**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





**[x]**
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**For
                the fiscal year endedDecember
                31, 2005




**or**




**[
                ]**
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**For
                the transition period from _____________ to
                _____________





**Commission
      File Number:** **1-12109**









**DELTA
      FINANCIAL CORPORATION**


(Exact
      name of registrant as specified in its charter)





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





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


(Address
      of principal executive offices) (Zip code)





**(516)
      364 - 8500**


(Registrant’s
      telephone number, including area code)





**Securities
      registered pursuant to Section 12(b) of the Act:**





**Common
                stock, par value $0.01 per share**
            
            **American
                Stock Exchange**(Title
                of each class)
            
            (Name
                of each exchange on which
                registered)





**Securities
      registered pursuant to Section 12(g) of the Act:** **None.**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes [ ]  No [ x
      ]





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or 15(d) of the Exchange Act. Yes [ ]  No [ x
      ]





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





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. [  ]





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




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





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








As
      of
      June 30, 2005, the aggregate market value of the voting stock held by
      non-affiliates of the Registrant, based on the closing price of $9.51 for such
      stock on that date, was approximately $108.4 million.





As
      of
      March 2, 2006, 20,462,587 shares of the Registrant’s common stock, par value
      $0.01 per share, were outstanding.





**DOCUMENTS
      INCORPORATED BY REFERENCE:**





Part
      III,
      Items 10, 11, 12, 13 and 14 are incorporated by reference from Delta Financial
      Corporation’s definitive proxy statement to stockholders, which will be filed
      with the Securities and Exchange Commission no later than 120 days after
      December 31, 2005.





**2**




**Delta
                  Financial Corporation****Table
                  of Contents****Part
                  I**Item
                  1.
              Business
              1Item
                  1A.
              Risk
                  Factors
              23Item
                  1B.
              Unresolved
                  Staff Comments
              40Item
                  2.
              Properties
              40Item
                  3.
              Legal
                  Proceedings
              40Item
                  4.
              Submission
                  of Matters to a Vote of Security
                  Holders
              43**Part
                  II**Item
                  5.
              Market
                  for the Registrant’s Common Equity,
                  Related Stockholder Matters and Issuer Purchases of Equity
                  Securities
              43Item
                  6.
              Selected
                  Financial Data
              45Item
                  7.
              Management’s
                  Discussion and Analysis of
                  Financial Condition and Results of Operation
              47Item
                  7A.
              Quantitative
                  and Qualitative Disclosures About Market
                  Risk
              76Item
                  8.
              Financial
                  Statements and Supplementary
                  Data
              78Item
                  9.
              Changes
                  in and Disagreements with
                  Accountants on Accounting and Financial Disclosure
              112Item
                  9A.
              Controls
                  and Procedures
              112Item
                  9B.
              Other
                  Information
              112**Part
                  III**Item
                  10.
              Directors
                  and Executive Officers of the
                  Registrant
              113Item
                  11.
              Executive
                  Compensation
              113Item
                  12.
              Security
                  Ownership of Certain Beneficial Owners
                  and Management and Related Shareholder Matters
              113Item
                  13.
              Certain
                  Relationships and Related
                  Transactions
              113Item
                  14.
              Principal
                  Accountant Fees and
                  Services
              113**Part
                  IV**Item
                  15.
              Exhibits
                  and Financial Statement
                  Schedules
              114**Signatures**
              115










**PART
      I**


**Item
      1. Business.**





*An
      investment in Delta Financial Corporation common stock involves substantial
      risks and uncertainties. Delta Financial Corporation encourages you to carefully
      review the information set forth under the caption “Forward Looking Statements
      and Risk Factors” and “Risk Factors” on page 20 for a description of some of
      these uncertainties.*





**Description
      of Our Business**




Delta
        Financial Corporation (and collectively with its wholly owned subsidiaries,
        the
“Company,” “we” or “us” and on a stand-alone basis “Delta Financial” or the
“Holding Company”) is a national specialty consumer finance company that
        originates, securitizes and sells (and, prior to May 2001, serviced)
        non-conforming mortgage loans. We were incorporated in 1996 as a Delaware
        corporation (prior to which we had been organized in 1982 as Delta Funding
        Corporation, a New York corporation). Our corporate offices are located at
        1000
        Woodbury Road, Woodbury, NY 11797 and we can be contacted at (516) 364-8500
        or
        through our Internet website at www.deltafinancial.com. We file annual,
        quarterly and special reports, proxy statements and other information with
        the
        Securities and Exchange Commission (“SEC”). You may access our filings with the
        SEC at no cost from the SEC’s website at http://www.sec.gov ,
        or on
        the Investor Relations page of our website. Information appearing on our
        website
        will not be deemed to be part of this report.
 
 Our
        loans
        primarily are secured by first mortgages on one- to four-family residential
        properties. Throughout our 24-year operating history, we have focused on
        lending
        to individuals who generally do not satisfy the credit, documentation or
        other
        underwriting standards set by more traditional sources of mortgage credit,
        including those entities that make loans in compliance with the conforming
        lending guidelines of Fannie Mae and Freddie Mac. We make mortgage loans
        to
        these borrowers for purposes such as debt consolidation, refinancing, education
        and home improvements.


We
      provide our customers with a variety of loan products designed to meet their
      needs, using a risk-based pricing strategy to develop products for different
      risk categories. Historically, the majority of our loan production has been
      fixed-rate with amortization schedules ranging from five years to 30 years.
      In
      2005, our average loan size was approximately $154,000 and, at the time of
      origination, the weighted average interest rate was 8.0%, the weighted average
      combined loan-to-value (“CLTV”) ratio was 78.8% and the weighted average credit
      score of the underlying borrowers was approximately 628. Since 2001, at least
      37% of our annual loan production has been related to borrowers located in
      either New York, New Jersey or Pennsylvania.





We
      adhere
      to our Best Practice Lending Program aimed at ensuring the origination of
      quality loans and helping to better protect consumers. This Best Practice
      Lending Program includes:





§
            fair
                lending initiatives aimed at ensuring that all borrowers are treated
                fairly and similarly regardless of race, color, creed, religion,
                national
                origin, sex, sexual orientation, marital status, age, disability
                and the
                applicant’s exercise, in good faith, of any right under the Consumer
                Credit Protection Act;





§
            oversight
                of mortgage brokers and closing
                agents;





§
            fraud
                detection and protection;





§
            Plain
                English disclosures; and





§
            other
                originations and underwriting initiatives which we believe help protect
                consumers.





We make mortgage loans to individual borrowers, which are a cash outlay for
        us.
        At the time we originate a loan, and prior to the time we securitize or sell
        the
        loan, we either finance the loan by borrowing under our warehouse lines of
        credit or utilizing our available working capital. Following this initial
        holding period, we either securitize our loans or sell them on a whole-loan
        basis, using the net proceeds from these transactions to repay our warehouse
        lines of credit and for working capital. Since the first quarter of 2004,
        we
        have structured our securitizations to be accounted for as on-balance sheet
        financings, in which we record interest income on the outstanding portfolio
        of
        loans in each securitization trust and interest expense from the pass-through
        securities issued by each securitization trust over time. Prior to 2004,
        we
        structured our securitizations to be accounted for as sales, which required
        us
        to record cash and non-cash revenues as gain-on-sale at the time the
        securitizations were completed. When we sell loans on a whole-loan basis,
        we
        record the premiums received upon sale as revenue, net of any premium recapture
        reserves. (See “-Origination of Mortgage Loans - Securitizations and Whole Loan
        Sales”).
 **1**


**Business
      Strategy**




Our
        core
        business strategy is to securitize the majority of our loan originations,
        and
        thereby increase the size of our on-balance sheet securitized loan portfolio,
        which we believe will ultimately help provide a relatively consistent source
        of
        income in the upcoming years. As part of this strategy, we will seek to continue
        to increase our overall loan production, while maintaining our adherence
        to
        stringent underwriting standards. We plan to increase loan production
        by:
 
 ***Strengthening
        our loan production capabilities*** **.** In 2005,
        we expanded our wholesale origination platform by hiring more commissioned-based
        account executives, and opened a regional office. At the same time, we expanded
        our retail origination platform by growing our existing loan origination
        centers, added a new origination center and hired more mortgage analysts.
        In
        2006, we plan to further penetrate existing and new markets by continuing
        to
        hire additional account executives for our wholesale channel and hiring more
        mortgage analysts in our retail channel. We believe that our 11 retail loan
        origination centers currently have the capacity to add a meaningful number
        of
        mortgage analysts without incurring significant capital
        expenditures.
 
 ***Building
        a portfolio of loans on our balance sheet*** **.** We
        intend to continue to structure our securitizations to be accounted for as
        secured financings and to securitize the majority of the mortgage loans we
        originate so as to increase the size of our on-balance sheet loan portfolio
        that
        generates interest income. As the size of our loan portfolio continues to
        increase in 2006, compared to 2005, we anticipate recording increased net
        interest income generated from our on-balance sheet loan portfolio.
 
 ***Maintaining
        our stringent loan underwriting standards*** **.** While we
        are focused on growing our loan originations and loan portfolio, we intend
        to
        continue to assess our extensive database of proprietary loan-level performance
        data to adjust our risk-based pricing model and underwriting guidelines.
        By
        doing so, we believe we can continue to originate quality mortgage
        loans.
 
 ***Capitalizing
        on our operating leverage.*** We
        intend to capitalize on our operating leverage by lowering our cost to originate
        loans as a percentage of mortgage loans originated by increasing our origination
        volume at a faster pace than the increase in expenses over the same period.
        We
        believe we will be able to use advances in technology and, in particular,
        our
        proprietary loan origination system Click & Close ® (“C&C”)
        to reduce our loan origination costs while increasing efficiency and providing
        a
        high level of service.
 
 **Origination
        of Mortgage Loans**
 
 We
        originate mortgage loans through two distribution channels, wholesale and
        retail. In the wholesale channel, we receive loan applications from independent
        third-party mortgage brokers, who submit applications on a borrower’s behalf. In
        the retail channel, we receive loan applications directly from borrowers.
        We
        process and underwrite the submission and, if the loan conforms to our
        underwriting criteria, approve the loan and lend the money to the borrower.
        We
        underwrite loan packages for approval through our Woodbury, New York
        headquarters, our Cincinnati, Ohio underwriting hub, and our regional offices
        in
        Phoenix, Arizona; Jacksonville, Florida; Boston, Massachusetts; and Dallas,
        Texas. We also purchase closed loans on a limited basis. (See “-Wholesale Loan
        Channel”).


For
      the
      year ended December 31, 2005, we originated $3.8 billion of loans, an increase
      of $1.2 billion, or 46.9%, over the $2.6 billion of loans originated in the
      year
      ended December 31, 2004. The amount originated in 2005 included approximately
      $2.0 billion of wholesale loans, representing 53.9% of total loan
      production, and $1.8 billion of retail loans, representing 46.1% of total loan
      production, compared to $1.5 billion of wholesale loans, or 57.4% of total
      loan production, and $1.1 billion of retail loans, or 42.6% of total loan
      production, during the year ended December 31, 2004.





**2**




The
      following table shows certain data regarding our loans, presented by channel
      of
      loan originations, for the years ended December 31, 2005, 2004 and
      2003:




**For
                  the Year Ended December 31,***(Dollars
                  in thousands)*
              
              **2005**
              
              **2004**
              
              **2003****Wholesale:**Number
                  of loans
              
              
              10,982
              
              
              8,434
              
              
              6,087Principal
                  balance
              
              $
              2,065,638
              
              $
              1,497,743
              
              $
              1,005,484Average
                  principal balance per loan
              
              
              188
              
              
              178
              
              
              165Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              77.5
              %
              
              76.5
              %
              
              74.2
              %Weighted
                  average interest rate
              
              
              7.7
              %
              
              7.7
              %
              
              8.0
              %Weighted
                  average credit score
              
              
              618
              
              
              623
              
              
              622**Retail:**Number
                  of loans
              
              
              13,927
              
              
              9,259
              
              
              6,309Principal
                  balance
              
              $
              1,770,007
              
              $
              1,113,783
              
              $
              707,253Average
                  principal balance per loan
              
              
              127
              
              
              120
              
              
              112Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              80.2
              %
              
              80.0
              %
              
              79.6
              %Weighted
                  average interest rate
              
              
              8.3
              %
              
              8.1
              %
              
              8.3
              %Weighted
                  average credit score
              
              
              639
              
              
              640
              
              
              633**Total Wholesale
                  and Retail:**Number
                  of loans
              
              
              24,909
              
              
              17,693
              
              
              12,396Principal
                  balance
              
              $
              3,835,645
              
              $
              2,611,526
              
              $
              1,712,737Average
                  principal balance per loan
              
              
              154
              
              
              148
              
              
              138Weighted
                  average initial LTV/CLTV ratio(1)
              
              
              78.8
              %
              
              78.0
              %
              
              76.4
              %Weighted
                  average interest rate
              
              
              8.0
              %
              
              7.9
              %
              
              8.1
              %Weighted
                  average credit score
              
              
              628
              
              
              630
              
              
              627**Percentage
                  of Loans Secured by:**First
                  mortgages
              
              
              97.8
              %
              
              97.7
              %
              
              97.7
              %Second
                  mortgages
              
              
              2.2
              %
              
              2.3
              %
              
              2.3
              %




*(1)*  *We
      determine the weighted average initial loan-to-value (“LTV”) ratio of a loan
      secured by a first mortgage by dividing the amount of the loan by the lesser
      of
      the purchase price or the appraised (or Insured Automated Valuation Model
      (“Insured AVM”)) value of the mortgage property at origination. We determine the
      weighted average CLTV ratio of a loan secured by a second mortgage by taking
      the
      sum of the loan secured by the first and second mortgages and dividing by the
      lesser of the purchase price or the appraised (or Insured AVM) value of the
      mortgage property at origination.*





**3**





The
      following table shows the weighted average interest rate and initial LTV or
      CLTV
      ratio by lien position for the years ended December 31, 2005, 2004 and
      2003:




**For
                  the Year Ended December 31,****2005**
              
              **2004**
              
              **2003****First
                  Mortgage:**Weighted
                  average initial LTV ratio(1)
              
              
              78.7
              %
              
              78.0
              %
              
              76.4
              %Weighted
                  average interest rate
              
              
              7.9
              %
              
              7.8
              %
              
              8.1
              %**Second
                  Mortgage:**Weighted
                  average initial CLTV ratio(1)
              
              
              80.2
              %
              
              80.1
              %
              
              78.5
              %Weighted
                  average interest rate
              
              
              9.3
              %
              
              9.1
              %
              
              9.3
              %
  *(1)*  *We
      determine the weighted average initial LTV ratio of a loan secured by a first
      mortgage by dividing the amount of the loan by the lesser of the purchase price
      or the appraised (or Insured AVM) value of the mortgage property at origination.
      We determine the weighted average initial CLTV ratio of a loan secured by a
      second mortgage by taking the sum of the loan secured by the first and second
      mortgages and dividing by the lesser of the purchase price or the appraised
      (or
      Insured AVM) value of the mortgage property at origination.*





The
      following table shows the geographic distribution of loan purchases and
      originations for the years ended December 31, 2005, 2004 and 2003:


**For
                  the Year Ended December 31,****2005**
              
              **2004**
              
              **2003****Percentage**
              
              **Amount**
              
              **Percentage**
              
              **Amount**
              
              **Percentage**
              
              **Amount****Region:**
              
              
              
              
              
              *(Dollars
                  in millions*)New
                  York, New Jerseyand
                  Pennsylvania
              
              
              37.7
              %
              $
              1,447.6
              
              
              41.5
              %
              $
              1,083.3
              
              
              45.8
              %
              $
              784.7Midwest
              
              
              16.0
              
              
              612.7
              
              
              17.8
              
              
              463.8
              
              
              16.8
              
              
              287.6Mid-Atlantic(1)
              
              
              14.4
              
              
              552.7
              
              
              15.3
              
              
              400.7
              
              
              17.8
              
              
              305.2Southeast
              
              
              15.5
              
              
              595.6
              
              
              10.1
              
              
              264.1
              
              
              7.4
              
              
              126.2New
                  England
              
              
              7.6
              
              
              290.8
              
              
              10.6
              
              
              277.7
              
              
              8.0
              
              
              136.5West
              
              
              8.8
              
              
              336.2
              
              
              4.7
              
              
              121.9
              
              
              4.2
              
              
              72.5Total
              
              
              100.0
              %
              $
              3,835.6
              
              
              100.0
              %
              $
              2,611.5
              
              
              100.0
              %
              $
              1,712.7


*(1)*  *Excluding
        New York, New Jersey and Pennsylvania.*


***Wholesale
        Loan Channel.*** Through
        our wholesale loan distribution channel, which is principally conducted out
        of
        our Woodbury, New York headquarters, we primarily originate mortgage loans
        indirectly through independent mortgage brokers and other real estate
        professionals who submit loan applications on behalf of borrowers. We currently
        originate the majority of our wholesale loans in 34 states, through a network
        of
        approximately 3,000 independent brokers. The brokers’ role is to source the
        business, identify the applicant, assist in completing the loan application,
        and
        process the loans, including, among other things, gathering the necessary
        information and documents, and serving as the liaison between the borrower
        and
        us through the entire origination process. We review, process and underwrite
        the
        applications submitted by the broker, approve or deny the application, set
        the
        interest rate and other terms of the loan and, upon acceptance by the borrower
        and satisfaction of all of the conditions that we impose as the lender, lend
        the
        money to the borrower. Due to the fact that brokers conduct their own marketing
        and employ their own personnel to complete loan applications and maintain
        contact with borrowers - for which they charge a broker fee - originating
        loans
        through our broker network generally allows us to increase our loan volume
        without incurring the higher marketing and employee costs associated with
        increased retail originations. Additionally, on a limited basis, we purchase
        loans on a flow basis from select independent correspondents. This typically
        involves purchasing individual loans shortly after the loans are originated,
        as
        opposed to bulk purchases, which entail purchasing typically larger pools
        of
        loans at one time. We re-underwrite each of these loans, in accordance with
        our
        underwriting standards, prior to purchasing. As
        of
        December 31, 2005, we employed 138 account executives focused exclusively
        on the
        broker community. For the year ended December 31, 2005, our wholesale
        network accounted for $2.0 billion, or 53.9% of our loan originations, compared
        to $1.5 billion, or 57.4%, of our loan originations for the year ended December
        31, 2004 and $1.0 billion, or 58.7%, of our loan originations for the year
        ended
        December 31, 2003. No single broker contributed more than 5.3%,  5.9%
        or
        5.0% of our total loan production in the years ended December 31, 2005, 2004
        and
        2003, respectively.
 **4**


*Wholesale
      Marketing.* Historically, we have established and maintained relationships with brokers
      offering non-conforming mortgage products.





Typically,
      we initiate contact with a broker through our Business Development Department,
      supervised by a senior officer with over 23 years of sales and marketing
      experience in the industry. We usually hire account executives that have
      contacts with brokers that originate non-conforming mortgage loans within their
      geographic territory. The account executives are responsible for developing
      and
      maintaining our broker network within their geographic territory by frequently
      visiting brokers, communicating our underwriting guidelines, disseminating
      new product information and pricing changes, soliciting loan leads, analyzing
      applications, providing pre-approvals and by demonstrating a continuing
      commitment to understanding the needs of the customer. The account executives
      attend industry trade shows and inform us about the products and pricing being
      offered by competitors and new market entrants. This information assists us
      in
      refining our programs and product offerings in order to remain competitive.
      Account executives are typically compensated with a base salary or draw, and
      commissions based on the volume of loans originated as a result of their
      efforts.





*Approval
      Process for Independent Mortgage Brokers.* Before a
      broker becomes part of our network, the broker must go through an approval
      process. Once approved, brokers may begin submitting applications and/or loans
      to us.





To
      be
      approved, a broker must:




·
              demonstrate
                  that he/she is properly licensed and registered in the state in
                  which
                  he/she seeks to transact business; and·
              sign
                  a standard broker agreement with us that requires the signer, among
                  other
                  things, to:·
              abide
                  by our fair lending policy;·
              follow
                  the National Association of Mortgage Brokers Best Practices
                  Policies;·
              comply
                  with all state and federal laws; and·
              submit
                  only true and accurate documents and
                  disclosures.




As
      part
      of the approval process we also perform searches on all new brokers using a
      third-party database that contains public and nonpublic information on
      individuals and companies that have incidents of potential fraud and
      misrepresentation. In addition, we regularly review the performance of loans
      originated through our brokers.





Once
      approved, a broker may submit loan applications for prospective borrowers.
      To
      process broker submissions, our broker originations channel is organized by
      geographic regions and into teams, each consisting of account executives and
      account managers/processors, which are generally assigned to specific brokers.
      Since we operate in a highly competitive environment where brokers often submit
      the same loan application to several prospective lenders simultaneously, we
      strive to provide brokers with a rapid and informed response. Account executives
      analyze the application and provide the broker with a preliminary approval,
      subject to final underwriting approval, or a denial, typically within the same
      business day. In addition, brokers can obtain preliminary approvals, typically
      within seconds, directly from our proprietary originations software program
      -
      Click & Close ® - by
      logging in and entering the basic loan information. Once a package is received
      from the broker, and the application is logged into C&C, the loan is
      automatically sent to an underwriting queue for review. If our underwriter
      approves the application, a “conditional approval” will be issued to the broker
      with a list of specific conditions to be met and additional documents to be
      supplied prior to funding the loan. The file is then queued back to the account
      manager/processor, who works directly with the submitting broker to collect
      the
      requested information, meet all underwriting conditions and send out all
      appropriate documentation and disclosures.





**5**


In
      most
      cases, we fund loans within 14 to 21 days after preliminary approval of the
      loan
      application. In the case of a denial, we will use reasonable efforts to ensure
      that there is no missing information concerning the borrower or the application
      that might change the denial decision on the loan.





We
      strive
      to have our account executives maintain the level of knowledge and experience
      integral to our commitment to provide the highest quality service for brokers.
      We believe that by maintaining an efficient, trained and experienced staff,
      we
      have addressed four central factors that influence where a broker sends its
      business:





§
            the
                service and support a lender
                provides;





§
            product
                offerings and pricing;





§
            the
                turn-around time, or speed in which a lender closes loans;
                and





§
            the
                lender’s knowledge concerning the broker and the broker’s
                business.





***Retail
      Loan Channel.*** Through
      our retail distribution channel, we develop retail loan leads primarily through
      our telemarketing system located in Cincinnati, Ohio, and also through Internet
      leads, direct mail, and our network of 11 origination centers located in 10
      states. We continually monitor the performance of our retail operations and
      evaluate current and potential retail office locations on the basis of selected
      demographic statistics, marketing analyses and other criteria that we have
      developed.





Typically,
      contact with the customer is handled initially through
      our telemarketing center. Through
      our marketing efforts, the retail loan channel is able to identify, locate
      and
      focus on individuals who, based on historic customer profiles, are likely
      customers for our products. Our telemarketing representatives identify
      interested customers and forward these potential borrowers to a branch manager
      through our C&C system. The branch managers, in turn, distribute these leads
      to mortgage analysts via C&C by queuing the loan to a mortgage analyst’s “to
      do” list in C&C. The assigned mortgage analyst discusses the applicant’s
      qualifications and available loan products, negotiates loan terms with the
      borrower, ensures
      that an appraisal has been ordered from an independent third party appraisal
      company (or may, when certain underwriting criteria have been met, obtain an
      Insured AVM value), orders a credit report from an independent, nationally
      recognized credit reporting agency and
      processes the loan through completion. Our
      mortgage analysts are trained to structure loans that meet the applicant’s needs
      while satisfying our lending guidelines. C&C
      is utilized to queue the loan to underwriters at the appropriate times for
      approvals and help to facilitate the loan application process through
      closing.  At
      December 31, 2005,we
      employed 413 loan officers, which represents a 13.2% increase over the 365
      loan
      officers employed at December 31, 2004. The
      retail
      channel accounted for $1.8 billion, or 46.1%, of our loan originations for
      the
      year ended December 31, 2005, compared to $1.1 billion, or 42.6%, of our loan
      originations for the year ended December 31, 2004 and $707.3 million, or 41.3%,
      of our loan originations for the year ended December 31, 2003. 
 ***Loan
        Underwriting***
  *Underwriting
        Guidelines.* We
        maintain written underwriting guidelines that are utilized by all of our
        employees associated with the underwriting process. Throughout our 24-year
        history, these guidelines have been reviewed and updated on an on-going basis
        by
        senior underwriters and the head of risk management. We provide our underwriting
        guidelines to all of the brokers from whom we accept loan applications. Loan
        applications are classified according to particular characteristics, including,
        but not limited to, the applicant’s:


§
            ability
                to pay;





§
            credit
                history (with emphasis on the applicant’s existing mortgage payment
                history);





§
            credit
                score;





§
            income
                documentation type;




§
            lien
                position;





§
            LTV
                ratio;





§
            property
                type; and





§
            general
                stability, in terms of employment history, time in residence, occupancy
                and condition and location of the
                collateral.





**6**


We
      have
      established classifications with respect to the credit profile of the applicant,
      and each loan is placed into one of four letter ratings ‘‘A’’ through ‘‘D’’,
      with sub-ratings within those categories. Terms of loans that we make, as well
      as maximum LTV ratios and debt-to-income ratios, vary depending on the
      classification of the applicant and the borrower’s credit score. Loan applicants
      with less favorable credit ratings and/or lower credit scores are generally
      offered loans with higher interest rates and lower LTV ratios than applicants
      with more favorable credit ratings and/or higher credit scores. The general
      criteria our underwriting staff uses in classifying loan applicants are set
      forth in the following table:





**Summary
      of Delta’s Principal Underwriting Criteria** **(1)**





**“A”
                Risk**
            
            **“B”
                Risk**
            
            **“C”
                Risk**
            
            **“D”
                Risk**Credit
                Profile
            Excellent
                credit history.
            
            Good
                overall credit history.
            
            Good
                to fair credit history.
            
            Fair
                to poor credit history.Existing
                Mortgage History
            Up
                to a maximum of two 30-day late payments in the last 12
                months.
            
            Up
                to a maximum of one 60-day late payment in the last 12
                months.
            
            Mortgage
                up to 60 days delinquent at close. Up to a maximum of one 90-day
                late
                payment in the last 12 months.
            
            Mortgage
                delinquent 90 days or more.Credit
                Scores(2)
            Generally,
                minimum credit score of 500.
            
            Generally,
                minimum credit score of 500.
            
            Generally,
                minimum credit score of 500.
            
            Generally,
                minimum credit score of 500.Bankruptcy
                Filings
            Generally,
                Ch. 7 discharged or Ch. 13 filed more than two years prior to closing.
                Ch.
                13 discharged prior to closing.
            
            Generally,
                Ch. 7 discharged or Ch. 13 filed more than 18 months prior to closing
                and
                open Ch. 13 is considered.
            
            Generally,
                Ch. 7 discharged or Ch. 13 filed prior to closing and open Ch. 13
                is
                considered.
            
            Generally,
                Ch. 7 discharged by closing. Open Ch. 13 considered.Debt
                Service to Income Ratio
            55%
                or less
            
            55%
                or less
            
            55%
                or less
            
            55%
                or lessMaximum
                LTV ratio:Owner-Occupied
            Up
                to 100% LTV with a 580 credit score for full income check loans if
                mortgage is 0x30 within last 12 months.
            
            Up
                to 90% LTV with a 580 credit score for full income check loans if
                mortgage
                is no worse than 3x30 within the last 12 months.
            
            Up
                to 80% LTV with a 550 credit score for full income check loans if
                0x90
                within the last 12 months.
            
            Up
                to 70% LTV with a 550 credit score for full income check, one 1x120
                within
                last 12 months.Non-Owner Occupied
            Up
                to 90% LTV with a 675 credit score for full income check loans if
                mortgage
                is no worse than 0x30 within the last 12 months.
            
            Up
                to 80% LTV with a 600 credit score for full income check loans if
                mortgage
                is no worse than 3x30 within the last 12 months.
            
            Up
                to 75% LTV with a 580 credit score for full income check loans if
                mortgage
                is 0x90 within the last 12 months.
            
            Not
                available.





*(1)*  *Each
      lettered risk classification has one or more sub-classifications. For example,
      within the “A” risk class, there are the following credit program
      sub-classifications: “A+”, “A1” and “A2”. The letter grades applied to each risk
      classification in the table reflect our internal standards and do not
      necessarily correspond to classifications used by other mortgage
      lenders.*





*(2)*  *The
      minimum credit score and maximum LTV set forth in the table is for borrowers
      providing full documentation for a first mortgage on a one to two family
      property. Depending on the risk parameters of the loan, the minimum credit
      score
      requirement may be higher and the maximum LTV may be lower, or require a higher
      credit score for the same LTV. (“0x30” means no payments late by 30 days, “3x30”
means three payments late by 30 days; “0x90” means no payments late by 90 days
      and “1x120” means one payment late by 120 days).*





**7**


*Underwriting
      Exceptions.* We use
      these categories and characteristics as a guideline only. On a case-by-case
      basis, we may determine that the prospective borrower warrants an exception
      from
      our underwriting guidelines if sufficient compensating factors exist. Examples
      of compensating factors we consider include the following:





§
            low
                debt ratio;





§
            long-term
                stability of employment and/or
                residence;





§
            excellent
                payment history on past mortgages;
                or





§
            a
                significant reduction in monthly
                expenses.




The
      following table sets forth the credit quality of our originations along with
      the
      weighted average coupon and weighted average LTV/CLTV, for the years ended
      December 31, 2005, 2004 and 2003:




*(Dollars
                  in thousands)*
              
              **Credit
                  Grade**
              
              **Total
                  Originations**
              
              **Percent**
                **of
                  Total Originations**
              
              **Weighted
                  Average**
                **Coupon**
              
              **Weighted
                  Average LTV/CLTV****For
                  the Year Ended****December
                  31, 2005**
              
              A
              
              $                                 
                  3,466,805
              
              90.4%
              
              7.9%
              
              80.1%B
              
              195,085
              
              5.1
              
              8.6
              
              69.8C
              
              96,780
              
              2.5
              
              8.9
              
              66.0D
              
              76,975
              
              2.0
              
              9.6
              
              56.6Total/Average
              
              
              
              $                                 
                  3,835,645
              
              100.0%
              
              8.0%
              
              78.8%**December
                  31, 2004**
              
              A
              
              $                                 
                  2,331,952
              
              89.3%
              
              7.7%
              
              79.4%B
              
              153,768
              
              5.9
              
              8.6
              
              70.4C
              
              81,369
              
              3.1
              
              9.0
              
              64.7D
              
              44,437
              
              1.7
              
              10.0
              
              55.7Total/Average
              
              
              
              $                                 
                  2,611,526
              
              100.0%
              
              7.9%
              
              78.0%**December
                  31, 2003**
              
              A
              
              $                                 
                  1,539,028
              
              89.9%
              
              8.0%
              
              77.5%B
              
              92,886
              
              5.4
              
              9.3
              
              69.9C
              
              55,431
              
              3.2
              
              9.7
              
              66.2D
              
              25,392
              
              1.5
              
              10.8
              
              56.2Total/Average
              
              
              
              $                                 
                  1,712,737
              
              100.0%
              
              8.1%
              
              76.4%




**8**


The
          mortgage loans we originate have amortization schedules ranging from five
          years
          to 30 years, generally bear interest at fixed rates and require equal monthly
          payments, which are due on a scheduled day of each month. The
          adjustable-rate mortgage loans we originate, referred to as “2/28” or “3/27”
products, generally contain features where rates are fixed for some period
          of
          time (two to three years) and then adjust every six months thereafter.
          During
          the third quarter of 2005 we began to offer
          a
          product referred to as a stepped fixed-rate mortgage. This product has
          a fixed
          rate throughout its term, and a 30-year maturity without a balloon payment.
          During the first 10 years of the mortgage loan’s term, the fixed monthly payment
          is based on a 40-year amortization, after which the fixed monthly payment
          is
          adjusted based on a 20-year amortization during the remaining 20 years
          of the
          term.
 
 The
          principal amounts of the loans we originate generally range from a minimum
          of
          $40,000 to a maximum of $800,000; however we will consider loans up to
          $1.0
          million. We will lend up to 100% of the CLTV ratio. Our loans are generally
          secured by one- to four-family residences, including condominiums and
          townhouses, and these properties are usually occupied by the owner. It
          is our
          policy not to accept commercial properties or unimproved land as collateral.
          However, we will accept mixed-use properties, such as a property where
          a portion
          of the property is used for residential purposes and the balance is used
          for
          commercial purposes, and we will accept small multifamily properties of
          five to
          eight units, both at reduced LTV ratios. We do not originate loans where
          any
          senior mortgage contains an open-end advance, negative amortization or
          shared
          appreciation provisions - all of which could have the effect of increasing
          the
          amount of the senior mortgage, thereby increasing the CLTV, and increasing
          the
          risk of the loan to us. Additionally, during the fourth quarter of 2005
          we
          ceased the origination of mortgages collateralized by double-wide mobile
          homes,
          which represented 2.9% of our annual 2005 loan origination volume, due
          to
          decreased interest in such products in the secondary market.


*Documentation
      and Review.* Our
      mortgage loan programs include:





·
            a
                full documentation program;





·
            a
                limited documentation program;





·
            a
                no income verification program for self-employed borrowers;
                and





·
            a
                stated income program.





Our
      borrowers’ total monthly debt obligations - which include principal and interest
      on the new loan and all other mortgages, loans, charge accounts and scheduled
      indebtedness - generally are 50% or less of the borrowers’ monthly gross income.
      Some of our borrowers will qualify using our maximum debt-to-income ratio of
      55%. For loans to borrowers who are salaried employees, we require current
      employment information in addition to employment history. We verify this
      information based on one or more of the following items: written confirmation
      from employers, a recent pay-stub, a recent W-2 tax form, recent tax return,
      bank statements and telephone confirmation from the employer. For our limited
      documentation program, we require either six months of bank statements or a
      job
      letter which contains substantially the same information one would find on
      a
      standard verification of employment form, including:





·
            job
                position;





·
            length
                of time on job;





·
            current
                salary; and





·
            the
                job letter should appear on the employer’s letterhead and include the
                telephone number and signature of the individual completing the letter
                on
                behalf of the employer.





**9**


For
      our
      no income verification program, we require proof of self-employment in the
      same
      business for two years. We only offer our stated income program, which
      represents a very small percentage of our loans, for better credit quality
      borrowers where telephone verification is performed by an underwriter to verify
      that the borrower is employed. We usually require lower combined LTV ratios
      with
      respect to loans made under programs other than the full documentation
      program.





We
      assess
      a borrower’s credit-worthiness primarily based on the borrower’s mortgage
      history and credit score, and we generally adjust our pricing and LTV ratios
      based on many other risk parameters. Our borrowers often have either (a)
      mortgage or other credit delinquencies, (b) problems providing documentation
      generally required by traditional lenders, and/or (c) collateral types against
      which traditional lenders may not lend. Qualification for a loan is based
      primarily upon our risk-based pricing model and guidelines, which we have
      developed over our 24-year history and our extensive database of prior loan
      performance. Because there are compelling circumstances with some borrowers,
      we
      employ experienced non-conforming mortgage loan underwriters to review the
      applicant’s credit profile and to evaluate whether an impaired credit history is
      a result of adverse circumstances or a continuing inability or unwillingness
      to
      meet credit obligations in a timely manner. An applicant's credit record will
      often be impaired by personal circumstances, including divorce, family illnesses
      or deaths and temporary job loss due to layoffs and corporate
      downsizing.





We
      have a
      staff of 98 underwriters, averaging eight years of non-conforming lending
      experience and four years working for us. All underwriting functions for broker
      originations are conducted in our Woodbury, New York headquarters, our
      Cincinnati, Ohio underwriting office and our regional offices in Jacksonville,
      Florida; Boston, Massachusetts; and Dallas, Texas. All underwriting functions
      for retail originations are conducted in our Cincinnati, Ohio retail
      underwriting ‘‘hub’’; our Phoenix, Arizona regional office and our Woodbury, New
      York headquarters. We do not delegate underwriting authority to any third party.
      Our underwriting department functions independently of our business development
      and sales departments and does not report to any individual directly involved
      in
      the sales origination process. Our underwriters are trained to review all
      components of the loan to determine its compliance with our underwriting
      guidelines.





As
      the
      underwriting department employs underwriters with different levels of experience
      and seniority, we have instituted underwriting internal controls that limit
      approval authority based on underwriting position. These limits are based on
      maximum loan amount and LTV ratios, ensuring that loans at the highest dollar
      or
      LTV limits we offer are reviewed and approved only by the underwriting
      department's most senior members. Also, for all files initially reviewed by
      lower level underwriters, a second review of the file is performed by a more
      senior underwriter prior to closing the loan.





*Appraisals,
      Insured AVMs and Quality Control.* We
      underwrite every loan submitted by thoroughly reviewing credit and by performing
      the following:





§
            a
                separate appraisal review is conducted by our underwriter and/or
                appraisal
                review department, except where an appraisal is centrally ordered
                by us or
                an Insured AVM is utilized; and





§
            a
                full compliance review, to ensure that all documents have been properly
                prepared, all applicable disclosures have been given in a timely
                fashion,
                and proper compliance with all federal and state
                regulations.





When
      we
      utilize appraisals, we require that they be performed by third-party, fee-based
      appraisers and to conform generally to current Fannie Mae and Freddie Mac
      secondary market requirements for residential property appraisals. Each
      appraisal includes, among other things, an inspection of both the exterior
      and
      interior of the subject property and data from sales within the preceding 12
      months of similar properties within the same general location as the subject
      property. We perform an appraisal review on each loan prior to closing on
      appraisals that were not centrally ordered by us. In addition to reviewing
      each
      of these appraisals for accuracy, we access alternate sources to validate sales
      used in the appraisals to determine market value. These sources
      include:





§
            Multiple
                Listing Services;





§
            assessment
                and sales services, such as Comps, Inc., Pace and
                RealQuest;





§
            on-line
                Internet services, such as Realtor.com;
                and





§
            other
                sources for verification, including broker price opinions and market
                analyses by local real estate
                agents.





**10**


For
      quality control purposes, using the criteria that we have developed over time,
      we actively track and grade all appraisers from whom we accept appraisals.
      We do
      not accept work from appraisers who have not conformed to our review
      standards.


When
        certain underwriting criteria have been met, we may utilize an Insured AVM
        in
        lieu of an
        appraisal for certain originations. If a borrower has a 620 or higher credit
        score, the property type is either one-family or condominium and the loan
        amount
        is $500,000 or less, we may utilize an Insured AVM in lieu of an appraisal,
        as
        described below.  An Insured AVM is
        the
        coupling of a third-party valuation estimate and insurance on that value.
        The
        third-party AVM providers have created computer programs that use relevant
        real
        estate information, such as sales prices, property characteristics and
        demographics, to calculate a value for a specific property. Public records
        are
        the primary data source for an Insured AVM, and the quality of the values
        that
        they generate varies depending upon the data they use and their design. AVMs
        are
        complex programs incorporating a variety of forecasting techniques including
        linear regression, expert systems, neural networks, artificial intelligence
        and
        other methodologies. The different methodologies, algorithms, and variables
        used
        by the third-party AVM providers may vary greatly and affect their reliability
        and accuracy.
 
 Once
        an
        acceptable AVM has been generated, we will order a property condition report.
        One of the weaknesses in using an AVM to value a property is the lack of
        a
        physical exterior or interior inspection of the property. To mitigate some
        of
        this inherent weakness, we require a property condition report for each AVM
        considered for use .
        A
        property condition report is a limited physical external inspection of the
        property. The
        primary benefit of using Insured AVMs is that they substantially reduce the
        time
        to complete a value estimate on a property. During the year ended December
        31,
        2005, we utilized an Insured AVM for approximately 11% of the loans we
        originated and those loans had a weighted average LTV of 77% and a weighted
        average credit score of 689.


At
      the
      closing of a loan, when an AVM is used we will purchase insurance that will
      insure the value of the property. In the event the borrower defaults upon the
      loan, resulting in the liquidation of the property, the insurance company may
      have to pay a portion of any losses we incur. A retroactive appraisal is
      performed as of the original valuation date when a loss arises involving an
      Insured AVM. If the Insured AVM value is found to exceed the appraisal value
      by
      more than a specific tolerance percentage ( *i.e* .,
      10%),
      the insurer must reimburse us for the losses incurred from the disposal of
      the
      property or for the difference in values, whichever is less, plus certain other
      expenses.




For
      quality control purposes, we perform post-funding reviews on Insured AVMs,
      similar to our appraisal post-funding reviews.





After
      completing the underwriting and processing of a brokered loan, we schedule
      the
      closing of the loan with an approved closing attorney or settlement agent.
      We
      hold the closing attorney or settlement agent responsible for completing the
      loan closing transaction in accordance with applicable law and our operating
      procedures. We also require title insurance that insures our interest as a
      lender, and evidence of adequate homeowner’s insurance naming us or our
      servicing agent as an additional insured party on all loans.





We
      perform a post-funding quality control review to monitor and evaluate our loan
      origination policies and procedures. Our quality control department is separate
      from our underwriting department and reports directly to a member of senior
      management.





**11**


Our
      quality control department samples at least 10% of all loan originations and
      performs a full quality control re-underwriting and review, the results of
      which
      are reported to senior management on a quarterly basis. On a daily basis, should
      the need arise, the manager of quality control underwriting will notify senior
      management of any critical loan findings. The sample of loans reviewed is
      selected in the following manner:





§
            all
                early default payments and customer
                complaints;





§
            at
                least 5% of all funded loans each month are selected on a random
                basis;
                and





§
            targets,
                which may be based on sources of business (both internal branches/teams
                and external brokers, areas or other third parties) or products (perceived
                riskier products and/or newly offered
                products).





If
      any
      discrepancies are discovered during the review process, a senior quality control
      underwriter re-reviews the loan and proceeds with any necessary follow-up
      actions. Discrepancies noted by the review are analyzed and corrective actions
      are instituted. A typical quality control underwriting review currently
      includes:





§
            re-verifying
                the credit report;





§
            reviewing
                loan applications for completeness, signature, and consistency with
                other
                processing documents;





§
            obtaining
                new written and/or verbal verification of income and employment from
                employer;





§
            obtaining
                new written and/or verbal verification of mortgage to re-verify any
                outstanding mortgages, if
                necessary;





§
            obtaining
                a new verification of value and/or photo for each property;
                and





§
            analyzing
                the underwriting and program selection
                decisions.





We
      update
      the quality control process from time-to-time as our policies and procedures
      change.




*Click
      & Close* *®* *.*  C&C
      is a proprietary web-based system that we developed internally to streamline
      and
      integrate our origination process. C&C opens an online channel of
      communications between us, brokers and a wide range of other mortgage
      information sources. C&C includes an integrated imaging system that reduces
      paper flow and allows loans to be handled simultaneously by multiple employees
      in the originations process. We currently use C&C to automate and facilitate
      many of our origination processes, including, but not limited to:





§
            logging
                in and tracking applications in our retail and wholesale
                channels;





§
            increasing
                the amount of internal loan origination processes that can be handled
                electronically, which reduces paper flow between account managers,
                mortgage analysts, loan processors and
                underwriters;





§
            generating
                pre-approvals utilizing our risk-based pricing
                model;





§
            generating
                stipulation sheets, preliminary disclosures and other documents;
                and





**§**
            easy,
                real-time supervisory oversights to ensure all applications are being
                worked on in a timely manner.





We
      are
      continuing to improve C&C to further streamline our processes and to reduce
      the paper flow required throughout the mortgage origination process. Our goal
      is
      to reduce our reliance on paper records, which we believe will lower our cost
      to
      originate.




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





**12**


***Securitizations
      and Whole-Loan Sales.*** We
      securitize or sell all of the mortgage loans we originate. As
      a
      fundamental part of our present business and financing strategy, we securitize
      a
      substantial portion of our mortgage loans. We may also sell a portion of our
      loans as whole loans. We
      select
      the outlet depending on market conditions, relative profitability and cash
      flows.  In
      the
      years ended December 31, 2005 and 2004, whole-loan sales comprised approximately 14.9%
      and
      6.5% ,
      respectively, of the total amount of our combined securitizations and whole-loan
      sales transactions.





