Financial
                Statements
            6Item
                2.
            Management’s
                Discussion and Analysis of
                Financial Condition and Results of Operations
            23Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            45Item
                4.
            Controls
                and Procedures
            49**PART
                II - OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            50Item
                1A.
            Risk
                Factors
            52Item
                6.
            Exhibits
            58Signatures
            59











**PART
      I - FINANCIAL INFORMATION**





**Item
      1 - Financial Statements.**





**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS (*****Unaudited*****)**


*(Dollars
      in thousands, except for share data)*





**At
                March 31,**
              **2006**
            
            **At
                December 31, 2005****Assets:**Cash
                and cash equivalents
            
            $
            5,695
            
            $
            4,673Mortgage
                loans held for investment, net of discounts and deferredorigination
                fees
            
            
            5,123,609
            
            
            4,663,662Less: Allowance for loan losses
            
            
            (41,911
            )
            
            (36,832
            )Mortgage loans held for investment, net
            
            
            5,081,698
            
            
            4,626,830Trustee
                receivable
            
            
            73,515
            
            
            56,164Accrued
                interest receivable
            
            
            29,307
            
            
            26,952Excess
                cashflow certificates
            
            
            5,056
            
            
            7,789Equipment,
                net
            
            
            6,956
            
            
            6,688Accounts
                receivable
            
            
            4,046
            
            
            5,123Prepaid
                and other assets
            
            
            35,678
            
            
            30,508Deferred
                tax asset
            
            
            49,662
            
            
            54,875Total assets
            
            $
            5,291,613
            
            $
            4,819,602**Liabilities
                and Stockholders’ Equity****Liabilities:**Bank
                payable
            
            $
            1,849
            
            $
            1,921Warehouse
                financing
            
            
            123,177
            
            
            222,843Financing
                on mortgage loans held for investment, net
            
            
            4,992,688
            
            
            4,436,938Other
                borrowings
            
            
            4,200
            
            
            4,785Accrued
                interest payable
            
            
            16,279
            
            
            13,091Accounts
                payable and other liabilities
            
            
            36,260
            
            
            33,242Total liabilities
            
            
            5,174,453
            
            
            4,712,820**Stockholders’
                Equity:**Common
                stock, $.01 par value. Authorized 49,000,000 shares;20,874,162
                and 20,736,362 shares issued and 20,600,087 and
              20,462,287
                shares outstanding at March 31, 2006 and December 31,2005,
                respectively
            
            
            207
            
            
            207Additional
                paid-in capital
            
            
            121,194
            
            
            121,561Accumulated
                deficit
            
            
            (9,529
            )
            
            (15,077
            )Accumulated
                other comprehensive income
            
            
            6,606
            
            
            2,536Unearned
                common stock held by stock incentive plan
            
            
            --
            
            
            (1,127
            )Treasury
                stock, at cost (116,800 shares)
            
            
            (1,318
            )
            
            (1,318
            )Total stockholders’ equity
            
            
            117,160
            
            
            106,782Total
                liabilities and stockholders’ equity
            
            $
            5,291,613
            
            $
            4,819,602








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


**1**


**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**(Unaudited)


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





**For
                  the Three Months Ended March 31,****2006**
              
              **2005**Interest
                  income
              
              $
              101,973
              
              $
              54,876Interest
                  expense
              
              
              67,266
              
              
              27,783Net
                  interest income
              
              
              34,707
              
              
              27,093Provision
                  for loan losses
              
              
              6,404
              
              
              6,864Net
                  interest income after provision for loan losses
              
              
              28,303
              
              
              20,229Non-interest
                  income:Net
                  gain on sale of mortgage loans
              
              
              7,236
              
              
              5,292Other
                  income
              
              
              3,376
              
              
              2,851Total
                  non-interest income
              
              
              10,612
              
              
              8,143Non-interest
                  expense:Payroll
                  and related costs
              
              
              17,030
              
              
              15,154General
                  and administrative
              
              
              11,337
              
              
              9,795Gain
                  on derivative instruments
              
              
              (275
              )
              
              (16
              )Total
                  non-interest expense
              
              
              28,092
              
              
              24,933Income
                  before income tax expense
              
              
              10,823
              
              
              3,439Provision
                  for income tax expense
              
              
              4,237
              
              
              1,380Net
                  income
              
              $
              6,586
              
              $
              2,059**Comprehensive
                  Income**:Other
                  comprehensive income
              
              
              4,070
              
              
              4,802Comprehensive
                  income
              
              $
              10,656
              
              $
              6,861**Per
                  Share Data:**Basic
                  - weighted average number of shares outstanding
              
              
              20,497,408
              
              
              20,295,874Diluted
                  - weighted average number of shares outstanding
              
              
              21,360,176
              
              
              21,236,140Net
                  income applicable to common shares
              
              $
              6,586
              
              $
              2,059Basic
                  earnings per share - net income
              
              $
              0.32
              
              $
              0.10Diluted
                  earnings per share - net income
              
              $
              0.31
              
              $
              0.10







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


**2**


**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**(Unaudited)


**For
      the Three Months Ended March 31, 2006**


*(Dollars
      in thousands)*





**Common
                Stock**
            
            **Additional**
              **Paid-in
                Capital**
            
            **Accumulated
                Deficit**
            
            **Other
                Comprehensive Income**
            
            **Unearned
                Common Stock Held by Stock Incentive Plan**
            
            **Treasury
                Stock**
            
            **Total**Balance
                at December 31, 2005
            
            $
            207
            
            $
            121,561
            
            $
            (15,077
            )
            $
            2,536
            
            $
            (1,127
            )
            $
            (1,318
            )
            $
            106,782Stock
                options exercised
            
            
            1
            
            
            136
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            137Excess
                tax benefit related to sharebased
                compensation
            
            
            --
            
            
            623
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            623Reversal
                of unearned commonstock
                held by stock incentive plan
            
            
            (1
            )
            
            (1,126
            )
            
            --
            
            
            --
            
            
            1,127
            
            
            --
            
            
            --Dividend
                declared and payable
            
            
            --
            
            
            --
            
            
            (1,038
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,038
            )Net
                unrealized gains onderivatives,
                net of tax
            
            
            --
            
            
            --
            
            
            --
            
            
            4,070
            
            
            --
            
            
            --
            
            
            4,070Net
                income
            
            
            --
            
            
            --
            
            
            6,586
            
            
            --
            
            
            --
            
            
            --
            
            
            6,586Balance
                at March 31, 2006
            
            $
            207
            
            $
            121,194
            
            $
            (9,529
            )
            $
            6,606
            
            $
            --
            
            $
            (1,318
            )
            $
            117,160







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


**3**


**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**(Unaudited)


*(Dollars
      in thousands)*





**Three
                Months Ended March 31,****2006**
            
            **2005**Cash
                flows from operating activities:Net
                income
            
            $
            6,586
            
            $
            2,059Adjustments
                to reconcile net income to net cash used in operatingactivities:Provision
                for loan losses
            
            
            6,404
            
            
            6,864Provision
                for (recovery of) recourse loans and secondary marketing
            
            
            175
            
            
            (163
            )Depreciation
                and amortization
            
            
            791
            
            
            562Deferred
                tax expense (benefit)
            
            
            2,611
            
            
            (3,833
            )Deferred
                origination costs (income)
            
            
            86
            
            
            (1,788
            )Gain
                on change in fair value of excess cashflow certificates
            
            
            (3,261
            )
            
            (2,738
            )Gain
              on sale of mortgage loans
            
            
            (7,236
            )
            
            (5,292
            )Gain
                on sale of mortgage servicing rights
            
            
            (46
            )
            
            (36
            )Amortization
                of bond securitizations deferred cost and premiums
            
            
            (3,101
            )
            
            (166
            )Cash flows received from excess cashflow certificates, net of 
              accretion
            
            
            5,994
            
            
            3,612Proceeds
                from sale of mortgage servicing rights, net
            
            
            6,387
            
            
            5,231Stock-based
                compensation expense
            
            
            188
            
            
            --Changes
                in operating assets and liabilities:Decrease
                (increase) in accounts receivable
            
            
            1,077
            
            
            (1,897
            )Increase
                in trustee receivable, net
            
            
            (17,351
            )
            
            (14,949
            )Increase
                in accrued interest receivable
            
            
            (2,377
            )
            
            (3,171
            )Decrease
                (increase) in prepaid and other assets
            
            
            981
            
            
            (3,071
            )Increase
                in accrued interest payable
            
            
            3,188
            
            
            1,546Increase
                in accounts payable and other liabilities
            
            
            3,045
            
            
            5,055Net
                cash provided by (used in) operating activities
            
            
            4,141
            
            
            (12,175
            )Cash
                flows from investing activities:Origination
                of mortgage loans held for investment, net of repayments
            
            
            (629,351
            )
            
            (690,354
            )Proceeds
                from sale of mortgage loans
            
            
            171,947
            
            
            110,711Purchase
                of equipment
            
            
            (1,059
            )
            
            (1,192
            )Net
                cash used in investing activities
            
            
            (458,463
            )
            
            (580,835
            )Cash
                flows from financing activities:Repayment
                of warehouse financing, net
            
            
            (99,666
            )
            
            (16,960
            )Proceeds
                of financing on mortgage loans held for investment, net
            
            
            556,125
            
            
            612,873Repayment
                of other borrowings, net
            
            
            (585
            )
            
            (389
            )(Decrease)
                increase in bank payable
            
            
            (72
            )
            
            479Cash
                dividends paid on common stock
            
            
            (1,030
            )
            
            (1,013
            )Excess
                tax benefit related to share-based compensation
            
            
            435
            
            
            59Proceeds
                from exercise of stock options
            
            
            137
            
            
            55Net
                cash provided by financing activities
            
            
            455,344
            
            
            595,104Net
                increase in cash and cash equivalents
            
            
            1,022
            
            
            2,094Cash
                and cash equivalents at beginning of period
            
            
            4,673
            
            
            5,187Cash
                and cash equivalents at end of period
            
            $
            5,695
            
            $
            7,281





**4**





**Three
                  Months Ended March 31,****2006**
              
              **2005**Supplemental
                  Information:Cash paid during the period for:Interest
              
              $
              63,593
              
              $
              25,022Income
                  taxes
              
              $
              1,736
              
              $
              4,366Non cash transactions:Dividends
                  payable
              
              $
              1,038
              
              $
              1,015Transfer
                  of mortgage loans held for investment to REO, net
              
              $
              5,442
              
              $
              912








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


**5**


**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**(1)**  **Basis
      of Presentation**





The
      accompanying unaudited consolidated financial statements include the accounts
      of
      Delta Financial Corporation and its subsidiaries (collectively, the “Company,”
“we” or “us”). The consolidated financial statements reflect all normal
      recurring adjustments that, in the opinion of management, are necessary to
      present a fair statement of the financial position and results of operations
      for
      the periods presented. Certain reclassifications have been made to prior-period
      financial statements to conform to the 2006 presentation.





Certain
      information and footnote disclosures normally included in financial statements
      prepared in accordance with United States (“U.S.”) generally accepted accounting
      principles (“GAAP”) have been condensed or omitted in accordance with the
      rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). The
      preparation of consolidated financial statements in conformity with GAAP
      requires our management to make estimates and assumptions that affect the
      reported amounts of assets, liabilities and stockholders’ equity and disclosure
      of contingent assets and liabilities at the date of the consolidated financial
      statements and the reported amounts of income and expenses during the reporting
      periods. Actual results could differ from those estimates and
      assumptions.





These
      unaudited consolidated financial statements should be read in conjunction with
      the audited consolidated financial statements and notes thereto included in
      our
      Annual Report on Form 10-K for the year ended December 31, 2005. The results
      of
      operations for the three months ended March 31, 2006 are not necessarily
      indicative of the results that should be expected for the entire
      year.





The
      accompanying unaudited consolidated financial statements have been prepared
      in
      conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
      Regulation S-X for interim financial statements. Accordingly, they do not
      include all of the information and footnotes required by GAAP for complete
      financial statements.





**(2)**  **Basis
      of Consolidation**





The
      accompanying consolidated financial statements are prepared on the accrual
      basis
      of accounting and include our accounts and those of our subsidiaries. All
      inter-company accounts and transactions have been eliminated in
      consolidation.





**(3)**  **Summary
      of Significant Accounting Policies**





***(a)
      Cash and Cash Equivalents***





For
      cash
      flow reporting purposes, cash and cash equivalents include; cash in checking
      accounts, cash in interest bearing deposit accounts, amounts due from banks,
      restricted cash and money market investments. Included in cash and cash
      equivalents were $5,000 and $6,000 of interest-bearing deposits with select
      financial institutions at March 31, 2006 and December 31, 2005,
      respectively.





Additionally,
      cash and cash equivalents as of March 31, 2006 and December 31, 2005 included
      restricted cash held in various accounts totaling $46,000 and $29,000,
      respectively.





***(b)
      Mortgage Loans Held for Investment, Net***





Mortgage
      loans held for investment, net represent fixed-rate and adjustable-rate mortgage
      loans that have a contractual maturity of up to 30 years that are securitized
      through transactions structured and accounted for as secured financings
      (mortgage loans held for investment - securitized) or held pending
      securitization or whole-loan sale (mortgage loans held for investment -
      pre-securitization). Mortgage loans held for investment are secured by
      residential properties and stated at amortized cost, including the outstanding
      principal balance, net of the allowance for loan losses, net of discounts and
      net of deferred origination fees or costs.





**6**


Discounts
      related to mortgage loans held for investment are recorded from the creation
      of
      mortgage servicing assets. The allocated cost basis of mortgage servicing rights
      (“MSRs”) is recorded as an asset with an offsetting reduction ( *i.e.* ,
      discount) in the cost basis of the mortgage loans. Under Statement of Financial
      Accounting Standards (“SFAS”) No. 140, “ Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities-a replacement of FASB Statement No. 125,” the discount is measured
      using the relative fair values of the mortgage loans and MSRs to allocate the
      carrying value between the two assets. The MSRs
      generally are sold to a third-party servicer. The resulting discount is accreted
      to interest income on a level-yield basis over the estimated life of the related
      loans, on a pool-by-pool basis, using the interest method
      calculation.





Additionally,
      in accordance with SFAS No. 91, “ Accounting
      for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
      and Initial Direct Costs of Leases - an amendment of FASB Statements No. 13,
      60,
      and 65 and a rescission of FASB Statement No. 17,” the
      net
      deferred origination fees or costs associated with our mortgage loans held
      for
      investment are amortized to income on a level-yield basis over the estimated
      life of the related loans, on a homogeneous pool basis, using the interest
      method calculation.





The
      amount of deferred nonrefundable fees is determined based on the amount of
      such
      fees collected at the time of loan closing. We determine the amount of direct
      loan origination costs to be deferred based on the amount of time spent and
      actual costs incurred by loan origination personnel in the performance of
      specific activities directly related to the origination of funded mortgage
      loans
      for that period. These activities include evaluating the prospective borrowers'
      financial condition, evaluating and recording collateral and security
      arrangements, negotiating loan terms, processing loan documents and closing
      the
      loan. Management believes these estimates reflect an accurate cost structure
      related to successful loan origination efforts. Management periodically reviews
      its time and cost estimates to determine if updates and refinements to the
      deferral amounts are necessary.





The
      secured financing related to the mortgage loans held for investment -
      securitized is included in our consolidated balance sheet as financing on
      mortgage loans held for investment. Once the mortgage loans are securitized,
      we
      earn the net pass-through rate of interest and pay interest on our financing
      on
      mortgage loans held for investment.





We
      typically hold our mortgage loans held for investment - pre-securitization
      for
      no more than 120 days, and for 60 days on average, before they are securitized,
      and from time-to-time sell on a whole-loan basis, in the secondary market.
      During the period in which the loans were held pending securitization or
      whole-loan sale, we earned the coupon rate of interest paid by the borrower
      and
      paid interest to the lenders that provide our warehouse financing, to the extent
      that we utilized such financing. We also paid a sub-servicing fee to a third
      party during the period the loans were held pending securitization or whole-loan
      sale. Any gains or losses on sales of mortgage loans were recognized based
      upon
      the difference between the selling price and the carrying value of the related
      mortgage loans sold.





***(c)
      Allowance and Provision for Loan Losses***





In
      connection with our mortgage loans held for investment, excluding those loans
      which meet the criteria for specific review under SFAS
      No.
      114, “Accounting by Creditors for Impairment of a Loan - an amendment of FASB
      Statement No. 5 and 15,” we
      established an allowance for loan losses based on our estimate of losses to
      be
      incurred in the foreseeable future. Provisions for loan losses are made for
      loans to the extent that probable losses on these loans are borne by us.
      Provision amounts are charged as a current period expense to operations. We
      charge-off uncollectible loans at the time they are deemed not probable of
      being
      collected. In order to estimate an appropriate allowance for loan losses on
      mortgage loans held for investment, we estimate losses using a detailed analysis
      of historical loan performance by product type, origination year and
      securitization issuance. We
      stratify the loans held for investment into separately identified loan pools
      corresponding to each securitization trust. In
      accordance with SFAS No. 5, “Accounting for Contingencies,” we believe that
      pooling of mortgages with similar characteristics is an appropriate methodology
      in which to calculate or estimate the allowance for loan losses. The results
      of
      that analysis are then applied to the current long-term mortgage portfolio
      and
      an allowance for loan losses estimate is created to take into account both
      known
      and inherent losses in the loan portfolio. Losses incurred are written-off
      against the allowance.





**7**


In
      evaluating the adequacy of this allowance, there are qualitative factors and
      estimates that must be taken into consideration when evaluating and measuring
      potential expected losses on mortgage loans. These items include, but are not
      limited to, current performance of the loans, economic indicators that may
      affect the borrower’s ability to pay, changes in the market value of the
      collateral, political factors and the general economic environment. As these
      factors and estimates are influenced by factors outside of our control, there
      is
      inherent uncertainty in these items and it is reasonably possible that they
      could change. In particular, if conditions were such that we were required
      to
      increase the provision for losses, any increase in the provision for losses
      would decrease our income for that period. Management considers the current
      allowance to be adequate.





In
      accordance with SFAS No. 114, a loan is impaired when, based on current
      information and events, it is probable that a creditor will be unable to collect
      all amounts due according to the contractual terms of the loan agreement. Due
      to
      the significant effects of Hurricanes Katrina and Rita on a portion of our
      mortgage loans held for investment portfolio, management identified certain
      loans located in Federal Emergency Management Agency (“FEMA”) declared disaster
      areas as meeting the criteria under SFAS No. 114, thereby requiring a separate
      loan impairment review. Based upon the analysis performed, we
      identified specific mortgage loans in which the borrowers’ ability to repay
      the loan in accordance with their contractual terms was impaired. We assessed
      the extent of damage to the underlying collateral and the extent to which
      damaged collateral is not covered by insurance in determining the amount of
      specific reserves needed. At March 31, 2006, we have a specific reserve of
      $1.5
      million (which is included in the $1.7 million in specific reserves on impaired
      loans) for these affected loans based upon estimates of loss exposure. As
      additional information is obtained and processed over the coming months and
      quarters, we will continue to assess the need for any adjustments to our
      estimates and the specific reserves related to the mortgage loans in the
      affected areas.





Additionally,
      in connection with loans sold on a recourse basis (prior to 1991), we have
      a
      recourse reserve (included on the balance sheet within “accounts payable and
      other liabilities”), which is based on our estimate of probable losses to be
      borne by us under the terms of the recourse obligation. The methodology under
      which the recourse reserve is calculated is similar to the methodology utilized
      in determining the allowance for loan losses. Management considers the current
      recourse reserve to be adequate.





***(d)
      Trustee Receivable***





Trustee
      receivable principally represents any un-remitted principal and interest
      payments collected by the securitization trust’s third-party loan servicer
      subsequent to the monthly remittance cut-off date on our mortgage loans held
      for
      investment - securitized portfolio. Each month the third-party loan servicer,
      on
      behalf of each securitization trustee, remits all of the scheduled loan payments
      and unscheduled principal payoffs and curtailments generally received through
      a
      mid-month cut-off date. Unscheduled principal and interest payments and prepaid
      principal loan payments received after the cut-off date for the current month
      are recorded by us as a trustee receivable on the consolidated balance sheet.
      The trustee or third-party loan servicer retains these unscheduled principal
      and
      interest payments until the following month’s scheduled remittance date, at
      which time they principally will be used to pay down financing on mortgage
      loans
      held for investment, net.





***(e)
      Excess Cashflow Certificates***





Prior
      to
      2004, we structured our securitization transactions to be accounted for as
      sales. In these transactions the excess cash flow certificates represent one
      or
      all of the following assets: (1) residual interest (“BIO”) certificates; (2) P
      certificates (prepayment penalty fees); (3) payments from our interest rate
      cap
      providers; and (4) net interest margin (“NIM”) owner trust certificates. Our
      excess cashflow certificates are classified as “trading securities” in
      accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and
      Equity Securities.” The amount initially recorded for the excess cashflow
      certificates at the date of a securitization structured as a sale reflected
      their then allocated fair value. The amount recorded for the excess cashflow
      certificates is reduced for cash distributions received, and is adjusted for
      income accretion and subsequent changes in the fair value in accordance with
      SFAS No. 140. Any changes in fair value are recorded as a component of “other
      income” in our consolidated statement of operations. For the three months ended
      March 31, 2006 and 2005, we recorded $3.3 million and $2.7 million,
      respectively, of income due to an increase in the fair value of excess cashflow
      certificates.





**8**


We
      are
      not aware of any active market for the sale of our excess cashflow certificates.
      Accordingly, our estimate of fair value is subjective. Although we believe
      that
      the assumptions we use are reasonable, there can be no assurance as to the
      accuracy of the assumptions or estimates. The valuation of our excess cashflow
      certificates requires us to forecast interest rates, mortgage principal
      payments, prepayments and loan loss assumptions, each of which is highly
      uncertain and requires a high degree of judgment. The rate used to discount
      the
      projected cash flows is also critical in the valuation of our excess cashflow
      certificates. Management uses internal historical mortgage loan performance
      data
      and forward London Inter-Bank Offered Rate (“LIBOR”) curves to value future
      expected excess cash flows. We regularly analyze and review our assumptions
      to
      determine if the expected return (interest income) on our excess cashflow
      certificates is within our expectations, and adjust them as deemed
      necessary.





The
      Emerging Issues Task Force (“EITF”) issued EITF 99-20, “Recognition of Interest
      and Impairment on Purchased and Retained Beneficial Interests in Securitized
      Financial Assets,” which provides
      guidance on expected return (interest income) recognition and fair value
      measurement for interests (excess cashflow certificates) retained in a
      securitization transaction accounted for as a sale. In order
      to determine
      whether there has been a favorable change (increase to earnings) or an adverse
      change (decrease to earnings) in excess
      cashflow certificates, a comparison is made between (1) the present value of
      the
      excess cash flows at period end, and (2) the estimated carrying value at period
      end - which is based on the change from the beginning period and adjusted for
      the required rate of return within the period (currently, the required rate
      of
      return is our discount rate of 18% per annum). If the present value of the
      excess cash flows at period end is greater than the carrying value at period
      end, the change is considered favorable. If the present value of the excess
      cash
      flows at the end of the period is less than the carrying value, the change is
      considered adverse. In both situations, the fair value adjustment, if any,
      will
      be equal to the excess above or the deficit below the required rate of return
      (the discount rate).





***(f)
      Equipment, Net***





Equipment,
      including leasehold improvements, is stated at cost, less accumulated
      depreciation and amortization. Depreciation of equipment is computed using
      the
      straight-line method over the estimated useful lives of three to seven years.
      Leasehold improvements are amortized over the lesser of the terms of the lease
      or the estimated useful lives of the improvements. Ordinary maintenance and
      repairs are charged to expense as incurred.





Depreciation
      and amortization are included in “non-interest expense - general and
      administrative” in our consolidated statements of operations, and amounted to
      approximately $791,000 and $562,000 for the three months ended March 31, 2006
      and 2005, respectively. Accumulated depreciation and amortization totaled $13.3
      million and $12.5 million at March 31, 2006 and December 31, 2005,
      respectively.





***(g)
      Real Estate Owned***





Real
      estate owned (“REO”) represents properties acquired through, or in lieu of,
      foreclosure. REO properties are recorded at the lower of cost or fair value,
      less estimated selling costs. The fair value of an REO property is determined
      based upon values (*i.e.,* appraisal or broker price opinion) obtained by
      the third party servicer. REO properties are evaluated periodically for
      recoverability and any subsequent declines in value are reserved for through
      a
      provision. Any costs incurred to maintain the REO properties are expensed as
      incurred. Gains or losses on the sale of REO properties are recognized upon
      disposition.





In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets,” we classify our REO as “held for sale” at the date of
      foreclosure. The REO properties held are actively marketed for sale by our
      third-party servicer at a price that is deemed reasonable in relation to the
      properties’ current fair value. We generally expect the REO properties to be
      disposed of within six months to one year after being acquired.





The
      balance of REO is included in “prepaid expenses and other assets” on the
      consolidated balance sheet. We had $8.5 million and $4.4 million of REO
      properties as of March 31, 2006 and December 31, 2005, respectively. A provision
      of $131,000 was made during the three months ended March 31, 2006 for the
      decrease in the fair value of the REO properties in
      “general and administrative expenses.” No
      provision was made during the three months ended March 31, 2005 as
      we did
      not experience any declines in the fair values of REO properties held during
      that period.





**9**


***(h)
      Warehouse Financing***





Warehouse
      financing represents the outstanding balance of our borrowings collateralized
      by
      mortgage loans held pending securitization. Generally, warehouse financing
      facilities are used as interim, short-term financing which bear interest at
      a
      fixed margin over an index, such as LIBOR. The outstanding balance of our
      warehouse financings will fluctuate based on our lending volume, cash flows
      from
      operations, other financing activities and equity transactions.





