**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 endedJune
                30, 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
      July 31, 2006, 23,361,112 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 Sheetsas of June 30, 2006 and
                December 31, 2005 (unaudited)
            1Consolidated
                Statements of Operationsfor the Three
                and Six Months Ended June
                30, 2006 and 2005 (unaudited)
            2Consolidated
                Statement of Changes in
                Stockholders’ Equityfor the Six Months Ended
                June 30, 2006 (unaudited)
            3Consolidated
                Statements of Cash Flowsfor the Six
                Months Ended June
                30, 2006 and 2005 (unaudited)
            4Notes
                to Consolidated Financial
                Statements (unaudited)
            6Item
                2.
            Management’s
                Discussion and Analysis of
                Financial Condition and Results of Operations
            25Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            53Item
                4.
            Controls
                and Procedures
            58**PART
                II - OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            58Item
                1A.
            Risk
                Factors
            60Item
                2.
            Unregistered
                Sales of Equity Securities and Use
                of Proceeds
            67Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            67Item
                6.
            Exhibits
            67Signatures
            68











**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
                June 30,**
              **2006**
            
            **At
                December 31, 2005****Assets:**Cash
                and cash equivalents
            
            $
            4,649
            
            $
            4,673Mortgage
                loans held for investment, net of discounts and deferredorigination
                fees
            
            
            5,572,135
            
            
            4,663,662Less:
                Allowance for loan losses
            
            
            (46,326
            )
            
            (36,832
            )Mortgage
                loans held for investment, net
            
            
            5,525,809
            
            
            4,626,830Trustee
                receivable
            
            
            61,102
            
            
            56,164Accrued
                interest receivable
            
            
            33,238
            
            
            26,952Excess
                cashflow certificates
            
            
            3,043
            
            
            7,789Equipment,
                net
            
            
            7,292
            
            
            6,688Accounts
                receivable
            
            
            8,374
            
            
            5,123Prepaid
                and other assets
            
            
            37,835
            
            
            30,508Deferred
                tax asset
            
            
            46,828
            
            
            54,875Total
                assets
            
            $
            5,728,170
            
            $
            4,819,602**Liabilities
                and Stockholders’ Equity****Liabilities:**Bank
                payable
            
            $
            1,973
            
            $
            1,921Warehouse
                financing
            
            
            89,210
            
            
            222,843Financing
                on mortgage loans held for investment, net
            
            
            5,429,292
            
            
            4,436,938Other
                borrowings
            
            
            5,544
            
            
            4,785Accrued
                interest payable
            
            
            19,259
            
            
            13,091Accounts
                payable and other liabilities
            
            
            38,606
            
            
            33,242Total
                liabilities
            
            
            5,583,884
            
            
            4,712,820**Stockholders’
                Equity:**Common
                stock, $.01 par value. Authorized 49,000,000 shares;23,477,312
                and 20,736,362 shares issued and 23,360,512 and
              20,619,562
                shares outstanding at June 30, 2006 and December 31,2005,
                respectively
            
            
            233
            
            
            207Additional
                paid-in capital
            
            
            141,212
            
            
            121,561Accumulated
                deficit
            
            
            (3,456
            )
            
            (15,077
            )Accumulated
                other comprehensive income
            
            
            7,615
            
            
            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
            
            
            144,286
            
            
            106,782Total
                liabilities and stockholders’ equity
            
            $
            5,728,170
            
            $
            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
                  June 30,**
              
              **For
                  the Six Months**
                **Ended
                  June 30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Interest
                  income
              
              $
              112,736
              
              $
              66,157
              
              $
              214,709
              
              $
              121,033Interest
                  expense
              
              
              76,294
              
              
              36,489
              
              
              143,560
              
              
              64,272Net
                  interest income
              
              
              36,442
              
              
              29,668
              
              
              71,149
              
              
              56,761Provision
                  for loan losses
              
              
              6,998
              
              
              7,478
              
              
              13,402
              
              
              14,342Net
                  interest income after provision forloan
                  losses
              
              
              29,444
              
              
              22,190
              
              
              57,747
              
              
              42,419Non-interest
                  income:Net
                  gain on sale of mortgage loans
              
              
              7,092
              
              
              6,628
              
              
              14,328
              
              
              11,920Other
                  income
              
              
              4,256
              
              
              2,545
              
              
              7,632
              
              
              5,396Total
                  non-interest income
              
              
              11,348
              
              
              9,173
              
              
              21,960
              
              
              17,316Non-interest
                  expense:Payroll
                  and related costs
              
              
              16,563
              
              
              15,027
              
              
              33,593
              
              
              30,181General
                  and administrative
              
              
              12,475
              
              
              10,099
              
              
              23,812
              
              
              19,894(Gain)/loss
                  on derivative instruments
              
              
              (148
              )
              
              334
              
              
              (423
              )
              
              318Total
                  non-interest expense
              
              
              28,890
              
              
              25,460
              
              
              56,982
              
              
              50,393Income
                  before income tax expense
              
              
              11,902
              
              
              5,903
              
              
              22,725
              
              
              9,342Provision
                  for income tax expense
              
              
              4,661
              
              
              2,328
              
              
              8,898
              
              
              3,708Net
                  income
              
              $
              7,241
              
              $
              3,575
              
              $
              13,827
              
              $
              5,634**Comprehensive
                  Income (Loss)**:Other
                  comprehensive income (loss)
              
              
              1,009
              
              
              (6,012
              )
              
              5,079
              
              
              (1,210
              )Comprehensive
                  income (loss)
              
              $
              8,250
              
              $
              (2,437
              )
              $
              18,906
              
              $
              4,424**Per
                  Share Data:**Basic
                  - weighted average number of sharesoutstanding
              
              
              22,903,098
              
              
              20,324,356
              
              
              21,706,899
              
              
              20,310,194Diluted
                  - weighted average number of sharesoutstanding
              
              
              23,696,358
              
              
              21,260,925
              
              
              22,535,209
              
              
              21,248,274Net
                  income applicable to common shares
              
              $
              7,241
              
              $
              3,575
              
              $
              13,827
              
              $
              5,634Basic
                  earnings per share - net income
              
              $
              0.32
              
              $
              0.18
              
              $
              0.64
              
              $
              0.28Diluted
                  earnings per share - net income
              
              $
              0.31
              
              $
              0.17
              
              $
              0.61
              
              $
              0.27











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 Six Months Ended June 30, 2006**


*(Dollars
      in thousands)*





**Common
                Stock**
            
            **Additional**
              **Paid-in
                Capital**
            
            **Accumulated
                Deficit**
            
            **Accumulated
                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
            
            
            2
            
            
            245
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            247Excess
                tax benefit related to sharebased
                compensation
            
            
            --
            
            
            768
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            768Share-based compensation
                expense
            
            
            --
            
            
            419
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            419Common
                stock issued in offering
            
            
            25
            
            
            19,345
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            19,370Reversal
                of unearned commonstock
                held by stock incentive plan
            
            
            (1
            )
            
            (1,126
            )
            
            --
            
            
            --
            
            
            1,127
            
            
            --
            
            
            --Cash
                dividend paid
            
            
            --
            
            
            --
            
            
            (1,038
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,038
            )Dividend
                declared and payable
            
            
            --
            
            
            --
            
            
            (1,168
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,168
            )Net
                unrealized gains onderivatives,
                net of tax
            
            
            --
            
            
            --
            
            
            --
            
            
            5,079
            
            
            --
            
            
            --
            
            
            5,079Net
                income
            
            
            --
            
            
            --
            
            
            13,827
            
            
            --
            
            
            --
            
            
            --
            
            
            13,827Balance
                at June 30, 2006
            
            $
            233
            
            $
            141,212
            
            $
            (3,456
            )
            $
            7,615
            
            $
            --
            
            $
            (1,318
            )
            $
            144,286





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)*





**For
                the Six Months Ended**
              **June
                30,****2006**
            
            **2005**Cash
                flows from operating activities:Net
                income
            
            $
            13,827
            
            $
            5,634Adjustments
                to reconcile net income to net cash used in operatingactivities:Provision
                for loan losses
            
            
            13,402
            
            
            14,342Provision
                for (recovery of) recourse loans and secondary marketing
            
            
            228
            
            
            (331
            )Depreciation
                and amortization
            
            
            1,626
            
            
            1,105Deferred
                tax expense (benefit)
            
            
            4,803
            
            
            (2,679
            )Deferred
                origination income (costs)
            
            
            109
            
            
            (3,779
            )Gain
                on change in fair value of excess cashflow certificates
            
            
            (7,449
            )
            
            (5,193
            )Gain
                on sale of mortgage loans, net
            
            
            (14,328
            )
            
            (11,920
            )Gain
                on sale of mortgage servicing rights
            
            
            (94
            )
            
            (72
            )Amortization
                of bond securitizations deferred cost and premiums
            
            
            (6,846
            )
            
            1,364Cash
                flows received from excess cashflow certificates, net of accretion
            
            
            10,695
            
            
            9,102Proceeds
                from sale of excess cashflow certificates
            
            
            1,500
            
            
            --Proceeds
                from sale of mortgage servicing rights
            
            
            12,657
            
            
            10,462Share-based
                compensation expense
            
            
            416
            
            
            --Changes
                in operating assets and liabilities:Increase
                in accrued interest receivable
            
            
            (6,276
            )
            
            (6,914
            )Increase
                in trustee receivable, net
            
            
            (4,938
            )
            
            (16,382
            )Increase
                in accounts receivable
            
            
            (3,251
            )
            
            (551
            )Increase
                in prepaid and other assets
            
            
            (6,982
            )
            
            (5,620
            )Increase
                in accrued interest payable
            
            
            6,168
            
            
            3,264Increase
                in accounts payable and other liabilities
            
            
            5,208
            
            
            2,791Net
                cash provided by (used in) operating activities
            
            
            20,475
            
            
            (5,377
            )Cash
                flows from investing activities:Origination
                of mortgage loans held for investment, net of repayments
            
            
            (1,237,321
            )
            
            (1,356,374
            )Proceeds
                from sale of mortgage loans
            
            
            333,046
            
            
            251,645Purchase
                of equipment
            
            
            (2,230
            )
            
            (1,770
            )Net
                cash used in investing activities
            
            
            (906,505
            )
            
            (1,106,499
            )Cash
                flows from financing activities:Repayment
                of warehouse financing, net
            
            
            (133,633
            )
            
            (16,549
            )Proceeds
                of financing on mortgage loans held for investment, net
            
            
            1,000,511
            
            
            1,130,194Proceeds
                (repayment) of other borrowings, net
            
            
            759
            
            
            (780
            )Increase
                (decrease) in bank payable
            
            
            52
            
            
            (138
            )Cash
                dividends paid on common stock
            
            
            (2,068
            )
            
            (2,028
            )Excess
                tax benefit related to share-based compensation
            
            
            768
            
            
            --Proceeds
                from issuance of common stock in secondary offering, net
            
            
            19,370
            
            
            --Proceeds
                from exercise of stock options
            
            
            247
            
            
            366Net
                cash provided by financing activities
            
            
            886,006
            
            
            1,111,065Net
                decrease in cash and cash equivalents
            
            
            (24
            )
            
            (811
            )Cash
                and cash equivalents at beginning of period
            
            
            4,673
            
            
            5,187Cash
                and cash equivalents at end of period
            
            $
            4,649
            
            $
            4,376








**4**




**For
                  the Six Months Ended**
                **June
                  30,****2006**
              
              **2005**Supplemental
                  Information:Cash
                  paid during the period for:Interest
              
              $
              137,103
              
              $
              58,844Income
                  taxes
              
              $
              9,941
              
              $
              11,285Non
                  cash transactions:Dividends
                  payable
              
              $
              1,168
              
              $
              1,018Transfer
                  of mortgage loans held for investment to REO, net
              
              $
              10,787
              
              $
              1,905






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

















**5**


**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL
      STATEMENTS** (Unaudited)




**(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 and six months ended June 30, 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 June 30, 2006 and December 31, 2005,
      respectively.





