**UNITEDSTATES****SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM10-Q**

 

ý                         **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2004**

 

**OR**

 

o                         **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the transition period from                    to                    **

 

**Commission file number 000-22633**

 

**NEWCENTURY FINANCIAL CORPORATION**

(Exactname of registrant as specified in its charter)

 
| **DELAWARE**                                                    | ** ** | **33-0683629**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |
|                                                            |       |                                 |
| **18400 VON KARMAN, SUITE 1000,  IRVINE, CALIFORNIA**           | ** ** | **92612**                            |
| (Address of principal executive offices)                        |       | (Zip code)                           |

 

Registrant’stelephone number, including area code:**         (949)440-7030**

 

**Not Applicable**

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

 

Indicate by check o whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding twelve months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

YES  ý    NO  o

 

Indicateby check  whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

 

YES  ý    NO  o

 

**As of July 31, 2004, the registrant had 34,045,201shares of common stock outstanding.**

 

 

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**NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES**

**FORM 10-Q**

**QUARTER ENDED JUNE 30, 2004**

 

**INDEX**

 
| PART  I—FINANCIAL INFORMATION                                                                   |   |
|------------------------------------------------------------------------------------------------------|--------|
| Item 1. Financial Statements                                                                         | 4      |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations | 20     |
| Item  3. Quantitative and Qualitative Disclosures About Market Risk                                  | 37     |
| Item  4. Controls and Procedures                                                                     | 40     |
| PART II—OTHER INFORMATION                                                                       |   |
| Item 1. Legal Proceedings                                                                            | 41     |
| Item  5. Other Information                                                                           | 43     |
| Item  6. Exhibits and Reports on Form 8-K                                                            | 44     |
| SIGNATURES                                                                                           | 46     |
| EXHIBIT INDEX                                                                                        | 47     |

 

2

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Certain information included in this Form 10-Q may include“forward-looking” statements under federal securities laws, and we intend thatsuch forward-looking statements be subject to the safe-harbor created thereby.Such statements include, without limitation, (i) the assumptions and estimatesunderlying our projections of our residual asset value and cash flow, (ii) ourprojections of our residual asset value and cash flow, (iii) the estimatesunderlying our allowance for losses on mortgage loans held for investment, (iv)our allowance for repurchase losses, (v) the estimates underlying our allowancefor repurchase losses, (vi) our goal of matching the timing of cash flows withthe recognition of earnings on our loans, (vii) our goal to continue to addmortgage loans held for investment to our balance sheet to reduce the relianceon the origination and sale of loans for earnings and cash flows, (viii) ourexpectation that we will continue to grow our balance sheet, (ix) our goal ofreducing our loan acquisition costs so that we can maintain a strong operatingmargin in periods when the secondary market for our loans is not as favorable,(x) our expectation that our loan production volume will stabilize during thesecond half of 2004, (xi) our expectation that loan acquisition costs willnormalize to 2.25% for the remainder of 2004, (xii) our goal to generateprimarily cash-based earnings rather than non-cash gain on sale revenue, (xiii)our expectation that the recognition of income as interest payments arereceived on the mortgage loans held for investment underlying an on-balancesheet securitization will result in higher income recognition in future periodsthan would an off-balance sheet securitization, (xiv) our beliefs regarding ourcritical accounting policies, (xv) our belief that our allowance for losses onmortgage loans held for investment is adequate for known and inherent losses inthe portfolio of mortgage loans that we hold for investment, (xvi) ourestimates regarding tax rates and future taxable income, (xvii) our goal ofsecuritizing approximately 20% of our loan production through sales structuredas financings and recorded on-balance sheet, (xviii) our expectation that secondarymarket prices will be lower than recent levels in the second half of 2004,(xix) our expectation that our net execution will be between 3.50% and 3.75%for all of 2004, (xx) our belief that the receipt of a rating of RPS3, oraverage, from Fitch Ratings and a rating of average from Standard & Poor’swill enable us to grow our servicing portfolio in the future through increasedsales of loans on a servicing retained basis, (xxi) our expectation that wewill service loans owned by third parties to take advantage of our technicalcapabilities, capitalization and economies of scale, (xxii) our expectationsregarding the renewal or non-renewal of certain of our credit facilities,(xxiii) the expectation that we will continue to concentrate on maintaining ourtargeted liquidity levels, (xxiv) our plan to effectively manage the percentageof loans sold through whole loan sales versus on-balance sheet securitizations,giving consideration to whole loan prices, the amount of cash required tofinance on-balance sheet securitizations and dividend requirements, (xxv) ourbelief that our liquidity, credit facilities and capital resources will besufficient to fund our operations for the foreseeable future, (xxvi) ourbeliefs with respect to our legal proceedings, (xxvii) our expectation that wewill qualify as a real estate investment trust, or REIT, for U.S. federalincome tax purposes, and (xxviii) our expectation that, in connection with ourconversion to a REIT, we will raise approximately $750 million of capital througha public offering of shares of common stock of New Century REIT, Inc., or NewCentury REIT, our wholly-owned subsidiary.

 

Wecaution that these statements are qualified by important factors that couldcause our actual results to differ materially from expected results in theforward-looking statements. Such factors include, but are not limited to, (i)the condition of the U.S. economy and financial system, (ii) the interest rateenvironment, (iii) the condition of the markets for whole loans and mortgage-backedsecurities, (iv) the stability of residential property values, (v) our abilityto continue to maintain low loan acquisition costs, (vi) the potential effectof new state or federal laws and regulations, (vii) the effect of increasingcompetition in our sector, (viii) our ability to accurately predict targetlevels of liquidity and capital, (ix) our ability to maintain adequate creditfacilities to finance our business, (x) our ability to adequately hedge ourresidual assets and mortgage loans held for investment, (xi) the accuracy ofour assumptions regarding our allowance for losses on mortgage loans held forinvestment, (xii) the accuracy of our assumptions regarding our allowance forrepurchase losses and residual valuations, (xiii) the ability of our servicingplatform to maintain high performance standards, (xiv) our ability to continueto designate our derivative financial instruments as accounting hedges underSFAS 133, as amended, (xv) the performance of our mortgage loans underlying oursecuritization transactions, (xvi) the initiation of a margin call under any ofour credit facilities, (xvii) our ability to obtain stockholder approval of theagreement and plan of merger in connection with the REIT conversion, (xviii)the satisfaction or, where permitted, waiver of the conditions specified in theagreement and plan of merger, and (xix) our ability to comply with therequirements applicable to REITs. Additional information on these and otherfactors is contained in our Annual Report on Form 10-K for the year endedDecember 31, 2003, as amended, and our other periodic filings with theSecurities and Exchange Commission.

 

Inaddition, on April 5, 2004, our Board of Directors unanimously voted infavor of converting New Century Financial Corporation, or New CenturyFinancial, to a Real Estate Investment Trust (“REIT”), subject to a number ofconditions, including Securities and Exchange Commission review and stockholderapproval of the merger component of the REIT conversion. New Century REIT has fileda registration statement on Form S-4, as amended, which includes a proxystatement/prospectus related to the proposed REIT conversion. Please refer tothat registration statement for detailed risk factors related to the REITconversion, as well as other matters, including the anticipated timing of theREIT conversion and our ability to satisfy the various other requirements forcompleting the REIT conversion. We assume no obligation to update theforward-looking statements contained in this Form 10-Q.

 

3

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**New Century Financial Corporation andSubsidiaries**

**Condensed Consolidated Balance Sheets**

**(Dollars in thousands, except share amounts)**

**(Unaudited)**

 
| ** **                                                                                                                                                                      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS:**                                                                                                                                                                     |       |                    |       |                        |       |
| Cash and cash equivalents (note 1)                                                                                                                                              |       | $                       | 68,891     |                        | $          | 269,540 |   |
| Restricted cash (note 1)                                                                                                                                                        |       | 322,369                 |       | 116,883                     |       |
| Mortgage loans held for sale, net (notes 2 and 7)                                                                                                                               |       | 4,784,222               |       | 3,422,211                   |       |
| Mortgage loans held for investment, net (notes 3  and 8)                                                                                                                        |       | 9,146,472               |       | 4,745,937                   |       |
| Residual interests in securitizations (note 4)                                                                                                                                  |       | 190,827                 |       | 179,498                     |       |
| Mortgage servicing assets (notes 6 and 11)                                                                                                                                      |       | 1,373                   |       | 1,900                       |       |
| Accrued interest receivable                                                                                                                                                     |       | 42,880                  |       | 35,824                      |       |
| Income taxes, net                                                                                                                                                               |       | 67,953                  |       | 52,377                      |       |
| Office property and equipment                                                                                                                                                   |       | 38,609                  |       | 32,258                      |       |
| Prepaid expenses and other assets (notes 6 and 11)                                                                                                                              |       | 70,114                  |       | 36,901                      |       |
| **TOTAL ASSETS**                                                                                                                                                                |       | $                       | 14,733,710 |                        | $          | 8,893,329 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY:**                                                                                                                                 |       |                    |       |                        |       |
| Credit facilities (note 7)                                                                                                                                                      |       | $                       | 4,439,518  |                        | $          | 3,311,837 |   |
| Financing on mortgage loans held for investment,  net (note 8)                                                                                                                  |       | 9,086,932               |       | 4,686,323                   |       |
| Convertible notes, net                                                                                                                                                          |       | 205,349                 |       | 204,858                     |       |
| Notes payable                                                                                                                                                                   |       | 30,485                  |       | 18,977                      |       |
| Accounts payable and accrued liabilities (note 11)                                                                                                                              |       | 228,089                 |       | 129,323                     |       |
| Total liabilities                                                                                                                                                               |       | 13,990,373              |       | 8,351,318                   |       |
| Stockholders’ equity:                                                                                                                                                      |       |                    |       |                        |       |
| Preferred stock, $0.01 par value.  Authorized 7,500,000 shares;  no shares outstanding at June 30, 2004 and December 31, 2003                                         |       | —                  |       | —                      |       |
| Common stock, $0.01 par value.  Authorized 100,000,000 shares;  issued and outstanding 33,905,609 shares at June 30, 2004 and 33,759,695  shares at December 31, 2003 |       | 340                     |       | 338                         |       |
| Additional paid-in capital                                                                                                                                                      |       | 49,310                  |       | 52,988                      |       |
| Accumulated other comprehensive income (loss)  (note 11)                                                                                                                        |       | 16,591                  |       | (1,742                      | )          |
| Retained earnings, restricted                                                                                                                                                   |       | 686,061                 |       | 509,998                     |       |
|                                                                                                                                                                            |       | 752,302                 |       | 561,582                     |       |
| Treasury stock, 2,500 shares at June 30, 2004  and 377,500 shares at December 31, 2003, respectively, at cost                                                         |       | (70                     | )          | (14,163                     | )          |
| Deferred compensation costs                                                                                                                                                     |       | (8,895                  | )          | (5,408                      | )          |
| Total stockholders’ equity                                                                                                                                                 |       | 743,337                 |       | 542,011                     |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                            |       | $                       | 14,733,710 |                        | $          | 8,893,329 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

4

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**New Century Financial Corporation and Subsidiaries**

**Condensed Consolidated Statements of Earnings**

**(Dollars in thousands, except per share amounts)**

**(Unaudited)**

 
| ** **                                                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues:**                                                             |       |                                  |       |                                |       |   |   |   |   |
| Gain on sale of loans                                                     |       | $                                     | 215,051    |                                | $          | 146,282 |   | $ | 417,027 |   | $ | 272,084 |   |
| Interest income (note 9)                                                  |       | 186,557                               |       | 59,715                              |       | 334,905 |   | 105,863 |   |
| Residual interest income (note 4)                                         |       | 4,578                                 |       | 6,119                               |       | 9,358 |   | 12,684 |   |
| Servicing and other income                                                |       | 8,582                                 |       | 3,348                               |       | 14,478 |   | 5,821 |   |
| Total revenues                                                            |       | 414,768                               |       | 215,464                             |       | 775,768 |   | 396,452 |   |
| **Expenses:**                                                             |       |                                  |       |                                |       |   |   |   |   |
| Personnel                                                                 |       | 109,000                               |       | 50,449                              |       | 189,966 |   | 99,628 |   |
| Interest (note 10)                                                        |       | 67,306                                |       | 19,748                              |       | 123,270 |   | 37,300 |   |
| General and administrative                                                |       | 39,477                                |       | 26,020                              |       | 72,976 |   | 50,102 |   |
| Provision for loan losses on mortgage loans held  for investment (note 3) |       | 17,112                                |       | 4,504                               |       | 36,981 |   | 7,686 |   |
| Advertising and promotion                                                 |       | 10,758                                |       | 6,388                               |       | 20,656 |   | 12,575 |   |
| Professional services                                                     |       | 8,729                                 |       | 4,221                               |       | 13,066 |   | 6,970 |   |
| Total expenses                                                            |       | 252,382                               |       | 111,330                             |       | 456,915 |   | 214,261 |   |
| Earnings before income taxes                                              |       | 162,386                               |       | 104,134                             |       | 318,853 |   | 182,191 |   |
| Income taxes                                                              |       | 60,009                                |       | 43,319                              |       | 129,231 |   | 75,637 |   |
| Net earnings                                                              |       | $                                     | 102,377    |                                | $          | 60,815 |   | $ | 189,622 |   | $ | 106,554 |   |
| Basic earnings per share (note 12)                                        |       | $                                     | 3.07       |                                | $          | 1.78 |   | $ | 5.72 |   | $ | 3.11 |   |
| Diluted earnings per share (note 12)                                      |       | $                                     | 2.41       |                                | $          | 1.61 |   | $ | 4.46 |   | $ | 2.83 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

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**New Century Financial Corporation andSubsidiaries**

**Condensed Consolidated Statements ofComprehensive Earnings**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net earnings                                                                                                                                          |       | $                                     | 102,377    |                                | $          | 60,815 |   | $ | 189,622 |   | $ | 106,554 |   |
| Other comprehensive income:                                                                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Unrealized gain on derivative instruments  designated as hedges, net of tax of $21,254 and $12,382 for the three months  and six months, respectively |       | 30,585                                |       | —                              |       | 18,333 |   | — |   |
| Comprehensive earnings                                                                                                                                |       | $                                     | 132,962    |                                | $          | 60,815 |   | $ | 207,955 |   | $ | 106,554 |   |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

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**New Century Financial Corporation andSubsidiaries**

**Condensed Consolidated Statements of CashFlows**

**Six Months Ended June 30, 2004 and 2003**

**(Dollars in thousands)**

 
| ** **                                                                                                                                 | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| Cash flows from operating activities:                                                                                                      |       |                    |       |                    |       |
| Net earnings                                                                                                                               |       | $                       | 189,622    |                    | $          | 106,554 |   |
| Adjustments to reconcile net earnings to net cash  provided by operating activities:                                                       |       |                    |       |                    |       |
| Depreciation and amortization                                                                                                              |       | 12,105                  |       | 8,492                   |       |
| Cash flows received from residual interests                                                                                                |       | 27,537                  |       | 49,785                  |       |
| Accretion of NIRs                                                                                                                          |       | (9,358                  | )          | (12,684                 | )          |
| NIR gains                                                                                                                                  |       | (21,871                 | )          | —                  |       |
| Deposits to over-collateralization accounts                                                                                                |       | (10,871                 | )          | —                  |       |
| Retained bond                                                                                                                              |       | (3,536                  | )          | —                  |       |
| Servicing gains                                                                                                                            |       | —                  |       | (7,777                  | )          |
| Fair value adjustment of residual securities                                                                                               |       | 6,770                   |       | (1,606                  | )          |
| Provision for losses on mortgage loans held for  investment                                                                                |       | 36,981                  |       | 7,686                   |       |
| Provision for repurchase losses                                                                                                            |       | 3,184                   |       | 6,413                   |       |
| Mortgage loans originated or acquired for sale                                                                                             |       | (17,234,447             | )          | (9,286,453              | )          |
| Mortgage loan sales, net                                                                                                                   |       | 14,140,969              |       | 9,036,341               |       |
| Principal payments on mortgage loans held for sale                                                                                         |       | 55,709                  |       | 40,591                  |       |
| Increase in credit facilities on mortgage loans  held for sale                                                                             |       | 2,808,168               |       | 164,074                 |       |
| Net change in other assets and liabilities                                                                                                 |       | 34,226                  |       | (46,829                 | )          |
| Net cash provided by operating activities                                                                                                  |       | 35,188                  |       | 64,587                  |       |
| Cash flows from investing activities:                                                                                                      |       |                    |       |                    |       |
| Mortgage loans originated or acquired for  investment, net                                                                                 |       | (3,457,776              | )          | (1,219,084              | )          |
| Principal payments on mortgage loans held for  investment                                                                                  |       | 739,313                 |       | 23,781                  |       |
| Purchase of office property and equipment                                                                                                  |       | (12,594                 | )          | (10,006                 | )          |
| Sale of mortgage servicing rights                                                                                                          |       | —                  |       | 15,568                  |       |
| Net cash used in investing activities                                                                                                      |       | (2,731,057              | )          | (1,189,741              | )          |
| Cash flows from financing activities:                                                                                                      |       |                    |       |                    |       |
| Proceeds from issuance of financing on mortgage  loans held for investment, net                                                            |       | 3,337,428               |       | 1,169,401               |       |
| Repayments of financing on mortgage loans held for  investment                                                                             |       | (640,625                | )          | (8,102                  | )          |
| Proceeds from (net repayments of) notes payable                                                                                            |       | 11,508                  |       | (4,183                  | )          |
| Change in restricted cash                                                                                                                  |       | (205,486                | )          | (16,477                 | )          |
| Payment of dividends on common stock                                                                                                       |       | (12,132                 | )          | (4,643                  | )          |
| Net proceeds from issuance of stock                                                                                                        |       | 4,527                   |       | 5,807                   |       |
| Purchase of treasury stock                                                                                                                 |       | —                  |       | (24,233                 | )          |
| Net cash provided by financing activities                                                                                                  |       | 2,495,220               |       | 1,117,570               |       |
| Net decrease in cash and cash equivalents                                                                                                  |       | (200,649                | )          | (7,584                  | )          |
| Cash and cash equivalents, beginning of period                                                                                             |       | 269,540                 |       | 176,669                 |       |
| Cash and cash equivalents, end of period                                                                                                   |       | $                       | 68,891     |                    | $          | 169,085 |   |
| Supplemental cash flow disclosure:                                                                                                         |       |                    |       |                    |       |
| Interest paid                                                                                                                              |       | $                       | 113,913    |                    | $          | 37,251 |   |
| Income taxes paid                                                                                                                          |       | 157,892                 |       | 103,193                 |       |
| Supplemental non-cash financing activity:                                                                                                  |       |                    |       |                    |       |
| Restricted stock issued                                                                                                                    |       | $                       | 5,782      |                    | $          | 4,928 |   |
| Accrued dividends                                                                                                                          |       | 6,781                   |       | 3,458                   |       |
| Reclassification of mortgage loans acquired for  investment and related financing from mortgage loans held for sale and  related financing |       | 1,680,487               |       | —                  |       |

 

Seeaccompanying notes to unaudited condensed consolidated financial statements.

 

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**NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES**

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

 

**June 30, 2004 and 2003**

**1.    Basisof Presentation**

 

Wehave prepared the accompanying unaudited consolidated financial statements inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions to Form10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the six monthsended June 30, 2004 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2004. For further information,refer to the consolidated financial statements and notes thereto included inour Annual Report on Form 10-K, as amended, for the year endedDecember 31, 2003, filed with the Securities and Exchange Commission.

 

*Reclassification*

 

Certainamounts from the prior year’s presentation have been reclassified to conform tothe current year’s presentation.

 

*Recent Accounting Developments*

 

InMarch 2004, the Securities and Exchange Commission issued Staff AccountingBulletin No. 105 (“SAB 105”). SAB 105 contains specific guidance thatsignificantly limits opportunities for registrants to recognize an assetrelated to a commitment to originate a mortgage loan that will be held for saleprior to funding the loan, which differs from the current accounting guidanceprovided by Statement of Financial Accounting Standards No. 149 (“SFAS 149”).SFAS 149 requires that the entity that makes the mortgage loan commitmentrecord the commitment on its balance sheet at fair value, but does not addresshow to measure the fair value of the loan commitment. SAB 105 requires thatfair value measurement of loan commitments include only differences between theguaranteed interest rate in the loan commitment and a market interest rate,excluding any expected cash flows related to the customer relationship or loanservicing. SAB 105 is effective for new loan commitments accounted for asderivatives entered into after March 31, 2004. SAB 105 permits registrantsto continue to use previously applied accounting policies to commitmentsentered into on or before March 31, 2004.

 

Wequote interest rates to borrowers, which are generally subject to change by us.Although we typically honor such interest rate quotes, the quotes do notconstitute interest rate locks, minimizing the potential interest rate exposure.We do not account for our interest rate quotes as derivatives. Additionally, wedo have an immaterial amount of interest rate locks outstanding at any balancesheet date. We consider the fair value of these interest rate locks to beimmaterial and as a result, we do not account for these interest rate locks asderivatives. As a result, the application of SAB 105 has not had a materialimpact on our consolidated financial statements.

 

*Cash and Cash Equivalents*

 

Forpurposes of the statements of cash flows, we consider all highly liquid debtinstruments with original maturities of three months or less to be cashequivalents. Cash equivalents consist of cash on hand and due from banks.

 

*Restricted Cash*

 

Asof June 30, 2004, restricted cash includes $17.4 million in cash held in amargin account associated with our interest rate risk management activities,$284.7 million in cash held in custodial accounts associated with our mortgageloans held for investment, and $20.3 million in cash held in a cash reserveaccount in connection with our asset-backed commercial paper facility. As ofDecember 31, 2003, restricted cash included $31.5 million in cash held ina margin account associated with our interest rate risk management activities,$63.7 million in cash held in custodial accounts associated with our mortgageloans held for investment, and $21.7 million in cash held in a cash reserveaccount in connection with our asset-backed commercial paper facility.

 

*Mortgage Loans Held for Sale*

 

Mortgageloans held for sale are stated at the lower of amortized cost or fair value asdetermined by outstanding commitments from investors or current investor yieldrequirements, calculated on an aggregate basis.

 

8

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*Mortgage Loans Held for Investment*

 

Mortgageloans held for investment represent loans securitized through transactionsstructured as financings. Mortgage loans held for investment are stated atamortized cost, including the outstanding principal balance, less the allowancefor loan losses, plus net deferred origination costs. The financing related tothese securitizations is included in our consolidated balance sheet asfinancing on mortgage loans held for investment.

 

Duringthe second quarter of 2004, we reclassified approximately $1.7 billion inmortgage loans from mortgage loans held for sale to mortgage loans held forinvestment because these loans were identified and pooled prior toJune 30, 2004, and was securitized through a transaction structured as afinancing during August, 2004.