The
      following table sets forth certain information regarding loan securitizations
      and loans sold on a whole loan basis for the years ended December 31, 2005
      and 2004:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Loan
                securitizations - gain on sale(1)
            
            $
            --
            
            $
            113,927Loan
                securitizations - portfolio based
            
            
            3,199,997
            
            
            2,309,989Whole-loan
                sales
            
            
            561,487
            
            
            169,326Total
                securitizations and whole-loan sales
            
            $
            3,761,484
            
            $
            2,593,242





*(1)
      For the year ended December 31, 2004, we delivered $113.9 million of mortgage
      loans under a pre-funding feature in our fourth quarter 2003 securitization
      and
      recorded gain-on-sale related revenue during the first quarter of 2004. Because
      the fourth quarter 2003 securitization was structured as a sale, we recorded
      gain-on-sale revenue during the year ended December 31, 2004 when we delivered
      the loans under the pre-funding feature to the securitization trust in January
      2004.*





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





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


The following table sets forth information about our on-balance sheet
        securitized mortgage loan portfolio, completed since the first quarter of
        2004,
        at December 31, 2005:


*(Dollars
                  in thousands*)
              
              **Issue
                  Date**
              
              **Current
                  Loan Principal Balance****(1)**
              
              **Total
                  Securitization**
                **Debt
                  Balance****(2)****Asset-backed
                  Security Series:**2004-1
              
              March
                  30, 2004
              
              $                            
                                   
                   288,073
              
              $                           
                                    
                   281,1712004-2
              
              June
                  29, 2004
              
              322,678
              
              308,0952004-3
              
              September
                  29, 2004
              
              403,910
              
              392,0572004-4
              
              December
                  29, 2004
              
              459,848
              
              453,1652005-1
              
              March
                  31, 2005
              
              634,592
              
              626,6132005-2
              
              June
                  29, 2005
              
              696,387
              
              697,1052005-3
              
              September
                  29, 2005
              
              806,494
              
              808,7422005-4
              
              December
                  30, 2005
              
              874,998
              
              875,313Total
              
              
              
              $                            
                               
                   4,486,980
              
              $                          
                                 
                   4,442,261


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





*(2)*  *The
      total securitization debt (financing on mortgage loans held for investment)
      balance shown excludes discounts of $5.3 million at December 31,
      2005.*





**13**


The
      securitization trust raises cash to purchase the mortgage loans from us
      generally by issuing securities to the public. These securities, known as
“asset-backed securities,” are secured, or backed, by the pool of mortgage loans
      held by the securitization trust. These asset-backed securities, which are
      usually purchased by insurance companies, mutual funds and/or other
      institutional investors, entitle their holders to receive the principal
      (including prepayments of principal) and a portion of the interest, collected
      on
      the mortgage loans in the securitization trust. We structured each of our
      securitizations in 2005 and 2004 to be accounted for as a secured financing,
      which is known as “portfolio accounting.” With portfolio accounting, the
      mortgage loans held in the securitization trust are recorded on our balance
      sheet as mortgage loans held for investment, together with the related financing
      on the mortgage loans held for investment (which are the senior securities
      or
      bonds issued by the securitization trust). Prior to 2004, we structured our
      securitizations to be accounted for as sales, which is known as “gain-on-sale
      accounting.” With gain-on-sale accounting, we recorded an upfront gain at the
      time of securitization and capitalized the excess cashflow certificates on
      our
      balance sheet.




Each
          pool
          of mortgage loans financed through the asset-backed securitization market
          includes a series of asset-backed securities with various credit ratings,
          maturities and interest rates. The combined weighted average interest rate
          of
          the asset-backed securities in each securitization will generally increase
          over
          time as the shorter-term asset-backed securities with higher credit ratings
          and
          lower interest costs mature, leaving the longer-term asset-backed securities
          with lower credit ratings and higher interest costs remaining.
 
 During
          the years ended December 31, 2005 and 2004, we issued four securitizations
          totaling $3.2 billion in collateral, and we issued four securitizations
          totaling
          $2.3 billion in collateral, respectively. We also delivered $113.9 million
          of
          mortgage loans in January 2004 using a pre-funding feature relating to
          the
          fourth quarter 2003 securitization. All of our 2005 and 2004 securitizations
          received ratings on various classes of securities ranging from AAA/Aaa
          to
          BBB-/Baa3 rated by Standard & Poor's Ratings Services (“S&P”), Moody's
          Investors Service, Inc (“Moody’s”), and/or Fitch Ratings, Inc. (“Fitch”),
          respectively, and AAA to BBB rated by Dominion
          Bond Rating Service, Inc. (“DBRS”). The following table sets forth information with respect to our 2005,
          2004 and 2003 securitizations as of their issuance date by offering size
          (which
          includes pre-funded amounts), collateral, initial weighted average pass-through
          rate and type of credit enhancement:
 **Securitization**
                  
                  **Issuance
                      Date**
                  
                  **Public**
                    **Offering
                      Size**
                  
                  **Collateral**
                  
                  **Initial
                      Weighted Average Pass-Through Rate**
                  
                  **Credit
                      Enhancement***(Dollars
                      in millions)***2005-1**
                  
                  March
                      31, 2005
                  
                  $     
                                              
                      728.6
                  
                  $
                                                   
                      750.0
                  
                  4.49%
                  
                  Senior/Sub**2005-2**
                  
                  June
                      29, 2005
                  
                  729.0
                  
                  750.0
                  
                  4.57
                  
                  Senior/Sub**2005-3**
                  
                  September
                      29, 2005
                  
                  797.8
                  
                  825.0
                  
                  4.92
                  
                  Senior/Sub**2005-4**
                  
                  December
                      30, 2005
                  
                  848.3
                  
                  875.0
                  
                  5.82
                  
                  Senior/Sub$                           
                      3,103.7
                  
                  $                           
                      3,200.0**2004-1**
                  
                  March
                      29, 2004
                  
                  $                              
                      542.3
                  
                  $                              
                      550.0
                  
                  1.71%
                  
                  Senior/Sub**2004-2**
                  
                  June
                      25, 2004
                  
                  504.4
                  
                  520.0
                  
                  4.44
                  
                  Senior/Sub**2004-3**
                  
                  September
                      28, 2004
                  
                  623.4
                  
                  640.0
                  
                  4.18
                  
                  Senior/Sub**2004-4**
                  
                  December
                      29, 2004
                  
                  583.8
                  
                  600.0
                  
                  4.34
                  
                  Senior/Sub$                           
                      2,253.9
                  
                  $                          
                       2,310.0**2003-1**
                  
                  March
                      27, 2003
                  
                  $                              
                      258.6
                  
                  $                              
                      263.1
                  
                  2.40%
                  
                  Senior/Sub**2003-2**
                  
                  June
                      26, 2003
                  
                  393.0
                  
                  400.0
                  
                  2.19
                  
                  Senior/Sub**2003-3**
                  
                  September
                      30, 2003
                  
                  434.7
                  
                  440.0
                  
                  1.83
                  
                  Senior/Sub**2003-4**(1)
                  
                  December
                      29, 2003
                  
                  470.0
                  
                  475.0
                  
                  2.13
                  
                  Senior/Sub$                           
                      1,556.3
                  
                  $                           
                      1,578.1
 
 *(1)*  *The
            2003-4 securitization collateral amount includes $113.9 million of mortgage
            loans we delivered during the first quarter of 2004, through a pre-funding
            feature in connection with our fourth quarter 2003
            securitization.*
 
 **14**
 Each
            of
            our securitizations of mortgage loans during 2005 and 2004 were structured
            and
            are accounted for as a secured financing. Under this securitization structure,
            the securitization trust holds mortgage loans as assets (referred to
            as
“securitized loans”) and issues debt represented by asset-backed securities.
            Accordingly, the securitized loans are recorded as an asset on our balance
            sheet
            under “mortgage loans held for investment, net” and the corresponding debt is
            recorded as a liability under “financing on mortgage loans held for investment,
            net.” This structure recognizes the related revenue as interest on mortgage
            loans held for investment and the related expense as interest expense
            on the
            bond financing. In contrast, the structures we used prior to 2004 required
            us to
            record virtually all of the anticipated income as an upfront gain on
            sale of
            mortgage loans under Statement of Financial Accounting Standards (“SFAS”) No.
            140, “ Accounting
            for Transfers and Servicing of Financial Assets and Extinguishments of
            Liabilities - a replacement of FASB Statement No. 125 .”
We
            plan to continue to structure our future securitizations to be accounted
            for as
            secured financings, which eliminates gain-on-sale accounting treatment.
            Consequently, income that would have otherwise been recognized upfront
            as net
            gain on sale of mortgage loans under our prior securitization structure
            has been
            recognized since the beginning of 2004 as net interest income (interest
            income
            received on the mortgage loans less the interest expense on the corresponding
            securitization debt) over the life of the loans. We believe structuring,
            and
            therefore accounting for, securitizations as secured financings more
            closely
            matches the recognition of income with the receipt of cash payments on
            the
            individual loans.
  Each
          of
          our securitizations contains an overcollateralization ("O/C") provision,
          which
          is a credit enhancement that is designed to protect the securities sold
          to the
          asset-backed securities investors from credit losses, which arise principally
          from defaults on the underlying mortgage loans. In short, O/C occurs when
          the
          amount of collateral (*i.e.*, mortgage loans) owned by a securitization
          trust exceeds the aggregate amount of asset-backed securities. The O/C
          is
          created to absorb losses that the securitization trust may suffer, as loans
          are
          liquidated at a loss. Beginning with our 2002 securitizations, and in each
          of
          our subsequent securitizations, we created the O/C by initially selling
          asset-backed securities totaling approximately 97% to 98.5% of the total
          amount
          of mortgage loans sold to the trust. In doing so, we created the full amount
          of
          the O/C required by the trust at the time we completed the securitization,
          instead of over time. For example, if a securitization trust contains collateral
          of $100 million principal amount of mortgage loans, and our O/C requirement
          is
          2%, we issue approximately $98 million in asset-backed securities. Prior
          to
          2002, we generally built up the O/C typically over the first 18 to 24 months
          of
          a securitization (with the specific timing depending upon the structure,
          amount
          of excess spread, and performance of the securitization), by utilizing
          the cash
          flows from the excess cash flow to make additional payments of principal
          to the
          holders of the asset-backed securities until the required O/C level was
          reached.
          We typically issued asset-backed securities for a par purchase price, or
          at a
          slight discount to par - with par representing the aggregate principal
          balance
          of the mortgage loans backing the asset-backed securities. For example,
          if a
          securitization trust contained collateral of $100 million of mortgage loans,
          we
          typically received close to $100 million in proceeds from the sales of
          those
          securities, depending upon the structure we used for the securitization. 
 **15**
 The
            O/C is generally expressed as a
            percentage of the initial mortgage loan or collateral principal balance
            sold to
            the securitization trust. The required O/C is initially determined by
            either the
            rating agencies and/or the bond insurer, if any, using various factors,
            including:
 
 ·
                  characteristics
                      of the mortgage loans sold to the trust, such as credit scores
                      of the
                      borrowers and LTV ratios;·
                  the
                      amount of excess spread between the interest rate on the pool
                      of mortgage
                      loans sold to the securitization trust and the interest paid
                      to the
                      asset-backed securities holders, less the servicing fees, and
                      other
                      related expenses such as trustee fees and bond insurer fees,
                      if any;
                      and·
                  the
                      structure of the underlying securitization (*e.g*., issuing BBB-
                      certificates creates greater credit enhancement in the securitization
                      transaction, which generally results in a lower
                      O/C).
  During
              2005 and 2004, our
              securitizations required an O/C ranging from 2.8% to 3.3% and 1.4%
              to 3.0%,
              respectively, of the initial mortgage loans sold to the securitization
              trust.
              The required O/C can increase or decrease throughout the life of the
              transaction
              depending upon subordination levels, delinquency and/or loss tests
              and is
              subject to minimum and maximum levels, as defined by the rating agencies
              and/or
              the bond insurer insuring the securitization. As long as the O/C requirement
              is
              met, any excess cash flows generated from the securitizations are distributed
              to
              us if we are the holder of the excess cashflow certificates, after
              all other
              distributions are made in accordance with the “waterfall” described
              below.
 
 Each
              month the holder of an excess cashflow certificate will receive payment
              only
              after all required payments have been made on all the other securities
              issued by
              the securitization trust, because the excess cashflow certificates
              are
              subordinate in right of payment to all other securities issued by the
              securitization trust. In addition, before the holder of the excess
              cashflow
              certificate receives payments, the excess cash flows are applied in
              a
“waterfall” manner as follows:
 ·
                  first,
                      to cover any losses on the mortgage loans in the related mortgage
                      pool;·
                  second,
                      to reimburse the bond insurer, if any, of the related series
                      of
                      asset-backed securities for amounts paid by or otherwise owing
                      to that
                      insurer;·
                  third,
                      to build or maintain the required level of the O/C provision,
                      as described
                      below, for that securitization trust by applying the funds
                      as an
                      accelerated payment of principal to the holders of the asset-backed
                      securities of the related series;·
                  fourth,
                      to reimburse holders of the subordinate certificates of the
                      related series
                      of asset-backed securities for unpaid interest and for any
                      losses
                      previously allocated to those securities; and·
                  fifth,
                      to pay “the net rate cap carryover”, if any, which relates to the interest
                      on the related asset-backed securities that exceeded the maximum
                      net
                      interest amount available from the mortgage loans underlying
                      the
                      securitization trust.
 
 Each
            securitization trust also has the benefit of either a financial guaranty
            insurance policy from a monoline insurance company or a “senior-subordinated”
securitization structure, or a combination of the two (referred to as
            a
“hybrid”). In a securitization trust with a financial guaranty insurance policy
            that is not a hybrid, all securities are senior securities. The monoline
            insurance company guarantees the timely payment of principal and interest
            to all
            security holders in the event that the cash flows are not sufficient.
            In
“senior-subordinated” securitization structures, the senior security
            holders are protected from losses (and payment shortfalls) first by the
            excess
            cash flows and the O/C, then by subordinated securities which absorb any
            losses prior to the senior security holders. In a hybrid structure, the
            senior securities generally have both the subordinated certificates to
            absorb
            losses and a monoline insurance company that guarantees timely principal
            and
            interest payments with respect to the senior securities.
 Beginning
            in 2002, we utilized a securitization structure in which we completed
            a
            concurrent net interest margin (“NIM”) transaction. In a NIM transaction, the
            excess cashflow certificate is sold to a NIM trust without recourse,
            except for
            standard representations and warranties. The NIM trust issues NIM note(s)
            that
            one or more third-party investors will purchase and we receive the net
            proceeds
            from the issuance of the NIM note(s).
 
 **16**
 The
            NIM
            note(s) entitles the holder to be paid a specified interest rate, and
            further
            provides for all cash flows generated by the excess cashflow certificate
            to be
            used to pay all principal and interest on the NIM note(s) until paid
            in full,
            which typically occurs approximately 18 to 24 months from the date the
            NIM
            note(s) were issued. The excess cashflow certificate entitles us to all
            cash
            flows generated by the excess cashflow certificate after the holder of
            the NIM
            note(s) has been paid in full.
 
 As
            part
            of a NIM transaction, we typically “fully fund” the O/C at closing - as opposed
            to having it build up over time as we had prior to 2002 - which enables
            the NIM
            investors to receive cash flows in the first month. We used a portion
            of the net
            proceeds we received from selling NIM note(s) to make up for the difference
            between (1) the principal amount of the mortgage loans sold, and (2)
            the
            proceeds from selling the asset-backed securities. During 2005, all of
            our
            securitizations had fully funded O/Cs at closing.
 
 NIM
            transactions generally enable us to generate upfront cash flow when the
            securitization and related NIM transaction close, net of funding the
            upfront
            O/C, securitization and NIM costs, which helps offset a substantial portion
            of
            our cost to originate the loans included in the transaction.
 
 Commencing
            in 2004, we structured our NIM transactions to be accounted for as a
            secured
            financing in which the amount of NIM notes are recorded as a liability
            on our
            balance sheet, as a component of the financing on mortgage loans held
            for
            investment, net. Conversely, in the securitizations and related NIM transactions
            we completed prior to 2004, the underlying securitization was structured
            as a
            gain-on-sale under SFAS No. 140. In these transactions, we recorded the
            net cash
            proceeds generated from the sale of the NIM notes as a component of our
            net gain
            on sale of mortgage loans. Under this structure, we also retained, and
            recorded
            as a component of our net gain on sale of mortgage loans, a relatively
            small
            excess cashflow certificate, representing the estimated fair value of
            the excess
            cash flows following the repayment of the NIM notes, which normally ranged
            from
            0.0% to 1.0% of the securitized collateral. The change to portfolio accounting
            from gain-on-sale accounting has not changed the overall economics of
            the
            transaction, only the timing of income recognition and how the transaction
            is
            recorded on our financial statements. The use of portfolio accounting
            structures
            will result in differences in our future expected results of operations
            as
            compared to historic results.
 
 ***Securitizations
            Structured as a Financing*** *.* All of
            the securitizations completed in 2005 and 2004 were structured and accounted
            for
            as secured financings. We intend to utilize this structure in the foreseeable
            future. The securitizations were structured for accounting purposes as
            secured
            financings under SFAS No. 140. The 2004 securitizations do not meet the
            qualifying special purpose entity ("QSPE") criteria under SFAS No. 140
            and
            related interpretations, because, after the loans are securitized, we
            have the
            unconditional right to repurchase from the trust up to one percent of
            the
            aggregate outstanding principal balance of the mortgage loans at any
            time
            subsequent to the securitization closing date. Additionally, the 2005
            and 2004
            securitizations do not meet the QSPE criteria as we have the option to
            contribute a derivative instrument into the trust. Prior securitization
            transactions met the QSPE criteria under SFAS No. 140 and were accounted
            for,
            recognized and recorded as a sale.
 
 In
            securitizations where we utilize a pre-funding feature, which enables
            us to
            deliver loans after the closing date of the securitization, we will record
            an
            asset - proceeds due from securitization trust - during the pre-funding
            period. The
            proceeds due from securitization trust represents the allocation of the
            cash
            proceeds received in connection with the trust issuing pass-through certificates
            and a NIM note with regards to the pre-funded mortgage loans.  Upon
            delivering the subsequent eligible pool of mortgage loans, the trustee
            for the
            securitization trust will release the securitization trust proceeds,
            which will
            be used to repay any warehouse financing used to finance the subsequent
            pool of
            mortgage loans and to replenish our working capital. As this structure
            is a
            financing, no gain-on-sale revenue is recorded at the time the securitization
            is
            closed. Rather, we record interest income from the securitized loans
            and
            interest expense from the pass-through certificates issued in connection
            with
            the securitization over the life of the securitization. Deferred securitization
            debt issuance costs are amortized on a level yield basis over the estimated
            life
            of the debt. We also defer on our balance sheet, as a component of mortgage
            loans held for investment, net of the incremental direct fees and costs
            to
            originate the loans in accordance with SFAS No. 91, “ Accounting
            for Nonrefundable Fees and Costs Associated with Originating or Acquiring
            Loans
            and Initial Direct Costs of Leases—an amendment of FASB Statements No. 13, 60,
            and 65 and a rescission of FASB Statement No. 17,” which
            are
            amortized on a level yield basis over the estimated life of the related
            loans
            using the interest method calculation. In addition, we allocate a portion
            of the
            accounting basis of the mortgage loans held for investment to the mortgage
            servicing rights, which results in a discount to the mortgage loans held
            for
            investment. The cost basis (fair value) of the mortgage servicing rights
            (“MSRs”) is determined based upon the price a third party servicer is willing
            to
            pay for the contract right to service that loan in the securitization.
            The
            allocation of the cost basis between the loan and the MSR, in accordance
            with
            SFAS No. 140, generally results in a discount being created on the loan
            retained
            in the securitization. The MSR related discount is accreted as an adjustment
            to
            yield on the mortgage loans over the estimated life of the related loans
            using
            the interest method calculation.
 
 **17**
 Since
            we
            began structuring our securitizations in 2004 as secured financings,
            and
            recording our income over time instead of upfront, there is a significant
            difference in our results of operations for the years ended December
            31, 2005
            and 2004 as compared to pre-2004 historical results. As such, we do not
            expect
            historical results will provide a meaningful comparison to 2005 or 2004
            results.
            We believe that portfolio accounting treatment, however, more closely
            matches
            the recognition of income with the receipt of cash payments on the individual
            loans.
 
 ***Securitizations
            Structured as a Sale - Off-Balance Sheet Arrangements.*** In
            securitizations structured to be accounted for as sales, we recorded
            gain-on-sale revenue upon the closing of each such securitization. For
            example,
            in each of the four securitizations that we issued in 2003 we derived,
            and
            recorded as gain-on-sale revenue, the following economic interests:
 ·
                    we
                        received a cash purchase price from the sale of the NIM note(s)
                        issued by
                        a NIM trust to which we sold the excess cashflow
                        certificates;·
                    we
                        received a cash purchase price from the sale of interest-only
                        certificates, which entitles the holders to receive payments
                        of interest
                        at a pre-determined rate over a fixed period of time;·
                    we
                        received a cash purchase price from selling the right to
                        service the loans
                        that we securitized. This right entitles the contractual
                        servicer to
                        service the loans on behalf of the securitization trust and
                        earn a
                        contractual servicing fee, and ancillary servicing fees,
                        including
                        prepayment penalties, in some cases, relating to the servicing
                        rights we
                        previously sold; and
  ·
                    we
                        retained an excess cashflow certificate, which entitles us
                        to receive cash
                        flow generated from the excess cashflow certificate issued
                        in connection
                        with the securitization after the holders of the NIM note(s)
                        have been
                        paid in full. Although the cash flows generated by the excess
                        cashflow
                        certificates are received over time, under U.S. generally
                        accepted
                        accounting principles (“GAAP”), we were required to report as income at
                        the time of the securitization the present value of all projected
                        cash
                        flow we expected to receive in the future based upon an assumed
                        discount
                        rate.
 At
            the
            time we completed the 2003 securitizations, we recognized as revenue
            each of the
            economic interests described above, which were recorded as net gain-on-sale
            of
            mortgage loans in our consolidated statement of operations. Our net investment
            in the pool of loans sold at the date of the securitization represented
            the
            amount originally paid to originate the loans, adjusted for the
            following:
 ·
                    any
                        direct loan origination costs incurred (an increase in the
                        investment) and
                        loan origination fees received (a decrease in the investment)
                        in
                        connection with the loans, which are treated as a component
                        of the initial
                        investment in loans;·
                    the
                        principal payments received, and the amortization of the
                        net loan fees or
                        costs, during the period we held the loans prior to their
                        securitization;
                        and·
                    any
                        gains (a decrease in the investment) or losses (an increase
                        in the
                        investment) we incurred on any hedging instruments that we
                        may have
                        utilized to hedge against the effects of changes in interest
                        rates during
                        the period we hold the loans prior to their securitizations.
                        (See
                        “-Summary of Critical Accounting Policies - Accounting for
                        Hedging
                        Activities”).
  We
            allocated our basis in the mortgage loans and excess cashflow certificates
            between the portion of the mortgage loans and excess cashflow certificates
            sold
            through securitization and the portion retained based on the relative
            fair
            values of those portions on the date of sale. We may recognize gains
            or losses
            attributable to the changes in fair value of the excess cashflow certificates,
            which are recorded at estimated fair value and accounted for as “trading”
securities. We are not aware of any active market for the sale of our
            excess
            cashflow certificates. Although we believe that the assumptions we use
            to
            determine fair value are reasonable, there can be no assurance as to
            the
            accuracy of the assumptions or estimates. The valuation of our excess
            cashflow
            certificates requires us to forecast interest rates, mortgage principal
            payments, prepayments and loan loss assumptions, each of which is highly
            uncertain and requires a high degree of judgment. The rate used to discount
            the
            projected cash flows is also critical in the valuation of our excess
            cashflow
            certificates. Management uses internal, historical mortgage loan performance
            data and forward LIBOR curves to value future expected excess cash flows.
            We
            regularly analyze and review our assumptions to determine whether the
            expected
            return (interest income) on our excess cash flows certificates is within
            our
            expected range.
 **18**
 ***Whole-Loan
        Sales*** *.* Whole-loan sales are the sale of pools of mortgage loans to banks, consumer
        finance-related companies and institutional investors on a servicing-released
        basis. We have found that, from time to time, we can receive better economic
        results by selling some of our mortgage loans on a whole-loan basis, without
        retaining servicing rights, generally in private transactions to financial
        institutions or consumer finance companies. We recognize a gain or loss when
        we
        sell loans on a whole-loan basis equal to the difference between the cash
        proceeds received for the loans and our investment in the loans, including
        any
        unamortized loan origination fees and costs. We generally sell these loans
        without recourse, except that we provide standard representations and warranties
        to the purchasers of such loans. During the years ended 2005 and 2004, we
        sold
        whole loans without recourse to third-party purchasers (with the exception
        of a
        premium recapture reserve described below) and on a servicing-released basis
        of
        $561.5 million and $169.3 million, respectively. The average gross premium
        we
        received for the whole loans sold during the year ended December 31, 2005
        was
        3.9%, compared to 4.6% for the comparable 2004 period. The gross premium
        paid to
        us by third-party purchasers in whole-loan sale transactions does not include
        premiums we pay to originate the mortgage loans, net deferred origination
        fees,
        or premium recapture - components of the gain on sale calculation.
 
 We
        maintain a premium recapture reserve related to our contractual obligation
        to
        rebate a portion of any premium paid by a purchaser when a borrower prepays
        a
        sold loan within an agreed period of time. The premium recapture reserve
        is
        established at the time of the whole-loan sale through a provision, which
        is
        reflected as a reduction of the gain on sale of mortgage loans. The premium
        recapture reserve is recorded as a liability on the consolidated balance
        sheet.
        We estimate recapture losses based primarily upon historical premium recaptures
        and by reviewing the types of loan products, interest rates, borrower prepayment
        fee, if any, and an estimate of the impact of future interest rate changes
        may
        have on early repayments. The premium recapture reserve totaled $619,000
        and
        $262,000 at December 31, 2005 and 2004, respectively.


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





·
            any
                fair value adjustments related to the excess cashflow certificates
                in
                accordance with Emerging Issues Task Force (“EITF”) 99-20, “Recognition of
                Interest and Impairment on Purchased and Retained Beneficial Interests
                in
                Securitized Financial Assets;” and





·
            miscellaneous
                interest income, including prepayment penalties received on some
                of the
                mortgage loans we sold in connection with our securitizations prior
                to
                2002.




**Loan
      Servicing**





The
      mortgage loans comprising our mortgage loans held for investment -
      pre-securitization are currently sub-serviced for us by a third-party servicer,
      Ocwen Loan Servicing, LLC, a subsidiary of Ocwen Financial Corporation, under
      a
      sub-servicing agreement. The sub-servicer is required, in servicing and
      administering the mortgage loans, to employ or cause to be employed procedures
      and exercise the same care that it customarily employs and exercises in
      servicing and administering mortgage loans for its own account, in accordance
      with accepted mortgage servicing practices of prudent lending institutions
      servicing mortgage loans similar to the mortgage loans in return for a
      fee.





Prior
      to
      May 2001, we directly serviced substantially all of the mortgage loans that
      we
      originated and securitized since our inception in 1982. In January 2001, we
      entered into an agreement to transfer our servicing portfolio to a third-party
      servicer, Ocwen
      Federal Bank, FSB (a
      related predecessor entity to Ocwen Loan Servicing, LLC, which presently
      services our loan portfolio). In May 2001, we physically transferred our entire
      servicing portfolio to Ocwen Federal
      Bank FSB .
      We no
      longer service loans, nor do we have a servicing operation. We do, however,
      maintain several employees to assist third parties with delinquent and defaulted
      loans, as well as portfolio retention. Currently, we sell the mortgage servicing
      rights related to our securitized mortgage loans to Ocwen Loan Servicing, LLC,
      or another third-party servicer, at the time we securitize our mortgage loans.
      If we choose to sell the mortgage servicing rights to another third-party
      servicer, Ocwen Loan Servicing, LLC will then, on our behalf, transfer the
      mortgage loans electronically on our behalf to the other third-party servicer.
      Normally a servicing transfer can be completed within 45 days following the
      close of the securitization. We continually assess third-party servicers in
      order to determine the one to which we will sell the servicing rights to on
      a
      securitization by securitization transaction basis.




**19**


In
        2005,
        Ocwen Financial Corporation terminated its banking subsidiary’s status as a
        federal savings bank under Office of Thrift Supervision (“OTS”) and Federal
        Deposit Insurance Corporation (“FDIC”) supervision. As such, Ocwen Federal Bank
        FSB is no longer a savings-and-loan holding company and is unable to take
        deposits in the United States or benefit from federal preemption of certain
        state laws. Ocwen Financial Corporation has advised us that it believes its
        decision to “debank” will not affect its ability to service our loans or prevent
        Ocwen Loan Servicing, LLC from performing any of its duties or responsibilities
        in accordance with our servicing agreements with them. Ocwen Financial
        Corporation's management, servicing portfolio and platform was not changed
        as a
        result of the foregoing transactions. See “- Forward Looking Statements and Risk
        Factors and "Item 1A. - Risk Factors.”
  **Competition**
 ** As
          an
          originator of mortgage loans, we face intense competition, primarily from
          diversified consumer financial companies and other diversified financial
          institutions, mortgage banking companies, commercial banks, credit unions,
          savings and loans, savings banks, mortgage real estate investment trusts
          (“REITs”), government-sponsored entities (such as Fannie Mae and Freddie Mac)
          and other finance companies. Many of these competitors in the financial
          services
          business are substantially larger, have more capital and substantially
          greater
          resources than we do, a lower cost of funds and a more established market
          presence than we have. In addition, we have experienced increased competition
          over the Internet, where barriers to entry are relatively low. Competition
          can
          take many forms, including interest rates and costs of the loan, less stringent
          underwriting standards, convenience in obtaining a loan, customer service,
          amount and term of a loan and marketing and distribution channels. Furthermore,
          the level of spreads and/or gains realized by us and our competitors on
          the
          securitization or sale of the type of loans originated has attracted additional
          competitors into this market, which has lowered the spreads and gains that
          may
          be realized by us on future securitizations and whole-loan sales. In addition,
          efficiencies in the asset-backed market have generally created a desire
          for even
          larger transactions, giving companies with greater volumes of originations
          a
          competitive advantage, including a pricing advantage. In the wholesale
          channel,
          we seek to compete with our competitors through an emphasis on quality
          of
          service, diversified products, use of technology and competitive
          pricing.
 
 We
          depend
          primarily on independent mortgage brokers for the origination of our wholesale
          mortgage loans, which constitute a significant portion of our loan production.
          These independent mortgage brokers have relationships with multiple lenders
          and
          are not obligated by contract or otherwise to do business with us. We compete
          with other lenders for the independent brokers’ business on the basis of
          pricing, service, loan fees, costs and other factors. Competition from
          other
          lenders could negatively affect the volume and pricing of our wholesale
          loans,
          which could reduce our loan production and/or increase our cost to originate
          such loans.
 
 If
          our
          competitors increase their marketing efforts to include our target market
          of
          borrowers, we may be forced to reduce the rates and fees we currently charge
          in
          order to maintain and/or expand our market share. Any reduction in our
          rates or
          fees could reduce our profitability and adversely affect our
          business.
 
 Over
          the
          past several years, many larger finance companies, financial institutions
          and
          conforming mortgage originators have adapted their conforming origination
          programs and allocated resources to the origination of non-conforming loans.
          Some of these companies have begun to offer products similar to
          those  offered
          by us to customers in our target market. For example, the government-sponsored
          entities Fannie Mae and Freddie Mac have begun to adapt some of their programs
          to include some products similar to those offered by us, and have begun
          to
          expand their presence into the non-conforming market. These government-sponsored
          entities have a size and cost-of-funds advantage that allows them to purchase
          loans with lower rates or fees than we are willing to offer. A material
          expansion of their involvement in the market to purchase sub-prime loans
          could
          change the dynamics of the industry in which we operate in ways adverse
          to us by
          virtue of their size, pricing power and the inherent advantages of a government
          charter. In addition, if as a result of their purchasing practices, these
          government-sponsored entities experience higher-than-expected losses, overall
          investor perception of the sub-prime mortgage industry may suffer. The
          entrance
          of these government-sponsored entities and other larger and better-capitalized
          competitors into our market may reduce our market share and/or our overall
          level
          of loan originations.


**20**




**Regulation**





We
      must
      comply with the laws, rules and regulations, as well as judicial and
      administrative decisions, in all of the jurisdictions in which we are licensed
      to originate mortgage loans, as well as an extensive body of federal law and
      regulations. Our
      business is subject to extensive regulation, supervision and licensing by
      federal, state and local governmental authorities. Our consumer lending
      activities are subject to, among other laws and regulations, the
      following :





§
            the
                Federal Truth-in-Lending Act (“TILA”) and Regulation Z, including the Home
                Ownership and Equity Protection Act of 1994
                (“HOEPA”);





§
            the
                Equal Credit Opportunity Act of 1974, as amended (“ECOA”) and Regulation
                B;





§
            the
                Fair Housing Act (“FHAct”), as
                amended;





§
            the
                Fair Credit Reporting Act of 1970, as
                amended;





§
            the
                Real Estate Settlement Procedures Act (“RESPA”), and Regulation
                X;





§
            the
                Home Mortgage Disclosure Act (“HMDA”) and Regulation
                C;





§
            the
                Telephone Consumer Protection Act;





§
            the
                CAN-SPAM Act;





§
            the
                Americans with Disabilities Act;





§
            the
                Sarbanes-Oxley Act of 2002 (“SOX”);
                and





§
            other
                federal, state and local statutes and regulations affecting our
                activities.





*Mortgage-Related
      Rules and Regulations* .
      We are
      subject to the rules and regulations of, and examinations by, the Department
      of
      Housing and Urban Development (“HUD”) and various state regulatory authorities,
      as well as the various other lending laws cited above, with respect to our
      core
      business of originating, processing and underwriting loans (and servicing loans
      prior to May 2001). These rules and regulations, among other
      things:





§
            impose
                licensing obligations on us;





§
            establish
                eligibility criteria for mortgage
                loans;





§
            prohibit
                discrimination;





§
            require
                credit reports on loan applicants;





§
            regulate
                assessment, collection, foreclosure and claims handling, investment
                and
                interest payments on escrow balances and payment
                features;





§
            mandate
                specified 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, among other things, loss of
      approved status, demands for indemnification or mortgage loan repurchases,
      rights of rescission for certain mortgage loans, class action and other
      lawsuits, and administrative enforcement actions.




**21**


Several
      states and local municipalities have recently enacted so-called anti-predatory
      lending laws and/or regulations. While many of these laws and regulations
      contain some provisions that are similar to one another, there are a variety
      of
      provisions that vary from state to state and municipality to municipality,
      which
      has significantly increased the costs of compliance. In addition, many other
      state and local laws and regulations are currently under consideration, with
      more likely to be proposed in the foreseeable future, that are intended to
      further regulate our industry. Many of these laws and regulations seek to impose
      broad restrictions on a number of commonly accepted lending practices, including
      some of our practices. There can be no assurance that these proposed laws,
      rules
      and regulations, or other similar laws, rules or regulations, will not be
      adopted in the future. Adoption of these laws, rules and regulations could
      harm
      our business by:





§
            substantially
                increasing the costs of compliance with a variety of potentially
                inconsistent federal, state and local
                laws;





§
            substantially
                increasing the risk of litigation or administrative action associated
                with
                complying with these proposed federal, state and local laws, particularly
                those aspects of such proposed laws that contain subjective, as opposed
                to
                objective, requirements;





§
            restricting
                our ability to charge rates and fees adequate to compensate us for
                the
                risk associated with a portion of our loans;
                or





§
            if
                the law, rule or regulation is too onerous, potentially limiting
                our
                ability or willingness to operate in a particular geographic
                area.





There
      are
      also several potential federal bills being proposed, at least one of which
      may
      provide for federal preemption over these existing and proposed state and local
      laws and regulations. There can be no assurance that any federal law will be
      passed addressing this matter, or that, if passed, it will contain a provision
      that preempts these state and local laws and regulations.





In
      July
      2003, regulations adopted by the OTS became effective. These regulations
      eliminated the ability of state-chartered financial institutions and bankers,
      such as us, to charge prepayment penalties on certain alternative mortgages
      under the Federal Alternative Mortgage Transactions Parity Act (“Parity Act”),
      while federally-regulated entities still enjoy that right. As a result, these
      regulations provide a competitive disadvantage for state-chartered entities,
      such as our company, in certain states with respect to alternative
      mortgages.




In
        late
        1999 and early 2000, we entered into a global settlement with various New
        York
        and Federal agencies, which had alleged that we had violated various state
        and
        federal lending laws. As part of the settlement agreements, which expired
        in
        2002 and 2003, we implemented agreed upon changes to our lending practices
        and
        provided payment subsidiaries to identified borrowers, among other things.


We
      believe that we are in compliance in all material respects with applicable
      federal and state laws and regulations. Changes
      to the laws and regulations by the federal government or in any state where
      we
      do business may affect our operations in substantial and unpredictable
      ways.





**Environmental
      Matters**




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


**Subsidiary
      Activities**





As
      of
      December 31, 2005, Delta Financial Corporation had three wholly-owned direct
      subsidiaries, Fidelity Mortgage Inc., DFC Financial Corporation and Delta
      Funding Corporation. The following is a summary of each of these subsidiaries
      activities at December 31, 2005:





*Fidelity
      Mortgage Inc* .
      -
      Originates mortgage loans directly with borrowers who submit loan applications.
      Develops loan leads primarily through a telemarketing system, and also through
      Internet leads, direct mail and a network of 12 origination centers located
      in
      10 states. During the first quarter of  2006, the business operations of
      Fidelity Mortgage Inc. were transferred to Fidelity Mortgage, a newly formed
      division of Delta Funding Corporation (except for one state’s operations which
      are expected to be transferred upon receipt of state approval). Additionally,
      we
      closed one of our origination centers located in Cincinnati, Ohio in February
      2006.





**22**


*DFC
      Financial Corporation* - Holds
      certain trademark rights for both Fidelity Mortgage Inc. and Delta Funding
      Corporation.





*Delta
      Funding Corporation* -
      Originates mortgage loans indirectly through independent mortgage brokers and
      other real estate professionals who submit loan applications on behalf of
      borrowers. The majority of the originations occur in 34 states, through a
      network of approximately 3,000 independent brokers. Additionally, Delta Funding
      Corporation has 15 wholly owned direct and indirect subsidiaries.




**Employees**





As
      of
      December 31, 2005 and 2004, we had a total of 1,327 and 1,123 employees,
      respectively, including both full-time and part-time employees. None of our
      employees are covered by a collective bargaining agreement. We consider our
      relations with our employees to be good.





**FORWARD-LOOKING
      STATEMENTS AND RISK FACTORS**




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





These
      risks and uncertainties, and those contained below, should be considered in
      evaluating forward-looking statements, and undue reliance should not be placed
      on any such forward-looking statements. We undertake no obligation to update
      publicly any of these statements in light of future events except as required
      by
      law. There can be no assurance, however, that our expectations will necessarily
      come to pass. Significant factors affecting these expectations are set forth
      under "Item 1A - Risk Factors."





**Item
      1A. Risk Factors.**





**Risks
      Related to Our Business Operations**





**We
      may operate on a negative cash flow basis and may not have sufficient capital
      resources to satisfy our fixed obligations and fund our
      operations.**





We
      require substantial amounts of cash to fund our loan originations and
      operations. We have operated on a negative cash flow basis at times over the
      past several quarters. We utilize cash proceeds from our securitizations,
      including net interest margin ("NIM") transactions as well as cash generated
      from our whole-loan sales to help offset the costs to originate on our current
      loan production.  We cannot assure you, however, that we will be able to
      earn a sufficient spread between our cost of funds and our average mortgage
      rates, or that we will be able to utilize optimal securitization structures
      (including the sale of NIM notes or interest-only certificates or bonds) or
      be
      able to securitize at all or at terms favorable to us, to generate sufficient
      revenues and cash flows to offset our current cost structure and cash uses
      or
      generate sufficient cash flow from whole-loan sales to offset the cost to
      originate on our current loan production. Furthermore, we cannot assure you
      that
      we will be able to continue to originate a sufficient number of loans, which
      could also impact our ability to generate enough cash from securitizations,
      whole-loan sales and net interest income to offset our costs and tax payments
      in
      the future.





**23**


In
      addition, we cannot assure you that we will generate positive cash flow in
      future periods, or at all, or that we will have sufficient working capital
      to
      fund our operations, the cost structure of which includes substantial fixed
      costs. If we do not have sufficient working capital, we may need to reduce
      the
      scope of our operations and may not be able to satisfy our obligations as they
      become due, which would harm our business.





**Our
      previous financial statements are not indicative of our future financial
      results.**





In
      March
      2004, we began using a securitization structure that we account for as a secured
      financing, also known as portfolio accounting. Portfolio accounting recognizes
      the related revenue as net interest income is received over the life of the
      securitized loans. In contrast, our prior securitization structures required
      us
      to record virtually all of the income received upfront as a gain on sale of
      mortgage loans. We structured all of our 2005 and 2004 securitizations as
      secured financings and plan to continue to utilize this structure, and portfolio
      accounting, for our future securitization transactions. As a result, income
      that
      would have otherwise been recognized upfront as gain-on-sale revenue at the
      time
      of a securitization is now recognized over the life of the loans.





As
      a
      result of these changes, our results of operations in 2005 and 2004 were
      recorded on a basis that is substantially different from years prior to 2004.
      We
      have recorded increased quarterly income during 2005, as compared to the same
      quarter in 2004. The increasing trend in same quarter over same quarter income
      we have experienced from the first quarter of 2004 through the fourth quarter
      of
      2005 reflects the time it took to build our loan portfolio to a size that
      generated sufficient net interest income to offset our operating expenses.
      Accordingly, our financial statements from years prior to 2004 will be of
      limited use to you in evaluating our performance in future periods.





In
      addition, during 2003, we recorded a tax benefit of $25.4 million, primarily
      relating to a reversal of a valuation allowance that we had established in
      2000
      against a deferred tax asset. The reversal of the valuation allowance had a
      significant effect on our financial statements, particularly our recognition
      of
      additional income equal to the amount of the valuation allowance reversal in
      the
      third quarter of 2003. Beginning in the third quarter of 2003, our financial
      statements reflected an effective income tax rate of approximately 39%, which
      is
      a higher effective rate than the rate we reflected from the time that we
      established the valuation allowance to the time that we reversed
      it.





**We
      depend primarily on independent mortgage brokers for the origination of our
      wholesale mortgage loans.**





Independent
      mortgage brokers produce the majority of our loan production. These independent
      mortgage brokers have relationships with multiple lenders and are not obligated
      by contract or otherwise to do business with us. For the years ended December
      31, 2005 and 2004, 54% and 57%, respectively, of our loan originations were
      originated through approximately 3,000 and 2,300 independent mortgage brokers,
      respectively. We compete with other lenders for the independent mortgage
      brokers’ business on the basis of pricing, service, loan fees, costs and other
      factors. Competition from other lenders could harm the volume and pricing of
      our
      wholesale loans, which could reduce our loan production.





**Intense
      competition in the non-conforming mortgage loan industry may result in reduced
      loan production, reduced net income or in revised underwriting standards, which
      could harm our business.**





As
      an
      originator of mortgage loans, we face intense competition, primarily from
      diversified consumer financial companies and other diversified financial
      institutions, mortgage banking companies, commercial banks, credit unions,
      savings and loans, mortgage REITs and other finance companies. Compared to
      us,
      many of these competitors are substantially larger than we are, have greater
      access to capital at a lower cost than we do, have substantially greater
      resources than we do and have a more established market presence than we have.
      In addition, we have experienced increased competition over the Internet, where
      barriers to entry are relatively low. Competition can take many forms, including
      lower interest rates and costs to the borrower, less stringent underwriting
      standards, convenience in obtaining a loan, customer service, the amount and
      term of a loan and more desirable or effective marketing and distribution
      channels. Furthermore, the entrance of additional competitors into our market
      could adversely affect the overall execution of our securitizations as well
      as
      reduce the gains that we may realize in future whole-loan sales. In addition,
      efficiencies in the asset-backed market have generally created a desire for
      even
      larger transactions, giving companies with greater volumes of originations
      a
      competitive advantage.





**24**


If
      our
      competitors increase their marketing efforts, we may be forced to expand our
      marketing efforts, reduce the rates and fees we currently charge or change
      our
      underwriting guidelines in order to maintain and expand our market share. Any
      reduction in our rates or fees, or any change to our underwriting guidelines,
      could harm our business. Any expansion of our marketing efforts could result
      in
      higher costs.