Additionally,
      cash and cash equivalents as of June 30, 2006 and December 31, 2005 included
      restricted cash held in various accounts totaling $29,000 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 (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 sold on a whole-loan basis, in the secondary market.
      During the period in which the loans are held pending securitization or
      whole-loan sale, we earn the coupon rate of interest paid by the borrower and
      pay interest to the lenders that provide our warehouse financing, to the extent
      that we utilize such financing. We also pay a sub-servicing fee to a third-party
      during the period the loans are held pending securitization or whole-loan
      sale. Any gains or losses on sales of mortgage loans are 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 we bear probable losses on these loans.  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
      based upon seasoning criteria. In
      accordance with SFAS No. 5, “Accounting for Contingencies,” we believe that
      pooling of mortgages with similar characteristics is an appropriate
      methodology with 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
      borrowers' 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 in 2005 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 loans 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 June 30, 2006, we have a specific reserve of $1.2 million (which
      is
      included in the $1.5 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 primarily 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
      June 30, 2006 and 2005, we recorded $4.2 million and $2.5 million, respectively,
      of other income due to an increase in the fair value of excess cashflow
      certificates. For the six months ended June 30, 2006 and 2005, we recorded
      $7.4
      million and $5.2 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 also is 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, such as 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 $835,000 and $543,000 for the three months ended June 30, 2006
      and
      2005, respectively, and $1.6 million and $1.1 million for the six months ended
      June 30, 2006 and 2005, respectively. Accumulated depreciation and amortization
      totaled $14.2 million and $12.5 million at June 30, 2006 and December 31, 2005,
      respectively.





**9**


**(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 values. 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 $11.0 million and $4.4 million of REO
      properties as of June 30, 2006 and December 31, 2005, respectively. A provision
      of $415,000 and $546,000 was made during the three and six months ended June
      30,
      2006, respectively, for the decrease in the fair value of the REO properties in
      “general and administrative expenses.” A
      provision of $25,000 was made during the three and six months ended June 30,
      2005, respectively, for the decrease in the fair value of the REO
      properties .





**(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 coupon rates of the
      variable-rate asset-backed securities adjusts 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.





**10**


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.





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 are no longer 90 days past due, 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; (d) hedge amortization; and (e) 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 the 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 June 30, 2006 and 2005, we sold $154.0 million and $134.3
      million, respectively, of whole-loans on a non-recourse basis. During the six
      months ended June 30, 2006 and 2005, we sold $318.7 million and $239.7 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.





**11**


**(m)
      Mortgage Servicing Rights Sales**





We
      generally sell the rights to service our securitization transactions to a
      third-party service provider 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 June
      30, 2006 and 2005, we received $6.3 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. For the six months ended June 30, 2006 and 2005, we received
      $12.7 million and $10.5 million, respectively, from a third-party servicer
      for
      the right to service the mortgage loans collateralizing our
      securitizations.





**(n)
                Derivative Instruments**





We
      regularly issue asset-backed securities collateralized by fixed- and
      variable-rate mortgage loans. 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) and/or amortizing notional
      balance interest rate swaps that are designed to mitigate our basis risk within
      the securitization. Both the interest rate swaps and corridors are derivative
      instruments that trade in liquid markets, and neither is used by us for
      speculative purposes.





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;




**12**


·
            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
      hedge exceeds 125% or falls below 80%, since the notional amount 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.





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





*Accounting
      for Uncertainty in Income Taxes.* In June 2006, the Financial Accounting
      Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 48, "Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109."
      FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized
      in a company's financial statements in accordance with SFAS No. 109,
      "*Accounting for Income Taxes*." Only tax positions meeting a
      "more-likely-than-not" threshold of being sustained are recognized under FIN
      No.
      48. FIN No. 48 also provides guidance on derecognition, classification of
      interest and penalties and accounting and disclosures for annual and interim
      financial statements. FIN No. 48 is effective for fiscal years beginning after
      December 15, 2006. The cumulative effect of the changes arising from the initial
      application of FIN No. 48 is required to be reported as an adjustment to the
      opening balance of retained earnings in the period of adoption. We are currently
      evaluating the impact, if any, the adoption of FIN No. 48 on January 1, 2007
      will have on our financial statements.





**13**





*Accounting
      for Certain Hybrid Financial Instruments.* In
      February 2006, the 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.


**14**


**(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.





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) generally are
      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 and six months ended
      June 30, 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 other 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.





In
      accordance with SFAS 123(R), our income before income tax expense and net income
      for the three months ended June 30, 2006 included stock option compensation
      cost
      of $148,000 and $90,000, respectively, which had no impact on basic and diluted
      earnings per share for the quarter. Additionally, our income before income
      tax
      expense and net income for the six months ended June 30, 2006 included stock
      option compensation cost of $253,000 and $154,000, respectively, which had
      no
      impact on basic earnings per share and $0.01 diluted earnings per share for
      the
      six month period.





The
      fair
      value of each option award is estimated on the date of grant using the Black
      Scholes Merton option pricing model. For options granted prior to January 1,
      2006, the fair value was calculated for purposes of the SFAS No. 123 pro forma
      disclosures only. The weighted average assumptions used in the valuations are
      summarized as follows:


**15**





**For
                the Six Months**
              **Ended
                June 30, 2006**
            
            **For
                the Six Months**
              **Ended
                June 30, 2005**Expected
                dividend yield
            2.0%
            
            2.3%Expected
                volatility
            57.6%
            
            42.1%Risk-free
                interest rate
            5.0%
            
            4.0%Expected
                term
            3.7
                years
            
            3.7
                yearsAnnual
                forfeiture rate
            7.8%
            
            N/A




The
      average grant date fair value of the stock options granted during the three
      months ended June 30, 2006 was $4.16. No stock options were granted during
      the
      three months ended June 30, 2005. The weighted average grant date fair value
      of
      the stock options granted during the six months ended June 30, 2006 and 2005
      was
      $4.16 and $2.68, respectively. 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.





The
      following table summarizes the option activity regarding the Option Plans for
      the six months ended June 30, 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
            
            
            5,000
            
            
            9.90Options
                exercised
            
            
            242,200
            
            
            1.02Options
                expired
            
            
            107,000
            
            
            5.68Options
                forfeited
            
            
            15,800
            
            
            3.38June
                30, 2006 balance
            
            
            1,814,300
            
            $
            2.97
            
            
            3.2
                years
            
            $
            12,491Options
                fully vested and exercisable
            
            
            1,268,167
            
            $
            1.84
            
            
            2.6
                years
            
            $
            10,157





The
      intrinsic value of a stock option is the amount by which the fair value of
      the
      underlying stock exceeds the exercise price of the option. The total intrinsic
      value of the stock options exercised during the three months ended June 30,
      2006
      and 2005 was $861,000 and $434,000, respectively. The total intrinsic value
      of
      the stock options exercised during the six months ended June 30, 2006 and 2005
      was $2.0 million and $610,000, respectively. As
      of
      June 30, 2006, there was $927,000 of total unrecognized compensation cost,
      net
      of estimated forfeitures, related to non-vested options under the Option Plans.
      The unrecognized compensation cost at June 30, 2006 is expected to be recognized
      over 4.9 years.





Cash
      received from option exercises under the Option Plans for the three months
      ended
      June 30, 2006 and 2005, was $110,000 and $102,000, respectively. Cash received
      from option exercises under the Option Plans for the six months ended June
      30,
      2006 and 2005, was $247,000 and $157,000, respectively. The actual tax benefit
      for the tax deductions from option exercises totaled $336,000 and $148,000,
      respectively, for the three months ended June 30, 2006 and 2005. The actual
      tax
      benefit for the tax deductions from option exercises totaled $768,000 and
      $207,000, respectively, for the six months ended June 30, 2006 and 2005. The
      fair value of the shares that vested during the three months ended June 30,
      2006
      and 2005, totaled $82,000 and $83,000, respectively. The fair value of the
      shares that vested during the six months ended June 30, 2006 and 2005, totaled
      $312,000 and $256,000, respectively.





**16**


Our
      income before income tax expense and net income for the three months ended
      June
      30, 2006 included a restricted stock award compensation cost of $80,000 and
      $49,000, respectively, which had no impact on basic and diluted earnings per
      share for the quarter. Additionally, our income before income tax expense and
      net income for the six months ended June 30, 2006 included restricted stock
      award compensation cost of $162,000 and $99,000, respectively, which had no
      impact on basic earnings per share and diluted earnings per share for the six
      months ended June 30, 2006. No restricted stock awards were outstanding during
      the six months ended June 30, 2005. The adoption of SFAS No. 123(R) did not
      result in material impact on our statement of operations related to restricted
      stock awards. The status of our non-vested restricted stock awards as of June
      30, 2006, and changes during the six months ended June 30, 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
            
            
            1,250
            
            
            7.46Non-vested
                restricted stock awards at June 30, 2006
            
            
            156,025
            
            $
            7.46




As
      of
      June 30, 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 4.4
      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.





The
      following table illustrates the pro forma net income for the three and six
      months ended June 30, 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**
              **June
                30, 2005**
            
            **For
                the Six**
              **Months
                Ended**
              **June
                30, 2005**Net
                income, as reported
            
            $
            3,575
            
            $
            5,634Deduct
                total stock-based employee compensation expense
                determined under fair-value-based method for all
                awards, net of tax
            
            
            88
            
            
            279Pro
                forma net income applicable to common shares
            
            $
            3,487
            
            $
            5,355**Earnings
                per share:**Basic
                - as reported
            
            $
            0.18
            
            $
            0.28Basic
                - pro forma
            
            $
            0.17
            
            $
            0.26Diluted
                - as reported
            
            $
            0.17
            
            $
            0.27Diluted
                - pro forma
            
            $
            0.16
            
            $
            0.25





**17**


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.





**(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 six months ended June 30, 2006 and 2005, we closed securitization
      transactions totaling $1.7 billion and $1.5 billion, respectively, which were
      structured to be accounted for as a secured financing and which were
      collateralized by $1.7 billion and $1.5 billion, respectively, of mortgage
      loans
      held for investment - securitized. Mortgage loans held for investment -
      securitized had a weighted-average interest rate of 8.00% and 7.77% per annum
      at
      June 30, 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 June 30, 2006 and December 31, 2005, was
      approximately $89.2 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 8.97%
      and 8.35% per annum at June 30, 2006 and December 31, 2005,
      respectively.





The
      following table presents a summary of mortgage loans held for investment, net
      at
      June 30, 2006 and December 31, 2005:





*(Dollars
                in thousands)*
            
            **At
                June 30,**
              **2006**
            
            **At
                December 31, 2005**Mortgage
                loans held for investment - securitized(1)
            
            $
            5,457,736
            
            $
            4,430,775Mortgage
                loans held for investment - pre-securitization(1)
            
            
            161,019
            
            
            270,372Discounts
                (MSR related)
            
            
            (32,864
            )
            
            (26,750
            )Net
                deferred origination fees
            
            
            (13,756
            )
            
            (10,735
            )Allowance
                for loan losses
            
            
            (46,326
            )
            
            (36,832
            )Mortgage
                loans held for investment, net
            
            $
            5,525,809
            
            $
            4,626,830





*(1)
      Included in the* *outstanding balance of the mortgage loans held for investment at June 30, 2006
      and December 31, 2005 were impaired loans located in the Hurricanes Katrina
      and
      Rita disaster areas designated by FEMA of approximately $2.6 million and $3.9
      million, respectively (of which $563,000 and $798,000, respectively, were
      pre-securitization loans).*





For
      the
      three months ended June 30, 2006 and 2005, we recorded interest income related
      to our mortgage loans held for investment - securitized of $101.1 million and
      $57.4 million, respectively. For the six months ended June 30, 2006 and 2005,
      we
      recorded interest income related to our mortgage loans held for investment
      -
      securitized, net of $190.1 million and $103.3 million, respectively. For the
      three months ended June 30, 2006 and 2005, we recorded interest income related
      to our mortgage loans held for investment - pre-securitization of $8.4 million
      and $6.9 million, respectively. For the six months ended June 30, 2006 and
      2005,
      we recorded interest income related to our mortgage loans held for investment
      -
      pre-securitization (mortgage loans held for sale), net of $17.7 million and
      $13.7 million, respectively.





