<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

                                   (Mark One)
[X]        Quarterly Report Pursuant to Section 13 or 15(d)
           of the Securities Exchange Act of 1934
           For the quarterly period ended December 31, 1998

                                       or

[ ]        Transition Report Pursuant to Section 13 or 15(d)
           of the Securities Exchange Act of 1934
           For the transition period from _____to _____


                         COMMISSION FILE NUMBER 0-19604


                           AAMES FINANCIAL CORPORATION
             [Exact name of Registrant as specified in its charter]

<TABLE>
<S>                                                          <C>
          DELAWARE                                               95-4340340
[State or other jurisdiction of                               [I.R.S. Employer
incorporation or organization]                               Identification No.]
</TABLE>


               350 SOUTH GRAND AVENUE, LOS ANGELES, CA 90071-3459
                       [Address of Registrant's principal
                      executive offices including zip code]

                                 (323) 210-5000
                         [Registrant's telephone number,
                              including area code]


                                   NO CHANGES
              [Former name, former address and former fiscal year,
                          if changed since last report]

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
                                      Yes    X          No
                                           -----            -----

     At February 3, 1999, Registrant had 31,015,893 shares of common stock
                                  outstanding.


<PAGE>   2

                                TABLE OF CONTENTS



<TABLE>
<CAPTION>
ITEM NO.                                                                                PAGE NO.
--------                                                                                --------

<S>                                                                                     <C>
PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

           Condensed Consolidated Balance Sheet at December 31, 1998 and
           June 30, 1998 (Restated)                                                            3

           Condensed Consolidated Statement of Operations for the three and six
           months ended December 31, 1998 and 1997 (Restated)                                  4

           Condensed Consolidated Statement of Cash Flows for the six months
           ended December 31, 1998 and 1997 (Restated)                                         5

           Notes to Condensed Consolidated Financial Statements                              6-8


Item 2 - Management's Discussion and Analysis of Financial Condition
             and Results of Operations                                                      9-43

Item 3 - Quantitative and Qualitative Disclosures About Market Risk                           43

PART II - OTHER INFORMATION

Item 6 - Exhibits and Reports on Form 8-K                                                     44

Signature Page                                                                                46
</TABLE>


                                        2

<PAGE>   3

                  AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEET
                                   (Unaudited)




<TABLE>
<CAPTION>
                                                                 DECEMBER 31, 1998         JUNE 30, 1998
                                                                 -----------------       ----------------
                                                                                            (Restated)
<S>                                                              <C>                           <C>       
ASSETS
Cash and cash equivalents                                        $      11,790,000             12,322,000
Loans held for sale, at lower of cost or market                        271,324,000            198,202,000
Accounts receivable                                                     48,844,000             51,072,000
Interest-only strips, estimated at fair market value                   323,246,000            490,542,000
Mortgage servicing rights, net                                          34,504,000             32,090,000
Equipment and improvements, net                                         14,730,000             13,939,000
Prepaid and other                                                       17,210,000             17,020,000
                                                                 -----------------       ----------------
      Total assets                                               $     721,648,000            815,187,000
                                                                 =================       ================

LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings                                                       $     306,990,000            286,990,000
Revolving warehouse facilities                                         249,500,000            141,012,000
Accounts payable and accrued expenses                                   45,003,000             49,964,000
Income taxes payable                                                    14,792,000             33,170,000
                                                                 -----------------       ----------------
      Total liabilities                                                616,285,000            511,136,000
                                                                 -----------------       ----------------

Stockholders' equity:
Preferred Stock, par value $.001 per
      share, 1,000,000 shares authorized;
      none outstanding                                                           -                      -
Common Stock, par value $.001 per share
      50,000,000 shares authorized;
      31,015,900 and 30,962,600 shares outstanding                          31,000                 31,000
Additional paid-in capital                                             250,096,000            249,851,000
Retained earnings (deficit)                                           (144,764,000)            54,169,000
                                                                 -----------------       ----------------
      Total stockholders' equity                                       105,363,000            304,051,000
                                                                 -----------------       ----------------
      Total liabilities and stockholders' equity                 $     721,648,000            815,187,000
                                                                 =================       ================
</TABLE>


See accompanying notes to consolidated financial statements.


                                        3

<PAGE>   4

                  AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
                 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
                                   (Unaudited)



<TABLE>
<CAPTION>
                                                           Three Months Ended                    Six Months Ended
                                                    ---------------------------------     -------------------------------
                                                     December 31,      December 31,        December 31,     December 31,
                                                         1998              1997                1998             1997
                                                    ---------------   ---------------     ---------------  --------------
                                                                        (Restated)          (Restated)       (Restated)
<S>                                                 <C>               <C>                 <C>              <C>       
Revenue:
    Gain on sale of loans                            $    8,752,000        35,130,000          28,429,000      66,438,000
    Net gain (loss) on valuation of interest-only
       strips and mortgage servicing rights            (191,646,000)        5,726,000        (186,451,000)     10,755,000
    Commissions                                           7,758,000         7,161,000          17,746,000      13,016,000
    Loan servicing                                       11,629,000        10,362,000          20,854,000      20,144,000
    Fees and other                                        9,084,000        11,962,000          22,760,000      24,487,000
                                                     --------------   ---------------     ---------------  --------------
       Total revenue including valuation adjustment    (154,423,000)       70,341,000         (96,662,000)    134,840,000
                                                     --------------   ---------------     ---------------  --------------

Expenses:
    Compensation                                         19,907,000        24,561,000          43,701,000      46,320,000
    Production                                           10,559,000         7,541,000          21,489,000      13,338,000
    General and administrative                           13,784,000         9,580,000          27,172,000      17,665,000
    Interest                                              9,403,000        10,819,000          22,285,000      20,917,000
                                                     --------------   ---------------     ---------------  --------------
       Total expenses                                    53,653,000        52,501,000         114,647,000      98,240,000
                                                     --------------   ---------------     ---------------  --------------
Income (loss) before income taxes                      (208,076,000)       17,840,000        (211,309,000)     36,600,000
Provision (benefit) for income taxes                    (12,331,000)        8,670,000         (13,408,000)     17,497,000
                                                     --------------   ---------------     ---------------  --------------
Net income (loss)                                    $ (195,745,000)        9,170,000        (197,901,000)     19,103,000
                                                     ==============   ===============     ===============  ==============

Net income (loss) per share:
Basic                                                $        (6.31)             0.33               (6.39)           0.69
Diluted                                                       (6.27)             0.29               (6.34)           0.59
Dividends per share                                               -              0.03                0.03            0.07

    Weighted average number shares outstanding:
    Basic                                                31,007,000        27,799,000          30,992,000      27,784,000
                                                     ==============   ===============     ===============  ==============
    Diluted                                              31,211,000        34,949,000          31,239,000      35,272,000
                                                     ==============   ===============     ===============  ==============
</TABLE>



See accompanying notes to consolidated financial statements.




                                        4

<PAGE>   5

                  AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
                  CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
                                   (Unaudited)




<TABLE>
<CAPTION>
                                                                                             SIX MONTHS ENDED
                                                                                --------------------------------------------

                                                                                    DECEMBER 31,            DECEMBER 31,
                                                                                        1998                    1997
                                                                                ---------------------     ------------------
                                                                                     (Restated)               (Restated)
<S>                                                                             <C>                       <C>               
Operating activities:
    Net income (loss)                                                           $        (197,901,000)    $       19,103,000
    Adjustments to reconcile net income to net cash used in operating
      activities:
      Depreciation and amortization                                                         2,469,000              1,845,000
      Gain on sale of loans                                                               (35,716,000)           (72,564,000)
      Net loss (gain) on valuation of interest-only strips and
        mortgage servicing rights                                                         186,451,000            (10,755,000)
      Amortization (accretion) of interest-only strips                                     14,386,000             (3,523,000)
      Mortgage servicing rights originated                                                 (6,194,000)           (10,664,000)
      Mortgage servicing rights amortized                                                   5,955,000              4,087,000
      Changes in assets and liabilities:
         Loans originated or purchased                                                 (1,275,276,000)        (1,138,802,000)
         Proceeds from sale of loans                                                    1,202,154,000          1,165,928,000
         Increased (decrease) in:
           Accounts receivable                                                              2,228,000             17,762,000
           Prepaid and other                                                                 (190,000)              (751,000)
         Increase in (decrease) in:
           Accounts payable and accrued expenses                                           (4,961,000)             9,008,000
           Income taxes payable                                                           (18,378,000)            12,700,000
                                                                                ----------------------    ------------------
Net cash used in operating activities                                                    (124,973,000)            (6,626,000)
                                                                                ----------------------    ------------------

Investing activities:
                                                                                                      
    Purchases of equipment and property improvements                                       (3,260,000)            (1,995,000)
                                                                                ---------------------     ------------------

Net cash used in investing activities                                                      (3,260,000)            (1,995,000)
                                                                                ---------------------     ------------------

Financing activities:
    Proceeds from sale of stock or exercise of options                                        235,000                244,000
    Proceeds from borrowings                                                               20,000,000                     --
    Net proceeds under revolving warehouse facilities                                     108,488,000             (8,000,000)
    Dividends paid                                                                         (1,022,000)            (1,834,000)
                                                                                ---------------------     ------------------
Net cash provided by (used in) financing activities                                       127,701,000             (9,590,000)
                                                                                ---------------------     ------------------
Net decrease in cash and cash equivalents                                                    (532,000)           (18,211,000)
Cash and cash equivalents at beginning of period                                           12,322,000             26,902,000
                                                                                ---------------------     ------------------
Cash and cash equivalents at end of period                                      $          11,790,000     $        8,691,000
                                                                                =====================     ==================
</TABLE>



See accompanying notes to consolidated financial statements.




                                        5

<PAGE>   6

                           AAMES FINANCIAL CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1:  BASIS OF PRESENTATION

           The condensed consolidated financial statements of Aames Financial
Corporation, a Delaware corporation, and its subsidiaries (collectively, the
"Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted.

           The condensed consolidated financial statements include the accounts
of the Company and all of its subsidiaries after eliminating all significant
intercompany transactions and reflect all normal, recurring adjustments which
are, in the opinion of management, necessary to present a fair statement of the
results of operations of the Company for the interim periods reported. The
results of operations for the Company for the three and six months ended
December 31, 1998 are not necessarily indicative of the results expected for the
full fiscal year.

           Additionally, certain amounts related to fiscal year 1998 have been
reclassified to conform to the fiscal year 1999 presentation.

NOTE 2: RESTATEMENT OF PRIOR PERIOD RESULTS

           In December 1998, the FASB issued, in question and answer format, "A
Guide to Implementation of Statement 125 on Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, Questions and
Answers, Second Edition" (the "Special Report"). The Special Report indicates
that two methods have arisen in practice for accounting for credit enhancements
relating to securitization. These methods are the cash-in method and the
cash-out method. The cash-in method treats credit enhancements (pledged loans or
cash) as belonging to the Company. As such, these assets are recorded at their
face value as of the time they are received by the trust. The cash-out method
treats credit enhancements as assets owned by the related securitization trust.
As such, these assets are treated as part of the interest-only strips and are
recorded at a discounted value for the period between when collected by the
trust and released to the Company. The Special Report indicates that if no true
market exists for credit enhancement assets, the cash-out method should be used
to measure the fair value of credit enhancements.

           The Company has historically used the cash-in method to account for
its interest-only strips. However, during the three months ended December 31,
1998, the Company retroactively changed its practice of measuring and accounting
for its interest-only strips to the cash-out

                                        6

<PAGE>   7

method in response to the FASB's Special Report and to public comments from the
Securities and Exchange Commission released on December 8, 1998.

           Under the cash-in method previously used by the Company, the assumed
discount period for measuring the present value of the interest-only strips
ended when the cash flows were received by the securitization trust; and, the
initial deposits to overcollateralization accounts were recorded at face value.
Under the cash-out method now required by the FASB and Securities and Exchange
Commission, the assumed discount period for measuring the present value of the
interest-only strips ends when cash, including the return of any initial
deposits, is distributed to the Company on an unrestricted basis. The change to
the cash-out method results only in a difference in the timing of revenue
recognition from a securitization and has no effect on the total cash flows of
securitization transactions. While the total amount of revenue recognized over
the term of a securitization is the same under either method, the cash-out
method results in lower initial gains on the sale of loans due to the longer
discount period, and higher subsequent loan servicing revenue resulting from the
impact of discounting cash flows.

           Accordingly, the Company's condensed consolidated results of
operations of all periods prior to December 31, 1998 as presented herein have
been restated. Results for the three months and six months ended December 31,
1998 also reflect the cash-out method.

           The Company's financial results for all prior periods will be
restated to reflect the cash- out method of accounting and reporting for its
interest-only strips. The aggregate pretax amount of this change in accounting
is $67.1 million.

           As used throughout this document, interest-only strips includes
overcollateralization amounts.




                                        7

<PAGE>   8

           The restatement resulted in the following changes to prior financial
information (Unaudited. Dollars in thousands, except per share amounts):


<TABLE>
<CAPTION>
                                 Three            Six
                                 Months         Months
                                 Ended           Ended                               Year Ended June 30,
                              ------------    -------------        -------------------------------------------------------
                                   December 31, 1997                  1998           1997          1996            1995
                              -----------------------------        ----------    -----------    ------------   -----------

<S>                           <C>                <C>               <C>            <C>             <C>            <C>   
Revenue:
       Previous               $  76,761          146,103           286,110        238,578         141,840        54,939
       As restated               70,341          134,840           266,489        214,531         128,428        48,400

Net income:
       Previous                  13,343           26,424            40,317         17,109          29,791        10,034
       As restated                9,170           19,103            27,563          1,478          21,073         5,784

Earnings per share:
    Basic:
       Previous                    0.48             0.95              1.41           0.65            1.37          0.74
       As restated                 0.33             0.69              0.97           0.06            0.97          0.43
    Diluted:
       Previous                    0.41             0.80              1.23           0.60            1.14          0.74
       As restated                 0.29             0.59              0.89           0.05            0.82          0.43

Interest-only strips:
(end of period)
       Previous                 481,354          481,354           554,161        383,249         173,789        56,960
       As restated              426,093          426,093           490,542        339,251         153,838        50,421

Stockholders' equity:
(end of period)
       Previous                 293,188          293,188           345,403        268,354         133,429        80,047
       As restated              257,268          257,268           304,051        239,755         120,461        75,797
</TABLE>

NOTE 3:  SUBSIDIARY GUARANTORS

           In October 1996, the Company completed an offering of its 9.125%
Senior Notes due 2003 which were guaranteed by all of the Company's operating
subsidiaries, all of which are wholly-owned. The guarantees are joint and
several, full, complete and unconditional. There are no restrictions on the
ability of such subsidiaries to transfer funds to the Company in the form of
cash dividends, loans or advances. The Company is a holding company with limited
assets or operations other than its investments in its subsidiaries. Separate
financial statements of the guarantors are not presented because the aggregate
total assets, net earnings and net equity of such subsidiaries are substantially
equivalent to the total assets, net earnings and net equity of the Company on a
consolidated basis.