**We
      are subject to losses due to fraudulent and negligent acts on the part of loan
      applicants, mortgage brokers, other vendors and our
      employees.**





At
      the
      time we originate mortgage loans, we rely heavily upon information supplied
      to
      us by third parties, including the information contained in the loan
      application, property appraisal, title information and employment and income
      documentation. If any of this information is intentionally or negligently
      misrepresented and we do not detect the misrepresentation prior to funding
      of
      the loan, the value of the loan may be significantly lower than expected.
      Whether any misrepresentation or fraudulent act is made by the loan applicant,
      the mortgage broker, another third party or one of our employees, we may bear
      the risk of loss. A loan subject to such misrepresentation or fraud is typically
      unsaleable or subject to repurchase by us if it is sold by us prior to detection
      of the misrepresentation or fraud. Even though we may have rights against
      persons and entities who made or knew about the misrepresentation or fraudulent
      act, these persons and entities are often difficult to locate, making it
      difficult to collect any monetary losses we may have suffered.





We
      have
      controls and processes that are designed to help us identify misrepresentations
      from our borrowers, mortgage brokers, other vendors and our employees. However,
      we cannot assure you that we have detected or will detect all misrepresentations
      or fraud in our loan originations. If we were to experience a significant number
      of these problems, our business would be harmed.





**We
      may be required to repurchase mortgage loans or indemnify investors if we breach
      representations and warranties in our mortgage loan sales agreements, which
      could harm our business.**





In
      connection with the sale and securitization of our loans, we are required to
      make customary representations and warranties regarding us and the loans. We
      are
      subject to these representations and warranties for the life of the loans and
      they relate to, among other things:





·
            compliance
                with laws;





·  regulations
      and underwriting standards;





·  the
      accuracy of information in the loan documents and loan files; and





·  the
      characteristics and enforceability of the loans.





A
      loan
      that does not comply with these representations and warranties may not be
      saleable or saleable only at a discount. If the loan is sold before we detect
      non-compliance with these requirements, we may be obligated to repurchase the
      loan and bear any associated loss, or we may be obligated to indemnify the
      purchaser against that loss. We believe that we have qualified personnel and
      have established controls to help ensure that all loans will be originated
      to
      the market’s requirements; however, we cannot provide any assurance that we will
      succeed in doing so. We seek to minimize losses from defective loans by
      correcting flaws if possible and then selling or re-selling these loans. We
      also
      create allowances to provide for defective loans in our financial statements.
      We
      cannot provide any assurance that losses associated with defective loans will
      not harm our business, or that the allowances in our financial statements will
      be sufficient to reflect the actual losses that we may incur.





**25**


**Our
      loan products may require payment adjustments during the term of the mortgage
      loan that may result in increased payment defaults by borrowers and higher
      losses to us.**





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





**We
      depend on key personnel and the continued ability to attract and retain
      qualified employees, the loss of which could disrupt our operations and result
      in reduced revenues.**





The
      success of our operations depends on the continued employment of our senior
      management. If key members of our senior management were unable to perform
      their
      duties or were to leave us, we may not be able to find capable replacements,
      which could disrupt operations and result in reduced revenues. We have entered
      into employment, change-in control and non-competition agreements with some
      members of our senior management; however, these individuals may leave us or
      compete against us in the future. In addition, a court might not enforce the
      non-competition provisions of these agreements.





Even
      if
      we retain our current employees, our management must continually recruit
      talented professionals in order to grow our business. These professionals must
      have skills in business strategy, marketing, sales and finance. Moreover, we
      depend, in large part, upon our wholesale account executives and retail loan
      analysts to attract borrowers by, among other things, developing relationships
      with financial institutions, other mortgage companies and brokers, real estate
      agents, borrowers and others. The market for these skilled professionals is
      highly competitive and may lead to increased hiring and retention costs. An
      inability to attract, motivate and retain qualified professionals could disrupt
      our operations and limit our growth.





**Any
      disruption to our Click and Close** **®** **** **system
      could disrupt our operations, expose us to litigation and require expensive
      investments in alternative technology.**





We
      are
      highly dependent upon our Click and Close **®** proprietary software to originate our mortgage loans. Any disruption to this
      software would substantially curtail our ability to originate new loans. The
      costs to replace this system may be extremely large.





Despite
      our efforts to maintain Internet security, we may not be able to stop
      unauthorized attempts to gain access to, or disrupt communications with, our
      brokers and our customers. Specifically, computer viruses, break-ins and other
      disruptions could lead to interruptions, delays, and loss of data or the
      inability to accept and confirm the receipt of information. Any of these events
      could substantially damage our reputation. We cannot assure you that our current
      technology or future advances in this technology or other developments will
      be
      able to prevent security breaches. We may need to incur significant costs or
      employ other resources to protect against the threat of security breaches or
      to
      alleviate problems caused by these breaches.





Because
      our activities involve the storage and transmission of proprietary information,
      such as a borrower’s personal financial information, if a third party were able
      to steal a customer’s confidential information, we could be subject to claims,
      litigation or other potential liabilities that could cause our expenses to
      increase substantially. In addition to purposeful security breaches, the
      inadvertent transmission of computer viruses could expose us to litigation
      or a
      significant loss of revenue.





**The
      success, growth and competitiveness of our business will depend upon our ability
      to adapt to and implement technological changes.**





The
      intense competition in the non-conforming mortgage industry has led to rapid
      technological developments, evolving industry standards and frequent releases
      of
      new products and enhancements. As mortgage products are offered more widely
      through alternative distribution channels, such as the Internet, we may be
      required to make significant changes to our current wholesale and retail
      structure and information systems to compete effectively. The origination
      process is becoming more dependent upon technological advancement, such as
      the
      ability to process applications over the Internet, accept electronic signatures,
      provide process status updates instantly and other conveniences that customers
      may expect. Implementing this new technology and becoming proficient with it
      may
      also require significant capital expenditures. Our inability to continue
      enhancing our current Internet capabilities, or to adapt to other technological
      changes in the industry, could reduce our ability to compete.




**26**


**Our
        use of Insured AVMs in lieu of appraisals could increase our
        losses.**
 
 We
        use
        Insured AVMs in lieu of appraisals for certain mortgage loan originations
        (totaling less than 11% of our 2005 total loan production). An Insured AVM
        is
        the coupling of a third-party valuation estimate and insurance on that value.
        The third-party AVM providers have created computer programs that use relevant
        real estate information, such as sales prices, property characteristics and
        demographics, to calculate a value for a specific property. Public records
        are
        the primary data source for an Insured AVM, and the quality of the values
        generated by them varies depending upon the data they use and their design.
        AVMs
        are complex programs incorporating a variety of forecasting techniques,
        including linear regression, expert systems, neural networks, artificial
        intelligence and other methodologies. The different methodologies, algorithms
        and variables used by the third-party AVM providers may vary greatly and
        affect
        their reliability and accuracy.




One
      of
      the weaknesses in using an AVM to value a property is the lack of a physical
      exterior or interior inspection of the property. To mitigate some of this
      inherent weakness, we require a property condition report to be completed for
      each AVM considered for use. A property condition report is a limited physical
      external inspection of the property. There can be no assurance, however, that
      these property inspections will uncover all potential issues with a property
      that a full appraisal might.





At
      the
      closing of the loan, we purchase insurance that insures the value of the
      property. In the event the borrower defaults upon their loan, resulting in
      the
      liquidation of the property, the insurance company may have to pay a portion
      of
      any losses incurred by the securitization trust. There can be no assurance,
      however, that the securitization trust will be able to collect any insurance
      in
      the event of a loss.





**Unpredictable
      delays or difficulties in the development of new loan products or loan programs
      can harm our business.**





We
      and
      our competitors are continually striving to develop new loan products and
      programs to gain a competitive advantage in the marketplace. New loan products
      and programs can have the effect of obtaining more business in the wholesale
      channel from mortgage brokers and/or in the retail channel directly
      with consumers, by providing greater flexibility and more alternatives to
      meeting borrowers’ needs. Any unpredictable delays or difficulties in developing
      and introducing new loan products or programs can result in the loss of business
      to competitors.





**If
       we make any acquisitions, we will incur a variety of costs and may never
      realize the anticipated benefits, which can harm our
      business.**





If
      appropriate opportunities become available, we may attempt to acquire businesses
      that we believe are a strategic fit with our business. We currently have no
      agreements to consummate any acquisitions. If we pursue any transaction, the
      process of negotiating the acquisition and integrating an acquired business
      may
      result in operating difficulties and expenditures and may require significant
      management attention that would otherwise be available for ongoing development
      of our business, whether or not any such transaction is ever consummated.
      Moreover, we may never realize the anticipated benefits of any acquisition.
      Future acquisitions could result in potentially dilutive issuances of equity
      securities, the incurrence of debt, contingent liabilities and/or the recording
      of goodwill and other intangible assets, which could harm our results of
      operations, financial condition and business prospects.





**Differences
      in our actual experience compared to the assumptions we used to estimate the
      value of our excess cashflow certificates could result in
      losses.**





Our
      securitization transactions prior to 2004 were structured to be accounted for
      as
      sales, which required the use of gain-on-sale accounting. At closing, we
      estimated the fair value of the excess cashflow certificates we received in
      the
      securitization based upon various economic factors, including loan types,
      balances, interest rates, dates of origination, terms and geographic locations.
      We also use other available information applicable to the types of loans we
      originate, such as reports on interest rates, collateral value, economic
      forecasts and historical default and prepayment rates of the portfolio under
      review. Realization of the estimated fair value of these excess cashflow
      certificates is subject to the prepayment and loss characteristics of the
      underlying loans and to the timing and ultimate realization of the stream of
      cash flow associated with these loans. Significant prepayment or loss experience
      would impair the future cash flow of the excess cashflow certificates. If actual
      experience differs from the assumptions we used to determine the asset values,
      future cash flow and earnings could be harmed and we could be required to
      write-down the value of our excess cashflow certificates. No assurance can
      be
      given that our excess cashflow certificates will not experience significant
      prepayments or losses or as to whether, and in what amounts, we, in the future,
      may have to write-down the value of the excess cashflow certificates from our
      securitization transactions. In addition, if the prevailing interest rates
      rise,
      the required discount rate might also rise, resulting in fair value adjustments
      related to the excess cashflow certificates. Actual results could vary
      significantly from the projections due to a variety of facts, including changes
      in interest rates, economic conditions, servicer defaults, loan defaults,
      prepayments, and delinquency triggers resulting in changes in the level of
      cash
      held by the securitization trust to prepay the holders of its asset-backed
      securities.


**27**


**Risks
      Related to Our Financing Activities**





**We
      depend on third party financing sources, which if unavailable to us in the
      future could harm our business.**





To
      accumulate loans for securitization or sale, we borrow money on a short-term
      basis through warehouse lines of credit. We have relied upon a limited number
      of
      lenders to provide the primary credit facilities for our loan originations.
      As
      of December 31, 2005, we had four warehouse facilities for this purpose, each
      from a different lender. These facilities are due to expire between April 2006
      and October 2006. We may not be able to either renew or replace these warehouse
      facilities at their respective maturities or at terms satisfactory to us or
      at
      all.





Any
      failure to renew or obtain adequate funding under these warehouse financing
      facilities or other financing arrangements, or any reduction in the size of,
      or
      increase in the cost of, these types of facilities, could harm our business.
      If
      we are not successful in maintaining adequate financing, we would not be able
      to
      hold a sufficient volume of loans pending securitization. As a result, we would
      have to curtail our loan origination activities or sell loans either through
      whole loan sales or in smaller securitizations, which could render our
      operations unprofitable.





During
      volatile times in the capital markets, our access to warehouse and other
      financing has been severely limited. If we are unable to maintain adequate
      financing and other sources of capital are not available, we would be forced
      to
      suspend or curtail our operations, which would harm our business.





**Our
      warehouse credit facilities contain covenants that restrict our operations
      and
      may inhibit our ability to grow our business and increase
      revenues.**





Our
      warehouse credit facilities contain restrictions and covenants that, among
      other
      things, require us to satisfy financial, asset quality and loan performance
      tests. If we fail to satisfy any of these covenants, we would be in default
      under these agreements and our lenders could elect to declare all amounts
      outstanding under the agreements to be immediately due and payable, enforce
      their interests against collateral pledged under these agreements and restrict
      our ability to make additional borrowings. These agreements also contain
      cross-default provisions, so that if a default occurs under any one agreement,
      the lenders under our other agreements could also declare a
      default.





The
      covenants and restrictions in our warehouse credit facilities may restrict
      our
      ability to, among other things:





·  finance
      loans which do not have specified attributes;





·  reduce
      our liquidity below minimum levels; and





·  hold
      loans for longer than established time periods.





These
      restrictions may interfere with our ability to enter into other financing
      arrangements or to engage in other business activities, which may harm our
      business.





**Our
      warehouse financing is subject to margin calls based on our lender’s opinion of
      the value of our collateral. An unanticipated margin call could harm our
      liquidity.**





The
      amount of financing we receive under our warehouse lines of credit depends
      in
      large part on our lenders’ valuation of the mortgage loans securing the
      financings. Each credit facility provides the lender the right to re-evaluate
      the loan collateral that secures our outstanding borrowings at any time. If
      the
      lender determines that the value of the collateral has decreased, the lender
      has
      the right to initiate a margin call. A margin call would require us to provide
      the lender with additional collateral or to repay a portion of our outstanding
      borrowings. Any margin call could force us to redeploy our assets in a manner
      which may not be favorable to us, and if we are not able to satisfy a margin
      call, could result in the loss of the related line of credit and a default
      under
      any other credit facility. Any loss of credit of this type could harm our
      business.





**28**


**Our
      inability to realize cash proceeds from securitizations and whole-loan sales
      in
      excess of the loan acquisition costs could harm our financial
      position.**





We
      rely,
      and expect to continue to rely, significantly upon our ability to securitize
      our
      mortgage loans - and, to a lesser extent, the premiums we receive on whole-loan
      sales in excess of the outstanding principal balance of the loans - to generate
      cash for repayment of our short-term credit and warehouse facilities and to
      finance mortgage loans for the remainder of each mortgage loan’s
      life.





We
      cannot
      assure you that we will be successful in securitizing mortgage loans that we
      accumulate in the future. Our ability to complete securitizations of our loans
      at favorable prices or at all will depend on a number of factors, including:
      conditions in the securities markets generally; conditions in the asset-backed
      securities market specifically; the availability of credit enhancement on
      acceptable economic terms or at all; and the performance of our portfolio of
      securitized loans.





If
      we are
      unable to originate loans at a cost lower than the cash proceeds realized from
      securitizations and loan sales, our results of operations, financial condition
      and business prospects could be harmed.





**We
      typically finance borrowers with lower credit ratings relative to those who
      would otherwise qualify for prime mortgage loans. This strategy may hinder
      our
      ability to obtain financing and to continue securitizing loans or selling loans
      on attractive terms in the future.**





We
      market
      a significant portion of our loans to borrowers who are either unable or
      unwilling to obtain financing from traditional sources, such as commercial
      banks. This type of borrower is commonly referred to as a sub-prime or
      non-conforming borrower. Loans made to non-conforming borrowers may entail
      a
      higher risk of delinquency and loss than loans made to borrowers who use
      traditional financing sources. This fact may hinder our ability to obtain
      financing and to continue securitizing loans or sell loans on attractive terms
      in the future. A borrower’s delinquency in making timely mortgage loan payment
      will interrupt the flow of projected interest income from the mortgage loans
      we
      hold and can ultimately lead to a borrower’s loan default and a loss to us if
      the net realizable value of the real property securing the mortgage loan is
      insufficient to cover the principal and interest due on the loan. In addition,
      our cost of financing a delinquent or defaulted loan is generally higher than
      for a performing loan. We bear the risk of delinquency and default on loans
      beginning at the time of origination. We continue to bear this risk until we
      sell these loans and, thereafter, we continue to bear this risk if we sell
      the
      loans with a retained interest or if we securitize the loans. We also reacquire
      the risk of delinquency and default for loans that we are obligated to
      repurchase in connection with a securitization or a loan sale. Repurchase
      obligations are typically triggered in loan sale transactions if the first
      payment due to the buyer following the loan sale is made more than 30 days
      after
      it is due or in any sale or securitization if the loan is not in material
      compliance with the representations and warranties we provided in our sales
      documents. Higher than anticipated loan delinquencies, including underestimating
      the extent of losses that our loans may incur, could cause us to incur
      substantial loan repurchase obligations, limit our ability to sell or securitize
      additional loans and limit the cash flow from our securitizations.





Historically,
      we have experienced higher rates of delinquency on loans made to these
      credit-impaired, non-conforming borrowers compared to delinquency rates
      experienced by other financial companies on loans to borrowers who are
      not credit impaired. While we use underwriting standards designed to mitigate
      the higher credit risk associated with lending to these non-conforming
      borrowers, our standards and procedures may not offer adequate protection
      against the risk of default.





**We
      have monetized some of our excess cashflow certificates. Our inability to do
      so
      in the future could harm our business.**





We
      have
      been able to monetize some of our existing excess cashflow certificates in
      2003,
      2001 and 2000 through a residual financing, a net interest margin transaction
      and outright sales. Each of these transactions has provided us with working
      capital to fund our operations. Any impairment of, or delay in, our ability
      to
      complete a sale, financing or securitization of our excess cashflow
      certificates, or our failure to do so upon terms favorable to us, could reduce
      the amount of cash available to us to fund our operations.





**29**


**We
      are exposed to contingent risks and liabilities related to all of the loans
      we
      originate.**





We
      have
      the following contingent risks with respect to loans that we originate and
      sell:





·
            We
                retain some degree of credit risk on all loans we originate or purchase
                during the period of time that we hold loans before securitization
                or
                sale. This credit risk includes the risk of borrower default, the
                risk of
                foreclosure and the risk that an increase in interest rates would
                result
                in a decline in the fair value of our loans to potential
                purchasers.





·
            Our
                securitizations generally require the use of the excess cash flow
                distributions related to the excess cashflow certificates to accelerate
                the amortization of the securities balances relative to the amortization
                of the mortgage loans held by the trust, up to specified O/C limits.
                The resulting O/C serves as credit enhancement for the related
                securitization trust and, therefore, is available to absorb losses
                realized on loans held by that securitization trust. Generally, the
                form
                of credit enhancement agreement entered into in connection with
                securitization transactions contains limits on the delinquency, default
                and loss rates on the loans included in each securitization trust.
                If, at
                any measuring date, the delinquency, default or loss rate with respect
                to
                any trust exceeds the specified delinquency, default and loss rates,
                excess cash flow from the securitization trust, if any, would be
                used to
                fund the increased overcollateralization limit instead of being
                distributed to us as holders of the excess cashflow certificate,
                which
                would harm our cash flow.





·
            When
                we sell or finance mortgage loans, either through securitization
                or on a
                whole-loan basis, we make standard representations and warranties
                regarding these loans and may be required to repurchase mortgage
                loans
                that are not in compliance with any of these representations and
                warranties. In the past, we also have sold loans and/or pools of
                loans
                directly to a network of commercial banks, savings and loans, insurance
                companies, pension funds and accredited investors. In general, we
                sold
                these pools of loans or individual loans with recourse, in which
                case we
                are obligated to repurchase any loan upon default and to acquire
                the
                related mortgage loan. This obligation is subject to various terms
                and
                conditions, including, in some instances, a time limit. At December
                31,
                2005, we had reserved $310,000 in potential losses against $762,000
                in
                aggregate principal amount of loans sold subject to future repurchase
                should these loans meet the default
                provisions.





**A
      decline in the quality of servicing could lower the value of our excess cashflow
      certificates and our ability to sell or securitize loans.**





In
      May
      2001, we transferred our servicing portfolio to Ocwen Federal Bank FSB, a
      subsidiary of Ocwen Financial Corporation
      and a related predecessor entity to Ocwen Loan Servicing, LLC, which presently
      services our loan portfolio. Poor
      servicing by Ocwen Loan Servicing, LLC (or its parent or subsidiaries) or any
      other third party servicer who services the loans we originate could harm the
      value of securitized mortgage loans (and our excess cashflow certificates in
      pre-2004 securitizations) and our ability to sell or securitize loans.
      Additionally, regulatory actions and class action lawsuits against these
      servicers could harm the value of our securitized loans (and our excess cashflow
      certificates in pre-2004 securitizations) and our ability to sell or securitize
      loans. Ocwen Financial Corporation and several of its affiliates have been
      named
      as defendants in a number of purported class action lawsuits that challenge
      its
      servicing practices under applicable federal and state laws. In addition,
      according to its public filings, Ocwen Financial Corporation and its affiliates
      maintain high levels of indebtedness. Ocwen
      Financial Corporation is a non-investment grade company and recently terminated
      its banking subsidiary's status as a federal savings bank under supervision
      of
      the OTS and FDIC and has obtained, or is in the process of obtaining, necessary
      licensing at the state and local level. If Ocwen Financial Corporation's
      operations are impaired as a result of litigation, governmental investigations,
      its inability to repay its indebtedness when due, or further degradation of
      its
      capitalization or credit rating, our profitability and operations may be
      harmed.





**30**


**An
      interruption in or breach of our information systems may result in lost
      business.**





We
      rely
      heavily upon communications and information systems to conduct our business.
      As
      we implement our growth strategy and increase our volume of loan production,
      that reliance will increase. Any failure or interruption or breach in security
      of our information systems or the third party information systems on which
      we
      rely could cause underwriting or other delays and could result in fewer loan
      applications being received, slower processing of applications and reduced
      efficiency in loan servicing. If we and the third parties upon whom we rely
      do
      not properly address these failures or interruptions, our business could be
      harmed.





**Risks
      Related to Economic Factors, Market Conditions and Other Factors Beyond Our
      Control**





**Interest
      rate fluctuations may reduce our loan origination volume, increase our
      prepayment, delinquency, default and foreclosure rates, and reduce the value
      of
      and income from our loans.**





Our
      primary market risk is interest rate risk. Our profitability may be directly
      affected by the level of, and fluctuation in, interest rates, which affects
      our
      ability to earn a spread between interest received on our loans and the cost
      of
      our borrowings, which are tied to various interest rate swap maturities,
      commercial paper rates and the London
      Inter-Bank Offered Rate (“LIBOR”) .
      Our
      profitability is likely to be harmed during any period of unexpected or rapid
      changes in interest rates. A substantial and sustained increase in interest
      rates could harm our ability to originate loans because refinancing an existing
      loan would be less attractive to the borrower, and qualifying for a purchase
      loan may be more difficult for the borrower.





*Risks
      Associated with Increased Interest Rates.* Some
      of
      the risks we face relating to an increase in interest rates are:





·
            reduced
                customer demand for our mortgage loan
                products;





·
            higher
                delinquency and default rates on the adjustable-rate mortgage loans
                that
                we have orginated;





·
            reduced
                profitability on future securitizations due to wider investor spread
                requirements or increased O/C requirements for securities issued in
                securitizations;





·
            increased
                cost of funds on our warehouse lines of credit or other corporate
                borrowings, which may result in a reduced spread between the rate
                of
                interest we receive on loans and interest rates we must pay under
                our
                credit facilities; and





·
            limited
                access to borrowings in the capital
                markets.




*Risks
        Associated with Lower Interest Rates.* A
        decline
        in market interest rates generally induces borrowers to refinance their loans,
        and could reduce our profitability. Because consumers in the United States
        have
        recently experienced a prolonged period of low interest rates (predominantly
        in
        late 2001 through mid-2004), many borrowers have already refinanced their
        existing debt, which could reduce the pool of borrowers interested in our
        mortgage products. Furthermore, a material decline in interest rates could
        increase the level of loan prepayments, which in turn could decrease the
        amount
        of collateral underlying our securitizations, and cause us to earn less income
        in connection with these loans. To the extent excess cashflow certificates
        have
        been capitalized on our financial statements (in our securitizations prior
        to
        2004), higher than anticipated rates of loan prepayments or losses could
        require
        us to write-down the value of these excess cash flow certificates, and reduce
        our earnings.
 *Risks Associated with Fluctuating Interest Rates.* Periods
        of unexpected or rapid changes in interest rates, and other volatility or
        uncertainty regarding interest rates, also can harm us by increasing the
        likelihood that asset-backed investors will demand higher than normal spreads
        to
        offset that volatility or uncertainty. In that event, the net interest spread
        we
        can expect to receive from our securitized assets would
        decrease.





Fluctuating
      interest rates may affect the net interest income we earn, based upon the
      difference between the yield we receive on loans held pending sales and the
      interest paid by us for funds borrowed under our warehouse facilities. A change
      in interest rates would reduce the spread between the average coupon rate on
      fixed rate loans and the weighted average pass-through rate paid to investors
      for coupons issued in connection with a securitization. Although the average
      loan coupon rate is fixed at the time the loan is originated, the pass-through
      rate to investors in a securitization is not fixed until the pricing of the
      securitization, which occurs shortly before our sale of the loans to the
      securitization trust. Therefore, if the market rates required by investors
      increase prior to securitization of the loans, the spread between the average
      coupon rate on the loans and the pass-through rate to investors may be reduced
      or eliminated, which would reduce or eliminate our net interest income from
      our
      on-balance sheet loan portfolio. Fluctuating interest rates also may affect
      the
      excess cash flows we receive from our excess cashflow certificates. A portion
      of
      our asset-backed securities are priced based on one-month LIBOR, but the
      collateral that backs these securities is comprised of mortgage loans with
      either fixed interest rates or “hybrid” interest rates — that is, fixed for the
      initial two or three years of the mortgage loan, and adjusting afterwards every
      six months thereafter. As a result, the cash flows that we receive from these
      securitized mortgage loans are dependent upon the interest rate environment.
      This is because “basis risk” exists between the assets and liabilities of the
      securitization trusts that we create. For example, the interest costs for that
      portion of our asset-backed securities that are priced on one-month LIBOR bears
      interest at a floating rate. As a result, each month the interest rate received
      by the security holders will adjust upwards or downwards as interest rates
      change. Therefore, as interest rates rise, the spread we earn on these assets
      (or the value of our excess cashflow certificates in pre-2004 securitizations)
      will fall, and as interest rates fall, the spread we earn on these assets (or
      the value of our excess cashflow certificates in pre-2004 securitizations)
      will
      rise. The decrease in the interest rate spread we earn (or the loss in value
      of
      our excess cashflow certificates in pre-2004 securitizations) as a result of
      rising interest rates will reduce our cash flow and harm our
      profitability.





**31**


**Our
      hedging strategies may not be successful in mitigating our risks associated
      with
      interest rates.**





Although
      we may seek to mitigate or offset our exposure to interest rate risks by using
      various hedging strategies, including interest rate swaps and/or “corridors”
(corresponding purchase and sale of interest rate caps with similar notional
      balances at different strike prices), these hedging strategies may not be
      effective and involve risk. There have been periods, and it is likely that
      there
      will be periods in the future, during which we will incur losses after
      accounting for our hedging strategies. The hedging strategies we select may
      not
      have the effect of reducing our interest rate risk. In addition, the nature
      and
      timing of our hedging transactions could actually increase our risk and losses.
      In addition, hedging strategies involve transaction costs and other costs.
      Our
      hedging strategies and the derivatives that we may use may not adequately
      mitigate or offset the risk of interest rate volatility, and our hedging
      transactions may result in losses.





**Potential
      changes in valuation of excess cashflow certificates will harm our
      business.**





As
      of
      December 31, 2005, our balance sheet reflected the fair value of excess cashflow
      certificates of $7.8 million. Realization of the estimated fair value of these
      excess cashflow certificates is subject to the prepayment and loss
      characteristics of the underlying loans and to the timing and ultimate
      realization of the stream of cash flow associated with those loans. As indicated
      above, a material change in prepayment or loss experience would impair the
      future cash flow of the excess cashflow certificates. If actual experience
      differs from the assumptions we used to determine the asset values, future
      cash
      flow and earnings could be harmed and we may have to adjust the fair value
      of
      our excess cashflow certificates. We cannot assure you that our excess cashflow
      certificates will not experience significant prepayments or losses or whether,
      and in what amounts, we may have to adjust the fair value of the excess cashflow
      certificates from our securitization transactions.





**Our
      business may be harmed by economic difficulties in the eastern United States,
      where we conduct a significant amount of our business.**





We
      lend
      primarily to borrowers that secure their obligations to us with real property
      located in the eastern half of the United States. Accordingly, an economic
      downturn in the eastern half of the United States could negatively impact our
      ability to meet our origination targets or harm the performance of our existing
      loan portfolio.





**An
      economic slowdown or recession could cause us to experience losses, including
      increasing delinquencies and foreclosures on our loans.**





Periods
      of economic slowdown or recession may be accompanied by decreased demand for
      consumer credit, declining real estate values and an increased rate of
      delinquencies, defaults and foreclosures, and may harm our business. In the
      mortgage business, any material decline in real estate values reduces the
      ability of borrowers to use the equity in their homes to support borrowings
      and
      increases the LTV ratios of loans we previously made. These factors weaken
      collateral coverage and increase the possibility of a loss on the loan if a
      borrower defaults on the loan. Delinquencies, foreclosures and losses on
      mortgage loans generally increase during economic slowdowns or recessions.
      However, delinquencies, foreclosures and losses on mortgage loans also have
      increased during periods of economic growth.  As a result, we cannot assure
      you that any delinquencies, foreclosures and losses will not increase in the
      future.





Because
      of our focus on non-conforming credit-impaired borrowers in the home equity
      loan
      market, the actual rates of delinquencies, foreclosures and losses on the loans
      we hold is likely to be higher under adverse economic conditions than
      delinquencies, foreclosures and losses currently experienced in the mortgage
      loan industry in general. Any sustained period of increased delinquencies,
      foreclosures, losses or increased costs could reduce our ability to sell, and
      could increase the cost of selling, loans through securitization or on a whole
      loan basis. Any sustained increase in delinquencies, defaults or foreclosures
      is
      likely to increase losses and harm the pricing of our future securitizations
      and
      whole-loan sales as well as our ability to finance our loan
      originations.





**32**


**Geopolitical
      risks may harm our business.**





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




Additionally,
        the economic impact of the United States’ military operations in Afghanistan,
        Iraq and other countries, as well as the possibility of any terrorist attacks
        in
        response to these operations, is uncertain, but could have a material effect
        on
        general economic conditions, consumer confidence and market liquidity. No
        assurance can be given as to the effect of these events on consumer confidence
        and the performance of our mortgage loans. United States military operations
        also may increase the likelihood of shortfalls under the Servicemembers Civil
        Relief Act or similar state laws, which provide for reduced interest payments
        for members of the armed forces while on active duty.
 
 **Natural
        disasters may harm our business, causing us to experience losses, and increasing
        delinquencies and foreclosures on our loans.**
 
 Natural
        disasters may adversely affect the performance of mortgage loans in a variety
        of
        ways, including but not limited to, impacting borrowers’ abilities to repay
        their loans, displacing the homeowners due to severe damage to the properties,
        and decreasing in the value of the mortgaged property, which may result in
        increased losses to us. Additionally, claims for insurance recoveries may
        be
        disputed if insured parties and their insurers disagree in their assessments
        or
        type of insurable damage, causing the timing and receipt of insurance payments
        for damages to be delayed or made at amounts lower than expected, if at all.
        We
        may not be able to readily determine the particular nature of such economic
        effects, how long any of these effects may last, or the impact on the
        performance of mortgage loans affected by the natural
        disaster.


**Risks
      Related to Laws, Regulations and Legal Actions**





**The
      scope of our business exposes us to risks of noncompliance with an increasing
      and, in some cases, inconsistent body of complex laws, rules and regulations
      at
      the federal, state and local levels.**





We
      must
      comply with the laws, rules and regulations, as well as judicial and
      administrative decisions, in all of the jurisdictions in which we are licensed
      to originate mortgage loans, as well as an extensive body of federal laws,
      rules
      and regulations. Moreover, our lending business is subject to extensive
      government regulation, supervision and licensing requirements by various state
      departments of banking or financial services, and the cost of compliance with
      such regulations may hinder our ability to operate profitably. Also, individual
      cities and counties have begun to enact laws that restrict non-conforming loan
      origination activities in those cities and counties. The laws, rules and
      regulations of each of these jurisdictions are different, complex and, in some
      cases, in conflict with each other. As our operations grow, and new laws, rules
      and regulations are added or amended, it may be more difficult to
      comprehensively identify, accurately interpret, properly program our technology
      systems and effectively train our personnel with respect to all of these laws,
      rules and regulations. Our inability to properly manage regulatory compliance
      could increase our potential exposure to the risks of noncompliance with these
      laws, rules and regulations.





**33**


Our
      failure to comply with these laws, rules and regulations may lead
      to:





·
            civil
                and criminal liability, including potential monetary
                penalties;





·
            loss
                of state licenses or other approved status required for continued
                lending
                operations;





·
            legal
                defenses delaying or otherwise harming the servicer's ability to
                enforce
                loans, or giving the borrower the right to rescind or cancel the
                loan
                transaction, or remove the security interest in the
                property;





·
            demands
                for indemnification or loan repurchases from purchases of our
                loans;





·
            difficulty
                in securitizing or selling our mortgage
                loans;





·
            our
                choosing or being forced to severely limit, or even cease our lending
                activities in a particular area;





·
            class
                action lawsuits; or





·
            administrative
                enforcement actions.





Any
      of
      these results could harm our business.





Compliance
      with a variety of potentially inconsistent federal, state and local laws, rules
      and regulations has increased our compliance costs, as well as the risk of
      litigation or administrative action associated with complying with these
      proposed and enacted federal, state and local laws, particularly those aspects
      of proposed and enacted laws that contain subjective requirements, with which
      it
      may be difficult to ensure compliance. In addition, federal, state and local
      laws, rules and regulations could impact over-collateralization requirements
      set
      by the rating agencies, which could decrease the cash proceeds we may receive
      from our securitizations. In some cases, rating agencies may refuse to rate
      securitization transactions that contain loans covered by laws, rules and
      regulations that they determine create too much risk or
      uncertainty.





**If 
      we do not comply with the TILA, aggrieved borrowers could have the right to
      rescind their loans.**





TILA
      and
      Regulation Z contain disclosure requirements designed to provide consumers
      with
      uniform and understandable information regarding the terms and conditions of
      loans and credit transactions in order that consumers may compare proposed
      credit terms. TILA also guarantees consumers a three-day right to cancel certain
      loan transactions and imposes specific loan feature restrictions on some loans,
      including the type of loans that we originate. If we do not comply with these
      requirements, in addition to fines and penalties, aggrieved borrowers could
      have
      the right to rescind their loans or to demand, among other things, the return
      of
      finance charges and fees paid to us at the time of the loan, as well as
      statutory, actual and other damages.





**If 
      we do not comply with Regulation X under the RESPA, we could be subject to
      substantial fees and potential limitations upon future business
      activities.**





We
      also
      are subject to the RESPA, and Regulation X under RESPA. These laws and
      regulations, which are administered by HUD, impose limits on the amount of
      funds
      a lender can require a borrower to deposit in any escrow account for the payment
      of taxes, insurance premiums or other charges; limits the types of fees which
      may be paid to third-parties; and imposes various disclosure requirements on
      the
      lender. If we do not comply with these requirements, we could be subject to
      refunding unearned fees, imposition of substantial fines and potential
      limitations upon future business activities.





**The
      increasing number of federal, state and local “anti-predatory” lending laws may
      restrict our ability to originate, or increase our risk of liability with
      respect to, some types of mortgage loans and could increase our cost of doing
      business.**





In
      recent
      years, several federal, state and local laws, rules and regulations have been
      adopted, or are under consideration for adoption, that are intended to eliminate
      so-called “predatory” lending practices. These laws, rules and regulations
      impose restrictions on mortgage loans on which certain points and fees or the
      annual percentage rate (“APR”) exceed specified amounts. Some of these
      restrictions expose lenders to risks of litigation and penalties no matter
      how
      carefully a loan is underwritten. In addition, an increasing number of these
      laws, rules and regulations seek to impose liability for violations on
      purchasers of loans, regardless of whether a purchaser knew of or participated
      in the violation. It is against our policy to engage in predatory lending
      practices.




**34**


We
        have
        decided not to originate loans that exceed the APR or “points and fees”
thresholds of these laws, rules and regulations, because the companies that
        buy
        our loans and/or provide financing for our loan origination operations generally
        do not want to buy or finance those types of loans. The continued enactment
        of
        these laws, rules and regulations may prevent us from making these loans
        and may
        cause us to reduce the APR or the points and fees on loans that we do make.
        In
        addition, the difficulty of managing the risks presented by these laws, rules
        and regulations may decrease the availability of warehouse financing and
        the
        overall demand for non-conforming loans, making it difficult to fund, sell
        or
        securitize any of our loans. If we decide to originate loans that are subject
        to
        these laws, rules and regulations, we will be exposed to greater risks for
        actual or perceived non-compliance with them. This could lead to demands
        for
        indemnification or loan repurchases from our lenders and loan purchasers,
        class
        action lawsuits, increased defenses to foreclosure of individual loans in
        default, individual claims for significant monetary damages and administrative
        enforcement actions. In any event, the growing number of these laws, rules
        and
        regulations will increase our cost of doing business as we are required to
        develop systems and procedures to ensure that we do not violate any aspect
        of
        these requirements.




**We
      are no longer able to rely on the Parity Act to preempt certain state law
      restrictions on prepayment penalties, which could harm our
      business.**





The
      value
      of a mortgage loan depends, in part, upon the expected period of time that
      the
      mortgage loan will be outstanding. If a borrower pays-off a mortgage loan in
      advance of this expected period, the holder of the mortgage loan does not
      realize the full value expected to be received from the loan. A prepayment
      penalty payable by a borrower who repays a loan earlier than expected helps
      offset the reduction in value resulting from the early pay-off. Consequently,
      the value of a mortgage loan is enhanced to the extent the loan includes a
      prepayment penalty, and a mortgage lender can offer a lower interest rate and/or
      lower loan fees on a loan which has a prepayment penalty. Prepayment penalties
      are an important feature to obtain value on the loans we originate.





Several
      state laws restrict or prohibit prepayment penalties on mortgage loans, and
      we
      have relied on the federal Parity Act and related rules issued in the past
      by
      the OTS, to preempt state limitations on prepayment penalties for certain types
      of loans. The Parity Act was enacted to extend to financial institutions, other
      than federally chartered depository institutions, the federal preemption that
      federally chartered depository institutions enjoy. However, in September 2002,
      the OTS released a new rule that reduced the scope of the Parity Act preemption.
      As a result, since July 1, 2003, we have no longer been able to rely on the
      Parity Act to preempt state restrictions on prepayment penalties and have,
      therefore, been required to comply with state restrictions on prepayment
      penalties. We believe that these restrictions prohibit us from charging any
      prepayment penalty in eight states and restrict the amount or duration of
      prepayment penalties that we may impose in an additional 14 states. This may
      place us at a competitive disadvantage relative to financial institutions that
      will continue to enjoy federal preemption of such state restrictions. These
      institutions will be able to charge prepayment penalties without regard to
      state
      restrictions and, as a result, may be able to offer loans with interest rates
      and loan fee structures that are more attractive than the interest rates and
      loan fee structures that we are able to offer. In addition, the lack of
      prepayment penalties on loans could harm our ability to complete securitizations
      and NIM transactions.





**We
      are a defendant in litigation relating to consumer lending practices, including
      class actions, and we may not prevail in these matters.**





We
      are a
      defendant in several class action lawsuits that are pending in courts in the
      states of New York and Illinois. These actions allege that we engaged in
      improper practices in connection with our origination of mortgage loans,
      including fraud, unjust enrichment and charging improper fees. These actions
      generally seek unspecified compensatory damages, punitive damages and the return
      of allegedly improperly collected fees. It is difficult to predict how these
      matters will be ultimately determined. We believe that we have meritorious
      defenses to these actions, and we intend to vigorously defend these actions.
      However, an adverse judgment in any of these matters could require us to pay
      substantial amounts.





**35**


**Changes
      in the mortgage interest deduction could decrease our loan production and harm
      our business.**





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. The competitive advantages of tax deductible interest, when compared
      to
      alternative sources of financing, could be eliminated or seriously impaired
      by
      this change. Accordingly, the reduction or elimination of these tax benefits
      could reduce the demand for our mortgage loans.




**The
        “Do Not Call Registries” administered by federal and state authorities, and
        other regulations affecting our telemarketing activities could reduce our
        loan production, increase our costs, or result in claims and/or
        penalties.**
 
 To
        date,
        a substantial portion of our retail loans have been generated through
        telemarketing. The federal “Do Not Call Registries,” and similar registries that
        various state authorities may now or in the future administer, along with
        Federal and state telemarketing laws, rules and regulations restricting the
        means, methods and timing of telemarketing, have reduced, and in the future
        will
        continue to reduce, our ability to use telemarketing to generate retail leads
        and originate retail loans. In such an event, we may not be able to offset
        any
        loss of business through alternative means, and our ability to effectively
        market our products and services to new customers may be harmed. Furthermore,
        compliance with these Do No Call Registries and telemarketing laws, rules
        and
        regulations may prove costly and difficult, and we may incur penalties or
        be
        subject to claims or lawsuits (including class actions) for improperly
        conducting our marketing activities.


**We
      have been, and in the future may be, subject to various settlement agreements
      arising from legal issues, and we may be subject to substantial claims and
      legal
      expenses if we do not comply with these agreements, or if allegations are made
      that we are not in compliance with them.**





The
      non-conforming mortgage market in which we operate has been the subject of
      significant scrutiny by various federal and state governmental agencies and
      legislators. In particular, in 1999, the lending practices we utilized were
      the
      subject of investigations by the New York State Banking Department ("NYSBD"),
      the New York Office of the Attorney General ("NYOAG") and the Department of
      Justice ("DOJ"). The investigations centered on our compliance with various
      federal and state laws. In September 1999 and March 2000, we entered into
      related settlement agreements with these regulatory agencies, joined by the
      HUD
      and the Federal Trade Commission ("FTC"), which provided for changes to our
      lending practices on a prospective basis, and retrospective relief to some
      borrowers. If similar claims are made in the future, defending those claims
      may
      result in significant legal expenses to us, which will reduce our profitability.
      A finding against us, or any settlement we may enter into, may result in our
      payment of damages, which may be costly to us.





**We
      may be subject to fines or other penalties based upon the conduct of the
      independent mortgage brokers who place loans with us.**





The
      independent mortgage brokers from whom we obtain mortgage loans have legal
      obligations to which they are subject. While these laws may not explicitly
      hold
      the originating lenders responsible for the legal violations of mortgage
      brokers, increasingly federal and state agencies have sought to impose liability
      upon assignees, as well as wholesale lenders. For example, the FTC recently
      entered into a settlement agreement with a mortgage lender where the FTC
      characterized a broker that had placed all of its loan production with a single
      lender as the “agent” of the lender; the FTC imposed a fine on the lender in
      part because, as “principal,” the lender was legally responsible for the
      mortgage broker’s unfair and deceptive acts and practices. Moreover, in the
      past, the DOJ has sought to hold non-conforming mortgage lenders responsible
      for
      the pricing practices of their mortgage brokers, alleging that the mortgage
      lenders were directly responsible for the total fees and charges paid by the
      borrower under the FHAct even if the lenders neither dictated what the mortgage
      broker could charge nor kept the money for its own account. This was one of
      the
      DOJ’s primary allegations against us at the time of our settlement with the
      DOJ.





Accordingly,
      we may be subject to fines or other penalties in the future based upon the
      conduct of our independent mortgage brokers.





**36**


**Regulatory
      actions and/or class actions against servicers who service the loans we
      originate could lower the value of our securitized mortgage loans, our excess
      cashflow certificates in pre-2004 securitizations and our ability to sell or
      securitize our loans.**





Federal
      agencies, including the FTC, HUD and the DOJ have recently investigated, and/or
      commenced regulatory actions against, several servicers who specialize in
      servicing nonconforming loans. Similarly, numerous class actions have been
      brought against servicers alleging improper servicing policies and procedures.
      Any regulatory actions and/or class actions of these kinds brought against
      any
      of the servicers who service the loans we originate could harm the value of
      our
      excess cashflow certificates and our ability to sell or securitize our
      loans.





**Legal
        actions are pending against us, including class action lawsuits, which if
        successful, could expose us to substantial liability.**
 
 Because
        the nature of our business involves the collection of numerous accounts,
        the
        validity of liens and compliance with federal, state and local lending
        laws, we are subject to numerous claims and legal actions in the ordinary
        course
        of our business. Generally, we are subject to claims made against us by
        borrowers and investors arising from, among other things:


·
            losses
                that are claimed to have been incurred as a result of alleged breaches
                of
                fiduciary obligations, misrepresentation, error and omission by our
                employees, officers and agents;





·  incomplete
      documentation; and





·  failure
      to comply with various laws, rules and regulations applicable to our
      business.





An
      adverse outcome in any potential litigation matters could subject us to
      significant monetary damages and legal fees, which could harm our business.
      While it is impossible to estimate with certainty the ultimate legal and
      financial liability with respect to claims and actions, regardless of the merits
      of a claim and regardless of the outcome, defending against these claims is
      expensive and time consuming. In addition, these cases could divert management’s
      attention from our business.