**18**


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 and six months
      ended June 30, 2006 and 2005:





*(Dollars
                in thousands)*
            
            **For
                the Three Months Ended June 30,**
            
            **For
                the Six Months Ended June 30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Beginning
                balance
            
            $
            41,911
            
            $
            16,808
            
            $
            36,832
            
            $
            10,278Provision(1)
            
            
            6,998
            
            
            7,478
            
            
            13,402
            
            
            14,342Charge-offs(2)
            
            
            (2,583
            )
            
            (303
            )
            
            (3,908
            )
            
            (637
            )Ending
                balance
            
            $
            46,326
            
            $
            23,983
            
            $
            46,326
            
            $
            23,983





*(1)*  *The
      provision for loan losses for the three and six months ended June 30, 2006
      includes $11,000 and $22,000, respectively, of provision, which is net of a
      $93,000 and $275,000, respectively, of reversals of a specific provision* *related
      to probable losses attributable to loans in Hurricanes Katrina and Rita disaster
      areas, for impaired loans.*





*(2)*  *The
      charge-offs for the three and six months ended June 30, 2006 includes $211,000
      and $282,000, respectively, 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 June 30, 2006 and December 31, 2005 contains $1.5
      million and $1.7 million, respectively, of specific reserves related to impaired
      loans. The majority of the specific reserve relates to the significant effect
      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 22 properties securing a total unpaid principal balance
      of $2.6 million in the affected areas at June 30, 2006, our allowance for loan
      losses includes a specific reserve of $1.2 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 six months
      ended
      June 30, 2006 we also identified four additional impaired loans requiring a
      specific reserve that were not related to Hurricane Katrina and
      Rita.





As
      of
      June 30, 2006, December 31, 2005 and June 30, 2005, we had $190.9 million,
      $123.0 million and $46.0 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 June 30, 2006 and 2005 performed in accordance with their
      contractual loan terms, we would have recognized an additional $2.0 million
      and
      $1.0 million of interest income during the three months ended June 30, 2006
      and
      2005, respectively, and an additional $4.2 million and $1.6 million of interest
      income during the six months ended June 30, 2006 and 2005, respectively. More
      detailed delinquency information regarding the loans collateralizing each of
      our
      securitizations (which comprise our mortgage loans held for investment -
      securitized portfolio) is available on our website at
      www.deltafinancial.com/regAB.htm.





Our
      recorded investment in impaired loans at June 30, 2006 and December 31, 2005
      was
      $3.6 million (including $2.6 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 $1.5
      million ($1.2 million relates to Hurricane Katrina and Rita affected loans)
      and
      $1.7 million at June 30, 2006 and December 31, 2005, respectively. The average
      recorded investment in impaired loans for the three and six months ended June
      30, 2006 was $3.6 million and $3.5 million, respectively. We recorded $61,000
      and $121,000 of interest income, based upon the cash received, on the loans
      classified as impaired during the three and six months ended June 30, 2006,
      respectively. We recorded no interest income on impaired loans during the three
      and six months ended June 30, 2005, as we held no loans classified as impaired
      during either period.


**19**


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





The
      following table presents the activity related to our excess cashflow
      certificates for the six months ended June 30, 2006 and the year ended December
      31, 2005:





*(Dollars
                in thousands)*
            
            **For
                the Six**
              **Months
                Ended**
              **June
                30, 2006**
            
            **For
                the**
              **Year
                Ended**
              **December
                31, 2005**Balance,
                beginning of year
            
            $
            7,789
            
            $
            14,933Excess
                cashflow certificates sold
            
            
            (1,500
            )
            
            --Accretion
            
            
            380
            
            
            1,593Cash
                receipts
            
            
            (11,075
            )
            
            (23,146
            )Net
                change in fair value
            
            
            7,449
            
            
            14,409Balance,
                end of period
            
            $
            3,043
            
            $
            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 June 30, 2006 and 2005,
      we
      recorded interest income related to our excess cashflow certificates of $138,000
      and $406,000, respectively. For the six months ended June 30, 2006 and 2005,
      we
      recorded interest income related to our excess cashflow certificates of $380,000
      and $895,000, respectively. For the three months ended June 30, 2006 and 2005,
      we recorded fair value gain in income related to our excess cashflow
      certificates of $4.2 million and $2.5 million, respectively. For the six months
      ended June 30, 2006 and 2005, we recorded fair value gain in income related
      to
      our excess cashflow certificates of $7.5 million and $5.2 million, respectively.
      Additionally, we sold at fair value, $1.5 million of excess cashflow
      certificates during the three and six months ended June 30, 2006. We had no
      sales of excess cashflow certificates during the three or six months ended
      June
      30, 2005.





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 judgments 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 securitizations, beginning in 2004, 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 warehouse 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 warehouse 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.





**20**


The
      following table summarizes information regarding warehouse financing at June
      30,
      2006 and December 31, 2005:


*(Dollars
                in thousands)*
              
              
              
              **Balance
                  at****Warehouse
                  Line of Credit**
              **Facility
                  Amount**
              **Interest
                  Rate**
              
              **6/30/06**
              
              **12/31/05**
              
              **Expiration
                  Date**RBS
                  Greenwich Capital
              $                            350,000
              Margin
                  over LIBOR
              
              $                 58,767
              
              $                 77,931
              
              October
                  2006Citigroup(1)
              350,000
              Margin
                  over LIBOR
              
              30,443
              
              144,912
              
              May
                  2007Bank
                  of America
              350,000
              Margin
                  over LIBOR
              
              --
              
              --
              
              August
                  2006JP
                  Morgan Chase(2)
              350,000
              Margin
                  over LIBOR
              
              --
              
              --
              
              May
                  2007Total
              $                         1,400,000
              
              
              $                 89,210
              
              $              
                  222,843




*(1)*  *In
      May 2006, we extended our warehouse financing facility with Citigroup to May
      2007.*





*(2)*  *In
      May 2006, we entered into a new warehouse financing facility with JP Morgan
      Chase. The facility amount is comprised of a $200.0 million committed line
      and a
      $150.0 million uncommitted line.*





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 $89.2 million we held at June 30, 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 June 30,
      2006.





During
      the three months ended June 30, 2006, we entered into a new $350.0 million
      warehouse line of credit facility with JP Morgan Chase and allowed our $200.0
      million warehouse line of credit facility with Friedman, Billings, Ramsey to
      expire.





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





For
      the
      10 securitizations completed since the beginning of 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 expect to continue to
      build our loan portfolio and 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
      June
      30, 2006 and December 31, 2005, the outstanding financing on mortgage loans
      held
      for investment, net consisted of $5.4 billion and $4.4 billion,
      respectively.


**21**


The
      following table summarizes the expected maturities on our secured financings
      at
      June 30, 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
            
            $
            5,429,292
            
            $
            2,039,160
            
            $
            2,077,646
            
            $
            725,721
            
            $
            586,765





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 (including amortizing notional balance interest rate swaps) as cash
      flow hedges. We utilize both corridors and amortizing notional balance interest
      rate swaps to hedge our interest payments on securitization variable-rate debt,
      while we utilize interest rate swaps to hedge uncertain cash flows associated
      with future securitization financing. At June 30, 2006 and December 31, 2005,
      the fair value of our corridors totaled $8.9 million and $11.7 million,
      respectively, and the fair value of our interest rate swaps (including
      amortizing notional balance interest rate swaps) totaled a gain of $1.2 million
      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
      June 30, 2006, the effective portion of the changes in fair value of the
      corridors (effective portion), interest rate swaps (effective portion)
      and any gains on terminated swaps (effective portion) are recorded as
      components of accumulated OCI and total gains, net of tax, of $2.1 million,
      $703,000 and $4.8 million, respectively. As of December 31, 2005, the changes
      in
      fair value of the corridors (effective portion), interest rate swaps (effective
      portion) and any gains on terminated swaps (effective portion) are recorded
      as
      components of accumulated OCI, and total, net of tax, gains of $1.9 million,
      losses of $128,000 and gains of $755,000, respectively. Accumulated OCI 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 $79,000 and losses
      of $334,000 for the three months ended June 30, 2006 and 2005, respectively.
      Hedge ineffectiveness associated with hedges resulted in gains of $139,000
      and
      losses of $318,000 for the six months ended June 30, 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
      hedge exceeds 125% or falls below 80%, since the notional amount 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 June 30, 2006 and December 31, 2005, we held $744,000 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 and six months ended June 30, 2006, a gain of $69,000
      and $284,000, respectively, 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 and six months ended June 30, 2005 were classified as trading
      securities.


**22**


The
      following table summarizes the notional amount, expected maturities and
      weighted-average strike price for the corridors and amortizing notional balance
      interest rate swaps that we held as of June 30, 2006:





*(Dollars
                in thousands,**except
                average strike price and rate)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years & Thereafter**Caps
                bought - notional
            
            $
            1,717,654
            
            $
            1,127,586
            
            $
            418,577
            
            $
            42,720
            
            $
            32,195
            
            $
            96,576Weighted
                average strikeprice
            
            $
            6.39
            
            $
            5.75
            
            $
            7.08
            
            $
            7.43
            
            $
            7.46
            
            $
            7.42Caps
                sold - notional
            
            $
            1,717,654
            
            $
            1,127,586
            
            $
            418,577
            
            $
            42,720
            
            $
            32,195
            
            $
            96,576Weighted
                average strikeprice
            
            $
            8.85
            
            $
            8.54
            
            $
            9.28
            
            $
            9.27
            
            $
            9.27
            
            $
            9.30Amortizing
                notional balance interest rate swaps:Notional
            
            $
            134,099
            
            $
            53,221
            
            $
            53,559
            
            $
            27,319
            
            $
            --
            
            $
            --Weighted
                average rate
            
            $
            5.41
            
            $
            5.41
            
            $
            5.41
            
            $
            5.41
            
            $
            --
            
            $
            --





The
      notional amount of the corridors totaled $2.5 billion at December 31, 2005.
      We
      had no amortizing notional balance interest rate swaps 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 six months ended June 30, 2006 and for the year ended December
      31,
      2005 are as follows:




*(Dollars
                in thousands)*
            
            **Before
                Tax Amount**
            
            **Tax
                Expense (Benefit)**
            
            **After
                Tax Amount**For
                the six months ended June 30, 2006:Net
                unrealized holding gains on derivatives arising during the
                period
            
            $
            12,671
            
            $
            (4,941
            )
            $
            7,730Reclassification
                adjustment for loss on derivatives included in net income
            
            
            (4,345
            )
            
            1,694
            
            
            (2,651
            )Other
                comprehensive income
            
            $
            8,326
            
            $
            (3,247
            )
            $
            5,079For
                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) and other share-based awards 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.