***(i)
      Financing on Mortgage Loans Held for Investment, Net***





Financing
      on mortgage loans held for investment, net represents the securitization debt
      (asset-backed certificates or notes, referred to as “asset-backed securities”)
      used to finance loans held for investment - securitized, along with any
      discounts on the financing. The balance of this account will generally increase
      in proportion to the increase in mortgage loans held for investment -
      securitized.





Asset-backed
      securities are secured, or backed, by the pool of mortgage loans held by the
      securitization trust, which are recorded as mortgage loans held for investment
      -
      securitized on our consolidated balance sheet. Generally,
      the asset-backed security financing is comprised of a series of senior and
      subordinate securities with varying maturities ranging generally from one to
      20
      years and bearing either a fixed-rate of interest or a variable-rate of interest
      (representing a fixed margin over one-month LIBOR). The variable-rate
      asset-backed securities adjust monthly. Prior
      to
      2004, we did not structure our securitizations as secured financings and we
      did
      not have mortgage loans held for investment or related borrowings.





Any securitization debt issuance costs are deferred and amortized, along with
      any discounts on the financing, on a level-yield basis over the estimated life
      of the debt issued. From time-to-time we may utilize derivative instruments
      (cash flow hedges as defined in SFAS No. 133, “Accounting for Derivative
      Instruments and Hedging Activities”), such as interest rate swap contracts and
      corridors (corresponding purchase and sale of interest rate caps with similar
      notional balances at different strike prices), in an effort to maintain a
      minimum margin or to lock in a pre-determined base interest rate on designated
      portions of our prospective future securitization financing (collectively,
      the
      hedged risk). (See -
      Note 3(n) - “Derivative Instruments” and Note 10 - “Derivative Instruments” for
      further information regarding hedging securitization financing).





Our securitizations are structured legally as sales and we
      are
      not legally required to make payments to the holders of the asset-backed
      securities. The only recourse of the asset-backed securities holders for
      repayment is from the underlying mortgages specifically collateralizing the
      debt. The assets held by the securitization trusts are not available to our
      general creditors. As with past securitizations, we have potential liability
      to
      each of the securitization trusts for any breach of the standard representations
      and warranties that we provided in connection with each
      securitization.





Under SFAS
      No.
      140, the securitizations are accounted for as financings. The securitization
      trusts do not meet the qualifying special purpose entity (“QSPE”) criteria under
      SFAS No. 140 and related interpretations due to their ability to enter into
      derivative contracts. Additionally, we have the option to purchase loans from
      the trust at our discretion. Our
      pre-2004 securitizations did meet the QSPE criteria, which required the
      securitizations to be accounted for as a sale of mortgage loans.





**(** ***j)***  ***Interest
      Income***





Interest
      income primarily represents the sum of (a) the gross interest, net of servicing
      fee, we earn on mortgage loans held for investment - securitized; (b) the gross
      interest we earn on mortgage loans held for investment - pre-securitization;
      (c)
      securitization accrued bond interest (income received from the securitization
      trust for fixed-rate asset-backed securities at the time of securitization
      settlement); (d) excess cashflow certificate income; (e) interest earned on
      bank
      accounts; (f) prepayment penalty fees; and (g) amortized discounts, deferred
      costs and fees recognized on a level-yield basis.





**10**


Interest
      on mortgage loans is recognized as revenue when earned according to the
      contractual terms of the mortgages and when, in the opinion of management,
      it is
      deemed collectible. Mortgage loans are placed on non-accrual status generally
      when the loan becomes greater than 90 days past due, or earlier when concern
      exists as to the ultimate collectability of principal or interest ( *i.e.,* an
      impaired loan), in accordance with contractual terms of the mortgage. A
      non-accrual loan will be returned to accrual status when principal and interest
      payments become current, and the loan is anticipated to be fully collectible.
      Cash receipts on non-accrual loans, including impaired loans, generally are
      applied to principal and interest in accordance with the contractual terms
      of
      the loan. If full payment of principal is not expected, we either
      will defer the recognition of interest until the loan performs according to
      its original terms or apply all of the principal and interest payments received
      as a reduction of the carrying value of the loan.





***(k)
      Interest Expense***





Interest
      expense primarily represents the borrowing costs under (a) our warehouse credit
      facilities to finance loan originations; (b) securitization debt; (c) equipment
      financing; and (d) amortized discounts and deferred costs on a level-yield
      basis.





***(l)
      Gain on Sale of Mortgage Loans***





Gains
      on
      the sale of mortgage loans are recognized at settlement date and are determined
      by the difference between the selling price and the carrying value of the
      mortgage loans sold. These transactions are accounted for as sales in accordance
      with SFAS No. 140.  Any
      unamortized origination fees or costs at the date of sale are reflected as
      an
      adjustment to gain on sale.




We
      generally sell mortgage loans on a non-recourse servicing-released basis and,
      as
      such, the risk of loss or default by the borrower generally has been assumed
      by
      the purchaser. However, we generally are required to make certain
      representations and warranties to these purchasers relating to borrowers’
creditworthiness, loan documentation and collateral. To the
      extent that we do not comply with such representations and warranties, or there
      are early payment defaults, we may be required to repurchase loans or indemnify
      these purchasers for any losses from borrower defaults.





During
      the three months ended March 31, 2006 and 2005, we sold $164.7 million and
      $105.4 million, respectively, of whole-loans on a non-recourse basis. We
      establish a reserve for the contractual obligation to rebate a portion of any
      premium paid by a purchaser when a borrower prepays a sold mortgage loan within
      an agreed period. The premium recapture reserve is recorded as a liability
      on
      our consolidated financial statements when the mortgage loans are sold based
      on
      our historical experience. The
      provision for premium recapture is recognized at the date of sale and is
      included in the consolidated statements of operations as a reduction of gain
      on
      sale of mortgage loans.





***(m)
      Mortgage Servicing Rights Sales***





We
      generally sell the MSRs to a third party as of the securitization date. Upon
      the
      sale, we allocate a portion of the accounting basis of the mortgage loans held
      for investment to the MSRs, which results in a discount to the mortgage loans
      held for investment. That discount is accreted as an adjustment to yield on
      the
      mortgage loans over the estimated life of the related loans, on a pool-by-pool
      basis, using the interest method calculation. For the three months ended March
      31, 2006 and 2005, we received $6.4 million and $5.2 million, respectively,
      from
      a third-party servicer for the right to service the mortgage loans
      collateralizing our securitizations that were structured to be accounted for
      as
      secured financings.





***(n)
                Derivative
                Instruments***





We
      regularly issue securitization asset-backed securities collateralized by fixed-
      and variable-rate mortgage loans. As a result of this activity, we are exposed
      to interest rate risk beginning when our mortgage loans close and are recorded
      as assets until permanent financing is arranged, such as when asset-backed
      securities are issued. Our strategy is to use derivative instruments, in the
      form of interest rate swap contracts, in an effort to effectively lock in a
      pre-determined interest rate on designated portions of our prospective future
      securitization financings. We also use corridors (corresponding purchase and
      sale of interest rate caps with similar notional balances at different strike
      prices) that are designed to limit our financing costs within the securitization
      by maintaining minimum margins. Both the interest rate swaps and corridors
      are
      derivative instruments that trade in liquid markets, and neither is used by
      us
      for speculative purposes.





**11**


In
      accordance with SFAS No. 133, all derivatives are recorded on the consolidated
      balance sheet at fair value. When derivatives are used as hedges, specific
      criteria must be met, including contemporaneous documentation, in order to
      qualify for hedge accounting. Under SFAS No. 133, cash flow hedge accounting
      is
      permitted only if a hedging relationship is properly documented and qualifying
      criteria are satisfied. For derivative financial instruments not designated
      as
      hedging instruments, all gains or losses, whether realized or unrealized, are
      recognized in current period earnings.





Cash
      flow
      hedge accounting is appropriate for hedges of forecasted interest payments
      associated with future periods - whether as a consequence of interest to be
      paid
      on existing variable-rate liabilities or in connection with intended debt
      issuances.





Under
      cash flow hedge accounting treatment, derivative results are divided into two
      portions, “effective” and “ineffective.” The effective portion of the
      derivative's gain or loss is initially reported as a component of other
      comprehensive income (“OCI”) and subsequently reclassified into earnings when
      the forecasted interest payments affects earnings. The ineffective portion
      of
      the gain or loss is reported in earnings immediately.





To
      qualify for cash flow hedge accounting treatment, all of the following factors
      must be met:





·
            hedges
                must be documented, with the objective and strategy stated, along
                with an
                explicit description of the methodology used to assess and measure
                hedge
                effectiveness;·
            dates
                (or periods) for the expected forecasted events and the nature of
                the
                exposure involved (including quantitative measures of the size of
                the
                exposure) must be explicitly documented;·
            hedges
                must be expected to be “highly effective” both at the inception of the
                hedge and on an ongoing basis. Effectiveness measures must relate
                the
                gains or losses of the derivative to the changes in cash flows associated
                with the hedged item;·
            forecasted
                transactions must be probable; and·
            forecasted
                transactions must be made with different counterparties than the
                reporting
                entity.





If
      and
      when hedge accounting is discontinued, typically when it is determined that
      the
      hedge no longer qualifies for hedge accounting, the derivative will continue
      to
      be recorded on the consolidated balance sheet at its fair value, with gains
      or
      losses being recorded in earnings. Any amounts previously recorded in OCI
      related to the discontinued hedge are classified to earnings over the remaining
      duration of the debt.





If
      a
      hedge fails the assessment of hedge effectiveness test (the ratio of the
      outstanding balance of the hedged item (debt) to the notional amount of the
      corridors exceeds 125% or falls below 80%, since the notional amount is the
      only
      critical term that varies) at any time, and therefore is not expected to be
      “highly effective” at achieving offsetting changes in cash flows, the hedge
      ceases to qualify for hedge accounting. An
      assessment analysis is then prepared by management to determine the prospective
      treatment of the hedges that failed the retrospective test to determine if
      any
      portion of the corridor may still qualify for hedge accounting treatment. If
      the
      analysis indicates future effectiveness for a portion of the hedge, the original
      hedge will effectively be allocated into two pieces, a trading security
      (ineffective portion) and “new hedge relationship” (effective
      portion).





The
“new
      hedge relationship” is determined by re-aligning the hedge with the projected
      remaining bond balances (debt) as of the date the original hedge became
      retrospectively ineffective. The ratio of the outstanding balance of the debt
      to
      notional size of the revised hedge will then be 100% as of the re-alignment
      date. The expected repayment pattern of the debt associated to the original
      hedge is used as the basis to establish the “new hedge relationship” future
      repayment pattern. The difference between the fair value of the original hedge
      and the “new hedge relationship” hedge on the re-alignment date is classified as
      a trading security. Once classified as a trading security, any changes in the
      fair value are recorded directly to the statement of operations as a component
      of gain or loss on derivative instruments.





**12**


**(4)**  **Recent
      Accounting Developments**





*Accounting
      for Certain Hybrid Financial Instruments.* In
      February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
      155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB
      Statements No. 133 and 140,” which amends SFAS No. 133 and No. 140. SFAS No.
      155, among other things, permits fair value re-measurement for any hybrid
      financial instrument that contains an embedded derivative that otherwise would
      require bifurcation and clarifies which interest-only strips and principal-only
      strips are not subject to the requirements of SFAS No. 133. Additionally, SFAS
      No. 155 establishes a requirement to evaluate interests in securitized financial
      assets to identify interests that are freestanding derivatives or that are
      hybrid financial instruments that contain an embedded derivative requiring
      bifurcation and clarifies that concentrations of credit risk in the form of
      subordination are not embedded derivatives. SFAS No. 155 amends SFAS No. 140
      to
      eliminate the prohibition on a QSPE from holding a derivative financial
      instrument that pertains to a beneficial interest other than another derivative
      financial instrument. SFAS No. 155 is effective for
      all
      financial instruments acquired or issued after the beginning of an entity’s
      first fiscal year that begins after
      September 15, 2006. We do not expect that the adoption of SFAS No. 155 will
      have
      a material impact on our financial condition or results of
      operations.





*Accounting
      for Servicing of Financial Assets.* In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets - an Amendment of FASB Statement No. 140.” SFAS No. 156 amends SFAS No.
      140 with respect to the  accounting
      for separately recognized servicing assets and servicing liabilities. SFAS
      No.
      156 requires, among other things, that (1) an entity recognize a servicing
      asset
      or servicing liability each time it undertakes an obligation to service a
      financial asset by entering into a servicing contract under certain situations;
      and (2) all separately recognized servicing assets and servicing liabilities
      be
      initially measured at fair value, if practicable.





SFAS
      No.
      156 also permits an entity to choose its measurement methods for each class
      of
      separately recognized servicing assets and servicing liabilities. At the date
      SFAS No. 156 is initially adopted, an entity with recognized servicing rights
      is
      permitted a one-time reclassification of available-for-sale securities to
      trading securities, without calling into question the treatment of other
      available-for-sale securities under SFAS No. 115, provided that the
      available-for-sale securities are identified in some manner as offsetting the
      entity’s exposure to changes in fair value of servicing assets or servicing
      liabilities that a servicer elects to subsequently measure at fair
      value.





Additionally
      required by SFAS No. 156 is the separate presentation of servicing assets and
      servicing liabilities subsequently measured at fair value in the statement
      of
      financial position and additional disclosures for all separately recognized
      servicing assets and servicing liabilities.





An
      entity
      should adopt SFAS No. 156 as of the beginning of its first fiscal year that
      begins after September 15, 2006. Earlier adoption is permitted as of the
      beginning of an entity’s fiscal year, provided the entity has not yet issued
      financial statements, including interim financial statements, for any period
      of
      that fiscal year. An entity should apply the requirements for recognition and
      initial measurement of servicing assets and servicing liabilities prospectively
      to all transactions after the effective date of SFAS No. 156. We do not expect
      the adoption of SFAS No. 156 will have a material impact on our financial
      condition or results of operations.





**(5)**  **Stock-Based
      Compensation**





Prior
      to
      January 1, 2006, we accounted for awards under our stock options plans
      under the recognition and measurement provisions of Accounting Principles Board
      (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees, ” as
      permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” No stock
      option compensation cost was recognized in our consolidated statement of
      operations as all options granted had an exercise price equal to the market
      value of the underlying common stock on the grant date.





**13**


Effective
      January 1, 2006, we adopted the fair value recognition provisions of SFAS No.
      123(R), “Share-Based Payment, ” using
      the modified-prospective adoption method. Under
      that method of adoption, the provisions of SFAS No. 123(R) are generally applied
      only to share-based awards granted subsequent to adoption. The consolidated
      financial statements for periods prior to adoption are not restated for the
      effects of adopting SFAS No. 123(R). Additionally, under
      this method, compensation cost recognized for the three months ended March
      31,
      2006 includes compensation cost for all options granted prior to, but not yet
      vested as of January 1, 2006, and all options granted subsequent to January
      1,
      2006, based on the grant date fair value estimated in accordance with the
      provisions of SFAS No. 123(R).





We
      have
      three stock benefit plans outstanding. The 2005 Stock Incentive Plan (“2005
      Plan” or “SIP”) provides for the granting of stock options, restricted stock,
      restricted stock units, stock appreciation rights and dividend equivalent rights
      (collectively referred to as “awards”). A total of 1,000,000 shares of our
      common stock are reserved for issuance under the 2005 Plan, subject to
      adjustment only in the event of a stock split, stock or other extraordinary
      dividend, or other similar change in our common stock or capital structure.
      Incentive stock options may be granted only to employees. Awards other than
      incentive stock options may be granted to employees, directors and consultants.
      The term of any award granted under the 2005 Plan may not be for more than
      10
      years (or five years in the case of an incentive stock option granted to any
      participant who owns stock representing more than 10% of the combined voting
      power of our company or any parent or subsidiary of ours), excluding any period
      for which the participant has elected to defer the receipt of the shares or
      cash
      issuable pursuant to the award.





In
      addition to the 2005 Plan, we have two outstanding stock option plans. The
      1996
      Stock Option Plan (the “1996 Option Plan”) and 2001 Stock Option Plan (the “2001
      Option Plan,” collectively with the 1996 Option Plan, the “Option Plans”)
      authorized the reserve of 2,200,000 shares and 1,500,000 shares, respectively,
      of unissued common stock for issuance. Substantially all of the options issued
      under the Option Plans vest over a five-year period at 20% per year and expire
      seven years from the grant date. Upon the exercise of a stock option, we will
      issue new shares of our common stock from authorized but unissued
      shares.





As
      a
      result of our adoption, our income before income tax expense and net income
      for
      the three months ended March 31, 2006 included stock option compensation cost
      of
      $106,000 and $65,000, respectively, which had no impact on basic and diluted
      earnings per share.





The
      fair
      value of each option award is estimated on the date of grant. For grants issued
      on and after January 1, 2006, the fair value will be determined using the Black
      Scholes Merton option pricing model. For options granted prior to January 1,
      2006, the fair value of these awards was based on the fair value calculated
      for
      purposes of the SFAS No. 123 pro forma disclosures which also used the Black
      Scholes Merton option pricing model. The weighted average assumptions used
      in
      the valuations for the disclosures are summarized as follows:


**For
                  the Three Months Ended**
                **March
                  31, 2005**
              
              **For
                  the Year Ended**
                **December
                  31, 2005**Dividend
                  yield
              2.3%
              
              2.5%Expected
                  volatility
              42.1%
              
              48.2%Risk-free
                  interest rate
              4.0%
              
              4.2%Expected
                  life
              3.7
                  years
              
              3.8
                  years






The
      expected volatility is based on the historical volatility of our common stock.
      For the Black Scholes Merton valuation model, the expected term of the options
      is estimated based on historical option exercise activity and represents the
      period of time that options granted are expected to be outstanding.  The
      risk-free interest rate for periods within the contractual life of the option
      is
      based on the U.S. Treasury yield curve in effect at the time of
      grant.





**14**


The
        following table summarizes the option activity regarding the Option Plans
        for
        the three months ended March 31, 2006:


(Dollars
                    in thousands, except per share amounts)
                
                **Number
                    of Options**
                
                **Weighted
                    Average Exercise Price**
                
                **Weighted
                    Average Remaining Contractual Term**
                
                **Aggregate
                    Intrinsic Value**January
                    1, 2006 balance
                
                
                2,174,300
                
                $
                2.87Options
                    granted
                
                
                --
                
                
                --Options
                    exercised
                
                
                137,800
                
                
                0.99Options
                    expired
                
                
                107,000
                
                
                5.68Options
                    forfeited
                
                
                2,200
                
                
                1.58March
                    31, 2006 balance
                
                
                1,927,300
                
                $
                2.85
                
                
                3.4
                    years
                
                $
                12,921Options
                    fully vested and exercisable
                
                
                1,196,507
                
                $
                1.90
                
                
                2.9
                    years
                
                $
                9,151




We did not grant any stock options during the three months ended March 31,
        2006.
        The total intrinsic value of the stock options exercised during the three
        months
        ended March 31, 2006 and 2005 was $1.1 million and $177,000, respectively.
        As of
        March 31, 2006, there was $1.0 million of total unrecognized compensation
        cost,
        net of estimated forfeitures, related to non-vested options under the Option
        Plans. The unrecognized compensation cost at March 31, 2006 is expected to
        be
        recognized over 4.7 years.




Cash received from option exercises under the Option Plans for the three months
      ended March 31, 2006 and 2005, was $137,000 and $55,000, respectively. The
      actual tax benefit for the tax deductions from option exercises totaled $53,000
      and $21,000, respectively, for the three months ended March 31, 2006 and
      2005.  The fair value of the shares that vested during the three months
      ended March 31, 2006 and 2005, totaled $231,000 and $256,000,
      respectively.





We recorded compensation cost of $82,000 related to the restricted stock awards
      granted under the 2005 Plan for the three months ended March 31, 2006. The
      adoption of SFAS No. 123(R) did not result in material impact on our statement
      of operations. The status of our non-vested restricted stock awards as of March
      31, 2006, and changes during the three months ended March 31, 2006, is set
      forth
      in the following table:





**Number
                of Shares**
            
            **Weighted-Average
                Grant Date Fair Value Per Share**Non-vested
                restricted stock awards at January 1, 2006
            
            
            157,275
            
            $
            7.46Granted
            
            
            --
            
            
            --Vested
            
            
            --
            
            
            --Forfeited
            
            
            --
            
            
            --Non-vested
                restricted stock awards at March 31, 2006
            
            
            157,275
            
            $
            7.46




As
      of
      March 31, 2006, there was $1.0 million of total unrecognized compensation costs
      related to non-vested restricted stock awards granted under the 2005 Plan.
      The
      unrecognized expense is expected to be recognized over a period of 4.6
      years.





Share-based
      employee awards granted for the year ended December 31, 2005 and prior years
      were accounted for under the intrinsic-value-based method prescribed by APB
      Opinion No. 25, as permitted by SFAS No. 123. Therefore, no compensation expense
      was recognized for unmodified stock options issued for years prior to 2006
      that
      had no intrinsic value on the date of grant.





**15**


The
      following table illustrates the pro forma net income for the three months ended
      March 31, 2005 as if the fair-value-based method of SFAS No. 123 had been
      applied to account for stock-based compensation expenses:





*(Dollars
                in thousands, except share data)*
            
            **For
                the Three Months Ended**
              **March
                31, 2005**Net
                income, as reported
            
            $
            2,059Deduct
                total stock-based employee compensation expense
                determined under fair-value-based method for all
                awards, net of tax
            
            
            190Pro
                forma net income applicable to common shares
            
            $
            1,869**Earnings
                per share:**Basic - as reported
            
            $
            0.10Basic - pro forma
            
            $
            0.09Diluted - as reported
            
            $
            0.10Diluted - pro forma
            
            $
            0.09





We
      estimate the fair value of our stock options using a Black Scholes Merton
      option-pricing model, which is used in estimating the fair value of traded
      options that have no vesting restrictions and are fully transferable. Stock
      option valuation models require the input of assumptions, including the expected
      stock price volatility. Our stock options have characteristics significantly
      different from those of traded options, and changes in the input assumptions
      can
      materially affect the fair value estimates. The weighted average fair value
      of
      the options granted during the three months ended March 31, 2005 was $2.69
      per
      option.





**(6)**  **Mortgage
      Loans Held for Investment, Net and Allowance for Loan
      Losses**





Mortgage
      loans held for investment represents our basis in the mortgage loans that either
      were delivered to securitization trusts (denoted as mortgage loans held for
      investment - securitized) or are pending delivery into future securitizations
      (denoted as mortgage loans held for investment - pre-securitization), net of
      discounts, deferred fees and allowance for loan losses.





Mortgage
      loans held for investment - securitized is comprised of the mortgage loans
      collateralizing our outstanding securitization asset-backed securities. During
      the three months ended March 31, 2006 and 2005, we closed securitization
      transactions totaling $848.3 million and $728.6 million, respectively, which
      were structured to be accounted for as a secured financing and which were
      collateralized by $875.0 million and $750.0 million, respectively, of mortgage
      loans held for investment - securitized. Mortgage loans held for investment
      -
      securitized had a weighted-average interest rate of 7.87% and 7.77% per annum
      at
      March 31, 2006 and December 31, 2005, respectively.





Mortgage
      loans held for investment - pre-securitization is comprised of mortgage loans
      to
      be included in a securitization and, to a lesser extent, an amount of loans
      that
      may be sold on a whole-loan basis. Included in our mortgage loans held for
      investment - pre-securitization at March 31, 2006 and December 31, 2005, was
      approximately $123.2 million and $222.8 million, respectively, of loans that
      were pledged as collateral for our warehouse financings. Mortgage loans held
      for
      investment - pre-securitization had a weighted-average interest rate of 9.02%
      and 8.35% per annum at March 31, 2006 and December 31, 2005,
      respectively.





**16**


The
      following table presents a summary of mortgage loans held for investment, net
      at
      March 31, 2006 and December 31, 2005:





*(Dollars
                in thousands)*
            
            **At**
              **March
                31,****2006**
            
            **At**
              **December
                31, 2005**Mortgage
                loans held for investment - securitized(1)
            
            $
            4,991,500
            
            $
            4,430,775Mortgage
                loans held for investment - pre-securitization(1)
            
            
            174,147
            
            
            270,372Discounts
                (MSR related)
            
            
            (30,033
            )
            
            (26,750
            )Net
                deferred origination fees
            
            
            (12,005
            )
            
            (10,735
            )Allowance
                for loan losses
            
            
            (41,911
            )
            
            (36,832
            )Mortgage
                loans held for investment, net
            
            $
            5,081,698
            
            $
            4,626,830





*(1)  
      Included in the* *outstanding balance of the mortgage loans held for investment at March 31,
      2006
      and December 31, 2005 were impaired loans located in the Hurricanes Katrina
      and
      Rita disaster areas designated by FEMA of approximately $3.1 million and $3.9
      million, respectively (of which $707,000 and $798,000, respectively, were
      pre-securitization loans).*





For
      the
      three months ended March 31, 2006 and 2005, we recorded interest income related
      to our mortgage loans held for investment - securitized of $89.1 million and
      $45.9 million, respectively. For the three months ended March 31, 2006 and
      2005,
      we recorded interest income related to our mortgage loans held for investment
      -pre-securitization of $9.3 million and $6.9 million, respectively.