We
      have
      been named in several lawsuits brought as class actions, alleging violations
      of
      various federal and state consumer protection laws, and have entered into
      settlement agreements with various governmental agencies following
      investigations of our lending practices. Defending these claims and any claims
      asserted in the future may result in significant legal expenses. A finding
      against us could result in the payment by us of damages, which may be
      costly.


**Our
        inability to comply with REIT qualification tests for our REIT subsidiary
        (Renaissance REIT Investment Corp.) may result in our securitization trusts
        being taxed as a taxable mortgage pool, which would reduce our earnings and
        cash
        flow and have a material adverse impact on us.**
  Our inability to comply with REIT qualification tests for our REIT subsidiary
        on
        a continuous basis would subject our securitization trusts issued by our
        REIT
        subsidiary to federal income tax as a corporation (as a taxable mortgage
        pool)
        and not allow it to be filed as part of consolidated income tax return with
        any
        other corporation. The REIT rules require compliance with asset, income,
        distribution and ownership tests. The ownership test prohibits five or fewer
        stockholders from owning more than 50% of our common stock. As of December
        31,
        2005, members of the Miller family (considered one stockholder under the
        attribution rule applicable to the ownership of REIT stock) own approximately
        38.1% of the common stock (including employees’ stock options as required by
        Internal Revenue Code of 1986, as amended ("Code") and related rules and
        regulations). There can be no assurance that we will be able to comply with
        these tests or remain compliant.
 
 Failure
        to remain compliant would result in the imposition of a tax upon our
        securitization trusts and would reduce cash flow that would otherwise be
        available to make payments on the offered asset-backed securities and reduce
        the
        amount that we would receive from the securitization trusts. Such a failure
        would cause us to breach our representation under each of our securitizations
        issued since the first quarter of 2005 that we would maintain Renaissance
        REIT
        Investment Corp. as a real estate investment trust. In addition, it would
        result
        in an event of default, unless waived, under our warehouse and certain other
        credit facilities. Accordingly, a failure to remain compliant with the REIT
        qualification tests may reduce our profitability and cash flow and have a
        material adverse impact on us.
  **37**
 **Complying
        with the Sarbanes-Oxley Act of 2002, as well as other recently-enacted and
        proposed changes to applicable securities laws, are likely to increase our
        costs.**


Sarbanes-Oxley Act of 2002 and the related regulations of the SEC and the
      American Stock Exchange (“AMEX”) have substantially increased the complexity and
      cost of corporate governance, financial reporting and disclosure practices
      for
      public companies such as ours. These rules and regulations could also make
      it
      more difficult for us to attract and retain qualified executive officers and
      members of our board of directors, particularly to serve in our finance
      department and on our audit committee.





**Risks
      Related to Our Capital Structure**





**We
      are controlled by principal stockholders, some of whom are also members of
      our
      senior management, who may have the ability to influence fundamental corporate
      changes if they act in concert.**





As
      of
      March 2, 2006, our principal stockholders, members of the Miller family,
      beneficially owned approximately 34.7% of the outstanding shares of our common
      stock. Accordingly, if members of the Miller family were to act in concert,
      they
      would have the ability to exercise significant control over us with respect
      to
      matters submitted to a stockholder vote, including the approval of fundamental
      corporate transactions, such as mergers and acquisitions, consolidations and
      asset sales, and electing all members of our Board of Directors. As long as
      the
      Miller family controls such a substantial percentage of our shares, third
      parties may not be able to gain control of us through purchases of our common
      stock. In addition, members of the Miller family hold positions as executive
      officers of our Company, including Chairman, Chief Executive Officer, Executive
      Vice President and Senior Vice President (General Counsel).





**Our
      stock price is volatile.**





The
      trading price of our stock is volatile, and this volatility will likely continue
      in the future. Wide fluctuations in our trading price or volume can be caused
      by:





·
            quarterly
                variations in our operating
                results;





·
            variations
                in the size and terms of our
                securitizations;





·
            conditions
                in the real estate industry and in the asset-backed securities
                market;





·
            announcements
                by significant investors of their intention to sell our
                shares;





·
            investor
                perception of our company and the business that we are in
                generally;





·
            announcements
                or implementation by us or our competitors of new products or
                services;





·
            financial
                estimates by securities analysts;
                and





·
            general
                economic and financial services market conditions, including changes
                in
                interest rates.





In
      addition, the stock market in general has experienced extreme price and volume
      fluctuations that have often been unrelated or disproportionate to the operating
      performance of companies. If investor interest in financial services companies
      declines, the price for our common stock could drop suddenly and significantly,
      even if our operating results are positive. Our common stock has historically
      traded at low volumes, which may increase the potential illiquidity of an
      investment in our common stock. If the trading volume of our common stock
      experiences significant changes, the price of our common stock could also be
      adversely affected. Furthermore, declines in the trading or price of our common
      stock could harm employee morale and retention, our access to capital and other
      aspects of our business.





**38**


Our
      common stock commenced trading on the AMEX in May 2003. However, we cannot
      assure you that an active public trading market for our common stock will be
      sustained. If active trading in our common stock does not continue, the price
      that you may receive in connection with any sale of your shares may be
      substantially less than the offering price that you paid for them.





**Our
      financial results or condition in any period may not meet market expectations,
      which could adversely affect our stock price.**





The
      public trading of our stock is based in large part on market expectations that
      our business will continue to grow and that we will achieve certain levels
      of
      net income. If the securities analysts that follow our stock lower their rating
      or lower their projections for future growth and financial performance, the
      market price of our stock is likely to drop significantly. In addition, if
      our
      quarterly financial performance does not meet the expectations of securities
      analysts, our stock price would likely decline. The decrease in the stock price
      may be disproportionate to the shortfall in our financial
      performance.





**We
      may need additional capital, which could dilute our stockholders or impose
      burdensome financial restrictions on our business.**





We
      may
      seek to raise additional funds through public or private debt or equity
      offerings. Additional equity financing may be dilutive to the holders of our
      common stock. If we obtain funds through a bank credit facility or by issuing
      debt securities or preferred shares, the indebtedness or preferred shares would
      have rights senior to the rights of holders of our common stock, and their
      terms
      could impose significant restrictions on our operations. If we need to raise
      additional funds, we may not be able to do so on favorable terms, or at all.
      If
      we cannot obtain adequate funds on acceptable terms, we may not be able to
      implement our business strategy as
      planned, or at all.





**Future
      sales of our common stock in the public market could adversely affect our stock
      price.**





Future
      sales of shares of our common stock or the availability for future sale of
      shares of our common stock may reduce the market price of our common stock
      prevailing from time to time.





Our
      current stockholders hold a substantial number of shares of our common stock,
      which they are able to sell in the public market today. Sales of these shares
      or
      the perception that these sales could occur, could harm the market price of
      our
      common stock and impair our ability to raise capital through the sale of
      additional equity securities. In addition, as of December 31, 2005, we had
      approximately 2.2 million shares of our common stock issuable upon exercise
      of
      options, approximately 1.3 million of which were currently exercisable, and
      157,275 shares of restricted common stock granted and outstanding.





**We
      have implemented anti-takeover provisions which could discourage or prevent
      a
      takeover, even if an acquisition would be beneficial to our
      stockholders.**




Provisions of our certificate of incorporation and our bylaws could make it
      more
      difficult for a third-party to acquire us, even if doing so would be beneficial
      to our stockholders. These provisions include:





·
            establishing
                a classified Board of Directors of which approximately one-third
                of the
                members of the board are elected each year, and lengthening the time
                needed to elect a new majority of the
                board;





·
            authorizing
                the issuance of “blank check” preferred stock that could be issued by our
                Board of Directors to increase the number of outstanding shares or
                change
                the balance of voting control and thwart a takeover attempt;
                and





·
            prohibiting
                stockholder action by written consent and requiring all stockholder
                actions to be taken at a meeting of our
                stockholders.





We
      also
      are subject to the anti-takeover provisions of Section 203 of the Delaware
      General Corporation Law. Subject to specified exceptions, this section provides
      that a corporation may not engage in any business combination with any
      interested stockholder during the three-year period following the time that
      such
      stockholder becomes an interested stockholder. This provision could have the
      effect of delaying or preventing a change in control of our Company. These
      factors could also limit the price that investors or an acquirer might be
      willing to pay in the future for shares of our common stock.





**39**


**Item
      1B. Unresolved Staff Comments.**





None.





**Item
      2. Properties.**





Our
      executive and administrative offices are located at 1000 Woodbury Road,
      Woodbury, New York 11797, where we lease approximately 99,000 square feet of
      office space at an aggregate annual base rent of approximately $2.6 million.
      The
      lease provides for certain scheduled rent increases and expires in
      2008.





In
      addition to our headquarters in New York, we also maintain four regional
      wholesale offices located in Florida, Massachusetts, Ohio and Texas. Our retail
      operation currently maintains 11 retail mortgage origination centers located
      in
      Arizona, Illinois, Kansas, Missouri, Nevada, New York, North Carolina, Ohio,
      Pennsylvania (2) and Tennessee. We also maintain one telemarketing hub located
      in Ohio and two underwriting hubs located in Arizona and Ohio. The terms of
      these leases vary as to duration and rent escalation provisions; with the latest
      expiring in 2011 (see “Part II, Item 8. - Financial Statements and Supplementary
      Data - Note 16 - Commitments and Contingencies - Operating Lease Obligations” in
      our audited consolidated financial statements, included elsewhere in this
      report).  We
      do not
      consider any specific leased location to be material to our operations. We
      believe that alternative locations are available in all areas where we currently
      do business.





**Item
      3. Legal Proceedings.**





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





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





**40**


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





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





**41**


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





·
            In
                our about November 2004, we received notice that we have been named
                in a
                lawsuit styled as a collective action filed in the United States
                District
                Court of the Western District of Pennsylvania, alleging that our
                subsidiary, Fidelity Mortgage Inc. (“Fidelity”), did not pay its loan
                officers overtime compensation and/or minimum wage in violation of
                the
                Federal Fair Labor Standards Act. The complaint seeks: (1) an amount
                equal
                to the unpaid wages at the applicable overtime rate, (2) an amount
                equal
                to the minimum wages at the applicable minimum wage, (3) an equal
                amount
                as liquidated damages, (4) costs and attorneys’ fees, (5) leave to add
                additional plaintiffs and (6) leave to amend to add claims under
                applicable state laws. We filed an answer and discovery has commenced.
                In
                April 2005, the plaintiff filed his motion for conditional class
                certification and in May 2005, Fidelity filed its opposition to that
                motion. In June 2005, the Magistrate Judge issued a Report and
                Recommendation, recommending that the plaintiff’s motion for conditional
                class certification be granted, and that plaintiff’s motion to authorize
                judicial notice be granted (subject to revision and final approval
                by the
                District Court). In July 2005, Fidelity filed with the District Court
                its
                objections to the Magistrate Judge’s Report and Recommendation and the
                plaintiff filed its opposition to our objections. In July 2005, the
                District Court upheld the Magistrate Judge’s Report and Recommendation.
                Any potential class members who desired to join the collective action
                were
                provided an opportunity to do so during an “opt-in” period that ended in
                October 2005. To date, we have received notice that approximately
                200
                individuals, virtually all of whom are former employees, have opted
                into
                the collective action. Discovery is continuing. We believe that we
                have
                meritorious defenses and intend to vigorously defend this suit, but
                cannot
                estimate with any certainty our ultimate legal or financial liability,
                if
                any, with respect to the alleged
                claims.





**42**


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





None.





**PART
      II**





**Item
      5. Market for Registrant’s Common Equity,
      Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities.**





**Market
      Information**





Our
      common stock trades on the AMEX under the symbol “DFC.” The following table sets
      forth, for the periods indicated, the range of the high and low closing sales
      prices for our common stock:


**High**
              
              **Low****2005**First
                  Quarter
              
              $
              10.03
              
              $
              8.11Second
                  Quarter
              
              
              9.74
              
              
              8.32Third
                  Quarter
              
              
              9.98
              
              
              7.08Fourth
                  Quarter
              
              
              8.60
              
              
              6.55**2004**First
                  Quarter
              
              $
              11.05
              
              $
              7.41Second
                  Quarter
              
              
              8.25
              
              
              6.12Third
                  Quarter
              
              
              8.86
              
              
              6.08Fourth
                  Quarter
              
              
              10.60
              
              
              7.96




From
      January through May 2003, our common stock traded on the Over-The-Counter
      (“OTC”) Bulletin Board under the ticker symbol “DLTO.” In May 2003, our common
      stock was listed on the AMEX.





**Holders**





On
      March
      7, 2006, we had approximately 426 stockholders of record. This number does
      not include beneficial owners holding shares through nominee or “street”
names.





**43**


**Dividends**





The
      following table indicates the quarterly dividends declared during the years
      ended December 31, 2005 and 2004:





*(Dollars
                in thousands, except per share amounts)***Quarter**
            
            **Record
                Date**
            
            **Payment
                Date**
            
            **Dividend
                Per**
              **Share**
            
            **Total
                Dividends Paid****(1)****2005**First
            
            March
                31, 2005
            
            April
                15, 2005
            
            $    
                 0.05
            
            $    
                 1,015Second
            
            June
                20, 2005
            
            July
                6, 2005
            
            0.05
            
            1,018Third
            
            September
                20, 2005
            
            October
                7, 2005
            
            0.05
            
            1,019Fourth
            
            December
                16, 2005
            
            January
                5, 2006
            
            0.05
            
            1,030**2004**First
            
            N/A
            
            N/A
            
            N/A
            
            N/ASecond
            
            June
                25, 2004
            
            July
                9, 2004
            
            $    
                 0.05
            
            $       
                 848Third
            
            September
                28, 2004
            
            October
                8, 2004
            
            0.05
            
            1,012Fourth
            
            December
                21, 2004
            
            January
                6, 2005
            
            0.05
            
            1,013





*(1)*  *Total
      dividends paid for the fourth quarter of 2005 includes approximately $8,000
      of
      dividends paid on 157,275 shares of granted but unvested restricted common
      stock
      awards.*





We
      paid
      $1.4 million in dividends on our Series A Preferred Stock in 2003 and did not
      pay any common stock dividends in 2003. In the second quarter of 2004, we
      redeemed all of our Series A Preferred Stock for $13.9 million. Following such
      redemption, we began paying dividends to the holders of our common
      stock.





**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      following table sets forth information about the shares of common stock issuable
      under our equity compensation plans at December 31, 2005:





**Equity
                Compensation Plan Information****Equity
                Compensation Plan Category**
            
            **Number
                of Shares to be Issued Upon Exercise of Outstanding
                Options**
            
            **Weighted
                Average Exercise Price of Outstanding Options**
            
            **Number
                of Common Stock Awards Granted and Outstanding**
            
            **Weighted
                Average Price of Outstanding Common Stock Awards**
            
            **Number
                of Securities Remaining Available for Future Issuance Under Equity
                Compensation Plans****(1)**Approved
                by security holders
            
            
            2,174,300
            
            $
            2.87
            
            
            157,275
            
            $
            7.46
            
            
            1,787,775Not
                approved by security holders
            
            
            N/A
            
            
            N/A
            
            
            N/A
            
            
            N/A
            
            
            N/ATotal
            
            
            2,174,300
            
            $
            2.87
            
            
            157,275
            
            $
            7.46
            
            
            1,787,775





*(1)
      Excludes securities reflected under the “number of shares to be issued upon
      exercise of outstanding options” and “number of common stock awards granted and
      outstanding” columns in the table above.*





**44**


**Item
      6. Selected Financial
      Data.**





The
      following selected financial information for the years ended December 31, 2005,
      2004, and 2003, and as of December 31, 2005 and 2004, has been derived from
      our
      audited consolidated financial statements included elsewhere in this report.
      The
      financial information for the years ended December 31, 2002 and 2001 and as
      of
      December 31, 2003, 2002 and 2001 has been derived from our audited financial
      statements not included in this report. Certain
      prior period amounts in the consolidated financial statements have been
      reclassified to conform to the current year presentation. The
      historical selected financial information may not be indicative of our future
      performance due to our change from gain-on-sale accounting to portfolio
      accounting in 2004. The information in the following table should be read in
      conjunction with the information contained in “- Item 7 - Management’s
      Discussion and Analysis of Financial Condition and Results of Operations” and in
“- Item 8 - Financial Statements and Supplementary Data.”




**At
                  or For the Year Ended December 31,***(Dollars
                  in thousands, except share and**per
                  share data)*
              
              **2005**
              
              **2004**
              
              **2003**
              
              **2002**
              
              **2001**Interest
                  income(1)
              
              $
              290,829
              
              $
              100,105
              
              $
              14,386
              
              $
              12,058
              
              $
              22,201Interest
                  expense(2)
              
              
              167,792
              
              
              39,782
              
              
              5,509
              
              
              5,273
              
              
              16,132Net
                  interest income
              
              
              123,037
              
              
              60,323
              
              
              8,877
              
              
              6,785
              
              
              6,069Provision
                  for loan losses
              
              
              28,592
              
              
              10,443
              
              
              --
              
              
              --
              
              
              --Net
                  interest income after provisionfor
                  loan losses
              
              
              94,445
              
              
              49,880
              
              
              8,877
              
              
              6,785
              
              
              6,069Non-interest
                  income:Net
                  gain on sale of mortgage loans
              
              
              27,193
              
              
              16,057
              
              
              94,782
              
              
              57,974
              
              
              38,326Other
                  income
              
              
              14,674
              
              
              1,722
              
              
              1,000
              
              
              2,999
              
              
              3,902Total
                  non-interest income
              
              
              41,867
              
              
              17,779
              
              
              95,782
              
              
              60,973
              
              
              42,228Non-interest
                  expense:Payroll
                  and related costs
              
              
              63,524
              
              
              52,005
              
              
              39,147
              
              
              27,120
              
              
              29,867General
                  and administrative
              
              
              42,467
              
              
              30,152
              
              
              23,460
              
              
              22,685
              
              
              48,333Other(3)
              
              
              --
              
              
              --
              
              
              --
              
              
              2,085
              
              
              67,011Loss
                  on derivative instruments(2)
              
              
              908
              
              
              100
              
              
              --
              
              
              --
              
              
              --Total
                  non-interest expense
              
              
              106,899
              
              
              82,257
              
              
              62,607
              
              
              51,890
              
              
              145,211Income
                  (loss) before income taxexpense
                  (benefit)
              
              
              29,413
              
              
              (14,598
              )
              
              42,052
              
              
              15,868
              
              
              (96,914
              )Provision
                  for income tax expense(benefit)
              
              
              11,458
              
              
              (5,249
              )
              
              (23,354
              )
              
              (1,769
              )
              
              2,876Net
                  income (loss)
              
              $
              17,955
              
              $
              (9,349
              )
              $
              67,406
              
              $
              17,637
              
              $
              (99,790
              )**Comprehensive
                  Income (Loss)**:Other
                    comprehensive income (loss)
              
              
              4,743
              
              
              (2,207
              )
              
              --
              
              
              --
              
              
              --Comprehensive
                  income (loss), net
              
              $
              22,698
              
              $
              (11,556
              )
              $
              67,406
              
              $
              17,637
              
              $
              (99,790
              )





**45**




**At
                  or For the Year Ended December 31,****2005**
              
              **2004**
              
              **2003**
              
              **2002**
              
              **2001****Per
                  Share Data:**Basic
                  - weighted average number ofshares
                  outstanding
              
              
              20,349,515
              
              
              18,375,864
              
              
              16,308,561
              
              
              15,894,913
              
              
              15,883,749Diluted
                  - weighted average numberof
                  shares outstanding(4)
              
              
              21,283,220
              
              
              18,375,864
              
              
              18,407,249
              
              
              16,971,028
              
              
              15,883,749Net
                  income (loss) applicable tocommon
                  shares
              
              $
              17,955
              
              $
              (9,349
              )
              $
              66,015
              
              $
              17,637
              
              $
              (99,790
              )Basic
                  earnings per share - netincome
                  (loss)
              
              $
              0.88
              
              $
              (0.51
              )
              $
              4.05
              
              $
              1.11
              
              $
              (6.28
              )Diluted
                  earnings per share - netincome
                  (loss)(4)
              
              $
              0.84
              
              $
              (0.51
              )
              $
              3.59
              
              $
              1.04
              
              $
              (6.28
              )Dividends
                  per common share
              
              $
              0.20
              
              $
              0.15
              
              $
              --
              
              $
              --
              
              $
              --**Selected
                  Balance Sheet Data:**Cash
                  and cash equivalents
              
              $
              4,673
              
              $
              5,187
              
              $
              4,576
              
              $
              3,405
              
              $
              6,410Mortgage
                  loans held for sale, net
              
              
              --
              
              
              --
              
              
              190,524
              
              
              33,945
              
              
              94,190Mortgage
                  loans held for investment, net
              
              
              4,626,830
              
              
              2,340,994
              
              
              --
              
              
              --
              
              
              --Excess
                  cashflow certificates
              
              
              7,789
              
              
              14,933
              
              
              19,853
              
              
              24,565
              
              
              16,765Trustee
                  receivable
              
              
              56,164
              
              
              32,915
              
              
              --
              
              
              --
              
              
              --Deferred
                  tax asset, net
              
              
              54,875
              
              
              50,326
              
              
              31,184
              
              
              5,600
              
              
              5,600Other
                  assets
              
              
              69,271
              
              
              46,438
              
              
              10,854
              
              
              6,029
              
              
              10,841Total
                  assets
              
              $
              4,819,602
              
              $
              2,490,793
              
              $
              256,991
              
              $
              73,544
              
              $
              133,806Warehouse
                  financing
              
              $
              222,843
              
              $
              135,653
              
              $
              144,826
              
              $
              13,757
              
              $
              80,877Financing
                  on mortgage loans held forinvestment,
                  net
              
              
              4,436,938
              
              
              2,236,215
              
              
              --
              
              
              --
              
              
              --Senior
                  notes
              
              
              --
              
              
              --
              
              
              --
              
              
              10,844
              
              
              10,844Other
                  liabilities
              
              
              53,039
              
              
              31,745
              
              
              16,212
              
              
              19,446
              
              
              30,235Total
                  liabilities
              
              $
              4,712,820
              
              $
              2,403,613
              
              $
              161,038
              
              $
              44,047
              
              $
              121,956Total
                  stockholders’ equity
              
              $
              106,782
              
              $
              87,180
              
              $
              95,953
              
              $
              29,497
              
              $
              11,850


**(1)**During
      the year ended December 31, 2005, we recorded in interest income $324,000 of
      income related to a cumulative**adjustment
      for the effects of an immaterial correction in recognition of net deferred
      fees
      in accordance with SFAS No. 91 “Accounting for Nonrefundable Fees and Costs
      Associated with Originating or Acquiring Loans” that related to the year ended
      December 31, 2004. This was the result of a revision in**2005
      to our methodology to separate respective securitization loan pools into
      homogeneous pools based upon product type - each of which contains a large
      number of similar loans for which prepayments are probable and the timing and
      amount of prepayments are reasonably predictable.**


*(2)*  *During
        the year ended December 31, 2005, we recorded in interest expense and loss
        on
        derivative instruments $1,000 and $29,000, respectively, of income and loss
        related to a cumulative adjustment for the effects of an immaterial correction
        to other comprehensive income (“OCI”) for the ineffectiveness on certain hedges
        that related to the year ended December 31, 2004. This revision is in accordance
        with Derivatives Implementation Group SFAS No. 133 Implementation Issue No.
        G17
“Cash Flow Hedges: Impact on Accumulated Other Comprehensive Income of Issuing
        Debt with a Term That Is Shorter Than Originally
        Forecasted.”*


*(3)
      Other non-interest expense for the year ended December 31, 2002 included a
      $2.1
      million charge related to impairment of excess cashflow certificates. Other
      non-interest expense for the year ended December 31, 2001 is comprised of (1)
      $19.7 million related to impairment of excess cashflow certificates, (2) $25.4
      million loss on the sale of excess cashflow certificates, (3) $2.7 million
      of
      restructuring charges and (4) $19.3 million related to the extinguishment of
      debt.*





*(4)
      For the years ended December 31, 2004 and 2001, stock options of approximately
      1.0 million and 23,000, respectively, are excluded from the calculation of
      diluted earnings per share because their effect was anti-dilutive in years
      where
      losses were reported.*





**46**


**Item
      7. Management’s Discussion and
      Analysis of
      Financial Condition and Results of Operation.**





*The
      following discussion should be read in conjunction with our Consolidated
      Financial Statements and accompanying Notes to Consolidated Financial Statements
      set forth therein. Please also see “Part I - Item 1. - *Forward
      Looking Statements and Risk**Factors”
      and “Part I - Item 1A. - Risk**Factors.”**




**General**





We are a national specialty consumer finance company that originates,
      securitizes and sells (and, prior to May 2001, serviced) non-conforming mortgage
      loans. Our loans are primarily secured by first mortgages on one- to four-family
      residential properties. Throughout our 24-year operating history, we have
      focused on lending to individuals who generally do not satisfy the credit,
      documentation or other underwriting standards set by more traditional sources
      of
      mortgage credit, including those entities that make loans in compliance with
      conventional mortgage lending guidelines established by Fannie Mae and Freddie
      Mac. We make loans to these borrowers for purposes such as debt consolidation,
      refinancing, education and home improvements.


We
        have
        historically financed
        or sold
        our
        loans through securitizations
        and sold whole
        loans .  Prior
        to 200 4 ,
        those
        securitizations were typically structured and
        accounted for as
        sales,
        which required us to record revenues as gain on sale at the time the
        securitizations were completed. In 2004, we began structuring our
        securitizations to be accounted for as secured financings, which requires
        us to
        record revenues and expenses from these transactions over time. We record
        interest income from the securitized loans and interest expense from the
        asset-backed securities issued in connection with each securitization over
        the
        life of the loans or securities issued in the securitization. When we sell
        loans
        on a whole-loan basis, we record the premiums received upon sale as revenue. We
        intend
        to continue to structure our securitizations to be accounted for as secured
        financings and to securitize the majority of the mortgage loans we originate
        so
        as to increase the size of our on-balance sheet loan portfolio that generates
        interest income. As the size of our loan portfolio continues to increase
        in
        2006, as compared to 2005, we anticipate recording increased net interest
        income
        generated from the loan portfolio.
 
 **Summary
        of Critical Accounting Policies**
 
 An
        appreciation of our critical accounting policies is necessary to understand
        our
        financial results. These policies may require management to make difficult
        and
        subjective judgments regarding uncertainties, and as a result, these estimates
        may significantly impact our financial results. The precision of these estimates
        and the likelihood of future changes depend on a range of possible outcomes
        and
        a number of underlying variables and there can be no assurance that our
        estimates are accurate.


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





·
            BIO
                certificate, which represents a subordinate right to receive excess
                cash
                flows, if any, generated by the related securitization pool. As a
                holder
                of the BIO certificate, we have the right to receive the difference,
                if
                any, between the interest payments due on the mortgage loans sold
                to the
                securitization trust and the interest payments due, at the pass-through
                rates, to the holders of the asset-backed securities of the same
                series,
                net of contractual servicing fees, trustee fees, insurer premiums,
                reimbursements and other costs and expenses of administering the
                securitization trust. As a holder of the BIO certificate, we will
                receive
                cash payments (which, when we sell NIM notes, is only received after
                the
                NIM notes are paid in full) only to the extent that the cash received
                by
                the securitization trust exceeds the amounts owed on all of the securities
                issued by that securitization trust, including amounts needed for
                the
                payment of any trust related
                expenses.





**47**


·
            P
                certificate, which represents a right to receive prepayment penalties
                on
                the mortgage loans sold to the securitization trust. Generally, prepayment
                penalties are received from borrowers who pay off their loans within
                the
                first few years after obtaining their loans (which, when we sell
                NIM
                notes, is only received after the NIM notes are paid in
                full).




·
            Cash
                flows from interest rate caps - we receive payments on corridors
                (corresponding purchase and sale of  interest rate caps with
                similar notional balances at different strike prices) from third-party
                cap
                providers through the securitization trusts (which, when we sell
                NIM
                notes, are only received after the NIM notes are paid in
                full).





The
      excess cash flows we receive are highly dependent upon the interest rate
      environment, because “basis-risk” exists between the securitization trust’s
      assets and liabilities. For example, in each of the securitizations that we
      issued in 2003 and 2002, the excess cashflow certificates are impacted by the
      securitization pass-through rate sold to investors, which is indexed against
      the
      one-month LIBOR. As a result, the interest rate received by the pass-through
      certificate holders from the securitization trust each month may adjust upwards
      or downwards as the one-month LIBOR changes (liability) - while the majority
      of
      the underlying mortgage loans (assets) in the securitization trust are
      fixed-rate loans, or are at a fixed-rate for at least two to three years before
      becoming adjustable-rate loans. As a result, as rates rise and fall, the amount
      of our excess cash flows will fall and rise, respectively. This in turn will
      increase or decrease the fair value of our excess cashflow certificates. The
      excess cashflow certificates held at December 31, 2005 are those we acquired
      before we began to structure our securitizations to be accounted for as secured
      financings in 2004.





In
      each
      of our securitizations in which we sold NIM note(s), we purchased an interest
      rate cap, which helps mitigate the basis risk for the approximate time that
      the NIM notes are anticipated to be outstanding.





The
      accounting estimates we use to value excess cashflow certificates are deemed
      to
      be “critical accounting estimates” because they can materially affect our
      income. The valuation of our excess cashflow certificates requires us to
      forecast interest rates, mortgage principal payments, prepayments, index rates
      and loan loss assumptions, each of which is highly uncertain and requires a
      high
      degree of judgment. The rate used to discount the projected cash flows is also
      critical in the valuation of our excess cashflow certificates. Management uses
      internal, historical mortgage loan performance data and forward LIBOR interest
      rate curves to value future expected excess cash flows. We believe that the
      value of our excess cashflow certificates at the date of a securitization
      reflected their fair value. The amount recorded for the excess cashflow
      certificates is subsequently reduced for cash distributions we receive,
      increased for the expected return and adjusted for changes in fair value of
      these excess cashflow certificates.





At
      the
      closing date of each securitization transaction structured to be accounted
      for
      as a sale, we determined the present value of the excess cashflow certificates
      using the same assumptions we made regarding the underlying mortgage loans.
      The
      excess cashflow certificate was then recorded on our consolidated financial
      statements at its estimated fair value. The value of each excess cashflow
      certificate represents the present value of the future cash flows we expect
      to
      receive in the future based upon our best estimates. Although we believe that
      the assumptions we use are reasonable, there can be no assurance as to the
      accuracy of the assumptions or estimates. Our estimates primarily include the
      following:





·
            future
                rate of prepayment of the mortgage loans - the expected amount of
                prepayments if the underlying borrowers pay off their mortgage loans
                prior
                to the expected maturity;





·
            credit
                losses (default rates) on the mortgage loans (including when the
                losses
                are expected to occur) - our estimated amount of losses or defaults
                that
                will take place on the underlying mortgage loans over their life
                because
                the excess cashflow certificates are subordinated to all other securities
                issued by the securitization trust. Consequently, any losses sustained
                on
                mortgage loans comprising a particular securitization trust are first
                absorbed by the excess cashflow
                certificates;





·
            the
                LIBOR forward curve (using current LIBOR as the floor rate) - our
                estimate
                of future interest rates, which affects both the rate paid to the
                floating
                rate asset-backed security investors (primarily the one-month LIBOR
                index)
                and the rates earned from the adjustable rate mortgage loans sold
                to the
                securitization trust (which typically provide for a fixed-rate of
                interest
                for the first 24 or 36 months and a six-month variable rate of interest
                thereafter using the six-month LIBOR index);
                and





·
            a
                discount rate used to calculate present
                value.





**48**


We
      monitor the performance of the mortgage loans underlying each excess cashflow
      certificate, and any changes in our estimates resulting in a change in fair
      value of the excess cashflow
      certificates is reflected as a change in fair value of excess cashflow
      certificates recorded in the statement of operations as a component of “other
      income” or “other expense” in the period in which we make the change in our
      estimate.





We
      revised our assumptions used to value our excess cashflow certificates during
      the third quarter of 2005. The impact of these changed assumptions resulted
      in
      an increase in the fair value of our excess cashflow certificates. In
      determining the fair value of each of the excess cashflow certificates, we
      make
      the following underlying assumptions regarding mortgage loan prepayments,
      mortgage loan default rates, the LIBOR forward curve and discount
      rates:





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





·
            whether
                or not a loan contains a prepayment penalty, which is the amount
                a
                borrower must pay to a lender if the borrower prepays the loan within
                a
                certain time period after the loan was originated. Historically,
                loans
                containing a prepayment penalty typically are not repaid as quickly
                as
                those without a penalty; and





·
            as
                is customary in our industry with adjustable-rate mortgage loans,
                the
                introductory interest rate we charge to the borrower is lower, between
                one
                and two full percentage points, than the rate for which the borrower
                would
                have otherwise qualified. Generally, once the interest rate begins
                to
                adjust, the interest rate payable on that mortgage loan generally
                increases, at times at a fairly substantial rate. This interest rate
                increase can be exacerbated if there is an absolute increase in interest
                rates. As a result of these increases, and the potential for future
                increases, adjustable rate mortgage loans typically are more susceptible
                to early prepayments.





There
      are
      several reasons why a loan may prepay prior to its maturity, including but
      not
      limited to:





·
            a
                decrease in interest rates;





·
            improvement
                in the borrower’s credit profile, which may allow the borrower to qualify
                for a mortgage loan with a lower interest
                rate;





·
            competition
                in the mortgage market, which may result in lower interest rates
                being
                offered to the borrower;





·
            the
                borrower’s sale of the home securing the
                mortgage;





·
            the
                borrower’s need for additional funds;
                and





·
            a
                default by the borrower, resulting in foreclosure by the
                lender.





It
      is
      unusual for a borrower to prepay a mortgage loan during the first few months
      because:





·
            it
                typically takes at least several months after the mortgage loans
                are
                originated for any of the above events to
                occur;





·
            there
                are costs involved with refinancing a loan;
                and





·
            the
                borrower does not want to incur prepayment
                penalties.





**49**


We
      have
      found that the rate at which borrowers prepay their loans tends to fluctuate.
      In
      general, prepayment speeds are lowest in the first month after origination,
      as
      described above. Thereafter, prepayment speeds generally increase until a peak
      speed is reached. Generally, loans will continue to prepay at the peak speed
      for
      some period of time, and then prepayment speeds typically begin to decline.
      We
      use prepayment assumptions that reflect these tendencies. The following table
      shows our assumptions regarding the percentage of mortgage loans that will
      be
      prepaid during the first month following the closing of a mortgage loan, peak
      speed over the life and the peak speed at December 31, 2005
      forward:





**Loan
                Type**
            
            **Month
                One**
            
            **Peak
                Speed**
              **Over
                the Life**
            
            **Peak
                Speed at**
              **December
                31, 2005 Forward**Fixed
                rate
            
            4.0%
            
            45.0%
                to 50.0%
            
            35.0%
                to 40.0%Adjustable
                rate
            
            4.0%
            
            75.0%
            
            35.0%
                to 75.0%





Our
      assumption regarding the peak speed over the life for fixed rate mortgage loans
      ranged from 35% to 40% prior to September 30, 2005, when we revised them to
      the
      speeds noted at December 31, 2005. We revised our peak speed over the life
      assumption to reflect the prepayment trend experienced within the mortgage
      loan
      pools.





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





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





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





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





**50**


We
      utilized a discount rate of 18% and 15% at December 31, 2005 and 2004,
      respectively, on all excess cashflow certificates.





Our
      valuation of retained excess cashflow certificates is highly dependent upon
      the
      reasonableness of our assumptions and the predictiveness of the relationships
      that drive the results of our valuation model. The assumptions we utilize,
      described above, are complex, as we must make judgment calls about the effects
      of matters that are inherently uncertain. As the number of variables and
      assumptions affecting the possible future resolution of the uncertainties
      increase, those judgments become even more complex.





In volatile markets, like those we have experienced over the past several years,
      there is increased risk that our actual results may vary significantly from
      our
      assumed results. The longer the time period over which the uncertainties exist,
      the greater the potential for volatility in our valuation assumptions and thus
      impacting the fair value of our excess cashflow certificates.





For
      example, assumptions regarding prepayment speeds, defaults and LIBOR rates
      are
      used in estimating the fair value of our excess cashflow certificates. If loans
      prepay slower than estimated, or loan loss levels are higher than anticipated,
      or LIBOR is higher than anticipated, a reduction in the fair value of these
      certificates will be recorded in earnings. We believe that our assumptions
      are
      reasonable based upon the estimates using our historical loan performance and
      the performance of similar mortgage loan pools from other lenders - in addition
      to accessing other public information about market factors such as interest
      rates, inflation, recession, unemployment and real estate market values, among
      other things. However, these are just estimates and it is virtually impossible
      to predict the actual level of prepayments and losses, which are also driven
      by
      consumer behavior.





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





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





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





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





**51**


To
      qualify for cash flow hedge accounting treatment:





·
            hedges
                must be documented, with the objective and strategy stated, along
                with an
                explicit description of the methodology used to assess and measure
                hedge
                effectiveness;





·
            dates
                (or periods) for the expected forecasted events and the nature of
                the
                exposure involved (including quantitative measures of the size of
                the
                exposure) must be explicitly
                documented;





·
            hedges
                must be expected to be “highly effective,” both at the inception of the
                hedge and on an ongoing basis. Effectiveness measures must relate
                the
                gains or losses of the derivative to changes in the cash flow associated
                with the hedged item;





·
            forecasted
                transactions must be probable; and





·
            forecasted
                transactions must be made with different counterparties other than
                the
                reporting entity.





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





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





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




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





**52**


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





In
      order
      to estimate an appropriate allowance for losses on mortgage loans held for
      investment, we estimate losses using a detailed analysis of historical mortgage
      loan performance data. This data is analyzed for loss performance and prepayment
      performance by product type, origination year and securitization issuance.
      The
      results of that analysis are then applied to the current long-term mortgage
      portfolio held for investment, excluding those loans which meet the criteria
      for
      specific review under SFAS
      No.
      114, “Accounting by Creditors for Impairment of a Loan an amendment of FASB
      Statement No. 5 and 15,” and an
      estimate is created. In accordance with SFAS No. 5, “ Accounting
      for Contingencies,” ****** we
      believe that pooling of mortgages with similar characteristics is an appropriate
      methodology in which to evaluate the amount of the allowance for loan losses.
      A
      provision for loan losses is charged to our consolidated statement of
      operations. Losses incurred, if any, will be written-off against the allowance
      for loan losses.





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





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





***Amortization
      of Deferred Loan Origination Fees and
      Costs.*** Interest
      income is recorded on our mortgage loans held for investment portfolio based
      upon a combination of interest accruals based on the outstanding balance and
      contractual terms of the mortgage loans, adjusted by the amortization of net
      deferred origination fees or costs accounted for in accordance with SFAS No.
      91, “ Accounting
      for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
      and Initial Direct Costs of Leases—an amendment of FASB Statements No. 13, 60,
      and 65 and a rescission of FASB Statement No. 17 .”
Our
      net deferred origination fees consist principally of origination fees, discount
      points, and payroll and commissions associated with originating our mortgage
      loans. For our loans held for investment, these net deferred fees or costs
      are
      accreted or amortized as adjustments to interest income over the estimated
      lives
      of the mortgage loans using the interest method. Our portfolio of mortgage
      loans
      held for investment is comprised of a large number of homogeneous loans for
      which we believe prepayments are probable. The periodic amortization of our
      deferred origination fees is based on a model that considers actual prepayment
      experience to date as well as forecasted prepayments based on the contractual
      interest rate on the mortgage loans, loan age, loan type and prepayment fee
      coverage, among other factors. Mortgage prepayments are affected by the terms
      and credit grades of the loans, conditions in the housing and financial markets
      and general economic conditions. Prepayment assumptions are reviewed regularly
      to ensure that our actual experiences, as well as industry data, are supportive
      of the prepayment assumptions used in our model. Any changes to these estimates
      are applied as if the revised estimates had been in place since the origination
      of the mortgage loans, and current period amortization is adjusted to reflect
      the effect of the changes.




**53**


During
        the year ended December 31, 2005, we recorded in interest income $324,000
        of
        income related to a cumulative adjustment for the effects of an immaterial
        correction in recognition of net deferred fees in accordance with SFAS No.
        91
“Accounting for Nonrefundable Fees and Costs Associated with Originating or
        Acquiring Loans” that related to the year ended December 31, 2004. This was the
        result of a revision in 2005 to our methodology to separate respective
        securitization loan pools into homogeneous pools based upon product type
        - each
        of which contains a large number of similar loans for which prepayments are
        probable and the timing and amount of prepayments are reasonably
        predictable.


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





**Federal,
      State and Local Taxation**





We
      report
      our income on a consolidated basis (excluding Renaissance REIT Investment Corp.
      and its subsidiary) using the calendar year and the accrual method of
      accounting. The following discussion of federal, state and local tax matters
      is
      intended only as a summary and does not purport to be a comprehensive
      description of the tax rules applicable to us.





We
      face
      audits from various tax authorities regarding the amount of taxes due. Such
      audits can involve complex issues and may require an extended period of time
      to
      resolve. Our United States federal income tax filings have been examined by
      the
      Internal Revenue Service ("IRS") for calendar years ending prior to 2001. All
      differences arising from those audits have been resolved and settled. We are
      currently under examination by New York State for the 1999 through 2001 calendar
      years. Although the outcome of tax audits is uncertain, in management's opinion,
      adequate provisions for income taxes have been made for potential liabilities
      resulting from such matters. Management believes that the ultimate outcome
      of
      these matters will not have a material impact on our financial condition or
      liquidity.





**Federal
      Taxation**





***Corporate
      Alternative Minimum Tax*** *.* In
      addition to the regular income tax, the Code imposes an alternative minimum
      tax
      (“AMT”) in an amount equal to 20% of alternative minimum taxable income (“AMTI”)
      to the extent the AMT exceeds the taxpayers’ regular income tax. AMTI is regular
      taxable income as modified by certain adjustments and tax preference items.
      AMTI
      includes an amount equal to 75% of the excess of adjusted current earnings
      over
      AMTI (determined without regard to this adjustment and prior to reduction for
      net operating losses). Only 90% of AMTI can be offset by net operating loss
      carry forwards. The AMT is available as a credit against future regular income
      tax. The AMT credit can be carried forward indefinitely. For 2005, we do not
      expect to be subject to the AMT.





*Excess
        Inclusion.* All or a
        portion of the income we receive from the residual interest certificates
        (excess
        cashflow certificates), which are created in a real estate mortgage investment
        conduit ("REMIC") securitization, is referred to as excess inclusion. In
        addition, all or a portion of the dividend Delta Funding Corporation receives
        from Renaissance REIT Investment Corp. will be considered excess inclusion,
        resulting from its ownership of the securitization trusts (that are classified
        as a taxable mortgage pool).
 
 With
        limited exceptions, excess inclusion is always subject to tax because it
        cannot
        be offset by other deductions or by net operating losses. Excess inclusion
        is
        primarily caused by the securitization trust utilizing cash, that otherwise
        would have been paid to the holder of the residual interest certificate,
        to make
        payments to other security holders thereby paying down the principal balance
        of
        the asset-backed securities in order to create or maintain
        over-collateralization. In the future, we expect to continue to receive income
        from excess inclusion.


***Dividends
      Received Deduction*** **.** Delta
      Financial and Delta Funding Corporation may exclude from its income 100% of
      dividends received from their consolidated subsidiaries. No dividends received
      deduction is available for dividends received from Renaissance REIT Investment
      Corp. However, a 100% dividends paid deduction is available to Renaissance
      REIT
      Investment Corp. for qualifying dividend payments.




**54**


***Taxation
        as a REIT*** *-* Although
        Delta Financial has not elected to be taxed as a REIT, we have elected to
        have
        one of our subsidiaries - Renaissance REIT Investment Corp. - to be taxed
        as a
        REIT under Sections 856 through 859 of the Code, commencing with its taxable
        year ended December 31, 2005. By using Renaissance REIT Investment Corp.
        in
        connection with our securitizations, we are able to structure our
        securitizations as debt for tax, which more closely conforms to GAAP accounting
        treatment. Renaissance REIT Investment Corp. must comply with several
        qualification tests on a continuous basis in order to maintain its REIT status,
        including asset, income, distribution and ownership tests.
 · The
            asset
            test, which must be met on a quarterly basis, requires that at least
            75% of its
            assets are represented by interests in real property, cash and government
            securities. There are certain other restrictions on the composition of
            the other
            assets that can be owned.
 · The
            income test, which must be met on annual basis, requires that at least
            75% of
            the gross income must come from real estate sources and that at least
            95% of the
            gross income must come from real estate sources and certain other sources
            that
            are specified in the Code.
 