 

Inconnection with our mortgage loans held for investment, we establish anallowance for loan losses based on our estimate of losses inherent and probableas of our balance sheet date. We charge off uncollectible loans at the time ofliquidation. We evaluate the adequacy of this allowance each quarter, givingconsideration to factors such as the current performance of the loans and thegeneral economic environment. In order to estimate an appropriate allowance forlosses on loans held for investment, we estimate losses using “static pooling,”which stratifies the loans held for investment into separately identifiedvintage pools. Using historic experience and taking into consideration eachpool’s credit characteristics, we estimate an allowance for credit losses,which we believe is adequate for known and inherent losses in the portfolio ofmortgage loans held for investment. Provision for losses is charged to ourconsolidated statement of earnings. Losses incurred on mortgage loans held forinvestment are charged to the allowance.

 

*Residual Interests in Securitizations*

 

Residualinterests in securitizations are recorded as a result of the sale of loansthrough securitizations that we structure as sales rather than financings,referred to as “off-balance sheet securitizations.” We may also sell residualinterests in securitizations through what are sometimes referred to as netinterest margin securities, or NIMS.

 

Wegenerally structure loan securitizations as follows: First, we sell a portfolioof mortgage loans to a special purpose entity, or SPE, that has beenestablished for the limited purpose of buying and reselling mortgage loans. TheSPE then transfers the same mortgage loans to a Real Estate Mortgage InvestmentConduit or Owner Trust (the “REMIC” or “Trust”), which is a qualifying specialpurpose entity (“QSPE”) as defined under Statement of Financial AccountingStandards No. 140 (“SFAS 140”). The Trust, in turn, issues interest-bearingasset-backed securities (the “Certificates”) generally in an amount equal tothe aggregate principal balance of the mortgage loans. The Certificates aretypically sold at face value and without recourse except that we providerepresentations and warranties customary to the mortgage banking industry tothe Trust. One or more investors purchase these Certificates for cash. TheTrust uses the cash proceeds to pay us the cash portion of the purchase pricefor the mortgage loans. The Trust also issues a certificate to us representinga residual interest in the payments on the securitized loans. In addition, wemay provide a credit enhancement for the benefit of the investors in the formof additional collateral (“Over-collateralization Account” or “OC Account”)held by the Trust. The servicing agreements typically require that the OCAccount be maintained at certain levels.

 

Atthe closing of each off-balance sheet securitization, we remove from ourconsolidated balance sheet the mortgage loans held for sale and add to ourconsolidated balance sheet (i) the cash received, (ii) the estimated fair valueof the interest in the mortgage loans retained from the securitizations(“Residuals”), which consist of (a) the OC Account and (b) the net interestreceivable (“NIR”), and (iii) the estimated fair value of the servicing asset.The NIR represents the discounted estimated cash flows that we will receive inthe future. The excess of the cash received and the assets retained over thecarrying value of the loans sold, less transaction costs, equals the net gainon sale of mortgage loans recorded by us.

 

TheNIMS are generally structured as follows: First, we sell or contribute theResiduals to a SPE that has been established for the limited purpose ofreceiving and selling asset-backed residual interests-in-securitizationcertificates. Next, the SPE transfers the Residuals to the Trust and the Trust,which is a QSPE as defined under SFAS 140, in turn issues interest-bearingasset-backed securities (the “Bonds and Certificates”). We sell the Residualswithout recourse except that we provide representations and warranties to theTrust customary within the mortgage banking industry. One or more investorspurchase the Bonds and Certificates, and the proceeds from the sale of theBonds and Certificates, along with a residual interest certificate that issubordinate to the Bonds and Certificates, represent the consideration receivedby us for the sale of the Residuals.

 

Atclosing of each NIMS transaction, we remove from our consolidated balance sheetthe carrying value of the Residuals sold and add to our consolidated balancesheet (i) the cash received and (ii) the estimated fair value of the portion ofthe Residuals retained, which consists of the NIR. The excess of the cashreceived and assets retained over the carrying value of the Residuals sold,less transaction costs, equals the net gain or loss on the sale of Residualsrecorded by us.

 

9

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Weallocate our basis in the mortgage loans and Residuals between the portion ofthe mortgage loans and Residuals sold through the Certificates and the portionretained (the Residuals and servicing assets) based on the relative fair valuesof those portions on the date of sale. We may recognize gains or lossesattributable to the changes in the fair value of the Residuals, which arerecorded at estimated fair value and accounted for as “held-for-trading”securities. We are not aware of an active market for the purchase or sale ofResiduals and, accordingly, we determine the estimated fair value of theResiduals by discounting the expected cash flows released from the OC Account(the cash out method) using a discount rate commensurate with the risksinvolved. For securitization executed prior to 2004, we utilize a discount rateof 12.0% on the estimated cash flows released from the OC Account to value theResiduals through securitization transactions and 14.0% on the estimated cashflows released from the Trust to value Residuals through NIMStransactions.  For the securitizationcompleted during the second quarter of 2004, we utilize a discount rate of14.5% on the estimated cash flows.  Thereis not a NIM transaction associated with the 2004 transaction.

 

Weare entitled to the cash flows from the Residuals that represent collections onthe mortgage loans in excess of the amounts required to pay the Certificates’principal and interest, the servicing fees and certain other fees, such astrustee and custodial fees. At the end of each collection period, the aggregatecash collections from the mortgage loans are allocated first to the baseservicing fees and certain other fees, such as trustee and custodial fees, forthe period, then to the Certificate holders for interest at the pass-throughrate on the Certificates plus principal as defined in the servicing agreements.If the amount of cash required for the above allocations exceeds the amountcollected during the collection period, the shortfall is drawn from the OCAccount. If the cash collected during the period exceeds the amount necessary forthe above allocation, and there is no shortfall in the related OC Account, theexcess is released to us. If the OC Account balance is not at the requiredcredit enhancement level, the excess cash collected is retained in the OCAccount until the specified level is achieved. We are restricted from using thecash and collateral in the OC Account. Pursuant to certain servicingagreements, we may use cash held in the OC Account to make acceleratedprincipal paydowns on the Certificates to create additional excess collateralin the OC Account. The specified credit enhancement levels are defined in ourservicing agreements as the OC Account balance expressed generally as apercentage of the current collateral principal balance. For NIMS transactions,we receive cash flows once the holders of the Bonds and Certificates created inthe NIMS transaction are fully paid.

 

TheAnnual Percentage Rate, or APR, on the mortgage loans is relatively high incomparison to the pass-through rate on the Certificates. In determining thevalue of the Residuals, we estimate the future rates of prepayments, prepaymentpenalties that we will receive, delinquencies, defaults and default lossseverity as they affect the amount and timing of the estimated cash flows. Weestimate average cumulative losses as a percentage of the original principalbalance of the mortgage loans of 1.35% to 4.15% for adjustable-rate securitiesand 2.09% to 5.23% for fixed-rate securities. These estimates are based onhistorical loss data for the loans, the specific characteristics of the loans,and the existence of mortgage insurance. While the range of estimatedcumulative pool losses is fairly broad, the weighted average cumulative poolloss estimate for the entire portfolio of residual assets was 3.73% at June 30,2004. We estimate prepayments by evaluating historical prepayment performanceof our loans and the impact of current trends. We use a prepayment curve toestimate the prepayment characteristics of the mortgage loans. The rate ofincrease, duration, severity, and decrease of the curve depends on the age andnature of the mortgage loans, primarily whether the mortgage loans are fixed oradjustable and the interest rate adjustment characteristics of the mortgageloans (6-month, 1-year, 2-year, 3-year, or 5-year adjustment periods). Theseprepayment curve and default estimates have resulted in weighted average livesof between 2.23 to 2.64 years for our adjustable-rate securities and 2.37 to3.56 years for our fixed-rate securities executed prior to 2004. The estimatesused in the 2004 Carrington securitization resulted in a blendedweighted-average life of 5.89 years.

 

Duringthe six months ended June 30, 2004, the Residuals provided $27.5 millionin cash flow to us. We perform an evaluation of the Residuals quarterly, takinginto consideration trends in actual cash flow performance, industry andeconomic developments, as well as other relevant factors. For the quarterending June 30, 2004, we updated the models for actual performance andchanges in interest rates, and made some slight adjustments to the prepaymentand loss assumptions, resulting in an $8.2 million downward fair valueadjustment for the quarter.

 

TheBond and Certificate holders and their securitization trusts have no recourseto us for failure of mortgage loan borrowers to pay when due. Our Residuals aresubordinate to the Bonds and Certificates until the Bond and Certificateholders are fully paid.

 

*Derivative Instruments Designated as Hedges*

 

Duringthe three and six months ended June 30, 2004 we accounted for certain EuroDollar Futures and Interest Rate Cap contracts designated and documented ashedges pursuant to the requirements of Statement of Financial AccountingStandard No. 133, “Accounting for Derivative Instruments and Hedging Activities”(“SFAS 133”), as amended.  Pursuant toSFAS 133 these contracts have been designated as hedging the exposure tovariability of cash flows from our financing on mortgage loans held forinvestment attributable to interest rate risk. Hedge accounting requires thatthe effective portion of the gain or loss in the fair value of a derivativeinstrument designated as a hedge be reported in other comprehensive income, andthe ineffective portion be reported in current earnings.  Additionally, in June 2004, certain EuroDollar Futures contracts were designated as hedges of the fair values ofcertain fixed-rate 

 

10

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mortgage loans held forinvestment and certain mortgage loans held for sale, pursuant to SFAS 133.  Hedge accounting requires that for a fairvalue hedge, changes in the fair value of the derivative instrument and changesin the fair value of the hedged asset or liability attributable to the hedgedrisk be reported in current earnings.

 

*Stock-Based Compensation*

 

Wehave elected to follow Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”), and related interpretations, inaccounting for employee stock options rather than the alternative fair valueaccounting allowed by Financial Accounting Standards Board (“FASB”) StatementNo. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). APB 25provides that compensation expense relative to our employee stock options isrecorded over the vesting period only if the current market price of theunderlying stock exceeds the exercise price. Under SFAS 123, the fair value ofstock options at the date of grant is recognized in earnings over the vestingperiod of the options. In December 2002, FASB issued Statement ofFinancial Accounting Standards No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure” (“SFAS 148”), which amends SFAS 123 toprovide alternative methods of transition for a voluntary change to the fairvalue method of accounting for stock-based employee compensation. In addition,SFAS 148 amends the disclosure requirements of SFAS 123 to require prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodon reported results.

 

Asof June 30, 2004 and 2003, there were stock options outstanding for thepurchase of 5,495,015 and 5,230,229 shares, respectively, of our common stock.The weighted average fair value of the stock options granted during thequarters ended June 30, 2004 and 2003 was $22.27 and $11.04, respectively.The weighted average fair value of the stock options granted during the sixmonths ended June 30, 2004 and 2003 was $19.06 and $9.08, respectively.  The following table shows the pro forma netincome as if the fair value method of SFAS No. 123 had been used to account forstock-based compensation expense (dollars in thousands, except per shareamounts):

 
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic net earnings:                              |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | $                                     | 102,377    |                                | $          | 60,815 |   | $ | 189,622 |   | $ | 106,554 |   |
| Compensation expense, net of related tax effects |       | (1,325                                | )          | (880                                | )          | (2,505 | ) | (1,659 | ) |
| Pro forma                                        |       | $                                     | 101,052    |                                | $          | 59,935 |   | $ | 187,117 |   | $ | 104,895 |   |
| Diluted net earnings:                            |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | $                                     | 103,631    |                                | $          | 60,815 |   | $ | 192,129 |   | $ | 106,554 |   |
| Compensation expense, net of related tax effects |       | (1,325                                | )          | (880                                | )          | (2,505 | ) | (1,659 | ) |
| Pro forma                                        |       | $                                     | 102,306    |                                | $          | 59,935 |   | $ | 189,624 |   | $ | 104,895 |   |
| Basic earnings per share:                        |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | $                                     | 3.07       |                                | $          | 1.78 |   | $ | 5.72 |   | $ | 3.11 |   |
| Pro forma                                        |       | 3.03                                  |       | 1.75                                |       | 5.65 |   | 3.06 |   |
| Diluted earnings per share:                      |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | $                                     | 2.41       |                                | $          | 1.61 |   | $ | 4.46 |   | $ | 2.83 |   |
| Pro forma                                        |       | 2.42                                  |       | 1.62                                |       | 4.48 |   | 2.87 |   |
| Basic weighted average shares outstanding:       |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | 33,299                                |       | 34,191                              |       | 33,129 |   | 34,237 |   |
| Pro forma                                        |       | 33,299                                |       | 34,191                              |       | 33,129 |   | 34,237 |   |
| Diluted weighted average shares outstanding      |       |                                  |       |                                |       |   |   |   |   |
| As reported                                      |       | 43,046                                |       | 37,827                              |       | 43,089 |   | 37,651 |   |
| Pro forma                                        |       | 42,279                                |       | 36,917                              |       | 42,315 |   | 36,546 |   |

 

**2.    MortgageLoans Held for Sale**

 

Asummary of mortgage loans held for sale, at the lower of cost or market atJune 30, 2004 and December 31, 2003, follows (dollars in thousands):

 

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| ** **                     | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| First trust deeds              |       | $                       | 4,368,254  |                        | $          | 3,307,749 |   |
| Second trust deeds             |       | 376,334                 |       | 75,517                      |       |
| Net deferred origination costs |       | 39,634                  |       | 38,945                      |       |
|                           |       | $                       | 4,784,222  |                        | $          | 3,422,211 |   |

 

**3.    MortgageLoans Held for Investment**

 

Thecomponents of mortgage loans held for investment at June 30, 2004 andDecember 31, 2003 were as follows (dollars in thousands):

 
| ** **                                 | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Unpaid principal balance of mortgage loans |       | $                       | 9,121,203  |                        | $          | 4,727,504 |   |
| Allowance for loan losses                  |       | (61,307                 | )          | (26,251                     | )          |
| Net deferred origination costs             |       | 86,576                  |       | 44,684                      |       |
|                                       |       | $                       | 9,146,472  |                        | $          | 4,745,937 |   |

 

Thebalance of mortgage loans held for investment includes $1.7 billion of loans,which were reclassified from mortgage loans held for sale in June 2004 andon August 4, 2004, we completed the related $1.7 billion securitizationstructured as an on-balance sheet securitization.

 

AtJune 30, 2004, we had mortgage loans held for investment of approximately$78.5 million on which the accrual of interest had been discontinued. If thesemortgage loans had been current throughout their terms, interest income wouldhave increased by approximately $3.0 million for the quarter endedJune 30, 2004.

 

Thefollowing table presents a summary of the activity for the allowance for losseson mortgage loans held for investment for the three and six months endedJune 30, 2004 and 2003 (dollars in thousands):

 
| ** **        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **        | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Beginning balance |       | $                                     | 45,596     |                                | $          | 3,182 |   | $ | 26,251 |   | $ | — |   |
| Additions         |       | 17,112                                |       | 4,504                               |       | 36,981 |   | 7,686 |   |
| Charge-offs, net  |       | (1,401                                | )          | —                              |       | (1,925 | ) | — |   |
| Ending balance    |       | $                                     | 61,307     |                                | $          | 7,686 |   | $ | 61,307 |   | $ | 7,686 |   |

 

**4.    Residual Interests in Securitizations**

 

Residualinterests in securitizations consisted of the following components atJune 30, 2004 and December 31, 2003 (dollars in thousands):

 
| ** **                     | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Over-collateralization account |       | $                       | 172,609    |                        | $          | 169,905 |   |
| Net interest receivable (NIR)  |       | 14,682                  |       | 9,593                       |       |
| Retained bond                  |       | 3,536                   |       | —                      |       |
|                           |       | $                       | 190,827    |                        | $          | 179,498 |   |

 

The NIR balance above represents the discounted value of cash flowsexpected to be received from net interest spread, while theover-collateralization account represents the current, un-discounted balance ofover-collateralization as of the period end.

 

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Thefollowing table summarizes activity in the OC Accounts for the six months endedJune 30, 2004 and 2003 (dollars in thousands):

 
| ** **                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Balance, beginning of period       |       | $                                   | 169,905    |   | $ | 185,658 |   |
| Additional deposits to OC Accounts |       | 10,871                              |       | 5,210 |   |
| Release of cash from OC Accounts   |       | (8,167                              | )          | (19,405 | ) |
| Balance, end of period             |       | $                                   | 172,609    |   | $ | 171,463 |   |

 

Thefollowing table summarizes activity in the NIR accounts for the six monthsended June 30, 2004 and 2003 (dollars in thousands):

 
| ** **                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Balance, beginning of period |       | $                                   | 9,593      |   | $ | 61,306 |   |
| NIR gains                    |       | 21,871                              |       |   |   |
| Cash received from NIRs      |       | (19,370                             | )          | (35,590 | ) |
| Accretion of NIRs            |       | 9,358                               |       | 12,684 |   |
| Fair value adjustment        |       | (6,770                              | )          | 1,606 |   |
| Balance, end of period       |       | $                                   | 14,682     |   | $ | 40,006 |   |

 

**5.    MortgageServicing Assets**

 

Mortgageservicing assets represent the carrying value of our mortgage loan servicingrights. The following table summarizes activity in mortgage servicing assetsfor the six months ended June 30, 2004 and 2003 (dollars in thousands):

 
| ** **                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Balance, beginning of period |       | $                                   | 1,900      |   | $ | 10,271 |   |
| Additions                    |       | —                              |       | 7,777 |   |
| Sales of servicing rights    |       | —                              |       | (15,568 | ) |
| Amortization                 |       | (527                                | )          | (201 | ) |
| Balance, end of period       |       | $                                   | 1,373      |   | $ | 2,279 |   |

 

Werecord mortgage servicing assets when we sell loans on a servicing retainedbasis and when we sell loans through whole loan sales to an investor in thecurrent period and sell the servicing rights to a third party in a subsequentperiod.

 

Theaddition of $7.8 million during the first six months of 2003 represents thevalue of servicing rights held temporarily for loans sold in those periods,pending the sale of those servicing rights to third parties in subsequentperiods. We did not sell loans on a permanent servicing-retained basis in thefirst six months of 2004 or 2003.

 

However,we did retain the right to service the loans totaling $9.1 billion underlyingour portfolio of mortgage loans held for investment. In accordance withgenerally accepted accounting principles, we do not record mortgage servicingassets for loans sold through securitizations structured as financings.

 

**6.    Goodwill**

 

Goodwillis recorded in connection with the acquisition of new subsidiaries and isincluded in prepaid expenses and other assets. As of June 30, 2004, we hadgoodwill of $12.7 million. No impairment existed at June 30, 2004.

 

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**7.    CreditFacilities and Other Short-Term Borrowings**

 

Creditfacilities and other short-term borrowings consist of the following atJune 30, 2004 and December 31, 2003 (dollars in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| A    $570  million master repurchase agreement among New Century Mortgage Corporation,  or New Century Mortgage, a wholly-owned subsidiary of New Century Financial,  NC Capital Corporation, or NC Capital, a wholly-owned subsidiary of New  Century Mortgage, and CDC Mortgage Capital Inc. expiring in July 2004,  secured by mortgage loans held for sale, bearing interest based on a margin  over one-month LIBOR. This facility was temporarily increased to $700 million  for the period and the expiration date was extended to August 15,  2004.  We expect to renew this facility  prior to its expiration. |       | $                       | 637,619    |                        | $          | 430,118 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $2.0  billion master loan and security agreement among New Century Mortgage, NC  Capital and Morgan Stanley Mortgage Capital Inc. expiring in  January 2005, secured by mortgage loans held for sale, bearing interest  based on a margin over one-month LIBOR.                                                                                                                                                                                                                                                                                                                                                              |       | 415                     |       | 284,643                     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $75  million master loan and security agreement among New Century Mortgage, NC  Capital, Citigroup Global Markets Realty Corp., successor to Salomon Brothers  Realty Corp., expiring in December 2004, secured by delinquent loans and  REO properties, bearing interest based on a margin over one-month LIBOR.                                                                                                                                                                                                                                                                                                            |       | 64,291                  |       | 6,789                       |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $650  million repurchase agreement between NC Capital and Citigroup Global Markets,  successor to Salomon Brothers, expiring in September 2004, secured by  mortgage loans held for sale, bearing interest based on a margin over  one-month LIBOR.  We expect to extend  or replace this facility prior to its expiration.                                                                                                                                                                                                                                                                                             |       | 633,666                 |       | 468,809                     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $2.0  billion master repurchase agreement between New Century Funding A, a Delaware  business trust which is a wholly-owned subsidiary of New Century Mortgage,  and Bank of America, N.A., $1.0 billion of which is committed and $1.0  billion of which is uncommitted, expiring in May 2005, secured by mortgage  loans held for sale, bearing interest based on a margin over one-month LIBOR.                                                                                                                                                                                                                                |       | 1,466,936               |       | 697,201                     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $2.0  billion asset-backed note purchase and security agreement between New Century  Funding I, a special-purpose vehicle established as a Delaware statutory  trust, which is a wholly-owned subsidiary of New Century Mortgage, and UBS  Real Estate Securities Inc., $1.5 billion of which is committed and $500  million of which is uncommitted, expiring in June 2006, secured by  mortgage loans held for sale, bearing interest based on a margin over  one-month LIBOR.                                                                                                                                             |       | 1,590,302               |       | 994,815                     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $150 million  master repurchase agreement between New Century Funding SB-1, a Delaware  business trust and wholly-owned subsidiary of New Century Mortgage, and  Citigroup Global Markets, successor to Salomon Brothers, expiring in  September 2004, secured by mortgage loans held for sale, bearing  interest based on a margin over one-month LIBOR.  We expect to extend or replace this  facility prior to its expiration.                                                                                                                                                                                       |       | —                  |       | —                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $2.0  billion asset-backed commercial paper facility for Von Karman Funding LLC, a  wholly-owned subsidiary of New Century Mortgage, expiring in  September 2006, secured by mortgage loans held for sale and cash  generated through the sale of loans, bearing interest based on a margin over  one-month LIBOR.                                                                                                                                                                                                                                                                                                           |       | —                  |       | 409,120                     |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $100  million master loan and security agreement between New Century Mortgage and  Greenwich Capital Financial Products, Inc. which expired in June 2004,  secured by small business commercial mortgage loans held for sale, bearing  interest based on a margin over one-month LIBOR.  This facility was replaced with the $250  million facility with Citigroup Global Markets.                                                                                                                                                                                                                                      |       | —                  |       | 20,342                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A    $250  million repurchase agreement between New Century Mortgage and Citigroup  Global Markets, which expires in June 2005, secured by small balance  commercial mortgage loans held for sale, bearing interest based on a margin  over one-month LIBOR.                                                                                                                                                                                                                                                                                                                                                                      |       | 68,143                  |       | —                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| An $800 million aggregation facility ($400 million  of which is uncommitted) from Bear Stearns Mortgage Capital expiring in  October 2004, secured by mortgage loans held for sale, bearing interest  based on a margin over one-month LIBOR.   This facility was temporarily increased to $1.8 billion until the  closing of our on-balance sheet transaction in August, 2004.                                                                                                                                                                                                                                                             |       | 1,649,498               |       | —                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| A $400 million warehouse agreement between  Carrington Mortgage Credit Fund I, LP and Citigroup Global Markets which  expires in April 2005.  The  uncommitted, renewable one-year agreement is secured by single family  residential mortgage loans, bearing interest based on a margin over one-month  LIBOR.                                                                                                                                                                                                                                                                                                                             |       | 9,135                   |       | —                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| Less: Credit facility amounts reclassified to  financing on mortgage loans held for investment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       | (1,680,487              | )          | —                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       | $                       | 4,439,518  |                        | $          | 3,311,837 |   |

 

Thevarious credit facilities contain certain restrictive financial and othercovenants that require us to, among other things, restrict dividends, maintaincertain levels of net worth, liquidity, available borrowing capacity, anddebt-to-net worth ratios and to comply with regulatory and investorrequirements. We were in compliance with these covenants at June 30, 2004.