NOTE 4: SUBSEQUENT EVENT - ISSUANCE OF PREFERRED STOCK

           On February 10, 1999, the Company issued 26,704 shares of Series B
Convertible Preferred Stock and 49,796 shares of Series C Convertible Preferred
Stock to Capital Z Financial Services Fund II, L.P. (and certain investors
designated by it) and received in return proceeds of $70.6 million, which were
net of $5.9 million of issuance related expenses.


                                        8

<PAGE>   9

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
           RESULTS OF OPERATIONS

           The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Condensed Consolidated Financial Statements included in Item 1 of this
Form 10-Q.

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

           This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934 and Section 27A of the Securities Act of 1933. The words "expect,"
"estimate," "anticipate," "predict," "believe," and similar expressions and
variations thereof are intended to identify forward-looking statements. Such
statements appear in a number of places in this filing and include statements
regarding the intent, belief or current expectations of the Company, its
directors or officers with respect to, among other things (a) market conditions
in the securitization, capital, credit and whole loan markets and their future
impact on the Company's operations, (b) trends affecting the Company's liquidity
position, including, but not limited to, its access to warehouse and other
credit facilities and its ability to effect whole loan sales, (c) the impact of
the various cash savings plans and other restructuring strategies being
considered by the Company, (d) the Company's on-going efforts in improving its
equity position, (e) trends affecting the Company's financial condition and
results of operations, (f) the Company's plans to address the Year 2000 problem
and (g) the Company's business and liquidity strategies. The stockholders of the
Company are cautioned not to put undue reliance on such forward-looking
statements. Such forward-looking statements are not guarantees of future
performance and involve risks and uncertainties. Actual results may differ
materially from those projected in this Report, for the reasons, among others,
discussed under the captions, "Overview-Market Conditions," "- Recent Events,"
and "- Risk Factors." The Company undertakes no obligation to publicly revise
these forward-looking statements to reflect events or circumstances that arise
after the date hereof. Readers should carefully review the factors referred to
above and the other documents the Company files from time to time with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K for the fiscal year ended June 30, 1998, the quarterly reports on Form
10-Q filed by the Company during the remainder of fiscal 1999, and any current
reports on Form 8-K filed by the Company.

RECENT EVENTS

           On December 23, 1998 the Company entered into a Preferred Stock
Purchase Agreement (the "Stock Purchase Agreement") with Capital Z Financial
Services Fund II, L.P., a Bermuda limited partnership ("Capital Z"), providing
for an equity investment of up to $100 million in the Company. The investment is
to be made in three stages, as follows: (i) on February 10, 1999 (the "Initial
Closing"), Capital Z and certain other investors designated by it purchased
26,704 shares of the Series B Convertible Preferred Stock ("Series B Preferred
Stock") of the Company and 49,796 shares of the Series C Convertible Preferred
Stock ("Series C Preferred Stock") of the Company for $1,000


                                        9

<PAGE>   10

per share, or an aggregate purchase price of $76.5 million (the "Initial
Investment"); (ii) as soon as practicable following the Initial Investment,
subject to the receipt of stockholder approval of an increase in the Company's
authorized common and preferred stock (together with a 1000 to 1 stock split of
the preferred stock (the "Recapitalization")), the Company intends to make a
distribution in the form of a dividend to the common stockholders of the Company
of nontransferable subscription rights to purchase up to $25 million of Series C
Preferred Stock for $1.00 per share (the "Rights Offering"), and (iii) Capital Z
has agreed to purchase any shares of the Series C Preferred Stock which are not
purchased by common stockholders in the Rights Offering. In addition, certain
members of the Company's management team have agreed to purchase 920 shares of
the Series C Preferred Stock for $1,000 per share, and other members of the 
Management team have agreed to exercise their rights to purchase $1,667,000 
shares of Series C Preferred Stock in the Rights Offering for $1.00 per share. 
On January 4, 1999, a designee of Capital Z received, as a standby commitment 
fee, warrants to purchase 1,250,000 of the Common Stock at an exercise price of
$1.00 per share. In addition, at the time of the Initial Closing, the Company
paid a designee of Capital Z a $1,000,000 transaction fee in connection with the
transactions contemplated by the Stock Purchase Agreement and Capital Z received
an additional warrant (the "Contingent Warrant") to purchase up to 3,000,000
shares of the common stock at an exercise price of $1.00 per share, which is
exercisable only if the Recapitalization is not completed by June 30, 1999. In
addition, in connection with the transactions contemplated by the Stock Purchase
Agreement, the Company has paid Capital Z aggregate additional fees of
$2,000,000 and has agreed to reimburse Capital Z for all of its expenses
incurred in connection with the negotiation and execution of the Stock Purchase
Agreement and the transactions contemplated thereby.

           Pursuant to the terms of the Series B Preferred Stock and Series C
Preferred Stock, if the Company fails to effect the Recapitalization prior to
June 30, 1999, (i) the dividend rate on the Series B Preferred Stock and Series
C Preferred Stock will increase from 6.5% to 15% per annum and (ii) the
Contingent Warrant will become exercisable. Further, prior to the
Recapitalization, in addition to its regular dividend rights and rights in
liquidation based on its stated value per share, the Series B Preferred Stock
and Series C Preferred Stock will participate in dividends and rights in
liquidation with holders of the common stock in any remaining assets of the
Company.

           The Board of Directors of the Company, effective as of the Initial
Closing, consists of nine Directors divided into two classes. One class,
consisting of four Directors (the "Series B Directors") are elected by the
holders of the Series B Preferred Stock, voting as a single class, annually and
the other class of Directors, consisting of five Directors (the "Common Stock
Directors"), one of whom is nominated by Capital Z, are elected by the holders
of the common stock and the holders of the Series B Preferred Stock, voting
together as a single class, for staggered three year terms. The holders of the
Series C Preferred Stock are not entitled to vote with respect to the election
of Directors. As of February 10, 1999, Capital Z holds Series B Preferred Stock
and Series C Preferred Stock representing 100% of the voting rights entitled to
elect the Series B Directors, 46.3% of the voting rights entitled to elect the
Common Stock Directors and 69.8% of the voting rights entitled to vote with
respect to all other matters. Moreover, the investment by Capital Z results in a
change in control for income tax purposes thereby limiting future net operating
loss and certain other future deductions.


                                       10

<PAGE>   11

OVERVIEW - MARKET CONDITIONS

           The results of operations for the quarter ended December 31, 1998
reflect the negative market conditions that existed in the quarter. While the
U.S. capital and credit markets stabilized in December from the global economic
crises of the previous months, the subprime home equity sector generally and the
Company specifically continued to feel the adverse effects of restricted access
to the capital and credit markets. As previously disclosed, the negative market
conditions resulted in an operational loss for the quarter. Further, these
negative market conditions caused the Company to record a net loss in valuation
of its interest-only strips for the quarter in the amount of $192 million (the
"Write-Down"). The Write-Down reflects the impact of these market conditions on
the prepayment, loss and discount rate assumptions applied by the Company in
estimating the fair value of its interest-only strips. See "- Certain Accounting
Considerations -- Accounting for Securitizations."

           As has been previously disclosed, during the quarter, the Company was
dependent upon one committed warehouse line in the amount of $300 million.
Throughout the quarter, the Company attempted to obtain additional lines.
However, the Company was unable to obtain such lines. In conjunction with the
Initial Closing under the Stock Purchase Agreement, effective February 10, 1999,
the Company obtained an additional $400 million in committed repurchase
facilities and an additional $100 million in an uncommitted facility. Further,
the Company is in negotiations with respect to additional warehouse and
repurchase lines. However, there can be no assurance that such negotiations will
be successful or that any additional warehouse or repurchase lines will be
obtained.

           The Company was precluded from completing a securitization during the
second fiscal quarter due to the negative cash flows associated with a
securitization and the weak asset-backed market. Foregoing the higher gains of
the securitization market had an adverse impact on the Company's profitability
as it was forced to rely upon less profitable whole loan sales as a means of
disposing of its loan production. Constraints upon the Company's access to
warehouse funding sources contributed to the Company's need to expedite its
whole loan sales putting further downward pressure on the whole loan prices.
Moreover, the weakness in the asset-based market caused other subprime lenders
to rely on the whole loan market for their loan disposition strategy. The result
was an abundance in the supply, and a lowering of the prices paid (in some cases
to prices lower than the Company's cost of producing loans), for whole loans and
tightening of underwriting guidelines applied by the whole loan purchasers. The
Company attempted to mitigate these effects by raising its prices and tightening
its underwriting guidelines for its loan products which had the effect of
decreasing loan production in the second quarter. See "- General." As previously
disclosed, sales of loans in the whole loan market contributed to the loss in
the quarter ended December 31, 1998. Additionally, the Company's sale of whole
loans during the quarter on a servicing released basis precluded the growth of
its servicing portfolio.

           Recent improvements in the asset-backed market and a reduction in the
number of whole loan sellers have lessened the over-supply of loan product in
that market and resulted in an increase in whole loan prices. Nevertheless, the
profitability of the whole loan market is significantly lower


                                       11

<PAGE>   12

than the securitization market. In the quarter ended March 31, 1999, the Company
expects to record a loss as it will continue to rely solely on the whole loan
market for its loan dispositions and will not yet have realized the benefits
from its cost savings plan. See "- Expenses." The Company will monitor market
conditions and cash flow to determine the optimal time to re-enter the
securitization market. Management currently expects that it will re-enter the
securitization market in the June 1999 quarter. However, no assurance can be
given that market conditions will not change or other events will not occur that
would preclude or inhibit the Company's ability to complete a securitization in
the June 1999 quarter.

           The Company's liquidity crisis was further exacerbated during the
quarter ended December 31, 1998 by the requirement of the Company, as servicer
of the loans it has securitized, to advance interest on delinquent loans in the
securitized pools on a monthly basis. This short-term cash requirement arises
once each month. Generally, the Company is obligated to make the servicing
payment in the middle of the month. The cash advances are then reimbursed from
payments received on performing loans in the pools, typically within 10 days.
Under its then existing credit facilities, the Company did not have sufficient
funds to make the payment in December 1998. However, an immediate insolvency
crisis was averted when one of the Company's lenders expanded the Company's
credit facility to provide the funds necessary to satisfy the December
obligation. Management believes that this lender was willing to expand the
facility due to the Company's then- advanced discussions with Capital Z.
Advances under the facility were secured by certain of the Company's
interest-only strips. Under the terms of the credit facility, funds were also
available to help satisfy the January 1999 servicing advance conditioned on the
Stock Purchase Agreement being in full force and effect, as well as the
satisfaction of other conditions. If the Company would have been unable to
arrange for funds necessary to make the servicing advances, the Company would
very likely have had to engage in extraordinary transactions, such as seeking
subservicing arrangements that included the obligation to make servicing
advances or strategic asset sales, to provide the liquidity necessary to
operate. In that event, the Company would very likely have been terminated as
servicer. Any such termination would have had a material adverse effect on the
Company and jeopardized its ability to continue to operate as a going concern.

           Management believes that the capital from the Initial Investment will
assist the Company in satisfying its servicing advance obligations. See "-
Liquidity." However, management is seeking to implement plans to reduce the
burden of these advances on its available cash. These plans may include
establishing working lines of credit secured by interest-only strips,
credit-enhancing servicing advances to efficiently borrow against them, entering
into sub-servicing arrangements (including the obligation to make servicing
advances) with respect to certain pools of loans with the highest percentage of
delinquencies or other financing arrangements.

GENERAL

           The Company is a consumer finance company primarily engaged, through
its subsidiaries, in the business of originating, purchasing, selling, and
servicing home equity mortgage loans secured by single family residences. Upon
its formation in 1991, the Company acquired Aames Home Loan,


                                       12

<PAGE>   13

a home equity lender founded in 1954. In August 1996, the Company acquired One
Stop Mortgage, Inc. ("One Stop") which originates mortgage loans primarily
through a broker network. In March 1998, the Company augmented its retail
production by establishing One Stop Retail Direct ("Retail Direct"). Unlike the
Company's traditional retail network, which uses a centralized marketing
approach, Retail Direct uses a decentralized marketing approach at the branch
level.

           The Company's principal market is borrowers whose financing needs are
not being met by traditional mortgage lenders for a variety of reasons,
including the need for specialized loan products or credit histories that may
limit such borrowers' access to credit. The Company believes these borrowers
continue to represent an underserved niche of the home equity loan market and
present an opportunity to earn a superior return for the risk assumed. The
residential mortgage loans originated and purchased by the Company, which
include fixed and adjustable rate loans, are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes.

           The Company originates and purchases loans nationally through three
production channels - retail, broker and correspondent. In recent quarters, the
Company has emphasized its core retail and broker loan production channels and
decreased its reliance on correspondent purchases. During the three and six
months ended December 31, 1998, the Company originated and purchased $550
million and $1.28 billion, respectively, of mortgage loans. The Company
underwrites and appraises every loan it originates and generally reviews
appraisals and re-underwrites all loans it purchases. Included in the $1.28
billion of loans originated during the six months ended December 31, 1998 is
$14.4 million of commercial loans originated through the Company's commercial
loan division which ceased operations in January 1999.

           The Company retains the servicing on the loans it originates or
purchases and securitizes. The Company completed the transfer in-house of $1.64
billion of loans previously subserviced for the Company by third parties in the
18 month period ending December 31, 1998, $1.32 billion of which was transferred
between December 1997 and March 1998. At December 31, 1998, the Company serviced
100% of its $4.43 billion servicing portfolio as compared to 75% of the $3.75
billion servicing portfolio at December 31, 1997. See "- Revenue."