The
      following table presents a summary of the activity for the allowance for loan
      losses on all mortgage loans held for investment for the three months ended
      March 31, 2006 and 2005:





**For
                the Three Months Ended March 31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Beginning
                balance
            
            $
            36,832
            
            $
            10,278Provision(1)
            
            
            6,404
            
            
            6,864Charge-offs(2)
            
            
            (1,325
            )
            
            (334
            )Ending
                balance
            
            $
            41,911
            
            $
            16,808





*(1)* *The
      provision for loan losses for the three months ended March 31, 2006 includes
      an
      $11,000 provision, which is net of a $182,000 reversal of specific provision* *related
      to probable losses attributable to loans in Hurricanes Katrina and Rita disaster
      areas, for impaired loans.*





*(2)   The
      charg* *e-offs
      for the three months ended March 31, 2006 includes $61,000 of charge-offs
      against the specific allowance for loan losses attributable to loans in
      Hurricanes Katrina and Rita disaster areas.*





The
      allowance for loan losses at March 31, 2006 and December 31, 2005 contains
      a
      $1.7 million specific reserve related to impaired loans. The majority of the
      specific reserve relates to the significant effects of Hurricanes Katrina and
      Rita had on a select portion of our loan portfolio. Management identified
      specific loans located in FEMA declared disaster areas as being impaired and
      requiring a specific reserve. Based upon our estimated loss exposure
      attributable to 26 properties securing a total unpaid principal balance of
      $3.1
      million in the affected areas at March 31, 2006, our allowance for loan losses
      includes a specific reserve of $1.5 million related to probable losses
      attributable to Hurricanes Katrina and Rita affected loans. As additional
      information is obtained and processed over the coming months and quarters,
      we
      will continue to assess the need for any adjustments to our specific reserves
      related to the mortgage loans in the affected areas. During the three months
      ended March 31, 2006 we also identified three additional impaired loans
      requiring a specific reserve that were not related to Hurricane Katrina and
      Rita.





As
      of
      March 31, 2006, December 31, 2005 and March 31, 2005, we had $151.5 million,
      $123.0 million and $33.2 million, respectively, of mortgage loans held for
      investment that were 90 days or more delinquent under their payment terms,
      all
      of which were on non-accrual status. If the non-accrual mortgage loans held
      for
      investment at March 31, 2006 and 2005 performed in accordance with their
      contractual loan terms, we would have recognized an additional $2.2 million
      and
      $754,000 of interest income during the three months ended March 31, 2006 and
      2005, respectively.





**17**


Our
      recorded investment in impaired loans at March 31, 2006 and December 31, 2005
      was $3.8 million (including $3.1 million of impaired loans that are Hurricane
      Katrina and Rita related) and $3.9 million (all were Hurricane Katrina and
      Rita
      related), respectively. We had no loans classified as impaired prior to December
      31, 2005. We have a related allowance for these impaired loans totaling $1.7
      million ($1.5 million relates to Hurricane Katrina and Rita affected loans)
      and
      $1.7 million at March 31, 2006 and December 31, 2005, respectively. The average
      recorded investment in impaired loans for the three months ended March 31,
      2006
      was $3.6 million. We recorded $65,000 of interest income on the loans classified
      as impaired during the three months ended March 31, 2006. We recorded no
      interest income on impaired loans during the three months ended March 31, 2005,
      as we held no loans classified as impaired during that period.





**(7)**  **Excess
      Cashflow Certificates**





The
      following table presents the activity related to our excess cashflow
      certificates for the three months ended March 31, 2006 and the year ended
      December 31, 2005:





*(Dollars
                in thousands)*
            
            **For
                the Three**
              **Months
                Ended**
              **March
                31, 2006**
            
            **For
                the**
              **Year
                Ended**
              **December
                31, 2005**Balance,
                beginning of year
            
            $
            7,789
            
            $
            14,933Accretion
            
            
            243
            
            
            1,593Cash
                receipts
            
            
            (6,237
            )
            
            (23,146
            )Net
                change in fair value
            
            
            3,261
            
            
            14,409Balance,
                end of period
            
            $
            5,056
            
            $
            7,789





In accordance with EITF 99-20, we regularly analyze and review our assumptions
      to determine that the actual rate of return (interest income) on our excess
      cashflow certificates is within our expected rate of return. The expected rate
      of return is recorded as a component of interest income. Any return that either
      is greater than or less than the expected rate of return is reflected as a
      fair
      value adjustment and is recorded as a component of “other income” in the
      consolidated statement of operations. For the three months ended March 31,
      2006
      and 2005, we recorded interest income related to our excess cashflow
      certificates of $243,000 and $488,000, respectively. For the three months ended
      March 31, 2006 and 2005, we recorded fair value gain in income related to our
      excess cashflow certificates of $3.3 million and $2.7 million,
      respectively.





Our
      valuation of retained excess cashflow certificates is highly dependent upon
      the
      reasonableness of our assumptions and the predictiveness of the relationships
      that drive the results of our valuation model. The assumptions we utilize are
      complex, as we must make judgment calls about the effect of matters that are
      inherently uncertain. As the number of variables and assumptions affecting
      the
      possible future resolution of the uncertainties increase, those judgments become
      even more complex. In volatile markets, like those we have experienced over
      the
      past several years, there is increased risk that our actual results may vary
      significantly from our assumed results. The longer the time period the
      uncertainty exists, the greater the potential for volatility in our valuation
      assumptions and the fair value of our excess cashflow certificates.





Since
      we
      structured our 2006 and 2005 securitizations to be accounted for as secured
      financings, we no longer record excess cashflow certificates on our consolidated
      balance sheet for our newly issued securitizations.





**(8)**  **Warehouse
      Financing**





Our
      warehouse lines of credit are collateralized by specific mortgage loans held
      for
      investment - pre-securitization, the balances of which are equal to or greater
      than the outstanding balances under the lines at any point in time. The amounts
      available under these warehouse lines are based on the amount of the collateral
      pledged. The amount we have outstanding on our committed facilities at any
      quarter end generally is a function of our mortgage loan originations relative
      to the timing of our securitizations and whole-loan sales.




**18**


The following table summarizes information regarding warehouse financing at
      March 31, 2006 and December 31, 2005:




*(Dollars
                    in thousands)*
                
                
                
                
                
                **Balance
                    at****Warehouse
                    Line of Credit**
                
                **Facility
                    Amount**
                
                **Interest
                    Rate**
                
                **3/31/06**
                
                **12/31/05**
                
                **Expiration
                    Date**RBS
                    Greenwich Capital
                
                $
                350,000
                
                
                Margin
                    over LIBOR
                
                $
                23,692
                
                $
                77,931
                
                
                October
                    2006Citigroup
                    (1)
                
                
                350,000
                
                
                Margin
                    over LIBOR
                
                
                99,485
                
                
                144,912
                
                
                May
                    2006Bank
                    of America
                
                
                350,000
                
                
                Margin
                    over LIBOR
                
                
                --
                
                
                --
                
                
                August
                    2006Friedman,
                    Billings, Ramsey (1)
                
                
                200,000
                
                
                Margin
                    over LIBOR
                
                
                --
                
                
                --
                
                
                May
                    2006Total
                
                $
                1,250,000
                
                
                
                
                $
                123,177
                
                $
                222,843
  *(1)*  *In
      April 2006, we extended our warehouse financing facilities with Citigroup and
      Friedman, Billings, Ramsey to May 2006.*





As
      securitization transactions are completed, a substantial portion of the proceeds
      from the long-term debt issued in the securitization is used to pay down our
      warehouse lines of credit. Therefore, the outstanding amount of warehouse
      financing will fluctuate from quarter to quarter, and could be significantly
      higher or lower than the $123.2 million we held at March 31, 2006, as our
      mortgage production and securitization programs continue.





The
      terms
      of our warehouse agreements require us to comply with various operating and
      financial covenants, which are customary for agreements of this type. The
      continued availability of funds provided to us under these agreements is subject
      to, among other conditions, our continued compliance with these covenants.
      We
      believe that we are in compliance with such covenants as of March 31,
      2006.





**(9)**  **Financing
      on Mortgage Loans Held for Investment, Net**





For
      the
      nine securitizations completed since March 2004, the securitization trust or
      special purpose entity (“SPE”) holds mortgage loans, referred to as
“securitization loans,” and issues debt represented by securitization
      asset-backed securities. Accordingly, the securitization loans are recorded
      as
      an asset on our consolidated balance sheet under “mortgage loans held for
      investment, net” and the corresponding securitization debt is recorded as a
      liability under “financing on mortgage loans held for investment, net.” Since
      these securitizations were structured as financings and not sales, no
      gain-on-sale revenue was recorded at the time the securitizations closed.
      Rather, we record interest income from the securitized loans and interest
      expense from the asset-backed securities issued in connection with each
      securitization over the life of the securitization. Deferred securitization
      debt
      issuance costs are amortized on a level-yield basis over the estimated life
      of
      the asset-backed securities.





We
      historically have sold or financed our mortgage loans through the securitization
      market, issuing asset-backed securities. We will continue to build our loan
      portfolio and match fund our mortgage loans using asset-backed securities issued
      in the securitization market. We believe that issuing asset-backed securities
      provides us a low cost method of financing our mortgage loan portfolio. In
      addition, it allows us to reduce our interest rate risk on our fixed-rate loans
      by securitizing them. Our ability to issue asset-backed securities depends
      on
      the overall performance of our assets, as well as the continued general demand
      for securities backed by non-conforming mortgage loans.





At
      March
      31, 2006 and December 31, 2005, the outstanding financing on mortgage loans
      held
      for investment, net consisted of $5.0 billion and $4.4 billion,
      respectively.





**19**


The
      following table summarizes the expected maturities on our secured financings
      at
      March 31, 2006:





*(Dollars
                in thousands)*
            
            **Total**
            
            **Less
                than**
              **One
                Year**
            
            **One
                to**
              **Three
                Years**
            
            **Three
                to**
              **Five
                Years**
            
            **More
                than**
              **Five
                Years**Securitization
                asset-backedsecurities,
                net
            
            $
            4,992,688
            
            $
            1,891,877
            
            $
            1,912,378
            
            $
            660,256
            
            $
            528,177





Amounts
      shown above reflect estimated repayments based on anticipated receipt of
      principal and interest on the underlying mortgage loan collateral using similar
      prepayment speed assumptions as we use to value our excess cashflow
      certificates. The funds used to repay these securitization asset-backed
      securities are generated solely from the underlying mortgage loans held for
      investment for each particular securitization trust. We have no recourse
      obligation to repay these securitization asset-backed securities, except
      for the standard representations and warranties typically made as part of a
      sale
      of loans on a non-recourse basis .





**(10)**  **Derivative
      Instruments**





We
      account for our derivative financial instruments such as corridors and interest
      rate swaps as cash flow hedges. The corridors hedge our interest payments on
      securitization variable-rate debt and the interest rate swaps hedge uncertain
      cash flows associated with future securitization financing. At March 31, 2006
      and December 31, 2005, the fair value of our corridors totaled $10.8 million
      and
      $11.7 million, respectively, and the fair value of our interest rate swaps
      totaled a gain of $940,000 and a loss of $210,000, respectively. The fair value
      of our corridors and interest rate swaps are recorded as a component of other
      assets and other liabilities.





As
      of
      March 31, 2006, the effective portion of the changes in fair value of the
      corridors (effective portion), interest rate swaps and the gain on the
      terminated swaps (effective portion) are recorded as components of accumulated
      OCI and total gains, net of tax, of $2.1 million, $573,000 and $3.9 million,
      respectively. As of December 31, 2005, the changes in fair value of the
      corridors (effective portion), interest rate swaps and any gains on terminated
      swaps (effective portion) are recorded as components of accumulated other
      comprehensive income, and total, net of tax, gains of $1.9 million, losses
      of
      $128,000 and gains of $755,000, respectively. Accumulated other comprehensive
      income or loss relating to cash flow hedging is reclassified to earnings as
      a
      yield adjustment to interest expense as the interest payments affect earnings.
      Hedge ineffectiveness associated with hedges resulted in gains of $60,000 and
      $16,000 for the three months ended March 31, 2006 and 2005,
      respectively.





If
      a
      hedge fails the assessment of hedge effectiveness test (the ratio of the
      outstanding balance of the hedged item (debt) to the notional amount of the
      corridors exceeds 125% or falls below 80%, since the notional amount is the
      only
      critical term that varies) at any time, and therefore is not expected to be
      “highly effective” at achieving offsetting changes in cash flows, the hedge
      ceases to qualify for hedge accounting. At March 31, 2006 and December 31,
      2005,
      we held $1.3 million and $1.7 million, respectively, of hedges (specifically
      corridors) classified as trading securities in prepaid and other assets as
      these
      hedges were no longer deemed highly effective, as the ratio of the outstanding
      balance of the hedged item (debt) to the notional amount of the corridors was
      outside of the range of 80% to 125%. During the three months ended March 31,
      2006, a gain of $215,000 was recorded to earnings on the changes in fair value
      of the hedges held as trading securities. None of the hedges held during the
      three months ended March 31, 2005 were classified as trading
      securities.





**20**


The
      following table summarizes the notional amount, expected maturities and
      weighted-average strike price for the corridors that we held as of March 31,
      2006:





*(Dollars
                in thousands**except
                strike price)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years & Thereafter**Caps
                bought - notional
            
            $
            2,169,692
            
            $
            1,493,065
            
            $
            423,062
            
            $
            115,219
            
            $
            34,554
            
            $
            103,792Weighted
                average strikeprice
            
            $
            6.12
            
            $
            5.45
            
            $
            6.84
            
            $
            7.47
            
            $
            7.47
            
            $
            7.41Caps
                sold - notional
            
            $
            2,169,692
            
            $
            1,493,065
            
            $
            423,062
            
            $
            115,219
            
            $
            34,554
            
            $
            103,792Weighted
                average strikeprice
            
            $
            8.70
            
            $
            8.32
            
            $
            9.24
            
            $
            9.30
            
            $
            9.27
            
            $
            9.29





The
      notional amount of the corridors totaled $2.5 billion at December 31,
      2005.





**(11)
      Accumulated Other Comprehensive Income**





Accumulated
      OCI is comprised of our net unrealized gains on derivatives. The components
      of
      OCI for the three months ended March 31, 2006 and for the year ended December
      31, 2005 are as follows:




*(Dollars
                in thousands)*
            
            **Before
                Tax Amount**
            
            **Tax
                Expense**
            
            **After
                Tax Amount**For
                the three months ended March 31, 2006:Net
                unrealized holding gains on derivatives arising during the
                period
            
            $
            5,092
            
            $
            (1,986
            )
            $
            3,106Reclassification
                adjustment for gain on derivatives included in net income
            
            
            1,580
            
            
            (616
            )
            
            964Other
                comprehensive income
            
            $
            6,672
            
            $
            (2,602
            )
            $
            4,070For
                the year ended December 31, 2005:Net
                unrealized holding gains on derivatives arising during the
                year
            
            $
            3,896
            
            $
            (1,519
            )
            $
            2,377Reclassification
                adjustment for gain on derivatives included in net income
            
            
            3,879
            
            
            (1,513
            )
            
            2,366Other
                comprehensive income
            
            $
            7,775
            
            $
            (3,032
            )
            $
            4,743





**(12)**  **Earnings
      Per Share**





Earnings
      per share (“EPS”) are computed in accordance with SFAS No. 128, “Earnings Per
      Share.” Basic
      EPS
      is computed by dividing net income by the weighted average number of shares
      of
      common stock outstanding during each period presented. The computation of
      diluted EPS gives effect to stock options (except for those stock options with
      an exercise price greater than the average market price of our common stock
      during the period) outstanding during the applicable periods. The
      following is a reconciliation of the denominators used in the computations
      of
      basic and diluted EPS. The numerator for calculating both basic and diluted
      EPS
      is net income.





**21**


**For
                the Three Months Ended**
              **March
                31,***(Dollars
                in thousands, except share and per share data)*
            
            **2006**
            
            **2005**Net
                income, as reported
            
            $
            6,586
            
            $
            2,059Less
                preferred stock dividends
            
            
            --
            
            
            --Net
                income available to common stockholders
            
            $
            6,586
            
            $
            2,059Basic
                - weighted-average shares
            
            
            20,497,408
            
            
            20,295,874Basic
                EPS
            
            $
            0.32
            
            $
            0.10Basic
                - weighted-average shares
            
            
            20,497,408
            
            
            20,295,874Incremental
                shares-options(1)(2)
            
            
            862,768
            
            
            940,266Diluted
                - weighted-average shares
            
            
            21,360,176
            
            
            21,236,140Diluted
                EPS(1)(2)
            
            $
            0.31
            
            $
            0.10





*(1)*  *For
      the three months ended March 31, 2006, approximately 1.9 million in-the-money
      employee stock options and approximately 157,000 restricted stock awards are
      included in the calculation of diluted EPS, while approximately 70,000 of
      out-of-the-money employee stock options have been excluded.*





*(2)*  *For
      the three months ended March 31, 2005, approximately 2.1 million in-the-money
      employee stock options are included in the calculation of diluted EPS, while
      approximately 72,000 of out-of-the-money employee stock have been
      excluded.*





**(13)**  **Subsequent
      Events**





We
      paid a
      cash dividend of $0.05 per share of common stock on April 14, 2006 to
      stockholders of record as of the close of business on March 31,
      2006.





On
      April
      5, 2006, we announced the pricing of a private placement of 2,500,000 newly
      issued shares of our common stock at a price of $8.25 per share to a combination
      of new and existing institutional investors. The offering closed on April 10,
      2006. We received proceeds of approximately $19.3 million, after deducting
      estimated expenses payable in connection with this offering. The
      proceeds were used to repay warehouse financings and originate mortgage
      loans.


**22**


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





*This
      Quarterly Report on Form 10-Q (“Quarterly Report”) should be read in conjunction
      with the more detailed and comprehensive disclosures included in our Annual
      Report on Form 10-K for the year ended December 31, 2005. In addition, please
      read this section in conjunction with our Consolidated Financial Statements
      and
      Notes to Consolidated Financial Statements herein, and please see “-
      Forward-Looking Statements” and “Part II - Item 1A. - Risk
      Factors.”*





**General**





We are a national specialty consumer finance company that originates,
      securitizes and sells non-conforming
      mortgage loans. Our
      loans
      are primarily secured by first mortgages on one- to four-family residential
      properties. Throughout our 24-year operating history, we have focused on lending
      to individuals who generally do not satisfy the credit, documentation or other
      underwriting standards set by more traditional sources of mortgage credit,
      including those entities that make loans in compliance with conforming lending
      guidelines of Fannie Mae and Freddie Mac. We make mortgage loans to these
      borrowers for purposes such as debt consolidation, refinancing, education and
      home improvements. We
      provide our customers with a variety of loan products designed to meet their
      needs, using a risk-based pricing strategy to develop products for different
      risk categories. Historically, the majority of our loan production has been
      fixed-rate with amortization schedules ranging from five years to 30
      years.





We make mortgage loans to individual borrowers, which are a cash outlay for
      us.
      At the time we originate a loan, and prior to the time we securitize or sell
      the
      loan, we either finance the loan by borrowing under our warehouse lines of
      credit or utilizing our available working capital. Following this initial
      holding period, we either securitize our loans or sell them on a whole-loan
      basis, using the net proceeds from these transactions to repay our warehouse
      lines of credit and for working capital. Since the first quarter of 2004, we
      have structured our securitizations to be accounted for as on-balance sheet
      financings, in which we record interest income on the outstanding portfolio
      of
      loans in each securitization trust and interest expense from the pass-through
      securities issued by each securitization trust over time. Prior to 2004, we
      structured our securitizations to be accounted for as sales, which required
      us
      to record cash and non-cash revenues as gain-on-sale at the time the
      securitizations were completed. When we sell loans on a whole-loan basis, we
      record the premiums received upon sale as revenue, net of any premium recapture
      reserves. (See
“-
      Securitizations and Whole-Loan Sales”).





**Origination
      of Mortgage Loans**





We
      originate mortgage loans through two distribution channels, wholesale and
      retail. In the wholesale channel, we receive loan applications from independent
      third-party mortgage brokers who submit applications on a borrower’s behalf. In
      the retail channel, we receive loan applications directly from borrowers. We
      process and underwrite the submission and, if the loan conforms to our
      underwriting criteria, approve the loan and lend the money to the borrower.
      We
      underwrite loan packages for approval through our Woodbury, New York
      headquarters, our Cincinnati, Ohio underwriting hub, or our regional offices
      in
      Phoenix, Arizona, Jacksonville, Florida and Dallas, Texas. We also purchase
      closed loans on a limited basis. (See “-Wholesale Loan Channel”).





For
      the
      three months ended March 31, 2006 and 2005, we originated the following loans
      by
      origination channel:


**For
                  the Three Months Ended March 31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**Originations
                  by channel:Wholesale
              
              $
              518,031
              
              $
              467,450Retail
              
              
              426,693
              
              
              369,270Total originations
              
              $
              944,724
              
              $
              836,720




For
      the
      three months ended March 31, 2006, we originated $944.7 million of loans, an
      increase of 12.9% over the $836.7 million of loans originated in the comparable
      period in 2005. Of these amounts, approximately $518.0 million were wholesale
      loans, representing 54.8% of total loan production, and $426.7 million were
      retail loans, representing 45.2% of total loan production, compared to $467.4
      million of wholesale loans, or 55.9% of total loan production, and $369.3
      million of retail loans, or 44.1% of total loan production, during the three
      months ended March 31, 2005.





**23**


***Wholesale
      Loan Channel.*** Through
      our wholesale loan distribution channel, which is principally conducted out
      of
      our Woodbury, New York headquarters, we primarily originate mortgage loans
      indirectly through independent mortgage brokers and other real estate
      professionals who submit loan applications on behalf of borrowers. We currently
      originate the majority of our wholesale loans primarily in 34 states, through
      a
      network of approximately 3,000 independent brokers. The broker’s role is to
      source the business, identify the applicant, assist in completing the loan
      application, and process the loans, including, among other things, gathering
      the
      necessary information and documents, and serving as the liaison between the
      borrower and us through the entire origination process. We review, process
      and
      underwrite the applications submitted by the broker, approve or deny the
      application, set the interest rate and other terms of the loan and, upon
      acceptance by the borrower and satisfaction of all of the conditions that we
      impose as the lender, lend the money to the borrower. Due to the fact that
      brokers conduct their own marketing and employ their own personnel to complete
      loan applications and maintain contact with borrowers - for which they charge
      a
      broker fee - originating loans through our broker network generally allows
      us to
      increase our loan volume without incurring the higher marketing and employee
      costs associated with increased retail originations. Additionally, on a limited
      basis, we purchased loans on a flow basis from select independent
      correspondents. This typically involves purchasing individual loans shortly
      after the loans are originated, as opposed to bulk purchases, which entail
      purchasing typically larger pools of loans at one time. We re-underwrite every
      correspondent loan, in accordance with our underwriting standards, prior to
      purchasing.





***Retail
      Loan Channel.***  Through
      our retail distribution channel, we develop retail loan leads primarily through
      our telemarketing system located in Cincinnati, Ohio, and also through Internet
      leads, direct mail and our network of 12 origination centers located in 11
      states. We continually monitor the performance of our retail operations and
      evaluate current and potential retail office locations on the basis of selected
      demographic statistics, marketing analyses and other criteria that we have
      developed.





Typically,
      contact with the customer initially is handled  through
      our telemarketing center. Through
      our marketing efforts, the retail loan channel is able to identify, locate
      and
      focus on individuals who, based on historic customer profiles, are likely
      customers for our products. Our telemarketing representatives identify
      interested customers and forward these potential borrowers to a branch manager
      through our proprietary loan origination system, Click & Close ® (“C&C”).
      The branch managers, in turn, distribute these leads to mortgage analysts via
      C&C by queuing the loan to a mortgage analyst’s “to do” list in C&C. The
      assigned mortgage analyst discusses the applicant’s qualifications and available
      loan products, negotiates loan terms with the borrower, ensures
      that an appraisal has been ordered from an independent third-party appraisal
      company or may, when certain underwriting criteria have been met, obtain an Insured
      Automated Valuation Model (“Insured AVM”) value ( the
      coupling of a third-party valuation estimate and insurance on that
      value) ,
      orders
      a credit report from an independent, nationally recognized credit reporting
      agency and
      processes the loan through completion. Our
      mortgage analysts are trained to structure loans that meet the applicant’s needs
      while satisfying our lending guidelines. C&C
      is utilized to queue the loan to underwriters at the appropriate times for
      approvals and help to facilitate the loan application process through
      closing.




***Pooling
      of Loans Prior to Securitization or Whole-Loan Sales.*** After we
      fund a loan, we typically pledge the loan as collateral under a warehouse line
      of credit to obtain financing against that loan. By doing so, we replenish
      our
      capital so we can make new loans. Typically, loans are financed through a
      warehouse line of credit for only a limited time - generally, not more than
      three months - long enough to enable us to either securitize or sell the loans.
      During the time we hold the loans prior to securitization or whole-loan sale,
      we
      earn interest income from the borrower. The income is partially offset by any
      interest we pay to our warehouse creditors for providing us with financing.
      Additionally, we pay a third-party servicer a sub-servicing fee to perform
      the
      servicing of the mortgage loans during this pre-securitization or pre-sale
      holding period.





***Securitizations
      and Whole-Loan Sales.***  As
      a
      fundamental part of our present business and financing strategy, we securitize
      a
      substantial portion of the mortgage loans we originate. We also sell a portion
      of our loans as whole loans when we believe that market conditions present
      an
      opportunity to achieve a better return through such sales. We
      select
      the outlet depending on market conditions, relative profitability and cash
      flows.  During
      the three months ended March 31, 2006 and 2005, whole-loan sales comprised
      approximately 15.8%
      and
      12.3% ,
      respectively, of the total amount of our combined securitizations and whole-loan
      sales transactions.





**24**


The
      following table sets forth certain information regarding loans sold through
      our
      securitizations and on a whole-loan basis during the three months ended March
      31, 2006 and 2005:





**For
                the Three Months Ended March 31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Loan
                securitizations - portfolio based
            
            $
            875,000
            
            $
            749,999Whole
                loan sales
            
            
            164,711
            
            
            105,419Total
                securitizations and whole loan sales
            
            $
            1,039,711
            
            $
            855,418





We
      apply
      the net proceeds from securitizations and whole-loan sales to pay down our
      warehouse lines of credit - in order to make available capacity under these
      facilities for future funding of mortgage loans - and utilize any additional
      funds for working capital.