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**8.    Financing on Mortgage Loans Held forInvestment**

 

Whenwe sell loans through securitizations structured as financings, the relatedbonds are added to our balance sheet. As of June 30, 2004 andDecember 31, 2003, the financing on mortgage loans held for investmentconsisted of the following (dollars in thousands):

 
| ** **                                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Securitized bonds                                                      |       | $                       | 7,432,222  |                        | $          | 4,688,921 |   |
| Short-term financing on retained bond                                  |       | 18,358                  |       | 4,665                       |       |
| 2003-NC5 NIM bond                                                      |       | 20,415                  |       | 33,969                      |       |
| Debt issuance costs                                                    |       | (64,550                 | )          | (41,232                     | )          |
| Credit facility amounts reclassified from  warehouse credit facilities |       | 1,680,487               |       | —                      |       |
| Total financing on mortgage loans held for  investment                 |       | $                       | 9,086,932  |                        | $          | 4,686,323 |   |

 

**9.    InterestIncome**

 

Thefollowing table presents the components of interest income for the three andsix months ended June 30, 2004 and 2003 (dollars in thousands):

 
| ** **                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest on mortgage loans held for sale       |       | $                                     | 89,071     |                                | $          | 50,071 |   | $ | 158,063 |   | $ | 89,909 |   |
| Interest on mortgage loans held for investment |       | 97,472                                |       | 9,600                               |       | 176,809 |   | 15,895 |   |
| Other interest income                          |       | 14                                    |       | 44                                  |       | 33 |   | 59 |   |
|                                           |       | $                                     | 186,557    |                                | $          | 59,715 |   | $ | 334,905 |   | $ | 105,863 |   |

 

**10.    InterestExpense**

 

Thefollowing table presents the components of interest expense for the three andsix months ended June 30, 2004 and 2003 (dollars in thousands):

 
| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                     | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest on credit facilities and other short-term  borrowings |       | $                                     | 29,743     |                                | $          | 16,757 |   | $ | 49,686 |   | $ | 32,274 |   |
| Interest on financing on mortgage loans held for  investment   |       | 33,430                                |       | 2,714                               |       | 66,415 |   | 4,453 |   |
| Interest on convertible notes                                  |       | 2,126                                 |       | —                              |       | 4,250 |   | — |   |
| Other interest expense                                         |       | 2,007                                 |       | 277                                 |       | 2,919 |   | 573 |   |
|                                                           |       | $                                     | 67,306     |                                | $          | 19,748 |   | $ | 123,270 |   | $ | 37,300 |   |

 

**11.    HedgingActivities**

 

Inconnection with our strategy to mitigate interest rate risk on our residualassets, mortgage loans held for sale and mortgage loans held for investment, weuse derivative financial instruments such as Euro Dollar Futures and InterestRate Cap contracts. It is not our policy to use derivatives to speculate oninterest rates. These derivative instruments have an active secondary market,and are intended to provide income and cash flow to offset potential reducedinterest income and cash flow under certain interest rate environments, as wellas to hedge the fair value of certain fixed-rate mortgage loans held forinvestment and certain mortgage loans held for sale. In accordance withStatement on Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities”, as amended and interpreted (“SFAS 133”),the derivative financial instruments and any related margin accounts arereported on the consolidated balance sheets at their fair value.

 

During2003, we began using hedge accounting as defined by SFAS 133 for certainderivative financial instruments used to hedge cash flows related to ourfinancing on mortgage loans held for investment. In June 2004, we beganusing hedge accounting for certain derivative financial instruments to hedgethe fair value of certain of our mortgage loans held for investment and certainof our mortgage 

 

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loans held for sale.  We designate certain derivative financialinstruments, Euro Dollar Futures and Interest Rate Cap contracts, as hedgeinstruments under SFAS 133, and, at trade date, these instruments and theirhedging relationship are identified, designated and documented.

 

Forderivative financial instruments designated as cash flow hedge instruments, weevaluate the effectiveness of these hedges against the interest paymentsrelated to our financing on mortgage loans held for investment being hedged toensure that there remains a highly effective correlation in the hedgerelationship. To hedge the adverse effect of interest rate changes on the cashflows as a result of changes in the benchmark interest rate, in our case LIBOR,of the interest payments related to our financing on mortgage loans held forinvestment (variable rate debt) being hedged, we use derivatives classified ascash flow hedges under SFAS 133. Once the hedge relationship is established,for those derivative instruments designated as qualifying cash flow hedges, theeffective portion of the gain or loss on the derivative is reported as acomponent of other comprehensive income during the current period, andreclassified into earnings in the period(s) during which the hedged transactionaffects earnings pursuant to SFAS 133. The ineffective portion and/or remaininggain or loss on the derivative instrument is recognized in earnings in thecurrent period. The ineffective portion of these hedges resulted in a charge toearnings of approximately $1.2 million and $3.0 million, respectively, for thethree-month and six-month periods ended June 30, 2004. There were noderivatives designated as cash flow hedges during the three-month and six-monthperiods ended June 30, 2003.

 

Forderivative financial instruments designated as fair value hedge instruments, weevaluate the effectiveness of these hedges against the fair value of the assetbeing hedged to ensure that there remains a highly effective correlation in thehedge relationship. To hedge the adverse effect of interest rate changes on thefair value of the hedged assets as a result of changes in the benchmark interestrate, in our case LIBOR, we use derivatives classified as fair value hedgesunder SFAS 133. Once the hedge relationship is established, for thosederivative instruments designated as qualifying fair value hedges, changes inthe fair value of the derivative instruments and changes in the fair value ofthe hedged asset or liability attributable to the hedged risk are recorded incurrent earnings pursuant to SFAS 133. The net charge to earnings was approximately $464,000 for thethree-month and six-month periods ended June 30, 2004. There were noderivatives designated as fair value hedges during the three-month andsix-month periods ended June 30, 2003

 

Wedocument the relationships between hedging instruments and hedged items, aswell as our risk-management objectives and strategies for undertaking varioushedge transactions. This process includes linking derivatives to specificassets and liabilities on the consolidated balance sheet. We also assess, bothat the inception of the hedge and on an ongoing basis, whether the derivativesused in hedging transactions are highly effective in offsetting changes in cashflows of the hedged items. When it is determined that a derivative is nothighly effective as a hedge or that it has ceased to be a highly effectivehedge, we discontinue hedge accounting prospectively.

 

Whenhedge accounting is discontinued because it is determined that the derivativeno longer qualifies as an effective hedge, the derivative will continue to berecorded on the balance sheet at its fair value. Any change in the fair valueof a derivative no longer qualifying as an effective hedge is recognized incurrent period earnings. When a hedge is terminated, it is derecognized at thetime of termination. For terminated hedges or hedges that no longer qualify aseffective, the effective position previously recorded remains in othercomprehensive income and continues to be amortized or accreted into earningswith the hedged item.

 

Forderivative financial instruments not designated as hedge instruments, realizedand unrealized changes in fair value are recognized in the period in which thechanges occur.

 

Asof June 30, 2004, we had open Euro Dollar Futures and Interest Rate Capcontracts that are designated as hedging the variability in expected cash flowsfrom the variable rate debt related to our financing on mortgage loans held forinvestment. The fair value of these contracts was $19.5 million and is includedin prepaid expenses and other assets.

 

Asof June 30, 2004, we had open Euro Dollar Futures contracts that aredesignated as hedging the fair value of certain fixed-rate mortgage loans heldfor investment and certain mortgage loans held for sale. The fair value ofthese contracts was a liability of $5.7 million.

 

Certainof our on-balance sheet securitizations are subject to Interest Rate Capcontracts (“Caplets”), designated and documented as hedges, used to mitigateinterest rate risk. The change in the fair value of these interest rate capcontracts is recorded through other comprehensive income each period until suchtime as the Caplets begin to expire, at which time the change in fair values isrecorded through earnings each period, and is included as a component ofinterest expense. For the three and six months 

 

16

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ended June 30, 2004, werecorded a charge to other comprehensive income of $1.0 million related to thechange in fair value of these Caplets. The fair value of these caplets was $1.6million at June 30, 2004, and is included in other assets.

 

Thechange in the fair value of Euro Dollar Futures contracts, not designated anddocumented as hedges, used to mitigate interest rate risk in our residualassets and mortgage loans held for investment is recorded through earnings eachperiod, and is included as a component of gain on sale. For the three monthsand six months ended June 30, 2004, we recognized a gain of $3.2 millionand $1.0 million, respectively, and for the three months and six months endedJune 30, 2003, we recognized a loss of $6.3 million and $6.7 million,respectively, related to the change in fair value of these contracts. The fairvalue of these contracts at June 30, 2004 was a $236,000 asset, and isincluded in other assets.  The fair valueof these contracts at June 30, 2003 was a $8.5 million liability, and isincluded in accounts payable and accrued liabilities.

 

Certainof our on-balance sheet securitizations are subject to Interest Rate Capcontracts, not designated and documented as hedges, used to mitigate interestrate risk. The change in the fair value of these interest rate cap contracts isrecorded through earnings each period, and is included as a component ofinterest expense. For the three months ended June 30, 2004, we recognizedan interest expense reduction of $1.8 million and for the six months endingJune 30, 2044 we recognized interest expense of $338,000 related to thechange in fair value of these cap contracts. The fair value of these capcontracts was $3.2 million at June 30, 2004, and is included in otherassets. The fair value of cap contracts was immaterial at June 30, 2003,and is included in other assets.

 

17

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**12.    Earningsper Share**

 

Thefollowing table illustrates the computation of basic and diluted earnings pershare for the periods indicated (dollars in thousands, except per shareamounts):

 
| ** **                                                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                              | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Basic:**                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net earnings available to common stockholders                                           |       | $                                     | 102,377    |                                | $          | 60,815 |   | $ | 189,622 |   | $ | 106,554 |   |
| Weighted average common shares outstanding                                              |       | 33,299                                |       | 34,191                              |       | 33,129 |   | 34,237 |   |
| Earnings per share                                                                      |       | $                                     | 3.07       |                                | $          | 1.78 |   | $ | 5.72 |   | $ | 3.11 |   |
| **Diluted:**                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net earnings                                                                            |       | $                                     | 102,377    |                                | $          | 60,815 |   | $ | 189,622 |   | $ | 106,554 |   |
| Add: Interest and amortization of debt issuance  costs on convertible notes, net of tax |       | 1,254                                 |       | —                              |       | 2,507 |   | — |   |
| Diluted net earnings                                                                    |       | $                                     | 103,631    |                                | $          | 60,815 |   | $ | 192,129 |   | $ | 106,554 |   |
| Weighted average number of common shares outstanding                                    |       | 33,299                                |       | 34,191                              |       | 33,129 |   | 34,237 |   |
| Dilutive effect of convertible notes, stock  options and warrants                       |       | 9,747                                 |       | 3,636                               |       | 9,960 |   | 3,414 |   |
|                                                                                    |       | 43,046                                |       | 37,827                              |       | 43,089 |   | 37,651 |   |
| Earnings per share                                                                      |       | $                                     | 2.41       |                                | $          | 1.61 |   | $ | 4.46 |   | $ | 2.83 |   |

 

Forthe three and six months ended June 30, 2004, we have included the effectof approximately 6.0 million shares of our common stock related to ourconvertible notes in our computation of diluted earnings per share. Theseshares are included because a conversion trigger event has occurred. Theclosing price of our common stock exceeded $38.28 for more than 20 of the last30 trading days during the three months ended March 31, 2004 and,therefore, the notes are now convertible. Diluted earnings have been adjustedto add the interest expense and amortization of debt issuance costs recordedrelated to the convertible notes, net of the applicable income tax effect, andthe 6.0 million shares of our common stock into which the convertible notes maybe converted are included in diluted shares outstanding.

 

Forthe three months ended June 30, 2004, options to purchase 855,000 sharesof our common stock and a warrant for 6.0 million shares of our common stockwhose exercise price exceeded the average market price of the shares of ourcommon stock are excluded from the calculation of diluted earnings per sharebecause their effect was anti-dilutive. For the six months ended June 30, 2004, options to purchase 795,000shares of our common stock and a warrant for 6.0 million shares of our commonstock whose exercise price exceeded the average market price of the shares ofour common stock are excluded from the calculation of diluted earnings pershare because their effect was anti-dilutive.

 

Forthe three months ended June 30, 2003, there were no stock options excludedfrom the calculation of diluted earnings per share.  For the six months ended June 30, 2003,options to purchase 262,000 shares of our common stock were excluded from thecalculation of diluted earnings per share because their effect wasanti-dilutive.

 

**13.    SegmentReporting**

 

Theoperating segments reported below are the segments for which separate financialinformation is available and for which revenues and operating income amountsare evaluated regularly by management in deciding how to allocate resources andin assessing performance. The accounting policies of the business segments aregenerally the same as those described in the summary of significant accountingpolicies, except as noted below.

 

Thesegment revenues and operating income amounts reported below include wholesaleand retail operations, servicing and other income, and net interest income fromour on-balance sheet securitizations. Estimated fair value of mortgage loansoriginated by our Wholesale and Retail Divisions represents the amount inexcess of the segment’s basis in its loan production that would be generatedassuming the mortgage loans were sold.

 

Certainamounts are not evaluated at the segment level and are included in the segmentnet operating income reconciliation below. The unallocated gain represents thedifference between the segment’s fair value of mortgage loans originated as ifthey were sold and the actual gain recorded on loans sold by us.

 

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Managementdoes not identify assets to the segments and evaluates assets only at theconsolidated level. As such, only operating results for the segments areincluded below (dollars in thousands):

 
| ** **                                                                            | ** ** | **Three Months  ended  June 30, 2004** | ** ** | **Three Months  ended  June 30, 2003** | ** ** | **Six Months  ended  June 30, 2004** | ** ** | **Six Months  ended  June 30, 2003** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                            | ** ** | ** **                             | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **                           | ** ** |
| **Funding Volume**                                                                    |       |                                   |       |                                   |       |                                 |       |                                 |       |
| Wholesale                                                                             |       | $                                      | 11,086,242 |                                   | 5,324,063  |                                 | 18,781,248 |                                 | 9,561,251  |   |
| Retail                                                                                |       | 1,169,625                              |       | 478,935                                |       | 1,910,975                            |       | 931,217                              |       |
|                                                                                  |       | $                                      | 12,255,867 |                                   | 5,802,998  |                                 | 20,692,223 |                                 | 10,492,468 |   |
|                                                                                  |       |                                   |       |                                   |       |                                 |       |                                 |       |
| **Mortgage Loans Held for Investment**                                                |       | $                                      | 3,457,776  |                                   | 712,410    |                                 | 3,457,776  |                                 | 1,206,015  |   |
|                                                                                  |       |                                   |       |                                   |       |                                 |       |                                 |       |
| **Segment Revenues:**                                                                 |       |                                   |       |                                   |       |                                 |       |                                 |       |
| Wholesale                                                                             |       | $                                      | 331,268    |                                   | 196,079    |                                 | 576,187    |                                 | 338,599    |   |
| Retail                                                                                |       | 64,065                                 |       | 41,642                                 |       | 110,284                              |       | 78,388                               |       |
| Mortgage loans held for investment                                                    |       | 97,472                                 |       | 9,600                                  |       | 176,809                              |       | 15,895                               |       |
| Servicing & other                                                                 |       | 11,526                                 |       | 9,011                                  |       | 21,433                               |       | 17,760                               |       |
| Interest income on mortgage loans held for  sale and other net interest income        |       | 89,085                                 |       | 50,115                                 |       | 158,096                              |       | 89,968                               |       |
| Elimination of allocated gain on sale and  net deferred origination fees and expenses |       | (178,648                               | )          | (90,983                                | )          | (267,041                             | )          | (144,158                             | )          |
|                                                                                  |       |                                   |       |                                   |       |                                 |       |                                 |       |
| Total revenues                                                                        |       | $                                      | 414,768    |                                   | 215,464    |                                 | 775,768    |                                 | 396,452    |   |
|                                                                                  |       |                                   |       |                                   |       |                                 |       |                                 |       |
| **Segment Net Operating Income:**                                                     |       |                                   |       |                                   |       |                                 |       |                                 |       |
| Wholesale                                                                             |       | $                                      | 182,483    |                                   | 112,195    |                                 | 308,398    |                                 | 180,534    |   |
| Retail                                                                                |       | 12,126                                 |       | 9,469                                  |       | 19,621                               |       | 15,211                               |       |
| Mortgage loans held for investment                                                    |       | 46,930                                 |       | 2,382                                  |       | 73,413                               |       | 3,756                                |       |
| Servicing & other                                                                 |       | 4,662                                  |       | 2,249                                  |       | 8,231                                |       | 6,123                                |       |
| Net interest income on mortgage loans held  for sale and other net interest income    |       | 55,209                                 |       | 33,081                                 |       | 101,241                              |       | 57,121                               |       |
| Elimination of allocated gain on sale                                                 |       | (117,179                               | )          | (40,768                                | )          | (154,741                             | )          | (60,839                              | )          |
| Unallocated shared general and  administrative expenses                               |       | (21,845                                | )          | (14,474                                | )          | (37,310                              | )          | (19,715                              | )          |
|                                                                                  |       |                                   |       |                                   |       |                                 |       |                                 |       |
| Total net operating income                                                            |       | $                                      | 162,386    |                                   | 104,134    |                                 | 318,853    |                                 | 182,191    |   |

 

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

 

ThisQuarterly Report on Form 10-Q represents an update to the more detailed andcomprehensive disclosures included in our Annual Report on Form 10-K, asamended, for the year ended December 31, 2003. As such, a reading of theAnnual Report on Form 10-K, as amended, is necessary to an informedunderstanding of the following discussions.

 

OnApril 5, 2004, our board of directors unanimously voted in favor ofconverting New Century Financial to a REIT, subject to a number of conditions,including Securities and Exchange Commission review and stockholder approval ofthe merger component of the REIT conversion. Because of the impact of taxes,distributions and the change in business focus following the merger and theother restructuring activities necessary for us to qualify as a REIT, ourhistorical results of operations may not be comparable to the results of ouroperations following the merger and those activities.

 

**The Company**

 

NewCentury Financial is one of the nation’s largest mortgage finance companies interms of subprime loan volume, providing first and second mortgage products toborrowers nationwide through our subsidiaries. New Century Financial wasincorporated in Delaware in November 1995 and commenced lending operationsin February 1996. We offer mortgage products designed for borrowers whogenerally do not satisfy the credit, documentation or other underwritingstandards prescribed by conventional mortgage lenders and loan buyers, such asFannie Mae and Freddie Mac. In connection with our loan origination business,we originate and purchase loans on the basis of the borrower’s perceivedability to repay the mortgage loan, the borrower’s historical pattern of debtrepayment and the amount of equity in the borrower’s property (as measured bythe borrower’s loan-to-value ratio, or LTV). We have been originating andpurchasing these types of loans since 1996 and we have created a proprietaryautomated credit grading and pricing methodology that we believe, as evidencedby our historical loan performance, gives us the ability to more effectivelyevaluate credit risk and more efficiently price our products.

 

Ourborrowers generally have considerable equity in the property securing the loan(as evidenced by the average LTV of loans we originated in 2004 of 78.2%), buthave impaired or limited credit profiles or higher debt-to-income ratios thantraditional mortgage lenders allow. Our borrowers also include individuals who,due to self-employment or other circumstances, have difficulty verifying theirincome, as well as individuals who prefer the prompt and personalized servicewe provide. We originate and purchase loans through wholesale and retailchannels. Wholesale loans are originated or purchased from independent mortgagebrokers by the Wholesale Division of one of our wholly-owned subsidiaries, NewCentury Mortgage. We do not purchase bulk pools of loans from third parties,although we do purchase closed loans on a flow basis from our correspondentlenders. Retail originations are made through New Century Mortgage’s network ofbranch offices and its centralized telemarketing unit. After originating orpurchasing loans, we then sell those loans through whole loan sales orsecuritizations. We may structure securitizations as sales (off-balance sheet securitizations)or financings (on-balance sheet securitizations). Under the on-balance sheetsecuritization structure, we do not recognize a gain on sale at the time of thetransaction, but rather recognize net interest income as payments are receivedon the underlying loans.

 

**Overview**

 

Ourorigination business relies on our ability to originate and purchase mortgageloans at a reasonable cost and to sell a portion of those loans in thesecondary mortgage market at prices that result in an attractive operatingmargin. We measure our operating margin as the sum of the price we receive forour loans, plus the net interest we earn for the period of time we hold theloans, less the cost to originate the loans. For the past several years we haveexecuted a secondary marketing strategy that included a combination of bothwhole loan sales and securitizations of our loans.

 

Loanorigination volumes in our industry have historically fluctuated from year toyear and are affected by such external factors as home values, the level ofconsumer debt and the overall condition of the economy. In addition, thepremiums we receive from the secondary market for our loans have alsofluctuated, are also influenced by the overall condition of the economy and,more importantly, the interest rate environment. As a consequence, the businessof originating and selling loans is cyclical.

 

Until2003, we typically structured our securitizations as sales for financialreporting purposes, and the gain on sale from loans sold through securitizationwas a significant percentage of our revenues. During 2003, we shifted ourstrategy to address the cyclical nature of our earnings with the goal ofgenerating a more stable long-term earnings stream. Our principal strategy toachieve this goal is to hold loans on our balance sheet. Because our financingfacilities are short-term in nature and generally do not allow loans to befinanced through the facility for longer than 180 days, a securitizationstructure offers the most attractive means to finance loans on our balancesheet. Consequently, during 2003 we began to structure our securitizations asfinancings rather than sales. To support the goal of matching the timing ofcash flows with the recognition of earnings on our loans, we make an initial cashinvestment so that the securitization trusts begin to return cash flow to usbeginning in the first month following securitization. Therefore, we requirecash

 

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and capital to make aninitial investment, as well as to support the loans on our balance sheet.During 2003 and the first half of 2004, we sold roughly 80% of our loansthrough whole loan sales, providing the cash and capital to support the 20% weadded to our balance sheet. Our goal is to continue to add mortgage loans toour balance sheet in order to reduce the reliance on the origination and saleof loans for earnings and cash flows.