**23**




**Three
                  Months Ended**
                **June
                  30,**
              
              **Six
                  Months Ended**
                **June
                  30,***(Dollars
                  in thousands, except share and**per
                  share data)*
              
              **2006**
              
              **2005**
              
              **2006**
              
              **2005**Net
                  income, as reported
              
              $
              7,241
              
              $
              3,575
              
              $
              13,827
              
              $
              5,634Less
                  preferred stock dividends
              
              
              --
              
              
              --
              
              
              --
              
              
              --Net
                  income available to common stockholders
              
              $
              7,241
              
              $
              3,575
              
              $
              13,827
              
              $
              5,634Basic
                  - weighted-average shares
              
              
              22,903,098
              
              
              20,324,356
              
              
              21,706,899
              
              
              20,310,194Basic
                  EPS
              
              $
              0.32
              
              $
              0.18
              
              $
              0.64
              
              $
              0.28Basic
                  - weighted-average shares
              
              
              22,903,098
              
              
              20,324,356
              
              
              21,706,899
              
              
              20,310,194Incremental
                  shares-options(1)
                  (2)
              
              
              793,260
              
              
              936,569
              
              
              828,310
              
              
              938,080Diluted
                  - weighted-average shares
              
              
              23,696,358
              
              
              21,260,925
              
              
              22,535,209
              
              
              21,248,274Diluted
                  EPS(1)
                  (2)
              
              $
              0.31
              
              $
              0.17
              
              $
              0.61
              
              $
              0.27


*(1)*  *For
      each of the three and six months ended June 30, 2006, approximately 1.8 million
      in-the-money employee stock options and approximately 156,000 restricted stock
      awards are included in the calculation of diluted EPS, while approximately
      25,000 of out-of-the-money employee stock options have been excluded as they
      are
      anti-dilutive.*





*(2)*  *For
      each of the three and six months ended June 30, 2005, approximately 2.0 million
      in-the-money employee stock options are included in the calculation of diluted
      EPS, while approximately 70,000 of out-of-the-money employee stock options
      have
      been excluded as they are anti-dilutive.*




On
      April
      6, 2006, we announced the pricing of a private placement of 2,500,000 newly
      issued shares, from
      authorized but unissued 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 $19.4 million, after deducting expenses payable in
      connection with this offering. The
      proceeds were used to repay warehouse financings and originate mortgage
      loans.





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





We
      paid a
      cash dividend of $0.05 per share of common stock on July 6, 2006 to stockholders
      of record as of the close of business on June 23, 2006.





**24**


**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,
      home
      purchase 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. 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.





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
      “Origination of Mortgage Loans - 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 the borrowers’
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.  **25**


For
      the
      three and six months ended June 30, 2006 and 2005, we originated the following
      loans by origination channel and by loan type:


**For
                  the Three Months**
                **Ended
                  June 30,**
              
              **For
                  the Six Months**
                **Ended
                  June 30***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2006**
              
              **2005**Originations
                  by channel:Wholesale
              
              $
              515,353
              
              $
              488,562
              
              $
              1,033,385
              
              $
              956,012Retail
              
              
              455,259
              
              
              392,567
              
              
              881,951
              
              
              761,837Total
                  originations
              
              $
              970,612
              
              $
              881,129
              
              $
              1,915,336
              
              $
              1,717,849Loan
                  type:Fixed
                  rate
              
              
              85.6
              %
              
              75.5
              %
              
              84.6
              %
              
              75.9
              %Adjustable-rate
              
              
              14.4
              
              
              24.5
              
              
              15.4
              
              
              24.1100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %


For
      the three
      and six months ended June 30, 2006, we originated $970.6 million and $1.9
      billion, respectively, of loans, an increase of 10.2% and 11.5%, respectively,
      over the $881.1 million and $1.7 billion, respectively, of loans originated
      in
      the comparable periods in 2005. Loan originations for the three and six months
      ended June 30, 2006 were comprised of approximately $515.4 million and $1.0
      billion, respectively, of wholesale loans, representing 53.1% and 54.0%,
      respectively, of total loan production, and $455.3 million and $882.0 million,
      respectively, of retail loans, representing 46.9% and 46.0%, respectively,
      of total loan production. This compares to originations for the three and six
      months ended June 30, 2005 of $488.6 million and $956.0 million, respectively,
      of wholesale loans, representing 55.4% and 55.7%, respectively, of total loan
      production, and $392.6 million and $761.8 million, respectively, of retail
      loans, representing 44.6% and 44.3%, respectively, of total loan
      production.





**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. We
      select
      the outlet depending on market conditions, relative profitability and cash
      flows.  During
      the three months ended June 30, 2006 and 2005, whole-loan sales comprised
      approximately 15.7%
      and
      15.2% ,
      respectively, of the total amount of our combined securitizations and whole-loan
      sales transactions. During the six months ended June 30, 2006 and 2005,
      whole-loan sales comprised approximately 15.8%
      and
      13.8% ,
      respectively, of the total amount of our combined securitizations and whole-loan
      sales transactions.





The
      following table sets forth certain information regarding loans sold through
      our
      securitizations and on a whole-loan basis during the three and six months ended
      June 30, 2006 and 2005:





**Three
                Months Ended**
              **June
                30,**
            
            **Six
                Months Ended**
              **June
                30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**
            
            **2006**
            
            **2005**Loan
                securitizations - portfolio based
            
            $
            824,978
            
            $
            750,000
            
            $
            1,699,978
            
            $
            1,499,999Whole-loan
                sales
            
            
            154,008
            
            
            134,306
            
            
            318,718
            
            
            239,725Total
                securitizations and whole-loan sales
            
            $
            978,986
            
            $
            884,306
            
            $
            2,018,696
            
            $
            1,739,724





**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.





**26**


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 six months ended June 30, 2006 and the year ended December 31, 2005, our
      securitizations required a range of O/C from 2.9% to 3.1% and from
      2.8%
      to 3.3%, respectively, of the initial mortgage loans sold to the securitization
      trust.





Prior
      to
      our change in accounting in 2004, from “gain-on-sale” to “portfolio,” we
      recorded excess cashflow certificates generated by the securitization
      transactions structured as sales. As holder of the excess cashflow certificate,
      we receive the spread between the coupon rate on the mortgage loans and the
      pass-through rate paid on the asset-backed securities, after payment of
      servicing fees, guarantor fees and other trust expenses if the specified O/C
      requirements are met. Over the past several years, we have issued NIM
      transactions simultaneously with the underlying securitization. In a NIM
      transaction, the rights to receive the excess cash flows generated by the pool
      of loans collateralizing the securitization structured as a financing, or from
      the excess cashflow certificates in transactions structured as sales, is
      transferred to a NIM investor, in exchange for an up front cash
      payment.





The
      NIM
      investor is paid a specified interest rate, and all cash flows generated by
      the
      excess cashflow certificate are 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. After the holder of the NIM has been
      paid in full, we receive the cash flows generated by the excess cashflow
      certificate.





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. 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.





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 QSPE criteria
      under SFAS No. 140 and related interpretations, because after the loans are
      securitized, (1) we have the unconditional right to 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.”





**27**


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 and six months ended
      June
      30, 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 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 in the foreseeable
      future.





The
      following table sets forth information about our securitized mortgage loan
      portfolio, completed since the first quarter of 2004, at June 30,
      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
              
              $                                         
                   235,718
              
              $                                         
                   228,0182004-2
              
              June
                  29, 2004
              
              272,037
              
              256,4372004-3
              
              September
                  29, 2004
              
              337,460
              
              320,8202004-4
              
              December
                  29, 2004
              
              377,003
              
              363,1522005-1
              
              March
                  31, 2005
              
              519,485
              
              502,0652005-2
              
              June
                  29, 2005
              
              588,665
              
              579,0112005-3
              
              September
                  29, 2005
              
              714,770
              
              705,6122005-4
              
              December
                  30, 2005
              
              808,604
              
              800,4962006-1
              
              March
                  30, 2006
              
              847,733
              
              848,5162006-2
              
              June
                  29, 2006
              
              824,978
              
              831,975Total
              
              
              
              $                                      
                   5,526,453
              
              $                                      
                   5,436,102




*(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 $6.8 million at June 30,
      2006.*





**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 distributions from the trust (excess cashflow
      certificate).





The
      fair
      value of the excess cashflow certificates are $3.0 million and $7.8 million
      at
      June 30, 2006 and December 31, 2005, respectively.





**28**


**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 using 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 recognize any taxable
      gains associated with the securitized mortgage loans over time. 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 and possibly negatively impact our stock
      price.




**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 June 30, 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 $154.0 million and $134.3 million, respectively.
      The
      average gross premium we received for the whole loans sold during the three
      months ended June 30, 2006 was 3.52%, compared to 4.04% for the comparable
      2005
      period. The gross premium paid to us by third-party purchasers in whole-loan
      sale transactions does not take into account premiums we pay to originate the
      mortgage loans, the origination fees we collect (whether deferred or not),
      or
      premium recapture - each of which are components of the net gain on sale
      calculation. During the six months ended June 30, 2006 and 2005, we sold whole
      loans without recourse and on a servicing-released basis of $318.7 million
      and
      $239.7 million, respectively. The average gross premium we received for the
      whole loans sold during the six months ended June 30, 2006 was 3.49%, compared
      to 4.01% for the comparable 2005 period.





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
      fees, if any, and an estimate of the impact of future interest rate changes
      may
      have on early repayments. The premium recapture reserve totaled $730,000 and
      $619,000 at June 30, 2006 and December 31, 2005, respectively.





During
      the three and six months ended June 30, 2006 we recorded a secondary market
      reserve provision of $53,000 and $228,000, respectively, 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 $160,000 at June
      30,
      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 June 30,
      2005.





**29**


**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 accuracy of these
      estimates and the likelihood of future changes depend on a range of possible
      outcomes and a number of underlying variables, many of which are beyond our
      control, and there can be no assurance that our estimates are
      accurate.




**Accounting
      for Hedging Activities.** We
      regularly issue securitization asset-backed securities, backed by fixed- and
      adjustable-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 )
      and/or
      amortizing notional balance interest rate swaps 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.





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.





**30**


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
      hedge exceeds 125% or falls below 80%, since the notional amount 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 June 30, 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.





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 are inherently uncertain, 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.





**31**


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 loans 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 experience, as well as industry
      data, is 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.





**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 received
                only
                after the NIM notes are paid in
                full).





**32**


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.





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 based on a spread over the
      six-month LIBOR, 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 related to the excess cashflow certificates held at June 30, 2006
      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 June 30, 2006 forward:





**Loan
                Type**
            
            **Month
                One**
            
            **Peak
                Speed**
              **Over
                the Life**
            
            **Peak
                Speed from**
              **June
                30, 2006 Forward**Fixed
                rate
            
            4.0%
            
            45.0%
            
            35.0%Adjustable-rate
            
            4.0%
            
            75.0%
            
            35.0%
                to 75.0%





**33**


Our
      assumption regarding the peak speed over the life ranged from 35.0% to
      40.0% for fixed rate loans and was 75.0% for adjustable-rate loans 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 June 30, 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 rate, which is consistent
      with the revised rate at September 30, 2005, applied on the excess cashflow
      certificates held at June 30, 2006 is 4.0%. Prior to September 30, 2005, our
      default rate assumption on the same excess cashflow certificates held at June
      30, 2006 was 4.5%.





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 generally 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 generally 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. We have not changed our LIBOR curve
      assumptions since March 31, 2006 and believe that the forward LIBOR curve we
      use
      reflects the estimate of future LIBOR rates.





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.





**34**


We
      utilized a discount rate of 18% at June 30, 2006 and December 31, 2005 on all
      excess cashflow certificates (a discount rate of 15% was utilized at June 30,
      2005).





**Results
      of Operations**





**Three
      Months Ended June 30, 2006 Compared to Three Months Ended June 30,
      2005**





**General**





Our
      net
      income for the three months ended June 30, 2006 was $7.2 million, or $0.32
      per
      share basic and $0.31 per share diluted, compared to net income of $3.6 million,
      or $0.18 per share basic and $0.17 per share diluted, for the three months
      ended
      June 30, 2005. The increase in net income during the three months ended June
      30,
      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
      $4.2
      million, pre-tax ($2.6 million after tax), recorded during the three months
      ended June 30, 2006, as compared to recording an increase of $2.5 million,
      pre-tax ($1.5 million after tax), on excess cashflow certificates during the
      three months ended June 30, 2005.