 · The
            distribution test requires the distribution of at least 90% of its annual
            REIT
            taxable income to stockholders (comprised of common stock owned by us
            and
            preferred stock owned by individual shareholders) primarily within the
            time
            frame set forth in the Code.
  · The
          ownership test requires that not more than 50% in value of the outstanding
          shares are owned, directly or indirectly, by five or fewer individuals
          (as
          defined Code to include certain entities) after applying certain attribution
          rules.
 If
        these requirements are met, a REIT generally will not be subject to Federal
        or
        state income taxation at the corporate level with respect to the REIT taxable
        income it distributes to its stockholders. The REIT may retain up to 10%
        of its
        REIT taxable income and pay corporate income taxes on this retained income
        while
        continuing to maintain its REIT status.


**State
      and Local Taxation**





We
      are
      subject to tax in the various states in which we operate, with New York being
      the state which has the most significant tax impact on us.





*New
      York State Taxation.* We are
      subject to the New York State franchise tax in annual amount equal to the
      greater of (a) 7.5% of “entire net income” allocable to New York State, or (b)
      the applicable alternative tax. The alternative tax is generally the greater
      of
      (a) 2.5% of our “alternative entire net income,” (b) .00178% of capital
      allocable to New York State, or (c) a fixed amount up to a maximum of $10,000.
      Entire net income is similar to federal taxable income, subject to certain
      modifications, and alternative entire net income is equal to entire net income
      without certain adjustments. Delta Financial and its subsidiaries (excluding
      Renaissance REIT Investment Corp. and its subsidiary) file a combined
      return.





We
      do
      business within the Metropolitan Transportation Business Tax District (the
      “District”), which is comprised of the counties of New York, Bronx, Kings,
      Richmond, Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk and Westchester.
      A
      tax surcharge is imposed on business corporations doing business within the
      District and has been applied since 1982. The District tax rate is 17% on the
      tax described above, subject to modification in certain circumstances, and
      is
      scheduled to expire for tax years ending on or after December 31,
      2009.





*Delaware
      Taxation.* Delta
      Financial, as a Delaware holding company not earning income in the State of
      Delaware, is exempted from corporate income tax. However, the Holding Company
      is
      required to file an annual report with, and pay an annual franchise tax to,
      the
      State of Delaware.





**55**


**Results
      of Operations**





Our
      results of operations reflect our change from gain-on sale accounting to
      portfolio accounting effective in the first quarter of 2004. Accordingly,
      our financial statements from prior years may be of limited use in evaluating
      our operating results.





**Year
      Ended December 31, 2005 Compared to the Year Ended December 31,
      2004**





**General**





Our
      net
      income for the year ended December 31, 2005 was $18.0 million, or $0.88 per
      share basic and $0.84 per share diluted, compared to net loss of $9.3 million,
      or $(0.51) per share basic and diluted, for the year ended December 31, 2004.
      As
      described in more detail below, the increase in net income recorded during
      the
      year ended December 31, 2005 relates primarily to (1) the growth in the net
      interest income we realized from our mortgage loans held for investment
      portfolio, which has grown since our
      change from gain-on-sale accounting to portfolio accounting in the first quarter
      of 2004, and (2) other income primarily related to the fair value changes on
      our
      excess cashflow certificates due to better-than-expected underlying loan
      performance of the securitizations. The
      loss
      recorded for the year ended December 31, 2004 reflects the effect of this change
      in accounting, coupled with the net impact of: (1) a $4.3
      million pre-tax loss we realized relating to the interest rate swaps used to
      hedge $542.3 million of the March 2004 securitization variable-rate debt that
      were not accounted for as hedge instruments; (2) a $4.2
      million pre-tax gain related
      to the fair value changes on our corridors that were not accounted for as
      hedging instruments prior to May 2004; and (3) a
      $6.6
      million pre-tax gain recorded upon the delivery
      of $113.9 million of mortgage loans in connection with our fourth quarter 2003 securitization
      (which was structured to be accounted for as a sale), under a pre-funding
      feature.





We
      recorded net interest income after provision for loan losses of $94.4 million
      during the year ended December 31, 2005, an increase of $44.5 million, or 89.3%,
      from $49.9 million in the same period in 2004. The increase in net interest
      income after provision for loan losses primarily reflects the net effect of
      recognizing interest income on $4.7 billion of mortgage loans held for
      investment at December 31, 2005, compared to $2.4 billion of these loans held
      at
      December 31, 2004. Similarly, the increase in interest expense primarily
      reflects the net effect of recognizing interest expense on $4.4 billion of
      financing on mortgage loans held for investment at December 31, 2005, compared
      to $2.2 billion of financing on mortgage loans held for investment at December
      31, 2004. During the year ended December 31, 2005, total non-interest income
      increased $24.1 million and total non-interest expense increased by $24.6
      million, compared to the same period in 2004. The increase in non-interest
      income primarily reflects the impact of the gain recorded on the $392.2 million
      increase in mortgage loans sold on a whole-loan basis and the $14.4 million
      increase in the fair value of our excess cashflow certificates we experienced
      during the year ended December 31, 2005, while the increase in non-interest
      expense primarily reflects the expenses associated with increases in origination
      volume, personnel and costs related to our on-going SOX initiatives, as compared
      to the same period in 2004.





We
      originated $3.8 billion of mortgage loans during the year ended December 31,
      2005, representing a $1.2 billion, or 46.9%, increase from $2.6 billion of
      mortgage loans originated during the year ended December 31, 2004. We
      securitized and/or sold $3.8 billion of loans during the year ended December
      31,
      2005, compared to $2.6 billion of loans (including $113.9 million of loans delivered
      in the first quarter of 2004 under a pre-funding feature in connection with
      our
      fourth quarter 2003 securitization accounted for as a sale) during
      the same period in 2004.





**56**
 **Net
        Interest Income**





We
      recorded net interest income of $123.0 million during the year ended December
      31, 2005, an increase of $62.7 million from the $60.3 million recorded in the
      same period in 2004. The increase in net interest income primarily reflects
      the
      net effect of the increases in the average balance of mortgage loans held for
      investment and the related financing during the year ended December 31, 2005
      compared to the same period in 2004. Net interest income represents the
      difference between our interest income and our interest expense, each of which
      is described in the following paragraphs:





***Interest
      Income.*** Interest
      income increased $190.7 million to $290.8 million for the year ended December
      31, 2005, from $100.1 million for the comparable period in 2004. The increase
      is
      primarily due to (1) the increase in interest income of $175.4 million on our
      loans held for investment - securitized, which totaled $4.4 billion at December
      31, 2005 as compared to $2.2 billion at December 31, 2004; (2) the increase
      in
      interest income of $12.2 million related to the increase in the average amount
      of mortgage loans we originated and held pending securitization or sale during
      the year ended December 31, 2005 compared to the same period in 2004; and (3)
      the increase in pass-through interest received from securitization trusts on
      fixed-rate asset-backed securities at the time of settlement - due to the
      increase in fixed-rate asset-backed securities issued during the year ended
      December 31, 2005, compared to the asset-backed securities issued in the same
      period of 2004.





The
      following table is a summary of interest income:





**For
                the Year Ended**
              **December
                31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Interest
                income on mortgage loans held for sale, net
            
            $
            --
            
            $
            12,801Interest
                income on mortgage loans held for investment - pre-securitization,
                net
            
            
            30,494
            
            
            5,531Interest
                income on mortgage loans held for investment - securitized, net(1)
            
            
            250,841
            
            
            75,469Interest
                income on excess cashflow certificates
            
            
            1,593
            
            
            2,073Securitization
                pass-through interest
            
            
            7,886
            
            
            4,116Miscellaneous
                interest income
            
            
            15
            
            
            115Total
                interest income
            
            $
            290,829
            
            $
            100,105





*(1)
      The amount for the year ended December 31, 2005 and 2004 includes $13.8 million
      and $2.6 million, respectively, of prepayment penalty fees.*





***Interest
      Expense.*** Interest
      expense increased by $128.0 million to $167.8 million for the year ended
      December 31, 2005 from $39.8 million for the comparable period in 2004. The
      increase was primarily due to the increase in interest expense related to the
      securitization debt and, to a lesser extent, the increase in loans originated
      and financed during the year ended December 31, 2005 on our warehouse
      facilities, compared to the same period in 2004. The weighted average cost
      of
      our mortgage loans held for investment financing increased during the year
      ended
      December 31, 2005 as compared to the same period in 2004. The weighted average
      cost at December 31, 2005 was 4.92%, an increase of 81 basis points over the
      weighted average cost of 4.11% at December 31, 2004. Additionally, contributing
      to the increase in interest expense was the higher warehouse financing costs
      due
      to a higher average one-month LIBOR rate, which is the benchmark index used
      to
      determine our cost of borrowed funds. The rate increased 189 basis points to
      an
      average of 3.39% for the year ended December 31, 2005, compared to an average
      of
      1.50% for the same period in 2004.




The
      following table presents the components of interest expense:




**For
                the Year Ended**
              **December
                31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Interest
                expense on warehouse financing
            
            $
            22,075
            
            $
            8,006Interest
                expense on mortgage loans held for investment financing
                (1)
            
            
            145,431
            
            
            31,480Interest
                expense on other borrowings
            
            
            286
            
            
            296Total
                interest expense
            
            $
            167,792
            
            $
            39,782





*(1)
      The amount for the year ended December 31, 2005 and 2004 includes $6.3 million
      and $2.0 million, respectively, of deferred securitization debt issuance
      expenses and trustee expenses recognized during the period, net of hedge
      amortization.*





**57**


**Provision
      for Loan Losses**





A
      provision for loan losses on mortgage loans held for investment is
      recorded to maintain the related allowance for loan losses at an appropriate
      level for currently existing probable losses of principal. We recorded a
      provision for loan losses of $28.6 million (including a $1.7 million specific
      provision related to Hurricanes
      Katrina and Rita loans)
      and $10.4 million for the year ended December 31, 2005 and 2004, respectively,
      related to mortgage loans held for investment. The amount of the provision
      for
      loan losses, excluding the specific provision related to hurricanes Katrina
      and
      Rita, corresponds to the increase in and the seasoning of our mortgage loans
      held for investment during the respective period.





During
      the fourth quarter of 2005, we established a specific allowance for loan
      losses related to certain loans deemed to be impaired by the effects of
      Hurricanes Katrina and Rita. Our
      provision for these loans was based upon our estimated loss exposure
      attributable to 35 properties securing a total unpaid principal balance of
      $3.9
      million at December 31, 2005 located in the disaster areas designated by FEMA.
      As additional information is obtained and processed over the coming months
      and
      quarters, we will continue to assess the need for any adjustments to our
      specific reserves related to the mortgage loans in the affected
      areas.





**Non-Interest
      Income**





Total
      non-interest income increased by $24.1 million to $41.9 million for the year
      ended December 31, 2005, from $17.8 million for the comparable period in 2004.
      The increase in non-interest income primarily resulted from a $11.1 million
      increase in the net gain on sale of mortgage loans and a $14.4 million increase
      in the fair value of our excess cashflow certificates recorded during the year
      ended December 31, 2005 as compared to the same period in 2004.





***Net
      Gain on Sale of Mortgage Loans.*** Net gain
      on sale of mortgage loans for the years ended December 31, 2005 and 2004 is
      comprised of the premium received from selling whole loans on a
      servicing-released basis, together with any deferred origination costs or fees
      associated with mortgage loans sold, less any premium recapture reserve. During
      the year ended December 31, 2005, we recorded a net gain on the sale of mortgage
      loans of $27.2 million on the sale of $561.5 million of mortgage loans on a
      whole-loan basis as compared to a $16.1 million gain recorded during the same
      period in 2004 on sales on a whole-loan basis, or through a securitization
      structured to be accounted for as a sale, of $283.3 million of mortgage loans.
      Additionally, the gain on sale amount of $16.1 million for the year ended
      December 31, 2004 includes a $6.6 million gain recorded from the January 2004
      delivery of $113.9 million of mortgage loans in connection with our fourth
      quarter 2003 securitization, which was structured to be accounted for as a
      sale
      under a pre-funding feature. Through the end of 2003, our securitizations were
      structured to be accounted for as sales under SFAS No. 140. Accordingly, we
      recorded gain-on-sale revenue upon the closing of each such securitization.
      For
      the year ended December 31, 2004, net gain on sale of mortgage loans included
      the following in addition to the gains recorded from whole-loan sales due to
      the
      first quarter of 2004 delivery of loans into the fourth quarter 2003
      securitization:





(1)
            the
                sum of:a)
            the
                cash purchase price we received in connection with selling (i) a
                NIM note,
                net of  O/C amount and interest rate cap and (ii) an interest-only
                certificate;b)
            the
                fair value of the excess cashflow certificates we retained and initially
                recorded in a securitization structured as a sale for such
                period;c)
            the
                premium received from selling mortgage servicing rights;
                andd)
            the
                difference between the selling price and the carrying value of the
                related
                mortgage loans sold;(2)
            less
                the:a)
            costs
                associated with the securitization structured as a
                sale;b)
            any
                hedge loss (gain) associated with such securitization accounted for
                as a
                sale;c)
            any
                premium recapture reserve; andd)
            any
                loss associated with loans sold at a discount, together with any
                deferred
                origination costs or fees associated with mortgage loans
                sold.





**58**


The
      following table is a summary of our net gain on sale of mortgage loans for
      the
      years ended December 31, 2005 and 2004:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Net
                Gain on Sale of Mortgage Loans:Loans
                sold(1)
            
            $
            561,487
            
            $
            283,253NIM
                proceeds, net
            
            $
            --
            
            $
            4,712Interest-only
                security proceeds
            
            
            --
            
            
            1,292Mortgage
                servicing rights(2)
            
            
            --
            
            
            661Gain
                on whole-loan sales
            
            
            21,862
            
            
            7,716Premium
                recapture reserve
            
            
            (1,077
            )
            
            (308
            )Net
                loan origination fees
            
            
            6,408
            
            
            2,468Securitization
                transaction costs
            
            
            --
            
            
            (484
            )Net
                gain on sale recorded
            
            $
            27,193
            
            $
            16,057Weighted-average
                net gain on sale ratio
            
            
            4.84
            %
            
            5.67
            %





*(1)*  *For
      the year ended December 31, 2004, we delivered $113.9 million of mortgage loans
      under a pre-funding feature in our fourth quarter 2003 securitization and
      recorded gain-on-sale revenue related thereto during the year ended December
      31,
      2004. Because the fourth quarter 2003 securitization was structured as a sale,
      we recorded gain-on-sale revenue during the year ended December 31, 2004 when
      we
      delivered the loans under the pre-funding feature to the securitization trust
      in
      January 2004.*





*(2)*  *For
      the year ended December 31, 2004, we recorded a $661,000 gain from the sale
      of
      mortgage servicing rights related to the mortgage loans collateralizing
      the* *fourth quarter 2003* *securitization.*





Net
      gain
      on sale of mortgage loans increased $11.1 million to $27.2 million for the
      year
      ended December 31, 2005, from $16.1 million for the comparable period in 2004.
      During the year ended December 31, 2005, we sold $561.5 million (at a weighted
      average gross sales price of 3.90%) of mortgage loans on a whole loan
      servicing-released basis, compared to $169.3 million (at a weighted average
      gross sales price of 4.56%) for the same period in the prior year. The gain
      on
      sale of mortgages recorded for the year ended December 31, 2004 also reflects
      the impact of our delivery of $113.9 million of mortgage loans in connection
      with our fourth quarter 2003 securitization (which was structured to be
      accounted for as a sale), under a pre-funding feature during the year ended
      December 31, 2004.





The
      weighted average net gain on sale ratio for the years ended December 31, 2005
      and 2004 was 4.84% and 5.67%, respectively. The weighted-average net gain on
      sale ratio is calculated by dividing the net gain on sale by the total amount
      of
      loans securitized and sold.





***Other
      Income.*** Other
      income increased $13.0 million to $14.7 million for the year ended December
      31,
      2005, from $1.7 million for the year ended December 31, 2004. The increase
      in
      other income primarily relates to a fair value adjustment on our excess cashflow
      certificates of $14.4 million for the year ended December 31, 2005, as compared
      to a $1.4 million fair value adjustment for the same period in 2004. The
      increase in the fair value of our excess cashflow certificates for the year
      ended December 31, 2005 was primarily driven by lower losses on the underlying
      loans and the impact of our revised assumptions made during the third quarter
      of
      2005, specifically the lowering of the expected losses (for most of the
      underlying securitizations) and/or changing of the shape of the loss curve
      to
      reflect losses occurring at a later date than originally
      anticipated.




**59**


**Non-interest
      Expense**





Total
      non-interest expense increased by $24.6 million, or 30.0%, to $106.9 million
      for
      the year ended December 31, 2005, from $82.3 million for the comparable period
      in 2004. The increase primarily is due to an increase in payroll and related
      costs associated with a 46.9% increase in our mortgage loan production and
      an
      18.2% increase in personnel, coupled with an increase in general and
      administrative expenses principally due to other production related expenses.
      Additionally, contributing to the increase in non-interest expense was an
      increase in the recorded loss on derivative instruments relating to the
      ineffective portion of our derivatives that is recognized through current
      earnings during the year ended December 31, 2005 as compared to the year ended
      December 31, 2004.





***Payroll
      and
      Related Costs.*** Payroll
      and related costs increased by $11.5 million, or 22.1%, to $63.5 million for
      the
      year ended December 31, 2005, from $52.0 million for the comparable period
      in
      2004. The increase was primarily the result of higher compensation and related
      payroll cost associated with an increase in our staff. As of December 31, 2005,
      we employed 1,327 full- and part-time employees, an increase of 18.2% over
      our
      1,123 full- and part-time employees as of December 31, 2004. Additionally,
      payroll and related costs were higher due to the higher loan commissions paid
      as
      a result of a 46.9% increase in loan production during the year ended December
      31, 2005 compared to the same period in 2004.





Payroll
      and related costs include salaries, benefits and payroll taxes for all
      employees, but excludes the deferrable portion of those costs attributable
      to
      production related employees.





***General
      and Administrative Expenses.***  General
      and administrative expenses increased $12.3 million, or 40.8%, to $42.5 million
      for the year ended December 31, 2005, from $30.2 million for the year ended
      December 31, 2004. The increase was primarily due to an increase in expenses
      associated with a 46.9% increase in loan production during the year ended
      December 31, 2005 compared to the same period in 2004 (which includes $4.1
      million of higher advertising, promotional and marketing expenses in 2005),
      and
      the consequent 18.2% increase in personnel and expenses related to the ongoing
      expansion of our wholesale and retail divisions. Also contributing to the
      increase in general and administrative expenses was a $3.2 million increase
      in
      legal, accounting and professional fees. The increase in legal, accounting
      and
      professional fees primarily relates to incurrence of $2.9 million in SOX
      expenses associated with our compliance efforts.





General
      and administrative expenses consist primarily of office rent, insurance,
      telephone, depreciation, legal reserves and fees, license fees, accounting
      fees,
      travel and entertainment expenses, advertising and promotional expenses and
      the
      provision for recourse loans. Our
      increase in marketing, advertising and promotional expenses in 2005 was due
      to
      our increased marketing efforts made during the year, primarily in the form
      of
      direct mail and other marketing campaigns.





*Loss
      on Derivative Instruments.* The loss
      on derivative instruments recorded during the year ended December 31, 2005
      represents the (1) ineffective portion of the change in fair value of interest
      rate swaps used to lock in a pre-determined interest rate on designated portions
      of our prospective future securitization financing, (2) ineffective portion
      related to the change in the fair value of our corridors we use to protect
      the
      variable-rate financing, and (3) c hanges
      in
      the fair value of the derivative instruments classified as trading
      securities.





During
      the year ended December 31, 2005, we recorded a net loss on derivative
      instruments of $908,000 as compared to a net loss on derivatives of $100,000
      during the year ended December 31, 2004. During the year ended December 31,
      2005, we recorded a loss of $1.5 million on the ineffective portion of 
corridors and interest rate swaps, compared to a $277,000 gain recorded on
      the
      ineffective portion of corridors and interest rate swaps during the year
      ended December 31, 2004. Additionally, at
      December 31, 2005, we held $1.7 million of corridors classified as trading
      securities in prepaid and other assets as these corridors were no longer deemed
      “highly effective”, as the ratio of the outstanding balance of the hedged item
      (debt) to the notional amount of the corridors was outside of the range of
      80%
      to 125%. During the year ended December 31, 2005, a gain of $545,000 was
      recorded to earnings on the changes in fair value of the corridors held as
      trading securities. During the year ended December 31, 2004, none of the
      corridors held were classified as trading securities.




In
      addition, during the year ended December 31, 2004, we recorded (1) a $4.5
      million loss relating to the interest rate swaps used to hedge approximately
      $542.3 million of securitization variable-rate debt that were not accounted
      for
      as hedge instruments; and (2) a $4.2 million gain related to the fair value
      changes on our corridors that were not accounted for as hedging instruments
      prior to May 2004.





**60**


**Provision
      for Income Tax Expense (Benefit)**





We
      recorded an income tax expense of $11.5 million for the year ended December
      31,
      2005 due to the pre-tax income of $29.4 million recorded for the year (utilizing
      an effective tax rate of approximately 39.0%). We recorded a tax benefit of
      $5.2
      million for the year ended December 31, 2004 on a pre-tax loss of $14.6 million
      (utilizing an effective tax rate of approximately 36.0%).





**Year
      Ended December 31, 2004 Compared to the Year Ended December 31,
      2003**





Our
      results of operations reflect our change from gain-on sale accounting to
      portfolio accounting effective in the first quarter of 2004. Accordingly,
      our financial statements from prior years may be of limited use in evaluating
      our operating results. In addition, we have re-organized the presentation of
      our
      financial statements to reflect our change from gain-on-sale to portfolio
      accounting.





**General**





Our
      net
      loss for the year ended December 31, 2004 was $9.3 million, or $(0.51) per
      share
      basic and diluted, compared to net income of $67.4 million, or $4.05 per share
      basic and $3.59 per share diluted, for the year ended December 31, 2003. The
      loss resulted primarily from structuring our 2004 securitizations to be
      accounted for as secured financings, instead of sales. Consequently, we did
      not
      record any gain-on-sale revenue in connection with these securitizations and
      instead recorded interest income from the securitized loans and interest expense
      from the pass-through certificates issued in connection with the securitizations
      over the life of the securitizations. Conversely, we structured our 2003
      securitizations to be accounted for as sales under SFAS No. 140, requiring
      us to
      record an upfront gain-on-sale equal to the present value of the estimated
      cash
      flows we expected to receive over the life of the securitizations. Additionally,
      the net income for the year ended December 31, 2003 was significantly impacted
      by a tax benefit of $25.4 million recorded during the year.





We
      recorded net interest income after provision for loan losses of $49.9 million
      during the year ended December 31, 2004, an increase of $41.0 million, from
      the
      $8.9 million recorded in the same period in 2003. The increase in interest
      income primarily reflects the net effect of recognizing interest income on
      $2.4
      billion of mortgage loans held for investment compared to no such loans held
      for
      investment in 2003. Similarly, the increase in interest expense primarily
      reflects the net effect of recognizing interest expense on $2.2 billion on
      financing on mortgage loans held for investment compared to no such financing
      on
      mortgage loans held for investment in 2003. We also recorded a provision for
      loan losses of $10.4 million during the year ended December 31, 2004, compared
      to no such provision in 2003. During the year ended December 31, 2004 as
      compared to the same period in 2003, total non-interest income decreased $78.0
      million and total non-interest expense increased by $19.7 million. The increases
      in interest income, interest expense and provision for loan losses as well
      as
      the decrease in non-interest income, primarily reflect the impact of our change
      from gain-on-sale accounting to portfolio accounting in 2004, while the increase
      in non-interest expense primarily reflects the 52.5% increase in origination
      volume and 23.1% increase in personnel for the year ended December 31, 2004
      as
      compared to the same period in 2003.





We
      originated $2.6 billion of mortgage loans during the year ended December 31,
      2004, an increase from $1.7 billion of mortgage loans originated for the
      comparable period in 2003. We securitized and sold $2.6 billion of loans during
      the year ended December 31, 2004, compared to $1.5 billion of loans during
      the
      same period in 2003.





**Net
      Interest Income**





We
      recorded net interest income before provision for loan losses of $60.3 million
      during the year ended December 31, 2004, an increase of $51.4 million from
      the
      $8.9 million recorded in the same period in 2003. The increase in net interest
      income primarily reflects the impact of our change from gain-on-sale accounting
      to portfolio accounting in 2004. Net interest income is comprised of the
      following:





***Interest
      Income.*** Interest
      income increased $85.7 million to $100.1 million for the year ended December
      31,
      2004, from $14.4 million for the comparable period in 2003. The increase is
      primarily due to (1) the recording of $75.5 million in interest income on our
      mortgage loans held for investment - securitized, which totaled $2.2 billion
      at
      December 31, 2004; (2) an increase in the amount of mortgage loans we originated
      and held pending securitization or sale during the year ended December 31,
      2004
      compared to the same period in 2003; and (3) the increase in pass-through
      certificate interest recognized at settlement - due to the composition of
      fixed-rate asset-backed securities issued during the year ended December 31,
      2004, compared to adjustable-rate asset-backed securities issued in the same
      period of 2003.





**61**


The
      following table is a summary of interest income:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2004**
            
            **2003**Interest
                income on mortgage loans held for sale, net
            
            $
            12,801
            
            $
            10,497Interest
                income on mortgage loans held for investment -
                pre-securitization
            
            
            5,531
            
            
            --Interest
                income on mortgage loans held for investment - securitized(1)
            
            
            75,469
            
            
            --Interest
                income on excess cashflow certificates
            
            
            2,073
            
            
            2,418Securitization
                pass-through interest
            
            
            4,116
            
            
            1,330Miscellaneous
                interest income
            
            
            115
            
            
            141Total
                interest
                income
            
            $
            100,105
            
            $
            14,386





*(1)*
            *The
                amount for the year ended December 31, 2004 includes $2.6 million
                of
                prepayment penalty fees.*





***Interest
      Expense.*** Interest
      expense increased by $34.3 million to $39.8 million for the year ended December
      31, 2004 from $5.5 million for the comparable period in 2003. The increase
      was
      primarily due to the interest expense related to the securitization debt and,
      to
      a lesser extent, the increase in loans originated and financed during the period
      on our warehouse facilities, compared to the same period in 2003. Additionally,
      contributing to the increase in interest expense was the slightly higher
      warehouse financing costs due to a higher average one-month LIBOR rate, which
      is
      the benchmark index used to determine our cost of borrowed funds. The rate
      increased on average to 1.50% for the twelve months of 2004, compared to an
      average of 1.21% for the same period in 2003. Partially offsetting these
      increases was the elimination of the interest expense paid on the senior notes
      which we redeemed during the fourth quarter of 2003.




The
      following table presents the components of interest expense:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2004**
            
            **2003**Interest
                expense on warehouse financing
            
            $
            8,006
            
            $
            4,390Interest
                expense on mortgage loans held for investment financing(1)
            
            
            31,480
            
            
            --Interest
                expense on other borrowings
            
            
            296
            
            
            265Interest
                expense on senior notes(2)
            
            
            --
            
            
            854Total interest expense
            
            $
            39,782
            
            $
            5,509





*(1)*  *The
      amount for the year ended December 31, 2004 includes $2.0 million of deferred
      securitization debt issuance expenses and trustee expenses recognized during
      the
      period, net of hedge amortization.*





*(2)*
            *On
                October 30, 2003, we redeemed, at par, all of our outstanding 9.5%
                senior
                notes due August 2004.*





**Provision
      for Loan Losses**





We
      recorded a provision for loan losses of $10.4 million for the year ended
      December 31, 2004 related to mortgage loans held for investment. The amount
      of
      the provision for loan losses is primarily driven by our securitization
      activities ($2.4 billion of mortgage loans held for investment at December
      31,
      2004) conducted during the year ended December 31, 2004. We did not have a
      provision for loan loss related to mortgage loans held for investment during
      the
      comparable period in 2003, as we did not hold loans for investment at that
      time.





**Non-interest
      Income**





Total
      non-interest income decreased $78.0 million, or 81.4%, to $17.8 million for
      the
      year ended December 31, 2004, from $95.8 million for the comparable period
      in
      2003. The decrease in non-interest income was primarily due to the $78.7 million
      decrease in net gain on sale of mortgage loans recorded in 2004 as compared
      to
      2003. The decrease in net gain on sale of mortgage loans was the result of
      our
      changing the securitization structure we used in 2004, and consequently, our
      accounting for securitizations of our mortgage loans to portfolio accounting,
      where interest income is recognized over the life of the loans, from
      gain-on-sale accounting, where revenue is recognized upfront at time of sale
      in
      accordance with SFAS No. 140. Non-interest income is comprised of the
      following:





**62**


***Net
      Gain on Sale of
      Mortgage Loans.*** Net gain on sale of mortgage loans for the year
      ended December 31, 2004 is comprised of (1) the difference between the selling
      price and the carrying value (including deferred net origination fees) of the
      related mortgage loans sold on a servicing released basis and (2) gain-on-sale
      revenue recognized upon the first quarter of 2004 delivery of mortgage loans
      under a pre-funding feature related to our fourth quarter 2003 securitization.
      Through the end of 2003, our securitizations were structured to be accounted
      for
      as sales under SFAS No. 140. Accordingly, we recorded gain-on-sale revenue
      upon
      the closing of, and delivery of mortgage loans to, each such securitization
      during 2003. For the year ended December 31, 2003, net gain on sale of mortgage
      loans was comprised of the following:




(1)
              the
                  sum of:a)
              the
                  cash purchase price we received in connection with selling one
                  or more of
                  the following securities in connection with our securitization(s)
                  structured to be accounted for as sales for a particular period:
                  (i) a NIM
                  note, net of O/C amount and interest rate cap and/or (ii) an
                  interest-only certificate;b)
              the
                  fair value of the excess cashflow certificates we retained and
                  initially
                  recorded in a securitization structured as a sale for such
                  period;c)
              the
                  premium received from selling mortgage servicing rights in connection
                  with
                  each securitization structured as a sale; andd)
              the
                  difference between the selling price and the carrying value of
                  the related
                  mortgage loans sold.(2)
              less
                  the:a)
              costs
                  associated with the securitization structured as a
                  sale;b)
              any
                  hedge loss (gain) associated with such securitization accounted
                  for as a
                  sale; andc)
              any
                  loss associated with loans sold at a discount, together with any
                  deferred
                  origination costs or fees associated with mortgage loans
                  sold.
 
 The following table is a summary of our net gain on sale of mortgage loans
        for
        the years ended December 31, 2004 and 2003:


**For
                the Year Ended December 31,***(Dollars
                in thousands*)
            
            **2004**
            
            **2003**Net
                Gain on Sale of Mortgage Loans:Loans
                sold(1)
            
            $
            283,253
            
            $
            1,537,600NIM
                proceeds, net
            
            $
            4,712
            
            $
            67,159Interest-only
                security proceeds
            
            
            1,292
            
            
            12,913Excess
                cashflow certificate (owner trust certificate)
            
            
            --
            
            
            6,941Mortgage
                servicing rights
            
            
            661
            
            
            8,910Hedging
            
            
            --
            
            
            438Gain
                on whole loan sales
            
            
            7,716
            
            
            2,223Premium
                recapture reserve
            
            
            (308
            )
            
            (86
            )Net
                loan origination fees
            
            
            2,468
            
            
            3,425Securitization
                transaction costs
            
            
            (484
            )
            
            (7,141
            )Net gain on sale recorded
            
            $
            16,057
            
            $
            94,782Weighted average net gain on sale ratio
            
            
            5.67
            %
            
            6.16
            %





*(1)*  *For
      the year ended December 31, 2004, we delivered $113.9 million of mortgage loans
      under a pre-funding feature in our fourth quarter 2003 securitization and
      recorded gain-on-sale revenue related thereto during the year ended December
      31,
      2004. Because the fourth quarter 2003 securitization was structured as a sale,
      we recorded gain-on-sale revenue during the year ended December 31, 2004 when
      we
      delivered the loans under the pre-funding feature to the securitization trust
      in
      January 2004.*





**63**


Net
      gain
      on sale of mortgage loans decreased $78.7 million to $16.1 million for the
      year
      ended December 31, 2004, from $94.8 million for the comparable period in 2003.
      This decrease was directly related to our structuring the securitizations we
      issued in 2004 to be accounted for as secured financings. This structure
      recognizes the related revenue as interest income over the life of the
      securitization instead of recording virtually all of the income upfront as
      a
      gain on sale as our 2003 and prior structures required under SFAS No. 140.
      During the year ended December 31, 2004, we delivered $113.9 million of mortgage
      loans through a pre-funding feature in connection with our fourth quarter 2003
      securitization (which was structured as a sale) and sold $169.3 million of
      mortgage loans on a servicing-released basis, compared to $1.5 billion of
      mortgage loans securitized (all of which in securitizations structured to be
      accounted for as sales) and $42.4 million of mortgage loans sold on a
      servicing-released basis during the same period in 2003.





The
      weighted average net gain on sale ratio for the year ended December 31, 2004
      (representing the mortgage loans we delivered under the pre-funding feature
      of
      our fourth quarter 2003 securitization and whole loans sales), and for the
      comparable period in 2003, was 5.67% and 6.16%, respectively. The
      weighted-average net gain on sale ratio is calculated by dividing the net gain
      on sale by the total amount of loans securitized and sold.





***Other
      Income.*** Other
      income increased $722,000, to $1.7 million for the year ended December 31,
      2004,
      from $1.0 million for the year ended December 31, 2003. The increase is
      primarily due to an increase in the net gains recorded on changes in the fair
      value of excess cashflow certificates during 2004. We recognized $1.4 million
      of
      net gains due to changes in fair value of our excess cashflow certificates
      for
      the year ended December, 31, 2004 as compared to $220,000 of such net gains
      in
      the same period in 2003. During the year ended December 31, 2003, we received
      $218,000 of income related to the LLC. We did not receive any income from the
      LLC during the year ended December 31, 2004. We have a non-voting membership
      interest in the LLC which entitles us to receive 10% to 15% of the net cash
      flows from the LLC. We have not received our distributions since the second
      quarter of 2003, due to a dispute with the LLC’s President, which has led us to
      commence a lawsuit to recover all of the amounts due to us and a counter-suit
      by
      the LLC. See
“Part
      I, Item 3. - Legal Proceedings.”




**Non-interest
      Expense**





Total non-interest expense increased by $19.7 million, or 31.4%, to $82.3
      million for the year ended December 31, 2004, from $62.6 million for the
      comparable period in 2003. The increase is primarily due to an increase in
      payroll and related costs associated with a 52.5% increase in our mortgage
      loan
      production, together with an increase in our personnel expenses and an increase
      in general and administrative expenses related primarily to other production
      related expenses.





***Payroll
      and Related Costs.*** Payroll
      and related costs increased by $12.9 million, or 32.8%, to $52.0 million for
      the
      year ended December 31, 2004, from $39.1 million for the comparable period
      in
      2003. The increase was primarily the result of higher compensation and related
      payroll costs (including medical and 401(k) expenses) associated with an
      increase in our staff. As of December 31, 2004, we employed 1,123 full- and
      part-time employees, an increase of 23.1% over the 912 full- and part-time
      employees as of December 31, 2003. Additionally, payroll and related costs
      were
      higher due to higher loan commissions paid, resulting from higher loan
      production during 2004 compared to 2003.





***General
      and Administrative Expenses.*** General
      and administrative expenses increased $6.7 million, or 28.5%, to $30.2 million
      for the year ended December 31, 2004, from $23.5 million for the year ended
      December 31, 2003. The increase was primarily due to an increase in
      non-deferrable expenses associated with a 52.5% year-over-year increase in
      loan
      production, the related 23.1% increase in personnel and the ongoing expansion
      of
      our wholesale and retail divisions. Additionally contributing to the increase
      in
      general and administrative expenses was a $1.2 million increase in marketing,
      advertising and promotional expenses which totaled $2.0 million for the year
      ended December 31, 2004, a $1.7 million increase in professional fees and a
      $568,000 provision related to mortgage loans we are required to repurchase
      in
      accordance with our securitization agreements. The increase in professional
      fees
      included, among other expenses, $480,000 of accounting and other professional
      fees incurred related to SOX documentation initiatives undertaken in
      2004.





**64**




***Loss
      on Derivative Instruments.*** During
      the year ended December 31, 2004, we recorded a net loss on derivative
      instruments of $100,000. The net loss was due to the recording of a $4.5 million
      loss relating to the interest rate swaps used to hedge approximately $542.3
      million of securitization variable-rate debt that were not accounted for as
      hedge instruments. The loss was primarily offset by (1) a $4.2 million gain
      related to the fair value changes on our corridors that were not accounted
      for
      as hedging instruments prior to May 2004 and (2) a $277,000 gain recorded on
      the
      ineffective portion of corridors and interest rate swaps. There were no
      gains or losses related to derivative instruments for the year ended December
      31, 2003.





**Provision
      for Income Tax Expense (Benefit)**





We
      recorded an income tax benefit of $5.2 million for the year ended December
      31,
      2004 due to the pre-tax loss of $14.6 million recorded for the year based on
      an
      effective tax rate of approximately 36.0%, net of adjustments for permanent
      differences. For
      the
      year ended December 31, 2003, we recorded an income tax benefit of approximately
      $25.4 million. This was comprised of a tax provision on current year’s earnings
      of approximately $16.9 million and a tax benefit of approximately $42.3 million
      relating to the reversal of a deferred tax valuation allowance based upon
      management’s assessment of the positive trend in our profitability and cash
      flows during the year ended December 31, 2003 together with the retirement
      of
      all our long-term unsecured debt.





**Quarterly
      Financial Data**





Please
      see “Item 8 - Financial Statements and Supplementary Data - Condensed Quarterly
      Financial Data” in our consolidated financial statements for a summary of
      selected financial data by quarter for the years ended December 31, 2005 and
      2004.




**Financial
      Condition**





***December
      31, 2005 compared to December 31, 2004***





**Cash
      and cash equivalents** .
      Cash
      and cash equivalents decreased $514,000, or 9.9%, to $4.7 million at December
      31, 2005, from $5.2 million at December 31, 2004. This decrease was primarily
      related to timing of cash received and disbursed from normal
      operations.





***Mortgage
      Loans Held for Investment, Net*** .
      Mortgage loans held for investment, net increased $2.3 billion, or 97.6%, to
      $4.6 billion at December 31, 2005, from $2.3 billion at December 31, 2004.
      This
      account represents our basis in the mortgage loans that were either delivered
      to
      the securitization trusts (denoted as mortgage loans held for investment -
      securitized) or are pending delivery into future securitizations or sale on
      a
      whole-loan basis (denoted as mortgage loans held for investment -
      pre-securitization), net of discounts, deferred fees and allowance for loan
      losses.





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





**At
                December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Mortgage
                loans held for investment - securitized
            
            $
            4,430,775
            
            $
            2,165,353Mortgage
                loans held for investment - pre-securitization
            
            
            270,372
            
            
            206,289Discounts
                (MSR related)
            
            
            (26,750
            )
            
            (14,570
            )Net
                deferred origination fees
            
            
            (10,735
            )
            
            (5,800
            )Allowance
                for loan losses
            
            
            (36,832
            )
            
            (10,278
            )Mortgage
                loans held for investment, net
            
            $
            4,626,830
            
            $
            2,340,994





We
      maintain an allowance for loan losses based on our estimate of losses to be
      incurred in the foreseeable future (generally an 18 to 24 month period) on
      our
      mortgage loans held for investment. At December 31, 2005 and 2004, we
      established an allowance for loan losses totaling $36.8 million and $10.3
      million, respectively, based upon our analysis of the mortgage loans held for
      investment portfolio, including a $1.7 million reserve for probable loan losses
      on mortgage loans specifically related to Hurricanes Katrina and Rita. The
      increase in the allowance for loan losses is primarily driven by the growth
      and
      seasoning of our mortgage loans held for investment portfolio. We have not
      substantively changed any aspect of our overall approach in the determination
      of
      the allowance for loan losses under SFAS No. 5, and there have been no material
      changes in our assumptions or estimates as compared to the prior year that
      impacted the determination of the allowance for loan losses at December 31,
      2005.





**65**


The
      following table sets forth a summary of the activity in the allowance for loan
      losses for the years ended December 31, 2005 and 2004:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Allowance
                for loan losses - beginning of year
            
            $
            10,278
            
            $
            --Provision
                for loan losses(1)
            
            
            28,592
            
            
            10,443Charge-offs(2)
            
            
            (2,038
            )
            
            (165
            )Allowance
                for loan losses - end of year
            
            $
            36,832
            
            $
            10,278





*(1)*  *The
      provision for loan losses for the year ended December 31, 2005 includes a $1.7
      million specific provision* *related
      to probable losses attributable to loans in Hurricanes Katrina and
      Rita disaster areas.*




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





The
      outstanding balance of the mortgage loans held for investment located in the
      Hurricanes Katrina and Rita disaster areas designated by FEMA at December 31,
      2005 is approximately $29.2 million (of which $1.5 million are
      pre-securitization loans), or 0.6% of the outstanding loans held for investment
      balance at that date. Our specific allowance for loan losses at December 31,
      2005 is based upon our probable loss exposure attributable to 35 properties
      securing a total unpaid principal balance of $3.9 million in the affected areas. As
      additional information is obtained and processed over the coming months and
      quarters, we will continue to assess the need for any adjustments to our
      specific reserves related to the mortgage loans in the affected
      areas .





***Trustee
      Receivable.*** Trustee
      receivable increased $23.3 million, or 70.6%, to $56.2 million at December
      31,
      2005 from $32.9 million at December 31, 2004. Trustee receivable principally
      represents any un-remitted principal and interest payments collected by the
      securitization trust’s third-party loan servicer subsequent to the monthly
      remittance cut-off date on our mortgage loans held for investment - securitized
      portfolio. The unscheduled principal payments and prepaid loan payments received
      after the remittance cut-off date as of December 31, 2005 and 2004 totaled
      $50.7
      million and $30.2 million, respectively, relating to the securitizations
      accounted for as secured financings. The trustee is expected to remit these
      amounts on the following month’s scheduled remittance date, at which time they
      mainly will be used to pay down principal on the related financing on mortgage
      loans held for investment, net. Additionally, comprising the balance in trustee
      receivable is the interest portion of mortgage payments collected by our loan
      servicing provider during the month which are remitted to us one month after
      collection ( *i.e.* ,
      interest collected by the third-party servicer after our December 2005
      remittance cut-off date will be remitted to us in January 2006).





***Accrued
      Interest Receivable.*** Accrued
      interest receivable increased $14.7 million, or 119.5%, to $27.0 million at
      December 31, 2005, from $12.3 million at December 31, 2004. The increase is
      due
      to the 104.6% increase in mortgage loans held for investment - securitized
      from
      December 31, 2004, and a 31.1% increase in mortgage loans held for investment
      -
      pre-securitization during the same period.





**66**


***Excess
      Cashflow Certificates*** .
      The
      following table presents the activity related to our excess cashflow
      certificates for the years ended December 31, 2005 and 2004:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Balance,
                beginning of year
            
            $
            14,933
            
            $
            19,853Accretion
            
            
            1,593
            
            
            2,073Cash
                receipts
            
            
            (23,146
            )
            
            (8,359
            )Net
                change in fair value
            
            
            14,409
            
            
            1,366Balance,
                end of year
            
            $
            7,789
            
            $
            14,933





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




The
      decrease in the fair value of our excess cashflow certificates for the year
      ended December 31, 2005, as compared to the same period in 2004, is primarily
      due to the timing of cash receipts and losses on the underlying loans, coupled
      with the change in the amount of remaining residual cash flows. Actual losses
      for the year ended December 31, 2005 were lower than the anticipated losses,
      resulting in the receipt of cash earlier than expected. In addition, we revised
      several of the assumptions used to determine the fair value of the excess
      cashflow certificates during the third quarter of 2005. The most notable of
      the
      changed assumptions was the decrease in the amount of expected losses over
      the
      remaining term of several of the certificates and the shape of the loss curve
      due to better-than-expected performance of the mortgage loans that underlie
      the
      excess cashflow certificates. As a result of the lower losses and the increased
      cash flow, the return was higher on the excess cashflow certificates during
      the
      year ended December 31, 2005.





***Equipment,
      Net*** .
      Equipment, net, increased $2.4 million, or 55.6%, to $6.7 million at December
      31, 2005, from $4.3 million at December 31, 2004. This increase is primarily
      due
      to increased purchases of computer equipment and office furnishings during
      the
      year ended December 31, 2005, which reflects the 18.2% increase in employees
      compared to December 31, 2004 and the effect of our office expansions. The
      bulk
      of the equipment purchased during 2005 will be amortized to expense over a
      3 to
      5 year period from the date acquired.