           As a fundamental part of its business and financing strategy, the
Company sells its loans to third party investors in the secondary market. The
Company maximizes opportunities in its loan disposition transactions by selling
its loan production through a combination of securitizations and whole loan
sales, depending on market conditions, profitability and cash flows. For a
discussion of the impact of current market conditions on the Company's loan
disposition strategies, see "Overview - Market Conditions." The Company sold
$501 million and $606 million of loans during the three months ended December
31, 1998 and 1997, respectively, and $1.20 billion and $1.15 billion of loans
during the six months ended December 31, 1998 and 1997, respectively. Of the
total amount of loans sold during the six months ended December 31, 1998 and
1997, $650 million and $1.10 billion were sold in securitizations, respectively.
The Company did not complete a securitization during the quarter ended December
31, 1998.


                                       13

<PAGE>   14

           The following table presents the volume of loans originated and
purchased by the Company and the portfolio serviced by the Company during the
periods presented:

<TABLE>
<CAPTION>
                                                        THREE MONTHS ENDED                       SIX MONTHS ENDED
                                                            DECEMBER 31,                           DECEMBER 31,
                                                    ---------------------------          -----------------------------
                                                          1998           1997               1998                1997
                                                          ----           ----               ----                ----
                                                                                (IN THOUSANDS)

           <S>                                      <C>                 <C>               <C>               <C>    
           Broker network                           $   289,492         273,756              640,293 (1)       535,590
           Retail (2)                                   197,937         157,292              426,114           290,838
           Correspondent                                 62,789         184,615              208,868           312,374
                                                    -----------         -------           ----------          --------
           Total                                    $   550,218         615,663            1,275,275         1,138,802
                                                    ===========         =======           ==========         =========

           Servicing portfolio at period end                                              $4,429,000 (3)     3,751,000
</TABLE>
------------------

(1)        Includes $14.4 million of commercial loans.
(2)        Includes loans brokered to institutional investors for 1997.
(3)        Includes $248 million of loans subserviced for others by the Company
           on an interim basis.

           Total originations decreased 11% from $616 million for the quarter
ended December 31, 1997 to $550 million for the quarter ended December 31, 1998.
More dramatic, however, was the $175 million, or 24%, decline in originations
from the previous fiscal quarter. The decline in originations resulted from a
combination of the Company's limited warehouse capacity and price and
underwriting changes implemented to permit the Company to access the whole loan
market and stay within its liquidity constraints. See "- Overview - Market
Conditions." Despite the decrease in total loan production on a sequential
quarterly basis, the Company's core operations, retail and broker, increased 13%
to $487 million for the quarter ended December 31, 1998 from $431 million for
the quarter ended December 31, 1997. The growth in core originations was due
primarily to the increase in retail and broker branches during the second fiscal
quarter of 1998 over those operating in the comparable period in 1997. The
Company's retail originations were $198 million for the quarter ended December
31, 1998 compared to $158 million for the quarter ended December 31, 1997.
Origination volume for the broker network reached $289 million for the quarter
ended December 31, 1998 compared to $274 million for the quarter ended December
31, 1997. Correspondent purchases were $63 million for the quarter ended
December 31, 1998 compared to $185 million for the quarter ended December 31,
1997. The decline in the second fiscal quarter of 1998 in correspondent loan
purchases reflects pricing changes implemented by the Company in response to the
Company's liquidity constraints and the emphasis on core operation loan
origination.

           Total loan production for the six months ended December 31, 1998
increased 12% to $1.28 billion from $1.14 billion for the six months ended
December 31, 1997. The Company's retail originations increased 46% to $426
million for the six months ended December 31, 1998 compared to $291 million for
the six months ended December 31, 1997. Origination volume for the broker
network reached $640 million for the six months ended December 31, 1998, up 19%
compared to $536 million for the six months ended December 31, 1997.
Correspondent volume decreased 33%

                                       14

<PAGE>   15

from $312 million in the six months ended December 31, 1997 to $209 million for
the six months ended December 31, 1998. See "- Overview - Market Conditions."

           In February 1999, the Company changed its pricing levels in its core
loan production and correspondent loan production channels. Management expects
that these changes will increase loan production from the December quarter's
volumes.

           At February 9, 1999, the Company operated 89 retail loan offices
serving 33 states (including the District of Columbia), compared to 73 offices
serving 30 states at December 31, 1997. At February 9, 1999, the broker division
operated 40 branches serving 46 states (including the District of Columbia),
compared to 41 branches serving 39 states at December 31, 1997. At February 9,
1999, Retail Direct operated 21 offices serving 12 states. See "- Expenses."





                                       15

<PAGE>   16

CERTAIN ACCOUNTING CONSIDERATIONS

           New Accounting Development. In December 1998, the FASB issued, in
question and answer format, "A Guide to Implementation of Statement 125 on
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, Questions and Answers, Second Edition" (the "Special Report").
The Special Report indicates that two methods have arisen in practice for
accounting for credit enhancements relating to securitization. These methods are
the cash-in method and the cash-out method. The cash-in method treats credit
enhancements (pledged loans or cash) as belonging to the Company. As such, these
assets are recorded at their face value as of the time they are received by the
trust. The cash-out method treats credit enhancements as assets owned by the
related securitization trust. As such, these assets are treated as part of the
interest-only strips and are recorded at a discounted value for the period
between when collected by the trust and released to the Company. The Special
Report indicates that if no true market exists for credit enhancement assets,
the cash-out method should be used to measure the fair value of credit
enhancements.

           Restatement of Prior Period Results. The Company has historically
used the cash-in method to account for its interest-only strips. However, during
the three months ended December 31, 1998, the Company retroactively changed its
practice of measuring and accounting for its interest-only strips to the
cash-out method in response to the FASB's Special Report and to public comments
from the Securities and Exchange Commission released on December 8, 1998.

           Under the cash-in method previously used by the Company, the assumed
discount period for measuring the present value of the interest-only strips
ended when the cash flows were received by the securitization trust; and, the
initial deposits to overcollateralization accounts were recorded at face value.
Under the cash-out method now required by the FASB and Securities and Exchange
Commission, the assumed discount period for measuring the present value of the
interest-only strips ends when cash, including the return of any initial
deposits, is distributed to the Company on an unrestricted basis.

           The change to the cash-out method results only in a difference in the
timing of revenue recognition from a securitization and has no effect on the
total cash flows of securitization transactions. While the total amount of
revenue recognized over the term of a securitization is the same under either
method, the cash-out method results in lower initial gains on the sale of loans
due to the longer discount period, and higher subsequent loan service revenue
resulting from the impact of discounting cash flows. See "- Revenue."

           To quantify the impact of the change in accounting, the Company
measured the difference between the face value of its residual assets and the
value of its residual assets when measured on a discounted basis. Further, the
Company used the same assumptions for prepayment, loss and discount rates as
were used in the periods affected. The impact of moving to the cash-out method
was approximately 11.5% of the interest-only strips asset (excluding the effects
of the Write-Down). The use of such a percentage was deemed reasonable for
purposes of restating prior period consolidated financial statements.


                                       16

<PAGE>   17

           As a result, the Company's consolidated results of operations for all
prior periods have been restated. The aggregate pretax amount of this change in
accounting is $67.1 million. Results for the three months and six months ended
December 31, 1998 also reflect the cash-out method.

           The restatement resulted in the following changes to prior financial
information (Unaudited. Dollars in thousands, except per share amounts):


<TABLE>
<CAPTION>
                                Three                Six
                                Months             Months
                                Ended               Ended                          Year Ended June 30,
                             ----------          -----------       ------------------------------------------------------
                                     December 31, 1997                1998           1997          1996          1995
                             -------------------------------       ---------       --------     -----------     ---------

<S>                          <C>                    <C>              <C>            <C>            <C>          <C>   
Revenue:
       Previous              $  76,761              146,103          286,110        238,578        141,840      54,939
       As restated              70,341              134,840          266,489        214,531        128,428      48,400

Net income:
       Previous                 13,343               26,424           40,317         17,109         29,791      10,034
       As restated               9,170               19,103           27,563          1,478         21,073       5,784

Earnings per share:
    Basic:
       Previous                   0.48                 0.95             1.41           0.65           1.37        0.74
       As restated                0.33                 0.69             0.97           0.06           0.97        0.43
    Diluted:
       Previous                   0.41                 0.80             1.23           0.60           1.14        0.74
       As restated                0.29                 0.59             0.89           0.05           0.82        0.43

Interest-only strips:
(end of period)
       Previous                481,354              481,354          554,161        383,249        173,789      56,960
       As restated             426,093              426,093          490,542        339,251        153,838      50,421

Stockholders' equity:
(end of period)
       Previous                293,188              293,188          345,403        268,354        133,429      80,047
       As restated             257,268              257,268          304,051        239,755        120,461      75,797
</TABLE>

           Accounting for Securitizations. Although the Company's loan
disposition strategy relies on a combination of securitization transactions and
whole loan sales, the Company relied solely on whole loan sales during the
quarter ended December 31, 1998. The following discusses certain accounting
considerations which arise only in the context of securitization transactions.

           In a securitization, the Company conveys loans that it has originated
or purchased to a separate entity (such as a trust or trust estate) in exchange
for cash proceeds and an interest in the loans securitized represented by the
non-cash gain on sale of loans. The cash proceeds are raised through an offering
of the pass-through certificates or bonds evidencing the right to receive
principal payments on the securitized loans and the interest rate on the
certificate balance or on the bonds. The non-cash gain on sale of loans
represents the difference between the proceeds (including premiums) from the
sale, net of related transaction costs, and the allocated carrying amount of the
loans sold. The allocated carrying amount is determined by allocating the
original amount of loans (including premiums paid on loans purchased) between
the portion sold and any retained interests (interest-only strip), based on
their relative fair values at the date of transfer. The interest-only strip


                                       17

<PAGE>   18

represents, over the estimated life of the loans, the present value of the
estimated cash flows. These cash flows are determined by the excess of the
weighted average coupon on each pool of loans sold over the sum of the interest
rate paid to investors, the contractual servicing fee (currently .50%), a
monoline insurance fee, if any, and an estimate for loan losses. In quarters
where the Company engaged in a securitization transaction, net gains or losses
in valuation of interest-only strips and mortgage servicing rights include the
recognition of a gain or loss which represents the initial difference between
the allocated carrying amount and the fair market value of the interest-only
strip at the date of sale. Additionally, increases or decreases in valuation of
the interest-only strips are also recognized as net gains or losses. Each
agreement that the Company has entered into in connection with its
securitizations requires either the overcollateralization of the trust or the
establishment of a reserve account that may initially be funded by cash
deposited by the Company.

           The Company determines the present value of the cash flows at the
time each securitization transaction closes using certain estimates made by
management at the time the loans are sold. These estimates include: (i) future
rate of prepayment; (ii) discount rate used to calculate present value; and
(iii) credit losses on loans sold. There can be no assurance of the accuracy of
management's estimates.

                      Rate of Prepayment. The estimated life of the securitized
                      loans depends on the assumed annual prepayment rate which
                      is a function of estimated voluntary (full and partial)
                      and involuntary (liquidations) prepayments. The prepayment
                      rate represents management's expectations of future
                      prepayment rates based on prior and expected loan
                      performance, the type of loans in the relevant pool (fixed
                      or adjustable rate), the production channel which produced
                      the loan, prevailing interest rates, the presence of
                      prepayment penalties, the loan-to-value ratios and the
                      credit grades of the loans included in the securitization
                      and other industry data. The rate of prepayment may be
                      affected by a variety of economic and other factors.

                      Discount Rate. In order to determine the fair value of the
                      cash flow from the interest-only strips, the Company
                      discounts the cash flows based upon rates prevalent in the
                      market.

                      Credit Losses. In determining the estimate for credit
                      losses on loans securitized, the Company uses assumptions
                      that it believes are reasonable based on information from
                      its prior securitizations, the loan-to-value ratios,
                      credit grades of the loans included in the current
                      securitizations and other industry data.

           The interest-only strips are recorded at estimated fair value and are
marked to market through a charge (or credit) to earnings. On a quarterly basis,
the Company reviews the fair value of the interest-only strips by analyzing its
prepayment, discount rate and loss assumptions in relation to its actual
experience and current rates of prepayment and loss prevalent in the industry
and may adjust or take a charge to earnings through an adjustment to net gain or
loss on valuation of interest-only strips.


                                       18

<PAGE>   19

           In its regular quarterly review of its interest-only strip, the
Company considered the historical performance of its securitized loan pools, the
recent prepayment experience of those pools, the credit performance of
previously securitized loans and other industry data and determined that it
should adjust each of its assumptions (rate of prepayment, discount rate and
credit loss) to reflect current market conditions. This change in estimates
resulted in the Write-Down in the quarter ended December 31, 1998. The
components of this adjustment are as follows:

           Rate of Prepayment. In its valuation analysis of prepayment speeds,
the Company considered the relationship between the rate paid on the
certificates or bonds issued in the securitization and the weighted average
coupons on the mortgages outstanding in each securitization pool from time to
time. Additionally, For the quarters up to and including September 30, 1998,
prepayment rates used by the Company were held constant, e.g. flat, over the
life of the pool. The estimates used by the Company for the quarters up to and
including September 30, 1998 were flat prepayment rates ranging from 26% for
fixed to 30.5% for adjustable and hybrid loan products. These rates represented
a weighted average loan life of approximately 2.6 to 3.8 years. During the
quarter ended December 31, 1998, the Company finalized the development of an
enhanced analytical model which more precisely reflected the performance of the
securitized loans. This analytical model enabled the Company to refine its
estimate of the prepayment rates associated with the performance of its
securitized loans. Additionally, data and information received from market
participants (credit and capital providers) assisted the Company in its
assessment of current market conditions which resulted in the Company applying a
more precise valuation estimate to its prepayment assumptions. The Company
incorporated this new information in developing its improved judgment as to
prepayment speeds and changed its estimate of prepayment rates from a flat
constant prepayment rate to a vectored rate, which more closely approximates the
performance of the securitized loans. These revised prepayment rates resulted in
a weighted average life of 2.86 years. The impact of the change in prepayment
speeds amounted to approximately $62 million, which is included in the
Write-Down recorded for the quarter ended December 31, 1998.