We
      recorded net interest income after provision for loan losses of $29.4 million
      during the three months ended June 30, 2006, an increase of $7.2 million, or
      32.7%, from $22.2 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 $5.6 billion of mortgage loans held
      for
      investment at June 30, 2006 compared to $3.5 billion of these loans held at
      June
      30, 2005. Similarly, the increase in interest expense primarily reflects the
      net
      effect of recognizing interest expense on $5.4 billion in financing on mortgage
      loans held for investment at June 30, 2006, compared to $3.4 billion of
      financing on mortgage loans held for investment at June 30, 2005. During the
      three months ended June 30, 2006, total non-interest income increased by $2.2
      million and total non-interest expense increased by $3.4 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 June 30, 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 $970.6 million of mortgage loans during the three months ended June
      30, 2006, representing an $89.5 million, or 10.2%, increase from the $881.1
      million of mortgage loans originated during the three months ended June 30,
      2005. We securitized and/or sold $979.0 million of loans during the three months
      ended June 30, 2006, representing a $94.7 million, or 10.7%, increase from
      the
      $884.3 million of loans securitized and/or sold during the same period in
      2005.





**Net
      Interest Income**





We
      recorded net interest income of $36.4 million during the three months ended
      June
      30, 2006, an increase of $6.7 million, or 22.8%, from the $29.7 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 June 30, 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 $46.5 million, or 70.4%, to $112.7 million for the three months
      ended June 30, 2006, from $66.2 million for the comparable period in 2005.
      The
      increase is primarily due to: (1) the increase in interest income of $43.7
      million on our loans held for investment - securitized, which totaled $5.5
      billion at June 30, 2006 as compared to $3.3 billion at June 30, 2005; (2)
      the
      increase in interest income of $1.5 million related to the increase in the
      average amount of mortgage loans held for investment - pre-securitization during
      the three months ended June 30, 2006 compared to the same period in 2005; and
      (3) the increase in asset-backed security interest relates to the increase
      in
      fixed-rate asset-backed securities issued by the securitization during the
      three
      months ended June 30, 2006, compared to the asset-backed securities issued
      in
      the same period of 2005.  Also contributing to the increase was a 26 basis
      point increase, to 8.00% at June 30, 2006, in the weighted-average interest
      rate
      on mortgage loans held for investment - securitized from June 30,
      2005.





**35**


The
      following table is a summary of interest income:





**For
                the Three Months Ended June 30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                income on mortgage loans held for investment - pre-securitization,
                net
            
            $
            8,396
            
            $
            6,869Interest
                income on mortgage loans held for investment - securitized, net(1)
            
            
            101,072
            
            
            57,408Asset-backed
                security interest
            
            
            3,130
            
            
            1,464Interest
                income on excess cashflow certificates
            
            
            138
            
            
            406Miscellaneous
                interest income
            
            
            --
            
            
            10Total
                interest income
            
            $
            112,736
            
            $
            66,157





*(1)*  *The
      amount for the three months ended June 30, 2006 and 2005 includes $5.0 million
      and $3.2 million, respectively, of prepayment penalty fees.*





**Interest
      Expense.** Interest
      expense increased by $39.8 million to $76.3 million for the three months ended
      June 30, 2006 from $36.5 million for the comparable period in 2005. The increase
      primarily was due to the increase in interest expense related to the increased
      securitization debt, which increased 61.2% from June 30, 2005 to June 30, 2006,
      and, to a lesser extent, the increase in loans originated and financed by our
      warehouse facilities during the three months ended June 30, 2006, compared
      to
      the same period in 2005. Additionally, the increase in interest expense also
      reflected the 101 basis point increase in the average cost of funds on the
      mortgage loans held for investment financing for the three months ended June
      30,
      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 5.09% for the three months ended June 30, 2006, compared to an
      average of 3.11% for the same period in 2005.





The
      following table presents the components of interest expense:





**For
                the Three Months Ended**
              **June
                30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                expense on warehouse financing
            
            $
            7,451
            
            $
            4,607Interest
                expense on mortgage loans held for investment financing(1)
            
            
            68,568
            
            
            31,816Interest
                expense on other borrowings
            
            
            105
            
            
            66Other
                interest expense
            
            
            170
            
            
            --Total
                interest expense
            
            $
            76,294
            
            $
            36,489





*(1)*  *The
      amount for the three months ended June 30, 2006 and 2005 includes $72,000 and
      $1.2 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 $7.0 million and $7.5 million for the three months ended June
      30,
      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.





**36**


**Non-Interest
      Income**





Total
      non-interest income increased by $2.1 million, or 23.7%, to $11.3 million for
      the three months ended June 30, 2006, from $9.2 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 $1.7 million, coupled with a $464,000 increase in
      the
      net gain on sale of mortgage loans, during the three months ended June 30,
      2006
      as compared to the same period in 2005.





**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 June 30, 2006 and 2005, we
      recorded a net gain on the sale of mortgage loans of $7.1 million and $6.6
      million, respectively, on the sale of $154.0 million and $134.3 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 June 30, 2006 and 2005:





**For
                the Three Months Ended**
              **June
                30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Net
                Gain on Sale of Mortgage Loans:Loans
                sold
            
            $
            154,008
            
            $
            134,306Gain
                on whole-loan sales
            
            $
            5,422
            
            $
            5,457Premium
                recapture reserve
            
            
            (248
            )
            
            (219
            )Net
                loan origination fees
            
            
            1,918
            
            
            1,390Net
                gain on sale recorded
            
            $
            7,092
            
            $
            6,628Net
                gain on sale recorded as a percent of loans sold
            
            
            4.60
            %
            
            4.93
            %





Net
      gain
      on sale of mortgage loans increased $464,000, or 7.0%, to $7.1 million for
      the
      three months ended June 30, 2006, from $6.6 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 June 30, 2006,
      we sold $154.0 million (at a weighted average gross sales price of 3.52%) of
      mortgage loans on a whole-loan servicing-released basis, compared to $134.3
      million (at a weighted average gross sales price of 4.06%) for the same period
      in the prior year.





The
      weighted average net gain-on-sale ratio for the three months ended June 30,
      2006
      and 2005 was 4.60% and 4.93%, respectively. The weighted-average net
      gain-on-sale ratio is calculated by dividing the net gain on sale by the total
      amount of loans sold.





**Other
      Income.** Other
      income increased $1.7 million, or 67.2%, to $4.3 million for the three months
      ended June 30, 2006, from $2.6 million for the three months ended June 30,
      2005.
      The increase in other income primarily relates to a fair value adjustment on
      our
      excess cashflow certificates of $4.2 million for the three months ended June
      30,
      2006, as compared to a $2.5 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 June 30, 2006 primarily was driven by the better-than-expected
      loan
      performance on the underlying loans.


**37**


**Non-Interest
      Expense**





Total
      non-interest expense increased by $3.4 million, or 13.5%, to $28.9 million
      for
      the three months ended June 30, 2006, from $25.5 million for the comparable
      period in 2005. The increase primarily is due to an increase in payroll and
      related costs associated with a 10.2% increase in our mortgage loan production
      and a 6.9% increase in personnel, coupled with an increase in other production
      related expenses. Additionally, offsetting non-interest expense was the $148,000
      gain recorded on derivative instruments relating to the ineffective portion
      of
      our derivatives that is recognized through current earnings during the three
      months ended June 30, 2006 compared to a $334,000 loss recorded for the three
      months ended June 30, 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.





Payroll
      and
      related costs increased by $1.5 million, or 10.2%, to $16.6 million for the
      three months ended June 30, 2006, from $15.0 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 June
      30,
      2006, we employed 1,333 full- and part-time employees, an increase of 6.9%
      over
      our 1,247 full- and part-time employees as of June 30, 2005. Additionally,
      payroll and related costs were higher due to the higher loan commissions paid
      as
      a result of a 10.2% increase in loan production during the three months ended
      June 30, 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 $2.4 million, or 23.5%, to $12.5 million
      for the three months ended June 30, 2006, from $10.1 million for the comparative
      period in 2005. The increase primarily was due to an increase in expenses
      associated with a 10.2% increase in loan production during the three months
      ended June 30, 2006 compared to the same period in 2005 (which includes higher
      advertising, promotional and marketing expenses), and the consequent 6.9%
      increase in personnel and expenses related to our ongoing expansion of our
      wholesale and retail divisions (which includes rent and depreciation
      expenses).





**(Gain)
      Loss
      on Derivative Instruments.** The gain
      on derivative instruments recorded during the three months ended June 30, 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 June 30, 2006, we recorded a net gain on derivative
      instruments of $148,000 as compared to a net loss on derivatives of $334,000
      during the three months ended June 30, 2005. During the three months ended
      June
      30, 2006 we recorded a gain of $79,000 on the ineffective portion of certain
      corridors and interest rate swaps, compared to a loss of $334,000 recorded
      on
      the ineffective portion of certain corridors and interest rate swaps during
      the
      three months ended June 30, 2005. At June 30,
      2006, we hold $744,000 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 June
      30, 2006, a gain of $69,000 was recorded to earnings on the changes in fair
      value of the corridors held as trading securities. During the three months
      ended
      June 30, 2005, none of the corridors tested failed the effectiveness test.
      None
      of the interest rate swaps (including the amortizing notional balance interest
      rate swaps) held at June 30, 2006 or June 30, 2005 were classified as trading
      securities.


**38**


**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 $4.7 million for the three months ended June 30, 2006
      on pre-tax income of $11.9 million recorded for the period (utilizing an
      effective tax rate of approximately 39.2%). We recorded income tax expense
      of
      $2.3 million for the three months ended June 30, 2005 on a pre-tax income of
      $5.9 million (utilizing an effective tax rate of approximately
      39.4%).




**Six
      Months Ended June 30, 2006 Compared to Six Months Ended June 30,
      2005**





**General**





Our
      net
      income for the six months ended June 30, 2006 was $13.8 million, or $0.64 per
      share basic and $0.61 per share diluted, compared to net income of $5.6 million,
      or $0.28 per share basic and $0.27 per share diluted, for the six months ended
      June 30, 2005. The increase in net income during the six months ended June
      30,
      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
      $7.4
      million, pre-tax ($4.5 million after tax), recorded during the six months ended
      June 30, 2006 as compared to recording an increase of $5.2 million, pre-tax
      ($3.2 million after tax), on excess cashflow certificates during the same period
      in 2005.





We
      recorded net interest income after provision for loan losses of $57.7 million
      during the six months ended June 30, 2006, an increase of $15.3 million, or
      36.1%, from $42.4 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 $5.6 billion of mortgage loans held
      for
      investment at June 30, 2006 compared to $3.5 billion of these loans held at
      June
      30, 2005. Similarly, the increase in interest expense primarily reflects the
      net
      effect of recognizing interest expense on $5.4 billion in financing on mortgage
      loans held for investment at June 30, 2006, compared to $3.4 billion of
      financing on mortgage loans held for investment at June 30, 2005. During the
      six
      months ended June 30, 2006, total non-interest income increased by $4.7 million
      and total non-interest expense increased by $6.6 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 six months ended June 30, 2006, while the increase in non-interest
      expense primarily reflects the expenses associated with increases in origination
      volume, primarily increases in payroll and related costs.





We
      originated $1.9 billion of mortgage loans during the six months ended June
      30,
      2006, representing a $197.5 million, or 11.5%, increase from the $1.7 billion
      of
      mortgage loans originated during the six months ended June 30, 2005. We
      securitized and/or sold $2.0 billion of loans during the six months ended June
      30, 2006, representing a $279.0 million, or 16.0%, increase from the $1.7
      billion of loans securitized and/or sold during the same period in
      2005.





**Net
      Interest Income**





We
      recorded net interest income of $71.1 million during the six months ended June
      30, 2006, an increase of $14.3 million, or 25.3%, from the $56.8 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 six
      months ended June 30, 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.