***Securitizations.*** In
      a
      securitization, we pool together loans, typically each quarter, and convey
      these
      loans to a newly formed securitization trust. These trusts are established
      for
      the limited purpose of receiving our mortgage loans and are bankruptcy remote
      -
      meaning that purchasers of “asset-backed securities” may rely only on the cash
      flows generated from the assets held by the securitization trust for payment
      and
      not upon us for payment; likewise, the assets held by the securitization trust
      are not available to our general creditors, despite carrying the securitized
      loans and the securitization financing on our consolidated financial statements.
      We carry no contractual obligation related to these trusts or the loans sold
      to
      them, nor do we have any direct or contingent liability related to the trusts,
      except for the standard representations and warranties typically made as part
      of
      a sale of loans on a non-recourse basis.  Furthermore, we provide no
      guarantees to investors with respect to the cash flow or performance of these
      trusts.





Each
      of
      our securitizations contains an overcollateralization (“O/C”) provision, which
      is a credit enhancement that is designed to protect the securities sold from
      credit losses, which arise principally from defaults on the underlying mortgage
      loans. In short, O/C occurs when the amount of collateral ( *i.e.* ,
      mortgage loans) owned by a securitization trust exceeds the aggregate amount
      of
      asset-backed securities.





During
      the three months ended March 31, 2006 and the year ended December 31, 2005,
      our
      securitizations required an O/C of 3.1% and ranged from
      2.8% to 3.3%, respectively, of the initial mortgage loans sold to the
      securitization trust.





Historically,
      we have issued NIMs (net interest margin transactions) simultaneously with
      the
      underlying securitization. NIM transactions generally enable us to generate
      upfront cash flow when the securitization and related NIM transaction close,
      net
      of funding the upfront O/C, securitization and NIM costs, which helps offset
      a
      substantial portion of our cost to originate the loans included in the
      transaction.





A
      NIM
      represents a portion of the spread between the coupon rate on the mortgage
      loans
      and the asset-backed investors’ pass-through rate on the asset-backed
      securities. The NIM investor is paid a specified interest rate, and all cash
      flows generated by the excess cashflow certificate used to pay all principal
      and
      interest on the NIM note(s) until paid in full, which typically occurs
      approximately 18 to 22 months from the date the NIM was issued. The excess
      cashflow certificate entitles us to all cash flows generated by the excess
      cashflow certificate after the holder of the NIM has been paid in full.





We
      intend
      to continue to issue NIMs in the foreseeable future.





Each
      securitization trust also has the additional credit benefit of either a
      financial guaranty insurance policy from a monoline insurance company or a
      “senior-subordinated” securitization structure, or a combination of the two
      (referred to as a “hybrid”). In a securitization trust with a financial guaranty
      insurance policy that is not a hybrid, all securities are senior securities.
      The
      monoline insurance company guarantees the timely payment of principal and
      interest to all security holders in the event that the cash flows are not
      sufficient. In “senior-subordinated” securitization structures, the senior
      security holders are protected from losses (and payment shortfalls) first by
      the
      excess cash flows and the O/C, then by subordinated securities which absorb
      any
      losses prior to the senior security holders. In a hybrid structure, the senior
      securities generally have both the subordinated securities to absorb losses
      and
      a monoline insurance company that guarantees timely principal and interest
      payments with respect to the senior securities.





**25**


Each
      of
      our securitizations includes a series of asset-backed securities with various
      credit ratings, maturities and interest rates. The combined weighted average
      interest rate of the asset-backed securities in each securitization will
      generally increase over time as the shorter-term asset-backed securities with
      higher credit ratings and lower interest costs mature, leaving the longer-term
      asset-backed securities with lower credit ratings and higher interest costs
      remaining.





***Securitizations
      Structured as a Financing*** *.* All
      of our securitizations completed since the beginning of 2004 were
      structured and accounted for as secured financings.  These
      securitizations  do
      not
      meet the qualifying
      special purpose entity (“QSPE”) criteria
      under SFAS No. 140 and related interpretations, because after the loans are
      securitized, we have the unconditional right to (1) repurchase from the trust
      up
      to one percent of the aggregate outstanding principal balance of the mortgage
      loans at any time after the securitization closing date, and (2) we have
      the option to contribute a derivative instrument into the trust. We refer to
      the
      recordation of these transactions as
      “portfolio accounting.”





With
      portfolio accounting, (1) the mortgage loans we originate remain on our
      consolidated balance sheet as loans held for investment; (2) the securitization
      debt replaces the warehouse debt associated with the securitized mortgage loans;
      and (3) we record interest income on the mortgage loans and interest expense
      on
      the securities issued in the securitization over the life of the securitization,
      instead of recognizing a gain or loss upon completion of the securitization. Since
      we
      began structuring our securitizations in 2004 as secured financings and
      recording our income over time instead of upfront, there is a significant
      difference in our results of operations for the three months ended March 31,
      2006 and 2005, as compared to pre-2004 historical results. As such, we do not
      expect our historical results will provide a meaningful comparison to our 2006
      or 2005 results. We believe that portfolio accounting treatment, however, more
      closely matches the recognition of income with the receipt of cash payments
      on
      the individual loans.




We
      intend
      to continue to utilize portfolio accounting this structure in the foreseeable
      future.





The
      following table sets forth information about our securitized mortgage loan
      portfolio, completed since the first quarter of 2004, at March 31,
      2006:


*(Dollars
                  in thousands*)**Asset-backed
                  Security Series:**
              
              **Issue
                  Date**
              
              **Current
                  Loan Principal Balance****(1)**
              
              **Total
                  Securitization Debt Balance****(2)**2004-1
              
              March
                  30, 2004
              
              $                                       
                  264,754
              
              $                                      
                   257,0542004-2
              
              June
                  29, 2004
              
              299,183
              
              283,5832004-3
              
              September
                  29, 2004
              
              365,586
              
              350,4662004-4
              
              December
                  29, 2004
              
              414,636
              
              404,0012005-1
              
              March
                  31, 2005
              
              572,381
              
              559,3272005-2
              
              June
                  29, 2005
              
              650,006
              
              645,0832005-3
              
              September
                  29, 2005
              
              769,095
              
              765,7242005-4
              
              December
                  30, 2005
              
              857,444
              
              853,8772006-1
              
              March
                  30, 2006
              
              875,000
              
              879,808Total
              
              
              
              $                                   
                   5,068,085
              
              $                                   
                   4,998,923


*(1)*  *The
      current loan principal balance shown includes amounts reflected on the
      consolidated balance sheet as mortgage loans held for investment - securitized
      (excluding discounts and net deferred origination fees), REO (at its trust
      basis
      value) and the principal portion of trustee receivables.*




*(2)*  *The
      total securitization debt (financing on mortgage loans held for investment)
      balance shown excludes discounts of $6.2 million at March 31,
      2006.*





**26**


***Securitizations
      Structured as a Sale.*** ** Prior
      to
      2004, we structured our securitizations to be accounted for as sales under
      SFAS 140 ,
      which
      is known as “gain-on-sale accounting.” With gain-on-sale accounting, we recorded
      an upfront gain at the time of securitization and recorded the fair value of
      the
      excess cashflow certificates on our balance sheet. The excess cashflow
      certificates are trading securities and are carried at their fair value. In
      a
      securitization structured as a sale, or off-balance sheet, we sell a pool of
      loans to a trust for a cash purchase price and a certificate evidencing our
      ownership in the trust (excess cashflow certificate). We receive the cash flows
      from the excess cashflow certificates after payment of servicing fees, guarantor
      fees and other trust expenses if the specified O/C requirements are met.





The
      fair
      value of the excess cashflow certificates are $5.1 million and $7.8 million
      at
      March 31, 2006 and December 31, 2005, respectively.





***Securitizations
      Structured as Real Estate Mortgage Investment Conduits and Owner-Trusts for
      Income Tax Purposes.*** Prior to
      2005, we
      typically structured our securitizations as Real Estate Mortgage Investment
      Conduits (“REMICs”), which for tax purposes required us to recognize an upfront
      taxable gain at the time of the securitization. Beginning in 2005, we began
      structuring our securitizations as owner-trust transactions and issued our
      securitizations from our Real Estate Investment Trust ("REIT") subsidiary.
      For
      federal tax purposes, owner-trust transactions are accounted for as borrowing
      transactions (debt-for-tax treatment), which facilitates compliance with the
      applicable REIT income and asset tests and allows us to defer recognition of
      any
      taxable gains associated with the securitized mortgage loans. Although we intend
      to continue to structure most of our securitizations as owner-trusts
      transactions, we may engage in REMIC securitizations in the future. We have
      in
      the past, and may in the future, recognize excess inclusion income attributable
      to the interests we retain in these securitization transactions, which could
      have negative tax consequences to us or our stockholders.





***Whole-Loan
      Sales*** *.* Whole-loan sales are the sale of pools of mortgage loans to banks, consumer
      finance-related companies and institutional investors on a servicing-released
      basis. We have found that, from time to time, we can receive better economic
      results by selling some of our mortgage loans on a whole-loan basis, without
      retaining servicing rights, generally in private transactions to financial
      institutions or consumer finance companies. We recognize a gain or loss when
      we
      sell loans on a whole-loan basis equal to the difference between the cash
      proceeds received for the loans and our investment in the loans, including
      any
      unamortized loan origination fees and costs. We generally sell these loans
      without recourse, except that we provide standard representations and warranties
      to the purchasers of such loans. During the three months ended March 31, 2006
      and 2005, we sold whole-loans without recourse to third-party purchasers (with
      the exception of a premium recapture reserve described below) and on a
      servicing-released basis of $164.7 million and $105.4 million, respectively.
      The
      average gross premium we received for the whole loans sold during the three
      months ended March 31, 2006 was 3.44%, compared to 3.95% for the comparable
      2005
      period. The gross premium paid to us by third-party purchasers in whole-loan
      sale transactions does not include premiums we pay to originate the mortgage
      loans, net deferred origination fees, or premium recapture - each of which
      are
      components of the gain on sale calculation.





We
      maintain a premium recapture reserve related to our contractual obligation
      to
      rebate a portion of any premium paid by a purchaser when a borrower prepays
      a
      sold loan within an agreed period of time. The premium recapture reserve is
      established at the time of the whole-loan sale through a provision, which is
      reflected as a reduction of the gain on sale of mortgage loans. The premium
      recapture reserve is recorded as a liability on the consolidated balance sheet.
      We estimate recapture losses primarily based  upon historical premium
      recaptures and by reviewing the types of loan products, interest rates, borrower
      prepayment fee, if any, and an estimate of the impact of future interest rate
      changes may have on early repayments. The premium recapture reserve totaled
      $745,000 and $619,000 at March 31, 2006 and December 31, 2005,
      respectively.





During
      the three months ended March 31, 2006 we established a secondary market reserve
      for losses that arise in connection with loans that we may be required to
      repurchase from whole-loan sale investors. The secondary market reserve, which
      totaled $175,000 at March 31, 2006, covers our estimated exposure to losses
      arising from loan repurchases, or the net settlement, related to representation
      and warranty claims by investors. We estimate the exposure primarily based
      upon
      historical repurchases and we estimate losses using a detailed analysis of
      historical loan performance by product type and origination year, similar to
      the
      analysis performed for the allowance for loan losses related to our mortgage
      loans held for investment portfolio. We had no such reserve at December 31,
      2005
      or March 31, 2005.





**27**


***Other
      Income.*** In
      addition to the income and cash flows we earn from securitizations (accounted
      for as sales and secured financings) and whole-loan sales, we also earn income
      and generate cash flows from:





·
            any
                fair value adjustments related to the excess cashflow certificates
                in
                accordance with EITF 99-20, and·
            miscellaneous
                interest income, including prepayment penalties received on some
                of the
                mortgage loans we sold in connection with our securitizations prior
                to
                2002.





**Summary
      of Critical Accounting Policies**





An
      appreciation of our critical accounting policies is necessary to understand
      our
      financial results. These policies may require management to make difficult
      and
      subjective judgments regarding uncertainties, and as a result, these estimates
      may significantly impact our financial results. The precision of these estimates
      and the likelihood of future changes depend on a range of possible outcomes
      and
      a number of underlying variables and there can be no assurance that our
      estimates are accurate.





***Excess
      Cashflow Certificates*** **.** In
      securitization transactions structured to be accounted for as a sale (prior
      to
      2004), the excess cash flow certificates represent one or all of the following
      assets:


·
            BIO
                certificate, which represents a subordinate right to receive excess
                cash
                flows, if any, generated by the related securitization
                pool.  ·
            P
                certificate, which represents a right to receive prepayment penalties
                on
                the mortgage loans sold to the securitization
                trust.  ·
            Cash
                flows from corridors - we receive payments on corridors (corresponding
                purchase and sale of interest rate caps with similar notional balances
                at
                different strike prices) from third-party cap providers through the
                securitization trusts (which, when we sell NIM notes, are only received
                after the NIM notes are paid in
                full).





The accounting estimates we use to value excess cashflow certificates are deemed
      to be “critical accounting estimates” because they can materially affect our
      income. The valuation of our excess cashflow certificates is highly dependent
      upon the reasonableness of our assumptions and the predictiveness of the
      relationships that drive the results of our valuation model. The assumptions
      we
      utilize, described below, are complex as we must make judgments about the
      effects of matters that are inherently uncertain. As the number of variables
      and
      assumptions affecting the possible future resolution of the uncertainties
      increase, those judgments become even more complex. Management uses internal,
      historical mortgage loan performance data and forward LIBOR interest rate curves
      to value future expected excess cash flows. The amount recorded for the excess
      cashflow certificates is subsequently reduced for cash distributions we receive,
      increased for the expected return and adjusted for changes in fair value of
      these excess cashflow certificates.





We
      believe that our assumptions used to determine fair value are reasonable based
      upon the estimates using our historical loan performance and the performance
      of
      similar mortgage pools from other lenders - in addition to accessing other
      public information about market factors such as interest rates, inflation,
      recession, unemployment and real estate market values, among other things.
      However, these are only estimates and it is virtually impossible to predict
      the
      actual level of prepayments and losses, which also are driven by consumer
      behavior and as such, there can be no assurance as to the accuracy of the
      assumptions or estimates.





In
      volatile markets, like those we have experienced over the past several years,
      there is increased risk that our actual results may vary significantly from
      our
      assumed results. The longer the time period over which the uncertainties exist,
      the greater the potential for volatility in our valuation assumptions, which
      may
      impact the fair value of our excess cashflow certificates. The fair value of
      each excess cashflow certificate represents the present value of the future
      cash
      flows we expect to receive in the future based upon our best estimates.





**28**


The
      assumptions used to determine fair value are the following:





A. *Prepayments.* We base
      our prepayment rate assumptions on our ongoing analysis of the performance
      of
      the mortgage pools we previously securitized, and the performance of similar
      pools of mortgage loans securitized by others in the industry. We apply
      different prepayment speed assumptions to different loan product types based
      on
      our experience with different loan product types exhibiting different prepayment
      patterns. Generally, our mortgage loans can be grouped into two loan products
      -
      fixed-rate loans and adjustable-rate loans. With fixed-rate loans, an underlying
      borrower’s interest rate remains fixed throughout the life of the loan. Our
      adjustable-rate loans are a “hybrid” between fixed- and adjustable-rate loans,
      in that the interest rate generally remains fixed, typically for the first
      two
      or three years of the loan, and then adjusts, typically every six months
      thereafter. We also take into account within each product type factors other
      than interest rates that can affect our prepayment rate
      assumptions.




We
      have
      found that the rate at which borrowers prepay their loans tends to fluctuate.
      In
      general, prepayment speeds are lowest in the first month after origination.
      Thereafter, prepayment speeds generally increase until a peak speed is reached.
      Generally, loans will continue to prepay at the peak speed for some period
      of
      time, and then prepayment speeds typically begin to decline. We use prepayment
      assumptions that reflect these tendencies. The following table shows our
      assumptions regarding the percentage of loans that will be prepaid during the
      first month following the closing of a loan, peak speed over the life of a
      loan and the peak speed from March 31, 2006 forward:





**Loan
                Type**
            
            **Month
                One**
            
            **Peak
                Speed**
              **Over
                the Life**
            
            **Peak
                Speed from**
              **March
                31, 2006 Forward**Fixed
                rate
            
            4.0%
            
            45.0%
                to 50.0%
            
            35.0%
                to 40.0%Adjustable-rate
            
            4.0%
            
            75.0%
            
            35.0%
                to 75.0%





Our
      assumption regarding the peak speed over the life for fixed rate loans ranged
      from 35% to 40% prior to September 30, 2005. We revised our peak speed over
      the
      life assumption as of September 30, 2005 to reflect the prepayment trend
      experienced within the loan pools, which has remained consistent through March
      31, 2006.





If
      mortgage loans prepay faster than anticipated, we generally will earn less
      income in connection with the mortgage loans and receive less excess cash flow
      in the future because the mortgage loans have paid off. Conversely, if mortgage
      loans prepay at a slower rate than anticipated, we generally earn more income
      and more excess cash flow in the future, subject to other factors that can
      affect the cash flow from, and our valuation of, the excess cashflow
      certificates.





B. *Default
      Rate.* The
      default rate is the percentage of estimated total loss of principal, interest
      and related advances that will take place over the life of the mortgage loans
      within a loan pool compared to the total original principal balance of the
      mortgage loans in the pool. A default rate is determined for each securitization
      reflecting the overall credit scores, average loan sizes and layered risks
      on
      the fixed- and adjustable-rate loans comprising each securitization trust.
      We
      apply a default or loss rate to the excess cashflow certificate because it
      is
      the “first-loss” piece and is subordinated in right of payment to all other
      securities issued by the securitization trust. If defaults are higher than
      we
      anticipate, we will receive less income and less excess cash flow than expected
      in the future. Conversely, if defaults are lower than we expected, we will
      receive more income and more excess cash flow than expected in the future,
      subject to the other factors that can affect the cash flow from, and our
      valuation of, the excess cashflow certificates. We revised our estimated default
      rates at September 30, 2005 to reflect the better-than-expected pool performance
      on our underlying securitizations. The current default rates, which are
      consistent with the revised rates at September 30, 2005, applied on the excess
      cashflow certificates range from 4.0% to 8.5%, with the majority ranging from
      4.0% to 5.0%. Prior to September 30, 2005, our default rate assumptions ranged
      from 4.5% to 8.0%, with the majority ranging from 4.5% to 5.0%.





C.  *Forward
      LIBOR Curve.* The
      forward LIBOR curve is used to project future interest rates, which affects
      both
      the rate to the floating-rate asset-backed security investors (primarily indexed
      off the one-month LIBOR) and the adjustable-rate mortgage loans sold to the
      securitization trust (a fixed rate of interest for either the first 24 or 36
      months and a variable rate of interest thereafter indexed off the six-month
      LIBOR). Most of our loans are fixed-rate mortgages, and a significant amount
      of
      the securities sold by the securitization trust are floating-rate securities
      (the interest rate adjusts based upon an index, such as one-month LIBOR). As
      a
      result, our excess cashflow certificates are subject to significant basis risk
      and a change in LIBOR will impact our excess spread. If LIBOR is lower than
      anticipated, we will receive more income and more excess cash flow than expected
      in the future, subject to the other factors that can affect the cash flow from,
      and our valuation of, the excess cashflow certificates. Conversely, if LIBOR
      is
      higher than expected, we will receive less income and less excess cash flow
      than
      expected in the future. In each of our securitizations in which we sold NIM
      note(s), we purchased an interest rate cap, which helps mitigate the basis
      risk
      for the approximate time that the NIM notes are outstanding. We have adjusted
      the valuation of each excess cashflow certificate to use a forward interest
      rate
      curve that represents both today’s rates and the expectation for rates in the
      future. We adjusted our forward LIBOR curve assumptions as of March 31, 2006,
      and believe that the forward LIBOR curve we use reflects the estimate of future
      LIBOR rates.





**29**


D.  *Discount
      Rate.* We use a
      discount rate that we believe reflects the risks associated with our excess
      cashflow certificates. Due to the unavailability of quoted market prices on
      comparable excess cashflow certificates, we compare our valuation assumptions
      and performance experience to our competitors in the non-conforming mortgage
      industry. Our discount rate takes into account the asset quality and the
      performance of our securitized mortgage loans compared to that of the industry
      and other characteristics of our securitized loans. We quantify the risks
      associated with our excess cashflow certificates by comparing the asset quality
      and payment and loss performance experience of the underlying securitized
      mortgage pools to comparable industry performance. The discount rate we use
      to
      determine the present value of the cash flow from excess cashflow certificates
      reflects increased uncertainty surrounding current and future market conditions,
      including, without limitation, uncertainty concerning inflation, recession,
      home
      prices, interest rates and conditions in the equity markets.





We
      utilized a discount rate of 18% at March 31, 2006 and December 31, 2005 on
      all
      excess cashflow certificates (a discount rate of 15% was utilized at March
      31,
      2005).




***Accounting
      for Hedging Activities.*** We
      regularly issue securitization asset-backed securities, backed by fixed- and
      variable-rate mortgage loans. As a result of this activity, we are exposed
      to
      interest rate risk beginning when our mortgage loans close and are recorded
      as
      assets until permanent financing is arranged, such as when the asset-backed
      securities are issued. Our strategy is to use interest rate swap contracts
      in an
      effort to lock in a pre-determined base interest rate on designated portions
      of
      our prospective future securitization financing. At times, we also use corridors
      ( corresponding
      purchase and sale of interest rate caps with similar notional balances at
      different strike prices )
      that
      are designed to limit our financing costs within the securitization to maintain
      minimum margins, with the possibility of allowing us to increase margins in
      lower than anticipated interest rate environments. Both the interest rate swaps
      and corridors are derivative instruments that trade in liquid markets, and
      we do
      not use either of them for speculative purposes.





In accordance with SFAS No. 133 , we
      record
      all of our derivatives on our consolidated balance sheet at fair value. For
      derivative financial instruments not designated as hedging instruments, gains
      or
      losses resulting from a change in fair value are recognized in current period
      earnings. When derivatives are used as hedges, hedge accounting is permitted
      only if we document the hedging relationship and its effectiveness at the time
      we designate the derivative as a hedge instrument. If we meet certain
      requirements under SFAS No. 133, we may account for the hedge instrument as
      a
      cash flow hedge.





Cash flow hedge accounting is appropriate for hedges of uncertain cash flows
      associated with future periods - whether as a consequence of interest to be
      received or paid on existing variable rate assets or liabilities or in
      connection with intended purchases or sales.





Under cash flow hedge accounting treatment, the changes in the fair value of
      the
      derivative instruments are divided into two portions, “effective” and
“ineffective.” The effective portion of the derivative's gain or loss is
      initially reported as a component of OCI and subsequently reclassified into
      earnings when the forecasted transaction affects earnings. The ineffective
      portion of the gain or loss is reported in earnings immediately.





**30**


To
      qualify for cash flow hedge accounting treatment:





·
            hedges
                must be documented, with the objective and strategy stated, along
                with an
                explicit description of the methodology used to assess and measure
                hedge
                effectiveness;·
            dates
                (or periods) for the expected forecasted events and the nature of
                the
                exposure involved (including quantitative measures of the size of
                the
                exposure) must be explicitly documented;·
            hedges
                must be expected to be “highly effective,” both at the inception of the
                hedge and on an ongoing basis. Effectiveness measures must relate
                the
                gains or losses of the derivative to changes in the cash flow associated
                with the hedged item;·
            forecasted
                transactions must be probable; and·
            forecasted
                transactions must be made with different counterparties other than
                the
                reporting entity.





If
      a
      hedge fails the assessment of hedge effectiveness test (the ratio of the
      outstanding balance of the hedged item (debt) to the notional amount of the
      corridors exceeds 125% or falls below 80%, since the notional amount is the
      only
      critical term that varies) at any time, and therefore is not expected to be
      “highly effective” at achieving offsetting changes in cash flows, the hedge
      ceases to qualify for hedge accounting. An
      assessment analysis is then prepared by management to determine the go-forward
      treatment of the hedges that failed the retrospective test to determine if
      any
      portion of the hedge may still qualify for hedge accounting treatment. If the
      analysis indicates future effectiveness for a portion of the hedge; the original
      hedge will effectively be allocated into two pieces, a trading security
      (ineffective portion) and “new hedge relationship” (effective
      portion).





The
“new
      hedge relationship” is determined by re-aligning the hedge with the projected
      remaining bond balances (debt) as of the date the original hedge became
      retrospectively ineffective. The ratio of the outstanding balance of the debt
      to
      notional size of the revised hedge will then be 100% as of the re-alignment
      date. The expected repayment pattern of the debt associated to the original
      hedge is used as the basis to establish the “new hedge relationship” future
      repayment pattern. The difference between the fair value of the original hedge
      and the “new hedge relationship” hedge on the re-alignment date is classified as
      a trading security. Once classified as a trading security, any changes in the
      fair value are recorded directly to the income statement as a component of
      gain
      or loss on derivative instruments.





***Accounting
      for Income Taxes.*** Significant management judgment is required in developing our provision for
      income taxes, including the determination of deferred tax assets and liabilities
      and any valuation allowances that might be required against the deferred tax
      asset. Management
      needs to consider the relative impact of negative and positive evidence related
      to the ability to recognize a deferred tax asset. This evaluation takes into
      consideration our recent earnings history, current tax position and estimates
      of
      taxable income in the near term. If actual results differ from these estimates,
      we may be required to record a valuation allowance on our deferred tax assets,
      which could negatively impact our consolidated financial position and results
      from operations. We recognize all of our deferred tax assets if we believe,
      on a
      more likely than not basis, that all of the benefits of the deferred tax assets
      will be realized. Management believes that, based upon on the available
      evidence, it is more likely than not that the
      results of future operations will generate sufficient taxable income to realize
      the deferred tax assets. Therefore, at March 31, 2006 and December 31, 2005, we did not maintain a
      valuation allowance against our deferred tax assets.





***Allowance for Loan Losses on Mortgage Loans Held for
      Investment.*** In
      connection with our change to portfolio accounting in 2004, we established
      an
      allowance for loan losses based on an estimate of losses to be incurred in
      the
      foreseeable future on our mortgage loans held for investment portfolio.
      Additionally, we charge-off uncollectible loans at the time they are deemed
      not
      probable of collection.