***Accounts
      Receivable.***  Accounts
      receivable increased $1.4 million, or 37.2%, to $5.1 million at December 31,
      2005, from $3.7 million at December 31, 2004. This
      increase primarily is due to an increase in amounts due from the third-party
      servicer. The increase in servicer receivables relates to the increase in our
      mortgage loans held for investment - pre-securitization portfolio during the
      year ended December 31, 2005. The servicer receivables generally are comprised
      of the principal and interest payments collected by our loan servicing provider
      during the month and remitted to us one month after collection ( *i.e.* ,
      principal and interest collected by the third-party servicer during December
      2005 will be remitted to us in January 2006).





***Prepaid
      and Other Assets.*** Prepaid
      and other assets increased $4.4 million, or 16.8%, to $30.5 million at December
      31, 2005, from $26.1 million at December 31, 2004. The increase is primarily
      due
      to (1) $4.0 million increase in deferred securitization debt issuance costs
      that
      are recognized over the estimated life of the securitization debt as a yield
      adjustment to interest expense, (2) a $3.9 million increase in REO due to the
      expected seasoning of the loan portfolio, and (3) $825,000 increase in prepaid
      insurance and computer related items. These increases were offset partially
      by a
      $4.3 million decrease in the fair value of our derivatives used to hedge our
      securitization debt.





At
      December 31, 2005 and 2004, we held $4.4 million and $578,000, respectively,
      of
      REO properties, which we carry at the lower of cost or fair value, less
      estimated selling costs.  A
      provision of $213,000 was made during the year ended December 31, 2005 for
      decreases in the fair value of the REO properties. We recorded no such provision
      during the year ended December 31, 2004.




***Deferred
      Tax Asset.***  The
      deferred tax asset increased by $4.6 million, or 9.0%, to $54.9 million at
      December 31, 2005, from $50.3 million at December 31, 2004. The increase is
      primarily due to timing differences in GAAP income and taxable income
      recognition. The differences in income between GAAP income and taxable income
      primarily relates to the loan loss provision and actual charge-offs, deferred
      origination fees, and realized gains and losses on derivatives (interest rate
      swaps) associated with hedging the securitization debt issuance (financing
      costs). The increase was partially offset by decreases in the differences
      related to gain-on-sale accounting versus REMIC tax accounting for
      securitizations entered into prior to 2004, the differences related to our
      2004
      securitizations, which were accounted for as secured financings, and which
      for
      tax purposes were accounted for as REMIC transactions and are treated as sales,
      and a $3.0 million decrease in deferred taxes related to the fair value of
      the
      hedge instruments within accumulated other comprehensive income.





**67**


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





***Bank
      Payable.*** Bank
      payable increased $811,000, or 73.1%, to $1.9 million at December 31, 2005,
      from
      $1.1 million at December 31, 2004. Bank payable represents the amount of checks
      written against our operating account which are subsequently covered as they
      are
      presented to the bank for payment by either drawing down our lines of credit
      or
      from subsequent deposits of operating cash.


******


***Warehouse Financing.*** Our
      warehouse financing increased $87.1 million, or 64.3%, to $222.8 million at
      December 31, 2005, from $135.7 million at December 31, 2004. The increase was
      primarily due to a $64.1 million increase in the amount of mortgage loans held
      for investment - pre-securitization. Additionally impacting the amount of
      outstanding borrowings under our warehouse credit facilities was the decrease
      in
      the amount of self-funded loans from December 31, 2004 to December 31,
      2005.  At December 31, 2005, we self-funded $47.5 million of these mortgage
      loans, as compared to $70.6 million at December 31, 2004.




***Financing
      on Mortgage Loans Held for Investment, Net.***Our
      financing on mortgage loans held for investment, net increased $2.2 billion,
      or
      98.4%, to $4.4 billion at December 31, 2005, from $2.2 billion at December
      31,
      2004. This increase in the issuance of asset-backed securities corresponds
      to
      the increase in loans held for investment - securitized during the year ended
      December 31, 2005. The balance of this account will generally increase in
      proportion to the increase in mortgage loans held for investment -
      securitized.





***Other
      Borrowings.***  Other
      borrowings increased $1.5 million, or 43.7%, to $4.8 million at December 31,
      2005, from $3.3 million at December 31, 2004. The increase was due to an
      increase in the amount of financed equipment during the year ended December
      31,
      2005 due to the increase in personnel and mortgage origination offices we
      experienced during 2005.




The following table summarizes certain information regarding other borrowings
        at
        December 31, 2005 and 2004:





*(Dollars
                  in thousands)*
            
            **Range
                of Interest Rates**
            
            **Balance
                at December 31,**
            
            **Range
                of Expiration Dates**Equipment
                  financing - 2005
            
            3.29%
                to 12.45%
            
            $                                           
                4,785
            
            January
                2006 to December 2008Equipment
                  financing - 2004
            
            3.29%
                to 12.45%
            
            $                                           
                3,330
            
            October
                2005 to December 2007




***Accrued Interest Payable.*** Accrued
      interest payable increased $8.8 million to $13.1 million at December 31, 2005,
      from $4.3 million at December 31, 2004. The increase was primarily related
      to
      the increase in the number of outstanding securitizations year over year (eight
      at December 31, 2005 as compared to four at December 31, 2004). The financing
      on
      mortgage loans held for investment, net increased $2.2 billion, or 98.4%, from
      the December 31, 2004 balance.  The amount of accrued interest payable also
      increased due to an increase in the weighted average cost on mortgage loans
      held
      for investment financing to 4.92% at December 31, 2005 from 4.11% at
      December 31, 2004.


Accrued interest payable related to warehouse borrowings represented $279,000
      and $101,000 of the balance at December 31, 2005 and 2004, respectively. The
      increase is due to a 64.3% increase in warehouse financing coupled with a 199
      basis point increase in the index utilized to calculate the interest expense
      related to those borrowings.





**68**


***Accounts
      Payable and Other Liabilities.*** Accounts
      payable and other liabilities increased $10.2 million, or 44.4%, to $33.2
      million at December 31, 2005, from $23.0 million at December 31, 2004. The
      increase was primarily due to (1) a $10.1 million increase in accrued servicer
      payables related primarily to our accounting for loan securitizations as secured
      financings beginning in 2004, (2) a $571,000 increase in payroll accruals for
      payroll related items ( *i.e.* ,
      salary
      and commissions) due to a combination of the 18.2% increase in personnel and
      timing of commission payments, (3) a $1.1 million increase in accrued
      professional fees, primarily related to SOX initiatives, and (4) a $1.0 million
      increase in accrued loan origination expenses. These increases were partially
      offset by a $2.4 million decrease in current taxes payable during the same
      period.





***Stockholders’
      Equity.*** Stockholders’ equity increased $19.6 million, or 22.5%, to $106.8 million at
      December 31, 2005 from $87.2 million at December 31, 2004. This increase is
      primarily due to (1) the recording of $18.0 million in net income for the year
      ended December 31, 2005, (2) a $4.7 million, net of tax, increase in the
      cumulative other comprehensive income related to the net unrealized gains from
      derivatives, and (3) the $940,000 of proceeds (and tax benefits) we received
      from the exercise of 175,900 stock options from authorized but unissued shares
      during the same period, offset by the payment of $3.1 million in common stock
      dividends and the accrual of $1.0 million in common stock dividends that were
      declared on December 16, 2005 and paid on January 5, 2006.





Additionally
      decreasing stockholders’ equity was the November 9, 2005 contribution of 157,275
      shares, or $1.2 million, of our common stock to the 2005 Stock Incentive Plan
      (“SIP”). The contributed shares were then granted on that same date, with a
      grant price equal to the closing price of our stock on that date, to certain
      of
      our employees. The contribution represents deferred compensation which is
      initially recorded as a component of stockholders’ equity. The shares allocated
      for the grant were from authorized shares and are deemed to be outstanding
      shares for earnings per share ("EPS") purposes.




**Contractual
      Obligations**


The following table summarizes our material contractual obligations as of
        December 31, 2005:
 *(Dollars
                    in thousands)*
                
                **Total**
                
                **Less
                    than**
                  **One
                    Year**
                
                **One
                    to**
                  **Three
                    Years**
                
                **Three
                    to**
                  **Five
                    Years**
                
                **More
                    than**
                  **Five
                    Years**Securitization
                    asset-backedsecurities(1)
                
                $
                4,436,938
                
                $
                1,659,669
                
                $
                1,725,443
                
                $
                586,230
                
                $
                465,596Operating
                    leases
                
                $
                21,365
                
                $
                6,315
                
                $
                10,463
                
                $
                4,492
                
                $
                95Equipment
                    financing
                
                $
                4,785
                
                $
                384
                
                $
                4,401
                
                $
                --
                
                $
                --




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





**Loan
      Commitments**





We
      provide commitments to fund mortgage loans to customers as long as all of the
      proper conditions are met. Our commitments have fixed expiration dates, but
      no
      locked-in interest rate. We quote interest rates to customers, which are
      generally subject to change. Although we typically honor these interest rate
      quotes, the quotes do not constitute future cash requirements, minimizing the
      potential interest rate risk exposure. We do not believe these non-conforming
      mortgage loan commitments meet the definition of a derivative under SFAS No.
      133.  Accordingly, they are not recorded in the consolidated financial
      statements. At December 31, 2005 and 2004, we had outstanding origination
      commitments to fund approximately $104.8 million and $92.2 million,
      respectively, in mortgage loans.





**69**


**Off-Balance
      Sheet Trusts**




Substantially
      our entire off-balance sheet arrangements relate to securitizations structured
      to be accounted for as sales prior to 2004. In connection with our
      securitization transactions that were structured as sales (and where we have
      recorded an economic interest, *i.e.* ,
      the
      excess cashflow certificates), there is $843.2 million and $1.4 billion in
      collateral (primarily mortgage loans) owned by off-balance sheet trusts as
      of
      December 31, 2005 and 2004, respectively. These trusts have issued pass-through
      certificates secured by these mortgage loans. We have no obligation to provide
      funding support to either the third party investors or the off-balance sheet
      trusts. The third party investors or the trusts have no recourse to our assets
      or us and have no ability to require us to repurchase their loans other than
      for
      non-credit-related recourse that can arise under standard representations and
      warranties.  See "Part I - Item 1. - Business - Securitizations -
      Securitizations Structured as a Sale - Off-Balance Sheet
      Arrangements."





**Liquidity
      and Capital Resources**





The
      term
“liquidity” refers to our ability to generate adequate amounts of cash to fund
      our operations, including our loan originations, loan purchases, operating
      expenses and planned dividend payments. We
      require substantial amounts of cash to fund our loan originations,
      securitization activities and operations. We generate working capital primarily
      from the cash proceeds we receive from our quarterly
      securitizations.





Currently,
      our primary sources of cash include:





·
            the
                proceeds we receive from selling or financing asset-backed securities
                (including NIMs) with our
                securitizations;





·
            the
                proceeds from the sale of MSRs to a third-party mortgage
                servicer;





·
            the
                premiums we receive from selling whole loans on a servicing released
                basis;





·
            origination
                fees collected on newly closed
                loans;





·
            the
                cash flow from caps;





·
            cash
                flows from excess cashflow certificates we retained in connection
                with our
                securitizations prior to 2004; and





·
            principal
                and interest payments we receive on our loans held for
                investment.




Currently,
      our primary uses of cash include the funding of:





·
            mortgage
                loans held for investment - pre-securitization which are not
                financed;





·
            interest
                expense on warehouse lines of credit, financing of mortgage loans
                held for
                investment, and other financings;





·
            transaction
                costs, derivative costs and credit enhancement (O/C) in connection
                with
                our securitization program;





·
            general
                ongoing administrative and operating expenses, including the cost
                to
                originate loans;





·
            tax
                payments, including those on excess inclusion income generated from
                our
                excess cashflow certificates;





·
            common
                stock dividends; and





·
            scheduled
                principal pay-downs on financing of mortgage loans held for investment
                and
                other financings.





Historically,
      we have financed our operations utilizing various secured credit financing
      facilities, issuance of asset-backed securities, issuance of corporate debt,
      issuances of equity, and the sale (or financing) of interest-only certificates
      and/or NIM notes and mortgage servicing rights sold in conjunction with each
      of
      our securitizations to support our originations, securitizations, and general
      operating expenses.





**70**


Currently,
      our primary sources of liquidity, subject to market conditions, continue to
      be:





·
            warehouse
                financing and other secured financing
                facilities;





·
            financing
                related to the securitization of mortgage loans depending upon the
                securitization structure;





·
            sales
                of whole loans and MSRs;





·
            cash
                flows from our mortgage loans held for
                investment;





·
            origination
                fees, interest income and other cash revenues;
                and





·
            cash
                flows from retained excess cashflow
                certificates.





We
      have
      repurchase agreements with several of the institutions that have purchased
      mortgage loans from us in the past. Some of the agreements provide for the
      repurchase by us of any of the mortgage loans that go to foreclosure sale.
      At
      the foreclosure sale, we will repurchase the mortgage, if necessary, and make
      the institution whole. The dollar amount of loans that were sold with recourse
      and are still outstanding totaled $762,000 and $1.2 million at December 31,
      2005
      and 2004, respectively. Included in “accounts payable and other liabilities” is
      an allowance for recourse loans related to those loans sold with recourse of
      $310,000 and $837,000 at December 31, 2005 and 2004.




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





**Financing
      Facilities**





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





***Warehouse
      Lines of Credit***





To
      originate and accumulate loans for securitization, we borrow money on a
      short-term basis through committed secured warehouse lines of credit. Throughout
      each quarter as we amass loans for inclusion in each quarter’s securitization, a
      significant portion of our total warehouse financing lines will be utilized
      to
      fund loans. We had the following financing facilities in place at December
      31,
      2005 and 2004:


*(Dollars
                  in thousands)*
              
              **Facility**
              
              
              
              **At
                  December 31,****Warehouse
                  Line of Credit**
              
              **Amount**
              
              **Interest
                  Rate**
              
              **2005**
              
              **2004**
              
              **Expiration
                  Date**RBS
                  Greenwich Capital
              
              $                               350,000
              
              Margin
                  over LIBOR
              
              $                  77,931
              
              $                135,653
              
              October
                  2006Citigroup
              
              350,000
              
              Margin
                  over LIBOR
              
              144,912
              
              --
              
              April
                  2006Bank
                  of America(1)
              
              350,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              August
                  2006Freidman,
                  Billings, Ramsey
              
              200,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              April
                  2006Total
              
              $         
                                    1,250,000
              
              
              
              $                222,843
              
              $                135,653





*(1)
      In September 2005, we obtained a new warehouse financing facility with Bank
      of
      America, N.A.*





**71**


Our
      warehouse agreements require us to comply with various operating and financial
      covenants. The continued availability of funds provided to us under these
      agreements is subject to, among other conditions, our continued compliance
      with
      these covenants. We believe we were in compliance with these covenants as of
      December 31, 2005.





In
      September 2005, we entered into a $350.0 million warehouse facility with Bank
      of
      America, N.A. This facility provides the ability to borrow against first and
      second lien loans and wet collateral. The
      interest and fees that we pay in connection with this facility are similar
      to
      the interest rates based on LIBOR that we pay to our other credit facility
      lenders. This facility will expire in August 2006. As of December 31, 2005,
      we
      had no balance outstanding under the facility.





**Securitization
      Financing**





Beginning
      in March 2004, we have financed, and expect to continue to finance, our mortgage
      loan portfolio on a long-term basis by issuing asset-backed securities. We
      believe that issuing asset-backed securities provides us a low-cost method
      of
      financing our mortgage loan portfolio. In addition, it allows us to reduce
      our
      interest rate risk on our mortgage loans by securitizing them. Our ability
      to issue asset-backed securities depends on the overall performance of our
      mortgage loans, as well as the continued general demand for securities backed
      by
      non-conforming mortgages and home equity loans.





We
      are  generally
      not legally obligated to make payments to the holders of the asset-backed
      securities issued as part of our securitizations. Instead, the holders of the
      asset-backed securities can expect repayment only from the cash flows from
      mortgage loans specifically collateralizing the debt.





We
      rely
      on our securitizations as an important capital resource and source of liquidity.
      Our current business strategy depends upon our ability to complete additional
      loan securitizations in the future. If we are unable to securitize our mortgage
      loans held for investment - pre-securitization, our net income could decline
      for
      the time period that those loans remain in our portfolio, depending upon market
      conditions present at that time. No assurance can be given that we will be
      able
      to complete loan securitizations in the future on favorable terms, or at
      all.





**Market
      Risk**





Market
      risks generally represent the risk of loss that may result from the potential
      change in the value of a financial instrument due to fluctuations in interest
      and foreign exchange rates and in equity and commodity prices. Our market risk
      relates primarily to interest rate fluctuations.





We
      use
      several tools and risk management strategies to monitor and address interest
      rate risk. Such tools allow us to monitor and evaluate our exposure to these
      and
      to manage the risk profile to our loan portfolio in response to changes in
      the
      market risk. We cannot assure you, however, that we will adequately offset
      all
      risks associated with our mortgage loan portfolio.





***Interest
      Rate Risk*** *.*  Our
      primary component of market risk is interest rate volatility. Net interest
      income is the primary component of our net income, and fluctuations in interest
      rates will impact the level of both income and expense recorded on a large
      portion of our assets and liabilities. Fluctuations in interest rates will
      also
      affect the market value of all interest-earning assets and interest-bearing
      liabilities, other than those that possess a short term to maturity. During
      2005, the yield curve flattened significantly from the prior year primarily
      caused by short-term interest rates increasing at a greater pace than long-term
      interest rates. This
      interest rate environment had an adverse impact on our net interest income
      as
      our interest-bearing liabilities generally price off short-term interest rates,
      while our interest-earning assets, a majority of which have initial terms to
      maturity or re-pricing greater than one year, generally price off long-term
      rates.





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


**72**


Periods
        of unexpected or rapid changes in interest rates, and/or other volatility
        or
        uncertainty regarding interest rates, also can harm us by increasing the
        likelihood that asset-backed investors will demand higher spreads than normal
        to
        offset the volatility and/or uncertainty, which decreases the value of the
        excess cashflow certificates we receive in connection with a
        securitization.
 Fluctuating interest rates may affect the net interest income we earn,
          based
          upon the difference between the yield we receive on loans held pending
          sales and
          the interest paid by us for funds borrowed under our warehouse facilities. In
          the
          past, from time to time, we have undertaken certain measures to hedge our
          exposure to this risk by using various hedging strategies, including Fannie
          Mae
          mortgage securities, treasury rate lock contracts and/or interest rate
          swaps. A
          change
          in interest rates would reduce the spread between the average coupon rate
          on
          fixed rate loans and the weighted average pass-through rate paid to investors
          on
          the asset-backed securities issued in connection with a securitization.
          Although
          the average loan coupon rate is fixed at the time the mortgage loan is
          originated, the pass-through rate to investors in a securitization is not
          fixed
          until the pricing of the securitization, which occurs just prior to our
          sale of
          the mortgage loans to the securitization trust. Therefore, if the market
          rates
          required by investors increase prior to securitization of the mortgage
          loans,
          the spread between the average coupon rate on the mortgage loans and the
          pass-through rate to investors may be reduced or eliminated, which would
          reduce
          or eliminate our net interest income from our on-balance sheet mortgage
          loan
          portfolio.
 
 Fluctuating interest rates also may affect the excess cash flows we receive
        from
        our excess cashflow certificates. Most of our asset-backed securities are
        priced
        based on one-month LIBOR, but the collateral that backs these securities
        is
        comprised of mortgage loans with either fixed interest rates or “hybrid”
interest rates - that is, fixed for the initial two or three years of the
        mortgage loan, and adjusting afterwards every six months thereafter. As a
        result, the cash flows that we receive from our excess cashflow certificates
        are
        dependent upon the interest rate environment. This is because “basis risk”
exists between the assets and liabilities of the securitization trusts that
        we
        create. For example, in each of the securitizations that we issued in 2002,
        2003, and the first quarter of 2004, the interest cost of the asset-backed
        securities sold to investors bears interest at a floating rate.  As a
        result, each month the
        interest rate received by the certificate holders will adjust upwards or
        downwards as interest rates change. Therefore,
        as interest rates rise, the value of our excess cashflow certificates will
        fall,
        and as interest rates fall, the value of our excess cashflow certificates
        will
        rise. The loss in value of our excess cashflow certificates as a result of
        rising interest rates will reduce our cash flow and harm our
        profitability.


When interest rates on our assets do not adjust at the same rates as our
        liabilities or when the assets have fixed-rates and the liabilities are
        adjusting, future earnings potential is affected. We express this interest
        rate
        risk as the risk that the market value of assets will increase or decrease
        at
        different rates than that of the liabilities. Expressed another way, this
        is the
        risk that net asset value will experience an adverse change when interest
        rates
        change. We assess
        the risk based on the change in market values given increases and decreases
        in
        interest rates. We also assess the risk based on the impact to net income
        in
        changing interest rate environments.
 
 Management
        primarily uses financing sources where the interest rate resets frequently.
        As
        of December 31, 2005, borrowings under all of our financing arrangements
        adjust
        daily or monthly. On the other hand, very few of the mortgage loans we own
        adjust on a monthly or daily basis. Most of the mortgage loans are fixed-rate;
        the remainder contain features where rates are fixed for some period of time
        and
        then adjust frequently thereafter. For example, one of our mortgage loan
        products is the “2/28” loan. This 30 year loan has its interest rate fixed for
        the first two years of the loan’s life and then adjusts every six months
        thereafter.
 
 While
        short-term borrowing rates are low and long-term asset rates are high, this
        portfolio structure produces good results. However, if short-term interest
        rates
        rise rapidly, the earnings potential is significantly affected, as the asset
        rate resets would lag behind the borrowing rate resets.




*Current
        Interest Rate Environment.* Net interest income after provision for loan
        loss represents 69.3% and 73.7% of our net revenues (net interest
        income and non-interest income, less provision for loan loss) during the
        years
        ended December 31, 2005 and 2004, respectively. Accordingly, the interest
        rate
        environment has a substantial impact on our earnings. Our balance sheet is
        currently liability sensitive. A company with a liability sensitive balance
        sheet generally experiences reduced net interest income in a rising or
        increasing rate environment, while earnings are enhanced in a sustained
        decreasing rate cycle. The impact of rising short-term interest rates and
        a
        flattening of the yield curve has negatively impacted our margin since the
        spread between our longer-term assets and our shorter-term liabilities has
        contracted.
  **73**


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





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





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





We
      refer
      to the one-year and the three-year projections of net interest income as the
      “base case.” Once the base case has been established, we “shock” the base case
      with instantaneous and parallel shifts in interest rates in 100 basis point
      increments upward and downward. Calculations are made for each of the defined
      instantaneous and parallel shifts in interest rates over or under the forward
      LIBOR curve used to determine the base and including any associated changes
      in
      projected mortgage prepayment speeds. The following tables present the results
      of each 100 basis point change in interest rates compared against the base
      case
      to determine the estimated dollar and percentage change to net interest income
      at December 31, 2005:





*(Dollars
                in thousands)*
            
            **Base
                Case**
            
            **Up
                100 Basis Points**
            
            **Up
                200 Basis Points**
            
            **Down
                100 Basis Points**
            
            **Down
                200 Basis Points*****One
                Year Projection:***Net
                interest income(1)(2)
            
            $
            91,707
            
            $
            89,247
            
            $
            85,310
            
            $
            92,543
            
            $
            99,851Percentage
                change from base
            
            
            
            
            
            (2.68
            )%
            
            (6.97
            )%
            
            0.91
            %
            
            8.88
            %***Three
                Year Projection:***Net
                interest income(1)(2)
            
            $
            168,499
            
            $
            161,574
            
            $
            153,483
            
            $
            173,449
            
            $
            185,666Percentage
                change from base
            
            
            
            
            
            (4.11
            )%
            
            (8.91
            )%
            
            2.94
            %
            
            10.19
            %





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





*(2)* *Assumes
      warehouse interest expense through March 31, 2006.*





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





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





**74**


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





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





***Operational
      Risk.*** Operational risk is the risk of loss resulting from inadequate or failed
      internal processes, human factors and systems, or from external events.
      Operational risk may result from, but is not limited to, errors related to
      transaction processing, breaches of the internal control system and compliance
      requirements, and the risk of fraud by our employees or persons outside of
      our
      organization or business interruption due to system failures or other events.
      The risk of loss from operational risk also includes potential legal or
      regulatory actions that could arise as a result of noncompliance with applicable
      laws and/or regulatory requirements.





In
      the
      event of an operational event, we could suffer financial loss, face regulatory
      or law enforcement action and/or suffer damage to our reputation.





To
      address this risk we maintain comprehensive policies and procedures and an
      internal control framework designed to provide a sound operational environment.
      These controls have been designed to manage operational risk at appropriate
      levels given our financial strength, the business environment and markets in
      which we operate, the nature of our businesses and considering factors such
      as
      competition and regulation.





We
      have
      also established procedures that are designed to ensure that policies relating
      to conduct, ethics and business practices are followed on a uniform basis.
      Among
      the procedures designed to ensure effectiveness are our “Code of Business
      Conduct and Ethics,” which may be found on our website at
      http://www.deltafinancial.com and compliance training programs.





We
      have
      developed a business continuity plan which prepares us for events that could
      damage our physical facilities, cause delays or disruptions to our operational
      functions, including telecommunications networks, or impair our clients,
      vendors, and broker partners. We have a standby datacenter facility in our
      Ohio
      office that receives real time data streams of mission critical data from our
      main datacenter in New York. This standby datacenter facility also replicates
      the network security infrastructure and houses replications of the mission
      critical applications used by our personnel.





In
      the
      data telecommunications area, we use one managed virtual private network to
      connect each office throughout the country together, and we use a different
      provider to access to the Internet as a backup solution. In the voice
      telecommunications area, we use one carrier for local and long distance service
      in each office. The carrier for our New York location is different than the
      one
      we use for all of our other branch offices. Since we use a voice over Internet
      Protocol telephone system in all of the branch offices, we are able to re-route
      inbound and outbound telephone calls through any other office in the country.
      This enables us to reduce any possible down time due to voice carrier
      outages.





**75**


**Maturity
      and Repricing Information**





The
      following table summarizes the notional amount, expected maturities and weighted
      average strike rates for corridors that we held as of December 31,
      2005:





*(Dollars
                in thousands,**except
                strike price)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years and Thereafter**Caps
                bought - notional
            
            $
            2,459,969
            
            $
            1,629,194
            
            $
            557,501
            
            $
            124,651
            
            $
            37,086
            
            $
            111,537Weighted
                average strikeprice
            
            $
            5.98
            
            $
            5.22
            
            $
            6.86
            
            $
            7.56
            
            $
            7.47
            
            $
            7.43Caps
                sold - notional
            
            $
            2,459,969
            
            $
            1,629,194
            
            $
            557,501
            
            $
            124,651
            
            $
            37,086
            
            $
            111,537Weighted
                average strikeprice
            
            $
            8.51
            
            $
            8.09
            
            $
            9.07
            
            $
            9.34
            
            $
            9.27
            
            $
            9.29





The
      notional amount of the caps bought and caps sold totaled $1.9 billion each
      at
      December 31, 2004. We did not hold corridors at December 31, 2003.





**Inflation**





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





**Impact
      of New Accounting Standards**





For
      discussion regarding the impact of new accounting standards, refer to Note
      No. 2
      of the Notes to the Consolidated Financial Statements. (See “Item 8. - Financial
      Statements and Supplementary Data”).





**Item
      7A. Quantitative and Qualitative Disclosures About
      Market
      Risk.**





We
      originate mortgage loans and then securitize the mortgage loans or sell them
      through whole-loan sales. As a result, our primary market risk is interest
      rate
      risk. (See “Item 7. - Management’s Discussion and Analysis of Financial
      Condition and Results of Operations - Market Risk”). In turn, interest rates are
      highly sensitive to many factors, including:





·
            Governmental
                monetary and tax policies;





·
            Domestic
                and international economic and political considerations;
                and





·
            Other
                factors that are also beyond our
                control.





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





**76**


The
      following table demonstrates the sensitivity, at December 31, 2005, of the
      estimated fair value of our excess cashflow certificates caused by an immediate
      10% and 20%, respectively, adverse change in the key assumptions we use to
      estimate the fair value:




*(Dollars
                  in thousands)*
              
              **Fair
                  Value of Excess**
                **Cashflow
                  Certificates**
              
              **Decrease
                  (Increase)**
                **To Earnings (pre-tax basis)**Fair
                  value as of December 31, 2005
              
              $
              7,78910%
                  increase in prepayment speed
              
              
              8,178
              
              $
              (389
              )20%
                  increase in prepayment speed
              
              
              8,618
              
              
              (829
              )10%
                  increase in credit losses
              
              
              6,854
              
              
              93520%
                  increase in credit losses
              
              
              6,308
              
              
              1,48110%
                  increase in discount rates
              
              
              7,712
              
              
              7720%
                  increase in discount rates
              
              
              7,642
              
              
              14710%
                  increase in one and six month LIBOR
              
              
              6,925
              
              
              86420%
                  increase in one and six month LIBOR
              
              
              6,748
              
              
              1,041


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





To
      reduce
      our financial exposure to changes in interest rates, we have and may continue
      to
      hedge our mortgage loans held for investment - pre-securitization (or held
      for
      sale in the past) through hedging products that are correlated to the
      asset-backed securities issued in connection with the securitization of our
      mortgage loans ( *e.g* .,
      interest rate swaps).  (See
      “Item 7. - Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation -
      Summary of Critical Accounting Policies - Accounting for Hedging Activities”
above). Changes in interest rates also could adversely affect our ability to
      originate loans and/or could affect the level of loan prepayments, impacting
      the
      amount of mortgage loans held for investment and/or the size of the loan
      portfolio underlying our excess cashflow certificates and, consequently, the
      value of our excess cashflow certificates. (See “Item 6. - Selected Financial
      Data - Interest Rate Risk,” “Part I., Item 1. - Forward Looking Statements and
      Risk Factors” and “Part I. Item 1A - Risk Factors”).





**77**




**Item
        8. Financial Statements
        and Supplementary
        Data.**


**Reports
        of Management**
 
 ***Management’s
        Responsibility for Financial Statements***
 
 Our
        management is responsible for the integrity and objectivity of all information
        presented in this annual report. The consolidated financial statements were
        prepared in conformity with accounting principles generally accepted in the
        United States of America and include amounts based on management’s best
        estimates and judgments. Management believes the consolidated financial
        statements fairly reflect the form and substance of transactions and that
        the
        financial statements fairly represent our financial position and results
        of
        operations.
 
 The
        Audit
        Committee of the Board of Directors, which is composed solely of independent
        directors, meets regularly with the independent auditors, KPMG LLP, the internal
        auditors and representatives of management to review accounting, financial
        reporting, internal control and audit matters, as well as the nature and
        extent
        of the audit effort. The Audit Committee is responsible for the engagement
        of
        the independent registered public accounting firm. The independent registered
        public accounting firm and internal auditors have free access to the Audit
        Committee.
 
 ***Management’s
        Report on Internal Control Over Financial Reporting***
 
 Our
        management is responsible for establishing and maintaining adequate internal
        control over financial reporting, as such term is defined in the rules
        promulgated under the Securities Exchange Act of 1934. Under the supervision
        and
        with the participation of our management, including our principal executive,
        financial and accounting officers, we have conducted an evaluation of the
        effectiveness of our internal control over financial reporting based on the
        framework in *“Internal Control—Integrated Framework”* issued by the
        Committee of Sponsoring Organizations of the Treadway Commission.
 
 Based
        on
        the above evaluation, management has concluded that, our internal control
        over
        financial reporting was effective as of December 31, 2005. Our management’s
        assessment of the effectiveness of our internal control over financial reporting
        as of December 31, 2005 has been audited by KPMG LLP, an independent registered
        public accounting firm, as stated in their report which is included
        herein.




**78**






**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and Stockholders of


Delta
      Financial Corporation:




We
      have
      audited management's assessment, included in the accompanying *Management’s Annual Report on Internal Control Over Financial Reporting,* that
      Delta Financial Corporation and subsidiaries (the “Company”) maintained
      effective internal control over financial reporting as of December 31, 2005,
      based on criteria established in Internal
      Control—Integrated Framework issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO) *.* The
      Company's management is responsible for maintaining effective internal control
      over financial reporting and for its assessment of the effectiveness of internal
      control over financial reporting. Our responsibility is to express an opinion
      on
      management's assessment and an opinion on the effectiveness of the Company’s
      internal control over financial reporting based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management's assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




A
      company's internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company's internal control
      over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our
      opinion, management's assessment that the Company maintained effective internal
      control over financial reporting as of December 31, 2005, is fairly stated,
      in
      all material respects, based on criteria established in Internal
      Control—Integrated Framework issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO). ** Also,
      in
      our opinion, the Company maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2005, based on criteria
      established in Internal
      Control—Integrated Framework issued
      by
      the Committee of
      Sponsoring Organizations of the Treadway Commission (COSO) .




We also
      have audited,
      in accordance with the standards of the Public Company Accounting Oversight
      Board (United States), the consolidated balance sheets of the Company as of
      December 31, 2005 and 2004, and the related consolidated statements of
      operations, changes in stockholders’ equity, and cash flows for each of the
      years in the three-year period ended December 31, 2005, and our report dated
      March 15, 2006 ** expressed
      an unqualified opinion on those consolidated financial statements.








New
      York,
      New York


March
      15,
      2006





**79**




**Report
        of Independent Registered Public Accounting Firm**
  To
        the
        Board of Directors and Stockholders of
 Delta
        Financial Corporation:
  We
        have
        audited the accompanying consolidated balance sheets of Delta Financial
        Corporation and subsidiaries (the “Company”) as of December 31, 2005 and 2004,
        and the related consolidated statements of operations, changes in stockholders’
equity, and cash flows for each of the years in the three-year period ended
        December 31, 2005. These consolidated financial statements are the
        responsibility of the Company’s management. Our responsibility is to express an
        opinion on these consolidated financial statements based on our
        audits.
  We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
  In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Delta Financial Corporation
        and subsidiaries as of December 31, 2005 and 2004, and the results of its
        operations and its cash flows for each of the years in the three-year period
        ended December 31, 2005, in conformity with U.S. generally accepted accounting
        principles.
  We
        have
        also audited ,
        in
        accordance with the standards of the Public Company Accounting Oversight
        Board
        (United States), the effectiveness of the Company’s internal control over
        financial reporting as of December 31, 2005, based on criteria established
        in *Internal
        Control - Integrated Framework* issued
        by
        the Committee of Sponsoring Organizations of the Treadway Commission (COSO),
        and
        our report dated March 15, 2006 expressed an unqualified opinion on management’s
        assessment of, and the effective operation of, internal control over financial
        reporting.
 
 
 New
        York,
        New York
 March
        15,
        2006




**80**




**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


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





**At
                December 31,****2005**
            
            **2004****Assets:**Cash
                and cash equivalents
            
            $
            4,673
            
            $
            5,187Mortgage
                loans held for investment, net of discounts and deferredorigination
                fees
            
            
            4,663,662
            
            
            2,351,272Less:
                Allowance for loan losses
            
            
            (36,832
            )
            
            (10,278
            )Mortgage
                loans held for investment, net
            
            
            4,626,830
            
            
            2,340,994Trustee
                receivable
            
            
            56,164
            
            
            32,915Accrued
                interest receivable
            
            
            26,952
            
            
            12,280Excess
                cashflow certificates
            
            
            7,789
            
            
            14,933Equipment,
                net
            
            
            6,688
            
            
            4,298Accounts
                receivable
            
            
            5,123
            
            
            3,735Prepaid
                and other assets
            
            
            30,508
            
            
            26,125Deferred
                tax asset
            
            
            54,875
            
            
            50,326Total
                assets
            
            $
            4,819,602
            
            $
            2,490,793**Liabilities
                and Stockholders’ Equity****Liabilities:**Bank
                payable
            
            $
            1,921
            
            $
            1,110Warehouse
                financing
            
            
            222,843
            
            
            135,653Financing
                on mortgage loans held for investment, net
            
            
            4,436,938
            
            
            2,236,215Other
                borrowings
            
            
            4,785
            
            
            3,330Accrued
                interest payable
            
            
            13,091
            
            
            4,282Accounts
                payable and other liabilities
            
            
            33,242
            
            
            23,023Total
                liabilities
            
            
            4,712,820
            
            
            2,403,613**Stockholders’
                Equity:**Common
                stock, $.01 par value. Authorized 49,000,000 shares;20,736,362
                and 20,403,187 shares issued and 20,462,287 and
              20,286,387 shares outstanding at December 31, 2005 and 2004,respectively
            
            
            207
            
            
            204Additional
                paid-in capital
            
            
            121,561
            
            
            119,451Accumulated
                deficit
            
            
            (15,077
            )
            
            (28,950
            )Accumulated
                other comprehensive income (loss)
            
            
            2,536
            
            
            (2,207
            )Unearned
                common stock held by stock incentive plan
            
            
            (1,127
            )
            
            --Treasury
                stock, at cost (116,800 shares)
            
            
            (1,318
            )
            
            (1,318
            )Total
                stockholders’ equity
            
            
            106,782
            
            
            87,180Total
                liabilities and stockholders’ equity
            
            $
            4,819,602
            
            $
            2,490,793





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







**81**





**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


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





**For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003**Interest
                income
            
            $
            290,829
            
            $
            100,105
            
            $
            14,386Interest
                expense
            
            
            167,792
            
            
            39,782
            
            
            5,509Net
                interest income
            
            
            123,037
            
            
            60,323
            
            
            8,877Provision
                for loan losses
            
            
            28,592
            
            
            10,443
            
            
            --Net
                interest income after provision for loan losses
            
            
            94,445
            
            
            49,880
            
            
            8,877Non-interest
                income:Net
                gain on sale of mortgage loans
            
            
            27,193
            
            
            16,057
            
            
            94,782Other
                income
            
            
            14,674
            
            
            1,722
            
            
            1,000Total
                non-interest income
            
            
            41,867
            
            
            17,779
            
            
            95,782Non-interest
                expense:Payroll
                and related costs
            
            
            63,524
            
            
            52,005
            
            
            39,147General
                and administrative
            
            
            42,467
            
            
            30,152
            
            
            23,460Loss
                on derivative instruments
            
            
            908
            
            
            100
            
            
            --Total
                non-interest expense
            
            
            106,899
            
            
            82,257
            
            
            62,607Income
                (loss) before income tax expense (benefit)
            
            
            29,413
            
            
            (14,598
            )
            
            42,052Provision
                for income tax expense (benefit)
            
            
            11,458
            
            
            (5,249
            )
            
            (25,354
            )Net
                income (loss)
            
            $
            17,955
            
            $
            (9,349
            )
            $
            67,406**Comprehensive
                Income (Loss)**:Other
                comprehensive income (loss)
            
            
            4,743
            
            
            (2,207
            )
            
            --Comprehensive
                income (loss)
            
            $
            22,698
            
            $
            (11,556
            )
            $
            67,406**Per
                Share Data:**Basic
                - weighted average number of shares outstanding
            
            
            20,349,515
            
            
            18,375,864
            
            
            16,308,561Diluted
                - weighted average number of shares outstanding
            
            
            21,283,220
            
            
            18,375,864
            
            
            18,407,249Net
                income (loss) applicable to common shares
            
            $
            17,955
            
            $
            (9,349
            )
            $
            66,015Basic
                earnings per share - net income (loss)
            
            $
            0.88
            
            $
            (0.51
            )
            $
            4.05Diluted
                earnings per share - net income (loss)
            
            $
            0.84
            
            $
            (0.51
            )
            $
            3.59




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








**82**




**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**


**For
      the Years Ended December 31, 2005, 2004 and 2003**


*(Dollars
      in thousands)*








**Preferred
                Stock**
            
            **Common
                Stock**
            
            **Additional**
              **Paid-in
                Capital**
            
            **Accumulated
                Deficit**
            
            **Accumulated
                Other Comprehensive Income (Loss)**
            
            **Unearned
                Common Stock Held by Stock Incentive Plan**
            
            **Treasury
                Stock**
            
            **Total**Balance
                at December 31, 2002
            
            $
            13,916
            
            $
            160
            
            $
            99,482
            
            $
            (82,743
            )
            $
            --
            
            $
            --
            
            $
            (1,318
            )
            $
            29,497Stock
                options exercised, inclusive of tax benefit
            
            
            --
            
            
            1
            
            
            431
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            432Warrants
                exercised
            
            
            --
            
            
            9
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            9Dividends
                paid on preferred stock
            
            
            --
            
            
            --
            
            
            --
            
            
            (1,391
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,391
            )Net
                income
            
            
            --
            
            
            --
            
            
            --
            
            
            67,406
            
            
            --
            
            
            --
            
            
            --
            
            
            67,406Balance
                at December 31, 2003
            
            $
            13,916
            
            $
            170
            
            $
            99,913
            
            $
            (16,728
            )
            $
            --
            
            $
            --
            
            $
            (1,318
            )
            $
            95,953Stock
                options exercised, inclusive of tax benefit
            
            
            --
            
            
            3
            
            
            828
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            831Redemption
                of preferred stock
            
            
            (13,916
            )
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            (13,916
            )Shares
                issued in secondary offering
            
            
            --
            
            
            31
            
            
            18,710
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            18,741Dividends
                paid on common stock
            
            
            --
            
            
            --
            
            
            --
            
            
            (1,860
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,860
            )Dividend
                declared and payable
            
            
            --
            
            
            --
            
            
            --
            
            
            (1,013
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,013
            )Net
                unrealized losses from derivatives, net of tax
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            (2,207
            )
            
            --
            
            
            --
            
            
            (2,207
            )Net
                loss
            
            
            --
            
            
            --
            
            
            --
            
            
            (9,349
            )
            
            --
            
            
            --
            
            
            --
            
            
            (9,349
            )Balance
                at December 31, 2004
            
            $
            --
            
            $
            204
            
            $
            119,451
            
            $
            (28,950
            )
            $
            (2,207
            )
            $
            --
            
            $
            (1,318
            )
            $
            87,180Stock
                options exercised, inclusive of tax benefit
            
            
            --
            
            
            2
            
            
            938
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            940Allocation
                of common stock to stock incentive plan
            
            
            --
            
            
            1
            
            
            1,172
            
            
            --
            
            
            --
            
            
            (1,173
            )
            
            --
            
            
            --Amortization
                of stock awards
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            46
            
            
            --
            
            
            46Dividends
                paid on common stock
            
            
            --
            
            
            --
            
            
            --
            
            
            (3,052
            )
            
            --
            
            
            --
            
            
            --
            
            
            (3,052
            )Dividend
                declared and payable
            
            
            --
            
            
            --
            
            
            --
            
            
            (1,030
            )
            
            --
            
            
            --
            
            
            --
            
            
            (1,030
            )Net
                unrealized gains from derivatives, net of tax
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            4,743
            
            
            --
            
            
            --
            
            
            4,743Net
                income
            
            
            --
            
            
            --
            
            
            --
            
            
            17,955
            
            
            --
            
            
            --
            
            
            --
            
            
            17,955Balance
                at December 31, 2005
            
            $
            --
            
            $
            207
            
            $
            121,561
            
            $
            (15,077
            )
            $
            2,536
            
            $
            (1,127
            )
            $
            (1,318
            )
            $
            106,782








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







**83**





**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


*(Dollars
      in thousands)*





**For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003**Cash
                flows from operating activities:Net
                income (loss)
            
            $
            17,955
            
            $
            (9,349
            )
            $
            67,406Adjustments
                to reconcile net income to net cash provided by (used in)operating
                activities:Provision
                for loan losses
            
            
            28,592
            
            
            10,443
            
            
            --(Recovery)/provision
                for recourse loans
            
            
            (380
            )
            
            (50
            )
            
            88Depreciation
                and amortization
            
            
            2,381
            
            
            1,940
            
            
            1,634Deferred
                tax benefit
            
            
            (7,581
            )
            
            (17,731
            )
            
            (25,584
            )Deferred
                origination (income) costs
            
            
            (10,666
            )
            
            (3,113
            )
            
            751Gain
                on change in fair value of excess cashflow certificates
            
            
            (14,409
            )
            
            (1,366
            )
            
            (220
            )Gain
                on sale of mortgage servicing rights
            
            
            (157
            )
            
            --
            
            
            --Amortization
                of bond securitizations deferred cost and premiums
            
            
            (4,340
            )
            
            (1,838
            )
            
            --Cash
                flows received from excess cashflow certificates, net of
                accretion
            
            
            21,553
            
            
            6,286
            
            
            (5,288
            )Proceeds
                on sale of excess cashflow certificates
            
            
            --
            
            
            --
            
            
            10,220Proceeds
                from sale of mortgage servicing rights, net
            
            
            22,449
            
            
            16,920
            
            
            --Stock
                incentive plan expense
            
            
            46
            
            
            --
            
            
            --Changes
                in operating assets and liabilities:Increase
                in accounts receivable
            
            
            (1,388
            )
            
            (842
            )
            
            (1,135
            )Decrease
                (increase) in mortgage loans held for sale, net
            
            
            --
            
            
            190,524
            
            
            (157,330
            )Increase
                in trustee receivable
            
            
            (23,249
            )
            
            (32,915
            )
            
            --Increase
                in accrued interest receivable
            
            
            (14,691
            )
            
            (12,676
            )
            
            (188
            )Increase
                in prepaid and other assets
            
            
            (5,535
            )
            
            (22,222
            )
            
            (2,908
            )Increase
                (decrease) in accrued interest payable
            
            
            8,809
            
            
            4,220
            
            
            (402
            )Increase
                (decrease) in accounts payable and other liabilities
            
            
            10,539
            
            
            10,564
            
            
            (3,610
            )Net
                cash provided by (used in) operating activities
            
            
            29,928
            
            
            138,795
            
            
            (116,566
            )Cash
                flows from investing activities:Increase
                in mortgage loans held for investment, net
            
            
            (2,315,943
            )
            
            (2,362,894
            )
            
            --Purchase
                of equipment
            
            
            (4,771
            )
            
            (3,091
            )
            
            (2,228
            )Net
                cash used in investing activities
            
            
            (2,320,714
            )
            
            (2,365,985
            )
            
            (2,228
            )Cash
                flows from financing activities:Proceeds
                from (repayment of) warehouse financing, net
            
            
            87,190
            
            
            (9,173
            )
            
            131,069Proceeds
                from financing on mortgage loans held for investment, net
            
            
            2,203,942
            
            
            2,233,392
            
            
            --Proceeds
                from (repayment of) other borrowings, net
            
            
            1,455
            
            
            968
            
            
            (233
            )Increase
                (decrease) in bank payable
            
            
            811
            
            
            (1,182
            )
            
            923Redemption
                of preferred stock
            
            
            --
            
            
            (13,916
            )
            
            --Redemption
                of senior notes
            
            
            --
            
            
            --
            
            
            (10,844
            )Cash
                dividends paid on preferred stock
            
            
            --
            
            
            --
            
            
            (1,391
            )Cash
                dividends paid on common stock
            
            
            (4,066
            )
            
            (1,860
            )
            
            --Proceeds
                from common stock issued in secondary offering, net
            
            
            --
            
            
            18,741
            
            
            --Proceeds
                from exercise of warrants
            
            
            --
            
            
            --
            
            
            9Proceeds
                from exercise of stock options, net
            
            
            940
            
            
            831
            
            
            432Net
                cash provided by financing activities
            
            
            2,290,272
            
            
            2,227,801
            
            
            119,965Net
                (decrease) increase in cash and cash equivalents
            
            
            (514
            )
            
            611
            
            
            1,171Cash
                and cash equivalents at beginning of year
            
            
            5,187
            
            
            4,576
            
            
            3,405Cash
                and cash equivalents at end of year
            
            $
            4,673
            
            $
            5,187
            
            $
            4,576










**84**





*(Dollars
              in thousands)*
            
            **For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003**Supplemental
                information:Cash paid during the year for:Interest
            
            $
            153,608
            
            $
            33,869
            
            $
            5,911Income
                taxes
            
            $
            21,975
            
            $
            6,424
            
            $
            1,018Non
                cash transactions:Transfer
                of mortgage loans held for investment to REO, net
            
            $
            5,970
            
            $
            578
            
            $
            --Dividends
                payable
            
            $
            1,030
            
            $
            1,013
            
            $
            --











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








**85**




**DELTA
      FINANCIAL CORPORATION AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**December
      31, 2005, 2004, and 2003**





**(1)**  **Organization
      and Summary of Significant Accounting Policies**




***(a)
      Organization***





Delta
      Financial Corporation (“Delta,” “we,” or the “Company”) is a Delaware
      corporation, which was organized in August 1996. On October 31, 1996, we
      acquired all of the outstanding common stock of Delta Funding Corporation
      (“Delta Funding”), a New York corporation which had been organized on January 8,
      1982 for the purpose of originating, selling, servicing and investing in
      residential first and second mortgages. On November 1, 1996, we completed an
      initial public offering of 4,600,000 shares of common stock, $.01 par value.
      Additionally, in July 2004, we sold 3,137,597 shares of common stock from
      authorized but unissued shares, and existing stockholders sold 1,237,403 shares,
      in a public follow-on offering of 4,375,000 shares of our common stock at a
      price of $6.50 per share.