**39**


**Interest
      Income.** Interest
      income increased $93.7 million, or 77.4%, to $214.7 million for the six months
      ended June 30, 2006, from $121.0 million for the comparable period in 2005.
      The
      increase is primarily due to: (1) the increase in interest income of $86.8
      million on our loans held for investment - securitized, which totaled $5.5
      billion at June 30, 2006 as compared to $3.3 billion at June 30, 2005; (2)
      the
      increase in interest income of $4.0 million related to the increase in the
      average amount of mortgage loans held for investment - pre-securitization during
      the six months ended June 30, 2006 compared to the same period in 2005; and
      (3)
      the increase in asset-backed security interest relates to the increase in
      fixed-rate asset-backed securities issued by each securitization during the
      six
      months ended June 30, 2006, compared to the asset-backed securities issued
      in
      the same period of 2005.  Also contributing to the increase was a 26 basis
      point increase, to 8.00% at June 30, 2006, in the weighted-average interest
      rate
      on mortgage loans held for investment - securitized from June 30,
      2005.





The
      following table is a summary of interest income:





**For
                the Six Months Ended June 30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                income on mortgage loans held for investment - pre-securitization,
                net
            
            $
            17,698
            
            $
            13,724Interest
                income on mortgage loans held for investment - securitized, net(1)
            
            
            190,126
            
            
            103,332Asset-backed
                security interest
            
            
            6,504
            
            
            3,071Interest
                income on excess cashflow certificates
            
            
            380
            
            
            895Miscellaneous
                interest income
            
            
            1
            
            
            11Total
                interest income
            
            $
            214,709
            
            $
            121,033


**


*(1)*  *The
      amount for the six months ended June 30, 2006 and 2005 includes $9.2 million
      and
      $5.4 million, respectively, of prepayment penalty fees.*




**Interest
      Expense.** Interest
      expense increased by $79.3 million to $143.6 million for the six months ended
      June 30, 2006 from $64.3 million for the comparable period in 2005. The increase
      primarily was due to the increase in interest expense related to the increased
      securitization debt, which increased 61.2% from June 30, 2005 to June 30, 2006,
      and, to a lesser extent, the increase in loans originated and financed by our
      warehouse facilities during the six months ended June 30, 2006, compared to
      the
      same period in 2005.  Additionally, the increase in interest expense
      also reflected the 104 basis point increase in the average cost of funds on
      the
      mortgage loans held for investment financing for the six months ended June
      30,
      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 4.85% for the six months ended June 30, 2006, compared to an average
      of 2.88% for the same period in 2005.





The
      following table presents the components of interest expense:





**For
                the Six Months Ended**
              **June
                30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Interest
                expense on warehouse financing
            
            $
            15,334
            
            $
            8,652Interest
                expense on mortgage loans held for investment financing(1)
            
            
            127,681
            
            
            55,484Interest
                expense on other borrowings
            
            
            210
            
            
            136Other
                interest expense
            
            
            335
            
            
            --Total
                interest expense
            
            $
            143,560
            
            $
            64,272





*(1)*  *The
      amount for the six months ended June 30, 2006 and 2005 includes $815,000 and
      $2.6 million, respectively, of amortized deferred securitization debt issuance
      expenses and trustee expenses recognized during the period, net of hedge
      amortization.*


**40**


**Provision
      for Loan Losses**





We
      recorded a provision for loan losses of $13.4 million and $14.3 million for
      the
      six months ended June 30, 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 period.





**Non-Interest
      Income**





Total
      non-interest income increased by $4.7 million, or 26.8%, to $22.0 million for
      the six months ended June 30, 2006, from $17.3 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 $2.3 million, and a $2.4 million increase in the net
      gain on sale of mortgage loans, during the six months ended June 30, 2006 as
      compared to the same period in 2005.





**Net
      Gain on Sale of Mortgage Loans.** During the six months ended June 30, 2006 and 2005, we recorded a net gain
      on
      the sale of mortgage loans of $14.3 million and $11.9 million, respectively,
      on
      the sale of $318.7 million and $239.7 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
      six months ended June 30, 2006 and 2005:





**For
                the Six Months Ended**
              **June
                30,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Net
                Gain on Sale of Mortgage Loans:Loans
                sold
            
            $
            318,718
            
            $
            239,725Gain
                on whole-loan sales
            
            $
            11,094
            
            $
            9,619Premium
                recapture reserve
            
            
            (483
            )
            
            (385
            )Net
                loan origination fees
            
            
            3,717
            
            
            2,686Net
                gain on sale recorded
            
            $
            14,328
            
            $
            11,920Net
                gain on sale recorded as a percent of loans sold
            
            
            4.50
            %
            
            4.97
            %





Net
      gain
      on sale of mortgage loans increased $2.4 million, or 20.2%, to $14.3 million
      for
      the six months ended June 30, 2006, from $11.9 million for the comparable period
      in 2005. This increase was directly related to the volume of loan sales period
      over period. The impact from the increase in volume was partially offset by
      a
      decrease in the premium received. During the six months ended June 30, 2006,
      we
      sold $318.7 million (at a weighted average gross sales price of 3.48%) of
      mortgage loans on a whole-loan servicing-released basis, compared to $239.7
      million (at a weighted average gross sales price of 4.01%) for the same period
      in the prior year.





The
      weighted
      average net gain-on-sale ratio for the six months ended June 30, 2006 and 2005
      was 4.50% and 4.97%, respectively. The weighted-average net gain-on-sale ratio
      is calculated by dividing the net gain on sale by the total amount of loans
      sold.





**Other
      Income.** Other
      income increased $2.2 million, or 41.4%, to $7.6 million for the six months
      ended June 30, 2006, from $5.4 million for the six months ended June 30, 2005.
      The increase in other income primarily relates to a fair value adjustment on
      our
      excess cashflow certificates of $7.4 million for the six months ended June
      30,
      2006, as compared to a $5.2 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 six
      months ended June 30, 2006 primarily was driven by the better-than expected
      loan
      performance on the underlying loans.





**41**


**Non-Interest
      Expense**





Total
      non-interest expense increased by $6.6 million, or 13.1%, to $57.0 million
      for
      the six months ended June 30, 2006, from $50.4 million for the comparable period
      in 2005. The increase primarily is due to an increase in payroll and related
      costs associated with a 11.5% increase in our mortgage loan production and
      a
      6.9% increase in personnel, coupled with an increase in other production related
      expenses Additionally, offsetting non-interest expense was the $423,000 gain
      recorded on derivative instruments relating to the ineffective portion of our
      derivatives that is recognized through current earnings during the six months
      ended June 30, 2006 compared to a $318,000 loss recorded for the six months
      ended June 30, 2005.





**Payroll
      and
      Related Costs.**  Payroll
      and related costs increased by $3.4 million, or 11.3%, to $33.6 million for
      the
      six months ended June 30, 2006, from $30.2 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 June 30, 2006,
      we
      employed 1,333 full- and part-time employees, an increase of 6.9% over our
      1,247
      full- and part-time employees as of June 30, 2005. Additionally, payroll and
      related costs were higher due to the higher loan commissions paid as a result
      of
      an 11.5% increase in loan production during the six months ended June 30, 2006
      compared to the same period in 2005.





**General
      and Administrative Expenses.** General
      and administrative expenses increased $3.9 million, or 19.7%, to $23.8 million
      for the six months ended June 30, 2006, from $19.9 million for the comparative
      period in 2005. The increase primarily was due to an increase in expenses
      associated with a 11.5% increase in loan production during the six months ended
      June 30, 2006 compared to the same period in 2005 (which includes higher
      advertising, promotional and marketing expenses), the consequent 6.9% increase
      in personnel and expenses related to our ongoing expansion of our wholesale
      and
      retail divisions (which includes rent and depreciation expenses).





**(Gain)
      Loss
      on Derivative Instruments.**  During
      the six months ended June 30, 2006, we recorded a net gain on derivative
      instruments of $423,000 as compared to a net loss on derivatives of $318,000
      during the six months ended June 30, 2005. During the six months ended June
      30,
      2006, we recorded a gain of $139,000 on the ineffective portion of certain
      corridors and interest rate swaps, compared to a loss of $318,000 recorded
      on
      the ineffective portion of certain corridors and interest rate swaps during
      the
      six months ended June 30, 2005. At June 30,
      2006, we hold $744,000 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 six months ended June
      30,
      2006, a gain of $284,000 was recorded to earnings on the changes in fair value
      of the corridors held as trading securities. During the six months ended June
      30, 2005, none of the corridors tested failed the effectiveness test. None
      of
      the interest rate swaps (including the amortizing notional interest rate swaps)
      held at June 30, 2006 or June 30, 2005 were classified as trading
      securities.


**42**


**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 $8.9 million for the six months ended June 30, 2006
      on
      pre-tax income of $22.7 million recorded for the period (utilizing an effective
      tax rate of approximately 39.2%). We recorded income tax expense of $3.7 million
      for the six months ended June 30, 2005 on a pre-tax income of $9.3 million
      (utilizing an effective tax rate of approximately 39.7%).





**Financial
      Condition**





**June
      30, 2006 Compared to December 31, 2005**





**Cash
      and Cash
      Equivalents.** Cash and
      cash equivalents decreased $24,000, or 5.1%, to $4.6 million at June 30, 2006,
      from $4.7 million at December 31, 2005. This decrease primarily was related
      to
      timing of cash received and disbursed from normal operations.





**Mortgage
      Loans Held for Investment, Net.** Mortgage
      loans held for investment, net increased $899.0 million, or 19.4%, to $5.5
      billion at June 30, 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
                June 30,**
            
            **At
                December 31,***(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Mortgage
                loans held for investment - securitized
            
            $
            5,457,736
            
            $
            4,430,775Mortgage
                loans held for investment - pre-securitization
            
            
            161,019
            
            
            270,372Discounts
                (MSR related)
            
            
            (32,864
            )
            
            (26,750
            )Net
                deferred origination fees
            
            
            (13,756
            )
            
            (10,735
            )Allowance
                for loan losses
            
            
            (46,326
            )
            
            (36,832
            )Mortgage
                loans held for investment, net
            
            $
            5,525,809
            
            $
            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 June 30, 2006 and December 31, 2005,
      we
      established an allowance for loan losses totaling $46.3 million and $36.8
      million, respectively, based upon our analysis of the mortgage loans held for
      investment portfolio, including a $1.5 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
      June 30, 2006.





The
      following table sets forth a summary of the activity in the allowance for loan
      losses for the six months ended June 30, 2006 and for the year ended December
      31, 2005:


**43**





*(Dollars
                in thousands)*
            
            **For
                the Six Months Ended June 30, 2006**
            
            **For
                the Year Ended December 31, 2005**Allowance
                for loan losses - beginning of year
            
            $
            36,832
            
            $
            10,278Provision
                for loan losses(1)
            
            
            13,402
            
            
            28,592Charge-offs(2)
            
            
            (3,908
            )
            
            (2,038
            )Allowance
                for loan losses - end of period
            
            $
            46,326
            
            $
            36,832





*(1)*  *The
      provision for loan losses for the six months ended June 30, 2006 and for the
      year ended December 31, 2005 includes a $22,000 and $1.7 million, respectively,
      specific provision* *related
      to probable losses attributable to impaired loans. The specific provision for
      the six months ended June 30, 2006 is net of a $275,000 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* *six
      months ended June 30, 2006 and for the* *year
      ended December 31, 2005 includes a $282,000 and $3,000, respectively, charge-off
      against the specific allowance for loan losses attributable to loans in
      Hurricanes Katrina and Rita disaster areas.*





At
      June
      30, 2006 and December 31, 2005, a specific reserve for impaired loans totaled
      $1.5 million and $1.7 million, respectively. The majority of the specific
      reserve at June 30, 2006 ($1.2 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 June 30, 2006
      and
      December 31, 2005 is based upon our probable loss exposure attributable to
      26
      properties (22 of these properties are Hurricane Katrina and Rita related)
      and
      35 properties (all of these properties were Hurricane Katrina and Rita related),
      respectively, securing a total unpaid principal balance of $3.6 million ($2.6
      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 .