In order to estimate an appropriate allowance for losses on mortgage loans
      held
      for investment, we estimate losses using a detailed analysis of historical
      mortgage loan performance data. This data is analyzed for loss performance
      and
      prepayment performance by product type, origination year and securitization
      issuance. The results of that analysis are then applied to the current long-term
      mortgage portfolio held for investment, excluding those loans which meet the
      criteria for specific review under SFAS
      No.
      114, and
      an
      estimate is created. In accordance with SFAS No. 5, we believe that pooling
      of
      mortgages with similar characteristics is an appropriate methodology in which
      to
      evaluate the amount of the allowance for loan losses. A provision for loan
      losses is charged to our consolidated statement of operations. Losses incurred,
      if any, will be written-off against the allowance for loan losses.





**31**


While
      we
      will continually evaluate the adequacy of the allowance for loan losses, we
      recognize that there are qualitative factors that must be taken into
      consideration when evaluating and measuring potential expected losses on
      mortgage loans. These items include, but are not limited to, current performance
      of the loans, economic indicators that may affect the borrower’s ability to pay,
      changes in the market value of the collateral, political factors and the general
      economic environment. As these estimates are influenced by factors outside
      of
      our control and as uncertainty is inherent in these estimates, it is reasonably
      possible that they could change. In particular, if conditions were such that
      we
      were required to increase the provision for loan losses, any increase in the
      provision for loan losses would negatively impact our results of
      operations.





In
      accordance with SFAS No. 114, a loan is impaired when, based on current
      information and events, it is probable that a creditor will be unable to collect
      all amounts due according to the contractual terms of the mortgage loan
      agreement. Due to the significant effects of Hurricanes Katrina and Rita on
      a
      portion of our mortgage loans held for investment portfolio, management
      identified certain loans located in FEMA declared disaster areas as meeting
      the
      criteria under SFAS No. 114 requiring a separate loan impairment review. Based
      upon the analysis performed, we identified specific mortgage loans in which
      the
      borrowers’ abilities to repay the loan in accordance with their contractual
      terms was impaired. We assessed the extent of damage to the underlying
      collateral and the extent to which damaged collateral is not covered by
      insurance in determining the amount of specific reserves needed. We established
      specific reserves for these affected mortgage loans based upon estimates of
      loss
      exposure. As additional information is obtained and processed over the coming
      months and quarters, we will continue to assess the need for any adjustments
      to
      our estimates and the specific reserves related to the mortgage loans in the
      affected areas.





***Amortization
      of Deferred Loan Origination Fees and Costs.*** Interest
      income is recorded on our mortgage loans held for investment portfolio based
      upon a combination of interest accruals based on the outstanding balance and
      contractual terms of the mortgage loans, adjusted by the amortization of net
      deferred origination fees or costs accounted for in accordance with SFAS No.
      91.
      Our net deferred origination fees/costs consist principally of origination
      fees,
      discount points, broker premiums, and payroll and commissions associated with
      originating our mortgage loans. For our loans held for investment, these net
      deferred fees or costs are accreted or amortized as adjustments to interest
      income over the estimated lives of the loans using the interest method. Our
      portfolio of mortgage loans held for investment is comprised of a large number
      of homogeneous loans for which we believe prepayments are probable. The periodic
      amortization of our deferred origination fees or costs is based on a model
      that
      considers actual prepayment experience to date as well as forecasted prepayments
      based on the contractual interest rate on the mortgage loans, loan age, loan
      type and prepayment fee coverage, among other factors. Mortgage prepayments
      are
      affected by the terms and credit grades of the loans, conditions in the housing
      and financial markets and general economic conditions. Prepayment assumptions
      are reviewed regularly to ensure that our actual experiences, as well as
      industry data, are supportive of the prepayment assumptions used in our model.
      Any changes to these estimates are applied as if the revised estimates had
      been
      in place since the origination of the loans, and current period amortization
      is
      adjusted to reflect the effect of the changes.





***Amortization
      of Deferred Debt Issue Discounts and Transaction
      Costs.*** Interest
      expense on our securitization financing is comprised of the accrual of interest
      based on the contractual terms, cash receipts and amortization related to our
      cash flow hedges (interest rate swaps and corridors), the amortization of
      deferred debt issue discounts and transaction costs. The deferred debt issue
      discounts and transaction costs are amortized as an adjustment to interest
      expense over the estimated lives of the related debt using the interest method
      and take into account the effect of estimated prepayments. Any changes made
      to
      these estimates are applied as if the revised estimates had been in place since
      the issuance of the related debt, and result in adjustments to the period
      amortization recorded to interest expense.





**32**


**Results
      of Operations**





***Three
      Months Ended March 31, 2006 Compared to Three Months Ended March 31,
      2005***





**General**





Our
      net
      income for the three months ended March 31, 2006 was $6.6 million, or $0.32
      per
      share basic and $0.31 per share diluted, compared to net income of $2.1 million,
      or $0.10 per share basic and diluted, for the three months ended March 31,
      2005.
      The increase in net income during the three months ended March 31, 2006
      primarily relates to the growth in the net interest income we realized from
      our
      mortgage loans held for investment portfolio, which has grown each quarter
      since our
      change from gain-on-sale accounting to portfolio accounting in the first quarter
      of 2004. Additionally,
      the increase in net income relates to an increase in non-interest income arising
      from the increase in the fair value of our excess cashflow certificates of
      $3.3 million, pre-tax, recorded during the three months ended March 31,
      2006.





We
      recorded net interest income after provision for loan losses of $28.3 million
      during the three months ended March 31, 2006, an increase of $8.1 million,
      or
      39.9%, from $20.2 million in the same period in 2005. The increase in net
      interest income after provision for loan losses primarily reflects the net
      effect of recognizing interest income on $5.1 billion of mortgage loans held
      for
      investment at March 31, 2006 compared to $2.9 billion of these loans held at
      March 31, 2005. Similarly, the increase in interest expense primarily reflects
      the net effect of recognizing interest expense on $5.0 billion in financing
      on
      mortgage loans held for investment at March 31, 2006, compared to $2.8 billion
      of financing on mortgage loans held for investment at March 31, 2005. During
      the
      three months ended March 31, 2006, total non-interest income increased by $2.5
      million and total non-interest expense increased by $3.2 million, compared
      to
      the same period in 2005. The increase in non-interest income primarily reflects
      the impact of increases in the net gain on the sale of mortgage loans and the
      increase in the fair value of our excess cashflow certificates we experienced
      during the three months ended March 31, 2006, while the increase in non-interest
      expense primarily reflects the expenses associated with increases in origination
      volume, primarily reflected in the increase in payroll and related
      costs.





We
      originated $944.7 million of mortgage loans during the three months ended March
      31, 2006, representing a $108.0 million, or 12.9%, increase from the $836.7
      million of mortgage loans originated during the three months ended March 31,
      2005. We securitized and/or sold $1.0 billion of loans during the three months
      ended March 31, 2006, representing a $184.3 million, or 21.5%, increase from
      the
      $855.4 million of loans securitized and/or sold during the same period in
      2005.





**Net
      Interest Income**





We
      recorded net interest income of $34.7 million during the three months ended
      March 31, 2006, an increase of $7.6 million, or 28.1%, from the $27.1 million
      recorded in the same period in 2005. The increase in net interest income
      primarily reflects the net effect of the increases in the average balance of
      mortgage loans held for investment and the related financing during the three
      months ended March 31, 2006 compared to the same period in 2005. Net interest
      income represents the difference between our interest income and our interest
      expense, each of which is described in the following paragraphs.





***Interest
      Income.*** Interest
      income increased $47.1 million, or 85.8%, to $102.0 million for the three months
      ended March 31, 2006, from $54.9 million for the comparable period in 2005.
      The
      increase is primarily due to (1) the increase in interest income of $43.1
      million on our loans held for investment - securitized, which totaled $5.0
      billion at March 31, 2006 as compared to $2.8 billion at March 31, 2005; (2)
      the
      increase in interest income of $2.4 million related to the increase in the
      average amount of mortgage loans held for investment - pre-securitization during
      the three months ended March 31, 2006 compared to the same period in 2005;
      and
      (3) the increase in asset-backed security interest received from securitization
      trusts on fixed-rate asset-backed securities at the time of settlement - due
      to
      the increase in fixed-rate asset-backed securities issued during the three
      months ended March 31, 2006, compared to the asset-backed securities issued
      in
      the same period of 2005.





**33**


The
      following table is a summary of interest income:





**For
                the Three Months Ended March 31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                income on mortgage loans held for investment - pre-securitization,
                net
            
            $
            9,301
            
            $
            6,854Interest
                income on mortgage loans held for investment - securitized, net(1)
            
            
            89,055
            
            
            45,926Interest
                income on excess cashflow certificates
            
            
            243
            
            
            488Asset-backed
                security interest
            
            
            3,374
            
            
            1,607Miscellaneous
                interest income
            
            
            --
            
            
            1Total
                interest income
            
            $
            101,973
            
            $
            54,876





*(1)*  *The
      amount for the three months ended March 31, 2006 and 2005 includes $4.2 million
      and $2.2 million, respectively, of prepayment penalty fees.*





***Interest
      Expense.*** Interest
      expense increased by $39.5 million to $67.3 million for the three months ended
      March 31, 2006 from $27.8 million for the comparable period in 2005. The
      increase primarily was due to the increase in interest expense related to the
      increased securitization debt and, to a lesser extent, the increase in loans
      originated and financed during the three months ended March 31, 2006 on our
      warehouse facilities, compared to the same period in 2005. The increase in
      interest expense also reflected the 108 basis point increase in the average
      cost
      of funds on the mortgage loans held for investment financing for the three
      months ended March 31, 2006 as compared to the comparable period in 2005. To
      a
      lesser extent, the increase in interest expense was due to higher warehouse
      financing costs due to a higher average one-month LIBOR rate, which is the
      benchmark index used to determine our cost of borrowed funds. The one-month
      LIBOR rate increased on average to 4.61% for the three months ended March 31,
      2006, compared to an average of 2.64% for the same period in 2005.





The
      following table presents the components of interest expense:





**For
                the Three Months Ended****March
                31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                expense on warehouse financing
            
            $
            7,883
            
            $
            4,046Interest
                expense on mortgage loans held for investment financing(1)
            
            
            59,113
            
            
            23,668Interest
                expense on other borrowings
            
            
            105
            
            
            69Other
                interest expense
            
            
            165
            
            
            --Total
                interest expense
            
            $
            67,266
            
            $
            27,783





*(1)
      The amount for the three months ended March 31, 2006 and 2005 includes $744,000
      and $1.4 million, respectively, of amortized deferred securitization debt
      issuance expenses and trustee expenses recognized during the period, net of
      hedge amortization.*


**Provision
      for Loan Losses**





A
      provision for loan losses on mortgage loans held for investment is recorded
      to
      maintain the related allowance for loan loss at an appropriate level for
      currently existing probable losses of principal. We recorded a provision for
      loan losses of $6.4 million and $6.9 million for the three months ended March
      31, 2006 and 2005, respectively, related to mortgage loans held for investment.
      The amount of the provision for loan losses reflects the performance and
      seasoning of our mortgage loans held for investment during the respective
      quarter.





**Non-Interest
      Income**





Total non-interest income increased by $2.5 million, or 30.3%, to $10.6 million
      for the three months ended March 31, 2006, from $8.1 million for the comparable
      period in 2005. The increase in non-interest income primarily resulted from
      the
      increase in the gain recorded from the increase in the fair value of the excess
      cashflow certificates of $523,000, coupled with a $1.9 million increase in
      the
      net gain on sale of mortgage loans, during the three months ended March 31,
      2006
      as compared to the same period in 2005.





**34**


***Net
      Gain on Sale of Mortgage Loans.*** Net gain
      on sale of mortgage loans is comprised of the premium received from selling
      whole loans on a servicing-released basis, together with any deferred
      origination costs or fees associated with mortgage loans sold, less any premium
      recapture reserve. During the three months ended March 31, 2006 and 2005, we
      recorded a net gain on the sale of mortgage loans of $7.2 million and $5.3
      million, respectively, on the sale of $164.7 million and $105.4 million,
      respectively, of mortgage loans on a whole-loan basis.





The
      following table is a summary of our net gain on sale of mortgage loans for
      the
      three months ended March 31, 2006 and 2005:





**For
                the Three Months Ended****March
                31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Net
                Gain on Sale of Mortgage Loans:Loans
                sold
            
            $
            164,711
            
            $
            105,419Gain
                on whole-loan sales
            
            $
            5,671
            
            $
            4,162Premium
                recapture reserve
            
            
            (235
            )
            
            (166
            )Net
                loan origination fees
            
            
            1,800
            
            
            1,296Net gain on sale recorded
            
            $
            7,236
            
            $
            5,292Net gain on sale recorded as a percent of loans sold
            
            
            4.39
            %
            
            5.02
            %





Net
      gain
      on sale of mortgage loans increased $1.9 million, or 36.7%, to $7.2 million
      for
      the three months ended March 31, 2006, from $5.3 million for the comparable
      period in 2005. This increase was directly related to the volume of loan sales
      quarter over quarter. The impact from the increase in volume was partially
      offset by a decrease in the premium received. During the three months ended
      March 31, 2006, we sold $164.7 million (at a weighted average gross sales price
      of 3.44%) of mortgage loans on a whole-loan servicing-released basis, compared
      to $105.4 million (at a weighted average gross sales price of 3.95%) for the
      same period in the prior year.





The
      weighted average net gain-on-sale ratio for the three months ended March 31,
      2006 and 2005 was 4.39% and 5.02%, respectively. The weighted-average net
      gain-on-sale ratio is calculated by dividing the net gain on sale by the total
      amount of loans securitized and sold.





***Other
      Income.*** Other
      income increased $525,000, or 18.4%, to $3.4 million for the three months ended
      March 31, 2006, from $2.9 million for the three months ended March 31, 2005.
      The
      increase in other income primarily relates to a fair value adjustment on our
      excess cashflow certificates of $3.3 million for the three months ended March
      31, 2006, as compared to a $2.7 million fair value adjustment on our excess
      cashflow certificates during the same period in 2005. The
      increase in the fair value of our excess cashflow certificates for the three
      months ended March 31, 2006 primarily was driven by lower losses on the
      underlying loans and the impact of our revised assumptions, specifically the
      lowering of the expected losses and/or changed shape of the loss curve used
      to
      value the excess cashflow certificates, to reflect losses occurring at a later
      date than originally anticipated.





**Non-interest
      Expense**





Total non-interest expense increased by $3.2 million, or 12.7%, to $28.1 million
      for the three months ended March 31, 2006, from $24.9 million for the comparable
      period in 2005. The increase primarily is due to an increase in payroll and
      related costs associated with a 12.9% increase in our mortgage loan production
      and a 13.2% increase in personnel, coupled with an increase in other production
      related expenses. Additionally, offsetting non-interest expense was the $275,000
      gain recorded on derivative instruments relating to the ineffective portion
      of
      our derivatives that is recognized through current earnings during the three
      months ended March 31, 2006 compared to a $16,000 gain recorded for the three
      months ended March 31, 2005.





***Payroll and Related Costs.*** Payroll
      and related costs include salaries, benefits and payroll taxes for all non-loan
      production related employees and non-deferrable loan production related
      employees cost.





**35**


Payroll and related costs increased by $1.8 million, or 12.4%, to $17.0 million
      for the three months ended March 31, 2006, from $15.2 million for the comparable
      period in 2005. The increase primarily was the result of higher compensation
      and
      related payroll costs associated with an increase in our staff. As of March
      31,
      2006, we employed 1,323 full- and part-time employees, an increase of 13.2%
      over
      our 1,169 full- and part-time employees as of March 31, 2005. Additionally,
      payroll and related costs were higher due to the higher loan commissions paid
      as
      a result of a 12.9% increase in loan production during the three months ended
      March 31, 2006 compared to the same period in 2005.




***General and Administrative Expenses.*** General
      and administrative expenses consist primarily of office rent, insurance,
      telephone, depreciation, legal reserves and fees, license fees, accounting
      fees,
      professional fees, travel and entertainment expenses, advertising and
      promotional expenses.





General
      and administrative expenses increased $1.5 million, or 15.7%, to $11.3 million
      for the three months ended March 31, 2006, from $9.8 million for the comparative
      period in 2005. The increase primarily was due to an increase in expenses
      associated with a 12.9% increase in loan production during the three months
      ended March 31, 2006 compared to the same period in 2005 (which includes higher
      advertising, promotional and marketing expenses), and the consequent 13.2%
      increase in personnel and expenses related to our ongoing expansion of our
      wholesale and retail divisions (which includes rent and depreciation
      expenses).





***Gain on Derivative Instruments.*** The gain
      on derivative instruments recorded during the three months ended March 31,
      2006
      represents the (1) ineffective portion of the change in fair value of interest
      rate swaps used to lock in a pre-determined interest rate on designated portions
      of our prospective future securitization financing, (2) ineffective portion
      related to the change in the fair value of our corridors we use to protect
      the
      variable-rate financing, and (3) c hanges
      in
      the fair value of the derivative instruments classified as trading securities.





During
      the three months ended March 31, 2006, we recorded a net gain on derivative
      instruments of $275,000 as compared to a net gain on derivatives of $16,000
      during the three months ended March 31, 2005. During the three months ended
      March 31, 2006 we recorded a gain of $60,000 on the ineffective portion of
      corridors and interest rate swaps, compared to a gain of $16,000 recorded on
      the
      ineffective portion of certain corridors and interest rate swaps during the
      three months ended March 31, 2005. At March
      31, 2006, we hold $1.3 million of corridors which have been classified as
      trading assets within prepaid and other assets. These corridors were no longer
      deemed “highly effective,” as the ratio of the outstanding balance of the hedged
      item (debt) to the notional amount of the corridors was outside of the range
      of
      80% to 125%, and were classified as trading securities. During the three months
      ended March 31, 2006, a gain of $215,000 was recorded to earnings on the changes
      in fair value of the corridors held as trading securities. During the three
      months ended March 31, 2005, none of the corridors tested failed the
      effectiveness test.





**Income
      Taxes**





Deferred
      tax assets and liabilities are recognized based upon the income reported in
      the
      consolidated financial statements regardless of when such taxes are paid. These
      deferred taxes are measured by applying current enacted tax rates.





We
      recorded an income tax expense of $4.2 million for the three months ended March
      31, 2006 on pre-tax income of $10.8 million recorded for the period (utilizing
      an effective tax rate of approximately 39.1%). We recorded income tax expense
      of
      $1.4 million for the three months ended March 31, 2005 on a pre-tax income
      of
      $3.4 million (utilizing an effective tax rate of approximately
      40.1%).





**Financial
      Condition**





***March
      31, 2006 compared to December 31, 2005***





*******Cash and
      cash****equivalents*** ***.***
      Cash and cash equivalents increased $1.0 million, or 21.9%, to $5.7 million
      at
      March 31, 2006, from $4.7 million at December 31, 2005. This increase primarily
      was related to timing of cash received and disbursed from normal
      operations.





**36**


***Mortgage
      Loans Held for Investment,****Net*** **.**
      Mortgage loans held for investment, net increased $454.9 million, or 9.8%,
      to
      $5.1 billion at March 31, 2006, from $4.6 billion at December 31, 2005. This
      account represents our basis in the mortgage loans that either were delivered
      to
      the securitization trusts (denoted as mortgage loans held for investment -
      securitized) or are pending delivery into future securitizations (denoted as
      mortgage loans held for investment - pre-securitization), net of discounts,
      deferred fees and allowance for loan losses.





The
      following table sets forth a summary of mortgage loans held for investment,
      net:





**At
                March 31,**
            
            **At
                December 31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Mortgage
                loans held for investment - securitized
            
            $
            4,991,500
            
            $
            4,430,775Mortgage
                loans held for investment - pre-securitization
            
            
            174,147
            
            
            270,372Discounts
                (MSR related)
            
            
            (30,033
            )
            
            (26,750
            )Net
                deferred origination fees
            
            
            (12,005
            )
            
            (10,735
            )Allowance
                for loan losses
            
            
            (41,911
            )
            
            (36,832
            )Mortgage
                loans held for investment, net
            
            $
            5,081,698
            
            $
            4,626,830





We
      maintain an allowance for loan losses based on our estimate of losses to be
      incurred in the foreseeable future (generally an 18-to 24-month period) on
      our
      mortgage loans held for investment. At March 31, 2006 and December 31, 2005,
      we
      established an allowance for loan losses totaling $41.9 million and $36.8
      million, respectively, based upon our analysis of the mortgage loans held for
      investment portfolio, including a $1.7 million and $1.7 million, respectively,
      reserve for probable loan losses on mortgage loans specifically identified
      as
      impaired (which primarily consists of loans related to Hurricanes Katrina and
      Rita). The increase in the allowance for loan losses primarily is driven by
      the
      growth and seasoning of our mortgage loans held for investment portfolio. We
      have not substantively changed any aspect of our overall approach in the
      determination of the allowance for loan losses under SFAS No. 5, and there
      have
      been no material changes in our assumptions or estimates as compared to the
      prior year that impacted the determination of the allowance for loan losses
      at
      March 31, 2006.





The
      following table sets forth a summary of the activity in the allowance for loan
      losses for the three months ended March 31, 2006 and for the year ended December
      31, 2005:





*(Dollars
                in thousands)*
            
            **For
                the Three Months Ended**
              **March
                31, 2006**
            
            **For
                the Year Ended December 31, 2005**Allowance
                for loan losses - beginning of year
            
            $
            36,832
            
            $
            10,278Provision
                for loan losses(1)
            
            
            6,404
            
            
            28,592Charge-offs(2)
            
            
            (1,325
            )
            
            (2,038
            )Allowance
                for loan losses - end of period
            
            $
            41,911
            
            $
            36,832





*(1)* *The
      provision for loan losses for the three months ended March 31, 2006 and for
      the
      year ended December 31, 2005 includes an $11,000 and $1.7 million, respectively,
      specific provision* *related
      to probable losses attributable to impaired loans. The specific provision for
      the three months ended March 31, 2006 is net of a $182,000 reversal in the
      portion of the provision related to the loans in Hurricanes Katrina and Rita
      disaster areas. The specific provision recorded for the year ended December
      31,
      2005 all related to the loans in Hurricanes Katrina and Rita disaster
      areas.*





*(2)* *The
      charge-offs for the* *three
      months ended March 31, 2006 and for the* *year
      ended December 31, 2005 includes a $61,000 and $3,000, respectively, charge-off
      against the specific allowance for loan losses attributable to loans in
      Hurricanes Katrina and Rita disaster areas.*





At
      March
      31, 2006 and December 31, 2005, a specific reserve for impaired loans totaled
      $1.7 million. The majority of the specific reserve at March 31, 2006 ($1.5
      million) and all of the specific reserve at December 31, 2005 relates to the
      impaired loans within mortgage loans held for investment that are located in
      the
      Hurricanes Katrina and Rita disaster areas designated by FEMA. Our specific
      allowance for loan losses at March 31, 2006 and December 31, 2005 is based
      upon
      our probable loss exposure attributable to 29 properties (26 of these properties
      are Hurricane Katrina and Rita related) and 35 properties, respectively,
      securing a total unpaid principal balance of $3.8 million ($3.1 million of
      this
      balance is Hurricane Katrina and Rita related) and $3.9 million, respectively,
      in the affected areas. As
      additional information is obtained and processed over the coming months and
      quarters, we will continue to assess the need for any adjustments to our
      specific reserves related to the mortgage loans in the affected
      areas .





**37**


***Trustee
      Receivable.*** Trustee
      receivable increased $17.3 million, or 30.9%, to $73.5 million at March 31,
      2006
      from $56.2 million at December 31, 2005. Trustee receivable principally
      represents any un-remitted principal and interest payments collected by the
      securitization trust’s third-party loan servicer subsequent to the monthly
      remittance cut-off date on our mortgage loans held for investment - securitized
      portfolio. The unscheduled principal payments and prepaid loan payments received
      after the remittance cut-off date as of March 31, 2006 and December 31, 2005
      totaled $66.6 million and $50.7 million, respectively, relating to the
      securitizations accounted for as secured financings. The trustee is expected
      to
      remit these amounts on the following month’s scheduled remittance date, at which
      time they mainly will be used to pay down principal on the related financing
      on
      mortgage loans held for investment, net. The balance in trustee receivable
      also
      includes the interest portion of mortgage payments collected by our loan
      servicing provider during the month which are remitted to us one month after
      collection ( *i.e.* ,
      interest collected by the third-party servicer after our March 2006 remittance
      cut-off date will be remitted to us in April 2006).





***Accrued
      Interest Receivable.*** Accrued
      interest receivable increased $2.3 million, or 8.7%, to $29.3 million at March
      31, 2006, from $27.0 million at December 31, 2005. The increase is due to the
      12.7% increase in mortgage loans held for investment - securitized from December
      31, 2005, offset by the 35.6% decrease in mortgage loans held for investment
      -
      pre-securitization during the same period. The increase in accrued interest
      receivable also includes the effect of an increase in the weighted-average
      interest rates on the mortgage loans held for investment - securitized and
      mortgage loans held for investment - pre-securitization of 10 basis points
      and
      67 basis points, respectively, from December 31, 2005 to March 31,
      2006.





***Excess
      Cashflow****Certificates*** **.**
      The following table presents the activity related to our excess cashflow
      certificates for the three months ended March 31, 2006 and for the year ended
      December 31, 2005:





*(Dollars
                in thousands)*
            
            **For
                the Three Months Ended**
              **March
                31, 2006**
            
            **For
                the Year Ended December 31, 2005**Balance,
                beginning of year
            
            $
            7,789
            
            $
            14,933Accretion
            
            
            243
            
            
            1,593Cash
                receipts
            
            
            (6,237
            )
            
            (23,146
            )Net
                change in fair value
            
            
            3,261
            
            
            14,409Balance,
                end of period
            
            $
            5,056
            
            $
            7,789





Since we began structuring our securitizations in 2004 to be accounted for
      as
      secured financings, we no longer record excess cashflow certificates (but rather
      the underlying mortgage loans) on newly issued securitizations on the
      consolidated balance sheet. We did not sell any excess cashflow certificates
      during the three months ended March 31, 2006 and 2005.