 

Whilewe expect to continue to grow our balance sheet, a significant portion of ournet income will still come from our origination franchise.

 

Theprincipal metric we use to measure the value of the origination franchise isthe operating margin described above, which has three components: (i) gain onsale of loans; (ii) net interest income; and (iii) loan origination oracquisition costs.

 

*Gain on Sale of Loans*

 

Gainon sale of loans is affected by the condition of the secondary market for ourloans. This market has been very strong for at least the past two years, partlyas a result of the interest rate environment (low short-term rates relative tolong-term rates, also known as a steep yield curve). In the past few quarters,as interest rates began to rise, the underlying factors that affect secondarymarket pricing remained relatively stable. However, because we and other lenders did not necessarily raise theinterest rates we charge our borrowers with the overall interest rateenvironment, pricing has declined, reducing overall gain on sale margins.

 

*Net Interest Income on Mortgage Loans Held for Sale*

 

Wetypically hold our mortgage loans held for sale for a period of 30 to 45 daysbefore they are sold in the secondary market. During that time, we earn thecoupon rate of interest paid by the borrower and we pay interest to the lendersthat provide our financing facilities. During 2003, the difference betweenthese interest rates was typically in excess of 5%. More recently, the marginhas decreased to between 4% and 5% as short-term rates have increased greaterthan our average coupon rates.   Wemanage the timing of our sales to optimize the net interest income we earn onthe loans, while preserving the ability to sell the loans at the maximum price.

 

*Loan Origination or Acquisition Costs*

 

Wealso measure and monitor the cost to originate our loans. Such costs includethe points and fees we may pay to brokers or correspondents, net of fees wereceive from borrowers, plus our operating expenses associated with theorigination business. We typically refer to this as our loan acquisition costs.For the past few years, our loan acquisition costs have steadily decreased as aresult of growth and technology initiatives. We continue to focus on reducingour loan acquisition costs so that we can maintain a strong operating margin inperiods when the secondary market for our loans is not as favorable.  The decrease in loan acquisition costs in thesecond quarter reflects the increase in production volume.  Based on our expectations that volume will stabilizeduring the second half of 2004, we anticipate loan acquisition costs tonormalize to 2.25% for the remainder of the year.  Loan acquisition cost is defined as the feespaid to wholesale brokers and correspondents, direct loan origination costs,including commissions and corporate overhead costs, less points and fees receivedfrom borrowers, divided by total production volume.  Loan acquisition costs do not includeprofit-based compensation, servicing division overhead and start-up expenses.

 

*Loan Originations and Purchases*

 

Asof June 30, 2004, our Wholesale and Retail Divisions operated through 26regional operating centers. The Wholesale Division originated or purchased$18.8 billion in loans during the six months ended June 30, 2004. As ofJune 30, 2004, our Retail Division originated loans through 74 sales offices,including our centralized telemarketing unit. Our Retail Division originated orpurchased $1.9 billion in loans during the six months ended June 30, 2004.

 

Duringthe six months ended June 30, 2004, approximately $12.9 billion, or 62.1%of our mortgage production consisted of cash-out refinancings, where theborrowers refinanced their existing mortgages and received cash representing aportion of the equity in their homes. For the same period, approximately $6.7 billion, or 32.4% of ourmortgage production was represented by home purchase finance loans.  The remainder of our mortgage production wasrepresented by transactions in which borrowers refinance their existingmortgages to obtain a better interest rate or loan maturity, or rate and termrefinance transactions.  For thesix months ended June 30, 2003, total originations consisted of $6.6 billion,or 63.2%, of cash-out refinancings, $2.2 billion, or 21.0% of home purchasefinancing, and $1.7 billion, or 15.8%, of rate and term refinancings.  Ourgeographic expansion and focus on increasing our home purchase business haveresulted in the shift in mix between home purchase and rate and termrefinancings.

 

For the six months ended June 30, 2004, full documentation loansas a percentage of total originations totaled $10.9 billion or 52.9%, limiteddocumentation loans totaled $978.2 million, or 4.7%, and stated documentationloans totaled $8.8 billion, or 42.4%.  Fulldocumentation loans generally require applicants to submit two written forms ofverification of stable income for at least 12 months.  Limited documentation loans generally requireapplicants to submit 12 consecutive monthly bank statements on their individualbank accounts.  Stated incomedocumentation loans are based upon stated monthly income if the applicant meetscertain criteria.  For the six monthsended June 30, 2003, full documentation loans as a percentage of totaloriginations totaled $6.1 billion, or 57.8%, limited documentation loanstotaled $559.8 million, or 5.3%, and stated documentation loans totaled $3.9billion, or 36.9%.

 

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*Loan Sales and Securitizations*

 

Oneof our primary sources of revenue is the recognition of gain on sale of ourloans through whole loan sales and from 1997 to 2002, off-balance sheetsecuritizations. In a whole loan sale, we recognize and receive a cash gainupon sale. In an off-balance sheet securitization transaction structured as asale for financial reporting purposes, we typically recognize a gain on sale atthe time the loans are sold, and receive cash flows over the actual life of theloans. The use of a net interest margin transaction, or NIM, concurrent with orshortly after an off-balance sheet securitization transaction allows us toreceive a substantial portion of the gain in cash at the closing of the NIMtransaction, rather than over the actual life of the loans.

 

Sincethe first quarter of 2003, we have structured most of our securitizations asfinancings rather than sales. Such structures do not result in gain on sale atthe time of the transaction, but rather yield interest income as the paymentson the underlying mortgages are received. The following table sets forthsecondary marketing transactions for the periods indicated (dollars inthousands):

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Premium whole loan sales            |       | $                                     | 6,403,993  |                                | $          | 4,820,523 |   | $ | 13,713,146 |   | $ | 8,928,265 |   |
| Off-balance sheet securitizations   |       | 337,148                               |       | —                              |       | 337,148 |   | — |   |
| Total premium sales                 |       | 6,741,141                             |       | 4,820,523                           |       | 14,050,294 |   | 8,928,265 |   |
| Discounted whole loan sales         |       | 50,153                                |       | 60,594                              |       | 90,675 |   | 108,076 |   |
| Total sales                         |       | 6,791,294                             |       | 4,881,117                           |       | 14,140,969 |   | 9,036,341 |   |
| On-balance sheet securitizations    |       | 3,457,776                             |       | 712,410                             |       | 3,457,776 |   | 1,206,015 |   |
| Total secondary market transactions |       | $                                     | 10,249,070 |                                | $          | 5,593,527 |   | $ | 17,598,745 |   | $ | 10,242,356 |   |

 

*On-Balance Sheet Securitizations*

 

Duringthe three and six months ended June 30, 2004, we completed twosecuritizations totaling $3.5 billion, which were structured as on-balancesheet securitizations for accounting purposes under SFAS No. 140.  On August 4, 2004, we completed a $1.7billion securitization structured as an on-balance sheet securitization, whichis included in the balance of mortgage loans held for investment at June 30,2004.  The “portfolio-based” accountingtreatment for securitizations structured as financings and recorded on-balancesheet is designed to more closely match the recognition of income with thereceipt of cash payments. Also, this on-balance sheet securitization structureis consistent with our strategy to generate primarily cash-based earningsrather than non-cash gain on sale revenue. Because we do not record gain onsale revenue in the period in which the on-balance sheet securitization occurs,the use of such portfolio-based accounting structures will result in lowerincome in the period in which the securitization occurs than would atraditional off-balance sheet securitization. However, the recognition ofincome as interest payments are received on the underlying mortgage loans isexpected to result in higher income recognition in future periods than would anoff-balance sheet securitization. During the six months ended June 30,2003, we completed two on-balance sheet securitizations totaling $1.2 billion.

 

*Off-Balance Sheet Securitizations*

 

Duringthe six months ended June 30, 2004 we completed one off-balance sheettransaction totaling $337.1 million, related to our investment in CarringtonMortgage Credit Fund I, LP.  During thesix months ended June 30, 2003, we did not complete any off-balance sheetsecuritization transactions.

 

Inthe first quarter of 2004, we invested $2 million in Carrington CapitalManagement, LLC and $25 million in Carrington Mortgage Credit Fund I, LP(“Carrington”), which is sponsored by Carrington Capital Management, LLC(“LLC”).  Carrington acquires individualand pooled single-family residential sub-prime loans and securitizes them intransactions structured as sales. Carrington then sells certain securities to the mortgage-backedsecurities market and retains other securities for investment.  Carrington may acquire additional assets(including regular and residual interests, whole loans, participation certificates,grantor trust and trust certificates, warehousing and servicing interests) ineither the primary or secondary markets. We are currently the sole investor in Carrington until additionalcapital is raised.  One year followingour investment, we may redeem our interest in Carrington on a quarterlybasis.  In addition, within one year ofour initial investment in Carrington, the General Partner (“GP”) of CarringtonCapital Management, LLC will purchase not less than 3 loan pools from us atcurrent market rates on behalf of Carrington, totaling not less than $750million.  We own 35% of LLC and areentitled to 35% of the net earnings paid as a dividend annually for a total of8 years.  The GP will be entitled to anannual management fee of 1.5% as well as an incentive fee of 20% of annual netprofits over a 7% preferred return.  Wewill exchange our Class A (voting) interest in 5 years for the return of ourcapital and a contractually designated rate of return for Class B (non-voting)interests, which are callable at the end of year 8 for $1.00.  The GP intends to register as an InvestmentAdvisor and a Broker/Dealer.    Theseinvestments are consolidated with our financial statements for financialreporting purposes.   In May 2004,Carrington executed a securitization transaction structured as a sale ratherthan a financing, resulting in the addition of a residual interest totaling$35.7 million.   Further, as thesecuritization was a sale to third parties, we recognized a gain of $13.5million, which represents the premium paid to us by Carrington to acquire thepool of loans to securitize.  Thispremium was based on market rates for similar transactions at the time ofexecution.

 

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Atthe closing of an off-balance sheet securitization, we add to our balance sheetthe residual interest retained based on our calculation of the present value ofestimated future cash flows to be received by us.  The residual interest we record consists ofthe overcollateralization, or OC, account and the net interest receivable, orNIR.  Combined, these are referred to asthe residual interests.

 

Ona quarterly basis, we review the underlying assumptions to value each residualinterest and adjust the carrying value of the securities based on actualexperience and industry trends.  Todetermine the residual asset value, we project cash flow for eachsecurity.  To project cash flow, we usebase assumptions for the constant prepayment rate, or CPR, and losses for eachproduct type based on historical performance. We updated each security to reflect actual performance to date and weadjust base assumptions for CPR and losses based on historical experience toproject performance of the security from that date forward.  We then use the London Interbank OfferedRate, or LIBOR, forward curve to project future interest rates and compute cashflow projections for each security.  Wethen discount the projected cash flows at a rate commensurate with the riskinvolved.  At June 30, 2004, forsecuritizations executed prior to 2004, we used discount rates of 12% forresidual interests and 14% for residual interests through NIMtransactions.  For the securitizationcompleted during the second quarter of 2004, we utilize a discount rate of 14.5%on the estimated cash flows.  There isnot a NIM transaction associated with the 2004 transaction.

 

Duringthe quarter ended June 30, 2004, as a result of our quarterly evaluationof the residual interests, we recorded an $8.2 million decrease in the fairvalue of the residual assets.  This fairvalue adjustment represents the change in the estimated present value of futurecash flows from the residual interests.  No fair value adjustment was made to the residual assets during thequarter ended June 30, 2003.

 

*Discounted Loan Sales*

 

Forthe quarter ended June 30, 2004, we sold $50.2 million in loans that hadbeen repurchased from or rejected by whole loan investors, compared to $60.6million in loans for the same period in 2003. Discounted sales as a percentageof whole loans sales declined to 0.74% for the quarter ended June 30, 2004from 1.24% for the quarter ended June 30, 2003, as a result of lowerrepurchase rates in 2004. The total loss severity was 7.19% for the threemonths ended June 30, 2004, a decline of 42.3% compared to 12.46% for thethree months ended June 30, 2003. The loss severity decreased primarily asa result of a stronger and more active secondary market for these types ofloans in 2004.

 

**CriticalAccounting Policies**

 

Wehave established various accounting policies that govern the application ofaccounting principles generally accepted in the United States of America in thepreparation of our financial statements. Certain accounting policies require usto make significant estimates and assumptions that may have a material impacton certain assets and liabilities or our results of operations, and we considerthese to be critical accounting policies. The estimates and assumptions we use are based on historical experienceand other factors which we believe to be reasonable under the circumstances.Actual results could differ materially from these estimates and assumptions,which could have a material impact on the carrying value of assets andliabilities and our results of operations.

 

Webelieve the following are critical accounting policies that require the mostsignificant estimates and assumptions that are subject to significant change inthe preparation of our consolidated financial statements. Theseestimates and assumptions include, but are not limited to, the interest rateenvironment, the economic environment, secondary market conditions, and theperformance of the loans underlying our residual assets and mortgage loans heldfor investment.

 

*Allowance for Losses on Mortgage Loans Held forInvestment*

 

Forour mortgage loans held for investment, we establish an allowance for loanlosses based on our estimate of losses inherent and probable as of our balancesheet date. We charge off uncollectible loans at the time of liquidation. Weevaluate the adequacy of this allowance each quarter, giving consideration tofactors such as the current performance of the loans, credit characteristics ofthe portfolio, the value of the underlying collateral, and the general economicenvironment. In order to estimate an appropriate allowance for losses on loansheld for investment, we estimate losses using “static pooling,” whichstratifies the loans held for investment into separately identified vintagepools. Using historic experience and taking into consideration the factorsabove, we estimate an allowance for credit losses, which we believe is adequatefor known and inherent losses in the portfolio of mortgage loans held forinvestment. Provision for losses is charged to our consolidated statement ofoperations. Losses incurred on mortgage loans held for investment are chargedto the allowance.

 

The allowance for losses on mortgage loans held for investment as apercentage of mortgage loans held for investment as of June 30, 2004 wasapproximately 0.7%.

 

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*Residual Interests in Securitizations*

 

Residualinterests in securitizations are recorded as a result of the sale of loansthrough securitizations that we structure as sales rather than financings,referred to as “off-balance sheet securitizations.” We may also sell residualinterests in securitizations through what are sometimes referred to as netinterest margin securities, or NIMS.

 

Wegenerally structure loan securitizations as follows: First, we sell a portfolioof mortgage loans to a special purpose entity, or SPE, that has beenestablished for the limited purpose of buying and reselling mortgage loans. TheSPE then transfers the same mortgage loans to a Real Estate Mortgage InvestmentConduit or Owner Trust (the “REMIC” or “Trust”), which is a qualifying specialpurpose entity (“QSPE”) as defined under Statement of Financial AccountingStandards No. 140 (“SFAS 140”). The Trust, in turn, issues interest-bearingasset-backed securities (the “Certificates”) generally in an amount equal tothe aggregate principal balance of the mortgage loans. The Certificates aretypically sold at face value and without recourse except that we providerepresentations and warranties customary to the mortgage banking industry tothe Trust. One or more investors purchase the Certificates for cash. The Trustuses the cash proceeds to pay us the cash portion of the purchase price for themortgage loans. The Trust also issues a certificate to us representing aresidual interest in the payments on the securitized loans. In addition, we mayprovide a credit enhancement for the benefit of the investors in the form ofadditional collateral (“Over-collateralization Account” or “OC Account”) heldby the Trust. The servicing agreements typically require that the OC Account bemaintained at certain levels.

 

Atthe closing of each off-balance sheet securitization, we remove from ourconsolidated balance sheet the mortgage loans held for sale and add to ourconsolidated balance sheet (i) the cash received, (ii) the estimated fair valueof the interest in the mortgage loans retained from the securitizations(“Residuals”), which consist of (a) the OC Account and (b) the net interestreceivable (“NIR”), and (iii) the estimated fair value of the servicing asset.The NIR represents the discounted estimated cash flows that we will receive inthe future. The excess of the cash received and the assets retained over thecarrying value of the loans sold, less transaction costs, equals the net gainon sale of mortgage loans recorded by us.

 

TheNIMS are generally structured as follows: First, we sell or contribute theResiduals to a SPE that has been established for the limited purpose ofreceiving and selling asset-backed residual interests-in-securitizationcertificates. Next, the SPE transfers the Residuals to the Trust and the Trust,which is a QSPE as defined under SFAS 140, in turn issues interest-bearingasset-backed securities (the “Bonds and Certificates”). We sell the Residualswithout recourse except that we provide representations and warranties to theTrust customary within the mortgage banking industry. One or more investorspurchase the Bonds and Certificates, and the proceeds from the sale of theBonds and Certificates, along with a residual interest certificate that is subordinateto the Bonds and Certificates, represent the consideration received by us forthe sale of the Residuals.

 

Atclosing of each NIMS transaction, we remove from our consolidated balance sheetthe carrying value of the Residuals sold and add to our consolidated balancesheet (i) the cash received and (ii) the estimated fair value of the portion ofthe Residuals retained, which consists of the NIR. The excess of the cashreceived and assets retained over the carrying value of the Residuals sold,less transaction costs, equals the net gain or loss on the sale of Residualsrecorded by us.

 

Weallocate our basis in the mortgage loans and Residuals between the portion ofthe mortgage loans and Residuals sold through the Certificates and the portionretained (the Residuals and servicing assets) based on the relative fair valuesof those portions on the date of sale. We may recognize gains or lossesattributable to the changes in the fair value of the Residuals, which arerecorded at estimated fair value and accounted for as “held-for-trading”securities. We are not aware of an active market for the purchase or sale ofResiduals and, accordingly, we determine the estimated fair value of theResiduals by discounting the expected cash flows released from the OC Account(the cash out method) using a discount rate commensurate with the risksinvolved.  For securitizations executedprior to 2004, we utilize a discount rate of 12.0% on the estimated cash flowsreleased from the OC Account to value the Residuals through securitizationtransactions and 14.0% on the estimated cash flows released from the Trust tovalue Residuals through NIMS transactions. For the securitization completed during the second quarter of 2004, weutilize a discount rate of 14.5% on the estimated cash flows.  There is not a NIM transaction associatedwith the 2004 transaction.

 

Weare entitled to the cash flows from the Residuals that represent collections onthe mortgage loans in excess of the amounts required to pay the Certificates’principal and interest, the servicing fees and certain other fees, such astrustee and custodial fees. At the end of each collection period, the aggregatecash collections from the mortgage loans are allocated first to the baseservicing fees and certain other fees, such as trustee and custodial fees, forthe period, then to the Certificate holders for interest at the pass-throughrate on the Certificates plus principal as defined in the servicing agreements.If the amount of cash required for the above allocations exceeds the amountcollected during the collection period, the shortfall is drawn from the OCAccount. If the cash collected during the period exceeds the amount necessaryfor the above allocation, and there is no shortfall in the related OC Account,the excess is released to us. If the OC Account balance is not at the requiredcredit enhancement level, the excess cash collected is retained in the OCAccount until the specified level is achieved. We are restricted from using thecash and collateral in the OC Account. Pursuant to certain servicingagreements, we may use cash held in the OC Account to make acceleratedprincipal paydowns on the Certificates to create additional excess collateralin the OC Account. The specified credit enhancement levels are defined in ourservicing agreements as the OC Account balance expressed generally as apercentage of the current collateral principal balance. For NIMS transactions,we receive cash flows once the holders of the Bonds and Certificates created inthe NIMS transaction are fully paid.

 

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TheAnnual Percentage Rate, or APR, on the mortgage loans is relatively high incomparison to the pass-through rate on the Certificates. Accordingly, theResiduals described above are a significant asset. In determining the value ofthe Residuals, we estimate the future rates of prepayments, prepaymentpenalties that we will receive, delinquencies, defaults and default lossseverity as they affect the amount and timing of the estimated cash flows. Weestimate average cumulative losses as a percentage of the original principalbalance of the mortgage loans of 1.35% to 4.15% for adjustable-rate securitiesand 2.09% to 5.23% for fixed-rate securities. These estimates are based onhistorical loss data for the loans, the specific characteristics of the loans, andthe existence of mortgage insurance. While the range of estimated cumulativepool losses is fairly broad, the weighted average cumulative pool loss estimatefor the entire portfolio of residual assets was 3.73% at June 30, 2004. Weestimate prepayments by evaluating historical prepayment performance of ourloans and the impact of current trends. We use a prepayment curve to estimatethe prepayment characteristics of the mortgage loans. The rate of increase,duration, severity, and decrease of the curve depends on the age and nature ofthe mortgage loans, primarily whether the mortgage loans are fixed oradjustable and the interest rate adjustment characteristics of the mortgageloans (6-month, 1-year, 2-year, 3-year, or 5-year adjustment periods). These prepaymentcurve and default estimates have resulted in weighted average lives of between2.23 to 2.64 years for our adjustable-rate securities and 2.37 to 3.56 yearsfor our fixed-rate securities executed prior to 2004.  The estimates used in the 2004 Carringtonsecuritization resulted in a blended weighted-average life of 5.89 years.

 

Duringthe six months ended June 30, 2004, the Residuals provided $27.5 millionin cash flow to us. We perform an evaluation of the Residuals quarterly, takinginto consideration trends in actual cash flow performance, industry andeconomic developments, as well as other relevant factors. For the quarterending June 30, 2004, we updated the models for actual performance and changein interest rates and made some slight adjustments to prepayment and lossassumptions, resulting in an $8.2 million downward fair value adjustment forthe quarter.

 

TheBond and Certificate holders and their securitization trusts have no recourseto us for failure of mortgage loan borrowers to pay when due. Our Residuals aresubordinate to the Bonds and Certificates until the Bond and Certificateholders are fully paid.

 

*Allowance for Repurchase Losses*

 

Theallowance for repurchase losses on loans sold relates to expenses incurred dueto the potential repurchase of loans or indemnification of losses based onalleged violations of representations and warranties which are customary to themortgage banking industry. Generally, repurchases are required within 90 daysfrom the date the loans are sold.  Occasionally,we may repurchase loans after 90 days have elapsed.  Provisions for losses are charged to gain onsale of loans and credited to the allowance while actual losses are charged tothe allowance.  As of June 30, 2004 andDecember 31, 2003, approximately $6.8 billion and $6.8 billion, respectively,are subject to repurchase, representing loans sold during the second quarter of2004 and the fourth quarter of 2003.

 

*Gain on Sale of Loans*

 

Werecognize gains or losses resulting from sales or securitizations of mortgageloans at the date of settlement based on the difference between the sellingprice for sales or securitizations and the carrying value of the related loanssold. Such gains and losses may be increased or decreased by the amount of anyservicing-released premiums received. We defer recognition of non-refundablefees and direct costs associated with the origination of mortgage loans untilthe loans are sold.