We
      are a
      national specialty consumer finance company that originates, securitizes and
      sells (and, prior to May 2001, serviced) non-conforming mortgage loans. We
      originate mortgage loans through two distribution channels, wholesale (directly
      from independent third-party mortgage brokers) and retail (directly from
      borrowers). We typically securitize the majority of the mortgage loans we
      originate. Securitization involves the public offering by a securitization
      trust
      of pass-through securities backed by a pool of mortgage loans, known as
      asset-backed securities. To a lesser extent, we also sell mortgage loans on
      a
      whole loan basis to banks, consumer finance-related companies and institutional
      investors on a servicing-released basis.





***(b)
      Principles of Consolidation***





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





***(c)
      Use of Estimates***





The
      preparation of the consolidated financial statements in conformity with U.S.
      generally accepted accounting principles (“GAAP”) requires our management to
      make estimates and assumptions that affect the reported amounts of assets and
      liabilities and the disclosure of contingent assets and liabilities at the
      date
      of the consolidated financial statements and the reported amounts of revenues
      and expenses during the reporting periods. Actual results could differ from
      those estimates and assumptions.





***(d)
      Reclassification***





Certain
      prior period amounts in the consolidated financial statements and notes have
      been reclassified to conform to the current year presentation.





***(e)
      Segment Reporting***





While
      our
      senior management monitors the revenue streams through wholesale and retail
      loan
      originations, operations are managed and financial performance is evaluated
      on a
      company-wide basis. Accordingly, we operate as one reportable operating
      segment.





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





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





For cash flow reporting purposes, cash and cash equivalents includes cash in
      checking accounts, cash in interest bearing deposit accounts, amounts due from
      banks, restricted cash and money market investments. Included in cash and cash
      equivalents were $6,000 and $215,000 of interest-bearing deposits with select
      financial institutions at December 31, 2005 and 2004, respectively.





Additionally,
      cash and cash equivalents as of December 31, 2005 and 2004, included restricted
      cash held for various reserve accounts totaling $29,000 and $461,000,
      respectively.





**86**


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





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





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





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





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


During the year ended December 31, 2005, we recorded in interest income
          $324,000
          of income related to a cumulative adjustment for the effects of an immaterial
          correction in recognition of net deferred fees in accordance with SFAS
          No.
          91 that related to the year ended December 31, 2004. This was the result of
          a revision in 2005 to our methodology to separate respective securitization
          loan
          pools into homogeneous pools based upon product type - each of which contains
          a
          large number of similar loans for which prepayments are probable and the
          timing
          and amount of prepayments are reasonably predictable.





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





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





**87**


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





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





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





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





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





***(d)
      Trustee Receivable***





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





**88**


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





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





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





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





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





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





Depreciation
      and amortization are included in “non-interest expense - general and
      administrative” in our consolidated statements of operations, and amounted to
      approximately $2.4 million, $1.9 million and $1.6 million, respectively, for
      the
      years ended December 31, 2005, 2004, and 2003. Accumulated depreciation and
      amortization totaled $12.5 million and $10.3 million, repectively, at December
      31, 2005 and 2004.





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





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





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





**89**


The
      balance of REO, if any, is included in “prepaid expenses and other assets” on
      the consolidated balance sheet. We had $4.4 million and $578,000 of REO
      properties as of December 31, 2005 and 2004, respectively. A provision of
      $173,000 was recognized during the year ended December 31, 2005 for the
      decrease in the fair value of the REO properties in "general and administrative
      expenses."  No provisions were recognized during the year ended
      December 31, 2004 as we did not experience any declines in the fair values
      of
      REO properties held during 2004. No provisions were made during the year ended
      December 31, 2003 as we had no REO properties during 2003.





***(h)
      Warehouse Financing***





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





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





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





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





Any
      securitization debt issuance costs are deferred and amortized, along with any
      discounts on the financing, on a level-yield basis over the estimated life
      of
      the debt issued. From time-to-time we may utilize derivative instruments (cash
      flow hedges as defined in SFAS No. 133, "Accounting for Derivative Instruments
      and Hedging Activities"), such as interest rate swap contracts and corridors
      (corresponding purchase and sale of interest rate caps with similar notional
      balances at different strike prices), in an effort to maintain a minimum margin
      or to lock in a pre-determined base interest rate on designated portions of
      our
      prospective future securitization financing (collectively, the hedged
      risk). (See
      -
      Note 2(p) - “Derivative Instruments” and Note 11 - “Derivative Instruments” for
      further detail regarding hedging securitization financing).





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





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





**90**


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





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





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





***(k)
      Interest Expense***





Interest
      expense primarily represents the borrowing costs under (a) our warehouse credit
      facilities to finance loan originations; (b) securitization debt; (c) equipment
      financing;  (d) amortized discounts and deferred costs on a level-yield
      basis; and (e) in 2003, our senior notes, which we redeemed in October
      2003.




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




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





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





We
      establish a reserve for the contractual obligation to rebate a portion of any
      premium paid by a purchaser when a borrower prepays a sold loan within an agreed
      period. The reserve is recorded as a liability on our consolidated financial
      statements when the mortgage loans are sold based
      on
      our historical experience. The
      provision for losses recognized at the date of sale is included in the
      consolidated statements of operations as a reduction of gain on sale of mortgage
      loans.





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





We
      generally sell the MSRs to a third party as of the securitization date. Upon
      the
      sale, we allocate a portion of the accounting basis of the mortgage loans held
      for investment to the MSRs based upon the relative fair values of the mortgage
      loans and the MSRs, which results in a discount to the mortgage loans held
      for
      investment. That discount is accreted as an adjustment to yield on the mortgage
      loans over the estimated life of the related loans, on a pool by pool basis,
      using the interest method calculation. For the years ended December 31, 2005
      and
      2004, we received $22.4 million and $16.9 million, respectively, from a
      third-party servicer for the right to service the mortgage loans collateralizing
      our securitizations that were structured to be accounted for as secured
      financings.





Prior
      to
      the first quarter 2004 securitization, the MSRs sold were treated as a component
      of the net gain on sale of mortgage loans. For the year ended December 31,
      2004
      we received $661,000 from a third-party servicer for the right to service the
      mortgage loans collateralizing our securitization transactions that were
      structured as sales. For the year ended December 31, 2004, we delivered
      $113.9 million of mortgage loans under a pre-funding feature in our fourth
      quarter 2003 securitization and recorded gain-on-sale revenue related thereto
      during the first quarter of 2004.





**91**


***(n)
      Advertising Expense***




******We
      account for our advertising costs as non-direct response advertising.
      Accordingly, advertising costs are expensed as incurred.





***(o)
      Income Taxes***





The
      provision for income taxes is determined using the asset and liability approach
      of accounting for income taxes in accordance with SFAS No. 109, ‘‘Accounting for
      Income Taxes.’’ The provision for income taxes consists of income taxes that are
      currently payable plus the change in deferred taxes. Deferred tax assets and
      liabilities are recognized for future tax consequences attributable to temporary
      differences between the financial statement carrying amounts of existing assets
      and liabilities and their respective tax bases. Deferred tax assets and
      liabilities are measured using enacted tax rates that are expected to apply
      to
      taxable income in years in which those temporary differences are expected to
      be
      recovered or settled. The realization of a deferred tax asset is assessed taking
      into consideration our recent earnings history, current tax position and
      estimates of future taxable income. Valuation allowances are recorded to reduce
      deferred tax assets when it is more likely than not that a tax benefit will
      not
      be realized.


In
        certain situations, a taxing authority may challenge positions that we have
        adopted in our income tax filings. Accordingly, we may apply different tax
        treatment for these selected transactions in filing our tax return than for
        financial reporting purposes. We regularly assess our tax position for such
        transactions and include reserves for the differences in position where it
        is
        not probable that our tax position will be sustained. The reserves are utilized
        or reversed once the statute of limitations has expired or the matter is
        otherwise resolved through settlement with the taxing
        authority.


***(p)
      Derivative
      Instruments***





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





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





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





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





**92**


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





·
            Hedges
                must be documented, with the objective and strategy stated, along
                with an
                explicit description of the methodology used to assess effectiveness
                and
                measure ineffectiveness;





·
            Dates
                (or periods) for the expected forecasted events and the nature of
                the
                exposure involved (including quantitative measures of the size of
                the
                exposure) must be explicitly
                documented;





·
            Hedges
                must be expected to be “highly effective,” both at the inception of the
                hedge and on an ongoing basis. Effectiveness measures must relate
                the
                gains or losses of the derivative to the changes in cash flows associated
                with the hedged item;





·  Forecasted
      transactions must be probable; and





·  Forecasted
      transactions must be made with different counterparties than the reporting
      entity.





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





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





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




***(q)*** ***Fair
        Value of Financial Instruments***





SFAS
      No.
      107, “Disclosure About Fair Value of Financial Instruments,” requires us to
      disclose the fair value of financial instruments for which it is practicable
      to
      estimate fair value. Fair value is defined as the amount at which a financial
      instrument could be exchanged in a current transaction between willing parties,
      other than in a forced sale or liquidation, and is best evidenced by a quoted
      market price.





***(r)
      Earnings Per Share***





Basic
      Earnings Per Share (“EPS”) excludes dilution and is computed by dividing income
      available to common stockholders by the weighted-average number of common shares
      outstanding for the period. Diluted EPS reflects the potential dilution that
      could occur if securities or other contracts to issue common stock were
      exercised or converted into common stock or resulted in the issuance of common
      stock that then shared in the earnings of the entity.




**93**


***(s)
      Recent Accounting Pronouncements***





*Share-Based
      Payment.* In
      December 2004, the Financial Accounting Standards Board (“FASB”) published SFAS
      No. 123 (revised), “Share-Based Payment.” ** SFAS No.
      123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and
      supersedes APB Opinion No. 25, “Accounting for Stock Issued to
      Employees.” ** SFAS
      No.
      123(R) also amends SFAS No. 95, “Statement of Cash Flows,” ** to
      require that excess tax benefits be reported as a financing cash inflow rather
      than as a reduction of taxes paid.


SFAS
        No.
        123(R) is intended to provide investors and other users of financial statements
        with more complete financial information by requiring that the compensation
        cost
        relating to share-based payment transactions be recognized in financial
        statements. The cost will be measured based on the fair value of the equity
        or
        liability instruments issued. SFAS No. 123(R) is effective as of the beginning
        of the first annual reporting period beginning after June 15, 2005 (our first
        quarter of 2006). SFAS No. 123(R) applies to all awards granted after the
        required effective date and to awards modified, repurchased or cancelled
        after
        that date. Additionally, beginning on the required effective date, we will
        recognize compensation costs for the portion of the outstanding awards for
        which
        the requisite service has not yet been rendered, based upon the grant date
        fair
        value of those awards calculated under SFAS No. 123 for proforma disclosures.
        The cumulative effect of initially applying SFAS No. 123(R), if any, is
        recognized as of the required effective date. We will begin expensing stock
        options in the first quarter of 2006.


SFAS
          No.123(R) provides two alternatives for adoption: (1) a "modified prospective"
          method in which compensation cost is recognized for all awards granted
          subsequent to the effective date of SFAS No. 123(R) as well as for the
          unvested
          portion of awards outstanding as of the effective date; or (2) a "modified
          retrospective" method which follows the approach in the "modified prospective"
          method, but also permits the restatement of prior periods to record compensation
          costs calculated under SFAS No. 123 for the pro forma disclosure. We will
          adopt
          SFAS No. 123(R) using the modified prospective method in 2006. Since we
          currently account for stock options granted to employees in accordance
          with the
          intrinsic value method permitted under APB Opinion No. 25, no compensation
          expense is recognized. Had we adopted SFAS No. 123(R) in a prior period,
          the
          impact would be approximately the impact as described in the disclosure
          of pro
          forma net income and earnings per share under SFAS No. 123 in Note 4 “-
          Stock-Based Compensation.” SFAS No. 123(R) also requires that tax benefits
          received in excess of compensation cost be reclassified from operating
          cash
          flows to financing cash flows in the consolidated statement of cash flows.
          This
          change in classification will reduce net operating cash flows and increase
          net
          financing cash flows in the periods after adoption. While the amount of
          this
          change cannot be estimated at this time, the amount of operating cash flows
          recognized in prior periods for such excess tax deductions was $354,000,
          $555,000 and $316,000 during the years ended December 31, 2005, 2004 and
          2003,
          respectively. Based upon the stock options that are currently outstanding,
          we
          estimate that compensation expense for stock options under SFAS No. 123R
          will be
          approximately $396,000 for the year ending December 31, 2006.





*Accounting
      Changes and Error Corrections* .
      In May
      2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154,
“Accounting Changes and Error Corrections - a replacement of APB Opinion No.
      20
      and FASB Statement No. 3,” which provides guidance on the accounting for and
      reporting of accounting changes and error corrections. SFAS No. 154 establishes,
      unless impracticable, retrospective application as the required method for
      reporting a change in accounting principle in the absence of explicit transition
      requirements specific to the newly adopted accounting principle. It also
      provides guidance for determining whether retrospective application of a change
      in accounting principle is impracticable and for reporting a change when
      retrospective application is impracticable. The correction of an error in
      previously issued financial statements is not an accounting change. However,
      the
      reporting of an error correction involves adjustments to previously issued
      financial statements similar to those generally applicable to reporting an
      accounting change retrospectively. Therefore, the reporting of a correction
      of
      an error by restating previously issued financial statements is also addressed
      by SFAS No. 154. SFAS
      No.
      154 is effective for accounting changes and corrections of errors made in fiscal
      years beginning after December 15, 2005. Early adoption is permitted for
      accounting changes and corrections of errors made in fiscal years beginning
      after the date SFAS No. 154 was issued. SFAS No. 154 does not change the
      transition provisions of any existing accounting pronouncements, including
      those
      that are in a transition phase as of the effective date of SFAS No. 154. We
      are
      not expecting any impact related to the adoption of SFAS No. 154 as we are
      not
      aware of any accounting changes or corrections of errors related to our
      financial statements.





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





**94**


**(3)**  **Concentrations
      of Risk**





Our
      ability to continue to originate mortgage loans is dependent, in part, upon
      our
      ability to securitize and sell mortgage loans in the secondary market in order
      to generate cash proceeds for new originations and purchases. The value of,
      and
      market for, our mortgage loans are dependent upon several factors, including
      general economic conditions, interest rates and governmental regulations.
      Adverse changes in such factors may affect our ability to securitize or sell
      loans for acceptable prices within reasonable periods of time.





A
      change
      in the secondary market for mortgage loans of the types we generate may
      adversely affect our ability to securitize and sell mortgage loans. A change
      may
      also adversely impact our profitability and ability to fund future originations
      and purchases, thus having a significant effect on our financial position,
      results of operations or cash flows.





***(a)
      Market Risk*** - We
      regularly review the interest rates on our mortgage loan products and make
      adjustments to the interest rates we offer in order to reflect current market
      conditions. In the normal course of business, we may use derivative financial
      instruments in order to reduce our exposure to fluctuations in interest rates
      and to reduce our exposure to changes in the excess cash flows related to
      securitized mortgage loans.





***(b)
      Credit Repurchase Risk*** - When
      we sell mortgage loans on a whole-loan basis we normally make standard
      mortgage industry representations and warranties, which may require us to
      repurchase one or more of the mortgage loans. These representations and
      warranties include provisions requiring us to repurchase a mortgage loan if
      a
      borrower fails to make one or more of the first loan payments due on the
      mortgage loan. At December 31, 2005 and 2004, mortgage loans held for investment
      - pre-securitization included approximately $723,000 and $450,000, respectively,
      of mortgage loans that were repurchased pursuant to such
      provisions.





***(c)
      Geographical Concentration*** -
      Properties securing our mortgage loans held for investment are geographically
      dispersed throughout the United States. For the year ended December 31, 2005,
      approximately 26% and 12%, based upon principal balance, of the mortgage loans
      we originated were on properties located in New York and Florida, respectively,
      with no other state representing more than 7% of the originations.





**95**


**(4)**  **Stock-Based
      Compensation**





In
      December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based
      Compensation - Transition and Disclosure,” which amended SFAS No. 123,
“Accounting for Stock-Based Compensation.” SFAS No. 148 provides three
      alternative methods for a voluntary change to fair value accounting for
      stock-based compensation as permitted under SFAS No. 123. SFAS No. 123
      established accounting and disclosure requirements using a fair-value-based
      method of accounting for stock-based employee compensation plans. In accordance
      with SFAS No. 148, and as allowed by SFAS No. 123, we continue to apply the
      intrinsic-value method of accounting prescribed by APB Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations,
      including FASB Interpretation (“FIN”) No. 44, “Accounting for Certain
      Transactions Involving Stock Compensation, an Interpretation of APB Opinion
      No.
      25,” to account for our stock incentive plans. Under this method, compensation
      expense is recognized in the financial statements only if the current market
      price of the underlying stock exceeded the exercise price on the date of grant.
      No compensation expense has been recognized for stock option awards granted
      through December 31, 2005 since the exercise price was at, or above, the market
      price of our common stock on the grant date. We have elected to adopt only
      the disclosure requirements of SFAS No. 123.





We
      estimate the fair value of our stock options using a Black-Scholes-Merton
      option-pricing model, which is used in estimating the fair value of traded
      options that have no vesting restrictions and are fully transferable. Stock
      option valuation models require the input of assumptions, including the expected
      stock price volatility. Our stock options have characteristics significantly
      different from those of traded options, and changes in the input assumptions
      can
      materially affect the fair value estimates. The following table illustrates
      the
      pro forma net income (loss) and earnings per share as if the fair-value-based
      method of SFAS No. 123 had been applied to account for stock-based compensation
      expenses:





**For
                the Year Ended December 31,***(Dollars
                in thousands, except per share data)*
            
            **2005**
            
            **2004**
            
            **2003**Net
                income (loss), as reported
            
            $
            17,955
            
            $
            (9,349
            )
            $
            67,406Deduct
                    total stock-based employee compensation expense determined under
                  fair-value-based
                    method for all awards, net of tax
            
            
            413
            
            
            285
            
            
            295Pro
                forma net income (loss)
            
            
            17,542
            
            
            (9,634
            )
            
            67,111Less
                preferred stock dividend
            
            
            --
            
            
            --
            
            
            1,391Pro
                forma net income (loss) applicable to common shares
            
            $
            17,542
            
            $
            (9,634
            )
            $
            65,720**Earnings
                per share:**Basic
                - as reported
            
            $
            0.88
            
            $
            (0.51
            )
            $
            4.05Basic
                - pro forma
            
            $
            0.86
            
            $
            (0.52
            )
            $
            4.03Diluted
                - as reported
            
            $
            0.84
            
            $
            (0.51
            )
            $
            3.59Diluted
                - pro forma
            
            $
            0.82
            
            $
            (0.52
            )
            $
            3.57





**(5)**  **** **Debt
      Modification and Debt Restructuring**




In
      August 2000, we announced an agreement to modify the terms of the indenture
      governing our senior notes (the “Debt Modification”). With the consent of the
      holders of greater than fifty percent of our senior notes, we modified a
      negative pledge covenant in the senior notes indenture, which had previously
      prevented us from selling or otherwise obtaining financing by using our excess
      cashflow certificates as collateral. In consideration for the senior
      noteholders’ consent, we agreed, in an exchange offer (the “First Exchange
      Offer”), to offer then current holders the opportunity to exchange their then
      existing senior notes for (a) new senior secured notes due 2004 (the “senior
      secured notes”) and (b) ten-year warrants to buy approximately 1.6 million
      shares of common stock, at an initial exercise price of $9.10 per share, subject
      to upward or downward adjustment in certain circumstances. In December 2002,
      the
      exercise price for the warrants issued by us was adjusted downward to $0.01
      per
      share in accordance with our agreement. The senior secured notes had
      the
      same coupon, face amount and maturity date as the senior notes and, up until
      the
      Second Debt Restructuring (see below) were
      secured by at least $165 million of our excess cashflow certificates. The First
      Exchange Offer was consummated in December 2000, with holders of greater than
      $148 million (of $150 million) of senior notes tendering in the
      exchange.





**96**


In
      February 2001, we entered
      into a letter of intent with the beneficial holders of over fifty percent of
      our
      senior secured notes to restructure, and ultimately extinguish, the senior
      secured notes (the “Second Debt Restructuring”). In March 2001, we obtained the
      formal consent of these beneficial holders of the senior secured notes through
      a
      consent solicitation that modified certain provisions of the senior secured
      notes indenture to, among other things, allow for the release of two excess
      cashflow certificates then securing the senior secured notes. We were first
      able
      to finance and then ultimately sell the excess cashflow certificates underlying
      five securitizations with a carrying value of $40.4 million (including two
      excess cashflow certificates that were released as part of the Second Debt
      Restructuring) for a $15 million cash purchase price to provide working
      capital.





In
      consideration for their consent, we agreed to offer the holders of the senior
      secured notes (and the senior notes, collectively, the “notes”), an opportunity
      to exchange their notes for new securities described immediately below (the
      “Second Exchange Offer”). The Second Exchange Offer was consummated on August
      29, 2001, pursuant to which holders of approximately $138.1 million (of $148.2
      million) in principal amount of our senior secured notes and $1.1 million (of
      $1.8 million) in principal amount of our senior notes, exchanged their notes
      for
      commensurate interests in:





§
            voting
                membership interests in Delta Funding Residual Exchange Company LLC
                (the
                "LLC"), a limited liability company (which is not our affiliate),
                to which
                we transferred all of the mortgage-related securities previously
                securing
                the senior secured notes (primarily comprised of excess cashflow
                certificates);





§
            shares
                of common stock of a then newly-formed management corporation that
                manages
                the LLC’s assets; and





§
            shares
                of our then newly-issued Series A preferred stock having an aggregate
                preference amount of $13.9 million.





The
      LLC
      is controlled by the former noteholders that now hold all the voting membership
      interest in the LLC. As part of the transaction, we obtained a non-voting
      membership interest in the LLC, which entitles us to receive 15% of the net
      cash
      flows from the LLC for the first three years (through June 2004) and,
      thereafter, 10% of the net cash flows from the LLC. The net cash flows from
      the
      LLC are equal to the total cash flows generated by the assets held by the LLC
      for a particular period, less (a) all expenses of the LLC, (b) certain related
      income tax payments, and (c) the New York State Banking Department
      ("NYSBD") subsidy payments. We began receiving distributions from the LLC
      in the first quarter of 2002 from a fourth quarter 2001 distribution. We have
      not received our distributions since the second quarter of 2003 due to a dispute
      with the LLC’s president, which has led us to commence a lawsuit to recover all
      of the amounts due to us. We have not recorded any revenue for distributions
      that we have not received.





As part of the Second Exchange Offer, all tendering noteholders waived their
      right to receive any future interest coupon payments on the tendered notes
      beginning with the August 2001 interest coupon payment. With the closing of
      the
      Second Exchange Offer, we recorded a charge of $19.3 million related to the
      extinguishment of debt and paid the August 2001 interest coupon payment on
      the
      approximately $10.8 million of notes that did not tender in the Second Exchange
      Offer. The notes bore interest at a rate of 9.5% per annum, payable
      semi-annually (on February 1 st and
      August 1 st )
      and had
      a maturity date of August 1, 2004 when all outstanding principal was due. On
      October 30, 2003, we redeemed, at par, all of our outstanding 9.5% Senior Notes
      due August 2004. The aggregate redemption price, including principal and accrued
      interest, was approximately $11.0 million.





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




Mortgage
      loans held for investment represents our basis in the mortgage loans that were
      either delivered to securitization trusts (denoted as mortgage loans held for
      investment - securitized) or are pending delivery into future securitizations
      (denoted as mortgage loans held for investment - pre-securitization), net of
      discounts, deferred fees and allowance for loan losses. Prior to 2004, we did
      not structure our securitizations as financings and, we did not have mortgage
      loans held for investment.




Mortgage
      loans held for investment - securitized is comprised of the mortgage loans
      collateralizing our outstanding securitization asset-backed securities. During
      each of the years ended December 31, 2005 and 2004, we closed four
      securitization transactions totaling $3.1 billion and $2.3 billion,
      respectively, which were structured to be accounted for as a secured financing
      and which were collateralized by $3.2 billion and $2.3 billion, respectively,
      of
      mortgage loans held for investment - securitized. Mortgage loans held for
      investment - securitized had a weighted-average interest rate of 7.77% and
      7.81%
      per annum at December 31, 2005 and 2004, respectively.


**97**




Mortgage
      loans held for investment - pre-securitization is comprised primarily of
      mortgage loans waiting to be either securitized, and to a lesser extent a
      relatively small amount of loans that may be sold on a whole loan basis.
      Included in our mortgage loans held for investment - pre-securitization at
      December 31, 2005 and 2004, was approximately $222.8 million and $135.7 million,
      respectively, of these mortgages that were pledged as collateral for our
      warehouse financings at December 31, 2005 and 2004, respectively. Mortgage
      loans
      held for investment - pre-securitization had a weighted-average interest rate
      of
      8.35% and 7.86% per annum at December 31, 2005 and 2004,
      respectively.





The
      following table presents a summary of mortgage loans held for investment, net
      at
      December 31, 2005 and 2004:





**At
                December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Mortgage
                loans held for investment - securitized(1)
            
            $
            4,430,775
            
            $
            2,165,353Mortgage
                loans held for investment - pre-securitization(1)
            
            
            270,372
            
            
            206,289Discounts
                (MSR related)
            
            
            (26,750
            )
            
            (14,570
            )Net
                deferred origination fees
            
            
            (10,735
            )
            
            (5,800
            )Allowance
                for loan losses
            
            
            (36,832
            )
            
            (10,278
            )Mortgage
                loans held for investment, net
            
            $
            4,626,830
            
            $
            2,340,994





(1)
      Included in theoutstanding balance of the mortgage loans held for investment at December 31,
      2005 were loans located in the Hurricanes Katrina and Rita disaster areas
      designated by Federal Emergency Management Agency (“FEMA”) of approximately
      $29.2 million (of which $1.5 million are pre-securitization loans), or 0.6%
      of
      the outstanding loans held for investment balance at that
      date.





For
      the
      years ended December 31, 2005 and 2004, we recorded interest income related
      to
      our mortgage loans held for investment - securitized of $250.8 million and
      $75.5
      million, respectively. We had no loans classified as mortgage loans held for
      investment - securitized during the year ended December 31, 2003. For the years
      ended December 31, 2005, 2004 and 2003, we recorded interest income related
      to
      our mortgage loans held for investment -pre-securitization (mortgage loans
      held
      for sale) of $30.5 million, $18.3 million and $10.5 million,
      respectively.





The following table presents a summary of the activity for the allowance for
      loan losses on all mortgage loans held for investment for the years ended
      December 31, 2005 and 2004. We did not have mortgage loans held for investment
      or a related allowance prior to 2004.





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Beginning
                balance
            
            $
            10,278
            
            $
            --Provision(1)
            
            
            28,592
            
            
            10,443Charge-offs(2)
            
            
            (2,038
            )
            
            (165
            )Ending
                balance
            
            $
            36,832
            
            $
            10,278




*(1)   T*he
        provision for loan losses for the year ended December 31, 2005 includes a
        $1.7
        million specific provisionrelated
        to probable losses attributable to loans in Hurricanes Katrina and Rita disaster
        areas.**


**
 *(2)  *The
        charge-offs for the year ended December 31, 2005 includes a $3,000 charge-off
        against the specific allowance for loan losses attributable to loans in
        Hurricanes Katrina and Rita disaster areas.**
 Due to the significant effects of Hurricanes Katrina and Rita on a select
        portion of our loan portfolio, management identified certain loans located
        in
        FEMA declared disaster areas requiring specific reserves. Based upon our
        estimated loss exposure attributable to 35 properties securing a total unpaid
        principal balance of $3.9 million in the affected areas at December 31, 2005,
        our allowance for loan losses includes a specific reserve of $1.7 million
        related to probable losses attributable to Hurricanes Katrina and Rita affected
        loans. As additional information is obtained and processed over the coming
        months and quarters, we will continue to assess the need for any adjustments
        to
        our specific reserves related to the mortgage loans in the affected
        areas.





**98**


As
      of
      December 31, 2005 and 2004, we had $123.0 million (including $6.1 million of
      loans located in Hurricanes Katrina and Rita disaster areas designated by FEMA)
      and $18.9 million of mortgage loans held for investment that were 90 days or
      more delinquent under their payment terms, all of which were on non-accrual
      status. If the non-accrual mortgage loans held for investment at December 31,
      2005 and 2004 performed in accordance with their contractual loan terms, we
      would have recognized an additional $5.9 million and $920,000 of interest income
      during the years ended December 31, 2005 and 2004, respectively. At and for
      the
      year ended December 31, 2003, we had no mortgage loans held for
      investment.





Our
      recorded investment in impaired loans at December 31, 2005 was $3.9 million.
      We
      had no loans classified as impaired prior to December 31, 2005. We established
      a
      related allowance for these impaired loans totaling $1.7 million at December
      31,
      2005. The average recorded investment in impaired loans for the year ended
      December 31, 2005 was $324,000. We recorded no interest income on impaired
      loans
      during the year ended December 31, 2005.





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





The
      following table presents the activity related to our excess cashflow
      certificates for the years ended December 31, 2005, 2004 and 2003:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**
            
            **2003**Balance,
                beginning of year
            
            $
            14,933
            
            $
            19,853
            
            $
            24,565Originated
                excess cashflow certificates
            
            
            --
            
            
            --
            
            
            6,941Excess
                cashflow certificates sold(1)
            
            
            --
            
            
            --
            
            
            (10,220
            )Accretion
            
            
            1,593
            
            
            2,073
            
            
            2,418Cash
                receipts
            
            
            (23,146
            )
            
            (8,359
            )
            
            (4,071
            )Net
                change in fair value
            
            
            14,409
            
            
            1,366
            
            
            220Balance,
                end of period
            
            $
            7,789
            
            $
            14,933
            
            $
            19,853





*(1)*  *In
      August 2003, we sold three of our excess cashflow certificates, which had a
      $10.2 million carrying value in the aggregate, for $10.2 million in
      cash.*





Since
      our
      first quarter 2004, we have structured our securitizations to be accounted
      for
      as secured financings, we no longer record excess cashflow certificates on
      the
      consolidated balance sheet for our newly issued securitizations. Additionally,
      during the year ended December 31, 2003, we sold $10.2 million of excess
      cashflow certificates for $10.2 million. No such sales occurred during the
      years
      ended December 31, 2005 or 2004.





In
      accordance with EITF 99-20, we regularly analyze and review our assumptions
      to
      determine that the actual rate of return (interest income) on our excess
      cashflow certificates is within our expected rate of return. The expected rate
      of return is recorded as a component of interest income. Any return that is
      either greater than or less than the expected rate of return is reflected as
      a
      fair value adjustment and is recorded as a component of  “other income” in
      the consolidated statement of operations. For the years ended December 31,
      2005,
      2004 and 2003, we recorded interest income related to our excess cashflow
      certificates of $1.6 million, $2.1 million and $2.4 million, respectively.
      For
      the years ended December 31, 2005, 2004 and 2003, we recorded fair value gain
      in
      income related to our excess cashflow certificates of $14.4 million, $1.4
      million and $220,000, respectively.





Our
      valuation of retained excess cashflow certificates is highly dependent upon
      the
      reasonableness of our assumptions and the predictiveness of the relationships
      that drive the results of our valuation model. The assumptions we utilize are
      complex, as we must make judgment calls about the effect of matters that are
      inherently uncertain. As the number of variables and assumptions affecting
      the
      possible future resolution of the uncertainties increase, those judgments become
      even more complex.





In
      volatile markets, like those we have experienced over the past several years,
      there is increased risk that our actual results may vary significantly from
      our
      assumed results. The longer the time period the uncertainty exists, the greater
      the potential volatility for our valuation assumptions and the fair value of
      our
      excess cashflow certificates.





**99**


**(8)**  **Bank
      Payable**





In
      order
      to maximize our cash management practices, we have instituted a procedure
      whereby checks written against our operating account are covered as they are
      presented to the bank for payment, either by drawing down our lines of credit
      or
      from subsequent deposits of operating cash. The amount of bank payable at
      December 31, 2005 and 2004 totaled $1.9 million and $1.1 million, respectively,
      and represented the checks outstanding at those respective dates to be paid
      in
      this manner.





**(9)**  **Warehouse
      Financing**





Our
      warehouse lines of credit are collateralized by specific mortgage loans held
      for
      investment - pre-securitization at December 31, 2005 and 2004, the balances
      of
      which are equal to or greater than the outstanding balances under the warehouse
      lines at any point in time. The amounts available under these warehouse lines
      are based on the amount of the collateral pledged. The amount we have
      outstanding on our committed facilities at any period end generally are a
      function of the pace of mortgage loan originations relative to the timing of
      our
      securitizations and whole loan sales.





The
      following table summarizes information regarding warehouse financing at December
      31, 2005 and 2004:


*(Dollars
                  in thousands)*
              
              **Facility**
              
              
              
              **At
                  December 31,****Warehouse
                  Line of Credit**
              
              **Amount**
              
              **Interest
                  Rate**
              
              **2005**
              
              **2004**
              
              **Expiration
                  Date**RBS
                  Greenwich Capital
              
              $                               350,000
              
              Margin
                  over LIBOR
              
              $                  77,931
              
              $                135,653
              
              October
                  2006Citigroup
              
              350,000
              
              Margin
                  over LIBOR
              
              144,912
              
              --
              
              April
                  2006Bank
                  of America(1)
              
              350,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              August
                  2006Freidman,
                  Billings, Ramsey
              
              200,000
              
              Margin
                  over LIBOR
              
              --
              
              --
              
              April
                  2006Total
              
              $         
                                    1,250,000
              
              
              
              $                222,843
              
              $                135,653





(1)
            *In
                September 2005, we obtained a new warehouse financing facility with
                Bank
                of America, N.A.*





As securitization transactions are completed, a portion of the proceeds from
      the
      long-term debt issued in the securitization will be used to pay down our
      warehouse lines of credit. Therefore, the outstanding amount of warehouse
      financing will fluctuate from quarter to quarter, and could be significantly
      higher or lower than the $222.8 million we held at December 31, 2005, as our
      mortgage production and securitization programs continue.





Our
      warehouse financing costs are determined based upon a margin over the one-month
      LIBOR rate, which is the benchmark index used to determine our cost of borrowed
      funds. The rate increased 189 basis points to an average of 3.39% for the year
      ended December 31, 2005, compared to an average of 1.50% for the same period
      in
      2004. For the years ended December 31, 2005, 2004 and 2003, we recorded interest
      expense related to our warehouse financing of $22.1 million, $8.0 million and
      $4.4 million, respectively.




The
      terms
      of our warehouse agreements require us to comply with various operating and
      financial covenants, which are customary for agreements of their type. The
      continued availability of funds provided to us under these agreements is subject
      to, among other conditions, our continued compliance with these covenants.
      We
      believe that we are in compliance with such covenants as of December 31,
      2005.





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





When
      we
      sell loans through securitizations that are structured as secured financings,
      the asset-backed securities are recorded on our balance sheet as “financing on
      mortgage loans held for investment, net.” Prior to 2004, we structured our
      securitizations as sales rather than financings.





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





**100**


At
      December 31, 2005 and 2004, the outstanding financing on mortgage loans held
      for
      investment, net consisted of $4.4 billion and $2.2 billion,
      respectively.





The
      following table summarizes the expected maturities on our secured financings
      at
      December 31, 2005:





*(Dollars
                in thousands)*
            
            **Total**
            
            **Less
                than**
              **One
                Year**
            
            **One
                to**
              **Three
                Years**
            
            **Three
                to**
              **Five
                Years**
            
            **More
                than**
              **Five
                Years**Securitization
                asset-backedsecurities,
                net
            
            $
            4,436,938
            
            $
            1,659,669
            
            $
            1,725,443
            
            $
            586,230
            
            $
            465,596





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




For
      the
      years ended December 31, 2005 and 2004, we recorded interest expense related
      to
      our securitization asset-backed securities of $145.4 million and $31.5 million,
      respectively. Included in securitization asset-backed securities, net at
      December 31, 2005 and 2004 are $5.3 million and $1.5 million, respectively,
      of
      unamortized discounts. Any discounts on the financing are amortized on a
      level-yield basis over the estimated life of the debt issued using the interest
      method.




**(11)**  **Derivative
      Instruments**





We
      account for our derivative financial instruments such as corridors and interest
      rate swaps as cash flow hedges. The corridors hedge our interest rate risk
      on
      securitization variable-rate debt and the interest rate swaps hedge forecasted
      interest payments associated with future securitization financing. At December
      31, 2005 and 2004, the fair value of our corridors totaled $11.7 million and
      $16.1 million, respectively, and the fair value of our interest rate swaps
      totaled losses of $210,000 and $166,000, respectively. The fair value of our
      corridors and interest rate swaps are recorded as a component of other assets
      and other liabilities.





As
      of
      December 31, 2005, the changes in fair value of the corridors (effective
      portion) and interest rate swaps and any gains on terminated swaps (effective
      portion) are recorded as components of accumulated other comprehensive income,
      and total, net of tax, gains of $1.9 million and losses of $128,000 and gains
      of
      $755,000, respectively. As of December 31, 2004, the effective portion of the
      changes in fair value of the corridors, interest rate swaps and the loss on
      the
      terminated swaps are recorded as components of accumulated other comprehensive
      loss and total losses, net of tax, of $476,000, $101,000 and $1.6 million,
      respectively. Accumulated other comprehensive income or loss relating to cash
      flow hedging is reclassified to earnings as a yield adjustment to interest
      expense as the interest payments affect earnings. Hedge ineffectiveness
      associated with hedges resulted in a $1.5 million loss and $277,000 gain for
      the
      years ended December 31, 2005 and 2004, respectively.





The
      estimated amortization of the accumulated other comprehensive income at December
      31, 2005 related to derivative instruments into earnings for the next twelve
      months is approximately $3.0 million of a reduction to expense (pre-tax),
      depending on future performance.





If
      a
      hedge fails the effectiveness test (the ratio of the outstanding balance of
      the
      hedged item (debt) to the notional amount of the corridors rise above 125%
      or
      falls below 80%) at any time, and therefore is not expected to be “highly
      effective” at achieving offsetting changes in cash flows, the hedge ceases to
      qualify for hedge accounting. At December 31, 2005, we held $1.7 million
      of hedges (specifically corridors) classified as trading securities in
      prepaid and other assets as these hedges were no longer deemed highly
      effective, as the ratio of the outstanding balance of the hedged item (debt)
      to
      the notional amount of the corridors was outside of the range of 80% to 125%.
      During the year ended December 31, 2005, a gain of $545,000 was recorded to
      earnings on the changes in fair value of the hedges held as trading
      securities. None of the hedges held during the year ended December 31, 2004
      were classified as trading securities.  We held no hedges during the
      year ended December 31, 2003.





**101**


Prior
      to
      May 2004, derivatives that were not designated as hedging instruments and thus
      classified as trading securities resulted in a $377,000 net loss for the year
      ended December 31, 2004.





The
      following table summarizes the notional amount, expected maturities and
      weighted-average strike price for the corridors that we held as of December
      31,
      2005:





*(Dollars
                in thousands**except
                strike price)*
            
            **Total**
            
            **One
                Year**
            
            **Two
                Years**
            
            **Three
                Years**
            
            **Four
                Years**
            
            **Five
                Years and Thereafter**Caps
                bought - notional
            
            $
            2,459,969
            
            $
            1,629,194
            
            $
            557,501
            
            $
            124,651
            
            $
            37,086
            
            $
            111,537Weighted
                average strikeprice
            
            $
            5.98
            
            $
            5.22
            
            $
            6.86
            
            $
            7.56
            
            $
            7.47
            
            $
            7.43Caps
                sold - notional
            
            $
            2,459,969
            
            $
            1,629,194
            
            $
            557,501
            
            $
            124,651
            
            $
            37,086
            
            $
            111,537Weighted
                average strikeprice
            
            $
            8.51
            
            $
            8.09
            
            $
            9.07
            
            $
            9.34
            
            $
            9.27
            
            $
            9.29





The
      notional amount of the corridors totaled $1.9 billion each at December 31,
      2004.