The
      decrease in the fair value of our excess cashflow certificates for the three
      months ended March 31, 2006, as compared to the same period in 2005, is
      primarily due to the timing of cash receipts and losses on the underlying loans,
      coupled with the change in the amount of remaining residual cash flows. Actual
      losses for the three months ended March 31, 2006 were lower than the anticipated
      losses, resulting in the receipt of cash earlier than expected. In addition,
      we
      revised the assumptions used to determine the fair value of the excess cashflow
      certificates during the first quarter of 2006 and the third quarter of 2005.
      The
      most notable of the changed assumptions was the third quarter 2005 decrease
      in
      the amount of expected losses over the remaining term of several of the
      certificates and the revised shape of the loss curve due to better-than-expected
      performance of the mortgage loans that underlie the excess cashflow
      certificates. As a result of the lower losses and the increased cash flow,
      the
      return was higher on the excess cashflow certificates during the three months
      ended March 31, 2006.





***Equipment,
      Net*** **.**
      Equipment, net, increased $268,000, or 4.0%, to $7.0 million at March 31, 2006,
      from $6.7 million at December 31, 2005. This increase primarily is due to
      increased purchases of computer equipment and office furnishings during the
      three months ended March 31, 2006, which reflects our office expansions
      occurring during the period. Most of the equipment purchased during the first
      three months of 2006 will be depreciated over a three- to five-year period
      from
      the date acquired.





**38**


***Accounts
      Receivable.***  Accounts
      receivable decreased $1.1 million, or 21.0%, to $4.0 million at March 31, 2006,
      from $5.1 million at December 31, 2005. This
      decrease primarily is due to a decrease in amounts due from the third-party
      servicer. The decrease in servicer receivables relates to the decrease in our
      mortgage loans held for investment - pre-securitization portfolio during the
      three months ended March 31, 2006. The servicer receivables generally are
      comprised of the principal and interest payments collected by our loan servicing
      provider during the month and remitted to us one month after collection
      ( *i.e.* ,
      principal and interest collected by the third-party servicer during March 2006
      will be remitted to us in April 2006).





***Prepaid
      and Other Assets.*** Prepaid
      and other assets increased $5.2 million, or 16.9%, to $35.7 million at March
      31,
      2006, from $30.5 million at December 31, 2005. The increase is primarily due
      to
      the (1) $1.1 million increase in deferred securitization debt issuance costs
      that are recognized over the estimated life of the securitization debt as a
      yield adjustment to interest expense, (2) $4.1 million increase in REO
      properties due to the expected seasoning of the loan portfolio, and (3)
      recording of a $940,000 deferred gain which represents the fair value of the
      derivatives (swaps) used to hedge our cost of funds on our expected second
      quarter 2006 securitization debt. These increases were offset partially by
      a
      $906,000 decrease in the fair value of our derivatives (prepaid corridors)
      used
      to hedge our securitization debt.





At
      March
      31, 2006 and December 31, 2005, we held $8.5 million and $4.4 million,
      respectively, of REO properties, which we carry at the lower of cost or fair
      value, less estimated selling costs.  The
      fair
      value of the REO properties were written down by $131,000 during the three
      months ended March 31, 2006. We recorded write downs of $213,000 during the
      year
      ended December 31, 2005.




***Deferred
      Tax Asset.***  The
      deferred tax asset decreased by $5.2 million, or 9.5%, to $49.7 million at
      March
      31, 2006, from $54.9 million at December 31, 2005. The decrease is primarily
      due
      to timing differences in GAAP income and taxable income recognition. The
      decrease in the deferred tax asset primarily relates to gain-on-sale accounting
      versus REMIC tax accounting for securitizations entered into prior to 2004,
      our
      2004 securitizations which were accounted for as secured financings, and which
      for tax purposes were accounted for as REMIC transactions and are treated as
      sales, deferred origination fees and a $2.6 million decrease in deferred taxes
      related to the increase in the fair value of the hedge instruments within
      accumulated OCI. The decrease partially was offset by increases in the
      differences related to loan loss provision and actual charge-offs, and realized
      gains and losses on derivatives (interest rate swaps) associated with hedging
      the securitization debt issuance (financing costs).





Commencing
      in the first quarter of 2005, we began issuing our securitizations from a newly
      created subsidiary that we elected to treat as a REIT (also referred to as
      a
“Captive REIT”) under the Internal Revenue Code of 1986, as amended (the
“Code”). The securitization was structured as a “debt-for-tax” transaction. Our
      prior to 2005 securitizations all were  structured as “sale-for-tax”
transactions. The tax structure was changed to more closely conform to the
      GAAP
      accounting treatment.





***Bank
      Payable.*** Bank
      payable decreased $71,000, or 3.7%, to $1.8 million at March 31, 2006, from
      $1.9
      million at December 31, 2005. Bank payable represents the amount of checks
      written against our operating account which subsequently are covered as they
      are
      presented to the bank for payment by either drawing down our lines of credit
      or
      from subsequent deposits of operating cash.





***Warehouse Financing.*** Our
      warehouse financing decreased $99.7 million, or 44.7%, to $123.2 million at
      March 31, 2006, from $222.8 million at December 31, 2005. The decrease was
      primarily due to a $96.2 million decrease in the amount of mortgage loans held
      for investment - pre-securitization. Additionally impacting the amount of
      outstanding borrowings under our warehouse credit facilities was the increase
      in
      the amount of self-funded loans from December 31, 2005 to March 31, 2006.




***Financing
      on Mortgage Loans Held for Investment, Net.*** Our
      financing on mortgage loans held for investment, net increased $555.8 million,
      or 12.5%, to $5.0 billion at March 31, 2006, from $4.4 billion at December
      31,
      2005. This increase in the issuance of asset-backed securities corresponds
      to
      the increase in loans held for investment - securitized during the three months
      ended March 31, 2006. The balance of this account generally will  increase
      in proportion to the increase in mortgage loans held for investment -
      securitized.





**39**


***Other
      Borrowings.***  Other
      borrowings decreased $585,000, or 12.2%, to $4.2 million at March 31, 2006,
      from
      $4.8 million at December 31, 2005. The decrease was due to the reduced need
      for
      equipment financing during the first quarter of 2006, as equipment purchases
      were made from available funds.





The
      following table summarizes certain information regarding other borrowings at
      March 31, 2006 and December 31, 2005:





*(Dollars
                in thousands*)**Equipment
                Financing**
            
            **Range
                of Interest Rates**
            
            **Balance**
            
            **Range
                of Expiration Dates**At
                March 31, 2006
            
            3.29%
                to 12.45%
            
            $                                   
                 4,200
            
            April
                2006 to December 2008At
                December 31, 2005
            
            3.29%
                to 12.45%
            
            $                                    
                4,785
            
            January
                2006 to December 2008





***Accrued
      Interest Payable.*** Accrued
      interest payable increased $3.2 million, or 24.4%, to $16.3 million at March
      31,
      2006, from $13.1 million at December 31, 2005. The increase primarily was
      related to the increase in the outstanding balance of our financing on mortgage
      loans held for investment, net, which increased $555.8 million, or 12.5%, at
      March 31, 2006 from December 31, 2005. The amount of accrued interest
      payable also increased due to an increase in the weighted average cost on
      mortgage loans held for investment financing to 5.30% at March 31, 2006 from
      4.92% at December 31, 2005.





Accrued
      interest payable related to warehouse borrowings represented $114,000 and
      $279,000 of the balance at March 31, 2006 and December 31, 2005, respectively.
      The decrease is due to a 44.7% decrease in warehouse financing offset by a
      44
      basis point increase (4.83% at March 31, 2006 compared to 4.39% at December
      31,
      2005) in the index utilized to calculate the interest expense related to those
      borrowings.





***Accounts Payable and Other Liabilities.*** Accounts
      payable and other liabilities increased $3.1 million, or 9.1%, to $36.3 million
      at March 31, 2006, from $33.2 million at December 31, 2005. The increase was
      primarily due to a $2.7 million increase in accrued servicer payables related
      primarily to our accounting for loan securitizations as secured financings
      beginning in 2004, and to the lesser extent, increases in reserves
      related to legal, premium recapture, recourse loans and representation and
      warranty indemnifications, partially offset by a reduction in current taxes
      payable during the same period.





***Stockholders’ Equity.*** Stockholders’ equity increased $10.4 million, or 9.7%, to $117.2 million at
      March 31, 2006 from $106.8 million at December 31, 2005. This increase primarily
      is  due to (1) the recording of $6.6 million in net income for the three
      months ended March 31, 2006, (2) a $4.1 million, net of tax, increase in the
      cumulative OCI related to the net unrealized gains from derivatives, and (3)
      the
      $137,000 of proceeds we received from the exercise of 137,800 stock options
      from
      authorized but unissued shares during the same period, offset by the accrual
      of
      $1.0 million in common stock dividends that were declared on March 31, 2006
      and
      paid on April 14, 2006.





Additionally
      increasing stockholders’ equity was the effect of the adoption of SFAS No.
      123(R) which removed from stockholders’ equity the unearned common stock held by
      the SIP on January 1, 2006. During the fourth quarter of 2005, we contributed
      157,275 shares, or $1.2 million, of our common stock to the SIP which
      represented deferred compensation and was initially recorded as a component
      of
      stockholders’ equity.




**40**


**Contractual
      Obligations**





The
      following table summarizes our material contractual obligations as of March
      31,
      2006:





*(Dollars
                in thousands)*
            
            **Total**
            
            **Less
                than**
              **One
                Year**
            
            **One
                to**
              **Three
                Years**
            
            **Three
                to**
              **Five
                Years**
            
            **More
                than**
              **Five
                Years**Securitization
                asset-backedsecurities(1)
            
            $
            4,992,688
            
            $
            1,891,877
            
            $
            1,912,378
            
            $
            660,256
            
            $
            528,177Operating
                leases
            
            $
            22,285
            
            $
            6,392
            
            $
            10,236
            
            $
            5,199
            
            $
            458Equipment
                financing
            
            $
            4,200
            
            $
            311
            
            $
            3,889
            
            $
            --
            
            $
            --





*(1)*  *Amounts
      shown above reflect estimated repayments based on anticipated receipt of
      principal and interest on underlying mortgage loan collateral using the same
      prepayment speed assumptions we use to value our excess cashflow
      certificates.*





**Loan
      Commitments**





We
      provide commitments to fund mortgage loans to customers as long as all of the
      proper conditions are met. Our commitments have fixed expiration dates. We
      quote
      interest rates to customers, which are generally subject to change by us.
      Although we typically honor these interest rate quotes, the quotes do not
      constitute future cash requirements, minimizing the potential interest rate
      risk
      exposure. We do not believe these non-conforming mortgage loan commitments
      meet
      the definition of a derivative under GAAP. Accordingly, they are not recorded
      in
      the consolidated financial statements. At March 31, 2006 and December 31, 2005,
      we had outstanding origination commitments to fund approximately $114.8 million
      and $104.8 million, respectively, in mortgage loans.





**Off-Balance
      Sheet Arrangements**





Substantially
      all of our off-balance sheet arrangements relate to securitizations structured
      as sales prior to 2004. In connection with our securitization transactions
      that
      were structured as sales (and where we have recorded an economic interest, *i.e.,* the
      excess cashflow certificates), there is $763.6 million in collateral (primarily
      mortgage loans) owned by off-balance sheet trusts as of March 31, 2006. These
      trusts have issued asset-backed securities secured by these mortgage loans.
      We
      have no obligation to provide funding support to either the third party
      investors or the off-balance sheet trusts. The third-party investors or the
      trusts have no recourse to our assets or us and have no ability to require
      us to
      repurchase their loans other than for non-credit-related recourse that can
      arise
      under standard representations and warranties. See “ - Securitizations” for
      additional information regarding these transactions.





**Liquidity
      and Capital Resources**





The term “liquidity” refers to our ability to generate adequate amounts of cash
      to fund our operations, including our loan originations, loan purchases,
      operating expenses, tax payments and planned dividend payments. We
      require substantial amounts of cash to fund our loan originations,
      securitization activities and operations. We generate working capital primarily
      from the cash proceeds from our quarterly securitizations, including the sale
      of
      MSRs. Our current cost structure has many embedded fixed costs, which are not
      likely to be significantly affected by a relatively substantial change in our
      loan origination volume. If we can continue to originate a sufficient amount
      of
      mortgage loans and continue our practice of securitizations, we expect to
      generate sufficient cash proceeds from our securitization financings, whole-loan
      sales and the cash flows from our growing portfolio of mortgage loans held
      for
      investment to offset our current cost structure and cash uses. However, we
      may
      choose to not sell MSRs or reduce the amount of securitization debt we issue,
      which will negatively impact our cash flow in any period we do so.





**41**


We
      believe we must generate sufficient cash from the following in order to sustain
      our current level of working capital:


·
            the
                proceeds we receive from selling or financing asset-backed securities
                in
                connection with our securitizations;  ·
            the
                proceeds from the sale of MSRs to a third-party mortgage
                servicer;  ·
            the
                premiums we receive from selling whole-loans on a servicing released
                basis;  ·
            origination
                fees collected on newly closed loans;  ·
            the
                cash flow from corridors;  ·
            excess
                cashflow certificates we retained in connection with our securitizations
                prior to 2004; and  ·
            principal
                and interest payments we receive on our loans held for
                investment.  Currently,
        our primary uses of cash include the funding of:
  ·
            mortgage
                loans held for investment - pre-securitization which are not
                financed;  ·
            interest
                expense on warehouse lines of credit, financing of mortgage loans
                held for
                investment, and other financings;  ·
            scheduled
                principal pay-downs on financing of mortgage loans held for investment,
                warehouse lines of credit and other
                financings;  ·
            transaction
                costs, derivative costs and credit enhancement (O/C) in connection
                with
                our securitizations;  ·
            general
                ongoing administrative and operating expenses, including the cost
                to
                originate loans;  ·
            tax
                payments, including those related to excess inclusion income generated
                from our excess cashflow certificates and all, or a portion, of our
                dividends received from our REIT subsidiary;
                and  ·
            common
                stock dividends.


Historically,
      we have financed our operations utilizing securitization financings, various
      secured credit financing facilities, issuances of corporate debt, issuances
      of
      equity, and MSRs sold in conjunction with each of our securitizations to support
      our originations, securitizations, and general operating expenses.


We have repurchase agreements with several of the institutions that have
        purchased mortgage loans from us in the past. Some of the agreements provide
        for
        our repurchase of any of the mortgage loans that become subject to foreclosure
        sale. At the foreclosure sale, we will repurchase the mortgage, if necessary,
        and make the institution whole. The dollar amount of loans that were sold
        with
        recourse and are still outstanding totaled $716,000 and $762,000 at March
        31,
        2006 and December 31, 2005, respectively. Included in “accounts payable and
        other liabilities” is an allowance for recourse loans related to those loans
        sold with recourse of $303,000 and $310,000 at March 31, 2006 and December
        31,
        2005, respectively.




Subject
      to our ability to execute our business strategy and the various uncertainties
      described above (and described in more detail in “Part II. Item 1A. - Risk
      Factors”), we anticipate that we will have sufficient cash flows from
      operations, short-term funding and capital resources to meet our liquidity
      obligations for at least the next 12 months, however, there can be no assurance
      that we will be successful in this regard.





**Financing
      Facilities**





We need to borrow substantial sums of money each quarter to originate mortgage
      loans. We have relied upon a limited number of counterparties to provide us
      with
      the financing facilities to fund our loan originations. Our ability to fund
      current operations and accumulate loans for securitization depends to a large
      extent upon our ability to secure short-term financing on acceptable terms.
      There can be no assurance that we will be able to either renew or replace our
      warehouse facilities at their maturities at terms satisfactory to us or at
      all.
      If we are not able to obtain financing, we will not be able to originate new
      loans and our business and results of operations will be negatively
      impacted.





**42**


To
      originate and accumulate loans for securitization, we borrow money on a
      short-term basis through committed secured warehouse lines of credit. Throughout
      each quarter as we amass loans for inclusion in each quarter’s securitization, a
      significant portion of our total warehouse financing lines will be utilized
      to
      fund loans. The material terms and features of our financing facilities in
      place
      at March 31, 2006 are as follows:





***RBS Greenwich Capital Warehouse Line of Credit*** *.* We have
      a $350.0 million facility with RBS Greenwich Capital Financial Products, Inc.,
      which bears interest based upon a fixed margin over one-month LIBOR. This
      facility provides us with the ability to borrow against first and second lien
      loans and “wet” collateral, which are loans that have closed and have been
      funded, but for which we have not yet received the loan documents from the
      closing agent. The facility provides the ability to borrow at the lesser of
      98%
      of fair market value or 100% of the par amount of the mortgage loans between
      0
      to 59 days delinquent. Mortgage loans between 60 to 89 days delinquent may
      be
      financed at lower borrowing percentages. This facility expires in October 2006.
      As of March 31, 2006, the outstanding balance under the facility was $23.7
      million.





***Citigroup Warehouse Line of Credit.*** We have
      a $350.0 million facility with Citigroup Global Markets Realty Corp., which
      bears interest based upon a fixed margin over one-month LIBOR. This facility
      provides the ability to borrow against first and second lien loans and wet
      collateral. The facility provides us with the ability to borrow at the lesser
      of
      98% of fair market value or 100% of the par amount of the mortgage loans between
      0 to 59 days delinquent. Mortgage loans between 60 to 89 days delinquent may
      be
      financed at lower borrowing percentages. This facility expires in May 2006.
      As
      of March 31, 2006, the outstanding balance under the facility was $99.5
      million.





***Bank
      of America Warehouse Line of Credit.*** We have
      a $350.0 million facility with Bank of America, LLC which bears interest based
      upon a fixed margin over one-month LIBOR. This facility provides the ability
      to
      borrow against first and second lien loans and wet collateral. The facility
      provides us with the ability to borrow at the lesser of 98% of fair market
      value
      or 100% of the par amount of the mortgage loans between 0 to 59 days delinquent
      and a limited amount of mortgage loans between 60 to 89 days delinquent. This
      facility expires in August 2006. As of March 31, 2006, we had no outstanding
      balance under the facility.





***Friedman,
      Billings, Ramsey Line of Credit.***  We
      have a
      $200.0 million multi-seller asset-backed commercial paper facility with
      Friedman, Billings, Ramsey (“FBR”), which
      bears interest based upon a fixed margin over one-month LIBOR .
      This
      facility allows for the funding and aggregation of mortgage loans using funds
      generated through the sale of short-term commercial paper. This facility expires
      in May 2006. As of March 31, 2006, we had no outstanding balance under the facility .





Our
      warehouse agreements require us to comply with various operating and financial
      covenants. The continued availability of funds provided to us under these
      agreements is subject to, among other conditions, our continued compliance
      with
      these covenants. We believe we were in compliance with these covenants as of
      March 31, 2006.





**Interest
      Rate Risk**





Our primary market risk exposure is interest rate risk. Our results of
      operations may be significantly affected by the level of and fluctuation in
      interest rates. (See “- Item 3. Quantitative and Qualitative Disclosures About
      Market Risk - Interest Rate Risk”).





*Current
      Interest Rate Environment.* Net
      interest income after provision for loan loss represents 72.7% and 71.3% of
      our
      net revenues (net interest income and non-interest income, less provision for
      loan loss) during the three months ended March 31, 2006 and 2005, respectively.
      Accordingly, the interest rate environment has a substantial impact on our
      earnings. Our balance sheet is currently liability sensitive. A company with
      a
      liability sensitive balance sheet generally experiences reduced net interest
      income in a rising or increasing rate environment, while earnings are enhanced
      in a sustained decreasing rate cycle. The impact of the flattening of the yield
      curve recently has negatively impacted our margin since the spread between
      our
      longer-term assets and our shorter-term liabilities has contracted. We would
      expect to be negatively impacted by any substantial sustained decrease in
      long-term interest rates or a parallel shift in interest rates if they
      occur.





**43**


**Valuation
      Risk**





In
      connection with the securitizations structured as sales, we have retained
      certain assets for which the market is limited and illiquid. As a result,
      valuations are derived using complex modeling and significant assumptions and
      judgments, in the absence of active market quotations or sale information to
      value such assets. These retained assets are primarily comprised of excess
      cashflow certificates. The fair value of these assets could vary significantly
      as market conditions change. (See “- Item 2. Management’s Discussion and
      Analysis of Financial Condition and Results of Operations - Summary of Critical
      Accounting Policies - Excess Cashflow Certificates”).





**Credit
      Risk**





A
      significant portion of our loans held for investment have been made to non-prime
      credit borrowers and are secured by residential property. There is no guarantee
      that, in the event of borrower default, we will be able to recoup the full
      principal amount and interest due on a loan. We have adopted underwriting and
      loan quality monitoring systems, procedures and credit policies, including
      the
      establishment and review of the allowance for loan losses, that management
      believe are prudent and appropriate to minimize this risk by tracking loan
      performance, assessing the likelihood of nonperformance and diversifying our
      loan portfolio. Such policies and procedures, however, may not prevent
      unexpected losses that could adversely affect our results.





We
      also
      sell loans on a whole-loan basis, from time-to-time, to banks and other
      financial institutions. When
      we
      sell mortgage loans on a whole-loan basis we are normally subjected to standard
      mortgage industry representations and warranties, which may require us to
      repurchase one or more of the mortgage loans. These representations and
      warranties include provisions requiring us to repurchase a mortgage loan if
      a
      borrower fails to make one or more of the first loan payments due on the
      mortgage loan. In
      these
      instances, we are subject to repurchase risk in the event of a breach of
      standard representations or warranties we make in connection with these
      whole-loan sales.





**Geographical
      Concentration**





Properties
      securing our mortgage loans held for investment are geographically dispersed
      throughout the United States. For the three months ended March 31, 2006,
      approximately 25% and 13%, based upon principal balance, of the mortgage loans
      we originated were on properties located in New York and Florida, respectively,
      with no other state representing more than 7% of the originations.





The
      concentration of mortgage loans in specific geographic areas may increase the
      risk of loss. Economic conditions in the states where borrowers reside may
      affect the delinquency, loss and foreclosure experience of the mortgage loans.
      These states may suffer economic problems or reductions in market values for
      residential properties that are not experienced in other states.





**E** **nvironmental
      Matters**





To
      date,
      we have not been required to perform any environmental investigation or clean-up
      activities, nor have we been subject to any environmental claims. There can
      be
      no assurance, however, that this will remain the case in the future. Although
      we
      primarily lend to owners of residential properties, in the course of our
      business, we may acquire properties securing loans that are in default. There
      is
      a risk that we could be required to investigate and clean-up hazardous or toxic
      substances or chemical releases at these properties, and may be held liable
      to a
      governmental entity or to third parties for property damage, personal injury
      and
      investigation and clean-up costs incurred in connection with the contamination.
      In addition, the owner or former owners of a contaminated site may be subject
      to
      common law claims by third parties based on damages and costs resulting from
      environmental contamination emanating from the property.





**44**


**Inflation**





Inflation affects us most significantly in the areas of mortgage loan
      originations and profit margins. Interest rates normally increase during periods
      of rising inflation (or in periods when the Federal Reserve Bank attempts to
      prevent inflation). Historically, as interest rates increase, mortgage loan
      production decreases, particularly from loan refinancing. Generally, in such
      periods of reduced mortgage loan production the associated profit margins also
      decline due to increased competition among loan originators and due to higher
      unit costs, thus further reducing our earnings. (See “- Item 3. Quantitative and
      Qualitative Disclosures About Market Risk - Interest Rate/Market
      Risk”).





**Impact
      of New Accounting Standards**





*Accounting
      for Certain Hybrid Financial Instruments.* In
      February 2006, the FASB issued SFAS No. 155, which amends SFAS No. 133 and
      No.
      140. SFAS No. 155, among other things, permits fair value re-measurement for
      any
      hybrid financial instrument that contains an embedded derivative that otherwise
      would require bifurcation and clarifies which interest-only strips and
      principal-only strips are not subject to the requirements of SFAS No. 133.
      Additionally, SFAS No. 155 establishes a requirement to evaluate interests
      in
      securitized financial assets to identify interests that are freestanding
      derivatives or that are hybrid financial instruments that contain an embedded
      derivative requiring bifurcation and clarifies that concentrations of credit
      risk in the form of subordination are not embedded derivatives. SFAS No. 155
      amends SFAS No. 140 to eliminate the prohibition on a QSPE from holding a
      derivative financial instrument that pertains to a beneficial interest other
      than another derivative financial instrument. SFAS No. 155 is effective for
      all
      financial instruments acquired or issued after the beginning of an entity’s
      first fiscal year that begins after
      September 15, 2006. We do not expect the adoption of SFAS No. 155 will have
      a
      material impact on our financial condition or results of
      operations.





*Accounting
      for Servicing of Financial Assets.* In
      March
      2006, the FASB issued SFAS No. 156. SFAS No. 156 amends SFAS No. 140 with
      respect to the  accounting
      for separately recognized servicing assets and servicing liabilities. SFAS
      No.
      156 requires, among other things, that (1) an entity recognize a servicing
      asset
      or servicing liability each time it undertakes an obligation to service a
      financial asset by entering into a servicing contract under certain situations
      and (2) all separately recognized servicing assets and servicing liabilities
      to
      be initially measured at fair value, if practicable.





SFAS
      No.
      156 also permits an entity to choose its measurement methods for each class
      of
      separately recognized servicing assets and servicing liabilities. At the date
      SFAS No. 156 is initially adopted, an entity with recognized servicing rights
      is
      permitted a one-time reclassification of available-for-sale securities to
      trading securities, without calling into question the treatment of other
      available-for-sale securities under SFAS No. 115, provided that the
      available-for-sale securities are identified in some manner as offsetting the
      entity’s exposure to changes in fair value of servicing assets or servicing
      liabilities that a servicer elects to subsequently measure at fair
      value.