           Discount Rate. For the quarters up to and including September 30,
1998, the Company used the weighted average interest rates of the loans included
in the pool as the best estimate available as an appropriate discount rate to
determine fair value. As the market deteriorated in the quarter ended December
31, 1998, it became apparent that a change in discount rate would be required in
order for the estimate of fair value to be consistent with market conditions. To
determine the appropriate discount rate, the Company reviewed general market
conditions as reflected by market sales of senior tranche asset-backed
securities. Management believed that the pass-through rate on senior tranche
securities should be lower than the discount rate applied to the subordinate,
and higher risk, interest-only strips. However, the adversity of the market
during the quarter ended December 31, 1998 was so severe that, in some
instances, transactions of senior tranche asset-backed securities could not even
be completed. Accordingly, the Company incorporated this current market
information in developing its judgment as to the appropriate risk adjusted rate
of return in establishing its change in estimate of the discount rate to be used
in estimating the fair value of the interest-only strips. For the quarter ended
December 31, 1998, the Company increased its discount rate to 15% to reflect
current market conditions. The impact of this change in discount rate


                                       19

<PAGE>   20

amounted to approximately $65 million, which is included in the Write-Down
recorded for the quarter ended December 31, 1998.

           Credit Losses. For the quarter up to and including September 30,
1998, the Company used a prospective cumulative loan loss estimate of 1.4% of
the balance of the loans in the securitization pools as an appropriate estimate
to determine fair value. This estimate was developed through a review of the
credit performance of securitized loans in the aggregate. In conjunction with
its previous quarterly review of loss estimates, the Company considered the
level of delinquency of securitized loans and the percentage of annualized
losses to securitized loans in the aggregate. As market conditions deteriorated
in the quarter ended December 31, 1998, the Company refined its estimate of
credit losses by expanding the factors it considers in developing its credit
loss estimates to include loss and delinquency information by channel, credit
grade and product, and information available from other market participants such
as investment bankers, credit providers and credit agencies. For the quarter
ended December 31, 1998, the percentage of losses to average servicing portfolio
amounted to 1.08%, a significant increase from the previous quarter's level of
 .80%. The Company had seen levels spike to .96% in the quarter ended June 30,
1998 but then subside to the .80% previously noted. This trend was in line with
the Company's assumption that losses were being realized as the servicing
portfolio was transferred in-house from sub-servicers. See "-General."
Management believes the increase in losses in the December 1998 quarter
reflected general market conditions rather than the continuing effects of the
transfer of servicing in-house. Publicly available information from investment
banking firms and credit agencies began to indicate a market expectation that
credit losses within the sub-prime home equity sector would rise. Those
indications, in part, arise from the impact of the adverse market conditions on
severely delinquent borrowers who, in a more favorable market, would avoid
default by refinancing with other lenders. In the current market, with
competition lessening and underwriting guidelines tightening, these borrowers
are much more likely to default. Accordingly, the Company increased its
prospective cumulative loan loss estimate to 2.7% of the balance of the loans in
the securitization pools at December 31, 1998. This change in credit loss
estimate resulted in a valuation adjustment of $67 million, which is included in
the Write-Down recorded for the quarter ended December 31, 1998.

           Additionally, upon sale or securitization of servicing retained
mortgages, the Company capitalizes the fair value of originated mortgage
servicing rights ("OMSRs") assets separate from the loan. The Company determines
fair value based on the present value of estimated net future cash flows related
to servicing income. The cost allocated to the servicing rights is amortized
over the period of estimated net future servicing fee income. The Company
periodically reviews the valuation of capitalized servicing fees receivable.
This review is performed on a disaggregated basis for the predominant risk
characteristics of the underlying loans which are loan type and origination
date.



                                       20

<PAGE>   21

RESULTS OF OPERATIONS - THREE AND SIX MONTHS ENDED DECEMBER 31, 1998 AND 1997
(RESTATED
AND UNAUDITED)

           The following table sets forth information regarding the components
of the Company's revenue and expenses for the three and six months ended
December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                  Three Months Ended               Six Months Ended
                                                      December 31,                    December 31,
                                               ------------------------           ----------------
                                                    1998        1997              1998        1997
                                                    ----        ----              ----        ----
                                                                    (In thousands)

Revenue:
<S>                                            <C>             <C>             <C>           <C>   
   Gain on sale of loans                       $    8,752      35,130            28,429       66,438
   Net gain (loss) on valuation of                                          
      interest-only strips                       (191,646)      5,726          (186,451)      10,755
   Commissions                                      7,758       7,161            17,746       13,016
   Loan servicing:                                                          
      Servicing spread                              5,458       5,251             8,827       11,421
      Prepayment fees                               3,649       3,263             7,149        5,618
      Late charge and other servicing fees          2,522       1,848             4,878        3,105
   Fees and other:                                                          
      Closing                                         572         670             1,190        1,257
      Appraisal                                       770         634             1,717        1,135
      Underwriting                                    384         294               837          540
      Interest income                               7,208      10,078            18,722       21,109
      Other                                           150         286               294          446
                                               ----------      ------          --------      -------
                                                                            
           Total revenue including                                          
            valuation adjustments                (154,423)     70,341           (96,662)     134,840
                                               ----------      ------          --------      -------
                                                                            
Expense:                                                                    
   Compensation                                    19,907      24,561            43,701       46,320
   Production                                      10,559       7,541            21,489       13,338
   General and administrative                      13,784       9,580            27,172       17,665
   Interest                                         9,403      10,819            22,285       20,917
                                               ----------      ------          --------      -------
                                                                            
                                                                            
           Total expense                           53,653      52,501           114,647       98,240
                                               ----------      ------          --------      -------
                                                                            
                                                                            
Income (loss) before income taxes                (208,076)     17,840          (211,309)      36,600
Provision (benefit) for income taxes              (12,331)      8,670           (13,408)      17,497
                                               ----------      ------          --------      -------
           Net income (loss)                   $ (195,745)      9,170          (197,901)      19,103
                                               ==========      ======          ========      =======
</TABLE>


REVENUE

           Total revenue for the three and six months ended December 31, 1998
was $(154) million and $(96.7) million, as compared to $70.3 million and $135
million for the three and six months ended December 31, 1997, respectively. The
1998 period revenues include the Write-Down. Excluding the Write-Down, revenues
for the three and six months ended December 31, 1998 were $37.2 million and
$89.8 million, a 47.1% and 33.3% decrease from 1997's comparable periods.
Excluding


                                       21

<PAGE>   22

the Write-Down, the decrease in total revenue during the quarter ended December
31, 1998 from the amount reported in the comparable period in 1997 primarily
reflects the Company's reliance on whole loan sales for cash during the quarter.
Gains associated with whole loans for cash are generally lower than those
recognized when such loans are securitized. This disparity was exacerbated
during the December 31, 1998 quarter as a consequence of the over-supply of
product for sale in the marketplace due to weaknesses in the asset-backed market
during the same period, as well as the Company's limited warehouse capacity
during the quarter which necessitated the expedited sale of loans. See "-
Overview - Market Conditions." During the three months ended December 31, 1997,
the Company relied almost completely on the securitization market for its loan
disposition strategy. In contrast, during the three months ended December 31,
1998, the Company relied exclusively on the whole loan market for its loan
disposition strategy. Further contributing to the results for the three months
ended December 31, 1998 was the 10.6% decrease in total loan production, from
$616 million during the December 1997 quarter to $550 million during the 1998
comparable quarter. The decrease in total revenue during the six months ended
December 31, 1998 from amounts reported in the comparable 1997 period was due
primarily to lower premiums on whole loan sales, lower gains on sale resulting
from hedge losses and lower than historical spreads on the Company's $650
million securitization closed in the quarter ended September 30, 1998. During
the first fiscal quarter, the Company, as it had historically, hedged its fixed
rate pipeline by purchasing hedges against U.S. Treasuries. In the past, changes
in Treasury rates were generally reflected in the pass-through rates of the
fixed rate portion of the Company's securitization. During fiscal 1999's first
quarter, unsettled market conditions resulted in a $15.3 million loss on the
Company's hedge position without an equivalent benefit from reductions in the
pass-through rate paid on certificates sold in the fixed rate portion of the
Company's securitization.

           Gain on sale for the three months ended December 31, 1998 declined
$26.4, or 75.1%, from $35.1 million gain on sale recorded for the three months
ended December 31, 1997. Gain on sale for the three months ended December 31,
1998 reflects the Company's reliance solely on the whole loan market for its
loan disposition strategy. During 1997's comparable quarter, the Company relied
almost completely on the securitization market for its loan disposition
strategy. The gains associated with the whole loan sales were substantially less
than the gains associated with the earlier quarter's securitization. Gain on
sale for the six month period ended December 31, 1998, which decreased $38.0
million, or 57.2%, from 1997's comparable period, was also adversely affected by
the $13.5 million hedge loss recorded in the period. (See above.) The lower
prices paid in the whole loan market also reflect the Company's need to sell
loans on an expedited basis to free up the limited warehouse capacity that
existed during the quarter ended December 31, 1998. In that regard, during the
quarter ended December 31, 1998, the Company entered into a forward commitment
to sell $500 million, subsequently amended to $750 million, of loans to an
affiliate of one of the Company's lenders. The commitment, which expires in May
1999, reflects the lower whole loan prices that existed during the quarter. As
of January 31, 1999, the Company had satisfied $379 million of its commitment.
Failure to satisfy the commitment subjects the Company to a substantial penalty.
This commitment is expected to adversely impact the gain on sale recognized by
the Company in subsequent quarters at least until the commitment is satisfied.
Accordingly, the Company expects to record a loss in the quarter ended March 31,
1999, as it will continue to rely solely on the whole


                                       22

<PAGE>   23

loan market for its loan dispositions and will not yet have realized the
benefits from its cost savings plan.

           Net gain (loss) on valuation of interest-only strips and mortgage
servicing rights for the three months and six months ended December 31, 1998
primarily reflects the impact of the Write-Down recorded in the three month
period ended December 31, 1998. The Company determines the fair value of the
interest-only strips by applying certain assumptions as to prepayments, losses
and discount rate to the future cash flows from prior securitizations. The
negative market conditions that existed during the quarter, as well as the
performance of the Company's pools of securitized loans, caused management to
adjust these assumptions which resulted in the Write-Down. See "Certain
Accounting Considerations -- Accounting for Securitizations." Net gain (loss) on
valuation of interest-only strips and mortgage servicing rights for the three
and six months ended December 31, 1997 in the amounts of $5.7 million and $10.8
million, respectively, represents the initial difference between the allocated
carrying amount and the fair value of the interest-only strip at the date of the
closing of the related securitization transaction.

           Commission revenue during the three and six month period ended
December 31, 1998 was $7.76 million and $17.7 million, an 8.4% and 36.2%
increase, respectively, from $7.16 million and $13.0 million during the three
and six months ended December 31, 1997. The increase in commissions for the
three and six months ended December 31, 1998 over the comparable 1997 periods
was due to higher retail loan volume and higher commission rates earned on loan
originations in the Company's retail and broker loan production channels.

           Loan servicing revenue for the three and six months ended December
31, 1998 increased to $11.6 million and $20.9 million, an increase of 11.5% and
4.0%, respectively, from $10.4 million and $20.1 million reported for the
comparable periods in 1997. Loan servicing revenue consists of net servicing
spread earned on the principal balances of the loans in the Company's loan
servicing portfolio, prepayment fees, late charges and other fees retained by
the Company in connection with the servicing of loans, increased by the
accretion of the interest-only strips and reduced by the amortization of the
OMSRs. The increase in loan servicing revenues for the three and six months
ended December 31, 1998 was due primarily to higher balances of loans being
serviced currently as compared to levels being serviced in the prior year.

           The Company's loan servicing portfolio at December 31, 1998 increased
to $4.43 billion, up 18.1% from $3.75 billion at December 31, 1997. At December
31, 1998, 100% of the Company's $4.43 billion servicing portfolio was serviced
in-house, compared to 75% at December 31, 1997. The growth of the Company's
servicing portfolio will be negatively impacted by the Company's reliance on
sales of whole loans on a servicing released basis. Nevertheless, management
believes that the business of loan servicing provides a more consistent revenue
stream and is less cyclical than the business of loan origination and
purchasing. See "- Risk Factors -- Delinquencies and Losses in Securitization
Trusts; Right to Terminate Mortgage Servicing; Negative Impact on Cash Flow."



                                       23

<PAGE>   24

           The Company has historically experienced delinquency rates that are
higher than those prevailing in its industry due to its origination of lower
credit grade loans. At the end of calendar year 1996, the Company started to
focus more on higher credit grade loans which should cause delinquencies in the
Company's servicing portfolio to decrease in the future. See "- Revenue."
However, by selling loans in the whole loan market on a servicing released
basis, which the Company intends to do in the current quarter as it did in the
preceding fiscal quarter, the Company will not be adding new loans to the
servicing portfolio. The seasoning of the old portfolio without the addition of
new loans could cause delinquency rates to rise. The delinquency rate for
December 31, 1998 was 16.3% compared to 14.9% at December 31, 1997.

           In some cases, the Company has determined that the proceeds from the
disposal of REO and foreclosed properties are maximized by accelerating
disposition of REO properties rather than holding such properties until market
conditions improve. During the six months ended December 31, 1998, losses
increased to $20.6 million from $9.95 million in the comparable prior period
due, in part, to a loss mitigation strategy adopted during the 1997 fiscal year
of minimizing the REO holding period, thereby reducing carrying costs. This
strategy was implemented in conjunction with the transfer in-house of a portion
of its servicing portfolio that was previously subserviced by third parties. See
"- General." It is the Company's goal to reduce the REO holding period to
maximize the economics of liquidation transactions. Current loss levels have
also increased due to the seasoning of the lower credit grade loans purchased in
bulk and included in the Company's earlier trusts. The Company has reduced
significantly its bulk purchase program and the purchase in bulk of lower credit
grade loans. While the accelerated efforts to sell properties is expected to
have a short-term impact on loss levels, the seasoning of the lower credit grade
bulk portfolio may contribute to an increase in losses over time. Further, the
adverse market conditions that existed in the quarter ended December 31, 1998
resulted in the tightening in underwriting guidelines by purchasers of whole
loans and the insolvency of several large subprime home equity lenders. These
factors have had the effect of decreasing the availability of credit to
delinquent lower credit grade borrowers who in the past had avoided default by
refinancing. Management believes that this will increase the Company's level of
losses in future periods.