**Trustee
      Receivable.** Trustee
      receivable increased $4.9 million, or 8.8%, to $61.1 million at June 30, 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 June 30, 2006 and December 31, 2005
      totaled $54.7 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 June 2006 remittance
      cut-off date will be remitted to us in July 2006).





**Accrued
      Interest Receivable.** Accrued
      interest receivable increased $6.2 million, or 23.3%, to $33.2 million at June
      30, 2006, from $27.0 million at December 31, 2005. The increase is due to the
      23.2% increase in mortgage loans held for investment - securitized from December
      31, 2005, offset by the 40.4% 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 23 basis points
      and
      62 basis points, respectively, from December 31, 2005 to June 30,
      2006.


**44**





**Excess
      Cashflow Certificates.** The
      following table presents the activity related to our excess cashflow
      certificates for the six months ended June 30, 2006 and for the year ended
      December 31, 2005:





*(Dollars
                in thousands)*
            
            **For
                the Six Months Ended June 30, 2006**
            
            **For
                the Year Ended December 31, 2005**Balance,
                beginning of year
            
            $
            7,789
            
            $
            14,933Excess
                cashflow certificates sold
            
            
            (1,500
            )
            
            --Accretion
            
            
            380
            
            
            1,593Cash
                receipts
            
            
            (11,075
            )
            
            (23,146
            )Net
                change in fair value
            
            
            7,449
            
            
            14,409Balance,
                end of period
            
            $
            3,043
            
            $
            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. During May 2006, we sold $1.5 million of excess cashflow
      certificates at par to a third-party without recourse. We did not sell any
      excess cashflow certificates during the six months ended June 30, 2005 or during
      the year ended December 31, 2005.





Aside
      from the impact of the sale of excess cashflow certificates, the
      decrease in the fair value of our excess cashflow certificates for the six
      months ended June 30, 2006, as compared to the same period in 2005, primarily
      is
      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 six months ended June 30, 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 six months
      ended June 30, 2006.





**Equipment,
      Net.** Equipment, net increased $604,000, or 9.0%, to $7.3 million at June 30, 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
      six
      months ended June 30, 2006, which reflects the impact of our office expansions
      during the first quarter of 2006. Most of the equipment purchased during the
      first six months of 2006 will be depreciated over a three- to five-year period
      from the date acquired.





**Accounts
      Receivable.**  Accounts
      receivable increased $3.3 million, or 63.5%, to $8.4 million at June 30, 2006,
      from $5.1 million at December 31, 2005. This
      increase primarily is due to an increase in amounts due from the third-party
      servicer and a $2.8 million increase in a current tax asset. The increase in
      servicer receivables relates to the early pay-offs occurring on our mortgage
      loans held for investment - pre-securitization portfolio during the last month
      of the six month period ended June 30, 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 June 2006
      will be remitted to us in July 2006).





**Prepaid
      and Other Assets.** Prepaid
      and other assets increased $7.3 million, or 24.0%, to $37.8 million at June
      30,
      2006, from $30.5 million at December 31, 2005. The increase is primarily due
      to
      the (1) $6.5 million increase in REO properties due to the expected seasoning
      of
      the loan portfolio, and (2) $1.8 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. These increases
      were partially offset by a $1.6 million net decrease in the fair value of our
      derivative instruments used to hedge our securitization debt during the six
      months ended June 30, 2006.





**45**


At
      June
      30, 2006 and December 31, 2005, we held $11.0 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 $546,000 during the six months
      ended June 30, 2006. We recorded write-downs of $213,000 during the year ended
      December 31, 2005.




**Deferred
      Tax Asset.**  The
      deferred tax asset decreased by $8.1 million, or 14.7%, to $46.8 million at
      June
      30, 2006, from $54.9 million at December 31, 2005. The decrease primarily is
      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 were treated
      as sales, deferred origination fees and a $3.2 million decrease in deferred
      taxes related to the increase in the fair value of the hedge instruments within
      accumulated OCI. The decrease was partially offset by increases in the
      differences related to the 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) and accrued
      expenses.





Commencing
      in the first quarter of 2005, we began issuing our securitizations using 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 Captive REIT securitizations are structured as “debt-for-tax”
transactions. Our securitizations prior to 2005 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 increased $52,000, or 2.7%, to $2.0 million at June 30, 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 $133.6 million, or 60.0%, to $89.2 million at
      June
      30, 2006, from $222.8 million at December 31, 2005. The decrease was primarily
      due to a $109.4 million, or 40.4%, decrease in the amount of mortgage loans
      held
      for investment - pre-securitization.





**Financing
      on Mortgage Loans Held for Investment, Net.** Our
      financing on mortgage loans held for investment, net increased $1.0 billion,
      or
      22.4%, to $5.4 billion at June 30, 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 six months ended
      June 30, 2006. The balance of this account generally will increase in proportion
      to the increase in mortgage loans held for investment -
      securitized.





**Other
      Borrowings.**  Other
      borrowings increased $759,000, or 15.9%, to $5.5 million at June 30, 2006,
      from
      $4.8 million at December 31, 2005. The increase was due to the increased need
      for equipment financing during the six months ended June 30, 2006.




The
      following table summarizes certain information regarding other borrowings at
      June 30, 2006 and December 31, 2005:





*(Dollars
                in thousands*)**Equipment
                Financing**
            
            **Range
                of Interest Rates**
            
            **Balance**
            
            **Range
                of Expiration Dates**At
                June 30, 2006
            
            6.26%
                to 9.09%
            
            $                                   
                 5,544
            
            July
                2006 to July 2009At
                December 31, 2005
            
            3.29%
                to 12.45%
            
            $                                    
                4,785
            
            January
                2006 to December 2008





**46**


**Accrued
      Interest Payable.** Accrued
      interest payable increased $6.2 million, or 47.1%, to $19.3 million at June
      30,
      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 $1.0 billion, or 22.4%, at
      June
      30, 2006 from December 31, 2005, coupled with the increase in the weighted
      average cost on mortgage loans held for investment financing. The weighted
      average cost on mortgage loans held for investment financing was 5.46% at June
      30, 2006 as compared to 4.92% at December 31, 2005.





Accrued
      interest payable related to warehouse borrowings represented $91,000 and
      $279,000 of the balance at June 30, 2006 and December 31, 2005, respectively.
      The decrease is due to the 60.0% decrease in warehouse financing offset by
      the
      94 basis point increase (5.33% at June 30, 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 $5.4 million, or 16.1%, to $38.6 million
      at June 30, 2006, from $33.2 million at December 31, 2005. The increase was
      primarily due to a $5.2 million increase in accrued servicer advances (payables)
      related to our accounting for loan securitizations as secured financings
      beginning in 2004, and to a lesser extent, increases in reserves related to
      legal, premium recapture and representation and warranty indemnifications,
      partially offset by a reduction in current taxes payable during the same
      period.





**Stockholders’
      Equity.** Stockholders’ equity increased $37.5 million, or 35.1%, to $144.3 million at
      June 30, 2006 from $106.8 million at December 31, 2005. This increase primarily
      is due to (1) the recording of $13.8 million in net income for the six months
      ended June 30, 2006, (2) a $5.1 million, net of tax, increase in the
      accumulative OCI related to the net unrealized gains from derivatives, (3)
      the
      $19.4 million of net proceeds we received from the issuance of 2.5 million
      shares of common stock in April 2006, and (4) the $247,000 of proceeds and
      $768,000 of excess tax benefits related to the exercise of 242,200 stock options
      from authorized but unissued shares during the same period. These increases
      were
      offset by the payment of $1.0 million of dividends and the accrual of $1.2
      million in common stock dividends that were declared on June 23, 2006 and paid
      on July 6, 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.




**Contractual
      Obligations**





The
      following table summarizes our material contractual obligations as of June
      30,
      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)
            
            $
            5,429,292
            
            $
            2,039,160
            
            $
            2,077,646
            
            $
            725,721
            
            $
            586,765Operating
                leases
            
            $
            23,471
            
            $
            6,533
            
            $
            10,388
            
            $
            5,880
            
            $
            670Equipment
                financing
            
            $
            5,544
            
            $
            434
            
            $
            3,181
            
            $
            1,929
            
            $
            --





*(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.*


**47**


**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 June 30, 2006 and December 31, 2005,
      we had outstanding origination commitments to fund approximately $131.4 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.,* excess
      cashflow certificates), there is $551.6 million in collateral (primarily
      mortgage loans) owned by off-balance sheet trusts as of June 30, 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 “Origination of Mortgage
      Loans - 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 we receive from our quarterly securitizations, including
      the NIM transactions and 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 largely 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. Additionally, although we believe our strategy
      to hedge our exposure to rising interest rates in an effort to “lock in” our
      spread (as discussed in more detail in “Summary of Critical Accounting Policies
      - Accounting for Hedging” above and “- Item 3.  Quantitative and
      Qualitative Disclsures About Market Risk - Hedging”) to be appropriate,
      decreasing interest rates could adversely impact our cash flow in any such
      period.





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 and interest rate swaps;·
            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.






**48**




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, interest rate swap payments 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 $612,000 and $762,000 at June 30, 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 $262,000 and $310,000 at June 30, 2006 and December 31, 2005,
      respectively.




Subject
      to our ability to execute our business strategy and the various uncertainties
      described in this section and described 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.





To
      originate and accumulate loans for securitization, we borrow money on a
      short-term basis primarily 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
      majority of the loans collateralizing warehouse borrowings are held for a period
      of up to 120 days, at which point they are securitized or sold. The
      material terms and features of our financing facilities in place at June 30,
      2006 are as follows:





**49**


**RBS
      Greenwich
      Capital Warehouse Line of Credit** .
      We have
      a $350.0 million committed 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 June 30, 2006, the outstanding balance under the facility was $58.8
      million.





**Citigroup
      Warehouse Line of Credit.** We have
      a $350.0 million committed 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 2007. As of June 30, 2006, the outstanding balance under the facility
      was
      $30.4 million.





**Bank
      of
      America Warehouse Line of Credit.** We have
      a $350.0 million committed 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 June 30, 2006, we had
      no
      outstanding balance under the facility.





**JP
      Morgan Chase Warehouse Line of Credit.** We have
      a $350.0 million facility ($200.0 million of which is committed) with JP Morgan
      Chase 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 May 2007. As of
      June
      30, 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
      June 30, 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 72.2% and 70.8% of
      our
      net revenues (net interest income and non-interest income, less provision for
      loan loss) during the three months ended June 30, 2006 and 2005, respectively.
      Net interest income after provision for loan loss represents 72.4% and 71.0%
      of
      our net revenues (net interest income and non-interest income, less provision
      for loan loss) during the six months ended June 30, 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, such as the present
      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.





**50**


**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. These 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 normally make standard mortgage
      industry representations and warranties, which may require us to repurchase
      one
      or more of the mortgage loans if they are breached. Additionally, certain
      whole-loan sale contracts include provisions that require us to repurchase
      a
      loan if a borrower fails to make one or more of the first loan payments due
      on
      the 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 June 30, 2006,
      approximately 24% and 14%, 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.





The
      value
      of mortgaged properties could decline as a result of an overall decline in
      the
      economy or residential real estate market, or from the occurrence of a natural
      disaster that is not covered by standard homeowners’ insurance policies
      ( *i.e.,* hurricane-related damages). This decline, in turn, would increase the risk
      of
      delinquency, default or foreclosures on mortgage loans in our mortgage loans
      held for investment portfolio and restrict our ability to originate, sell,
      or
      securitize mortgage loans, which would significantly harm our business,
      financial condition and liquidity.