Additionally
      required by SFAS No. 156 is the separate presentation of servicing assets and
      servicing liabilities subsequently measured at fair value in the statement
      of
      financial position and additional disclosures for all separately recognized
      servicing assets and servicing liabilities.





An
      entity
      should adopt SFAS No. 156 as of the beginning of its first fiscal year that
      begins after September 15, 2006. Earlier adoption is permitted as of the
      beginning of an entity’s fiscal year, provided the entity has not yet issued
      financial statements, including interim financial statements, for any period
      of
      that fiscal year. An entity should apply the requirements for recognition and
      initial measurement of servicing assets and servicing liabilities prospectively
      to all transactions after the effective date of SFAS No. 156. We do not expect
      that the adoption of SFAS No. 156 will have a material impact on our financial
      condition or results of operations.





**Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk.**





We originate mortgage loans and then securitize the mortgage loans or sell
      them
      through whole loan sales. As a result, our primary market risk is interest
      rate
      risk. Interest rates are highly sensitive to many factors,
      including:





·
            governmental
                monetary and tax policies;





·
            domestic
                and international economic and political considerations;
                and





·
            other
                factors that are also beyond our
                control.





**45**


Changes
      in the general interest rate levels between the time we originate mortgage
      loans
      and the time we securitize or sell the mortgage loans can affect their value
      and, consequently, our net interest income revenue by affecting the “excess
      spread” between the interest rate on the mortgage loans and the interest paid on
      the asset-backed securities issued by the securitization trusts. If interest
      rates rise between the time we originate the loans and the time we securitize
      or
      sell the loans, the excess spread generally narrows, resulting in a loss in
      value of the loans and lower net interest income for us on mortgage loans we
      securitize and a lower net gain on sale for us on whole loan sales. Since we
      close and fund mortgage loans at a specified interest rate with an expected
      spread to be earned over their life in the case of securitizations and an
      expected gain on sale to be booked at the time of their sale, our exposure
      to
      decreases in the fair value of the mortgage loans rises when moving from a
      lower
      to a higher interest rate environment. A higher interest rate environment
      results in our having a higher cost of funds. This decreases both the fair
      value
      of the mortgage loans and the net spread we earn between the mortgage interest
      rate on each mortgage loan and our cost of funds under available warehouse
      lines
      of credit used to finance the loans prior to their securitization or sale.
      As a
      result, we may experience lower spreads on securitized loans and a lower gain
      on
      whole-loan sales.





The
      following table demonstrates the sensitivity, at March 31, 2006, of the
      estimated fair value of our excess cashflow certificates caused by an immediate
      10% and 20%, respectively, adverse change in the key assumptions we use to
      estimate fair value:





*(Dollars
                in thousands)*
            
            **Fair
                Value of**
              **Excess
                Cashflow**
              **Certificates**
            
            **Decrease
                (Increase)**
              **To
                Earnings**
              **(Pre-tax
                basis)**Fair
                value as of March 31, 2006
            
            $
            5,05610%
                increase in prepayment speed
            
            
            5,244
            
            $
            (188
            )20%
                increase in prepayment speed
            
            
            5,508
            
            
            (452
            )10%
                increase in credit losses
            
            
            4,722
            
            
            33420%
                increase in credit losses
            
            
            4,492
            
            
            56410%
                increase in discount rates
            
            
            5,013
            
            
            4320%
                increase in discount rates
            
            
            4,978
            
            
            7810%
                increase in one- and six-month LIBOR
            
            
            5,032
            
            
            2420%
                increase in one- and six-month LIBOR
            
            
            5,557
            
            
            (501
            )





The sensitivities are hypothetical and are presented for illustrative purposes
      only. Changes in the fair value resulting from a change in assumptions generally
      cannot be extrapolated because the relationship of the change in assumption
      to
      the resulting change in fair value may not be linear. Each change in assumptions
      presented above was calculated independently, without changing any other
      assumption. However, in reality, changes in one assumption may result in changes
      in another assumption, which may magnify or counteract the sensitivities. For
      example, a change in market interest rates may simultaneously impact prepayment
      speeds, credit losses and the discount rate. It is impossible to predict how
      one
      change in a particular assumption may impact other assumptions.


We regularly issue securitization asset-backed securities collateralized
        by
        fixed- and variable-rate mortgage loans. As a result of this activity, we
        are
        exposed to interest rate risk beginning when our mortgage loans close and
        are
        recorded as assets until permanent financing is arranged, such as when
        asset-backed securities are issued. To reduce our financial exposure to changes
        in interest rates, our strategy is to use derivative instruments, in the
        form of
        interest rate swap contracts, in an effort to effectively lock in a
        pre-determined interest rate on designated portions of our prospective future
        securitization financings. We also use corridors (corresponding purchase
        and
        sale of interest rate caps with similar notional balances at different strike
        prices) that are designed to limit our financing costs within the securitization
        by maintaining minimum margins. (See “- Item 2. - Management’s Discussion and
        Analysis of Financial Condition and Results of Operations - Summary of Critical
        Accounting Policies - Accounting for Hedging Activities”). Changes in interest
        rates also could adversely affect our ability to originate loans and/or could
        affect the level of loan prepayments, impacting the amount of mortgage loans
        held for investment and/or the size of the loan portfolio underlying our
        excess
        cashflow certificates and, consequently, the value of our excess cashflow
        certificates. (See “- Interest Rate Risk/Market Risk” and “Part II. - Item 1A. -
        Risk Factors”).
  **46**


**Interest
      Rate/Market Risk**





Our
      general investment policy is to maintain the net interest margin between assets
      and liabilities.





***Loan Price Volatility*** *.* Under
      our current mode of operation, we depend heavily on the market for wholesale
      non-conforming mortgage loans. To conserve capital, we may sell loans we
      originate. Our financial results will depend, in part, on our ability to find
      purchasers for our loans at prices that cover origination expenses. Exposure
      to
      loan price volatility is reduced as we acquire and retain mortgage
      loans.





***Interest Rate Risk*** *.* Interest
      rates affect our ability to earn a spread between interest received on our loans
      and the cost of our borrowings, including the cost of corridors, if any, that
      are tied to various interest rate swap maturities, LIBOR, and other interest
      rate spread products, such as mortgage, auto and credit card backed receivable
      securities. Our profitability is likely to be negatively impacted during any
      period of unexpected or rapid changes in interest rates. A substantial and
      sustained increase in interest rates could impact our ability to originate
      loans. A significant decline in interest rates could increase the level of
      loan
      prepayments, which would decrease the size of the loan servicing portfolio
      underlying our securitizations. To the extent excess cashflow certificates
      have
      been capitalized on our financial statements, higher than anticipated rates
      of
      loan prepayments or losses could require us to write down the value of these
      excess cashflow certificates, which adversely impact our earnings. In an effort
      to mitigate the effect of interest rate risk, we periodically review our various
      mortgage products and identify and modify those that have proven historically
      more susceptible to prepayments. However, there can be no assurance that these
      modifications to our product line will mitigate effectively any interest rate
      risk in the future.





Periods
      of unexpected or rapid changes in interest rates, and/or other volatility or
      uncertainty regarding interest rates, also can harm us by increasing the
      likelihood that asset-backed investors will demand higher spreads than normal
      to
      offset the volatility and/or uncertainty, which decreases the value of the
      excess cashflow certificates we receive in connection with a
      securitization.





Fluctuating interest rates also may affect the net interest income we earn,
      resulting from the difference between the yield we receive on the loans held
      pending securitization or sale and the interest paid by us for funds borrowed
      under our warehouse facilities. In the past, from time to time, we have
      undertaken specific measures to hedge our exposure to this risk by using
      various hedging strategies, including Fannie Mae mortgage securities, treasury
      rate lock contracts and/or interest rate swaps. (See “- Item 2. - Management’s
      Discussion and Analysis of Financial Condition and Results of Operations -
      Summary of Critical Accounting Policies - Accounting for Hedging Activities”).
      Fluctuating interest rates also may significantly affect the excess cash flows
      from our excess cashflow certificates, as the interest rate on some of our
      asset-backed securities change monthly based on one-month LIBOR, but the
      collateral that backs such securities are comprised of mortgage loans with
      either fixed interest rates or “hybrid” interest rates (*e.g.,* fixed for
      the initial two or three years of the mortgage loan, and adjusting thereafter
      every six month) which creates basis risk. (See “- Item 2. - Management’s
      Discussion and Analysis of Financial Condition and Results of Operations -
      Summary of Critical Accounting Policies - Excess Cashflow Certificates”). With
      our transition to on-balance sheet portfolio securitizations in 2004, we may
      undertake to hedge our exposure to interest rate risk as described above in
“-
      Item 2. - Management’s Discussion and Analysis of Financial Condition and
      Results of Operations - Summary of Critical Accounting Policies - Accounting
      for
      Hedging Activities.”





When interest rates on our assets do not adjust at the same rates as our
      liabilities or when the assets have fixed-rates and the liabilities are
      adjusting, our future earnings potential is affected. We express this interest
      rate risk as the risk that the market value of assets will increase or decrease
      at different rates than that of the liabilities. Expressed another way, this
      is
      the risk that net asset value will experience an adverse change when interest
      rates change. We assess the risk based on the change in market values given
      increases and decreases in interest rates. We also assess the risk based on
      the
      impact to net income in changing interest rate environments.





**47**


Management primarily uses financing sources where the interest rate resets
      frequently. As of March 31, 2006, borrowings under all of our financing
      arrangements adjust daily or monthly. On the other hand, very few of the
      mortgage assets we own adjust on a monthly or daily basis. Most of the mortgage
      loans are fixed-rate; the remainder contains features where their rates are
      fixed for some period of time and then adjust frequently thereafter. For
      example, one of our loan products is the “2/28” loan. This 30-year loan is fixed
      for its first two years and then adjusts every six months
      thereafter.





While
      short-term borrowing rates are low and long-term asset rates are high, this
      portfolio structure enhances our net interest income during the relevant period.
      However, if short-term interest rates rise rapidly, the earnings potential
      is
      significantly affected, as the asset rate resets would lag behind the borrowing
      rate resets.





***Interest Rate Sensitivity Analysis.*** To
      assess interest sensitivity as an indication of exposure to interest rate risk,
      management relies on models of financial information in a variety of interest
      rate scenarios. Using these models, the fair value and interest rate sensitivity
      of each financial instrument, or groups of similar instruments, is estimated
      and
      then aggregated to form a comprehensive picture of the risk characteristics
      of
      the consolidated balance sheet.





We
      measure the sensitivity of our net interest income to changes in interest rates
      affecting interest sensitive assets and liabilities using various interest
      rate
      simulations. These simulations take into consideration changes that may occur
      in
      the forward LIBOR curve and changes in mortgage prepayment speeds.





As
      part
      of various interest rate simulations, we calculate the effect of potential
      changes in interest rates on our interest-earning assets and interest-bearing
      liabilities and their effect on overall earnings. The simulations assume
      instantaneous and parallel shifts in interest rates and to what degree those
      shifts affect net interest income. First, we project our net interest income
      for
      the next 12 months and 36 months using current period end data along with a
      forward LIBOR curve and the prepayment speed assumptions we used to estimate
      the
      fair value of our excess cashflow certificates.





We
      refer
      to the one-year and the three-year projections of net interest income as the
      “base case.”  Second, once the base case has been established, we “shock”
the base case with instantaneous and parallel shifts in interest rates in 100
      basis point increments upward and downward. Calculations are made for each
      of
      the defined instantaneous and parallel shifts in interest rates over or under
      the forward LIBOR curve used to determine the base and including any associated
      changes in projected mortgage prepayment speeds. The following sensitivity
      tables present the results of each 100 basis point change in interest rates
      compared against the base case to determine the estimated dollar and percentage
      change to net interest income at March 31, 2006:





*(Dollars
                in thousands)*
            
            **Base
                Case**
            
            **Up
                100 Basis Points**
            
            **Up
                200 Basis Points**
            
            **Down
                100 Basis Points**
            
            **Down
                200 Basis Points*****One
                Year Projection:***Net
                interest income(1)(2)
            
            $
            114,413
            
            $
            111,807
            
            $
            110,191
            
            $
            118,576
            
            $
            125,769Percentage
                change from base
            
            
            
            
            
            (2.28)%
            
            
            (3.69)%
            
            
            3.64%
            
            
            9.93%***Three
                Year Projection:***Net
                interest income(1)(2)
            
            $
            218,631
            
            $
            211,755
            
            $
            206,966
            
            $
            227,320
            
            $
            239,395Percentage
                change from base
            
            
            
            
            
            (3.14)%
            
            
            (5.34)%
            
            
            3.97%
            
            
            9.50%





*(1)*  *Net
      interest income from assets (income from mortgage loans held for investment
      and
      interest rate caps) less expense from liabilities (financing on mortgage loans
      held for investment and warehouse interest expense) in a parallel shift in
      the
      yield curve, up and down 1% and 2%.*





*(2)*  *Assumes
      warehouse interest expense through June 30, 2006.*





**48**


Because
      the assumptions used in the sensitivity tables are inherently uncertain, we
      cannot predict precisely the effect of higher or lower interest rates on net
      interest income. Actual results will differ from simulated results due to the
      timing, magnitude and frequency of interest rate changes, the difference between
      actual experience and the assumed volume and characteristics of new business
      and
      behavior of existing positions, and changes in market conditions and management
      strategies, among other factors.





***Hedging*** *.* From an
      interest rate risk management perspective, we use interest rate swaps and
      corridors in an effort to offset the potential adverse effects of our exposure
      during a period of rising rates. In this way, management intends generally
      to
      hedge as much of the interest rate risk as determined to be in our best
      interest, given the cost of hedging transactions.





We
      seek
      to build a consolidated balance sheet and undertake an interest risk management
      program that is likely, in management’s view, to enable us to maintain an equity
      liquidation value sufficient to maintain operations given a variety of
      potentially adverse circumstances. Accordingly, the hedging program addresses
      income preservation, as discussed in the first part of this
      section.





Corridors are legal contracts between us and a third party firm or
“counterparty.” The counterparty agrees to make payments to us in the future
      (net of the in-the-money interest rate cap sold as part of the corridor) should
      the one- or three-month LIBOR interest rate rise above the strike rate specified
      in the net purchased option contract. Each contract has both a fixed or
      amortizing notional face amount on which the interest is computed, and a set
      term to maturity. When the referenced LIBOR interest rate rises above the
      contractual strike rate, we earn corridor income (net of the in-the-money
      interest rate cap sold as part of the corridor). Payments on an annualized
      basis
      equal the difference between actual LIBOR and the strike rate. Interest rate
      swaps have similar characteristics. However, interest rate swap agreements
      allow
      us to pay a fixed-rate of interest while receiving a rate that adjusts with
      one-month LIBOR.





**Maturity
      and Repricing Information**





The
      following table summarizes the notional amount, expected maturities and weighted
      average strike rates for corridors that we held as of March 31,
      2006:





*(Dollars
                in thousands,**except
                strike price)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years & Thereafter**Caps
                bought - notional
            
            $
            2,169,692
            
            $
            1,493,065
            
            $
            423,062
            
            $
            115,219
            
            $
            34,554
            
            $
            103,792Weighted
                average strikeprice
            
            $
            6.12
            
            $
            5.45
            
            $
            6.84
            
            $
            7.47
            
            $
            7.47
            
            $
            7.41Caps
                sold - notional
            
            $
            2,169,692
            
            $
            1,493,065
            
            $
            423,062
            
            $
            115,219
            
            $
            34,554
            
            $
            103,792Weighted
                average strikeprice
            
            $
            8.70
            
            $
            8.32
            
            $
            9.24
            
            $
            9.30
            
            $
            9.27
            
            $
            9.29





**Item
      4. Controls and
      Procedures.**





Prior to the filing of this report, management, including the Chief Executive
      Officer and Chief Financial Officer, evaluated the effectiveness and operation
      of our disclosure controls and procedures. Our Chief Executive Officer and
      Chief
      Financial Officer concluded that, as of March 31, 2006, these disclosure
      controls and procedures were effective to ensure that information required
      to be
      disclosed in the reports we file or submit under the Securities Exchange Act
      of
      1934 is recorded, processed, summarized and reported as and when required.
      Our
      Chief Executive Officer and Chief Financial Officer have concluded that our
      disclosure controls and procedures also are effective to ensure that the
      information required to be disclosed in the reports that we file or submit
      under
      the Exchange Act is accumulated and communicated to management, including our
      Chief Executive Officer and Chief Financial Officer, as appropriate to allow
      timely decisions regarding required disclosure. There were no significant
      deficiencies or material weaknesses identified during the course of this
      evaluation.  There have not been any changes in our internal controls over
      financial reporting that occurred during the three months ended March 31, 2006
      that materially affected, or are reasonably likely to materially affect, our
      internal controls over financial reporting.




**49**


**Part
      II - OTHER INFORMATION**





**Item
      1. Legal Proceedings.**





Because
      the nature of our business involves the collection of numerous accounts, the
      validity of liens and compliance with various state and federal lending laws,
      we
      are subject, in the normal course of business, to numerous claims and legal
      proceedings, including class actions. The current status of the pending class
      actions and other material litigation is summarized below:





·
            In
                or about November 1998, we received notice that we had been named
                in a
                lawsuit filed in the United States District Court for the Eastern
                District
                of New York. In December 1998, the plaintiffs filed an amended complaint
                alleging that we had violated theHome
                Ownership and Equity Protection Act of 1994,
                theTruth-in-Lending
                Act,
                and Section 349 of the New York State General Business Law, which
                relates
                to consumer protection for deceptive practices. The complaint sought:
                (a)
                certification of a class of plaintiffs, (b) declaratory judgment
                permitting rescission, (c) unspecified actual, statutory, treble
                and
                punitive damages, including attorneys’ fees, (d) injunctive relief and (e)
                declaratory judgment declaring the loan transactions as void and
                unconscionable. On December 7, 1998, plaintiff filed a motion seeking
                a
                temporary restraining order and preliminary injunction, enjoining
                us from
                conducting foreclosure sales on 11 properties. The District Court Judge
                ruled that in order to consider the motion, plaintiff must move to
                intervene on behalf of these 11 borrowers. Thereafter, plaintiff
                moved to
                intervene on behalf of three of these 11 borrowers and sought injunctive
                relief on their behalf. We opposed the motions. On December 14, 1998,
                the
                District Court Judge granted the motion to intervene and on December
                23,
                1998, the District Court Judge issued a preliminary injunction that
                enjoined us from proceeding with the foreclosure sales of the three
                interveners’ properties. We filed a motion for reconsideration of the
                December 23, 1998 order. In January 1999, we filed an answer to
                plaintiffs’ first amended complaint. In July 1999, the plaintiffs were
                granted leave, on consent, to file a second amended complaint. In
                August
                1999, the plaintiffs filed a second amended complaint that, among
                other
                things, added additional parties but contained the same causes of
                action
                alleged in the first amended complaint. In September 1999, we filed
                a
                motion to dismiss the complaint, which was opposed by plaintiffs
                and, in
                June 2000, was denied in part and granted in part by the District
                Court.
                In or about October 1999, plaintiffs filed a motion seeking an order
                preventing us, our attorneys and/or the New York State Banking Department
                ("NYSBD") from issuing notices to a number of our borrowers, in accordance
                with the settlement agreement entered into by and between the NYSBD
                and
                us. In the fourth quarter of 1999, we and the NYSBD submitted opposition
                to the plaintiffs’ motion. In March 2000, the District Court issued an
                order that permitted us to issue an approved form of the notice.
                In
                September 1999, the plaintiffs filed a motion for class certification,
                which we opposed in February 2000, and which was ultimately withdrawn
                without prejudice by the plaintiffs in January 2001. In February
                2002, we
                executed a settlement agreement with the plaintiffs, under which
                we denied
                all wrongdoing, but agreed to resolve the litigation on a class-wide
                basis. The District Court preliminarily approved the settlement and
                a
                fairness hearing was held in May 2002. We submitted supplemental
                briefing
                at the District Court’s request in or about April 2004. In August 2004,
                the District Court conditionally approved the settlement, subject
                to our
                submitting supplemental documentation regarding a change in the settlement
                agreement and proposed supplemental notices to be sent to those borrowers
                who either opted out or objected. We, plaintiffs and certain objectors
                submitted our respective supplemental submissions in August 2004
                and the
                District Court granted its final approval to the settlement in January
                2005. In February 2005, certain objectors filed a notice of appeal.
                The
                objectors filed their appellate brief in July 2005. We filed our
                appellate
                papers in opposition in September 2005, and the objectors filed their
                reply papers in September 2005. In February 2006, the Appellate Court
                vacated the District Court’s decision to approve the settlement, not based
                on the merits of the settlement, but because a motion to intervene
                was
                decided by the District Court magistrate judge and not the District
                Court
                judge. The Appellate Court instructed the District Court judge to
                rule on
                the motion to intervene and, until then, it cannot be determined
                if the
                District Court judge will also have to rule on the fairness of the
                settlement, or if that issue will have to return to the Appellate
                Court.
                If the settlement is not approved, we believe we have meritorious
                defenses
                and intend to vigorously defend this suit, but cannot estimate with
                any
                certainty our ultimate legal or financial liability, if any, with
                respect
                to the alleged claims.






**50**


·
            In
                or about March 1999, we received notice that we and certain of our
                officers and directors had been named in a lawsuit filed in the Supreme
                Court of the State of New York, New York County, alleging that we
                had
                improperly charged certain borrowers processing fees. The complaint
                sought: (a) certification of a class of plaintiffs, (b) an accounting
                and
                (c) unspecified compensatory and punitive damages, including attorneys’
                fees, based upon alleged (i) unjust enrichment, (ii) fraud and (iii)
                deceptive trade practices. In April 1999, we filed an answer to the
                complaint. In September 1999, we filed a motion to dismiss the complaint,
                which was opposed by the plaintiffs, and in February 2000, the Court
                denied the motion to dismiss. In April 1999, we filed a motion to
                change
                venue and the plaintiffs opposed the motion. In July 1999, the Court
                denied the motion. We appealed, and in March 2000, the Appellate
                Court
                granted our appeal to change venue from New York County to Nassau
                County.
                In August 1999, the plaintiffs filed a motion for class certification,
                which we opposed in July 2000. In or about September 2000, the Appellate
                Court granted the plaintiffs’ motion for class certification, from which
                we appealed. The Appellate Court denied our appeal in December 2001.
                In or
                about June 2001, we filed a motion for summary judgment to dismiss
                the
                complaint, which was denied by the Court in October 2001. We appealed
                that
                decision, but the Appellate Court denied our appeal in November 2002.
                We
                filed a motion to reargue in December 2002, which was denied by the
                Appellate Court in January 2003. Discovery is continuing in the lower
                Court. We believe that we have meritorious defenses and intend to
                vigorously defend this suit, but cannot estimate with any certainty
                our
                ultimate legal or financial liability, if any, with respect to the
                alleged
                claims.





·
            In
                July 2003, we commenced a lawsuit in the Supreme Court of the State
                of New
                York, Nassau County, against Delta Funding Residual Exchange Company
                LLC
                (the “LLC”), an unaffiliated limited liability company, Delta Funding
                Residual Management, Inc. (“DFRM”), and James E. Morrison, President of
                the LLC and DFRM, alleging that (1) the LLC breached its contractual
                duties by failing to pay approximately $142,000 due to us in June
                2003,
                and (2) that Mr. Morrison and DFRM knowingly and intentionally caused
                the
                default, thereby breaching their respective fiduciary duties to the
                LLC.
                The complaint seeks: (a) payment of amounts past due under our agreement
                with the LLC, plus interest (b) specific performance of the LLC’s
                obligations to us in the future and (c) monetary damages for breach
                of
                fiduciary duty, in an amount to be determined by the Court. In September
                2003, Mr. Morrison, the LLC and DFRM filed a motion to dismiss our
                complaint and the LLC and DFRM filed a countersuit in the Supreme
                Court of
                the State of New York, New York County, against several of our directors
                and officers and us seeking, among other things, damages of not less
                than
                $110 million. The countersuit alleges misrepresentation, negligence
                and/or
                fraud by defendants in that case relating to our August 2001 exchange
                offer. In October 2003, we filed our opposition to the motion to
                dismiss
                and cross-moved to consolidate the two actions in Nassau County.
                In
                November 2003, we answered the New York County action. In February
                2004,
                the Nassau County Supreme Court denied Mr. Morrison’s motion to dismiss
                our causes of action seeking (a) payment of amounts due under our
                agreements with the LLC and (b) monetary damages for breach of fiduciary
                duty, and granted Mr. Morrison’s motion to dismiss our cause of action
                seeking specific performance to preclude future defaults by Morrison
                and
                the LLC. The Supreme Court also granted our motion to consolidate
                the
                cases in Nassau County. In April 2004, we filed a motion to dismiss
                Mr.
                Morrison’s countersuit, which the Supreme Court denied in September 2004.
                Discovery is proceeding. In or about October 2004, the LLC commenced
                an
                action against KPMG LLP based upon similar allegations as asserted
                in this
                action. In September 2005, it was agreed that the action against
                KPMG LLP
                would be joined with this action. In the countersuit, the LLC was
                granted
                permission to serve an amended complaint, which it did in November
                2005.
                The amended complaint included two additional causes of action alleging
                breach of fiduciary duty owed to the LLC, one against us and the
                other
                against several of our officers and directors. In December 2005,
                we filed
                a motion to amend our complaint to add claims (both individually
                and as a
                member of the LLC) against Mr. Morrison arising from the same and/or
                similar facts and circumstances, seeking recovery for waste, for
                improper
                personal benefit, for breach of fiduciary duty (beyond those already
                alleged in the complaint) and for a material misstatement in the
                LLC’s
                financial statements. In April 2006 the Supreme Court dismissed our
                motion
                to amend and granted us permission to revise the motion and refile
                it. We
                believe we have meritorious claims in our lawsuit and meritorious
                defenses
                in the countersuit. We intend to vigorously prosecute our claims
                and
                vigorously defend ourselves against the countersuit. We cannot estimate
                with any certainty our ultimate legal or financial recovery and/or
                liability, if any, with respect to the alleged claims in the
                countersuit.