 

Weaccount for loan sales and securitizations as sales when we surrender controlof the loans, to the extent that we receive consideration other than beneficialinterests in the loans transferred in the exchange. Liabilities and derivativesincurred or obtained by the transfer of loans are required to be measured atfair value, if practicable. Also, we measure servicing assets and otherretained interests in the loans by allocating the previous carrying valuebetween the loans sold and the interest retained, if any, based on theirrelative fair values at the date of transfer.

 

*Income Taxes*

 

NewCentury Financial and its subsidiaries file a consolidated federal income andcombined state franchise tax returns. We utilize the asset and liability methodof accounting for income taxes, under which deferred income taxes arerecognized for the future tax consequences attributable to the differencesbetween the financial statement values of existing assets and liabilities andtheir respective tax bases. We measure deferred tax assets and liabilitiesusing enacted tax rates we expect to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Werecognize the effect on deferred taxes of a change in tax rates in income inthe period that includes the enactment date. As and when taxing authorities reviewour tax filings, differences may arise. The impact of such reviews will berecorded when probable and estimable.

 

Indetermining the possible realization of deferred tax assets, we consider futuretaxable income from the following sources: (a) the reversal of taxabletemporary differences, (b) future operations exclusive of reversing temporarydifferences, and (c) tax planning

 

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strategies that, if necessary, would be implemented toaccelerate taxable income into periods in which net operating losses mightotherwise expire.

 

*Derivative Instruments Designated as Hedges*

 

Duringthe three months ended June 30, 2004, we accounted for certain Euro DollarFutures and Interest Rate Cap contracts designated and documented as hedgespursuant to the requirements of Statement of Financial Accounting Standard No.133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS133”). Pursuant to SFAS 133 these contracts have been designated as hedging theexposure to variability of cash flows from our financing on mortgage loans heldfor investment attributable to changes in interest rates. Hedge accountingrequires that the effective portion of the gain or loss in the fair value of aderivative instrument designated as a hedge be reported in other comprehensiveincome and the ineffective portion be reported in current earnings.  Additionally, in June 2004, certain EuroDollar Futures contracts were designated as hedges of the fair values ofcertain fixed-rate mortgage loans held for investment and certain mortgageloans held for sale, pursuant to SFAS 133. Hedge accounting requires that for a fair value hedge, changes in thefair value of the derivative instrument and changes in the fair value of the hedgedasset or liability attributable to the hedged risk be reported in currentearnings.

 

**Results of Operations**

 

The following table setsforth our results of operations as a percentage of total revenues for theperiods indicated:

 
| ** **                                                       | ** ** | **Three Months  ended June 30,** | ** ** | **Six Months  ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues**                                                     |       |                             |       |                           |       |   |   |   |   |
| Gain on sale of loans                                            |       | 51.8                             | %          | 67.9                           | %          | 53.7 | % | 68.6 | % |
| Interest income                                                  |       |                             |       |                           |       |   |   |   |   |
| Interest on mortgage loans held for sale                         |       | 21.5                             | %          | 23.2                           | %          | 20.4 | % | 22.7 | % |
| Interest on mortgage loans held for  investment                  |       | 23.5                             | %          | 4.5                            | %          | 22.8 | % | 4.0 | % |
| Other interest income                                            |       | 0.0                              | %          | 0.0                            | %          | 0.0 | % | 0.0 | % |
| Residual interest income                                         |       | 1.1                              | %          | 2.8                            | %          | 1.2 | % | 3.2 | % |
| Servicing income                                                 |       | 2.1                              | %          | 1.6                            | %          | 1.9 | % | 1.5 | % |
| Total revenues                                                   |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| **Expenses**                                                     |       |                             |       |                           |       |   |   |   |   |
| Personnel                                                        |       | 26.3                             | %          | 23.4                           | %          | 24.5 | % | 25.1 | % |
| Interest Expense                                                 |       |                             |       |                           |       |   |   |   |   |
| Interest on credit facilities and other  short-term borrowings   |       | 7.2                              | %          | 7.8                            | %          | 6.4 | % | 8.1 | % |
| Interest on financing on mortgage loans  held for investment     |       | 8.0                              | %          | 1.3                            | %          | 8.5 | % | 1.1 | % |
| Interest on convertible notes                                    |       | 0.5                              | %          | 0.0                            | %          | 0.5 | % | 0.0 | % |
| Other interest expense                                           |       | 0.5                              | %          | 0.1                            | %          | 0.4 | % | 0.2 | % |
| General and administrative                                       |       | 9.5                              | %          | 12.1                           | %          | 9.4 | % | 12.6 | % |
| Provision for loan losses on mortgage loans  held for investment |       | 4.1                              | %          | 2.1                            | %          | 4.8 | % | 1.9 | % |
| Advertising and promotion                                        |       | 2.6                              | %          | 3.0                            | %          | 2.7 | % | 3.2 | % |
| Professional services                                            |       | 2.1                              | %          | 1.9                            | %          | 1.7 | % | 1.8 | % |
| Total expenses                                                   |       | 60.8                             | %          | 51.7                           | %          | 58.9 | % | 54.0 | % |
| Earnings before income taxes                                     |       | 39.2                             | %          | 48.3                           | %          | 41.1 | % | 46.0 | % |
| Income taxes                                                     |       | 14.5                             | %          | 20.1                           | %          | 16.7 | % | 19.1 | % |
| Net earnings                                                     |       | 24.7                             | %          | 28.2                           | %          | 24.4 | % | 26.9 | % |

 

As our portfolio ofon-balance sheet securitizations increases, a greater percentage of ourrevenues are derived from interest income. The increase in interest expense and provision for loan losses are alsoreflective of the growth of the on-balance sheet securitization portfolio.

 

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***Six Months Ended June 30, 2004 Compared toSix Months Ended June 30, 2003***

 

*Originations and Purchases*

 

Weoriginated and purchased $20.7 billion in loans for the six months ended June30, 2004, compared to $10.5 billion for the six months ended June 30, 2003. Forthe six months ended June 30, 2004, full documentation loans as a percentage oftotal originations totaled $10.9 billion or 52.9%, limited documentation loanstotaled $978.2 million, or 4.7%, and stated documentation loans totaled $8.8billion, or 42.4%.  The weighted averageFICO score of our borrowers for the six months ended June 30, 2004 was 628.  For the six months ended June 30, 2003, fulldocumentation loans as a percentage of total originations totaled $6.1 billionor 57.8%, limited documentation loans totaled $559.8 million, or 5.3%, andstated documentation loans totaled $3.9 billion, or 36.9%.  The weighted average FICO score of ourborrowers for the six months ended June 30, 2003 was 598.  Wholesale loan originations and purchaseswere $18.8 billion, representing 90.8% of total originations and purchases forthe six months ended June 30, 2004. Retail loan originations and purchases were$1.9 billion, representing 9.2% of total originations and purchases for the sixmonths ended June 30, 2004. For the same period in 2003, wholesale and retailoriginations and purchases totaled $9.6 billion and $931.2 million,respectively, representing 91.1% and 8.9% of total originations and purchasesfor that period. The increase in originations in 2004 is primarily the resultof incremental volume generated by our strategy to price competitively withinour market in the face of a rising interest rate environment.  This strategy resulted in the origination ofan incremental volume of mortgage loans with higher FICO scores and a greaterpercentage of fixed rate product than our historicalcore business. In addition, we have continued our previously announcedinitiative to expand geographically, and are receiving additional contributionsfrom operating centers opened during 2003.

 

During the first six monthsof 2004, our wholesale loan originations and purchases totaled $18.8 billion,or 90.8% of our total loan production, compared to $9.6 billion, or 91.1%, ofour total loan production during the first six months of 2003.  This production consisted of $11.3 billion,or 60.1%, of cash-out refinancings, $6.6 billion, or 35.3%, of home purchasefinancing, and $874.3 million, or 4.6%, of rate and term refinancings.  During the six months ended June 30, 2003,wholesale production consisted of $5.9 billion, or 61.3%, of cash-outrefinancings, $2.2 billion, or 22.8%, of home purchase financing, and $1.5 billion,or 15.9%, rate and term refinancings. Further, total wholesale production for the six months ended June 30,2004 consisted of $13.1 billion, or 69.7%, of adjustable-rate loans, and $5.7billion, or 30.3%, of fixed rate loans. For the six months ended June 30, 2003, wholesale production consistedof $7.2 billion, or 75.7%, of adjustable-rate loans, and $2.3 billion, or24.3%, of fixed rate loans.

 

For the sixmonths ended June 30, 2004, full documentation loans as a percentage ofwholesale originations totaled $9.5 billion, or 50.7%, limited documentationloans totaled $877.1 million, or 4.7%, and stated documentation loans totaled$8.4 billion, or 44.6%.  For the sixmonths ended June 30, 2003, full documentation loans as a percentage ofwholesale originations totaled $5.4 billion, or 56.0%, limited documentationloans totaled $503.5 million, or 5.2%, and stated documentation loans totaled$3.7 billion, or 38.8%.

 

During the first six monthsof 2004, our Retail Division originated $1.9 billion, or 9.2%, of our totalloan production, compared to $931.2 million, or 8.9%, of our total loanproduction during the first six months of 2003. This production consisted of $1.6 billion, or 81.9%, of cash-outrefinancings, $80.7 million, or 4.2%, of home purchase financing, and $264.4million, or 13.9%, of rate and term refinancings.  During the six months ended June 30, 2003,retail production consisted of $774.9 million, or 83.2% of cash-outrefinancings, $20.1 million, or 2.2%, of home purchase financing, and $136.2million, or 14.6%, rate and term refinancings. Further, total retail production for the six months ended June 30, 2004consisted of $950.8 million, or 49.8%, of adjustable-rate loans, and $960.2million, or 50.2%, of fixed rate loans. For the six months ended June 30, 2003, retail production consisted of$639.2 million, or 68.6%, of adjustable-rate loans, and $292.0 million, or31.4%, of fixed rate loans.

 

For the sixmonths ended June 30, 2004, full documentation loans as a percentage of retailoriginations totaled $1.4 billion, or 74.5%, limited documentation loanstotaled $101.1 million, or 5.3%, and stated documentation loans totaled $386.1million, or 20.2%.  For the six monthsended June 30, 2003, full documentation loans as a percentage of retailoriginations totaled $712.5 million, or 76.5%, limited documentation loanstotaled $56.3 million, or 6.1%, and stated documentation loans totaled $162.4million, or 17.4%.

 

Historically, the subprimemortgage market has focused on home purchases and cash-out refinancings, ratherthan interest rate driven refinancings, which have caused this market segmentto be less interest rate sensitive, and therefore less volatile, than the primemortgage market.

 

*Loan Sales and Mortgage Loans Held for Investment*

 

Loan sales increased to$14.1 billion for the six months ended June 30, 2004, from $9.0 billion for thecorresponding period in 2003, an increase of 56.5%. This increase is the resultof an increased inventory of mortgage loans available for sale due to higherproduction volume, as well as favorable conditions in the whole loan salemarket. In addition, we added approximately $5.1 billion to our portfolio ofmortgage loans held for investment during the first six months of 2004,compared to the addition of $1.2 billion in mortgage loans held for investmentin 2003, which is consistent with our goal of securitizing approximately 20% ofour production through sales structured as financings and recorded on-balancesheet.

 

*Revenues*

 

Total revenues for the sixmonths ended June 30, 2004, increased by 95.7% to $775.8 million, from $396.5million for the same period a year ago. This increase was primarily due to a53.3% increase in gain on sale of loans, a 216.4% increase in interest incomeand a 148.7% increase in servicing income, partially offset by a 26.2% decreasein residual interest income.

 

*Gain on Sale*

 

Gain on sale of loansincreased to $417.0 million, a 53.3% increase for the six months ended June 30,2004, compared to the same period in 2003. The increase in gain on sale ofloans was the result of loan sale volume increasing to $14.1 billion in 2004from $9.0 billion in 2003, and lower losses on discounted sales, partiallyoffset by a reduction in the net execution to 4.04% in 2004 from 4.28% in 2003.We anticipate prices in the second half of 2004 to be lower than recent levels,and for all of 2004 we expect our net execution to be between 3.50% and 3.75%.Net execution represents the premium paid to us by third party investors inwhole loans sale transactions. It does not include premiums we pay to originatethe loans, hedging gains or losses, fair value adjustments or net deferredorigination fees. The components of the gain on sale of loans are illustratedin the following table (dollars in thousands):

 

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| ** **                                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| Cash gain from loan sale transactions        |       | $                              | 554,061    |   | $ | 356,034 |   |
| Gain from securitization of loans (1)        |       | 13,452                         |       | — |   |
| Non-cash gain from servicing asset           |       | —                         |       | 7,777 |   |
| Cash gain on sale of servicing rights        |       | —                         |       | 24,110 |   |
| Provision for repurchase losses              |       | (3,184                         | )          | (4,413 | ) |
| Fair value adjustment of residual securities |       | (6,770                         | )          | 1,606 |   |
| Non-refundable loan fees (2)                 |       | 104,591                        |       | 61,836 |   |
| Premiums paid (3)                            |       | (131,460                       | )          | (84,262 | ) |
| Origination costs                            |       | (114,700                       | )          | (83,900 | ) |
| Hedging gains (losses)                       |       | 1,037                          |       | (6,704 | ) |
| Gain on sale of loans                        |       | $                              | 417,027    |   | $ | 272,084 |   |

 

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(1)                         Gain from Carrington securitization transaction, which was structuredas a sale.

(2)                         Non-refundable loan fees represent points and fees collected fromborrowers.

(3)                         Premiums paid represent fees paid to brokers for wholesale loanoriginations and purchases.

 

*Interest Income*

 

Interest income increased by216.4% to $334.9 million for the six months ended June 30, 2004, compared to$105.9 million for the same period in 2003, primarily as a result of higheraverage balances of mortgage loans held for sale and mortgage loans held forinvestment.

 

Interest income on mortgageloans held for sale increased 75.8% to $158.1 million for the six months endedJune 30, 2004 versus $89.9 million for the six months ended June 30, 2003, duemainly to higher average outstanding balances of unsold inventory, whichresulted from higher production volume during the six months ended June 30,2004. The average balance of loans held for sale grew from $2.4 billion for thesix months ended June 30, 2003 to $4.6 billion for the comparable period in2004; this increase was partially offset by a reduction in the weighted averageinterest rate from 7.41% for the six months ended June 30, 2003 to 6.89% forthe comparable period in 2004.  Interestincome from mortgage loans held for investment from our on-balance sheetportfolio was $176.8 million versus $15.9 million, due to an increase in averagebalance for the six months ended June 30, 2004 versus the six months ended June30, 2003.  The average balance ofmortgage loans held for investment grew from $410 million for the six monthsended June 30, 2003 to $5.1 billion for the comparable period in 2004; thisincrease was partially offset by a reduction in the weighted average interestrate from 7.75% for the six months ended June 30, 2003 to 6.91% for thecomparable period in 2004.

 

Changes in our net interestincome are a function of changes in both interest rates and volumes ofinterest-earning assets and interest-bearing liabilities.  The following table sets forth informationregarding changes in our interest income and expense for the periods indicated.  For each category of interest-earning assetsand interest-bearing liabilities, we have provided information on changesattributable to:

 

•                  changes in volume – changes in volume multiplied bycomparative period rate;

•                  changes in rate – changes in rate multiplied by comparativeperiod volume; and

•                  changes in rate/volume – changes in rate multiplied bychanges in volume.

 

Interest-earningasset and interest-bearing liability balances used in the calculation representquarterly average balances computed using the average of each month’s daily averagebalance during the period indicated.

 

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| ** **                                       | ** ** | **Three Months Ended  June 30, 2004 Versus June 30, 2003  Changes Due To** | ** ** | **Six Months Ended  June 30, 2004 Versus June 30, 2003  Changes Due To** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Volume**                                                                 | ** ** | **Rate**                                                                 | ** ** | **Rate/  Volume** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Rate/  Volume** | ** ** | **Net** | ** ** |
| Interest income:                                 |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage loans held for sale                     |       | $                                                                          | 48,505     |                                                                     | (4,829     | ) | (4,676 | ) | 39,000 |   | $ | 80,285 |   | (6,408 | ) | (5,723 | ) | 68,154 |   |
| Mortgage loans held for investment               |       | 99,107                                                                     |       | (992                                                                     | )          | (10,243 | ) | 87,872 |   | 182,643 |   | (1,740 | ) | (19,989 | ) | 160,914 |   |
| Cash and investments                             |       | 162                                                                        |       | (41                                                                      | )          | (151 | ) | (30 | ) | 203 |   | (52 | ) | (177 | ) | (26 | ) |
| Change in interest income                        |       | 147,774                                                                    |       | (5,862                                                                   | )          | (15,070 | ) | 126,842 |   | 263,131 |   | (8,200 | ) | (25,889 | ) | 229,042 |   |
|                                             |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense:                                |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Credit facilities                                |       | 18,648                                                                     |       | (2,680                                                                   | )          | (2,982 | ) | 12,986 |   | 31,424 |   | (7,100 | ) | (6,912 | ) | 17,412 |   |
| Financing on mortgage loans held for  investment |       | 29,213                                                                     |       | 128                                                                      |       | 1,375 |   | 30,716 |   | 52,744 |   | 718 |   | 8,500 |   | 61,962 |   |
| Convertible notes                                |       | —                                                                     |       | —                                                                   |       | 2,126 |   | 2,126 |   | — |   | — |   | 4,250 |   | 4,250 |   |
| Other borrowings                                 |       | 398                                                                        |       | 546                                                                      |       | 786 |   | 1,730 |   | 450 |   | 1,062 |   | 834 |   | 2,346 |   |
| Change in interest expense                       |       | 48,259                                                                     |       | (2,006                                                                   | )          | 1,305 |   | 47,558 |   | 84,618 |   | (5,320 | ) | 6,672 |   | 85,970 |   |
|                                             |       |                                                                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in net interest income                    |       | $                                                                          | 99,515     |                                                                     | $          | (3,856 | ) | $ | (16,375 | ) | $ | 79,284 |   | $ | 178,513 |   | $ | (2,880 | ) | $ | (32,561 | ) | $ | 143,072 |   |
|                                                  |            |                                                                            |            |                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Residual Interest Income*

 

Residualinterest income decreased 26.2% to $9.4 million for the six months ended June30, 2004, compared to $12.7 million for the corresponding period in 2003,primarily as a result of the decrease in the average balance of residualinterests in securitizations, excluding the residual interest in securitizationresulting from the Carrington securitization transaction.

 

*Servicing Income*

 

Servicingincome increased to $13.6 million for the six months ended June 30, 2004,from $5.8 million for the six months ended June 30, 2003. This increase was dueto a larger income generating mortgage loan servicing portfolio during the sixmonths ending June 30, 2004. While the total portfolio grew to $20.9 billion asof June 30, 2004, the portion of the portfolio which contributes to servicingincome was $7.0 billion, consisting of  $0.6 billion of loans sold servicingretained, and $6.4 billion of loans serviced for others on an interim basispending transfer to investors. As of June 30, 2003, the total portfolio ofloans serviced by us included $0.5 billion of loans sold servicing retained and$1.8 billion of loans serviced for others on an interim basis pending transferto investors.  In April 2004, we receivedan initial rating of average from Fitch Ratings, and a rating of average fromStandard & Poors in June 2004, which we believe will enable us to grow ourservicing portfolio in the future through increased sales of loans on aservicing retained basis. We expect to service loans owned by third parties totake advantage of our technical capabilities, capitalization and economies ofscale.

 

*Expenses*

 

Expensesincreased 113.3% to $456.9 million for the six months ended June 30, 2004,compared to $214.3 million for the same period in 2003, due primarily toincreases in personnel expenses, provision for losses on mortgage loans heldfor investment and interest expense.

 

Personnelexpenses increased to $190.0 million for the six months ended June 30, 2004,from $99.6 million for the same period in 2003, an increase of 90.7%. Theincrease was due to growth in the number of employees, as well as highercommission and bonus expenses that are variable expenses dependent upon loanproduction volume and profits.  Totalstaffing was 4,624 on June 30, 2004, compared to 2,973 on June 30, 2003, anincrease of 55.5%.

 

Provisionfor losses on mortgage loans held for investment increased to $37.0 million forthe six months ended June 30, 2004, from $7.7 million for the same period in2003, due to the increase in the portfolio of mortgage loans held forinvestment and related allowance for loan losses.   We establish an allowance for loan lossesbased on our estimate of losses inherent and probable as of our balance sheetdate.  Mortgage loans held for investmentgrew from $1.2 billion at June 30, 2003 to $9.1 billion at June 30, 2004.

 

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Interest expense representsthe interest incurred on all outstanding debt and securitization bondfinancing, as well as the amortization of bond issue costs on thesecuritization bond financing, interest incurred on the convertible debt, andother costs associated with accessing our credit facilities.  Interest expense increased to $123.3 millionfor the six months ended June 30, 2004, from $37.3 million for the same periodin 2003, primarily due to an increase in average outstanding balances on creditfacilities due to higher production volume, the convertible debt, and interestexpense on the increased financing of securitized mortgage loans.  The average balance of our credit facilitiesincreased from $2.3 billion to $4.5 billion; while our average borrowing rateon the credit facilities decreased from 2.85% for the six months ended June 30,2003 to 2.22% for the comparable period in 2004.  Our average balance of securitization bondfinancing increased from $399 million for the six months ended June 30, 2003 to$5.1 billion for the comparable period in 2004; and our average borrowing rateon the securitization bond financing grew slightly from 2.23% for the sixmonths ended June 30, 2003 to 2.59% for the comparable period in 2004.  The convertible debt balance at June 30, 2004was $210 million compared to zero at June 30, 2003.

 

*Income Taxes*

 

Income taxes increased to$129.2 million for the six months ended June 30, 2004, from $75.6 million forthe comparable period in 2003. This increase was due to a $136.7 millionincrease in pretax income resulting from higher production volume, and anadditional provision of $3.5 million related to the reversal of the 2002California tax benefit from NC Residual II Corporation, our existing realestate investment trust, which holds our residual interests and certainmortgage loans held for investment, offset by the reversal of $5 million ofincome tax expense previously provided and a decrease in the effective taxrate.  During the second quarter of 2004,we resolved an Internal Revenue Service examination of our consolidated taxreturns for the years 1998 through 2001. The conclusion of the examination resulted in the reversal of $5 millionof income tax expense previously provided. Further, the outcome of the examination allowed us to reduce ourexpected income tax rate to 41 percent from 42 percent.  The combined impact of these adjustments inthe second quarter of 2004 was $8.2 million.