           The following table sets forth delinquency, foreclosure, and loss
information of the Company's servicing portfolio for the periods indicated:





                                       24

<PAGE>   25


<TABLE>
<CAPTION>
                                                                       Year Ended                         Six Months Ended
                                                                        June 30,                             December 31,
                                                       ---------------------------------------      --------------------------
                                                              1998        1997          1996             1998           1997
                                                              ----        ----          ----             ----           ----
                                                                                     (Dollars in thousands)

<S>                                                    <C>              <C>          <C>             <C>             <C>      
Percentage of dollar amount of delinquent loans
  to loans serviced (period end) (1)(2)(3)(4)

One month                                                       3.8%          4.3          4.9             4.0             4.0
Two months                                                      1.3           1.9          1.8             1.2             1.4
Three or more months:

 Not foreclosed (4)(5)                                          9.0           8.1          8.0             9.4             8.3
 Foreclosed (6)                                                 1.5           1.0          1.0             1.7             1.2
                                                       ------------     ---------   ----------      ----------      ----------
    Total                                                      15.6%         15.3         15.7            16.3            14.9
                                                       ============     =========   ==========      ==========      ==========
Percentage of dollar amount of loans foreclosed to
  loans serviced (period end)(2)(4)                             2.0%          1.5          1.1             1.3             1.1
Number of loans foreclosed(7)                                 1,125           560          221             785             519
Principal amount of foreclosed loans(7)                $     84,613        48,029       14,349          57,814          41,975
Net losses on liquidations(8)                                26,488         5,470          931          20,575           9,947
                                                                                                              
Percentage of annualized losses to average
servicing portfolio(4)                                         0.72%         0.24         0.09            0.96            0.57
Servicing portfolio (period end)                       $  4,147,000     3,174,000    1,370,000       4,429,000       3,751,000
</TABLE>

------------

(1)   Delinquent loans are loans for which more than one payment is due.

(2)   The delinquency and foreclosure percentages are calculated on the basis of
      the total dollar amount of mortgage loans originated or purchased by the
      Company and, in each case, serviced by the Company, and any subservicers
      as of the end of the periods indicated. Percentages for fiscal year 1996
      have not been restated to include delinquencies on loans originated by One
      Stop. The Company believes any such adjustment would not be material.

(3)   At December 31, 1998, the dollar volume of loans delinquent more than 90
      days in ten of the Company's REMIC trusts, five of which, plus one
      additional, also exceeded certain loss limits, formed in December 1992 and
      during the period from March 1995 to March 1997 exceeded the permitted
      limit in the related pooling and servicing agreements. See "-- Capital
      Resources" and "- Risk Factors -- Delinquencies and Losses in
      Securitizations; Trusts Right to Terminate Mortgage Servicing; Negative
      Impact on Cash Flow."

(4)   The servicing portfolio used in the percentage calculations includes $248
      million of loans subserviced for others by the Company on an interim basis
      at December 31, 1998.

(5)   Represents loans which are in foreclosure but as to which foreclosure
      proceedings have not concluded.

(6)   Represents properties acquired following a foreclosure sale and still
      serviced by the Company.

(7)   The increase in the number of loans foreclosed and principal amount of
      loans foreclosed in the periods presented is due to the larger, more
      seasoned servicing portfolio.

(8)   Represents losses, net of gains, on foreclosed properties in pools sold
      during the period indicated.

           Fee and other revenue, which consist of fees received by the Company
through its retail loan office network in the form of closing, appraisal,
underwriting and other fees, and interest income, for the three and six months
ended December 31, 1998 decreased 24.3% and 6.9% to $9.08 million and $22.8
million from $12.0 million and $24.5 million, respectively, when compared to the
comparable 1997 periods. The dollar amount of fees and other revenue decreased
during the three months ended December 31, 1998 from the comparable 1997 periods
due to interest earned on lower



                                       25

<PAGE>   26

amounts of loans held by the Company during the period from origination or
purchase of the loans until the date sold by the Company, offset by increasing
weighted average interest rates on loans held. Interest income should continue
to decline so long as the Company relies on whole loan sales which decreases the
average number of days loans are held by the Company prior to sale. See
"Overview - Market Conditions."

EXPENSES

            Compensation expense for the three and six months ended December 31,
1998 decreased 19.1% and 5.6% from $24.6 million and $46.3 million for the three
and six months ended December 31, 1997, respectively, to $19.9 million and $43.7
million for the three and six months ended December 31, 1998, respectively. This
decrease was primarily due to employee attrition brought about by declines in
branch expansion, a decrease in compensation incentives as a consequence of the
decline in loan origination during the three and six months ended December 31,
1998 and the absence of incentive compensation due to the Company's results of
operations. Compensation as a percentage of total loan originations and
purchases decreased to 3.6% and 3.4% for the three and six months ended December
31, 1998, respectively, from 4.0% and 4.1% for the three and six months ended
December 31, 1997, respectively. Also contributing to decreased compensation
expenses was the waiver by Neil Kornswiet, President of the Company, of his
quarterly bonus due for the quarters ended September 30, 1998 and December 31,
1998 in the aggregate amount of $3.1 million. In mid-February, 1999 and
subsequent to the Initial Closing, management commenced a cost savings program
designed to reduce the Company's operating expenses. The implementation of this
recent cost savings plan initially included personnel reductions on a
Company-wide basis. The effects of these reductions are expected to reduce
compensation costs on an annualized basis in a pretax amount of approximately
$6.7 million. The estimated pretax savings in compensation expense during the
remainder of fiscal 1999 are expected to approximate $2.0 million. Severance
costs, estimated at the pretax amount of approximately $500 thousand, will be
recognized in the quarter ended March 31, 1999.

            Production expense, primarily advertising, outside appraisal costs,
travel and entertainment, and credit reporting fees, increased 41.3% and 61.7%
to $10.6 million and $21.5 million during the three and six months ended
December 31, 1998, respectively, from $7.5 million and $13.3 million in the
comparable periods last year. The increase in production expenses during the
three and six months ended December 31, 1998 from amounts reported during the
comparable periods in 1997 was due, in part, to the increase in retail loan
volume, the rise in advertising costs and the additional cost of outsourcing
appraisal work. Production costs as a percentage of total loan originations and
purchases for the three and six months ended December 31, 1998 were 1.9% and
1.7%, respectively, compared to 1.2% for both of the three and six months ended
December 31, 1997, respectively. This was due to the constriction of loan
production after advertising expenses had already been incurred.

            General and administrative expense for the three and six months
ended December 31, 1998 increased 43.8% and 53.7% to $13.8 million and $27.2
million, respectively, from $9.6 million and $17.7 million for the three and six
months ended December 31, 1997, respectively. The increase was


                                       26

<PAGE>   27

primarily the result of increased occupancy, communication and technology costs
related to the Company's core origination channel expansion and increased
origination volumes and, to a lesser extent, increases in legal and other
professional costs. As part of the costs savings program implemented in
February, 1999, the Company ceased activities in certain retail and broker
branches that were deemed unprofitable by management. The office space for such
branches remains subject to operating leases that management has yet to sublease
or terminate. If such office space is subleased at lease rates less than
existing base lease terms or if the lease commitments are bought-out as a
consequence of a negotiated lease termination, occupancy expense in future
periods will increase for these effects.

            Interest expense during the three months ended December 31, 1998
decreased 13.0% to $9.4 million from $10.8 million in the comparable three month
period in 1997. During the six months ended December 31, 1998, interest expense
increased 6.7% to $22.3 million from $20.9 million during the six months ended
December 31, 1997. The decrease in interest expense during the three months
ended December 31, 1998 was due to lower borrowings used to fund lower loan
originations relative to the comparable 1997 quarter. The increase in interest
expense during the six months ended December 31, 1998 reflects the Company's
recent increased reliance on external financing to fund loan originations and
operations when compared to the comparable period in 1997.

INCOME TAXES

            During the three and six months ended December 31, 1999, the Company
recorded an estimated tax benefit of $12.3 million and $13.4 million,
respectively, due to its net operating losses during those periods. The tax
benefits reflect effective rates of (5.9%) and (6.3%), respectively, and are net
of tax valuation adjustments recorded to account for estimated nonrealizable
deferred tax assets. The investment in the Company by Capital Z results in a
change in control for income tax purposes thereby limiting future net operating
loss and certain other future deductions. During the three and six months ended
December 31, 1997, the Company's provisions for taxes were $8.7 million and
$17.5 million, respectively, reflecting effective estimated tax rates of 48.5%
and 47.8%, respectively.

FINANCIAL CONDITION

            Loans Held for Sale. The Company's portfolio of loans held for sale
increased to $271 million at December 31, 1998, from $198 million at June 30,
1998. This increase is directly related to production volume and the size and
timing of the Company's securitization and sales in the secondary market during
the fiscal periods ended on such dates. During January 1999, the Company sold
$127 million of the $271 million held for sale at December 31, 1998 in whole
loan sales for cash.

            Accounts Receivable. Accounts receivable, representing servicing
fees and advances and other receivables, decreased to $48.8 million at December
31, 1998, from $51.1 million at June 30, 1998. The level of servicing related
advances, in any given period, is dependent on portfolio delinquencies and the
timing of cash collections.

                                       27

<PAGE>   28

            Interest-Only Strips. Interest-only strips decreased to $323 million
at December 31, 1998 from $490 million at June 30, 1998 reflecting the
Write-Down in the December quarter, offset by the non-cash gain recognized on
the Company's securitization in the quarter ended September 30, 1998, net of
amortization.

            Mortgage Servicing Rights, net. Mortgage servicing rights, net
increased to $34.5 million at December 31, 1998 from $32.1 million at June 30,
1998 reflecting the capitalization of mortgage servicing rights on the
securitization in the quarter ended September 30, 1998, net of amortization.

            Equipment and Improvements, net. Equipment and improvements, net,
increased slightly to $14.7 million at December 31, 1998 from $13.9 million at
June 30, 1998.

            Prepaid and Other Assets. Prepaid and other assets increased to
$17.2 million at December 31, 1998 from $17.0 million at June 30, 1998.

            Borrowings. Borrowings at December 31, 1998 increased to $307
million from $287 million at June 30, 1998 due to advances on the Company's
residual financing line completed in September 1998 which the Company used to
fund its negative cash flow.

            Revolving Warehouse Facilities. Amounts outstanding under warehouse
facilities increased to $250 million at December 31, 1998 from $141 million at
June 30, 1998, primarily as a result of the increase in mortgage loans held for
sale and from the negative cash flow from operations during the six months ended
December 31, 1998 and the resulting decrease in equity capital. Proceeds from
the Company's whole loan sales and securitizations are used to pay down the
Company's warehouse facilities.

LIQUIDITY

            The Company's operations require continued access to short-term and
long-term sources of cash. The Company's primary operating cash requirements
include the funding of: (i) mortgage loan originations and purchases prior to
their securitization and sale, (ii) fees, expenses and hedging costs, if any,
incurred in connection with the securitization and sale of loans, (iii) cash
reserve accounts or overcollateralization requirements in connection with the
securitization and sale of mortgage loans, (iv) tax payments due on recognition
of non-cash gain on sale other than in a debt-for-tax securitization structure,
(v) ongoing administrative and other operating expenses, (vi) interest and
principal payments under the Company's warehouse credit facilities and other
existing indebtedness, (vii) advances in connection with the Company's servicing
portfolio and (viii) costs associated with expanding the Company's core
production units.

            Historically, the Company funded its negative operating cash flow
principally through borrowings from financial institutions, sales of equity
securities and sales of senior and subordinated notes, among other sources. The
deterioration of the credit and capital markets severely restricted


                                       28

<PAGE>   29

the Company's access to these markets during the quarter ended December 31, 1998
and in the current quarter until the Initial Closing on February 10, 1999. The
$76.5 million ($70.6 million net of issuance expenses) in equity capital from
the Initial Investment will help fund the Company's negative operating cash
until additional working capital lines are established. The Company is currently
in negotiations regarding establishing those lines. However, there can be no
assurance that the Company will be able to establish those lines. There is a
working capital sublimit in the Company's $300 million warehouse facility with a
syndicate of banks. See "- Capital Resources." As previously disclosed,
provisions in that line required the Company to maintain a certain level of
profitability over two consecutive quarters. The loss incurred in the December
31, 1998 quarter caused the Company to violate this provision, as well as
provisions requiring the Company to maintain a certain level of net worth and to
satisfy certain debt to equity ratios. The Company received a waiver from the
syndicate for those violations (the "Waiver"). This line, therefore, remains in
place. It expires on April 8, 1999. See "- Overview - Market Conditions" and "-
Recent Events."

            Under the terms of the Company's Indenture, dated October 21, 1996
with respect to its 9.125% Senior Notes due 2003, the Company's ability to incur
certain additional indebtedness, including residual financing, is limited to two
times adjusted stockholders' equity. In February 1999, the Company received a
waiver from the holders of the Senior Notes, the effect of which was to permit
the Company to record the Write-Down without violating the Indenture's
limitations on indebtedness and conditioned upon the Initial Investment being
made. Warehouse indebtedness is not included in the indebtedness limitations.
The Company's new repurchase facilities contain similar limits on the Company's
ability to incur additional indebtedness. Further, until the Company receives
investment grade ratings for the notes issued under the Indenture, the amount of
residual financing the Company may incur on its interest-only strips allocable
to post-September 1996 securitizations is limited to 75% of the difference
between such post-September 1996 residuals and $225 million. Under the Company's
warehouse line which expires on April 8, 1999, the Company is currently limited
to $50 million of indebtedness secured by its interest-only strips.

            Although the Company's loan disposition strategy consists of a
combination of securitizations and whole loan sales, whole loan sales were the
sole disposition method during the second fiscal quarter and will be the sole
disposition method during the third fiscal quarter. The Company will continue to
monitor market conditions and cash flow to determine the optimal time to
re-enter the securitization market. Management currently anticipates that it
will complete a securitization transaction during 1999's fourth fiscal quarter.
However, no assurance can be given that market conditions will not change or
other events will not occur that would preclude or inhibit the Company's ability
to complete a securitization in the June 1999 quarter. During the three and six
months ended December 31, 1998, the Company securitized -0- and $650 million,
respectively, compared to $605 million and $1.1 billion, respectively, in the
comparable 1997 periods. In connection with securitization transactions
completed during these periods, the Company was required to provide credit
enhancements in the form of overcollateralization amounts or reserve accounts.
In addition, during the life of the related securitization trusts, the Company
subordinates a portion of the excess cash flow otherwise due it to the rights of
holders of senior interests as a credit enhancement to support the sale of the
senior interests. The terms of the securitization trusts


                                       29

<PAGE>   30

generally require that all excess cash flow otherwise payable to the Company
during the early months of the trusts be used to increase the cash reserve
accounts or to repay the senior interests in order to increase
overcollateralization to specified maximums. Overcollateralization requirements
increase up to approximately twice the level otherwise required when the
delinquency rates exceed the specified limit. At December 31, 1998, the Company
was required to maintain an additional $85.0 million in overcollateralization
amounts as a result of the level of its delinquency rates above that which would
have been required to be maintained if the applicable delinquency rates had been
below the specified limit. Of this amount, at December 31, 1998, $54.2 million
remains to be added to the overcollateralization amounts from future spread
income on the loans held by these trusts. See "Risk Factors -- Delinquencies and
Losses in Securitization Trusts; Right to Terminate Mortgage Servicing; Negative
Impact on Cash Flow."