**51**


·
            In
                or about December 2003, we received a notice that we had been named
                in two
                lawsuits filed by the same plaintiff in the Circuit Court, Third
                Judicial
                Circuit in Madison County, Illinois. One alleged that we had improperly
                charged certain borrowers fax fees, and one alleged that we improperly
                retained extra per diem interest when loans were satisfied. The complaints
                seek (a) certification of a class of plaintiffs, (b) direction to
                return
                fax fees charged to borrowers, and (c) unspecified compensatory and
                statutory damages, including prejudgment and post judgment interest
                and
                attorneys’ fees, based upon alleged (1) breach of contract, (2) statutory
                fraud and (3) unjust enrichment. In February 2004, we filed a motion
                to
                dismiss the case pertaining to fax fees claims. The plaintiff was
                granted
                leave to file a motion to amend his complaint in the fax fee case,
                which
                rendered our February 2004 motion to dismiss moot. The plaintiff
                filed an
                amended complaint in July 2004 and we filed a new motion to dismiss
                in
                August 2004, which the court denied in January 2005, and we have
                since
                filed an answer in that case. In March 2004, we filed a motion to
                dismiss
                the case pertaining to per diem interest claims, which the court
                denied in
                September 2004. We have since filed an answer in that case and plaintiffs
                filed a motion to dismiss our affirmative defenses, which the Circuit
                Court granted, permitting us leave to replead the defenses with more
                particularity, which we have done. Discovery has commenced in both
                cases.
                In June 2005, we filed opposition papers to the plaintiff’s motion for
                class certification in the case pertaining to fax fee claims. We
                believe
                that we have meritorious defenses and intend to vigorously defend
                these
                suits, but cannot estimate with any certainty our ultimate legal
                or
                financial liability, if any, with respect to the alleged
                claims.





·
            In
                our about November 2004, we received notice that we have been named
                in a
                lawsuit styled as a collective action filed in the United States
                District
                Court of the Western District of Pennsylvania, alleging that our
                subsidiary, Fidelity Mortgage Inc. (“Fidelity”), did not pay its loan
                officers overtime compensation and/or minimum wage in violation of
                the
                Federal Fair Labor Standards Act. The complaint seeks: (1) an amount
                equal
                to the unpaid wages at the applicable overtime rate, (2) an amount
                equal
                to the minimum wages at the applicable minimum wage, (3) an equal
                amount
                as liquidated damages, (4) costs and attorneys’ fees, (5) leave to add
                additional plaintiffs and (6) leave to amend to add claims under
                applicable state laws. We filed an answer and discovery has commenced.
                In
                April 2005, the plaintiff filed his motion for conditional class
                certification and in May 2005, Fidelity filed its opposition to that
                motion. In June 2005, the Magistrate Judge issued a Report and
                Recommendation, recommending that the plaintiff’s motion for conditional
                class certification be granted, and that plaintiff’s motion to authorize
                judicial notice be granted (subject to revision and final approval
                by the
                District Court). In July 2005, Fidelity filed with the District Court
                its
                objections to the Magistrate Judge’s Report and Recommendation and the
                plaintiff filed its opposition to our objections. In July 2005, the
                District Court upheld the Magistrate Judge’s Report and Recommendation.
                Any potential class members who desired to join the collective action
                were
                provided an opportunity to do so during an “opt-in” period that ended in
                October 2005. Approximately 180 individuals, virtually all of whom
                are
                former employees, are plaintiffs in the collective action. In April
                2006,
                the plaintiffs filed a motion for summary judgment, which we expect
                to
                oppose in May 2006. We believe that we have meritorious defenses
                and
                intend to vigorously defend this suit, but cannot estimate with any
                certainty our ultimate legal or financial liability, if any, with
                respect
                to the alleged claims.





**Item
      1A. Risk Factors.**


Certain
        information contained in this Quarterly Report constitutes forward-looking
        statements within the meaning of Section 27A of the Securities Act of 1933
        and
        Section 21E of the Securities Exchange Act of 1934, which
        involve risks and uncertainties that exist in our operations and business
        environment, and are subject to change based on a variety of important factors.
        Generally, forward-looking statements can be identified by the use of
        forward-looking terminology including, but not limited to, “anticipate that,”
“believes,” “continue to,” “estimates,” “expects to,” “hopes,” “intends,” “may,”
“plans,” “potential,” “predict,” “should,” “could,” “is likely to,” “believe,”
“to be,” “will be,” “will continue to be,” or similar words or terminology. These
        statements include, but are not limited to, our future profitability and
        our
        future net interest income, our future cash flows and liquidity requirements,
        the future performance of our loan portfolios, our plans to grow originations,
        the impact of changes in interest rates, our future hedging strategy, the
        anticipated impact to our financial statements of our change to our accounting
        for securitizations, our ability to realize benefits from our deferred tax
        asset, and our anticipated outcome of litigation and regulatory matters, as
        well
        as statements expressing optimism or pessimism about future operating
        results .
        Such
        statements are subject to the “safe harbor” provisions of the Private Securities
        Litigation Reform Act (“PSLRA”) of 1995. The
        forward-looking statements are based upon management’s views and assumptions as
        of the date of this Quarterly Report, regarding future events and operating
        performance and are applicable only as of the date of such statements. By
        their
        nature, all forward-looking statements involve risk and uncertainties. We
        caution readers that numerous important factors discussed in this section
        , or
        detailed in our Annual Report on Form 10-K for the year ended December 31,
        2005
        under the caption "Risk Factors,", in some cases have caused, and in the
        future
        could cause, our actual results to differ materially from those expressed
        in any
        forward-looking statements made in this Quarterly Report.
  **52**


The
      following risks and uncertainties, and those contained in our Annual Report
      on
      10-K for the year ended December 31, 2005, should be considered in evaluating
      forward-looking statements, and undue reliance should not be placed on any
      such
      forward-looking statements. We undertake no obligation to update publicly any
      of
      these statements in light of future events except as required by law. There
      can
      be no assurance, however, that our expectations will necessarily come to pass. The
      following include some, but not all, of the factors or uncertainties that could
      cause our actual results to differ from our projections:





·
            Our
                ability or inability to earn a sufficient spread between our cost
                of funds
                and our average mortgage rates to generate sufficient revenues and
                cash
                flows to offset our current cost structure and cash
                uses;





·
            Our
                ability or inability to originate a sufficient amount of mortgage
                loans,
                and subsequent sale or securitization of such loans, to offset our
                current
                cost structure and cash uses;





·
            Our
                ability or inability to continue our practice of securitizing mortgage
                loans, as well as our ability to utilize optimal securitization structures
                (including the sale of MSRs, at the time of securitization) at terms
                favorable to us to generate sufficient cash proceeds to offset our
                current
                cost structure;





·
            Our
                ability or inability to manage interest rate risk. Our primary interest
                rate exposure relates to our mortgage loans and variable-rate debt,
                as
                well as the interest rate swaps and caps that we use for risk management
                purposes. Changes in interest rates may affect our net interest income,
                which is the difference between the interest income we earn on our
                interest-earning assets and the interest expense we incur on our
                interest-bearing liabilities. Changes in the level of interest rates
                also
                can affect our ability to originate or acquire mortgage loans, the
                value
                of our assets and our ability to realize gains from the sale of such
                assets. In a period of rising short-term interest rates, our interest
                expense could increase while the interest we earn on our interest-earning
                assets would not change as rapidly.We
                generally finance loans prior to securitization or whole-loan sale
                through
                warehouse financing. The net income we receive on these mortgage
                loans is
                the difference between the interest income we receive from the borrower
                on
                the mortgage loan, less the sub-servicing fee and interest expense
                we pay.
                The warehouse financing is based upon one-month LIBOR. An increase
                in
                one-month LIBOR, without a corresponding increase in the rates at
                which we
                lend would reduce our net income;





·
            The
                impact of changes in our accounting policies, including our change
                to
                on-balance sheet treatment of our
                securitizations;





·
            Our
                ability or inability to continue to employ on-balance sheet
                securitizations to generate cash flows and earnings from net interest
                spread income;





·
            Our
                ability or inability to continue to access lines of credit at favorable
                terms and conditions, including without limitation, warehouse and
                other
                credit facilities used to finance newly originated mortgage loans
                held for
                investment - pre-securitization and our ability or inability to comply
                with covenants contained in these lines of credit.  In
                the past our warehouse providers have agreed to increase the available
                capacity on our warehouse lines beyond their contractual limits.
                There can
                be no assurance that our warehouse providers would do so in the future
                should the need arise;





**53**


·
            The
                effects of interest rate fluctuations and our ability or inability
                to
                hedge effectively against these fluctuations in interest rates, the
                effect
                of changes in monetary and fiscal policies, social and economic
                conditions, unforeseen inflationary pressures and monetary
                fluctuation;





·
            Any
                significant change in the credit quality of our loan portfolio would
                have
                a significant effect on our financial position and results of
                operations.





·
            Increased
                competition within our markets, particularly in the wholesale loan
                channel, where an increasing number of lenders are competing for
                business
                from independent mortgage brokers;





·
            The
                potential effect that possible conflicts with other sovereign nations,
                including the conflict in Iraq, or terrorist acts and/or threats,
                may have
                on the U.S. economy and capital markets, and in particular the
                asset-backed market;





·
            Our
                loan products may require payment adjustments during the term of
                the
                mortgage loan that may result in increased payment defaults by borrowers
                and higher losses to us. Some of our loan products require payment
                adjustments during the term of the mortgage loan. This can result
                in
                payment defaults by borrowers who are unprepared or unable to meet
                higher
                payment requirements. In addition, some of our loan products do not
                amortize evenly and generally enable the borrower to either pay only
                interest for several years before the loan begins amortizing or pay
                a
                reduced principal and interest payment for the first 10 years. These
                loan
                products, in addition to possibly having increased payment defaults,
                also
                may result in higher losses to us due to higher principal balances
                outstanding at the time of a borrower default than would be the case
                for a
                loan that amortizes evenly throughout its
                term;





·
            Our
                ability to securitize or sell certain of the mortgage loans we originate
                depends upon the acceptance of those products by various parties
                in the
                market, including, among others, underwriters or purchasers of our
                asset-backed securities, ratings agencies, bond insurers and/or whole
                loan
                purchasers. Any one of these or other parties can determine that
                certain
                of the loan products that we originate (now or in the future) are
                undesirable or problematic, which can make it more difficult to securitize
                these loans or sell them at par in the future. Our inability to securitize
                or sell certain types of loan products in the future may cause us
                to
                retain such loans in our portfolio, which may have an adverse impact
                on
                our cash position or generate losses, or sell them at a significant
                discount, which may generate
                losses;





·
            The
                effect that the adoption of new, or amendments to, federal, state
                or local
                lending laws and regulations and the application of these laws and
                regulations may have on our ability to originate loans within a particular
                area, or to ultimately sell those loans through securitization or
                on a
                whole-loan basis. In some instances, we may choose or be forced to
                severely limit, or even cease, our lending activities in a particular
                area. Many states and local municipalities have adopted and/or are
                considering adopting laws that are intended to further regulate our
                industry. Many of these laws and regulations seek to impose broad
                restrictions on certain commonly accepted lending practices, including
                some of our practices. In addition, federal, state and local laws
                could
                impact O/C requirements set by the rating agencies, which could decrease
                the cash proceeds we may receive from our
                securitizations;





·
            Changes
                in the deductibility of mortgage interest and real estate taxes could
                decrease our loan production and harm our business.Members
                of Congress and government officials have from time to time suggested
                the
                elimination of deductions for mortgage interest and real estate taxes
                for
                federal income tax purposes, either entirely or in part. The competitive
                advantages of tax deductible interest and real estate taxes, when
                compared
                to alternative sources of financing, could be eliminated or seriously
                impaired by this change. Accordingly, the reduction or elimination
                of
                these tax benefits could reduce the demand for our mortgage
                loans;





·
            Costs
                associated with litigation and rapid or unforeseen escalation of
                the cost
                of regulatory compliance, generally including but not limited to,
                the
                adoption of new, or changes in, federal, state or local lending laws
                and
                regulations and the application of such laws and regulations, licenses,
                environmental compliance, the adoption of new, or changes in, accounting
                policies and practices and the application of such policies and practices.
                Failure to comply with various federal, state and local regulations,
                accounting policies and/or environmental compliance can lead to the
                loss
                of approved status, rights of rescission for mortgage loans, class
                action
                lawsuits, demands for indemnification or loan repurchases by purchasers
                of
                our loans and administrative enforcement action again
                us;





**54**


·
            Potentially
                unfavorable outcomes related to pending legal matters, including
                those
                matters described above in “Item 1. - Legal
                Proceedings;”





·
            Our
                ability or inability to find alternative methods of generating retail
                leads and originating retail loans in light of the Federal Trade
                Commission (“FTC”) “do not call” registries, which were implemented in
                2003 and may limit our ability to utilize telemarketing to generate
                retail
                leads and originate retail loans. Our marketing operations are or
                may
                become subject to various federal and state “do not call” list
                requirements. Under the FTC’s regulations, consumers may have their phone
                numbers added to the national “do not call” registry. Generally, we are
                prohibited from cold calling anyone on that registry. These regulations
                may restrict our ability to market effectively our products and services
                to new customers. Furthermore, compliance with these regulations
                may prove
                costly and difficult, and we may incur penalties for improperly conducting
                our marketing activities;





·
            The
                risk that we will be subject to claims under environmental
                laws;





·
            Geopolitical
                risks, such as terrorist attacks in the United States or other parts
                of
                the world, conflicts involving the United States or its allies, or
                military or trade disruptions, may harm our business. These types
                of
                events could cause, among other things, the delay or cancellation
                of plans
                to finance a mortgage with us on the part of our customers or potential
                customers, or could negatively impact the capital markets and the
                asset-backed market in particular. Any of these events could cause
                business and consumer confidence and spending to decrease further,
                resulting in increased volatility in the United States and worldwide
                financial markets and potentially an economic recession in the United
                States and internationally, which could harm our
                business;





·
            Natural
                disasters may adversely affect the performance of mortgage loans
                in a
                variety of ways, including but not limited to, impacting borrowers’
                abilities to repay their loans, displacing the homeowners due to
                severe
                damage to the properties, and decreasing in the value of the mortgaged
                property, which may result in increased losses to us. Additionally,
                claims
                for insurance recoveries may be disputed if insured parties and their
                insurers disagree in their assessments or type of insurable damage,
                causing the timing and receipt of insurance payments for damages
                to be
                delayed or made at amounts lower than expected, if at all. We may
                not be
                able to readily determine the particular nature of such economic
                effects,
                how long any of these effects may last, or the impact on the performance
                of mortgage loans affected by the natural
                disaster;





·
            The
                risk that any material decline in real estate values would weaken
                our
                collateral loan-to-value ratios and increase the possibility of loss
                if a
                borrower defaults. In such event, we would be subject to the risk
                of loss
                on such mortgage asset arising from borrower defaults to the extent
                not
                covered by a third-party credit
                enhancement;





·
            The
                risk that using Insured AVMs in lieu of appraisals could increase
                our
                losses. An AVM may be considered a less accurate measure to value
                a
                property than a full appraisal with an interior inspection performed
                by a
                licensed appraiser. If the values received from the AVM are higher
                than
                the actual property values, we may incur higher losses. While we
                obtain an
                insurance policy on the AVM value at the time of origination, there
                can be
                no assurance that we will recover claims from this policy in the
                event of
                a loss;





·
            Our
                ability or inability to detect misrepresentations, fraudulent information
                or negligent acts on the part of loan applicants, mortgage brokers,
                other
                vendors or our employees in our loan originations prior to funding
                and the
                effect it may have on our business, including potentially harming
                our
                reputation or resulting in poorer performing loans. A loan obtained
                as a
                result of a material misrepresentation is typically unsaleable or
                subject
                to repurchase if it is sold prior to detection of the
                misrepresentation;





**55**


·
            The
                risks of defaults on the loans that we make to non-prime credit borrowers,
                and that our underwriting and loan quality monitoring systems will
                not be
                sufficient to minimize the impact from these
                defaults;





·
            The
                risk that demand for cash-out refinancing may decrease as interest
                rates
                rise and the prices of homes decline, which would reduce our origination
                volumes for this type of
                refinancing;





·
            The
                risk that we may need to repurchase loans securitized or sold on
                a
                whole-loan basis if we breach the representations and warranties
                that we
                make in connection with the sales;





·
            Our
                ability or inability to continue monetizing our existing excess cashflow
                certificates, including without limitation, selling, financing or
                securitizing such assets;





·
            The
                accuracy of our estimates of the value of our excess cashflow
                certificates;





·
            Periods
                of general economic slowdown or recession may be accompanied by decreased
                demand for consumer credit and declining real estate values. Because
                of
                our focus on credit-impaired borrowers, the actual rate of delinquencies,
                foreclosures and losses on loans affected by the borrowers’ reduced
                ability to use home equity to support borrowings could be higher
                than
                those generally experienced in the mortgage lending industry. We
                are
                particularly subject to economic conditions in the northeastern U.S.,
                where approximately 44.0% of our loans were originated during the
                three
                months ended March 31, 2006. Any sustained period of increased
                delinquencies, foreclosure, losses or increased costs could adversely
                affect our ability to securitize or sell loans in the secondary
                market;





·
            The
                effect that poor servicing or collections by third-party servicers
                that
                service the loans we originate, and/or regulatory actions and class
                action
                lawsuits against these servicers, could have on the value of our
                excess
                cashflow certificates, the net interest spread we earn, and/or our
                ability
                to sell or securitize loans in the
                future;





·
            A
                  decline in the quality of servicing and/or a degradation in the
                  financial
                  condition of the entity servicing our mortgage loans could lower
                  the value
                  of our excess cashflow certificates and our securitized loan portfolio,
                  as
                  well as our ability to sell or securitize loans. In May 2001, we
                  transferred our servicing portfolio to Ocwen Federal Bank FSB,
                  a
                  subsidiary of Ocwen Financial Corporation and a related predecessor
                  entity
                  to Ocwen Loan Servicing, LLC, which presently services our loan
                  portfolio.
                  Poor servicing by Ocwen Loan Servicing, LLC (or its parent or
                  subsidiaries) or any other third party servicer who services the
                  loans we
                  originate could harm the value of securitized mortgage loans (and
                  our
                  excess cashflow certificates in pre-2004 securitizations) and our
                  ability
                  to sell or securitize loans. Additionally, regulatory actions and
                  class
                  action lawsuits against these servicers could harm the value of
                  our
                  securitized loans (and our excess cashflow certificates in pre-2004
                  securitizations) and our ability to sell or securitize loans. Ocwen
                  Financial Corporation and several of its affiliates have been named
                  as
                  defendants in a number of purported class action lawsuits that
                  challenge
                  its servicing practices under applicable federal and state laws.
                  In
                  addition, on November 29, 2005, a jury in County Court for Galveston
                  County, Texas, returned a verdict of $11,500,000 in compensatory
                  and
                  punitive damages and attorneys' fees against Ocwen Loan Servicing,
                  LLC, in
                  favor of a plaintiff borrower who defaulted on a mortgage loan
                  it
                  serviced. The plaintiff claimed that Ocwen Loan Servicing, LLC's
                  foreclosure on the loan violated the Texas Deceptive Trade Practices
                  Act
                  and other state statutes and common law. On February 9, 2006, the
                  trial
                  court reduced the jury verdict and entered judgment in the amount
                  of
                  $1,830,375. Ocwen Loan Servicing, LLC believes the judgment was
                  against
                  the weight of evidence and contrary to law and has asked the trial
                  court
                  to set it aside. Ocwen Loan Servicing, LLC intends to continue
                  to
                  vigorously defend this matter and, if necessary, intends to take
                  an appeal
                  to the Texas Court of Appeals. Further, according to its public
                  filings,
                  Ocwen Financial Corporation and its affiliates maintain high levels
                  of
                  indebtedness. Ocwen Financial Corporation is a non-investment grade
                  company and recently terminated its banking subsidiary's status
                  as a
                  federal savings bank under supervision of the Office of Thrift
                  Supervision
                  ("OTS") and Federal Deposit Insurance Corporation ("FDIC") and
                  has
                  obtained, or is in the process of obtaining, necessary licensing
                  at the
                  state and local level. If Ocwen Financial Corporation's operations
                  are
                  impaired as a result of litigation, judgments, governmental
                  investigations, its inability to repay its indebtedness when due,
                  or
                  further degradation of its capitalization or credit rating, our
                  profitability and operations may be
                  harmed.





**56**


·
            The
                failure of a counterparty to complete an agreed-upon transaction
                or
                perform an agreed-upon service may subject us to potential
                losses;





·
            The
                effect that an interruption in, or breach of, our information systems
                could have on our business;





·
            Our
                ability or inability to adapt to and implement technological changes
                to
                become and/or remain competitive and/or
                efficient;





·
            The
                possibility of failure of our operating facilities, computer systems,
                and
                communication systems during a catastrophic
                event;





·
            Unpredictable
                delays or difficulties in the development of new product
                programs;





·
            Changes
                in regulations issued by the OTS have limited our ability to charge
                prepayment penalties on some of the mortgage loans we originate.
                These
                changes do not affect our competitors that are federally regulated
                institutions, which could have an adverse impact on ability to compete
                in
                certain states. In addition, the absence of prepayment penalties
                on some
                of our loans could also adversely impact our securitizations and
                related
                profitability;





·
            The
                unanticipated expenses of assimilating newly acquired business, if
                any,
                into our structure, as well as the impact of unusual expenses from
                ongoing
                evaluations of business strategies, asset valuations, acquisitions,
                divestitures and organizational
                structures;





·
            A
                portion of the income we receive from our excess cashflow certificates,
                which are created in a REMIC securitization, is referred to as excess
                inclusion. In addition, all or a portion of the dividend we receive
                from
                our REIT subsidiary is considered excess inclusion, resulting from
                the
                subsidiary’s ownership of the securitization trusts (that are classified
                as a taxable mortgage pool). With limited exceptions, excess inclusion
                is
                always subject to tax because it cannot be offset by other deductions
                or
                by net operating losses. If the total amount of excess inclusion
                exceeds
                our regular taxable income, our liquidity would be impacted as our
                cash
                payments for federal income taxes would exceed the amount that would
                otherwise be required.





·
            Our
                inability to comply with REIT qualification tests for our REIT subsidiary
                on a continuous basis would subject our securitization trusts issued
                by
                our REIT subsidiary to federal income tax as a corporation (as a
                taxable
                mortgage pool) and not allow it to be filed as part of consolidated
                income
                tax return with any other corporation. The REIT rules require compliance
                with asset, income, distribution and ownership tests. The ownership
                test
                prohibits five or fewer stockholders from owning more than 50% of
                our
                common stock. As of April 12, 2006, members of the Miller family
                (considered one stockholder under the attribution rule applicable
                to the
                ownership of REIT stock) own approximately 33.8% of the common stock
                (including employees’ stock options as required by the Code and related
                rules and regulations). There can be no assurance that we will be
                able to
                comply with these tests or remain compliant. Failure to remain compliant
                would result in the imposition of a tax upon our securitization trusts
                and
                would reduce cash flow that would otherwise be available to make
                payments
                on the offered asset-backed securities and reduce the amount that
                we would
                receive from the securitization trusts. Such a failure would cause
                us to
                breach our representation, under each of our securitizations issued
                since
                the first quarter of 2005, that we would maintain Renaissance REIT
                Investment Corp. as a real estate investment trust. In addition,
                it would
                result in an event of default, unless waived, under our warehouse
                and
                certain other credit facilities. Accordingly, a failure to remain
                compliant with the REIT qualification tests may reduce our profitability
                and cash flow and have a material adverse impact on
                us;




**57**


·
            Our
                executive officers (specifically, members of the Miller family)
                collectively own a large percentage of our common shares and could
                influence or control matters requiring shareholder approval. Accordingly,
                if members of the Miller family were to act in concert, they would
                have
                the ability to exercise significant control over us with respect
                to
                matters submitted to a stockholder vote, including the approval of
                fundamental corporate transactions, such as mergers and acquisitions,
                consolidations and asset sales, and electing all members of our Board
                of
                Directors. As long as the Miller family controls such a substantial
                percentage of our shares, third parties may not be able to gain control
                of
                us through purchases of our common stock. In addition, members of
                the
                Miller family hold positions as executive officers of our Company,
                including Chairman, Chief Executive Officer, Executive Vice President
                and
                Senior Vice President (General
                Counsel);




·
            Compliance
                with the Sarbanes-Oxley Act of 2002 and proposed and recently enacted
                changes in securities laws and regulations are likely to increase
                our
                operating costs; and





·
            Future
                sales of shares of our common stock, including shares of common stock
                held
                by our insiders, may negatively impact the price of our common stock.
                The
                market price of our common stock may decline if a substantial number
                of
                shares of our common stock is sold, or the perception that those
                sales
                might occur. We are unable to predict whether significant numbers
                of
                shares will be sold in the open market in anticipation of or following
                a
                sale by insiders.





**Item
      6. Exhibits.**





**Exhibit
                No.**
            
            **Filed**
            
            **Description**31.1
            
            (a)
            
            Rule
                13a-14(a)/15d-14(a) Certification of the Chief Executive
                Officer31.2
            
            (a)
            
            Rule
                13a-14(a)/15d-14(a) Certification of the Chief Financial
                Officer32.1
            
            (a)
            
            Section
                1350 Certification of the Chief Executive Officer32.2
            
            (a)
            
            Section
                1350 Certification of the Chief Financial
                Officer


_______________


(a)
            Filed
                herewith.





**58**





**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, as amended, the
      Registrant has duly caused this report to be signed on its behalf by the
      undersigned, thereunto duly authorized.




**Dated:** May
      8,
      2006








**DELTA FINANCIAL CORPORATION**


(Registrant)








By: ________________________________


**Hugh
      Miller**


President
      and Chief Executive Officer





By: ________________________________


**Richard Blass**


Executive
      Vice President and Chief Financial Officer







**59**