 

***Three Months Ended June 30, 2004 Comparedto Three Months Ended June 30, 2003***

 

*Originations and Purchases*

 

Weoriginated and purchased $12.3 billion in loans for the three months ended June30, 2004, compared to $5.8 billion for the three months ended June 30, 2003.For the quarter ended June 30, 2004, full documentation loans as a percentageof total originations totaled $6.5 billion, or 52.7%, limited documentationloans totaled $546.9 million, or 4.5%, and stated documentation loans totaled$5.2 billion or 42.8%.  The weightedaverage FICO score of our borrowers for the three months ended June 30, 2004was 634.  For the quarter ended June 30,2003, full documentation loans as a percentage of total originations totaled$3.4 billion, or 57.9%, limited documentation loans totaled $285.0 million, or4.9%, and stated documentation loans totaled $2.2 billion or 37.2%.  The weighted average FICO score of ourborrowers for the three months ended June 30, 2003 was 599.  Wholesale loan originations and purchaseswere $11.1 billion, representing 90.5% of total originations and purchases forthe three months ended June 30, 2004. Retail loan originations and purchaseswere $1.2 billion, representing 9.5% of total originations and purchases forthe three months ended June 30, 2004. For the same period in 2003, wholesaleand retail originations and purchases totaled $5.3 billion and $478.9 million,respectively, representing 91.7% and 8.3% of total originations and purchasesfor that period. The increase in originations in 2004 is primarily the resultof incremental volume generated by our strategy to price competitively withinour market in the face of a rising interest rate environment.  This strategy resulted in the origination ofan incremental volume of mortgage loans with higher FICO scores and a greaterpercentage of fixed rate product than our historicalcore business. In addition, we have continued our previously announcedinitiative to expand geographically, and are receiving additional contributionsfrom operating centers opened during 2003.

 

During the three monthsended June 30, 2004, our wholesale loan originations and purchases totaled$11.1 billion, or 90.5%, of our total loan production, compared to $5.3billion, or 91.7%, of our total loan production during the same period in 2003.  This production consisted of $6.4 billion, or57.8%, of cash-out refinancings, $4.2 billion, or 37.6%, of home purchasefinancing, and $514.8 million, or 4.6%, of rate and term refinancings.  During the three months ended June 30, 2003,wholesale production consisted of $3.2 billion, or 60.6%, of cash-outrefinancings, $1.3 billion, or 24.9%, of home purchase financing, and $775.7million, or 14.5%, rate and term refinancings. Further, total wholesale production for the three months ended June 30,2004 consisted of $7.4 billion, or 66.7%, of adjustable-rate loans, and $3.7billion, or 33.3%, of fixed rate loans. For the three months ended June 30, 2003, wholesale production consistedof $4.1 billion, or 77.0%, of adjustable-rate loans, and $1.2 billion, or23.0%, of fixed rate loans.

 

For the three months endedJune 30, 2004, full documentation loans as a percentage of wholesaleoriginations totaled $5.6 billion, or 50.4%, limited documentation loanstotaled $487.9 million, or 4.4%, and stated documentation loans totaled $5.0billion, or 45.2%.  For the three monthsended June 30, 2003, full documentation loans as a percentage of wholesaleoriginations totaled $3.0 billion, or 56.2%, limited documentation loans totaled$260.5 million, or 4.9%, and stated documentation loans totaled $2.1 billion,or 38.9%.

 

During the quarter endedJune 30, 2004, our Retail Division originated $1.2 billion, or 9.5%, of ourtotal loan production, compared to $478.9 million, or 8.3%, of our total loanproduction during the same period of 2003. This production consisted of $960.7 million, or 82.2%, of cash-outrefinancings, $55.2 million, or 4.7%, of home purchase financing, and $153.7million, or 13.1%, of rate and term refinancings.  During the quarter ended June 30, 2003,retail production consisted of $400.5 million, or 83.6%, of cash-outrefinancings, $11.5 million, or 2.4%, of home purchase financing, and $66.9million, or 14.0%, rate and term refinancings. Further, total retail production for the three months ended June 30,2004 consisted of $531.5 million, or 45.4%, of adjustable-rate loans, and$638.1 million, or 54.6%, of fixed rate loans. For the quarter ended June 30, 2003, retail production consisted of$328.3 million, or 68.6%, of adjustable-rate loans, and $150.6 million, or31.4%, of fixed rate loans.

 

For the quarter ended June30, 2004, full documentation loans as a percentage of retail originationstotaled $876.2 million, or 74.9%, limited documentation loans totaled $59.0million, or 5.1%, and stated documentation loans totaled $234.4 million, or20.0%.  For the quarter ended June 30,2003, full documentation loans as a percentage of retail originations totaled$366.8 million, or 76.6%, limited documentation loans totaled $24.5 million, or5.1%, and stated documentation loans totaled $87.6 million, or 18.3%.

 

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*Loan Sales and Mortgage Loans Held for Investment*

 

Loan sales increased to $6.8billion for the three months ended June 30, 2004, from $4.9 billion for thecorresponding period in 2003, an increase of 39.1%. This increase is due to anincrease in the inventory of mortgage loans available for sale due to higherproduction volume, as well as favorable conditions in the whole loan salemarket.  In addition, we addedapproximately $3.5 billion to our portfolio of mortgage loans held forinvestment during the second quarter of 2004, compared to the addition of$712.4 million in mortgage loans held for investment in the second quarter of2003.

 

*Revenues*

 

Total revenues for the threemonths ended June 30, 2004, increased by 92.5% to $414.8 million, from $215.5million for the same period a year ago. This increase was primarily due to a47.0% increase in gain on sale of loans, a 212.4% increase in interest incomeand a 156.3% increase in servicing income, partially offset by a 25.2% decreasein residual interest income.

 

*Gain on Sale*

 

Gain on sale of loansincreased to $215.1 million, a 47.0% increase for the three months ended June30, 2004, compared to the same period in 2003. The increase in gain on sale ofloans was the result of loan sale volume increasing to $6.8 billion in 2004from $4.9 billion in 2003, and lower losses on discounted sales, partiallyoffset by a reduction in the net execution to 4.27% in 2004 from 4.45% in2003.  We anticipate prices in the secondhalf of 2004 to be lower than recent levels, and for all of 2004 we expect ournet execution to be between 3.50% and 3.75%. Net execution represents the premiumpaid to us by third party investors in whole loans sale transactions. It doesnot include premiums we pay to originate the loans, hedging gains or losses,fair value adjustments or net deferred origination fees. The components of thegain on sale of loans are illustrated in the following table (dollars inthousands):

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2004**                         | ** ** | **2003** | ** ** |
| Cash gain from loan sale transactions        |       | $                                | 274,081    |   | $ | 206,867 |   |
| Gain from securitization of loans (1)        |       | 13,452                           |       | — |   |
| Cash gain on sale of servicing rights        |       | —                           |       | 12,920 |   |
| Provision for repurchase losses              |       | (1,827                           | )          | (3,234 | ) |
| Fair value adjustment of residual securities |       | (8,212                           | )          | — |   |
| Non-refundable loan fees (2)                 |       | 61,169                           |       | 33,912 |   |
| Premiums paid (3)                            |       | (63,681                          | )          | (49,415 | ) |
| Origination costs                            |       | (63,100                          | )          | (48,500 | ) |
| Hedging gains (losses)                       |       | 3,169                            |       | (6,268 | ) |
| Gain on sale of loans                        |       | $                                | 215,051    |   | $ | 146,282 |   |

 

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(1)                         Gain from Carrington securitization transaction, which was structuredas a sale.

(2)                         Non-refundable loan fees represent points and fees collected fromborrowers.

(3)                         Premiums paid represent fees paid to brokers for wholesale loanoriginations and purchases.

 

*Interest Income*

 

Interest income increased by212.4% to $186.6 million for the three months ended June 30, 2004, compared to$59.7 million for the same period in 2003, primarily as a result of higheraverage balances of mortgage loans held for sale and mortgage loans held forinvestment.

 

Interest income on mortgageloans held for sale increased 77.9% to $89.1 million for the three months endedJune 30, 2004 versus $50.1 million for the three months ended June 30, 2003,due to higher average outstanding balances of unsold inventory, which resultedfrom higher production volume during the three months ended June 30, 2004. Theaverage balance of loans held for sale grew from $2.7 billion for the threemonths ended June 30, 2003 to $5.3 billion for the comparable period in 2004;this increase was partially offset by a reduction in the weighted averageinterest rate from 7.50% for the three months ended June 30, 2003 to 6.77% forthe comparable period in 2004.  Interestincome from mortgage loans held for investment from our on-balance sheetportfolio was $97.5 million versus $9.6 million, due to an increase in averagebalance for the three months ended June 30, 2004 versus the three months endedJune 30, 2003.  The average balance ofmortgage loans held for investment grew from $490 million for the three

 

31

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months ended June 30, 2003 to $5.5 billion for thecomparable period in 2004; this increase was partially offset by a reduction inthe weighted average interest rate from 7.84% for the three months ended June30, 2003 to 7.03% for the comparable period in 2004.

 

*Residual Interest Income*

 

Residual interest incomedecreased 25.2% to $4.6 million for the three months ended June 30, 2004,compared to $6.1 million for the corresponding period in 2003, primarily as aresult of the decrease in the average balance of residual interests insecuritizations.

 

*Servicing Income*

 

Servicing income increasedto $7.8 million for the three months ended June 30, 2004, from $3.3 million forthe three months ended June 30, 2003. This increase was due to a larger incomegenerating mortgage loan servicing portfolio during the three months ended June30, 2004. While the total portfolio grew to $20.9 billion on June 30, 2004, theportion of the portfolio which contributes to servicing income was $7.0billion, consisting of $0.6 billion of loans sold servicing retained, and $6.4billion of loans serviced for others on an interim basis pending transfer toinvestors. As of June 30, 2003, the total portfolio of loans serviced by usincluded $0.5 billion of loans sold servicing retained and $1.8 billion ofloans serviced for others on an interim basis pending transfer to investors. InApril 2004, we received an rating of average fromFitch Ratings, and a rating of average from Standard & Poors in June 2004,which we believe will enable us to grow our servicing portfolio in the futurethrough increased sales of loans on a servicing retained basis. We expect toservice loans owned by third parties to take advantage of our technicalcapabilities, capitalization and economies of scale.

 

*Expenses*

 

Expenses increased 126.7% to$252.4 million for the three months ended June 30, 2004, compared to $111.3million for the same period in 2003, due primarily to increases in personnelexpenses, provision for losses on mortgage loans held for investment, andinterest expense.

 

Personnel expenses increasedto $109.0 million for the three months ended June 30, 2004, from $50.4 millionfor the same period in 2003, an increase of 116.1%.  The increase was due to growth in the numberof employees, as well as higher commission and bonus expenses that are variableexpenses dependent upon loan production volume and profits. Total staffing was4,624 on June 30, 2004, compared to 2,973 on June 30, 2003, an increase of55.5%.

 

Provision for losses onmortgage loans held for investment increased to $17.1 million for the threemonths ended June 30, 2004, from $4.5 million for the same period in 2003, dueto the increase in the portfolio of mortgage loans held for investment andrelated allowance for loan losses.  Weestablish an allowance for loan losses based on our estimate of losses inherentand probable as of our balance sheet date.

 

Interest expense representsthe interest incurred on all outstanding debt and securitization bondfinancing, as well as the amortization of bond issue costs on thesecuritization bond financing, interest incurred on the convertible debt, andother costs associated with accessing our credit facilities.  Interest expense increased to $67.3 millionfor the three months ended June 30, 2004, from $19.7 million for the sameperiod in 2003, primarily due to an increase in average outstanding balances oncredit facilities due to higher production volume, convertible debt, as well asinterest expense on the increased financing of securitized mortgage loans.  The average balance of our credit facilitiesincreased from $2.5 billion for the three months ended June 30, 2003 to $5.4billion for the comparable period in 2004; and our average borrowing rate onthe credit facilities decreased from 2.64% for the three months ended June 30,2003 to 2.22% for the comparable period in 2004.  Our average securitization bond financingincreased from $477 million for the three months ended June 30, 2003 to $5.6billion for the comparable period in 2004; our average borrowing rate on thesecuritization bond financing grew slightly from 2.28% for the three monthsended June 30, 2003 to 2.38% for the comparable period in 2004.    The convertible debt balance at June 30,2004 was $210 million compared to zero at June 30, 2003.

 

*Income Taxes*

 

Income taxes increased to$60.0 million for the three months ended June 30, 2004, from $43.3 million forthe comparable period in 2003. This increase was due to a $58.3 millionincrease in pretax income resulting from higher production volume partiallyoffset by a decrease in the effective tax rate and a reversal of $5 million ofincome tax expense previously provided. During the second quarter of 2004, we resolved an Internal RevenueService examination of our consolidated tax returns for the years 1998 through2001.  The conclusion of the examinationresulted in the reversal of $5 million of income tax expense previouslyprovided.  Further, the outcome of theexamination allowed us to reduce our expected income tax rate to 41 percentfrom 42 percent.   The combined impact ofthese adjustments in the second quarter of 2004 was $8.2 million.

 

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**Liquidity and Capital Resources**

 

*Credit Facilities*

 

We need to borrowsubstantial sums of money each quarter to originate and purchase mortgageloans. We need separate credit arrangements to finance these loans until wehave aggregated one or more pools for sale. The amount of credit we seek tohave available is based on our expectation of future origination volume.

 

Duringthe three months ended June 30, 2004, we have used credit facilities with Bankof America, Bear Stearns, CDC Mortgage Capital, Citigroup Global Markets(formerly Salomon Brothers), Greenwich Capital Financial Products, MorganStanley, and UBS Real Estate Securities and we also have an asset-backedcommercial paper facility. We use these facilities to finance the actualfunding of our loan originations and purchases and to aggregate pools ofmortgage loans pending sale through securitizations or whole loan sales. Wetypically sell all of our mortgage loans within one to three months and paydown the credit facilities with the proceeds.

 

Ourcredit facilities contain certain customary covenants, which, among otherprovisions, require us to maintain specified levels of liquidity and net worthand debt-to-equity ratios, restrict indebtedness and investments and requirecompliance with applicable laws. The maximum level of liquidity required underour credit facilities is $60 million, the maximum amount of net worth requiredis approximately $500 million, and debt-to-equity ratio limitations range from10 to 1 to 15 to 1.  We preparecompliance certificates on a monthly and quarterly basis to monitor the statusof our compliance with the covenants.  Ifwe fail to comply with any of these covenants, the lender has the right toterminate the facility and require immediate repayment. In addition, if wedefault under one facility, it would generally trigger a default under ourother facilities. The material terms and features of our various creditfacilities are as follows:

 

*Asset-backed Commercial PaperFacility*.    In September 2003, weestablished a $2.0 billion asset-backed commercial paper facility. Thisfacility allows for the funding and aggregation of mortgage loans using funds raised through the sale of short-term commercial paper. Theinterest and fees that we pay in connection with this facility are similar tothe interest rates based on LIBOR that we pay to our other credit facilitylenders. This facility will expire in September 2006. As of June 30, 2004, thebalance outstanding under the facility was zero.

 

*Bank of America Line of Credit.*    We have a $2.0billion credit facility with Bank of America, $1.0 billion of which iscommitted and $1.0 billion of which is uncommitted.  The agreement allows for both funding of loanoriginations and aggregation of loans for up to four months pending their saleor securitization. The facility expires in May 2005 and bears interest based ona margin over the one-month LIBOR. As of June 30, 2004, the balance outstandingunder the facility was $1.5 billion.

 

*Bear Stearns Line of Credit*.    We have an $800million line of credit with Bear Stearns Mortgage Capital, $400 million ofwhich is committed and $400 million of which is uncommitted. The facilityexpires in October 2004 and bears interest based on a margin over one-monthLIBOR. This facility was temporarily increased to $1.8 billion until theclosing of the securitization transaction in August 2004. As of June 30, 2004,the balance outstanding under this facility was $1.6 billion.

 

*CDC Line of Credit*.    We have a repurchase agreement with CDCMortgage Capital. The agreement allows for both funding of loan originationsand aggregation of loans for up to six months pending their sale orsecuritization. The facility expires in July 2004 and bears interest basedon a margin over the one-month LIBOR. As of June 30, 2004, the maximum creditavailable under this facility was $570 million and the balance outstandingunder this facility was $638 million. In June 2004, we entered into an amendmentto this facility that temporarily increased the maximum credit available from$570 million to $700 million and on July 15, 2004, we extended the expirationdate until August 15, 2004.  We expect torenew this facility before it expires.

 

*Citigroup Warehouse Line ofCredit.*    Asof June 30, 2004, we had a $150 million wet funding facility with CitigroupGlobal Markets (formerly Salomon Brothers), which bears interest based on amargin over the one-month LIBOR. This facility expires in September 2004. As ofJune 30, 2004, the outstanding balance under the facility was zero.  We expect to extend or replace this facilityprior to its expiration.

 

*Citigroup Aggregation Line ofCredit*.    As of June 30, 2004,we had a $650 million aggregation facility with Citigroup Global Markets(formerly Salomon Brothers), which bears interest based on a margin over theone-month LIBOR. This facility expires in September 2004. The total amountoutstanding among this and our other two Citigroup credit facilities may notexceed $800 million. As of June 30, 2004, the outstanding balance under thisfacility was $634 million.  We expect toextend or replace this facility prior to its expiration.

 

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*Citigroup Commercial Loan Line ofCredit.*    InJune 2004, we established a $250 million repurchase agreement with CitigroupGlobal Markets.  The agreement allows forboth funding of commercial mortgage loan originations and aggregation ofcommercial mortgage loans for up to six months pending their sale orsecuritization.  This facility expires inJune 2005 and bears interest based on a margin over the one-month LIBOR.  As of June 30, 2004, the balance outstandingunder this facility was $68.1 million.

 

*Citigroup Line of Credit forDelinquent and Problem Loans.*    We also have a Master Loan and SecurityAgreement with Citigroup Global Markets (formerly Salomon Brothers) that issecured by delinquent or problem loans and by properties we obtain inforeclosures. This facility expires in December 2004 and bears interest basedon a margin over the one-month LIBOR. As of June 30, 2004, the maximum creditavailable under this facility was $75 million and the balance outstanding underthis facility was $64 million.

 

*Greenwich Capital Line of Credit.*    We had a $100 millioncredit facility with Greenwich Capital Financial Products. The agreementallowed for both funding of commercial loan originations and aggregation ofcommercial real estate loans for up to six months pending their sale orsecuritization. The facility expired in June 2004 and bore interest based on amargin over the one-month LIBOR. We utilized the proceeds from our CitigroupCommercial Loan Line of Credit to repay amounts outstanding on this line priorto its expiration.  As of June 30, 2004,the balance outstanding under this facility was zero.

 

*Morgan Stanley Line of Credit*.    We also have a $2.0 billion aggregationfacility with Morgan Stanley Mortgage Capital Inc. This facility expires inJanuary 2005 and bears interest based on a margin over the one-month LIBOR. Asof June 30, 2004, the balance outstanding under this facility was $415,000.

 

*UBS Real Estate Securities, Inc.Line of Credit.*    NewCentury Mortgage’s special-purpose subsidiary, New Century Funding I, has a$2.0 billion asset-backed note purchase and security agreement with UBS RealEstate Securities, Inc., $1.5 billion of which is committed and $0.5 billion ofwhich is uncommitted. The agreement allows for both funding of loanoriginations and aggregation of loans for up to six months pending their saleor securitization. The facility expires in June 2006 and bears interest basedon a margin over the one-month LIBOR. As of June 30, 2004, the balanceoutstanding under this facility was $1.6 billion.

 

*Carrington Mortgage Credit Fund I, LP CitigroupWarehousing Agreement**. *   Asof June 30, 2004, the Carrington Fund had a $400 million uncommitted WarehouseAgreement with Citigroup Global Markets (formerly Salomon Brothers), whichbears interest based on a margin over the one-month LIBOR. The agreement allowsfor both funding of loan originations and aggregation of loans for up to sixmonths pending their sale or securitization. This facility expires in April2005. As of June 30, 2004, the outstanding balance under this facility was $9.1million.

 

Asa result of the merger and the restructuring necessary for us to qualify as aREIT, we will need the consent of the various lenders discussed above in orderfor New Century REIT and/or one of its qualified REIT subsidiaries to succeedto our current rights. In the event that such consents cannot be obtained, orcan only be obtained on terms unfavorable to us, we will need to securereplacements for such credit facilities, the availability of which on favorableterms cannot be assured. We may also obtain new credit facilities to financeour origination and purchase of mortgage loans. A further discussion of theREIT conversion appears below.

 

*Other Borrowings*

 

Weperiodically enter into equipment financing arrangements from time to time thatare treated as notes payable for financial statement purposes. As of June 30,2004, the balance outstanding under these borrowing arrangements was $30.5million.

 

Duringthe third quarter of 2003, we entered into a $20 million servicer advanceagreement, which allows us to borrow up to 95% of servicing advances on ourservicing portfolio. As of June 30, 2004, the balance outstanding under thisfacility was $1.4 million. This facility expires in August 2004.  We expect to renew this facility before itexpires.

 

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*On-Balance Sheet Securitizations*

 

Priorto 2003, in our securitization transactions we realized net cash proceeds in anamount similar to whole loan sales, as a result of NIMS transactions closedconcurrent with our securitizations. During the six months ended June 30, 2004,we completed two on-balance sheet securitizations, resulting in the recordingof loans held for investment as an asset and financing on loans held for investmentas a liability. Without a concurrent NIMS transaction, on-balance sheetsecuritizations generally require an initial cash investment ranging fromapproximately 2% to 4% of the principal balance of the loans. Immediatelyfollowing the securitization, we start to receive interest payments on theunderlying mortgage loans and pay interest payments to the bondholders,creating positive cash flow. As the loans age, losses on the portfolio willbegin to reduce this cash flow.

 

Forthe six months ending June 30, 2004, the initial cash investment in on-balancesheet securitizations was $64.5 million. For the six months ending June 30, 2003, the initial cash investment foron-balance sheet securitizations was $40.0 million. For the six monthsending June 30, 2004 and 2003, we received $127.4 million and $11.6 million,respectively, in cash flows from these securitizations.

 

*Off-Balance Sheet Arrangements*

 

Weare party to various transactions that have an off-balance sheet component. Inconnection with our off-balance sheet securitization transactions, there are$1.5 billion in loans owned by off-balance sheet trusts, including the loanssecuritized by Carrington. The Trusts have issued bonds secured by these loans.The bondholders generally do not have recourse to us in the event that theloans in the various trusts do not perform as expected. Because these trustsare “qualifying special purpose entities,” in accordance with generallyaccepted accounting principles, we have included only our residual interest in theseloans on our balance sheet. The performance of the loans in the Trusts willimpact our ability to realize the current estimated fair value of theseresidual assets. See “Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Loan Sales and Securitizations” for furtherdiscussion of the risks to us regarding these off-balance sheet arrangements.

 

Asof June 30, 2004, in connection with our strategy to mitigate interest raterisk in our residual assets and our mortgage loans held for investment, we hadapproximately $55.8 billion notional amount of Euro Dollar Futures contractsoutstanding, expiring between September 2004 and March 2011.