            In the Company's securitizations structured as a REMIC, the
recognition of non-cash gain on sale has a negative impact on the cash flow of
the Company since the Company is required to pay federal and state taxes on a
portion of these amounts in the period recognized although it does not receive
the cash representing the gain until later periods as the related service fees
are collected and applicable reserve or overcollateralization requirements are
met.

            The Company's primary sources of liquidity are expected to be cash
from the Initial Investment and the Rights Offering, fundings under warehouse
facilities, working capital facilities and whole loan sales. See "- Overview -
Market Conditions."

            The Company's primary and potential sources of liquidity as
described in the paragraph above (assuming access to working capital financing,
completion of the Rights Offering and implementation of the cash savings plans
which by no means can be assured) are expected to be sufficient to fund the
Company's liquidity requirements through at least the next 12 months if the
Company's future operations are consistent with management's current growth
expectations. If available at all, the type, timing and terms of financing
selected by the Company will be dependent upon the Company's cash needs, the
availability of other financing sources, limitations under debt covenants and
the prevailing conditions in the financial markets. Further, the $100 million
committed and $100 million uncommitted repurchase lines obtained on February 10,
1999 require the Company to obtain an additional working capital facility by no
later than March 26, 1999. See "Capital Resources -- Warehouse, Repurchase and
Working Capital Facilities." There can be no assurance that any such sources
will be available to the Company at any given time or that favorable terms will
be available. As a result of the limitations described above, the Company may be
restricted in the amount of loans that it will be able to produce and dispose
of.

CAPITAL RESOURCES

            The Company has historically financed its operating cash
requirements primarily through (i) warehouse facilities and working capital
lines of credit, (ii) the securitization and sale of mortgage loans, and (iii)
the issuance of debt and equity securities. Market conditions severely limited
the


                                       30

<PAGE>   31

Company's ability to access the credit, securitization and capital markets
during the quarter ended December 31, 1998. See "- Overview - Market
Conditions."

            Warehouse, Repurchase and Working Capital Facilities. At December
31, 1998, the Company retained access to warehouse and other credit facilities
with borrowing limits aggregating in excess of $1.0 billion. Changes in advance
rates imposed by lenders effectively limited the Company to a single $300
million committed warehouse line during the December 31, 1998 quarter. The
warehouse line includes a working capital line of credit with a syndicate of ten
commercial banks. This facility is secured by loans originated and purchased by
the Company, as well as certain servicing receivables. The loss reported for the
December 31, 1998 quarter would have caused the Company to be in violation of
certain financial covenants contained in the line. In February 1999, the Company
received the Waiver. This line is currently scheduled to expire on April 8,
1999. The Company is engaging in efforts to establish a new syndicate. On
February 10, 1999, and conditioned upon the Initial Closing occurring, the
Company entered into two committed repurchase facilities aggregating $400
million and one uncommitted repurchase facility in the amount of $100 million.
These facilities are each secured by the Company's home equity mortgage loans.
One of the committed facilities, in the amount of $300 million, bears interest
at a rate of 1.25% over one month LIBOR and expires on February 9, 2000, subject
to different interest rates for selected sublimits under the facility. The other
committed facility in the amount of $100 million bears interest at a rate of
1.50% over one month LIBOR and expires on February 9, 2000. The uncommitted
facility bears interest at 1.50% over one month LIBOR and expires on February 9,
2000. The Company's ability to continue to draw under these three facilities is
conditioned upon the Rights Offering closing on or prior to June 30, 1999. The
Company will continue to require short-term warehouse facilities. If the Company
is unable to maintain existing warehouse or repurchase lines, it would have to
cease loan production operations which would negatively impact profitability and
jeopardize the Company's ability to continue to operate as a going concern.

            In September 1998, the Company entered into a revolving line of
credit with a maximum borrowing capacity of $50 million secured by certain of
the Company's interest-only strips. The collateral is subject to mark-to-market
valuation, or may otherwise be deemed unacceptable, in the sole discretion of
the lender. To the extent such provisions result in a shortfall, the line
provides for the term out of the loan or the delivery of additional collateral
to bring the line back to compliance. Access to this line originally depended
upon the Company completing a new securitization and pledging the related
interest-only strips. However, during each of the months of December 1998 and
January and February 1999, the lender allowed the Company to borrow $20 million
on a short-term basis to satisfy the Company's obligation as servicer of the
loans it securitizes to advance interest on delinquent loans. See "- Overview -
Market Conditions." This line had $20 million outstanding at December 31, 1998
and expires on September 3, 1999. The Company is currently in negotiations with
this line's lender for an additional repurchase facility. Management expects
that any such repurchase facility will be conditioned, in part, on the
prepayment and accelerated expiration of the revolving line of credit. See "-
Risk Factors -- Dependence on Funding Sources."




                                       31

<PAGE>   32

            Loan Sales. The Company's ability to sell loans originated and
purchased by it in the secondary market is necessary to generate cash proceeds
to pay down its warehouse and repurchase facilities and fund new originations
and purchases. The ability of the Company to sell loans in the secondary market
on acceptable terms is essential for the continuation of the Company's loan
origination and purchase operations. Current market conditions have restricted
access to the asset- backed market and adversely impacted the availability of,
and pricing in, the whole loan market. See "- Overview - Market Conditions," and
"- Risk Factors -- Risk of Adverse Changes in the Secondary Market for Mortgage
Loans."

            Other Capital Resources. The Company has historically funded
negative cash flow primarily from the sale of its equity and debt securities.
However, current market conditions have restricted the Company's ability to
access its traditional public equity and debt sources. In December 1991, July
1993, June 1995, October 1996 and April 1998, the Company effected public
offerings of its common stock with net proceeds to the Company aggregating $217
million. In March 1995, the Company completed an offering of its 10.5% Senior
Notes due 2002 with net proceeds to the Company of $22.2 million. In February
1996, the Company completed an offering of its 5.5% Convertible Subordinated
Debentures due 2006 with net proceeds to the Company of $112 million. In October
1996, the Company completed an offering of its 9.125% Senior Notes due 2003 with
net proceeds to the Company of $145 million. Under the agreements relating to
these debt issuances, the Company is required to comply with various operating
and financial covenants including covenants which may restrict the Company's
ability to pay certain distributions, including dividends. At December 31, 1998,
the Company had no money available for the payment of such distributions under
the most restrictive of such covenants.

            On April 27, 1998, the Company issued 2.78 million shares of its
common stock, or 9.9% of the Company's outstanding shares, to private entities
controlled by Ronald Perelman and Gerald Ford, at an aggregate purchase price of
approximately $38 million. The Company also issued warrants to these entities to
purchase an aggregate additional 5.3 million shares (as adjusted) of the
Company's common stock at an exercise price of $9.06 (as adjusted), subject to
customary anti-dilution provisions. The warrants are exercisable only upon a
change in control of the Company and expire in three years.

            On February 10, 1999, the Company raised an additional $76.5 million
($70.6 million net of issuance expenses) in the Initial Investment by Capital Z.
Subsequent to receiving stockholder approval of the Recapitalization, the
Company will commence the Rights Offering. Capital Z has agreed to purchase any
shares of the Series C Preferred Stock which are not purchased by the common
stockholders in the Rights Offering.

            The Company had cash and cash equivalents of approximately $11.8
million at December 31, 1998. See "- Risk Factors -- Negative Cash Flow and
Capital Needs."

YEAR 2000 COMPLIANCE AND TECHNOLOGICAL ENHANCEMENT



                                       32

<PAGE>   33

            Readers are cautioned that forward-looking statements contained in
this Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Special Note on Forward-looking Statements,"
beginning on page 9 above. Readers should understand that the dates on which the
Company believes the Year 2000 project will be completed are based upon
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the availability of certain resources, third-party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, or that there will not be a delay in, or
increased costs associated with, the implementation of the Company's Year 2000
Compliance Project. A delay in specific factors that might cause differences
between the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability of
locating and correcting all relevant computer codes, timely responses to and
corrections by third parties and suppliers, the ability to implement interfaces
between the new systems and the systems not being replaced, and similar
uncertainties. Due to the general uncertainty inherent in the Year 2000 problem,
resulting in part from the uncertainty of the Year 2000 readiness of third
parties and the inter-connection of national and international businesses, the
Company cannot ensure its ability to timely and cost effectively resolve
problems associated with the Year 2000 issue that may effect its operations and
business, or expose it to third party liability.

            The Company's year 2000 compliance program consists of four
phases--inventory, risk assessment process, corrective action and testing. The
Company has completed the inventory phase which included the identification of
all computer hardware and software, electronic data exchanges, operating
systems, communications systems and non-information items. As a corollary to the
inventory phase, the Company has made inquiries of its significant vendors as to
their year 2000 readiness.

            The Company has also completed the risk assessment process of
assigning risk factors to each system used by the Company to determine the
priority and resource allocation of its year 2000 efforts. The Company expects
to complete the corrective action and testing phases with respect to mission
critical systems by September 1999. The Company will complete any remaining
testing and compliance by the end of 1999.

            Costs to Address the Company's Year 2000 Issues. The Company
anticipates that costs relating to year 2000 issues are not expected to be
material since the Company primarily relies on third party software for its
primary information technology systems and does not require significant internal
reprogramming resources to change program codes. The Company is in the process
of converting or is scheduled to convert its major computer systems, including
the loan origination system and the financial system from in-house to
vendor-supported systems. These conversions were planned to upgrade and improve
functionality rather than as a result of year 2000 issues.

            Risks of the Company's Year 2000 Issues. The most significant risk
associated with the Company's year 2000 compliance would result from the loss of
the Company's vendor supported servicing system and the inability to maintain
the ongoing loan service operations, including payment processing, collections
and investor remittance processing. The Company's servicing platform uses


                                       33

<PAGE>   34

software supplied by a subsidiary of Fiserv, Inc. To reduce the risk of
non-compliance, the Company intends to rely on the vendor's representations
regarding year 2000 compliance, the Company's testing efforts, as well as the
testing results of other companies that use the same software. The testing and
other costs relating to the Company's year 2000 compliance program are not
expected to be material.

            Another year 2000 risk relates to the Company's vendor supported
loan origination system. In the event of year 2000 issues with respect to the
software used with such system (also supplied by a subsidiary of Fiserv, Inc.),
the Company's ability to originate loans would be diminished and may result in
reduced loan production until the problem is resolved. The Company intends to
rely on the vendor's assurances and Company testing to minimize the risk of
non-compliance of this system.

            Contingency Plans. The Company has not developed a contingency plan.
The Company has no reason to believe that its most significant systems will not
be year 2000 compliant. If testing indicates any of the systems are not
compliant, the Company will develop appropriate contingency plans.

RISK MANAGEMENT

            The Company is currently re-evaluating its current hedging policy,
and currently has no effective hedge in place. While the Company monitors the
interest rate environment and employs fixed rate hedging strategies, there can
be no assurance that the earnings of the Company would not be adversely affected
during any period of unexpected changes in interest rates or prepayment rates.

RISK FACTORS

            Negative Cash Flow and Capital Needs. The Company has historically
operated, and expects to continue to operate, on a negative cash flow basis. The
Company's primary cash requirements include the funding of: (i) mortgage loan
originations and purchases pending their securitization and sale; (ii) fees,
expenses and hedging costs, if any, incurred in connection with the
securitization of loans; (iii) cash reserve accounts or overcollateralization
requirements in connection with the securitization and sale of the loans; (iv)
tax payments due on recognition of non-cash gain on sale, other than in a
debt-for-tax securitization structure; (v) ongoing administrative and other
operating expenses; (vi) interest and principal payments under the Company's
warehouse credit facilities and other existing indebtedness; (vii) advances in
connection with the Company's servicing portfolio; and (viii) costs associated
with expanding the Company's core production units. The more significant of
these cash requirements is a result of the Company's use of securitization as a
loan disposition strategy. In a securitization, the Company recognizes a
non-cash gain on sale of the loans securitized upon the closing of the
securitization, but does not receive the cash representing such gain until it
receives the excess cash flow, which in general is payable over the actual life
of the loans securitized after overcollateralization requirements are met. The
Company incurs significant expense in connection with a securitization and
generally incurs both current and deferred tax liabilities as a result of the
gain on sale. Although the Company will not execute a securitization during the
quarter


                                       34

<PAGE>   35

ended March 31, 1999 and will rely on whole loan sales for cash, the cash
received upon such sales will not be sufficient to eliminate the Company's
negative cash flow. Further, the Company has implemented, is in the process of
implementing or has under discussion various cash savings plans. However, there
can be no assurance that such plans will be successfully implemented or if
successfully implemented will provide liquidity sufficient to eliminate the
Company's negative cash flow. Therefore, the Company requires continued access
to short- and long-term external sources of cash to fund its operations.

            The Company's primary sources of liquidity are expected to be cash
from the Initial Investment and the Rights Offering, fundings under warehouse
facilities, working capital facilities and whole loan sales. See "- Overview -
Market Conditions."

            The Company's primary and potential sources of liquidity as
described in the paragraph above (assuming access to working capital financing,
completion of the Rights Offering and implementation of the cash savings plans
which by no means can be assured) are expected to be sufficient to fund the
Company's liquidity requirements through at least the next 12 months if the
Company's future operations are consistent with management's current growth
expectations. If available at all, the type, timing and terms of financing
selected by the Company will be dependent upon the Company's cash needs, the
availability of other financing sources, limitations under debt covenants and
the prevailing conditions in the financial markets. There can be no assurance
that any such sources will be available to the Company at any given time or that
favorable terms will be available. As a result of the limitations described
above, the Company may be restricted in the amount of loans that it will be able
to produce and dispose of.

            Delinquencies and Losses in Securitization Trusts; Right to
Terminate Mortgage Servicing; Negative Impact on Cash Flow. A substantial
majority of the Company's servicing portfolio consists of loans securitized by
the Company and sold to REMIC or owner trusts in securitization transactions.
Generally, the form of agreement entered into in connection with these
securitizations contains specified limits on delinquencies (i.e., loans past due
90 days or more) and losses that may be incurred in each trust. Losses occur
when the liquidation proceeds from disposal of foreclosed properties, less
liquidation expenses, are less than the principal balances of the loans
previously secured by such properties and related interest and servicing
advances (see below). If, at any measuring date, the delinquencies or losses
with respect to any trust credit-enhanced by monoline insurance were to exceed
the limits applicable to such trust, provisions of the agreements permit the
monoline insurance company to terminate the Company's servicing rights to the
affected trust.