**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.





**51**


**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, such as the current trend,
      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 Uncertainty in Income Taxes.* In June 2006, the
      FASB
      issued FIN No. 48.   FIN No. 48 clarifies the accounting for
      uncertainty in income taxes recognized in  a
      company's financial statements in accordance with SFAS No.
      109. Only tax positions meeting a "more-likely-than-not" threshold of being
      sustained are recognized under FIN No. 48. FIN No. 48 also provides guidance
      on
      derecognition, classification of interest and penalties and accounting and
      disclosures for annual and interim financial statements. FIN No. 48 is effective
      for fiscal years beginning after December 15, 2006. The cumulative effect of
      the
      changes arising from the initial application of FIN No. 48 is required to be
      reported as an adjustment to the opening balance of retained earnings in the
      period of adoption. We are currently evaluating the impact, if any, the adoption
      of FIN No. 48 on January 1, 2007 will have on our financial
      statements.




*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 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. 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.


**52**





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.





**53**


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. We may use
      hedges, such as interest rate swaps and corridors, to mitigate the effect of
      changing interest rates between the time we originate loans and the time we
      either securitize or sell loans. If hedges are not utilized, as interest rates
      rise between the time we originate the loans and the time we securitize or
      sell
      the loans, the excess spread generally would narrow, resulting in a loss of
      value on the loans and lowering the net interest income we would receive on
      the
      mortgage loans we securitize and lower net gains, or possibly produce losses
      on
      the whole loans we sell. 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, such
      as
      the current 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 June 30, 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 June 30, 2006
            
            $
            3,04310%
                increase in prepayment speed
            
            
            3,149
            
            $
            (106
            )20%
                increase in prepayment speed
            
            
            3,268
            
            
            (225
            )10%
                increase in credit losses
            
            
            2,993
            
            
            5020%
                increase in credit losses
            
            
            2,941
            
            
            10210%
                increase in discount rates
            
            
            3,040
            
            
            320%
                increase in discount rates
            
            
            3,035
            
            
            810%
                increase in one- and six-month LIBOR
            
            
            3,233
            
            
            (190
            )20%
                increase in one- and six-month LIBOR
            
            
            3,861
            
            
            (818
            )





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. We are unable 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) and/or
      amoritizing notional balance interest rate swaps that are designed to mitigate
      our basis risk within the securitization. (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”).





**54**


**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, decreasing our net interest
      margin.





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 months) 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 have
      and may continue 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.”





**55**


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.





Management
      uses financing sources where the interest rate resets frequently. As of June
      30,
      2006, the adjustable-rate borrowings under all of our financing arrangements
      adjust daily ( *i.e.* ,
      all of
      our warehouse lines of credit) or monthly ( *i.e.,* portions
      of our securitization debt). 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 June 30, 2006:


**56**





*(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)
            
            $
            118,437
            
            $
            115,619
            
            $
            114,216
            
            $
            121,738
            
            $
            126,691Percentage
                change from base
            
            
            
            
            
            (2.38)%
            
            
            (3.56)%
            
            
            2.79%
            
            
            6.97%***Three
                Year Projection:***Net
                interest income(1)(2)
            
            $
            227,722
            
            $
            221,520
            
            $
            217,306
            
            $
            234,854
            
            $
            246,801Percentage
                change from base
            
            
            
            
            
            (2.72)%
            
            
            (4.57)%
            
            
            3.13%
            
            
            8.38%





*(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 September 30, 2006.*





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, such as the current environment. In this way,
      management generally intends 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 and amortizing notional balance interest rate swaps
      that we held as of June 30, 2006:


**57**





*(Dollars
                in thousands,**except
                average strike price and rate)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years & Thereafter**Caps
                bought - notional
            
            $
            1,717,654
            
            $
            1,127,586
            
            $
            418,577
            
            $
            42,720
            
            $
            32,195
            
            $
            96,576Weighted
                average strikeprice
            
            $
            6.39
            
            $
            5.75
            
            $
            7.08
            
            $
            7.43
            
            $
            7.46
            
            $
            7.42Caps
                sold - notional
            
            $
            1,717,654
            
            $
            1,127,586
            
            $
            418,577
            
            $
            42,720
            
            $
            32,195
            
            $
            96,576Weighted
                average strikeprice
            
            $
            8.85
            
            $
            8.54
            
            $
            9.28
            
            $
            9.27
            
            $
            9.27
            
            $
            9.30Amortizing
                notional balance interest rate swaps:Notional
            
            $
            134,099
            
            $
            53,221
            
            $
            53,559
            
            $
            27,319
            
            $
            --
            
            $
            --Weighted
                average rate
            
            $
            5.41
            
            $
            5.41
            
            $
            5.41
            
            $
            5.41
            
            $
            --
            
            $
            --





**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 June 30, 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, as amended (the "Exchange Act") 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 June 30, 2006 that materially affected, or are reasonably likely to
      materially affect, our internal controls over financial reporting.





**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.
                Briefing on the intervention motion was re-submitted to the District
                Court
                Judge in July 2006. 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.





**58**


·
            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. In
                July 2006, we re-filed our motion to amend our complaint. 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.





**59**


·
            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. In
                June
                2006, we filed a motion for summary judgment in the case pertaining
                to the
                fax fees 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”, now a division of our
                other subsidiary, Delta Funding Corporation), 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. By agreement
                in June
                2006, the Court stayed the action permitting the parties to engage
                in
                non-binding mediation, and plaintiffs’ motion for summary judgment was
                withdrawn without prejudice to it being re-filed. Unless the matter
                is
                resolved, the stay will be lifted in August 2006, the plaintiffs’ motion
                re-filed and we will file our opposition to the motion. 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, the impact of changes to accounting rules, 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.





**60**


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.
      We qualify any and all of our forward-looking statements entirely by these
      cautionary factors. 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 execution of NIM transactions and 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, such as
                the
                current environment, 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;





·
            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;





**61**


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





·
            The
                leveling off of or decline in the value of residential properties
                could
                have a significant impact on our origination levels and/or financial
                position and results of operations. The increase in home prices over
                the
                last several years has contributed to the growth in our origination
                volume, as well as, reducing the risk of losses by improving LTV
                ratios.
                The slowing of home-price growth, or perhaps a decline in values
                in some
                markets, could have a significant impact on our mortgage loan origination
                growth, as well as impact our prepayment speed and credit loss assumptions
                on the mortgage loans held for investment and the corresponding allowance
                for loan losses;





·
            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;





**62**


·
            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;





·
            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”) and various state “do not call” registries, which were
                implemented beginning 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 the value of the mortgaged
                property, which may result in increased losses to us. Standard homeowner
                insurance policies generally do not provide coverage for natural
                disasters, such as hurricanes and floods. Furthermore, nonconforming
                borrowers are not likely to have special hazard insurance. To the
                extent
                that borrowers do not have insurance coverage for natural disasters,
                they
                may not be able to repair the property or may stop paying their mortgages
                if the property is damaged. 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;





**63**


·
            The
                risk that any material decline in real estate values would weaken
                our
                collateral LTV 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. We utilized an Insured AVM on approximately 12%
                of the
                loans we originated during the three months ended June 30, 2006.
                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;





·
            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 42.3% and 43.2% of our loans were originated
                during
                the three and six months ended June 30, 2006, respectively. 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 and we may cause us to sustain a reduction in our
                net
                income or incur losses;





·
            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;





**64**


·
            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. We have a third-party
                mortgage loan servicer, Ocwen Loan Servicing, LLC, which presently
                services our loan portfolio. Poor servicing by Ocwen Loan Servicing,
                LLC
                (or its parent Ocwen Financial Corporation, or subsidiaries, collectively
                referred to as “Ocwen”) 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
                has
                been named as a defendant 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, in favor
                of a
                plaintiff borrower who defaulted on a mortgage loan it serviced.
                The
                plaintiff claimed that Ocwen’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 has indicated in its
                public
                filings that it believes the judgment was against the weight of evidence
                and contrary to law and has asked the trial court to set it aside.
                Ocwen
                also has indicated in its public filings that it 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 maintains high levels of indebtedness. Ocwen is a non-investment
                grade company and in 2004 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”). Ocwen is now
                licensed and regulated primarily at the state and local level. If
                Ocwen’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.





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




·
            In
                2006 we adopted SFAS 123(R), which requires us to measure compensation
                cost for stock awards at fair value and recognize compensation over
                the
                service period the awards expected to vest. The determination of
                compensation cost requires us to make many assumptions regarding
                volatility, expected option life and forfeiture rates. In addition,
                changes in our stock price or prevailing interest rates will also
                impact
                the determination of fair value and compensation cost. If any of
                our
                assumptions used to determine fair value change significantly, future
                share-based compensation may differ materially from that recorded
                in the
                current period;





·
            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;





·
            We
                rely heavily upon communications and information systems to conduct
                our
                business. Any material interruption or breach in security of our
                communication or information systems or the third-party systems on
                which
                we rely could cause underwriting or other delays and could result
                in fewer
                loan applications being received, slower processing of applications
                and
                reduced efficiency in loan servicing. Additionally, in connection
                with our
                loan file due diligence reviews, we have access to the personal financial
                information of the borrowers which is highly sensitive and confidential,
                and subject to significant federal and state regulation. If a third
                party
                were to misappropriate this information, we potentially could be
                subject
                to both private and public legal actions. Our policies and safeguards
                may
                not be sufficient to prevent the misappropriation of confidential
                information, may become noncompliant with existing federal or state
                laws
                or regulations governing privacy, or with those laws or regulations
                that
                may be adopted in the future;





**65**


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





·
            While
                we are not subject to direct supervision by the OTS, changes in
                regulations issued by them 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 dividends 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 owned
                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 June 30, 2006, members of the Miller family
                (considered one stockholder under the attribution rule applicable
                to the
                ownership of REIT stock) own approximately 33.7% 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. 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;




·
            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 of the 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




**66**




·
            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
      2. Unregistered Sales of Equity Securities and Use
      of Proceeds**





On
      April
      6, 2006, we announced the pricing of a private placement of 2,500,000 newly
      issued shares, from
      authorized but unissued shares, of our
      common stock at a price of $8.25 per share to a combination of new and existing
      institutional investors. The offering was made to accredited investors and
      was
      exempt from registration under the Securities Act of 1933. The offering closed
      on April 10, 2006. We received proceeds of approximately $19.4 million, after
      deducting expenses payable in connection with this offering. The
      proceeds were used to repay warehouse financings and originate mortgage
      loans.





**Item
      4. Submission of Matters to a Vote of Security
      Holders.**





Our
      annual
      meeting of stockholders was held on May 25, 2006. At the meeting, Arnold B.
      Pollard and Richard Blass were re-elected as Class I Directors for a term of
      three years and John Adamovich and William Addas were elected as a Class II
      and
      Class III Director, respectively, for terms of one year and two years,
      respectively. Sidney A. Miller and Martin D. Payson continue to serve as Class
      II Directors and Hugh Miller and Margaret A. Williams continue to serve as
      Class
      III Directors.




§ Votes
      cast in favor of Mr. Arnold Pollard’s selection totaled 15,539,598; while 54,556
      votes were withheld.




§ Votes
      cast in favor of Mr. Richard Blass’ selection totaled 15,509,573; while 84,581
      votes were withheld.




§ Votes
      cast in favor of Mr. John Adamovich’s selection totaled 15,538,951; while 55,203
      votes were withheld.




§ Votes
      cast in favor of Mr. William Addas’ selection totaled 15,539,651; while 54,503
      votes were withheld.





The stockholders also voted to ratify the appointment of KPMG LLP as our
      independent registered public accounting firm for the fiscal year ending
      December 31, 2006. Votes cast in favor of this ratification were 15,495,610;
      while votes cast against were 54,400 and abstentions totaled
      44,144.





**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.


**67**








**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.


**DELTA
                FINANCIAL CORPORATION**
              ****(Registrant)Date: August
              8, 2006
            By:**Hugh
              Miller**President
              and Chief Executive Officer By:**Richard
              Blass**Executive
              Vice President and Chief Financial
              Officer





**68**