 

*Contractual Obligations*

 

The following tablesummarizes our material contractual obligations as of June 30, 2004.  The maturity of our financing on mortgageloans held for investment is based on certain prepayment assumptions (see“Management’s Discussion and Analysis of Financial Condition and Results ofOperations - Results of Operations” for further details).

 
| ** **                                      | ** ** | ** ** | ** ** | ** **            | ** ** | **Payment Due By Period** | ** ** | ** **        | ** ** |
|-------------------------------------------------|------------|------------|------------|-----------------------|------------|---------------------------|------------|-------------------|------------|
| **(dollars in thousands)**                      | ** ** | **Total**  | ** ** | **Less than  1 Year** | ** ** | **1 to 3  Years**         | ** ** | **3 to 5  Years** | ** ** | **5+ Years** | ** ** |
| Notes payable                                   |       | $          | 30,485     |                  | 13,636     |                      | 16,849     |              | —     |   | — |   |
| Operating leases                                |       |       | 85,356     |                  | 29,161     |                      | 43,239     |              | 12,215     |   | 741 |   |
| Credit facilities                               |       |       | 4,439,518  |                  | 4,439,518  |                      | —     |              | —     |   | — |   |
| Financing on mortgage loans held for investment |       |       | 9,151,482  |                  | 1,822,408  |                      | 4,040,793  |              | 1,286,319  |   | 2,001,962 |   |

 

*Cash Flow*

 

For the six months endedJune 30, 2004, our cash flow provided by operations was $35.2 million, comparedto $64.6 million for the same period in 2003. This decrease was due primarilyto a lower utilization of the borrowing capacity of $166.9 million and NIRgains of $21.9 million, deposits of $10.9 million to over-collateralizationaccounts, for the six months ended June 30, 2004; offset by (i) $83.1 millionincrease in net income, (ii) $26.1 million increase in provision for losses onmortgage loans held for investment, (iii) $81.1 million positive change inother assets and liabilities, and (iv) $15.1 million higher principal paymentsreceived on mortgage loans held for sale.

 

For the six months endedJune 30, 2004, our cash flow used in investing activities was $2.7 billioncompared to $1.2 billion for the same period in 2003. This increase in cashused is due to $3.5 billion of cash used to acquire mortgage loans forinvestment for the six months ended June 30, 2004, compared to $1.2 billion in2003, partially offset by $739.3 million in payments received on our mortgageloans held for investment for the six months ended June 30, 2004, compared to$23.8 million for the same period in 2003.

 

For the six months endedJune 30, 2004, cash provided by financing activities was $2.5 billion comparedto $1.1 billion for the six months ended June 30, 2003. This increase is duemainly to:  (i) net financing on mortgageloans held for investment of $3.3 billion in 2004 compared to $1.2 billion in2003, (ii) higher proceeds from fixed asset financing, (net of repayments) of$15.7 million in 2004 and (iii) no stock

 

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repurchases in 2004 compared to $24.2 million in 2003,offset by higher repayments of securitization financing on mortgage loans heldfor investment of $633 million in 2004, and an increase in restricted cash of$189.0 million in 2004.

 

Our loan origination andpurchase and servicing programs require significant cash investments, includingthe funding of: (i) fees paid to brokers and correspondents in connection withgenerating loans through wholesale lending activities, (ii) commissions paid tosales employees to originate loans, (iii) any difference between the amountfunded per loan and the amount advanced under our credit facilities, (iv)servicing-related advance requirements, and (v) income tax payments arisingfrom the timing differences between income for financial reporting purposes andtaxable income. We also require cash to fund on-balance sheet securitizations,ongoing operating and administrative expenses, and capital expenditures. Oursources of operating cash flow include: (i) cash premiums obtained in wholeloan sales, (ii) mortgage origination income and fees, (iii) interest income, (iv) cash flows from residual interests in securitizations,and (v) servicing fee income.

 

*Liquidity Strategy*

 

We establish target levelsof liquidity and capital based on a number of factors including our productionvolume, the condition of the secondary market for our loans and our currentbalance sheet.

 

Weintend to continue to concentrate on maintaining our targeted liquidity levels.Our principal strategy is to effectively manage the percentage of loans soldthrough whole loan sales versus on-balance sheet securitizations, givingconsideration to whole loan prices, the amount of cash required to financeon-balance sheet securitizations and dividend requirements. There can be noassurance that we will be able to achieve this goal and operate on a cashflow-neutral or cash flow-positive basis.

 

Subjectto the various uncertainties described above, and assuming that we will be ableto successfully execute our liquidity strategy, we anticipate that ourliquidity, credit facilities and capital resources will be sufficient to fundour operations for the foreseeable future.

 

Cash and liquidity, which includes available borrowing capacity, was$275.5 million at June 30, 2004 compared to $212.7 million at June 30, 2003.Available borrowing capacity represents the excess of mortgage loan collateralpledged over the amount borrowed under our credit facilities.

 

*Conversion to a Real Estate Investment Trust andRelated Public Offering*

 

On April 5, 2004, our board of directors unanimously voted in favor ofconverting New Century Financial to a REIT, subject to a number of conditions,including SEC review and stockholder approval of the merger component of theREIT conversion.  The REIT conversionwill include a merger and related restructuring transactions.  Pursuant to the merger, New Century Financialwill become a wholly-owned subsidiary of New Century REIT, a corporation thatNew Century Financial has formed for purposes of the REIT conversion, andstockholders of New Century Financial will receive one share of New CenturyREIT common stock for each share of New Century Financial common stock they ownat that time.  Financial Following thecompletion of the merger, New Century REIT will be renamed “New CenturyFinancial Corporation.”  Our stockholderswill vote on these items at our 2004 annual meeting, which we expect to occurin September 2004.

 

In connection with the REIT conversion, we also plan to raise additionalcapital in the form of equity, debt or some combination of the two.  We currently anticipate raising approximately$750 million of capital through a public offering of shares of New Century REITcommon stock, which is contingent upon, among other things, the completion ofthe merger described above, subject to satisfactory terms and conditions,market conditions and the price of our common stock.  We expect to complete the capital raise andadopt REIT status by the end of 2004. Additionally, we have applied to have the REIT common stock listed onthe New York Stock Exchange.

 

A registrationstatement relating to these securities has been filed by New Century REIT withthe Securities and Exchange Commission but has not yet become effective.  These securities may not be sold nor mayoffers to buy be accepted prior to the time the registration statement becomeseffective.  This Quarterly Report on Form10-Q shall not constitute an offer to sell or the solicitation of an offer tobuy nor shall there be any sale of these securities in any state in which suchoffer, solicitation or sale would be unlawful prior toregistration or qualification under the securities laws of any such state.

 

*Quarterly Dividend*

 

On June 24, 2004, our board of directors approved a quarterly cashdividend at the rate of $0.20 per share to be paid on July 30, 2004 tostockholders of record at the close of business on July 15, 2004.  Any future declaration of dividends will besubject to our earnings, financial position, capital requirements, contractualrestrictions and other relevant factors.

 

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

 

**General**

 

We carry interest-sensitiveassets on our balance sheet that are financed by interest-sensitiveliabilities. Since the interval for re-pricing of the assets and liabilities isnot matched, we are subject to interest-rate risk. A sudden, sustained increaseor decrease in interest rates would impact our net interest income, aswell as the fair value of our mortgage loans held for investment and relatedfinancing, and our residual interests in securitizations. We employ hedgingstrategies from time to time to manage the interest-rate risk inherent in ourassets and liabilities. These strategies are designed to create gains whenmovements in interest rates cause our cash flows and/or the value of our assetsto decline, and result in losses when movements in interest rates cause ourcash flows and/or the value of our assets to increase.

 

Changes inmarket interest rates affect our estimations of the fair value of mortgageloans held for sale, and the fair value of our mortgage loans held forinvestment and related derivatives. Changes in fair value that are stated below are derived based uponimmediate and equal changes to market interest rates of variousmaturities.  The base or current interestrate curve is adjusted by the levels shown below (dollars in thousands):

 

As of June 30, 2004:

 
| ** **                                                                            | ** ** | **+ 50bp** | ** ** | **+ 100bp** | ** ** | **- 50bp** | ** ** | **- 100bp** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|-------------|------------|
| Change in fair value of residual interests  in securitizations                        |       | $          | (1,555     | )           | (2,584     | )          | 2,050      |        | 4,936      |   |
| Change in fair value of derivatives related  to residual interests in securitizations |       | 1,425      |       | 2,850       |       | (1,425     | )          | (2,850      | )          |
| Change in fair value of mortgage loans held  for investment                           |       | (59,655    | )          | (109,207    | )          | 44,886     |       | 96,802      |       |
| Change in fair value of derivatives related  to mortgage loans held for investment    |       | 48,288     |       | 96,575      |       | (48,288    | )          | (96,575     | )          |
|                                                                                  |       |       |       |        |       |       |       |        |       |
| Net change                                                                            |       | $          | (11,497    | )           | (12,366    | )          | (2,777     | )           | 2,313      |   |

 

As of December 31, 2003:

 
| ** **                                                                            | ** ** | **+ 50bp** | ** ** | **+ 100bp** | ** ** | **- 50bp** | ** ** | **- 100bp** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|-------------|------------|
| Change in fair value of residual interests  in securitizations                        |       | $          | (3,937     | )           | (7,055     | )          | 4,596      |        | 9,886      |   |
| Change in fair value of derivatives related  to residual interests in securitizations |       | 3,275      |       | 6,550       |       | (3,275     | )          | (6,550      | )          |
| Change in fair value of mortgage loans held  for investment                           |       | (30,302    | )          | (62,629     | )          | 28,915     |       | 56,785      |       |
| Change in fair value of derivatives related  to mortgage loans held for investment    |       | 24,325     |       | 48,650      |       | (24,325    | )          | (48,650     | )          |
|                                                                                  |       |       |       |        |       |       |       |        |       |
| Net change                                                                            |       | $          | (6,639     | )           | (14,484    | )          | 5,911      |        | 11,471     |   |

 

Thefollowing table illustrates the maturity of our interest-sensitive assets andliabilities as of June 30, 2004. We have made certain assumptions indetermining the maturity of such assets and liabilities. One of the moresignificant assumptions is that all of our mortgage loans held for sale will besold within six months. In addition, the timing of maturity of our mortgageloans held for investment and related financing and our residual interests insecuritizations is based on certain prepayment and loss assumptions (See“Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Results of Operations” for further details). We purchase Euro DollarFutures contracts designed to mitigate interest rate risk associated with ourresidual interests in securitizations and our portfolio of mortgage loans heldfor investment. The Euro Dollar

 

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Futures contracts had a notional value of$55.8 billion, their fair value was a gain of $14.0 million and they hadmaturity dates of less than 7 years at June 30, 2004.

 
| **Description**                                                                        | ** ** | **Zero to  six months**    | ** ** | **Six months  to one year** | ** ** | **1-2 Years** | ** ** | **3-4 Years** | ** ** | **5-6 Years** | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|---------------|------------|---------------|------------|---------------|------------|----------------|------------|------------|------------|
| ** **                                                                             | ** ** | **(dollars in thousands)** | ** ** |
| Interest  – sensitive assets:                                                     |       |                       |       |                        |       |          |       |          |       |          |       |           |       |       |       |
| Cash  and cash equivalents                                                             |       | $                          | 68,891     |                        | —     |          | —     |          | —     |          | —     |           | —     |       | 68,891     |   |
| Restricted  cash                                                                       |       | 322,369                    |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 322,369    |       |
| Loans  receivable held for sale, net                                                   |       | 4,784,222                  |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 4,784,222  |       |
| Mortgage  loans held for investment, net (1)                                           |       | 634,058                    |       | 1,156,185                   |       | 2,573,800     |       | 2,266,401     |       | 969,829       |       | 1,546,199      |       | 9,146,472  |       |
| Cap  Contracts                                                                         |       | 2,655                      |       | —                      |       | 397           |       | 1,711         |       | —        |       | —         |       | 4,763      |       |
| Euro  Dollar Futures contracts:                                                        |       |                       |       |                        |       |          |       |          |       |          |       |           |       |       |       |
| Trading                                                                                |       | 165                        |       | 71                          |       | —        |       | —        |       | —        |       | —         |       | 236        |       |
| Non-trading                                                                            |       | 4,646                      |       | 5,773                       |       | 5,074         |       | (328          | )          | (1,125        | )          | (274           | )          | 13,766     |       |
| Residual  interests in securitizations                                                 |       | 11,776                     |       | 12,290                      |       | 42,122        |       | 96,669        |       | 20,664        |       | 7,306          |       | 190,827    |       |
| Total  interest – sensitive assets                                                |       | 5,828,782                  |       | 1,174,319                   |       | 2,621,393     |       | 2,364,453     |       | 989,368       |       | 1,553,231      |       | 14,531,546 |       |
| Interest  – sensitive liabilities:                                                |       |                       |       |                        |       |          |       |          |       |          |       |           |       |       |       |
| Credit  facilities                                                                     |       | 4,439,518                  |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 4,439,518  |       |
| Financing  on mortgage loans held for investment                                       |       | 672,003                    |       | 1,150,405                   |       | 2,531,330     |       | 2,293,256     |       | 941,323       |       | 1,498,615      |       | 9,086,932  |       |
| Notes  payable                                                                         |       | 6,685                      |       | 6,951                       |       | 11,113        |       | 5,736         |       | —        |       | —         |       | 30,485     |       |
| Convertible  notes                                                                     |       | —                     |       | —                      |       | —        |       | 205,349       |       | —        |       | —         |       | 205,349    |       |
| Total  interest – sensitive liabilities                                           |       | 5,118,206                  |       | 1,157,356                   |       | 2,542,443     |       | 2,504,341     |       | 941,323       |       | 1,498,615      |       | 13,762,284 |       |
| Excess  of interest – sensitive assets over interest – sensitive liabilities |       | 710,576                    |       | 16,963                      |       | 78,950        |       | (139,888      | )          | 48,045        |       | 54,616         |       | 769,262    |       |
| Cumulative  net interest – sensitivity gap                                        |       | $                          | 710,576    |                        | 727,539    |          | 806,489    |          | 666,601    |          | 714,646    |           | 769,262    |       | 769,262    |   |

 

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(1)          Treats mortgage loans held for investment tobe securitized during the third quarter 2004 as if securitization occurred June30, 2004.

 

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As of December 31, 2003:

 
| **Description**                                                                        | ** ** | **Zero to  six months**    | ** ** | **Six months  to one year** | ** ** | **1-2 Years** | ** ** | **3-4 Years** | ** ** | **5-6 Years** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|---------------|------------|---------------|------------|---------------|------------|----------------|------------|-----------|------------|
| ** **                                                                             | ** ** | **(dollars in thousands)** | ** ** |
| Interest – sensitive assets:                                                      |       |                       |       |                        |       |          |       |          |       |          |       |           |       |      |       |
| Cash and cash equivalents                                                              |       | $                          | 269,540    |                        | —     |          | —     |          | —     |          | —     |           | —     |      | 269,540    |   |
| Restricted cash                                                                        |       | 116,883                    |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 116,883   |       |
| Loans receivable held for sale, net                                                    |       | 3,422,211                  |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 3,422,211 |       |
| Mortgage loans held for investment, net                                                |       | 426,976                    |       | 589,793                     |       | 1,402,794     |       | 722,691       |       | 390,294       |       | 1,213,389      |       | 4,745,937 |       |
| Residual interests in securitizations                                                  |       | 13,428                     |       | 5,875                       |       | 36,139        |       | 14,071        |       | 61,556        |       | 48,429         |       | 179,498   |       |
| Total interest – sensitive assets                                                 |       | 4,249,038                  |       | 595,668                     |       | 1,438,933     |       | 736,762       |       | 451,850       |       | 1,261,818      |       | 8,734,069 |       |
|                                                                                   |       |                       |       |                        |       |          |       |          |       |          |       |           |       |      |       |
| Interest – sensitive liabilities:                                                 |       |                       |       |                        |       |          |       |          |       |          |       |           |       |      |       |
| Credit facilities                                                                      |       | 3,311,837                  |       | —                      |       | —        |       | —        |       | —        |       | —         |       | 3,311,837 |       |
| Financing on mortgage loans held for  investment                                       |       | 377,212                    |       | 575,609                     |       | 1,402,310     |       | 762,843       |       | 398,554       |       | 1,169,795      |       | 4,686,323 |       |
| Convertible notes                                                                      |       | —                     |       | —                      |       | —        |       | —        |       | 204,858       |       | —         |       | 204,858   |       |
| Notes payable                                                                          |       | 4,768                      |       | 4,219                       |       | 7,212         |       | 2,778         |       | —        |       | —         |       | 18,977    |       |
| Total interest – sensitive liabilities                                            |       | 3,693,817                  |       | 579,828                     |       | 1,409,522     |       | 765,621       |       | 603,412       |       | 1,169,795      |       | 8,221,995 |       |
| Excess of interest – sensitive assets over  interest – sensitive liabilities |       | 555,221                    |       | 15,840                      |       | 29,411        |       | (28,859       | )          | (151,562      | )          | 92,023         |       | 512,074   |       |
| Cumulative net interest – sensitivity gap                                         |       | $                          | 555,221    |                        | 571,061    |          | 600,472    |          | 571,613    |          | 420,051    |           | 512,074    |      | 512,074    |   |

 

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**Item 4.****    *Controlsand Procedures***

 

As of June 30, 2004, the endof our second quarter, our management, including our Chief Executive Officer,Chief Financial Officer, Vice Chairman – Finance, and President and ChiefOperating Officer, has evaluated the effectiveness of our disclosure controlsand procedures, as such term is defined in Rule 13a-15(e) promulgated under theSecurities and Exchange Act of 1934, as amended. Based on that evaluation, ourChief Executive Officer, Chief Financial Officer, Vice Chairman - Finance andPresident and Chief Operating Officer concluded, as of June 30, 2004, that ourdisclosure controls and procedures were effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under theSecurities and Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in Securities and Exchange Commissionrules and forms. There was no change in our internal control over financialreporting during our quarter ended June 30, 2004 that materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II****—OTHER INFORMATION**

 

**Item 1.****    *Legal Proceedings***

 

We have previously disclosed our material litigation and regulatoryissues in our Annual Report on Form 10-K, as amended, for the period endedDecember 31, 2003, and in our other filings with the Securities and ExchangeCommission pursuant to the Securities and Exchange Act of 1934, asamended.  Below are updates on thosematters as to which there were material developments during the second quarterof 2004.

 

*Barney. *In December 2001, Sandra Barney filed a classaction complaint against New Century Mortgage in the Circuit Court in CookCounty, Illinois.  The complaint allegesthe unauthorized practice of law and violation of the Illinois Consumer FraudAct for performing document preparation services for a fee by non-lawyers, andseeks to recover the fees charged for the document preparation, compensatoryand punitive damages, attorneys’ fees and costs.  We filed a motion to dismiss in February2002.  The court thereafter consolidatedour case with other similar cases filed against other lenders.  In August 2002, the court ordered plaintiffsin all the consolidated cases to dismiss their cases with prejudice.  Our individual plaintiff filed her notice ofappeal in September 2002 and the appeal was then consolidated with 36 similarcases (Jenkins case).  Appellate argumentwas heard on December 2, 2003.  Theappellate court affirmed the dismissal of the consolidated cases onDecember 31, 2003.  The plaintiffthen timely filed a petition for leave to appeal the appellate court’sdecision.  Our response to the petitionwas filed in February 2004.  The supreme court granted leave to appeal the consolidatedcases, thus consolidating the Jenkins case with a similar appellate action alsoproceeding in Illinois (King case).  Theplaintiffs/appellants filed their opening brief in April 2004.  We filed our consolidated response brief inJuly 2004.  The plaintiffs were grantedan extension until August 13, 2004 to file their reply brief.

 

*Bernstein. *In April 2002, Paul Bernstein filed a classaction complaint against New Century Mortgage in the Circuit Court of CookCounty, Chicago, Illinois seeking damages for receiving unsolicitedadvertisements to telephone facsimile machines in violation of the TelephoneConsumer Protection Act, 47 U.S.C. §227, and the Illinois Consumer FraudAct.  The plaintiffs filed an amendedcomplaint on May 1, 2003 and on September 18, 2003 the judge grantedNew Century Mortgage’s motion to dismiss with respect to the Illinois ConsumerFraud Act and permitted the plaintiff to replead on an individual, notconsolidated, basis.  OnSeptember 30, 2003, the plaintiff filed a motion for class certificationand second amended complaint.  The courthas consolidated similar cases into three groups.  We sought and obtained an order permitting usto join other defendants in this consolidated action and file a motion todismiss the second amended complaint. Oral argument on our consolidated motion was heard on March 30,2004.  The judge dismissed the IllinoisConsumer Fraud count.  We filed ourresponse to the plaintiffs’ motion for class certification and the hearing isset for August 10, 2004.  Discoveryis currently proceeding.  Our insurancecarriers have agreed to defend us with a reservation of rights.

 

*Overman.** *InSeptember 2002, Robert E. Overman and Martin Lemp filed a class actioncomplaint in the Superior Court for Alameda County, California, against NewCentury Financial, New Century Mortgage, U.S. Bancorp, Loan ManagementServices, Inc., and certain individuals affiliated with Loan ManagementServices.  The complaint allegesviolations of the California Consumers Legal Remedies Act, Unfair, Unlawful andDeceptive Business and Advertising Practices in violation of Business &Professions Code §§17200 and 17500, Fraud-Misrepresentation and Concealment andConstructive Trust/Breach of Fiduciary Duty and damages including restitution,compensatory and punitive damages, and attorneys’ fees and costs.  The plaintiffs filed an amended complaint inJuly 2003 and in September 2003 the judge granted our demurrer challengingtheir claims in part.  The ConsumersLegal Remedies claim was dismissed and the plaintiffs withdrew the ConstructiveTrust/ Breach of Fiduciary Duty claim. We filed our answer to the plaintiffs’ amended complaint in September2003.  We then filed a §128.7 sanctionsmotion seeking dismissal of the case.  OnDecember 8, 2003, the court granted the motion for sanctions against theplaintiffs for filing a first amended complaint whose allegations against NewCentury Financial and New Century Mortgage were devoid of evidentiary supportand ordered all those claims stricken without prejudice.  On January  27,2004, the court entered a judgment of dismissal without prejudice in favor ofus.  Plaintiffs filed a notice of appealon February 20, 2004 from the judgment entered in our favor and the ordergranting our motion for sanctions.  Theplaintiffs also filed a motion with the appellate court to consolidate thisappeal with three additional appeals they have sought in similar cases againstother lenders.  On May 28, 2004, thecourt denied the motion.  Theplaintiffs/appellants filed their opening brief on July 12, 2004.  The parties stipulated to extend the due datefor New Century’s response brief to be October 8, 2004.