            At December 31, 1998, the dollar volume of loans delinquent more
than 90 days in the Company's 10 securitization trusts formed in December 1992
and during the period from March 1995 to March 1997 exceeded the permitted limit
in the related pooling and servicing agreements. The higher delinquency rates
negatively affect the Company's cash flows by increasing the required
overcollateralization levels, thereby deferring the Company's receipt of cash
and by obligating the Company, as servicer, to advance past due interest. Higher
delinquency levels leading to higher loss levels also adversely influence the
Company's assumptions underlying the gain on sale in a


                                       35

<PAGE>   36

securitization transaction. Additionally, the higher delinquency rates permit
the monoline insurance company to terminate the Company's servicing rights with
respect to the affected trusts. The Company has implemented various plans to
lower the delinquency rates in its future trusts, including diversifying the
loans it originates and purchases to include higher credit grade loans. The
delinquency rate at December 31, 1998 was 16.3% and at June 30, 1998 was 15.6%.

            Five of the ten trusts referred to above plus one additional trust
(representing in the aggregate 16% of the dollar volume of the Company's
servicing portfolio) exceeded one of two loss limits at December 31, 1998. The
limit that has been exceeded provides that losses may not exceed a certain
threshold (which ranges from .50% to .94% of the original pool balances in the
relevant securitization trusts) on a rolling 12 month basis. The other limit,
which was not exceeded, provides that losses may not exceed a certain cumulative
threshold (which ranges from 1.8% to 2.0% of the original pool balances in the
relevant securitization trusts) since the inception of the trust.

            Management believes that current loss levels have increased in part
due to a loss mitigation strategy of minimizing the real estate owned ("REO")
holding period, thereby reducing carrying costs, which accelerated the volume of
liquidated properties in the recent period. It is the Company's goal to reduce
the REO holding period to maximize the economics of liquidation transactions.
Current loss levels have also increased due to the seasoning of the lower credit
grade loans purchased in bulk and included in the Company's earlier trusts. The
Company has reduced significantly purchases in bulk of lower credit grade loans.
While the accelerated efforts to sell properties is expected to have a
short-term impact on loss levels, the seasoning of the lower credit grade bulk
portfolio and the current origination of higher credit grade loans may
contribute to an increase in losses over time. Further, the adverse market
conditions that existed in the quarter ended December 31, 1998 resulted in the
tightening in underwriting guidelines by purchasers of whole loans and the
insolvency of several large subprime home equity lenders. These factors have had
the effect of decreasing the availability of credit to delinquent lower credit
grade borrowers who in the past had avoided default by refinancing. Management
believes that this will increase the Company's level of losses.

            Although the monoline insurance company has the right to terminate
servicing with respect to the trusts referred to above, no servicing rights have
been terminated and the Company believes that the likelihood of such an event is
remote. There can be no assurance, however, that the Company's servicing rights
with respect to the mortgage loans in such trusts, or any other trusts which
exceeds the specified delinquency or loss limits in future periods, will not be
terminated.

            The Company's cash flow is also adversely impacted by high
delinquency rates in its trusts. Generally, provisions in the agreements have
the effect of requiring the overcollateralization account, which is funded
primarily by the excess spread on the loans held in the trust, to be increased
when the delinquency rates exceed the specified limit up to approximately twice
the level otherwise required when the delinquency rates do not exceed the
specified limit. As of December 31, 1998, the Company was required to maintain
an additional $85 million in overcollateralization amounts as a result of the
level of its delinquency rates above that which would have been required to be


                                       36

<PAGE>   37

maintained if the applicable delinquency rates had been below the specified
limit. Of this amount, at December 31, 1998, $54.2 million remains to be added
to the overcollateralization amounts from future spread income on the loans held
by these trusts.

            Risk of Changes in Interest Rate Environment. A substantial and
sustained increase in long-term interest rates could, among other things: (i)
decrease the demand for consumer credit; (ii) adversely affect the ability of
the Company to originate or purchase loans; and (iii) reduce the average size of
loans underwritten by the Company. A significant decline in long-term interest
rates could decrease the size of the Company's loan servicing portfolio by
increasing the level of loan prepayments, thereby shortening the life and
reducing the value of the Company's interest-only strips and also reduce the
gains on loan dispositions. A substantial and sustained increase in short-term
interest rates could, among other things, (i) increase the Company's borrowing
cost and (ii) reduce the gains recognized by the Company upon their
securitization and sale of loans.

            Year 2000 Compliance and Technology Enhancements. As part of the
Company's overall systems enhancement program, the Company is utilizing both
internal and external resources to identify, correct, reprogram or replace, and
test its systems for year 2000 compliance. It is anticipated that all of the
Company's year 2000 compliance efforts will be completed on time. There can be
no assurance, however, that the systems of other companies on which the
Company's systems rely will be timely reprogrammed for year 2000 compliance.

            The Company has recently installed and is testing a year 2000
compliant loan origination system that is expected to add approximately $2.0
million per year to the Company's technology costs over the next three years.
Other technology enhancements are being reviewed but, to date, the costs for
such enhancements have not been determined.

            Prepayment Risk. If actual prepayments occur more quickly than was
projected at the time loans were sold, the carrying value of the interest-only
strips may have to be adjusted through a charge to earnings in the period of
adjustment. Non-cash gain on sale on securitizations has historically been the
most significant component of the Company's reported revenues. Gain on sale
represents the recognition of the present value of the excess cash flow on
securitized loans, which is based on certain estimates made by management at the
time loans are sold, including estimates regarding prepayment rates. The rate of
prepayment of loans may be affected by a variety of economic and other factors,
as discussed above. Estimates of prepayment rates are made based on management's
expectations of future prepayment rates, which are based, in part, on the
historic performance of the Company's loans and other considerations. See "-
Certain Accounting Considerations." There can be no assurance of the accuracy of
management's estimates.

            Credit Risk. Loans made to borrowers in the lower credit grades have
historically resulted in a higher risk of delinquency and loss than loans made
to borrowers who utilize conventional mortgage sources. While the Company
believes that the underwriting criteria and collection methods it employs enable
it to mitigate the higher risks inherent in loans made to these borrowers, no
assurance can be given that such criteria or methods will afford adequate
protection against such risks.


                                       37

<PAGE>   38

In the event that loans originated and purchased by the Company experience
higher delinquencies, foreclosures or losses than anticipated, the Company's
results of operations or financial condition could be adversely affected.

            Collateral securing the Company's loans may not be sufficient to
cover the principal amount of the loans in the event of liquidation. Losses not
covered by the underlying properties, if in excess of the Company's provision
for such losses, could have a material adverse effect on the Company's results
of operations and financial condition. In addition, historical loss rates affect
the assumptions used by the Company in computing its non-cash gain on sale.

            Adjustable rate loans account for a substantial portion of the
mortgage loans originated or purchased by the Company. Substantially all such
adjustable rate mortgages include a "teaser" rate, i.e., an initial interest
rate significantly below the fully indexed interest rate at origination.
Although these loans are underwritten at the indexed rate as of the first
adjustment date, credit-impaired borrowers may encounter financial difficulties
as a result of increases in the interest rate over the life of the loan.

            Basis Risk. The value of the Company's interest-only strips created
as a result of the securitization of adjustable rate mortgage ("ARM") loans is
subject to so-called basis risk. Basis risk arises when the ARM (including fixed
initial rate mortgage) loans in a securitization trust bear interest based on an
index or adjustment period that is different from the mortgage-backed securities
issued by the trust. Accordingly, in the absence of effective hedging
strategies, in a period of increasing interest rates, the value of the
interest-only strips would be adversely affected because the interest rates on
the mortgage-backed securities issued by a securitization trust could adjust
faster than the interest rates on the Company's ARMs in the trust. Moreover,
ARMs are typically subject to periodic and lifetime interest rate caps, which
limit the amount an ARM's interest rate can change during any given period.
Hence, in a period of rapidly increasing interest rates, the value of the
interest-only strips could be adversely affected in the absence of effective
hedging strategies because the interest rates on the mortgage-backed securities
issued by a securitization trust could increase without limitation by caps,
while the interest rates on the Company's ARMs would be so limited.

            Dependence on Funding Sources. The Company is dependent upon its
access to warehouse and other credit facilities in order to fund new
originations and purchases of mortgage loans pending securitization or sale. At
December 31, 1998, the Company effectively was limited to one $300 million
committed warehouse line. This line expires in April 1999 and will most likely
not be renewed. Effective February 10, 1999 and conditioned upon the Initial
Closing occurring, the Company obtained two additional committed repurchase
lines with aggregate borrowing capacity of $400 million and one $100 million
uncommitted repurchase line. In September 1998, the Company entered into a $50
million revolving line of credit secured by its interest-only strips which
expires on September 3, 1999. The Company currently has $20 million outstanding
on this line. The Company is currently in negotiations with this line's lender
for an additional repurchase facility. Management expects that any such
repurchase facility will be conditioned, in part, on the prepayment and
accelerated expiration of the revolving line of credit. The Company is currently
negotiating with


                                       38

<PAGE>   39

various financial institutions and investment banks to obtain additional credit
facilities. There can be no assurance that the Company will be able to secure
such financing. Further, there can be no assurance that such financing will be
obtainable on favorable terms. To the extent that the Company is unable to
maintain existing facilities, arrange new warehouse or other credit facilities
or obtain additional forward commitments, the Company may have to curtail loan
origination and purchasing activities, which would have a material adverse
effect on the Company's financial position and results of operations and
jeopardize the Company's ability to continue to operate as a going concern.

            Risk of Adverse Changes in the Secondary Market for Mortgage Loans.
The Company's ability to sell loans originated and purchased by it in the
secondary market is necessary to generate cash proceeds to pay down its
warehouse facilities and fund new originations and purchases. See "-- Dependence
on Funding Sources." The ability of the Company to sell loans in the secondary
market on acceptable terms is essential for the continuation of the Company's
loan origination and purchase operations. The value of and market for the
Company's loans are dependent upon a number of factors, including general
economic conditions, interest rates and governmental regulations. Adverse
changes in such factors may affect the Company's ability to securitize or sell
whole loans for acceptable prices within a reasonable period of time. Adverse
changes in the global markets severely weakened the asset-backed market.
Although the asset-backed market has shown some recent improvement, many
subprime lenders have continued to rely more heavily on the whole loan market
for liquidity. This has resulted in an abundant supply of loans in the whole
loan market thereby putting downward pressure on the price for loans so sold and
tightening underwriting guidelines for loans to be purchased. In response to
these conditions, the Company increased its prices and modified its underwriting
guidelines. There can be no assurance, however, that these changes will make the
whole loan market more profitable for, or more accessible to, the Company.

            The Company has in the past sold a substantial portion of its loans
through securitizations, and will again securitize a significant portion of its
loans. In order to gain access to the secondary market in securitization
transactions, the Company has utilized monoline insurance companies to provide
financial guarantee insurance on the senior interests in loans sold in the
secondary market in order to obtain ratings for such interests. Although the
Company has used the senior/subordinated structure, which relies on the internal
credit enhancements of the pool rather than monoline insurance, the Company
expects to utilize monoline insurance companies for at least a portion of its
future securitizations. Any substantial reduction in the size or availability of
the secondary market for the Company's loans, or the unwillingness of the
monoline insurance companies to provide financial guarantee insurance for the
senior interests in loans sold in the secondary market, or other accounting, tax
or regulatory changes adversely affecting the Company's securitization program,
could have a material adverse effect on the Company's financial position and
results of operations.

            With its strategy of selling a portion of its loans on a whole loan
basis in the secondary market, the Company relies on institutional purchasers,
such as investment banks, financial institutions and other mortgage lenders, to
purchase loans directly from the Company. There can be no assurance that such
purchasers will be willing to purchase loans on terms satisfactory to the
Company or that the market for such loans will continue. To the extent the
Company cannot


                                       39

<PAGE>   40

successfully identify whole loan purchasers or negotiate favorable terms for
loan purchases, the Company's results of operations and financial condition
could be materially adversely affected.

            Dependence on Broker Network. The Company depends on independent
mortgage brokers for the origination and purchase of its broker loans, which
constitute a significant portion of the Company's loan production. These
independent mortgage brokers negotiate with multiple lenders for each
prospective borrower. The Company competes with these lenders for the
independent brokers' business on pricing, service, loan fees, costs and other
factors. The Company's competitors also seek to establish relationships with
such brokers, who are not obligated by contract or otherwise to do business with
the Company. The Company's future results of operations and financial condition
may be vulnerable to changes in the volume and cost of its broker loans
resulting from, among other things, competition from other lenders and
purchasers of such loans.

            Competition. The Company faces intense competition in the business
of originating, purchasing and selling mortgage loans. Competition among
industry participants can take many forms, including convenience in obtaining a
loan, customer service, marketing and distribution channels, amount and term of
the loan, loan origination fees and interest rates. Many of the Company's
competitors are substantially larger and have considerably greater financial,
technical and marketing resources than the Company. The Company's competitors in
the industry include other consumer finance companies, mortgage banking
companies, commercial banks, investment banks, credit unions, thrift
institutions, credit card issuers and insurance companies. In the future, the
Company may also face competition from government-sponsored entities, such as
FNMA and FHLMC. These government-sponsored entities may enter the subprime
mortgage market and target potential customers in the Company's highest credit
grades, who constitute a significant portion of the Company's customer base.

            The historical level of gains realized by the Company and its
competitors on the sale of non-conforming mortgage loans could attract
additional competitors into this market. Certain large finance companies and
conforming mortgage originators have announced their intention to originate, or
have purchased companies that originate and purchase, non-conforming mortgage
loans, and some of these large mortgage companies, thrifts and commercial banks
have begun offering non-conforming loan products to customers similar to the
borrowers targeted by the Company. In addition, establishing a broker-sourced
loan business requires a substantially smaller commitment of capital and human
resources than a direct-sourced loan business. This relatively low barrier to
entry permits new competitors to enter this market quickly and compete with the
Company's wholesale lending business.

            Additional competition may lower the rates the Company can charge
borrowers and increase the cost to purchase loans, thereby potentially lowering
the gain on future loan sales or securitizations. Increased competition may also
reduce the volume of the Company's loan origination and loan sales and increase
the demand for the Company's experienced personnel and the potential that such
personnel will leave the Company for the Company's competitors.