**(12)**  **Other
      Borrowings**





Other
      borrowings represents capital leases and other arrangements related to our
      equipment financing. The
      following table summarizes certain information regarding other borrowings at
      December 31, 2005 and 2004:


*(Dollars
                  in thousands)*
              
              **Range
                  of Interest Rates**
              
              **Balance
                  at December 31,**
              
              **Range
                  of Expiration Dates**Equipment
                  financing - 2005
              
              3.29%
                  to 12.45%
              
              $                                   
                   4,785
              
              January
                  2006 to December 2008Equipment
                  financing - 2004
              
              3.29%
                  to 12.45%
              
              $                                   
                   3,330
              
              October
                  2005 to December 2007





For
      the
      years ended December 31, 2005, 2004 and 2003, we recorded interest expense
      related to our other borrowings of $286,000, $296,000 and $265,000,
      respectively.





**(13)**  **Stockholders’
      Equity**


**Stock
        Offering.** In July
        2004, we sold 3,137,597 shares of common stock from authorized but unissued
        shares, and existing stockholders sold 1,237,403 shares, in a public follow-on
        offering of 4,375,000 shares of our common stock at a price of $6.50 per
        share.
        The effect of the offering was to increase our common stock and additional
        paid-in capital accounts by the net proceeds received. In August 2004, the
        underwriters exercised a portion of their over-allotment option, which resulted
        in existing stockholders selling 85,000 additional shares. We received $18.7
        million in net proceeds from the offering after paying underwriting and other
        related professional fees, and which also excluded the proceeds related to
        the
        shares sold by existing stockholders. We
        utilized the proceeds to repay warehouse financings and originate mortgage
        loans.


**Preferred
      Stock - Series A.** In
      August 2001, as part of our August 2001 exchange offer, the holders of
      approximately $139.2 million (of the initial $150.0 million) principal amount
      of
      our 9.5% senior notes due 2004 exchanged their notes for, among other interests,
      139,156 shares of our then newly issued Series A 10% Preferred Stock, having
      an
      aggregate preference amount of approximately $13.9 million.





In
      June
      2004, we redeemed all of our outstanding Series A 10% Preferred Stock at its
      preference amount, or approximately $13.9 million. Holders of the Series A
      10%
      Preferred Stock were previously entitled to receive cumulative preferential
      dividends at the rate of 10% per annum of the preference amount, payable in
      cash
      semi-annually, commencing in July 2003. We paid $1.4 million of dividends to
      the
      Series A 10% Preferred Stock holders in 2003.





**102**


**Unearned
      Common Stock Held by Incentive Plan** . 
      In November 2005, we granted 157,275 shares of our common stock to
      certain officers and employees, at a grant price of $7.46 per share (closing
      price on the award date of November 9, 2005) under the 2005 Plan. The shares
      were issued from our authorized shares on the grant date of November 9, 2005
      and
      vest over a five-year period (50% in year 3 and 25% in each year thereafter).
      The deferred compensation related to the 2005 Plan awards of our common stock
      was recorded as a reduction of stockholders' equity and represents the closing
      market price of our common stock on the date the shares were contributed to
      the
      2005 Plan. Compensation expense is recognized over the vesting period of stock
      awards based upon the fair value of our common stock at the grant date. For
      the
      year ended December 31, 2005, we recorded $46,000 of compensation expense
      related to the amortization of outstanding stock award grants.




**Other Comprehensive Income.**Accumulated OCI
      is comprised of our net gains (losses) on derivatives.  The componenets of
      OCI for the years ended December 31, 2005 and 2004 are as follows: *(Dollars
                  in thousands)*
              
              **Before
                  Tax Amount**
              
              **Tax
                  (Expense) Benefit**
              
              **After
                  Tax Amount**For
                  the year ended December 31, 2005:Net
                  unrealized holding gains on derivatives arising during the
                  year
              
              $
              3,896
              
              $
              (1,519
              )
              $
              2,377Reclassification
                  adjustment for gain on derivatives included in net income
              
              
              3,879
              
              
              (1,513
              )
              
              2,366Other
                  comprehensive gain
              
              $
              7,775
              
              $
              (3,032
              )
              $
              4,743For
                  the year ended December 31, 2004:Net
                  unrealized holding losses on derivatives arising during the
                  year
              
              $
              (4,383
              )
              $
              1,709
              
              $
              (2,674
              )Reclassification
                  adjustment for gain on derivatives included in net
                  income
              
              
              765
              
              
              (298
              )
              
              467Other
                  comprehensive loss
              
              $
              (3,618
              )
              $
              1,411
              
              $
              (2,207
              )


**(14)**  **Senior
      Notes**





On
      October 30, 2003, we redeemed, at par, all of our outstanding 9.5% senior notes
      due August 2004. The aggregate redemption price, including principal and accrued
      interest, was approximately $11.0 million. We used available working capital
      to
      fund the redemption.





For
      the
      year ended December 31, 2003 we recorded interest expense related to our senior
      notes of $854,000.





**(15)**  **Employee
      Benefit Plans**





We
      sponsor a 401(k) Retirement Savings Plan (the “Plan”). Substantially all our
      employees who are at least 21 years old are eligible to participate in the
      Plan
      after completing one year of service. Contributions are made from employees’
elected salary deferrals. We elected to make discretionary matching
      contributions to the Plan of $1.3 million, $916,000 and $539,000 for the years
      ended December 31, 2005, 2004 and 2003, respectively. The discretionary matching
      contributions are included as a component of “payroll and related costs” in the
      consolidated statement of operations.  Our discretionary matching
      contribution vests ratably based on an employee's years of service, and fully
      vests after five years.





**(16)**  **Commitments
      and Contingencies**





**Loan
      Commitments.** We
      provide commitments to fund mortgage loans to customers as long as all of the
      proper conditions are met. Our commitments have fixed expiration dates, but
      no
      locked in interest rate. We quote interest rates to customers, which are
      generally subject to change. Although we typically honor these interest rate
      quotes, the quotes do not constitute future cash requirements, minimizing the
      potential interest rate risk exposure. We do not believe these non-conforming
      mortgage loan commitments meet the definition of a derivative under SFAS No.
      133. Accordingly, they are not recorded in the consolidated financial
      statements. At December 31, 2005 and 2004, we had outstanding origination
      commitments to fund approximately $104.8 million and $92.2 million,
      respectively, in mortgage loans.





**103**


**Off-Balance
      Sheet Arrangements.** Substantially all of our entire off-balance sheet arrangements relate to
      securitizations structured as sales prior to 2004. In connection with our
      securitization transactions that were structured as sales (and where we have
      recorded an economic interest, *i.e.* ,
      the
      excess cashflow certificates), there is $843.2 million in collateral (primarily
      mortgage loans) owned by off-balance sheet trusts as of December 31, 2005.
      These
      trusts have issued asset-backed securities secured by these mortgage loans.
      We
      have no obligation to provide funding support to either the third-party
      investors or the off-balance sheet trusts. The third party investors or the
      trusts have no recourse to our assets or us and have no ability to require
      us to
      repurchase their loans other than for non-credit-related recourse that can
      arise
      under standard representations and warranties.




**Contractual
      Obligations.** The
      following table summarizes our material contractual obligations at December
      31,
      2005:


*Dollars
                  in thousands)*
              
              **Total**
              
              **Less
                  than One Year**
              
              **One
                  to Three Years**
              
              **Three
                  to Five Years**
              
              **More
                  than Five Years**Securitization
                  pass-through certificates(1)
              
              $
              4,436,938
              
              $
              1,659,669
              
              $
              1,725,443
              
              $
              586,230
              
              $
              465,596Operating
                  leases
              
              $
              21,365
              
              $
              6,315
              
              $
              10,463
              
              $
              4,492
              
              $
              95Equipment
                  financing
              
              $
              4,785
              
              $
              384
              
              $
              4,401
              
              $
              --
              
              $
              --




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





**Repurchase
      Obligations.** We have
      repurchase agreements with several of the institutions that we have sold
      mortgage loans to prior to 1991. Some of the agreements provide for the
      repurchase by us of any of the mortgage loans that go to foreclosure sale.
      At
      the foreclosure sale, we will repurchase the mortgage, if necessary, and make
      the institution whole. The dollar amount of loans that were sold with recourse
      and are still outstanding totaled $762,000 and $1.2 million at December 31,
      2005
      and 2004. Included in “accounts payable and other liabilities” is an allowance
      for recourse loans related to those loans sold with recourse of $310,000 and
      $837,000 at December 31, 2005 and 2004, respectively.





We
      recognized a recovery of $380,000 and $50,000 to the provision for recourse
      loans for the years ended December 31, 2005 and 2004, respectively. We
      recognized, as a charge to operations, a provision for recourse losses of
      approximately $88,000 for the year ended December 31, 2003. The adequacy of
      the
      recourse reserve is based upon management’s judgment after evaluating the
      historical loss experience, delinquency trends, loan volume and the impact
      of
      economic conditions in our market area.





**Premium
      Recapture on Whole Loan Sales.** During
      the years ended December 31, 2005 and 2004, we sold $561.5 million and $169.3
      million, respectively, of whole-loans on a non-recourse basis. With respect
      to
      the loans we sell on a non-recourse basis, we maintain a premium recapture
      reserve related to our contractual obligation to rebate a portion of any premium
      paid by a purchaser when a borrower prepays a sold loan within an agreed period
      of time. The premium recapture reserve is established at the time of the loan
      sale through a provision for losses, which is reflected as a reduction of the
      gain on sale of mortgage loans. The premium recapture reserve is recorded as
      a
      liability on the consolidated balance sheet. We estimate the amount of premium
      recaptures due to early loan prepayments by reviewing loan product and interest
      rate, borrower prepayment fee, if any, and estimate the impact of future
      interest rate changes. The premium recapture reserve totaled $619,000 and
      $262,000 at December 31, 2005 and 2004, respectively. We recorded a provision,
      net of reversals, for premium recaptures of $1.1 million, $309,000 and $6,000
      for the years ended December 31, 2005, 2004 and 2003, respectively. We recorded
      refunds related to premium recapture of $718,000, $126,000 and $77,000 for
      the
      years ended December 31, 2005, 2004 and 2003, respectively.


**Operating
        Lease Obligations.** Our
        rental expense, net of sublease income, for the years ended December 31,
        2005,
        2004 and 2003 amounted to $6.7 million, $5.1 million and $4.8 million,
        respectively. At
        December 31, 2005, we were obligated under 21 non-cancelable operating lease
        agreements with renewal options on properties used principally for branch
        operations. We expect to renew such agreements upon their expiration in the
        normal course of business. The agreements may contain escalation clauses
        commencing at various times during the lives of the agreements. Such clauses
        provide for increases in the annual rent. Any rent holidays in our operating
        leases are recognized on a straight-line basis over the lease term (including
        any rent holiday period).
 
 **104**




The
        minimum future rentals under non-cancelable operating leases as of December
        31,
        2005 are as follows:


*(Dollars
                in thousands)*
            
            **Amount**For
                the year ended December 31,:2006
            
            $
            6,3152007
            
            
            6,4842008
            
            
            3,9792009
            
            
            2,7152010
            
            
            1,7772011
                and thereafter
            
            
            95$
            21,365





**Ot** **her.** Because
      the nature of our business involves the collection of numerous accounts, the
      validity of liens and compliance with various state and federal lending laws,
      we
      are subject, in the normal course of business, to numerous legal proceedings
      and
      claims, including several class action lawsuits. Based
      on
      facts currently available, management believes that the disposition of matters
      that are pending or asserted will not have a materially adverse effect on our
      financial position, results of operations or liquidity.





**(17)**  **Stock
      Based Incentive Plans**





At
      our
      annual stockholders meeting on May 24, 2005, our stockholders approved our
      2005
      Stock Incentive Plan (“2005 Plan”). A total of 1,000,000 shares of our common
      stock are reserved for issuance under the 2005 Plan, subject to adjustment
      only
      in the event of a stock split, stock or other extraordinary dividend, or other
      similar change in our common stock or capital structure.





The
      2005
      Plan provides for the grant of stock options, restricted stock, restricted
      stock
      units, stock appreciation rights and dividend equivalent rights (collectively
      referred to as “awards”). Incentive stock options may be granted only to
      employees. Awards other than incentive stock options may be granted to
      employees, directors and consultants.





The
      term
      of any award granted under the 2005 Plan may not be for more than ten years
      (or
      five years in the case of an incentive stock option granted to any participant
      who owns stock representing more than 10% of the combined voting power of our
      company or any parent or subsidiary of ours), excluding any period for which
      the
      participant has elected to defer the receipt of the shares or cash issuable
      pursuant to the award.





The
      2005
      Plan authorizes the administrator to grant incentive stock options and
      non-qualified stock options at an exercise price not less than 100% of the
      fair
      market value of our common stock on the date the option is granted (or 110%,
      in
      the case of an incentive stock option granted to any employee who owns stock
      representing more than 10% of the combined voting power of us or any parent
      or
      any of our subsidiaries). In the case of stock appreciation rights, the base
      appreciation amount will not be less than 100% of the fair market value of
      our
      common stock on the date of grant. In the case of all other awards granted
      under
      the 2005 Plan, the exercise or purchase price will be determined by the
      administrator. The exercise or purchase price is generally payable in cash,
      check, shares of common stock or with respect to options, payment through a
      broker-dealer sale and remittance procedure.





For
      the
      year ended December 31, 2005, we granted awards of 157,275 shares of restricted
      stock granted to certain officers and employees, at a grant price of $7.46
      per
      share (closing price on the award date of November 9, 2005) under the 2005
      Plan.
      The grants vest over a 5 year period on a prorate basis (50% vest in year
      3, 25% vest in year 4 and 25% vest in year 5). We incurred an expense of $46,000
      during the year ended December 31, 2005 related to these stock
      awards.





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





**105**


The
      following table summarizes certain information regarding the Option
      Plans:





**For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003****Number
                of Options**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                of Options**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                of Options**
            
            **Weighted
                Average Exercise Price**January
                1stbalance
            
            
            2,091,500
            
            $
            2.23
            
            
            2,234,450
            
            $
            2.00
            
            
            2,512,550
            
            $
            2.01Options
                granted
            
            
            281,500
            
            
            8.14
            
            
            165,000
            
            
            7.64
            
            
            126,000
            
            
            6.32Options
                exercised
            
            
            175,900
            
            
            3.33
            
            
            233,750
            
            
            1.18
            
            
            147,300
            
            
            0.79Options
                canceled
            
            
            22,800
            
            
            5.24
            
            
            74,200
            
            
            10.65
            
            
            256,800
            
            
            4.89December
                31stbalance
            
            
            2,174,300
            
            $
            2.87
            
            
            2,091,500
            
            $
            2.23
            
            
            2,234,450
            
            $
            2.00Options
                exercisable
            
            
            1,321,973
            
            $
            1.79
            
            
            944,780
            
            $
            2.01
            
            
            755,805
            
            $
            2.86





The
      following table summarizes information about stock options outstanding and
      exercisable at December 31, 2005:





**At
                December 31, 2005****Outstanding**
            
            **Exercisable****Range
                of Exercise Prices**
            
            **Number**
              **of
                Options**
            
            **Weighted
                Average Remaining Contractual Life (Yrs)**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                of Options**
            
            **Weighted
                Average Exercise Price**$0.50
                - $2.00
            
            
            1,436,800
            
            
            2.75
            
            $
            0.89
            
            
            1,053,840
            
            $
            0.78$2.50
                - $3.00
            
            
            100,000
            
            
            3.16
            
            
            2.75
            
            
            60,000
            
            
            2.75$4.60
                - $5.94
            
            
            161,000
            
            
            1.67
            
            
            5.84
            
            
            125,900
            
            
            5.86$6.67
                - $8.20
            
            
            406,500
            
            
            5.87
            
            
            7.61
            
            
            80,233
            
            
            7.75$9.17
                - $10.30
            
            
            70,000
            
            
            6.03
            
            
            9.46
            
            
            2,000
            
            
            10.102,174,300
            
            
            3.38
            
            $
            2.87
            
            
            1,321,973
            
            $
            1.79





The
      weighted-average fair value of options granted during 2005, 2004 and 2003 was
      $3.11, $4.48 and $4.25, respectively. For purposes of the pro-forma calculation
      under SFAS No. 123, the fair value of the options granted is estimated using
      the
      Black-Scholes Merton option-pricing model with the following weighted-average
      assumptions used for the 2005, 2004 and 2003 grants:





**For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003**Dividend
                yield
            
            
            2.5
            %
            
            0.2
            %
            
            0.0
            %Expected
                volatility
            
            
            48
            %
            
            63
            %
            
            84
            %Risk-free
                interest rate
            
            
            4.22
            %
            
            3.61
            %
            
            3.17
            %Expected
                life
            
            
            5
                years
            
            
            5
                years
            
            
            5
                yearsAverage
                remaining contractual life
            
            
            7
                years
            
            
            7
                years
            
            
            7
                years




**106**
 **(18)**  **Income
        Taxes**





The
      provision (benefit) for income taxes for the years ended December 31, 2005,
      2004
      and 2003 is as follows:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**
            
            **2003**Current
                income taxes:Federal
            
            $
            16,211
            
            $
            10,606
            
            $
            (267
            )State
                and local
            
            
            2,828
            
            
            1,876
            
            
            180Total
                current income taxes
            
            
            19,039
            
            
            12,482
            
            
            (87
            )Deferred
                income taxes:Federal
            
            
            (6,385
            )
            
            (14,933
            )
            
            12,716State
                and local
            
            
            (1,196
            )
            
            (2,798
            )
            
            4,352Valuation
                allowance
            
            
            --
            
            
            --
            
            
            (42,335
            )Total
                deferred income taxes
            
            
            (7,581
            )
            
            (17,731
            )
            
            (25,267
            )Total
                provision (benefit) for income taxes
            
            $
            11,458
            
            $
            (5,249
            )
            $
            (25,354
            )




The
      tax
      effect of significant temporary differences comprising our net deferred tax
      asset as of December 31, 2005 and 2004 were as follows:





**At
                December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004****Deferred
                tax assets:**Excess
                cashflow certificates
            
            $
            21,795
            
            $
            25,824Mortgage
                loans held for investment
            
            
            8,353
            
            
            14,893Allowance
                for loan losses
            
            
            14,364
            
            
            4,009Capitalized
                origination fees and related costs, net
            
            
            9,528
            
            
            2,262Other
                comprehensive income
            
            
            --
            
            
            1,411Accrued
                expenses
            
            
            1,667
            
            
            1,375Deferred
                hedge gain
            
            
            1,039
            
            
            --Depreciation
            
            
            --
            
            
            552Deferred
                tax assets
            
            
            56,746
            
            
            50,326**Deferred
                tax liabilities:**Other
                comprehensive income
            
            
            (1,621
            )
            
            --Depreciation
            
            
            (250
            )
            
            --Deferred
                tax liabilities
            
            
            (1,871
            )
            
            --Total
                deferred tax assets
            
            $
            54,875
            
            $
            50,326





We
      had no
      valuation allowances at December 31, 2005 and 2004.


We
        are
        required to recognize all or a portion of our gross deferred tax assets if
        we
        believe that it is more likely than not, given the weight of all available
        evidence, that all or a portion of the benefits of the carryforward losses
        and
        other deferred tax assets will be realized. Management believes that, based
        on
        the available evidence, it is more likely than not that the results of future
        operations will generate sufficient taxable income to realize the deferred
        tax
        assets.


During
      2003, we reversed a valuation allowance that we had established in 2000 against
      our deferred tax asset. Management believed that the reversal was appropriate
      at
      the time principally because of our eight consecutive quarters of profitability
      and positive cash flow, together with the planned retirement of all our
      long-term unsecured debt. We recorded minimal taxes in our results of operations
      for the year ended December 31, 2003 as a result of the reversal of a valuation
      allowance against our deferred tax asset, which was primarily generated by
      net
      operating losses (“NOLs”) in 2000 and 2001.





**107**


At
      December 31, 2005 there were no NOL carryforwards.





A
      reconciliation of the statutory income tax rate to the effective income tax
      rate, as applied to income (loss) for the years ended December 31, 2005,
      2004 and 2003 is as follows:





**For
                the Year Ended December 31,****2005**
            
            **2004**
            
            **2003**Statutory
                tax rate
            
            
            35.0
            %
            
            (35.0
            )%
            
            35.0
            %State
                and local taxes, net of federal benefit
            
            
            3.6
            
            
            (4.1
            )
            
            7.0Change
                in deferred tax valuation allowance
            
            
            --
            
            
            --
            
            
            (100.7
            )Non-deductible
                expenses and other(1)
            
            
            0.4
            
            
            3.1
            
            
            (1.6
            )Total
                tax rate
            
            
            39.0
            %
            
            (36.0
            )%
            
            (60.3
            )%


*(1)*  *For
        the year ended December 31, 2004, the non-deductible expenses and other relates
        primarily to non-deductible compensation under the Internal Revenue Code
        Section
        162(m).*




**(19)**  **Earnings
      Per Share**





We
      calculate our EPS in accordance with SFAS No. 128, “Earnings Per Share.” The
      following is a reconciliation of the denominators used in the computations
      of
      basic and diluted EPS. The numerator for calculating both basic and diluted
      EPS
      is net income (loss).





**For
                the Year Ended December 31,***(Dollars
                in thousands, except share and per share data)*
            
            **2005**
            
            **2004**
            
            **2003**Net
                income (loss), as reported
            
            $
            17,955
            
            $
            (9,349
            )
            $
            67,406Less:
                preferred stock dividends
            
            
            --
            
            
            --
            
            
            1,391Net
                income (loss) available to common shareholders
            
            $
            17,955
            
            $
            (9,349
            )
            $
            66,015Basic
                - weighted-average shares
            
            
            20,349,515
            
            
            18,375,864
            
            
            16,308,561Basic
                EPS
            
            $
            0.88
            
            $
            (0.51
            )
            $
            4.05Basic
                - weighted-average shares
            
            
            20,349,515
            
            
            18,375,864
            
            
            16,308,561Incremental
                shares-options(1)(2)(3)
            
            
            933,705
            
            
            1,005,762
            
            
            2,098,688Diluted
                - weighted-average shares
            
            
            21,283,220
            
            
            19,381,626
            
            
            18,407,249Diluted
                EPS
            
            $
            0.84
            
            $
            (0.51
            )
            $
            3.59





*(1)*  *For
      the year ended December 31, 2005, the weighted average of 157,275 restricted
      stock awards granted on November 9, 2005 are included in the calculation of
      diluted earnings per share.  Also, for the year ended December 31, 2005,
      approximately 68,000 out-of-the-money employee stock option on a weighted
      average basis, were excluded from the calculation of diluted earnings per share
      since their effect is anti-dilutive.*





*(2)*  *For
      the year ended December 31, 2004, approximately 1.0 million in-the-money
      employee stock options were excluded from the calculation of diluted earnings
      per share since their effect is anti-dilutive.  Also, for the year ended
      December 31, 2004, approximately 44,000 out-of-the-money employee stock option
      on a weighted average basis, were excluded from the calculation of diluted
      earnings per share since their effect is anti-dilutive.*




*(3)*  *For
      the year ended December 31, 2003 approximately 1.1 million of in-the-money
      warrants are included in the calculation of diluted earnings per share. 
Also, for the year ended December 31, 2003, approximately 313,000
      out-of-the-money employee stock option on a weighted average basis, were
      excluded from the calculation of diluted earnings per share since their effect
      is anti-dilutive.*




**108**


**(20)**  **Fair
      Value of Financial Instruments**





SFAS
      No.
      107 requires disclosure of fair value information about our on- and off-balance
      sheet financial instruments. Quoted market prices, when available, are used
      as
      the measure of fair value. In cases where quoted market prices are not
      available, fair values are based on present-value estimates or other valuation
      techniques. These derived fair values are significantly affected by assumptions
      used, the timing of future cash flows and the discount rate.





As
      the
      assumptions utilized are inherently subjective in nature, the estimated fair
      values cannot be substantiated by comparison to independent market quotes.
      In
      addition, in many cases, the estimated fair values would not necessarily be
      realized in an immediate sale or settlement of the instrument.




The
      following table summarizes the carrying values and estimated fair values of
      our
      on-balance sheet financial instruments at December 31, 2005 and
      2004:




**At
                December 31, 2005**
            
            **At
                December 31, 2004***(Dollars
                in thousands)*
            
            **Carrying
                Amount**
            
            **Estimated
                Fair Value**
            
            **Carrying
                Amount**
            
            **Estimated
                Fair Value****Financial
                Assets:**Cash
                and cash equivalents
            
            $
            4,673
            
            $
            4,673
            
            $
            5,187
            
            $
            5,187Mortgage
                loans held for investment, net
            
            
            4,626,830
            
            
            4,718,788
            
            
            2,340,994
            
            
            2,426,042Trustee
                receivable
            
            
            56,164
            
            
            56,164
            
            
            32,915
            
            
            32,915Accrued
                interest receivable
            
            
            26,952
            
            
            26,952
            
            
            12,280
            
            
            12,280Excess
                cashflow certificates
            
            
            7,789
            
            
            7,789
            
            
            14,933
            
            
            14,933Derivative
                assets
            
            
            11,744
            
            
            11,744
            
            
            16,073
            
            
            16,073**Financial
                Liabilities:**Bank
                payable
            
            
            1,921
            
            
            1,921
            
            
            1,110
            
            
            1,110Warehouse
                financing
            
            
            222,843
            
            
            222,843
            
            
            135,653
            
            
            135,653Financing
                on mortgage loans heldfor
                investment, net
            
            
            4,436,938
            
            
            4,388,118
            
            
            2,236,215
            
            
            2,198,052Other
                borrowings
            
            
            4,785
            
            
            4,785
            
            
            3,330
            
            
            3,330Accrued
                interest payable
            
            
            13,091
            
            
            13,091
            
            
            4,282
            
            
            4,282Derivative
                liabilities
            
            
            210
            
            
            210
            
            
            166
            
            
            166





The
      methods and significant assumptions used to estimate fair values pertaining
      to
      our financial instruments are as follows:





***Cash
      and Cash Equivalents*** - The
      estimated fair values of cash and cash equivalents are assumed to equal their
      carrying values, as these financial instruments are either due on demand or
      have
      short-term maturities.





***Mortgage
      Loans Held for Investment*** - The
      estimated fair value for mortgage loans held for investment is determined based
      upon discounted cash flow model in 2005 and a combination of whole-loan sale
      commitment prices if we were to sell our loans on or about the balance sheet
      date and discounted cash flows obtained from third-party dealers (market maker)
      in 2004.





***Trustee
      Receivable, Accrued Interest Receivable and Accrued Interest
      Payable*** - The
      fair values are estimated to equal their respective carrying values since they
      are short-term.





***Excess
      Cashflow Certificates -*** As
      there
      is no active market for the sale of excess cashflow certificates, we use a
      discounted cash flow model in order to estimate fair value. Accordingly, our
      estimate of fair value is subjective. While we believe that the assumptions
      we
      use are reasonable, there can be no assurance as to the accuracy of the
      assumptions or estimates.





***Derivative
      Financial Instruments*** - The
      fair value is based on a third-party pricing model in 2005 and quoted market
      prices from security dealers or on prices obtained from firms specializing
      in
      providing security pricing services in 2004.





***Bank
      Payable, Warehouse Financing, and Other Borrowings -*** The
      carrying amount of bank payable, warehouse financing and other borrowings
      approximates their fair value due to the variable interest rate and short
      durations.





**109**


***Financing
      on Mortgage Loans Held for Investment*** -
      Financing on mortgage loans held for investment is secured by mortgage loans
      held for investment. The fair value was determined using market prices obtained
      by third-party dealers (market makers).





***Off-balance
      Sheet Financial Instruments*** **** -
      We
      ascribe no value to loan origination commitments as of December 31, 2005 and
      2004 because there are no interest rate-lock commitments on the mortgage loans.
      We had no forward sale commitments as of December 31, 2005 and
      2004.




**(21)**  **General
      and Administrative Expenses**





The
      following table is a summary of general and administrative
      expenses:





**For
                the Year Ended December 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**
            
            **2003**General
                and administrative expenses:Rent
                and occupancy
            
            $
            7,102
            
            $
            5,444
            
            $
            5,200Professional
                fees
            
            
            6,886
            
            
            2,745
            
            
            999Advertising,
                promotional and marketing
            
            
            6,080
            
            
            1,987
            
            
            801Telephone
            
            
            3,801
            
            
            3,193
            
            
            2,861Fees
                and licenses
            
            
            2,738
            
            
            2,871
            
            
            2,419Depreciation
                and amortization
            
            
            2,381
            
            
            1,940
            
            
            1,634Computer
                expenses
            
            
            1,059
            
            
            1,827
            
            
            1,615Management
                and consulting
            
            
            701
            
            
            1,647
            
            
            1,472Other
                administrative expenses
            
            
            11,719
            
            
            8,498
            
            
            6,459Total
                general and administrative expenses
            
            $
            42,467
            
            $
            30,152
            
            $
            23,460




**110**





**Condensed
      Quarterly Financial Data (Unaudited)**





The
      following table is a summary of financial data by quarter for the years ended
      December 31, 2005 and 2004:





**For
                the 2005 Quarters Ended***(Dollars
                in thousands)*
            
            **March
                31**
            
            **June
                30**
            
            **September
                30**
            
            **December
                31**Net
                interest income(1)(2)
            
            $
            27,093
            
            $
            29,668
            
            $
            32,410
            
            $
            33,866Provision
                for loan losses
            
            
            6,864
            
            
            7,478
            
            
            6,586
            
            
            7,664Net
                interest income after provisionfor
                loan losses
            
            
            20,229
            
            
            22,190
            
            
            25,824
            
            
            26,202Net
                gain on sale of mortgages
            
            
            5,328
            
            
            6,592
            
            
            7,494
            
            
            7,779Other
                income
            
            
            2,815
            
            
            2,581
            
            
            6,263
            
            
            3,015Non-interest
                expense(2)
            
            
            24,933
            
            
            25,460
            
            
            28,664
            
            
            27,842Income
                before income tax expense
            
            
            3,439
            
            
            5,903
            
            
            10,917
            
            
            9,154Income
                tax expense
            
            
            1,380
            
            
            2,328
            
            
            4,283
            
            
            3,467Net
                income
            
            $
            2,059
            
            $
            3,575
            
            $
            6,634
            
            $
            5,687Basic
                earnings per share(3)
            
            $
            0.10
            
            $
            0.18
            
            $
            0.33
            
            $
            0.28Diluted
                earnings per share(3)
            
            $
            0.10
            
            $
            0.17
            
            $
            0.31
            
            $
            0.27





**For
                the 2004 Quarters Ended***(Dollars
                in thousands)*
            
            **March
                31**
            
            **June
                30**
            
            **September
                30**
            
            **December
                31**Net
                interest income(1)(2)
            
            $
            5,371
            
            $
            13,249
            
            $
            18,492
            
            $
            23,210Provision
                for loan losses
            
            
            432
            
            
            2,243
            
            
            3,113
            
            
            4,654Net
                interest income after provisionfor
                loan losses
            
            
            4,939
            
            
            11,006
            
            
            15,379
            
            
            18,556Net
                gain on sale of mortgages
            
            
            7,740
            
            
            1,513
            
            
            2,630
            
            
            4,174Other
                income
            
            
            96
            
            
            108
            
            
            393
            
            
            1,125Non-interest
                expense(2)
            
            
            22,412
            
            
            15,593
            
            
            21,370
            
            
            22,882(Loss)
                income before income tax(benefit)
                expense
            
            
            (9,637
            )
            
            (2,966
            )
            
            (2,968
            )
            
            973Income
                tax (benefit) expense
            
            
            (3,722
            )
            
            (1,136
            )
            
            (1,149
            )
            
            758Net
                (loss) income
            
            $
            (5,915
            )
            $
            (1,830
            )
            $
            (1,819
            )
            $
            215Basic
                (loss) earnings per share(3)
            
            $
            (0.35
            )
            $
            (0.11
            )
            $
            (0.09
            )
            $
            0.01Diluted
                (loss) earnings per share(3)
            
            $
            (0.35
            )
            $
            (0.11
            )
            $
            (0.09
            )
            $
            0.01




*(1)*  *During
        the quarter ended December 31, 2005, we recorded in interest income $803,000
        of
        income related to a cumulative*  *adjustment
        for the effects of an immaterial correction in recognition of net deferred
        fees
        in accordance with SFAS No. 91 “Accounting for Nonrefundable Fees and Costs
        Associated with Originating or Acquiring Loans” that related to the quarters
        ended March 31, 2004 through September 30, 2005. This was the result of a
        revision in*  *2005
        to our methodology to separate respective securitization loan pools into
        homogeneous pools based upon product type - each of which contains a large
        number of similar loans for which prepayments are probable and the timing
        and
        amount of prepayments are reasonably predictable.*
 
 *(2)*  *During
        the quarter ended December 31, 2005, we recorded in interest expense and
        loss on
        derivative instruments $258,000 and $263,000, respectively, of income and
        gain
        related to a cumulative adjustment for the effects of an immaterial correction
        to other comprehensive income (“OCI”) for the ineffectiveness on certain hedges
        that related to the quarters ended December 31, 2004 through September 30,
        2005.
        This revision is in accordance with Derivatives Implementation Group SFAS
        No.
        133 Implementation Issue No. G17 “Cash Flow Hedges: Impact on Accumulated Other
        Comprehensive Income of Issuing Debt with a Term That Is Shorter Than Originally
        Forecasted.”*




*(3)*  *Earnings
        per share are computed independently for each of the quarters presented.
        Therefore, the sum of the quarterly earnings per share amounts may not equal
        the
        annual amount. This is caused by rounding and the averaging effect of the
        number
        of share equivalents utilized throughout the year, which changes with the
        market
        price of the common stock.*
 **111**


**Item
      9. Changes
      in and Disagreements with
      Accountants on Accounting and Financial Disclosure.**





None.





**Item
      9A. Controls and
      Procedures.**


*Evaluation
        of Disclosure Controls and Procedures* *.* As of
        December 31, 2005, an evaluation of the effectiveness of our disclosure controls
        and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under
        the
        Securities Exchange Act of 1934, as amended (the “Exchange Act”)) was performed
        under the supervision and with the participation of our management, including
        the Chief Executive Officer and Chief Financial Officer. Based on that
        evaluation, the Chief Executive Officer and Chief Financial Officer have
        concluded that our disclosure controls and procedures are effective to ensure
        that information required to be disclosed by us in our reports we file or
        submit
        under the Exchange Act is recorded, processed, summarized and reported within
        the time periods specified in the SEC rules and forms.
  *Management’s
        Annual Report on Internal Control over Financial Reporting.* Our
        management is responsible for establishing and maintaining adequate internal
        control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f)
        promulgated under the Exchange Act). Our internal control over financial
        reporting is a process designed to provide reasonable assurance regarding
        the
        reliability of financial reporting and the preparation of financial statements
        for external purposes in accordance with GAAP. Our internal control over
        financial reporting includes those policies and procedures that (i) pertain
        to
        the maintenance of records that, in reasonable detail, accurately and fairly
        reflect the transactions and dispositions of our assets; (ii) provide reasonable
        assurance that transactions are recorded as necessary to permit preparation
        of
        financial statements in accordance with GAAP, and that receipts and expenditures
        are being made only in accordance with authorizations of our management and
        directors; and (iii) provide reasonable assurance regarding prevention or
        timely
        detection of unauthorized acquisition, use, or disposition of our assets
        that
        could have a material effect on the financial statements.
  Because
        of its inherent limitations, internal control over financial reporting may
        not
        prevent or detect misstatements. Also, projections of any evaluation of
        effectiveness to future periods are subject to the risk that controls may
        become
        inadequate because of changes in conditions, or that the degree of compliance
        with the policies or procedures may deteriorate.
  Management
        assessed the effectiveness of our internal control over financial reporting
        as
        of December 31, 2005, based on the framework set forth by the Committee of
        Sponsoring Organizations of the Treadway Commission (“COSO”) in *Internal
        Control-Integrated Framework* .
        Based
        on that assessment, management concluded that, as of December 31, 2005, our
        internal control over financial reporting is effective based on the criteria
        established in *Internal
        Control-Integrated Framework* .
  *Attestation
        Report of the Registered Public Accounting Firm.* Management’s assessment of the effectiveness of our internal control over
        financial reporting as of December 31, 2005, has been audited by KPMG, LLP,
        an
        independent registered public accounting firm. Their report, which appears
        in
        Item 8 -  Financial Statement and Supplementary Data included herein,
        expresses unqualified opinions on management’s assessment and on the
        effectiveness of our internal control over financial reporting as of December
        31, 2005.
  *Changes
        in Internal Control over Financial Reporting* *.* During
        the first quarter of 2006, there has been no change in our internal controls
        over financial reporting that has materially affected, or is reasonably likely
        to materially affect, our internal controls over financial
        reporting.




Item
      9B. **Other** Information.


None.





**112**


**PART
      III**




**Item
      10.** **Directors
      and Executive Officers of the
      Registrant.**





We
      incorporate by reference information in our proxy statement that complies with
      the information called for by Item 10 of Form 10-K. The proxy will be filed
      within 120 days of December 31, 2005.




**Item
      11.** **Executive
      Compensation.**





We
      incorporate by reference information in our proxy statement that complies with
      the information called for by Item 11 of Form 10-K. The proxy will be filed
      within 120 days of December 31, 2005.


**Item
        12.**  **Security
        Ownership of Certain Beneficial Owners and
        Management and Related Stockholder
        Matters.**





We
      incorporate by reference information in our proxy statement that complies with
      the information called for by Item 12 of Form 10-K. The proxy will be filed
      within 120 days of December 31, 2005.




**Items
      13.** **Certain
      Relationships and Related
      Transactions.**





We
      incorporate by reference information in our proxy statement that complies with
      the information called for by Item 13 of Form 10-K. The proxy will be filed
      within 120 days of December 31, 2005.





**Item
      14.**  **Principal
      Accountant Fees and
      Services.**





We
      incorporate by reference information in our proxy statement that complies with
      the information called for by Item 14 of Form 10-K. The proxy will be filed
      within 120 days of December 31, 2005.







**113**





**PART
      IV**





**Item
      15. Exhibits and Financial
      Statement
      Schedules.**





*(a)
      Financial Statements:*





The
      following Consolidated Financial Statements of Delta Financial Corporation
      and
      Subsidiaries are included in Part II, Item 8 of this report:




**Page**Report
                of Independent Registered Public Accounting Firm
            79Consolidated
                Balance Sheets - At December 31, 2005 and 2004
            81Consolidated
                Statements of Operations - Years ended December 31, 2005, 2004 and
                2003
            82Consolidated
                Statement of Changes in Stockholders’ Equity - Years ended December 31,
                2005,2004
                and 2003
            83Consolidated
                Statements of Cash Flows - Years ended December 31, 2005, 2004 and
                2003
            84Notes
                to Consolidated Financial Statements
            86





*(b)
      Exhibits:*





**Exhibit
                No.**
            
            **Filed**
            
            **Description**3.1
            
            (a)
            
            Certificate
                of Incorporation of Delta Financial Corporation3.2
            
            (b)
            
            Second
                Amended Bylaws of Delta Financial Corporation3.3
            
            (c)
            
            Certificate
                of Designations, Voting Powers, Preferences and Rights of Series
                A
                Preferred Stock of Delta Financial Corporation10.1
            
            (c)
            
            Employment
                Agreement dated February 27, 2002 between the Registrant and Hugh
                Miller10.2
            
            (i)
            
            Employment
                Agreement dated December 30, 2005 between the Registrant and Sidney
                A.
                Miller10.3
            
            (f)
            
            Employment
                Agreement dated August 13, 2003 between the Registrant and Randall
                F.
                Michaels10.4
            
            (g)
            
            Employment
                Agreement dated March 24, 2005 between the Registrant and Richard
                Blass10.5
            
            (a)
            
            Lease
                  Agreement between Delta Funding Corporation and the Tilles Investment
                  Company, and the Second, Third and Fourth Amendments to Lease
                  Agreement10.6
            
            (d)
            
            Fifth,
                  Sixth and Seventh Amendments to Lease Agreement between Delta Funding
                  Corporation and the Tilles Investment Company10.7
            
            (e)
            
            Eighth
                  Amendment to Lease Agreement between Delta Funding Corporation
                  and the
                  Tilles Investment Company10.8
            
            (c)
            
            Ninth
                Amendment to Lease Agreement between Delta Funding Corporation and
                the
                Tilles Investment Company10.9
            
            (a)
            
            1996
                  Stock Option Plan of Delta Financial Corporation10.10
            
            (c)
            
            2001
                  Stock Option Plan of Delta Financial Corporation10.11
            
            (h)
            
            2005
                Stock Incentive Plan of Delta Financial Corporation10.12
            
            (h)
            
            2005
                Senior Executive Bonus Plan of Delta Financial
                Corporation11.0
            
            (j)
            
            Statement
                Re: Computation of Per Share Earnings21.1
            
            (j)
            
            Subsidiaries
                of Registrant23.1
            
            (j)
            
            Consent
                of Independent Registered Public Accounting Firm31.1
            
            (j)
            
            Rule
                13a-14(a)/15d-14(a) Certification of the Chief Executive
                Officer31.2
            
            (j)
            
            Rule
                13a-14(a)/15d-14(a) Certification of the Chief Financial
                Officer32.1
            
            (j)
            
            Section
                1350 Certification of the Chief Executive Officer32.2
            
            (j)
            
            Section
                1350 Certification of the Chief Financial
                Officer


_______________


(a)
              Incorporated
                  by reference from our Registration Statement on Form S-1 (No. 333-11289),
                  filed with the Commission on September 3, 1996, and related amendments
                  to
                  the Form S-1.(b)
              Incorporated
                  by reference from our Annual Report on Form 10-K for the year ended
                  December 31, 1998 (File No. 1-12109), filed with the Commission
                  on March
                  31, 1999.(c)
              Incorporated
                  by reference from our Annual Report on Form 10-K for the year ended
                  December 31, 2001 (File No. 1-12109), filed with the Commission
                  on April
                  1, 2002.(d)
              Incorporated
                  by reference from our Annual Report on Form 10-K for the year ended
                  December 31, 1997 (File No. 1-12109), filed with the Commission
                  on March
                  31, 1998.(e)
              Incorporated
                  by reference from our Quarterly Report on Form 10-Q for the quarter
                  ended
                  March 31, 1998 (File No. 1-12109), filed with the Commission on
                  May 12,
                  1998.(f)
              Incorporated
                  by reference from our Quarterly Report on Form 10-Q for the quarter
                  ended
                  June 30, 2003 (File No. 1-12109), filed with the Commission on
                  August 14,
                  2003.(g)
              Incorporated
                  by reference from our Annual Report on Form 10-K for the year ended
                  December 31, 2004 (File No. 1-12109), filed with the Commission
                  on March
                  31, 2005.(h)
              Incorporated
                  by reference from our Quarterly Current Report on Form 8-K (File
                  No.
                  1-12109), filed with the Commission on May 25, 2005.(i)
              Incorporated
                  by reference from our Current Report on Form 8-K (File No. 1-12109),
                  filed
                  with the Commission on December 30, 2005.(j)
              Filed
                  herewith.




**114**





**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.


**DELTA
                FINANCIAL CORPORATION**(Registrant)Date: 
March
                15, 2006
              By:
              /s/ HUGH
                MILLERTitle:
                 President and Chief Executive
                Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
      has been signed below by the following persons on behalf of the Registrant
      and
      in the capacities and on the dates indicated.




**Signature**
              
              **Capacity
                  in Which Signed**
              
              **Date**/s/
                  SIDNEY A. MILLER
                Sidney
                  A. Miller
              
              Chairman
                  of the Board of Directors
              
              March
                  15, 2006/s/
                  HUGH MILLER
                Hugh
                  Miller
              
              President,
                  Chief Executive Officer and Director
                (Principal
                  Executive Officer)
              
              March
                  15, 2006/s/
                  RICHARD BLASS
                Richard
                  Blass
              
              Executive
                  Vice President, Chief Financial Officer
                and
                  Director (Principal Financial Officer)
              
              March
                  15, 2006/s/
                  MARTIN D. PAYSON
                Martin
                  D. Payson
              
              Director
              
              March
                  15, 2006/s/
                  ARNOLD B. POLLARD
                Arnold
                  B. Pollard
              
              Director
              
              March
                  15, 2006/s/MARGARET
                  A. WILLIAMS
                Margaret
                  A. Williams
              
              Director
              
              March
                  15, 2006/s/
                  JOHN ADAMOVICH, JR.
                John
                  Adamovich, Jr.
              
              Director
              
              March
                  15, 2006/s/
                  WILLIAM ADDAS
                William
                  Addas
              
              Director
              
              March
                  15, 2006













**115**