 

*England. *In April 2003, we were served with a complaintseeking class action status filed by two former, short-term employees,Kimberly A. England and Gregory M. Foshee, against New CenturyFinancial, New Century Mortgage, Worth Funding Incorporated (now known as NewCentury Credit Corporation) and The Anyloan Company.  The action was removed on May 12, 2003from the 19th Judicial District Court, Parish of East Baton Rouge, State of Louisiana to the U.S. District Court for theMiddle District of Louisiana in response to our Petition for Removal.  The complaint alleges failure to pay overtimewages in violation of the federal Fair Labor Standards Act.  The plaintiffs filed an additional action inLouisiana state court (19th Judicial District Court, Parish of East BatonRouge) on September 8, 2003, adding James Gray as a plaintiff and seekingunpaid wages under state law, with no class claims.  This second actionwas removed on October 3, 2003 to the U.S. District Court for theMiddle District of Louisiana, and was

 

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orderedconsolidated with the first action.  InApril 2004, the U.S. District Court unilaterally de-consolidated the JamesGray individual action.  In September2003, the plaintiffs also filed a motion to dismiss their claims in Louisianato enable them to join in a subsequently filed case in Minnesota entitled *Klas vs. New Century Financial, et al. *We opposed the motion and thecourt agreed with our position and refused to dismiss the plaintiffs’ case, asit was filed first.  The *Klas*case has now been consolidated withthis case and discovery is proceeding. We filed a motion to dismiss Worth Funding Incorporated (now known asNew Century Credit Corporation) and The Anyloan Company as defendants.  The court granted our motion to dismiss inApril 2004.

 

*Klas.** *InJune 2003, New Century Financial and New Century Mortgage were served with acomplaint seeking class action status and alleging failure to pay overtimewages in violation of the federal Fair Labor Standards Act.  The case was filed in the U.S. DistrictCourt, District of Minnesota, by Michael Klas, a former loan officer of NewCentury Mortgage’s retail branch in Minnesota. We filed our answer in July 2003. Discovery thereafter commenced. In September 2003, we filed a motion to dismiss, transfer or stay thecase due to the fact that similar claims were raised in the earlier filed *England*case.  The court granted our motion onMarch 11, 2004, transferring the entire case to Louisiana to beconsolidated with the *England* case.

 

*Ines & Marquez.** *InOctober 2003, New Century Mortgage was served with a complaint filed by CanalesJose Ines and Maria S. Marquez seeking class action status filed in theU.S. District Court, Northern District of Illinois.  The complaint also named the broker, title company and related parties as defendants:  Tamayo Financial Title, Inc., PresidentialTitle, Inc., Juan Tamayo Jr., Jose Tamayo and Luis Tamayo.  The complaint alleged violations of the TILArelated to the fees charged for title insurance and recording fees.  We filedour motion to dismiss in December 2003 and the motion was fully briefed inJanuary 2004.  On April 5, 2004, thecourt granted our motion to dismiss and directed the clerk of the court toenter judgment in our favor and terminate the case from the court’sdocket.  On April 13, 2004, theplaintiffs filed a motion for reconsideration and for leave to amend theircomplaint.  The motion was fully briefedin June 2004.  On July 20, 2004 the courtdenied plaintiff’s motion for reconsideration and plaintiff’s motion for leaveto amend.

 

*Wade. *InOctober 2003, New Century Mortgage was served with a complaint filed by DeniseWade seeking class action status filed in the U.S. District Court,Northern District of Illinois.  Thecomplaint was filed by the same attorney as the *Ines*case and named the broker, title company, and currentservicer:  Providential Bancorp, Ltd.,Jet Title Services, LLC, and Ocwen Federal Bank, FSB.  The complaint similarly alleges violations ofthe TILA related to the fees charged for title insurance and recording fees. Wefiled our motion to dismiss in November 2003 and the motion was fully briefedin January 2004.  The plaintiff filed amotion to amend in May 2004 and it was fully briefed in June 2004.  We await a ruling on both motions.

 

*Lum.** *InDecember 2003, New Century Mortgage was served with a class action complaintfiled by Elaine Lum in the state court in Suffolk County, New York.  The complaint alleged that certain paymentsNew Century Mortgage makes to mortgage brokers, sometimes referred to as yieldspread premiums, interfered with the contractual relationship betweenMs. Lum and her broker.  The complaintalso sought damages related thereto for fraud, wrongful inducement/breach offiduciary duty, violation of deceptive acts and practices, unjust enrichmentand commercial bribing.  The complaintseeks class certification for similarly situated borrowers in the State of New York.  We filed a motion to dismiss onJanuary 30, 2004.  The judge grantedour motion and dismissed all claims on March 23, 2004.  On April 12, 2004, the plaintiff filed anotice of appeal, seeking review of the court’s order granting our motion todismiss.

 

*Warburton.** *InJune 2004, New Century Financial and New Century Mortgage were named asdefendants and served with a class action complaint filed by Joseph and EmmaWarburton, as plaintiffs, in the United States District Court of New Jersey.  The complaint alleges violations of the RealEstate Settlement Procedures Act, the TILA and the New Jersey ConsumerFraud Act, and unjust enrichment. Thecomplaint also alleges certain other violations against defendants unrelated toNew Century Financial and New Century Mortgage, including Foxtons, Inc.,Foxtons North America, Foxtons Realtor and Foxtons Financial, Inc., which werefer to collectively as Foxtons, and Worldwide Financial Resources, Inc.  The plaintiffs allege, among other things,that Foxtons, acting as the plaintiffs’ broker, charged fees and received ayield spread premium without disclosing the same to the plaintiffs until thetime of closing.  The class is defined asall persons in the state of New Jersey who have purchased, or sought topurchase, a home listed for sale by Foxtons and who have paid aprequalification application fee, or who have received and accepted an offerfrom Foxtons for a fixed interest rate mortgage loan that Foxtons failed todeliver as promised and who have suffered damages as a result.  The complaint seeks to enjoin the wrongfulconduct alleged, recovery of actual and statutorydamages, and attorneys’ fees and costs. The complaint does not specify the amount of damages sought.  On July 28, 2004, we filed a motion todismiss the complaint for failure to state a claim.

 

*Randall. *In June 2004, New Century Mortgage was named asa defendant and served with a class action complaint filed by Kristi LynRandall, as plaintiff, in the Circuit Court of Cook County, Illinois.  The complaint alleges that New CenturyMortgage violated Section 4.1a of the Illinois Interest Act by charging morethan 3 points on loans with an interest rate of 8% per annum or higher.  The complaint also alleges that New CenturyMortgage and defendant Nations Title Agency of Illinois, Inc. violated statelaw by improperly charging certain fees and taxes.  The class is defined as all persons who areresidents of Illinois who obtained loans

 

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fromNew Century Mortgage (which loans are still outstanding or were paid off withintwo years prior to the filing of this action) at an interest rate of 8% perannum or higher and were charged more than 3 points on such loans.  The complaint seeks recovery of statutory,compensatory, punitive and restitutionary damages, and attorneys’ fees andcosts.  The complaint does not specifythe amount of damages sought.  Theplaintiff was granted leave to file an amended complaint on July 21, 2004,which adds Robert and Alice Elibasich as plaintiffs.  Our response is due on August 18, 2004.

 

*DOL Investigation*.  On August 2, 2004, the U.S. Department ofLabor, Wage & Hour Division, orDOL, informed us that it is conducting aninvestigation to determine whether we are in compliance with the Fair LaborStandards Act, or FLSA.  We are workingwith the DOL to seek to narrow the scope of its investigation.  We believe we are in compliance with the FLSAand properly pay overtime wages.

 

We are also a party to various legal proceedings arising out of theordinary course of our business. Management believes that any liability with respect to these legalactions, individually or in the aggregate, will not have a material adverseeffect on our business, results of operation or financial position.

 

**Item 5****.****    *****Other Information***

 

**(b)   Director Nominations by Stockholders**

 

*We are providing the following information inresponse to Item 401(j) of Regulation S-K. This information is also contained in the registration statement on FormS-4, as amended, filed by New Century REIT.*

 

*The policy of our governance and nominatingcommittee is to consider candidates properly recommended by our stockholders.In evaluating any such candidates, our governance and nominating committee willconsider the criteria set forth below. Any such recommendations should includethe nominee’s name and qualifications for membership on our board of directorsand should be directed to our corporate secretary, New Century FinancialCorporation, 18400 Von Karman, Suite 1000, Irvine,California 92612. In addition, our bylaws permit stockholders to nominatedirectors for election at stockholder meetings. To nominate a director,stockholders must give timely notice to our corporate secretary in accordancewith our bylaws.  To submit a proposal tonominate a director for presentation at our 2005 annual meeting, our corporatesecretary must receive notice of such proposal no later than January 22, 2005.  If the date of the 2005 annual meeting ischanged by more than 30 days from the anniversary date of the annual meeting,the deadline for receiving such a proposal is a reasonable time before we beginto print and mail our proxy materials. For more information on how to include aproposal in the proxy statement for our 2005 annual meeting, please see Rule14a-8 promulgated under the Securities Exchange Act of 1934, as amended, or theExchange Act.*

 

Our *Corporate Governance Guidelines*include criteria that apply to the screening and recommendation by ourGovernance and Nominating Committee of candidates to fill vacancies or standfor election to our Board of Directors. Under these criteria, candidates are considered on the basis of theirintegrity, experience, achievements, judgment, intelligence, understanding ofthe business in which we are engaged, and their willingness to devote adequatetime to fulfilling the responsibilities of a director.  In recommending a candidate, our Governanceand Nominating Committee considers our Board of Directors’ overall balance ofdiversity of perspectives, backgrounds and experience – all in the context ofan assessment of the perceived needs of our Board of Directors.

 

Initially, ourGovernance and Nominating Committee will determine whether the candidates meetthe requisite qualifications and criteria and have any specific qualities orskills being sought at that point in time. Our Governance and Nominating Committee evaluates the candidates byreviewing their biographical information and qualifications and checking theirreferences.  Qualified candidates arethen interviewed by one or more members of our Governance and NominatingCommittee.  Depending on the outcome ofthese interviews, candidates may meet with our Chief Executive Officer andother members of our Board of Directors and, using input from these interviewsand the information obtained, our Governance and Nominating Committee willdetermine whether the prospective candidate is qualified to serve as a directorand whether he or she should be recommended to our Board of Directors.Candidates recommended by our Governance and Nominating Committee are thenpresented to our Board of Directors for selection to fill a vacancy or asnominees for election by our stockholders. Our Governance and Nominating Committee expects that a similar processwill be used to evaluate candidates recommended by our stockholders.

 

For a free copy of therelevant provisions of our bylaws regarding the requirements for makingstockholder proposals and nominating director candidates, please visit the InvestorRelations section of our website at *http://www.ncen.com/companyInformation/investorRelations/index.htm*,or you may write to Carrie Marrelli, our vice president of investor relations,at 18400 Von Karman, Suite 1000, Irvine, California 92612, or send her ane-mail at cmarrell@ncen.com.

 

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**Item 6.****    *Exhibits**and Reports on Form 8-K***

 

**(a)  Exhibits**

 

See “Exhibit Index”.

 

**(b)  Reports on Form 8-K**

 

On April 7, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) NC Capital had entered intoa $1.5 billion Master Repurchase Agreement with Bank of America that expiredupon the completion of an on- balance sheet securitization transaction by NCResidual II Corporation, a wholly-owned subsidiary of NC Capital, in April 2004and that New Century Financial and New Century Mortgage had entered into aGuaranty with Bank of America with respect to such temporary facility, (2) NewCentury Mortgage and NC Capital had entered into Waiver and Amendment No. 5 tothe Master Repurchase Agreement with CDC Mortgage Capital for the purpose ofwaiving certain sections of such agreement to permit New Century Mortgage tomake a small investment and asset acquisition and to increase the leverageratio for New Century Mortgage, (3) New Century Mortgage and NC Capital hadentered into Amendment No. 5 to the Letter Agreement with Citigroup GlobalMarkets, as successor to Salomon Brothers, for the purpose of extending theexpiration date of two credit facilities to June 30, 2004, (4) the state courtin Suffolk County, New York had granted New Century Mortgage’s motion todismiss the complaint filed by Ms. Elaine Lum and (5) New Century Financial hadinvested $2 million in Carrington Capital Management, LLC followed by an investmentof $25 million in Carrington Mortgage Credit Fund I, LP, which is sponsored byCarrington Capital Management.

 

On April 22, 2004, we fileda report on Form 8-K under Items 5 and 12 reporting that we had issued a pressrelease announcing our financial results for the quarter ended March 31, 2004.

 

On May 7, 2004, we filed areport on Form 8-K under Item 12 reporting a correction to the calculation ofour diluted earnings per share we had reported in our press release announcingour financial results for the quarter ended March 31, 2004.

 

On May 20, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Funding A, awholly-owned subsidiary of New Century Mortgage, had entered into AmendmentNumber Two to the Master Repurchase Agreement with Bank of America for thepurpose of extending the termination date to June 10, 2004, (2) New CenturyFinancial, New Century Mortgage and NC Capital had executed a Letter Agreementamending the Master Repurchase Agreement with CDC Mortgage Capital for thepurpose of temporarily increasing the maximum credit available under thefacility to $700 million for the period from May 14, 2004, to June 1, 2004 and(3) New Century Funding I, a wholly-owned subsidiary of New Century Mortgage,had entered into Amendment No. 4 to the Note Purchase Agreement with UBS RealEstate Securities for the purpose of extending the termination date of the NotePurchase Agreement to June 14, 2004.

 

On June 1, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Funding A hadentered into an Amended and Restated Master Purchase Agreement with Bank ofAmerica for the purpose of renewing the existing credit facility with Bank ofAmerica increasing the maximum credit available to $2.0 billion ($1.0 billionof which was uncommitted) and that New Century Financial and New CenturyMortgage had entered into an Amended and Restated Guaranty and Pledge Agreementwith Bank of America with respect to such agreement and (2) New CenturyMortgage and NC Capital had entered into Amendment No. 1 and Joinder withMorgan Stanley Bank and Morgan Stanley Mortgage Capital for the purpose oftemporarily increasing the maximum credit available under the facility to $2.0billion through and including the completion of a securitization in June 2004by an indirect subsidiary of New Century Financial and to add New CenturyResidual II Corporation, an indirect subsidiary of New Century Financial, as aco-borrower on the facility.

 

On June 17, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Financial andNew Century Mortgage were named as defendants and served with a class actioncompliant filed by Joseph and Emma Warburton, as plaintiffs, in the UnitedStates District Court of New Jersey, alleging violations of the Real EstateSettlement Procedures Act, the Federal Truth in

 

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Lending Act and the new Jersey Consumer FraudAct, and unjust enrichment, (2) New Century Mortgage was named and a defendantand served with a class action complaint filed by Kristi Lyn Randall, asplaintiff, in the Circuit Court of Cook County Illinois, alleging violation ofSection 4.1a of the Illinois Interest Act, (3) New Century Mortgage, NC Capitaland NC Residual II had entered into Amendment No. 2 to the Second Amended andrestated Master Loan and Security Agreement with Morgan Stanley Bank and MorganStanley Mortgage Capital for the purposes of modifying several sublimits forthe period from June 9, 2004 to June 30, 2004 to $125 million, and (4) NewCentury Funding I had entered into Amendment No. 5 to the Note PurchaseAgreement with UBS Real Estate Securities for the purpose of extending thetermination date of the Note Purchase Agreement to June 21, 2004.

 

On June 18, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Funding I hadentered into Amendment No. 5 to the Note Purchase Agreement with UBS RealEstate Securities and New Century Funding I, New Century Financial, New CenturyMortgage and NC Capital had entered into Amendment No. 3 to the Loan PurchaseAgreement, the purpose of which was to renew and extend the credit facilitywith UBS Real Estate Securities through June 21, 2006 and increase the maximumcredit under the facility to $2.0 billion ($500 million of which isuncommitted), (2) New Century Mortgage had entered into a Master RepurchaseAgreement with Citigroup Global Markets Realty for the purpose of financing upto $250 million of small balance commercial mortgage loans, (3) New CenturyMortgage, NC Capital and NC Residual II had entered into Amendment No. 3 to theSecond Amended and Restated Master Loan and Security Agreement with MorganStanley Bank and Morgan Stanley Mortgage Capital for the purposes of removingthe limitation on “Alt-A” mortgages which may be financed using the facility,(4) New Century Mortgage and NC Capital had entered into a letter agreementwith CDC Mortgage Capital for the purpose of extending the expiration date ofthe facility to July 7, 2004, and (5) we had issued a press release announcinginformation regarding our quarterly dividend.

 

On June 25, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Funding SB-1, anindirect wholly-owned subsidiary of New Century Financial, had entered intoAmendment Number Six to the Master Repurchase Agreement with Citigroup GlobalMarkets Realty for the purpose of extending the expiration date of the facilityto September 30, 2004, (2) New Century Mortgage and NC Capital had entered intoAmendment Number Six to the Letter Agreement with Citigroup Global MarketsRealty for the purpose of extending the expiration date of the facility toSeptember 30, 2004, (3) NC Capital and NC Residual II entered into AmendmentNo. 2 to Master Repurchase Agreement with Bear Stearns Mortgage Capital for thepurpose of temporarily increasing the maximum credit available under thefacility to $1.8 billion until July 31, 2004 and to add NC Residual II as aco-borrower under the facility, and that New Century Financial and New CenturyMortgage had entered into a Guaranty with respect to such amendment, and (3) wehad issued a press release announcing the appointment of Dr. Harold A. Black toour Board of Directors.

 

On July 7, 2004, we filed areport on Form 8-K reporting that we were filing therewith a corrected versionof the Amended and Restated Master Purchase Agreement dated May 21, 2004, byand between New Century Funding A and Bank of America, which we had previouslyfiled on Form 8-K dated June 1, 2004.

 

On July 13, 2004, we filed areport on Form 8-K under Item 5 reporting that New Century Mortgage and NCCapital had entered into a letter agreement with CDC Mortgage Capital for thepurpose of extending the expiration date of the facility to July 21, 2004.

 

On July 20, 2004, we filed areport on Form 8-K under Item 5 reporting that (1) New Century Mortgage and NCCapital had entered into a letter agreement with CDC Mortgage Capital for thepurpose of extending the expiration date of the facility to July 30, 2004, and(2) we had issued a press release announcing the appointment of Ms. Patti M.Dodge as our Chief Financial Officer.

 

On July 22,2004, we filed a report on Form 8-K under Items 5 and 12 reporting that we hadissued a press release announcing our financial results for the quarter endedJune 30, 2004.

 

On August 2,2004, we filed a report on Form 8-K under Item 5 reporting that New CenturyMortgage and NC Capital had entered into a letter agreement with CDC MortgageCapital for the purpose of extending the expiration date of the facility toAugust 15, 2004.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                  | NEW CENTURY FINANCIAL CORPORATION |
|-----------------------|-----------------------------------|
|                  |                              |
| DATE:  August 9, 2004 | By:                               | /s/    ROBERT K. COLE |
|                  |                              | **Robert K. Cole  Chief Executive Officer** |
|                  |                              | ** ** |
| DATE:  August 9, 2004 | By:                               | /s/ PATTI M. DODGE |
|                  |                              | **Patti M. Dodge  Executive Vice President, Chief Financial Officer and Controller  (Principal Financial and Chief Accounting Officer)** |
|                  |                              | ** ** |
| DATE:  August 9, 2004 | By:                               | /s/    EDWARD F. GOTSCHALL |
|                  | ** **                        | **Edward F. Gotschall  Vice Chairman - Finance** |
|                  | ** **                        | ** ** |
| DATE:  August 9, 2004 | By:                               | /s/    BRAD A. MORRICE |
|                  |                              | **Brad A. Morrice  President and Chief Operating Officer** |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description of Exhibit** |
|---------------------|------------|----------------------------|
| 3.1                 |       |                       | First  Amended and Restated Certificate of Incorporation of New Century Financial  Corporation (1) |
|                |       |                       |   |
| 3.2                 |       |                       | Certificate  of Designation for Series 1998A Convertible Preferred Stock (2) |
|                |       |                       |   |
| 3.3                 |       |                       | Certificate  of Designation for Series 1999A Convertible Preferred Stock (3) |
|                |       |                       |   |
| 3.4                 |       |                       | First  Amended and Restated Bylaws of New Century (1) |
|                |       |                       |   |
| 3.5                 |       |                       | Amended  Certificate of Designation for Series 1999A Convertible Preferred Stock (4) |
|                |       |                       |   |
| 3.6                 |       |                       | Certificate  of Designations for Series 2003A Convertible Preferred Stock (5) |
|                |       |                       |   |
| 3.7                 |       |                       | Certificate  of Amendment of Amended and Restated Certificate of Incorporation of New  Century Financial Corporation (6) |
|                |       |                       |   |
| 4.1                 |       |                       | Specimen  Stock Certificate (1) |
|                |       |                       |   |
| 10.1                |       |                       | New  Century Financial Corporation Deferred Compensation Plan, Amended and  Restated July 1, 2004* |
|                |       |                       |   |
| 10.2                |       |                       | Amendment  No. 5 to Second Amended and Restated Master Loan and Security Agreement,  dated as of August 6, 2004, among NC Capital Corporation, New Century  Mortgage Corporation, NC Residual II Corporation, Morgan Stanley Bank and  Morgan Stanley Capital Inc. |
|                |       |                       |   |
| 31.1                |       |                       | Certification  of Robert K. Cole pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 31.2                |       |                       | Certification  of Patti M. Dodge pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 31.3                |       |                       | Certification  of Edward F. Gotschall pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 |
|                |       |                       |   |
| 31.4                |       |                       | Certification  of Brad A. Morrice pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 32.1                |       |                       | Certification  of Robert K. Cole pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 32.2                |       |                       | Certification  of Patti M. Dodge pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 32.3                |       |                       | Certification  of Edward F. Gotschall pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|                |       |                       |   |
| 32.4                |       |                       | Certification  of Brad A. Morrice pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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*                                Management contract or compensatory plan orarrangement.

 

(1)                         Incorporated by reference from our Form S-1 Registration Statement (No.333-25483) as filed with the Securities Exchange Commission on September 23,1997.

 

(2)                         Incorporated by reference from our Current Report on Form 8-K as filedwith the Securities and Exchange Commission on December 8, 1998.

 

(3)                         Incorporated by reference from our Annual Report on Form 10-K for theyear ended December 31, 1997, on file with the Securities and ExchangeCommission.

 

(4)                         Incorporated by reference from our Quarterly Report on Form 10-Q asfiled with the Securities and Exchange Commission on May 15, 2000.

 

(5)                         Incorporated by reference from our Quarterly Report on Form 10-Q asfiled with the Securities and Exchange Commission on August 13, 2003.

 

(6)                         Incorporated by reference from our Current Report on Form 8-K as filedwith the Securities and Exchange Commission on November 14, 2003.

 

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