                                       40

<PAGE>   41

            Competitors with lower costs of capital have a competitive advantage
over the Company. During periods of declining rates, competitors may solicit the
Company's customers to refinance their loans. In addition, during periods of
economic slowdown or recession, the Company's borrowers may face financial
difficulties and be more receptive to the offers of the Company's competitors to
refinance their loans.

            The Company's correspondent and broker programs depend largely on
independent mortgage bankers and brokers and other financial institutions for
the purchases of new loans. The Company's competitors also seek to establish
relationships with the same sources. The Company's future results may become
more exposed to fluctuations in the volume and cost of the Company's purchases
resulting from competition from other purchasers of such loans, market
conditions and other factors.

            Concentration of Operations in California. At December 31, 1998, a
significant portion of the loans serviced by the Company were secured by
properties located in California. Because the Company's servicing portfolio is
currently 21.5% concentrated in California, the Company's financial position and
results of operations have been and are expected to continue to be influenced by
general trends in the California economy and its residential real estate market.
Residential real estate market declines may adversely affect the values of the
properties securing loans such that the principal balances of such loans,
together with any primary financing on the mortgaged properties, will equal or
exceed the value of the mortgaged properties. In addition, California
historically has been vulnerable to certain natural disaster risks, such as
earthquakes and erosion-caused mudslides, which are not typically covered by the
standard hazard insurance policies maintained by borrowers. Uninsured disasters
may adversely impact the Company's ability to recover losses on properties
affected by such disasters and adversely impact the Company's results of
operations.

            Timing of Loan Sales. The Company's loan disposition strategy calls
for substantially all of its production to be sold in the secondary market each
quarter. However, market and other considerations, including the conformity of
loan pools to monoline insurance company and rating agency requirements, could
affect the timing of such transactions. Any delay in the sale of a significant
portion of the Company's loan production beyond a quarter-end would postpone the
recognition of gain on sale related to such loans until their sale and would
likely result in losses for such quarter being reported by the Company.

            Economic Conditions. The risks associated with the Company's
business become more acute in any economic slowdown or recession. Periods of
economic slowdown or recession may be accompanied by decreased demand for
consumer credit and declining real estate values. Any material decline in real
estate values reduces the ability of borrowers to use home equity to support
borrowings and increases the current combined loan-to-value ratios of loans
previously made by the Company, thereby weakening collateral coverage and
increasing the possibility of a loss in the event of liquidation. Further,
delinquencies, foreclosures and losses generally increase during economic
slowdowns or recessions. Because of the Company's focus on credit-impaired
borrowers, the actual rates of delinquencies, foreclosures and losses on such
loans could be higher than those generally experienced in the mortgage lending
industry. In addition, in an economic slowdown or recession,


                                       41

<PAGE>   42

the Company's servicing costs may increase. Any sustained period of increased
delinquencies, foreclosure, losses or increased costs could adversely affect the
Company's ability to securitize or sell loans in the secondary market and could
increase the cost of these transactions. See "-- Credit Risk" and "-- Risk of
Adverse Changes in the Secondary Market for Mortgage Loans."

            Contingent Risks. Although the Company sells substantially all the
mortgage loans which it originates or purchases, the Company retains some degree
of credit risk on substantially all loans sold on a servicing retained basis.
During the period of time that loans are held pending sale, the Company is
subject to the various business risks associated with the lending business
including the risk of borrower default, the risk of foreclosure and the risk
that a rapid increase in interest rates would result in a decline in the value
of loans to potential purchasers. The documents governing the Company's
securitization program require the Company to establish deposit accounts or
build overcollateralization levels through retention of excess cash flow
distributions in such accounts or application of excess cash flow distributions
to reduce the principal balances of the senior interests issued by the related
trust, respectively. Such amounts serve as credit enhancement for the related
trust and are therefore available to fund losses realized on loans held by such
trust. The Company continues to be subject to the risks of default and
foreclosure following securitization and the sale of loans to the extent of
excess cash flow distributions required to be retained or applied to reduce
principal from time-to-time. Such amounts are a condition to obtaining the
requisite rating on the related interests in each trust. In addition, documents
governing the Company's securitization program and whole loan sales require the
Company to commit to repurchase or replace loans which do not conform to the
representations and warranties made by the Company at the time of sale.

            When borrowers are delinquent in making monthly payments on loans
included in a securitization trust, the Company is required to advance interest
payments with respect to such delinquent loans. These advances require funding
from the Company's capital resources but have priority of repayment from
collections or recoveries on the loans in the related pool in the succeeding
month.

            In the ordinary course of its business, the Company is subject to
claims made against it by borrowers and private investors arising from, among
other things, losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of employees and officers of the Company, incomplete documentation and
failures by the Company to comply with various laws and regulations applicable
to its business. The Company believes that liability with respect to any
currently asserted claims or legal actions is not likely to be material to the
Company's financial position or results of operations; however, any claims
asserted in the future may result in legal expenses or liabilities which could
have a material adverse effect on the Company's financial position and results
of operations.

            Government Regulation. The Company's operations are subject to
extensive regulation, supervision and licensing by federal, state and local
governmental authorities and are subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on part or all
of its operations. The Company's consumer lending activities are subject to the
Federal Truth-


                                       42

<PAGE>   43

in-Lending Act and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994), the Federal Equal Credit Opportunity Act, as amended,
and Regulation B, the Fair Credit Reporting Act of 1970, as amended, the Federal
Real Estate Settlement Procedures Act and Regulation X, the Home Mortgage
Disclosure Act, the Federal Debt Collection Practices Act and the National
Housing Act of 1934, as well as other federal and state statutes and regulations
affecting the Company's activities. The Company is also subject to the rules and
regulations of, and examinations by, state regulatory authorities with respect
to originating, processing, underwriting, selling, securitizing and servicing
loans. These rules and regulations, among other things, impose licensing
obligations on the Company, establish eligibility criteria for mortgage loans,
prohibit discrimination, govern inspections and appraisals of properties and
credit reports on loan applicants, regulate assessment, collection, foreclosure
and claims handling, investment and interest payments on escrow balances and
payment features, mandate certain disclosures and notices to borrowers and, in
some cases, fix maximum interest rates, fees and mortgage loan amounts. Failure
to comply with these requirements can lead to loss of approved status, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement action.

          Members of Congress and government officials have from time-to-time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.

ITEM 3.             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

           Securitizations - Hedging Interest Rate Risk. The most significant
variable in the determination of gain on sale in a securitization is the spread
between the weighted average coupon on the securitized loans and the
pass-through interest rate. In the interim period between loan origination or
purchase and securitization of such loans, the Company is exposed to interest
rate risk. The majority of loans are securitized or sold within 90 days of
origination or purchase. However, a portion of the loans are held for sale or
securitization for as long as 12 months (or longer, in very limited
circumstances) prior to securitization. If interest rates rise during the period
that the mortgage loans are held, in the case of a securitization, the spread
between the weighted average interest rate on the loans to be securitized and
the pass-through interest rates on the securities to be sold (the latter having
increased as a result of market rate movements) would narrow. Upon
securitization, this would result in a reduction of the Company's related gain
on sale. During the three and six months ended December 31,1998, gain on sale
included a hedge gain of $1.8 million and a hedge loss of $13.5 million,
respectively.

           Interest-Only Strips and OMSRs. The Company had interest-only strips
of $323 million and $490 million outstanding at December 31, 1998 and June 30,
1998, respectively. The Company also


                                       43

<PAGE>   44

had OMSRs outstanding at December 31, 1998 and June 30, 1998 in the amount of
$34.5 million and $32.1 million, respectively. Both of these instruments are
valued at market at December 31, 1998 and June 30, 1998. The Company values
these assets based on the present value of future cash flow streams net of
expenses using various assumptions. See "Certain Accounting Considerations --
Accounting for Securitizations."

          These assets are subject to risk of accelerated mortgage prepayment or
losses in excess of assumptions used in valuation. Ultimate cash flows realized
from these assets would be reduced should prepayments or losses exceed
assumptions used in the valuation. Conversely, cash flows realized would be
greater should prepayments or losses be below expectations.


PART II - OTHER INFORMATION

Item 6.                       Exhibits and Reports on Form 8-K

<TABLE>
<S>                 <C>
          (a)       Exhibits

          3.3       Certificate of Designation for Registrant's Series B Convertible Preferred Stock

          3.4       Certificate of Designation for Registrant's Series C Convertible Preferred Stock

          4.2(c)    Amendment to Rights Agreement, dated as of December 23, 1998 (1)

          4.7       Registration Rights Agreement, dated as of December 23, 1998 between Registrant
                    and Capital Z Financial Services Fund II, L.P., and certain designated investors

          10.22(b)  First Amendment to Residuals Financing Agreement, dated as of October 6, 1998
                    between Registrant and NationsBank, N.A.

          10.22(c)  Second Amendment to Residual Financing Agreement, dated as of December 10,
                    1998 between Registrant and NationsBank, N.A.

          10.23(a)  Employment Agreement between Registrant and Cary H. Thompson

          10.23(b)  Amendment No. 1 to the Employment Agreement between the Registrant and
                    Cary H. Thompson.

          10.24     Management Investment Agreement between Registrant and Cary H. Thompson,
                    dated as of February 10, 1999.

          10.25     Employment Agreement between Registrant and Neil B. Kornswiet

          10.26     Management Investment Agreement between Registrant and Neil B. Kornswiet,
                    dated as of February 10, 1999.

          10.27     Management Voting Agreement between Registrant, Cary H. Thompson and
                    Neil B. Kornswiet, dated as of February 10, 1999.
</TABLE>



                                       44

<PAGE>   45

<TABLE>
<S>                 <C>
          10.28(a)  Preferred Stock Purchase Agreement, dated as of December 23, 1998 between
                    Registrant and Capital Z Financial Services Fund II, L.P. (1)

          10.28(b)  Amendment No. 1 to Preferred Stock Purchase Agreement, dated as of February 10,
                    1999 between Registrant and Capital Z Financial Services Fund II, L.P.

          10.29     Second Supplemental Indenture, dated as of February 10, 1999, between Registrant,
                    The Chase Manhattan Bank and certain wholly owned subsidiaries of Registrant,
                    relating to Registrant's 9.125% Senior Notes due 2003.

          11        Computation of Per Share Earnings (Loss)

          27        Financial Disclosure Schedule
</TABLE>

          ------------
          (1) Incorporated by reference from Registrant's Current Report on Form
          8-K dated December 31, 1998

          (b) Reports on Form 8-K: During the fiscal quarter ended December 31,
          1998, the Company filed (i) a Current Report on Form 8-K dated
          November 17, 1998 (earliest event reported November 16, 1998),
          reporting information under Item 5 with respect to discussions with a
          strategic partner for an equity infusion in the Company, first quarter
          earnings, production volume, the execution of a forward commitment, a
          loss on the Company's hedge position and cancellation of the Company's
          regular quarterly dividend; (ii) a Current Report on Form 8-K dated
          December 15, 1998 (earliest event reported December 14, 1998),
          reporting information under Item 5 with respect to the execution of
          the Second Amendment to the Residuals Financing Agreement by and among
          the Company and NationsBank, N.A. and the postponement of the
          Company's 1998 Annual Meeting; and (iii) a Current Report on Form 8-K
          dated December 31, 1998 (earliest event reported December 23, 1998),
          reporting information under Item 5 with respect to the execution of
          the Preferred Stock Purchase Agreement by and between the Company and
          Capital Z Financial Services Fund II, L.P. and an amendment of the
          Company's Rights Agreement.



                                

                                       45

<PAGE>   46
                           AAMES FINANCIAL CORPORATION

                                   SIGNATURES






          Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, the Registrant has duly caused this Report on Form 10-Q to be signed
on its behalf by the undersigned, thereunto duly authorized.












                                         AAMES FINANCIAL CORPORATION



Date: February 22, 1999                  By:  /s/  David A. Sklar
                                              ----------------------
                                              David A. Sklar
                                              Executive Vice President-Finance
                                              and Chief Financial and
                                              Accounting Officer





                                       46

<PAGE>   47
                          AAMES FINANCIAL CORPORATION

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>

EXHIBIT
NUMBER                                DESCRIPTION
-------                               -----------
<S>                 <C>

          3.3       Certificate of Designation for Registrant's Series B Convertible Preferred Stock

          3.4       Certificate of Designation for Registrant's Series C Convertible Preferred Stock

          4.2(c)    Amendment to Rights Agreement, dated as of December 23, 1998 (1)

          4.7       Registration Rights Agreement, dated as of December 23, 1998 between Registrant
                    and Capital Z Financial Services Fund II, L.P., and certain designated investors

          10.22(b)  First Amendment to Residuals Financing Agreement, dated as of October 6, 1998
                    between Registrant and NationsBank, N.A.

          10.22(c)  Second Amendment to Residual Financing Agreement, dated as of December 10,
                    1998 between Registrant and NationsBank, N.A.

          10.23(a)  Employment Agreement between Registrant and Cary H. Thompson

          10.23(b)  Amendment No. 1 to the Employment Agreement between the Registrant and
                    Cary H. Thompson.

          10.24     Management Investment Agreement between Registrant and Cary H. Thompson,
                    dated as of February 10, 1999.

          10.25     Employment Agreement between Registrant and Neil B. Kornswiet

          10.26     Management Investment Agreement between Registrant and Neil B. Kornswiet,
                    dated as of February 10, 1999.

          10.27     Management Voting Agreement between Registrant, Cary H. Thompson and
                    Neil B. Kornswiet, dated as of February 10, 1999.

          10.28(a)  Preferred Stock Purchase Agreement, dated as of December 23, 1998 between
                    Registrant and Capital Z Financial Services Fund II, L.P. (1)

          10.28(b)  Amendment No. 1 to Preferred Stock Purchase Agreement, dated as of February 10,
                    1999 between Registrant and Capital Z Financial Services Fund II, L.P.

          10.29     Second Supplemental Indenture, dated as of February 10, 1999, between Registrant,
                    The Chase Manhattan Bank and certain wholly owned subsidiaries of Registrant,
                    relating to Registrant's 9.125% Senior Notes due 2003.

          11        Computation of Per Share Earnings (Loss)

          27        Financial Disclosure Schedule
</TABLE>

          ------------
          (1) Incorporated by reference from Registrant's Current Report on Form
          8-K dated December 31, 1998